Congressional Testimony

S. HRG. 112–483 FEDERAL RESERVE’S FIRST MONETARY POLICY REPORT FOR 2012 HEARING BEFORETHE COMMITTEE ON BANKING, HOUSING, ANDURBANAFFAIRS UNITED STATES SENATE ONE HUNDRED TWELFTH CONGRESS SECOND SESSION ON OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU- ANTTOTHEFULLEMPLOYMENTANDBALANCEDGROWTHACTOF1978 MARCH 1, 2012 Printed for the use of the Committee on Banking, Housing, and Urban Affairs ( Available at: http://www.fdsys.gov/ U.S. GOVERNMENT PRINTING OFFICE 75–206 PDF WASHINGTON : 2013 For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800 Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS TIM JOHNSON, South Dakota, Chairman JACK REED, Rhode Island RICHARD C. SHELBY, Alabama CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee DANIEL K. AKAKA, Hawaii JIM DEMINT, South Carolina SHERROD BROWN, Ohio DAVID VITTER, Louisiana JON TESTER, Montana MIKE JOHANNS, Nebraska HERB KOHL, Wisconsin PATRICK J. TOOMEY, Pennsylvania MARK R. WARNER, Virginia MARK KIRK, Illinois JEFF MERKLEY, Oregon JERRY MORAN, Kansas MICHAEL F. BENNET, Colorado ROGER F. WICKER, Mississippi KAY HAGAN, North Carolina DWIGHT FETTIG, Staff Director WILLIAM D. DUHNKE, Republican Staff Director CHARLES YI, Chief Counsel LAURA SWANSON, Policy Director GLEN SEARS, Senior Policy Advisor JANA STEENHOLDT, Legislative Assistant ANDREW J. OLMEM, Republican Chief Counsel MICHAEL PIWOWAR, Republican Chief Economist DAWN RATLIFF, Chief Clerk RYKER VERMILYE, Hearing Clerk SHELVIN SIMMONS, IT Director JIM CROWELL, Editor (II) VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00002 Fmt 0486 Sfmt 0486 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON C O N T E N T S THURSDAY, MARCH 1, 2012 Page Opening statement of Chairman Johnson ............................................................. 1 Prepared statement .......................................................................................... 31 Opening statements, comments, or prepared statements of: Senator Shelby .................................................................................................. 2 WITNESS Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve System ................................................................................................................... 4 Prepared statement .......................................................................................... 31 Responses to written questions of: Chairman Johnson .................................................................................... 35 Senator Menendez ..................................................................................... 38 Senator Hagan ........................................................................................... 44 Senator Crapo ............................................................................................ 46 Senator Toomey ......................................................................................... 47 Senator Wicker .......................................................................................... 50 ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD Monetary Policy Report to the Congress dated February 29, 2012 ..................... 52 (III) VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON FEDERAL RESERVE’S FIRST MONETARY POLICY REPORT FOR 2012 THURSDAY, MARCH 1, 2012 U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. The Committee met at 10:04 a.m., in room SD–538, Dirksen Sen- ate Office Building, Hon. Tim Johnson, Chairman of the Com- mittee, presiding. OPENING STATEMENT OF CHAIRMAN TIM JOHNSON Chairman JOHNSON. I call this hearing to order. Today I welcome Chairman Bernanke back to this Committee to deliver the Federal Reserve’s semiannual Monetary Report to Con- gress. There are reasons to be optimistic about our Nation’s economic recovery. The U.S. economy has expanded for 10 straight quarters, and private sector employment has increased for 23 straight months. Private employers added 2.1 million jobs last year, the most since 2005. But there are also reasons to be concerned, such as the European debt crisis and the continuing drag of the housing market on the broader economy. This Committee has paid close attention to these two issues and held numerous hearings. While I remain hopeful that we are moving in the right direction, we must continue to monitor the situation in Europe closely. On housing, there is a va- riety of policy proposals—some that do not require an act of Con- gress—that should be considered to improve the housing market. I want to thank Governor Duke for her thoughtful testimony on Tuesday before this Committee on the Federal Reserve’s white paper on options to improve the housing market. An additional challenge, the sharp increase in oil prices, has the potential to impede the economic recovery. Americans continue to grapple with higher fuel costs when they fill up their cars or heat their homes. It is important that oil markets are closely monitored for signs of manipulation or supply disruption, and I look forward to hearing the Fed’s views on how rising oil prices may affect con- sumer spending and economic growth. I appreciate all the Fed has done to ensure continued economic recovery. Chairman Bernanke, I look forward to hearing more from you on the Fed’s recent actions and possible future actions to pro- tect our economy. Congress also has an important role in making sure the economy continues to grow and more Americans continue to find the jobs (1) VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 2 they need. This week, the full Senate continues to consider the transportation bill. This bill includes the bipartisan effort of this Committee to update our Nation’s public transit infrastructure and create jobs. I am also hopeful that the Senate can find consensus on capital formation initiatives, the topic of another hearing next week before this Committee, to promote job creation while pro- tecting investors. With so many Americans in search of work, it is not too late for bipartisan action to create jobs and promote sustainable growth. I look forward to your views, Chairman Bernanke, on these and other steps Congress can take to improve our Nation’s economy. To preserve time for questions, opening statements will be lim- ited to the Chair and Ranking Member. However, I would like to remind my colleagues that the record will be open for the next 7 days for additional statements and other materials. I will now turn to Ranking Member Shelby. STATEMENT OF SENATOR RICHARD C. SHELBY Senator SHELBY. Thank you, Mr. Chairman. Welcome again, Mr. Chairman. Since the Federal Reserve took unprecedented actions in re- sponse to the financial crisis, there has been a growing recognition that the Fed needs to become more transparent. There was a time when central bankers met behind closed doors and stubbornly re- fused to inform the public of their decisions. Those days are clearly over. The public now rightly demands that policy makers not only ex- plain their decisions but also be accountable for their actions. This is especially true of the Federal Reserve, which, thanks to Dodd- Frank, now exercises even greater authority over the American economy and the lives of every American. To his credit, Chairman Bernanke has long recognized the need to modernize the Fed. In his first confirmation hearing before this Committee, he stated that he believed making the Fed more trans- parent would, and I will quote his words, ‘‘increase democratic ac- countability, promote constructive dialog between policy makers and informed outsiders, and reduce uncertainty in financial mar- kets and help anchor the public’s expectations of long-run infla- tion.’’ During Chairman Bernanke’s last Humphrey-Hawkins appear- ance, I noted that he has taken some important steps to improve the transparency of the FOMC, including holding press conferences to discuss monetary policy. Since then, the FOMC has taken an- other step to improve transparency by adopting an explicit inflation goal of 2 percent. This is a significant event in the history of the Federal Reserve. As Chairman Bernanke himself has stated, an explicit inflation target could reduce the public’s uncertainty about monetary policy and more effectively anchor inflation expectations. Yet it remains uncertain if the Fed’s recently announced inflation goal will achieve these objectives. While the Fed was establishing its inflation goal, it was at the same time communicating contradictory signals about his commit- ment to that inflation target. The FOMC minutes reveal that VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 3 Chairman Bernanke indicated that he believed the inflation goal would not represent a change in the FOMC’s policy. In addition, the FOMC has stated that it believes economic conditions are ‘‘like- ly to warrant exceptionally low levels for the Federal funds rate at least through late 2014.’’ In other words, the Fed is signaling to market participants that it expects to continue its near zero inter- est rate policy for at least 3 more years. I believe that begs the question: Is the FOMC focused on tar- geting low interest rates or its new inflation goal? If the inflation goal conflicts with keeping interest rates near zero, which target will prevail? In other words, why should market participants have confidence that the Fed is actually committed to achieving its infla- tion goal? And if the Fed is not serious about achieving its inflation goal, how will the Fed’s credibility suffer when inflation rises above 2 percent? Accordingly, today I hope that Chairman Bernanke can give the Committee more insight into how the FOMC’s inflation goal will work in practice. I would also like to hear whether he believes Con- gress should hold the FOMC accountable for meeting its inflation goal. And while the Chairman has taken steps to improve the transparency of the FOMC, the transparency of the Board of Gov- ernors appears to be getting worse. A recent Wall Street Journal article noted that the Board has held 47—yes, 47—separate votes on financial regulations since Dodd-Frank became law, yet they have held only two public meet- ings, Mr. Chairman. The article noted that there has been a steady reduction in the number of open meetings by the Board since the early 1980s when the Board had more than 30 open meetings. As a result, the Fed is making sweeping financial regulatory policy de- cisions behind closed doors. This is inconsistent with, Mr. Chair- man, your professed goal of making the Fed more transparent. In another troubling new development, the Fed recently decided to enter into the debate on housing policy. On January 4th, the Fed issued a white paper entitled ‘‘The U.S. Housing Market: Current Conditions and Policy Considerations.’’ The stated goal of the paper was not to provide a blueprint but, rather, to outline issues and tradeoffs that policy makers might consider. However, subsequent actions by Fed officials suggest that the Fed has views about the policies Congress should enact. Just 2 days after the white paper was released, Fed Governor Elizabeth Duke gave a speech in which she advocated for specific housing policies and effectively asked the GSE conservator to ig- nore his statutory mandate to conserve and preserve assets of the GSEs. That same day, Mr. Chairman, New York Fed President William Dudley gave a speech in which he argued that it would, in his words, ‘‘make sense’’ for Fannie and Freddie to ‘‘routinely re- duce principal on delinquent mortgages using taxpayer dollars.’’ These statements suggest to many that the Fed does, in fact, have a blueprint there for housing market policy. That blueprint appears to involve using the taxpayer-supported GSEs as a piggy bank. In weighing in on housing policy, certain Fed Governors have begun to take sides in what should be a congressional policy de- bate, I believe. The Fed’s independence for monetary policy has al- VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 4 ways been premised on its remaining nonpartisan and not advo- cating for specific legislative measures. The Fed has been and should, I believe, continue to be a useful resource for information and analysis on the housing market. I believe it should not become an active participant in the legislative debate over the future of housing finance. I hope that the Fed’s recent foray into housing policy will not become common practice. Mr. Chairman, I believe when you say that you believe the Fed is most effective when it is nonpartisan, transparent, and account- able, I believe that is right. I am interested in hearing from you today, Mr. Chairman, on how you intend to continue to improve the Fed’s performance on all three objectives. Thank you. Chairman JOHNSON. Thank you, Senator Shelby. Welcome, Chairman Bernanke. Dr. Ben Bernanke is currently serving his second term as Chair- man of the Board of Governors of the Federal Reserve System. His first term began under President Bush in 2006. Dr. Bernanke was Chairman of the Council of Economic Advisers during the Bush ad- ministration from June 2005 to January 2006. Prior to that, Dr. Bernanke served as a member of the Board of Governors of the Federal Reserve System from 2002 to 2005. Chairman Bernanke, please begin your testimony. STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Mr. BERNANKE. Thank you. Chairman Johnson, Ranking Member Shelby, and other Members of the Committee, I am pleased to present the Federal Reserve’s Semiannual Monetary Policy Report to the Congress. I will begin with a discussion of current economic conditions and the outlook and then turn to monetary policy. The recovery of the U.S. economy continues, but the pace of the expansion has been uneven and modest by historical standards. After minimal gains in the first half of last year, real GDP in- creased at a 21⁄ 4 -percent annual rate in the second half. The lim- ited information available for 2012 is consistent with growth pro- ceeding, in coming quarters, at a pace close to or somewhat above the pace that was registered during the second half of last year. We have seen some positive developments in the labor market. Private payroll employment has increased by 165,000 jobs per month on average since the middle of last year, and nearly 260,000 new private sector jobs were added in January. The job gains in recent months have been relatively widespread across industries. In the public sector, by contrast, layoffs by State and local govern- ments have continued. The unemployment rate hovered around 9 percent for much of last year but has moved down appreciably since September, reaching 8.3 percent in January. New claims for unemployment insurance benefits have also moderated. The decline in the unemployment rate over the past year has been somewhat more rapid than might have been expected, given that the economy appears to have been growing during that time- frame at or below its longer-term trend; continued improvement in the job market is likely to require stronger growth in final demand and production. Notwithstanding the better recent data, the job VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 5 market remains far from normal: The unemployment rate remains elevated, long-term unemployment is still near record levels, and the number of persons working part time for economic reasons is very high. Household spending advanced moderately in the second half of last year, boosted by a fourth-quarter surge in motor vehicle pur- chases that was facilitated by an easing of constraints on supply related to the earthquake in Japan. However, the fundamentals that support spending continue to be weak: Real household income and wealth were flat in 2011, and access to credit remained re- stricted for many potential borrowers. Consumer sentiment, which dropped sharply last summer, has since rebounded but remains rel- atively low. In the housing sector, affordability has increased dramatically as a result of the decline in house prices and historically low interest rates on conventional mortgages. Unfortunately, many potential buyers lack the down payment and credit history required to qual- ify for loans; others are reluctant to buy a house now because of concerns about their income, employment prospects, and the future path of home prices. On the supply side of the market, about 30 percent of recent home sales have consisted of foreclosed or dis- tressed properties, and home vacancy rates remain high, putting downward pressure on house prices. More positive signs include a pickup in construction in the multifamily sector and recent in- creases in homebuilder sentiment. Manufacturing production has increased 15 percent since the trough of the recession and has posted solid gains since the middle of last year, supported by the recovery in motor vehicle supply chains and ongoing increases in business investment and exports. Real business spending for equipment and software rose at an an- nual rate of about 12 percent over the second half of 2011, a bit faster than in the first half of the year. But real export growth, while remaining solid, slowed somewhat over the same period as foreign economic activity decelerated, particularly in Europe. The members of the Board and the presidents of the Federal Re- serve Banks recently projected that economic activity in 2012 will expand at or somewhat above the pace registered in the second half of last year. Specifically, their projections for growth in real GDP this year, provided in conjunction with the January meeting of the FOMC, have a central tendency of 2.2 to 2.7 percent. These fore- casts were considerably lower than the projections they made last June. A number of factors have played a role in this reassessment. First, the annual revisions to the national income and product ac- counts released last summer indicated that the recovery had been somewhat slower than previously estimated. In addition, fiscal and financial strains in Europe have weighed on financial conditions and global economic growth, and problems in U.S. housing and mortgage markets have continued to hold down not only construc- tion and related industries, but also household wealth and con- fidence. Looking beyond 2012, FOMC participants expect that eco- nomic activity will pick up gradually as these headwinds fade, sup- ported by a continuation of the highly accommodative stance for monetary policy. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 6 With output growth in 2012 projected to remain close to its longer-run trend, participants did not anticipate further substan- tial declines in the unemployment rate over the course of this year. Looking beyond this year, FOMC participants expect the unemploy- ment rate to continue to edge down only slowly toward levels con- sistent with the Committee’s statutory mandate. In light of the somewhat different signals received recently from the labor market than from indicators of final demand and production, however, it will be especially important to evaluate incoming information to as- sess the underlying pace of the economic recovery. At our January meeting, participants agreed that strains in glob- al financial markets posed significant downside risks to the eco- nomic outlook. Investors’ concerns about fiscal deficits and the lev- els of Government debt in a number of European countries have led to substantial increases in sovereign borrowing costs, stresses in the European banking system, and associated reductions in the availability of credit and economic activity in the euro area. To help prevent strains in Europe from spilling over to the U.S. economy, the Federal Reserve in November agreed to extend and to modify the terms of its swap lines with other major central banks, and it continues to monitor the European exposures of U.S. financial in- stitutions. A number of constructive policy actions have been taken of late in Europe, including the European Central Bank’s program to ex- tend 3-year collateralized loans to European financial institutions. Most recently, European policy makers agreed on a new package of measures for Greece, which combines additional official sector loans with a sizable reduction of Greek debt held by the private sector. However, critical fiscal and financial challenges remain for the euro zone, the resolution of which will require concerted action on the part of the European authorities. Further steps will also be required to boost growth and competitiveness in a number of coun- tries. We are in frequent contact with our counterparts in Europe and will continue to follow the situation closely. As I discussed in my July testimony, inflation picked up during the early part of 2011. A surge in the prices of oil and other com- modities, along with supply disruptions associated with the dis- aster in Japan that put upward pressure on motor vehicle prices, pushed overall inflation to an annual rate of more than 3 percent over the first half of last year. As we had expected, however, these factors proved transitory, and inflation moderated to an annual rate of 11⁄ 2 percent during the second half of the year—close to its average pace in the preceding 2 years. In the projections made in January, the Committee anticipated that, over coming quarters, in- flation will run at or below the 2-percent level we judge most con- sistent with our statutory mandate. Specifically, the central tend- ency of participants’ forecasts for inflation in 2012 ranged from 1.4 to 1.8 percent, about unchanged from the projections made last June. Looking farther ahead, participants expected the subdued level of inflation to persist beyond this year. Since these projections were made, gasoline prices have moved up, primarily reflecting higher global oil prices—a development that is likely to push up in- flation temporarily while reducing consumers’ purchasing power. We will continue to monitor energy markets carefully. Longer-term VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 7 inflation expectations, as measured by surveys and financial mar- ket indicators, appear consistent with the view that inflation will remain subdued. Against this backdrop of restrained growth, persistent downside risks to the outlook for real activity, and moderating inflation, the Committee took several steps to provide additional monetary ac- commodation during the second half of 2011 and early 2012. These steps included changes to the forward rate guidance included in the Committee’s postmeeting statements and adjustments to the Fed- eral Reserve’s holdings of Treasury and agency securities. The target range for the Federal funds rate remains at 0 to 1⁄ 4 percent, and the forward guidance language in the FOMC policy statement provides an indication of how long the Committee ex- pects that target range to be appropriate. In August, the Com- mittee clarified the forward guidance language, noting that eco- nomic conditions—including low rates of resource utilization and a subdued outlook for inflation over the medium run—were likely to warrant exceptionally low levels for the Federal funds rate at least through the middle of 2013. By providing a longer time horizon than had previously been expected by the public, the statement tended to put downward pressure on longer-term interest rates. At the January 2012 FOMC meeting, the Committee amended the for- ward guidance further, extending the horizon over which it expects economic conditions to warrant exceptionally low levels of the Fed- eral funds rate to at least through late 2014. In addition to the adjustments made to the forward guidance, the Committee modified its policies regarding the Federal Reserve’s holdings of securities. In September, the Committee put in place a maturity extension program that combines purchases of longer- term Treasury securities with sales of shorter-term Treasury secu- rities. The objective of this program is to lengthen the average ma- turity of our securities holdings without generating a significant change in the size of our balance sheet. Removing longer-term se- curities from the market should put downward pressure on longer- term interest rates and help make financial market conditions more supportive of economic growth than they otherwise would have been. To help support conditions in mortgage markets, the Committee also decided at its September meeting to reinvest prin- cipal received from its holdings of agency debt and agency mort- gage-backed securities back into agency MBS, rather than con- tinuing to reinvest those proceeds in longer-term Treasury securi- ties as had been the practice since August 2010. The Committee re- views the size and composition of its securities holdings regularly and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in the context of price stability. Before concluding, I would like to say just a few words about the statement of longer-run goals and policy strategy that the FOMC issued at the conclusion of its January meeting. The statement re- affirms our commitment to our statutory objectives, given to us by the Congress, of price stability and maximum employment. Its pur- pose is to provide additional transparency and increase the effec- tiveness of monetary policy. The statement does not imply a change in how the Committee conducts policy. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 8 Transparency is enhanced by providing greater specificity about our objectives. Because the inflation rate over the longer run is de- termined primarily by monetary policy, it is feasible and appro- priate for the Committee to set a numerical goal for that key vari- able. The FOMC judges that an inflation rate of 2 percent, as measured by the annual change in the price index for personal con- sumption expenditures, is most consistent over the longer run with its statutory mandate. While maximum employment stands on an equal footing with price stability as an objective of monetary policy, the maximum level of employment in the economy is largely deter- mined by nonmonetary factors that affect the structure and dynam- ics of the labor market; it is, therefore, not feasible for any central bank to specify a fixed goal for the longer-run level of employment. However, the Committee can estimate the level of maximum em- ployment and use that estimate to inform policy decisions. In our most recent projections in January, for example, FOMC partici- pants’ estimates of the longer-run, normal rate of unemployment had a central tendency of 5.2 to 6.0 percent. As I noted a moment ago, the level of maximum employment in an economy is subject to change; for instance, it can be affected by shifts in the structure of the economy and by a range of economic policies. If at some stage the Committee estimated that the maximum level of employ- ment had increased, for example, we would adjust monetary policy accordingly. The dual objectives of price stability and maximum employment are generally complementary. Indeed, at present, with the unem- ployment rate elevated and the inflation outlook subdued, the Com- mittee judges that sustaining a highly accommodative stance for monetary policy is consistent with promoting both objectives. How- ever, in cases where these objectives are not complementary, the Committee follows a balanced approach in promoting them, taking into account the magnitudes of the deviations of inflation and em- ployment from levels judged to be consistent with the dual man- date, as well as the potentially different time horizons over which employment and inflation are projected to return to such levels. Thank you. And, of course, I am pleased to take your questions. Chairman JOHNSON. Thank you for your testimony. We will now begin the questioning of our witness. Will the clerk please put 5 minutes on the clock for each Member for their ques- tions? Dr. Bernanke, what are the reasons for the modest pace of the current expansion? Is the economy recovering as you would expect following a major financial crisis? Or has the Great Recession led to any permanent adjustments in either output or unemployment levels? Mr. BERNANKE. Mr. Chairman, normally when an economy suf- fers a severe recession, the recovery is comparatively stronger. So a sharp decline tends to have a stronger expansion subsequently. However, our economy has been hit by two unusual shocks. One is the housing boom and bust, and we know from history—and recent Fed research supports this—that housing busts tend to take some time to be offset, in particular since housing is an important part of the recovery process in most expansions. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 9 Additionally, we have had a severe financial crisis which has left still many stresses in the banking system and on the financial sys- tem, and, again, research, notably by Ken Rogoff and Carmen Reinhart, has pointed out that historically recoveries following fi- nancial crises also tend to be somewhat slower than they otherwise would be. So having been hit by both of these factors and with housing problems still being important, as you noted, and as finan- cial conditions, including some of the stresses coming from Europe, still being a drag to some extent on economic activity, we have had a slower recovery than we otherwise would have anticipated. Nevertheless, of course, we have now had growth since mid-2009 and unemployment has come down, but, of course, the growth is not as strong and the improvement in the unemployment rate is not as quick as obviously we would like. Chairman JOHNSON. U.S. consumers are deleveraging to reduce high debt levels, credit is still tight for U.S. companies and house- holds, and fiscal policy has begun to tighten. As we consider eco- nomic growth in the near and long term, should Congress enact drastic spending cuts and balance the budget this year? Or would a plan to curb deficits and address structural issues over a longer time horizon make more sense economically? Also, what sectors of our economy could provide sustainable growth over the long term? Mr. BERNANKE. Well, Mr. Chairman, first of all, as Senator Shel- by correctly pointed out, the Federal Reserve does not make rec- ommendations on specific fiscal policy decisions. But in the broad context, let me make two points. The first is that, as I have said on a number of occasions, includ- ing in front of this Committee, the United States is on an unsustainable fiscal path looking out over the next couple of dec- ades. If we continue along that path, eventually we will face a fis- cal and financial crisis that would be very bad for growth and for stability. So, therefore, whatever we do, it is very important that we be planning now for a long-term improvement in our situation in terms of long-term fiscal sustainability. At the same time, I think it is important that we keep in mind that the recovery is not yet complete. Unemployment remains high. The rate of growth is modest. And under current law, as you know, on January 1st of 2013, there will be a major shift in the fiscal po- sition of the United States, including the expiration of a number of tax cuts and other tax provisions, together with the sequestra- tion and other provisions that would together create a very sharp shift in the fiscal stance of the Federal Government. I think that we could achieve the very desirable long-run fiscal consolidation that we definitely need and we need to do soon, but we can do that in a way that does not provide such a major shock to the recovery in the near term. And so I am sure that Congress will be debating the details of this over the next year and trying to take into account both the need for protecting the recovery, at the same ensuring that we do achieve fiscal sustainability in the long term. On the second part of your question, Mr. Chairman, we are see- ing that manufacturing and industrial production in general have been leading the recovery. Housing, which normally does lead the recovery, of course is lagging. But, generally, it is—and auto- VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 10 mobiles, of course, being one part of manufacturing. But, generally, it is hard to predict, of course, what sectors—will have the greatest growth in the longer term. You asked me earlier in the first question about potential growth. We do not see at this point that the very severe recession has permanently affected the growth potential of the U.S. economy, although, of course, we continue to monitor productivity gains and the like. But one concern we do have, of course, is the fact that more than 40 percent of the unemployed have been unemployed for 6 months or more. Those folks are either leaving the labor force or having their skills eroded, and although we have not seen much sign of it yet, if that situation persists for much longer, then that will reduce the human capital that is part of our growth process going forward. Chairman JOHNSON. I have been working with my colleagues in the Senate to move forward a set of proposals to update securities laws and make it easier for startups and small businesses to raise capital while maintaining critical investor protections. Do you gen- erally agree that these types of proposals will help create jobs and strengthen our economic recovery? Mr. BERNANKE. Well, Mr. Chairman, I do not know the specific proposals, but it is certainly true that startup companies, compa- nies under 5 years old, create a very substantial part of the jobs that are added in our economy. And, of course, if there is anything that can be done to encourage startups and entrepreneurship, whether it is reducing burdensome regulation or providing other kinds of assistance—of course, Congress makes all the decisions about the specifics, but, again, promoting startups is, I think, an important direction for job creation. And, in particular, the fact that startups and business creation has been quite weak during the expansion is one of the reasons that job creation has lagged behind the usual recovery pattern. Chairman JOHNSON. Senator Shelby. Senator SHELBY. Thank you. Chairman Bernanke, at our last hearing right here in the Com- mittee on the European debt crisis, I asked the Federal Reserve witness about the exposure of our largest banks to the European financial system. The Fed has yet to respond to my request for this information. Will you provide the Committee with this information regarding the individual exposures of our largest banks to Europe? Mr. BERNANKE. Of course, supervisory information has legal pro- tections, but we would be happy to work with the Committee to provide you with the information—— Senator SHELBY. Well, we need to know what is going on as far as our exposure of our banks to Europe. Mr. BERNANKE. Yes. We want to make sure you understand the situation and have all the information you need to make good deci- sions. I just wanted to add that the SEC, working with other agen- cies, has provided now some guidance and templates to banks to provide public information on a quarterly basis about their expo- sures and their hedges. But, yes, we certainly can work with you to help you understand everything you need to know to make good decisions. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 11 Senator SHELBY. Are you concerned with some exposure of our largest banks to Europe? Mr. BERNANKE. Well, we are concerned in the sense that we are paying a lot of attention to it. Our sense is, having done a lot of work on this, including asking banks to stress their European posi- tions in their current capital stress tests that they are doing now, our sense is that the direct exposures of U.S. bank to sovereign debt in Europe, particularly that of the weaker countries, is quite limited and is well hedged, and that those hedges in turn are pret- ty good hedges, that is, the counterparties are diversified and fi- nancially strong. So if you look more broadly, of course, our banks are exposed to European companies and banks, inevitably their major trading partners and major financial partners. Again, they have been work- ing hard to provide adequate hedges, but let me just say I think it is very important to note that if there is a major financial prob- lem in Europe, there will be so many different channels that would affect the stability of our financial system that I would not want to take too much comfort from that. Senator SHELBY. Could you explain to the Committee, to this Member, too, the situation as far as credit default swaps and why they are not deemed to—certain Nations have defaulted—to trigger the action on that? What is going on here? Is this a Government intervention in the market? Or what is it? Mr. BERNANKE. No, sir. There is a private body, the ISDA, which makes determinations as to whether a credit event has oc- curred—— Senator SHELBY. When a default happens? Mr. BERNANKE. When default occurred, that is right. And in the case of Greece, which is the relevant issue, thus far there has been a so-called private sector involvement, purportedly voluntary agree- ment with the private sector bond holders. And there has also been an exchange of bonds by ECB and other Government agencies with Greece that essentially give some protection to the ECB for its Greek debt holdings. The news this morning, I believe, was that the ISDA had deter- mined that those two events did not constitute a credit event for the purpose of a CDS activation. However—— Senator SHELBY. And why did it not create the dynamic there? Why did it not cause voluntary—— Mr. BERNANKE. Well, I guess their view is that so far the nego- tiations have been voluntary. Now, the possibility exists—the Greek Government has retroactively created so-called collective ac- tion clauses which it could use in the future to force other private sector investors to take losses even if they have not agreed to this voluntary deal. And in that case, the ISDA would look at it again. and perhaps in that case it would declare a default had occurred. But that has not occurred yet. Senator SHELBY. I want to go into one other thing. The Dodd- Frank Act created a new position of Vice Chairman for Supervision at the Fed, which is subject to Senate confirmation. It is almost 2 years later. That was 2 years ago. The President has still not nomi- nated anyone for this position. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 12 Who is currently fulfilling those duties as Vice Chairman of Su- pervision would have at the Fed, if they are being done? Mr. BERNANKE. They are, of course, being done, and the duties are distributed across the Governors and the staff. But I would say that the point person, as you know, is Governor Tarullo, who is the head of the Bank Supervision Committee and has on many occa- sions testified before this Committee on regulatory matters. Senator SHELBY. Do you believe that that position should be filled, nominated and filled? Mr. BERNANKE. Well, Congress created that position, and, yes, I would like to see it filled, and I would also like to see the Board filled as well. Senator SHELBY. And my last question has to do with the bal- ance sheet of the Fed, which is approximately, to my under- standing, about $2.9 trillion. How are you going to shrink that? I know you are not going to shrink it now, but do you have a plan? I am sure you have talked about it. We have talked about it a little bit at times, but that is a huge balance sheet to start shrinking, and it probably is not the time to shrink it now. I do not have any information on that, but how are you going to do that? Mr. BERNANKE. Senator, we have provided on numerous occa- sions an exit plan. For example, in the minutes, I think sometime ago, we provided an agreement of the Committee about how we would proceed. In the very short term, we can both, of course, allow securities to run off, which we have not been—we have been rein- vesting them at this point. And we can reduce the impact of those securities on the economy, both through various sterilization meas- ures and by raising the interest rate we pay on reserves to keep those reserves locked up at the Fed. Over a longer period of time, of course, we are going to have to sell some of the securities and, of course, we will. Our goal is to get back to—eventually, at the appropriate time, our goal is to get back to a more normal size balance sheet consisting only of Treas- ury securities. Senator SHELBY. Thank you. Thank you, Mr. Chairman. Chairman JOHNSON. Senator Reed. Senator REED. Well, thank you very much, Mr. Chairman, and thank you, Chairman Bernanke. And let me just say I thought that the Federal Reserve’s white paper on housing was very thoughtful, very analytical, and nonprescriptive, which is appropriate. I think also, thinking back, such an analytical paper might have been ex- tremely useful to us in 2005 or 2006 or 2007 to alert policy makers to develop it into a housing market that proved to be catastrophic. And the final point, I think, is that it is fully consistent with the enhanced responsibilities under the FSOC that the Federal Reserve must display. So on all those points, I think it was appropriate. One of the issues that was raised in the paper, which you might elaborate on, is that there are short-term programs that might in the long term produce more returns, enhanced value to the Govern- ment and taxpayers. But if they are not pursued, even if there is an up-front cost, ironically we could have even a further deteriora- VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 13 tion in the profit, the profitability, assets of these GSEs. Can you elaborate on that, Mr. Chairman? Mr. BERNANKE. Certainly, and I would like just quickly to men- tion to Senator Shelby, who asked about this, that the speeches given by Governors Duke and President Dudley are their own re- cognizance. They do not represent official Fed positions, and, of course, as you know, Fed members often give their views, their own individual views. Sorry, Senator Reed. One point that we make is that in a typical negotiation between a borrower and a lender, a modification or some other arrangement like a short sale or a deed in lieu, for ex- ample, or other activities like REO-to-rental are typically taken on a narrow economic basis, the benefits of the lender and the bor- rower, which makes sense in a free market economy. But in the current situation, I think it is important at least to recognize that the problems in the housing sector, including massive numbers of foreclosures, uncertainty about the number of houses coming on the market, whole neighborhoods with many empty houses, all of those things have implications not only for the borrower and the lender but also for the neighborhood, for the community, and, of course, for the national economy because the weaknesses in the housing market, again, as I mentioned earlier, are slowing the pace of the recovery, and from the Federal Reserve’s point of view are probably muting, to some extent, the impact of our low interest rate policy because low mortgage rates do not help if people cannot get mort- gage credit. So some of the benefits of actions to improve conditions in the housing market go beyond just those of the lender and the bor- rower and accrue to the broader society as well. Senator REED. And one other point you might comment upon is that we have several challenges facing us economically, as you have illustrated. One is the housing market. The other is potential energy spikes. Relatively speaking, it seems to me that we have much more ability to influence effectively and correctly housing pol- icy here than international energy prices, and as a result, it would be, I think, a good investment of our time and effort to do so. Is that a fair comment? Mr. BERNANKE. Well, I think if there was a goal of the white paper, it was simply to encourage Congress to look at these issues, which represent, I think, one of the directions whereby we could be doing something on a policy basis that might help the recovery be stronger. Senator REED. Let me turn to the issue of the Volcker Rule, which is pending. The European Governments are urging that their sovereign equities be sort of treated preferentially in the rule, even though, as I understand it—and you might correct me—that under the Basel rules there is a zero risk weighting to sovereign debt. Is that correct? Mr. BERNANKE. There is a zero risk weighting yes. Senator REED. So the Greek debt has no risk? Mr. BERNANKE. Well, the way that it has been handled by the European banking authorities at the moment is to force the banks to write down their sovereign debt, and that in turn affects the amount of capital that they can claim. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 14 Senator REED. And in addition, too, the level of capital and re- sulting liquidity for European banks is rather substantial relative to ours in terms of the kind of liquidity ratios they can bear under Basel. Is that also accurate? Mr. BERNANKE. That it is lower? Senator REED. No, that they can have much higher liquidity than we can or a much higher ratio of debt to equity. Mr. BERNANKE. Oh, I see. At the moment there are several issues. In principle, we are all agreeing to the same set of rules, the Basel III rules. But there are at least two questions. One has to do with the fact that the ratio of risk-weighted assets to total assets is lower in Europe than the United States, and the question, therefore, is: Are European supervisors in some way allowing lower risk weights being put on comparable assets? The Basel Committee takes this very seriously and has a process underway to try to verify that the two continents are operating comparably. The other issue is that the Basel rules have not yet been imple- mented in Europe or, of course, in the United States either. There is a European Union directive in process which we are looking at carefully. It does not in our view completely—it is not completely consistent with the Basel III agreements, but it is not a final docu- ment. But we want to be sure that the capital rules in Europe do, in fact, adhere to the agreement that we all signed on to. Senator REED. Just a final, quick point, Mr. Chairman. In the context of the Volcker Rule, you are still looking very, very closely at these differentials between European treatment of their sov- ereign debt and ultimately the way the Volcker Rule will treat it. Mr. BERNANKE. Well, the issue that the Europeans and the Ca- nadians and the Japanese and others have raised is that because there is an exemption for U.S. Treasurys but not for foreign sovereigns in the Volcker Rule, they believe they are being dis- criminated against and that the Volcker Rule might affect the li- quidity and effectiveness of their sovereign debt markets. We take this very seriously. We are in close discussions with those counter- parts, and, of course, we will be looking carefully to see if changes are needed, and we will do what is necessary. Senator REED. Thank you, Mr. Chairman. Chairman JOHNSON. Senator Crapo. Senator CRAPO. Thank you, Mr. Chairman. And, Chairman Bernanke, I want to follow up on the Volcker Rule. I read with in- terest your comments yesterday, and, frankly, candid comments, that the regulators will not be ready to issue the rule by the dead- line of July, which I think is becoming more and more self-evident. I assume the reason for that is that because you have 17,000 com- ments, you have the issues that were just raised by Senator Reed with regard to the reaction of other markets in the world to what we may do with that rule, and the need to conduct a cost/benefit analysis, which is likely not to happen by the time we hit the stat- utory deadline in July. Is that correct? Mr. BERNANKE. Yes, and in addition, it is a multiagency rule, and that requires coordination. But I do want to say that, of course, we will be working as quickly and as effectively as we can to get it done. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 15 Senator CRAPO. Well, I appreciate that. The question I have is: As I read the statute, there is a deadline in July for the agencies to act, but if the agencies do not act, the rule, whatever it is, goes into effect. And the market participants are, understandably, I be- lieve, concerned about what they should do on July 21st if the agencies have not been able to coordinate effectively and promul- gate a rule. The question I have to you is: Wouldn’t it be helpful if Congress were to correct that aspect of the statute and make it clear that on July 21st we are not going to have a Volcker Rule go into effect that does not have the clarification and cost/benefit analysis and fine-tuning that the agencies are now trying to give it? Mr. BERNANKE. Well, Senator, we certainly do not expect people to obey a rule that does not exist. There is a 2-year conformance period built into the statute that allows 2 years from July of this year before they have to conform to the rule, and we will certainly make sure that firms have all the time they need to respond. And I think 2 years will probably be adequate in that respect. Senator CRAPO. Well, thank you. I would like to shift during the remainder of my questions to the topic of a question that the Chairman asked you about whether it is time for us to begin more aggressively controlling the spend-out rate in Congress’ spending habits or whether we need to continue to hold off because of the impact on the economy. And I believe, as I understood your re- sponse, you indicated that in January we are going to see tax cuts expire, and we are going to see the sequestration impact and a number of other things will happen. I believe your answer was that soon we need to take some action, and I want to pursue that with you a little more in this context. We have been having this debate in Congress now for a number of years, but I want to go back to the Bowles-Simpson Commission, which issued its report 2-plus years ago now. In that report it was recognized that there needed to be an easing into the aggressive control of spending in Washington, and immediately following that, we had the debate over the $800 billion stimulus bill where the ar- gument was made, you know, it is not time to control Federal spending yet, we need another year or two before we start getting into the serious control of spending. And between then and now, we have basically put about another $5 trillion on the national debt, not to count the trillions of dollars that have been used to help sustain economic activity, whether we agree with them or not from the Fed’s actions. And we still see the argument being made that it is not time yet for us to become aggressively engaged in con- trolling the spending excesses in Washington, even though we have over 40 cents of every dollar borrowed today, and the budgets that are being proposed continue that trend for the next decade. I know you do not get heavily engaged in fiscal policy, but you have already tiptoed a little bit into those waters, and I would like to ask you: When will it be time? I believe it is past time. But when will it be time if it is not time now for us to start aggressively deal- ing with the fiscal structure of our country on the spending side of the equation? VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 16 Mr. BERNANKE. Just a word on the Fed. The Fed’s purchase of securities actually reduced the deficit because of the interest that comes back to the Treasury. The two things are not incompatible. You know, you can mod- erate the very near term impact at the same time that you make strong and decisive actions to put us on a path—I mean, you have not done—you have not taken any actions, you have not passed the laws that will bring us on a glidepath into sustainability over the next decade or so. And I would add that I think one concern there, as I mentioned yesterday, is that the 10-year budget window may artificially constrain some of the things that Congress should be thinking about because many of the issues that we face in terms of not only entitlements but other issues as well are multidecade issues. And I think you could take strong actions that would be taking place over time. I think about the early 1980s Social Secu- rity reform that phased in a whole bunch of things, including the later retirement age, which is still happening today 30 years later. So you could take those actions, lock them in, you could get the benefit of the confidence there, but it would not have necessarily quite as big an impact as the very big shock that would otherwise occur next January 1st. I am not saying that you cannot do it and take serious action. I just think you should balance those objectives. Senator CRAPO. Well, thank you. I take it that you are saying that we need to adopt a long-term plan to deal with this crisis. Mr. BERNANKE. Absolutely. Senator CRAPO. And I would just observe that at this point the budgets that are being proposed simply go the other direction. Other than some others, like the Bowles-Simpson Commission and others, we still have not got proposals on the table here in Con- gress to deal with that long-term plan, and I personally think it is time we get at it. Chairman JOHNSON. Senator Menendez. Senator MENENDEZ. Well, thank you, Mr. Chairman. Thank you, Chairman Bernanke, for your service. I read your statement, and, you know, obviously creating jobs is the single most important issue in our country for families, for our collective economy. When such a large part of our GDP is consumer demand, obviously, without income, there is not the opportunity to make that demand. How would you describe—how are the latest programs of quan- titative easing and Operation Twist helping us get to a more robust growth and creating those opportunities? Mr. BERNANKE. Well, of course, it is very difficult to figure out exactly how to attribute the progress that we have made to mone- tary policy, to fiscal policy, to other sources of growth. But if you look at the record, for example, if you look back at the Quantitative Easing 2, so-called, in November 2010, the concerns at the time were that it would be highly inflationary, it would hurt the dollar, that it would not have much effect on growth, et cetera. But since November 2010, where we have had since then the QE2 and the so-called Operation Twist, we have had about 2.5 million jobs cre- ated. We have seen big gains in stock prices, improvements in cred- it markets. The dollar is about flat. Commodity prices ex oil are not VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 17 much changed. Inflation is doing well in the sense that we are looking at about a 2-percent inflation rate for this year. So I think that one other point is that in November 2010 we had some concerns about deflation, and I think we have sort of gotten rid of those and brought ourselves back to a more stable inflation environment as well. So I think that the record is positive, again, acknowledging you cannot necessarily disentangle all the different factors. But it is a constructive tool, but obviously monetary policy cannot do it all. We need to have good policies across the board, including housing, in- cluding fiscal policy and so on. But looking back, I think that those actions played a constructive role. Senator MENENDEZ. Well, let me go to that point you just made on other elements, housing as one of them. Mr. Dudley, who is the president of the Federal Reserve Bank of New York, in a recent speech in my home State of New Jersey talked about those bor- rowers who are underwater, and he said, in part, without a signifi- cant turnaround in home prices and employment, a substantial portion of those loans that are deeply underwater will ultimately default absent an earned principal reduction program. Do you agree with his analysis? Mr. BERNANKE. No, I want to be clear, the Federal Reserve does not have an official position on principal reduction, and I think it is a complicated issue. It depends on what your objectives are. In terms of avoiding delinquency, there is, I think, a reasonable de- bate in the literature about whether reducing principal or reducing payments is more important. So that is one issue. In terms of issues like mobility for example, ability to sell your home and move elsewhere, there are also alternatives to principal reduction, including things like deed in lieu and short sales. So I think it is a complicated issue. There are certainly cir- cumstances where principal reduction would be constructive and would be cost-effective in terms of reducing default risk and im- proving the economy, but I do not think there is a blanket state- ment that you can make on that. Senator MENENDEZ. Well, let me ask you a broader question. Right now, Fannie Mae and Freddie Mac currently own or guar- antee 60 percent of the mortgage market in the country. Do you think that their regulator at the FHFA has been aggressive enough in using their market power to stabilize the housing market? Mr. BERNANKE. Well, he has to make judgments about the effect of those policies on the balance sheet of the GSEs and whether or not they meet the conservatorship requirements, and he has made judgments about that. I guess what I would just suggest is that a variety of different tools can be tried, that you can make a mix of different things, and that you can be experimental. And the GSEs look to be doing that to some extent. We are seeing the experi- mental REO-to-rental program, for example. They have done HARP II. So they have been taking steps in that direction, and I think there is a big element here of trying to figure out what works best per dollar of cost. And FHFA and the GSEs, we may not all agree exactly on their particular actions, but I think they are trying some things, and we will see what benefits accrue from. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 18 Senator MENENDEZ. Well, let me just make a final note that there are two ways of preserving, you know, the corpus of your in- terest. One is through foreclosure; the other one is through looking at the whole process of refinancing and, where appropriate, the pri- vate sector has taken about 20 percent of its portfolio in the banks and said it makes sense to do, you know, reductions in principal. So I just worry that our whole focus seems to be in those entities, preserving the corpus through foreclosure, which at the end of the day has a whole other destabilizing element in the marketplace. Mr. BERNANKE. Senator, I would just like to agree with you on that. Foreclosure is very costly not only for the borrower and the lender but for the community and for the country. And what I was discussing was not whether foreclosure is a good thing. I was talk- ing about what are the best ways to address the foreclosure issue. Senator MENENDEZ. Thank you, Mr. Chairman. Chairman JOHNSON. Senator Corker. Senator CORKER. Thank you, Mr. Chairman. And thank you, Mr. Chairman, for being here. I know we alternate between the House and Senate going first. This is sort of a postgame interview, but we thank you for being here today. I want to home in a little bit on the Volcker Rule since there has been a lot of testimony about the economy and quantitative easing and all those things related to how that affects prices and savers and all of that over the last day and a half. Let me just ask you, with the Volcker Rule—and I think most of us are in a place where we are just trying to make it work now. We understand that it is passed. Why were Treasurys and mort- gage-backed securities excluded from the Volcker Rule in the first place? It is quite odd that those would be the only two instruments that it did not apply to? Mr. BERNANKE. Well, of course, Congress made that decision, and I assume it had to do with a desire to maintain the depth and li- quidity of the Treasury market. Senator CORKER. And so by that statement you just made, we have taken away the depth of liquidity in all other instruments, and thus we have had an outcry from foreign Governments and just middle American companies that realize they are not going to have the depth of liquidity. And I know you focus on economic issues. You are a renowned economist. Is that something that is good for our country to lose liquidity with those other instruments? Or would we be better off putting Treasurys and mortgage-backed securities on the same basis and maybe moving them into the Volcker arrangement? Mr. BERNANKE. Well, there is certainly a tradeoff. There is going to be at least some marginal effect from Volcker on markets. In principle, there is a market-making exemption, as you know, and we are going to try and do our best to clarify the distinction be- tween proprietary trading and market making. Senator CORKER. And you think market making is a good thing for our country and by these regulated entities, by virtue of that statement. Is that correct? Mr. BERNANKE. I do, and it is exempted from the Volcker Rule, but, of course, we have got to draw that line in a way that does not inhibit good market making. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 19 Senator CORKER. Yes. You know, I have talked with some of the folks who are advocates for the Volcker Rule, and we have tried to come up with a one-sentence solution to allow appropriate market making to take place by the regulated entities. And some of the people, at least the people we have talked to, actually want to see the Volcker Rule used as a way to get to Glass-Steagall through the back door. By virtue of what you have just said, I think you would believe that to be not a good thing for our country. Is that correct, or at least as it relates to market making? Mr. BERNANKE. Well, I have not been an advocate of Glass- Steagall because I think if you look back at the crisis, the separa- tion of commercial and investment banking was not particularly helpful. Investment banks obviously were a big source of the prob- lem by themselves, separately. Senator CORKER. Right. Mr. BERNANKE. But, again, you know, as I was saying before, there are tradeoffs. The goal of the Volcker Rule is to reduce risk taking by institutions, and we are trying to do that in a way that will permit hedging and market making. Senator CORKER. Well, when you have a rule that, you know, people describe like in many ways pornography—in other words, you know it when you see it. It is hard, I know, to make a rule. And would it be helpful if Congress clarified the fact that market making is not intended to be overturned by virtue of the Volcker Rule, that market making is a very valid and appropriate process for these regulated entities to be involved in? And do you think that might help—you know, you have had all these comments, you have got all these regulators that are trying to come to a conclu- sion, each with—being pushed, by the way, by various constitu- encies in Congress and outside. Would it be helpful to you if we clarified that we as a Congress do believe that market making should not be negatively impacted by the Volcker Rule. Mr. BERNANKE. Well, Senator, of course, the Federal Reserve pushed for these exemptions, and I think the statute is clear that market making is exempt, and we want to do our best to make that operational. I understand your intent, I hear your intent, that market making and hedging should be excluded from proprietary trading—or dis- tinguished from proprietary trading. Senator CORKER. So I think we are, generally speaking, on the same page as it relates to the Volcker Rule, and we do not want it to do damage to the depth of liquidity unnecessarily for lending activities in this country. Is that correct? Mr. BERNANKE. That is correct. Senator CORKER. And I think we are on the same page that it is probably a legitimate concern for other sovereign Governments, like Canada, like Japan, like other ones, to say, look, this is incred- ibly unfair for the largest economy in the world to place a tremen- dous bias on liquidity of Treasurys and mortgage-backed securities, unbelievably, but not our own sovereign debt. Would you agree that that is a little bit of a problem? Mr. BERNANKE. Well, there is an issue. We are certainly in con- versations with our partners there. Of course, there is one dif- VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 20 ference, which is that the primary markets for, say, Japanese debt are in Japan and, of course, therefore are not broadly affected by the Volcker Rule, except to the extent that U.S. banks are doing it. Senator CORKER. Right. Mr. BERNANKE. But, yes, I agree that we want to make sure that we are not doing unnecessary damage to those markets. Senator CORKER. OK. Do you agree that the zero weighting that we place on sovereign debt, especially in this world and especially in light of the fact that we are our own worst enemy in this country and we still have not been able to, as Senator Crapo was alluding to, deal with our longer-term issues with the Basel rules that are in place? Should there be a zero risk weighting for Treasurys or any other kind of sovereign debt? We have seen some big risk out there. Mr. BERNANKE. Well, none of those securities is completely risk- less. That is true. We have in the case of non-U.S.—we have ap- proached this in various ways. In the case of non-U.S. sovereign debt, as I mentioned before, the Europeans have asked the banks to write down the value of that debt so in some sense it is sub- tracted from capital one for one. And in the United States, we have been making banks—we are not just relying on the capital ratio. We are making banks do stress tests and look at their European holdings and their hedges and so on to make sure that they are safe and sound. So we are not ignoring that by any means. In the case of U.S. Treasurys, our assumption is that the biggest source of risk is interest rate risk as opposed to default risk. Under a default, I think the whole Fiscal Commission would be in enor- mous trouble. Senator CORKER. Right. Mr. BERNANKE. But we do ask banks to stress test their interest rate risk, including their risk of holdings of Treasurys and munici- palities and so on. Senator CORKER. Mr. Chairman, I thank you, and I know you have received some criticism over the housing white paper, and I know we had a brief conversation about it, and I know you shared that those were not your ideas necessarily. I do hope that in your core area, since the Fed has been pretty active in giving advice in outside their core areas, I would love to see a white paper on the effect of the financial regulation that we just passed on our coun- try. I do not know if that would be forthcoming, but I would just suggest, especially since it is in your core area, it would be very useful to us as we try to work through these details. Thank you for your testimony, and thank you, Mr. Chairman. Chairman JOHNSON. Senator Akaka. Senator AKAKA. Thank you, Mr. Chairman. Chairman Bernanke, this is a question which is a follow-up on your discussion with Chairman Johnson and Senator Crapo. In your testimony you note there has been some modestly encouraging data recently, including slightly better performance in the labor market, improved consumer sentiment, and some increases in man- ufacturing. But these signs of economic recovery are not necessarily reflected yet in the experiences of our workers and their families in the communities. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 21 Putting aside a crash in the euro zone, what possible setbacks concern you the most with respect to risks and our economic recov- ery? For instance, could action to cut critical investments too quick- ly send the economy back into a slowdown? Mr. BERNANKE. Well, let me just say first that one of the points that I talked about in my remarks was that there still is a little bit of a contradiction between the improvement in the labor market and the speed of the overall recovery in terms of growth. In par- ticular, I mentioned that income had been flat for consumers in 2011. The revised data from yesterday actually says it was a little bit better than flat but still less than 1 percent, so you have still got consumption spending growing relatively weakly. You have got the fiscal issues that are hanging over our heads. So in order to make this a really sustainable, strong recovery, we need to have both declines in unemployment and strong growth in demand in production, and I think that is something we have to watch very carefully. In terms of the risks to that, I do have to mention Europe be- cause I think that is important. Another is the oil prices. We have seen a number of movements up and down in energy prices. To some extent, a little bit of the movement in commodity prices is es- sentially inevitable because if the economy is growing and the world economy is growing, the demand for commodities goes up, and that is going to create some tendency toward higher commodity prices. But when you have shocks to commodity prices arising from geopolitical events and the like, those are unambiguously negative and are bad for both households and for the broader economy. Housing I think remains a very difficult area. We are hoping for price stabilization. We think once people have gotten a sense that the housing markets have stabilized, they will be much more will- ing to buy and that banks will be more willing to lend. But right now there is still uncertainty about where the housing market is going, which I think is troubling. And finally, I would mention fis- cal policy, which both in the short term, in terms of the uncertainty about where fiscal policy is going to go over the next year, and in the long term, in terms of whether or not Congress and the admin- istration will work together to have a sustainable fiscal path, I think both of those things are creating some uncertainty and con- cern that do pose some risks to the economy. So there are a number of different things, but overall, of course, there has been some good news, and, of course, that is welcome. Senator AKAKA. Thank you for that response. Chairman Bernanke, as you know, I am most concerned with the well-being of consumers. In the current economic climate, con- sumers are confronted with difficult financial decisions, and this is the case in Hawaii where many homeowners face possible fore- closure, and the average credit card debt of a resident is the second highest in the country. We know that by saving, individuals can help protect themselves during economic downturns and unforeseen life events. We also know that our slow economic recovery is partially due to low con- sumption or consumer spending. My question to you relates to the intersection of these two fac- tors. How can we continue our efforts to promote economic recovery VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 22 and at the same time encourage responsible consumer behavior and financial decision making? Mr. BERNANKE. Well, that is a very good question. Part of the problem now is that the demand, the total demand in the economy is not adequate to fully utilize the resources of the economy, and that is why we talk about the need for greater consumer spending and greater investment and so on. Of course, we want consumers to be responsible as well, and they have, in fact, raised their savings rates and have reduced their le- verage, and all that is positive. I think there are two answers to your question. One is that de- mand comes from places other than consumer spending. It can come from capital investment, for example; it can come from net exports. Those are some areas where unambiguously higher invest- ment creates more capital and more potential growth in the future. Greater exports reduces our trade deficit, increases our foreign earnings, makes us more competitive internationally. So those are alternatives to consumer spending to provide growth. But then there is also the bit of a paradox that consumer spend- ing collectively, if it generates more activity, more hiring, more wage income, actually can in the end lead to sounder consumer fi- nances than the alternative because if the economy is growing strongly and jobs are being created, income is being created, then consumers will actually be better off. So confidence is really important. If people are confident about their job prospects and about their income prospects, it can be a self-fulfilling prophecy as they go out and they become more con- fident in their purchasing habits. Of course, this all relates, as you have often mentioned, to finan- cial literacy and the ability to make good decisions. We obviously want people to make decisions that are appropriate for their own needs, for their stage in the life cycle, for their family responsibil- ities, for their retirement, and all those things. And that remains an important goal even, you know, as we worry about trying to get the economy back to full employment. Chairman JOHNSON. Senator DeMint. Senator AKAKA. Thank you very much, Mr. Chairman. Senator DEMINT. Thank you, Mr. Chairman. Mr. Chairman, thank you for being here. You have mentioned several times the need for us to have a plan for a sustainable fiscal policy. Would a plan that balanced our Federal budget within a 10- year window be what you consider a reasonable transition toward good fiscal policy? Mr. BERNANKE. I would go for—at a minimum I would aim for— in the next 10 to 15 years, I would aim for eliminating the so-called primary deficit, that is, everything except interest payments, be- cause once you eliminate the primary deficit so that current spend- ing and current revenues are equal, that means that the ratio of your debt to your GDP will stabilize. And then as you go beyond that, you start to bring the debt-to-GDP ratio down. You mentioned 10 years. The other thing I would say, as I men- tioned earlier, is, of course, that many of the things that are going to be problems are kicking in after 10 years, and so I hope Con- VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 23 gress will take, at least for planning purposes, a longer-term hori- zon than that. Senator DEMINT. In my conversations with some of your Gov- ernors and some of the central bankers around the world, there seems to be a broad consensus that there is not the political will here, Europe, and many other places to actually get control of fiscal policy, and that much of our monetary policy here and around the world is really driven by trying to clean up the mess that policy makers make. And you may not want to comment on that, but quantitative easing, for instance, is dealing with the tremendous we have created as policy makers, and what we see in Europe hap- pening today, again, dealing with debt but from a monetary policy rather than fiscal policy. My concern now—and I know you meet with central bankers all over the world regularly, and as I see what appears to be a coordi- nated increase in money supplies here, Europe, and other places, it may not be formal coordination, I do not know. But there ap- pears to be an effort to keep relative values of currencies the same as we increase our monetary supply, others are doing it. And I would just love to have some insight beyond just the individual policies here as to what degree you feel like you can be honest with us as the ones who primarily create the problems. Is it at least within the—is it true that a lot of monetary policy is now driven by irresponsible fiscal policy from policy makers? And is there an effort for central banks around the world to work together to deal with that? Mr. BERNANKE. I would say no to both questions. Our monetary policy is aimed at our dual mandate, which is maximum employ- ment and price stability. We are trying to set monetary policy at a setting that will help the economy recover in the context of price stability. I think it is interesting that other countries are following our basic approach. It is not because we have coordinated in any way. It is because they face similar situations—weak recoveries, low inflation, and the fact that interest rates are close to zero, and so some of these quantitative easing type policies are the main al- ternative once you have got interest rates close to zero. So, no, this is not an attempt to cover up or clean up fiscal policy. On the other hand, I think the concerns that people express both about the United States and other countries about the political will and the ability of the political system to deliver better fiscal results over the long term, I think that is an issue that a lot of people are concerned about. I have noted on previous occasions that the rea- son S&P downgraded U.S. Treasurys last August was not because of the size of the debt but because they took the view that our po- litical system was not adequately progressing on making long-term sustainable fiscal plans. I hope we can prove them wrong. I think that this January 1st event where so many things, if left unchanged, will be happening that would be I think on net contractionary, I hope that will be sort of a trigger point to sort of force Congress to say, well, how are we going to solve this problem? And so, of course, I realize how dif- ficult it is politically, but I encourage you to make every effort to help restore fiscal sustainability in the United States. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 24 Senator DEMINT. Well, my concern is that I really do believe ob- viously we would not have $16 trillion in debt going on 25 or what- ever the projections are if we had not been irresponsible as policy makers over many years. I am not blaming that on any President or party, but it is clearly a problem. But as has been pointed out by the Wall Street Journal today and in other articles in financial magazines, the loose monetary policy is compounding the potential problems in the future. And I think as Senator Shelby talked about, the need for transparency, the need to understand where we are headed with this is pretty important to us as policy makers, first for you to be brutally hon- est, and maybe even more than you have been today, that we are on an unsustainable path. It hurts me to hear you say in 10 or 20 years we need to bring it under control when the analysis I have seen of worldwide available credit suggests that a 5-year window may be tough for us on our current pace as far as borrowing the money. But we seem to have a compounding and growing problem and not a sense of urgency that one would expect given where we are from a political side and now a monetary system around the world that seems to be potentially making that much worse. I will just let you comment, and then I will yield back. Mr. BERNANKE. Well, I would only say that I do not mean that no actions should be taken until 10 or 20 years. I mean that the plan needs to be a long-run plan because our problems are long- run problems, and that looking only at 2013 is not going to be help- ful. We need to look at the whole horizon. Chairman JOHNSON. Senator Bennet. Senator BENNET. Thank you, Mr. Chairman. And thank you, Mr. Chairman, for being here today. I wanted to focus my questions on the economy with you since you actually know what you are talking about. But before I do that, I wanted to go back to an answer that you made earlier on interest rates. You had said that you thought the risk of default was not a serious one— obviously, it would be catastrophic if it happened— but that the risk that you are worrying about is interest rate risk for our financial institutions and economy. Could you talk a little bit more about that, what would cause that interest rate risk and what the effects would be of a more normalized interest rate than the one we have today? Mr. BERNANKE. Well—— Senator BENNET. Which is at a historic low, isn’t it? Mr. BERNANKE. Right. So both short-term and long-term interest rates are quite low. You know, our current expectation, as we have said in our statement, is that the short-run rate will stay low for a good bit more time. But eventually at some point, the economy will strengthen, inflation may begin to rise, and the Fed will have to begin to raise short-term interest rates. At the same time, stronger economic conditions here and globally will cause longer- term rates to begin to rise, and that is a good thing. That is a nor- mal, healthy thing as the economy returns to normal. But, of course, depending on how your portfolio is structured, you could have the risk of losing money on holdings of bonds. And we just want to make sure that banks understand their risks and that they VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 25 are well protected and hedged against whatever course interest rates might take in the future. I mean, eventually they will begin to rise. We just do not know when. Senator BENNET. Senator Akaka made the point earlier that we have seen some economic growth, but it has not yet hit home in many ways. I have a chart that is not useful for this because it is so small, but I will carve it in the air for you. The top line is GDP growth, and what we see is that our GDP is actually higher than it was before we went into this recession, which surprises a lot of people when they hear that our economic output is higher today than it was when the recession started. It has gone up since the early 1990s. Productivity has risen mightily over that same period of time because—think of our response to competition from abroad and the use of technology and then the recession itself, which drove the productivity index straight up because firms were trying to fig- ure out how to get through with fewer people. As you observed, median family income has actually fallen over the decade, and we are producing that economic output with 23 or 24 million people that are either unemployed or underemployed in this economy. So we are in a sense stuck with a gap of economic output and productivity here and wages and jobs here. As a learned economist, can you help me think about the kinds of things that would begin to lift that median income curve in the right direction, that job curve in the right direction? And I would encourage you to think broadly about that so education and immi- gration and whatever it is you think will—— Mr. BERNANKE. Well, sure—— Senator BENNET. ——because that, unlike the political stuff we are all talking about in Washington that actually does not make any sense to people at home, that is the issue that they are con- fronting, is what I just described. Mr. BERNANKE. Of course. Well, let us not belittle the impact of getting back to full employment. That would obviously be very helpful, and that is what the Fed is trying to do with our monetary policy. But more generally, there are a couple of interesting things. One is that the profit share of GDP is unusually high, the share of in- come going to wage earners is lower than normal, and that is a bit of a puzzle. It may have to do with globalization, it may have to do with the fact that a lot of profits are earned overseas rather than domestically and so on. So that is one question. But I think more generally, there is a whole raft of issues associ- ated with globalization, including trade competition, including the fact that low-skilled workers are now effectively competing with low-skilled workers around the world, advent of new technologies provides a lot of benefits to people with greater education and greater training and creates discrepancies between them and peo- ple with less training and education. So from that there are not a lot of good answers, but certainly the most basic thing is training and skills because those are highly rewarded in our society still, but the low-skilled workers are effec- tively competing with low-skilled workers globally, and it is very difficult for them to earn a high income. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 26 Senator BENNET. I am out of time, Mr. Chairman. I realize that. I just would say that the worst the unemployment rate got for peo- ple in this recession with a college degree was 4.5 percent, and there is a lot, I think, that we can learn from that. I will submit my other questions for the record. Thank you for being here today. Mr. BERNANKE. Thank you. Chairman JOHNSON. Senator Vitter. Senator VITTER. Thank you, Mr. Chairman. And thank you, Mr. Chairman, for being here. I am concerned about some of the negatives, which could clearly grow over time, about the zero interest rate policy. What would you consider the list of present or potential negatives? And how do you go about sort of monitoring those to always determine whether this continues to make sense in your mind? Mr. BERNANKE. Well, a number of issues have been raised. One that is often raised is the return to savers—with low interest rates, that we not penalize savers. We are aware of that. We take that into account in our discussions. But as I mentioned yesterday, of total household wealth, something only less than 10 percent, ac- cording to the Survey of Consumer Finances, is in fixed income in- struments like CDs or bonds and so on. Most household wealth is in other forms—equity, small business ownership, real estate, et cetera. And our efforts to strengthen the economy will increase the returns and value of those assets, and so on net our activities are raising household wealth overall even if they are reducing the in- terest rate you can receive on fixed income assets. And, of course, keeping inflation low also helps in that respect. The second issue that we hear a lot about is pension and insur- ance that low interest rates increase the contributions that those companies have to make. Again, we have had many conversations with those folks about these issues. I would say that it is a serious issue and one that we look at. There, again, are countervailing fac- tors. If you look, for example, at compensation to workers, which includes pension contributions, it remains quite low, like 2 percent a year growing. So these pension contributions are significant but not massive. And on the other side of the balance sheet, of course, pension funds and insurance companies have to invest in the econ- omy. And, once again, a stronger economy produces higher returns in equity markets, real estate markets, and the like. The third issue, which is very tricky, has to do with possibly cre- ating financial bubbles of various kinds. People have different views about that. Our view is basically that the first line of defense against bubbles should be what is called macroprudential super- vision. There should be supervisory approaches looking at what is happening in the system and making sure that financial institu- tions are as strong as possible through capital, for example, and we have greatly upgraded our ability to monitor the financial system since the crisis, and we are both trying to identify potential prob- lems but also making sure the institutions are sufficiently strong that if there is a problem, they will be able to withstand it. If those things do not seem to be working, then we are prepared, I think, to take that into account in monetary policy. But those are some issues, and we are aware of them. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 27 Senator VITTER. One thing that might have been first on my list is commodity prices, a weak dollar pushing investment toward commodities, pushing up commodity prices. And, of course, now the most obvious example of that is gasoline prices. Briefly, how would you analyze that? And when does that start becoming such a negative that you rethink this? Mr. BERNANKE. So I think there are two ways in which low inter- est rate policies realistically would affect commodity prices. First would be through weakening the dollar, but the dollar has been pretty stable. It really has not moved much since, for example, No- vember 2010 when we introduced QE2. The second is by creating growth both here and perhaps to some extent internationally. Higher growth increases demand for commodities. That raises prices. That is kind of inevitable. If you want to have a growing economy, that is going to put more pressure on oil prices and so on. So those two things I think have not been a big problem. I think particularly if you look at commodities, the one commodity that has been particularly troublesome has been oil, and currently, I mean, it is quite obvious that there are a number of factors affecting the supply of oil, including concerns about Iran and supply issues in Africa and so on that are contributing to that increase. Senator VITTER. Most of the quantitative easing announcements have more or less coincided with increases in oil prices. Are you saying that is largely a coincidence or not? Mr. BERNANKE. No, it is not entirely a coincidence. First of all, if you look over longer periods, it is not quite as close a correlation as you might think. But I think part of the reason, again, that there is a coincidence is because to the extent that monetary policy is structured in a way to increase growth expectations, that feeds into commodity prices through the demand channel. So that is one link that I do agree exists. Senator VITTER. And if I can just wrap up, Mr. Chairman, at what point, particularly with regard to oil, at what point would that factor driving up prices be a sufficient negative in terms of economic growth that you would pause in terms of this 2014 zero interest rate policy? Mr. BERNANKE. Well, we will always keep looking at it, but our analysis suggests that the other benefits of low interest rates through a whole range of asset prices, through increased consump- tion and investment spending and so on, outweighs reasonable esti- mates of the effects of that on commodity prices in terms of growth. And, again, I think the reason we have seen these sharp move- ments has more to do with the international situation than with U.S. monetary policy. But, obviously, it is a negative and some- thing we want to keep monitoring. Senator VITTER. Thank you, Mr. Chairman. Chairman JOHNSON. Chairman Bernanke, I would like to thank you for your testimony today. There is a vote going on which re- quires my attention, and I will turn over the gavel to Senator Schumer for a few last questions. Senator SCHUMER [presiding]. Well, I would like to recognize Senator Schumer to ask 5 minutes of questions. Thank you, Mr. Chairman. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 28 The first question is about the highway bill, the surface transpor- tation bill that is on the floor. It will, according to its sponsors, cre- ate or save 2 million jobs, has broad bipartisan support. APTA, the Public Transportation Association, estimates that every $1 billion of Federal investments in highways creates 36,000 jobs. What impact would passing long-term transportation reauthor- ization legislation have on the pace of economic growth? Mr. BERNANKE. I do not know enough about the details of that bill to give you any kind of estimate. I just would like to make one observation, which is the jobs part is important. That is part of helping the recovery. But I think when you think about long-term infrastructure investments, you also want to think about whether these are good investments in terms of the returns. President Eisenhower’s investment, as you know, in the inter- state system produced tremendous dividends in terms of reduced transportation costs and integration of our economy. So I would urge you—and I know you are doing this—as you approve projects that you take very seriously that you want to do the ones that are going to be more productive. Senator SCHUMER. That goes to the quality of the project, but at this point in time, that kind of stimulus in a sense would serve the economy well and would be needed. Mr. BERNANKE. Well, there are different ways to provide stim- ulus—— Senator SCHUMER. Assume it would be spent decently well. Mr. BERNANKE. Well, Senator, you know, there are different ways to provide stimulus. Infrastructure, if it is well designed and has a good return, I think is often a good approach. But you under- stand that I do not want to—— Senator SCHUMER. Endorse a specific bill. Mr. BERNANKE. ——endorse a specific bill. Senator SCHUMER. No, I did not ask you that because you made the caveat it may not have good projects. But I am just making the point that at this time when you have said the economy is moving forward but at a slow pace, taking away infrastructure money might hurt the economy, adding infrastructure money would cer- tainly help the economy. And, of course, you want to do it as well as possible so there are other long-term benefits. Is that a fair re- capitulation? Mr. BERNANKE. Yes, although, again—— Senator SCHUMER. Say no more. Mr. BERNANKE. ——there are various alternatives. Senator SCHUMER. OK. Yes, but those alternatives are not—this is a yes-or-no situation for us now. Money market funds. We all re- member the dark days of the fall of 2008, the panic that ensued when a large money market fund broke the buck and there was a run on the funds. The SEC instituted some reforms, as you know, in 2010 to address the problems that led to the run in 2008. However, Chairman Schapiro and FSOC, you remember, have made it clear they believe more should be done, so in their recent reports they have discussed a few options—this was in the news- paper—including a requirement that would lock up a portion of in- vestors’ money and a proposal to require funds to abandon the sta- ble $1-a-share net asset value. The proposals have the potential to VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 29 fundamentally change the nature of the product. Some would say it would drive it out of existence. We would not have money market funds. Obviously, they play an important role in short-term financ- ing of many different types of businesses. What are the risks to the economy and financial system if we were to fundamentally alter the nature of the money market funds? What do you think of the two different proposals made to strength- en them? I am particularly interested—I have heard that if inves- tors have to keep 3 percent or a certain percentage aside, you know, and cannot pull it out right away, it is not worth an invest- ment to them anymore—it is not worth investing in a money mar- ket fund to them anymore. Mr. BERNANKE. Well, first, as you pointed out, the SEC has al- ready done some constructive things in terms of, for example, im- proving liquidity requirements. I think, though, the Federal Re- serve in general and I personally would have to agree that there are still some risks in the money market mutual funds. In par- ticular, they still could be subject to runs, and one of the implica- tions of Dodd-Frank is that some of the tools that we used in 2008 to arrest the run on the funds are no longer available. As you know, the Treasury can no longer provide the ad hoc insurance it provided. The Fed’s ability to lend to money market mutual funds is greatly restricted because of the fact that we would have to take a hair cut on their assets, and that is not going to work with their economics. So we support the SEC’s attempts to look at alternatives, and you mentioned some different things, but I believe their idea is to put out a number of alternative strategies. One would be to go away from the fixed net asset value approach. I think that the in- dustry will reject that pretty categorically, and so then the question is what else could be done. One approach would be essentially to create some more capital. They have very limited capital at this point, and there might be ways maybe over time to build up the capital base. So that is one possible approach. And then either complementing that or as a sep- arate approach would be something that involved not allowing the investors to draw out 100 percent immediately. Senator SCHUMER. Right. Mr. BERNANKE. If you think about that, what that really does is that it makes it unattractive to be the first person to be to with- draw your money and, therefore, it reduces the risk of runs consid- erably. It also has an investor protection benefit, which is that if you are ‘‘a slow investor’’ and you are not monitoring the situation moment by moment and so you are the last guy to take your money out, you are still protected because there is this 3 percent, or what- ever—— Senator SCHUMER. But I have heard from some investors and from some funds that, given the low margin that money market funds pay, it would just end the business more or less. Or certainly I have heard from investors that they would not put money in if they knew they had to keep 2 or 3 percent in there. Does that worry you? Mr. BERNANKE. Well, it is certainly a difficult time because inter- est rates are very low and, therefore, their attractiveness is less. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 30 I do not know. I think you would have to have some kind of discus- sion here because part of the reason that investors invest in money market mutual funds is because they think they are absolutely 100 percent safe and there is no way to lose money. And that is not true. Senator SCHUMER. We learned that the hard way. Mr. BERNANKE. If that is not true, then we have to make sure that investors are aware and that we take whatever actions are necessary to protect their investment. Senator SCHUMER. Do you think money market funds play a use- ful role, though, in the economy and we should try to keep them going? Mr. BERNANKE. Well, generally speaking, they do, and they are a useful source of short-run money. And, again, please do not overread this, but Europe does not have any, and they have a fi- nancial system—there are different ways of structuring—— Senator SCHUMER. And they are in great shape. Mr. BERNANKE. They are in great shape, yes. There are many ways to structure your financial system, but, again, I envision that money market mutual funds will be part of the future of the U.S. financial system. Senator SCHUMER. Thank you, Mr. Chairman. I appreciate it. Senator REED [presiding]. There are no more questions. Thank you, Mr. Chairman. On behalf of the Chairman, unless I am in- structed otherwise, I will adjourn the hearing. Mr. BERNANKE. Thank you. [Whereupon, at 11:45 a.m., the hearing was adjourned.] [Prepared statements, responses to written questions, and addi- tional material supplied for the record follow:] VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 31 PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON Today I welcome Chairman Bernanke back to this Committee to deliver the Fed- eral Reserve’s Semiannual Monetary Report to Congress. There are reasons to be optimistic about our Nation’s economic recovery. The U.S. economy has expanded for 10 straight quarters, and private sector employment has increased for 23 straight months. Private employers added 2.1 million jobs last year, the most since 2005. But there are also reasons to be concerned, such as the European debt crisis and the continuing drag of the housing market on the broader economy. This Committee has paid close attention to these two issues and held numerous hearings. While I remain hopeful that we are moving in the right direction, we must continue to mon- itor the situation in Europe closely. On housing, there is a variety of policy pro- posals—some that do not require an act of Congress—that should be considered to improve the housing market. I want to thank Governor Duke for her thoughtful tes- timony on Tuesday before this Committee on the Federal Reserve’s white paper on options to improve the housing market. An additional challenge, the sharp increase in oil prices, has the potential to im- pede the economic recovery. Americans continue to grapple with higher fuel costs when they fill up their cars or heat their homes. It is important that oil markets are closely monitored for signs of manipulation or supply disruption, and I look for- ward to hearing the Fed’s views on how rising oil prices may affect consumer spend- ing and economic growth. I appreciate all the Fed has done to ensure continued economic recovery. Chair- man Bernanke, I look forward to hearing more from you on the Fed’s recent actions and possible future actions to protect our economy. Congress also has an important role in making sure the economy continues to grow, and more Americans continue to find the jobs they need. This week, the full Senate continues to consider the Transportation bill. This bill includes the bipar- tisan effort of this Committee to update our Nation’s public transit infrastructure and create jobs. I am also hopeful that the Senate can find consensus on capital for- mation initiatives, the topic of another hearing next week before this Committee, to promote job creation while protecting investors. With so many Americans in search of work, it is not too late for bipartisan action to create jobs and promote sustainable growth. I look forward to your views, Chair- man Bernanke, on these and other steps Congress can take to improve our Nation’s economy. PREPARED STATEMENT OF BEN S. BERNANKE CHAIRMAN, BOARDOFGOVERNORSOFTHEFEDERALRESERVESYSTEM MARCH1, 2012 Chairman Johnson, Ranking Member Shelby, and other Members of the Com- mittee, I am pleased to present the Federal Reserve’s semiannual Monetary Policy Report to the Congress. I will begin with a discussion of current economic conditions and the outlook and then turn to monetary policy. The Economic Outlook The recovery of the U.S. economy continues, but the pace of expansion has been uneven and modest by historical standards. After minimal gains in the first half of last year, real gross domestic product (GDP) increased at a 21⁄4 percent annual rate in the second half.1 The limited information available for 2012 is consistent with growth proceeding, in coming quarters, at a pace close to or somewhat above the pace that was registered during the second half of last year. We have seen some positive developments in the labor market. Private payroll employment has increased by 165,000 jobs per month on average since the middle of last year, and nearly 260,000 new private-sector jobs were added in January. The job gains in recent months have been relatively widespread across industries. In the public sector, by contrast, layoffs by State and local governments have continued. The unemployment rate hovered around 9 percent for much of last year but has moved down appreciably since September, reaching 8.3 percent in January. New claims for unemployment insurance benefits have also moderated. 1Data for the fourth quarter of 2011 from the national income and product accounts reflect the advance estimate released on January 27, 2012. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00035 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 32 The decline in the unemployment rate over the past year has been somewhat more rapid than might have been expected, given that the economy appears to have been growing during that time frame at or below its longer-term trend; continued improvement in the job market is likely to require stronger growth in final demand and production. Notwithstanding the better recent data, the job market remains far from normal: The unemployment rate remains elevated, long-term unemployment is still near record levels, and the number of persons working part time for economic reasons is very high.2 Household spending advanced moderately in the second half of last year, boosted by a fourth-quarter surge in motor vehicle purchases that was facilitated by an eas- ing of constraints on supply related to the earthquake in Japan. However, the fun- damentals that support spending continue to be weak: Real household income and wealth were flat in 2011, and access to credit remained restricted for many potential borrowers. Consumer sentiment, which dropped sharply last summer, has since re- bounded but remains relatively low. In the housing sector, affordability has increased dramatically as a result of the decline in house prices and historically low interest rates on conventional mort- gages. Unfortunately, many potential buyers lack the down payment and credit his- tory required to qualify for loans; others are reluctant to buy a house now because of concerns about their income, employment prospects, and the future path of home prices. On the supply side of the market, about 30 percent of recent home sales have consisted of foreclosed or distressed properties, and home vacancy rates remain high, putting downward pressure on house prices. More-positive signs include a pickup in construction in the multifamily sector and recent increases in homebuilder sentiment. Manufacturing production has increased 15 percent since the trough of the reces- sion and has posted solid gains since the middle of last year, supported by the recov- ery in motor vehicle supply chains and ongoing increases in business investment and exports. Real business spending for equipment and software rose at an annual rate of about 12 percent over the second half of 2011, a bit faster than in the first half of the year. But real export growth, while remaining solid, slowed somewhat over the same period as foreign economic activity decelerated, particularly in Eu- rope. The members of the Board and the presidents of the Federal Reserve Banks re- cently projected that economic activity in 2012 will expand at or somewhat above the pace registered in the second half of last year. Specifically, their projections for growth in real GDP this year, provided in conjunction with the January meeting of the Federal Open Market Committee (FOMC), have a central tendency of 2.2 to 2.7 percent.3 These forecasts were considerably lower than the projections they made last June.4 A number of factors have played a role in this reassessment. First, the annual revisions to the national income and product accounts released last summer indicated that the recovery had been somewhat slower than previously estimated. In addition, fiscal and financial strains in Europe have weighed on financial condi- tions and global economic growth, and problems in U.S. housing and mortgage mar- kets have continued to hold down not only construction and related industries, but also household wealth and confidence. Looking beyond 2012, FOMC participants ex- pect that economic activity will pick up gradually as these headwinds fade, sup- ported by a continuation of the highly accommodative stance for monetary policy. With output growth in 2012 projected to remain close to its longer-run trend, par- ticipants did not anticipate further substantial declines in the unemployment rate over the course of this year. Looking beyond this year, FOMC participants expect the unemployment rate to continue to edge down only slowly toward levels con- sistent with the Committee’s statutory mandate. In light of the somewhat different signals received recently from the labor market than from indicators of final de- mand and production, however, it will be especially important to evaluate incoming information to assess the underlying pace of economic recovery. 2In January, 51⁄2 million persons among those counted as unemployed—about 43 percent of the total—had been out of work for more than 6 months, and 81⁄4million persons were working part time for economic reasons. 3See, table 1, ‘‘Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents, January 2012’’, of the Summary of Economic Projections available at Board of Governors of the Federal Reserve System (2012), ‘‘Federal Reserve Board and Federal Open Market Committee Release Economic Projections From the January 24–25 FOMC Meeting’’, press release, January 25, www.federalreserve.gov/newsevents/press/monetary/20120125b.htm; also available in Part 4 of the February 2012 Monetary Policy Report to the Congress. 4Ben S. Bernanke (2011), ‘‘Semiannual Monetary Policy Report to the Congress’’, statement before the Committee on Financial Services, U.S. House of Representatives, July 13, www.federalreserve.gov/newsevents/testimony/bernanke20110713a.htm. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00036 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 33 At our January meeting, participants agreed that strains in global financial mar- kets posed significant downside risks to the economic outlook. Investors’ concerns about fiscal deficits and the levels of Government debt in a number of European countries have led to substantial increases in sovereign borrowing costs, stresses in the European banking system, and associated reductions in the availability of credit and economic activity in the euro area. To help prevent strains in Europe from spill- ing over to the U.S. economy, the Federal Reserve in November agreed to extend and to modify the terms of its swap lines with other major central banks, and it continues to monitor the European exposures of U.S. financial institutions. A number of constructive policy actions have been taken of late in Europe, includ- ing the European Central Bank’s program to extend 3-year collateralized loans to European financial institutions. Most recently, European policy makers agreed on a new package of measures for Greece, which combines additional official-sector loans with a sizable reduction of Greek debt held by the private sector. However, critical fiscal and financial challenges remain for the euro zone, the resolution of which will require concerted action on the part of European authorities. Further steps will also be required to boost growth and competitiveness in a number of coun- tries. We are in frequent contact with our counterparts in Europe and will continue to follow the situation closely. As I discussed in my July testimony, inflation picked up during the early part of 2011.5A surge in the prices of oil and other commodities, along with supply disrup- tions associated with the disaster in Japan that put upward pressure on motor vehi- cle prices, pushed overall inflation to an annual rate of more than 3 percent over the first half of last year.6 As we had expected, however, these factors proved tran- sitory, and inflation moderated to an annual rate of 11⁄2 percent during the second half of the year—close to its average pace in the preceding 2 years. In the projec- tions made in January, the Committee anticipated that, over coming quarters, infla- tion will run at or below the 2 percent level we judge most consistent with our stat- utory mandate. Specifically, the central tendency of participants’ forecasts for infla- tion in 2012 ranged from 1.4 to 1.8 percent, about unchanged from the projections made last June.7 Looking farther ahead, participants expected the subdued level of inflation to persist beyond this year. Since these projections were made, gasoline prices have moved up, primarily reflecting higher global oil prices—a development that is likely to push up inflation temporarily while reducing consumers’ purchasing power. We will continue to monitor energy markets carefully. Longer-term inflation expectations, as measured by surveys and financial market indicators, appear con- sistent with the view that inflation will remain subdued. Monetary Policy Against this backdrop of restrained growth, persistent downside risks to the out- look for real activity, and moderating inflation, the Committee took several steps to provide additional monetary accommodation during the second half of 2011 and early 2012. These steps included changes to the forward rate guidance included in the Committee’s postmeeting statements and adjustments to the Federal Reserve’s holdings of Treasury and agency securities. The target range for the Federal funds rate remains at 0 to 1⁄4 percent, and the forward guidance language in the FOMC policy statement provides an indication of how long the Committee expects that target range to be appropriate. In August, the Committee clarified the forward guidance language, noting that economic condi- tions—including low rates of resource utilization and a subdued outlook for inflation over the medium run—were likely to warrant exceptionally low levels for the Fed- eral funds rate at least through the middle of 2013. By providing a longer time hori- zon than had previously been expected by the public, the statement tended to put downward pressure on longer-term interest rates. At the January 2012 FOMC meet- ing, the Committee amended the forward guidance further, extending the horizon over which it expects economic conditions to warrant exceptionally low levels of the Federal funds rate to at least through late 2014. In addition to the adjustments made to the forward guidance, the Committee modified its policies regarding the Federal Reserve’s holdings of securities. In Sep- tember, the Committee put in place a maturity extension program that combines purchases of longer-term Treasury securities with sales of shorter-term Treasury se- curities. The objective of this program is to lengthen the average maturity of our securities holdings without generating a significant change in the size of our balance 5Bernanke, ‘‘Semiannual Monetary Policy Report to the Congress’’ (see, n. 4). 6Inflation is measured using the price index for personal consumption expenditures. 7See, table 1 available at Board of Governors, ‘‘Federal Reserve Board and Federal Open Mar- ket Committee Release Economic Projections’’ (see, n. 3). VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00037 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 34 sheet. Removing longer-term securities from the market should put downward pres- sure on longer-term interest rates and help make financial market conditions more supportive of economic growth than they otherwise would have been. To help sup- port conditions in mortgage markets, the Committee also decided at its September meeting to reinvest principal received from its holdings of agency debt and agency mortgage-backed securities (MBS) in agency MBS, rather than continuing to rein- vest those proceeds in longer-term Treasury securities as had been the practice since August 2010. The Committee reviews the size and composition of its securities holdings regularly and is prepared to adjust those holdings as appropriate to pro- mote a stronger economic recovery in the context of price stability. Before concluding, I would like to say a few words about the statement of longer- run goals and policy strategy that the FOMC issued at the conclusion of its January meeting. The statement reaffirms our commitment to our statutory objectives, given to us by the Congress, of price stability and maximum employment. Its purpose is to provide additional transparency and increase the effectiveness of monetary policy. The statement does not imply a change in how the Committee conducts policy. Transparency is enhanced by providing greater specificity about our objectives. Because the inflation rate over the longer run is determined primarily by monetary policy, it is feasible and appropriate for the Committee to set a numerical goal for that key variable. The FOMC judges that an inflation 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 its statutory mandate. While maximum employment stands on an equal footing with price stability as an objective of mone- tary policy, the maximum level of employment in an economy is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market; it is therefore not feasible for any central bank to specify a fixed goal for the longer- run level of employment. However, the Committee can estimate the level of max- imum employment and use that estimate to inform policy decisions. In our most re- cent projections in January, for example, FOMC participants’ estimates of the longer-run, normal rate of unemployment had a central tendency of 5.2 to 6.0 per- cent.8 As I noted a moment ago, the level of maximum employment in an economy is subject to change; for instance, it can be affected by shifts in the structure of the economy and by a range of economic policies. If at some stage the Committee esti- mated that the maximum level of employment had increased, for example, we would adjust monetary policy accordingly. The dual objectives of price stability and maximum employment are generally complementary. Indeed, at present, with the unemployment rate elevated and the inflation outlook subdued, the Committee judges that sustaining a highly accom- modative stance for monetary policy is consistent with promoting both objectives. However, in cases where these objectives are not complementary, the Committee fol- lows a balanced approach in promoting them, taking into account the magnitudes of the deviations of inflation and employment from levels judged to be consistent with the dual mandate, as well as the potentially different time horizons over which employment and inflation are projected to return to such levels. Thank you. I would be pleased to take your questions. 8See, table 1 available at Board of Governors, ‘‘Federal Reserve Board and Federal Open Mar- ket Committee Release Economic Projections’’ (see, n. 3). VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00038 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 35 RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON FROM BEN S. BERNANKE Q.1. Before the House Financial Services Committee on February 29th, in a response to Representative Velazquez, you said that ‘‘There are some reasons why lending has fallen, which no doubt will improve over time. But I think it’s still the case that we’re a little bit too far on this side of the—the pendulum has swung a lit- tle bit too far.’’ To strengthen the economic recovery, I think it is important to find the right balance between safe and sound lending and making loans to credit worthy borrowers. What steps has the Fed taken to ensure the pendulum is swinging in the right direc- tion? Is there anything else the Fed can do? A.1. A critically important step taken by the Federal Reserve to support the economic recovery and improve the pace of lending has been to ease the stance of monetary policy. The easing has taken three main forms: First, we aggressively reduced the interest rate that we traditionally have relied on as our main policy tool. Since late 2008, that rate—known as the Federal funds rate—has been essentially at its zero lower bound. Second, we have provided par- ticipants in financial markets much greater clarity about where we see the Federal funds going in the future. In the statement re- leased after its September meeting, the Federal Open Market Com- mittee stated that ‘‘exceptionally low levels for the Federal funds rate are likely to be warranted at least through mid-2015.’’ Third, we have purchased longer-term Treasury and agency securities, with the goal of bringing down longer-term interest rates and im- proving conditions in markets in which many households and busi- nesses borrow, including mortgage markets. In our judgment, these steps have caused financial and economic conditions to be much better than they otherwise would have been. The Federal Reserve has also taken several actions using its su- pervisory authority to promote lending to creditworthy households and businesses: • In conjunction with other Federal banking regulators, we issued interagency policy statements to reinforce our position that, while maintaining appropriately prudent standards, lend- ers should do all they can to meet the legitimate needs of cred- itworthy borrowers (Interagency Statement on Meeting the Needs of Creditworthy Borrowers, November 12, 2008; Inter- agency Statement on Meeting the Credit Needs of Credit- worthy Small Business Borrowers, February 5, 2010). We also issued guidance that encourages banks to work constructively with borrowers experiencing financial distress and provides specific examples of ways in which banks can prudently re- structure commercial real estate transactions to the benefit of both banks and their borrowers (Supervision and Regulation Letter 09-4, ‘‘Prudent Commercial Real Estate Loan Work- outs,’’ October 30, 2009). • To support these statements, we have held training sessions for lenders in order to promote awareness about both the credit environment and available lending guidance and resources (Addressing the Financing Needs of Small Businesses, July 12, 2010). And we have continued to train bank examiners to use VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00039 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 36 a balanced approach to reviewing banks’ credit policies and practices with respect to lending. • Along with the other Federal banking agencies, the Federal Reserve assisted the Treasury Department in implementing its Small Business Lending Fund program (SBLF), which was es- tablished by the Small Business Jobs Act of 2010. The SBLF is intended to facilitate new lending to creditworthy small business borrowers by providing affordable capital support to community banks. • We have also looked into specific concerns raised about the ex- amination process and its effect on banks’ willingness to lend. For example, during 2011, we reviewed commercial real estate loan classification practices to assess whether examiners were properly implementing the interagency policy statement on workouts of commercial real estate loans. We analyzed docu- mentation for more than 300 loans with identified weaknesses in six Federal Reserve Districts. We found that Federal Re- serve examiners were appropriately implementing the guid- ance and were consistently taking a balanced approach in de- termining loan classifications. Moreover, the documentation we reviewed indicated that examiners were carefully considering the full range of information provided by bankers, including relevant mitigating factors, in determining the regulatory treatment for the loans. More recently, we investigated reports from some banks that examiners were inappropriately criti- cizing performing commercial loans. We found no evidence that Federal Reserve examiners were deviating from well-estab- lished supervisory practices and rules for classifying commer- cial loans. • During 2012, we issued guidance to examiners stressing the importance of promptly upgrading a bank’s supervisory rating when warranted by a sustainable improvement in its condition and risk management (Supervision and Regulation Letter 12- 4, ‘‘Upgrades of Supervisory Ratings for Banking Organizations with $10 Billion or Less in Total Assets,’’ March 1, 2012); Some analysis has indicated that, all else being equal, banks with lower supervisory ratings tend to lend less; prompt upgrades by supervisors when such upgrades are appropriate may thus ease an unnecessary constraint on lending. The Federal Reserve continues to evaluate options to improve credit conditions and is committed to taking additional steps as needed to facilitate a balanced lending climate that ensures access to loans for credit worthy borrowers. Q.2. I have heard some concerns about the liquidity coverage ratios promulgated under the Basel III Committee and specifically the ex- clusion of agency debt from Level 1 assets. Some suggest that this might encourage U.S. financial institutions to bulk-up on Treas- uries and cash. Also, there are concerns that small financial insti- tutions will have to hold and buy Treasuries at much higher levels than they currently do, further impacting their ability to lend. What do you think about these concerns? And would this exclusion put U.S. institutions at a disadvantage to their European counter- parts? VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00040 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 37 A.2. The Board, in conjunction with the other U.S. Federal banking agencies, anticipates undertaking a domestic rulemaking in the United States based on the international liquidity standards estab- lished by the Basel Committee on Banking Supervision (BCBS) in 2010 (Basel III liquidity framework). The Basel III liquidity frame- work, like BCBS capital standards, applies to ‘‘internationally ac- tive’’ institutions. In the U.S., these are banking organizations with $250 billion or more in consolidated assets or $10 billion or more in foreign exposure. The Board has not determined that it is appro- priate to apply the Basel III liquidity framework to community banking organizations. The Board, along with the other U.S. Federal banking agencies, carefully considers the appropriate scope of application when im- plementing any Basel standard or other prudential standard in the United States, including the impact of such standard on institu- tions of various sizes and complexity. In addition, the particular characteristics of U.S. markets and the U.S. banking system and the impact of new prudential standards on relevant markets, in- cluding competitive factors, are important concerns the Board takes into account when developing a rulemaking. In this respect, the Board would carefully consider the appropriate categorization of as- sets when implementing the Basel III liquidity framework. Any proposal the Board puts forth to implement the Basel III li- quidity standards would be subject to a notice and comment proc- ess. We will carefully consider your comments and any others we receive regarding these proposals. Q.3. As regulators implement the Wall Street Reform Act—which I believe is critical to returning our economy to sustainable growth—I’ve heard a wide range of concerns about the proposed Volcker Rule. Specifically, once the rule is finalized, which agency will take the lead to interpret, supervise, and ultimately enforce the final rule? A.3. Section 619(b)(2) of the Dodd-Frank Act itself divides author- ity for developing and adopting regulations to implement its prohi- bitions and restrictions between the Federal Reserve, the OCC, FDIC, SEC, and CFTC based on the type of entities for which each agency is explicitly charged or is the primary financial regulatory agency. The statute also requires these agencies, in developing and issuing implementing rules, to consult and coordinate with each other for the purposes of assuring that such rules are comparable and to provide for consistent application and implementation. Under the statutory framework, the CFTC is the primary Federal regulatory agency with respect to a swap dealer and the SEC is the primary financial regulatory agency with respect to a security- based swap dealer; the Federal Reserve is explicitly charged with issuing regulations with respect to companies that control an in- sured depository institution, including bank holding companies. The OCC, Federal Reserve, and FDIC must jointly issue rules to implement section 619 with respect to insured depository institu- tions. To enhance uniformity in both rules that implement section 619 and administration of the requirements of section 619, the Federal Reserve, OCC, FDIC, SEC, and CFTC have been regularly con- VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00041 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 38 sulting with each other in the development of rules and policies that implement section 619. The rule proposed by the agencies to implement section 619 contemplates that firms will develop and adopt a single, enterprise-wide compliance program and that the agencies would strive for uniform enforcement of section 619. RESPONSES TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM BEN S. BERNANKE Q.1. There has been some speculation in the press about the Fed- eral Reserve and OCC’s thoughts on whether borrowers should be required to waive their legal rights as a condition of compensation under the foreclosure review being conducted under the consent or- ders. Does the Federal Reserve agree that homeowners should not be required to waive their legal rights in order to receive relief under the consent order process? Does the OCC agree with you on this issue? A.1. The Board and OCC publicly stated their position on waivers in guidance issued by the agencies on June 21, 2012. In that guid- ance, the agencies stated that servicers may not ask borrowers to release any claims in order to receive remediation payments under the consent orders issued by the agencies. The guidance can be found on the Board’s Web site at http://www.federalreserve.gov/ newsevents/press/bcreg/bcreg20 120621b1.pdf, item 34. Q.2. During the past year or so, while the private sector has added about 2 million jobs, state and local governments continue to shed jobs. One estimate says that there have been 500,000 public sector job losses since the start of the recession. First, Chairman Bernanke, are you concerned about the level of public sector job losses, and can you comment on their effect on our economic recovery? Do you see a continued loss of public sector jobs to be a downside risk in our economic recovery? From the Federal fiscal policy perspective, is there anything Con- gress can be doing to mitigate against these public sector job losses? A.2. The recent recession and the relatively sluggish pace of the subsequent recovery have placed significant fiscal strains on state and local governments. State and local tax revenues declined in the wake of the recession, and revenue gains since then have been rel- atively moderate, reflecting the slow recovery. As a result, state and local government spending has been under intense pressure. In particular, State and local governments have reduced the number of their employees by about 500,000 since the beginning of the re- cession, which represents 21⁄ 2 percent of their workforce. (By com- parison, private-sector employment remains around 4 million- or 33⁄ 4 percent-below its level at the start of the recession, even though there have been private job gains since early 2010.) The de- cline in state and local employment has contributed importantly to the overall contraction in purchases of goods and services by these governments over the past 21⁄ 2 years, which has been a notable headwind for the economy as a whole. For example, the decline in inflation-adjusted state and local purchases subtracted 1⁄ 4 percent- VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00042 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 39 age point, on average, from the rate of real GDP growth over the past four quarters. As the pace of the economic recovery picks up and state and local finances continue to improve, net hiring by these governments is anticipated to eventually turn positive. The most helpful thing that the Congress could do to improve the fiscal conditions of State and local governments would be to help ensure that the economic recovery becomes stronger. As I have stated on many occasions, the primary task for Federal fiscal pol- icymakers should be to put in place a credible medium-term budget plan that would put fiscal policy on a sustainable trajectory while also avoiding undue risk to the pace of the recovery in the near term. Doing so earlier rather than later would assist the current recovery by reducing uncertainty, holding down long-term interest rates, and maintaining the U.S. government’s credibility in finan- cial markets. Q.3. Since your last testimony on the economy, oil prices have spiked, rising about 15 percent. I’m curious to probe what you think the causes are of this in- crease in oil prices. To what extent are the price increases due to tensions with Iran or instability in Europe? And to what extent are prices rising simply because people hope that the economy is recov- ering, and therefore oil demand might increase? Finally, to what extent do speculators continue to drive up the price of oil? Does the increase in oil prices at all change the Fed’s view that inflation will remain at or below your 2 percent goal over the me- dium term? A.3. Oil prices have been volatile since the beginning of the year with the spot price of Brent crude oil, a widely regarded bench- mark for global oil prices, exhibiting a long swing up over the first 3 months of the year only to fall back sharply moving into the early summer. In recent weeks, oil prices have turned up once again and have recently returned to a level close to that which prevailed late last year. Along with other developments, we think that both geo- political risk and uncertainty regarding the prospects for global growth—owing, in part, to developments in Europe—likely played a significant role in shaping oil price dynamics over this period. The Brent spot price averaged just under $110 per barrel in De- cember of last year, supported by the loss of a significant amount of production due to the civil war in Libya. Rising geopolitical ten- sions stemming from the announcement of a new round of sanc- tions on Iran pushed oil prices steadily higher over the first three months of this year, with the spot price of Brent rising to an aver- age of just under $125 per barrel in March. However, beginning in late March the intensification of the European debt crisis as well as data pointing to a slowdown in growth in both China and the United States began to raise concerns regarding the strength of global growth. Moreover, geopolitical tensions eased owing to in- creased diplomacy with Iran, while near-record high production from Saudi Arabia helped to assuage concerns regarding the ability of producers to offset any Iranian production lost as a result of the sanctions. Spot Brent prices subsequently declined over the next 3 months to touch just over $95 per barrel in June. Tensions with Iran have ratcheted up in recent weeks, and the geopolitical risk VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00043 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 40 premium appears to have pushed spot Brent prices back up to the $110 per barrel range that prevailed late last year. There is little compelling evidence to support the claim that spec- ulators were a significant factor in driving up the oil price early this year. If speculation drove oil prices well above levels consistent with physical supply and demand, then we would have expected in- ventories to rise as high prices both encouraged additional produc- tion and, at the same time, discouraged consumption. In fact, avail- able measures of crude oil inventories were low relative to historic norms earlier this year and remained at relatively low levels until only recently. This was particularly true in both Europe and Asia, where crude oil inventories only slowly recovered from the loss of Libyan oil production last summer. In contrast, crude oil inven- tories have been elevated in the United States, particularly in Cushing Oklahoma, the delivery point for the benchmark West Texas Intermediate (WTI) contract. However, rather than specula- tion the buildup of inventories at Cushing likely reflects a rapid in- crease in crude oil supply in the Midwest, particularly from North Dakota, and the lack of sufficient infrastructure to integrate the re- gion with the GUlf Coast and global markets. A consequence of the increase in inventories in the Midwest has been the emergence of a large price discount for WTI relative to similar grades of crude oil. The recent run up in oil prices is likely to be largely temporary. This view is supported by the oil futures curves, which are cur- rently downward sloping, suggesting that financial market partici- pants expect oil prices to decline. To the degree that an increase in oil prices is temporary in nature, it has a muted impact on un- derlying core inflation. As such, despite the run up in oil prices, our view that inflation will remain at or below 2 percent over the me- dium term is not materially altered. That said, going forward we will continue to closely monitor developments in commodity mar- kets and the Fed stands ready to act if broader inflationary pres- sures materialize. Q.4. Last September you called the unemployment situation a ‘‘na- tional crisis,’’ noting in particular the plight of the long-term unem- ployed. You said ‘‘This has never happened in the post-war period in the United States. They [the long-term unemployed] are losing the skills they had, they are losing their connections, their attach- ment to the labor force.’’ In light of recent studies that show America falling behind in our commitment to providing workers the opportunities to train for skills needed in the 21st century economy, can you comment on your view of the magnitude of this challenge for the long-term un- employed? Do you believe that business focused training, that is partner- ships between businesses and colleges where unemployed and un- deremployed are provided the opportunity to train in the skills needed by employers in the region, can be an effective way to meet this challenge both for our current recovery and America’s long- term competitiveness? A.4. Long-term unemployment presents a serious challenge. Unem- ployment creates enormous financial hardship for families, and VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00044 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 41 workers who lose their jobs and remain unemployed for some time often experience sharp declines in earnings that may last for many years, even after they find new work. There is evidence that unem- ployment takes a toll on people’s health as well. And unemploy- ment strains public finances because of both lost tax revenue and the payment of unemployment benefits and other types of income support. The high rates of unemployment and long-term unemploy- ment, and the prospect that these could remain elevated for some time, are important reasons why the Federal Reserve has pursued a highly accommodative monetary policy over the past several years. People unemployed for a long time have historically found jobs less easily than those experiencing shorter spells of unemployment, perhaps because their skills erode, they lose relationships within the workforce, or they acquire a stigma that deters firms from hir- ing them. I have frequently spoken about the importance of life- long learning, including continuing education for adults, and well- designed programs to assist the unemployed can play a valuable role in that regard. In particular, many in the business and aca- demic communities believe that business-focused training, of the sort you describe, has been effective in many cases where it has been tried. Such approaches may be a fruitful avenue to explore, in concert with general improvements in our educational system and broader actions to address our current macroeconomic situa- tion. Q.5. Safeguarding the U.S. financial systems from proliferation fi- nancing, terror financing, money laundering and other criminal acts is crucial to the long term health of the U.S. economy and the security of our Nation. I believe the Federal Reserve has a central role in ensuring all U.S. based financial institutions maintain ro- bust risk management and compliance programs to address these threats. Can you describe the efforts of the Federal Reserve to ensure the U.S. financial system is not abused to aid the financing of ter- rorism and weapons proliferation, and money laundering, particu- larly when it comes to Iran? A.5. The Federal Reserve, in coordination with the Department of the Treasury and the other U.S. Federal financial regulatory agen- cies, seeks to ensure that financial institutions maintain appro- priate risk management and compliance programs related to money laundering, financing of terrorism, and sanctions administered by the Office of Foreign Assets Control (OFAC), including the exten- sive sanctions against Iran. While the Department of the Treasury maintains primary re- sponsibility for issuing and enforcing regulations to implement the Bank Secrecy Act (BSA), the comprehensive Federal antimoney laundering (AML) and counter-terrorism financing (CFT) statute, it has delegated to the Federal banking agencies responsibility for monitoring banks’ compliance with the BSA. During bank examina- tions, Federal Reserve examiners review and assess an institution’s compliance with relevant BSA and OFAC sanctions requirements, following a risk-based approach. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00045 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 42 The Federal Reserve has coordinated extensively with OFAC on its efforts under the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010 (CISADA). This law builds upon the U.S. Government’s role in protecting its domestic financial system from exposure to Iran’s illicit and deceptive financial practices by strengthening existing U.S. sanctions. The Federal Reserve regu- larly shares examination findings and enforcement proceedings with OFAC under the 2006 interagency memorandum of under- standing. The Federal Reserve actively participates in a number of coordi- nation initiatives related to money laundering, terrorism financing, and sanctions. These include the Treasury-led BSA Advisory Group, which includes representatives of regulatory agencies, law enforcement, and the financial services industry and the FFIEC BSA/ AML working group, a monthly forum for the discussion of pending BSA policy and regulatory matters. In addition to the Fed- eral banking agencies, the BSA/AML working group includes FinCEN and, on a quarterly basis, the Securities and Exchange Commission, the Commodity Futures Trading Commission, the In- ternal Revenue Service, and OFAC in order to share and discuss information on policy issues and general trends more broadly. In the international context, the Federal Reserve is a member of the U.S. delegation to the intergovernmental Financial Action Task Force (FATF) and its working groups, contributing a banking su- pervisory perspective to the formulation of international standards on these matters. Recently, the Federal Reserve provided input and review of ongoing work to revise the FATF Recommendations in order to ensure that they continue to provide a comprehensive and current framework for combating money laundering and terrorist financing. The Federal Reserve also participates in ongoing work of the Basel Committee that focuses on AML/counterterrorism financ- ing issues. Q.6. A few months ago, I met with many of the OMWI directors at the Federal Reserve about the steps you are taking on diversity, particularly in the procurement area. I was not particularly happy with the meeting, as I did not feel that sufficient progress was being made when it comes to contracting with Hispanic-owned businesses. One of the responses we heard echoed by the Directors was that Hispanic diversity has been an ongoing challenge, al- though I was not able to get specifics. Therefore, I am asking now what barriers you have identified for women- and minority-owned firms to compete. What barriers are unique to Hispanic-owned firms? What are you doing to overcome those barriers? A.6. What barriers have been identified for women- and minority- owned firms to compete? The following challenges have been identified: • Lack of knowledge by businesses on how to do business with the Federal Reserve Board • Lack of knowledge by businesses on the goods and services pro- cured by the Board VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00046 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 43 • Ability to identify and track women- and minority-owned busi- nesses and the products and services they offer in order to match to the products and services contracted by the Board • Lack of networking opportunities between prime contractors and women- and minority-owned firms interested in subcon- tracting opportunities What barriers are unique to Hispanic-owned firms? There are no unique barriers and/or challenges for Hispanic- owned firms to compete in relation to those identified for women- and minority-owned firms. What is being done to overcome barriers? The Board has hired a Supplier Diversity Specialist to focus on the inclusion of minority- and women-owned businesses in the busi- ness practices of the Board. A public Web site is also being devel- oped that will enable companies to register, identify their business classification, and include information regarding their products and services. The Web site will also enable the Board to search for com- panies that provide goods or services called for in specific solicita- tions. The Web site is in final testing and is projected to be avail- able the fourth quarter of 2012. The Board has instituted a number of initiatives to communicate how to do business with the Board. For example, the Board con- tinues to host an annual business fair to attract diverse pools of vendors. These annual fairs provide an opportunity for businesses that provide the products and services the Board procures to dis- cuss their companies with specific Board purchasing departments. Participants also attend a workshop on how to compete for busi- ness contracts at the Board. The most recent business fair, held in May 2012, included information about the projected Board’s 2012– 2013 acquisition forecast. In April 2012, the Board hosted a busi- ness forum for minority- and women-owned firms which provided information on building business capacity to compete for Federal contracts. This forum is projected to be yearly. The Supplier Diver- sity Specialist also meets with prospective suppliers to prequalify and offer technical assistance to minority- and women-owned busi- nesses that are interested in and/or responding to open solicita- tions. The Board continues to operate under its Small Disadvan- taged Business Acquisition policy, consistent with applicable law, to ensure small and socially and economically disadvantaged busi- nesses have an equitable opportunity to compete in the Board’s procurement activities. The Boards general contract provisions in- clude standard language that requires contractors to confirm their commitment to ensuring fair inclusion of women and minorities in employment and contracting. During the contract solicitation phase, prospective vendors can submit a subcontracting plan with their proposal that supports this requirement. The Board’s external strategies focus on developing partnerships with minority- and women-owned business advocacy, community and industry groups to further cultivate relationships. We are ap- plying for membership in local and national associations focusing on minority- and women-owned business such as Women Business Enterprise National Council (WBENC), National Minority Supplier Development Council (NMSDC), and the Greater Washington His- VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00047 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 44 panic Chamber of Commerce (GWHCC). The Board has signifi- cantly strengthened its relationship with Hispanic advocacy groups, by forging relationships through collaboration. The Board regularly submits pertinent information regarding upcoming solici- tations to the GWHCC for their members to participate in the Board’s acquisition process. We also participated in the GWHCC Business Expo to meet with Hispanic firms to discuss future oppor- tunities as well. Through our partnership with the GWHCC, we have identified over 20 Hispanic firms to participate in our 2012– 2013 acquisition process. The Board also exhibits at various con- ferences to promote our contracting opportunities. We continue to participate at the national business conferences such as National 8 (a) Association Conference, WBENC, NMSDC, and continue to work with chambers of commerce including the U.S. Hispanic Chamber of Commerce. The Board’s Procurement staff met with Hispanic firms during the U.S. Hispanic Chamber of Commerce Legislative Summit to discuss their capabilities both for current and future acquisitions. The OMWI Director also has participated on panels at con- ferences discussing minority-and women-owned firms doing busi- ness with the Federal government which included the 2011 Minor- ity Economic Conference hosted by the Florida Minority Commu- nity Reinvestment Coalition. The Board has had a continued commitment to the inclusion of minority- and women-owned businesses in its procurement prac- tices. The OMWI and Procurement offices, which have the primary responsibility for ensuring current and proposed policies and prac- tices affecting inclusion of minority- and women-owned businesses, will meet on a regular basis to assess results of supplier diversity objectives and activities and to determine whether additional ef- forts would be helpful in assisting minority- and women-owned firms to compete successfully in the Board’s acquisition process. RESPONSES TO WRITTEN QUESTIONS OF SENATOR HAGAN FROM BEN S. BERNANKE Q.1. Section 1: Chairman Bernanke, in your testimony you noted that in September of last year the Federal Open Market Committee determined that it would reinvest principal received from holdings of agency MBS and agency debt in agency MBS. What is the impact of a dollar of principal that is reinvested in a Treasury security relative to a dollar of principal invested in agency MBS? A.1. The Federal Reserve’s purchases of longer-term assets are in- tended to put downward pressure on longer-term interest rates and ease financial conditions more generally. The effect of a dollar in- vested in a Treasury security relative to a dollar invested in an agency MBS depends on many factors, including the remaining ma- turity of the securities. In general, longer-term securities would be thought to have a somewhat more powerful effect. Both Treasury securities and agency MBS purchases have the effect of easing broad financial conditions and putting downward pressure on longer-term interest rates. In principle, MBS purchases should also improve conditions in mortgage markets and so help support the VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00048 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 45 housing sector and thereby contribute to a stronger economic recov- ery. Q.2. Is reinvested principal going into new or seasoned or new issues of Agency MBS? A.2. The Open Market Desk (the Desk) at the Federal Reserve Bank of New York purchases agency MBS that are concentrated in newly-issued agency MBS in the To-Be-Announced market, al- though the Desk may purchase other fixed-rate agency MBS securi- ties guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae if market conditions warrant. The eligible assets include, but are not limited to, 30-year and 15-year securities of these issuers. A sum- mary of agency MBS purchases is reported on the Federal Reserve Bank of New York’s (http://www.newyorkfed.org/markets/ambs). Additional information on the Desk’s agency MBS purchases can be found at the following link: http://www.newyorkfed.org/mar- kets/ambs/ambslfaq.html. Q.3. As borrowers take advantage of historically low rates to refi- nance, is the Fed seeing an acceleration in principal payments? A.3. Principal payments of agency mortgage-backed securities (MBS) tend to increase when mortgage rates decline. Since the summer of 2011, mortgage rates have fallen to very low levels and principal payments have increased. The Federal Reserve has seen an acceleration in principal payments on its agency MBS holdings, with principal payments averaging about $25 billion per month since October 2011, roughly double the level seen during the sum- mer of 2011. A number of other factors also influence the speed of principal payments. Currently, tight underwriting standards and low levels of housing equity are likely damping mortgage refi- nancing activity and, hence, holding down prepayments. Q.4. Section 2: Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) seeks to prohibit feder- ally insured depository institutions and their affiliates from engag- ing in short-term proprietary trading and to limit certain relation- ships with hedge funds and private equity funds. Specifically, Section 619 added a new Section 13 to the Bank Holding Company Act of 1956 (BHC Act), that prohibits a ‘‘banking entity’’ from acquiring or retaining an ownership interest in or sponsoring a ‘‘hedge fund’’ or ‘‘private equity fund,’’ subject to cer- tain exceptions. I want to applaud the Federal Reserve, with its expertise as the primary regulator of bank holding companies, for acknowledging the importance of traditional asset management services and for attempting to propose a rule that does not unduly constrain the ability of U.S. banking entities to provide those services. It is clear from the statute and the congressional record that Congress intended to cover only those funds that ‘‘engage in activi- ties or have characteristics of a traditional private equity fund or hedge fund.’’ Generally speaking, does the Federal Reserve see non-U.S. funds that are publicly offered by U.S. banking entities as posing the same risks as traditional hedge funds and private equity funds? VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00049 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 46 A.4. The joint proposal issued by the Federal Reserve, OCC, FDIC, and SEC requested comment on a wide variety of issues, including regarding how section 619 applies to non-U.S. funds, as well as the scope of the statutory exemption for certain hedge fund and private equity fund activity and investment that occurs ‘‘solely outside of the United States.’’ See 12 U.S.C. 1851(d)(l)(l). The agencies’ pro- posal invited comment on whether non-U.S. funds posed the same risks to U.S. banking entities as U.S. funds. The agencies received a significant amount of comment on the joint proposal and the Fed- eral Reserve is carefully reviewing and considering these comments as we work to finalize implementing rules. Q.5. Would the Federal Reserve be willing to work to craft a ‘‘cov- ered fund’’ definition that would treat analogous U.S. and non-U.S. funds similarly, as was the intent of the statute? A.5. The joint proposal issued by the Federal Reserve, OCC, FDIC, and SEC applies to activities by U.S. banking entities involving non-U.S. funds in the same way it applies to activities by those en- tities in U.S. funds to the extent that the non-U.S. fund would be covered by the statute were it a U.S. fund. The joint agency pro- posal also invited public comment on whether the proposed rule ef- fectively and correctly implemented the statutory definition of hedge fund and private equity fund and treatment of non-U.S. funds for purposes of section 619. The agencies received a signifi- cant amount of comment on the joint proposal and the Federal Re- serve is carefully reviewing and considering these comments as we work to finalize implementing rules. RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM BEN S. BERNANKE Q.1. Following up on your Volcker comments, I agree with you that ‘‘we certainly don’t expect people to obey a rule that doesn’t exist’’ and welcome your comment that the Agencies ‘‘will certainly make sure that firms have all the time they need to respond.’’ And yet, while Dodd-Frank provides a two-year conformance period, the pre- amble to the proposed rule states that the Agencies expect full compliance ‘‘as soon as practicable’’ after the effective date (July 21, 2012). In addition, commenters are concerned that the proposed rule would effectively require firms to have sophisticated reporting and recordkeeping systems and procedures in place on the effective date, notwithstanding the 2-year conformance period. This is be- cause, as drafted, the proposed rule conditions the availability of key statutory exemptions (e.g., market making and hedging) on the existence of these systems and procedures. How do you intend to resolve this discrepancy? A.1. Section 619 of the Dodd-Frank Wall Street Reform and Con- sumer Protection Act (Dodd–Frank Act) required the Federal Re- serve to adopt rules governing the conformance periods for activi- ties and investments restricted by section 619, which the Federal Reserve did on February 9, 2011 (Conformance Rule). In its Con- formance Rule, the Federal Reserve explained that it would revisit the conformance period rule, as necessary, in light of the require- ments of the final rule implementing the substantive provisions of VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00050 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 47 the Volcker Rule. Subsequently, the Federal Reserve received a number of requests for clarification of the manner in which this conformance period would apply and how the prohibitions would be enforced. On April 19, 2012, the Federal Reserve issued a state- ment clarifying that an entity covered by section 619 has the full 2-year period provided by statute to fully conform its activities and investments to the requirements of section 619 and any imple- menting rules adopted in final under that section, unless the Board extends that conformance period. The other agencies charged with enforcing section 619 simultaneously announced that they would enforce section 619 in accordance with the Federal Reserve’s state- ments regarding the conformance period. Additionally, the Federal Reserve, the OCC, the FDIC, SEC, and CFTC have proposed rules to implement section 619; as part of those proposals, the agencies met with many interested representa- tives of the public, including banking firms, trade associations and consumer advocates, and provided an extended period of time for the public to submit comments to the agencies. The agencies have received over 19,000 comments addressing a wide variety of aspects of the proposal, including the exemptions for market making-re- lated activities, risk-mitigating hedging activities, the use of metrics, and the reporting proposals. The agencies are carefully re- viewing those comments and considering the suggestions and issues they raise in light of the statutory restrictions and provi- sions. We will carefully consider the issues you note as we continue to review all comments submitted in crafting a final rule to imple- ment section 619. RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY FROM BEN S. BERNANKE Q.1. Chairman Bernanke, I would like to ask you about the Fed- eral Reserve’s supervisory authority over thrift holding companies, which is new authority granted to the Federal Reserve as part of the Dodd-Frank Act. Some of these thrift holding companies are, or own, life insurers. It is my understanding that the Federal Reserve, in exercising this new authority, has placed supervisors on site at some of these thrift holding companies. Can you discuss the Fed’s efforts to supervise thrift holding com- panies as well as what the Fed is doing to increase its expertise and knowledge base with regard to insurers? A.1. As of December 31, 2011, there were 417 top tier Savings and Loan Holding Companies (SLHCs) with estimated total consoli- dated assets of $3 trillion. These SLHCs include approximately 48 companies engaged primarily in nonbanking activities, such as in- surance underwriting (approximately 26 SLHCs), commercial ac- tivities (approximately 11 SLHCs), and securities brokerage (11 SLHCs). Since the transfer of SLHC supervision to the Federal Re- serve on July 21, 2011, 114 SLHCs have been issued indicative rat- VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00051 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 48 ings,1 50 discovery reviews2 have been completed, and an addi- tional 34 discovery reviews, 27 inspections and 21 offsite reviews have been initiated. A dedicated SLHC section in the Board’s Division of Banking Su- pervision and Regulation has been staffed and is working to con- tinue the supervisory and policy oversight of the SLHCs. Regarding the 26 SLHCs that are primarily engaged in insurance activities, the Federal Reserve is using the first cycle of SLHC inspections to learn more about the particular operations of each insurance SLHC (ISLHC), as explained in SR letter 11-11 (July 21, 2011)3 Super- visory assessments are currently being conducted at each ISLHC and its subsidiaries to more fully understand the activity make up of each ISLHC and to determine if any activities pose safety and soundness concerns. The Board’s consolidated supervisory program is applied to ISLHCs in a risk-focused manner and supervisory ac- tivities (such as, continuous monitoring, discovery reviews, and testing) vary across the portfolios of institutions based on size, com- plexity, and risk. Board and Reserve Bank staffs are working to create supervisory plans that address the risks associated with the activities of ISLHCs. For example, pilot ISLHC inspection proce- dures have been developed and are currently being used by exam- iners in the inspection of ISLHCs. Staff will revise and finalize these procedures based on feedback received from examiners. To foster consistency and assist examiners in developing their knowledge of the unique aspects of ISLHCs, the following activities also have been instituted: • Four conferences for Board and Reserve Bank staff supervising ISLHCs have been held since the transfer of SLHC supervision to the Federal Reserve. (August 2012, D.C.; June .2012, D.C.; November 2011, D.C.; and August 2011, Chicago). • Ongoing System-wide calls are held and have included training sessions conducted by outside vendors on insurance related issues and discussions on ISLHC supervision. Participants in- clude Reserve Bank and Board staff. Internal insurance train- ing courses also are under development. • Regular communication with the National Association of Insur- ance Commissioners (NAIC)4 along with Reserve Bank and Board attendance at NAIC conferences. • Regular communication with the Federal Insurance Office and the Financial Stability Oversight Council. Q.2. Previously, when asked, Mr. Volcker was unable to give a clear definition of ‘‘proprietary trading’’ but essentially said that he knew it when he saw it. As the regulators draft the Volcker Rule, which is focused on pro- prietary trading, what is your definition of the term? 1An ‘‘indicative rating’’ indicates to the SLHC how it would be rated if the RFI rating system was formally applied. 2A discovery review is an inspection activity designed to improve the Federal Reserve’s un- derstanding of a particular business activity or control process. 3SR letter 11-11, ‘‘Supervision of Savings and Loan Holding Companies’’ (July 21, 2011), de- scribes the supervisory approach to be used for the first cycle of supervision of SLHCs (www.federalreserve.gov/bankinforeg/srletters/sr1111.htm). 4NAIC is an organization formed by State insurance regulators and has no regulatory author- ity. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00052 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 49 Is this the exact definition used in the proposed rule? If not, how does the definition in the proposed rule differ? A.2. Section 619 of the Dodd-Frank Wall Street Reform and Con- sumer Protection Act (Dodd-Frank Act) generally prohibits banking entities from engaging in proprietary trading. Section 619(h)(4) of that Act defines ‘‘proprietary trading’’ to mean ‘‘engaging as prin- cipal for the trading account in any transaction to purchase or sell, or otherwise acquire or dispose of specified financial instruments. See 12 U.S.C. 1851(h)(4). Another part of section 619 defines ‘‘trad- ing account’’ as any account used to engage in proprietary trading for the purposes of profiting from short-term price movements. See 12 U.S.C. 1851(h)(6). The statute also provides a number of exemp- tions from the prohibition on proprietary trading, such as exemp- tions for market making-related activity or risk-mitigating hedging activity. See U.S.C. 1851(d)(l)(B) and (C). The proposal to imple- ment section 619 of the Dodd-Frank Act by the Federal Reserve, OCC, FDIC, SEC, and CFTC (the ‘‘Agencies’’) requested public com- ment on a definition of ‘‘proprietary trading’’ that restates the stat- utory definition. The Agencies received over 19,000 comments regarding the pro- posed implementing rules, including comments that specifically ad- dressed the issues of proprietary trading and related definitions. The Agencies are currently considering these comments as we work to finalize implementing rules. Q.3. Apparently, the definition of state and municipal securities in the Dodd-Frank Act does not conform with the earlier Securities Exchange Act definitions, subjecting these securities to the Volcker Rule. What will the additional costs be to State and local governments in issuing bonds? A.3. Section 619(d)(l)(A) of the Dodd-Frank Act provides an exemp- tion for proprietary trading in obligations of the United States or any agency thereof, obligations, participations, or other instru- ments of or issued by certain Government sponsored entities, and obligations of any State or of any political subdivision thereof. See 12 U.S.C. 1851(d)(l)(A). A number of Securities Exchange Act provi- sions apply to obligations and instruments of any agency of a State or political subdivision thereof, as well as to obligations of the State of a political subdivision itself. The Dodd-Frank Act, however, did not by its terms extend its exemption to proprietary trading in obli- gations of an agency of any State or political subdivision thereof. The Agencies proposed an exemption for municipal securities that mirrored the words of the Dodd-Frank Act. The Agencies also re- quested public comment on whether the exemption should be ex- tended to include the broader definition of ‘‘municipal security’’ used in the Securities Exchange Act. The Agencies received over 19,000 comments regarding the pro- posed implementing rules, including comments that specifically ad- dressed the exemption for government obligations and the defini- tion of municipal security. The Agencies are currently considering these comments as we work to finalize implementing rules. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00053 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 50 Q.4. Do you believe that, as proposed, the Volcker Rule has the po- tential to raise the cost of capital for nonfinancial small and mid- size businesses? Has any analysis been performed on this issue in relation to the proposed Volcker Rule? Has any analysis been performed on the potential impact on ac- cess to capital for nonfinancial small- and mid-sized businesses that may be created by the confluence of the Volcker Rule, the im- plementation of Basel III, and the SEC’s impending money market regulations? Will you please provide my office with copies of any such analysis or assessments? A.4. As part of the proposed rules to implement section 619 of the Dodd-Frank Act, the Agencies proposed a multifaceted regulatory framework to implement the statute in accordance with its terms. In the proposal, the Agencies recognized that there are economic impacts that may arise from the proposed rule, and invited com- ments on potential economic impacts. The Agencies also encour- aged commenters to provide quantitative information about the im- pact of the proposal not only on entities subject to section 619, but also their clients, customers, and counterparties, specific markets or asset classes, and any other entities potentially affected by the proposed rule, including nonfinancial small and mid-size busi- nesses. The Agencies received over 19,000 comments regarding the proposed implementing rules, including comments regarding poten- tial costs and benefits. The Agencies are currently considering these comments as we work to finalize implementing rules and will take account of the potential costs and benefits of any imple- menting rules as the agencies develop a final rule consistent with the requirements of the statute. RESPONSES TO WRITTEN QUESTIONS OF SENATOR WICKER FROM BEN S. BERNANKE Q.1. The unemployment rate’s drop in recent months to 8.3 percent may have overshadowed a troublesome trend, which is the fact fewer Americans are looking for work. For example, the latest jobs report showed that the share of working-age people in the labor force had declined to the lowest level in 29 years. Furthermore, while unemployment has fallen 1.4 percentage points over the past 24 months, the participation rate has dropped 1.1 percentage points. The share of Americans with jobs, known as the employ- ment-to-population ratio, hasn’t budged—posting the same number last month (58.5) as in January 2010. This information combined with the fact we have seen record numbers of long-term unem- ployed is very concerning. Chairman Bernanke, is the recent trend of lower labor force participation a significant indicator of the strength of the U.S. economic recovery? Should U.S. policy makers be concerned about this trend? A.1. Several factors account for the decline in labor force participa- tion that we have seen. Part of the decline reflects longer-term de- mographics that are largely distinct from the weak economic situa- tion. In particular, as the baby boom cohort ages, larger numbers of individuals have been reaching ages at which, typically, labor VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00054 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 51 force participation is lower. But demographics probably cannot fully explain the relatively low participation rate that we have seen. The fact that the labor market remains weak, with relatively few jobs available, has likely led many individuals to remain out of the labor force. On the other hand, the loss of housing and stock- market wealth associated with the housing collapse and the reces- sion no doubt induced many others to stay in the labor force for longer than they otherwise might have. Quantifying these various forces is difficult, but to the extent that the slowing in participation does reflect cyclical factors, then as the economy strengthens, par- ticipation may be expected to increase, or at least to decline by less than the underlying demographic trend would suggest. A downward trend in labor force participation that represents natural demographics may not be a cause for concern. However, there are some potentially concerning aspects to the decline. The effect of a declining workforce on public finances is one potential issue. Another concern stems from the large rise in disability rolls, and the possibility that part of that rise represents individuals who could and would work if more jobs were available. Moreover, par- ticipation rates for teens and young adults have declined. To some extent, this decline for young people reflects increased schooling, which is likely for the good; but if the lower participation implies that young people are not gaining valuable work experience, it would be a cause for concern. Q.2. Chairman Bernanke, you noted in your testimony that the job market has seen some improvement but that ‘‘continued improve- ment in the job market is likely to require stronger growth in final demand and production . . . The unemployment rate remains ele- vated, long-term unemployment is still near record levels, and the number of persons working part time for economic reasons is very high.’’ What type of ‘‘stronger growth’’ is necessary to tackle the problem of anemic job creation? A.2. In the latter part of 2011 and early this year, job growth picked up and the unemployment rate declined even though GDP was rising at only a modest rate. Normally, when GDP rises at its longer run ‘‘potential’’ rate associated with normal growth of the labor force and productivity, the unemployment rate will remain stable; a declining unemployment rate generally requires GDP to rise at a rate faster than potential. A number of factors might help account for the decline in the unemployment rate despite only mod- est GDP growth, but part of the story could be that last year’s de- cline in unemployment represented a ‘‘catch up’’ from the deepest part of the recession, when employers were cutting payrolls even more sharply than would have been predicted given the declines in demand that they were facing, perhaps because they feared that an even sharper contraction might be in the offing. Such a period of catch up eventually will come to an end, and indeed, since early this year the unemployment rate has been about flat at 81⁄ 4 per- cent, while GDP growth has slowed only a little. Thus, to achieve further declines in unemployment, we will likely need to see GDP growth rising more rapidly than we have seen over the past year. VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00055 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 52 ADDITIONALMATERIALSUPPLIEDFORTHERECORD VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00056 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.10021103 53 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00057 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.20021103 Monetary Policy Report to the Congress Submitted pursuant to section 2B of the Federal Reserve Act February 29, 2012 Board of Governors of the Federal Reserve System 54 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00058 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.30021103 Letter of Transmittal BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Washington, D.C., February 29, 2012 THE PRESIDENT OF THE SENATE THE SPEAKErR OF THE HOUSE OF REPRESENTATIVES The Board of Governors is pleased to submit its Monetary Policy Report to the Congress pursuant to section 2B of the Federal Reserve Act. Sincerely, ~ke' Chainnan 55 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00059 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.40021103 Contents I Part 1: Overview ; Part 2: Recent Economie and FUlancial Developments 6 Domestic Developments 6 The Household Sector 6 Consi/mer Spending and Household Finance 8 /lousing ActiJJity and Finance 10 The Business Sector 10 Fixed /l1\'eSlmelll 11 Jm"emory /l1\'eSlmenl 11 Corporate Profits and Business Finllllce 13 The Go\'ernmenl Sector 13 Federal Goremmen/ [5 Stale and Local GOl"ernmelll [5 The External Sector 17 National Sa'"ing 17 11le Labor Markel 17 Emp/O}lnelll and Unemp!oymeIU 18 Productivity and Labo, Compensation 18 Prices 56 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00060 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.50021103 20 Financial Developments 20 Monetary Policy Expectations and Treasury Rates 21 Short· Term Funding Markets 22 Financial Institutions 26 Corporate Debt and Equity Markets 28 Monetary Aggregates and the Federal Reserve's Balance Sheet 30 International Developments 30 internatiotk'l.l Financial Markets 33 The Financial Aocount 3S Advanced Foreign Economies 36 Emerging Market Economies 39 Part 3: Monetary Policy 39 Monetary Policy over the Second Half of 201 I and Early 2012 43 FOMCCommunications 47 Part 4: Sununal1' of Economic Projections 49 The Outlook for Economic Acti\~ty SI The Outlook for InHation 54 Appropriate Monetary Policy S8 Uncertainty and Risks 61 Abbreviations List of Boxes 24 Financial Stability at the Federal Reserve 32 An Update on the European Fiscal Crisis 36 U.S. Dollar Funding Pressures and Dollar Liquidity Swap Arrangements 4S FOMC Statement Regarding Longer·Run Goals and Monetary Policy Strategy 60 FOlrolst Uncertainty 57 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00061 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.60021103 Part 1 Overview: Monetary Policy and the Economic Outlook Economic aCli,ity in the Uniled States expanded at a investors seemed to become more confident that Euro tmderate rate in the second half of 2011 followiogan pean poliC)1lUkerswould take tlie steps necessary to anemic gain in the first half, and the tmderate pace or address tbe crisis. Tbe more posith-e market sentiment expansion appears to have continued inlo the opening was bolstered by recent Us. data releases, which lmnthsof 2012. Actr<'ityWls held down in the first pointed 10 greater strength, on OOlance, than inl'estors half of WI I by lempmry factors., particularly supply bad expected. Nonetbeless, market p,lrticip,lnts report chain disruptiom stemming from the earthquake in edly renuin cautious about risks in the financial hpan and Ihedampiog effect of bigherenergy prices system, and credit default SI\'ap spreads for Us. finan on consumer spending. As the effects of these factors cial institutions have lIidened, on net. sinct early last wilned over the second half of the year, economic summer. actr.'ity picked up. Conditions in the boor nurket han After rising at an annual rate of just V. percent in tbe impro,"ed since last summer, with an increase in the first balf of WI!. real gross domestic product(GDP) is p:ux of job gains and a noticeable reduction in the estimated 10 haw increased at a 2Y. percent rate in the unemployment rale. Meanwhile, consumer price infla· second bal[1 The growth rate of rei! consumer spend tion has stepped down from the temporarily higb lewis ing also firmed a bil in the second balf of the year. obselwd over the first balf of 2011. asconumdity and although tbe fundamenul determinan\Sof household imJXlfl prices remaled and as longcHerrn inflation spending improl'ed little: Rell household inoome and expectations remained stable"L ooking ahead. growth wealth s!agnated, and access to credit remained tight is !ike~'to be lOOdest during the coming year. as several for nuny potential borrowers. Consumer sentiment has factors appear like~'to continue to restrain activity. rebounded from the summer'sdepressed ItI'els but including restricted access to credit for many bouse remains low by historical sundard& Meanwhile. reJl boldsand sm.ill businesses, the still-depressed bousing investment in equipment and software and exports market. tight fiscal policy at aU levels of g<ll"ernment, posted solid gainso\"er the second half of the year. In and some >lowing in global economic growtb. contrast. the housing nurket remains depressed. In light of tbese conditions, the Federal Open Mar weighed down by tbe large inventory of vacant houses ket Commil1ee (FO~tq took a number of steps dur for sale. tbe substantial lulume of distressed sales, and ing the strond balf of 2011 and early 2012 to provide bomebuyers' COnctrnli about the strength of tbe ltCOI' additional moneury policy accornm;x\ation and ery and tbe potential lOr further declines in bouse thereby support a stronger economic ltCOver)' in the prices. In the government sector. reJl purchases of contexl of price stability. These steps included modify goods and services continued to decline over the sec ing the IOrw:ud rate guidance included in postmeeting ond balf of the year. sutements, increasing tbe x,-erage nulUrity of tbe Fed Labor market conditions 001'( improved. The unem eral Reserve's5eCurities holdings. and shifting tbe rein ployment rate ITIOled down from around 9 percent vesDnent of prindpll PJymentson agency securities om the first eight months of 2011 to 8Y. percent in from Treasury securities to agency-guaranteed JanUlry 2012. HO\\"eleT. eYen with this irnprovemen~ mortgage-OOcked securities(MBS). the jobless rate remainsquiteelevlted. Furthermore, Throughout the second half of 2011 and ear~' 2012, the share of the unemployed who have been jobless for participants in financial markets focused on the fiscal more than six months. although down slightly from its and OOnking crisis in Europe. Concerns regarding tbe pelk, was still abol"e40 percent in Janual)'--roughly potential ror spillovers to the US. economy and finan double the fraction tblt prtl'liled during the economic cial markets weighed on inl"estor sentiment. contribut exfUnsion of the prtl'KlU5 decade. Meanwhile, private ing to significant lulatility in a wide range of asset prices and at times prompting sharp puUbacks from t. The aumkn; io this t<pC'It IR' basN 011 tl1< Bur.au or risk-taking. Strains eased somewb.n in 1 number of G Ec D O p l1 , O ~ l ' D b i i c c A h n ~ o ~ I I y s r i d s t '. a ( s B <d E A 0 ) 0 a A a. t o I a II 1 O lC l e )' I 2 S J I , i r 2 o 0 a \ t 2 l: . o T f h f o o u B r E tb .-\ " . l ~ U ;t i l r t , t " t , iSI' financial markets in late 2011 and early this year as • ",iscd<Stimatl: 011 February 29. 2011 58 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00062 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.70021103 MoneUI)' ltllicy Report to the CongressO February 2012 payroU employment gains averaged 165,1XXl jobs per spreads remain ele-.'ated. Panly as a result of the hr month in the ~nd hJlf of 20\ I, a bit slower tbn the ward guidance and ongoing maturity extension pro pace in the first half of the year, but gains in December gram prol;ded~' the Federal Resent, market p,lrtici. and hnu31)' were more robust, a\'eraging almost p,ln1S expect the target federal funds rate to remain loll' 240,000 per month, for a longer period than they thought early 11st July, Consumer price inflation stepped down in the se<" and Trelsury yields hal'e Ir£ll"ed dOllll significant~', ond balf of 2011. Afier rising at an annual rate of Meanwbile. measuresof inHation compensation ol'er 3\4 pelttllt in the first half of tbe ~'ear, prices for per· the next he years deril'ed from jields on nominal and sonal consumption expenditures (PCE) rose just inHation-indexed Treasury securities are little cbanged. lYi pelttllt in the second half. PCE prices excluding on balance. though the fOf\\'lrd melsure 5-to-1O years !Ood and energy also decelerated, rising at an annual ahud remains below its level intbe middle of !lst year. rateof roughly 1Y , perctnt in the second half of 2011. Among nonfinancial corporations, larger and compared with about 2 perctnt in tbe first hJlf. The bigher -credit-quality finns with access to capital mar decline in inflation W3S largely in response to decreases ket5took advantage of generally attractive financing in global conumdity prices following their surge early conditions to raise funds in the second half of 2011. in 2011, as well as a restoration of supply chJins for On tbe other band, for smaller finns without access to motor I'ehicle production that had been disrupted after credit markets and those with less-solid financial situa the earthquake in Jap,ln and some deceleration in the tions, boITOlliog conditions remained more challeng· prices of imported goods other thJn raw conumdities. ing. Reflecting these developments, inl'e5tment-grade The European fiscal and banting crisis intensified in nonfinancial corporations oontinued to issue debt at a the second balf of theyear. During the summer. tbe robust p,lct while spe\:ulative-grade issuance declined, gOI'ernmenl>of haly and Spain came under significant as investors' appetite for riskier assets diminisbed. financial pressure and borrowing com increased for Similar issuance patterns were evident in the market many euro-area governments and banks In ear~' for syndicated loans, where invesUllent-grade is>"1laDct August. the European CenlIll Bank (EeB) re§pCInded continued to be strong wbile tbat of bigber.}ieJding by resuming purcbases of marketable debt securities. leveraged loans feU back. In addition, commercial and Although yields on the government debt of haly and industrial(C&I) loans on banks' books expanded Spain temporarily moved lower, market conditions strongly, particular~' for 11rgerdomestic banks tbatare deteriorated in the fall and funding pressures for some mo5l1ikely to lend to big firms. Accenting \0 the hnu gol'ernmentsand banks increased furtber, Om the ary Senior Loan Officer Opinion Sur,ey on Bank seo:md half of the year, European leaders worked Lending Practices (SLOOS), domestic banks eased toward bolsming tbe financial backstop foreuro-area term. on C&I loons and experienced increased loan gonrnments, reinforcing the fiscal discipline of tbose demand during tbe fourth quarter of tbe year. tbe lat· gOI'ernments, aDd strengthening the capital and liquid terdeveJopment in part reflecting a shift in some bor ity positions of banh Additionally. the ECB made a rowing away from European bank~l Byoontrast. significant injection of euro liquidity via its fim three although credit supply conditions for smaller firms year refinancing operation, and central banks agreed to appear to baveeased somewhat in tbe last 5e\'eral reduce the priceof U.S. doUar Uquidity based on swap months, they remained tighter relative to bistorical Unes with the Federal Reser\"¢. Since December. hUow nonns than for larger firms. Conunerdal mortgage ing these actions, yields on tbe debt of vulnerable deht continued to decline tbrough tbe third quarter of European governments declined to some extent and 2011, albeit at a Ir£lre Ir£ldmte pace than in 2010. funding pressures on European bankseased. Household debt appears to have declined at a A number of so\IJCes of investor anxiety-including slightly slower pace in the second balf of 2011 than in the European crisis, concerns about the ;ustainabi1ity the first half, lIith tbe continued contraction in mort· of US. fiscal policy. and a slowdown in global gage debt partiaUy offset by growtb in consumer credit. growth- weighed on U.s. financial market. early in the Enn though Ir£lrtgage rales continued to be near his· second half of 2011. More recent~', tbeseconcerns toric.ally low lel'els, tbe I"Olume of nell' mortgage loans eased somewbat. reHecting actions taken by global cen remained muted. The smallerquantit), of new IDJrt tral banks as well as US. dJta releases tbat pointed to gage origination reHects potential buyers' lack of either greater strengtb. on balance, than market participants the down payment or credit history required to qualify bad anticipated. Broad equity prices fell notab~' in August but subsequently retraced, and they are now 2. The SLOOS ~ ;>lilablt OIl the FNeraI ReseM Iloard'i ~m;te lilt Ie changed, on net, since early Ju~'. Corporate bond ol " ...... l"tJmt ..! tI'~V"lOOardJo<:&lS"LoonSU"'t;t 59 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00063 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.80021103 BoanIojwlV'/!ol'l'ojlhe Federal ResmeSystem J tor these loans. and many appear reluctant to buy a second balf of 201 I and ear~' 2012. In Augus~ the house now because of concerosabout their income Corruninee JOOdifie<! its forward rate guidance, noting prospect. and emplo}1Tlent statu;, as well as the risk of that eoonomicconditions were likely to warrant excep further declines in house price~ Delinquency rates on tional~' low Imls forthe fe<leral funds rate at least most categories of residential mortgage; edged lower through mid-20ll The FOMe decided at its Septem but stayed nelf recent highs. and the number of prop ber meetiIlg to extend the 31-erage maturity of its erties in the foreclosure process remained de\"ated. Treasury boldings, and to reinvest principal payments Issuance of consumer asset-b.tcked securities in the from its holding;; of agency debt and agency MSS in serond half of 2011 ran at aoouttbe same rate as it agency MBS rather tban in Treasury securities. ~ bad over the previous 18 month A modest net frac Finally, at tbe Committee's January 2012 meeting, the tion of SLOOS respondents to both the Cktober and FaMC JOOdified its fOfll'lrd guidance to indicate that hnuary sU!1·eys indicated that they had eased tbeir it expected eoonomicconditions to warrant exception sundardson all c':llegories of consumer loan~ a1~' low le\·els for the federal funds rate at leaS! through '\Ieasuresof the profitabmty of the u.s. banking late 2014. The Comminee note<! that it would regullrly industry hal·e edged up, on net. since mid-lOll, as review the size and composition of its securities bold· indiCltorsof credit quality continued to show sigm of ings and is prepared to adjust those holdings as appro improl·enlent and banks trimmed noninterest expense~ priate to promote a stJOngereconomic recol"ery in the Meanwbile, banks' regulatory capital ratios remained context of price .tability. at historically high levels, as authorities rontinued to [n .1ddition to these policy action;, the Federal take step; to enhance their regulation of financial insti Rese!1"e took further step. to improl·ecommunkations tution~ Nonetheless, conditions in unsecured inter regarding its lmnetary po!icydecisionsand delibera bank funding markets deteriorated. Strains were par tions. At the Comminee's January 2012 meeting, the ticular~' evident for European financial institutions, FaMC released a statement of its longer-run goal;; with funding rosts increasing and maturities sborten and policy strategy in an effort to enhance the trans ing, on balance, as investors focused on counterparty partncy. acoounubility, and elfectil"enessof monetary credit risk amid growing anxiety abouttheongoing policy and to facilitate well·informed decisionmaking crisis in Europe. Gil·en solid deposit growtb and JOOd. by bousebolds and businesses. The statement empba est expansion in bank credit across the industry, most sizes the Fe<!eral Reser\"e'sfirm commitment to pursue domestic banks reportedly had limited need for unse its congressional tn.1odate to promote maximum cured funding. employment .•t able prices, and rooderate Iong·term Concerns about the condition of 1'm.1ncial institu interest rates. To cl.1rify how it see!:s to achiel·e the;.;: tions gal·e rise to heightened inmtor anxiety regarding objectil·es,tbe FaMC SUted that inHation at the rate countelJlarty exposures during tbe second half of of 2 percent. as measured by the annual cbange in tbe 201I . Responses to tbe December Senior Credit Officer PCE price index, is I\l)st consistento\·er the longer fUn Opinion SU!1·ey on Dealer Financing Terms. or \lith tbe Federal Rese!1·e's statutory mandate. While SCOOS. indicated thatdellersdevoted increased time noting tbattheCommittee's assessments of the maxi· and attention to the management of concentrated mum lenl of employment are neceSS:lri~' unceruin credit exposures to other financial intermediaries over and subject to revision. the 5Utement indicated that the prel'ious three lmnths, and 80 percent of dealers the central tendency of FO.\fC participants" current reported re<!ucing credit ~mit; for some specificcoun. estimates of the longer·run nonna! rate of unemploy· terpartie~l Respondentsalso reported a broad but ment is between 5.2 and 6.0 percent It stressed that the rooderate tightening of credit terms applicable to Federal Rescm's sUtutory objecti\'esare generally important classes of counterparties Ol·er the pm-ious complementary, but when they lit not, the Committee three months, importantly refte<"ting a worsening in \lill follow a balanced approach in its efforts to return general markc:t ~quidity and functioning as weU asa botb inflation and empJo:1Tlent to Ie\·e!sconsistent reduced \liUingness to take on risk. \lith its mandate. In order to support a stronger economic recove£)' In addition.tbe January Summary of Economic and belp ensure that inflation. over time, is at Ie\·el, Projections(SEP) PlQlided information for the first consistent with itsdua! mandate. the FOMC pf()\'ided time about FO.\IC participants' indilidua! assessments additional lmneta£)' policy acoomroodation during the 4. !let,...cu lbo AugUSl2010acd Sq>ttnlbr, 20t t FOMC 1DI!diugs.. 1 TI» SOXlS ~ ....i bbleon lbo Folenl R<smoe IIo,ard·, ubsitt prilripat M·",...l. from l<:Curil;" beLl on II» F<Jmt Rt:;:t"" 'l"""'.f.t.:r.l,.,.,.,.,.~",·!cconr<sdI.lalrdeasesl~tm. N/ance ,bed b.d \'CCI! mn_ed ill longc-r·term Trtuu'l' """",1", 60 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00064 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.90021103 4 Moneury ltllicy Report to the CongressO February 2012 of the appropriate timing of the first increase in the the 2012-14 period at rates at or below tbe FOMC's target federal funds rate gn'en their view of the eco longer-run objectire of 2 percent. nomic situation and outlook, as well as participants' With Ihe unemployment rate projected to remain asses;mentsof the appropriate lel'el of the target fed elevated over the projection period and inHation eral fund; rate in the fourth quarter of each yelr expected 10 be subdued, most participantsexpe<:ted through 2014 and over the longer run, The SEP also that the froeral funds rate would remain extraordi included quaUtative information regarding individual nari~' loll' lOr some time. Six participants anticipated participants' eXpe<:tations for the Federal Reserve's that. under appropriate monetary policy, the 6rst b:ilance sheet under appropriate JOOnetary poUcy, increase in the target federal funds rate would occur The economic projections in tbe hnuary SEP(pre after 2014, and fr.-e eXpe<:ted (XlUcy firming to corn seoted in Part 4 of tbis report) iDdicated that FO~1C mence during 2014, The remaining six participants participants(the membersof tbe Board of Governors judged that raising the federal funds rate sooner would and the presidents of the 12 Federal Reserve Banks) be required to forestall inl\ationary pre>suresor avoid general~' anticipated aggregate output to incmse at a dinortions in the financial system AU of the individual somewbat faster pace in 2012 tban in 2011, Altbough asseS>tnents of the appropriate target federal funds rate the participant> marked down their GDP gro\llh pro Ol'er the next few years were below the p3rticipanB' jections slightly compartd \lith those prepared in estinutesof the longer-run lel'el of the federal funds Norember, they stated that the economic information rate. EltI'en of the 17 participants placed the tlrget rt(eived since that time showed continued gradual federal funds rate at 1 percent or lower althe end of impromnent in the pace of economic activity during 2014, while 5 >.1\1' the appropriate Tate as 2 percent or the second balf of 2011, as the inOuence of the tempo bigher, rary factors tbat damped actil'ity in the first half of tbe A sizable majority of participants continued to year subsided, Howtl-er, a number of additional fac judge the leYe! of uncertainty a:.sociated witb tbeir pro tors, including ongoing weakness in tbe housing sector, jections for real activity and the unemployment rate as roode,t growth in real dispoSlble income, and the exceeding tbe al'erage of the pan 20 years. Many also restraining effect~ of fiscal consolidation, suggested attached a greater-than-nomulltl'el of uncertainty 10 that the pace of the recoI'ery would be modest in corn their forecasts for inflation, As in November, many ing quarter~ Participants also read the information 00 participants 5.111' downside risks anending their fore economic activity abroad, particularly in Europe, as casts of T¢al GOP growth and upside risk; to their pointing to weaker demand for U.S, exports. As these fort<'astsof the unemployment Tate; most participants factors wane, FOMC participants anticipated that the viewed the risks to their inHation projections as pace of the ecooomicexpansion wiU gradual~' broadly b.1lanced, Participants also reported tbeir strengtben over the 2013-14 period, pushing the rate of asses;;ment, of the values to wbich key macroeconomic increase in real GDP above their estimates of tbe variables would be expected to convergeovcr the longer-run rate of output growtb, Witb ~I GOP longer term under appropriate monetary poUcy and in expected to increase at a me,t rate in 2012, tbe the absence of further shocks to tbe economy, The cen unemployment rate was projected to decline only a traltendencies of tbese longer-run projections were Ullie tbis year, Participantsexpe<:ted further gradual 2.3 to 2,6 percent lOr real GOP growtb and 5.2 10 improl'elOOlt in labor J11.'Irket conditionsol'er 2013 and 6,0 percent for the unemployment rate, In lightof the 2014 a~ the pace of output grolllh picks up. They also 2 percent inHation tiut is the objective included in the noted that inHation expectations had remained stable statement of longer-run goals and policy strategy over tbe past year despite Ouctuations in headline adopted at the bnuary meeting, the range and central inHation, Most participant; anticipated that both tendenc:-' of participants' projections of longer-run beadline and core inRation 1I0uid remain subdued oyer inflation were aU equal to 2 percent. 61 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00065 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.01021103 Part 2 Recent Economic and Financial Developments Real grossdomeSlic product (GDP) increased at an The fiscal and banting crisis in Europewasa pri annual raleor 2\1. percent in the second half of 2011, mary focusof financial marketso\,er tbe course of tbe according to the ad\'loce eslinule prepared by the second balf of 2011 and ear~' 2012, Grolling concerns u.s. Bureau of EoonomicAollysis, following growth of Jess regarding the potential for spillovers to the than 1 percent in the first half (figure I). Actil'it)' WlS economy and financial markets weighed on inl'estor held down in the 6rsl b31f of the year by temporary sentiment, contributing to significant I'olatility in a factors, particularly supply chain disruptions stenuning lIide range of asset prices. Nonetheless. de',elopments from the earthquake in bpan and tbe damping effect in financial markets ha,'e been mixed, on bJlance, since of higher energy priet; on consumer spending. As the July. Unsecured dollar funding markets became signifi effec!! of these factors wanedo\'er tl!{ second half of cantly strained, particularly for European institutions, the year, the pace of eoooomic activity picked up. But though U.S, institutions generaUy did not appear to growth remained quilt lOOdestcompared lIith previ face substaDlial funding difficulties. Risk spread! on ous eronomicexpansions. and a Dumberof factors corporate debt stayed elel'ated, on nel, but )ields on appear likely lD continue to restrain the pace of activ corporate bonds geoeraUy IOOwd lower, Broad equity ity into 2012; these factors include restricted access to prices, which declined significantly in July and Augusl, credit for nuny bouseboldsand snuI[ businesses. the subsequently returned to levels near those seen in early depres5e\l housing nurkel tight fiscsl policy. and the July, Credit conditions for trostlarge nonfinancial spiUovereffeclsof the fiscal and financial difficulties in firms were accommodative and corporate profit growth Europe. relTllined strong. Conditions in the labor nurket ha-.'e improved since In response to a paaof oconornicgrowth tbat was la,t summer. The PJce of pril'lte job gains has somewhat slower than expected, the r-ederal Reserve increased, and the unemployment rate has JOOred prolided additionallOOnetary policy acronunodation lower. Nonetheless, at 811. perctnt, the jobless rate is during the second half of 2011 and early 2012, Part~' still quite elevated, Meanwhile, consumer price infla, as a result, Treasul)' yields mnl'ed down signifieantly, tion stepped down from the higher lerelsobser.edorer and market participants pushed out the date at wbicb the first half of last year, as conumdity and import they expect the federal funds rate to more abo"e its prices retreated wbile Ionger,term infiltion expecta current target range of 0 to II, percent and built in tions remained subJe (figure 2), l. OIange inrtal gross OOmestic proouC!, XIOS-ll 2, (baoge in \hecwill-t)"pe price iD;Jo; f(I personal coosuu:¢oo expenditures, XIOS-ll - , -, - , -, - , - , It t I :D.lS m 'YfI m 10CJIl altO altt I I :D. ! lS m 'YfI t ) Xl! m altO ! alIt t 1 Non: 1'-..t n """""""r(II ... <=Jt .. Id!<l~ b 'V'''' pttJCd ...a sondlnf' fNl.".,n&o.1ho rNl~<l.lhoft~ Non: ')h, dill. "" ..nhIy ..t"m;J ~ D<ctmb<r 201 t; cl\q« """ a-.i.,.,..,Y""'''';'' SoolCl: ~Qie:.lDtfct,8In",Qi"""-"AfI3ty'k Sow;,;; n.p.._<l.O:a. ...c t,II_IIU<I.~Ana!)·.;._ 62 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00066 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.11021103 6 Monetary ItIli<:y Report to the CongressO February 2012 expectations of a 100ft gradual pactof increase in the 4. Pe!SODll sal·ingrate, \988-20\1 - federal funds rate after liftoff. -. Domestic Del·elopments -. The Household Sector Consumer Spending and Household Finance - , Real personal consumption expenditures (PCE) rose at an annual rate of about 2 percent in the second half of 2011. follollinga rise of just lYi percent in the first half of the year (figure 3). Part of the spending gain was attributable to a fourth"'luarter surge in purchases of t ]!!!II II ]]]]]]]II III III]] IOOtor vehicles fol\oll;ng I·ery weak spending last 1991 tm 1999 m 'XIJI 3Jll spring and summer stemming from the damping effects NO'll: n..u. .. ~nl<1t<n:1tm.gh::nll:Q1 of the earthquake in bpan on IOOtor vehicle supply. Sow;,.; n.p.._olOJm""'ce.Il"'lIDof~AruIy';"" Even lIith the srep--up. however, PCE growth was mod est compared with prel'ious busincsscyde recoveries. both the number of hours lI'orked and lverage hourly This subpar performance rellects the continued weak wages adjusted for infiation, rose at an annual rate of ness in the underlying determinants of consumption, J peltent in 201). The increase in realwlge and salary including sluggish income growth, sentiment that income reflected the continued. thougb tepid. re\Xl1-er· remains relatil'e~'lowdespite recent improvements, the ies in both employment and hours worked; in contrast, lingering elfectsof the earlier declines in household hourly pay w3slinie changed in re.1lterms. wealth, and tight access to credit for many potential The ratio of household net lIurth to DP! dropped borrower~ With consumer spending subdued. the sav back a lillIe in the second half of 2011, reOecting fur ing rate, although down from its rerent high poin~ ther declines in house prices and equity values remained above levels tbat prevailed prior to the reces (figure 6). The wealth-to-income ratio has hovered siOD (figure 4). close to 5 in recent years, roughly the le\,elthat pre Real income grolllh iscurrent~' estimated to hal'e I'ailed prior to the late 19901, but well below the highs been I-ery weak in 201 1. After rising 2 percent in 2010, recorded during the boom in house prices in the mid- aggregate real disposable personal income (DPI} 2Q((1s. Consumer sentiment, which dropped sharply personal income less personaltues, adjusted for price last sununer, has reboullded since then; ne\"ertheless. changes-was e5St'lltial~'fiat in 2011 (figure 5). The wage and salary romponent of real DP!, which reHetts s. a.:mge in real dispc&bJe pt'rsoJl:ll ilK'Ol!le and inrt;ll \\'age and salary disoorsements, 2OOS-11 - 3. (bange in ml pmooal oonsumpuoo e:qltnditwcs, 200$--1] -. -"'-"" -, -, =11 ni'i=~ - , I -, I - , -. - , -, - , - , !] I ! ] ! :ro; :ro; m )Xl! m lOtO )'lIt I] ] :ro; m 'K1fl m m IlIO !lIt d N ill a u n: o C o b _ q o t m ,, . & . i . 1 .. , D .. o , o m :t . I . _ .. " .0 ' 0 • ~ .... . .,. d T i h I ! t u ,. , . , 1 _ . d . d . l . M -.:1 o w d . by , S N o o o n o : c t: n : . ~ .d < II l .. . .. e .,.. o ... . ,1j _ -n . l B "' o _t . lr . n . J . t d h . < "" l " :l - l , l , :Q A - n l aIy1,~ " S " o p w. < -?: r n « . D p. O . I ._ ~ d t C ~ om d _ t ce o , . I c \_ . l . ID of~AruIy';" 63 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00067 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.21021103 &wd of a>\~or$ of/he Federal ~r\'e Syslem 7 6_ We3lth-lo-iocOO1e rltio, 1988-20[ I and interest payment on existing IOOrtgagesand con _____- -"0. sumerdebt relative to income-also decreased further and now isat a lel·ella;t seen in 1994 and 1995 (figure 8). -1 The IOOderateexpansion in con;umer credit in the secoDd balf of 2011, at an annual rale of about /I -. - II. 4Yi percent, has been dri'.-en prinurily by an increase in nonrevo\ving credit, which acrounts for about two· -~ ~ ~- l thirds of total consumer credit and is composed nuinly of auto and student loans, Re\1)ll'ing consumer credit (prinurily credit card lending). while conlinuing 10 Jag, appeared to pick up somewbatlOwlrd the end of tbe year. The increase in consumer credit is consis tent with recent re;ponses 10 the Senior Loan Officer [""" ' " '"'"" '"" ' " I 19'11 1995 1m :m3 1«J/ Xlll Opinion Surwy on Bank Lending Practices(SLOOS). .. N . o . n : Tho <10:. "" """"ly..t nt<n:l ~ )Jll:Ql Tho ... olth· Indeed. trodest net fractions of bank; in both the "'~,...,islhern,d_ ... wtttlrt()~~p"o<:tl.ol Cktober and January sur.·e}'S reported that they had ScoRe!: Fa "" ....... r.dtrol R.ooorn Boood.lIowoflirldsd. .; for eased standards on aU major C3.legoriesof consumer _.~oCCom..,.".s... .. de.",.,.i<Ar..tyri< loans, and that demand had strengthened fOf auto and credit cards loan. on bllance. HcwC\·er, data on credit the.>e gains only IOOvcd sentiment back 10 near the top card solicitations suggesllhatlenders in tbat area are of the range tbat bas prevailed since late 2009 prinurily interested in pursuing bigher-quality (figure 7). borrowers. Housebold debt-tbe sumof both IOOrtgage and Indic3.tors of consumer credit quality generaUy consumerdebt----mntinued to IOOI"e lower in the sec improl~. Delinquency rates on credit card loans ond half of 2011. Since peaking in 2008, household IOOVoo down in the second half of 2011 to the low end debt has fallen a tOLl) of 5 per«nl. Thedrop in debt in of tbe range ob>en-OO in recent decades. Delinquencies the second balf of 201 I reflected a continued contrac and chlrge-offson nonrevol\'ing consumer loans also tion in mortgage debt that lI'asonly partiallY offset by generally imprc\~. MOr(:()\'er, a majority of respon a m:xiest expansion in consumer credit. L1rge!y due to dents to the hnuary SLOOS reported that tbe)' expect the reduction in OI-era1l household debt levels in 2011, further impl"()\'ement in the quality of credit card and the debt ser.'ice ratio-the aggregate required prinCipal other consumer loans this year. 7. Coosumer sentiment iIJde.\es, [998-2012 8. HousdloIddebl senice, 1984-2011 - '00 I ' I ) ' ) X I I I m ' , I m ' I ' m I I ' X I l12 ' I ! [![ 1 I m [[ [ 1 [ 9 I 91 [ !1[m! [! 1 [ m [[ [ » I[ )l ![ x ! m [ ![ X [ I [ II ! R X ~ l N S . ) I t 2 o M o o ; J i n : . C 1 . . : u . ! . T 2 : . . . h . T ; . o m . h c m " o . i r n " y c n . . : . m . i d . s r . . . . . . m r ~ : . - ! . . . i . . . B d u . u . O m t O d ; 8 . ' I . o " d . ' o d d " o 1 l ; ' < J O u 1 0 « " : . " • p " . J > • t I a . ' l : • I n r I 1 c 1 . - h : 0 0 . . 0 l 0 . . . y h " . i . , . n l r j . 1 - 9 t ~ 6 1 n 9 6 . 8 t . . 1 t e _ r n . d T . t ~ h u e o " l r " . d m n. l . ~ .: } .. " ... ,.. o .r f P O . N S I b . o o ) q I n " E I , : _ ! f ! T i . ~ < < h r U o n . I d r d. < i t .i r ~ u R l . l d l " m R " " . . , . ~ - . . r . . v - . 3 - . f . t< b I d . , . d " " " t ' ' . P . . I . " I . - 1 « I I m ru [l o O ./ d h l d n ' _ r D s t h a b > t X " o l " ll u i : f Q < u 3 d . a n - q d .b . F t a i o w t m l r 4 ' i . o . < .. l M"-1Ij~:n S. ...~ 'd C;o.um..~ 64 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00068 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.31021103 8 MonetaI)' ItIli<:y Report to the CongressO February 2012 Interest rates 00 consumer Joans held fairly steady, 10. PriI"lubousiogstlrtS,I'I98-20l2 on net, in the second half of 2011 and into 2012. Inter est rates on new-auto Joanscontinued to be quite low, while rates on credit md loons reffi1ined stubbornly high. Indeed, spreads of credit md interest rates to the -u two-)'eJrTre3iury yield are I"er)' elel'ated. Consumer asset-backed smlritieS (ABS) issuance in the second half of 2011 was in Une with that of the prel'ioui 18 IOOnths. Securities backed by auto loans " continued to dominate the market, while issuance of credit card ABS remained weak. as growth of credit card Joans has reffilined subdued and IOOst ffi1jor -~ banks have chosen to fUDd such JoaDson their balaDce sheets. Yields on ABS and their spreads over I I I I I I I I I I I I I I I I I comparable. maturity swap rates were little chaDged. on 1m 2(0) 3Xl2 IDI m m ))10 ))12 net, om the second half of 2011 and C.1.rly 2012 and Nom: Thod:r.a ... ..-hIynltlt<fldlk;qh~))ll reffi1ined in the low range that has prevailed since 500= I:<po.!_ofeo."""",B ...... oflhtc...u. C.1.r~' 2010 (figure 9). IOOrtgage insured by one of the housing gol'ernment sponsored enterprises (GSEs)-rontinue to fatt diffi Housing Acth'ity and Finance culty in obtaining mortgage financing. Mor(:(lI'er, much of thedeffi1nd that does exist has been chan Actil'ity in the housing sector remains depressed by neled to the abundant stock of relatil'e!y inexpensil'e, historical standards(figure 10). Although affordabilit)' vacant single-family house~ thereby limiting the need hH beeD boosted by declines in bouse prices and his for ntw construction aail;ty. Gil'en the ffilgnilUde of torically low interest rates for conl'entionallOOrtgages, the pipeline of delinquent and foreclosed homes, this many potential buyers either lack the down payment factor seems likely 10 continue 10 weigh on activity for and credit history to qualify for Jo:lDsor are discour someume. aged byongoing ooncern, about future income, Nonetheless, ftctllt indiCllDrsof housing construc empJo)1l1eJlt. and the potential for further declines in tion actil'ity Jure been slightly ITKlre enoouraging. In house prices. Yet other potential buyers-(I'en those particula~ from July 2011 to Jln~ary 2012, new single lI;th sufficient~' good aedit records to qualify lOr a fami~' homes were SlJrted at an average annUlI rate of about 455,000 units, up a bit from the pace in the first 9. Spre3ds of assel-backed securities }iekk 0I'e( rates 011 half of 2011. In the multifamily mlrket, deffi1nd lOr oompanble-maturity interest rate SWl(lS, 2007-12 apartments appears to be increlSing and I'aeaney rates have falkn, as families who are unable or unwilling to -------------------------."'.~ purchase homes are renting properties instead. Asa result, starts in the multifamily sector aI'eraged about -" 200,000 units at an annUlI rate in the second JuIf of 2011, still below the 3OO,000-unit rate thai had pre vailed for much of the previous decade but well alx)I'e the !oil'S recorded in 2009 and e:lfly 2010. Uouse prices, as measured by several national inde:xe~ fell furtherorer the second half of 2011 (figuft 11). One such measure with wide geographic coverage-the CoreLogic rtpelt-sales index- fell at an annual rate of about 6 percent in the socond half of the year. House priCes are being held down by the same factors that are re.training bousing construction: the high Dumberof distressed sale~ the la~e inl'enlOl)' of Non:; Tho <hi, 10' -u,. nl ..t ml ~ F.«u.y 23, ))11 Tho unsold homes., tight IOOrtgage credit conditions, and o le p u t l . i . l . , . . . .. " . " . t ,. w " - 1 j 0 ' ' < t i h I o _ )'l I t i il l ; l " < " l . _ ., ,, l ,, U " r1.Ud-,. """.bo.:bd ..,..,. .. lackluster deJl1.'lnd. The inl'eJ)tof)' of un>old homes 5cm:C!: /P!olcqan 0.... &: Co. likely will remain high for some time. gil'en the large 65 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00069 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.41021103 &wd of a>\~or$ of/he Federal ~r\'e Syslem 9 II. PrictS of existing single-flDlily booses. 2001-1.1 ... 12. Mortgage delinquency rates. 2(0)..11 -------------------------',. ------' _ Pnroe and rear prime I I I { I I I • :DJt lID 100S =Sut>prime ('-=:!iJ I I I I I I I I I I. n I I "" '" '" " Al "N F o A "m .:> r r u u<t . " .". c ,1 ( b I h u b I a _ i n I, l . p ) .; ' d '. < J O I is y IN o 1 I. 0 l a t 0 !< l . O d i W tl b l ) l d ' tl n l b e e o C ) 0 t ) u f I I I l .' : . . Q o . . s ! < i . < i W . I F '' o '' d r i n i rr l a l n e l J I . H . n . O . t l U w b Il n e ! -~- IO E S 1I & I M P <I K I I : q t _ < . I . l ; S ~ h O " i . o l . lt m . < . . m g,. '' ) 'l le< "" t , < U I . O . .. ! . '1 · ,· m ~ . . I . f . 1 . In '' : ' t '' io ''' n - I w . 0 . f i I n Iy , . . . ..." u 1« " I I I I X OI I I X O} I I 1 00S I I m 1 I I ) ))9 I I ) )ll I I n ~ u S m ; w b tc b e ! r ; R o s w f . t h C I' o !l a : m . tl . o e .- s s S " h t . h l I C a tt t a . S t a L t r o o e n p : a b :; r l d r f e & a a P d A o y o lF r A i · n • . . F th o e dn f a o l f ~ tClmu " re '" "" ; n 'h N t o .. n p " ! : ' K P Th " <" : ' l" " d t<" l In i u .' l m't l '. . '. ~ . 9 II 0 N C d f o o Ih p ! o e y < . < . - _ d " , " , " ". " ) n " ) d " 1 l l 1 b ~ b e l < , l . i q o n < n n t . " . . . : . " b D a "" ) ) o 1I k ~ rl . '_ . pipeline or could be entering the pipeline in the coming C~atlosic . iind .." p" .... J1ISAwlitdAnol)-to::s;b oUlp' .... month~ Al a mul! of the cumulatil'e dedint in bouse pricesowr the put several years. roughly one in fixe Intere!t rates on fixed·rate mortgage! fell steadily mortgage holders owe more on their mortgages than during the sroJnd half of 2011 and in elrly 2012 thdr home;; are worth. (figure 13), though not as much as Treasul)' yields. Indicatorsof credit quaUt)' in the residential mort leal'ing spreads to Treasury securities of comparable gage sector continued to rellect strains on homeowners confronting depressed home values and high unem. maturities wider. The ability of potential borroll~rs to obtain mortgage credit for purchase transactions or ploymenl. In December, serious delinquency rates on refinancing continued to be limited. In part, the low prime and near-prime loam stood at 5 percent and level of mortglge boIT(llling reflected characteristics of 13 perct'nt for fixed· and variable-rate loans, respec tively (figure 12). While delinquencies on variable·rate the would-he borrowers, most prominent~'the wide spread incidence of negatil'e equity and unemploy mortgages for both prime and subprime borroll'ers ment. In addition, credit supply conditions remained have mol'ed down OYer the past two years, delinquen tight. Indeed, it appeared that some lenders were reluc cieSOD fixed·rate mortgages hal'e held ;teady at lel'els near their peak! in early 2010.1 Meanwhile, delin· tant 10 extend mortgages to borrowers with leSHlian· pristine credit even when the resulting loans would be quency and cbarge-olf rates on second-lien mortgages eligible for purchase or guarantee by GSh' One held by ronks also are at elel'ated lel·e[s. and they have nunifestation of tbis constriction was the facttbat the declined only slightly from tbeir peaks. distribution of credit ;;cores among borrowers who The numberof properties at some stage of the fore succeed in obtaining mortgages had shifted up signifi. closure process remained elel'ated in 2011. This high cantly (figure 14). As a result of these inOuences, the ltl~l partly rellected the difficulties that ITVrtgage ser· pace of mortgage appUC.1tions for home purchase ' t l h c e e i r r s f o c r o e n c t l i o n s u u e r d e t p o r o h c a e \ d ~ u r w e i ~ th R r e e r r o o l l u l'i t n io g n d o ef f i c t i h e e n s c e i e i s s s i u n e s d re e m c~ a n i e n d s , v o er n y n s e lu t. g o g v is e h r . t T he h e s r S o l J m n e d f h a a c l t f o r o s f a 2 l 0 so 1 1 a p an p d e ar to could el'entually be associated with a sustained bare limited refinancing actil;ty. whicli remain! sub increase in the p:1ce of completed foreclosures as seT dued compared with the large number of households I;cers work through the backlog of St\'erely delinquent loans. 6. M e:wupIc, <>DIy aboullatf of leaden ..p emJ to Lo:nSifler dati 1lt'I'i:u lhat ~ muid o/ft1ao om'ttIUooal fully doctuueclo.:! 5_AmM~agtu""iiDol>l!eriOU$/yddj"lu"l!;flbe~jl mMpg< ..i 1b.90"• • ttll!\oa"l"'''''hrftliofor~ ..' i!h 90 day.; or """" behind in pi)1llClll< or {be prorerty iI in k...::100= FICO~of 620. 66 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00070 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.51021103 10 Monetary ftlhcy Report to the CongrtssO February 2012 [3. MOI1gageinle!eslrlles, [99S-2012 ... faster than in the fif'lt half (figure [5). Much of tbis strength was recorded in the third quarter. Spending growth dropped back in the fourth quarter, to 5 per -, cenl,likely reOetting-among other inHuences -, heightened uncertainty of business owners about global economic and financial condition~ Allhougb spending by busine.se;; for high-tech equipment has held up reasonably weU, outlays for a broad range of other E&S slowed appreciab~'. More m:ently, boWell:r, indicators of business sentiment and capital spending plans generaJ~' hal'e improved, suggesting that firms -, J1l.1.)' be in the process of becoming more willing to undertake new in\'estment~ After tumbling throughout J1X)st of 2009 and 2010, [ I II1 9I 9" 72" OI :)I )I n"n m" mI :rI ll" 2 I real inl·estment in nonresidential structures other than Non: Thtdn, """,,,:I"< wt<kI)' RI",,1tIId h"'IdIf.tbru.y12. ~Il. drilling and mining turned up last spring, rising at a ... ",""",,,,,. .. <tl:JO.)'<,,""".!~ surprisingly brisk PJce in the second and third quarter> SooOCL Fodn~ I"-l<>IIII~htt. Capc:ulm. of 2011, Howem, inyeslment dropped back in Ihe that would potentially benefit from the low ratesalllil fourth quarter. Conditions in tbe ~tor remain diffi cult: Vacancy rate. are sliU high, pri«.of existing able to high.quality borrowers. structures are low, and financing conditions lOr build· The outstanding stock of nxmgage-backed securi er> are still tight Spending on driUing and mining ties(MBS) guaranteed by the GSEs was little changed, structures also dropped back in the fourth quarter, but on net, om the second half of 201 l. The securitization J1l.1.rket for IOOrtgage loans not guaranteed by a housing-related GSE or the FederalllousingAdminis 15. Change in real business fIXed iIlvesbDeot, 2005-11 [ration continued to be e~ntiallycloscd, -" The Business Sedor Fixed lm'estnrent Real spending by businesses for equipment and soft ware (E&S) rose at an annual rate of about II perctnt over the second half of 2011, a pace tht wasa bit -" 14. Cr.:dil sroreSOODeW prime mortgages, 2((13-11 - ------------------=~- t [ [! [[ [ , I mmmmml.llOl.lll.. ,""""- -~- " o s..rt.. . ndudqIlDltDl~i11iot - -~-'> - - ' 1 " 00 • ~lnrI!DI~,n", - 00 - -1.rJ -< Mfdillll - 1lJ ::~::: - 1,.,,,,,_,10 - WJ - -"" I I [ [[ 1 I I I nnmmml.ll1 NO'!!: Thtdn, _i1."'W<!U<haoo __ l~<rly>.,._hlyRi ",1tIIdtt..;qh~l.l11 Soom: IPSAp;IIiodAnolytri 67 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00071 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.61021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 11 outlay~ in thi~C3.tegOly should continue to be ~up' at a I'ery high level. and the aggregate ratio of debt to ported by elevated oil prices and advances in technol, assets-a measure of corporate lel'erage-stayed low. ogy for horizontal drilling and hydraulic fracturing, With corporate bJ.1ance sheets iu generally healthy shape, credit rating upgrades once again outpaced downgrades, and the bond default rate for nonfinancial In~'tntory Investnrent firms remained low, In addition, the delinquency rate on commercial and industrial (C&I) loans at commer Real inventory investment stepped down a bit in tbe second half of 2011 (figure 16), Stoc1building outside cial banks rontinued 10 dcdine and stood at around l'h percent at yeaHnd, a level near tbe low end of its of Imtor I'ebicles increased at a mode;! pace, and ~ur­ bj",orica1 range. Most banks responding to the January l'eyS sugge;t that firms are generally comfortlble \I;th SLOOS rqx>rted thai they expected further improve theiro\lll, and their customers', current inventory ments in the credit quality of C&I loans in 2012. position~ In tbe Imtorvebicle sector, inventories were Borrowing by nonfinanciil corporations continued drawn down in the second half, as the rise in sales out at a reasonably robust p3ce through the second half of paced tbe rebound in production foUowing tbe supp~' 2011, particularly for larger, higher-credit-quality firms disruptions associated witb the earthquake in Japan (figure 17), Issuance of inl'eStment-gflde bonds pro Ia;t spring, gtt;.sed at a strong p3te, similar to that observed in the first balf of the year, buoyed by good corporate credit Corporate Profits and Business FiNlnce quality, allracti\'e financing conditions. and an improv ing eronomicoutlooi:.. In contrast to higher-grade Operating earnings per share for S&P 500 firms contin bonds. issuance of s~ulatil'C-grade bonds dropped in ued to rise in the third quarter of 2011, increasing at a the second half of tbe year as investors' appetite lOr quarterly nne of nearly 10 percent. Fourth.quarter riskier assets waned, In the market for syndicated earnings reports by firms in the S&P 500 published loans. investmeDl-grade issuance JOOved up in tbe sec through late February indicate tbat this measure bas ond bilf of 2011 from its ilready strong first,bilf pace. remained at or near its pre<risis peaks throughout the wbile issuance of bigher,yielding syndicated leveraged second half of 2011, loans weakened (figure 18), In the corporate lector as a whole, economic profits. C&lloanson banks' books gr(N,' steadily o\·er the which had been rising rapidly since 2008, increased second half of 2011, Banks reporledlycompeted further in the second half of 2011. This rel3tiwl), aggressil'ely for higher-rated credits in the syndicated strong profit gr<l\l1h contributed to the continued leveraged loan market, and some nonfinancial firms robust credit quality of nonfinancial firms in the sev reportedly substituted away from bond financing ond balf of 2011. Although the ratio of liquid assets to OO:auseof volatility in bond sPreJd~ In addition, total asselson tbe balance sheetsof nonfinancial cor according to the Sl(X)S, some domestic banks gained porations edged dO\\'ll in tbe tbird quarter, it remained 17. Selecto:l oom!XJlleDlS of 00 financing for nooflDlIlCial businesses, 2005-1I 16 OJangein lealllIsilWss illl'('fItories, 2005--11 _ '00 -" -< I I I I I I I I ! ! t Dl'i3ll6mmm3:l1O))1 t I l I ))l\ m VJ1 m m ;010 ))Il Non: fu<b!'k<~--,<=p_",........tIj' Idj.-L Sow::>;; Fo.kalJ<e.o.o..Bo.d.tIo.<l.ltn!t:dat~ 68 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00072 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.71021103 12 Monetary ftlhcy Report to the CongrtssO February 2012 18. Syndicated ioonissulDCt, by credit quality, 2005-[ I Borrowing condition, for muller businesses contin ued 10 be tighter tban thOl:e for larger 6rms, and their dern.'wd for credit rermined reLltively weak. \Iowe\'er, "' - ,., some signs of easing began to emerge. Surveys con ducted by the National Federation of Independent "' Business showed tbat the net fraction of snull busi nesses reponing that credit bad become rrvre difficult - <00 to obtain relative to tbe previous tbree montbs HI HI decUned, on baJaoce. during the second balf of 2011 (figure 20). l\loreo\'e~ tbe January 2012 SLOOS found that terms for smaUer borrowers bad continued to ease. and about 15 percent of banks. on net. reponed that demand farC&lloans from smaUer firms had [ I I I incre3sed, the highest reading ~ince 200S.lndeed, C&I loans held by regional and cotrulUlnity banks-those Nom: L<-m~Io;n-..< Io;n-,*"lIBt,. _.,.1H*<IIo;n-.liII not in tbe 25 Largest banks and likely to lend mostly to . .. - ... . , . . I _ lB 1 C I il u .1 I 1 " > , o , ·• b • 'o • t o o p f I .. r . H '1 'I '. ' . . . i :1 l d rt l q o .J l n h d t l l. e < t n . b lo J o n io l o O t b r o h f l t a : b d t f l t o tt :l d . middle-market and small firms-adl'anced at about a 1rnrO«d1oon v. .... aoo::<dOJglo_oordiIio:m..Jircmtlllly 6 perttnt annual rate in the serond balf of 2011, up U' s l . b o ! < < m K z p : o T !If< h . o.smRMt.,~ from a 2~ percent pace in the 6rst hair. Commercial mortgage debt hascoDtinued to decline, albeit at a!mre mxlerate pace tban during 2010. business fromcu~tomer; that sbifted away from Euro Commercial real estate (eRE) iOlDsheJd on banks' pean banh Altbough domestic banks reported ~ule bookscontracled funher in the second balf of 2011 change, on net, in lending slJndards forC&lloans and ear~' 2012, though the runoff appeared to ebb (figure 19). they reduced the spreads on these l03nS3; somewhat in 2011. That slowing is!mre or less consis well as the coS!! of credit lines. Banks that reported tent lIith recent SLOOS responses, in which JOOderate ba\ing eased tbeir credit standards or terms for C&! net fractioDsof domestic banks reported thatdemaDd loans onr tbe second balf of 2011 unanirmuslycited far such loans had strengthened. In the January survey. increased competition from other banks or nonbank bank; also reported that, for the first time since 2007, SOUKtS of funds as a factor. Ihey had raised Ihe nuximurn loan size and trimmed 19. G ind a u n s g lr e i a i l n l s o t o a n ll s ( , b 1 rd 99 s 1 a - n 2 d 0 ~ 1 l 2 l llIld fa: OOIlIIllercial and 20 Net percentage of smaU busiresses IlIat reported lIKKe difficulty in obtainingcr~di{, 1990-2012 ------------.------."'--~'.' --------------------------~.~ ,,,,,", -J5 - .1$ I I I I ! I I ! I I ! I I ! I I ! I I ! I I " I I Iml996m:n»m8))1? ; )' Q <' N 0 1 < O ; l : ! Q I ! h : 4 t 1 . 1 E I > t 0 o ! < I d 11 " > 1 " . > . " n " " . , . " , 'I < 't' i '. . ' ' ~ " ' n '. I p t f r o o f I r • o ,, • . " . " D . " . I n . J , . h . g t . ' , I . , I y , tD , ,t 3 l o l : y l n t r 2 l o I n . .l h . h : . ! t .t < ) . ' d . , . . . p . ·h t . K to . < h . fI . , I , , . " ! , < P 'm o '" f ..> N S = a lOl) T ' h o o d il d S o I l t o < I; 1 r 0 f ' t : th Ia\ . ( n " "" i " < '1 a lb < • C . I . . i . . ' . & y . < . m tho ir t J « D I lK ~ )' 3:112 - U .I " ' . Y . , "'1I"",cioimlini.o"'ioI""",,,,domtsIitft~·bolm;<""foI ~hio."'''''''''O'':' ... 3:II1,Thod3<.rtp<stnlIht~ofb«roo.. ... P .r '" u : h h " b , a -rmt.r..t p 'II O 'fh < I ~ t . d b ~ o ~ > O < W d l " : , I C u . d r o I O R l < ~ p I o w r I t d d : m . - "n 1 : 1> l 0 O < " h < > I do r : f Ib t o : n ' .m *" tw Ul g I l n o ! a : « n ti . d .. i t r h l o m p" t ' h . o .. ~ .. t . h .. o m I . r - < t p h O o I : I ,~ f ' d " - "" .. < . i . / . f . o ~ ruky .. nli<lI<ptnod>olba ..... """""" .. d:lln.dbylht N.1iomI Bm. .. of """ E S > ow x : m !:: . ~ ,, . ~ I ~. Bod s.n.x to.n Off_ Oponm s...y on Soula: NaIIOrI>lFodtfall<llofl~B""""" Bri.~~ordC.IIRt9om. 69 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00073 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.81021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 13 spreads of rates on CRE loam overtheir cost of funds completely. Delinquency rates on eRE loans in CMBS during the past 12 I1'I)nths. By contrast. life insurance pools held steady just below 10 percent. companies reportedly increased their holdings of CRE [n the corporate equity market gross issuance loam, e>pe<:bJly of loam issued to bigher-qullity bor dropped significantly in the third quarter amid sub rower~ Althougb delinquency rates on CRE loans at Slantial eqUity market I'olatiliry, bur it retraced a part commmill blnks edged down further in the lOurth of thm dedille in the fourth quarter as some previously quarter, they remained at high levels. especiaUyon withdrawn issues were brought back: to rhe market. loans hrconstruction and land dC\'elopmen~ delill Net equity issuance continued to dec~ne in the Ihird quencics on loans held by life insurance companies quarter, reOeclillg the contillued strength of cash· remained extraordinarily low, as they have done hr financed mergers and share repurchases (figure 22). I1'I)I'l: than a decade (figure 21), Vacancy rates for !TKlst types of commercial propenies are still elevlted, exert The Gowrnn.:ot Sedor iIlg downward pressure on property prices and impair ing the performance of CRE loans. Federal Government Conditions ill the market for commercial trortgage backed securities (O-IBS) worsened somewhat in the The deficit in the federal unified budget remains I'ery second half of the year, Risk spreads on highly rated wide. The budget deficit for fiscal year 2011 was tranchesof CJ\tBS 11'1)\'00 up, on balance, and about $IJlrillion, or 8~ pelttnt of nominal GOP-a leI'eI half of the rtSjXIndents to the December Senior Credit comparable \\;th deficits recorded in 2009 and 2010 Officer Opinion Surrey on Dealer Financing Terms but sharply higher than the deficits recorded prior to (SCOOS) indicated that liquidity coDditions in the theonstt of the financial crisis aDd recession, The bud· markets for sucb securities had deteriorated somewhat. get deficit continued to be boosted by spendillg that Issuance of CMBS slowed further, but did not halt wascommil1ed by the American Rccol'ery and Rein vestment Act of 2009 (ARRA) and other stimulus policy actions as well as by thewe:lk:ness of rhe 21. DelinCfleocy rales OIl COOlIIlerci31 rell estale loans, economy, whicb has reduced tax revenues and 1991-2012 iIlcreased payment:; for income support. __c _. _._._.• _ _.. _" _ _______________- -C.. . Tax receipts rose 6\1 percent in fi;ca[ 2011. Howel'er, the lel'el of receipts remained very low: indeed, at around 15\1 percent of GOP, the ratio of receipts to national income is only slightly abol'e the 6O-year lows 22. COIIlpQllf'ntsQf net tqnity issuance, 200s-11 IIIII! IIII ! II! II I I! III I! I • 1991 t9'/.l t997 3D) 200J :m6 VII :.!O12_. ~~-;:: ( ='j • ~~- -.PIt.li<......,. - ,; • 1m. .. ,,,,,,,,,,, I I! III I! III I! II! III I! II! I - . Rt!u<holn 19'11 19'/.1 1997 3D) 200J :m6 VII :.!OIl - D _ M T" " ,. -F"m~ Non: Th:dJuf«~a1l>dfonJliCtlll\l"...,«JIIIPD'$ .. I I I I [ I! ! I I " h h " - -< " ~ q " i h '" .J o I.. n .l. J , . . " - " 2 . t 0 I > 1 g I 1 b < u T o ·b h g : h r l n : t . . ! d 0 ln 1 . 1 v . , . Q n . 4 < . n n J n ' ! , ( . ll . a l . l m : b Q s J ) . . . , " . . , , " . . " n _ " < I ,i J 1 v I o I y I ! l y o b . n T r J i h t o U : < f o f b n i : d > J Non :. ; r oN5 t!:m..6,. ...W..J,. . m the di/ m for .,.,.b 2O d t - O . .f< 2 J 0 I 1 I 1 O )";"",.j b)' OIBS ..... perMr!<iIonJOdo)-~<t ""'poII cb", rw:j """""' ~"""P""" ... pojIl"", P"" _btl m..:pty,<1t<d1buogh m bm .. ; . 60 o d ; o . j T - h ,< : t n _ . p ~ oI r I . h . < f< t t r l n il l t "..."..". ,"..",l._~~ t"'perMr!oI d U u .s. r < f. ~ . ~ ~ < ~ ..t> - im f u " rr " oe , -n"oOdr_. " I , in f i: < n riv j ts p I< l d , , by , , p , i. , .. , . , . , . 0 .. 1 , E S ll o .. o .. . . ~ ., . R , U :. :tn ., " . , , l . g C m ao l o l l l r lll: b od H R :l l , p ct1 ~ I . <i . C ar F lr " " " " ' i m al rr 1 . n :- o . 6 ( u C " o " Il , ~" S " < , :M , . , ta o : n n J . >t - : m l F o i : o lr m " o ' i ' a ' l :' , ' ! P n ~ I ""'_~Rtpc:t1;M""'I'T"" Rop:xt);f«if<'n'.n-.'. . ~.~Comcil<il4.r. ...." ~b Rop::rtbyPr""~~NObOrral\'. ..... Co{ootalA""".oon. alBS,Cil~ mV<rn<&m:-.", 70 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00074 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.91021103 14 Monetary ftlhcy Report to the CongrtssO February 2012 recorded in 2009 and 2010 (figure 23). The rise in re\'o spending that is a direct comp:ment of GDP.....{je enue~ in fiscal2011 wa~ the reiult of a robust increase creased at an annual rate of about 3 percent in the soc of more than 20 perrent in individual inrome tax pay ond half of 2011, a little less rapidly than in the first ments that reOected strong final payments on 2010 half of the year (figure 24). Defense spending fell at an inrome. Social insurance tax receipts fell about 5 per annual rate of about 4 percent in the 5C«1nd half of the cenl in fiscal 2011, held down by the temporar), 2 per year. a somewbat sharper pace of decline than in the centage point reduction in payroll tamenactw in first half. wbile nondefense purchases were unchanged 2010. Corporate taxes also fell around 5 percenl in ol·er this period. 2011, with the decline largely the result of legislation Federal debt surged in the second half of 2011, after providing more-favorable tax treaDnent for some busi the debt ceiling was raised in early August by the Bud ness inl·e.tment In the first four months of fiscal 2012. get Control Act of 2011.1 Standard and fuor·s (S&Pj, total tax receipts increased 4 perrent relatil·e to the which had put the U.S.long.termsovereigo credit rat comparable Ye3.r-earlier period. ing on credit watch negative in June, downgraded that Total federal oUIl.1.)"S rose 4 percent in fiscal 2011. wing fromAAA to AA + following the passage of the Much of the increase relatiw to bst yell" is attributable act. citing the risks of a continued rise in federal gOI' to theeulier unwinding of the effects of finlDcial eroment deht ratios oyer the me<lium term and dedin transactions, such as the repayments to the Treasury of ing conftdence that timely fiscal measure! nectSS.1.!)' to obligations lOr the Troubled Asset Relief Program, place U.s' pub~c finances on a sustainable path v,ould \\·hich temporarily lowered measuredoutl.1.ys in fiscal be forthroming. Other credit rating ageocie; subse 2010. Excluding these transactions. oullays were up quently posted a negative outlook 00 their rating of about 2 perrent in 2011. This small increase reHects U.S. sovereign debt. on similar grounds, butdid not reductions in both ARRA spending and unemploy change their credit ratings. These actions do not ment insurance payments as well as a subdued pace of appear to hll·e affected participation in Treasury auc defense and Medicaid spending. By contrast. net inter tions. which continued to be well subscribed. Demand est payments rose sharply, reHecting the increase in for Treasury securities was supported by market par· federal debt. Spending has remained restrained in tbe ticipants' preference for tbe relative safety and liquidity current fiscal year, with outlays(adjusted to exclude financial transactions) down about 5 perrent in tbe fifSl 1. On ~by 16, tilt frknl o'dlI ",,,,btd tl<: $14194 1riI~"" I;mi~ four months of fiscal 2012 relatr.·c to the comparable .00 lbe Secretary <>f lbe Tr=ury dcclarc.la -<kbt ;"""'''''' <IIipCIl year-tarlier period. o:ioo period" h !be 0.;1S micc R.tittment ,nd Disability Fun;\. pnmjnio;g!be TIWWy to !<dma , l'C'tioa of ni;mg T",OSU/)' As measured in the national income and product !l<"IlI"i!ies bdd by Ih>I fwd *1 invellnlttlli and 10 snspn>d ;"""'''''' rJ acrounl!(NIPA), real federal e.>:pendiIUfe! on con ".... TrtaSllr)'OO:wilico; to Ibal fund a, invei!IMIlS. The T",as"'Y sumption and gross investment- the part of federal .""bel!i'nsu;pcndill800med.··daily~lofT"",sury se<:IIriri<s bdd .. ~ by !be G<lImIlImI Securitiool,.....· ID<I!t Fund d t~ Fcdml Emplo)..s' R<timnent S)st<ID Thrift Saviogsi'bn 23. FeO.>raJ receipts andeJ:peOOitur~, 1991-201 1 . 2-:1 Cb:IDgI! in lell gOl·emroeut expenditures /¥<>IIct".,,,.IOOI' OIl consnmption illld inl"estmml, 2005-11 - -. ..." - D -. 1 1 " 9 'Il " 1 1 m ! " 1 " 9 99 " m" " m ! 7 " " lilt ! 1 _ Na fu , r ,; ; fl n l<" . >l . ) " "t " a. , «,(),,;@,nn: l I Ir ~ w . gh w . s. . p I . R "" . " . , . ~ . I t r " i '" I " d , o . w .j \l ~ " n ".;m.u.:I. (GDP) " fur tie klzo:pWl • ..-df\tonQ3. $oolCl: OIf""'d.~ianal<_ul~. 71 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00075 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.02021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 15 of such securities. Bid,to-cQI'er ratios were within his cneed a decrease in grants-in-aid from tbeir state torical ranges. and indicato~ of foreign participation gOl'ernment rert\1ined near their recentleveJs. Federal debt held by Issuance of Iong·term sccurities by state and loci! the public, as a percentage of GDP. oontinued to rise gOl'ernmenlS IOOVe<! up in the second half of 2011 to a in the third quarter, reaching about 68 percent p.1ce similar 10 tMt seen in 2009 and 20W.lssuance (figure 25), bad betn subdued during tbe first half of tbe year, in pan bcalusc the expiration of the Build America Bonds program led to some shifting of financing from State and Local Gomnmtnt 2011 intolate20lO, Yields on state and local gOl-emmeDl securities State and local governments rert\1in under significant decUned in tbe strond half of 2011 and into 2012, fi;cal strain, Since July, employment in the s(:(tor has reacbing 1¢I'els ne-ar tbe lower end of their range over declined by an average of 15,0CKl jobs per IOOnth,just the past decade, buttbey fell to a lesser degree than slightly un<!er the pace of job lossesreroroed for the first half of 2011, Meanwhile, reduction! in real con· }ield~ on comparable-l1llturityTrea~ury securitie~ The increase in the ratio of municipal boDd yields 10 Treas struction expendilUtesabated after a precipitous drop ury yields likely reOecte<!, in part, continued concern in the first half of lOll, As measured in tbe NIPA, real regarding the financial he:dth of state and local gOI'em· state and local expenditures on consumption and gross ments. Indeed, credit default swap(CDS) indexes for inl'estment decreased at an annual rate of about 2 per municipal bonds rose, on balance, om the strond half cent in the second half of lOll. a somewbat slower of 2011 but haw narrowed som:lI'hat in early 2012, pace of decline than in the first half of the year Credit rating downgrade;; outpaced upgrades in the (figure 24). State and local government rel'enuesappear to haw secoDd bIlf of 2011. panicular~' in December, iollow ing tbe downgrade of a municipal bond guarantor,3 increased modestly in 2011, Notably, althe stale level. third-<juarter tax re\'enues rose 5~ percentO\'er the year-(Jrl~r period, \lith the rt\1jorit}' of the stales experiencing gains. Ho\\-e\"e~ tbis inntasc in tax rev· The External Sector enueswas pan~' offset by a reduction in federal stimu lu! grants. Tax ooll(:(tionshave!>ten Its. robust at tbe Real exporlSof goods and servKesro;;e at an annual 1oc.tI1eI'CL Propeny tax receipts bave been roughly Oat, rate of 4'1. percent in the strond balf of 2011, booste<! on net, since the .tan of 2010 (based on data through by continued gJ\)\\1h in ol'erall foreign ecooomic actil' the third quarter of 2011), reflecting the downturn in ity and the lagged effect of declines in the foreign bome prices. Funherroore, many localities have experi- excbange value of the dollar earUer in the year (figure 26), Exportsof aircraft and ooosumergoods registered some of tbe largest gains. The increase in 25, Federal gol'emment dcl>t held by the public, 1960-2011 export demand was concentrated in the emerging I1llr· ket economies (HIEs), while exports 10 the euro area declined toward the en<! of the ~'ear, With growtb of eronorrOC activity in tbe United States IOOderateduriog the second half of 2011, real - 0 imports of goodsand services rose at only about a 3 percent annual rate, down from about 5 percent in the fim half. Import groll1h was weak across most trading partoe~ in the second balf of last year, lIith the notable exception of imports from hpan, which grew significantly after dropping sharply in the wake of the Marcb earthquake. Altogether, net exports contribute<! about \I. per· I t"96"t """1"91"1 ""'"t9"8t" """19"91" ""':"ro"t "'""2"0 1! I centage point to real GOP growth in the second balf of N(I!'I!: Thou.fadtl:< ..... ofY".«rl;""""'""':rirnh3:111;,., .,,1>0 . Q . I . . 0 . 1 ..._, .n...w.O ,C. .1. I E. ~ <.: h . d .. o . o . .". "h"t"r.a"..' " h" ~ :1 ' f _ " " I'h ' ' _ 1(mP o ) f I • !d • o f t> a l IlIU 8 I . I ! ic k i > p v al .l l i g l. l " 'l P d r c i & Iie 1 s 0 g b I o l> o l d 'lC g l u < a td ,. b . y ' o t r b s O a i D t f inn, as ik l l 1 1 u ti o D g g o o o f r a I l l ,.-~ lttIIrilyis ikhigh<rofeitber'btpublisbtdWl<krl)-ing9tClll'i!}' $OOlCl: F..:mI!l.=wBoa-d,l\:;lwoffinkdato. I1tiDg Of ik tltiogof ike,ui!}, PfO''iJing ,begumntoo 72 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00076 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.12021103 16 Monetary ftllicy Report to the CongrtssO February 2012 26. Change in real inlpa"ts and exports of goods 27. U.S.lJadt lOd C\lITC\lt aCCQ\lIIt baJaoces, 2003-1I an.d s-m1Ces, 2007-11 OI,,1UI< , - -, - <0 - ) ,,," -, - , - ) I I I I I I I I I I I I nnm1f1!lnYl2011 I I I I mmnYll:l102011 NOT!: Th<<b" .. ~. f<:rthon!d< _ "" <in""t<n:I <Inug/l2011:Q!;hthe<UR<ll"""""'.theJ".xt<n:I<Inug/l201LQJ.Cll£' "p:ao-.~~. Sooi:ce: Dtport_d.C-'O'.B ..... d.Ii«n>D:AnI/y<is. 2011. as export growth outpaced import growth. Atan increased in February, tbough by less tban Brent. fol annual rate. the cum:nt aerount deficit in the third lowing a relatr,ely rapid rist ol·er tbe finaltbret quarter of 2011 (the latc>tal-ailabledata) II-aS $441 bil months of last j'ear.9 lion, or about 3 percent of nominal GDP, a touch nar After pelDngearly in 2011, prices of nuny non-oil rower than the $470 biUion deficit recorded in 2010 co!l1lOOdities also tml·ed lower during the remainder (figure 27). of 201!. Despite lJlO\'ing up recent~', copper prices Oil prices moved down, on net, om the second lialf remain well below their early 2011 1e-.·eJ. In agricullural of last year. The spot price of West Texas Intermediate rn.1rket,;, coru and wheat prict'l ended WI 1 down (WTI) crude oil, which jumped to $110 per barreilasl about 20 percent from their relatil·ely high levels at the April after a near-rornplete shutdown of Libyan oil endof August as global production reached record production. subsequently rtl·ersed course and dec~ned levels. In early 2012, howe-.·er. corn prices edged up on sharJl~' to an average of just undtr 586 per burtl in worries aoom dry growing conditions in SOUlh September. The price! of olher rn.1JOr benchnurk America. crude oils aoo feU over this period, although by Ie>! After increasing at an annual rate of 6~ percent in than the spot price of \Vf1 (figure 28). The drop in oil the first half of WI I, prices of non-oil imported goods prices through September likely was prompted by the Wert Hal in the second balf. Fluctuations in prict'lof winding down of the conHict in Libya as weU as grow imported finished goods (such as consumer goods and ing concern about the ;trength of global grolllh as the capital goods) were JOOdernte. European sol·ereign debt criiis intensified, particullr~' toward the end of summer. From September to hnu· 9. The 1Il0lt llrid fiIloofWTI lhao od>t1 grades of cru.:lt oil allix ary of this year, the price of oil from the North Sea Old of 2011 rdl<c1S !be narmwmg of. di;:counl {bal bad optOt>l up (the Brent benclimark) w:lsesstntiaUy Hat as tlie poten bet_n WIlandOlbergrades ..r liet iIIlbe)"". "lbrougboolmool. tial implications of increased geopolitical tensions- C of a n 2 a 0 d 11 a , . c n o d n l N in o u r o l . h l i D n a c ~ m < . u . , .. . in ,~ ! 'j b a e h l " e '! ' 1 P 0 l f y lo o y, f . o in i t l o p C ri l m lib a i r D il & y f O ro U m a · most notably lIith Iran-have offset ongoing concern boma (Ibe dd~· poinl f<>r!be \\'I1 <m oiI~ and lbe lock of over the strengtb of global denund and a raster-than tflDSJ'OrtatiOll iofflAAICl\lJI~ 10 pls;!be "'Wlies 011 to global expected reoound in Lib)'an oil production. In Febru o m iL " t tn ru m , i d J o .N pR O : Y SS e < Jn d b ! c b r e . ~ p p ric b e n , o , f , W ,, II , " !d , a a l " i t " > , O 10 I a l d D . O .. O . d gr l a o d , < ,, ; , o ,, f , c , r , u 'b d e t ary, the price of Brent tml"ed higher. both with b·d. teypipcl.,.,hat=tIy tIlIrnporucrudt oil from tbe increasing optimism regarding the outlook for global Gulf 0-into o..sbiug. BJ· flismg {be poiQ"bitity d al!o-iahlql lbe growth as well asa further heightening of tensions S b U f p t p \ l a y o gl a ul t h of a c s ru I d e e .l I o jl i O t i ! u W lb I e ! M p i r d i l c l1 e e s S { l, o ! r b i" e " . O O ' k ~ <.d l I hal i s o " f " !h "" i! ill with Iran. The spot price of \Vn crude oil also line "i!h lbe price of otller gra<b of crudt oiL 73 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00077 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.22021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 17 28. Prices of "I and ooofuel cOOllllOOities. 2007-12 29. Nel sal'ing, 1991-2011 0.:._2000.100 DoInprt_,1. ,oo- - ,. ~:: ,.- - -, _'00 - . '''' '"- • ~-.~ - - , '00 - • ~ - 00- • _ ~_9 I I I I I ttl Itt t it tt l t tt l t ttl t t t t :rm m :oJIl 3)10 3)11 3)11 19'11 1m 1m 200J :rm 3:l11 NOTIi' n..d. .... ~_ n..oiI prioeis .... """ prioe <:JBr<ltcml< NOTIi: n., <In ". """"'" mJ two:! Ibwgh 3:l1l:Ql ~III oil mJ .... I. . ~. . "" is !be ..- ..~ b ""', ....-q:i,Ib._<l.ptI...w..-.:!ntlbus. .... , ..· ir>&..-.:!lb.ntI....-"'!<I. lUll)' l-ZI,3)I2. Thep:""<J"'""'I~,.,,,,,,.m<J4S '''I'mJ''''''"~.GCf',,'' ... '*-''"'pro:b:I. p:,. ..) '."..IOOdio:yp:.,..mJ"I!fds~'.......,.3)(l So~: Dot-I_<l.Com_oo,B. .." '<l.r.:.:....i<AnaI)' ... Soom: IU oil. "., eo.~ R. .." clI B. ..a o; f« r>;JO/u<l oom...-:db<-s.n.....autMooflIll)'Fmi 165,000 jobs per roonth in the second half of 2011, a bit slower than the pace in the first half of Ihe year. but pins in December and hnuary were!IDre robust. National Sa\'ing a..-eraging al!IDst 240,CKXl per !IDnth (figure 30). The unemployment rate. which hOI'ered around 9 percent Total US. nel nalional sal'iog- lhat is, lhe saving of for much of last year. is estimated to have nwed do\\n Us. households, husinesses, and g<lI'ernmeDls, nel of noticeably ~ince September, re3ching gy. perrent in depreciation charges-relTllin~ extremely loll' by his, January. the lowest reading in almosl tbrtt years torical standards(figure 29). Aller having reached (figure 31). 4 perctllt of nominal GDP in 2006. net natiooal saving Although the rectnt decline in the jobless rate is dropped over the subsequent Ihrtt years. reaching a encouraging, the iel"tl of unemployment remains I-ery low of negatil'e 2\4 percent in 2009. Since then. the elevated. In addition, Iong-duration joblessness contin national Sowing rale ha~ increased on halloce: In the ues to account for an espelially large share of the total. third quarttrof 2011 (the latest quarter for \\hich data Indeed. in January, 5\1, million persons among those are al'ailable), net national saving was negath'e \4 per· counted as unemployed-about 43 perrent of the centof nominal GDP. The recent contour of the 5.11', totaJ-had been OUI of work for!IDre than six fIIlnlhs, ing rate importln~y reflects the pattern of federal bud· get deficits, which widened sharply in 2008 and 2009, 30. Netcbangein pri\'3Ie pa)loU employment. 200>'12 but have edged down as a share of GDP since then. National saving will likely renuin relatively loll' this year in light of the continuing large federal budgel -'" deficit. If loll' leI'elsof national 5a1'ing persist over the longer run, theywilllike~' be associated wilb both low rates of mpital fonrution and heal'Y borrowing from abroad, limiting tbe rise in tbe rundard of Ih'ingof Us. residents Ol'er time. - m -<00 The Labor Market - '" Employment and Unemployment I I )))5 I m t :rm m i :oJIl t 3)10 3 )11 3)11 I I Conditions in the labor market hal'e improved someof N".., The dolo:n...wy mJtlItId Ik<qh JnJ.y »11 late. Pril"Jte payroll employmeot pins al'eraged s.oo..a:n.p... ..... <l.LM.s. ..... <l.LM"". ." , 74 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00078 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.32021103 18 Monetary ftlhcy Report to the CongrtssO February 2012 31. Civilian unemploymeO! nle, 1978-2012 ... hour in the nonfarm husiness sector rose only Yo: per cent (figure 33). ----------------------~ Increases in hourly compen5.ltion rtnuined subdued in 2011, restrained by the lIide nutzin of llbor market slack (figure 34). The employment C05t index, which meJsures both wages an<! the cost to employers of pro viding benefits, for pril'atc industry rose just 2\t, per· cent in nominal terms in 2011. Nominal compensation per hour in the nonfarm business sector-derived from the laoorcompensation data in the NIPA- ise,ti· mated to have increased only 1';' percent in 2011. well - , below the average gain of about4 percent in the yms before the recession. Adjusted for the rise in conSllmer 1111111111111111111111111111111111111 I prices, hourly compensation WlS roughly unclunged in 1900 1988 199Ii mI ))12 2011. Unit labor cost> rose I \I. percent in 2011, as the N;m: n..dr':RlIOIrh/ynl<ll<n:lh«>ghI~))ll rise in nominal hourly compensation outpaced tlut of S~ n.r--<l.Ux..Bo:<IOI<1.Ii>crSUL~ri. labor productivity in the nonfarm business sector. In 2010, unit1abor COStS fellalroostl percent. 6gures that were only a Unle below rerord Jel"els (6gure 32). Moreover, the numherof individual! who art working part time for economic reasons-another Prices indicator of the underutiliz3tion of laoor-remained roughly twice its pre-recession value. Consumer pri« inflation stepped down in the second half of 2011. After rising at an annual rate of 3\1 per· cent in the first half of the year, theol'erall PCE chain Producti~'ity and Labor Compensation type price index inmased justlY> percent in the sec Dod half (6gure 35). PCE prices excluding food and 1..1oor productivity groll1h slowed last year. Produni\'· energy also dt("tlenlled in the second half of 2011, ris ity had risen rapidly in 2000 and 2010 as !irlm strove to ing atan annual rate of aooutl \1 percent. compared cut OOStSi n an environment of ~'ere e<:onomil: stress. with rough~' 2 percent in the first half. The recent con In 2011, hOIl"ever, with operations leaner and won: tourof consumer price inHation has reOected rrme IOrces stretched tbin, !irlm needed to add boor inputs ments in global col1llOOdity prices, which rose sharp~' to achiel'e the desired output gains, and output per 33. Cbaogein output perhour, 1948-2011 32. Loog-Imn ufi'mployed, 1978-2012 ... -. --------------------~ - " - , -~ -, -~ - , -~ -, .. 111 " 1 " 1' 11111,1 1'11111,,'.11 11111'1111111 '" 1' ! t I t'/ 1 . 3 1 3- I ]99S7 4- I : t r m oJ - I "lO () O I t- I lX IS I I W I I I m I I ) )11 I Sa,,;; Thr. do. :R IIOIrh/y nl"tm:l1lIwth J.-, ))\1 Thr. ... io< Ncm: Nrnf. . boo ..... _ ~ f<A ,*",...tot:.-P"»;];, ."..".. ~ ""I'I " i ' I Y ! I I..J..!..~. < < A I. .: ~ n . . ...... lIpIoy<dptt""'.M""~Mn ' . f. . 'W . .. I . < .. I : . I " .. , .. , , y ,, t . b . d . I J O ~ <d < i .. I . ! . y~ ! ! IJ I ! J r. ! .. 1 .J " ) ' u f' < O l. ' . i .. . pttJO:t,.,. .... kuth SOOlCl: ~<l.Ux..Bo:<IOI<1.Ii>crS"",ri. ~: 0tp0r!_ <l.1i>cr.a..."'d.Ux.s... .' " 75 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00079 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.42021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 19 34. MeaSllJes of chlnge in boutly oompet6luoo. ably mild temperatures and increases in supply from 2001-11 •.. Dell' domestic wells helped boost inventories abol'e -. typicallel'els. All told. the ol'erall index of consumer energy prices edged lower during the second half of -. 2011, compared with an incrtJseof allTlJst JO percent - , in tbe first half of tbe year, -, Consumer prices for lOod and beI'erage; exhibited a similar pattern as Ihal of energy prices. Prices for farm - , comroodities rose briliklyearly laslyear, reOecting the - , combinalion of poor harvests in several countries that - , are major producers along with tbe emerging recovery - , in the global economy, Tht'Se comroodity price inCteases fed through to higber conswner prices hr meats and a wide range of other lOOre-proce;sed food~ I I I I I I I I I I I I I I With the downturn in farm coll1lOOdity prices late in lXlI m m mI 3XJIl !lll the summer. tbe index of consumer food prices rose at Non: Tho cbu .. <p.-dy nl.,1ml hwth !lll:Q\. fir ..n". an annual rate of just Jy. percent in the second half of ~ nJa{E " a " ~ "" d " w " g ,. o m. 5 " " " ' " '' ' ' t '' o '' i o 1 , 2 ,,. 11 . 1 k Cft u hs < ~ J. 1 ll I lWt " ~ " k 1 t I " o "' ! ' ' III ' O ' II ' II ' I ' c ' i ' . ' a ' :b _ 2011 after in('teasing 6Y.. peKent in the first half. " .. " . " - " -. .n .. . . . n " lO ,, C " " . "O ~ O " U ' '. " fu 1 < "" W " = " " W " « "' " "" ' by '' 'e.~. Eel _ _," . , ~ . i.e.. Prices for consumer goods and sen'ices other than Mnf• • boonm_ plw",......'inotitt".,.. energy and food ba,'e also slowed, on net in rectm SOO.a:~olLtlxt.IIIr• .,olLoba:SlIII<5tiot. IOOnlru. Core PCE prices had been boosted in tbe spring and summer of 2011 by a numberof transitory factors, including Ihe pasHhrough of Ihe first-balf ear~' in 2011 but h.r.-e rrvved lower during the second surge in prices of raw comrooditiesand other imported half of the year. Information from the consumer price goods and a boost to IOOlOr I'ehicle prices tbat index and other sources suggests that inllation stemmed from supply shortages follolling the earth remained subdued through hnuary 2012, although quake in hpan, As the impulse from these factors energy prices have turned up ITIJre recent~'. faded, core PCE price inflation stepped down so that. The index of comumer energy prices. which surged for 2011 as a whole, core PCE price inflation was just in the first half of 2011, feU back in tbe second half of p;. pereent the year. TheconlOur mainly reflected tbe rise and sulr Surl'e}'-b.1sed measures of near-term inflation expev sequent rel'etsal in the price of crudeoi~ howC\'cr, talions are down sioce Ibe middle of 2011. Median gasoline pricesSiarted to rise again in FebrUlry follow· year-ahead ioOation expectations as reported in the ing a T«ent upturn in crude oil prices. Consumer natu Thomson ReuterslUnil'ersity of Mi('higan Sumysof ral gas prices also fell at tbe end of 2011. as unseason- Consumers (Micbigan suney), which had risen sharply earlier in the year reOecting the run-up in energy and 35. O co l o a s n ll g m e p in li ! o b o e e c > b ip :1 e i I J l l d .t i y tu p l e \' S p , r 2 ic 0 e 0 5 in - d 1 e 1 x forp - enoo-al - food prices. subsequently feU back u tbose prices de\Xlerated (figure 36), Longtr-term expectations have remained generally stable, In tbe Michigan survey. the ... inflation rate expected over the next 5to \0 yem was 2,9 percent in FebrUll)', within the range that has pre vailed orer the past \0 yea~ in the Sun'ey of Profes 1/1 _ 4 sional Foreca5ter~ conducted by the Federal Resem Bank of Philadelphia. expectation; for the increase in the price index for PCE over tbe next 10 years remained at 2V. pef<'en(, in the middle of its recent range, Measuresof inDation compensation derived from }ields on nominal and inflation-indexed Treasury secu rities declined early in the second balf of 2011 at both medium-term and longer-term horizons. likely reOeet ing a '1'orsening in the economic outlook and the 76 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00080 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.52021103 20 Monetary ftlhcy Report to the CongrtssO February 2012 36. Median ioflltiOO e.qlOCla~ODS, 2001-12 .. . 37. IO/h~ODrompeIlsa~on.2006-12 - - , -, Nat I,..,.. -, hdO,... . nad -, 4~l""'V"~"" -, - , = r-/''''¥ - , - , 1 -, V~"'''~''''~J -, I I I I I I I I I I I I I I 1111l11l1111l !1I 1111111 1 m:! ::IDI :o:l6 m ))10 ))12 ;m] m m ))10 ))I! ))12 N So o o n t" : , T ; h n o . "" : . . .. " ~ " z ' d ~' " ."..."..." ,r ' yd f M n i q ch h q J :I . O .., ls ." .n ll . i y l , da:...-.. ~" N " O i 'll ' : h ] ~ h b ,d t r n .> " _ " < '" b j ily i t z l d d ..- o . r ;! n h " "o " u " g " h " F " . T br I u < .. " y , Z , 4 , .l , lI ! 1 " ln " f " l ' il ' i< ' : ' o zdTm.IIi}'","""",p;~"""""""(IIPS)d""",,,,.~_t .... b....Jrnyitld~fll<dbyF«lnol~ou/flOoff.·nJI,.".m1 intensification of the European fiscal crisis. More a TI< l " j O I II - I:) ' " l a ... , t . t . . .. , i t , i f t< fe z d d d " ;, , m . n .It i " o , f I f , .u !~ .. .nJI nps. Tho Sol'''' ........ ;, reantly, inflation compensation e.timatesover the nm Sow::!; Ftdo<oI &.om. . Rri dN.., Yak; belay<; I'td."i Room. . fin years haw edged rock up, apparently refieeting BOIIdsufl<ll,. ..... investors· more optimistic economic outlook. and is about unchanged. on net. for the period. However. the IOrward measure of he-year inflation compensation 6n yearsahud remains about 55 basis points below its hel in the middle of last year(6gure 37). were lillie changed, although they exhibited unusually high l'Olatility. Partial~' reflecting additional monetary Financial De,·e1opmenls policy accommodation. Treasury j;elds mo\·ed down significantly. Similarly, illl·estors pushed out the date at which they expect the federal fundi rate to rise abow In lightof the disappointing pace of progres,toward its current target range, and they are currently antici meeting its statutory mandate to promote maximum pating a tmre gradual pace of increase in the funds employment and price stability, the Federal Open Mar· ket Committee (Fm.IC) took a number of step. to rate following liftoff than they did last Ju~'. pMide additional monetary po~cy aCIXIll1lOOdation during the second half of 2011 and early 2012. These steps inclnded increasing the a.,.trage maturity of the Monetary Policy Expectations and Federal Reserve's serurities holdings, shifting the Treasury Rates reinl"e.,tment of principal JllymenlS on agency securi ties from Treasury securities to agency-guaranteed In response to the ~teps taken by the FOMe to MBS, and strengthening the forward rate guidance strengthen its for\\'3.rd guidance and pro\ide additional included in postmeeting statement~ support to the economic recovery, market participants Financial markets were buffeted Ol·er the second half pushed out further the date when they expect the fed of 20\1 and in early 2012 by changes in investors' eral funds rate to first rise above its current target assessments of theongoing European crisis as well as range of 0 to Yo percent and scaled back theirexpecta. in their eI'3.luation of the u.s. economic outlook. As a tionsof the pact at which monetary policy accoll1!OO result. de.,.elopments in financial market conditions dation wiU be remo\·ed. On balance. quotes on over have been mixed since Ju~'. Unserured dollar funding night index .wap(OIS) contracts, as of late February, markets, particular~' for European in5titution~ imply that investors anticipate the federal funds rate became significantly strained. though domestic finan wiU rise abcl\"l: its current taQlet range in the lOunh cial firms generaUy maintained ready access to short quanerof 2013, about fourquaners bterthan the term unsecured funding. Corporate bond spre:tds date implied in July. Investors expect. on average, that remained elel-ated, on net, while broad equity priets the effective federal funds rale wiU be aoout 70 basis 77 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00081 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.62021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 21 JXlint~ by late 2014, roughly 165 b3si~ )XIints lower ner the failure 'Of the Joint Select Commillee 'On Deficit than anticipated in mid_201I,w Reduction to reach an agreement in Nel·ember Yield; on nominal Treuury securities declined sig appeared to !eal'e a permanent imprint on the Treasury nilklntlyoyer the second half of 2011 (figure 38), The market. Unceruinty aboutlenger.term interest rales, bulk of this decline occurred in late July and August, as mea;ured by the implied volatility on 100year Treas in pJrI reflecting weaker-than-anti<'ipJted US. eco ury securities, moyed sidl:ll'ays through most of the nomic data and increased inl"tStor demand for the rela second half of lOll and then declined late in the year tive safety and liquidity ofTre,lSury securities amid an and into 2012, reflecting imprDl"ed sentiment in finan intensification of roncerns about the situation in cial markets follo\\iog a numbcrof policy actions by Europe, Following the FOMC announcement of the centnl banks and some signs of strengthening in the maturityextcnsion program(MEP) at its September pJct of economic rerol-eT)'. meeting, yields on Ionger-dated Treasury securities Measuresof market functiening suggest that the declined further, while yields on shorter-dated securi Treasury market has continued to 'Operate stmOtbly lies held steady at wry lowleyel~l1 On net, };elds on since mid·2011 despite the S&Pdowngrade in August. 2-,5-, and lCl-yearTreasury notes have declined Bid-asked spreads fer most Treasury securitie~ were roughly 10, 65, and 110 basi, )XIints from their lewl, in roughly unchanged, thougb they hare widened a bit, mid-2011, respectil'ely, The yield on the 3Cl-year bond on net, for the 3O-}'elr bond sinct August. Dealer has dropped about 120 basis )XIintl. Though liquidity transaction 1'Olume. h3l-e remained within historically and functioning in money markets deteriorated nota nermal ranges. bly for 5eI'eral day! at the height of the debt ctiling debate last SU/lUllef, neither the downgrade of the US, long-term sovereign credit rating by S&P in August Sbort-Term Funding Markets Conditions in unserured short-termdellar funding 10_I I ...... iOl<ml"'lrS.~d(litl(>W\\drl<nniningllltpoill.t markets deteriorated, on net, over the second half 'Of "bich financial motte! qu«cs indicale lhottllt f<Jen.1 fund> ",Ie "ill """'" .b.:lo'. iu=t "'ll!!" ca. lit complic.ted Tho p"lh dcscrtM:d 2011 and in ear~' 2012 amid elevated anxiety about the iltllt le>:t is tbt mon d. diSlrilo.lIioo <akul.l<\I ["'Ill OIS "le& crisis in Europe and its implicatiens for European A i IC ld l I t I ) m ,} ' ; , I 1 , o t 0 i r l l " " i m d t ) m o ', o d _ r a e I w : c ~ b n lo t b U . o i T < f h ' R t i h . r o o o i I f t t . M e ! m & m o er t l i M v l' a II m o tn d 't e : s S a " > t ' ( t I > o R c , a • b k . n ; . t , J a > '1 o I e " r , t n ~ ~ t t I h D a O I i II a fi n rm d s t e a n n e d r s t h s e h i o r r c te o n un e t d e r d p r a a r m t a i t e i ~ c a F l u ~' n f d e i r n g E u c r o o s p ts e a in n c r in ea st s i e · d 00.,11, <>Dnet,sin<e tbtmi..-lJk of1011, but it RJFUI fblle'r"'~­ tutions throughout the third and into the fourth quar a tf ll f « 11 ti 1 l' F t t r o a r l ) e ' d IQ o r o ti a lt o l t a r r i g s l e : t .o f< c J . e - n e . 1 i u f c u l n O ds m " l t ! o t ; o " f " i " d ,, " T . O li n n g g e t t o h r ~ o b u i g : h h l t i h l o t ter. Funding pressures eased somewhat late in the year rodd!(l15. fellowing tbe European Central B.:mk·s (ECB) first II. "" of Ftbruory 24, tbe Optu M.tte! Dcl had ",Id injection of euro liquidity via a three.year refinancing S;l2J bia;on ill .l»ner·lC1lll r,.asury sccurit ....M purtb""'d operation and the reduction of the price of U.S, dollar $;11 t bia;on ill longer-term Tru>UrJ' occurities. liquidity offered by the ECB and other central banks; 38. 1ll1eresl mes OIl TrelSul)' se.:urities at selected they subsequently eased further following the passage malwities, 200+-12 ... of year-end. On balance, spreads 'Of London interbank 'Offered rates(UBOR) 'Over comparable-maturity OlS rates-----a measure of stress in short·term bank funding -, markets-have widened coDSiderab~' since July, par· -. ticularly ferteners bey'Ond 'One month, though they h3\'e lOO\·ed down since late last year. Indeed, through - , out much 'Of the third and fourth quarters, many Euro pean institutiens were reportedly unable to ebuin unsecured dollar funding at tenors beyond one week. Additionally, JOOre--folll'ard-looking measures of inter -, bank funding roS15-such as the spread between a three-month forward rate agreemc:nt and the rate on an OIS contraci three 10 six monthsahcad-m'O.,-ed up I I ! ! I I ! I I I considerably in the second half 'Of lOll and have 'Only "" "" em 3:l1O 3:lt2 partially retraced in 2012 (figure 39). Despite the pres· Non: Thodr.l<edoily n:lnlmltlwtqhl'tbru.yu' 3:lt2 sures faced by European financial institutions, US. Soo.C[;~ofIheT",...., firms generally mainuined ready access t'O shert-term 78 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00082 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.72021103 22 Monetary ftlhcy Report to the CongrtssO February 2012 unsecured funding markets. Against a backdrop of 40. COllDl1ercialpaperspreads.2007-l2 solid deposit growth and modest expansion in bank credit across the indUstry, most domestic banks report edly Iud limited need lOr unsecured funding. Pressures were also evident in the oommercial paper (CP) market. issuanCt in the United States of un;;t cured financial CP and negotiable cenifiCltesof deposit by entities with European parentsdedined sig - ", nikmtly in the second half of 2011. By oontrast, the pace of issuance by us. firms edged down only - , ' " " , r s a 1i t g e h s t ~ o · n . o u n n s n e e c t u . r o e r d e A r t 2 h I e P 2 p e c r o io m d m . O er n c ia b l a l p a a n p c e e r . o sp re re r ads of - - '00. equivalent maturity A.-\·rated nonfinancial CP ro;;t a " bit for both orernight and 30-day tenori AA-rated o ! ~ 0 asset-backed CP spreads increased more notably orer Ion. m Jul y 'on. )X Iol l y ! , .... m kiy , .... l. l l i 1 ll O y Jon. l I l iZ ll I Ion l . . l12 the second balf of 2011 bUllargely retraced following year-end (figure 40). C N" - ," , " a Th i e P d IP au " . )'" . I d . .. ' . P l1 . y . .. o . rd . . t U h m . ! . . . " . . r .. u .. t . h ,p I : 't Io IIl r H u.y I} 2 ' 1 o rd l .l • t • l In oomrast to unsecured dollar funding markets, ox~ ..b !"~!O ... AAnonfnar."~ , .... signs of stress were large~' absent in secured short· ~~T. ... ordCIo.i>tC<:quoo:il;n term doliar fuDding maTlets. For example. in the mar ket for repurchase agreements (repos). bid-asked concerns became more e\-ident. Res)Xlndents to the spreads for most oollateral types were ~ttle clunged. In SCOOS in both September and December noted a addition, despite a seasonal dip around year-end, vol oontinued increase in demand for funding across 001- umes in the triparty repo maTlet were largely stable on lateral types but reponed a genen.! tightening in credit lulane¢. That Slid, the oomposition of oollateral terms under which several securities types are financed. pledged in the repo market mored funher away from equities and fixed-income oollateral that isnot eligible In addition, maTtet panicipants reponed~' became S<lmewhatle;s lIilling to fund riski<r rollateraltypes at lOr open market operations, shifting eren more hmily toward Treasury and agency securities as rounterpany longer tenors as ~'ear-<:Dd approached. Howeyer, yeJ.r end pressures remained muted o\'eral~ with few sign! of dislocations in either sec:ured or unSCI:ured short 39. UBOR minn~ QI'ffiliglu iodeJ; swap rate, 2007-12 term markets. and oonditions in term funding markets hare improred in early 2012. Mone), market funds. a major provider of funds to shon·term funding markets such as those for CP and for repo, experienced significant outllows across fund Cltegories in July, as inwstor;' focus turned to the -", deteriorating situation in Eurnpe and to the debt ceil· ing debate in the United States. Those outllows large~' shifted to bank deposits, resulting in significant pres sureon the regulatory lererage ratios of a few large banks. Howe'Ier, inl"estmenls in money market funds rose, on net, orer the remainder of 2011, lIith the oom position of those increases reflecting the general tone I ! , ! of increased risk al'mion, as gorernment-only funds I .... lilly I .... lilly Jan. July I .... July J. ... July , .... m :leO> m l.l1O l.llt l.l12 faced notable inflows while prime funds experienced Nan: The dau,.. d.dy ord at<fId tItc:qh FcUu.r 2-1. l.lll An steadyoutOows. QI'...,;v. ..... "''P(OlS);,II"I ........... ,.,.,.·lIl1'" fboi",!"",btd » _ " . ' A m I ' - < .. i . d y a . . i .. l . t y .. ~ , , p . n . .. . ! . O n t/. , . . ' . ' ' ' ' ' " P '' ' " 't/ " ., " tf _ f''' ' n '' t 'J tm tQ v " . . . . . _ , the n w .d . . , w . : U 'c r .s l L t . U / d d . o , " o l " '" p . r ( « U u l O n S l o l t ) t ) ~ l . . , O . , . . . l . l . . : . ~ l . l c _ . oI J t c h b u ) e I ' " d " ' i . " . f . f . o . . .t . , " t.. " il " .Io b !n « ::d - l . wo . : m n~ . <" t A I "" l " a "" . " > *" . .- " f" t I U "I" O l. O. d . Financial Institutions _(UBOl1.)h-.l,.",..-(FltA)tu.»m"",,",theru.u ord ... illlp B lo i o o : o tk d . . > .. n . , : . tas""'bthe ..... J"<tOO' Market sentiment toll'lrd the banking industry SOJ~: dec~ned rapidly early in the second half of 2011 as 79 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00083 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.82021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 23 investors turned their heus OD exposures to European 42. Spreads OIl credit (\efault swaps for sel~ted sovereigns and financial institutions and on the pos U,S. banl:iog organizations, 2007-12 sible spillowr effects of the European crisis. Some large Us. institutions also retJ\3ined iignificantly expo;e<lto legal risks stemming from their mortgage banking operations and for«Josure practices.ll More -- recently, bO\\l!l"tr. investor sentiment has iroprolW ...... somewbat follo\\;ng the actions of central bank. and inroming dall suggesting a somewhat bener eronomic outlook in tbe United States. On bllaoce. equity prices lOr banting organizations (figure 41) bave rompletdy retraced their declines from last summer, wbile CDS spreads(6gure 42}-whkh rellee! in"estors' assess mentsof and \\;Uingness to belI the risk that these institutions will default on their debt obligations-bave declined from their peaks re3ched in the fall. hut not all In 'M J J u / ly In 1 J W uly J In 'M Ju I ly l In ) J )1 ul 0 y In )) J 1 u 1 ly In D t:l the way rock to mid·201 J Imls. N"", n., dol ••• doil'l .....l ....t ..~ FtbruIry 'l4, Xlll ~I!di., Measures of bank profitability edged up, on net. in 'P.ad<icf<ixbri~~",,,,,,,oktNrh rectnt quarters but remained lI'en below the \evels that SMa: ~uru prevailed before the financial crisis began (figure 43). Altbough profits attbe largest institutions '.I'm sup p;lned ol'er that period by reductions in noninterest DOrms, and a fev.' banks booked llrge reserves for ~ti· expenses. net interest margins remained I'ery loll'. capi. gation risks associated lIith their lmngage portfolios. tal markets rel'enues were subdued, loan loss provi. Indic3.torsof credit quality at commercial ronks sionsare stiD somewhat tlCl'ated relath~ 10 pre-crisis continued to show signs of improvement. Aggregate delinquency and charge-offratts mol'ed down, though they remained quite ele1'ated on residential mortgage. aDd both residentill aDd oommertill construction U. 0. FebruarJ 9, it ~-.s iIltI<'IIIICCI.:I th.tl"" feJetat g<I'O<1IlD<I)l loans. loss provisioning has Inded out in ret'entquar· . " . i , l d h 4 t" 9 " i . n .l ' li t o l n ( ', I f O i. ~ . ' l> i f g ll r C o il m m l o 4 r l tg a tt g a e e lf l 1 ll> \'i . < l. e S r$ 2 l S o b a i d l < ~ l o rts o :<! ~ lIO . f1 1 g'l! l' tel'S near the upper end of its pre-crisis range. NODe· loon "",icing ,nd [,""burt .." "", lbt>gr<e1lltllt doco lIOl thele.lS, in the January SLOOS. a large fraction of the r<"""nl Wlte..,d fo.:lenJ authorities from pursuing crimilli]..,foo;e. respondent! indicated that they expect credit qUality to l p D .t I 1 :t I I i l s " h , i , n "0 g 1 " 1 w 1 m ng a f t u ed ill > (0 'U th r i it s i t o a r l i o o l l b l n CQ ' l c l " d " o d o: o ~ c i t I b a y ls ( o b d e O " l " S , i 0 r 0 : ( t n pf o N r ' " f O ro t m imp!(l\~ over the next 12 months for mostll'lljor loan 211J'''''[ioo by"Jiyidll3l~"'b.lwi<b lobringlboi,CIO'U 1I.,,>OJit. _._, 41 Profilability of banlookling cOOlpmes, 1998-2011 .. -II. Equilypriceindc.\forbW,2009-12 - a.,.,.. .....-l"" ...... - " 1.5- - " 1.,0 - ...... - " .,., - w - i • s- -w 1,0 _ _ u -" J.!i- -" LI "'"""l9"9"I'/--'-1 "'~;o"!-'" '--'-, ";~I"--'-I" '-o.c"UI N"", n"doI:''''oJIn'I'l)-... .,._h<uth:ml:Q! ScM",: FodItai Rtoer>. . &.rd. I'll: Y-9C. C"",,,hd.r<d Finlaoal NO'!'!: n.,cbuncbily ... ,,~dnughFtllruoryU,Xlll 51 ..._ fa Sri Hollins CooDpw:o. Soom: Stnhd&lI::tt'. 80 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00084 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.92021103 24 Monetary ftlhcy Report to the CongrtssO February 2012 Financial Stability at the Federal Reserve Tne Federal Reserve's responsib;lity fa. promo/ing As rgn;licant aspect of the maaoprudent'al financial >tab;lity >terns from its role in SUI>e,vising approach is tne Ileighlened focus on entities arK! regulat'"& ballks, operating tile mtton's pay who:sefaiureor finaocialdistresscould resuk in ments s)'SIeJT\ arK! se"'lng as the !errde!' oflast outsized desOOlllllng effects OIl the rest of the reso.1.ln the decMl':S prior tothe financial cri;i" S)'stem. Under the Dodd-frank Act the Federal financial stab;llty poIicyteOOed to be overshad Resffi"e is responsible for thesupe!\ision of all S)s owed by monetary polK.)', which had come to be temically importanl financrallnstrtutions (51Fls1 ___ 'ed as the I"incrpal fund>on of ~ntral baris. which ,ndude both large bank hold'ng comparues Howe'l'ef, .., the aftermath of the manOal aisis, and nonbart finarrcial firfll!j dl':S,~ed t.,·the financial stabrlity polK.)' has tal:en on greater I"omr· fSOC as S)'S1emically i~nI. h-en beforelhe nenre and is row generally coosidered an equally Dodd-FrankActwasenacted, the Federal Resm"e (frtical respon-;ib~ityof centla! banks. /'oj such, the was making organtzatlOflai ch.Yrges to facilitale the Federal Reserve has made significant organizational iocorporatioo of S)~temic rislconsiderations into changes aoo taken other nions to imprOl"e lIS the SUpe!\lSO!)' pr~. Notably, rt created the abriityto uooerstand and address sy>temic nd:.ln large If"6tltUtIOflSYpe!\1S1Ofl Coordinating Com additiol\ Its statutory role In malntainmg financial mltee (lISCQ to bnng an Interdisciplinary and stability has been expaoded by the Dodd-Frallk (foss·film perspedr.-elo the superr.,ron oflarge, lVal15l:reet Reform and Consumer ProtectlOfl Ad of compIexm;nial 'nst,tutions; the usce act> 10 2010 (Dodd-FranlAct). ensurethat tile financiall'Osrtions of these large One ley featureof lhe Dodd-Frallk Act is its if"61itutions arestrong eroogh 10 w,thstand am'er>e maaoprudential orientatIOn, as ref\ected in many !hods. A$ imilat body has been set up to help in of the prOl1siol'tsto be ,mplemented by the federal the oversight of S)'SIemically important IinanciaI Reser\"e arK! othe, manOal regularors. Tile macro ma,ke\utilities. prudential approach to regulatlOfl and sUpeI\ision The Federal Reser.-e has ako established the slill pa)Hiose altentoon to the xtfety aoo wurid· Office ofFinaooal Stability PolK.)' and Research ness of indi\'iodual manoal 'f"6t'tulrons, but ,t alw (OFS) to help the federal Reserve more elfed"eiy takes Intoaccount the linl.:age> among tho5eenti· mon~or the finaocial S)'SIem and devek:.p polroes t,es and the cond~'on of lhe financial S)~\em as a fQrm.'gal"'gS)stemicr~ks. The OISsfundion illo whole. To implement the macroprudenl'al coordinate iltId an<V)"l:e informaroon bearing on apl"oactr. the Dodd-Franl Act ~blished the finaocialstabilityfromawide rangeofperspect~,es multiagen<:y financial Stability o..'ersight Council and to place the supervi$ion ofif,dividual instrtu· (FSOC), whorn is tasled with promoting a more lIOns w~hin a broader maaoerooomic and finaocial romprehef"6l\"e approach to monitonng arid mitl ronteXlln addrtron, the Federal Reserve works with ga~ng S)~temic risl The Federal Resffi-e is one of other US. agencies and internatronal bodies on a 1O.uling members oflhe FSOC. raoge of ISSues tostrengthen the financial S)~tem. categorie, if eronomic activity progre»e, in line with tile. also grtI\' rapidly over that period as did holdings com;ensu~ IOrecasts. of agency MRS. Consumer loonsheJd by banks edged Credit pfO\ided by domestic banks-the sum of up in the third and lOunh quarter~ Those increases loans and securities-increased tmderately in the sec.. offset ongoing declines in commercill rell esL:lte and ond half of 2011. its first suck rise since tbe first half of bomeequity loans, both of wbich remained rery welk. 2008. RJn~ credit grew as holdings of agency MBS Regulatorsoontinued to take steps to strengthen expanded steadily and most major loon categories their orersight of the fiDancial industry. In plnkular, a exhibited improl'ement in the SI!COnd half of the )"elr. variety of measures I11lndated by the Dodd-Fran~ The expansion was consistent \\;Ih reant SLOOS Wall Street Reformand Comurrrer Protection Actof resJXlnses indicaling that lending standards and loan 2010 are being, or are soon 10 be. implemented. indud· terms eased somewhal and that denund for loons from ing enhanced c.:rpital and liquidity requirements lOr businesses and households increased. on net. in the large banking org:lnizations, annual stress te5ling, serond half of 201 I. In pankular, C&lloans showed addilioDli rnk-nunagement requirements, and the persisteD! and considerable strength ol'er the second development of early remedi:ltion plans (see the box half of 201 1 aDd into elr~' 2012. loaDS to nonbaDk "Financial Stability at the Federnl Reserve'). As pan financi:ll institutions, a category that tends to be \u]a· of those efJoru, the Federal Reserve began annual 81 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00085 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.03021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 25 Systemic financial risks can take seo,'e.al b'ms, would causeserK>usdamage to the financial Some risks can be desaibed as structural in nature system. In all ofits rulemal:ing respon>ibdities. the bec311se tlley are associated with structural ~.lIure5 Federa Reser.-e is attentive to the inlernational of financial marlets and !hIlS oxe 1.Yge~ indepen dimension of financial regulation. It IS also wor\.;rng dent of ewnomiccondihons; these mclu<x>, b' with Its regulatory counterp;jffi 10 ImprO\e the example, the risk posed by aSIFIw hosefallure can qualityand bmeimessoffinancra data. hil'-e oul5rzed e!fects on the finilllOal S}~tem or the The Federal Resen-e is likewise 11)()\'lng forwoxd degreeto which monq' market mutual fur.&; oxe to address cyclical S}~\emIc risks. To identify such su:;ceptible to liquodi~' pressures. Other risks can risks, it rOlJtlne1y rnorotOfS a number of items-in be de5Cfibed as cyclical in natureand irr:lude, fOr cluding. b'e>3ITlple, measures ofb'erageand example, elevated asset valuations and exre\S;"e maturity mi,m.llC"h .lI1inarriai intelrnediilf>es-and aedlt growth that allse in buoyal1. economic limes oo~ for sig.nsof a aedn-induced buildup of S}~­ but can unwind in destab~iling wa)~ should condi ternie risk. In addition,. ~ conducts regular stress tions mange. Allenul-e1leSS to tJoIh ~'pes of IIsk is tests of the nation's largest bar*ng firms; these artical,n the mOllltorlllg of S}~mic risk and the tests oxe based on detailed confidential data about fonnulationof ap!>,opriate macroprudemral polK)' the balance sheets oflhe firms and !>'ol"KIe a corn responses. !>'ehens;"-e, r%orous a>sessmenl of r.ow the firrns' The FWera Re!e"-e has taken step> to odentrfy financial condrtions wOIJId likely e-.'01I.e over a structural vuloerab~ities in thefinancia system and rrulli)-ear period under ad\"ersee<:enomic and to devise policies 10 mitigate the associated risks. financials~narios_Me""while, efforts ilIe under Fo< exa~le, in Clecembef 201~ the Board released way to evau.lle and develop new rm::ro!>,udentlal a proposa to strengthen the regulatlOll and super tools that could help limn IUture buildup> of cycli mir:m oflarge b.YIk holding cornpar»e! and S}~­ cal s~emic nsk. temical~ Important oonbanl:. financial firms. The In summai)', the Federal Reser\-e h.ts tal..en a proposa comprISeS a wide range of measures, senesof actrons 10 Implemenlthe reiel-anl prOll' Including nsk·based capital and Ie. ..e rage requ"e SIOIlS of the Oodd-FrankAct and to meet rts ments, liquodlty requlrernenl5, stress tests, ~ngIe' broader ooanaal stabihty respoo>ibrlitres In a counterp.:fiyaedit limol5, and eox~ remedlat>on time!)' w~. The Federal Reser.-e h.ts made impor requiremr:r-ts.lnaddition, inWobe<2011, the tanl dur.ges to its orgam:atlOflal structure to sup' Board apprO\ed a final rule 10 implemenl the reso' """ a rnacroprudentia ap!>,oach tosupet\i!ion lution plan (1;"'ing will) requirement of the Dodd and regulation, and ithas instituted processesfo< FrankAct,. which is intended to reducethe li~eI;­ odeml~ing and re5JX111ding tosources of S)stemic hood that thefailure of a SlFl--should «ocrur- risk. rtviewsof the capital plans for u.s. bank holding com (figure 44).11 [n addition, survey respondents reponed panies with total consolidated assets of $50 billion or that they had reduced aggregate credit limits for cer IOOre under its Comprehensi\"e Capital Analysis and tain specific institutions. Investors appeared to be pl!" Re\iew program Going into those reviews. reponed ticularly concerned about tbe stability of funding in regulatorYClpital ratios of US. banking institutions thee\'ent of financial market stress b«ause most dealer generally remained at historiCllly high le\'els orer the Hrms are highly reli."lnt 00 short-term secured funding. secondhalfof2011. Respondents to tbe December SCOOS reported a Concerns aboUlt~ condition of European financial broad but m::xlerate tighteoingof crtl.lit terms appli institutions. coupled with periods of heightened allen cable to important classes of oounterp.1rtieso\'er the tion paid to US. securities dealers. raised im'estoranxi prt'.ious three months. This tightening was especially ety regarding counterpart), exposure to dealers during evident for he<lge fund clients and trading real estate the second balf of 2011, Indeed, responses to the December scaos suggested that dealers de\"Oled increased time and altention to tbe management of 11 FolIMg lbo faiNt. of. prima!), deale<; lbo IUnl Rtscn~ concentrated credit exposures to dealers and otber r li t n qu k R o d f p N r t- i o m . . Y !) o ' r d t e i a n le lp r; i m to l p tu :l$ k I J m . > r r i gi ; n I 0 : 0 ' r I " D ", ' , D ,r ~ J' 1 ' ' p ' r ' o th g ~ ram ag t e h n ' c l y financial intermediaries over the pm'ious three Imntbs MBSInnsa<tioa~ 82 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00086 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.13021103 26 Monetary ftlhcy Report to the CongressO February 2012 44. Net percemage of dealm reporting increased attention 45. Net perceotage of dealers rep.xtiug a tigilteuiDg 10 e~posure 10 odJer dealers, 201 0-11 ... of price terrm, by COI1Ilto.'l"))3rties, 2Q1O-II --------------------------~ --------------------------~.~ ., -" ... -w !'tll. ... pool. - " - < , I ' I 1 I Q' ll~ ~ QI Ql llll Ql ~ .. N , u Ia n I ; t d T :> h _< t m d K , " . >n . tU . l . " d . f . " . " . , " th , e - . o . .. . : . .. . . . b .. o , f « : l r O d l l l .- . u ... d .. n .., . • t. • . t . . .: l P I « " W " < " " ; l' tho N < I. m . : . T . h . o . d . a " b " ' • " • " d . n .. o " . r. h :. e . . n .. . . . . : . .. . , f b )' « < :< l n il b t :u d U V fro f) : ' • " • .. 1 . I . i: h P " 1 X 1 1 < '< ~ r' 1 . _ . 0 . 1 . 1 . : 1 Q I . i t I n h . o l N t " ! " " C "_ < ~ t t~ ' " l tm a h ! o< t ~ d _" _ , ~ . , . " d .. ' " < " I ' hy ' ;"t ' 1 ' t<fJ ' [0 '" 1 n" '< h: l t. " ." " _' "" ! . " ' I '- l& '_1t _ u« m nl l f _ ~ l • l • l ~ u . . . l . o . P . t . l J .. u e .. n t . o !" ' J " lU ~ "< " -I, ' .( l R p l E oo T l l . . l d ) < . " > . p " . ta . " l , . . . ~ . N t . t . ~ o . . P n fI " h n C , k < , . t ; 'l . . a h ! . t . . o . d " . l . l . « ! a ; p . lI t . I h . J e . ' id S M OO t la _« : 1 F I td I o S <a d I n R ~ .. · , . '" . . " B ' o * a < d, t S t e _ n . io . r - Cr - < '* d 1 it . o rr.:..~s..v.y<J[l " rv " > " r d « n l" 1 lt" b . ly d - " R ~'! b I> u It " n< '" d . o - IIa w I tt · p< ) >t . < . d . .. t' ¢ he lt l " ' " f " f «I t " " I . t . ~ d ( 0 '" " t 1 ;y 0 . 1 t< "' r " N ", D.mF""""",!:T",-. Ilutr<porUd<",",&"" .., <_"",id. ..b ly·,,"<_..-.t..") ~; ~al~1Io.d S«nc..ditOff""OpnionSIDf)'OII D.oInF ......" ""'&T. ..... inreSlmenttrnS1S(fignre 45).1' The institutions that transactions \I;th such client;, had decrea;e<i reported having tightene<l credit tenm pointed to a somewhal. worsening in general market liquidity and functioning and a redUC(d willingness to 13ke on risk as the most Corponte Debt and Equity i\'larkets important reasons fordoing so. Indeed. for eacb type of collateral cowred in the survey, notable net frae On net since July of Ian year, yield~on investment tionsof respondeDls reported that liquidity and func grade corporate bonds haw declined notably, while tioning in tbe underlying asset market bad deteriorate<l those on specu13tive-grade corporate debt posted ol"er tbe pm'ious thftt month~ Dealers reported tbat mixed changes. I~O\\"e\'er, reflecting a decline in inws the demand for funding most types of securities con· tor risk-taking amid concerns about the European situ tinued to increase OI'er the previous three months. par ation and heigbtened I"OlatiUty in financial market& ticularly the demand for tennfunding with a maturity spreads of these );elds to those on comparable greater than 30 days. which increa;e<i fOr all security maturity Treasury securities widened notably in tbe W' third quarter and bave only pmly retraced since that Net in\'estment Ilows to bedge funds in the tbird and time (figure 46). In the secondary market for leveraged fOurth quarters were reportedly significantly smaller loans, the average bid price dropped in line with the than in tbe first balf of the yeJT as bedge fund. mark prices of other risk assets in August but has recovered edly underperformed the broader market in 2011. since then. as institutiollli im'estors-which include Information from a \'al"kty of sources suggts15that tbe COllateralized loan Obligations, pension funds. insur· use of dealer-intennedilted lel"erage has dedine<l. on ance companies and other funds inl'ening in fixed· balance, since mid-2011.lndetd, while tbe use of income instruments-h.1I·e reportedly continued 10 dealer-intermediated leverage was roughly unchlnged exhibit strong appetites for higher·yielding leveraged for most types of counterparties according to Septem loans against a backdrop of linle new supply of sucb ber and December SCOOS respondeDls. about half of 10m (figure 41). Liquidity in that market has reco\' those sur,eyed indklted tbat hedge funds' use of ertd rocently after a sbarpdeterioration during tbe financiille\·erage. considering theentire range of summer. Broad equity prices are about uncbanged, on bal 14. T,..diIlg,..1 <St>.tt im<Stmellt tlllSU j","tiI. in lSittI NeW by ance, since mid·20\ I but exhibited an unusually high lnI ..... t.,..oo thaD dim:tl} io rtolewtt. lel"el of lulatiUty (figure 48). Equity markets feU 83 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00087 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.23021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 27 46. Sprm of corp:lI'alt hood yields ol'er canparable 48. Stoctpriceindex,I995-20[2 off·lIle-l1ln Treasul)' yields. by securities rating, 1997-2012 1..,~l(l(lloIOO [ , , , , ! ! , " " , , , , , ! , , [ 19% 1m m 2f11I))}I m m 2010 2012 11 1 ! 998 1 :lO 1 ll 1 2f11I ! ! W ! I ! I m ! 2 ! 00 ! 8 ! ))10 I 2 ! 012 ! ' S N o " o " .& " c! T : h D od o :r w .a l o .. o . e c o b h il l y .. : . n . l","", ...« Jth~U,J)I" N"", Tho dn .. cbiIy :nl ""kn:I Ihoogh r.m..y U. 201 .. Tho ",.od..t.m. .. "'" )i<!dr rn Io.y.. bmillm "'" Io.y.. TI<"""Y 'i S ~1 O i Ola: 1mI'<d ""'" ,~""""" ... yitlJ .,..... _ ~\:n~1 ramped up in the third quarter of 2011 but has since LJ ...... t.:nJdft reversed I\JJch of that rise (figure 49), Amid heightened stock nurket rolalilityowr the course of the second half of 2011. equity mutual funds sharply in late July and early Augusl in response to experienctd siubleoutHows. Loan funds. which im'est concerns about the European crisis. the U.S, debt ctil prinuri[y in UBOR-based syndicated lewraged loans, ing debate, and a possible slowdown in globll groll1h. also experienced ou!Hows as retail in\'es!ors responded Equity prim roughly retraced these Ios;esduring the to loan priCt changes following indications tbattht lOurth quamrof 2011 and ear~' 2012. rtllecting some Federal Resen-e would keep interest rates lower for what bener-than-<xpected economic data in the United longer than prel'ious~' anticipated, With declining States as weU as actions taken by nujorctntrll banks }ields on fixed-income securities boosting the perfor 10 mitigate the financialruains in Europe. Nonetheless. nunce of bond mutual funds, these funds, including equity prices hal'e renuined highly sensitive to news speculath'e-grade and municipal bond funds, al1racted regarding dmlopments in Europe. Implied rolatmty ne! inOoll's(figure 50). lOr the S&P 500 index, calculated from option prices. 49. Implied S&P 5OOvolltility, [995-2012 47. Seroooary·lIIllrl:eI I1d prices fir s)lIrncaled Imns, 2007-12 ------------------------~.~ - >00 • • I, , ! , ! , , , , , , , , , , ! , ! , I t9%l998lOll2f11l2OOlm2008:l!!02012 Non: Tho dol. •• -kIJt :n:t ",,",,, hwsh tht .....r. tndq " r " .m OIi . b .y ty < U l. ... 2 . 0 S 12 & . P Th S o O " O " . '" . " ,. " ' " t ' " _ " . V m IX '. -is ~ r ibe r o .. . pi .e.d. .J 1 O f . h dr « y I N""" Thocb. . ncbily:nl,,~IInu;ghFtl!ruoryU,)lll 1\. ... <1.0\1""'" ..... Soom: ISTAJ'Tl.-:rIRru:. .. M. .t .t<>.\llOt.oPti<in&- ~, ~J!o,.dl#i<m~. 84 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00088 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.33021103 28 Monetary ftlhcy Report to the CongressO February 2012 SO. .Nell 1owsiDtODl\llualfunds,~ll 51. ,1.12 growth tlle, 2005-1I o - • . E M. k .a rd ,. l , n .. l . l . r .. i . b k r d o f d ll f 'd ll o 'd o -" " - 12 "' • • • I I I ! I I I " I I Non: Md<fDliondMl ___ 1S Sow;,.; ~ol IQ".,.. bd. St.ri>t~ .. 11. ..... IU, "Mon.y St<d M. .....• Monetary Aggregates and the Federal onshore. Indeed. ~quid deposits, the single largest component of M2, grew at an annual rate of 20 per Resem's Balance Sheet cent in the socond half of 201 po Tbe currency compo nent of the I1lJney stock grew at an annual rate of The Mll1lJnetary aggregate expanded at an annual 7 percent om the second half of 2011, a bit faster rattof about 12 peKenl over the socood half of lOll than the biltorical al·erage bUI a slower pace tban in (figure SI),IITbe rapid growth in 1\12 appears to be the the first half of the year. The l1lJoeury base-which is result of increased demand for safe and liquid asset, eqU.1.110 the sum of currency in circulation and the duc to concerns aboU1the European situation, com rescl"I'e balances of depositol)' institutions held lithe bifl(d with a ICI)' low lel'cl of intere,t rates on a1tCrol Federal Rescn-e-expanded at an annual rate of uIe short-term invesUt1eDts. In addition, a number of 3% perrent in the seeond half of the Ye.1r, as the rise in regulltol}'changes h:m likely boosted M2 of late. [n currency JOOre lhan offset a slight decrease in resene particular, unlimited insurance by the Federal Deposit balances.l1 Insurance Corporation (FDIC) of onshore non Tbe size of the Federal Reserve's balance slieet interest-belring deposits bas made these deposits remained ata hi,torically high lel'Cl throughoUl the increasingly auractive al limes of heightened volatilit)' second half of 2011 and into e.1r~' 2012. and,tood at and uncer1.1inty in financial mar~ets. [n addition, the about S2.9trillioo as of FebrU.1.1)' 22. Tbe small rise of change in the FDIC assessmenl base in April2011 about S61 billion since July largely reflected increases added depo,it, in dome5lic banks' offshore offices., in temporary Us. dollar liquidity swap balances with e~minating someof the bencfits 10 banhof booking the ECB, which were pal1ial~' offset by a decline in deposits abroad and apparently leading. in some cases, securities holdings(table I). Holdingsof U.S. Treasul}' to a ded,ion to rebook some of these deposits securities grew S32 billion om the socond half of lOll, as the proceeds from paydowns of agency debl t5. M2 ooDsisu<>l' (l)t""""')' oullide It.. u.s. T..asuTY, FeJmI and agency MBS were reinl'C,led in longer-lerm Treas ~ BaDn.. .OJ It.. '''''''10<>1' dqlo;ilO!), iostil'!(iou~ (2) 1W'ritr'1 ury securities until the FOMe decision in September ( d C l I < < c lu h d o in f g n to"n"b"o" D .. k , o i; u $! , > l : I < . s " ; ( " 1 " ) d b e y m de ." p ,d o s d il t o p r < y J i i n j1 s S li . l 1 U e l> o o m m m , : t ! b c e i. J u b s a . nh to ,witch the reinl-estmcnl of those proceeds to agency V'crtlIIXtI~ ,tid ~ bank, aDd official iosritutioa,) Iosicaih MSS: total boldingsof MBS declined into the fall. Tbe "IllS io tbe procc;$ of oolk>:~ atld Fedenl ksm.: BOII~ (4) other subsequent ,mall increase in MBS holding, reflects the ,,,,,,bble depoGilS ("'lloriable adtr of ~;Ibdra~"'. <Jf NOW, ""'''''01> aDd aUlomatic InlIIfer om'icc ac.rouDI< at deposiI"'l' insri· IIlrion~ rrtdil uoioo $ha .. draft "",runts;.tId dem,nd depoI:ilO>I 16. RegulatiOll Q, ~'brh had pmhibitnllh< l")"""[ <>f iD~ on l!!rift ioSlitutioo,~ (5) ....i ~depoI:il«i""luding..,...,. markt dematlddepooils. ~~'''f''akdbylbeBoardOll July14. Th~ repeal deposit ,=unl<~ (6) ...a ll-drnomioatioo lime depoiil«timo<Jeroo- m'l' ""'" ali.:>cOIItnbuled, in, imiIl ~~~ to !he growth in M2. uisRoeJiniID""'IS<>fIcsiIh", $IOO.OOiJ) bJilldr.iduai rtlirtm:ol 11. Tho MEPtbat"~I'DlIOIIII<:eJ.at IboSorlemkf FmtCm«\ ""''''''I (IRA) and Keogh boan:es at depoiitOl)· i(Jl;lil:ntions; and ing ~udes~1X>i 1~i1XrtaSe!he ~ malurilY of Ibe Fe<haI (7) l:»lan:e< in rtIa~ monrymartet fund! less IRA and Keogh Rr;tr:e• • ""uriit; hoIJiDg ...' bilo Ieal';"g !hequantil}' '" """'"'" biJ'IK:es,'mooeymorb:tt'tmd:< boa""," roughly wrha. 85 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00089 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.43021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 29 l. Sclw:ed coo:p.mtllli ofllx Federal Reserve balano: 1bte1, 2{l1O-12 MiIioo,ofdoD .., -_. 0. M .:, O 29 , F.ebn.1l . ToI,I_. l,lll,m l.87.\.&19 l.9.lS,J.19 , Orail '"'rto:ltd /a iqalizotJ "",,, .., ,., ..Jilt"", P. ...' YcreJit " Ct.~,j W lirsiJill ""I". " ,,,. 101,91~ T Or " a . i . l .. ' . "' . r . t l - o B :l a t d J : / t a .l O !s!.tnr~ .l..:..t.t L F o " a " . " F ip d 4 i u t r y (TALI') 24 . ,M , 1. .2 9 Nt< pon"lio loI.limpofTALF LLC .. m '" ~';::.i~1.~:":ft. . . o. iJ oO w. u.c. MoiJn J..o n LLC. oo.l MoiJoo La. . TIl UC' 66.312 19,637 ;1),822 "" ~~:.:=~~ ~~~~~i&~~ij;.;pLi.C··· :Ji,l}51 SOYWJOtIJ ..., iF.' = U : s : .T = I ~ ta ~ S i O ; 'Y ,; . ; ... , .. ; " r ' i . . · . . . ; . .:;(iXIi)i·:·· 1, m 1 0 ( 1 1 ', , , 1 4 H 1 0 l 0 I l 1. " 1 1 i I l " 4 l . .0 1 .1 I ,0 l 1. ~ I " O ) " O , , l M S M 1 l 1 T. ..I l>1i1U<! .. 1.w;,8..~ lJl:!.ll:! tiIM_'56 S<kcIoJIiabiliIir< Fe.ioI>lR<s.r>'tOOlelilomlllioo .. 943,149 990,861 1.00,(1).1 ~",,,po"'''''1I9_0U \9,24.1 '1.m ~,Sl4 ~ ~ ' ~ oor . i .\-hj = bid) ~ d.,tT : ro,, ~ <.di<t ~ "p' = oJs' - iiuo ~ <I F ~ ; - ;; . '- u ; c .d . .; . i . ·~;~i" 1.0 ' " " 2 I 5 ' , , ' 8 m " " )9 1.6 6 6 , 1 J. . , l 1 l . 1 2 .• 0 1 1,6 ; 2 6 2, , 0 o 0 n • • 0 T. ..I <>';I>I 56~1 51,661 "'"' No!!. LLCinbm,,«IliIbiilJ'<OlOpaoy 1 Th, I'.~ . R . =w!w Clloldtol aodll ",><>er1II LLCs ",onl"""'" 'II"1th d!oru ~"'PPOO ",U<o] imt. ." """ M""",, Lao. LLC ... furntod "''''I''"''''''''' =~"S":- =::-~~";:~~I:(~r:"L:.mtuli:.:~:=":tb<Ji.~;":=~= -.ttl<ltthtF~PtOO_,"",pO/AlG1w-.n","<r«IL1c1e1ultrwap<Olltra<l1 llD<lcd ....~ MSSpo_tbot""oIlea1yKttl«l SoiRa: P.~ Ratn-o B<aN. StutI:oI RdtoI'e H. 1. "Fi<IOt1A11"«It", Ram B>Jao""o/ Dtpooto<yl,Itt\lltrlllllDl Coo<t:ooo Sti.1<I:t<"Olo/ F«I"~ Rn<no ~n· reinl'e5[men[ of tn1[uring agency debt into MBS. from the Maiden Lane 11 JXlrtfo[io in early 2012 Agency debt declined about $14 billion om the entire through tll"O competitive processes conducted by the period. TheromJXIsition of Treasury holdings also FRS}''Y's inm[ment tn1l!3ger.1l cbanged over this period as 1 result of the implemen[a Use of regular disrountwindow lending facilities, [ion of the MEP: I\S of Febrl11ry 24, 2012, the Open such as the pritn1ry credit facility, continued to be Marke[ Desk ltthe Federal Re5CI1'e Bank of Nell' minitn11l.oans outstanding under the Term AS5e[ York (FRBNY) had purchased $211 billion in Treas Backed S~ritie; Loan FaciUty dedined and stood ury securities with remaining tn1turities of 610 just below $8 billion in la[e February. 30 years and sold $223 billion in Treasury securities On No\'Cmber 30, 2011, in order [0 ease strains in with tn1turi[iesof 3 yelrs or less. globll financial market;; and tbereby mitigate the In the second balf of 2011 and elT~' 2012, [he Fed· effects of such strains on the supply of credit [0 U.S. ernl Reserve reduced some of it; exposure 10 lending households and businesses, the Federll Reserve facilities established during the financial crisis to sup announced coordinated actions lIitb other central port speci6c institutions. The portfolio holdings of banh to enhance their capacity 10 provide liquidi[), Maiden Lane LLC, Maiden Lane II LLC, and Maiden Llne III LLC---tn[ities tbat lI"ere mated during the crisis to acquire certain assets from the Bear Steams [8. 0. .b.1lIIiI'Y 19, 2012, tho FRBNY .DDouo;;a:] tho",leof .sst .. Companies. Inc"~ and American Internationa[ Group, . p .i o l n h fo . i ~ o lh r iI o ID u O gh tI Il 0 l o <o f m S p 1 e .0 1 j b li iD »o i . p . ro f c ro es m s. t 0 ho . M Fd a l i l J l e l> u l ) L ' a & . , . 20 II 1 2 L , l 11 C 10 Inc., or A[G, to x.-oid the disorderly failures of those FRBNY .DDoo1n>.llbe We of oddiU ...[ ........i lb. flU "Doo1l1 ins[i1ution5-----declined, on net, primarily asa result of of $6.2 billioo ff\)l1l tbe ~bi&e., LaDO 11 lLCponfolio. abo lhrough asset sa1esand principal pa)'men[~ Of note. the o m o 1 < b > 1 m et p h d o" ir l i" " , ) ) m Y( e I t tl l t l S of 5 t . h l' o ro < c n tt I J in s : f n ro :m m a l i b n e in s g t O tt O l" 1 I . n lt " il ,, n ,, d t i i n 0 g 1 b li a . l . . i D 1I CCof FRBNY sold assets witb a face aroount of 513 billion lbe...nor loa" from tho FRSNY 10 M.iko La .. [[ nc. 86 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00090 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.53021103 30 Monetary ftlhcy Report to the CongrtssO February 2012 support to the global financial system.19The FOMC 52. U,S,doUlroominal e.~chaoge tale, tlood inde.~. authorized an extension of the existing temporary 2007-12 Us. dolbr liquidity !",.ap arrangement! through Feb o. ...: b"ll.lOOI_1OO ruary I, 2013. and the rate on these !i\\'ap arrangements was reduced from the US dolbr DIS rate plu! 100 basis points to the DIS rate plusSO blSis points The lower cost spurred increased use of those swap -m Unes; the outstandingamounl of doUm prol'ided through the swap lines rose from zero in July to - )]0 rough~' S108 billion in bte February. On the Uability side of the Federal Resef'-e's balance sheet, reserve balances held by depository institutions - '00 declined roughly S40 billion in the second half of 2011 " and early 2012 while Federal Reserve notes in circub tion increased roughly S57 billion. The Federal Reserve I t t I conducted a series of SlJl3!I-scale reverse repurchase 'IfJJI m m ))10 W1I ))12 trJnS.1ctions in\"olling all eligible collateral types and N<m: Thedaa. ~·hId. .... kw.'PlaDIrr)'miI'p"Itibr, .. daiIy its expanded list of counterparties. The Federal T ~ h I o $ h ~ o " d " " " . ' . " . "" o , lth b o n " . ' ' . ' . P .. I . . t x io d lf m lr t . t . . . ,- . 2 .. I . . . W ol I : t ! . . e T U he . s b . r d o o o l : la I. r . .t , n ! . m io Il . i R ts e t s h e r n o t u g a h ls o t h c e o T nt e i r n m ue D d e to p o o s f i f t e F r a lr c tl i . l 1 it .1 y 1 . ·v In al u J e u l t y e r o m f d la e S p t o s 1 1 " h 1 t . - , . . o ' .. m l . it . > . , : . ! . f , . r i . « o . 1 o . g l U Io . . ~ s b . m n r! .. < i "h b P d < . l " ' q 4 " ' < o iO l " i l l : p ' h " Il < " ,. _ . - . o , ' . . . pli t;.. . d . . t . r i U '« . l s f . ro w . ~ l U ' .s f . l < > Ep " J . I1 YeJr, the Treasury reduced the balance of its SuppJe. Sowa: Ndnal Rts<r.'. 8oIItd. SUhll>:al R<~ ... 1l10; ~ menlary Financing Account at the Federal Resm'e ~h.~- from $5 billion to zero. ticipants became increaSingly pessimisticaoout the International Del"clopments situatioo in Europe. Safe-hal'en Hows buoyed the yen and the 511"i:.> franc, and in rtsponse. the Bank of In the second half of theyen, financial market devel Japan and the SlIiss National Bank separate~' inter vened to counter fnrther appreciation of theircuITen· opmen15 abroad wert he.ll'i~' inftuenced by concerns cies (figure 53). about the heightened fiscal Slre>se, in Europe and the resullant risks to the global economic outlook. Foreign On net in the second half of the yea~ government oood }ields klr Canada, Germany, and the United real GDP growth stepped up in the third quarter, as Kingdom feU ol'er 100 basis points to record lows, hpan reoounded from theelfectsof its March earth quake and tsunami, 1e3d.ing to an easing of supply chain disruptions. In contrast, recent data indiC3te that 53. U,S,dolllre:o:roaoge flle 3gilinslseledoo Illljor foreign economicgroWlh slowed in the klurth quarter, currencies,20W-12 as activity in the euro area appears to ba\"econtracted and as Hooding in Thailand weighed on growth in SCI' eral ecooomie! in Asia. International Financial Markets The tOreign exchange value of thedoUar has risen since July aoout Wl percent on a trade-weighted basis against a broad set of curreucies(figure 52). Mostor • the appreciation occurred in September as market par- " " I t t9. The B""k of c'nw, the Bank of Engl>nd, the BanI: of Japan. the Elropem c.nt ..1 B ank, the Fe.Jent ~~ ""d the SwiA National B,n' coonIin,led tbis action. In l<Uiti"" IS I N<m: Thedaa.~ .... kw.IPI~_,pttdolbr, .. daiIy " C iq I 0 } u 1 ' i I J " i ' t t ~ y i p i ~ l : . y t n m y Jr o . Q n f S g lb U n e I t ' i t l , r ' w c th u e ~ m ; F t : O ! b l ~ < tb 1 i t e C s s e W i f f t u . t " .. t d C .. . f t . t o l s l a t e l r i s y . a b t . l a is n b h l I i ~ r o p- i < ll M ll . a ... l l]» T ~ h S o o I o _ h ta c : t o N tr d . . . n - .- l a l l i o R n t " s ' < .d r.' l . ... 8 . o .. I . It d ; . , S ~ U 2 IlI I I> . :a ) l ) R 1 <~ 2 . .. 1l10; '1'<mtn 87 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00091 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.63021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 31 54. Yields on reoctmarl:. government bonds in selected )6. Equityindexes in selectcl i\(iI'lOCtd foreign ecooom:~s. advanced foreign ecooomies. 2009-12 2009-12 • I, I I I I I I I I I I ~Qm, t.I. .. Ap. '. I !O u w ly Q,t.I. .. Ap, I I l o l I ! y Q,t I. . '.! . O I' Iu!y m Q ,t I. .. A,". '.! ~ OIO Oct. I. .. Ap. I l l l l I) ! " Q,t In '.!O 12 Non: n.. dab. otrl at f<t to-yt. bmdo ••• d.dy. n.. lOll N<JrL n.. dMt ... d.d". n.. I. ... a....,'MIrn fa ...-h ...i H it ~M"'" f<t ....t . ....... §FcbruKy21,'.!011 Fmu.yU,'.!Oll Soolc!:Ilb>mbe<t. <1 S m o w .. n . : . f n«oc.:.. . J n o . r. J .. o F . a T oS " T " O " XX " , Ir , dn S ; l h- o ' c - k~ T X ck l r< ) > ~ Si . c . rl M ~ l;b (TOOX~ ui b dIt !bled ~ l<nlon Slrl ~ (FISE drnu by safe-haven lIows as well as a deteriorating ;oo~"I" .. B"""""",. global OUlloo1:. (6gure 54). By oontl'3St, sovereign bond spreads for Greece rose steeply, and Spanish and hal· (figure 56). Thoseequity markets remained quite vola ian sovereign spreads over German bund; also tile but Ilrgely depressed through early December, increased (figure 55). Pricesof other rist:)' asset; were when market senlimenl seemed to take a more con very 1'O)atik om Ihe period as market participanl. certed turn for the bener. Although tmst AFEequity reacted 10 newsaboUl tbe crisi& (See lhe box "An indexes reTI1lin below their mid-sununer levels, they Update on the EUrope.1D Fiscil Crisi&") hare risen markedly in the past two tmnlh& Emerging As sovereign funding pressures spread \0 Italyand markelS equity pri~e> followed a path similar 10 tbose: Spain in July and August and as concerns also in the AFEs(6gure 57). Emerging markets bond and truunted regarding US. fiscal policy and tbe durability equity funds experienced largeouillowsduring periods of the global recovery, equity prices in tbe adl'anced tOrdgn eoonomies(AFEs) generally plunged 57. Aggregale equity ilXlms fIX eme!gingrmrktt eoornxnies,2009-12 55. GIl\'enment debt sprelds for peripheral EUf()jlean econanies, 2009-12 --------------------~-.. F I t N br " I u " a , y ; T 2 h .1 o m , I < l 1 l M l . I n ,,< .. I ' - P tt ' I y d . I l " I I T O " h " o " I a » tl b I ~ o M j . I I .1 r '. : ! h O n ' i " l b IO -y , t r I ' . . ! l O b 1 m . 2 . . d ' o " !. . " . ' O C F. h N W b i r l o o w , m . r 0 y I : n : n : : U 0 b . 0 ~ , . .b " I d X n u M : . l l l o t l M n o n l " l i , . . t i ~ , o o d M r , a " . i . ' l n ) . I " . ' . l ' A n ' P . ~ . . t . . r u ! i ' ; < & I. . I . i b . . . . o . . ~ o . . . b . . I c b . < o ., r n " I I '1 " ' : " I z , A < I b ' ; I A : " z ~ f . o « . O S c .-1 c a 1 . : . t . m . : . : . . . i . 1 H K " I r " r. u . ,; i ~ t . . , dltIO-yt.a... ... bcrd)';,1d T.won.nlThaiInl. Soom: llIoomIJtt-t. Sown: B~ 88 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00092 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.73021103 32 Monetary ftlhcy Report to the CongrtssO February 2012 An Update on the European Fiscal Crisis Tne turopean fiscal crisis Inter'tlified In the second tions, caused sO\·ereign)'ieIds 10 rise sha'ply in the haif of20n, il$~nsO\'effiscll ,ustainability fall for otheo euro·area countries, irdudingAll5tll(l,. spread to additional euro-area economil's amid Beigrum, am france. weakening erooomic growth prospects.nl missed European leaders responded to these deo.'elop fiscal t<vgets. European fin.nciallr'tIlitutlOO> also ments w.th a number of poItcy measures. In Ju~, fm sharply reduced access to funds, gr,'en their amid the grOWing realizailOfI that Creecewoold large exposures to lulnerab!eso>",reogn5.ln need fuJlhe!firraJJCiai ass.stance, EUand LWoffi· respon>e, poIicpnakers tool ~evs to imprO\", fiscal cials annoo~ plans for a se::ond .escue pack. balarJCe>, boI~e< the ref,Km's ~nanoal bacl5top, 3f,e, inc1udingacal forlimrted reduction inthe and iddress liquidit)" s~ k>< banl.:s. On bai· value of the debt held by p"vate creditors. In Feb· ance, rffiIkeI conditions Ime imprO\w !lO<1leWhat ruary 2012, in .espon;e to Creece·, falte"ng IiscaJ sioce Decembef, oot concerns about apossible j)elformance and plungi~ ootpo~ the Creel: goy Creek defauh and the adequacyof the financial emmentand its creditors ayeed on an enhanced bacl5top for other lulnerable eronomies h<J,,,, rescue package, looudlnga large! reduction in pri· kept )1eld5 on SOIerelgn debt eleo.-ated and funding l"atecreditors' dalms. The Creekgo',ernment and for Eurorem ~nancial InstnutKlr'tl hmlted. its creditors are now worl:Jng to pot In place the The OISl5 began In >mailer euro-<veacountries prll-ate-;ector debt exchange and the new offiaal· with hlgt. fi5C.l1 defiot> or debt and I"ulnerable ;ector support program before a la.ge debt amorti· banking systems. In 2010 am tne fir~ half of2011, urian P"rment <:orneS due in mid·Ma.ch. gO\",rll/Tll'f1ll; in Cr~, Ireland, and Portugal suf· In recenl months. [u.opean illIthor.tre5 hal", also fered reduced access to marl;et funding.nl made progress on plans to impfOl'l! fiscal gOVel· required fmncial assistance &om the European nance within troe region. EU members (exduding Union (W) and the Inle<nalional Mooelaf)' Fund the UMed Kingdom am Czech Republic) ha-.e (I,~ If). Last .kJ~, SO\·eretgn spreads O\er German agreed on thet""'t of a new iiscaJ compact treaty bunds rose marked~ for Italy and Spain,. as ero de>igned to strengthen fiscal rules, surI .... lllance, nomicp1h d~polllted, doubts increased 0\"" and enforcement. Among othe! mea5ures, thrs poitK:ai commitment to fiscal cor'tlohdallon,. and treaty \\ill require coontJles to 1egr,Iale naltonal calls k>< the r~ructuring of Creek SOI",retgn debt fisca rules, which shoukl general~ lill1lt structural rallied ifll-estor conIideoce. The dete<iorationof fisca deIiots to ~ pelCeJlt of gross domesticprod· finarcial conditions led to heoghtened "aIrtical ten· uct. The Ifeaty is e<pede<J to be ,igned .n "''Ia.ch, ,ions in \1.lnerable t)COf"()mies, rontllbuting to after which naiionaJ parliaments mUSl.ai.fy it am leadefship changes in Cr~, lta~, and Spain late< implement the requrred iegistation. tnthefall. Leaders also tool:a number of stevs to irrcrease Financial stresses spread quidly to European the SIZe of thefmncial badstop for theeuro area. banks with large exposures to Italy, Spaln,.nl the The flexlbihty. scope, and effectil'l! 1eodlng capac· other 1'Ulnerab!e economies, and access to funding ityof the 4€40 b.llion Eu.opean Fin.n.ial Stab~rty became limrted for all oot the short~ matuntres faality (HSf), deslgrred to >upport \"uIJJefablegO\~ and ~rongest rn~.tutlOll5.ln turn,. ~1"6 0\"" e!nmenll;, were illl1eitied. Autr.or.tresa1", m:;>o,'ed the potential fisOlI burdens for gO\'I!.rYnents, up the introduction of the [u.opean Stabilrty shookl they need to recaprtalire linancial.nstir:u- MecIlar-.sm(£5.\Il, a j)ermallenl S€OO billron lend· of heightened concerns about the European crisi~ but tal adequacy of large European banb persisted. Partly inflows have resumed m::lre recently. in respon;e to the;e concern~ the EBA announced in Euro-area hank stock prices underperformed the October that banb would be required to PUI in place a broader nurket. asconcernsa'oout the health of Euro temporary extraordinary capital buffer by June 2012. pean bank. intensified over Ihe second half of 2011. boosting their core Tier I risk·based capital ratio to The CDS premiums on the debt of many luge banks 9 percent. As market sentiment about European blots in Europe rose substantially, reRecting nurket views of deteriorated over the period, their aC(:ess to unsecured increased risk of default (figure 58). Quanerly earnings doUar funding diminished. particularly altenors lOr nuny banks were reduced bywrite-downs on beyond one week. (See the box ··U.S. DoUar Funding Greek debt. Although only eight banks failed the Pressures and DoUar Liquidity SwapArrangemenlS. ") European Banking Authority (EBA) European European blOks also faced pressure in euro funding Union-wide stress lest in Ju~'. coocerns aboutlhe capi. nurkets As banks' willingness to lend excess liquidity 89 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00093 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.83021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 33 ingfacility, to Ju~2012, about ayear etrliefthan eamlllgs, issurng new shares, and coo"elli~ h)ilrid original~ planned, This Marm, euro-area leaders instruments to common equ,ty)to achie\.e i€S bil will consider lifting the S€OO billion reiling on the lion of their buffer. The remainder of the buffer will rombn1W ~dlllgoftheHs/" and the[SM,ln be genetated by measures that reduct! risk additKlfl, [uropt'Ml offiaak called k>r an expansIOn weighted a56e15-p<lmanly §ellingassel$ and of the 1,\lF's lending ca~ty and iJledged a JOInt ~~chrng from the standNdiled to the ad\!iO"ICed contriblJllOn of I€SO billion towNd that goal. approach to me<l>ure Jlsk welght~. These measures Final~, to Imp<O\'l thefundiOfllflg of SO\erelgn will be subject 10 supervisory aweement debt marlet5. the European Central Bank (EeB) To address spilloo.er> to Us. doilN fundl;g mar· resumed purchases of eunrarea marketable debt kets from ,tresses In [urope. in late NO\ember the in August, repo<ted~ including the debt of Italy federal Reserve. the £CB, and fOur othei milJOl' arK! Spain, cmtral banks agreed to reduce thefee on draws on PoIic)makers also lockstep:! 10 support financial their dollar liquidity ~ap Ii.-.es and e>;tend the m~eIS and InstitutIOnS affected by the SO'o'eleign durationof ~UCIl facihties.ln early December, the aislS, To imprO\'e transparenq' Mld boIslerthe a~l· [CB announced a reduction In 11$ poii<)' Interest Ity of[ulopean ronks 10 w~hstand losses OfISO\'{'f raleand I\Sre§el';erequirement,an ea.si~of rules elgn holdings, the EuropeiO"l BanIJ~Authorlty on collateral for ECB refir.ancr~ operall()flS, and (EBA) conducted a =end ~ress test oflarge EU theprO"o"iSlOllofthr_yeN refrnancingtobanksto finarriallrt>fitutions, the resull$ of whim were imprO\'e their fuooi~ ,ituation. Banks oo.rowed released in mid-Ju~, a~ with detailed infO/ma £489 billion at tfle new facility in ~mbi:<, ral$ tionabout tIanls-e..posuresto oo.rowers inW i~ the to!al afT'lOlJnt of outstandi~ £CB refir.aoc roonllies. I<la!h.1 concerns about bankcapital pel i~ operatlOll5 by rOlJgh~ £100 ~lIion. As erond sisted, howe..er, and in October, the £BA tlv_)'ea, liqUidity operation is scheduled for the anoounced thatlargebankswOIJId be required to end of February. bUild up 'excepliOflai and temporary" capital buf· The Imp!"O\ed availabtlityof dollar and euro fers to meet a core Tie< I cap<tal ratIO of 9 percent funds late in tfle )'ear, agaifl>lthe bad;uound of arK! COI'er the cost of mMj~so\'{'felgn exposures the other ~Kles bemg emplo)ed 10 address the to mallet l:>fthe end of June 2012.ln December, alSOS, appears to ha'>e part~ allayed marlet c0n the EBA dO$dosed that the aggregate requirw <api cerns about banLs as wdlas gO\"ernrnertts In ",I· tal bufferk>r large banLs woold be l€IS billion if r.erableeuro-area roontries. Over the pM! two risk-we.ghted assets we.e to remam at the b-els rroolh$, European banks ha,-eseen imprO\ements theyha::l reached at. theend of September 20n. in their oc:ress to fundillg. and in '1Jinerable erooo The ronks subm.tted tr.e.r capital plans to their m.es, aed~ sp<eads OIl the banks and spreads on natioml supeJ\1SOfsfor appJOl'a~ and the [BA has gDI'ernment bondslm-e general~ declined. Never now summarized these plans. £xcIudl~ the Creek theless. significanl nsks remain <I> Europeans banks and three other 1ns1ltutl()flS thai Will be struggle to Implement the fleW Greek p<0lf'I" and recapitalized §epNateiy by natioml authorities, the debt exchange, meet targets fOr budgel$ and bank rerrtaHl"'g 62 banks HlterK! to aeate capital buffer> capital, arid expand the finanoal ba::btop. CNerthe equi"alent 10 -£98 billion, about 25 percenliarr,er 'enger term, the region must meet the difficuk chal than thel! requrred buffers, and they plan to use lenges of oc'"e~ingsustalOed fiscaJ consolidation, di'ect Qlpital measures burn a\ retaining stimulatingwowth, and improving competitiveness. to one another decreased, the co;t of obtaining fund The Finaocial Accounl ing in the m.utet roSt', ami banks relied more heal'ily on tbe ECB for funding. The first three·year refinanc Financial Hows in the S(:cond half of 2011 reOeCled ing operation, held by the EeB on Dccrmber 21, led 10 beightened concerns about risk and tbe pressures in a significant injoction of nC\'.' liquidity, and funding currency markets resulting from the European crisi~ condilion;; in Europe seemed to improve gradually in Based on data for the third quarter and tronthly indi the week> that followed. Sbort-term earo interbank cators for the founh quarter(not shown), foreign pri rate, declined, euro-area sborter-\luration sovereign vate investors Hocked 10 U.S. Treasury securities as a rond yields fell sharp~', and botb governments and safe-baven iltye;tment while selling U.S. corporate bank> were able to raise funds trore easily. S(:curities., especiaUy in trontbs wben appetite for risk 90 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00094 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.93021103 )4 Monetary ftlhcy Report to the CongrtssO February 2012 58. Credildefaull SWlP premiums fOf haol:s in 60. Net U.S, purcblStSofforeigo seo:urities, 2007-11 selected Europe:m rouoUies, 2011-12 .. ----------------------~"=- .. - '00 -M '. .. - - '" ~ _ <oo - ~Spa, - 300 - '00 - •. . U_I:. - 3),J - - 100 II I I N= Nq:,""" IUIIbor< -... Nbrn of 1'")_ ",flow ~.ilhf"'.""'U.s_~ofkuip'''''';';'' N"",Thodal>vo.ily.TholaltoWo·""", b .>do",,;" iI Sow:.; o.,..t_clc-....Bo:. ... of~AnaIy<,~ ~ 24.2012. CudoI o.fUl'~V"" bri _dobIonJ .., g.,d by bri 1<UI ....... SooiC!: M..tf;IIloo.t...-&;~ .. R..or.veBo;ro.uif<>lrnl.rm. was puticularlyweak (figure 59). Us. investors also affiliates abroad overthe course of 2011, building pulled oock from investments in Europe, siguifiC30!ly rese[\'e b.l!ances in the first half of the year and co\'er reducing deposits with European banks lnd seUing ing pcrsislent declines in U.S. funding sources. In con· securities from euro-area couDlries. OveraO, U.S. pur trast, U.s. banks. subjocttO less-severe market sire5.$., chases of foreign securities edged down in the tbird sent funds abroad to lll«t strong dollar demand. quarter (figure 60). InOows from foreign official institutions slowed The large purc-hasesof Treasury securities domi· notabl)' in the second balf of 20ll (figure 61). A DUm nated t01l1 privlte financial HOII'5 in the third quarter, a !lerof advanced countries acquired some U.S. assets. paltern that likely continued in the fourth quarter. Net seeking to counteract upward pressureoD tbeircurren Oows by bank510cated in the United States were small, cie, by plJIClilsing u.s. doOm in foreign exchange but these ftOIl'! masked large offsetting mol"ements by markets. Howerer, inllow, from official institutions in IOreign-and US.-owDed banks. US. branches of the EMEs trended dO\\ll signifiC3Dtly in 2011, espe European banks brought in substantial funds from cially in the tbiro and fourtb quarters when tbe 59. Net f(l"eigu JXlrctwes of U.S, securities, 2007-1 I 61. U.S.netfinancialinflows.2007-11 .. o • OO'~loI~ofU.s. TI<OIII)',.".... ... - P" •• (n:hdiog briq) o . F Pt lr i d v u a o <~ rr o o r f U " . "" s U .T .s , _ .. O . K .. U , l . t" . , . "..rie< - " . . U ~l .s 7 . ' o o ff I o f :i ~ a - l -w - "" -<00 -'" -'" -" -<00 - '00 -'" -" II t I WI m )XJ'! 2010 201t WI m )XJ'! 2OtO 2011 N",,; ot...U.s.......,;.,iDoW."""".f<pII. .. onJl<nl<.~ Non: u.s. off.rut n.:,.., irrW, .... k ..' !" all'''')" ~ ....... l<nl<.m~l<nl<. k:ttlgI ....... oI bril.tow """". ,..'IIp ......' m .... Hdttollwnw. SOIII:C!: ~ofeo..,.,.,..BInouorli«n>m~Wyci;. ~: Dop:01_oic-.:..Bo:,. .. dIi<<n>Di<AnaIy<I~ 91 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00095 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.04021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 35 strength of the dollar Jed to rt'\Iuctions in their inter rellecting the run·up in conunodity prices earlier last I'ention actility, year and, in some countries. currency depreciation and increases in taxes(figure 62). However. underl}ing inllation pressures renuined conuined and, in recent Am'anced Foreign Econonies monlh~ inllation r:ues hal'e begun to turn down, rellecting weJ.ter economic activity and, as in the The intensification of the euro-area sovereign deht cri United Sutes., declines in comroodity prices since Ian sis was accompanied by a lIidespread s10lling of ec0- spring. As with output, inllation performlnce differs nomic activity in the AFEs..ln the euro area, financial significantly aCrDS,countries. Tweh-e-roonth headline tensions increased despite the various measures inllation current~· ranges from 3.6 percent in the announced by European leaders to combat the crisis. United Kingdom partly due to hikes in utility prices, Real GDPcontracted in theeuro area at the end of to slightly negath-e in Japan, wheredellation resumed Ian year according to preliminary estUrutes. and spill, toward the eod of 2011 aseuergy price inllation trod· overs from the euro area likely contributed to the erated. tOurth-quarterGDPdecline in the United Kingdom Several foreign central banb in the AFEseased In Japan, economic activit}' rebounded rapid~' from moneury policy in the second balf of ]a,t year the disruptions of the March earthquake and tsunami (figure 63), The ECB cut its policy rale 50 basis points but dipped again in the last quamr of 2011 as exports in the fourth quarter, bringing the nuin refinancing slumped, In Canada, elevated conunodity price; and a rate back to 1 percent. where it was at the beginning of resilient labor nurket hal'e supported economic actil" the year. At its De«mber metting,the ECB also ity, but the export sector is sholling sign, of expanded its pfO\"ision of liquidity to the banking sec weakening. tor by introducing two three.year longer ·term refi SUI'-ey indicators suggest that conditions improved nancing operations. rt'\Iucing its resme ratio require somewhat around the tum of the year, with wide ment from2 perceDi to I percent, and easing its spread upticks in different countries' purchasing nun collateral requirements The Bank of England has held agers indexes. However, uncertainty about the resolu· the Bank Rate at 0.5 percent but announced a£7; bil· tion of tbe euro-area crisis continues to affect lion expansion of its asset purchase facility in October inreSlors' sentiment, while trade and fiD3.ncialspill. and a further £50 billion increase in Fehruary that wiu overs weigh on actility for all of the AFEs. bring toul a;set holdings to £325 billion upon its Tllcll'¢·month headline inHation renuined elevated completion in ~Iay 2012. The funk of Japan also in mon of the AFEs through the end of 2011, largely expanded its asset purchase program raising it from _. 62 0I31lg~ in consmne! prices for m::Ijcr [creign ecooomies,2007-12 63 Official or tMg!"ledimerest rates in seltcted 3dvm.:e<l fCleigIl e.:ooomies, 2008-12 -. - •, - - •, -, - , - , - · ", - , -, - , ,- ! ! I '!WI m m JJ10 :lit! :lit, NOlI: Thedol ... ...:ttliy ...h uOfd*oqhl_y:llt2f<tc...do. t..e\W .... arddwoUnll<dK~ardt~Do<t.bor:lltt '" ""N"O"l_I: .Tbho edO"!o" ."." d aily ard",l«ddw,\dl """"'" U. Wl1. Thodll. bpar!;1Il<""_<hq:<i<Irooo"""J'<", .... "'u'g<lfa ",,,,-..nip_;fa oho..., .... Iht K S q o o oo o c . z . ; I R h w t U 1Il K < e \ 0 W 0 ". . . .. . f< t t h e N E OI t m .q o > i e . S . tM ~ ..h ~ ,.; B b . :t I ; " " b " , 1I t l o < . tn I. o . e ,. d , o • a . I - t, . . . . b ; K .... l . , b . th . o " U " n • i l . e ." dK < ir f J . t . d .. o , o " a '! .d :. w ,, o .. o - f " li o < t o m oI ; I f 1 a ri l . " R " o " I ' t t . h e'a-v!f"lht StM'"~' &.<111;..-.J. fa C"""" $urom::. c...da; oItvi. Hmr AnaI),~. . ~:Tho«ffiolWo/ ..: b". . "..........ay.ro..n. 92 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00096 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.14021103 36 Monetary ftlhcy Report to the CongrtssO February 2012 u.s. DollarFunding Pressures and Dollarliquidity Swap Anangements As the euro-area crisis ,ntens,lied, European b.Yl1s A U,S. money m:u\.::('\ fuod iloldings, WI I faced yeater dollat hllld'rlf,pressures. Mar'l'f Euro pean banls were especially lulnerable to chMges rn illo"e5tor sentiment through the" relialce on sOOr\-term doIlar-denornmated funding_ A5 mallet sentrment deteriorated, European b.Yiks' acce\S to mediurr.. and long-term dollar funding market> dunrIMshed markedly, with maII)' unallie to obtajn Ull5l'C\lred dollar funding at maturrtres exceeding onewm. ThepulibadofUS. moneymarket funds{I\t\,fs) from liabilities of euro-area t:.anks beginning in mid-2011 {figure AI was an rmportant part of the ruo-off of short-term dollar funds, although ~ l\\Fs were not the only im'eS'ors to redu~!herr apo5ures to European banls. As a resuk, many European banls faced hrgher dollar funding cost>. for eo;ample, the cost for euro-oYea banks to obtain thr~month dollar funding I I trvough theforeign ",change (fXI swap market rClSeru;finar>::ial pr~ures increased. The cost of dollar fUMing through this market {the bIacI: line in N= The ..... -.onIhIyald ... .mIlw"'!hS<:wt..,.,))IL figure Bl, as banks borrow euros atheeuro LOIl OIhe!E...,.,.=. . d.Dmllld.~Ncr,,'I',S.tdm. d do o l o la r r n s t e I r n b t a h n e k fX of f !i e W re a d p m ra a t r e k ( e L t, l B ro O s R e j f M rom ds w 40 a p b a i s n i t s o M Ss < n. n o. h .. l m y c .. & : t rs w .d e .- B .a. d . t l. d .d . . I h \ R n U f l o n & t. f , . H < o . d k ~ I ~ q < C o d. m ~1 m o i o m ;y :n M 0 n . . . . I N U , d \! o F P. POints early last >ummer to about 200 Msrs pomt> rn late N()\-ember. sell thelr dollar a>sets or refra'" from further doItar Akhough the efffrts of these dollar funding lending. which could In turn re;uk In a reductlOll of straHl! are difficult to g<luge, they pose substantoal the credit thepupply to U.s. frrlll!i and household! risls for the US. ocommy. Larlt European banb while also redUCIng creditlo European am other borrow he""ily in doIl<fi "artly be<:oose they ¥e foreign firlll!i in'."olved in trade with the United act~'e rn US. markets, purchasrng gOl'ernment and Stales. Theodore, Iirrtherstresse$OO European corporate secunties as well as making loans to US. banl.:scould spill OI-er to the United States by households and busillel.\es. A possible res~ to weighing on OOSIIlesS and CORiumer actr-;ity, dollar funding marns, along with ooghtened capi restrarlllngour exports. and adding to pressures on tal requirements, might be for European banks to US. fiww-Klal rnar'.;ets and loslltullons. \'15trillion 10 no aillion in October and then 10 and tbe IIoods in Thailand impeded supply chain~ In \'30 trillion in February. the second half of last year, concerns about the global eronomy prompted EME authorities either 10 put tmnetary policy tightening on hold or. in several Emerging Markel Economies cases.-such as Brazil, China, Indonesil, and Thai land-to loosen tmnetary policy. Many EM& experienced a slowdown in economic In China, real GDP growth stepped down to an growth in the third quarter of L15t year relatiw to the annual rate of about 8 percent in the fourth quarter. pace seen in the first hal[ Both earlier policy tighten Retail sales and fixed-asset inl"eStmem slowed a touch ing, undertaken amid concerns about o\'crheating, and but continued to grow briskly, reflecting solid domestic weakening external demand weighed on groll1h. How demand. But net export> exerted a smlll dragon ever, third-quarter gro\\1h in China and Mexico groWlh. as weak external demand clamped exports. remained strong, supported by robust domestic Twelve-tmnth headline inllation tmderated to arout demand. Ret'entdata indicale thlttbe ,k1\\do\\'l1 con" 4'h percent in January, as food priCtS retreated from tinued and broadened in Ihe fourth quarter, as the earlier sharp rises. With gtOlllh slowing and inllation finandll crisis in Europe softened externll demand on the decline, Chinese authorities rt\"ersed the course 93 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00097 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.24021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 37 B. COSIS oftlree-mooth dollar fundiog lll'oogb agreement on N()\\'~mber 30 to rel'ise, extend, and tbt> for<'ign exclmlge swap martel,!be central exp<Vld the U.s.doIlarswiljJ lines, Tnere>'iled· 00.01: swap line, aM dollar UBOR, 2011-12 agreement klwere:l the IHire of dollar fuooirlf, pro lided through the swaps (the red line 10 figure B) to a rate of50 basls pOUlt> 0I'l'f the dollar O\ernrght iooex swap rate, a reductKlllofSO basls POHlts In the rate at which the fOJelgn central bart> had l>een pr()',iding doll", loans Slr.;dla)' 2010. The reduction In dollar fuMing costs dueto the revised proong of the centlai bani; swap lines nelped strengthen the liquidity positions of [uro rean and other foreign banks, thereby benefrtlng -])J the Un~ed States bysuppo<t,rlf, the continued sup plyof oedit to US households .100 businesses whde mitigating other charrrrels of nsk Draws on the swap lioes, e:Sj>eCially nom the ECB, ha'.e l>een s.gnlilavlt. On December 7, at thefir>t three-month dollar tender uooerthenew prOcingrnme, the ECB allocated about ~51 billion, asub$tanlial increase ()\e< pre. ... ious operations. As ofFebrll3l)' 24, the ECB, the Bankof Ja~ and the SwiS$ -- National Bankhad mut$89 bdliol\ SIS billion, N"", The dolo .. doiI), The 1asI<:bo'lIimf" .rlIsorie<" aM 105 billion outsIMCimg, respectively, from 1'<kuy24, :lIl1. n... ...... 00II. fIrIdi1tdl"""dIt k«o:gn their dollar swap hne allotments, for a total of rn/lq< (FX) "'II' ...uo: .......... m. bart< ft~ 110)' tWO about SlOB billKlll.ln an ,ndocatoon that the swap LlBOl1;(Lcni;:"idtrbftoll't.<d_)toobuan...,fIming. lines ha'e l>een effect;"e at reduong O\"eJall dollar funding pressure, the cost of obIamUlgdoilars OIl the FX swap marlet has dropped sub>tant,allys,nce To acidness >trains in dollar fuooirlf, m",kels, the Novtmbeo" 30. Doll", lIBOR, which measure> dol· Federal Reserve, the [ulOpean Central Bank (£CBt lar fuMing cost:; mthe interbank market for US aM the central tlanks of Canada. Japan, Swiller· aM foreign inst,tutions, has 31$0 declined ()',er the 1.100, and the UllIted Kingdom arll)()(Jnced an pasttl'Klmonths. of trunetal)' policy toward ca~ing by lowering the slowdown in the fourtb quarter. Mexican consumer reserve requirement for large banb 100 bnis point~ to price inflation rose sharply in the second balf of the 20.5 percent. In 2011, the Chinese renminbi appreci year, driven I.1rgely by rising food prices and the ated 4\', percent against the doUar and aoout6 percent rem:)\'alof electrical eoefJiY subsidie~ In Brazil, in 000· on a T¢31 trade-weighted basis; the latter measure ttast to trust H,IEs, GDP contracted slightly in the gauges the renminbi's value against tbe currtlK"ies of third quarter, but inooming indicators point to a return Cbina's major trading panners and adjusts for differ· to groWlh in the founh quamr, panly as a result of ences in inflation rate~ se,'eral rounds of m:lDetary policy eaSing that began in In Mexico, «XJnomicactil"ity arxelerated in the sec August. As the direction of capital flows turned to a ond and third quarters as domestic demand expanded netoutilow, Brazilian authorities loosened Clpitalcon robustly. Howe\'e~ incoming indicators, such as tepid troIs tbat had been introduced elr~er in the face of growth of exports to the United States., point to a massive inflows and associated fears of ovemcating. 94 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00098 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.34021103 J9 Part 3 Monetary Policy: Recent Developments and Outlook MOnelar)' PoUcy O\'er the Second Half guarantee{[ tmrtgage-backed securities(MBS) rather of 201 t and Early 2012 than Trea~ury securitie~ On August!, the Commillee met by lideoconfer To promote the Federal Open Markel Committee's enee 10 discuss issues associated with ooDtingenciesin (FOMC)objeetil'es of rmxiroom employment and thee\'entthatthe Treasury was temporarily UMble 10 pritt stabi~ty, the Commiuee rn1intained a target meet ils obligations becluse the statutory federal dtbt range lOr the federal funds r.lle of 0 to Yo percent limit was not raised or in the ewnt of a downgrade of tbroughoul1he second balf of 2011 and into 2012 the U.S, sovereign credit rating, Participants generally (figure 64). With the incoming data suggesting a some· anticipated that there would be DO nee{[ to make what slower paCtOr economic recovery than the Com change, to exi>ling bank regUlations, the operation of mil!ee bad anticipated, and with inflation seen as set thedis:count window, or the conduct of open market tling al levels 11 or below those coosi;tent with ils operation~2°With respect to potential policy actions, statutory tnlndale, the Connninee look slepsduring participaDls agreed that the appropriate response the second half of 2011 and in early 2012 to prol'ide would depend important~' on the actualoonditiom in additional monetary accommodation in order to sup markets lnd ,hould generally oonsi>l of standard port a stronger economic reool"ery and to help ensure operation~ that inflation, Ol'er lime, runs at \evelsoonsistenl \Iith The information rel'iewed at the regularly scheduled ils mandate. These steps included strengthening ils FOMe meeting on Augu.t 9 indicated that the pace of IOrward rale guidance regarding the Committee's expect31ioDSfoT the periodorer which eronorrOCoon· ditions wiU warrant exceptionally low hds for the <Jl 2 o 0 - . m M . tm :.n h < m J < l J { l b t e b e F F e O .k ~ r t a C l l C b O c tI = $i S ;I y o . f t e {b m el l p > lu < s 1 l { lb b m e ~ <J . l t r b n e { B o c a ( N federal funds nile, increasing Ihe average maturity of tbe Federal R.seroo Banl:ofN. ... Yort:.nd4c({be ....a inin8 the Federal Reserve's securities holdings through a II Rc!e"" Baok p,..;dtuu. ~..., '""" OIlO')',ar {<mil"" • rolaUIl8 program of purcbasesand sales, and reinve,ting princi basis. fprid;l.l~rs It FO~!c ~iug>oo.gll <Jl {hi: nxrob<n c( tbe BoaN <Jl Go\~ of the Fe.Ienl ~ Syu<m Ind.D pal paymeDlson agency securities in agency- 12~Bankp"';dtutG. 6t Seloct«l inleJ\'St rales, 2008-12 ... - , - , , - ~--------" { { { { { { { { { { { { { { { No:"' n., ,L. ... doily .....l <D:Ihnlgh FtI:m:.y U, KIll lb.11).)'<III T",aDJ' _ i<t..""",. ...._. _m_v. , yi<lll>....t "''''' ....., ;.,.lytrUd ...".t,.,_lb._",""IoIZ<Ill. . atir .. ~<i.rttuI<l:lykherulrdr.dml~M_Ct.. ...... S""m: o.pw..nt<i. .... T. .. ~ ... thorodt ..l ksffI' •• 95 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00099 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.44021103 40 Monetary fulicy Report to the CongrtssO Fcbruary 2012 the economic recovcry hd fttnlined slow in recent The data in hand at the Seplember 20-21 FOMe months and tht labor tnlrket conditions oontinued to meeting indicated that economic acti\ity continued to be weak. In addition, m'ised data for 2008 through expand at a slow pace and that labor market condi 2010 from the Bureau of Eoonomic Analysis indicated tions remained weak. Consumer price inHation that the ment recession Md been deeper than pre-li appeared 10 hal'e rooderated sinC(' C.1rher in the yC.1r as oU51y tbought and that the lnel of real gross domestic prices of energy and some oortlJll;Xlities declined from product (GOP) had not yet regained its pre-rece>Sion their peaks. but it had not yet come down as mucb as peak by the second quarter of 2011. MortOwr, down partidplDlS had expected at previous meetings. Indus ward revisions to fir51-qumer GOP growtb and tbe trial production expanded in July and August. real 0011' groll1h reported for the second quarter indicated business spending on equipment and software that the recovery bad betn quite sluggisb in the first appeared to expaoo further. and real consumer spend half of 2011. Private nonfarm pa}TOU employment rose ing posted a solid gain in Ju~'. However. private non at a oonsiderably slower pace in June and July tMn farm employment rose only slight~' in August, and the earlier in tbe year, and participants noted a deteriora unemployment rate renuined high. Consumer senti tion in labor market oonditions. slower household ment deteriorated significantly further in August and spending, a drop in oon;umer and husiness oonfidence, stayed downbeat in early September. Acti\'ity in the and continued wcakne;s in the housing sector, Infla housing sector oontinued to bedepressed by weak tion. which had pided up earlier in tbe ~'ear asa result denund, uncertainty about future home prices, tight of higher prices for some oortlJll;Xlities and imported credit oonditions for mortgages and oonstruction goods as well as supply chain dilruptions resulting loans. and a substantial iOl'enlOry of foreclosed and from tbe natural di>aster in Japan. rooderated more db,ressed properties. Financial tnlrkets were volatile recently as prices of energy and some oortlJll;Xlities fell ol'er the intermeeting period as investors responded to IxIck from their earUer peaks. Longer-term inOation somewhat disappointing nN's. on IxIlance, regarding expectationsretnlined stable. u.s. financial markets economicaClivity in the United States and abroad, were strong~' influenced by del'elopments regarding Weak economic data oontributed to rising expeC'l3tions the fiscal situations in the United States and in Europe among tnlrket participants of additional monetary and by generallyweaker-thao-expected readings on accortlJll;Xlation: tbose expeC'l3tionsand increasing economic activity. as foreign oconomicgroll'th concern;; about the financial situation in Europe led to appeared to have slowed significant~'. Yields on nomi an appreciable decline in intermediate-and longer nal Treasury S¢("urities feU notably, on net, while yields term nominal Treasury )ields. Fluctuations in inm on both inmtment-and speruJatil'e-gradecorporate tors' level of coneun about European fiscal and finan bonds feU a little le:;s than thoseon comparable cial prospects also contributed to nurket lulatility, tnlturityTreasury securities. iel"ing risk spreads wider. particularly in equity nurkets. and spread, of yields on Broad u.s. stock price indexes declined significantly. investment-and speculati\-c-grade oorporate bonds Most members agreed that tbe economic outlook over those on comparable-tnlturity Treasury securities had deteriorated by enough to warrant a Comminee rose significantly oyer the intermeeting period, reach response at the August meeting. Those I'iewing a shift ing lel'els last registered in late 2009. toward more accortlJll;Xlati\'e policy as appropriate In the discussion of monetary policy, most members general~' agreed that a strengthening of the Commit agreed that the outlook had deteriorated somewhat, tee'~ forward guidlnre regarding the federal funds rate, and that there were ~ignificant downside risks to the by being more explicit about the period o\'erwhich the ecooomicoutlook, including strains in global financial Comminee expected the federal fund:; rate to remain tnlrket~ As a result. the Comminee decided that pro exceptionally low, would be a measured response to the ~iding additional monetary lcronunodation would be deterioration in the outlook oyer the intermeeting appropriate to support a stronger rtOOl'ery and to help period. TheCommilte<: agreed to keep the target range ensure tbat inllation, ol-er time, was at a leYel oonsis fOr the federal funds rate at 0 to \I, pef("ent and to state tent lIith the Comminee'sdual tnlndate. Those view that roJnomic conditions-induding loll' rates of ing greater poUcy acrolIUllodation as appropriate at resource utilization and a subdued outlook for infla this meeting generally supported a tnlturity extension tion over the medium run-are likely to warmnt excep program that would combine asset purchases and sales tionally low leyels for the federal funds rate at least to extend tbe l"erage maturity of securities held in tbe through mid-20ll That anticipated path for the fed System Open ~bIket Acoount without generating a eral funds rate was viewed as appropriate in ligbt of substantial expansion of the Federal Reserl-e's IxIllnce most members' outlook for the eronOlll)'. sheet or resme lxllanccs. Specifically, those members 96 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00100 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.54021103 &ard of Gtn'erno/'l' of lhe Fedaa! &serre SysteJII 41 supported a program under which the Committee regarding possible Slep~ to contain the fiSC3.l and bank would announce its intention 10 purchase. by the end ing problems there, Longer-term Treasury yields of June 2012, $400 billion ofTreJsury securit~s lIith dedined appreciably, on ner, orer the period, and remaining maturities of 6 yell'S to 30 years and 10 sell yield, on investment-and speculath'e-grade oorporate an equal amount of Treasury securities \\ith remaining bonds mol'cd lower, lea~;ng their spread; to Treasury maturities of 3 years or leso. They expected this pro securities sUghtly narroller, Although equit)' martets gram 10 put downward pressure on longer-term inter, were I'olatik, broad u.s. equity price indexes ended the eSI rates and to beip make broader financial oonditions interm«tiog period Utile changed. more acronuoodative. In addition. to help support Most FO;"IC members anticipated that the pace of oonditions in mortgage markets, tbe Committee economic growth would remain moderate ol'er ooming decided to reinw;;1 principal received from its holdings quarters. with unemploymentdedining only gradually of agency debt and agency MBS in agency MBS rather and inflation settling ator below levels consistent with than continuing to reinl'est those funds in Ionger,term the dual mandate, Moreover, the recovery was stiUs een Treasury ;ocurit~; as had been the Comminee's prac as subject to significant downside risks, including tice since tbe August 2010 FOMC meeting, At the strains in global financial markets. Accordingly, in the same time, the Committee decided 10 maintain its discussion of IOOnetary jXllicy, all Commiuee members existing poliC)' of rolling over maturingTreasury secu agreed to coptiMe tlie program of extending tlie 3Vtr ritiesat auction, In its statement, the Committee DOted age maturity of the Fe<leral Reserl'e's holdings of secu that it liQuid continue to regularly rel'iell' the size and rities as announced in September, The Comminee composition of its securities boldingsand tbat it was de<ide<l to maintain its existiog policy of ftinmting prepared to adjust those holdings as appropriate, The principal payment> from its holdings of agency debt Comminee aoo decided to keep tbe target range for and agency MRS in agency MBS and of rolling ol'er the federal funds rate at 0 to Yo percent and to reaffirm maturing TrelSU!)' securities at auction. In addition. its anticipation that economic conditions were likely 10 the Committee agreed to keep the target range for the warrant exceptional~' loll' lel'els for the federal funds federal funds rate at 0 10 Y. percent and to reiterate its rate at least through mid·20ll expectation that economic conditions were likely 10 The information re\iewed at tbe NOI'ember 1-2 warrant exceptional~' low le\'el, for the federal fuod, l1'Jetting indicated that the pace of economic activity rate at least through mid-201l strengthened ;ome'what in the third quarter, reflecting Om subsequent wee~s. financial market; appeared in part a reversal of the temporary factors that to be<:ome increaSingly oonOO'ned that a timely re;olu weighed on economic growth in the 6rst half of tlie tion of tlie European ;ol'ereign debt situation might year. Global supply chain disruptions associated lI;th not ocrur despite the melsures that authorities there the natural disaster in hpan bad diminished, and the announced in October; pftssuftson European sol'er prices of energy and;ome ootniOOdities had oome eign deht markets increased, and condition, in Euro down from their fteeDt peaks. easing strains on house pean funding markets deteriorated apprecilb~'. The hold budgets and likely contributing to a ;omewhat greater financial ,tress appeared likely to damp eco ,tronger pace of consumer spending in recent Jmnths. nomicactivity in theeum area and potentially to pose Real equipment and software inl'estment expanded a risk 10 the economic recoW1Y in the United State~ appreciahly, and real per;ollli oonsumption expendi On NOI'ember 28, the Commiuee met by videocon tures(pcE) rose moderately in the third qUlrter, How· ference to discus; a proposilto amend and augment ever, ftal disjXI53hle income declined in the third qU3r· tlie Federal Reserve's temjXIrary liquidity swap ter and oonsumer sentiment continued to be downbe:11 arrangements with foreign central ronks in light of the in October, In addition, labor tn.'lrket conditions increased strains in global financial markets. The pro remained weak as the pace of private-sector job gains posil included a six-month extension of the sunset in the third quarter asa whole was less than it was in date and a 50 basi;; point reduclion in the pricing on the fir.t half of the year, Oreral! consumer price infla· the existing dollar liquidity swap arrangement; lI;th tion was IOOre moderale than earlier in the year, as the Bunk of Canada, the Bunk of England, the Bank prices of energy and;ome cotniOOditiesdedined from of Japan, the European Central Bank (ECB), and the their recent peaks. and mea,ufts of longer.run infla· Swiss National Bunk, In addition, the proposal tion expectation, remained stahle. Financial market, included the establishment, as a contingency measure, were quite volatile and inl'eslOr sentiment was strong~' of swap amngements that would allow the Federal influenced by prospects for Europe, a~ market partici Reserl'e to prol'ide liquidity 10 U.S, institutions in for pants ftmained highly alluned to developments eign currencies should the nee<! arise, The propo$.11 was 97 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00101 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.64021103 42 Monetary fuhcy Report to the CongressO February 2012 aimed at helping to ease strains in financial markets not cbanged greatly since their pm'ious meeting. A, a and thereby 10 mitigate the effects of such strains on reSUlt, the Conunillee decided to continue the program the supply of credit 10 US, households and businesses. of extending the amage outurity of the Federal thus supporting the economic recovery, Most partici, Resen'e's holdings of securities as announced in Sep pants agreed that the proposed changes 10 the SI\'ap tember, 10 reuin the existing policies TegaJding the arrangements would repm.ent an important delOOn reinvestment of principal payments from Federal stration of theconunitmenlof the Federal Resen-e and Resen'e holdings of securities, and to keep the target tlie other central I>3nb 10 work together 10 support tbe range for the federal fund, rate at 0 to Y. percent global financial system Atthecondusion of the dis, While several members noted that tbe reference to mid- cussion, ahrust all members agreed to support the 2013 in the forward rate guidance might need to be changes to the existing swap ~ne arrangement, and the adjusted before long, and a number of tbem looked establishment of tbe new foreign currency swap fOrw:lrd to oonsidering possible enhancements to the agrttments. Conunillee's communications. the Conuninee agreed Asof the December 13 FOMC meeting, the dau to reiterate its anticipation that economic condilions u.s. indiclIed tlut economic actil·ity had expanded were likely to warrant exceptionally low levels for the rmderately despite some apparent slowing in the federal funds rate at least through mid-lOll growth of toreign economies and strains in gl01>31 The inforoution Tel'iewed at the January 24-25 u.s. finan,iil markets. Conditions in tbe labor market meeting indicated that economic activity contin seemed to have improved SOmell'hat, as the unemploy ued to expand rmderately, while global gro\\lh ment rate dropped in NOI'ember and private nonfarm appeared 10 be slowing, Labor market indicators employment continued to increase rmderately, In pointed 10 some furtber improvement in labor market October, industrial production rose, and overall real conditions, but progress WlS gradual and the unem PCE grew l1l"Jdestly following significlntgains in the ployment rate remained elented, Housebold spending previous IOOnth, However, revised estimates indicated bad oontinued to adl'ance at a IOOderate pace despite that bousebolds' real disposable income declined in the diminished growth in real disposable income, but second and third quarters, the net wealth of house gro\\1h in business fixed inl'estment had slowed, The 'ooIds decreased, and consumer sentiment was stiU at a bousing sector remained depressed, InDation Iud been suMued lel'el in early December. Actn'ity in the bous subdued in recent IOOnths, there was linle e\'idence of ing ourret renuined depre;sed by the substantial wage or cost pressures, and Ionger,term inflation inl'entory of toredosed and distressed properties and expectations bad renuined stable. Meeting participant. by weak demand that reflected tight credit conditions observed that financial condition; had improved and tor IOOrtgage loans and uncertainty about future home financial nurket stresses had eased somewhat during prices. O. . erallconsumer price inHation continued 10 be the interrneeting period: Equity prices Wert bigher, more rmde>t than earlier in tbe year, and measures of volatility had d~lined, and bank lending conditions long-run inflation expecutions had been >table. The appeared 10 be iroproving, Participants noted that tbe risks associated witb tbe fiscal and financial difficulties ECB's three,year refinancing operation bad apparently in Europe remained the focus of allention in financial resulted in iropl\J\'ed conditions in European so\'ereign marketsol'er the intermeeting period and coDlributed debt nurkets. Nonetheless. participants expected that to beightened volatility in a wide rangeof asset mar global financial nurket> would remain focused on the kets. HOIm'cr, ;tock prices and Ionger,term intere;t erolving situation in Europe and they anticipated thlt !"ltcs had cbanged little. on balance, since the NOI'em further policy efforts \\uuld be required to fully ber meeting, address tbe 6scal and financial problems there. Members viewed the infornution on U.S, ~onomic With the economy facing continuing head\\inds and u.s. Jctn'it)' receil'ed ol'er the intermeeting period as .ug gro\\lh slowing in a number of export ourket~ gesting tlut the economy \\uuld oontinue to expand members generally expected a rmdest pace of eco rmderately, Strains in globJ.l finan,iil nurkm contin nomiegro\\th over coming quarters, with the unem ued to pose significant downside risks 10 t\."Onomic ployment rate d~lining only gradU11~', At the same J("(n'ity, Members alw anticipated that inflation \\uuld time, members tbought tlut inOation would fUn at lev sellJe, over comingquarlers, at levels at or below those elsat or below those consistent with the Conuninee'1i consistent with tbe Conunittee's dual nuO(late. In the dual nundate. Against tbis backdrop, members agreed discussion of IOOneury policy lOr the period innnedi that it \\uuJd be appropriate to mainuin the existing ately ahead, Conunillee members generally agreed that bighly accommodatr.'e >tance of moneury poUcy, theirorerall asscssments of the economic outlook had They agreed to keep the target range tor the federal 98 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00102 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.74021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 43 funds rate at 0 10 ~~ percent, to continue the program Commillee's policy decision~ Participantsgeneral~' of extending the awrage maturity of tbe Federal agreed that a dt.1r statement of the Commil1ee's Re>erl'e's boldingsof 5t(urities as announced in Sep Ionger,run policy objective; could be helpful: some tember, and to retain the existing policies reglrding the noted that it would also be uscfullO clarify the ~nkage reinl'e5tment of principal p1yments from Federal between these longer-run objectil'es and the Commit Resene boldingsof senJrities. In ~ght of theeeDnomic tee'sapproach to selling the stanet of rmottary po~c:' outlook, /IlJst members also agrttd to indicate tbattbe in tbe sbort and medium run~ Participants generally CommiUee expects to maintain a highly accomrooda· saw tbe Commillee', poslmteting statements as not tive stance for monetary policy and anticipates that weU suited 10 communicate fuUy tlx Commillee's economicconditioDsare likely 10 warrant exceptionally thinkiDgabout its objectives and its policy framework, low lel1:1s for tbe federal funds rate at least through late aDd they agreed that tbe Comminee would need 10 usc 2014, longer than bad beeD indicated in recent FO~lC other means 10 rommunicate that information or 10 stalement~ The Comminee al>o stated that it is pre supplement inform:ltion in the SUlemenl. A number of p1red to adjust the size and composition of ils 5t(uri, participants suggested that the Committee's periodic ties holdings as appropriate 10 pro/llJle a stronger eco Summary of Economic Projt'ctions (SEP) could be nomic recol'ery in a contexl of price stability, used to prol'ide more information about their I'iell'soo the longer-run objectives and the likely evolution of monetal)' policy, FOMC Communications At the NOl'ember 1-2 FOMC meeting, participants discuS5ed alternatil'e /IlJnetar)' po~C}' strategies and potential approaches for enhancing the clarity of their Transplreucy is an essential principle of rmdem cen, public communications. tbough DO decision was made tral banking because it appropriately contribules to Ihe at that meeting to change tbe Comminee's plUcy strat accountability of central banks to the gOl"emment and egy or communications. It was noted that many central to the public and because it can enhance the effective. banks around tbe lI\Jfld pursue an explicit infiation nmof central banks in achiel'ing their macroeco objectil'¢, mainl3in tbe Hexibmty to stabilizeeconomic nomic objectives. To this end, the Federal Reserl'e pro vides to the public a considerable alJKlunt of actilit)', and seek \0 communicate their kJrecasts and policy plans a:; clearly as possible. Many participants inlOrnution concerning the conduct of IJKlnetary pointed 10 the merits of specifying an explicit longer policy, Immediately IOUowiDg eacb meeting of the run inllation goal. but itwls nOled that such a step FOMC, Ihe Commil1ee releases a statement thtlays rould be misperceil'ed a, placing greater weight on out the rationale for its policy decision, and detailed price stability tban on maximum employment: conse minutes of each FOMC meeting are made public three quently, some suggested tbal a numerical inOation goal weeks foUo\ling tbe meeting. lightly edited transcripts of FOMC meetings are released to the public \lith a would need 10 be set forth within a coDtext tbat clear~' uDdmcored tbe Commil1ee', commitment to fostering fil'e-},car lag.11 Moreom, since last April, the Chair' both pam of its dual mandate. Mostof participants man has held press conferences after regularly sched agreed that it could be beneficial to formubte and pub uled two-day FOMC meeting;. At the press confer Usb a statement tbat1l'0uld elucidate the Commillee's eDCts, tbe Chairman prc!CntS the cumnt economic policy approach, and participants generally expressed projections of FOMC participlntsand pro\'idesaddi interest in prol'idingadditional inlOrmation 10 the pub tional context lOr its po~cy decision~ lic about the likely future path of the target federal The Commillee continued 10 consider additional funds rate. The Chairm:ln asked tlx subcommillee on improl"ements in its communications approacb in the rommunications, Ixaded by GOI'emor Yellen, to gil'e second half of 2011 and the first pan of 2012, In a romideration to a possible statement of tbe Commit· discussion on external rommunicationsat the Septem tee'slonger-ruD goals and policy slIategy, and he also ber 20--21 FOMCmeeting, rmst participants indicated encouraged the subcommittee to explore potential that they fal'ored taking steps 10 incre:J.se further the approaches for incorp::>rating information about plr transparency of /IlJnetary policy, including providing ticipants' assessmeDts of appropriate IJKlneury plUcy rmre information abouttheCommillee's longer,rnn into the SEP.22 policy objectil'es and the factors that inHuence the m. 2 1 1 < . d F i O n M to C rm Sl . a r I i t o T a D , t l O ~ IS , . , r ~ o i i t u a u b l l e e s 0 . 0 an t d h o u I n ' S td < r T n ip I t R s. < a s s m . o .- o d I e a ,. s " Q d I ' b , tt Ye n IIn . ! T l h .d e . . i . o .. ' < oo lI :> lJ l\ • lJ • 1 l o iU ", te " , 0 " 11 " " C O R J a 1 s ) t m iD w , "n"l.iIo u P s r t i s s i d c t b Il . l ; S ,w E " b . ~ .u G s . <l . \> d tr oor ...m1e'l .." ",f~g"'im"""tarypo"",,Ibn:,blDL "- 99 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00103 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.84021103 44 Monetary fuhcy Report to the CongrtssO February 2012 At the December 13 Fm.IC meeting, participants Conuninee might Dot, in fact, enbance public under· further considered ways in which the Comminee might standing of the Conuninee's actions and intention~ enhance the clarity and tramp,Utney of its public com Participant! commented on the draft sta!ement, and munic;lIion~ The 'iubcomminee 00 communications the Chairman encouraged the subconunillee to nuke rerommended an approach for incorporating inforlTll' adjustments to the draft and 10 present a revised \'cr· tion about participants' projection> of appropriate sion for tbe Conuninee's further consideration in future IlXlnetary poUcy into tbe SEP, wbicb the FOMC hnua£)~ releases four timeseaeh year, In the SEP, participants' At tbe hnna£)' 24-25 meeting, the subconuninee on proje<:tions lOr economic growth, unemployment, and communications presented a rtlised draft of a state· inllation are conditioned on tbeirindi\idual assess ment of principles regarding the FOMC's longer.run mentsof the patb of IlXlnetary poJicy that is roost goals and monetary policy strategy, Almost all partici. likely to be consistent witb tbe Federal Reserve's SUtu· pants suPPJrted adopting and releasing the revised tory mandate to promote maximum employment and sutement (see the box "FO~IC Slltement Regarding price Slahmty, but inforl1l3tion about those assessments Longer.Run Goalsand Monetary Policy Strategy'l lt bas DOt been included io the SEP: Most participant> was noted thattbe proposed slltement did not repre· agree<ilhat adding their proje<:tionsof the urget fed· sent a change in the Conuninee's policy approacb. eral fund, rale to the eronomie projections alreJdy Instead, the statement wa, intended 10 help enhance provided in the SEPwould belp the public beuer the transparency, accountability, and effectiveness of undersl.1nd the Conuninee's monetary policy decisions monel.1ry policy. and the ways in which tbose deci,ions depend on mem In addition, in light of the decision I1l3de at tbe bers' asse.,ments of eronomicand financial condi· December meeting, the Conuninee provided in tbe tion~ !\ttbe conclusion of thediscus.ion, panicipaDls January SEP inlOrmation about each participant's decided to incorporate information abouttbeir projec. me.,menl> of appropriate monetary policy, Specifi. tionsof appropriate monetary poUcy into the SEP c:illy, tbe SEP included information about participants' beginning in hnua£)~ estimates of the appropriate le\·el of the target federal Following up 00 tbe Conuninee', discussion of funds rate in the fourth quarter of the current year and policy frameworks at its November meeting, the sub the next few calendar years. and over the longer run: commineeon conununiC3.1ions preseoted a draft state· the SEP also reported participants' current projections ment of theComminee's longer.run goals and policy of the likely timing of the appropriate first increase in strategy. Participants generally agreed that issuing such the target rate given their projectiom of future eco· a statement could be helpful in enhancing the tran'p:n· nomiecondition;. The accompanying narrative cncy and acroumability of monetary policy and in described the key factors underlying those asse.,menl! facilitating weD·informed decisionJ11.1l;:ing by bouse· and provided some qualitative information regarding boldsand businesses. and thus in enhancing tbe Com participlnts' expectations for the Federal Reser,e's mittee's ability to prollXlte the goals specified in its balance sheet. A number of participants suggested fur· statutory mandate in tbe face of significant economic ther possible enhancements to the SEP: the Cbairman di;turblDCe~ Howe\'er, a coDpleof participants asked the subcomminee to explore such enbancements expressed the concern tbat a sutemeDlthat was suffi· ol-er coming months. ciently nuanced to capture the di\'ersityofviewson tbe 100 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00104 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.94021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 45 FOMe Statement Regarding Longer-Run Goals and Monetary Policy Strategy Following careli.d deliber.JIions 31 its ~nt meeI price stabilr!)' and moderate long-term Interest irw, the Fede.al Open Market Committee (FO.\lq rate! and eriurocing the (omrlllttee's ability to pro has reached mood Weement 00 thefollowlng mote maxImum emploj'me.~ in the fare of signifi prinaples regarrhng Its longer-run goals and mon cant economic di>lurb.n:es. etary polK:'( 51",tegy. The (omllllttee intend> to The maxImum bel of emplo)lnent is largely reaffirm these pnocipies and to make adjustments detelJfMroed by nonmooetary factors that affect the ;c; appropriate at Its aooual orglllllZatlooal meetIng strudureanddynarnic!ofthe labor mar\et. Theie each January. factorsma'ichangeOl'ett,mea<Jd mayJlOl be The rO~1C is f.mlycorrmitted to fulfilling Its directlymeasurab~. Consequently, ,twould JIOI ,taMory mandatefrOffl the Congress of ",omoting be appropnate to specify a Ii<ed goal k>r employ maximum emplojment, stable prices, and moder ment; rather, the Corrwrunee's policy decisions ate lang-term Interest. ",tes. The Commmeeseels must be informed by assessmenlS of the maXImum to e.:pIain its monet;uy poIicydeciOOns to the pub level of emplo)men~ recognizing that sum assess lic as dearly as possIble. Sum dan!)' facilitates ments are nocessarl~ Uncertain and subject to re.i- well·rnformed demlooomang by households and 1IOfI. The Comrl1lttee constders a wide range of businesses, reduceseconomic and financial UI"lC'ef iooicators in makmgtheseassessmerts. Informa tamty, Increases the e/fectl\"l'Ol'SS of mooetary tlOfl about CommIttee iJ<IflIcipanll' es~mates of poky, and enflance; transparency and account· the Ionger.run normal rates of output growth and amli!)" which :.ee5selllial in a demooatic $OcieIy. unemplojment ~ pu~ished four times per lear in InIlalion,employment,and Iong·term interest the FO,\ICs SumlTl3l)' of Economic PrOJections_f or rates fluctuate over time in re$pon5e to economic example, inthemost recent prOJfdions, FO,"tC and fmncial disturbance;. MOfOOl"er, monetary participants' es~mates of the langel-run oormal poky actions tend to Influe~ economIC actJ\i!)' raleof unemplo)'JJ\eIlI had a centraJ tendencyof and price:switha lag. Therefore,theCommmee's 51 petrefllto 6.0 percent, roughly unchanged poky demlOflS rdlect Its langel·run goals, Its from last January but substanhally hIgher than the medlU ..... term outlook, and (s assessmentsof the co<res.,ond ing IIItervai se.eral Yell! e.vlrer. balaroce of nsb, lrocludllg flsls to the financial Insettlngmonetary polK.)', theCommitteeseffi sptemthat could HllpeOe thealtalnment of the to mlbgate de\latlOflS of InilatlOfl from rts longer· Comminee'$ goals. rungoal and de-.-.alionsofempIo)1TIe<ltfrom the The inflation rate o"er the longer run is primaflly Committee'sassessmertsofits """"mum bel. determined by!l'lOflelar)' fIOIOcy,and heocethe TheseobJect;..·es are generally complementary. Comm,nee hasthe abili!), to specify a langer-run Howe."er, undel circumstance; in which the Com goal for inflatlOfl. The Commmee Judges thai "'fla rrnttee JUdges that theobjectl\"t5 are JIOI comple tion at the rate of2 percent, as measured by the mentary, it follows a balanced approach In promol aooual mange in the price In<ie; for personal coo Ingthefl\ takinglntoarx:ountthe m<rgnltudeofthe sumption expend,ures, IS most con\~tent 0I'et the de\1at1OflS and the potentlalo/ diffelent bme hori· longer runwlth the fede",1 ReseJ\e's statutory ZOfI) o,er whICh emploj'ment and IIlllabon <we ",0- mand<lle. Commumcabng thIS ini1ation goal deaJfy jeded to retumto bets Judged consIstent Wlth its to the public helps keep Iooge<.term inflatl:rn mardate. expedations firmly anchored, thereby fostenng 101 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00105 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.05021103 47 Part 4 Summary of Economic Projections The/allowing material appeared as an addemium /0 the sures on inllation in lOll from faclors such as supply minules {)j IheJl1Iluary 14--15,1012, meeling oj the chain disruptions and rising comroodity prices as bav Fedulli Opt/! Marktt ummlil/u. ing waned, aDd they anticipated Ihal inftation would faU back in 2012, Ol'er the projection period, rmst par In conjunction \lith the hOlJ3ry 24-25, 2012, Federal ticipantsexp«led inllation, as measured by the annual Open Market Commiuee (FO~tq rowing, the mem change in the price index for personal consumption bersof the Board of Go\'ernors lDd the presidents of expenditures (PC£), 10 be at or below the FO;\lC's the Federal Reserve Banks, all of whom paniciPlte in objectr.-e of 2 percent that was expressed in the Com the deUberalioDsof the FOMe, submilled projectioD' millet's statement of longer-run goals aDd policy strat lOr growth of real output, the unemployment rale, and egy, Core inllation was projected to run at about the inllation for the years 2012 \0 2014aod over the longer same: flte as overall iollation. run. Theeconomic projections were based on infOfll1l· As indicated in table I, reLnil-e to their prel'ious pro liOD available lithe time of the metting and partici. jections in November 2011, participants rnade smali paDtS' individual assumptions aoou1 factors like~' to downward revisions 10 their exp«tatioo> for the rate affect eoonomicoutoolDts, including their lS>e'S5men\S of increase in real GDP in 2012 and 2013, buttbey did of appropriate JOOoetary policy. Starting with the not rnlterially alter tbeir proje<"tionsfor a noticeably January roo:ling. participants aJ;;o submitted their stronger pace of expansion by 2014. With the unem as.sessmeDlsof the path lOr the target federal funds rale ployment rate having declined in rtttnt rmnths by that they \1ewed as appropriate and compatible with rmre than participants bad anticipated in the previous their individual eronomic projections.. Longer-run pro Surnnury of Economic Pro,J(C1ioo> (SEP), Ihey gener jections represent each puticipani's assessment of the al~'lowered their IOrecasts for the !eyel of the unem rale to wbicb each I'ariabk would beexp«ted to con ployment rateorer the next t\\O years. Participants' I"age over time under appropriate rmnetar)' policy exp«tations for both tbe longer-run flte of increase in and in the absence of further sboch "Appropriate real GDP and the longer-run unemployment rate were rmnetary po~cy" is defined as Ihe fUlure palh of ~tt!e cbanged from November. They did not signifi policy that participant! deem rmst likely to fosteroul cantly alter their folt("asls for Ihe rale of inllation over comes for eronomicactil'ity and iollation that best the nextthrtt years. HowCl-er, in light of the 2 percent satisfy their indi,;dual interpretation of tbe Federal inflation that is the objectil'e included in the statement Resene's objectil-es of maximum employment and of longer-run goals and policy strategy adopted at the stable prices.. hnuary meeting, the range and central tendene~' of Asdepicted in figure I, FOMC participants pro their projections of longer-run infialion were all equal jected continued economic expansion over tbe 2012-14 to 2 pem-nt. period, with real gross domestic product (GDP) rising As shown in figure 2, JOOst paIticipaDls judged tbat at a IOOdest rate tbisyear and then strengthening fur bigh~' accommodatil'e rmnetary policy was ~keJy 10 ther througb 2014, Participants geneflUy anticipated be warranted over coming years to proJOOte a stronger only a mull decline in tlie unempkl~'ment rate tliis eronomicexplnsion in the context of price stability. In year. In 2013 and 2014, the pace of the expansion was particu\a~ with the unemployment rate proje<"ted to projected to exceed participants' estirnates of the rernain eJel'ated ol'er tbe projection period and inlla longer-run sustainable rate of incre.1se in real GOP by tion expected to be subdued, six participants antici enough to result in a gradual further decline in the pated that, under appropriate rmnetary policy, the fim unemployment rale. Hown'er, at tbe end of 2014, par increase in the target federal funds flle would occur ticipants generally exp«ted Ihat the unemployment after 2014, and five e.>:pected policy firming to com fltewould still be well abol"t their estimates of tbe mence during 2014 (tbe upper panel). The remaining longer-run nornul unemployment flte thai they cur six participants judged that flising the federal fuDds rent~' view as consistent witb tbe FOMC's statutory flte sooner would be required to furestall infiationary rnandate for prormting maximum employment and pressures or avoid distortions in the financial system. price stabmty. Participants I'iewed the upward pres- As indicated in tbe lower panel. aD of the inwI'idu.:d 102 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00106 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.15021103 48 Monetary ftlhcy Report to the CongrtssO February 2012 .. - Figuu L Centtal lenoi'ocies and ranges of e«lOcmic ~ojt"CtiOflS, 2012-1~ aodOl·('[" tile Iongerrun - , - , iii -, - 1 -0, -- , - , , Coo., I ~" ~I! WI1 WI> 1014 .0 , - Unemp.o)"llIem 11l~ - , -, ~ ~ -, -, III - , I I ,., ,.. C . o . o ,. I I '" ~'" WI! 2011 2013 2014 - !U:inflation • -, -, i iii , - ,., ,.. ,.. .0 WIO Wit 1012 WI> 1014 '-' - Con PCE inlbtion - , -, ~ II ~ III!II , - ,., ,., I I I I '" WIO WI! 2012 Wil 2014 Ncm: Dtlino"",d ••_ .. in ......... tot~ I. ~d:r.ahh lk"IIIlII ....... dtbe ... _ .. ....w. llrduh .... dill!vin .... rnP. PCE inI\oI:""," aid .... PCE inI\oI:m ..... ktW11 ...-.xp:<'" h odI·. ......." 'dGDPf<t .... bIIh"""" dWI I. """'" iIIo &rtto dr..:m-: ANI). •, ..I t"":!at JIIlW)' "II. :lm. n... m ill'!!"" .... ..x .... ail3I>1t to FQ\]C IIIt<IItl! porI>:I(IIU'a! .... I_ d ..... _lilt- 103 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00107 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.25021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 49 .T.a.b.l.e ,1 . Econooic projediom of Fedtrlll Resm't &lllrd m::mbo:!I aDd Fedtral Resm't Bank prtOOmu, .Ja.n uary 2012 \'ariablo l!jll I " C " <o (fah• I .o .O< N !" I 4 w.II""" lOll I "" I " , ." '--, a s u . g . < . i . u b .,p " r o G j O rc P ti o . o . 1 2 . . 1 5 1 1 0 0 1 1 1 9 ! > S 'O 1 lo . B n ) 1 J .0 IO lo U H l H J! t O o l ! . 7 6 ! 2 H 3 o to 3. B 0 1 H 1 ! 1 O 0 J 4 . . S 0 l l. 1 8! . O ,H U 1 2 1 .2 1 to 0 1 3 . . 0 0 Uot.,pioy ....t ,1II< ... 8.1t08.5 Ht08.1 PooH U!OU 1.3toH 1.01081 6J.,1.1 .\.OtoU N. ......' pfOje«ioo. &.Sloll J.8lo8.1 6.8IOJ.1 51106.0 tl!OS.9 1.5 IOU 6.5lOs.o S,O!OU PCEiotwioo . iAlo1.8 I.HolO 1.61010 " 1.3102.5 U!OlJ 1.51Ol.1 " N. ... bM-projt<-!ioo IAto1.O 1.5to1.0 ]j!OlO Utol.O Hto1.8 14",lS U",l.4 ]jtol.O Cot<PCEiolbtioo' . UtolJ 1.5to1.0 1.61010 I.3tol.O I.~"'",O 1.4"'".0 N. ......' 1".jrctioo . UI.10 1.41.1.9 1.51010 1.310l.1 1.41021 1.~!Ol1 N:ra Proj_oI~LOraI"",ckm""cpro1oct(GOPJud~iJ<I:ct.bIll"""",oI"kIoo ... h"",tb<btrth~IW"'oI<h'pr<YIOOIyear"'th< bor!itqOWld..l borou_ ~E~blmud_l'CE"tio.o." '!h<_tit'''!ao/olIao!''''.~Ibo~'''lDltlktpemoal.o.:..c.s tlll.l..p.!.i. <,,1tlh . ~""(I'a!J dth.po",~"'I'a!<lOIl>l",rM d",,,,,,p""""CC1b-th<'''''''~l''''.,.ktth<_cma.o ~ m<!hqOWldlboroui_ Eaeb;atti<ipao('"""""""""'_OdbllOfllo:.......,. .t d'll"OJ>'IlI<"""""'7poUql..oo$e<'''''""""",",,,,,,,,,"' ;:t'=~=~\c!:::...~~-:;:=:"!~=:::-~::ro;.~=='h=.'~,~,~oIr'"lI<rlbo<b''' I 1b.'«rIttoI!<O<I"",_tb<w..¥"udw.._~1:><<aobI'illOlJ<"oa<iI)'!at 1 Th<"""rOl • ..,. ... II."'"")'W=_~PllII<OpI!It(prqt<tiom.r"'"'_"'III(l>M.b-tllat_iotbllyear J. L<qor~" I'f\li""">ni br "'" l'C£"ht>oa ... "",<Ul<aod. assessmeDlsof lhe appropriate urget federal funds rate The Outlook for Econonic Ac!i"ity over Ihe nexl ;e\'eral years were below Ihe longer-run leI'el of Ihe federal funds rale, and II parlicip.1nls The centrallendency of participJnl;" forecasts for the plated the Urget federal funds rate at I pereent or change in !'tal GDP in 2012 was2.2 to 2.7 percent. lower al the end of 2014. Most p.1rticipants indicaled This forecasl for 2012. while slightly lower than the that the), expected that the DOrmalization of tbe Fed projection prepared in November. would represent a eral Reserve's halance sbett sbould OCCIlr in a way oon pickup in OUtpUI grolltb from 201110 a rate close to sistent with the principles agreed on ltthe June 2011 its longer-run trend, Participanls stated tbat the eco· meeting of the FQ,\IC, with the timing of adjustments nomic information recen'ed since NOlmlber showed dependent on the expected dale of the first poUcy continued gradual improvement in the pace of eco tightening. A few participants judged that. gn'en their nomicacth'ity during the second half of 2011, as the current assessments of the economicoulloo~. appro inflnenceof the lemporary factors tMI damped activo priate lXllicy would include additional asset purchases ity in tbe first Mlf of the year subsided. Consumer in 2012, and one assumed an e:Hly ending of Ihe maJUr spending incTe3sed ala mxierale rale, exports It)' exlenSlon program. expJnded solidly, and business im'cstmenl rose further. A sizable majority of p.1rticipJnts continued to Rettntly, oonsumers and businesses appeared to judge Ihe Iml of unceruinl)' associated lI;th lheir pro· become semewMI roore optimisikaboul the outlook. jections for !'tal actn;t)' and the unemployment rate as Financial condition! for dcmesticnonfinancial busi unusually high relative 10 historical norms. Many also nesses were gcneral~' falurable, and ooDditioDsin COD attached a greater-lhan.normallel~1 of uncertainty to sumercredil markets showed signs of improl~ment. their forecasts for inflation, bUI. comparro witb the Howcyer. a number of factors suggested tbllthe NOI'ember SEP, IWO additional participants viewed pace of tbe expansion would continue to be restrained. uncertainty as broadly similar to longer-run norms. As Although some indicalOrsof acth·it)' in the bousing in November. many pJrticipanls S3W downside risks seclor impro\'ed slighll)' lilhe end of 2011, new home auending their forecasts of real GDPgrollth and building and sales remained at depressed levels, hou;e upside risb to their forecasts of lhe unemployment price; were stilI falling, and roortgage credit remained rale; !l'I.)st pJrticipanls vicl';ed the risks 10 their inf\.1- tight. Households' real di;posable income rose only lion projections as broadly balanced. roodesl~·through llie 2011. In addilion, federal spend- 104 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00108 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.35021103 50 Monetary ftlhcy Report to the CongrtssO February 2012 ,I • 1 6 5 5 • , , , 3 2 2 I 0 >112 >113 >11, >115 >116 6 Tqet Feu Pnnoh R-= • Y~-&Id ...... 5 ... • • I ..•. 3 2 • .. • .. I • .....•.. .... .. . • .. . I .......H ..... >112 :.n >II, 0 No;nE:"'~"""pood.~ho/cbI<Ltadlbotac-.1bc"'""'*ofl'OYC~ ...1 hor, ..... ~-rpolir;J_io ~ obocnctofm.tbcrolloc:b ...... """"""'J.1IIom.ilc:rtutio1llo.1i:dt!a1 fudo 1ft r...n .. _,..01010 ~ pao:otd ....... i11 _opcQ6cdco,lQ:dqo,...1A1bcJo.u!*'d."""lhtdedcildc ___ .(I!IIIIOkdI01bc_~~oE.iDdioidDd~ jodgII>o:IIIoE_"fIf""P'ioItltw:lal_.&:dasIfuodolft ...... cadal_optci&dcobdu,..."' ...... ~Jarrca ..... 105 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00109 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.45021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 51 ing oontracted towlId year-eod, and tbe re,training CUrrtllt unemployment rate and their estimates of the effects of fiscal consolidation appeared ~ke!y to be Ionger·run rate, althougb some noted thatlTlJre time greater this year than anticipated at the time of the would likely be needed. November projection~ Participants also read the infor Figures 3.A and 1B providedetai1s on the dim'sity mation on economic actil;ty abroad. particularly in of partiCipants' viC'll'S regarding the likely outcomes for Europe. as pointing to weaker demand for US. exports real GDP growth and the unemployment rateol'¢r tbe in comingquartm than had seemed likely when the)' next three years and OHr tbe longer run. The disper. prepared their forecasts in November. sion in tbese projections reOected differenm in partici Participants anticipated that the pact of the eco pants' asse55mentsof many fal'lors, including appro nomic expan,ion would strengthen ol'er the 2013--14 priate lTIJnetal)' policy and its effects on economic period, reaching rates of increase in real GOP aool'e actil'ity. tbe underlying lTIJmentum in economicactil' their estimates of the longer-run rates of output ity, the effects of tbe European situation, the prosper growth. The central tendencies of participlnts' fore til'e path for Us. fiscal policy, the likelye\'Olution of elsts for the change in real GDP were 2.8 to 12 per credit and financial market condition;, and tbe extent ctnt in WI3 and 3.3 to 4.0 percent in 2014. AlTIJng tbe of ,tructural disJocatiom in the laoor market. Com comiderations supporting their forocJ.st>, participlnts pared with their NOI'ember projections, the range of cited their expectation that the expan;ion liQuId be participants' forecasts for the change in real GOP in supported by lTIJnelary policy acconunodalion, ongo 2012 narrowed somewbat and shifted slightly lower. as ing improvements in cre<lit condition;. rising house· some participants reassessed the outlook for global bold and business confidence. and strengthening economic growlh and for US. 6scal poUcy. Many, how· bousehold balance ,heet~ Many partidpantsjudged e\'er. made no material cbange 10 tbeir forecasts for that US. fiscal policy would ,till be a drag on eco growth of real GOP this year. The dispersion of par nomic actil'ity in 2013. but man)' anticipated that prog. ticiplDts' forecasts for output growtb in 2013 and 2014 re;;s would be made in resolling the fi,;ca\ situation in remained relatil'¢ly wide. Having incorporated the data Europe and that tbe foreign economic outlook would shOllinga lower rate of unemployment attbe end of be lTIJre positil'e, Orer time and in the absence of 2011 tban previou;Jyexpected, the distribution of par ,;hocks, participants expected that the rate of increase ticipants' projections for the end of 2012 shifted of real GOP would converge to their estimates of its noticeab~' down relative to the NO\'ember forecast;. longer-run rate, with a central tendency of 2J to The ranges for the unemployment rate in 2013 and 2,6 percent, little changed from their estimltes in 2014 sbowed less pronounced shifl! toward lower rates NOI'ember. and, as was the case lIith the ranges for output grDIIlh, The unemployment rate improved more in late lOll remained wide. Participants made only modest adjust· than lTIJst participants had anticipated wben they pre ments to their projections of the rates of output pared their Nowmber projection;, falling from 9.1 to growth and unemployment over the longer run, and, 8.7 percent between the third and fourth quarters. Asa on net. the dispersions of tbeir projections for both result. lTIJst participants adjusted down their projec were lillIe cbanged from those reponed in November. tions for the unemployment rate this year. Nonetheless, The di~persion of estimates for the Ionger.run rate of with real GDP expected to increase at a JOOde,t rate in output growth is narrow. with only one participant's 2012, the unemployment rate wa~ projected to decline estimlte outside of a range of 2.2 to 2.7 percent. By only a lillIe this year, lIitb the central tendency of par complrison, participants' viC'll'S about the Ie\'el to ticip:mt;' foreca515 at 8.210 8.5 percent at year-end. which the unemplo}ment rate would conl'erge in the Thereafter, participaDls expected that the pickup in tbe long run are more diverse, reflecting, alTlJng otber pace of the expansion in 2013 and 2014 would be things. different Viell'S on the outlook for labor supply acrompanied by a further gradual improl'ement in and on the extent of structural impediments in the labor market oonditions. Thecentral tendency of par· labor market. ticipant,' forecast. for the unemployment rate at the end of 2013 was 7.4 to 8.1 percent, and it was 6.7 to 7.6 percent at the end of 2014, The cenlfaltendency of The Oullook for Inflation plrticipanl:i' estimates of the longer-run normal rate of unemployment tbal would prtl'ail in the absence of Participants generaUy viewed the outlook for inOation further shocks wa~ 5.2 to 6.0 percent. Most partici as very similar to that in NOI'¢mber. Most indicated pants indicated that they anticipated that fil'c or six that, as tbey expected, the effects of the run-up in years would be required to dose the gap betnen the price; of energy and other colllIOOdities and the supply 106 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00110 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.55021103 52 Monetary ftlhcy Report to the CongrtssO February 2012 Figuu 3.A. Distribulioo ofpanicipants' j:fQ)ectioos fQfthe ch:mge in r~31 GOP, 2012-14 30001'("., ~ Iooger run _ 2012 - ._ IN<7- .'<II-Iborrpuj'<~ . cti< m . .- -~ ,--_ I " _ '" I-r-------~ ~ ft ~ ~ I . t . t . .. R tt ~ H ~ _ 2013 -Oi -" -" --". -. - 00 - , - , it _ 2014 - Oi -" -" --". -. -00 '0' -, _____1_---1- 11 1. '---__ ---,-,2 1 1 ~ R ~ ~ fr tt R li ~ ~ a a tt _ lollge, .. n - Oi -" -" --". - 00 --., -, 107 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00111 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.65021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 53 Figuu 3.B Dislribution Orpaititipanrs' projectioos ref lh~un('fllploymmt r:lI~, 2012-14 and OWl' !he Iong\'f roo _ 2012 - ._ IN<7-'<II-Iborrpuj<~cti< m _ 2013 -" -" -" -" -m - • - ,• - , I ~ ~ ~u ~u u u u ~ ~u u~ u~ u u u~ u v "~ ""'''''''''''!' _ 2014 -" -" -" --". --m. -, -, I tt H li ~ R U R tt ~ H n H li li B K H H tt " " ""'''''''''''!' _ lollgernm tt a li ~ R U fr tt ~ H ~ H n ~ a W li ""'''''''''''!' 108 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00112 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.75021103 54 Monetary ftlhcy Report to the CongressO February 2012 diIDJptions that occurred in the fim balf of 2011 had federal funds rate would be)h percent at the end of largely waned, and tbat inflation had been subdued in that rear. For the two participants who put the first re«nt months. PartiCipant; also noted that inflation increase in 2016, the appropriate target federal funds e:<pectatiooshad reJ11.'lined suble om the past year rate at the end of tbat rear was 1)h and 11;' percent. In despite the fluctuations in headline inftation. Assuming contrast, six participants expected that an increase in DO furtber supply shocks, most participants anticipated the target federal funds rate would be appropriate that both headline and core inflation would reJ11.'lin within the next two years, and those participants subdued ol'er the 2012-14 period at rates at or below anticipated that the target rate would need to be the FO;\IC's longer-run objeaive of 2 percent. Specifi. increased to around l)h to 2't. percent at the end of cally, theceDiral tendency of participants' projections 2014. lOr the increase in inflation, as measumi by the PCE Participants' a»essments of the appropriate path for price index, in 2012 was 1.4 to 1.8 percent. and it edged the federal funds rate rellected their judgments of the up to a central tendency of 1.6 to 2.0 percent in 2014; policy that would best support progress in achieving the central tendencies of the forecasts for core peE the Federal Reserve's mandate for prolOOting J11.'lxi inflation were large~' the sam: as those for the total mum employment and stable price~ AlOOng the key melsure. factors informing participants' expecutiom about the Figures 3.C and 3.D prol'ide inforrmtion about the appropriate setting for monetary policy were their dil'crsity of participants' I;ews about the outlook. for assessment! of the rmximum lel'eI of employment, the infution. Compared with their November proje(tions, Corrunittee'S longer-run inllation goal, the extent to expect3tionsfor inflation in 2012 shifted down a bit, which current conditions deviate from these mandate with some participants noting that the slowing in infla consistent kl"el~ and their projections of the like~' tion at the end of 2011 had been greater than they time horizons required to relUro employment and anticipated. Nonetheless, the range of participants' inllation to such Ie\"el~ SeYeral partidpants COJ1l.. IOrecasts for ioDation in 2012 remained wide, and the mented that their assessments took into aemunt the dispersion was only slight~' narrower in 2013. By 2014, risks to the outlook. foreconomicactility and infla the range of inflation forecasts narrowed IOOre notice tion, and a few pointed specifically to the relevance of ably, as participants expected tbat, under appropriate financial stahility in their po~cy judgments, Partici· IOOneury po~cy, inflation would begin to converge to pants also noted that becuse the appropri:tte sunce of the Corruninee'S longer.run objeail'c. In general. the IOOneul)' polity depends importantly on the evolution dispersion of I'iellson the ontlook for inflation om of Ttl! actil'ity and inflation over time, their assess the projeaion period represented differences in judg mentsof the appropriate future patb of the federal ments regarding the degree of slack in resource utiliza funds rate could change if economic conditions were tion and the extent to which slack influences ioDation to e\"oll'e in an unexpected maDner. and inllation expecution~ In addition. pmicipants All participants reponed INls for the appropriate differed in their estimates of bow the sunct of mon target federal funds rate at the end of 2014 that were etary policy would influence inflation expecution~ well below their estimates of the level expected to pre vail in the longer run. The lODger-run nomiDallevels were in a range from 3'/. to 4\1, percent, relJecting par· Appropriate Monetary Policy ticipants' judgments about the longer.run equilibrium level of the real federal funds rate and the Corrunittee's Most participants judged that the current outlook. inflation objectil'e of 2 percent. lOr a tmderate pluof economic recovery with the Participants also provided qualiutil'e information unemployment rate declining only gradually and infla on their ~;ews regarding the appropriate path of the tion subdued-warranted exceptionally low levels of Federal Resel'l't', balance sheet. A kll' participants' the federal funds rate at least until late 2014. In par messmenl5 of appropriate InJDetary policy incorpo ticular, 111'e participants viewed approprilte policy rated additional purchases of longer-term 5e(:urities in firming as commencing during 2014. while six others 2012, and a number of participants indkated that they judged that the 6rst increase in the federal funds rate reJ11.'lined open to a consideration of additional asset would not be warranted until2015 or 2016. As a result, purchases if the economic outlook deteriorated. All those II participants anticipated tbat the appropriate but one of the plflicipants continued to expm that federal funds rate at the end of 2014 would be I per theCommiuee would carry out the normalization of cent or lower. Those who saw the first increaseoccur the halance sheet according to the principles approved ring in 2015 reported that they anticipated that the at the June 2011 FOMe meeting. That is. prior to the 109 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00113 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.85021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 55 Figuu 3.c. Dislribution of paititipanrs' projectioos f(l" PCE inf\atioo, 2012-14 and o."er tilt" loIlger /uP _ 2012 - ._ IN<7-'<II-Iborrpuj<~cti< m _ 2013 110 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00114 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.95021103 56 Monetary ftllicy Report to the CongrtssO February 2012 Figuu 3.D. Distribulioo ofpanicipants' j:fQ)ectioos forcore PCE inf\atioo, 2012-\4 _ 2012 - ._ IN<7-'<II-Iborrpuj<~cti< m _ 2013 , --------,- --< first increase in the federal funds rate, the Committee assumed aD early end of the m.:Iturity extension would likelyceasc reim'esting some or all p.1}mentson program the securitie'llioJdings in the System Open ~lJrl::et Figure lE details the distribution of particip:!n15' Account (SOMA). and it would 1i~ely begin sales or judgments regarding the appropriate 1m! of the target agency seeurities from the SOMA sometime after the federal funds rate at the end of each calendJr year first rate inma5e, aiming to eliminate the SO'\'1A', from 2012 to 2014 and ol-er tbe longer run. "'lost par holdings of agency stcuritie'l over a period of three 10 ticipants anticipated thaI economic conditions would 6n years. Indeed. most partkiplnts saw sale,of warrant maintaining tbe current low k.,e\of the fed, agency seeurities starting no ear~er than 2015. How eral funds rateo.,er tbe next two yeJrs, Hov,c. .. cr, ... iews ever. tbose p.1niciplntsanticiplting an earlier increase on the appropriate leI'el of tbe federal funds rate at the in the federal funds rate also called for earlier adjust. end of 2014 were moft widely dispersed, with two ments to tbe blllnct sbeet. and one paIticiplnt thirds of participants seeing tbe appropriate leI'dof 111 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00115 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.06021103 Board of w,'erno/'l' of lhe Federal &serre SysleJII 57 figure lE. Distributioo ofparticip.lDlS' projections for !he targel feder31 funds rlle, 20[2-[4 andO\'er the longer run _ .. pri;p. .. _ 2012 -" _.Inw}'~ -" -" -. -" -" 01. - , - -, .• .. .. .. .• -, , ., ,. ,w~ = ~ = on " ' '" " '" o,n~ '" P 1 ' . " 1 c 1 c_ •~ , • _ = w " " ' 'w" "' "on '" '...1 , 1 •• W -"pri>p1u _ 2013 -" -" -" __ - --." -" ,~I - , - , . .• .. --•. . .. . ,. ,. - , , '"~ = M = on = " , '" ," o,n~ , '" P' I, "c ll · c _,_ = on " " ' , w . •• " W '.11 ' ' ,1 " 1 · u '" · o.n~ -"poniopuU _ 2014 -" -" -" --". .- -" - - , ,=1_ _ - - -, .• .. .. . .. . . • . - , , ,'"~' ' M " = on . I, , ll , '" '" = on '" P ,wc . . c _,o~ _n = on " l.ll ' , W "' o,n~ , " . . ''.1."1 o.n~ _ longer"," -" -" -" --". -" -, -, -, , ~ ~ oo. O ~ J.'- o r w n . ( L li I s l . 1 W ,1 .). l W Ja . 1 W .o J. aI.!uI· u I,l l· W l.l ~ W lO J. i li l S l . ) i , l 1. l ). ~ l J ~ a. I M n J. ' l. .1 !l 1 · ' 0 , 1 Il· , 0, . & ) 2 I . o',OnJ . -~ 112 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00116 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.16021103 58 Monetary ftlhcy Report to the CongrtssO February 2012 the federal funds rate as 1 percent or below and five Table 2. A'mlg<: historical projection error rangel seeing the appropriate rate as 2 percent or higher. Po""''"9'poiol! Those particip:mt; who judged that a longer period of roliablt 1II! !\Ill !\II( exceptionally low levels of the federal funds rate would be appropriate generally also anticipated that the pace a...uio...JGDP' .. !U ±17 lU of the economic expansion would be moderate and u. ... f'Io) .... t ..' •• ±0.7 ±H ±U that the unemployment rate would decline on~' gradu To ... ""'. ............ !O.9 no lUI ally, remaining weU above ils IongeHun rate at the end Non: """'''"¥''Ibon&r<_o:I .. pJ .... ''''''''tbt'''''' ..... of 2014, Ahoost all of these panicipantsexpected that .._ "'. . of~_famllhiooCltl!JIOI2IaI_,._ .. tbt_ inllation would be relatively suble at or below the .t.<..r b u_ -j , " ~ " · " " " < , I ,, o ,_ :< O f D tI d 1 _ I O l, < ."..<., , I .p l I t > r O o O r I - , , . , . . . . < . r J < d ~D d : = lo r t i . b J o !l : " ll " l ' t ' b ' t ' U 'p · O " O " ob ,, I , I . ­ Fm.-ICs longer-run objective of 2 percent until tbe nJIlIal_ootoO<Dafo<'eaiGDP.""",pIoJm<ll~ODd~""'PI""wilI bo"~""pbo:lb)"b""'lg<"lIZ<ofPl"""""mon",,",,, ..... port.FtI. time of the first increase in the federal funds rate. A tbu",Ior_~"DftlRelfICb_IWd"" .. Tl:4Jp(lOOJ),~"tbt number of them also mentioned their assessment that F U " _ " .t " y " o u fth d . E EO oo O a O " Q ". IO . D IC I Q >: a c l m l:; o Jo o l s : . ." r , " lO " O "H J. ~ II c J a (W lF u " '" " 'lf " L " 'I " I . B , o E a , r , d , , 0 ,, 1 , ·a .-. a longer period of low federal funds rates isappropri .... 01 tbt FedmI R...... s,..ID, Nootmb<l~ lR>r~,"OOI,r<fu"reo«aI_lllOj)~l a e t f e fe w ct h ir e e n lo th w e e f r e b d o er u a n l d f . u n In d s c o ra n t t e r a i s s t c , o th n e s t s ra ix i n p e a d r t b ic y i p in a nt; " " " " d" " 1 '" '" < " f I M , M 0l " :l1 "I { I, ) J.O " u ' >t m O r b t el; b _. ~ *~ 1 "I W """ ' " " .. " o .". f ." ! . I " t < l ' O P P d I I p " . " " . I . " I . " c , " l . ' a . " . . 1 t , 0 . b t , h t . . p . " n . " c ; " < c " " " " ' ~ ' " " ' , " ' " , ' ' t ' o l ' f w ' ' t . h ~ . o ~ . Y p bo < '" e t ' o . who judged that policy firming should begin in 2012 or 2013 mdi(:;lted that the Committee would need to act decisirely to keep inftation at mandate-consistent le\'els recoveries over the past 60 }'ears. In that regard, par and to limit the risk of undennining Federal Reser-I'e ticipantscontinued to be unCtrtain about the pace at credibility and causing a rise in inDation expecutiono. which credit condition; would ease and about pros Several were projecting a faster pickup in economic pects for a JtCO\'ery in the housing sector. In addition. activit)'. and a f¢ll' stressed the risk of distortions in the participants generally saw the outlook for fiscal and financial system from an extended period of exception. regulatory p:lUciesas still highly uncertain. Regarding ally low interest rate~ the unemployment rate. several expressed uncertainty about how labor demand and supply liQuId evoh'e Ol'er the IOrecast period. Am:mg the sources of UnCtf· tainty about the outlook for inOation were the dil!kul Uncertainly and Risks ties in assessing the current and prospectil"e margins of slack in resource markets and the effect of such slack Figure 4 shows that tmst participants continued to shm the I'iew that their projections for real GDP 00 pnCtt A majority of participants continued to report that growth and the unemployment rate were subject to a they saw the risk; to Iheir IOrecastsof real GDP higher le'lel of uncertainty than W3S the norm during groll1h as weighted to the downside and. accordingly. the previous 20 years.ll Many also judged the le',el of the risks to their projections for tbe unemployment uncertainty associated lIith their inRation forecasts to rate as skewed to the upside. AU but one of the rmum be higher than the longer-run norm, bUlthat assess ment was somewhat less prevalentamoog participants ing participants ~i¢ll'ed the risks to both projections as than was the case for uncertainty about real activity. broad~' balanced, while one noted a risk thai the Participants identified a number of factors that con unemployment rate might continue to decUne tm/t rapidly than expected. The Imst frequently cited tributed \0 the elel'lted leI'el of u!!Certainty about the downside risks to the projected pace of the economic outlook. In particular, many plrticipanlscontinued to expansion were the p:lssibility of financial market and cite risks related to ongoing del'elopments in Europe. economic spillo\"ers from the fiscal and financial issue; More broldly, they again noted difficulties in fortClst mthe earo area and the chance that some of the fac ing the path of economic recovery from a deep reces IOrs that hal'Cr estrained the JtCO\'ery in recent years sion that was the result of a seI'ere financial crisis and oould persist and weigh on economic activity to a Ihusdiffered important~' from tbe experience with greater extt"Dt than assumed in participants' blseline forecast~ In particular, some participants mentioned 23. Tal* I p""'&<$im.1!<$<>ftbtf<mnS{IIl>IlM.intyfortbt chango;. ...t GDP, tbt u. ....p loy"'.'u nte, .Dd totat OODiumer the downside risks to oonsumer spending from still ;ticeinllation""", tbt period from t99t lo2010.AI Ihc..,d<>flbis weak: household balance sheets and only tmdest gams AIm ....! )', lbtbox "ro..c. .. UlICC(uinlJ~ ~ Ibt~ ..d m real income, along with tbe p:lssible effects of still i I J I l » Q o " W prf " tl " l " io b o I o R f d Il I t n o 1 1 U 1 n $ U _ y !b in e w tb . t : e . c ru oo .i o tl m l)' i o o n f d o lnisr'u" u o u a . n ., d d i e n x g p l t . b in t . high leI'cl.! of uncertainty regarding fiscal and regula ",nicip"'''pro:i<cIion, tory p:llicies that might damp businesses' lIiUingness 113 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00117 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.26021103 Board of w,"ernQ/1 of lhe Federal &serre SysleJII 59 Fi&ure4"U nctrUinty and liw in OCOIlCIllk pro;e.:tioos _ U"-" Ib<U (l)P It""'" - - , " -~~ -" --". -, ~, , -. -. .. - ~ ', • - , " -" -, -" -" -,,-- -" -" -, -" -" -" ,_ _____ ,_11 -" -, -. ,'~- ., -. L ~, . . -, -----, r ' • -,,-- -" R,ib toea. PCE D1alOO -" -, -, -" -" -" -" -, --.. -. -N.O,IIt -F,< r"'m-<i..........,.lI<Iri;b • ..,..,.;.,~""""ta:"_c""""""'.·Dt_<i..oriobb ..... IIo<_. . 114 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00118 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.36021103 60 Monetary ftlhcy Report to the CongrtssO February 2012 Forecast Uncertainty The economic projections prOlided by the mem tile second year, and 11 to 4.8 in tile third lear. The befs of the Board of Go\-erllOfS m the presidenlS correspooding 70 percent confidence IrrtE'IVaiS for of the Federal Re:\e,,'e Banks inform discussions of OIerall inflation woold be \.I to 2.9 percent in the monetary policy ~ poIiqmakers and can ilId rurrerrt lear m 1.0 to 3.0 percent In the second pu~ic uoderst3llding of the basis for polItY aridtt.rd)'eilr>. acbons. Coosidera~e uncertainty attends these Becauserurrent condrtions maydtlJer !Tom prqectioos. howe--ef. The ~ arid >t<tI~fC3.1 those that prevailed, 0fI a~ratr, OI-er t.,tory, par models and 'elatoonsh'pl' used to help produce ticipants pr0\1Oe Judgments a> to whether the ~/Orecasts are necessarily imperiect UncertaInty attached to their projectlOlls of eocll desoiptions of the real wo<ld, and the futme path ~ariable i$ greater than. smaller than, or broadly of the economy eM t:.e affected by ffi)"fiad Urfore similar to typical bels of forecast uncertainty in seen de.elopments and events. Th.ts, in setting the the pas~ a> shown in taMe 2. Participanl! also pro stance of monetaJy policy, partICipants Cort!idef lide Judgments as to whetne. the risksto their pro- not only what appears to bethe most hlely em jections are we.glned to the upside, are wetghted nomicoutcome as embodied in the,r prOfOOK>n>, to the OOwro>ide, or are broadly balanced. That IS, but also the ra'lge of aiternat"·e po5Sibilitie>, the participa'll5 Judge whether each vdlable i, more likeliflOOd of their ooo.rrnng. arid the potential likely to be.iJO\e or bdowtherr prOJection> of the CO>Il; tothee<:orlOlf1)·,hould they occur most lilelyoutcome. These judgments alx>ut the TaWe 2 SUITlr'l'W~es the a>-erage t.$Iorir:aJ a<:t:\l UncertaInty ard the risks atterding eocll partKi· racy of a ~e of fore:.:asts, including trose pant·s projection> are di)\lnc\ from the d~=,tyof reported in pastMootlary Pdjcy II.q>Orls arid trose participants' \"M :!bout the IJ'IOn likely outcomes. prepared bytheFedelal Reser\'e Bm-d's staffrn forecast uncertaUlty i$ coocemed wIth the risks advanceof meetings of the Federal Open ~ \ar\.:et associated with a partlClJlar prOJeclion rathe! than Committee. The prOfOOKln errOf ranges shown in with dr.-ergeoces across a number of different the ta~e rllustrate tile considerable uncertarnty I"ojections. ~ted with economrcfore::<OO. For aample. A>w,threal actll1tym ,ni1axion, theoutlookfor suppose a participant projectS that real gross thefuturepathofthel'edeJlllfund, rate lS>ubJecl domestic produd (COP)and total con,Urnef prire> to con>idelabie UJl(%J\alnty. ThIS UJl(%rtajnty arise will rise steadily at aooual rares o~ respect,,-e\y, primarily because each participant·$ assessment of 3 pe!cent and 2 j}eJcent.lf the uncertajnty attend the appropriate stance of moneta')' [dicy ing those proyrtions i$ >imjlar to that exjlenenced deperds importanllyontheevolutionof realadiv In the past and the risks around the projections are ity and inilationO'."eI time. If economic conditKlns broadly balanced, the numbers reported In ta~e 2 e\ooe III an unapected manner, then ilSse>sments would imply a probabrlityof about 70 percerrt that of the appropriate setting of thefederal fund> rate actual COP would eo.pand wdlln a rangeof1.7 to woold cMlgefromthat ~ntforward. 43 pe;cent on the ament lear, 13 to 4.i pe;cent In to inH'st and hire. A number of plrticipanl5 noted the these panicipanls sa\\" the persistence of sub>1anlial risk of another disruption in global oil markets that slack in resource utilization as likely to keep inDalion could not on~' OOoS! inlhtion but also reduce real subdued Ol'er the projection period, a few others DOled income and spending. The panicipan!s who judged the the risk that elevated resource slack might put more risks to be broadly balanced also recognized a number downward pressure on inlhtion than expected. In con· of these downside risks to the outlook but saw them as trast, some participants noted the upside risl;:s to inDa· counterbllanced by the possibmty that the resilienceof tion from developments in global oil and cotnmJdity cconomicacti~;ty in late 2011 and the recent drop in ITl.1.rtets, and meral indicated that the current highly the unemployment rate might signal greater underlying accommodatire stance of troneta£), policy and the momentum in economic activity. suhstantialliquidity currently in the 6nancial system In contrast to Iheir OUllook for economic activity, risked a pickup in inHation 10 a level above the Com most participants judged the risks 10 Iheir projections miuee'sobjeclil"e. A fnl· also pointed to Ihe risk that of inflation as broadly balanced. Participants geneTal~' uncertainty about the Commitlee·, ability 10 effectil·ely I;ewed Ihe recenl doxline in inHalion as having been in retrol"e po~cy acconunodalion when approprim could line with their earlier wrecas!s, and they nOled that lead 10 a rise in inilation expectalions. inllation expectations remain stable. While many of 115 VerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00119 Fmt 6621 Sfmt 6621 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.46021103 61 Abbreviations A'S asset·bJcked securities AFE advanced foreign economy AIG Armrican International Group, Inc. ARRA ArmrieaD Reconry and Reinvestment Act CDS credit default swap C&l oommercill and indumill oms commercial mortgage-backed securities CP commercial paper CRE commercial real estlte DPl disposable periOoal inoome EBA European Banking Authority ECR European Central Bank E:\!E emerging nurkel economy E&S equipment and software FDIC Federal Deposit Insurance Corporation FOMe Federal Open Mar~el Comminee: also, the Corruninee FRBNY Federal Resel"l"¢ funk of Nt'll' York GOP gro;sdome>tic product GSE govemment-spomored enterprise UBOR London interbank offered rate MEP nuturityextenSlOn program MBS mortgage-bJded securities NIP.. ... national income and producI1OCOUnlS OIS overnight index swap FCE personal consumption expenditures .po repurcblse agreement SCOOS Senior Credit Officer Opinion Survey on Dealer Financing Terms SEP Summary of EcoDOmic Projections SLOOS Senior Loan Officer Opinion Survey on funk Lending Practices s&P Sundard and funr'! Sm.!A System Open Market Account 'Vfl We;t Texas Intermediate

Ben S. Bernanke (2012, February 29). Congressional Testimony. Testimony, Federal Reserve. https://whenthefedspeaks.com/doc/testimony_20120301_chair_federal_reserves_first_monetary_policy

@misc{wtfs_testimony_20120301_chair_federal_reserves_first_monetary_policy,
  author = {Ben S. Bernanke},
  title = {Congressional Testimony},
  year = {2012},
  month = {Feb},
  howpublished = {Testimony, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/testimony_20120301_chair_federal_reserves_first_monetary_policy},
  note = {Retrieved via When the Fed Speaks corpus}
}