Congressional Testimony

S. HRG. 113–6 FEDERAL RESERVE’S FIRST MONETARY POLICY REPORT FOR 2013 HEARING BEFORETHE COMMITTEE ON BANKING, HOUSING, ANDURBANAFFAIRS UNITED STATES SENATE ONE HUNDRED THIRTEENTH CONGRESS FIRST SESSION ON OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU- ANTTOTHEFULLEMPLOYMENTANDBALANCEDGROWTHACTOF1978 FEBRUARY 26, 2013 Printed for the use of the Committee on Banking, Housing, and Urban Affairs ( Available at: http://www.fdsys.gov/ U.S. GOVERNMENT PRINTING OFFICE 80–509 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 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS TIM JOHNSON, South Dakota, Chairman JACK REED, Rhode Island MIKE CRAPO, Idaho CHARLES E. SCHUMER, New York RICHARD C. SHELBY, Alabama ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee SHERROD BROWN, Ohio DAVID VITTER, Louisiana JON TESTER, Montana MIKE JOHANNS, Nebraska MARK R. WARNER, Virginia PATRICK J. TOOMEY, Pennsylvania JEFF MERKLEY, Oregon MARK KIRK, Illinois KAY HAGAN, North Carolina JERRY MORAN, Kansas JOE MANCHIN III, West Virginia TOM COBURN, Oklahoma ELIZABETH WARREN, Massachusetts DEAN HELLER, Nevada HEIDI HEITKAMP, North Dakota CHARLES YI, Staff Director GREGG RICHARD, Republican Staff Director LAURA SWANSON, Deputy Staff Director COLIN MCGINNIS, Policy Director GLEN SEARS, Deputy Policy Director GREG DEAN, Republican Chief Counsel MIKE PIWOWAR, Republican Senior Economist DAWN RATLIFF, Chief Clerk RIKER VERMILYE, Hearing Clerk SHELVIN SIMMONS, IT Director JIM CROWELL, Editor (II) VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00002 Fmt 0486 Sfmt 0486 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON C O N T E N T S THURSDAY, FEBRUARY 26, 2013 Page Opening statement of Chairman Johnson ............................................................. 1 Prepared statement .......................................................................................... 37 Opening statements, comments, or prepared statements of: Senator Crapo ................................................................................................... 2 WITNESS Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve System ................................................................................................................... 3 Prepared statement .......................................................................................... 37 Responses to written questions of: Senator Warren ......................................................................................... 41 Senator Corker .......................................................................................... 44 Senator Johanns ........................................................................................ 45 ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD Monetary Policy Report to the Congress dated February 26, 2013 ..................... 47 (III) VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON FEDERAL RESERVE’S FIRST MONETARY POLICY REPORT FOR 2013 TUESDAY, FEBRUARY 26, 2013 U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. The Committee met at 10:15 a.m., in room SD–106, Dirksen Sen- ate Office Building, Hon. Tim Johnson, Chairman of the Com- mittee, presiding. OPENING STATEMENT OF CHAIRMAN TIM JOHNSON Chairman JOHNSON. Today’s hearing is with Chairman Bernanke on the Federal Reserve’s Monetary Policy Report to Congress. While progress toward maximum employment has been slow, it has been positive and steady, thanks in part to the Fed’s thought- ful and well-measured monetary actions. Our economy has added private sector jobs for 35 straight months. During that time, over six million new jobs have been created, but we should not sacrifice those gains by slamming on the brakes now. Without a fix, automatic spending cuts will take effect in just a few days and could send our economy into reverse at a time when we should continue moving forward on creating jobs. Projections suggest that the sequester will cost us 750,000 jobs this year. In addition to layoffs for cops, fire fighters, and teachers that could devastate our communities, these cuts will impact many of our Na- tion’s most vulnerable citizens, including kids, seniors, and the dis- abled. At a time when the U.S. faces an array of national security threats, the sequester will affect our military readiness. It is unacceptable that we are lurching from one manufactured crisis to the next, and Americans have had enough. These fights are bad for the economy and are making it harder for families to make ends meet. The steep drops in consumer confidence during the fights over the debt limit and the fiscal cliff rival the fallout after Lehman Brothers’ failure and 9/11. This has consequences. If consumers do not spend, businesses will not prosper and hire more workers. If businesses are not hiring, our economy will not grow. It is that simple. We must do all we can to restore confidence in not only our fi- nancial system, but also in our ability as a country to tackle long- term challenges in a responsible, bipartisan manner. In addition to Congress acting on a deficit reduction plan that is balanced and promotes job creation, there are things this Committee can do to help achieve these goals. From rigorous oversight, to confirming (1) VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 2 well-qualified nominees, to reauthorizing expiring laws, to reaching consensus on the future of housing finance, there are steps this Committee can take to promote consumer confidence, provide busi- nesses clarity to move forward with long-term plans, and strength- en our economic recovery. Chairman Bernanke, I look forward to hearing your views as both the Fed and the Congress pursue policies supporting our Na- tion’s economic recovery. I now turn to Ranking Member Crapo. STATEMENT OF SENATOR MIKE CRAPO Senator CRAPO. Thank you, Mr. Chairman. Today, we will hear from our Federal Reserve Chairman Ben Bernanke, who will testify on the Fed’s monetary policy and the state of the economy. Mr. Bernanke, I want to thank you at the outset for your ongoing initiatives to improve the transparency of the Federal Open Market Committee. Because so much is at stake for the U.S. economy, the Fed has the responsibility to make as much information available to the American people as possible on its actions. I also thank Chairman Bernanke for his steadfast reminder to us that one of the most important risks to our economy is our fiscal situation. I completely agree with him. That is why I have consist- ently said that the fiscal reform and economic growth should top the list of our priorities in Congress. We need to address the Fed- eral spending problem, reform our badly broken tax system, and promote a sustainable economic recovery that will result in in- creased jobs. Unfortunately, with the fiscal cliff deal completed, some officials are looking for an easy way out by claiming that our fiscal prob- lems are nearly solved. Nothing could be further from the truth. Our economy contracted in the last quarter. Our unemployment rate remains far too high. Medicare will be insolvent in just over 10 years, and Social Security will be insolvent after that. Until we take specific steps to reform our entitlements and to make them solvent for generations to come and reform our tax code to produce significant, sustained economic growth, our fiscal problems are far from solved. In addition to our own fiscal situation, the ongoing fiscal and banking crisis in Europe also presents substantial risks to our economy. In response to unsustainable fiscal policies here and abroad, central bankers throughout the world have turned to un- conventional monetary policies over the past few years. Near-zero interest rates, large-scale asset purchases, and record-size central bank balance sheets have become the norm. However, some authorities have become increasingly concerned that the costs of prolonged easy money policy outweigh the bene- fits. In its annual report released last June, the Bank of Inter- national Settlements laid out the risks entailed with the worldwide expansion of central bank balance sheets and their extended low interest rate policies. Not only did the report conclude that such ac- tions may delay the return to a self-sustaining recovery, but they create longer-term risks to central banks’ credibility and oper- ational independence. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 3 More recently, the minutes of the Federal Open Market Commit- tee’s January meeting show that several FOMC members ex- pressed concern that the Fed’s prolonged easy money policies could result in excessive risk taking and threaten the financial stability of the United States. These concerns warrant serious consideration, given the scale, scope, and duration of the Fed’s unconventional monetary policies. The Fed has kept the target range for the Federal Funds Rate at zero to one-quarter percent for more than 4 years. The Fed has engaged in multiple rounds of asset purchases, commonly referred to as quantitative easing. The Fed is currently buying $40 billion of agency mortgage-backed securities per month and $45 billion of longer-term Treasury securities per month, for a total monthly pace of $85 billion, or an annualized pace of more than $1 trillion. And primarily as a result of its large-scale asset purchases, the Fed has ballooned its balance sheet to more than $3 trillion and growing. I look forward to hearing from Chairman Bernanke about the concerns raised about the risks of the Fed’s prolonged easy money policies and why they cannot overcome our bad fiscal policy. I also look forward to hearing from Chairman Bernanke about how the uncertainty surrounding the Dodd-Frank implementation is hampering our recovery. In particular, what specific legislative fixes can be achieved to remove this uncertainty? At our last Humphrey-Hawkins hearing, Chairman Bernanke confirmed that regardless of Congressional intent, the banking reg- ulators view the plain language of the statute as requiring them to impose some kind of margin requirement on nonfinancial end users of derivatives unless Congress changes the statute. Chairman Bernanke also confirmed that the Fed is comfortable with an ex- plicit statutory exemption. I look forward to hearing Chairman Bernanke’s suggestions for other legislative fixes to Dodd-Frank that could garner bipartisan support. These and many other issues are critical to us and I appreciate again, Chairman Bernanke, your attendance at this hearing. Chairman JOHNSON. Thank you, Senator Crapo. This morning, opening statements will be limited to the Chair- man and Ranking Member to allow more time for questions from the Committee Members. I want to remind my colleagues that the record will be open for the next 7 days for opening statements, questions for the record, and any other materials you would like to submit. Now, I would like to introduce our witness. Ben Bernanke is Chairman of the Board of Governors of the Federal Reserve Sys- tem, a position he has held since February 2006. I thank you for being here today to testify on the Monetary Policy Report to the Congress. Your written statement will be included in the hearing record. Chairman Bernanke, you may begin your testimony. STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Mr. BERNANKE. Thank you, Mr. Chairman, Ranking Member, Members, I am pleased to present the Federal Reserve’s Semi- annual Monetary Policy Report. I am going to begin with a short VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 4 summary of current economic conditions and then discuss aspects of monetary and fiscal policy. Since I last reported to this Committee in mid-2012, economic ac- tivity in the United States has continued to expand at a moderate if somewhat uneven pace. In particular, real GDP is estimated to have risen at an annual rate of about 3 percent in the third quar- ter, but to have been essentially flat in the fourth quarter. The pause in real GDP growth last quarter does not appear to reflect a stalling out of the recovery. Rather, economic activity was tempo- rarily restrained by weather-related disruptions and by transitory declines in a few volatile categories of spending, even as demand by U.S. households and businesses continued to expand. Available information suggests that economic growth has picked up again this year. Consistent with the moderate pace of economic growth, conditions in the labor market have been improving gradu- ally. Since July, nonfarm payroll employment has increased by 175,000 jobs per month, on average, and the unemployment rate declined three-tenths of a percentage point, to 7.9 percent, over the same period. Cumulatively, private sector payrolls have now grown by about 6.1 million jobs since their low point in early 2010, and the unemployment rate has fallen a bit more than 2 percentage points since the cyclical peak in late 2009. Despite these gains, however, the job market remains generally weak, with the unemployment rate well above its longer-run nor- mal level. About 4.7 million of the unemployed have been without a job for 6 months or more, and millions more would like full-time employment but are able to find only part-time work. High unemployment has substantial costs, including not only the hardship faced by the unemployed and their families, but also the harm done to the vitality and productive potential of our economy as a whole. Lengthy periods of unemployment and underemploy- ment can erode workers’ skills and attachment to the labor force or prevent young people from gaining skills and experience in the first place, developments that could significantly reduce their pro- ductivity and earnings in the longer term. The loss of output and earnings associated with high unemployment also reduces Govern- ment revenues and increases spending, thereby leading to larger deficits and higher levels of debt. The recent increase in gasoline prices, which reflects both higher crude oil prices and wider refining margins, is hitting family budg- ets. However, overall inflation remains low. Over the second half of 2012, the price index for personal consumption expenditures rose at an annual rate of 1.5 percent, similar to the rate of increase in the first half of the year. Measures of longer-term inflation expecta- tions have remained in the narrow ranges seen over the past sev- eral years. Against this backdrop, the Federal Open Market Com- mittee, the FOMC, anticipates that inflation over the medium term will likely run at or below its 2 percent objective. With unemployment well above normal levels and inflation sub- dued, progress toward the Federal Reserve’s mandated objectives of maximum employment and price stability has required a highly ac- commodative monetary policy. Under normal circumstances, policy accommodation would be provided through reductions in the FOMC’s target for the Federal Funds Rate, the interest rate on VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 5 overnight loans between banks. However, as this rate has been close to zero since December 2008, the Federal Reserve has had to use alternative policy tools. These alternative tools have fallen into two categories. The first is forward guidance regarding the FOMC’s anticipated path for the Federal Funds Rate. Since longer-term interest rates reflect market expectations for shorter-term rates over time, our guidance influ- ences longer-term rates and thus supports a stronger recovery. The formulation of this guidance has evolved over time. Between August 2011 and December 2012, the Committee used calendar dates to indicate how long it expected economic conditions to war- rant exceptionally low levels for the Federal Funds Rate. At its De- cember 2012 meeting, the FOMC agreed to shift to providing more explicit guidance on how it expects the policy rate to respond to economic developments. Specifically, the December post-meeting statement indicated that the current exceptionally low range for the Federal Funds Rate will, quote, ‘‘be appropriate at least as long as the unemployment rates above 6.5 percent, inflation between 1 and 2 years ahead is projected to be no more than half-a-percent- age point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored,’’ close quote. An advantage of the new formulation relative to the previous date-based guidance is that it allows market participants and the public to update their monetary policy expectations more accu- rately in response to new information about the economic outlook. The new guidance also serves to underscore the Committee’s inten- tion to maintain accommodation as long as needed to promote a stronger economic recovery with stable prices. The second type of nontraditional policy tool employed by the FOMC is large-scale purchases of longer-term securities, which, like our forward guidance, are intended to support economic growth by putting downward pressure on longer-term interest rates. The Federal Reserve has engaged in several rounds of such purchases since 2008. Last September, the FOMC announced it would pur- chase agency mortgage-backed securities at a pace of $40 billion per month, as Senator Crapo noted, and in December, the Com- mittee stated that, in addition, beginning in January, it would pur- chase Treasury securities at an initial pace of $45 billion per month. These additional purchases of longer-term Treasury securities re- place the purchases we were conducting under our now completed Maturity Extension Program, which lengthened the maturity of our securities portfolio without increasing its size. The FOMC has indi- cated that it will continue purchases until it observes a substantial improvement in the outlook for the labor market in a context of price stability. The Committee also stated that in determining the size, pace, and composition of its asset purchases, it will take appropriate ac- count of their likely efficacy and costs. In other words, with all of its policy decisions, the Committee continues to assess its program of asset purchases within a cost-benefit framework. In the current economic environment, the benefits of asset pur- chases and of policy accommodation more generally are clear. Mon- VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 6 etary policy is providing important support to the recovery while keeping inflation close to the FOMC’s 2 percent objective. Notably, keeping longer-term interest rates low has helped spark recovery in the housing market and led to increased sales and production of automobiles and other durable goods. By raising employment and household wealth, for example, through higher home prices, these developments have, in turn, supported consumer sentiment and spending. Highly accommodative monetary policy also has several potential costs and risks, which the Committee is monitoring closely. For ex- ample, if further expansion of the Federal Reserve’s balance sheet were to undermine public confidence in our ability to exit smoothly from our accommodative policies at the appropriate time, inflation expectations could rise, putting the FOMC’s price stability objective at risk. However, the Committee remains confident that it has the tools necessary to tighten monetary policy when the time comes to do so. As I noted, inflation is currently subdued and inflation ex- pectations appear well anchored. Neither the FOMC nor private forecasters are projecting the development of significant inflation pressures. Another potential cost that the Committee takes very seriously is the possibility that very low interest rates, if maintained for a considerable time, could impair financial stability. For example, portfolio managers dissatisfied with low returns might reach for yield by taking on more credit risk, duration risk, or leverage. On the other hand, some risk taking, such as when an entrepreneur takes out a loan to start a new business, or an existing firm ex- pands capacity, is a necessary element of a healthy economic recov- ery. Moreover, although accommodative monetary policies may in- crease certain types of risk taking, in the present circumstances, they also serve in some ways to reduce the risk in the system, most importantly by strengthening the overall economy, but also by en- couraging firms to rely more on longer-term funding and by reduc- ing debt service costs for households and businesses. In any case, the Federal Reserve is responding actively to finan- cial stability concerns through substantially expanded monitoring of emerging risks in the financial system, an approach to the su- pervision of financial firms that takes a more systemic perspective, and the ongoing implementation of reforms to make the financial system more transparent and resilient. Although a long period of low rates could encourage excessive risk taking and continued close attention to such developments is certainly warranted, to this point, we do not see potential costs of the increased risk taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more rapid job creation. Another aspect of the Federal Reserve’s policies that has been discussed is their implications for the Federal budget. The Federal Reserve earns substantial interest on the assets it holds in its port- folio, and other than the amount needed to fund our cost of oper- ations, all net income is remitted back to the Treasury. With the expansion of the Federal Reserve’s balance sheet, yearly remit- tances have roughly tripled in recent years, with payments to the Treasury totaling approximately $290 billion between 2009 and 2012. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 7 However, if the economy continues to strengthen, as we antici- pate, and policy accommodation is accordingly reduced, these re- mittances would likely decline in coming years. Federal Reserve analysis shows that remittances to the Treasury could be quite low for a time in some scenarios, particularly if interest rates were to rise quickly. However, even in such scenarios, it is highly likely that average annual remittances over the period affected by the Federal Re- serve’s purchases will remain higher than the precrisis norm, per- haps substantially so. Moreover, to the extent that monetary policy promotes growth and job creation, the resulting reduction in the Federal deficit would dwarf any variation in the Federal Reserve’s remittances to the Treasury. Although monetary policy is working to promote a more robust recovery, it cannot carry the entire burden of ensuring a speedier return to economic health. The economy’s performance, both over the near term and in the longer run, will depend importantly on the course of fiscal policy. The challenge for the Congress and the Administration is to put the Federal budget on a sustainable long- run path that promotes economic growth and stability without un- necessarily impeding the current recovery. Significant progress has been made recently toward reducing the Federal budget deficit over the next few years. The projections re- leased earlier this month by the CBO indicate that under current law, the Federal deficit will narrow from 7 percent of GDP last year to 21⁄ 2 percent in fiscal year 2015. As a result, the Federal debt held by the public, including that held by the Federal Reserve, is projected to remain roughly 75 percent of GDP through much of the current decade. However, a substantial portion of the recent progress in lowering the deficit has been concentrated in near-term budget changes, which, taken together, could create a significant headwind for the economic recovery. The CBO estimates the deficit reduction policies in current law will slow the pace of real GDP growth by about 11⁄ 2 percentage points this year relative to what it would have been otherwise. A significant portion of this effect is related to the auto- matic spending sequestration that is scheduled to begin on March 1, which, according to the CBO’s estimates, will contribute about six-tenths of a percentage point to the fiscal drag on economic growth this year. Given the still moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant. Moreover, besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run for any given set of fiscal actions. At the same time, and despite progress in reducing near-term budget deficits, the difficult progress of addressing longer-term fis- cal imbalances has only begun. Indeed, the CBO projects that the Federal deficit and debt as a percentage of GDP will begin rising again in the latter part of this decade, reflecting in large part the aging of the population and fast rising health care costs. To promote economic growth in the longer term and to preserve economic and financial stability, fiscal policy makers will have to put the Federal budget on a sustainable long-run path that first VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 8 stabilizes the ratio of Federal debt to GDP, and given the current elevated level of debt, eventually places that ratio on a downward trajectory. Between 1960 and the onset of the financial crisis, Fed- eral debt averaged less than 40 percent of GDP. This relatively low level of debt provided the Nation much needed flexibility to meet the economic challenges of the past few years. Replenishing this fiscal capacity will give future Congresses and Administrations greater scope to deal with unforseen events. To address both the near and longer-term issues, the Congress and the Administration should consider replacing the sharp front- loaded spending cuts required by the sequestration with policies that reduce the Federal deficit more gradually in the near term but more substantially in the longer run. Such an approach could less- en the near-term fiscal headwinds facing the recovery while more effectively addressing the longer-term imbalances in the Federal budget. Finally, the size of deficits and debt matter, of course, but not all tax and spending programs are created equal with respect to their effects on the economy. To the greatest extent possible, in their ef- forts to achieve sound public finances, fiscal policy makers should not lose sight of the need for Federal tax and spending policies that increase incentives to work and save, encourage investments in workforce skills, advance private capital formation, promote re- search and development, and provide necessary and productive public infrastructure. Although economic growth alone cannot eliminate Federal budget imbalances in either the short run or the longer term, a more rapidly expanding economic pie will ease the difficult choices that we face. Thank you, Mr. Chairman. Chairman JOHNSON. Thank you for your testimony. As we begin questions, I will ask the Clerk to put 5 minutes on the clock for each Member. Chairman Bernanke, what is your assessment—please elabo- rate—of the sequester’s impact on our economy in the short term if Congress did nothing, and what would be the impact if Congress manufactures another crisis with a fight over the CR? Mr. BERNANKE. Well, Mr. Chairman, as I mentioned in my re- marks, with respect to the sequester, the CBO estimates that it would cost about six-tenths a percent of growth in this year and the equivalent of about 750,000 jobs, and so it would be a drag on near-term economic recovery. More broadly, all of the actions taken this year, according to the CBO, would be a drag of about 11⁄ 2 per- centage points, which is quite significant. So in that respect, I think an appropriate balance would be to introduce these cuts more gradually and to compensate with larger and more sustained cuts in the longer run to address our long-run fiscal issues. As you note, there are a couple of other issues this year, includ- ing the continuing resolution and the debt ceiling. Again, I hope that Congress can work together effectively to address these issues with a minimum of uncertainty, because the uncertainty itself, of course, is also costly in terms of the ability of the private sector to plan, to take risks, and to help grow the economy. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 9 Chairman JOHNSON. Housing is important to our economic growth and the Fed is working on mortgage rules in Basel that will have a major impact on housing. Chairman Bernanke, do you agree with Governor Tarullo that nothing prevents QRM from being the same as QM, and what will you do to ensure new Basel rules do not hinder mortgage lending? Mr. BERNANKE. Mr. Chairman, as you know, the QRM is re- quired to be no more broad than the QM, so we have had to wait for the QM to be done before we could attack the QRM process, al- though we have put out previous proposed rulemakings. The QM, of course, is intended to help consumers. The QRM is meant to try to strengthen the securitization market. They are somewhat different purposes. But I would say, responding to your question, that the six agencies which are currently discussing the QRM consider the idea of making the QRM essentially identical to the QM is a realistic option and is one that we are considering. Chairman JOHNSON. Thank you for your answer. Also regarding Basel, Ranking Member Crapo and I sent you a letter on the potential impact of Basel rules on insurance compa- nies and community banks. I look forward to your response. Chairman Bernanke, there is an increased focus on cybersecurity and the United States, including within our financial system. FSOC has noted the issue in its annual reports. What is the Fed doing, both with the banks you supervise and your own networks, to strengthen financial data protection and enhance the cybersecurity of the financial sector? Mr. BERNANKE. Well, Mr. Chairman, as you know, your point is absolutely right, that cybersecurity concerns in the financial sys- tem have become more acute lately. Since last fall, there have been a number of so-called denial of service attacks on banks, which es- sentially flood the public-facing Web sites and prevent the public from accessing their accounts, for example. These are obviously quite disruptive and problematic. The leadership on cybersecurity for the financial system is being taken, on the one hand, by the Treasury, and on the other hand by the various intelligence and securities agencies. The Federal Re- serve is very much engaged in cooperating with these agencies, sharing information, and working with our banks to make sure that they have appropriate procedures and oversight in place to deal with such problems. But, I have to say, we do not have to press them very hard because they recognize it is very much in their own interest to do whatever they can to prevent these attacks from being effective. Chairman JOHNSON. While some urge the Fed to focus solely on inflation, which has been a bigger threat to our economic prosperity since 2007, Chairman Bernanke, unemployment or inflation, what is the most important step the Fed has taken to promote maximum employment? Mr. BERNANKE. Well, Senator, as you know, we have a dual man- date given to us by Congress. That is entirely appropriate. Con- gress should set our objectives and then the Federal Reserve should figure out how to meet them. So we are interested both in achieving higher levels of employment and in maintaining low in- flation and price stability. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 10 Our monetary policy, as I mentioned in my remarks, has been quite accommodative in that respect. It is very much like that es- sentially in all other advanced economies. In doing so, we have, ob- viously, in the first instance, provided support for the real economy and for job growth through strengthening housing, for example, through strengthening the demand for automobiles and other dura- bles, through wealth effects and the like. But I would note that with inflation at or below our 2 percent target, our policies have also had the effect of greatly reducing any risk of deflation, which at the moment does not seem like much of a concern, but at certain times, as inflation gets close to the zero critical level, that risk increases. And keeping inflation from going too low—I realize sometimes it is hard to explain to people why in- flation that is too low is a problem—but if it is too low, you run the risk of a Japanese-style situation, where prolonged deflation is a barrier to economic growth and stability. So our accommodative monetary policy has not really traded off one of these against the other. It has supported both real growth in employment and kept inflation close to our target. We have many other things that we do on the regulatory side and so on, but the monetary policy, of course, is the tool that the Fed has to try to address that mandate. Chairman JOHNSON. Senator Crapo. Senator CRAPO. Thank you, Mr. Chairman. Chairman Bernanke, as you mentioned in your testimony, the Fed is currently monitoring whether its prolonged near-zero inter- est rate policy could result in excessive risk taking and threaten the financial stability of the United States. I am interested in what specific metrics you used to evaluate whether these risks are in- creasing. Mr. BERNANKE. Well, first, Senator, we have greatly expanded our resources that we use in the monitoring process. We have cre- ated a new Office for Financial Stability. We are working very in- tensively with the Financial Stability Oversight Council. So the amount of effort we put into this has greatly increased. Our inter- nal monitors, in turn, report regularly to the Board and they report to the Federal Open Market Committee. So our discussions of mon- etary policy include extensive discussions of financial stability issues. The kind of metrics that are used include things like leverage, are people who are investing taking on too much leverage? Are asset valuations out of line according to standard metrics? Is inter- est rate risk or other kinds of risk too concentrated? As you know, of course, the Fed is also a bank supervisor, so we spend a lot of effort looking at banks and other financial institutions, trying to ensure that they have appropriate capital, appropriate liquidity, and are appropriately managing their risk. And so there’s a wide range of ways in which we look at this. Again, as I indicated, we are watching this very carefully. To this point, and I think this is a view shared by others on the Com- mittee, while there are things that we really have to pay attention to, at this point, they are not of sufficient concern that they out- weigh the important benefits of trying to support a continued re- covery. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 11 Senator CRAPO. Well, thank you. I probably would disagree with those conclusions. I know a number of my colleagues are going to get into this issue a little further, so I am going to go on because of the shortness of time. I want to talk with you briefly about Dodd-Frank reform. If we are able to achieve some bipartisan consensus on steps to improve Dodd-Frank, what are some of the provisions that you think need clarification or improvement for reconsideration? Mr. BERNANKE. Well, first, as a general matter, Senator, Dodd- Frank is a very big, complicated piece of legislation. It addresses many different issues and I am sure there are many aspects of it that could be improved in one way or another. I recall, in fact, that you yourself had a bill 5 or 6 years ago on regulatory reform and simplification—— Senator CRAPO. That is right. Mr. BERNANKE. ——which was a bipartisan effort to find ways to reduce costs without losing the purposes of the regulation, and I think something along those lines would be very doable in this con- text. The Federal Reserve would certainly be willing to work with you closely. In terms of specifics, we would want to do the work, of course, but you mentioned in your opening remarks the end user issue, clarity on what Congress would like us to do about end users, for example. Another area which is proving difficult is the push-out provision for derivatives. And I think, more generally, I think we all agree that the burden of regulation falls particularly heavily on small community banks, which do not have the resources to man- age those regulations very effectively. So I would say as a general proposition that we ought to work together to try to find ways to lower that regulatory burden on those smaller institutions. Senator CRAPO. Well, thank you, Mr. Chairman, and I appreciate your advice and your expression of willingness to work with us on these and others as we move forward to try to improve our regu- latory climate. The last issue, at least that I will have time for in this round, is I want to talk about the crisis in Europe. Last week, the Euro- pean Union released its 2013 forecast for the eurozone economy and the E.U. economists predict that the eurozone economy will shrink for the second year in a row and the third in the last five. What specific risks does a prolonged recession in Europe present to the outlook for the U.S. economy? Mr. BERNANKE. Well, the risks that we have been facing for the last couple of years have been primarily financial, given uncertain- ties about the stability of certain countries’ sovereign debt, given the risk on, risk off behavior we have been seeing in financial mar- kets as news comes in about financial developments. The European Central Bank has taken a number of important steps, including most recently the outright monetary transactions, which have helped to bring down the sovereign debt yields for the more fiscally challenged countries. That has been helpful. There have been a number of other positive steps which have generally reduced the financial stresses in Europe, notwithstanding the issues raised by the Italian election yesterday and today. And so VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 12 while that remains a concern, I think the financial stresses are cer- tainly less today than they were over the last 2 years. At the same time, as you mentioned, even as the financial stresses have moderated to some extent, the European economy and the eurozone is in recession. Unemployment is rising, not fall- ing. And that affects us in a number of ways, partly through the financial sector, but also simply through trade. Our economy pros- pers when we can export and the European market is an important market for us and we have noticed a decline in our ability to export to Europe. So that is a risk, as well. Senator CRAPO. Thank you. Chairman JOHNSON. Senator Reed. Senator REED. Thank you very much, Mr. Chairman. Thank you, Mr. Chairman, for your testimony. Over the last sev- eral years, the Federal Reserve has been providing stimulus to the economy through QE3, through other programs, and particularly as we are on the verge of the sequestration, it seems that our fiscal policy is not complementary to your policy. In fact, contradictory. And as you suggest in your testimony, if we could in the short run have a complementary policy, that would also add jobs rather than subtract them in the short run, add growth that would actually do better in closing the deficit and, in fact, provide an opportunity in the long run to solve some of the challenging problems. In addition, and I would like your comments, if we continue to sort of use austerity as our major approach, that, I presume, would complicate your ability, as you suggest you can do, to, in a meas- ured way, move away from quantitative easing at the right time. Could you comment on those points? Mr. BERNANKE. Well, as I have noted, and I noted again today, monetary policy is no panacea, is no cure all, and we do not have the ability—we can all disagree on how powerful these measures are, and I do think they are effective, but I do not think that they can offset the 11⁄ 2 percentage points of fiscal restraint we are see- ing this year, for example. So in terms of the near-term recovery, I think there is a sense in which monetary and fiscal policy are working at cross purposes. Having said that, I want to just be clear that I am not in any way denying the importance of long-run fiscal stability. I just think that, to some extent, the fiscal policy decisions being made are mis- matched with the timing of the problem. The problem is a longer- term problem and should be addressed over a longer timeframe and in a way that, to the extent possible, and perhaps it is not en- tirely possible, but to the extent possible, does no harm with re- spect to the ongoing recovery. And that is the kind of balance I hope that the Congress will consider. Senator REED. So do I. I may be repeating myself, is that if our policies in the short run were complementary, that would probably bring down the deficit faster than the current sort of cross pur- poses. Is that your sense, too? Mr. BERNANKE. Well, certainly the—I do not know if it would be literally faster in the short run, because on the one hand, you would have fewer cuts and tax increases. On the other hand, you have greater growth. So those two factors might be going in the other direction. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 13 But it is true that you get less bang for the buck, so to speak, for a given cut or a given tax increase because of the effect on short-term growth. So you would get a longer and larger long-run deficit impact and do less damage to the growth process by looking at this over a longer timeframe. Senator REED. Thank you very much. Let me quickly turn to another issue, and that is the Basel Com- mittee announced significantly weaker liquidity coverage ratio rules, allowing sort of the use of mortgage-backed securities as liq- uid assets, et cetera. Do you intend to follow that approach with respect to the Fed, particularly the cautionary words you gave us today about risk taking and adding leverage to the financial mar- kets? Mr. BERNANKE. Well, I think that will be our starting point. We need to start with the international agreement and ask ourselves, to what extent do we need to strengthen it? To what extent do we need to customize it for the U.S. context? You have to remember that, unlike capital, liquidity requirements are a new thing, and there was a significant amount of discussion about what was rea- sonable, what might be the side effects of liquidity requirements in other markets, and the like. And so there was a bit of iteration in terms of what the international agreement was. But we will cer- tainly, of course, meet the international agreement, and then we will be looking to see whether additional steps or U.S. customization is necessary. Senator REED. Finally, and very quickly, Senator Crapo touched on the European situation. From afar, it looks like their policies of austerity have not helped them grow at all, in fact, have com- plicated their economic situation. Is that a fair judgment? Mr. BERNANKE. Well, austerity is not the only problem. They have, obviously, high interest rates and a variety of other factors that are affecting their economies. But, again, I would say that it is possible to achieve both objectives, short-term growth and longer-term financial sustainability, with a more judicious com- bination of short-term and long-term fiscal adjustments. Senator REED. Thank you very much, Mr. Chairman. Thank you, Mr. Bernanke. Chairman JOHNSON. Senator Shelby. Senator SHELBY. Thank you. Mr. Chairman, welcome again to the Committee. The portfolio or the balance sheet of the Fed, you said is $3 trillion, more or less, is that right? Mr. BERNANKE. I did not say, but yes, that is about right. Senator SHELBY. Is that about right? Mr. BERNANKE. Yes, sir. Senator SHELBY. But you said it then, did you not? It is about $3 trillion. Mr. BERNANKE. Yes, sir. Senator SHELBY. You studied the Fed a long time before you ever came to the Fed. Has there ever been that type of balance sheet, close to that? Mr. BERNANKE. I do not think so. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 14 Senator SHELBY. No. OK. Does it concern you, not how you add to the balance sheet, but how you might have to deleverage the bal- ance sheet, and will that be a challenge for the Fed, or could it be? Mr. BERNANKE. Well, Senator, I should comment that although the Fed has not had a balance sheet this size, other central banks, like the Japanese, for example, have—— Senator SHELBY. And they have paid for it, too, have they not? Mr. BERNANKE. Well, it depends on your point of view. The cur- rent Prime Minister thinks they have not done enough. Senator SHELBY. What do you think? Mr. BERNANKE. I think that they should try to get rid of defla- tion. I support their attempts to get rid of deflation. In terms of exiting from our balance sheet, we have put out—a couple years ago, we put out a plan. We have a set of tools. I think we have belts, suspenders, two pairs of suspenders. We have dif- ferent ways that we can do it. So I am not—I think we have the technical means to unwind it at the appropriate time. Of course, picking the exact moment to do it, of course, is always difficult. You know, you want to withdraw the support at the right time, not too early, not too late. That is always a judgment call. But in terms of the ability to get out and to normalize our bal- ance sheet, we have, again, a set of tools, which I would be happy to go into, if you like, but which will allow us to normalize policy either by selling assets or by retaining assets and doing other things, like raising the interest rate we pay on reserves. Senator SHELBY. Do you think you will grow to a $4 trillion bal- ance sheet? Mr. BERNANKE. Well, we do not have—we did not announce any number. What we are doing is we are looking—we are tying our asset purchases to the state of the economy. We want to continue purchases until we see a substantial improvement in the outlook for the labor market, conditional on inflation remaining stable. We are also, as I mentioned in my remarks, we are looking at the costs and benefits, including the financial stability issues that Senator Crapo alluded to. So we do not have—we have not given a specific number, but we are certainly paying close attention to all of these issues. Senator Crapo mentioned the transparency of the Fed. We are having this debate in public. You may have noticed that many Members of the Committee talk in public. We want everyone to un- derstand that we are looking at all these issues. We are taking them all into account. And we are trying to do the right balancing of our objectives. Senator SHELBY. Is your portfolio public? Mr. BERNANKE. Yes, sir. Senator SHELBY. It is public. In other words, the $3 trillion value of your portfolio, it is public as to what securities you have and how they are doing, performing and nonperforming, is that—— Mr. BERNANKE. They are all performing, every single one. I mean, they are all Treasuries and Treasury-guaranteed agency se- curities. Senator SHELBY. Just about all of them are Treasury and Treas- ury-related securities? VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 15 Mr. BERNANKE. By law, we can only buy Treasuries and agen- cies. Senator SHELBY. And they are all performing right now? Mr. BERNANKE. A hundred percent. Senator SHELBY. OK. I want to discuss Basel III—I just have a minute. Where is Basel III as far as implementation in Europe and the U.S.? Bring us up to date. Mr. BERNANKE. Yes, sir—— Senator SHELBY. Because I think this is a very important regu- latory challenge for everybody. Mr. BERNANKE. Right. Well, as you know, we put out a proposed rule on Basel III. We received lots of comments. We work to those comments. We have continued to talk to our international partners and we are planning to have a final rule out on Basel III—I cannot give you an exact date, but somewhere in the middle of this year, and with the aim of getting the implementation of Basel III during 2013. I would point out, also, that as far as we can tell through our stress tests and other measures, virtually all of our banks are al- ready well on track to meet the Basel III requirements. So it is not a question of the banks not being adequately capitalized. They are already either at or about to reach the Basel III capital levels. Senator SHELBY. What about Europe and their banks? Mr. BERNANKE. Europe is also in the process of implementing Basel III. Their banking system is weaker, I think. It has strength- ened some in recent quarters. We are discussing with them some of the details of their plans, some of which differ from the inter- national agreement, in our view. But they are also in the process of implementing this agreement. Senator SHELBY. Thank you, Mr. Chairman. Chairman JOHNSON. Senator Schumer. Senator SCHUMER. Thank you, Mr. Chairman. First, I want to welcome Senator Crapo as our new Ranking Member and look forward to working with you on the Committee. And to the other new Members of the Committee, welcome. It is a great Committee with a great group, and I hope we will have a good, productive time under the Chairman’s leadership. OK. My first few questions are about sequestration, and then I want to talk a little about Italy. Estimates suggest that letting sequester take effect could reduce the GDP by as much as half a point over the remainder of the year. I first want to know if it is—I am going to ask you a series and you can answer them. Is that a fair estimate? Instead of stopping sequestration, some have suggested letting the full amount of cuts take effect, but rearranging the cuts rather than imposing them across the board. In your opinion, would this reshuffling mitigate the negative effect of GDP growth in any meaningful way this year or next, or would the net effect on short- term GDP be more or less the same since the total amounts of cuts would be the same? And my second question on sequestration is this. It goes into ef- fect Friday. There is some debate about how quickly the cuts will take place and how quickly the impact on jobs and the economy will be felt. CBO says sequestration will cost 750,000 jobs. When VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 16 do you think we will start seeing the impact in the job market? In the March job numbers? In April? When? Those are my questions on sequestration. Mr. BERNANKE. Sure. The six-tenths on GDP growth in 2013 is a CBO number, and we get very similar results to that. I think that is a reasonable estimate. In terms of whether or not rearranging the cuts would be bene- ficial, it could be beneficial from the point of view of more efficient allocation of the cuts or cuts that are more consistent with the pref- erences of Congress, but that, of course, is a Congressional deci- sion. I have no input there other than to say that I think the near- term effect on growth would probably not be substantially different if you did it that way. In terms of the effects on jobs and employment, the spending im- plications of the sequester take place over a period of time, so I—— Senator SCHUMER. Mr. Chairman, you did not answer the second one. I asked you, would it—regardless of the political preferences that the Congress might have—would the rearrangement, if there is flexibility, affect economic growth in any real way—— Mr. BERNANKE. Oh, sorry—— Senator SCHUMER. ——if the cut level is the same? Mr. BERNANKE. Not significantly. It would be about the same, I think. Senator SCHUMER. Got you. Good. Mr. BERNANKE. In terms of the impact, the sequestration takes place over time. Furloughs take place over time. Spending cuts take place over time. So I would not expect to see a big impact im- mediately. I think it would probably build over a period of months. Senator SCHUMER. Right. One of my colleagues—I do not want to steal his thunder, he is not here—but at a meeting earlier de- scribed it like the metaphor of the frog who jumps into a pot and the water just starts boiling, and you do not feel it at first, but if you stay in that pot, you are going to be singed pretty badly. Is that a fair analogy? Mr. BERNANKE. Well, again, I think that it would take effect over a period of time, and remember, it is also in conjunction with the other measures that have been taken this year, as well. Senator SCHUMER. Yes. Thank you. The next question is on Italy. So the markets reacted quite nerv- ously, shall we say, to the elections in Italy and the idea that they might not be able to form a Government, or might form a Govern- ment that would be less willing to go along with the present eco- nomic policies. My question is, A, what do you think of that, but B, more importantly, what is the exposure of our American finan- cial institutions to Italy’s debt? How dangerous—let us say—let us take the worst case scenario and let us say they cannot form a Gov- ernment and they go through a little bit of what Greece or Spain has. How big an effect would that have on the stability—not on the world economy, not on our selling to Italy, but on the stability of our American financial institutions? Mr. BERNANKE. Well, the market is reacting, first and foremost, to uncertainty. It does not know which way the Italian Government is going to go and how those policies will be affected. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 17 I am not an expert in Italian politics, but I do not think that any of the candidates have outright rejected either staying in the Euro or maintaining the policies that are being required of Italy in order to continue to receive—you know, in order to continue to be in the eurozone. But, again, there is a lot of uncertainty there to see what happens. Italy is unusual in that its current deficits are not very large, but it has a very large outstanding debt, and so there is a lot of Italian debt held around the world. Our assessments, going back, is that our banking exposure to Italian and Spanish debt is moderate, that it would be meaningful, but—again, I am not forecasting in any way—would not inflict serious damage on our financial institutions. There are, of course, also money market funds that lend a lot of funds to European banks, including Italian banks, and those are connected. The fate of those institutions is connected to the fate of the fiscal situation. But, again, I think that the main effects would be more indirect. I think—and again, I want to emphasize, this is totally hypo- thetical—that serious concerns about, say, the ability of Italy to re- main in the Euro would probably have much broader effects on other asset classes—stock market, bond yields around the world, bank stocks, et cetera—and those effects would be more unpredict- able and more concerning probably than direct losses and expo- sures in terms of Italian debt holdings. Senator SCHUMER. Thank you, Mr. Chairman. Chairman JOHNSON. Senator Corker. Senator CORKER. Thank you, Mr. Chairman. When the Fed decided that it was going to stimulate a global currency war as it did, did you embark on that thinking, well, our country is in trouble and let us sort of the heck with everybody else, or did you think it would leverage the wealth effect, if you will, if everybody had a race to the bottom? I know the Fed has been really purposeful in trying to create this sort of faux wealth effect. Did you think it would multiply your efforts? And speaking to that, so overall wealth effect, I know you all do calculations all the time, but could you tell us exactly what sort of the wealth effect is, the part of it that is not real, that if you were to stop doing what you are doing as it relates to monetary supply today, how much of a diminishment in national wealth would take place? Mr. BERNANKE. On the first question, we are not engaged in a currency war. We are not targeting our currency. The G7 put out a statement which was very clear that it is entirely appropriate for countries to use monetary policy to address their domestic objec- tives, in our case, employment and price stability. Our position is that our expansionary monetary policies, which are being rep- licated, of course, in other industrial countries, are increasing de- mand globally and helping not only our businesses but also the businesses in other countries that export to us. And so this is not a ‘‘beggar thy neighbor’’ policy. It is one that benefits our trading partners. Senator CORKER. But the wealth effect is something you have tried to stimulate here, and I wonder if you could tell me—— Mr. BERNANKE. Yes, that—— VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 18 Senator CORKER. ——how much wealth diminishment would take place if you were to, if you will, move away from the punch bowl. Mr. BERNANKE. Well, there would be some, but I would point out that if you look at the stock market, for example, that the so-called equity premium, the risk premium associated with stock prices, is actually quite wide. In other words, stock prices by that metric do not appear over-valued, given earnings and given interest rates. Now, if interest rates went up some, that would have some effect on stock prices. But the point here is not to create what you call a faux wealth effect. The point here is to stimulate the economy, create some for- ward momentum in growth and employment, and that, in turn, shows up in earnings and that creates a genuine increase in wealth, the same with house prices. Senator CORKER. So I think that, you know, I do not think there is any question that you would be the biggest dove, if you will, since World War II. I think that is something you are rather proud of. And we have a Federal Government that is spending more rel- ative to GDP than at any time since World War II. Those are work- ing well together in that the Fed is actually purchasing a large por- tion of the new debt issuances as we live beyond our means, and so it is working very well together in that regard. I am just wondering if you all talk at all in your meetings about the degrading effect that is having on our society and how it is ba- sically punishing people who have done the right things and throw- ing seniors under the bus and others that have saved money. Do you all ever talk about the longer-term degrading effect of these policies as we try to live for today? Mr. BERNANKE. I think one concern we have is about the effect of long-term unemployment and people who do not have jobs for years. That means they are never going to acquire skills. They are never going to be a productive part of our workforce. So the jobs part is very important. You called me a dove. Well, maybe in some respects, I am, but on the other hand, my inflation record is the best of any Federal Reserve Chairman in the postwar period, or at least one of the best, about 2 percent average inflation. So we have worked on both sides of the mandate and we are trying to achieve a stronger econ- omy for everybody. I do not think there is any degrading going on. You mentioned, in particular, the issue of savers, and I think that is an important issue. I would just point out that if we tried to raise interest rates from, say, the current 10-year yield is 2 per- cent—if we tried to raise it to three or four or 5 percent while the economy was still weak, it could not be sustained. Our economy is not weak enough to sustain high real returns to savers. If we tried to do that, we would throw our economy back into recession and we would have low interest rates like the Japanese do. The only way to get interest rates up for savers is to get a strong recovery, and the only way to get a strong recovery is to provide adequate support to the recovery. So I do not agree with that premise. Senator CORKER. Do you concern yourself at all with just the whole notion of being perceived—you know, we watch regulatory capture take place here, where basically the regulators end up VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 19 working for the people that they regulate. You know, we have TARP, which most people who voted felt like that was a needed thing during a crisis, and then we have had this easy money policy which really allowed the big institutions, especially on Wall Street, to really reap tremendous benefits in the early stages without doing anything. And then you are getting ready, I guess, in a few years, as you alluded to, when interest rates rise, to basically have to print money to sell securities at losses and then pay interest on reserves, which people have pointed out, and I think all have talked about, is going to be billions and billions of dollars going to these institutions that, again, you regulate. Do you concern your- self at all with the Fed being viewed as not as independent as it used to be and working so closely with many of these institutions that you regulate? Mr. BERNANKE. Well, we are concerned about perceptions, that is true, but none of the things you said are accurate. For example—— Senator CORKER. Well, yes, they are. Mr. BERNANKE. Well, so to take the case of paying interest on re- serves in the exit, for example, that is, number one, that is bene- ficial for the taxpayer because on the left hand side of the balance sheet is reserves, but on the right hand side is the securities that we hold, which pay a higher interest rate than the reserves. So by doing that, we actually make a profit which we remit to the Treas- ury. Senator CORKER. Well, it is really good for the institutions. Mr. BERNANKE. We are not helping the banks. We are not help- ing the banks because—— Senator CORKER. No, when you exit. When you begin to draw the money supply in, it is going to be very, very beneficial to these in- stitutions. Mr. BERNANKE. Why? Senator CORKER. Oh, they are going to be yielding huge returns on their reserves as you pay the—— Mr. BERNANKE. We will be paying market rates. We will be pay- ing exactly what they can be getting in the repo market, in the commercial paper market, anywhere else. There is no subsidy in- volved. Senator CORKER. OK. Chairman JOHNSON. Senator Menendez. Senator MENENDEZ. Thank you, Mr. Chairman. Chairman Bernanke, thanks for your testimony. You mentioned the housing market and that being important. It has always been one of the drivers of our economic recovery. And in that respect, Senator Boxer and I have reintroduced the Responsible Homeowner Refinancing Act, which would remove barriers to refinancing for borrowers with GSE mortgages and have a history of paying their mortgage on time. In the State of the Union, President Obama said too many families who have never missed a payment and want to refinance are being told no and urged the Congress to act. In that respect, could you discuss the benefit to both individuals and the national economy of enabling more families to refinance mortgages at today’s historically low interest rates? Mr. BERNANKE. Well, on the side of the borrowers, if they are able to refinance, then they will have, obviously, lower payments, VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 20 lower debt burdens, and to some extent, more income and ability to spend. I guess the question on the other side is whether there are needed subsides or other costs and how large those would be. That would be the tradeoff I would look at. But it is true from the borrower’s point of view, being able to re- finance at a lower rate is going to increase the chance that you can stay in your house and increase your income. Senator MENENDEZ. Would we not be, in essence, solidifying an entire universe of responsible, so far responsible, borrowers to be able to ensure that they can continue to be a responsible borrower, be able to avert any movement toward foreclosure and create an economic stimulus, because if I have been patching the roof on my house because I do not have the money to fully repair it and now I am paying $300 or $400 less a month, I am going to have the wherewithal to spend that money in an economy that would ulti- mately have a ripple effect? Would that not be a fair statement? Mr. BERNANKE. Well, Senator, as you know, I do not like to en- dorse specific legislative proposals. In this case—— Senator MENENDEZ. Well, forget about the proposal. Just the question in general of the possibility of refinancing at historically lower rates. Mr. BERNANKE. Again, from the borrower’s point of view, that is clearly better. They will have lower payments. They will have more income, discretionary income, a better chance of staying in their house. And I guess the question is, what implications would it have on the lenders’ side or on the fiscal side. Would there be some money coming in from the Government to offset it on the other side, would be the question I think you would have to look at. But your basic point, would it help borrowers, obviously, it would. Senator MENENDEZ. Let me ask you this. With reference—you said in your testimony—I do not know if you verbalized this, but I read it—it says, the sizes of deficits and debt matter, of course, but not all tax and spending programs are created equal with re- spect to their effects on the economy. To the greatest extent pos- sible, in their efforts to achieve sound public finances, fiscal policy makers should not lose sight of the need for Federal tax and spend- ing policies that increase incentives to work and save, encourage investments in workforce skills, advance private capital formation, promote research and development, and provide necessary and pro- ductive public infrastructure. With that view being your statement, is not sequester—which is something I did not vote for because I saw exactly where we were going to be headed—is not the way sequester takes place totally in contrary to that view? Mr. BERNANKE. I think there is a tendency, Senator, when you are thinking about the budget and the deficit, to just talk about total spending, total taxes, and I am saying, and I think it is con- sistent with your point, that it is also very important whether the tax policy is a good tax policy, whether the spending is productive spending that increases the productive capacity of our economy or achieves desirable social goals. So I hope it is not too controversial to say that I think the Congress ought to think carefully about how it taxes and spends and try and achieve the best outcomes it can. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 21 Senator MENENDEZ. Well, in sequester, you have across-the- board cuts. Mr. BERNANKE. That is right. Senator MENENDEZ. Now, if you are in the private sector and you lost revenue, either you try to make up that revenue or, if you had to make cuts in your business, you would make it in accordance with what would pose you for growth again. So it might be in the context of one company human capital. In another company, it might be technology, whatever. Mr. BERNANKE. Mm-hmm. Senator MENENDEZ. Across-the-board cuts are indiscriminate and, therefore, do not have the balance that you suggest is nec- essary. Would that be a fair statement? Mr. BERNANKE. That is fair, but the question is, will the Senate and the Congress be able to agree on how to replace the sequester with a different set of programs? If they can, obviously, if they can find a better combination, obviously, that would be better for our economy. Senator MENENDEZ. Well, it would certainly be more desirable, assuming that that agreement could be achieved, than a meat axe approach, across the board, regardless of understanding the very issues that you raise. How do you create policies that create incen- tives to work and save, encourage workforce skills, capital forma- tion, and what not. Mr. BERNANKE. I agree. Senator MENENDEZ. Thank you. Chairman JOHNSON. Senator Toomey. Senator TOOMEY. Thank you, Mr. Chairman, and thank you, Chairman Bernanke, for joining us. I would just like to follow up for a moment on the point that the Senator from New Jersey was making, because I think, if I under- stood the gist of what he was saying, we might have a lot of agree- ment on this, and that is whether we like it or not, it is certainly possible and actually looks quite likely that the sequester will at least begin. And as it is currently codified, it is without regard to any sense of what are higher and lower priorities in the different agencies that would be affected. It is hard to imagine that that is the optimal way to go about cutting spending. It is impossible for me to believe that all spend- ing is equally meritorious and that every category of spending within every agency has equal merit and equal priority. And so it seems to me that the most sensible way to go about this would be to give some flexibility to the people who are closest to these spend- ing decisions—the agency heads, the Administration, the OMB—so that they can at least make the cuts that are least disruptive. Some cuts are more disruptive than others, and it just seems that it could be less disruptive to our economy if they had a chance to do this through a thoughtful process than if it has to be done uni- formly across the board. Does that make some sense? Mr. BERNANKE. Yes, sir. Senator TOOMEY. Thank you. Another point about the sequester I just have to make—I was not going to get into this, but I just have to strongly disagree with the notion that we have some kind of severe austerity program that is about to kick in. We have a VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 22 Federal Government that has doubled in size in the last 10 years, 100 percent growth in total spending. The sequestration con- templates 2.5 percent budget authority reduction, which, as you know, about half of that would be actually spent in this fiscal year. So we are talking less than 1.3 percent of Federal spending and outlays that would be curbed. The fact is, if the sequestration fully goes into effect, in fiscal year 2013, the Federal Government will spend more money than it did in 2012. It is hard for me to understand that as draconian spending cuts and austerity. And, by the way, by my math, the ac- tual outlay is a reduction that is equal to about one-quarter of 1 percent of GDP. How that has a disastrous impact on GDP growth escapes me. And, frankly, the idea that we would somehow postpone it and promise that we will make cuts in the future, I think the credibility of those promises would be worth zero and our economy would re- spond in a very adverse way, because it would see that we have absolutely no willingness, no political ability, to begin even the slightest imposition of fiscal discipline. And so I think that has very negative implications. My specific question is for you on monetary policy, Mr. Chair- man. You talked about the fact that inflation has not manifested itself as a problem by conventional measures at this point. I take your point. To what extent are you concerned about asset bubbles? There are people who think we have bubbles in the works right now in Treasury securities and agricultural real estate, some even in the equity markets. How do you know when there is a bubble, and how concerned are you that this absolutely unprecedented monetary policy could manifest itself in inappropriate asset appre- ciation? Mr. BERNANKE. It is a concern, as I said in my remarks. We are approaching it two ways. First, we are putting a lot of effort into measuring, monitoring, assessing asset prices and financial activi- ties. Second, we are trying to make sure that, to the extent that there may be some frothiness in a particular asset class, that the holders of those assets are prepared to deal with the losses. So, for example, banks have twice as much capital today than they did a few years ago and we stress them according to different possible scenarios where asset prices move sharply and ask, would they still be able to lend and be stable. Senator TOOMEY. And I have got very little time, so I acknowl- edge that, but I think you perhaps would agree that it can be very difficult to know when a bubble is really forming and it is getting frothy as opposed to being driven by fundamentals. And the other concern that I have, as you mentioned earlier, I think, in conversation with Senator Shelby and perhaps Senator Corker, that you are confident that you have the ability to unwind the very large balance sheet that you have got. There is no ques- tion, you have the ability to unwind. What worries me is the impos- sibility of knowing the impact of the unwind. For instance, just the suggestion of maybe a little bit more dis- sent within the FOMC than people previously thought existed pre- cipitated a significant sell-off in equities a week or two ago. What VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 23 would the impact be of actually having to liquidate a big portion of your holdings on the bond market, on the equity markets? Mr. BERNANKE. We do not anticipate having to do that. We think that we can—— Senator TOOMEY. Not ever? Mr. BERNANKE. We could exit without ever selling by letting it run off, and we could tighten policy by raising interest rates that we pay on reserves. That would be one strategy, for example. In any case, we have said that we will sell slowly, with lots of notice, and we will, of course, also be offering our forward guidance about rates so that there will not be a shift in rates, expectations on the part of the market. So we are giving a lot of thought to these issues. Senator, if I could just make one very quick point, there is no risk-free approach to this situation. I mean, the risk of not doing anything is severe, as well. So we are trying to balance these things as best we can. Senator TOOMEY. Thank you, Mr. Chairman. Chairman JOHNSON. Senator Warner. Senator WARNER. Thank you, Mr. Chairman, and Chairman Bernanke, thank you for your work and your efforts to, as I think we all have some concerns, take extraordinary actions, oftentimes because, at least to date, it seems like we have failed to keep up our end of the bargain to put in place the kind of balanced, com- prehensive, phased in deficit reduction plan that you have called for and many of us have worked on for years. I would add, as well, that every one of those plans from Simpson- Bowles on had a revenue component that was substantially higher than the revenue secured on the New Year’s Eve deal. I would also acknowledge all of those had an entitlement reform component that also has not been part of the agreements to date. I do want to come back at one level on the sequestration, because I heard some of my colleagues say the hit to the economy of seques- trations, which was set up to be the stupidest option possible, such an outrageous option that rational people would never allow it to come to pass, we look at that kind of top-line number and its effect it would have on the economy, and one of the things—I know you have got great folks who do analysis—whether you have been able to kind of dig in at a kind of level below—beyond just the kind of top-line cut, the failure to have it phased in, the failure, for exam- ple, to have a balance with some revenue additions, but to actually get to the level of granularity where, in many cases, because of this across-the-board approach without any prioritization, 975 separate line items in the Navy not of equal value to the taxpayer or to our defense, where in many cases we will actually be costing the tax- payer more money by these cuts, where we will be either in one case breaking volume contract purchases on—not just on the DOD side, but on other sides, or the cases where—I had a university president here today with me where NIH grants that may have had three or 4 years’ worth of research where the last year of re- search now cannot be let and consequently all of the previous work kind of goes down the drain. Or, while we talk about the economic costs of furloughing individuals, whether you have been able to do the analysis and say what that downstream might mean when it VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 24 is meat inspectors or poultry inspectors which then might have a subsequent driving up of prices to consumers because not as much food gets into the grocery store. Has your analysis taken on the kind of, not just top line, but the kind of the extra added stupidity value that was not built into this legislation? Mr. BERNANKE. Well, I agree with a couple of previous speakers on both sides that a thoughtful approach that looked at all these issues would be better if it could be agreed upon than a just across- the-board approach. But we do not get into line items and specific programs. Senator WARNER. And I agree. Top line, the number is going to have an enormously detrimental effect, and again, why I think we need balance. But I would argue that there is a perhaps stupid and slightly less stupid way and I am, I think, only digging into some of the—literally some of the absurdities that will take place. And, actually, some of the costs that the taxpayers will incur under the guise of, quote-unquote, ‘‘cutting’’ is pretty remarkable. I want to come back to—I have a host of questions, and my time is quickly going away, as well—two other items. One, a lot of con- versation for those of us who have been wrestling with the fiscal issues on any kind of historic basis. Clearly, we are at historic spending levels, historically high spending levels. We are also at historically low, the last 50 years, at least, revenue levels. One of the things that sometimes is cited is, well, our goal ought to be a 50-year running average of what our revenue should be as a percent of GDP. I guess I just really wonder, with the demo- graphic bulge that we have, with the aging of our population, that even those of us who have been very strong proponents of major entitlement reform, do you really think that kind of a backwards- looking 50-year historic revenue target is appropriate as an econo- mist when you look at both our aging population and the kind of demographic bulge of the baby boom coming in, even with mean- ingful entitlement reform? Mr. BERNANKE. Well, the way I think about it is in terms of debt- to-GDP ratio. As I mentioned in my remarks, we had a national asset of a 40 percent debt-to-GDP ratio before the crisis and we have lost a lot of that asset. And given what is happening, you know, 10, 20, 30 years out, we should be trying to buildup over the next decade some fiscal capacity to deal with it. Senator WARNER. My time is up, but just would you say what that debt-to-GDP goal should be going forward? You have made that comment at various times—— Mr. BERNANKE. I do not think there is a magic number, but his- torically, we have not been at 75 percent at any time since just after World War II. So if we can bring it down from here some, it would be helpful, I think. Senator WARNER. Thank you, Mr. Chairman. Chairman JOHNSON. Senator Coburn. Senator COBURN. Thank you, Mr. Chairman, for being here. I ap- preciate your work. Just a comment on Senator Warner. The revenue that was passed was certainly less than what Simpson-Bowles had agreed to, but I would remind my colleague, Simpson-Bowles revenue was VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 25 used to lower tax rates to stimulate the economy, not to raise taxes and not stimulate the economy. And what is outrageous is that we have not done anything to address our long-term problems. And I know my colleague from Virginia has been very effective in work- ing across the aisle to try to accomplish that. My questions really have to do with QE. Do you think—is there a diminishing return on your efforts at quantitative easing, in terms of its effect? Mr. BERNANKE. That is a good question when we have debated. On the one hand, the first round in 2009 had some very substantial benefits in terms of market functioning. Markets were in turmoil. Our purchases helped calm markets and set the stage for recovery in financial markets. Of course, we do not have quite that situation today. On the other hand, there are some things working in the other direction. For example, credit markets are more open today. Banks are lending more today. And so in some sense, the low interest rates can pass through more easily today than they could have a couple years ago. So that is a good question. We do not know exactly which way it goes, but I think, as I said in my remarks, I think there is pretty good evidence that 3.5 percent mortgage rates are one of the rea- sons why housing looks like it is turning around, low auto rates one of the reasons why car sales are up. So whether it is bigger or less, I am not sure, but it does seem to be having some positive benefits in terms of growth. Senator COBURN. Now that we have Japan actually pretty well duplicating some of our efforts in terms of QE to fight deflation, which I agree is a proper goal for them—they have struggled with that for 20 years—do you worry at all, now that the European countries have done a quantitative easing, in effect, Japan has done it, the Bank of China has done it, we have done it, that the competitive ratio or the net competitive differences might divert away and we see this in terms of trade protectionism in terms of the international markets? Mr. BERNANKE. Well, first, Senator, you make a good point that the Fed is not at all extraordinary. In terms of balance sheets, in terms of long-term interest rates, we are very similar to a lot of other countries. As I was saying before, we do not view monetary policy aimed at domestic goals as being a currency war. It is not like putting tariffs on your imports so that you can ‘‘beggar thy neighbor’’ to the benefit of your domestic industries. That is not what we are doing. If all the major economies that need support provide stimulus and extra aggregate demand, that is mutually beneficial because, for example, China depends on the strength of Europe and the U.S. as their export market, and we, too, depend on other countries, as well, as a market for our goods. So this is, I think, a positive sum game, not a zero sum game, that we have here. Senator COBURN. But there was some concern in the last G20 meeting in terms of this target of the end being at 110 instead of 90—instead of 78, like it was 90 days ago, or maybe longer. But there is some concern that currencies can get out of balance and VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 26 that will have a significant impact on trade. Would you agree with that? Mr. BERNANKE. Well—— Senator COBURN. There was certainly discussion in the press. Mr. BERNANKE. There was certainly discussion of the issue. The emerging market economies, which are at full employment in many cases, are unhappy because low interest rates in the advanced economies give them a choice they do not like. Either they have to accept low interest rates, which they feel causes inflation or prob- lems in their own economy, or, alternatively, they have to raise— let their exchange rate appreciate, which hurts their export mar- ket. So they have had some concerns with accommodative mone- tary policy in advanced economies, in general, but I do not think Japan really raises a special case, notwithstanding the rhetoric. Of course, we have not seen what they are going to do yet. I mean, they have not even officially appointed the new Governor. But, pre- sumably, what they are going to do is monetary policy aimed at do- mestic objectives and not specifically at the exchange rate. Senator COBURN. One final, and you do not have to answer this, but if you would give me your thoughts. A recent paper, ‘‘Crunch Time: Fiscal Crises and the Role of Monetary Policy,’’ would you mind at some point in time giving me your thoughts on that? I think you have seen that. Mr. BERNANKE. I will, but I think the main thing I would say is that—and I want to be very clear—the CBO agrees that the Fed- eral Reserve’s balance sheet policies are with very high probability going to be a very significant boom to the taxpayer in terms of re- turns to the Treasury. Chairman JOHNSON. Senator Merkley. Senator MERKLEY. Thank you, Mr. Chair, and thank you for your testimony. I wanted to start with too big to jail. We had the situation with Hong Kong-Shanghai Bank Corporation, HSBC, where the United States decided not only not to investigate any individual, but not to investigate the bank as a whole, related to money laundering or related to terrorist organizations and drug organizations. It is no small thing, no small thing. Drug organizations in Northern Mexico are responsible for 40,000 deaths. Terrorist organizations, obvi- ously, are a threat to the United States. And the too big to jail echoes the fact that we still have banks that are so large that we are concerned about creating any ripples. In this case, it sends a message, as well, about future behavior. If current behavior, be it manipulation of the LIBOR rate, which have had fines associated with it but not criminal prosecutions, I do not believe, or too big to jail for money laundering, does this not kind of undermine in a way our international regulatory structure for financial institu- tions? Mr. BERNANKE. Well, I agree that no individual and no institu- tion should be exempt from paying for crimes that they commit. On this particular case, we worked very closely with the Department of Justice. We cooperated in every possible way to give them infor- mation. In the end, the company paid a $2 billion fine. If it relates to the bigger issue you are thinking of, of too big to fail, we also agree that that is something that really needs to be addressed and VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 27 that many of the parts of Dodd-Frank are intended to address that and we are pushing those as hard as we can. Senator MERKLEY. Thank you. And I think it does certainly say to us we are a long ways from getting there if we are that con- cerned about any form of shakiness in these large banks. But there is another aspect of this, too, and that it continues to tell folks that it is safer to invest, if you will, in large banks than, say, community banks. A community bank would have been shut down or at least investigated thoroughly. And in what I see in the economy in Oregon is often it is the community banks that are will- ing to lend into the local economies because they understand it bet- ter. They are more comfortable with it. They understand they may have relationships to know the competency of any individual com- panies and so forth. And is this sort of bias kind of counter- productive to our overall health of our economy? Mr. BERNANKE. Absolutely. It means the playing field is not level. It means that there is not market discipline, so there is too much risk taking. So getting rid of too big to fail is, I think, an in- credibly important objective and we are working in that direction. Senator MERKLEY. Thank you. I want to turn now to the fiscal cliff. We had a drop in GDP in the fourth quarter of last year. Do you share the view somehow that that was, in part, attributable to the December 31 fiscal cliff? Mr. BERNANKE. Only incidentally. One of the factors that hap- pened to contribute to the fourth quarter was a 22 percent annual rate drop in defense spending, and it is possible that in anticipa- tion of the sequester, for example, there may have been some changes in spending patterns. But, as I said in my remarks, I think the fourth quarter was really a combination of transitory factors. I do not think it really signaled any real change in the pace of growth of the economy. On the other hand, the pace of growth of the economy remains around 2 percent, which is positive, but it is not as strong as we would like. Senator MERKLEY. So now we are looking at the different items that you mentioned, the debt ceiling, continuing resolution, the se- quester, which does convey a feeling of lurching from crisis to cri- sis. We have heard many companies have put substantial money aside, that they have not reinvested. They have had some very profitable years. Is this style that we seem to have adopted, of being unable to get our act together and plan a year at a time, if you will, in the traditional sense, really kind of shooting ourselves in the foot? Mr. BERNANKE. I think so, Senator. We have not been able to identify with accuracy the quantitative impact of uncertainty about policy, but we certainly, around the FOMC table, hear many anec- dotes from businesses about their reluctance to expand or hire, given that they are not sure what the fiscal situation is going to be. Senator MERKLEY. Switching gears, the Volcker Rule, or Volcker firewall between hedge fund -style activities and banks that take deposits and make loans, still has not—the rulemaking has not been completed. We are well past the 2-year mark headed toward 3 years. Does this need to get done so that institutions know what the appropriate boundaries are and also so that here, we can dem- VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 28 onstrate that we actually have the ability to pass laws and the rules that go with them and operate as a competent society? Mr. BERNANKE. We would like to get it done and we have made a lot of progress on it. The issue at this point is that there really— the Volcker Rule is really three or four different rules. The CFTC, the SEC, and the banking agencies each has a Volcker Rule which applies to the institutions that they supervise and there is a strong sense that we have that we would be much better served if those rules were closely coordinated and as close to being identical as possible. So I think the issues at this point are not the work that we have done at the Federal Reserve, for example, the issues are finding agreement and closure among the different agencies who are working on the rule. Senator MERKLEY. Thank you. Chairman JOHNSON. Senator Heller. Senator HELLER. Thank you, Mr. Chairman, and Mr. Chairman, thank you for being here today. I have not had a chance to raise some questions since 2008 on the Financial Services Committee on the other side, so it is good to have you in front of me and thanks for taking time. Mr. BERNANKE. Sure. Senator HELLER. You know, we ask a lot of questions a lot of dif- ferent ways, and I am probably not going to be any different, but let us give it a shot. You know, we have not passed a budget around here in 4 years. Are you optimistic that sometime in your lifetime we may pass an- other budget around here in Washington, DC? For that matter, let me ask you another question, and you can answer them together. Do you think we will ever balance a budget, have a balanced budg- et in your lifetime? Mr. BERNANKE. Well, I would settle for stabilization of the ratio of debt-to-GDP, which is a slightly less tough level. Senator HELLER. It sounds like a ‘‘no.’’ Mr. BERNANKE. I have—you know, it is easy to criticize, but the politics is very difficult. I understand that there are a lot of very different views and strongly held views and it is not easy to come to an agreement. So I do not think Congress is not trying. I know you are trying, and I hope that you can find the agreement to see these important objectives. Senator HELLER. Well, the reason I raise the question, I think the sequestration issue that we have in front of us on Friday is a result of our lack of budgeting and effort to budget. I am from Ne- vada, so if I am putting money down, I am putting $100 down that sequestration comes and goes on Friday. Then as soon as that oc- curs, we get into our Budget Committee markups that are sup- posed to happen on March 11 through the 15th. I am putting an- other $100 down that that does not happen. Then we are supposed to bring those bills down to the floor some- time on March 18, and then March 27, Government funding ex- pires because we do not budget, and I am arguing that that day comes and goes and we have a big argument. All I am talking about is the instability that we have and how difficult does that make your job? VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 29 Mr. BERNANKE. Well, it makes my job difficult, but it also makes the economy’s job difficult. Again, as Senator Merkley mentioned, the uncertainty associated with not knowing how policy is going to be developed and what tax rates will be and what spending will be and what programs will be and which contractors will be receiving funding, et cetera, those are important concerns. Senator HELLER. And I know your policies are based on mone- tary policy and also unemployment and employment, and I have to believe that our indecisiveness and inability to get things done is causing a lot of consternation. You made a comment, and you have actually repeated this in this hearing, that you will continue—I want to go to quantitative easing, that is your purchasing of these assets—will continue until substantial improvements in the outlook of the labor market in the context of price stability. Will you explain to me a little bit more in depth what that means? Mr. BERNANKE. Well, sure. We are going to be looking at a vari- ety of variables. We will be looking at payroll employment, is it strengthening, is it sustainably strengthening? Is the unemploy- ment rate coming down? So those are indications—— Senator HELLER. Do you have a target? Mr. BERNANKE. We do not have a specific target. We have given thresholds for our rate policy. We have not extended those to our asset purchases, and there are a couple of reasons. One is, as you mentioned, there are a lot of other things happening in our econ- omy, like the fiscal issues that you referred to. But in addition, we are paying very close attention, as a number of you have men- tioned, to the efficacy and cost of these policies and that makes it very difficult to say this is the number we are going to achieve. So we are doing our best to communicate the criteria for action, but we have not been able to come to a specific number which en- capsulates both the change in outlook for the labor market and the assessment of costs and efficacy, which is another part of the deci- sion process. Senator HELLER. Do you believe that your asset purchases are causing any kind of an equity bubble? Mr. BERNANKE. I do not see much evidence of an equity bubble. Earnings are very high. As I said, the equity risk premium is above normal. That is, in other words, equity holders are still being some- what risk averse in their behavior. But again, we have a two-part plan. First is to monitor these dif- ferent asset markets. The second is to try to understand what would be the implications if we are wrong. What would happen? Who would be hurt? What would happen to financial institutions? Would there be broad knock-on effects if, in fact, some particular asset turned out to be in a bubble? So we are trying to do both of those things and we do not rule out that if these problems become sufficiently worrisome, that they would be taken into account in our monetary policy. Senator HELLER. Mr. Chairman, thank you. Mr. Chairman, thank you. Chairman JOHNSON. Senator Warren. Senator WARREN. Thank you, Mr. Chairman, and I also want to say thank you, Mr. Chairman. This has been my first chance to say VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 30 in public how grateful I am for your help in setting up the con- sumer agency and how helpful all the people were at the Fed dur- ing the time of transition of the consumer function, so thank you very much. I would like to go to the question about too big to fail, that we have not gotten rid of it yet, and so now we have a double problem and that is that the big banks, big at the time that they were bailed out the first time, have gotten bigger, and at the same time that investors believe with too big to fail out there that it is safer to put your money into the big banks and not the little banks, in effect creating an insurance policy for the big banks, that the Gov- ernment is creating this insurance policy not there for the small banks. And now some economists, including an economist at the IMF, have started to document exactly how much that subsidy is worth. Last week, Bloomberg did the math on it and came up with the number $83 billion that the big banks get in what is essentially a free insurance policy. They borrow cheaper than the small banks do. So I understand that we are all trying to get to the end of too big to fail, but my question, Mr. Chairman, is, until we do, should those biggest financial institutions be repaying the American tax- payer that $83 billion subsidy that they are getting? Mr. BERNANKE. Well, the subsidy is coming because of market expectations that the Government would bail out these firms if they failed. Those expectations are incorrect. We have an orderly liquidation authority. And even in the crisis, in the cases of AIG, for example, we wiped out the shareholders—— Senator WARREN. Excuse me, Mr. Chairman. You did not wipe out the shareholders of the largest financial institutions, did you, the big banks? Mr. BERNANKE. Because we did not have the tools. Now, we could. Senator WARREN. Well, but the—— Mr. BERNANKE. Now we have the tools. Senator WARNER. Eighty-three billion dollars says that whatever you are saying, Mr. Chairman, $83 billion says that there really will be a bailout for the largest financial institutions if they fail. Mr. BERNANKE. No, that is the expectation of markets, but that does not mean that we have to do it. I think what we have to do is solve the problem, Senator. I think we are really in agreement on this. Too big to fail is not absolute. There are spreads. The cred- it default swaps say there is some probability of failure. Moody’s and others have downgraded these firms. They have taken down some of their Government support ratings, as you know. But we have a lot more to do, I agree, and I think that is a good debate to have, but we are in complete agreement that we need to stop too big to fail. Senator WARREN. But I do not understand. It is working like an insurance policy. Ordinary folks pay for homeowners’ insurance. Ordinary folks pay for car insurance. And these big financial insti- tutions are getting cheaper borrowing to the tune of $83 billion in a single year simply because people believe that the Government VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 31 would step in and bail them out. And I am just saying, if they are getting it, why should they not pay for it? Mr. BERNANKE. I think we should get rid of it. Senator WARREN. Well, all right, then I will ask the other ques- tion. You were here in July and you said that you were—you com- mended Dodd-Frank for providing a blueprint to get rid of too big to fail. We have now understood this problem for nearly 5 years. So when are we going to get rid of too big to fail? Mr. BERNANKE. Well, as we have been discussing, some of these rules take time to develop. The orderly liquidation authority, I think we made a lot of progress on that. We have got the living wills. I think we are moving in the right direction. If additional steps are needed, then Congress obviously can discuss those. But we do have a plan and I think it is moving in the right direction. Senator WARREN. Any idea about when we are going to arrive in the right direction? Mr. BERNANKE. It is not a zero, one kind of thing. It is over time you will see increasing market expectations that these institutions can fail. And I would make another prediction, and predictions are always dangerous, that the benefits of being large are going to de- cline over time, which means that some banks are going to volun- tarily begin to reduce their size because they are not getting the benefit that they used to get. Senator WARREN. I read you on this. I read your predictions on this in your earlier testimony. But so far, it looks like they are get- ting $83 billion for staying big. Mr. BERNANKE. Well, that is one study, Senator. You do not know whether that is an accurate number or—— Senator WARREN. Well, OK. We will go back and look at it again if you think there is a problem with it. But does it worry you? Mr. BERNANKE. Of course. I think this is very important, and we are putting a lot of effort into this. It is a problem that we have had for a very long time and I do not think we can solve it imme- diately, but I assure that, as somebody who has spent a lot of late nights trying to deal with these problems and the crisis, I would very much like to have the confidence that we could close down a large institution without causing damage to the rest of the econ- omy. Senator WARREN. Fair enough. I know we are both trying to go in the same direction. I am just pointing out that in all that space in between, what is happening is the big banks are getting a ter- rific break and the little banks are just getting smashed on this. They are not getting that kind of break, and that has long-term im- pact for all of the financial system. Mr. BERNANKE. I agree with you 100 percent. Senator WARREN. Thank you. Chairman JOHNSON. Senator Vitter. Senator VITTER. Thank you, Mr. Chairman, and thank you, Mr. Chairman, for being here. My top concern is actually exactly the same as Ms. Warren’s, and I think that is a statement in and of itself that there is growing bipartisan concern across the whole political spectrum about the fact—I believe it is a fact—that too big to fail is alive and well. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 32 First of all, in terms of the study, Ms. Warren cited the Bloomberg calculations, but that is clearly not the only thing out there. There is an FDIC study released in September that con- cludes that, quote, ‘‘The largest banks do, in fact, pay less for com- parable deposits. Furthermore, we show that some of the difference in the cost of funding cannot be attributed to either differences in balance sheet risk or any non- risk-related factors. The remaining unexplained risk premium gap is on the order of 45 basis points. Such a gap is consistent with an economically significant too big to fail subsidy paid to the largest banks,’’ close quote. In addition, an IMF working paper has attempted to quantify this subsidy and it said the subsidy, quote, ‘‘was already sizable, 60 basis points, as of the end of 2007, before the crisis. It increased to 80 basis points by the end of 2009,’’ close quote. Then we have the Bloomberg quantification which was working off that IMF work that was mentioned, and also a Board member, Daniel Tarullo, who says, quote, ‘‘To the extent that a growing sys- temic footprint increases perceptions of at least some residual too big to fail quality in such a firm, notwithstanding the panoply of measures in Dodd-Frank and our regulations, there may be fund- ing advantages for the firm which reinforces the impulse to grow,’’ close quote. So my first point is it is not just one outlier study. Given all of that, what specifically is in process in terms of regulations or should be put in process to counteract that, because my concern is even if this problem is solved 2 years from now, the entire land- scape of American banking will be different by then, including a lot of solid smaller firms gone, and I think that is a real loss to our financial system. Mr. BERNANKE. There is a three-part plan under Dodd-Frank. Part number one is to impose costs on large institutions that offset the benefits they get in the funding markets, for example, capital surcharges, activity restrictions, liquidity requirements, living wills, a whole bunch of other things that impose greater cost and force the largest firms to take into account their systemic footprint. That is number one. Number two is the orderly liquidation authority, which we are working closely with the FDIC and with our foreign counterparts to figure out how we would take down a large institution without bringing down the system. And part three is a whole raft of measures to try to strengthen the overall financial system so that it would be more credible that we could take down a large institution without bringing down the system. That is sort of the three-part plan. It is working to some extent. For example, even though U.S. banks are stronger financially than European banks. Frequently, U.S. banks have wider credit default swap spreads, indicating a higher probability of actual failure, be- cause the differences between U.S. and Europe in terms of Govern- ment—perceived Government support. So that is the process. That is the plan. There have been additional ideas, such as, essentially reinstating Glass-Steagall, separating the commercial banking and investment banking activities. We are doing that to some extent, for example, VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 33 with the Volcker Rule, but I do not think that Glass-Steagall by itself really would be all that helpful because, after all, in the cri- sis, some of the firms that failed were straight investment banks and some of the firms that were in trouble were straight commer- cial banks. So I am open to discussing additional measures, but the plan is to impose costs on the largest banks to make them internalize their systemic imprint, to develop a liquidation authority, and to strengthen the overall system. And over time, that ought to im- prove the situation, but if it does not, I think we ought to consider alternative and additional steps. Senator VITTER. Well, in closing, I would really continue to en- courage you all doing that now. And again, I think this is a bipar- tisan concern. I have expressed this concern and several ideas, for instance, with Senator Brown on the Committee. The three components you described are understood by the mar- ket. In my opinion, they have been digested and valued by the mar- ket and the market still says there is too big to fail. In particular, I would continue to urge you to revisit higher capital requirements beyond the marginally higher requirements that you have insti- tuted so far for megabanks and I would continue to urge you all to think of alternatives to Basel III, as well, in the same spirit. Thank you. Mr. BERNANKE. Thank you, Senator. Chairman JOHNSON. Senator Manchin. Senator MANCHIN. Mr. Chairman, thank you. Chairman Bernanke, thank you for being here. First of all, when I first came to the Senate 21⁄ 2 years ago, I was in the Armed Services Committee and Admiral Mullins at that time was asked, what is the greatest threat the United States faces, and I thought I would hear some military challenge. And he did not even hesitate by saying that the debt of this Nation is our greatest threat, and I did not know if you shared that same thought. Mr. BERNANKE. It is certainly an important economic risk and I think it is very important that, over the longer term, that we de- velop a sustainable fiscal plan, no question about it. Senator MANCHIN. I mean, his assessment was it was the great- est threat we faced. Mr. BERNANKE. I do not know. There are many possible can- didates for that. Senator MANCHIN. Also, I know they talked a lot about seques- tering today, and we were talking back and forth the consequences if we do and if we do not. The bottom line, sequestering came into being because in 2011, the summer of 2011, we thought we put a supercommittee together that had a goal of $1.5 trillion. If they did not reach that goal, they had a minimum penalty of $1.2 trillion across the board in defense and nondefense. We voted on that as a body. Now, we are looking for every way to get out of that, saying it was too draconian. We should never have done it. But we did it. And what we were saying is if we do not do it at all and negate that responsibility and promise of a vote that we made for the public, what effect would that have on the market? I know I have heard everything about the effects that it would VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 34 have if we do it. What effects would it have on the market if we do not do it? Mr. BERNANKE. Well, my recommendation, and, of course, I can only recommend to you—— Senator MANCHIN. Sure. I agree. Mr. BERNANKE. ——it is obviously Congress’s decision how to proceed—is a two-part recommendation. Look at both the short run and the long run. I think it is true that just canceling the sequester would not solve the overall problem—— Senator MANCHIN. No—— Mr. BERNANKE. ——which is the long-term fiscal issue. So if you cut the sequester or delay it, however you modify it—— Senator MANCHIN. Right. Mr. BERNANKE. ——you ought to compensate for that with, in my recommendation, by looking at measures that address the longer- term fiscal concerns, which is what the CBO shows to be the point where the debt really begins to explode. And that is the trade-off I would suggest. Senator MANCHIN. It would be irresponsible for us not to do something. We have two alternatives, two paths to take here. Ei- ther fix the financial problems in a longer-term, bigger fix, or do something with sequestering that we punished ourself basically be- cause we have been unable as a body to come together. So I think that was also said. If we are going to do a sequestering, should it not be done in a more or smarter way to where there is more flexi- bility? Mr. BERNANKE. Well, as you point out, it was done to be sort of like Dr. Strangelove—— Senator MANCHIN. Right. Right. Mr. BERNANKE. ——you know, the bomb that goes off. So obvi- ously, if you can find a way to, in a bipartisan way, to make it more effective and better prioritized, that would be a good thing. Senator MANCHIN. OK. Mr. BERNANKE. And people disagree on the second point, but again, what I suggested today is trying to make some tradeoff be- tween the effects on the near-term recovery and aligning the policy with the timing. The timing says that you have made progress in the very near term as far as the budget is concerned. Where the problem still remains unaddressed is in the longer term. And so it does not quite match to be doing tough policies today when the real problem is a somewhat longer-term problem. Senator MANCHIN. Sure. Mr. BERNANKE. That is what I am trying to suggest. Senator MANCHIN. Well, I am just saying that there are a lot of us concerned about we keep kicking the can down the road, but that is a whole another conversation. My final question would be, sir, how big is our national debt? Mr. BERNANKE. Well, there are a lot of different measures of it. The—— Senator MANCHIN. What would be your explanation of it? Mr. BERNANKE. Well, the basic measure, which is the debt held by the public, which includes the debt held by the Fed, it is about $11 trillion—— Senator MANCHIN. Right. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 35 Mr. BERNANKE. ——about 75 or 73 percent of GDP. Senator MANCHIN. Correct. Mr. BERNANKE. That does not include, though, for example, so- called unfunded liabilities, such as the promises that have been made to future Medicare recipients, for example—— Senator MANCHIN. Well, the average person would understand that they have a responsibility and their ability to pay back in good faith. So how much of what is our total national debt that is re- sponsible by the good faith of this country and the people in this country? Mr. BERNANKE. It is currently about $11 trillion. Senator MANCHIN. OK, but if you had everything when you—our gross Federal debt? Mr. BERNANKE. Gross Federal debt includes debt owed by parts of the Government to other parts of the Government, like the So- cial Security Trust Fund, for example—— Senator MANCHIN. Responsibilities of Fannie and Freddie? Mr. BERNANKE. So that is another element. That is guarantees. That is not direct debt. That is a potential liability. So it is com- plicated. Senator MANCHIN. Yes. Mr. BERNANKE. As I said at the beginning, it is hard to—— Senator MANCHIN. If you looked at all of the—— Mr. BERNANKE. ——get a single number. Senator MANCHIN. ——the worst case scenario, the faith and full credit of this country, what would you say it would be? Mr. BERNANKE. Well, I saw the article I think you are referring to and it included the possibility that—— Senator MANCHIN. Is it accurate? Mr. BERNANKE. It included the possibility that the Government would have to pay off every deposit in the United States through the FDIC—— Senator MANCHIN. Yes. Mr. BERNANKE. ——which is not a realistic possibility. There are some alternative measures which are certainly bigger than $11 tril- lion—— Senator MANCHIN. I think they were saying—— Mr. BERNANKE. ——but I do not have those numbers—— Senator MANCHIN. They said as much as $30 trillion it could be, total exposure. Mr. BERNANKE. If you include all of the Medicare and—— Senator MANCHIN. But it is definitely higher than $16 trillion. Mr. BERNANKE. Yes, I would say that is fair. Senator MANCHIN. Thank you. Chairman JOHNSON. There is a vote pending, but does the Sen- ator from Tennessee care to make a brief—— Senator CORKER. Just one very quick question, and I was inter- ested—I went back to the office and did not expect to come back, but listening to the exchange with Senator Warren and Senator Vitter, it reminded me of—the questioning was Tarullo, who was in last, who you served with on the Fed Board, and just—he had mentioned—I asked him about systemic risk, and I know that the Fed is obviously a member of the FSOC and your goal is to identify systemic risk and deal with that. And that was much like the an- VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 36 swer that you gave to Senator Warren a minute ago. It is kind of, we are on this journey. But I would ask the question. Is there any entity in our country that if it failed would create systemic risk, and if so, why is that still the case after the creation of Dodd-Frank? I mean, why have we not moved more quickly? Why are we taking so long on this journey? And is there an institution that if it failed would pose sys- temic risk to our country? And if so, would you identify it? Mr. BERNANKE. The only answer I can give you is that Dodd- Frank is a complicated bill. Many of the rules are not—— Senator CORKER. But that piece of it is not very complicated. It is only about eight words, and so that is not complicated. It is a directive to you, and you are a big part of this and you came out a big winner in Dodd-Frank. And I guess I would just ask the ques- tion, why would you not go ahead and identify that, and if there is an entity that is in our Nation, if it failed, something that poses systemic risk, you would know that. Why do we not go ahead and move to deal with that? Mr. BERNANKE. Well, the FSOC actually has the authority to designate nonbank firms that it views as systemic and they come under the oversight of the Fed. Senator CORKER. Well, let me ask you, if we have firms, though, are we going to—is it your thought that under this power that you have been given, is it your thought that we could continue to have firms operating in our country that if they failed, they would pose systemic risk, or are we going to try to mitigate that in some other way? I would just be curious. Mr. BERNANKE. The goal of the powers that you gave to the Fed and other agencies is to, as much as possible, eliminate that prob- lem over time. Additional steps, I think, would require Congres- sional action beyond what we have implemented. Senator CORKER. I do not think so. I am going to follow up with a letter. I thank you for your testimony—— Mr. BERNANKE. Sure. Senator CORKER. And I do not think that is the case. Chairman JOHNSON. Thank you again, Chairman Bernanke, for your testimony and for being here with us today. This hearing is adjourned. [Whereupon, at 12:10 p.m., the hearing was adjourned.] [Prepared statements, responses to written questions, and addi- tional material supplied for the record follow:] VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 37 PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON The Committee will come to order. Today’s hearing is with Chairman Bernanke on the Federal Reserve’s Monetary Policy Report to Congress. While progress toward maximum employment has been slow, it has been positive and steady thanks in part to the Fed’s thoughtful and well-measured monetary actions. Our economy has added private sector jobs for 35 straight months. During that time, over 6 million new jobs have been created, but we should not sacrifice those gains by slamming on the brakes now. Without a fix, automatic spending cuts will take effect in just a few days, and could send our economy into reverse at a time we should continue moving forward on creating jobs. Projections suggest the sequester will cost us 750,000 jobs this year. In addition to layoffs for cops, fire fighters, and teachers that could devastate our communities, these cuts will impact many of our Nation’s most vulnerable citi- zens including children, seniors, and the disabled. At a time when the U.S. faces an array of national security threats, the sequester will affect our military readi- ness. It is unacceptable that we are lurching from one manufactured crisis to the next, and Americans have had enough. These fights are bad for the economy and are making it harder for families to make ends meet. The steep drops in consumer confidence during the fights over the debt limit and the fiscal cliff rival the fallout after Lehman Brothers’ failure and 9/11. This has consequences. If consumers do not spend, businesses will not prosper and hire more workers. If businesses are not hiring, our economy will not grow. It is that simple. We must do all we can to restore confidence in not only our financial system, but also in our ability as a country to tackle long-term challenges in a responsible, bi- partisan manner. In addition to Congress acting on a deficit reduction plan that is balanced and promotes job creation, there are things this Committee can do to help achieve these goals. From rigorous oversight, to confirming well-qualified nominees, to reauthorizing expiring laws, to reaching consensus on the future of housing fi- nance, there are steps this Committee can take to promote consumer confidence, provide businesses clarity to move forward with long-term plans, and strengthen our economic recovery. Chairman Bernanke, I look forward to hearing your views as both the Fed and the Congress pursue policies supporting our Nation’s economic recovery. PREPARED STATEMENT OF BEN S. BERNANKE CHAIRMAN, BOARDOFGOVERNORSOFTHEFEDERALRESERVESYSTEM FEBRUARY26, 2013 Chairman Johnson, Ranking Member Crapo, and other Members of the Com- mittee, I am pleased to present the Federal Reserve’s Semiannual Monetary Policy Report. I will begin with a short summary of current economic conditions and then discuss aspects of monetary and fiscal policy. Current Economic Conditions Since I last reported to this Committee in mid-2012, economic activity in the United States has continued to expand at a moderate if somewhat uneven pace. In particular, real gross domestic product (GDP) is estimated to have risen at an an- nual rate of about 3 percent in the third quarter but to have been essentially flat in the fourth quarter.1 The pause in real GDP growth last quarter does not appear to reflect a stalling-out of the recovery. Rather, economic activity was temporarily restrained by weather-related disruptions and by transitory declines in a few vola- tile categories of spending, even as demand by U.S. households and businesses con- tinued to expand. Available information suggests that economic growth has picked up again this year. Consistent with the moderate pace of economic growth, conditions in the labor market have been improving gradually. Since July, nonfarm payroll employment has increased by 175,000 jobs per month on average, and the unemployment rate declined 0.3 percentage point to 7.9 percent over the same period. Cumulatively, pri- vate-sector payrolls have now grown by about 6.1 million jobs since their low point in early 2010, and the unemployment rate has fallen a bit more than 2 percentage points since its cyclical peak in late 2009. Despite these gains, however, the job mar- ket remains generally weak, with the unemployment rate well above its longer-run 1Data for the fourth quarter of 2012 from the national income and product accounts reflect the advance estimate released on January 30, 2013. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00041 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 38 normal level. About 4.7 million of the unemployed have been without a job for 6 months or more, and millions more would like full-time employment but are able to find only part-time work. High unemployment has substantial costs, including not only the hardship faced by the unemployed and their families, but also the harm done to the vitality and productive potential of our economy as a whole. Lengthy periods of unemployment and underemployment can erode workers’ skills and at- tachment to the labor force or prevent young people from gaining skills and experi- ence in the first place—developments that could significantly reduce their produc- tivity and earnings in the longer term. The loss of output and earnings associated with high unemployment also reduces Government revenues and increases spend- ing, thereby leading to larger deficits and higher levels of debt. The recent increase in gasoline prices, which reflects both higher crude oil prices and wider refining margins, is hitting family budgets. However, overall inflation re- mains low. Over the second half of 2012, the price index for personal consumption expenditures rose at an annual rate of 11⁄2 percent, similar to the rate of increase in the first half of the year. Measures of longer-term inflation expectations have re- mained in the narrow ranges seen over the past several years. Against this back- drop, the Federal Open Market Committee (FOMC) anticipates that inflation over the medium term likely will run at or below its 2 percent objective. Monetary Policy With unemployment well above normal levels and inflation subdued, progress to- ward the Federal Reserve’s mandated objectives of maximum employment and price stability has required a highly accommodative monetary policy. Under normal cir- cumstances, policy accommodation would be provided through reductions in the FOMC’s target for the Federal funds rate—the interest rate on overnight loans be- tween banks. However, as this rate has been close to zero since December 2008, the Federal Reserve has had to use alternative policy tools. These alternative tools have fallen into two categories. The first is ‘‘forward guid- ance’’ regarding the FOMC’s anticipated path for the Federal funds rate. Since longer-term interest rates reflect market expectations for shorter-term rates over time, our guidance influences longer-term rates and thus supports a stronger recov- ery. The formulation of this guidance has evolved over time. Between August 2011 and December 2012, the Committee used calendar dates to indicate how long it ex- pected economic conditions to warrant exceptionally low levels for the Federal funds rate. At its December 2012 meeting, the FOMC agreed to shift to providing more explicit guidance on how it expects the policy rate to respond to economic develop- ments. Specifically, the December postmeeting statement indicated that the current exceptionally low range for the Federal funds rate ‘‘will be appropriate at least as long as the unemployment rate remains above 61⁄2 percent, inflation between 1 and 2 years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations con- tinue to be well anchored.’’2 An advantage of the new formulation, relative to the previous date-based guidance, is that it allows market participants and the public to update their monetary policy expectations more accurately in response to new in- formation about the economic outlook. The new guidance also serves to underscore the Committee’s intention to maintain accommodation as long as needed to promote a stronger economic recovery with stable prices.3 The second type of nontraditional policy tool employed by the FOMC is large-scale purchases of longer-term securities, which, like our forward guidance, are intended to support economic growth by putting downward pressure on longer-term interest rates. The Federal Reserve has engaged in several rounds of such purchases since late 2008. Last September the FOMC announced that it would purchase agency mortgage-backed securities at a pace of $40 billion per month, and in December the Committee stated that, in addition, beginning in January it would purchase longer- 2See, Board of Governors of the Federal Reserve System (2012), ‘‘Federal Reserve Issues FOMC Statement’’, press release, December 12, www.federalreserve.gov/newsevents/press/mon- etary/20121212a.htm. 3The numerical values for unemployment and inflation included in the guidance are thresh- olds, not triggers; that is, depending on economic circumstances at the time, the Committee may judge that it is not appropriate to begin raising its target for the Federal funds rate as soon as one or both of the thresholds is reached. The 61⁄2 percent threshold for the unemployment rate should not be interpreted as the Committee’s longer-term objective for unemployment; be- cause monetary policy affects the economy with a lag, the first increase in the target for the funds rate will likely have to occur when the unemployment rate is still above its longer-run normal level. Likewise, the Committee has not altered its longer-run goal for inflation of 2 per- cent, and it neither seeks nor expects a persistent increase in inflation above that target. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00042 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 39 term Treasury securities at an initial pace of $45 billion per month.4 These addi- tional purchases of longer-term Treasury securities replace the purchases we were conducting under our now-completed maturity extension program, which lengthened the maturity of our securities portfolio without increasing its size. The FOMC has indicated that it will continue purchases until it observes a substantial improve- ment in the outlook for the labor market in a context of price stability. The Committee also stated that in determining the size, pace, and composition of its asset purchases, it will take appropriate account of their likely efficacy and costs. In other words, as with all of its policy decisions, the Committee continues to assess its program of asset purchases within a cost-benefit framework. In the current eco- nomic environment, the benefits of asset purchases, and of policy accommodation more generally, are clear: Monetary policy is providing important support to the re- covery while keeping inflation close to the FOMC’s 2 percent objective. Notably, keeping longer-term interest rates low has helped spark recovery in the housing market and led to increased sales and production of automobiles and other durable goods. By raising employment and household wealth—for example, through higher home prices—these developments have in turn supported consumer sentiment and spending. Highly accommodative monetary policy also has several potential costs and risks, which the Committee is monitoring closely. For example, if further expansion of the Federal Reserve’s balance sheet were to undermine public confidence in our ability to exit smoothly from our accommodative policies at the appropriate time, inflation expectations could rise, putting the FOMC’s price-stability objective at risk. How- ever, the Committee remains confident that it has the tools necessary to tighten monetary policy when the time comes to do so. As I noted, inflation is currently sub- dued, and inflation expectations appear well anchored; neither the FOMC nor pri- vate forecasters are projecting the development of significant inflation pressures. Another potential cost that the Committee takes very seriously is the possibility that very low interest rates, if maintained for a considerable time, could impair fi- nancial stability. For example, portfolio managers dissatisfied with low returns may ‘‘reach for yield’’ by taking on more credit risk, duration risk, or leverage. On the other hand, some risk-taking—such as when an entrepreneur takes out a loan to start a new business or an existing firm expands capacity—is a necessary element of a healthy economic recovery. Moreover, although accommodative monetary poli- cies may increase certain types of risk-taking, in the present circumstances they also serve in some ways to reduce risk in the system, most importantly by strength- ening the overall economy, but also by encouraging firms to rely more on longer- term funding, and by reducing debt service costs for households and businesses. In any case, the Federal Reserve is responding actively to financial stability concerns through substantially expanded monitoring of emerging risks in the financial sys- tem, an approach to the supervision of financial firms that takes a more systemic perspective, and the ongoing implementation of reforms to make the financial sys- tem more transparent and resilient. Although a long period of low rates could en- courage excessive risk-taking, and continued close attention to such developments is certainly warranted, to this point we do not see the potential costs of the in- creased risk-taking in some financial markets as outweighing the benefits of pro- moting a stronger economic recovery and more-rapid job creation.5 Another aspect of the Federal Reserve’s policies that has been discussed is their implications for the Federal budget. The Federal Reserve earns substantial interest on the assets it holds in its portfolio, and, other than the amount needed to fund our cost of operations, all net income is remitted to the Treasury. With the expan- sion of the Federal Reserve’s balance sheet, yearly remittances have roughly tripled in recent years, with payments to the Treasury totaling approximately $290 billion between 2009 and 2012.6 However, if the economy continues to strengthen, as we anticipate, and policy accommodation is accordingly reduced, these remittances would likely decline in coming years. Federal Reserve analysis shows that remit- tances to the Treasury could be quite low for a time in some scenarios, particularly 4See, Board of Governors of the Federal Reserve System (2012), ‘‘Federal Reserve Issues FOMC Statement’’, press release, September 13, www.federalreserve.gov/newsevents/press/mon- etary/20120913a.htm; and Board of Governors, ‘‘FOMC Statement’’, December 12, in n. 2. 5The Federal Reserve is also monitoring financial markets to ensure that asset purchases do not impair their functioning. 6See, Board of Governors of the Federal Reserve System (2013), ‘‘Reserve Bank Income and Expense Data and Transfers to the Treasury for 2012’’, press release, January 10, www.federalreserve.gov/newsevents/press/other/20130110a.htm. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00043 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 40 if interest rates were to rise quickly.7 However, even in such scenarios, it is highly likely that average annual remittances over the period affected by the Federal Re- serve’s purchases will remain higher than the precrisis norm, perhaps substantially so. Moreover, to the extent that monetary policy promotes growth and job creation, the resulting reduction in the Federal deficit would dwarf any variation in the Fed- eral Reserve’s remittances to the Treasury. Thoughts on Fiscal Policy Although monetary policy is working to promote a more robust recovery, it cannot carry the entire burden of ensuring a speedier return to economic health. The econo- my’s performance both over the near term and in the longer run will depend impor- tantly on the course of fiscal policy. The challenge for the Congress and the Admin- istration is to put the Federal budget on a sustainable long-run path that promotes economic growth and stability without unnecessarily impeding the current recovery. Significant progress has been made recently toward reducing the Federal budget deficit over the next few years. The projections released earlier this month by the Congressional Budget Office (CBO) indicate that, under current law, the Federal deficit will narrow from 7 percent of GDP last year to 21⁄2 percent in fiscal year 2015.8 As a result, the Federal debt held by the public (including that held by the Federal Reserve) is projected to remain roughly 75 percent of GDP through much of the current decade. However, a substantial portion of the recent progress in lowering the deficit has been concentrated in near-term budget changes, which, taken together, could create a significant headwind for the economic recovery. The CBO estimates that deficit- reduction policies in current law will slow the pace of real GDP growth by about 11⁄2 percentage points this year, relative to what it would have been otherwise. A significant portion of this effect is related to the automatic spending sequestration that is scheduled to begin on March 1, which, according to the CBO’s estimates, will contribute about 0.6 percentage point to the fiscal drag on economic growth this year. Given the still-moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant. Moreover, besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduc- tion in the short run for any given set of fiscal actions. At the same time, and despite progress in reducing near-term budget deficits, the difficult process of addressing longer-term fiscal imbalances has only begun. Indeed, the CBO projects that the Federal deficit and debt as a percentage of GDP will begin rising again in the latter part of this decade, reflecting in large part the aging of the population and fast-rising health care costs. To promote economic growth in the longer term, and to preserve economic and financial stability, fiscal policy mak- ers will have to put the Federal budget on a sustainable long-run path that first stabilizes the ratio of Federal debt to GDP and, given the current elevated level of debt, eventually places that ratio on a downward trajectory. Between 1960 and the onset of the financial crisis, Federal debt averaged less than 40 percent of GDP. This relatively low level of debt provided the Nation much-needed flexibility to meet the economic challenges of the past few years. Replenishing this fiscal capacity will give future Congresses and Administrations greater scope to deal with unforeseen events. To address both the near- and longer-term issues, the Congress and the Adminis- tration should consider replacing the sharp, frontloaded spending cuts required by the sequestration with policies that reduce the Federal deficit more gradually in the near term but more substantially in the longer run. Such an approach could lessen the near-term fiscal headwinds facing the recovery while more effectively addressing the longer-term imbalances in the Federal budget. The sizes of deficits and debt matter, of course, but not all tax and spending pro- grams are created equal with respect to their effects on the economy. To the great- est extent possible, in their efforts to achieve sound public finances, fiscal policy makers should not lose sight of the need for Federal tax and spending policies that increase incentives to work and save, encourage investments in workforce skills, ad- vance private capital formation, promote research and development, and provide necessary and productive public infrastructure. Although economic growth alone cannot eliminate Federal budget imbalances, in either the short or longer term, a more rapidly expanding economic pie will ease the difficult choices we face. 7See, Carpenter, Seth B., Jane E. Ihrig, Elizabeth C. Klee, Daniel W. Quinn, and Alexander H. Boote (2013), ‘‘The Federal Reserve’s Balance Sheet and Earnings: A Primer and Projections’’, Finance and Economics Discussion Series 2013-01 (Washington: Federal Reserve Board, Janu- ary), available at http://www.federalreserve.gov/pubs/feds/2013/201301/201301pap.pdf. 8See, Congressional Budget Office (2013), ‘‘The Budget and Economic Outlook: Fiscal Years 2013 to 2023’’ (Washington: CBO, February), available at www.cbo.gov/publication/43907. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00044 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 41 RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN FROM BEN S. BERNANKE Q.1. The United Kingdom has had a Financial Transactions Tax (FTT), in the form of stamp duty on stock purchases, for more than 300 years. It does not seem to have hindered London’s financial de- velopment. And now 11 European countries are about to impose a new FTT of 10 basis points on trading. They say it will discourage certain kinds of quick in-and-out transactions that benefit traders but not investors—and pull in about $41B in revenue. Today, there is widespread belief in this country that a lot of trading activity is unproductive, and we also have a serious deficit problem. My col- league Senator Tom Harkin has a bill for a FTT that would be 3 basis points and that the Joint Tax Committee has scored at $350 billion in revenue. Do you think that this tax would succeed at raising revenue while making our stock markets less about flash trading and more about real value investing? A.1. Existing studies present mixed evidence on the net effect of FTTs on revenues. A 2011 European Commission working paper presents evidence that, despite a relatively low tax rate, the U.K. stamp duty has generated substantial revenue over the last decade. However, a different academic study found that when Sweden im- plemented an FTT in the 1980s, the country experienced a net loss in revenue as investors, in an effort to avoid the tax, moved trades offshore. While an FTT likely would discourage high frequency trading in financial markets that are subject to the tax, studies of the effect of FTTs on asset market price volatility show mixed results. One study by staff at the International Monetary Fund found that FTTs are associated with an increase in volatility, possibly resulting from lower trading volume and reduced liquidity caused by FTTs. An- other study of the U.K. stamp tax found no significant effect of the tax on the volatility of U.K. equity prices, though intermediaries like broker-dealers are exempt from the U.K. stamp duty (but would not be under the European FTT). A study by Federal Re- serve staff of the 2010 U.S. ‘‘flash crash,’’ a day in which U.S. eq- uity markets exhibited extremely high volatility, found that al- though high frequency trading did not cause or prevent the ‘‘flash crash,’’ it did exacerbate volatility on that day.1 Further considerations of the FTT may include its impact on market efficiency, security valuation, and the cost of capital for cor- porations. Some academic studies have suggested that if FTTs re- sult in reduced trading volume and diminished market liquidity, then they may hamper the price discovery process in financial mar- kets, so that asset prices are less able to quickly reflect changes in economic and financial market conditions. Other studies have found that the implementation of FTTs is associated with lower eq- uity prices, and thus higher costs of capital for domestic firms, which may discourage investment. 1Kirilenko, Andrei A., Kyle, Albert S., Samadi, Mehrdad, and Tuzun, Tugkan, ‘‘The Flash Crash’’, The Impact of High Frequency Trading on an Electronic Market (May 26, 2011). Avail- able at SSNR: http://ssrn.com/abstract=1686004 or http://dx.doi.org/10.2139/ssrn.1686004. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00045 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 42 Q.2. What do you think the impact will be on the markets of the FTT taking affect across Europe? A.2. The impact is very difficult to assess at this stage. The FTT proposal is still at a relatively early stage, with many important details yet to be determined, and the details matter to its impact. Moreover, as noted previously, existing evidence about the impact of FTTs is inconclusive. As with any tax, market participants will try to avoid it, and in the case of trading may try to do so by locating their trading activ- ity elsewhere in the world. Their ability and willingness to do so is likely to depend greatly on the details of the tax and on the de- tails of transaction taxes in other jurisdictions. At the margin, trading activity is likely to migrate to jurisdictions without such taxes, especially in the case of over-the-counter trading that does not require an exchange. Q.3. It has been exactly a century since Congress designed the Fed structure that is still to a large extent in place today, and a lot of people might be surprised to know that bankers get to select the Class A and Class B boards of directors of the regional Federal Re- serve banks. That means, of course, that oftentimes they select themselves. So, for example, when the New York Federal Reserve Bank played a central role in the 2008 bank bailouts, it had big bank CEOs on its boards at that time. There are real advantages of Federal Reserve officials consulting with banks to understand what is going on, but, at the same time, a lot of people worry about the influence the biggest banks have on our Government. Do you think it still makes sense for bank executives to be able to select Class A and Class B directors at the regional Feds? A.3. Congress designed the structure of the Federal Reserve Sys- tem to give it a broad perspective on the economy and on economic activity in all parts of the Nation and to provide the Reserve Banks, as the operational arms of the central bank, with banking experience on their boards of directors. The public–private struc- ture of a Government agency composed of presidentially appointed and Senate-confirmed members that oversee 12 banks with stock ownership and some directors chosen by member banks also al- lowed Congress to fund the Federal Reserve System with capital paid-in by member banks rather than the taxpayer. Congress chose also to include a two-thirds majority of representatives of other parts of the economy, including representatives from agriculture, commerce, industry, services, labor, and consumers, including three nonbankers chosen by the Board of Governors. The Federal Reserve recognizes the potential conflicts of interest that could arise from the statutory requirement that the boards of directors of Reserve Banks be comprised of the presence of bankers and other private citizens. As a result, the Federal Reserve has long had policies in place that prevent members of the Reserve Bank boards of directors (from any class of directors) from partici- pating in any lending decisions involving the discount window or an emergency credit facility, having access to confidential super- visory information, or participating in setting regulatory or super- visory policies. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00046 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 43 The GAO, in its Report No. 12-18 regarding Federal Reserve Bank governance, confirmed that the Federal Reserve has policies in place that are effective in addressing these conflicts of interest. The GAO also noted in that report that, in choosing Class C direc- tors, the Federal Reserve Board makes it a priority to encourage selection of directors that represent broad and diverse perspectives. Q.4. What would be the advantages and disadvantages of Congress taking action to make the regional Fed boards more independent of the bankers they regulate? A.4. As explained above, the Federal Reserve has taken important steps to ensure that the boards of directors of Reserve Banks are not involved in supervision or regulation of banking entities. More- over, Congress in the Dodd-Frank Act reinforced these policies by eliminating the role of Class A directors in the selection of the Re- serve Bank presidents. The GAO recognized that the Federal Re- serve Board and Reserve Banks have been sensitive to avoid both potential and perceived conflicts of interest associated with a statu- torily mandated governance structure that includes bankers on the boards of Reserve Banks. For example, the report confirmed that Reserve Bank directors are not involved in supervision and regula- tion activities, such as examinations and enforcement actions. The GAO also confirmed that Reserve Bank directors took no part in approving loans extended to banks through the discount window or other emergency liquidity facilities, and that institutions with rep- resentatives on Reserve Bank boards were not given special treat- ment at the discount window or at emergency liquidity facilities. The Federal Reserve Board believes that representation on Re- serve Bank boards of directors by local bankers, as well as partici- pants in other aspects of the real economy helps provide a broad perspective on the economy in various Reserve Bank districts. Re- ducing this avenue of information would weaken that insight with- out providing any significant advantage to Federal Reserve super- vision or regulation of banks. Q.5. In the wake of Canning v. NLRB, some commentators have questioned whether CFPB Director Rich Cordray’s recess appoint- ment in 2011 was a valid use of the President’s executive powers. While there is abundant evidence that Director Cordray’s appoint- ment was valid and that assertions to the contrary are based on flawed legal reasoning, the ongoing assault on the President’s at- tempts to nominate a Director to the CFPB has nonetheless created additional anxiety in the marketplace. In particular, some com- mentators have argued that, if the Director’s recess appointment was invalid, then the CFPB’s recently issued mortgage rules are also invalid, and thus various Dodd-Frank default mortgage re- quirements in Title IV were instead operative as of January 21, 2013. While I disagree strongly with that view, some have ex- pressed concern that many financial institutions would be out of compliance with the law if the Dodd-Frank rules are in fact in ef- fect. Can you reassure investors or others who are concerned about mortgage issuers’ potential legal exposure from noncompliance with the Dodd-Frank automatic rules that the risks are not sufficient to VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00047 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 44 pose a safety and soundness threat to individual banks or systemic threat to the economy? A.5. We expect banking organizations and other entities that are subject to oversight by the prudential regulators to assess the legal and other applicable risks in connection with their mortgage lend- ing activities and to properly manage these risks, which includes using prudent underwriting standards. It is not clear how courts might eventually rule in determining whether the Dodd-Frank Act’s default effective date applies, or the potential liabilities that might stem from any court decision. Q.6. What do you believe is the cost to the ongoing uncertainty about CFPB’s future? A.6. The Federal Reserve has not conducted any qualitative or quantitative analysis regarding the cost of any uncertainty about the CFPB’s future and thus has no estimates as to any such cost. Q.7. Has the Federal Reserve conducted any analysis regarding the ongoing cost of uncertainty about CFPB’s future? If so, can you share it with the Committee? A.7. Please see response for [Question 6]. RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORKER FROM BEN S. BERNANKE Q.1. Are there any individual financial institutions whose failure would pose a systemic risk to the United States? Are there cur- rently any financial institutions so large or so complex that their failure would threaten the financial stability of the United States? If so, how do you plan to resolve this issue? A.1. The Dodd-Frank Act contemplates three types of financial in- stitution whose failure could potentially pose a systemic risk to the United States. These include bank holding companies with greater than $50 billion in assets, nonbank financial companies designated by the Financial Stability Oversight Council (‘‘FSOC’’ or ‘‘Council’’), and financial market utilities (FMUs) designated by the Council. In accordance with the Dodd-Frank Act, the Federal Reserve has de- veloped enhanced prudential standards under Section 165 and 166 to reduce the risk posed by the first two of these categories of insti- tutions, including regular stress tests, capital requirements, counterparty credit limits, and more. Bank holding companies with $50 billion or greater in assets have been identified and are subject to these standards. In addition, the Council has issued a final rule and interpretive guidance pursuant to which the Council is consid- ering nonbank financial companies for designation. The Council also designated eight FMUs under its Dodd-Frank authority, and those firms are now subject to the enhanced standards issued by the relevant supervisory agencies, including the Federal Reserve. As a supervisory agency, the Federal Reserve has also instituted a merger screen that considers the financial stability implications of mergers or acquisitions proposed by its largest firms, and, as a member of the Basel Committee on Banking Supervision and the Financial Stability Board, has supported additional capital require- ments for firms that are found to be systemically important inter- nationally. While these measures have not eliminated the risk VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00048 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 45 posed by these firms, measures such as the capital requirements and surcharges on the largest financial institutions will help to equalize their cost of funding with other banks and make them safer so that the risk of their failure is more limited. RESPONSES TO WRITTEN QUESTIONS OF SENATOR JOHANNS FROM BEN S. BERNANKE Q.1. Mr. Chairman, as you know, numerous Senators have weighed in with the Board of Governors that, in enacting Dodd-Frank, Con- gress intended to utilize State-risk based capital rules governing capital for insurance-based SLHCs. As you have heard in your re- cent appearances before the House Financial Services and Senate Banking Committees, many of us remain deeply troubled by the Federal Reserve’s insistence in applying bank-centric standards to such companies. In particular, Senator Collins has written to you pointing out that ‘‘it was not Congress’ intent that Federal regu- lators supplant prudential State-based insurance regulation with a bank-centric capital regime.’’ In your recent appearance before the House Financial Services Committee, however, you indicated the Board of Governors was constrained by the Collins Amendment in addressing the insurance-banking distinction. Given that the statute does not preclude utilizing insurance cap- ital standards to satisfy minimum capital requirements that are equivalent to Basel standards, and that congressional intent is now clear on permitting the use of such insurance standards, will the Board continue to insist that the Collins Amendment mandates the use of bank-centric standards for insurance-based SLHCs and grants the Board no flexibility or discretion in this area? If so, could you provide the legal rationale as to why the Board of Gov- ernors believes it has no such flexibility and discretion? A.1. Section 171 of the Dodd-Frank Act, by its terms, requires the appropriate Federal banking agencies to establish minimum capital requirements for bank holding companies (BHCs) and savings and loan holding companies (SLHCs) that ‘‘shall not be less than’’ ‘‘nor quantitatively lower than’’ the generally applicable capital require- ments for insured depository institutions. Section 171 does not con- tain an exception from these requirements for an insurance com- pany that is a BHC or an SLHC, or for a BHC or an SLHC that controls an insurance company. To allow the Board an additional opportunity to consider prudent approaches to establish capital requirements for SLHCs that en- gage substantially in insurance activities within the requirements of the terms of section 171, the Board, on July 2, 2013, determined to defer application of the new Basel III capital framework to SLHCs with significant insurance activities (i.e., those with more than 25 percent of their assets derived from insurance under- writing activities other than credit insurance) and to SLHCs that are themselves state regulated insurance companies. After consid- ering the concerns raised by commenters regarding the proposed application of the proposed regulatory capital rules to SLHCs with significant insurance activities, the Board concluded that it would be appropriate to take additional time to evaluate the appropriate capital requirements for these companies in light of their business VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00049 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 46 models and risks. Among other issues, commenters argued that the final capital rules should take into account insurance company li- abilities and asset-liability matching practices, the risks associated with separate accounts, the interaction of consolidated capital re- quirements with the capital requirements of State insurance regu- lators, and differences in accounting practices for banks and insur- ance companies. The Board is carefully considering these issues in determining how to move forward in developing a capital frame- work for these SLHCs, consistent with section 171 of the Dodd- Frank Act. VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00050 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 47 ADDITIONALMATERIALSUPPLIEDFORTHERECORD VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00051 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.10031622 LETTER OF TRANSMITTAL BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Washington, D.c., February 26, 2013 THE PRESIDENT OF THE SENATE THE SPEAKER OF THE HOUSE OF REPRESENTATIVES The Board of Governors is pleased to submit its Monelary Policy Report pursuant to section 2B of the Federal Reserve Act. Sincerely, ~f!:::- 48 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00052 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.20031622 CONTENTS Summary ............................................................... . Part 1 Recent Economic and Financial Developments . 5 Domestic Developments. 5 Financial Developments .................................................. 22 International Developments ............................................... 29 Part 2 Monetary Policy .................... . . ............................ 37 Part 3 Summary of Economic Projections . . .... 43 The Outlook for Economic Activity ......................................... 45 The Outlook for Inflation. . ... 47 Appropriate Monetary Policy .............................................. 52 Uncertainty and Risks. . . . . . . . . . . . . . . . . . ............................... 53 Abbreviations ....................... . . .......... 59 List of Boxes Statement on Longer-Run Goals and Monetary Policy Strategy ........ . 3 Assessing Conditions in the Labor Market. 8 The Federal Reserve's Actions to Foster Financial Stability ......... . . .... JO An Update on the European Fiscal and Banking Crisis .. . J2 Efficacy and Costs of Large-Scale Asset Purchases .............• . .... 39 Forecast Un certa inty ...................................•. . .... 57 49 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00053 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.30031622 SUMMARY The u.s. economy continued to expand at a gradually over time, as some of the factors moderate rate, on average, over the second half restraining activity- including restrictive credit of 2012. The housing recovery appeared 10 for some borrowers, continuing concerns about gain additional traction, consumer spending the domestic and international economic rose moderately, and business investment environments, and the ongoing shift to ....- ard advanced further. Financial conditions eased tighter federal fiscal policy-were thought over the period but credit remained tight for likely to recede only slowly. Moreover, the many households and businesses, and concerns Commil1ee judged that the possibility of an about the course of federal fiscal policy escalation of the financial crisis in Europe and and the ongoing European situation likely uncenainty about the course of fiscal policy in restrained private-sector demand. In addition, the United States posed significant downside total government purchases continued to risks to the outlook for economic activity. move lower in an environment of budget However, the Committee expected that, restraint, while export growth was held back with appropriate monetary accommodation, by slow foreign economic growth. All told, real economic growth would proceed at a moderate gross domestic product (GDP) is estimated pace, with the unemployment rate gradually to have increased at an average annual rale declining to ....- ard levels consistent with of 1Y 2p ercent in the second half of the year, the FOMes dual mandate of maximum similar to the pace in the first half. employment and price stability. Against this backdrop, and with long-run inflation Conditions in the labor market gradually expectations well anchored, the FOMC improved. Employment increased at an projected that inflation would remain at or average monthly pace of 175,00J in the below the rate consistent with the Committee's second half of the year, about the same as in dual mandate. the first half. The unemployment rate moved down from 8~ percent last summer to a Accordingly, to promote its objectives, linle below 8 percent in January. Even so, the FOMC provided additional monetary the unemployment rate ....- as still well above accommodation during the second half levels observed prior to the recent recession. of 2012 by both Strengthening its for ....- ard Moreover, it remained the case that a large guidance regarding the federal funds rate share of the unemployed had been out of and initiating additional asset purchases. In work for more than six months, and that a September, the Comminee announced that significant ponion of the employed had pan it would continue its program to extend the time jobs because they were unable to find full average maturity of its Treasury holdings and time employment. Meanwhile, consumer price would begin purchasing additional agency inflation remained subdued amid stable long guaranteed mortgage-backed securities (MBS) term inflation expectations and persistent slack at a pace of $40 billion per month. The in labor markets. Over the second half of the Commil1ee also stated its intention to continue year, the price index for personal consumption its purchases of agency MBS, undertake expenditures increased at an annual rate of additional asset purchases, and employ I \Ii percent. its other policy tools as appropriate until the outlook for the labor market improves During the summer and fall, the Federal Open substantially in a context of price stability. The Market Comminee (FOMC) judged that the Commil1ee agreed that in determining tbe size, economic recovery would strengthen only pace, and composition of its asset purchases, 50 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00054 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.40031622 2 SUMW\RY it would, as always, take account of the likely broad financial conditions eased over the efficacy and costs of such purchases. The second half of 2012. Although yields on Committee also modified its forward guidance nominal Treasury securities rose, on net, yields regarding the federal funds rate at the on inflation-protected Treasury securities September meeting, noting that exceptionally declined, and longer-term interest rates low levels for the federal funds rate were paid by households and firms generally fell. likely to be warranted at least through mid- Yields on agency MBS and investment-and 2015, longer than had been indicated in speculative-grade corporate bonds touched previous FOMC statements. Moreover, the record lows, and broad equity price indexes Committee stated its expectation that a highly rose. Conditions in short-term dollar funding accommodative stance of monetary policy markets eased over the summer and remained would remain appropriate for a considerable stable thereafter, and market sentiment tovo>ard time after the economic recovery strengthens. the banking industry improved. Nonetheless, credit remained tight for borrowers with lower In December, the Committee announced credit scores, and borrowing conditions for that in addition to continuing its purchases small businesses continued to improve more of agency MBS, it would purchase longer gradually than for large firms. term Treasury securities, initially at a pace of $45 billion per month, starting after the At the time of the most recent FOMC completion at the end of the year of its meeting in January, Committee panicipants program to extend the maturity of its Treasury S3\\' the economic outlook as little changed holdings. It also further modified its forward or modestly improved from the time of their rate guidance, replacing the earlier date-based December meeting, when the most recent guidance with numerical thresholds for the Summary of Economic Projections (SEP) was unemployment rate and projected inflation. compiled. (The December SEP is included as In particular, the Committee indicated that it Part 3 of this reporL) Participants generally expected the exceptionally low range for the judged that strains in global financial markets federal funds rate would remain appropriate had eased somewhat, and that the downside at least as long as the unemployment rate risks to the economic outlook had lessened. remains above 6Y2 percent, inflation between Under the assumption of appropriate one and two years ahead is projected 10 be monetary policy- that is, policy consistem no more than Y2 percentage point above the with the Comminee's Statemem on Longer Committee's 2 percent longer -run goal, and Run Goals and Monetary Policy Strategy longer-term inflation expectations continue to (see box)- FOMC participants expected the be ".ell anchored. economy to expand at a moderate pace, with the unemployment rate gradually declining Partly in response to this additional monetary and inflation remaining at or below the accommodation, as ....e ll as to improved Committee's 2 percem longer-run goal. sentiment regarding the situation in Europe, 51 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00055 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.50031622 MONETARY POLICY R[PORT: FEBRUARY 2013 3 Statement on Longer-Run Goals and Monetary Policy Strategy As amended effective on January 29, 2013 The Federal Open Market Committee (FOMC) The maximum level of errployment is largely is firmly committed to fulfilling its statutory deternined by nonmonetary factors that affect the mandate from the Congress of promoting maximum structure and dynamics of the laoor market. These employment, stable prices, and moderate long-term factors may change over time and may not be intere5t rate;. The Comnittee seeks to explain its directly measurable. Consequently, it would not be monetary policy decisions to the public as clearly appropriate to specify a fixed goal for errployment; as possible. Such clarity facilitates well-informed rather, the Corrmittee's policy decisions rTI.Ist be decisionmaking by households and busine;ses, informed by assessments of the maximum level of reduces O€ :ononic and financial uncertainty, increases employment, recognizing that such assessments are the effectiveness 01 monetary policy, and enhance; necessarily uncertain and subject to revision. The transparency and accountability, which are essential in Committee considers a wide range of indicators a democratic society. in making these assessments. Information about Inflation, employment, and long-term interest Committee participants' estimates of the longer-run rates fluctuate over time in response to economic and normal rates of output )y'(1.vth and unemployment is financial disturbances. Moroover, monetary policy published four times per year in the FOMC's Summary actions tend to influence economic activity and prices of Economic Projections. For example, in the most with a lag. Therefore, the ComniUee's p:lIicy decisions recent projections, fOMC participants' e;timates of the reflect its longer-run goals, its medium-term outlook, longer-run normal rate of unemployment had a central and its assessments of the balance of risks, including tendency 01 5.2 percent to 6.0 percent, unchanged risks to the financial system that could impede the from one year ago but substantially higher than the attainment of the Committee's goals. corresponding inter.'al sel'eral years earlier. The inflation rate over the longer run is primarily In setting monetary policy, the Committee seeks deternined by monetary policy, and hence the to mitigate deviatiorJS of inflation from its longer- Committee has the ability to specify a longer-run run goal and deviations of empjoyment from the goal for inflation. The Committee judges that inflation Committee's assessments of its maximum level. These at the rate of 2 percent, as measured by the annual objectives are generally complementary. However, change in the price index for personal consurrption under circumstances in which the Committee judges expenditures, is most consistent over the longer that the objO€ :til'eS are not complementary, it follows run with the Federal Reserve's statutory mandate. a balanced approach in promoting them, taking Communicating this inflation goal clearly to the into account the magnitude c4 the deviations and public helps keep longer-term inflation expectations the potentially different tim: horizons over which firmy anchored, thereby fostering price stability employment and inflation are projected to return to and moderate long-term interest rates and enhancing levels judged consistent with its mandate. the Committee's ability to promote maximum The Conrnittee intends to reaffirm these principles employment in the face of significant economic and to make adjustments as appropriate at its annual disturbances. organizational meeting each January. 52 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00056 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.60031622 5 PART 1 RECENT ECONOMIC AND FINANCIAL DEVElOPMENTS Real gross domestic product (COP) increased at a moderate annual rate of I V2 percent, on average, in the second half of 20 12 -similar to the rale of increase in the first half-as various headwinds continued 10 restrain grolVth. Financial conditions eased over the second half in response to the additional monetary accommodation provided by the Federal Open Markel Committee (FOMe) and to improved sentiment regarding the crisis in Europe. However, credit availability remained light for many households and businesses. In addition, declines in real government purchases continued /0 weigh on economic activity, as did household and business concerns aboullhe economic outlook, while \veak foreign demand restrained exports. In/his environment, conditions in the labor market continued 10 improve gradually but remained \veak. At a little under 8 percent in January, the unemployment rale was still lvell above levels prevailing prior to the recent recession. Inflation remained subdued at the end of last year, Ivith consumer prices rising at about a 1V 2 percent annual rate in the second half, and measures of longer-run inflation expectations remained in the narrow ranges seen over the past several years Domestic Developments GOP increased moderately but continued to be restrained by various headwinds Real GOP is estimated to have increased at an annual rate of 3 percent in the third quarter but to have been essentially flat in the OIange in rcal gross dOOlestic product, 2006-12 fourth, as economic activity was temporarily restrained by weather-related disruptions and declines in some erratic categories of spending, including inventory investmem and federal defense spending.l On average, real GOP expanded at an annual rate of 1Y 2 percent in -II I i " l ' ir; the second half of 2012, similar to the pace of increase in the first half of the year (figure 1). I The housing recovery gained additional traction, consumer spending continued to - , increase moderately, and business iIwestment rose further. Hov."f\"er, a severe drought 11 11 in much of the country held down farm 200Ii 1001 200& 2009 2010 2011 21112 production, and disruptions from Hurricane ..N.O.ll : Hm on<l in subseque::l flglJmo, =<pt. no:ed, chc:g, for. g;'e:: Sandy also likely held back economic activity ""':00 i,,,,,,..,,,..,;! to ... f,::oI gUM« Ihn th, ft:al <rartor ofth'JI",,,,rli:lc somewhat in the fourth quarter. More SoolcE DopIrtmec.lofCcm......c',BurnuofEc.,.""" Acaly>i~ fundamentally, some of the same factors that restrained grov.'1h in the first half of last year likely continued to weigh on activity. Although financial conditions continued to I. Data for the fourth quarter of 2012 from the national income and product acoowlts reflect the ad\'ance estimate released on January 30, 2013. 53 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00057 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.70031622 6 PART 1: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 2. Net change in pa}roll employment, 2006-13 improve overall, the financial system has not fully recovered from the financial crisis, and banks remained cautious in their lending to many housebolds and businesses. In particular, - - ,~., restricted financing for home mongages and new-home construction projects, along ,., with the depressing effects on bousing - demand of an uncenain outlook for bouse - "" prices and jobs, kept the level of activity in the housing sector well below longer-run - oro .., norms. Budgetary pressures at all levels of - government also continued to ..v eigh on GDP 1 I I I I I I I I I I growth. Moreover, businesses and households lOO6 W07 :!llO> ltlO9 2010 ))11 2012 2013 remained C{)ncerned about many aspects of )0' N "1 O >1 ' ) ll , : 2 0 1 1 11 3 < data .... thffl,·"""lth movi::g tm1ll\" t:JI ,rt<:>i tlwugh the economic environment, including the Soula: Deparunetil. ofLcb<r, Bure", ofLebor SlItisti". uncertain course of u.s. fiscal policy al the turn of the year as well as the still-worrisome 1 Civilian l.lI1employment rate, 1979-2013 European situation and the slow recovery more generally. --------------------------~~~ The labor market improved somewhat, -n but the unemployment rate remained high In this economic environment, firms increased their workforces moderately. Over the second half of last year, nonfarm payroll employment rose an average of about 175,0IXl per month, similar to the average increase in the first half (figure 2). These job gains helped lo ....- er 11111111"11"111"11111111111" 11111 I 1~1 1989 1997 ;!OOS 2013 the unemployment rate from 8.2 percent in NO'll; 11I<dalaottm<r:lhIy ..d all!ndthroughJan""Y2013 the second quaner of last year to 7.9 percent Soula: Depan:nclofLtbor, Bureau ofLcb<r Stati01ic •. in January (figure 3). Nen:rtheless, the unemployment rate remained much higher 4. Loog·tenn Ullemployed, 1979-21)13 than it was prior to the recent recession, ____________________________- ".d and long-term unemployment continued to be widespread. In the fourth quarter, about 40 percent of the unemployed had been out of work for more than six months (figure 4). - ~ Moreover, the proportion of workers employed part time because they were unable to find full-time work remained elevated. Some of the increase in the unemploymem rate since the beginning of the recem recession could - w reflect structural changes in the labor market such as a greater mismatch bet ....- een the types 1 "1]1"11" 11"111111]1" 11"1]1" " 1 of jobs that are open and the skills of workers 19&1 19&9 t997 200S 201l available to fill them- that would reduce the NO'll: 111< data ott lDOllthlym!e=d1lJrou&!l )""UL"y 20tl. 11I<..no. sl:0WlI i. th. ~. of total ~Ioyed pe:'SOllO who have b=. maximum sustainable level of employment. ~l S o o y o o tt c E l f D < q r la 2 rt 7 m w tn . 1 . " of " L ' e ' b ' o ' r ' , ' B ureou O(LIbor Sail1;"" Ho ....- e'·er, most of the economic analysis 54 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00058 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.80031622 MONfTARY POLICY REPORT: FEBRUARY 2(lt3 7 on this subject suggests that the bulk of the increase in unemployment probably reflects a deficiency in labor demand.l As a result, the unemployment rate likely remains well above levels consistent .....i th maximum sustainable employment. As described in the box "Assessing Conditions in the Labor Market," the unemployment rate appears to be a very good indicator of labor market conditions. That said, other indicators also provide important perspectives on the health of the labor market, and the most accurate assessment of labor market conditions can be obtained by combining the signals from many such indicators. Aside from the decline in the unemployment rate, probably the most important other pieces of evidence corroborating the gradual improvement in labor market conditions over the second half of last year were the gains in nonfarm payrolls noted earlier and the slight net reduction in 5. Mmures of change ill hourly compensation, initial claims for unemployment insurance. 2002-12 Restrained by the ongoing v.eak conditions in the labor market, labor compensation has increased slowly. The employment COSt -, index for private industry workers, which encompasses both wages and the cost 10 employers of providing benefits, increased only 2 percent over the 12 months of 2012, similar to the rate of gain since 2010 (figure 5). - , Similarly, nominal compensation per hour in the nonfarm business sector~a measure deri\'ed from the labor compensation data in II I I 1 1 I I I I 1 2002 2001 2006 21m 2010 2012 the national income and product accounts (NIPA)~increased 2Y:z percent over the four IrJ N .in O . . li: . ~ T c h l e w ," > , t to . .. i ,. . . O q V u f o ! m t t f y o o u : r xI q o o; t tc t < t I m < ; llh f r " o , u ! ¢ h 2 e 0 " 1 " 2 , : O ~ > . y r m " e , m " « " > "" J " I , . " quarters of 2012, well below average increases , i . n : d .o e : x te ( r E . n CI) , , n " -x . f , a . r . n . i. ~ w ... !h e ~ 1 " 2 " m , o I nt a hs ! < . n . < to !q m i . l . l , t 1 h 1 e l V Ia 'm sI . . m ... o m o , t h " " o " { " . " .. f . ~ h imtil:llions, wi """,,,hol.U. The ot.cto< ~ by 11:. EO u...:! W II th, 2. See, for example, Mary C. Daly, Bart Hobijn, II< S In o W m m e < I : r .a o m .p. . . . - . t m O e « n to t r o p { lu lJ s O : O lO r : , : . B p 1 : l o U f~ I I i . : u : a o i { tu lJ li O o O ns r . stotistil"S Ay~giil $ahin, and Robert G. Valletta (2012), "A Search and Matching Approach to Labor Market;;: Did the Natural Rate of Unemployment Rise?» ]Oiuna! of Economic PerspeCfi~es, \"01. 26 (Swllmer), pp. 3-26; Michael W. L. E1;by, Bart Hobijn, A}"~giil $allin, and Robert G. Valletta (2011), "The Laoor Market in the Great Recession-An Update to September 2011," Brookings Papers on Economic AClirilY, Fall, pp. 353-71; alld Jesse Rothstein (2012), "The Labor Market Four Yearn into the Crisis: Assessing Structural Explanatioos,» lLRReriew, \"01. 65 (July), pp. 467-500. 55 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00059 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.90031622 8 PART 1: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS Assessing Conditions in the Labor Market No single statistic can prol'ide a complete picture generally a reliable indicator of the overall state 01 the of a labor market as large and diverse as that in businesscycle.2 the United States. The evidence suggests that the Of course, the unefllJloyment rate does not, by unemployment rate is probably the most useful itself, provide a cOfllJlete and fully accurate portrait single summary indicator of labor market conditions. of labor market conditions. As with most iro:!icators, However, other indicators, prominently including but the unemployrrent rate is subject to sampling and not limited to nonfarm payroll employment, provide other measurement errors, so month-to-month imjXIrtant additional infOfmation. movements should be interpreted with some caution. The unemployment rate is intended to measure Even over longer periods, the unefllJloyment rate the extent of the most obvious, and arguably the may not always characterize the situation in the labor most important, problem in a slack labor market: the market altogether accurately. for example, if many inability of some people who are looking for work to unemplo)'ed indil'iduals cease looking for work (aro:! find acceptable jobs. The unemployment rate is also so are no longer counted as unemployed) because well correlated with, and representative of, a broad set they have become discouraged about their job of labor market indicators that portray many aspects prospects, the measured unemployment rate could of the job market. This relationship is demonstrated decline even if the del1l3nd for labor has not improved. in iigure A, which plots the detrended unemployment Also, the unemployment rate may not always move rate along with the first principal component from in step with other types of underemployment, such as a lactor rrodel of labor market indicators described in a paper by Barnes and others.' In addition, other 2. fOf two ex3lll'les, seeCharlesA. fleischrn.lo aod research suggests that the unemployment rate is John M. Roberts (2011), "From Many Series, One Cycle: Illl'rOYE'd E,timatl>S 01 the Business Cycle lrom a Muttivariate Uocbserved COI"JllOnent5 Model: fil\.loceand Ecooomics 1. The first prirocipal COfIlIO!leru is a sUlllllilry ~tistic Discussion Series 2011-46 (Washing\l)n: Boord of that captures thecommon llDI'emellt among a IIlrie!y of Governors 01 the federal ReserVE' S)'51enl, October), WWW. indicators. See Michelle Sa,r.es, Ryan Chahrour, GiOI\lnni ledf'lalreserve.govlpoos/ledsI20 l1f2011461201146pap, Olivei, and Gaoyan Tang(2007), "A Priocipal ConpHlents jldf; and Jf'lenl)' J. Nalewaik (2011), "Fore.-;asting Recessioos Aw'OiIrn w Estimating Lalxx Market Pressure and Its Using Stall Speeds: Finanre and Economics Diso,J!O,ioo Illl'lications 100Inllation," Public Policy Briefs 07-2 (Boston: Series 2011-24 (Washingwn: Boord of Govf'lrlOlS oftne fedf'lal Res<>I\'E' Bank of Boston, Decerrber), www.bostooled. fedf'lal Res<>I\'E'Systt>m. April), www.federalres<>l\'E'.govl\JlbsI orglecorromiclprbnOO7Ippb071.pdf fooj/2011nOI1241201124pap.pd!. A. Detrended unemploymwl rate and principal component, 1%7-2012 - 1 , - , - -1 ,., ,., 'm "" "" '"' "" ,00> 2012 N<m: The ~d tar. i::dra porio<l:l-ofbulil:rll-="-I»n .. "'fi...,d b)' 0):, Notional BuJ"u of&<l:tllO".io R"",,,,cll Sooo.a;: r,dmt~,Bcl.{_'T1ff 56 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00060 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.01031622 MONfTARY POliCY REPORT: FEBRUARY Xlt3 9 persons working part time because they cannot find and provide information about some specifiC aspects full-time jobs. For this reason, broader measures of 01 the labor market. labor underulilization, such as the Bureau of labor One set of useful supplementary indicators consists Statistics' (BlS) U-4, U-S, and U-6 rates, can be useful 01 measures of job losses and hiring. These measures supplements to the standard unemployment rate. These describe the large gross flows of workers in and out of measures include the number of discouraged workers employment that underlie the net changes reflected and part· time workers who are unable to find a full· in the unemployment rate and payroll employment. time job, and they are derived from the same survey For exal"lllle, the improvements in the employment of households as is the offICial unel"lllloyment rate situation thus far during the current recovery have (figure B). been driven fOOre by reductions in job losses than Other than the unemployment rate, payroll by increases in hiring. A second set d indicators, the employment as measured in the BlS survey of rate of job vacancies and measures 01 firms' hiring establishments may be the most uselullabor market plans, may be informatil'e about the sustainability indicator. A decline in the unemployment rate that 01 any increase in hiring. Quit rates, a third set, are is accompanied by a roughly prOfXlrtionate increase useful because workers hal'e, historically, been much in payroll employment is rll:)re likely to truly rellect more likely to quit their jobs when they perceive or improvement in the labor market. Of course, payroll anticipate a strong labor market. In addition, surveys of employment is also an impenect measure, and on consumers and businesses provide information about some occasions the initial estimates of payrolls have the perceptions d a large number of individuals about been revised to show a substantially different picture labor market conditions. As with the unemployment than they originally did. Therefore, it can be useful to rate and payroll employment, these other indicators also look at a I\.uiety 01 other labor market indicators. have, lor the most part, improved considerably during These indicators may be less brood·based than either the economic recovery but remain substantially the unemployment rate or payroll employment, weaker than would normally be associated with a but--<;olloctil'ely-they may reduce the uncertainty healthy labor market. surrounding the message from the primary measures B, Measures of labor underutilization, 2001-13 -p~----------~--,---------~- Uoli _ 16 - " - 10 ,., ,-tl l I I '"" '"" ;00; "'" W" 2011 1 d w l l l o < l N t r c l k I o o I . p o n . I r 0 . > : 0 " f 0 n : , M ' • d . • , p " 0 " < m 1 , 1 !k " m . < o u : t " h ~ " m e " a I l r l " a i g " b s i ' o c n f r o > : J o t f y l o I ) a ' r l t . g D e t t . t d : c ! w . l w , o , . , " , o d , t , l ! : D \ k d 0 a : t W ! ! t n o ~ o r o t , ". t . : . . I . ," . > . . . . l I a i f b , m . r b . u c a I r o t r r y . t { l . I 2 o l . l 0 r ) ' " J ' 1 " 'f ; , I I . ! o o k U o l . - 1 ti 4 l o l D l g " : o ! " f f " h c o ' a b C r . . t . : w . . I " a o ~ L b r O o k , t 2 b fo l t I O t l f < ." S o t " l : p " l . l ' t i j m p o t i h o b p ' y Y m m td < b m P t I I l . i ~ ' . m p . _ ." . . a IO : > g n f i o n 1 l a 2 j 1 o : l m y b M s o w :n . o _ I : I . b I U . t a U d v r o " t a li , , i ot l h " " :eo ' ' ' > J ' lsa I W f b ' , f . o . e C r' t ( h \ " o o m ' r l l r l : . o t . . f u u ~ l n h . · e s , a m I t . m . p l ., u I . ) o . " ' y f " o t . r . d t r . t p t c b l< ~ l U M a J U i m c a d rg i< .. n .. U p y e r O io Il < I l c I l 0 x 1 d " " w "' " '', , < k $ m $ = p m ~ i O 1O l :a l 1 . . . . . d , p m !o O y < M 'd b p y a: l 1 h t e i " N .. . " ; f O o: I l < at C a « w I" . " , , . k , , o . f . E o o w rl n ~ o " tn . r J R 'f ts I . = .,c t h o f lobo: 10"" ph,. all ....." 'P»UyOl""btd wO!\;m. n., L':ad<d In:< ~ ~,ofl.aM:.BIttl'.,ofL>borSta:ii!iot. 57 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00061 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.11031622 10 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS of close 10 4 percent in the years prior to the recent recession. As a result of these modest gains, nominal compensation has increased only about as fast as consumer prices over the recovery. Inflation remained low ... Consumer price inflation was low over the Change in the chain-type: price index for pc:rsonal cons\DllptiOil expenditures, 2006-12 second half of 2012. With considerable slack in labor markets and limited increases in labor ________________________c 'c-' coSts, relatively stable prices for commodities and impons, and well-anchored longer-term inflation expectations, prices for personal consumption expenditures (peE) increased -1 at an annual rate of 1Y :z percent in the second -1 half of the year, similar to the rate of increase - , in the first half (figure 6). Excluding food and energy prices, consumer prices increased only I percent in the second half of the year, down , - from 2 percent in the first half. A deceleration I I I I in prices of imported goods likely contributed 200Ii 2001 1008 2009 1010 1011 lj)11 to the low rate of inflation seen in the second NOli: The elm.,.. """,thtymi exIeod th:"uahDmmber lOt!; cha:ig. . half, though price increases for non-energy .,.. So f o r 1 o c " ! " :: " ' D Y tp W or " tm " tn ~' l " o fCOJll:Ilmt, SurtauofEcona:n", Analysi~ services were also low. As noted, gains in labor compensation have 7. a.angeinQ\l1pl~perho\lr,'9_l.8__2012 been subdued given the weak conditions in labor markets, and unit labor costs-which measure the extent to which compensation . rises in excess of productivity- have increased very little over the recovery. That said, - compensation per hour rose more rapidly last year, and productivity gro\\'th, which - 1 has averaged IY l percent per year over the - 1 - , recovery, was relatively low (figure 7). As a result, unit labor costs rose 2 percent in 2012, , v.-ell above average increases earlier in the - recovery. I I I I I I I I I t94S- 1974_ 19096- 200t_ 2008 2010 2012 73 95 2000 07 Global oil prices rose in early 2012 but Ncm N<mfama bu>io ....._ . Chor.g. for each multiyear pniod i. subsequently gave up those gains and remained "...,.=1 to the fou:lh qua:tcT ofth. fmat )_ o,the pciod from the ,o::nh qUtrttr ofth, yw i:n.. ... dia ..1 y """ediq t/:.pniod. about fiat through the laler pan of the year SoolC]t o.par.-«Labor, Burt"" ofLabot swistil'S (figure 8). Developments related to Iran, including a tightening embargo on Iranian oil exports, likely put upward pressure on prices, but these pressures were apparently offset by continued concerns about weak global demand. However, in recent v.-eeks, global oil 58 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00062 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.21031622 MONETARY POlICY REPORT: FEBRUARY 2013 11 prices have increased in restxlnse to generally S. Prices of oil and oonfuel cO!IUIIodities, 2003-13 positive demand indicators from China and some reductions in Saudi production. Partly D<_~-IOO [101 ... ",,_ in response to this rise, retail gasoline prices, ,. - -140 which changed lillie, on net, over 2012, have moved up appreciably. 140 - - 120 - '0.0. Nonfuel commodity prices have remained 120 _ relatively flat over the past year despite significant movements in the prices of a few '00 _ • specific commodities. Of particular interest, prices for com and soybeans eased some over 00 - '" the fall after having risen sharply during the ! I I I 200& 2009 U)]O 20ll 2012 WI) summer as the scale of the drought at1"ecting G m i u v c e h n o th f i t s h e e a U sin n g it e a d n d S t t a h t e e s s m be a c ll a m sh e a r a e p p o a f r g en ra t i . n o oi r ~ N . " . c " " m , ' m : ! h o T e l h " l o a " s d " t " . o o " b t " s a " e . r , . r . i V o m l s ti a o o i l s ! l h i ! l s I y l l l h . e i T a : h v d o e a r o o i o l g p l o r 4 i f S c o e r p F is r t i I m b h n e a w r 1 y p y · O c u t 1 n p - : 2 r n ic I o , e d 2 i o I ! l y l l B l p . t " r T i " h « ! . s c p r ~ u r d i« . <'Xttndothrrugh.la::t!ary201J costs in the retail price of food, the effect of Sruus:: For oil, Ihe CIIIII:lIOdiIy RtSN<"h BlIrtal!; r", nontu..1 the drought on U.S. consumer food prices is ~ilios, l:!omoIional Monetoryfund. likely to be modest: Consumer food prices rose at an annual rate of 2 percent in the fourth quarter following increases of less than 1 percent in the middle of last year. In line with these flat overall commodity prices, as well as earlier dollar appreciation, prices for imported goods excluding oil were about unchanged on average over the last fi\"e months of 2012 and the early part of 2013 . . , . and longer-term inflation expectations stayed in their historical range 9. Median innation expectations, 2001-13 Survey measures of longer-term inflation expectations have changed lillIe, on net, since - , last summer. Median expected inflation over the next 5 to 10 years, as reported in the - , Thomson ReuterslUniversity of Michigan M;"hipnlUM")"eq>t&tiom Surveys of Consumers, was 3 percent in rOf=:lSto 10 "'" early February, within the narrow range of -~ the past 10 years (figure 9). In the Survey of -, Professional Forecasters, conducted by the ~ f"",wIO)"..,. - , Federal Reserve Bank of Philadelphia, the median expectation for the increase in the price index for PeE over the next 10 years I! [ [ [ [ [ [ [ [ ! I 1 I 1 was 2 percent in the first quarter of this 2001 2003 2005 2001 2009 2011 20ll year, similar to its level in recent years. A Ncm: Tho Mid:igon '""0)" ""ta .... monthly and .xtend from January 2001 w.".:gh. prdimi::ary ..~ mate fOf Fdm!a:)" lOll. 11>: SPF data .... measure of 5-year inflation compensation quaJ'''''iyar.i ....t ndfIO.:Il 2007:Q1 throughlO13:QI derh"ed from nominal and inflation-protected and S r S o u r r u Y :J e : } ' T .f 1 P x r Im oc < . o . o . R i o " n ' a t l = F lU .,. n .. . i. . . . 1 . : c " " i o l y (S . P f ! M '). ;"hipn S\ll"W")'"SofC""'''''' .... 59 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00063 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.31031622 12 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 10. rnflatiOll compensation, 2004---[3 Treasury securities has increased 55 basis points since the end of June, while a similar -----------------------=~ measure of inflation compensation for the - , period 5 to 10 years ahead has increased about - , 30 basis points; both measures are within their , respective ranges observed in the several years - before the recent financial crisis (figure 10). - , While the increases in these measures could reflect changes in market participants' - , expectations of future inflation, they may , also ha\'e been affected by improved investor - risk sentiment and an associated reduction in I I .I. 1 .. 01 .I. 1 ... 1 .I. 11101 01 I demand for the relatively greater liquidity of 20()~ 2007 2009 2011 2013 nominal Treasury securities Ncm;: Tho data ate we<l:Iy 1Vm&" of d&iIy dall ond OXleruilMough f o e n b n t o = m y in a t5 l . r ! r O .& l S l. " 'Y [" n I« o 1 ti l o r o i ti C .. U I o lp ru " I ". . T .: rt i a o s u u r io y ! b d e 1 < at li i f o l'= n-p « :ol b "' o W tw t " et " l " y " ie t l i d . s . Consumer spending continued to ( n T om IP ; S ;> ) ! « T , r ~ ea " su a ry b . l . e . .- m .m at t u i r . i . t i l . I ~ d b a o s n e< · ! o lI n d y i o el / d r·t h cu e- n r r u n n f T it I te P d S . t o 1 o 1 l : f :. - lh j e . - Y -nm '" increase moderately "'. ... ",. . io O<!j\l<led fer lb. <'if"" of iodao,onlags Soowi: F..r..I Roserve &:ik .fN"", YOlk; Bacclays; F,clmI R.SCTV< Turning to some important components Boord .... ff.OIiroate1. of final demand, real PCE increased at a moderate annual rate of 2 percent over the 11 Change in real pmonal CO!lSIDDptiOll expenditures and second half of 2012, similar to the rate of disposable personal incoox:, 2006-12 increase in the first half (figure 11). Household v..e alth- buoyed by increases in house prices • o C C h la a n n & & < < i i n n r r e e a > l l P D C P B ] -. a h n al d f e o q f u t i h ty e v ye a a lu r e a s n - d m p o r v o e v d id e u d p s o o v m er e t s h u e p s p e o c r o t n d for consumer spending (figure 12). In addition, for those households with access to credit, low interest rates spurred spending on motor IJ vehicles and other consumer durables, which increased at an annual rate of 11 percent over the second half of last year. But increases in real wages and salaries were modest over the second half of the year, and overall grol,l:th in I I 2006 2007 !008 2009 20]0 2011 2012 consumer spending continued to be held back by concerns about the economic outlook and N01t: Th!dall .. quarttrlyondexle!<!Ihrout!t2012:QoI Scmci: DepanmetiI ofC=~ .. Bu. ...u ofEe"""",,, ArooIysiL limited access to credit for some households. After rising earlier in the year, consumer sentiment- which reflects household views on their own financial situations as well as broader economic conditions-fell back at the end of the year and stood well below Ionger run norms (figure 13). Real disposable personal income (DPI) rose at an annual rate of 3Y2p ercent over the second half of 2012. HOI,I,'Cvcf, much of this increase was a result of unusually large increases in dividends and employee bonuses, as many firms apparently shifted income disbursements 60 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00064 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.41031622 MONETARY POlICY REPORT: FEBRUARY 2013 13 into 2012 in anticipation of an increase in 12. Weahh-to-income mlio, 1989-2012 marginal ta.x rates for high-income households ______________________ at the beginning of this year. Excluding these -C~o special payments, real DP! is estimated to -, have increased at a modest annual rate of 1Y . percent over the second half of the year, similar to the average pace of increase over the recovery. The surge in dividend and bonus payments also led the personal saving rate to jump from 3.8 percent in the second quarter to 4.7 percent in the fourth quarter (figure 14). -, In their absence, the saving rate would have likely been [il1[e changed over the second half 1 I I I I I I I I , I I I I , I I I I I I I I I " I of the year. 1992 1996 2000 2000: ~ 2012 NOl"I: The c!ala.,. qUIMIy and =d Ihrough 2012:QJ. Th • .....,.;, Households continue to pay down debt lh S ' o r o l m I i i : > F o o f r h n ~ o l t J " n m o I t h " , . F . : od t m b J ! l P l .o ~ ." . " p " m B o o n a 1 rrl l , "n"o.".." o ' f " f .J>ld1 <!ota; for and gain access to credit inro:l>o, Dc-partm",\ <Ie.""",.,..,., B::r<"" ofEoo::o:n;; Alla~~;, 13. Consumer sentiment indexes, 1999-2013 Household debt- the sum of mortgage and consumer debt-edged down further in the third quarter of 2012 as a continued contraction in mortgage debt more than offset a solid expansion in consumer credit. With the reduction in household debt, [ow levels '00 of most interest rates, and modest income growth, the household debt service ratio the ratio of required principal and interest pa}wents on outstanding household debt to DPI-decreased further and, at the end of the third quarter, stood at a level last seen in 1983 I I I I I I I I I I I I I I I I I I (figc.re 15). 2001 2001 2001 2010 2~lJ Consumer credit expanded at an annual and N o ,> n . : : : t l> T d h o I : h r C o , u ,: g If h < , J . I ., ! . I ; . . 2 B 0 . 1 .. 1 .- . d T d h . o Ia , M il ;; l h ll . o ; s . u d r ! v l e l y 1 0 d 0 o la i:a , i t n 9 d 8 t 5 " , , I d I" < ,, , m 1 O 0 t 0 it h " ly ' rate of about 5Y. percent in the second half 19 S 6 o 6, o 1 t. I a "< ;; ! Il T O h tI e Ih Iy C a o n :l d fm .lI : < >e II e d t & II a ro r u d z h a . n ! d " < T I. h ., o i: : w n' y ''" F e R b ! . I 1 lI 0 < 1 r 3 S I a U ti. n 'D i,· I . ! , e .il . y "f of 2012. Nonrevolvingcredit (mostly auto Mi.;:hip:l Surv<),ofCo=m. loans and student loans), which accounts for 14. Personals3vingmle,1989-2012 about two-thirds of total consumer credit outstanding, drove the increase. Revolving consumer credit (primarily credit card -. lending) was about flat on net. Overall, the increase in nonrevolving consumer credit is consistent with banks' recent responses to the Senior Loan Officer Opinion Sun'eY on Bank Lending Practices (SLOOS), which indicated that demand had strengthened and standards eased, on net, for auto loans (figure \6).l 3. The S100S is 2I'ailable on the Federal Reser..-e I1 111 11111 11111 11111 111111 Board's website at www.federaJresen·e.glJlilboarddocsl 1992 1996 2000 2000 200> 2012 SnLoanSuney. NOli: Thed>ru ..e qU1rt<r1y and<':ln!\luDugh2Q12:Ql Saru::r;: Dc-partmon,ofC""""",,,,,. Bumn"fEcOtl""'" A<.o~'is 61 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00065 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.51031622 14 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 15 HQllSehold debt service, 1980 21)12 Changes in interest rates on consumer loans v,ere mixed over the second half of 2012. Interest rates on auto loans declined a bit, as did most measures of the spreads of rates on these loans over yields on Treasury securities of comparable maturity. Interest rates on -B credit card debt quoted by banks generally declined slightly, while rates observed in credit -B card offer mailings continued 10 increase. The housing market recovery gained -H traction ... ' 11I111111I111111I111111I1111111111 I The housing market has continued to recover. 19&0 1984 1~&8 1992 19% 2000 2004 2008 2012 Ncm: 1M <!ata .:. quonaty and <Xttnd!hrrugh 2011:03. Debt 'eM"" Housing starts, sales of new and existing poy:n<w """,iot or nWio:oi .." ,~oi pa)n><:rts QtI outN:l!iug~. homes, and builder and realtor sentiment all an S d o o o " . " a , c u I : : n e F r . d ~ e a b o t l . R. ....... Boord, '1Imaehold D<bl Servk< m! FiI=oial increased over the second half of last year, Qblig,ti""" Rati ..; .~ti$ti"" .. I<>$<. and residential investment rose at an annual rate of nearly 15 percent. Combined, single· 16 Change in standards and demand for alrto loons., family and multifamily housing starts rose 21)11 12 from an average annual rate of 740,CKXl in the )1,,1"""" second quaner of last year to 9C(),OOO in the fourth quarter (figure 17). Activity increased most noticeably in the smaller multifamily sector -where starts have nearly reached pre· recession lewis- as demand for new housing has apparently shifted toward smaller rental units and away from larger, typically owner· occupied single·family units. - w ... as mortgage interest rates reached record lows and house prices rose ... I I Ql Q2 OJ Q4 01 Q2 QJ 0' Mortgage interest rates declined to 2011 2012 historically low levels toward the end of NCf1I: lkdatamfro:n''''"''"Y!'''''''Iy<:<ltl<!::,ted4Unospo!"yeor; tho Iut obsorudion j. fro::n d:. Jan. 2011 "'"""Y, wl'.icll '"""" 2012:Q4 20l2- importantly reflecting Federal Reserve ; & ti.g : "l h ::". o . 'i . u" n g o s o r r q . n ~ o I en . s > th " e " "DO'''t' 'I p l e '' r '' u n o t < : o nW f o l u r f v " e , y e O d 11 t b o a I : " k " s " , t h o a v t e r r e p tb o a r te,d.. .~t policy actions-making housing quite affordable for households v,~th good credit Soo1a: Fedaal R. ...... Board, S<nior Loon Oill ... O(Rtlion Surv<y" BODklr..JlitlgPtu!m ratings (figure 18). However, the spread between mortgage rates and yields on agency· guaranteed mortgage·backed securities (M13S) remained elevated by historical standards. This unusually wide spread probably reflects still-elevated risk aversion and some capacity constraints among mortgage originators. Overall, refinance activity increased briskly om the second half of 20l2- though it was still less than might have been expected, given the level of interest rates- while the pace of mortgage applications for home purchases 62 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00066 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.61031622 MONETARY POlICY REPORT: FEBRUARY 2013 15 remained sluggish (figure 19). Recent responses 17 Private housing starts, 1999-2013 to the SLOOS indicate that banks' lending standards for residential mortgage loans were little changed over the second half of 2012. - 1.8 House prices., as measured by several national indexes, continued to increase in the second - l.4 half of 2012. For example, the Core Logic repeal-sales index rose 3~ percent (nol an - l.0 annual rate) over the lasl six months of the year 10 reach ils highest le\'el since late - , 2008 (figure 20). This recent improvement notwithstanding, this measure of house prices I! , ! ! I ! I ' , , ! , t ! , remained 27 percent below its peak in early 1m 2001 ))(IJ 2005 2007 2009 2011 20ll 2006. NOll: Th. data .,. <I>lIlthly anda:el:d Ihrou&b )."ua:y2013. Soo.acI: [)eponrnontmC"""""",., Bum.u<ith< C=u ... but the level of new construction 18. Mortgage intmst rates., 1995-2013 remained low, and mortgage delinquencies remained elevated Despite the improvements seen over the second half of 2012, housing starts remained well below the 1960-2000 average of 1.5 million per year, as concerns about the job market and tight mortgage credit for less-credit worthy households continued to restrain demand for housing. In addition, although the number of vacant homes for sale has declined -, significantly, the stock of vacant homes held otT the market remained quite elevated. Once I I I I I I ! I I I I I I I I I I I 1!I'll 1998 ))(11 201.).: 2007 2010 put on the market, this "shadow" inventory, which likely includes many bank-owned ... N " c " m ,,1 : r I; l ; b t!l t 1 < d ' a O ta I , I J " O 'h - i ) o 'tI !! l" L Il . I . O . : . I ~ 8 . I1 t & dy < a ' n . d rom! thmJgb. FeImwy lG, lOt;, properties., may redirect some demand a\vay $(mo. r.&r.lHo:uo[.oo.nMOItglgtCo.:p"":I.ion from new homes and toward attractively priced 19. Mortgage Bankers Association purchase and refinance existing homes. With home values depressed indexes, 19%-2013 and unemployment still high, measures of M.-:I>'~'91".1-'OO _'~'990-1QO late-stage mortgage delinquency, such as the im·entory of properties in foreclosure, ;00 - - 10,00:1 remained elevated, keeping high the risk of .., homes transitioning to vacant bank-owned - ,,00 properties (figure 21). '00 - ,oro Growth of business investment has '00 - , ', , o , r , o slowed since earlier in the recovery '00 - After increasing at double-digit rates in 2010 and 20 II, business expenditures on equipment 1111!!!!!!IIIIIIII!!I!!!1 I and software (E&S) decelerated in 2012 1992 1995 1m 2001 201.).: lim 2010 201l (figure 22). Pent-up demand for capital goods, Ncm: Th: data, w~"h II< ..l ><Ially O<!r~w, .", I f"""· ...... k movin, an important contribulor to earlier increases avmte and rom! ~ Fdnwy 15, 2013. SOOlCl!. M<r.glll.&tik<:-sAssoci.tiOll- 63 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00067 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.71031622 16 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 20 Prices of existing single-family houses, 2002-1.2. in E&S spending, has likely diminished as the recovery has aged. In addition, concerns ----------------------~ ~. about possible threats to economic growth and stability from U.S. fiscal policy and the situation in Europe may have contributed to soft investment spending in the middle of last year. As a result, despite a pickup in the pace of gains toward the end of the year, E&S investment increased at an annual S&P,C ...· Sh'" .. rate of 5 percem in the second half of the 2O.",ty i:>!ox year, similar to the first-half pace. As for business investment in structures, a sustained I I I ' 00' I I , .,. I I, ., I I 2 012 I I r r e a c te o s v , e t r ig y h h t a c s r e y d et i t to fo t r a n k e e w h o co ld n , s a tr s u h c i t g io h n v , acancy "" N "" O o T l i i : u T d h . e . d t a b ll t m i l t J . l " O ' : " :'. h is l y 1 a 0 n 0 d . = B c o ! t i h n 1 u 0 .. 1 C 01 _ 1 L : > Q g o i : < . E ~ ach i i n o d < o kx x h a a n s d b t « h n e and low prices for commercial real estate FHF A ""'" inobl. puro .... tt=aclioru only_ The S&PiCu.·ShiU", iode:< (eRE) are still hampering investment in new r< S I- o .. I . . r ru u : o E l : l u F m . ' . .- C Ie o :: : & -d t . h og . i . < l , e > C tm _L IJ o a g C i t c i" ; " " ( i " II s f d 1 e I t F tc A < , l ll F lO .d lr m O I p O H i o it u a s o ill L j . ; . F .. W . ce buildings. However, in the drilling and mining A~"''Y; for S&PiCaOI!.shilkr, Sa!>lanI & Poo!'~ sector, elevated oil prices and new drilling technologies have kept investment in structures 21. Current prinx: mortgages becoming delinquent at a relatively high leveL and foreclosure inventory, 2000-12 r..-,l·_ _ _ Inventory investment remained at a moderate le\'el in the second half of last year, as limited 15 _ gro\,\'1h in final sales and the uncertain 1.4 _ economic environment continued to limit IJ - firms' incentives to accumulate inventories. 12- -15 Census Bureau measures of book-value l.l- inventorY-lo-sales ratios, as well as SUf\'eys 1...0. - -1.0 of private inventory satisfaction and plans, - generally suggest that stocks were fairly well - , aligned with sales at the end of 2012. ,- Corporate earnings growth slowed, but 2(1(10 2002 !(!O.! 2006 lllOO 2010 2011 firms' balance sheets remained strong NO'!!! Thedmf"lli:nelD<l:lg.,..l>e«tDi:l,:do6"""""tmlllO:ltl:!yand "",-"", thrO'.:gh n",.".,.,. 2012 The data rqmstnl tho pettentage <i: After having risen 6 percent over the firSI half m &'I o io : q \ \ i l< Ii ll " \ " th ,h Il m t o rI n Im \h i . ti wn .! M dlT n l b fo e r i :l f c w C " I l I w ITe .. :: , l . t " o , V b < e ll i t o o g : y . . 1 . . 1 . q . u .1 s r t 3 m 0 y d a a ) n -- d . of 2012, aggregate operating earnings per " rt " C ,- < " S " . , i o t n b . ro . u d ! e h f m 2 < 0 d 1 b 1 y :Q th J e . N T a h t e i .., s . h 1 a B d . t d .. . b .u o n o fB c : l < ii: w O o le :n i , , .. R .. . ; c .. w .. . o h r . busi:l<oi share for S&P 500 firms were about Bat on a s.oo.c.; For ptirD!-OI<rtgag1S, LPS App6"" k.!Iyti. .; for f"""I0._ seasonally adjusted basis in the second half inVttlcry, F!:danl R...,.. Boord IW1 ,olculatiol:s lw!:d on <Iota !Mn MOIIpg' &Ilk.,. A.ooeiolion. of 2012, held down, in part, by weak demand from Europe and some emerging market economies (EMEs). However, Ihe ratio of corporate profits to gross national product in the second half of 2012 hovered around its historical high, and cash Bow remained solid. In addition, the ratio of liquid assets to total assets for nonfinancial corporations was close to its highest level in more than 20 years, and the aggregate debt-to-asset ratio remained low by historical standards (figure 23). 64 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00068 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.81031622 MONETARY POlICY REPORT: FEBRUARY 2013 17 With corporate credit quality remaining robust 22 Change in real business fixed investment, 2006--[2 and interest rates at historically low levels, nonfinancial firms continued to raise funds at a strong pace in the second half of 2012, Bond issuance by both investment-and speculative -w grade nonfinancial firms was extraordinarily strong, although much of the proceeds from IcI ~IH2-1O bond issuance appeared to be earmarked for c the refinancing of existing debt (figure 24). 1 ~ - w Meanwhile, nonfinancial commercial paper -w (CP) outstanding ....' aS about unchanged. Issuance in the institutional segment of - w the syndicated le\"eraged loan market 1 I [ 1 accelerated in the second half of the year, 2006 2007 2001 2009 ~IO ~ll 1012 boosted by rapid growth of newly established collateralized loan obligations. Commercial 23. Financial ratios for nonfinancial cocporations. and industrial (C&l) loans outstanding at 1990-2012 commercial banking organizations in the United States continued to expand at a brisk ..C -_____________._._ -_______ ~ . . pace in the second half of 2012, Moreover, L'quidWOlSov<:< according to the SLOOS, modest net fractions ;; - --.l.l of banks continued to report having eased their lending standards on C&I loans over the W - second half of the year, and large net fractions " - of banks indicated having reduced the spread - .m of rates on C&I loans over their cost of funds, " - largely in response to increased competition D.t.t.,.." from other banks or nonbank lenders " - tow ....... - .0 (figurd5). 1""""""""""",,1 1992 1996 2000 XII)4 2008 2012 Gross public equity issuance by nonfinancial No,.., n. dall are..""".] thm:gh 1995, quuterly th"",.n.:, and",ttlOl! firms slowed a bit in the second half of 2012, thrvuch2!l11:QJ. SooJcE: C."..,.. ..t at. held down by a moderate pace of initial public offerings. Meanwhile, data for the 24. Selected cOOlpooents of net fmancing foc noofmancial third quarter of 2012 indicate that net equity businesses, 2005-12 issuance remained deeply negative, as share repurchases and cash-financed mergers by nonfinancial firms remained robust (figure 26). .D"C=":r"t. lI'Oi!lp&p<r .-W Borrowing conditions for small . - s & " n " k , l l)&;1$ -w businesses continued to improve, albeit more gradually than for large firms - w Borrowing conditions for small businesses continued to improve over the second half of - w 2012, but as has been the case in recent years, the improvement was mOfe gradual than -~ for larger firms. Moreover, the demand for I I 2005 2(106 2001 lOOS ,009 2010 lOll I :o , n I I credit from small firms apparently remained subdued. C&I loans with original amounts N Sc o m n c : J; T h F ! r d o .. m to ! f o R r < Ih S < < J ' V '' < '' B p< o l a r : I d < , I ! l l ~ o w .;t c o < f : f p u t n b d o s n d c s la l m l. "!I$():>llty tdj. .t o:d 65 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00069 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.91031622 18 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 25 Change in standards and spreads nf1nan rates nvcr of $1m illion or less-a large share of which banks' cns! nf fimds fm cntruneTCial and industrial likely consist of loans to small businesses lOOIls, 1991-2012 fose slightly in the second half of 2012, at about the same rate that prevailed in the first half. Recent readings from the Survey of Terms of Business Lending indicate that the spreads charged by commercial banks on newly originated C&I loans v.;th original amounts less than $1 million, while still quite elevated, continued to decline.4 .... According to surveys conducted by the National Federation of Independent Business during the second half of 2012, the fraction of small businesses with borrowing needs stayed 19'92 1996 2000 2004 2000 2012 low. The net percentage of respondents that N<YIII: Thod.m"",cI:a""'fm:n."",~yttnmllyoondt!cttdf<llrtimes ptr 2 t y t 0 m p 12 I ; ; I Q m t o h 1 d e , . l E t a ig s " t , h b ~ t tn .. in n t . o . r. f t < aJ P > i I . l " a " f t ' r : d o I/ s m . ' " th t h e in o m 0 J 0 I . I \ D . . i P u o a j < : : y < = 2 p I 0 r u l o d l s '\ fo ItV f,.. t' , ) . ', ~. w ra ! h . b i . :h c 1 l 1 r . o m v t b th m o e t f m ou o n n d th c s r p ed ri i o t r m e o d r g e e d d i u ff p ic , u o l n t t b o a l o a b n t c a e i , n o t v h e a r n t h th is r ee b m a o :: : k' : s ~ C < T I h O o l o I r h I > 'u d n N d1 I b r a M rs c i l o ll i l l l i, l . l , l t m < 'i l a " i " io o d n I d . o in i d h u . s u tr io ia o l l. I l " " " ", " , " o i v o e n r t ' h " e d p <o a f s ", t ,, 1 ,,- h b m y period, as did the net percentage that expected theNO!i.o::l.aIllIlfflw.oi~'R". ." ",!t. tighter credit conditions over the next three &I S l o k o J L i:'J e ;; n : d F q "r lrorr.a.:l uR: .,.Il.'t '.', Boord, Sf:lio:r u.n orii"", OpiniM SuMy OJ> months; both measures remained at relatively high levels in the January survey. 26. Cnmponents of net equity issuance, 2006-12 Financial conditions in the commercial real estate sector eased but remained relatively tight 30 Financial conditions in the eRE sector continued to ease but remained relatively tight amid weak fundamentals. According to the SLOOS, a modest net fraction of banks reported having eased standards on eRE - I Public issumc< loans oyer the second half of last year, and I PriYatoil$"""'o - I o Rqrnro!w/S ,,. a significant net fraction of banks reported Mergers and acquisitions increased demand for such loans. Consistent - _ Total I I I I I I I with these readings, the multiyear contraction 2006 2007 2008 2009 2010 201l 20\2 in banks' holdings of CRE loans continued NOT>; Net eqJ.ity ;"",noo is the diITmnco b<two." <qcity i'o.Jod by to slow and, indeed, came roughly to a halt domesli<: eo"",ani .. ill public II" pri ....: . mllk<'.s and equity mimi tbrougb as banks' holdings of CRE loans were about share "V.crcr...... dom .... i. <:I.1b·Iinanc.d mergm, II" fmtign:aktovtrs of U.s. rl:!DS. Eq-.:ity iSiS'"""'" i:>::b. .. ftwdo ilI",s:od by prival' <qt:ily flat over the last quarter of 2012. Issuance partI><:1hil"and ,took "I".ion p:=t<h SOOAC!:: n.o:."", Rtulers Fm:.:iol, llIvestrn<Il1 8t!>:.h:Ilck RtpOIl; of commercial mortgage-backed securities I'ricewtt~~ and NotioOll V<Iltc.'< C~ital Al$OOiOlion. (CMBS) continued to increase over the second M""oyTrt.R<pon. half of 2012 from the low levels observed in 2011. Nonetheless., the delinquency rate on loans in CMBS pools remained extremely 4. Data releases for the Survey ofTenns of Business Lendingare available on the Federal Re:;en'e Board's website at wwwJedera1reserve.gov/releasesle2ldefault. him. 66 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00070 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.02031622 MONETARY POlICY REPORT: FEBRUARY 2013 19 high, as some borrowers with five-year loans issued in 2007 were unable to refinance upon the maturity of those loans because of high loan-to-value ratios. While delinquency rates for eRE loans at commercial banks continued to decline, they remained somewhat elevated, especially for construction and land development loans. Budget strains for state and local governments eased, bul federal purchases continued 10 decline Strains on state and local government budgets appear to have lessened some since earlier in the recovery. Although federal grants provided to state governments in the American Recovery and Reinvestment Act 27 Change in real gOI'erJUIItllt e,;:pendirures have essentially pbased out, state and local 011 consumption and investment, 2006-12 tax receipts, which have been increasing since 2010, rose moderately further o\'er the second o half of last year. Accordingly, after declining fedm.1 - , • Stot.l!:ld at an annual rate of I Viz percent in the first "" - , half of last year, real government purchases at the state and local level changed little in tbe second half (figure 27). Similarly, employment levels at states and municipalities, which had • been declining since 2009, changed little, on balance, over the second half of last year. - , Federal purchases continued to decline over I I I I the second half of 2012, reflecting ongoing 2006 2007 2008 2IXl9 2010 21111 2011 efforts to reduce the budget deficit and tbe Soo.ruJj: D!partmtntofCom:n""., Bum.u ofEo"",:"i< Analysi~ scaling back of overseas military activities. As measured in the NIPA, real federal expenditures on consumption and gross investment- the part of federal spending included in the calculation of GDP- fell at an annual rate of 3Viz percent over the second half of 2012. Real defense spending fell at an annual rate of a little over 6 percent, while nondefense purchases increased al an annual rate of 2 percent. The deficit in the federal unified budget remains high. The budget deficit for fiscal year 2012 was SI.1 trillion, or 7 percent of nominal GDP, down from the deficit recorded in 2011 but still sharply higher than tbe 67 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00071 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.12031622 20 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 28 Federnl receipts IlIXI aperxlitures, 1992 2012 deficits recorded prior to the onset of the last recession. The narrowing of the budget deficit relative to fiscal 20 II reflected an increase in ta,\ revenues that largely stemmed from the gradual increase in economic activity as well as a decline in spending. Despite the rise in - n Rectipts tax revenues, the ratio of federal receipts to national income, at 16 percent in fiscal 2012, remained near the low end of the range for this ratio over the past 60 years (figure 28). The ratio of federal outlays to GOP declined but was still high by historical standards, at I " 111 "' 11 ' '' '' 111''111 I 23 percent. With deficits still large, federal 1992 19915 nJO 200l 2OOl! 101. debt held by the public rose to 73 percent of ( a O n N ! O D f P o T ) r I i : s f = n fo . r - l r t l e : ) . c ' t . a f i o t p : u I t r s ( " O . , . = c d t o o .. b r .. o t , r . . e . t . n h .d r d o i m t u u & ; .. . h io . d S Q q a : J ta r . . a "" r , o b . e . r , ~ . " 1 " : i " f ' . " . d d . < b r u n d . g .t e io l lw ~ i.oru! 5 no p m er i c n e a n l t G ag D e P p o in in t t h s e h f ig o h u e rt r h t h q a u n a r a t t e r t h o e f e 2 n 0 d 1 2 o , f s.c..tacJ;: Ofil,.ofM.nag,""""tandBudt<!t. 2011 (5gur<29). 29 Federal govcnunent debt heM by the public, 196IJ-2012 Net exports added modestly to real GOP growth Real imports of goods and services contracted at an annual rate of nearly 2 percent over the second half of 2012, held back by the sluggish pace of U.S. demand (figure 30). The decline in imports was fairly broad based across major trading partners and categories of trade. Real exports of goods and services also fell at I 1,II.I,I IIt'll 1 lI m lt lltltll,ml!t llltll 1 ll 99 'l 2 I tlllt 2 l 0 ' 0 l 2 l llt!tl 2 l 0 l 1 t 2 I a h n a lf a n d n e u s a p l i te ra c te o n o t f i n a u b e o d u t e x 2 p p a e n r s c i e o n n t i i n n d th e e m s a e n c d o nd _ N<"I1 . 1: no da!a for dtbt tI:too&h 1011 art 11 of ym.end, and tho from EM&. Exports v.'Cfe dragged down by C<msp<l:ilin3 vW. f. .. "",. WmtsIr product (GDp) art for Q4 JI II:! a steep falloff in demand from the euro area all:,,!.''':'' ~"~"""",,!JO.MI~ .. ~:.<>ffedml~ and declining export sales to Japan, consistent F So = om . : . :I I ! M : B "" u " r ,, = ,.. o o t f S < Er , o ,, n , o ,, m .. > :-AllaIY"~ D<partmrllI of tho Treasury. with weak economic conditions in those areas. In contrast, exports to Canada remained 30 Change in real imports and exports of goods essentially flal. Across the major categories and s-ervices, 2007-12 . of exports, industrial supplies, automoti\'e products, and agricultural goodscomributed DI~ to the overall decrease . Overall, real net exports added an estimated J - w 0.1 percentage point to real GOP growth in the second half of 2012, according to the advance estimate of GOP from the Bureau of Economic Analysis, but data received since then suggest a somewhat larger positive contribution. I I I I 1JJfJ7 200lI ))1)9 2010 lOll 2012 Soola: Depa!1ml<llofC"""" ..... Bure",.fEronornioAWysiL 68 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00072 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.22031622 MONETARY POlICY REPORT: FEBRUARY 2013 21 The nominal trade deficit shrank, on net, 3t US track and currml 3c\:Oll!lt balances, 2004-12 o\'er the second half of 2012, contributing to the narrowing of the current account deficit to 2* percent of GOP in the third quarter , (figure 3\). The trade deficit as a share of GOP - , narrowed substantially in late 2008 and early - , 2009 when U.S. imports dropped sharply, in - part reflecting the steep decline in oil prices. - • Since then, the lrade deficit as a share of GOP , - has remained close to its 20091e\'el: Although imports recovered from their earlier drop, - , • exports strengthened as well. , , - I! ! ",. I I I I I The current account deficit in the third '''' 200s 1010 WI> quarter was financed by strong inflo\\'$ from Non: Th< <!ala.,.. quanerly o:d ex!<":Id !hrou&h2012:QJ for!ht CUIml! aro>UIl! ond 2012:Q4 for!Ilde. GD? i. groo. Wmc-oti, pro<!::OI. foreign official institutions and by foreign Soot",: o,.p..-w.n! "'C~B"". .. "of&o""",;" A:>aly>i~ private purchases of Treasury securities and equities (figure 32). More-recent data 32. US net financial inflows, 200S-l2 suggest continued strong foreign purchases of Treasury securities and equities in the fourth quaner of 2012. Consistent with improved o U.S.p:;\*(iodudi:gbcl.irI&) "., market sentiment over the third quaner, U.S. • FmiY'P:;\':!!.(indlldintN.ol:t:.g) ... investors also increased lheir holdings of • • F U m .S i o Y lT ' . 0 d f .1 f" ial ... foreign assets, as shown in figure 32. '00 National saving is very low '00 Total U.S. net national saving-that is, the saving of U.S. households, businesses, and '00 governments, net of depreciation charges '00 remains extremely low by historical standards I I I I '" 2009 1010 "" 2012 (figure 33). In the third quarter of last year, net NOli: Th< dJIa art C[IWI<rIy a::d ...." ,nd !hrou&h 2012:Q3. Negative national saving as a percent of nominal GDP numbon indica'" • babnce of p.)metlts OUIO"... ~ whOII u.s. w na a t s i o c n lo a s l e s a to v i z n e g r o r . a t T e h o e v r e e r la th ti e v e p a fl s a t tn fe e w ss y o e f a r t s h e • m 0< f 1 i f 1 d " M u io . n r s s . , i : . o : . . n . ~ " ! I n , S . . t . t o , J T ~ " h " m i:t i = O u r t r e , o ' ; m " , ' g g r n . o . t . . ; . . : . . " . " • , " n jr u n o m iu r b w o e a r h o " r . , , . u . f . o · s U r . Io • .s i g f . f t , p , ~ ; r . i ] v o a" t. , " , ~ o i r o t n ·U d n< .S l . , . reflects the ofTsening efTects of a narrowing ! l h io t I f s . " . · . i i \ g h n l h = eF " < " d 1 m ' I ." R q . u .. i . r . N .. . . . . !.-n f<I-,;Y' "':~ t.cl1 drow on I!><ir...-.p in the federal budget deficit as a share of Sooru:1: ~"'C"""".r. .. B""'.uofEoono:ni"~I)'>i~ nominal GOP and a downward movement in the private saving rate. National saving will likely remain low this year, in light of the still-large federal budget deficit. A ponion of the decline in federal savings relative to pre-recession levels is cyclical and would be expected to reverse as the economy recovers. If low levels of national sa'~ng persist over the longer run, they \\~lllikely be associated \\~th both low rates of capital formation and heavy borrowing from abroad, limiting the rise in the standard of living for U.S. residents over time. 69 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00073 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.32031622 22 PART I: RECENT ECONOMICA ND fiNANCIAL DEVElOPMENTS 33. Net saving, 1992-2(112 Financial Developments l'tt:<o,oI_rnp Expectations regarding the future stance of monetary policy reflected the additional accommodation provided by the Federal Open Market Committee ... In response to the steps taken by the FOMe to provide additional monetary policy accommodation over the second half of 2012, market participants pushed out the date when they expect the federal funds rate to first rise atxwe its current target range of I t I ! l9 I ! I I 1 I 9 96 I I I ! I o oo I I I ! I 0 04 I I I !0 I 08 I I ' ! I O I n I ot o ~ percent. In particular, interest rates on NOlI n. dst.a.,.. """,my o::d ",to<,d ~ 2Il12:Ql N,,::f<:drn.1 overnight index ~aps indicate that investors ,.,..;"gi,Ih.""", ~~m:lnO!bu$io"'I&>ing""" tMIl<'t ..v i:ogof currently anticipate that the effective federal state and 10<01 l<N<mmelltJ. GDP io VO"1lomt"", product. SooJa: Depon:n",' "fCOOlIllOTC<, Bum.u "fEcotJ>mi, Anal},>". funds rate will rise above its curremtarget range around the fourth quarter of 2014, roughly four quarters later than they expected 34. Interest rates on Treasury securities at selected at the end of June 2012. Meanwhile, the modal ma.turities, 2004-13 target rate path-the most likely values for ,- future federal funds rates derived from interest --., rate options-suggests that investors think the rate is most likely to remain in its current I{).~"'''''''''!III range through the first quarter of 2016. In - , ~I-~v,,,, addition, recent readings from the Survey - , of Primary Dealers conducted by the Open - , Market Desk at the Federal Reserve Bank of -f~ \, ""w' New York suggest that market participams V" expect the Federal Reserve to hold about -, , )~ $3.75 trillion of Treasury and agency securities I I I I at the end of 2014, roughly $1 trillion more ." '''' '''' '''' "" than was expected in the middle of 2012.1 Nom: n. dati. n daityand exte:od throochFebnwy 21,2011. Trwwy f u . : r /b .m ti( l l: R .p . r " o " lfl , " • t • td t l .f " ft l < ' > Il o n n ~ · " a n ( d T o I C P f S ·f ) h t . . , r . un . n .. p .. s . '" yield <1m'" frtW. II)' ... and held yields on longer-term SoulcE Dtpart::IeIl! ~ lb. TmsuI)': BL."Ia)'l; F.r.ml R,,,,,,. Bolrd Treasury securities and agency mortgage ,uff ..! CWe<. backed securities near historic lows Yields on nominal and inflation-protected Treasury securities remained near historic 10. ...' S over the second half of 2012 and into 2013. Yields on longer-term nominal Treasury securities rose, on balance, over this period, while yields on inflation-protected securities fell (figure 34). These changes likely 5. The Sur;·ey of Primary Dealers is available on the Federal Reser;·e Balik of New York's website at www.newyorkfed.org/marketslprimarydealeuumy_ questiolls.html. 70 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00074 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.42031622 MONETARY POlICY REPORT: FEBRUARY 1Q13 23 reftectthe effects of additional monetary accommodation, a substantial improvement in sentiment regarding the crisis in Europe that reduced demand for the relative safety and liquidity of nominal Treasury securities., and increases in the prices of key commodities since the end of June 2012. On balance, yields on 5-, 10-, and 3D-year nominal Treasury securities increased roughly 15 basis points, 30 basis points, and 40 basis points, respectively, from their levels at the end of June 2012, while yields on 5-and IO-year inflation-protected securities decreased roughly 55 basis points and 15 basis points, respectively. Treasury auctions generally continued to be ""'ell received by im'estors, and the Desk's outright purchases and sales of Treasury securities did not appear to have a material adverse effect on liquidity or market functioning. Yields on agency MBS were lin Ie changed, on net, o\·er the second half of 2012 and 35. Current-coupon yield and spread fOf agency into 2013. They fell sharply following the guaranteed mortgage-backed securities, 2009-13 FOMe's announcement of additional agency '-:,-------------=- MBS purcbases in September but retraced o\"er subsequent months. Spreads of yields on agency MBS over yields on nominal m Treasury securities narrowed, largely reflecting ,. the effects of tbe additional monetary - accommodation (figure 35). The Desk's outright purcbases of agency MBS did nOI - m appear to have a material adverse effect on liquidity or market functioning, although implied financing rates for some securities in the MBS dollar roll market declined in the I I I " I " I Jon July JOil. My Jan. July Jan. kly JOil. second half of 2012, and tbe Desk responded 2009 ~10 2011 2012 lOll by postponing senlement of some purchases N<m The do!>. 1ft d>ily and <'Xtrnd throu#t Fobrtwy 21, ~IJ Yiot.! using dollar rolliransaciions. 6 s w h h o ic w h n • i . s , . C ! o I r I O Ih t o \ p f !. o -b tc o i c . k < M d 1 s t o : 3 u O ri _ ti y . u . r W = l 1 rJd 1 b 1 o O p O i. " : f o lO d O a , t t p h a o r , « o q r > r O ", l . I , r v a a l I t u < a . t Spreod shown is to tho 0"""3' of tho l·wllQ.y""~T'"""wyyield& ~ !)qwtmom oltho TrtlIS1l/Y; 1latt1a)'S. 6. Dollar roO transactioos consist of a purchase or sale of agency MRS with the simultaneous agreement to sell or purchase substantially similar securities on a specified future date. The Conuuittee dim:ts the Desk to engage in these transactions as necessary to facilitate settlement of the federal Reserve's agency MRS purchases. 71 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00075 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.52031622 24 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 36 Spreads ofcOJporate bond yields over comparable Yields on corporate bonds reached record ofI·tbe·nDJ Treasury yields, by securities rating, lows, and equity prices increased 1997 2013 Yields on in\'estmem-and speculative-grade bonds reached record 10v.'S in the second half of 2012 and early 2013, respectively, partly reflecting the effects of the FOMe's additional monetary policy accommodation and increased il1\'estor appetite for bearing risk. Spreads to comparable-maturity Treasury securities also narrowed substamially but remained above the narrowest levels that they reached prior to the financial crisis (figure 36). Prices in the secondary market for syndicated ti t I I I I I I I ! I I ! I I I tit leveraged loans have increased, on balance, 1997 1999 1001 2003 ZOOS 1007 2009 20ll 2013 since the middle of 2012. NOTt: 1M dIIIa m daily and .xtend through F!bruary 11, 1013. Th. !p!uds sh""",m th< yiolds on to-ytar bonds 10 .. tit. to-yea< T'"""'Y ) L 'i y o & ! t d c . . r l I u b : o i: c : : d D d ! a :t : i a v . e d fm:n s:nooth.d oO!pO!ll. yidd = <:sing, Me:riIt a B b r o o u ad t 1 e 0 q u p i e ty rc e p n ri t c s e i n in c d e e t x h e e s e h n a d v e o f in J c u r n e e a s 2 e 0 d 1 2, boosted by the same factors that comributed 37. S&P500index,199'>-2013 10 the narrowing in bond spreads (figure 37). Nevertheless, the spread between the 12-month forward earnings-price ratio for the S&P 500 and a long-run real Treasury yield- a rough jlvY - gauge of the equity risk premium-remained ,~ at the high end of its historical range (figure 38). Implied volatility for the S&P 500 index, as calculated from option prices, spiked at times but is currently neaf the bottom end of the range it has occupied since the onset of -/ the financial crisis (figure 39). I I I I " " 1 I I II 1 I I I " " I Conditions in short-term dollar funding t995 1998 200t 2004 2007 2010 1013 markets improved some in the third NOTli: Thtdall "" daily ooda:e::dlhnrJgb February 21,201J. quarter and remained stable thereafter Sovm:: StaI&rd & l'ooI'l Measures of stress in unsecured dollar funding markets eased somewhat in the third quarter of 2012 and remained stable at relatively low le\'els thereafter, reflecting impro\'ed semimem regarding the crisis in Europe. For example, the average maturity of unsecured financial CP issued by institutions with European parents increased, on nel, to around the same length as such CP issued by institutions with U.S. parents. Signs of stre~ were largely absent in secured short-term dollar funding markets. In the market for repurchase agreements (repos), 72 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00076 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.62031622 MONETARY POlICY REPORT: FEBRUARY 2013 25 bid-asked spreads and haircuts for most 38 ReallOf1g·nuJ Treasury yiekl and 12·month forward collateral types have changed little since the earnings-price ratio for the S&P 500, 1995-2013 middle of 2012. Howen:r, repo rates continued to edge up over the second half of 2012, likely ------------------------~,-- reflecting in part the financing of the increase -w in dealers' inventories of shorter-term Treasury securities that resulted from the maturity extension program (MEP). Following year end, repo rates fell back as the MEP came to an end and the level of reserve balances began to increase. In asset-backed commercial paper (ABCP) markets, volumes outstanding declined a bit for programs with European and U.S. sponsors, while spreads on ABCPwith 1 1 I 9 '1:S I I 1 1 m 1 1 2 I 0 01 I I 2 I (1 (14 1 I 2 I 0 07 1 I 2 I 0 10 1 I l 1 Ol 1 l 1 European bank sponsors remained slightly N01I!: Th. data .... IIIOllthly cd ..t end lhrou&!> .ianill:)' 2011. lb< above those on ABCP with U.S. bank sponsors. "'I"""I<dral y;.ld on 10.1""' fItMIll)' ~ Mfrntd .. tht o(f·tht·"", 10"1""' Trtuury y;.1d Ie" tbt F<dml R.oerve Bank of Philadtlrtia', IO·ynr ~il:fIolion. Year-end pressures in short-term funding SWm: S~ &: P(Wli~ Th>:n$<ll) R<U!rn Fin.a:rio1;F<dm.1 R~ B=d; FtdmI R".,... Bank ofPhilodtljrnL markets were generally modest and roughly in line with the experiences during other years since the financial crisis. 39 Implied S&P 500 volatiliry, 1995 2013 Market sentiment toward the banking industry improved as the profitability of - w banks increased - ," Market sentiment toward the banking -- ,~. industry improved in the second half of 2012, reportedly driven in large part by perceptions --,~. of reduced downside risks stemming from the European crisis. Equity prices for bank holding -w companies (BHCs) increased, outpacing -w the increases in broad equity price indexes, , I I 111 I 1 1 I 1 1 1 I 1 1 I 1 1 I 1 I and BHC credit default swap (CDS) spreads 1m 1998 2001 200< 2007 2010 lOll declined (figure 40). N01I!: The dato "" weekly aM <'XtrruI througb tht w..o: rn.!i", F<'bruary 15, 2Il13. Th. w:rits sl»wn--tht VLX_is tbt imp~td )O.doy wlQilily of tbt S&P 500 0I<>d: I'ri<,< io<!O< .. ,o1cu1l1e1l from , " ..i glmd The profitability of BHCs increased in the '¥mg' rI. opions Iri:<~ Sool£i: Chi:a&" BoudOp;imIs Exohar!&" second half of 2012 but continued to run well below the levels that prevailed before the financial crisis (figure 41). Measures of asset quality generally improved further, as delinquency and charge-otT rates decreased for almost all major loan categories, although the recent improvement in delinquency rates for consumer credit in part reflects a compositional shift of credit supply toward higber-credit quality borrowers. Loan loss provisions were flat at around the slightly elevated levels seen prior to the crisis., though they continued \0 be outpaced by charge-otTs. Regulatory 73 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00077 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.72031622 26 PART I: RECENT ECONOMICA ND fiNANCIAL DEVElOPMENTS 4<l. Spreads 011 credit default swaps for selected capital ratios remained at high levels based U.S. bankingorganizatioM, 2007-13 on current standards., but the implementation B_,_ of generally more stringent Basel III capital requirements will likely lead to some decline in - '00 reported regulatory capital ratios at the largest - '" banks. Overall, banks remain well funded ~~ - '00 with deposits., and their reliance on short-term I - '" wholesale funding stayed near its low levels ho\ruojJ""""o". .. seen in re<:em quarters. The expiration of - '00 ~,\ ~ the Federal Deposit Insurance Corporation'S '" ".L v ~ '00 T on ra D ns e a c c e t m io b n e A r 3 cc 1 o , u 20 n 1 t 2 G , d u o a e ra s n n te o e t a p p ro p g ea ra r m to " have caused any significant change in the 2001 200& 1009 2010 2011 lOtl 2013 availability of deposit funding for banks. NO'JII: n.. dA:a 1ft daily ood attnd Ihrou&h FdIruary 21, 2013. M«!ia:I 'f't<Ids fOlIi>; Iq< bonk holdiq ,ornpW<> oed oW< oll:<rbcls. Credit provided by commercial banking Soolc>;,Ma:kit organizations in the United Slates increased in the second half of 2012 at about the same 41. Profitability of bank holding companies, 1997 2012 moderate pace as in the first half of the year. Core loans- the sum of C&I loans, real estate loans, and consumer loans-expanded l.l - modestly, with strong growth in C&I loans offsetting l,I:eakness in real estate and credit 1.0 - card loans (figure 42). Banks' holdings of securities continued to rise moderately overall, as strong growth in holdings of Treasury and municipal securities more than offset modest declines in holdings of agency MBS. 1.0 - l.l - Despite continued improvements in I ! I I I I ! I II I I I I I I II I market conditions, risks to the stability of t!)97 100) »)3 1006 1009 1012 financial markets remain NOT!' Th. dat>., whiob .,.. """",Dy uljusttd, L.. . qUOrlrny and <l1<::o tbrou#1012Q4. While conditions in short-term dollar funding Scoc:i: FodmI R• . .,.... &ord, FR Y-9C, COIISOUo.t<d Fin.o:!oiaJ S:o.t""",(sfor&:il<Hoidi",C"",,,,,,,i ... markets have improved, these markets remain vulnerable to potential stresses. Money market funds (MMFs) han! sharply reduced their overall exposures to Europe since the middle of 2011, but prime fund exposures to Europe continue to be substantial. MMFs also remain susceptible to the risk of investor runs due to structural vulnerabilities posed by the rounding of net asset values and the absence of loss-absorbing capital.) 7. In November 2012, the Financial Stability O..-eroigbt CoWlcil proposed reconunendations for structural refonns of U.S. MMFs to reduce their vulnerability to runs and mitigate as:!OCiated risks to the financial system. 74 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00078 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.82031622 MONETARY POlICY REPORT: FEBRUARY 1Q13 27 Dealer firms have reduced their wholesale 42 Change in commercial811d industrial loans and core short -term funding ratios and have increased loans, 1990-2012 their liquidity butTers in recent years, but they still heavily rely on wholesale short -term funding. As a result, they remain susceptible to swings in market confidence and a possible resurgence of anxiety regarding counterparty w credit risk. Respondents to the Senior Credit Officer Opinion Survey on Dealer Financing Terms indicated that credit terms applicable to -w important classes of counterparties were lillie changed over the second half of 2012.8 Dealers '" reported increased demand for funding of - securitized products and indicated that the use I I I I I I I I I I II I I I I I I I I I I I I I I t991 1'194 1!m 2000 1003 2006 100\1 1012 o in f v e fi s n t a m n e c n ia t l t l r e u v s e ts r , a g o e r a R m E o I n T g s, t h ra a d d i n in g c r r e e a a s l e e d s tate !hn N >u O g l b I: :! T 0 h 1 e 2 :Q cl 4 a . , C ., O w f< h i " c " h ' . " ", = ,e s t i I _ <I Q lII f .l ' l O y : a o d : j" q .: , s m t«I l , l . o . : . : . d q i u w or i te u I s ly t r a i n o d l l " _ , . n ., ~ I somewhat. Hov.'ever, respondents continued ..t ate k>o::s, o.nd 0""'''''''''' k>a:u. Data hove """" adjUJll:d for bo:W" inl>l<memation Qfe<r!lin ",,=tiog 11lI. dlongt< (i:1'~.Idio& tho Finan..-iol to note an increase in the amount of resources A"' ... :::!i:1,S~Il<>&nf.Stat""'<C.tiQfFi=iol~ su:.lOO Noo. 160 aru:l167jandf<Itho.ffe<Uo>flq.nort.clir.stitntion!«>nmliog and allention devoted to the management toro:n:n~iol DaW O:!IIOT!in3 ..; thl""""",~iol h:lk. of concentrated exposures 10 Central Soolt::i; F<dmI Rfiervo JkIo.--d, SlItist.,.1 R. ..... H.S, "AWtl aru:l Liahi~ti .. o>fC"""",mol Bcl:s "' tho U.-.... ed Swos: counterparties and other financial utilities as well as, to a smaller extent, dealers and other financial intermediaries. With prospective returns on safe assets remaining low, some financial market participants appeared willing to take on more duration and credit risk to boost returns. The pace of speculative-grade corporate bond issuance has been rapid in recent months, and while most of this issuance appears to have been earmarked for the refinancing of existing debt, there has also been an increase in debt to facilitate transactions involving significant risks. In particular, in bonds issued to finance private equity transactions, there has been a reemergence of payment-in-kind options that permit the issuer to increase the face value of debt in lieu of a cash interest payment, and anecdotal reports indicate that bond covenants are becoming less restricti\'e. Similarly, issuance of bank loans \0 finance dividend recapitalization deals as \\'ell as covenant -lite loans was robust over the second half of the 8. The Senior Credit Officer Opinion Sumy on Dealer Financing Term;; is available en the Federal Rese!'\'e Board's website at wwwJederairesen·e.gOllleconresdatal releaseslscoos.htm. 75 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00079 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.92031622 28 PART I: RECENTE CONOMIC AND fiNANCIAL DEVElOPMENTS Table I. Selected components of the Federal Resen'e balance sheet, 2012-13 ;\li!li"",ofdolJars ~b " . " 22 , " W " B " T. ..I ....t <" .. 1.9~.149 1.S6S,ms J.Il9Ii.801 Selo:ltJu ..t I Crodi! e:<~ lori.:ponMl 'Im·r.JJWnJ rM dealen Primlryortdit... " 107,959 27,059 5.192 Crodi! tx~IOC'!JD".".Wparri~" ,m Term AoseI·BaobJ Securities Loilo Facilily (TAL!'). ... 7,679 '" N<I portfolio boidioy ofTALF LLC '" 'OS ~, itI,i/w'"" S~pon b/ ctiN,,1 N<t portfolio boldi""of Maiden La .. LLC, Maiden La ... II LLC, and Maiden La .. III LLC' .. >0,822 15,031 1,4S1 SmI~""IoddOUlrit;Jt' U.s,Tr",u'Y9l!Cllrilieo .. . 1,656,581 1,666,530 1,136,456 AlJOIICYdobt...:urit;.., .. . 100,817 91,41 ;4,613 Ayo<y""'rt~"""Bl9l!Clllilieo(MBSJ .... 353,M5 854,9j9 1,031,112 T. ..n ,WiriH '"'"'' 2.811.019 J.{).I1.8W Selo:"" liabilities IW:ral RneM AQ(t< ill cimJlatioo ... 1.{I48,00I 1,061,911 1,12l,l2J Re. ..... rep"rcb""'~.u .. S9,S~ Sl,nJ !n,ll) o.po o . r it . < .' b bo ib l.l : T bo t t r d m o d "" o " p i o t" s ') i ' u i ..t iulli"", .. 1,622,800• 1,491,988• 1,668,381• U U . . s s , . T T" , ~ u ' , ' u "' 'l Y l , I S : " ' ~ ' p " l " t r r aI u O t < o X l : i < l ) ' "n Y l Finfin<illtA""'""l. ... >6,033• m.m • 40)03• TOIllcopill1 "'" "'" 5-4.982 n N 1 , i "n t "". " F L S~ e l . d C " m ' . . l , R e ' o o i O " " l " " p " d > . b > I" i u t b l u i 1 li > t l . 0 y . . " M d " e " d . ' . 1 m ,, " d , l i W ' l t o o ' ," n " L ,, L ,1 C u .. . . c . f . < " r m "" o j l U '" ll e p o tl o tO , w lu it t l l " o ,r i r J . , . , " ';" . l , l I " > 'I O 'P rt " g " ' t . l , ! . '· " b ~ « '" h ; 4 ,, " '" ro "" o " o ~ , . . I M " a " i d ,h " e lA US o . . " U " C " ' . , . . . , . k f< ' r d O i le ' d l ' " 0 ' " ~ ' m l t " o ; t " ' " " " p " o ~ n f . o . J . i , o ~ o l o f , J , u , W ,,! i , d o , l u A iu IO or • A • I I d l .".,n~t . t . " . I - >~ = " I , . " " d ' , ' b ' u ' l , O ' r " o 'I u '"e ~ o' '' " O' ' ''l ~ Y, , ( " A ,, l " a ), Maid" La, m LlC .... formed to pur<l> .....o Iti_r ",It.<mliz<d d.bt oliiptiouoo. ...,io\. Ib, Fi. .o ci~ I'rod""b ~ "'~d" "'I)' MRS purlOb .... "''' ."" ,mb:! Scola; Fed.,,1 R<""", lloanl,S,,"=!C>I R, • ..., H~ I, "F"" .. A!I;,,"'i R,,,,,,, lIo.1u<to of Dtp«;,'1)' 1. ..." ,_ ..d eo.d.". St~''''''' of Fe4",1 R,,,,,,, 11>,1:0.' year. (For a discussion of regulatory steps value of Treasury securities and agency MB S taken related to financial stability, see the held by the Federal Reserve had increased box "The Federal Reserve's Actions to Foster $70 billion and $178 billion, respectively, Financial Stability.") since the end of June 2012. The composition of Treasury securities holdings also changed over the second half of 2012 as a result Federal Reserve assets increased, and the of the continuation of the MEP, which was average maturity of its Treasury holdings announced at the June 2012 FOMC meeting. lengthened, . , Under this program, betv.een July and Total assets of the Federal Reserve increased December, the Desk purchased $267 billion in to $3,097 billion as of February 20, 2013, Treasury securities \\'ith remaining maturities $231 billion more than attbe end of of 6 to 30 years and sold or redeemed an June 2012 (table 1). The increase primarily equal par value of Treasury securities with reflects growth in Federal Reserve holdings maturities of 3 years or less. As a result, the of Treasury securities and agency MBS as a average maturity of the Federal Reserve's result of the purchase programs initiated at the Treasury holdings increased 1.7 years over the September 2012 and December 2012 FOMC second half of 2012 and into 2013 and, as of meetings. As of February 20, 2013, the par February 2013, stood at 10.5 years. 76 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00080 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.03031622 MONETARY POlICY REPORT: FEBRUARY 2Ot3 29 · .. while exposure to facilities June 2012, while Federal Reserve notes in established during the crisis continued to circulation rose $60 billion, reflecting solid wind down demand botb at home and abroad. M2 bas increased at an annual rate of about In the second half of 2012, the Federal 8 percent since June 2012. Holdings of M2 Reserve continued to reduce its exposure to assets, including its largest component, liquid facilities established during the financial crisis deposits, remain elevated relative to what to support specific institutions. The portfolio would have been expected based on historical holdings of Maiden Lane LLC and Maiden relationships with nominal income and Lane III LLC-entities that were created interest rates, likely due to investors' continued during the crisis to acquire certain assets preference to hold safe and liquid assets. from The Bear Steams Companies, Inc., and American International Group, Inc., to avoid As pan of its ongoing program to ellsure the the disorderly failures of those institutions readiness of tools to manage resen'es, the declined $14 billion to approximately Federal Reserve conducted a series of small $1 billion, primarily reflecting the sale of the value re\·erse repurchase transactions using remaining securities in Maiden Lane III LLC all eligible collateral types with its expanded that was announced in August 2012. These list of counter parties, as \\'ell as a few small sales resulted in a net gain of $6.6 billion for value repurchase agreements with primary the benefit of the U.S. public. The Federal dealers. In the same vein, the Federal Reserve Reserve's loans to Maiden Lane LLC continued to otTer small-value term deposits and Maiden Lane III LLC had been fully through the Term Deposit Facility to provide repaid, with interest, as of June 2012. Loans eligible institutions with an opportunity outstanding under the Term Asset-Backed to become familiar with term deposit Securities Loan Facility (TALF) decreased operations. $4 billion to under 51 billion because of prepayments and maturities of TALF loans. With accumulated fees collected through International Developments TALF exceeding the amount of TALF loans outstanding, the Federal Reserve and Foreign financial market stresses the Treasury agreed in January to end the abated ... backstop for TALF provided by the Troubled Asset Relief Program. Since mid-July, global financial market conditions ha\·e improved, on balance, in The improvement in ofTshore U.S. dollar part reflecting reduced fears of a significant funding markets over the second half of 2012 worsening of the European fiscal and financial led to a decline in the outstanding amount crisis. Market sentiment was bolstered of dollars provided through the temporary by a new European Central Bank (ECB) U.S. dollar liquidity swap arrangements framework for purchases of sovereign debt with other central banks. As of February 20, known as Outright Monetary Transactions 2013, drav.--s on the liquidity swap lines "'ere (OMT), agreements on continued official $5 billion, down from $27 billion at the end of sector support for Greece, progress by Spain June 2012. On December 13, 2012, the Federal in recapitalizing its troubled banks, and some Resef\'e announced the extension of these steps toward fiscal and financial integration arrangements through February 1, 2014. in Europe. Nevertheless, financial market stresses in Europe remained elevated, and On tbe liability side of the Federal Resen'e's policymakers still face significant challenges balance sheet, deposits held by depository (see the bo:< "An Update on the European institutions increased $176 billion since Fiscal and Banking Crisis"). 77 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00081 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.13031622 30 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS The Federal Reserve's Actions to Foster Financial Stability The Federal Reserve continued to take actions For example, as mandated by the Dodd-frank Act, in Ihe second half of 2012 and ea~y 2013 to met€ the nl€v supervisory framework for systemically its financial stability responsibilities. Although important financial market utilities IFMUs}-that much remains 10 be done, the Federal Reserve is, lhose entities that provide the infrastructure has implemented regulatory reforms to streogthen to make payments and clear and settle financial the U.S. financial system, and it has taken further lransactions-has continued to take shape. In steps to gather in/ormation from the supervisioo of July 2011, the Financial Stability O:ersight Council large banks, market reports, and other aonomic IFSOC) designated eight FMUs as systemically and financial sources to assess threats to financial important and thus subject to enhanced risk· stability. The Federal Reserve also has continued management standards. On July 30, the Federal to work closely with its domestic regulatory Reserve Board approved a final rule establishing counterparts and has taken actions to increase the enhaoced risk.management standards for designated resilience of the international financial regulatory FMUs supervised by the Federal Reserve. The rule architature. also establishes processes to review and consult with the Saurities and Exchange Commission (SEC) and Regulation theCorrmxlity Futures Trading Commission (CFTC) on any proposed changes to the rules, Il"ocedures, A core element of the global regulatory or opetations of certain designated fMUs that could comrrunity's efforts to improve banking regulation materially affect the nature or 1\€Iei of their risk. has been the d\€felopment 0/ the Basel III capital The FSOC has also continued to make progress in reforms. In June lOll, the Federal ReselVe Board and its work to designate systemically important nonbank the other u.s. banking agencies issued a proposal financial companies for consolidated supetllision by to amend the u.s. bank capital rules to implement the federal Reserve. Relying primarily 011 data from these reforms. The Basel III reforms will raise the publicly a\'ailable reports, the fSOC is evaluating quantity of capital that must be held by u.s. banking the potential systemic importance of a nurrber 0/ firms, improve the quality of regulatory capital 01 nonbank firms that meet the quantitative criteria those firms, and strengthen the risk.weight framework for a flrst.stage review; to date, it has concluded of u.s. bank capital rules. that some firms warranted further consideration Consistent with the requirements of the Dodd and has advanced them to the third and final stage Frank Wall Street Re/orm and Consumer Protection of the determination process. Meanwhile, the Act r:i 2010 (Dodd-Frank Act), the Board has International Association 0/ Insuraoce Supetvisors, also proposed rules to strengthen the oversight 01 under the oversight of the Financial Stability the U.S. operations 01 foreign banks. Under the Board, has continued to move forward on crafting Board's Decerrber 2012 proposal, foreign banking a methooology to identify global systemically organizations (FBOs) with a large U.S. presence important insurers and developing policy measures would be required to create an intermediate holding that would be applicable to those institutions. company (IHC) over their U.S. subsidiaries, which In addition, efforts to increase the resilience would help/acilitate cOllSistent and enhanced of NshadoY.t banking," which refers to credit supetvision and regulation of the U.S. operations of intermediation that occurs at least partly outside these/oreign banks. An IHC 01 a foreign bank would of the traditional banking system, are continuing. be required to meet the same U.S. risk·based capital In November 2012, the FSCX: proposed and leverage rules as a U.S. bank holding company recommendations for structural reforms of U.S. (BHC).ln addition, IHCs and the U.S. branches and money market funds to reduce their vulnerability to agencies of foreign banks lvith a large U.S. presence runs and mitigate associated risks to the financial would need to meet liquidity requirements simlaI' to system. Another set 0/ reforms has been aimed those imposed on U.S. BHCs. at the triparty repurchase agreement markets, Progress in regulato!), reform outside 01 the including efforts by the federal Reserve to reduce traditional banking sector has been notable as well. the vulnerabilities created by the large amounts of 78 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00082 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.23031622 MONETARY POlICY REPORT: FEBRUARY 2013 31 inlraday credil provided by clearing wnks in these to work with the SEC and the CfTC to develop markels.lnlemalional regulalory groups have also and implement effective supervisory practices been addressing the financial slabilily risks of and techniques for designated fMUs, including shadow wnking. appropriate information.sharing arrangements and Federal Reserve participalion in SEC and CfTC Supervision examinations of designated FMUs. The Federal Reserve has conlinued to work 10 Monitoring enDed its superlisory lXactices wilhin a broader macroprudenlial framework. Annual stress tests. The Federal Reserve has continued to pursue which assess the internal capilal planning processes an acti\' € program of research and data collection, and capilal adequacy of Ihe largesl SHCs, conlinue often in conjunclion with other u.s. and foreign to be an i~rtanl element in its strengthened. regulators and supervisors, and to work on cross·firm supervisory approach. The latest deo.'eloping a framework and infrastructure for ComlXehensi\l € Capital Analysis and Review (Co\R monitoring risks to financial stability. It continues 1013), which covers the 18 largest SHCs (and is to regularly monitor a variety of items that measure being conducted in a modified form for 11 other key financial vulnerabilities, such as leverage, large SHCs), is IlOW under way. In O::tober 2012, maturity m'smatch, interconnectedness, and the Soard published final stress·testing rules under complexity of financial institutions, markets, and the Dodd-frank Act, and it released the economic products. In a context of ad\'f€S € shocks, such and financial market stress scenarios for CO\R IlUlnerabilities could lead to fire sales and an 1013 in November.' Co\R 2013 results will be adverse feedback loop with credit availability, released in March of this year. which could, in turn, inflict harm on the real The Federal Reserve has also been working economy. to impro\l € the resolvability of the largest, most The Federal Reserve pays special attention cOITfllex banking firm;. The Dodd-frank Act to de\ll€opments at the largest, most complex created the Orderly Liquidation Authority (OLA) to financial firms, using both information gathered improve the prospects for an orderly liquidalion of through supervision and indicators 01 financial a systemic financial firm and requires that all large conditions and systemic risk from financial markets. BHes submit resolution plans to their supervisors. It has been analyzing the consequences for firms The Federal Deposit Insurance Corporation (FDIC) and markets resulting from the ongoing strains has been developing a single-lX!int.of.entry strategy in European financial markets as well as those for resolving systemic financial firm; under OLA, associated with the fiscal situation in the United and the federal Reserve, working closely with the States. Another issue that the Federal Reserve is FDIC, has been carefully revieo.'1ing the resolution monitoring closely is the potential incentive for plans (the so·called living wills) submilled in the some investors and institutions to take on excessive sUn1ll"'er and fall of 2012 by the largest and most risk- for example, by inaeasing I'€.'r€age, credit cOITfllex BHCs and FBOs. risk, and duration risk- in an allemptto reach for In line with a joint agency report to the Congress yield in a sustained 1(1,'1 interest rate environment. in July 2011, the Federal Reserve has continued Moreover, efforts are ongoing, both at the Federal Reserve and elsewhere, to evaluate and develop neo.'1 macroprudential tools that could help limit I. Information on the Dodd-FrankAcl >tr~ teSIS buildups of systemic risk or increase the resilience and CO\.R areal\lilable on the Federal Reser"", Board·! website at www.federalre;erve.govlbankinforeg!stres~ of financial institutions and markets to potential tests<api!.ll-planning.htm. adverse shocks. 79 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00083 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.33031622 32 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS An Update on the European Fiscal and Banking Crisis In the second half of 2012, European generally fulfilling their policy comnitments under policymakers stepped up efforts 10 supporl Iheir official financial assistance programs. In vulnerable euro·area economies, strengthefl Spain, the government secured euro·area official domestic public finances and banking systems, approval and financing for its bank restructuring and and reinforce the monetary union. As a result, recapitalization plans. In Greece, the government European financial stresses have moderated over reinvigorated its long-stalled austerity and reform the past several months. Neverthdess, they remain initiatives. In response, European authorities resumed elevated, and European policymakers still face financial assistance to the Greek govE'rnment and significant challenges as they sed to improve fiscal look steps to address Greece's public debt burden, positions, implemeflt growth-augmenting structural including E'asing thE' terms 01 euro·area official reforms, and bolster regional integration in a difficult financing and funding a discounted buyback economic environment. of roughly £30 billion in privately hE'ld Greek A key turning point in the euro·area crisis government debt. More generally, offICial financial occurred in late July, when Mario Draghi, the assistance is continuing to provide vulnerable European Central Bank (ECB) presideflt, stated, countries with brE'athing room to make the difficult 'Within oUI mandate, the ECB is ready to do adjustments needed to resolve their crises. whatever it takes to preser:e the euro."' The ECB European governments have also made some subsequeflily unveiled a frame'lvork for Outright progress toward a European banking union. After Monetary Transactions (DMT) to address distortions protracted nE'gotiations, European leaders agreed in euro·area government bond markets that in December on key details of a single supervisory underrrine the transmission 01 monetary po1icy. mechanism (SSM) for European banks with the Under certain conditions, the ECB can purchase ECB at its center. The SSM is E.>Xpected to be potentially unlimited amounts of government established sometime this spring and should enter bonds.2 To date, the ECB has not purchased any into force in early 2014. The ECB will directly bonds under the OMT frame\vork. Neverthdess, supervise large euro·area banks and will be able the announcement of the framework has rritigated to assume (from national authorities) super~ision investors' concerns about the adequacy of financial of any euro-arE'a bank whE'n necessary to ensure backstops for the Italian and Spanish governments consistent application of high supervisory standards. and, more generally, about the integrity of the euro Establishment 01 the SSM is ~iewed as a necessary area. precondition for euro·arE'a governments to share Vulnerable euro·area countries have made more directly the fiscal burden of resolVing progress in strengthening their banking systems national banking crises. In addition, European and public finances in recent months. The governments recently set objecti\lS€ to accelerate governments of Ireland and Portugal have been the harmonization of national policy frame'lvorks for bank resolution and deposit insurance and, further down the road, to create a single mechanism for I. See Mario Draghi (20121. 'Verbatim oftoc Remnb Made by Mario Draghi: speech delivered at theGkbal bank resolution and recovery. tnves!merlt Confereoce, london, July 26, www.ecb.intl In part because of the positil'e de~'elopments prew1;ey/datel201 2/html/SP I 10726.erJ.htrrl. highlighted previously, financial stresses facing 2. The EeB's purchases will focus ongo~rnment yulner.lble European governments and banks oonds with maturities of OJlE' tothree years. The ECB will though still elellated-mcxlerated substantially in the have full discretion over thesepurchases. A necessary condition for ECB purchases is that a go'I('fnment reqllt'St second half of 2012 and E'arly 2013. Sovereign yields a full or precaution.Jry financial a~stancE'program from declined signifICantly evE'n as the Italian and Spanish the Eurcvean Financial Stability racili!)' or the European governments issued substantial armunts 01 debt. Stlbility Meo:hanism.A goo.'E'lnment that already has In addition, the Irish and Portuguese governments g su o c v h e r a n m pr e o n g t r s a m m u m st u f s u t l fo rg€ ll a i t n h eir m p a o rk li !€ c y a c c o c m e m ss. i tm In e a n d l d S i t u io n n d , e r began returning to bond markets; elch conducted a their programs and the elJro-ared govf>lnancE' framE'WOO:. limited, yet successiul, sale of bonds in January. 80 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00084 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.43031622 MONETARY POlICY REPORT: FEBRUARY 1Q13 33 Reduced concerns about the European crisis 43. Equity indexes for selected foreign ecooomies, contributed to an easing of funding conditions 2009 13 for European banks. Euro-area banks have _30.bM-lOO relied somewhat less on ECB funding in recent months, and use of cemral bank dollar liquidity S\\'ap lines declined significantly. ReSecting market vie ....- s of the decreased risk of default, CDS premiums on the debt of many large banks in Europe dropped significantly, on net, especially for Italy and Spain, and euro-area bank stocks increased about 30 percent since mid-2012 (figure 43). As risk sentimem improved, foreign equity , I indexes rose significantly: Over the second half Nm: Tho dala .,. doily. Tho lui observol .... fOf .." h se:i .. is of 2012 and into early 2013, equity indexes fdm:uy 20, 2013. E.....wog "'unto .... Bm;il, Cl:il,. Chilli, C. .o M;'" increased about 10 percent for the United C=h Rq>UbI;". Eg)l'I. Hung&y, Jru!i>, Ic&:.n.<ia. Malay<io. Maim, M",""""" PmI, til< Phjuppincs, Poland, Russi .. So\llh Afuc: .. Soulh Kom, Kingdom and Canada, about 15 percent in nillu, lb!ib::d, and Turk'}" the eUfO area, and about 25 percent in Japan; C. S .. o i t u & .C t I I I I ; l k F x o ; r" fo " :- '"' t Z h: i n < tr U o N a r . h ,. u . , . M D . o 'g w " S J 1 m a . n l . t y E E u : : n o < rsgriongxMxo. r I I n : d ' o 1 < S : ~ D f E o f r equity indexes in EMEs also moved up across ouro-atU be.nk:s, Dow Jonn Ell," STOXX Bel: Indo<; ftt I"""" T<i-yo S1O<'kExcl:ant:o(TOPL\); aUviaBIoo:Ii>trg. the board, as shown in figure 43. Likewise, yields on IO-year government bonds in many countries increased moderately, though 44 Gl:Ivemment debt spreads for peripheral Japanese yields remained below I percent. El.IJopean ~oooomies, 2009-13 Spreads of peripheral European sovereign ----------------~----~~ yields over German bond yields of comparable -n maturity declined significantly as overall - u euro-area financial strains abated (figure 44). - u Corporate credit spreads also declined, and - w bond issuance picked up. - " - " The U.S. dollar depreciated nearly I percent against a broad set of currencies over the second half of 2012 and into early 2013 (figure 45). Some of this depreciation reflected a reversal of flight-to-safety flows, in pan ." I , 20 I t 2 I , 2(llJ stemming from the reduction in European NOll: Tho dr. . are ..~ <ldy. Tho tast ob>.......:ioo. for ...,h se:i .. is financial stress. Indeed, the dollar depreciated Feb:uaIy IS, 20ll. Tho 'llftods ~n.,. th: yi.l<!> ... 10·y.a: bonds 10" th: IO.yoa:-Gtrroanbo.:>:ly;..td. 4 percent against the euro. In contrast, the Sow:Ii: For G,...,., ttaly, PmrugaJ, a:.rl SJ-,in. Sloont>trg; for Irdand, dollar appreciated 17 percent against the .toft" ..: imateJ \!SCi trad<d bwd Jri..~ Ii"", Ibo:>l"", R",tm II!Id Bl'">:obtrz. Japanese yen. Most of this rise came in recent months, as Shinzo Abe, the newly elected prime minister of Japan, called for the Bank of Japan to employ "unlimited easing" of monetary policy to overcome deflation. 81 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00085 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.53031622 34 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 4S U.S mllar exchange mte against broad index ... but economic activity in the advanced and selected maj(J£ clUTCllCies, 2010 13 foreign economies continued to weaken ... ll«<d>erll,Z009-I00 Despite the easing of financial stresses in the euro area and some improvement in global financial markets, activity in the advanced foreign economies (AFEs) continued to lose stearn in the second half of 2012 (figure 46). The euro area fell further into recession, as fiscal austerity, rising unemployment, and depressed confidence restrained spending, especially in the countries al the center of the ." crisis, Real GOP also contracted in Japan, ! I I I I! 2010 2012 2013 reflecting plummeting exports. In the United Ncm:: Tho daa, whim .... in foreign oum:ry wts perdollar, are d.!ily Kingdom, real GOP growth resumed in the Thotal1observatimfQaoc:b..n.." Frilruary2t, 20t3, third quarter, partly thanks to a temporary Soutc!: fodml Res.,." &oro, Stotist".1 R.I/Z$< H.10, "fo:.ign El<d:ang.Raus," boost to demand from the London Olympics, but contracted again in the fourth quarter. Canadian real GOP growth remained positive 46. Real gross domestic product gro"th in selected advanced fOKign ecooomies, 2010-12 but also weakened, largely owing to lower external demand. Survey indicators suggest that conditions in the AFEs improved only marginally around the turn of the year. Amid " this weakness in economic activity and limited pressures from commodity prices, inflation readings for most AFEs remained contained. Several foreign cemral banks expanded their balance sheets further and took other actions to support their economies (figure 47). In -" addition to its introduction of the OMT, the I I I I EeB lowered its main policy rate. The Bank 2010 2012 of England completed its latest round of asset NQll: 1'bo <IOto IIr'Q~lyond.xtrnd thm.Igh101IQ3 forCIII:lI.da on! purchases, bringing its holdings to £375 billion, 2012:Q4forlho __ ...... Jq:u, ondthoUnMlKingdom. Soma: fill" CIlIOda, S:'l~ti", Caaada; for tho ...: ro ...... Eurosto~ ro: and began the implementation of its Funding kpan, Collioot O/f.,. of 1'fllIl; cd f.:tt l!l. Unit", K.i::!¢o.:n, Oflj" fo: for Lending Scheme, designed to boost lending Nlti<m.tStot~ti"" to households and firms. The Bank of Japan took a number of steps. It introduced a new Stimulating Bank Lending Facility in October and raised its inflation target from I percent to 2 percent in January. In addition, it increased the size of its Asset Purchase Program by ¥30 trillion, to ¥lOltrillion, by the end of 2013 and announced tbat purcbases would be open ended beginning in 2014. 82 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00086 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.63031622 MONETARY POlICY REPORT: FEBRUARY 2013 35 · .. even as economic growth stabilized in 47 Central bank assets in selected advanced emerging market economies I!CrnJ(Jrnies., 200S-12 After slowing earlier in the year, in part because of headwinds associated with Europe's troubles, economic growth in EMEs stabilized in the third quarter and appeared to pick up in the fourth. This modest pickup in economic activity in the face of continued v.eakness in - w e.xports to advanced economies was supported - " by monetary and fiscal policy stimulus. - " , In China, following slO\>,er growth in the - first half of 2012, stimulus measures helped I I , II , , , , I! ' I boost the pace of real GDP growth in the 100& 2009 1010 1011 1012 second half of the year. Improved economic NOTIi: Ib,datunqua:urlycdox1Olld1hrougb 2Il12:Q3 forlho""" ..... conditions in China also provided a lift tru s l . l . h :m oU c. o : it F td " ' K I i h n o g~ " " " " " , L o . n . d .. 2 . 0 E 1 u 2 t Q o .\ p f < o a r n J C : ' I : p O II ~ I l L B ankoodEuro:!to!:forj1pOll, to other emerging Asian economies. GDP BalIk of J...." 0!Id Clbe..! Off. .. of J..,.n; owl for tho u"i".o<l Ki::g~orII, Bank tiEnglt:>d andOrr.,. for r;.~"",,1 Stlti"-,,," accelerated in Hong Kong and Tai\\'<ln in the third quarter; in the fourth quarter, exports and purchasing managers indexes moved higher in most of the region, and GDP growth rebounded in a number of economies. After stagnating for about a year, economic activity in Brazil picked up in the third quarter to a still-lackluster pace of 2Y:z percent. Indicators for the fourth quarter suggest a further modest pickup, supported by accommodative policies. In contrast, GDP growth in Mexico continued to fall in the third quarter as the growth of U.S. manufacturing production slowed; however, Mexican gro\\1h picked up to 3 percent in the fourth quarter, boosted by services and the volatile agricultural sector. Despite occasional spikes in food price~ inflation in most emerging Asian economies remained \\eU contained as moderate output growth limited broader price pressures. India was a notable exception, with 12-month inflation around 10 percent in recent months. In some Latin American economies., increases in food prices had a greater effect on inflation than in Asia, leading to 12-month price increases of around 5Y:z percent in Brazil and around 4Y. percent in Mexico over the second half of last year. 83 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00087 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.73031622 37 2 PART MONETARY POLICY To promote the objectives given to it by the Congress, the Federal Open Market CommWee (FOMe) provided additional monetary accommodation al its September 20 12 and December 20 12 meetings, by both strengthening its forward gUidance regarding the federal funds rale and initiating additional asset purchases. As discussed in Pan 1, incoming economic sharper-than-anticipated fiscal contraction in data throughout the second half of 2012 the United States. With longer-term inflation and into 2013 indicated that economic expectations stable and still-considerable slack activity was expanding at a moderate pace. in resource markets, most members anticipated Employment gains v.. e re modest, and although that inflation over the medium term would run the unemployment rate declined somewhat at or below the Comminee's longer-run goal of over the period, it remained elevated relative to 2 percent. le\~ls Ihat almost all members of the FOMe viev.'ed as consistent with the Committee's dual Accordingly, to promote the FOMCs objectives mandate. Inilation remained sutxlued, apan of maximum employment and price stability, from some temporary variations that largely the Comminee maintained a target range reflected fluctuations in commodities prices. for the federal funds rate of 0 to Y. percent Members generally anached an unusually throughout the second half of 2012 and high level of uncenainty to their assessments provided additional monetary accommodation of the economic outlook. Moreover, they at its September and December meetings, continued to judge that the risks to economic by both strengthening its forward guidance grov.1h were tilted to the downside because regarding the federal funds rate and initiating of strains in financial markets stemming from additional purchases of longer-term securities the sovereign debt and banking situation in (figure 48). The Committee also completed Europe, as well as the potential for a significant at year-end the continuation of the program slov.'dov.'n in global economic grov.1h and for a to extend the average maturity of its holdings 48. Sel~lcd interest rates. 2008-13 - s -, - , ______________I IIIIIiI _____ : - , , ----, , -" -"-"-"-"-"- -" ----- , , - , , - , IOO<M 1IIl 1M9lm oll2SO Imll"lm ~ liIOIl~II2I","",l " III.! II2l <I2l lillM4 11!O 200S 2009 20tO 2011 2012 2013 oc N tiv cm dy : m T d h < < d d . a < ta = .. iI . a d . a i T ty h o m d d a l a ai t Q m lI l U t " h la = w g iw h . F t:. . . b t n . w .. y . o 2 re t . t h 2 o O s t . J o . f T " h g o c l 2 ., - .1 y y a r ", m l1< d d - t . o :l. - d y F u e r d e r I r I a 1 . O ." p ') . ' o l M it. ., . \: : o I: r t e C th w o . c :n o i n tt s . ta . n m t-m « o ti r : u l r p i: . ) , yi.1d! buod", tho ",. .I So\ru:t:: D<panm<:nofIheT"osurymdtbe Ftdaot R. ........ 84 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00088 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.83031622 38 PART 2: MONETARY POLICY of Treasury securities that was announced The Comminee also modified its forward in June 2012 and continued its policy of guidance regarding the federal funds rate at the reinvesting principal payments from its holdings September meeting, noting that exceptionally of agency debt and agency-guaranteed low levels for the federal funds rate were mortgage-backed securities (MilS) into agency likely to be v.arranted at least through mid- MBS. 2015, longer than had been indicated in previous FOMCstatements. Moreover, the At the September 12-13 meeting, the Committee stated its expeaation that a highly Comminee agreed that the outlook called for accommodative stance of monetary policy additional monetary accommodation, and would remain appropriate for a considerable that such accommodation should be provided time after the economic reco\'ery strengthens. by both strengthening its forward guidance The new language was meant to clarify that regarding the federal funds rate and initiating the Committee's anticipation that exceptionally additional purchases of agency MBS at a low levels for the federal funds rate v.-ere likely pace of $40 billion per month. Along with the to be warranted at least through mid-2015 did ongoing purchases of $45 billion per month not reflect an expeaation that the economy of longer-term Treasury securities under the would remain weak, but rather reflected the maturity extension program announced in June, Committee's determination to suppon a these purchases increased the Committee's stronger economic recovery. holdings of longer-term securities by about $85 billion each month through the end of the At the December 11-12 meeting, members year. These actions were taken to put downward judged that continued provision of monetary pressure on longer-term interest rates, sllppon accommodation was warranted in order mortgage markets, and help make broader 10 support further progress toward the financial conditions more accommodative (see Committee's goals of maximum employment the box "Efficacy and Costs of Large-Scale and price stability. TheCommineejudged A&<>et Purchases"). The Committee agreed that that, following the completion of the maturity it would closely monitor incoming information e.'{tension program at the end of the year, on economic and financial developments in such accommodation should be provided in coming months, and that if the outlook for the part by continuing to purchase agency MilS labor market did not improve substantially, it at a pace of $40 billion per month and by would continue its purchases of agency MBS, purchasing longer-term Treasury securities at undenake additional asset purchases, and a pace initially set at $45 billion per month. employ its other policy tools as appropriate The Comminee also decided that, starting in until such improvement is achieved in a January, il would resume rolling o\'er maturing context of price stability_T he Comminee also Treasury securities at auction. agreed that in determining the size, pace, and composition of its asset purchases, it would, With regard to its forv.ard rate guidance, the as alv.ays, take appropriate account of the Committee decided to indicate in thestatemem likely eflicacy and costs of such purchases. that it e.xpects the highly accommodative stance This llexible approach was seen as allowing of monetary policy to remain appropriate for the Committee to tailor its policy o\'er time a considerable time after the asset purchase in response to incoming information while program ends and the economic recovery clarifying its intention to improve labor market strengthens. In addition, it replaced the conditions, thereby enhancing the effectiveness date-based guidance for the federal funds of the action by helping to bolster business and rate with numerical thresholds linked to the consumer confidence. unemployment rate and projected inflation. 85 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00089 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.93031622 MONETARY POLICY REPORT: FEBRUARY 2013 39 Efficacy and Costs of large.Scale Asset Purchases In order to provide additional monetary stimulus Significantly lowered longer.term Treasury yields.' when short-term interest rates are near zero, the More important, the effects of LSAPs do not S€€Il) to be Federal Reserve has undertakeo a series of large- restricted to Treasury yields. In particular, LSAPs have scale asset purchase (lSAP) programs. Between late been found to be associated with Significant declines 2008 and early 2010, the Federal Reserve purchased in MBS yields and corporate bond yields as well as approximately $1.7 trillion in longer.term Treasury with increases in equity prices. S<€urities, agency deb~ and ageocy mortgage-backed Continued on nex( page S<€urities (MBS). From late 2010 to mid·10l1, a S<€ond round of LSAPs was implemented, consisting of purchases of S600 billion in longer-term Treasury S<€urities. Bet\",een September 2011 and the end of I. for a selective lislof releJeI1ces regarding theelfect of 2012, the Federal Reserve implemented the maturity t A h S e > e fi \ r P st u lS rc A h p a , s e S s €( ' ' in th B eb o o ar x d " o T f h G e o E _ ff n ec o ts r s 0 4 o F it e h d e er a ff l f iE R - (> ra '.( 1 'fV e extension program and its continuation, under which ReserveSystem{2011), MOl1etary Policy Rfpon (0 rhe it purchased approximately $700 billion in longer. COtlgIl'S5 (\Vashington: Board of Governors, March), "'v.w. term Treasury securities and sold or allowed to run off lederalreserve.gov/monet.lrypolicy/~r_2011 0301_partl .hIm. For additional references, including lOOse thai analyze the an equal amount of shorter·term Treasury securities. effectol thesecood LSAP as ",eH as the maturity extension And in September and December 2012, the Federal prograrT\. see, forexa~le, Stelania D'Arrico, William Reserve announced flow·based purchases of agency [nglish, David lOpez·Salido, and Edward Nelson (2012), "The MBS and longer-term Treasury securities at initial paces Federal Res-efl'!"s Large-Scale Asset Purchase Progr.tJTJTll>S: of $40 billion and S45 billion per m::mth, respectively. Rationaleaoo Effects,' Economic Joumal, vol. 122 (NOI'eni>et), pp. F415-45; Arvind KrishnalllJMYa nd Annette These purchases were undertaken in order to put Vissing.JOIJ:leo>en (20111, "The Effec!S of Quantitative Easing downward pressure on longer.term interest rates, on Interest Rates: Channels and 1~lications for Policy,' support mortgage markets, and help to make broader !irookif18S Papers OIl ECOf1(tI1i( AaNity, Fall, pp. 21 5-(;5; financial conditions more accommodative, thereby Canlin Li and Min Wei (l012), "Tetm Stwcture Modelling supporting the economic recovery. One mechanism with S~ly factors and the Federal R(>'.('fVe's la'ge Scale Asset Purchase PrograJT6: FinallCeand Ecooomi~ through which asset purchases can affect financial Dis.cLlSsion Series 2012·37 (Washington: Boord 0/ GOI't'I"nors conditions is the "portfolio balance channel: which of the Federal R(>'.('fVe SysterT\. May), www.lederalreser"",. is based on the premise that different financial assets gOl',pubsJIedsl101112012371201237pap.pdf; and re/t'I"ences may be reasonably close but imperfect substitutes in those studies. For work that >pe<:ifically eovhasizes the in im'S€lors' portfolios. This assumption implies that s B ig a n ue a r l in an g d c h G a l n e n n e n l D of . L R S u A d P E s tl , u S s. €( c ', h ( f 2 o 0 r 1 e 2 ) ) ( . , ) " ~ T l h e e , S M ig i n c a h l a i e n l g D. changes in the supplies of various assets available Channel lor Federal R(>'.('fVe Bond Purcha>e-i,' Working P.!Pt'l" to private investors may affect the prices or yields Series 2011·21 (San Francisro: Federal Reserve Bank of San of those assets and tne prices of assets that may be FrallCis.co, Auguw, \\wwJlbsf.orglptblications/economicsi reasonably close substitutes. As a result, the Federal t p h a e p e e lf r e s c l ! 2 S O 0 l 0 ll w cr p e l d l. i 2 t d Ib el k a . u p l d t l r . i s F .k o . r s e w e o . r f k o r t h e a x t a f r o rp c l u e s , e S so im n on Reserve's asset purchases can push up the prices Gilchrist and [goo Zakraj~{lOll), "The Irrpact 0/ the and lower the yields on the securities purchased Federal Reser"",'s large-Scale Asset Purchase Progr.tJT6 on and influence other asset prices as well. As investors Df'lault Risk: paper presented at 'Macroeconomics and furtner rebalance their portfolios, overall financial FinallCiallntemlediation: Directions sillC € theCrisis,' a conference held at theNational Bank 04 Belgium, B'ussels, conditions should ease more generally, stirrulating Decf.>lTber 9-10. 2011.Although the rn.Jjority of rese.Jrch economic activity through channels similar to those on the effec!S 0/ LSAPs appears to s~ort a signifICant for conventional monetary policy. In addition, asset innuence OIl asset prices, theo\'f'fall resultol sllCh prograJT6 purchases could also Signal that the central bank is generally difficult to estirn.Jte precisely: [1If'()\ studies can intends to pursue a more accomrmdative policy rn.Jkeonly \.harp predictions on theelfec!S \I"itllin a relatively short ti1l"E! horizon, where.J\ approaches based on time· stance than previously thought, thereby lowering series models tend 10 face challenges in i§Oiating theelf~ investor expectations about the future path of the of theprograJT6 from other economic develcprren!S. for a federal funds rate and putting additional dC1.vnward more skEPtical \~ew 00 the f'lfecl 04 LSAPs, see, for e)(,)~le, pressure on longer-term yields.. Daniell. Thornton (l012), 'Evi~llCe on the Portfolio BalallCe Channel of Quantitati"", [a,iog.' Working P.!per Selies 2012- A substantial body of empirical research finds that 015A (St loui,: federal Reser"", Bank 04 St louis, October), the Federal Reserve's asset purchase programs have http://research.stiouisfed.orgNipl2012nOI2-015.pdf. 86 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00090 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.04031622 40 PART 2: MONETARY POLICY Efficacy and Costs of Large-Scale Asset Purchases, continued While there seems to be substlntial evidence that a balanced reading of the evidence supports the lSAPs have 10IVered longer-term yields and eased conclusion that LSAPs have prol'ided meaningful broader financial conditions, obtaining accurate support to the econorric recovery while rritigating estimates 01 the effects 01 LSAPs on the macroewnomy deflationary risks. is inherently difficult, as the counteriactual case-holV The potential benefits of lSAPs fTlJst be considered the economy would have performed without LSAPs alongside their possible costs. One potential cost of cannot be directly observed. However, econometric conducting additional LSAPs is that the operatiof"6 models can be used to estimate the effects 01 lSAPs coold lead to a deterioration in market functioning on the economy under the aSSUfTlltion that the or liquidity in markets where the Federal Reserve economic effects of the easier finandal conditions is eflgaged in purchasing. More specifically, if the that are induced by LSAPs are similar to those that Federal Resefl'e becomes too dominant a bu)'er in are induced by conventional m:metary policy easing. a certain market, trading among private participants Model simulations conducted at the Federal Reserve coold decrease eflough that market liquidity and have geflerally found that asset purchases provide price discovery become irrpaired. As the global a signifICant boost to the economy. For example, financial system relies on deep and liquid markets a $\udy based on the Federal Reserve Boord's for U.S. Treasury securities, significant impairment of FRBlUS model estimated that, as of 2012, the first this market would be especially costly; impairment two rounds of LSAPs had raised real gross domestic of this market could also impede the transmission of product almost 3 percent and increased fXivate pa)lfoH monetary policy. Although the large volume of the efTllloyment by about 3 million jobs, while 1000ering Federal Resefl,'€s purchases relative to the size of the unem~oy~nt rate about 1.5 percentage points, the markets for Treasury or agency securities could relative 10 what would have been expected other.vise. ultimately become an issue, few if any problems have These simulations also sLJggS€t that the program been observed in those markets thus far. materially reduced the risk of deflation.' A second potential cost of LSAPs is that they may Of course, all model-based es~mates of the undernine public confidence in the Federal Reserve's macroeconomic effects of LSAPs are subject to ability to exit smoothly from its accommodative coosiderable statistical and modeling uncertainty policies at the appropriate ti~. Such a reduction and thus should be treated with caution. Indeed, in confidence might increase the risk that long-term while some other stooies also report signifICant inflation expeclJlions beco~ unanchored. The macroewnomic effects from asset purchases, Federal Resefl' € is certainly aware 01 these concems other research finds smaller effects.' Nonetheless, and accordingly has placed great emphasis on developing the necessary tools to ef"6ure that policy 2. These resullS are discussed further in Hess Chung. accommodation can be removed when appropriate. JE'.ln-l'Ililippe laforte, David Reifschneider, andJohn C. For example, the Federal Reserve will be able to William; (2012), "Hal'eWe UnderestiITLlted the ti~elillOOd put upward pressure on short-term interest rates at and SeverityofZero LOII-er Boond Evenl5?' Journalol Moo'€)', the appropriate time by raising the interest rate it Credit and 8Jnking, voL 44 (fEbruaryso..wlemenO, pp.47---{12. pays on resel"l's€, using draining tools like reverse 3. For studies reponingsignificantmacroecooomic effeclS repurchase agreements or term deposits with from asset purchases, see, lor e~fIlIle, Jeffrey C. Fuhrer and depository institutions, or selling securities from the Giov.mni P. Olivei (2011), "The Es~ITLlted Macroeconomic Federal Resefl,'€s portfoliO. To date, the expansion of E/feclS of the Federal Reserve's Large-Scale TrE'.lsury Purchas.e Prograll\" Public Policy Brie(s 11-{)2 (Boston: Federal Reserve the balance sheet does not appear to have materially Bankol Boston,April), lIWoI'.bosJrb.orgiecooomidppMOlll affected long-term inflation expeclJlions. f'Pbl I 2.pdf; and Christiane Baumeister and luca Benati A third cost to be weighed is that of risks to (2012), 'Unconventional Monetary Policy and the Greal financial stability. for example, some observers have Recession: EstiITLlting the Macroeconomic EffeclS of a Spread Compression at the Zero Lower Boond: Working ""pers 2012-21 (Ol\awa: Bank of Canada, July), www.b.Jnkofcanada. "TheAggregale Demilnd Effects of Short-and Loog-Term calwp·conteOOuploads!2012107/lIp2012-21.pd1. Also, the Interest Rates,' Financeand Economics Discus>ion Series Bankor Eng1and has ifllliemeoted LSAPs similar to those 2012-54 (\Vashington: Boo rd of Governors of the Federal undertaken by the Federal Reserve, and its stafl research finds Resefl'e System, August), www.federalreserve.govlpubsl that the effeclS appear to he quantitatively similar to thas<> in fedsl2012n012541201254pap.pdi; and Han Chen, Vasco the United States. Curdia, and AndrE'.l Ferrero (2012), "The Macroeconomic fur ~tudies reporting smaller elleclSlrom asset ElfeclS of large-Scale Asset Purchase Prograrrrnes: Economic purchases, see, for exaflllle, Michael T. Kiley (2012), Journal, vol. I n (Noverrber), pp. F289-31S. 87 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00091 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.14031622 MONETARY POlICY REPORT: FEBRUARY 2013 41 raised concerns that, by dril'ing longer.term yields decline in coming years. Indeed, in some scenarios, lower, nontraditional policies could induce imprudent particularly if interest rates were to rise quickly, risk.taking by some investors. 0/ course, some risk· remittances to the Treasury could be quite low for taking is a necessary element 01 a healthy economic a time.~ EVe!1 in such scenarios, however, average recovery, and accommodative moneta!)' policies annual remittances Oller the period affected by the could el'1€1 se"'e to reduce the risk in the system federal Reserve's purchases are highly likely to be by strengthe!1ing the overall economy. Nonetheless, greater than the pre-crisis nOfm, perhaps substantially the federal Reserve has substantially expanded its so. Moreover, if monetary policy promotes a stronger monitoring of the financial s)'stem and modified recOliery, the associated reduction in the federal its supelVisory approach to take a more systenlc defICit would far exceed any variation in the Federal perspective. Reserve's remittances to the Treasury. That said, the There has been limited evidence so far of excessil'e Federal Reserve conducts monetary policy to rreeI buildups of duration, credit risk, or leverage, but the its congressionally mandated objectil'eS of maximum Federal ReselVe will continue both its careful oversight employment and price stability and nol primarily for and its implementation of financial regulatory reforms the purpose of turning a prof~ for the U.S. Department designed to reduce systemic risk.' of the Treasury. The Federal Reserve has remitted substantial income to the Treasury from its earnings on securities, totaling some $290 billion since 2009. However, 5. For additional detail" see Seth B. Carpenter, Jane E. if the economy continues to strengthen and policy Ihrig. Elizabeth C. Klee, Daniel W. Quinn, aooAlexandef H. Boote (2013), "The federal Reserve', Balance Sheet and accorrmodation is withdrawn, remittances will likely Earnings: A Primer and Projection>: Finaoce and [Conomi03 Oi5(u55lon Series 1013·01 (Washington: Boord 01 Governors 4, For additional detail" see the box "The Federal Reserve', 01 the Federal ReserveSystem, January), www.federalreseIW. ActiorD to Foster Finaocial Stability" in f'.ln L govlpwslleds!2013120 13011201301 ab,.html. 88 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00092 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.24031622 42 PART 2: MONETARY POLICY In panicular, the Commil1ee indicated that it information when determining how long to expected that the exceptionally low range for maintain the highly accommodative stance of the federal funds rate \\'Ould be appropriate monetary policy, including additional measures at least as long as the unemployment rate of labor market conditions, indicators of remains above 6Y;. percent, inflation between inflation pre~ures and inflation expectations, one and 1\.\'0 years ahead is projected to be and reading<; on financial developments. no more than Y2 percentage point abo\'e the Comminee's 2 percent longer-run goal, and At the conclusion of its January 29-30 meeting, longer-term inflation f.'ipectations continue to the Committee made no changes to its target be well anchored, These thresholds were seen as range for the federal funds rate, its asset helping the public to more readily understand purchase program, or its forward guidance for how the likely timing of an eventual increase in the federal funds rate. The Committee stated the federal funds rate would shift in response to that, with appropriate policy accommodation, it unanticipated changes in economic conditions expected that economic gro\.l/th would proceed and the outlook. Accordingly, thresholds could at a moderate pace and the unemployment increase the probability that market reactions rate would gradually decline toward levels to economic developments \.\'Ould move longer the Committee judges consistent with its term interest rates m a manner consIstent dual mandate. It noted that strains in global with the Comminee's assessment of the likely financial markets had eased somewhat, but future path of shon-term interest rates. The that it continued to see downside risks to the Comminee indicated in its December statement economic outlook. The Committee continued that il viewed the economic thresholds, at to anticipate that inflation over the medium least initially, as consistent with its earlier, term likely would run at or below its 2 percent date-based guidance. The new language noted objective. that the Committee would also consider other 89 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00093 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.34031622 43 3 PART SUMMARY OF ECONOMIC PROJECTIONS The {ollowing malerial appeared as an addendum to the minutes of the December 11-12,2012, meeting of the Federal Open Market Commillee. In conjunction wilh the December 11-12, most likely to foster outcomes for economic 2012, Federal Open Market Committee activily and inflation that best satisfy his or (FOMq meeting, meeting participants-the her individual interpretation of the Federal 7 members of the Board of Governors and the Reserve's objecti,·es of maximum employment 12 presidents of the Federal Reserve Banks, and stable prices. all of whom participate in the deliberations of the FOMC-submined their assessments of Overall, the assessments submitted in real output gro\\'th, the unemployment rate, December indicated that FOMe participants inflation, and the target federal funds rale for projected that, under appropriate monetary each year from 2012 through 2015 and over policy, the pace of economic recovery would the longer run. Each participant'S assessment gradually pick up over the 2012-15 period was based on information available at the time and inflation would remain subdued (table I of the meeting plus his Of her judgment of and figure 1). Participants anticipated that the appropriate monetary policy and assumptions growth rate of real gross domestic product about the factors likely to affect economic (ODP) would increase somewhat in 2013 and outcomes. The longer-run projections again in 2014, and that economic gro\l:th in represent each participant'S judgment of the 2014 and 2015 would exceed their estimates value to which each variable would be expected of the longer -run sustainable rate of growth, to converge, over time, under appropriate while the unemployment rate would decline monetary policy and in the absence of gradually through 2015. Participants projected further shocks to the economy. "Appropriate that each year's inflation, as measured by the monetary policy" is defined as the future annual change in the price index for personal path of policy that each participant deems consumption expenditures (PCE), would run Table I. Eoonomk projections of Federal Resent Board members and Federal Resen-e Bank presidents, December 2012 ~~. R.,., I I I I I I I I lOll lOll 2014 2015 Lo~r 2012 lOll ))14 :!(lIS Lonter Rln Cbant"'in ..a IGDP ... 1.1101.8 2.3103.0 3.O1~3.5 3.0103.1 ! 2.31025 1.6IOU UIOU UtoU UIO~IUIo3.0 Stp .. rnbtr projoctio. 1.7102.0 2.510>.0 >.Olo1.8 >.01I>H ! 2Jt025 1.61020 lJto15 2.11041 25104.21 UlolO i U. .. mploj.",.nlrlltt 7.810 7.9 7.410 1.1 6.8t~13 6.0106.6 52106_0 1.11080 6911>18 6.11014 Stp,"rnbtr projoctio •... 8.0108.2 7.610 1.9 6.110J.> 5 8.0108.3 1.0108.0 6.3101.5 :.::::: 1 .2::6.0 PCEi.ll:olio. 1.6 to l.l 1.311>20 1.S102.0 1.61Ol.8 UiolO 1.41022 15lo2.2l 20 Stp,"rnbtrprojoctiol ... 1.1101.8 1.61020 1.6102.0 1.8102.0 ,i 20 15101.9 151021 1.6102.2 1.8102.l ,i 20 ! ! eo .. PCE mllalio.' ... 1.6101.7 1.6101.9 l.61~2.0 1.8102.0 i 1.61Ol.8 1.5102.0 1.1102.2 i Stptrmbtr projection 1.7101.9 1.71020 I.8t~2.0 1.911>20 L61020 1.61022 18102.3 . , p P . , t O n i , N c ~ o . < o " b f T ' i k - ' p l 1 ! o d ; . a " ' " ) ' P " , , - I r , ' o 1 l f l u ) 1 : p < , ! C r ; P ' o ' I " d C K j " ,! > . .! " U " . o . p _ : o e . 1 < d. . 1 f . « ~. P l ~ . C t a o b ! . ! " " J " ~ ," o I d o '" 1 d " > •' ' , o U B• , J , < b' . I g. i \ l " r. l . " i o ' ' d d i a l " b " d ' O - ' o ' T P ' D p ' . l' < r r P . o o ~ C j p - ~ o ! r ! o , i p " o t r l " " , o I . > d ' . . " t . o " " f . u f " . , ( ' " P I G . " P I .. . Y I N , . O I " l p ' j > > ) " . o , . . ' . J p . . ' i e ' . d l ' r . ' t P < " P . D ' ~ " . ' ' d ' t ' J a '' ' g " , ' , e l I ' . ' , p " . , h . u ' o . . " . , I f u l i " o . , ' s " l f b ' a " . o f > ' « 't L ' ' l' o o g , . ' b o f . g , " f e ' ; " ' ", " ' , . ~ t " ' " '' I ' " 'S I " ' . P ! o , ' ' . ' f f < O b ~ " i " o > P l " I i d I ' > l . y i . l o . . , . o . . ," , • b . b " .' • r . " e p ~ i ' p » ' r ' , f , ' ' > r , " ' , o 0 , Y , i . . " , . & d» " th 0 " , ' e ', 1 ' T f 1 ~ "u h ", p . P lS1 i " . ot l q i " p b a . " "p , . " " u f ~ " " > , '"- i " , l ' t " ~ l _ P f b " " q " I j " l> o . " . . c . . P . t . p . i . ' o . . ' ' . ' . , ' ' I . ' o " ' o . ' f . I f ' " . ' ' t ' . ' i . y ' l . , d . ) ' I . ' L Ut ' . l I " d ' r l " J . i U I I , l l . > . ( d " . p ~ . " " , c f , ' u l . E ~ . O j b ) . d u l 1 . O . l " > . . £ " d q . 0 " . . . , ' . I - . . . . _ ...! II lb. "'''~iI of lU Fool .... Ope. ",. . rIoot eo,,"'tt. ... s.p~,,"" 11.-1l.1011 J. Th. "",,,,J,,.d,,oyoxd"",,l., ,b~.l.ip •• U<I!II", _p/"O!"'i>. . fi>' ...... "obloi ••o obl"" 1 l. . n Lo . ' l " " "g -I\ e II I f u p , r • o .. j ,, " & , 1 , > ,, 1 , < f u i • , • " ' g " i ' f P t. C )' ! n ! i,. IlII><'"b. :.I.".o. l.. p"o ~ " i , a i p " " ,o '' : ' ! ' P"'I''' .... froID t-~ '" kigl.,,~ fu, til .. "';"b~ in "''' ,.. .. 90 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00094 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.44031622 44 PART 3: SUMM.I,RY OF ECONOMIC PROJEalONS figure 1. Central tendencies and range. of economic projections, 2012-15 and over the longer run ,.- _ OJaDge in real GDP _ • Ctnlrlllttndcocy<>fprojoctiollI -- ii!ii I Rrmge{)fprt;ectiooi iiiiI!ii ~ ;;.I;; Aclual I I "" 2008 ",. ~10 Wll W12 2M3 ~14 WIS too", ,~ ,- UnempJ~nt rale - ll ..... ~ ~ iiijiii !I!II!! I I "" 2008 ",. WIO Wll ~12 2013 ~14 WIS too", ,-- ,~ PCEinHatioll ~ • = Ii iIijiii 11 I I "" 2008 "" WIO Wll 2012 2J)1J 2014 2015 too~, ,~ ,- Core PCE iutlalion ~ = iiiiI!ii ~ ~ I I I I 2001 2008 "" WI. 2J)1l 2012 2013 2014 2015 Longer ,~ Note: Definitions of variables are in the gellt'ral note to table L The data forthe actual values of the ,miabies are annual 91 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00095 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.54031622 MONETARY POLICY REPORT: fEBRUARY 1013 45 close to or below the FOMes longer-run while conditions in the housing and labor inflation objective of 2 percent. markets appeared to have improved recently, uncenainty about fiscal policy appeared to As shown in figure 2, most panicipants judged be holding back business and household that highly accommodative monetary policy spending. Participants' projections for 2013 was likely to be warranted over the next few through 2015 were generally linie changed years. In particular, 14 participants thought relative to their September projections. The that it would be appropriate for the first central tendency of participants' projections increase in the target federal funds rate to for real GDP growth in 2013 was 2.3 to occur during 2015 or later. Most panicipants 3.0 percent, followed by a central tendency of judged that appropriate monetary ]Xllicy 3.0 to 3.5 percent for 2014 and one of 3.0 to would include purchasing agency mortgage 3.7 percent for 2015. The central tendency backed securities (MBS) and longer-term for the longer-run rate of increase of real Treasury securities after the completion of the GDP remained 2.3 to 2.5 percent, unchanged maturity extension program at the end of 2012. from September. Most participants noted that the high degree of monetary policy As in September, participants judged the accommodation a§umed in their projections uncenainty associated with the outlook would help promote the economic recovery for real activity and the unemployment over the forecast period; however, they also rate to be unusually high compared with judged that several factors would likely historical norms, with the risks weighted hold back the pace of economic expansion, mainly toward slower economic growth including slower growth abroad, a still- and a higher unemployment rate. While a weak housing market, the difficult fiscal number of participants viewed the uncertainty and financial situation in Europe, and fiscal surrounding their projections for inflation restraint in the United States. to be unusually high, more saw the level of uncenainty to be broadly similar to historical Participants projected the unemployment norms; most considered the risks to inBation rate for the final quaner of 2012 to be close to be roughly balanced. to its average level in October and November, implying a rate some\l.'hat below that projected The Outlook for Economic Activity in September. Participants anticipated a gradual decline in the unemployment rate over Participants judged that the economy grew the forecast period; even so, they generally at a moderate pace over the second half of thought that the unemployment rate at the 2012 and projected that, conditional on their end of 2015 would still be well above their individual assumptions about appropriate individual estimates of its longer-run normal monetary ]Xllicy, the economy would grow level. The central tendencies of participants' at a somewhat faster pace in 2013 before forecasts for the unemployment rate were expanding in 20\4 and 20\5 at a rate above 7.4 to 7.7 percent at the end of 2013, 6.8 to what panicipantssaw as the longer-run rate 7.3 percent at the end of 2014, and 6.0 to of output growth. The central tendency of 6.6 percent at the end of 2015. The central their projections for the change in real GDP tendency of participants' estimates of the in 2012 v.'3S 1.7 to 1.8 percent, slightly lower longer-run normal rate of unemployment that than in September. A number of participants would prevail under appropriate monetary mentioned that last summer's drought and policy and in the absence of further shocks to the efiects of Hurricane Sandy likely had held the economy was 5.2 to 6.0 percent, unchanged down economic activity in the second half of from September. Most participants projected this year. Many panicipants also noted that, that the unemployment rate would converge 92 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00096 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.64031622 46 PART 3: SUMM.I,RY OF ECONOMIC I'ROJEalONS figure 2. Onl""iew of roMe participants' assessments of appropriate monetary policy, December 2012 Nod>erolpuhcip. .. to Awopriale liming of policy fuming 2013 20[4 2015 ~16 Awopriale pace of policy fuming Target federal funds rate aI year.e)d ••••• "1 , " . ......... ~ 6 - - • ...................................................... · - ···················································1········_········~ 4 • • • · • • -- ......................................•.. ·····························. ··········1, ············· ............ 1 ~ • ................................................................................................. ··1······· ................. ~ 0 1 ~12 ~lJ 2{1[4 ~15 Longer run Nott: Iu the U[lpfr panel, tbe height of each bar dfDO~S the number of FOMC participants who judge that, under appropriale monetary policy, tbe filit increase in the target federal funds rate from its CllJTfDt mge of 0 to Y. perctot \\ill oocuriu tbespecifJed caleodar lear [u September 2012, tbe numbersof FOMC palticipants who judged thal the first increase in thelilrget federal funds rate would oocurin 2012, 2013, 2014, 20[5, and 2016 \\ere,re;~ti\"e1y, 1,3, 2, 12, and I. In the I~r panel, each shaded circle indicales the ,alue (rounded to the nearest Y. perctlliage point) of an inw,idual participant's judgment of the appropriate lew[ of the target federal funds rate aI the end of the specified .:aIendar )\'"3J or over the 1000ger J"\IIl 93 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00097 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.74031622 MONITARY POLICY RtPORT: fEBRUARY 2013 47 to their estimates of its longer-run normal rate The Outlook for Inflation in five or six rears, while a few judged that less time would be needed. Participants' views on the broad outlook for inflation under appropriate monetary policy Figures 3.A and 3.B provide details on the were little changed from September. Most diversity of panicipants' views regarding the anticipated that inflation for 2012 as a whole likely outcomes for real GOP growth and would be close to 1.6 percent, somewhat lov.t:r the unemployment rate over the next three than projected in September. A number of years and o\'er the longer run. The dispersion participants remarked that recent inflation in these projections reflects differences in readings had come in below their expectations. participants' assessmentS of many factors, Almost all of the participants judged that including appropriate monetary policy bolh headline and core inAation would remain and its etfects on tbe economy, the rate sulxlued over the 2013-15 period, running al of improvement in the housing sector, the rates equal to or below the FOMe's longer spillo"er effects of the fiscal atxl financial run objective of 2 percent. Specifically, the situation in Europe, the prospective path for central tendency of participants' projections U.S. fiscal policy, the extent of structural for inflation, as measured by the PeE price dislocations in the labor market, the likely index, mo\'ed down to 1.3102.0 percent for evolution of credit and financial market 2013 and v.~ little changed for 2014 and 2015 conditions, and longer-term trends in at 1.5 to 2.0 percent and 1.7 10 2.0 percent, productivity and the labor force. With the data respecti\'ely. The central tendencies of the for much of 20 12 now in hand, the dispersion forecasts for core inflation wl;!re broadly similar of participants' projections of real GOP to those for the headline measure for 2013 growth and the unemployment rate this year through 2015. In discussing factors likely to narro",:ed compared with their September sustain low inAation, several participants cited submissions. Meanwhile, the distribution stable inBation expectations and expectations of participants' forecasts for tile change in for continued sizable resource slack. real GOP in 2013 shifted down a bit, and that for 2014 narrowed slightly. Hov.'e\"er, the Figures lC and 3.0 provide information range of projections for real GOP growth aboul the diversity of participants' views in 2015 was little changed from September. about the outlook for inflation. The range of The distributions of the unemployment rate participants' projections for headline inAation projections at the end of 2012, 2013, and 2014 for 2012 narro\'.'ed from 1.5 to 1.9 percent all shifted lower, wllile the range of projections in September to 1.6 to L8 percent in for the unemplo:yment rate for 2015, at 5.1 to December; nearly all participants' projections 6.8 percent, remained close to its September in December were at 1.6 percent or 1.7 percent, level. The dispersion of estimates for the broadly in line with recent infiation readings. longer-run rate of output growth sla}'ed fairly The distributions of participants' projections narrow, with all but one between 2.2 and for headline inflation in 2013 and 2014 shifted 2.5 percent. The range of participants' lower compared with the corresponding estimates of the longer-run rate of distributions for September, while Ihe range of unemployment, at 5.0 to 6.0 percent, narrowed projections for core inAation narrowed slightly relatht: 10 September. This range reflected for both years. The distributions for core and different judgments among participants about on:rall infiation in 2015 were concentrated several factors, including the outlook for labor near the Committee's longer-run inflation force participation and the structure of tbe objective of 2 percent, although somewhat less labor market. so than in September, 94 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00098 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.84031622 48 PART 3: SUMM.I,RY OF ECONOMIC I'ROJEalONS Flgul'l! 3A. Dis(ribu(ioo of participants' projwtions for (he change in l'I!aJ GDp, 2012-15 and over (he longer run 2012 C _. S D e e p o lt o m "" b " o , r p p r r o o je je ct c io t" n ,' ' " - - - " " " ~ --->w2, -- ,6 ~~~~~~,~, •. "-,c,c.--~"c.--~,.~-c,~,.--c,oo.---,c,c.--~"c-~,.c.--c,7,--c,o,---,c,c.--' 2 11 U U U U 11 U ~ U U '1 U Pen:ult range Wll _ ..... . . - , -- :1 ,.-, c - -. " tl- H- 12- u- 16- 11- J.O- J.l- 1. 1.6- " " II 11 U U U U 11 U 11 1.7 H Perceot ratlge -- ~ "IS -" --- w>,2 -- ,6 c .. - ".~- ••'' ''':'''''-=--'';'';I -,2 " tl H· 2.'- 2_';' 2_1- J.O- 11- H- lb- H- I~- 12- " " " U 11 Pe U rc ent ra I n I g e 1) II 1.1 J~ '1 '.1 WI> c " " Nod>"orp"'dp. ... _ Longerrun c I';' II J.O n,., 1. H· u· H· II II " " " " " Perceot ratlge Note: DclmitioDI of variabks areiD tile geDerai note to table I 95 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00099 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.94031622 MONETARY POLICY REPORT: fEBRUARY 2013 49 Figure lB. Distribution of participants' projectioos for the unempbyment rate, 2012-15 and oYer the longer rw] =2 012 = • :: _ D -- n So . p .: l a Om m b .r o r p p r r o o je je c c ti t o iO n l s l ' I -" -_II '" -' 1= =j : ij c _ I ,_ 1 ,- _ - ,24 I S n ol · I ~ .! ~ 1 ~ 5 l ~ . t J · H ~~ 6 ~ .1 u 6.) · 6 ~ .1 6 ~ ,1 u 63 · 1 J -1 . J J , ~ ) I IA S ' nJ6 - J J, ! t } . u l.\ · I I J .l· Percent rn.nge .. , _ _ I"''';'&.. _ , • •' _L_. 1 In· 1.1· H· H· ~ ~ u· ~ ~ O· 3 1~ u· U ),] Sol 1,1 ).J H 6,1 6.J 6.1 6.1 63 7.1 ),J IJ JJ Percen'rn.nge 2015 .. _ , _ [3B_;;':': ". ~ H· ~ ~ u· ~ ~ u· a ),) ,a.• · " lJl.JH6,1636.16.1631-l " " Percent =ge w -" -" -" --n. --,'" .. - , ~_iDD: -.~., ,. --, ' I ), ~ ] H So l- 1 1, . 1 ' - H l. l H \.1 - 6 6. , ( 1 1 - 6 62 J 6 61 .' - 6 6. 6 1 - 6 63 t n 1.0 - " 1,) " " " ,".• •. , 1 n .) Percent rn.nge Note: DefilliuOlIs of l"ariabieS are in the ge!leral note to lable 1 96 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00100 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.05031622 50 PART 3: SUMM.I,RY OF ECONOMIC I'ROJEalONS Figure lC. Distribution of participants' projections for PCE inflation, 2012-15 and om the longer run =2[ 0]1 2 " _ •• s n .p . l o tm . b _ trp p r r o o j jo e c c l ~ io O l I lS I' r----' - - - - - " " " 1 . 8 - 10 - , L____ - 4 ~~~~ __~ ______" ,_ _~ l " " Percent range WIJ == - "---- ______ I_----~ cJIIIII, -----~ I U A I \. ' 1 - t \1 l 2 \, ] U ~\ Percent range W14 Pero'nt range 2015 .. ----, I Percent range loDger rllD -" " " -" -" -- 1,0 -, ,-,l " " " ",. " " " Percent range Note: Definitions of Iwiableureio lhegeneral DOte \0 table I 97 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00101 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.15031622 MONETARY POLICY REPORT: fEBRUARY 2013 51 Figure 1D. Distribution of participants' projections for core PCE inflation, 2012-15 ~"Qfp>rti:ipu" - 21HZ - 0 0.0._ p<oj<cti"'" _ •• S<pt<mb<Tproj<clioo, r-----' IL _____ _ Per«ntrange - 2013 _____ J-- - - - -, I - 20[4 Per«ntrange N,.erofpll10p0.I, - 20[5 -" -I< - " r-----' - I< - 12 -- IQ, -, --':.IIII,I~~-; , " " " Per«ntrn.ge Note, DdinitiOllS of\'anablesare in the general note to table [ 98 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00102 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.25031622 52 PART 3: SUMM,>,RY OF ECONOMIC PROJECTIONS Appropriate Monetary Policy federal funds rate ranged from 3 to 4~ percent, reflecting the Committee's inflation objective As indicated in figure 2, most participants of 2 percent and participants' judgments about judged that e.xceptionally [ow levels of the the longer -run equilibrium le'·el of the real federal funds rate would remain appropriate federal funds rate. for several more years. In particular, 13 participants thought that the first increase Participants also provided information on in the target federal funds rate v.'Ou[d nOI be their views regarding the appropriate path warranted until 2015, and 1 judged that policy of the Federal Reserve's balance sheet. Most firming would likely not be appropriate until participants thought it was appropriate for 2016 (upper panel), The 13 participants who the Committee to continue purchasing MBS expected that the target federal funds rate and longer-term Treasury securities after would not move above ils effective lower completing the maturity extension program bound until 20151houghllhe federal funds at the end of this year. In their projections, rate would be 1Y . percent or lower at the taking imo account the likely benefits and end of that year, while the I participant who costs of purchases as v.-ell as the expected expected that policy firming would commence evolution of the outlook, these participants in 2016 sav.' the federal funds rate target at v.-ere approximately evenly divided between 50 basis points at the end of that year. Five those who judged that it would likely be participants judged that an earlier increase in appropriate for the Committee to complete its the federal funds rate, in 2013 or 2014, would asset purchases sometime around the middle be most consistent with the Committee's of 2013 and those who judged that it would statutory mandate. Those participants judged likely be appropriate for the asset purchases that the appropriate value for the federal funds to continue beyond that date. In contrast, rate would range from ~ to 20/. percent at the several participants believed the Committee end of 2014 and from 2to 4Y2 percent at the would beSt foster its dual objectives by ending end of 2015. its purcbases of Treasury securities or all of its asset purchases at the end of this year Among the participants who saw a later when tbe maturity extension program was tightening of policy, a majority indicated that completed. they believed it was appropriate to maintain the current [evel of the federal funds rate Key factors informing participants' until the unemployment rate is less than or views of tbe economic outlook and the equal to 6~ percent. In contrast, a majority appropriate setting for monetary policy of those who favored an earlier tightening of include their judgments regarding labor policy pointed to concerns about inflation as market conditions that would be consistent a primary reason for expecting that it would with maximum employment, the extenl to be appropriate to tighten policy sooner. which employment currently deviated from Participants were about evenly split between maximum employmem, the extent to which those who judged the appropriate path for the projected inflation om the medium term federal funds rate to be unchanged relative to deviated from tbe Committee's longer-term September and those who saw the appropriate objective of 2 percent, and participants' path as [ov.-er. projections of the likely time horizon necessary to return employment and inflation to Nearly all participants saw the appropriate mandate-consistentleve\s. Many participants target for the federal funds rate at the end of mentioned economic thresholds based on the 2015 as still well below its expected [onger unemployment rate and the inflation outlook run value. Estimates of the longer-run target that were consistent with their judgments 99 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00103 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.35031622 MONETARY POLICY REPORT: fEBRUARY 1013 53 of when it would be appropriate to consider Table 2. AWJ1Ige historical projection enor I1IIlges beginning to raise the federal funds rate. """,,nto!')OpoIn" ." A couple of participants noted that their Variable "" "" "" assessments of the appropriate path for the Ch'ny i. ,"IODI" ±0.6 ±1.4 ±1.7 fl.? federal funds rate took into account the U. ..... pkl)lIlOmru. . ±0.2 10.9 ±1.5 !l.9 likelihood that the neutral level of the federal Tau.lc""'Ill"'''prioer' .. ±05 J:O.9 J:I.I no funds rate was somewhat below its historical Nt.m: Error "'II#' ,.""'" ... """,..-..:I os pl., "r min., rlit roo! "",an oq.aro<! .""r"r projoc!io., for 19921brougb :!(Ill rhal ...... norm. There was some concern expressed that .. It""'" in tho raU ~. "orio ... privlr..0<1 t",.....,.,.1 r.....,.".". A. a protracted period of very accommodative dacribod ill tho I><I< "For«aR U"",rWDly.-.odtr",rW. iJO.mJl!io.~ tho .. i. about a 70 po""'"t probabilirylhlU octuol """"'""" ilr ,..1 GDP, monetary PJlicy could lead to imbalances in u..",p~monl, a,.j ""."",." pr>:.. will bo in nOV' implied by tho the financial system. It v.'aS also noted that " m "' a " y '" b Y o i , l i .o ,. < " I r i n p r [ o )a je .. c 'id ti o R n . . il " 1d " . " . . m i < a l, d r e a o ill d t h P o < p l< o f s T t, u f li u p o ( t : h l( o JQ r 7 io j, r" ··a rm a a u ti y " . " t because the appropriate stance of monetary tho U..-:mai.ory "r tho Eco.<lII1ic Ou~ook from Hiororical ror«aRint; policy is conditional on the evolution of real ! E lo rr a o n " l , " * r F G iI o I - ~ . 1 m U I a . o .. < . l " E r c r o ho o o F m o. b kr a D l i R .c . o .. " . ; . " . n . S S ) < ~ r l i t rs m , ) ) N (I? " - " 6 , 0 m ( b \\ tr '" ) " . hi.gtoo activity and inflation over time, a&')essments 1,o.fiDitio .. "r,...riorblo.a .. i.th.r:<D<r1l1ooto-totorblt 1 2, Mt3<ure i,lb. "",,,,Ueoo,umo, pn.:., iodt .. tho pnc. """" .. that of the appropriate future path of the federal ... boo. most "ideIy .oed in t"", ... ,..11IIId pri":. .. ""'.". ., , r"r«aR~ funds rate and the balance sheet could change P'ojoctio. is I""".r cha"", rounh qua,lt, of tho pmi"",)'eor to tho r""'tbqlllrttrortho)~or~ if economic conditions were to evolve in an unexpected manner. Uncertainty and Risks Figure 3.E details the distribution of Nearly all of the participants judged their participants' judgments regarding the current levels of uncertainty about real GDP appropriate level of the target federal funds grov.1h and unemployment to be higher than rate at the end of each calendar year from was the norm during the previous 20 years 201210 2015 and over the longer run. As (figure 4).1 Se\'en participants judged that the previously noted, most participants judged levels of uncertainty associated with their that economic conditions would warrant forecasts of total PCE inflation were higher maintaining the current low level of the as well, while another 10 participants viewed federal funds rate until 2015. Views on the uncertainty about inflation as broadly similar appropriate level of the federal funds rate by to historical norms. The main factors cited the end of 2015 varied, with 12 participants as contributing to the elevated uncertainty seeing the appropriate level of the federal aboul economic outcomes were the difficulties funds rate as 1 percent or lower and 4 of them invoh'ed in predicting fiscal policy in the seeing the appropriate level as 21f:. percent or United States, the continuing potential for higher. Generally, the participants who judged European developments to threaten financial that a longer period of \·ery accommodative stability, and the possibility of a general monetary PJlicy would be appropriate were slol,l,TIown in global economic growth. As in those who projected that a sizable gap between September, participants noted the challenges the unemployment rate and the longer-run associated with forecasting the path of the normal level of the unemployment rate would persist until 2015 or later. in contrast, the majority of the 5 panicipants who judged that I. Table 2 plUlides estimates of the forecast uncertainty for the change in real GDp, the policy firming should begin in 2013 or 2014 unemplO}ment rate, and total conswner price inflation indicated that the Committee would need to om the pericd frem 1992 through 2011. At the end act relatively soon in order to keep inflation of this swnmary, the box "Fomast Uncertainty" near the FOMCs longer-run objective of discusses the sources and interpretation of IUlcertainty 2 percent and to prevent a rise in inflation in the economic forecasts and explains the approach used 10 assess the Wlcertaintyand risks attending the expectations. participants' projections. 100 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00104 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.45031622 54 PART 3: SUMM.I,RY OF ECONOMIC I'ROJEalONS Figure 3.E. Distribution of participants' projections for the target federal fund. rate, 2012-15 and over the longer run Wil o =UI Deuoi>erp.-oject.,,. i: ., StplOruberproj«otion. :: -" :=:.1 1 - - " " =: I C L _, 'J' 0r_n00 · 1 ~ )jI: . W u) · O I, ,a U ! ' 1 I, 1 D ) · 1 1M )! ' 1 1 6 1 J . · : l 1 a .11 t · : m UJ · :w1.)1 :' Hw) ' l ) a Il t · ) ) 1 D ). ) ) ) Q 1: . 1 H 1 J 1 · , ) . , 1 3 2 t .• j_ 1 D ) · ' j 6 _) 2 l: . Pen:tnt rallge -. Wll - ". = 1! -" --" =! -I.;;: , 'J' 1.1l· 1.!!. HI· 2.11· 2.)1:. I.6J· ll8· 1.13· 1.)1:. J.6J. J,3t. '11· ,,)1:. 1.17 1.62 \,11 :1.11 :1.11 2.61 211 ),\1 ),17 ),62 311 ',11 '11 '6) Perceolrallge WI' 1!IjjQ=-=' US- 11J- 1,)1- \.6J. \ lIS· :1.11- .. : I.! r I O - ' l.6)- POU :"S .· . ),13- ),)1:. 3.63- ),3t. '11· '!I. U2 1.D 1.62 III 2.11 I_D 1.61 211 1.U 1.D 1.Q JJ1 '11 ',D '62 Pen:tnt range WI5 ::i:. -" --",. - = ! ---- - ,=]' ) ), I 1 J 7 · l ), J 62 I · H H1 J· ' lD ,11 · .'1n1· ' . 6 _) ) 1: . -. Loogernm - - " ". -" = li - _ .. iji._,~ i 0r.n00 0m31 W U) - U II S I - l U D 3- 1I.!.1- 1\.n63 : 1 1 . . 1 1 I 1 S - :m1.11 - :wI.!I l 2 . 1 6 1 ) - I 1 I 18 I - ) ) , D 1)- ) )6 ,J 2 i - ) J. 1 63 1 - . J. 1 II 1 S , . 1 D 1 . ' 6 ! 2 I NOle: The target federal fWlds rare is measured as lIie Ie>'eJ of tile target Tate at the rod of the caleudar year or io the 1000ger nm 101 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00105 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.55031622 MONETARY POLICY REPORT: fEBRUARY 2013 55 figure 4. Uncerlainty and risks in economic projections -Uncertaintyaoout GDP growth -Risks toGDP gr0\\1h -" _ 1:1 ~p<o.ie<ti"", _ 1:1 D=ri>orproj."6,,o. -" _ •• StplOmberproj«otioA' _ •• StplOmbeT projection, -" -". -12 ->0 - , - , - .. .... -,-:::---,-,----' ' , Bmadly Weighted to Ihoadly Weighted to """ d(lYonslde upside rr--.... -U~rtaiuty aboUllhe uneruplO)"rotllt rate -2t) _ Risks tOlhe unemplo)ment rate ·=:! 1-14 1-12 ,1-= l,~ ,- , r ;1' r Ihoadly \\'e!ghted to Broadly WeIghted to stllIIlar d(M"DSlde oola1lCed upside -Uoctrtaiuty all-out PCE in8atioD -Risks to PCE inIIatioD -" -" -" -". ,....-.."" ----- - - 1 > 2 0 - , - 1. ____ - 4 .. ~1ILJ 2 Bmadly Higher W~igltltd to Br,o"a"d'l"y Weigltledto snullar d(M"Ds!de UpsIde -Uncertainty about core PCEinilatiOll -Risks tocore peE inllatiOll -" -" -" -". -12 ->0 - , - I.----,-~ .. Ihoadly Higher Weiglttedto Ih,o"a"dl'y" Weighted to SUlIIlar d(M"DSlde Upllde Note: For deliDitiOlls oflWCtrtaiuty 3lld risks in OCOItoruic p-ojeoiOllS, set the box ·forecasl U~rtaiD\(·Deliui­ tiOilS of variables are in the getICr&1 note to I3bIe 1 102 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00106 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.65031622 56 PART 3: SUMM,>,RY OF ECONOMIC PROJEalONS u.s. economic recovery following a financial of risk were U.S. fiscal policy, which many crisis and recession that difi'ered markedly participants thought had the potential to slow from recent historical experience. A number economic activity significantly over the near of participants also commented that in the term, and the situation in Europe. aftermath of the financial crisis, they were more uncertain about the level of potential Most participants cominued to judge the risks output and its rate of growth. It was noted to their projections for inflation as broadly that some of the uncertainty about potential balanced, with several highlighting the recent output arose from the risk that a continuation stability of longer-term inl1ation expectations. of elevated levels of long-term unemployment Howewr, three participants saw the risks to might impair the skills of the affected inflation as tilted to the dov.llside, reflecting, individuals or cause some of them to drop out for example, risks of disinl1atiollthat could of the labor force, thereby reducing potential arise from ad\'erse shocks to the economy that output in the medium term. policy would have limited scope 10 offset. A couple of participants saw the risks to inflation A majority of participants reported that they as weighted to the upside in light of concerns saw the risks to their forecasts of real GDP about U.S. fiscal imbalances, the current highly growth as weighted tov.'<lrd the downside and, accommodative stance of monetary policy, accordingly, the risks to their projections and uncertainty about the Committee's ability of the unemployment rate as tilted to the to shift to a less accommodative policy stance upside. The most frequently identified sources when it becomes appropriate to do so, 103 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00107 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.75031622 MONETARY POLICY REPORT: fEBRUARY 1013 57 Forecast Uncertainty The economc projections provided by the and fourth years. The corresponding 70 percent members of the Board of Governors and the confidence intervals for overall inflation would presidents of the Federal Reserve Banks inform be 1.5 to 2.S percent in the current year, 1.1 to discussions of moneliry policy among policymakers 2.9 percent in the second year, 0.9 to 3.1 percent in and can aid public understanding of the basis for the third year, and 1.0 to 3,0 percent in the fourth policy actions. Considerable uncertainty attends year. these projections, howel'r€. The economic and Because current conditions may differ from statistical models and relationships used to help those that prevailed, on average, over history, produce economic forecasts are necessarily participants provide judgments as to whether the imperfect descriptions of the real world, and the uncertainty attached to their projections of each future path of the economy can be affected by variable is greater than, smaller than, or broadly myriad unforeseen del'l€opments and events, Thus, similar to typical levels of forecast uncertainty in setting the stance of monetary policy, participants in the past, as shewn in table 2. Participants also consider not only what appears to be the most likely provide judgments as to whether the risks to their economic outcome as erIDodied in their projections, projections are weighted to the upside, are weightoo but also the range of alternative possibilities, the to the da.vnside, or are broadly balanced. That is, likelihood of their occurring, and the potential costs participants judge whether each variable is more to the economy should they occur. likely to be above or belew their projections of the Table 2 summarizes the average historical most likely outcome. These judgments about the accuracy of a range of forecasts, including those uncertainty and the risks attending each participant's reported in past Monel.ary Policy Reports and those projections are distiflCt from the diversity of preraroo by the Fooeral Reser\' € Boord's staff in participants' \'iews about the most likely outcomes. advance of meetings of the Fooeral Open Marlce! Forecast uncertainty is concerned with the risks Committee. The projection error ranges shewn in associatoo with a particular projection rather than the table illustrate the considerable uncertainty 10th divergences across a number of different associated with economc forecasts. For example, projections. suppose a participant projects that real gross As with real activity and inflation, the outlook domestic product (GOP) and total consumer prices for the future path of the federal funds rate is subject will rise steadily at annual rates of, respectively, to considerable uncertainty. This uncertainty arises 3 percent and 2 percent. If the uncertainty attending primarily because each participant's assessment of those projections is similar to that experienced in the awropriate stance of rmnetary policy depends the past and the risks around the projections are importantly on the evolution of real activity and broadly balanced, the numbers reported in table 2 inflation over time. tf economic conditions evolve would imply a probability of about 70 percent that in an unexpectoo manner, then assessments of the actual GOP would eKpaod within a range of 2.4 to appropriate setting of the fooeral funds rate would 3.6 percent in the current year, 1.6 to 4.4 percent in change from that point forward. the second year, and 1J to 4.7 percent in the third 104 VerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00108 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON spe.85031622 59 ABBREVIATIONS ABCP asset·backed commercial paper AFE advanced foreign economy BHC bank holding company CDS credit default ~v:aps C&I commercial and industrial CMBS commercial mortgage-backed securities CP C{)mmercial paper CRE commercial real estate DPI disposable personal income ECB European Central Bank EME emerging market economy E&S equipment and software FOMe Federal Open Market Committee; also, the Committee GDP gross domestic product MBS mortgage-backed securities MEP matunty exlenslOO program MMF money market fund NIPA nalional income and product accounts OMT Outright Monetary Transactions PCE personal consumption e.xpenditures REIT real estate investment trust repo repurchase agreement SEP Summary of Economic Projections SLOOS Seoior Loan Officer Opinion Survey on Bank Lending Practices S&P Standard and Poor's TALF Term Asset-Backed Securities Loan Facility

Ben S. Bernanke (2013, February 25). Congressional Testimony. Testimony, Federal Reserve. https://whenthefedspeaks.com/doc/testimony_20130226_chair_federal_reserves_first_monetary_policy

@misc{wtfs_testimony_20130226_chair_federal_reserves_first_monetary_policy,
  author = {Ben S. Bernanke},
  title = {Congressional Testimony},
  year = {2013},
  month = {Feb},
  howpublished = {Testimony, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/testimony_20130226_chair_federal_reserves_first_monetary_policy},
  note = {Retrieved via When the Fed Speaks corpus}
}