Congressional Testimony

S. HRG. 114–4 FEDERAL RESERVE’S FIRST MONETARY POLICY REPORT FOR 2015 HEARING BEFORETHE COMMITTEE ON BANKING, HOUSING, ANDURBANAFFAIRS UNITED STATES SENATE ONE HUNDRED FOURTEENTH CONGRESS FIRST SESSION ON OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU- ANTTOTHEFULLEMPLOYMENTANDBALANCEDGROWTHACTOF1978 FEBRUARY 24, 2015 Printed for the use of the Committee on Banking, Housing, and Urban Affairs ( Available at: http://www.fdsys.gov/ U.S. GOVERNMENT PUBLISHING OFFICE 93–836 PDF WASHINGTON : 2016 For sale by the Superintendent of Documents, U.S. Government Publishing 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 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS RICHARD C. SHELBY, Alabama, Chairman MICHAEL CRAPO, Idaho SHERROD BROWN, Ohio BOB CORKER, Tennessee JACK REED, Rhode Island DAVID VITTER, Louisiana CHARLES E. SCHUMER, New York PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey MARK KIRK, Illinois JON TESTER, Montana DEAN HELLER, Nevada MARK R. WARNER, Virginia TIM SCOTT, South Carolina JEFF MERKLEY, Oregon BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana JERRY MORAN, Kansas WILLIAM D. DUHNKE III, Staff Director and Counsel MARK POWDEN, Democratic Staff Director JELENA MCWILLIAMS, Chief Counsel DANA WADE, Deputy Staff Director JACK DUNN III, Professional Staff Member LAURA SWANSON, Democratic Deputy Staff Director GRAHAM STEELE, Democratic Chief Counsel PHIL RUDD, Democratic Legislative Assistant DAWN RATLIFF, Chief Clerk TROY CORNELL, Hearing Clerk SHELVIN SIMMONS, IT Director JIM CROWELL, Editor (II) VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00002 Fmt 0486 Sfmt 0486 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON C O N T E N T S TUESDAY, FEBRUARY 24, 2015 Page Opening statement of Chairman Shelby ................................................................ 1 Opening statements, comments, or prepared statements of: Senator Brown .................................................................................................. 2 WITNESS Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System ...... 3 Prepared statement .......................................................................................... 36 Responses to written questions of: Chairman Shelby ....................................................................................... 39 Senator Crapo ............................................................................................ 44 Senator Vitter ............................................................................................ 45 Senator Kirk .............................................................................................. 46 Senator Heller ........................................................................................... 49 Senator Menendez ..................................................................................... 50 ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD Monetary Policy Report to the Congress dated February 24, 2015 ..................... 59 (III) VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON FEDERAL RESERVE’S FIRST MONETARY POLICY REPORT FOR 2015 TUESDAY, FEBRUARY 24, 2015 U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. The Committee met at 10:05 a.m., in room SD–106, Dirksen Sen- ate Office Building, Hon. Richard C. Shelby, Chairman of the Com- mittee, presiding. OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY Chairman SHELBY. Today the Committee will receive testimony from Federal Reserve Chair Yellen, as has been required by statute since 1978. And although the Federal Reserve Chair has been using this venue for decades to communicate directly to Congress and the American people, I and many of my colleagues have been calling for greater accountability and more effective disclosure for years. In response, we have heard a chorus of current and former Fed- eral Reserve officials who have lined up to defend the structure and the degree of transparency of the Fed. Further accountability to Congress, some have argued, is not needed. I am interested to hear whether the current Chair shares this view and whether she be- lieves that the Fed should be immune from any reforms. As far as monetary policy is concerned, many question whether the Fed can rein in inflation and avoid destabilizing asset prices when the time comes to unwind its massive $4.5 trillion balance sheet. The minutes posted online do little to answer the questions of when and how this will be done, and the most recent FOMC transcript available to the public is from 2008, over 7 years ago. Even though the Fed has several monetary policy tools at its dis- posal, an action of this magnitude has never before been taken, to my knowledge. The Federal Open Market Committee continues to report that it can be patient in keeping the Federal funds rate near zero. Too much delay could lead to a more painful correction down the road. What the FOMC is thinking and how they are analyzing this very difficult problem set remains a mystery, however; and yet some continue to dismiss calls for change or more transparency at the Fed. I would argue, however, that there is an even greater need for additional oversight by Congress and further reforms. Our central bank has expanded its influence over households, businesses, and markets in recent years. Not only has it pushed the boundaries of (1) VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 2 traditional monetary policy, but it has also consolidated unmatched authority as a financial regulator. As the Fed grows larger and more powerful, much of this author- ity has become more concentrated in Washington, DC, and in New York. The Fed emerged from the financial crisis as a super regu- lator, with unprecedented power over entities that it had not pre- viously overseen. With such a delegation of authority comes a heightened responsibility, I believe, for Congress to know the im- pact these new requirements place on our economy as a whole. The role of Congress is not to serve on the Federal Open Market Committee, but it is to provide strong oversight and, when times demand it, bring about structural reforms. As part of this process, the Committee will be holding another hearing next week to dis- cuss options for enhanced oversight and reform in the Fed. Senator Brown. STATEMENT OF SENATOR SHERROD BROWN Senator BROWN. Thank you, Mr. Chairman. Chair Yellen, wel- come back. It is good to see you again and good to have you in front of our Committee. Our economy continued to see strong employment gains and eco- nomic growth at the end of 2014, but we know the improvements in the economy are not being felt by enough Americans. The gains we have made over the past 5 years, 11.5 million net private sector job growth in the last 5 years, come on the heels of 9 years when we lost 4.5 million jobs. Some pundits and politicians have been predicting runaway inflation for years. They clearly do not have a very good grasp of what is happening for most Americans. Low wage growth has continued for the majority of Americans. The de- clining participation in the workforce is troubling. In fact, as you pointed out, Madam Chair, the income inequality gap has actually widened during this recovery. It is good, Mr. Chairman, that we began our session today by commemorating the Selma Foot Soldiers. We must also note, though, that the wealth gap between white and black American families has widened. Low- and middle-income Americans have not benefited much from low interest rates. Workers with stagnant wages have trouble saving for a downpayment or their retirement or their children’s education. These are issues that Congress should be addressing, but the everyday struggle of Americans needs to be part of the Fed’s consideration in making monetary policy, too. I appreciate, Chair Yellen, your announcement last month of plans to create the Community Advisory Council. It will have 15 members, meet twice a year with the Board in Washington to offer perspectives on their economic circumstances and the needs of low- and moderate-income communities and consumers. I hope the en- tire Federal Reserve System—the 12 regional banks as well as the Board in Washington—will engage community leaders way more than they have in the past and will do what you have done by set- ting the tone in Washington and incorporate the diverse perspec- tives into their decision making. We too often hear concerns that the Fed is a system that is run by and to benefit the very largest banks. Last November, I held a Subcommittee hearing on one facet of this: regulatory capture. The VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 3 hearing explores concerns about the culture of the banks and the regulators. A regulatory culture that is fair and tough, that chal- lenges group think, and that produces rules and regulations de- signed to strengthen the financial stability of our economy will pro- tect Americans’ financial interests. I applaud the Fed for finalizing strong rules for the Nation’s larg- est and riskiest financial institutions. I encourage you to move for- ward to finalize outstanding proposals so that everyone will benefit from the certainty of having appropriate rules in place. It has been more than a year since the Fed released an Advanced Notice of Proposed Rulemaking on commodities trading and phys- ical asset ownership. For example, in today’s papers, there are re- ports of a DOJ investigation of 10 banks for activities in the pre- cious metals markets, and we have yet to see a proposed rule. The job does not end there. You must then send the message to your examiners that these rules must be implemented and enforced. Finally, while some of my colleagues are eager to help you and the Fed decide monetary policy, I think that is the wrong role for Congress. I am all for transparency. I think more is better as a general rule. But every one of us knows there are times when you can do better by having a candid discussion in private. One real goal must be to have a Federal Reserve that works for all Americans, to have a strong economy that benefits low-wage workers and the middle class as much as the wealthiest, and to have a stable and diverse financial system that provides opportuni- ties for all Americans, not one that threatens their savings. That is why your dual mandate to promote price stability and employ- ment, and I so appreciate, perhaps more than you, perhaps more than any of your predecessors, or at least as much understands the dual mandate, including employment, how important that is. It re- mains important today. Thank you. Chairman SHELBY. Madam Chair, welcome to the Committee. We look forward to your testimony and our question-and-answer pe- riod. Your written testimony will be made part of the record in its entirety. You may proceed briefly to outline what you want to tell us. STATEMENT OF JANET L. YELLEN, CHAIR, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Ms. YELLEN. Chairman Shelby, Ranking Member Brown, and Members of the Committee, I am pleased to present the Federal Reserve’s semiannual Monetary Policy Report to the Congress. In my remarks today, I will discuss the current economic situation and outlook before turning to monetary policy. Since my appearance before the Committee last July, the employ- ment situation in the United States has been improving along many dimensions. The unemployment rate now stands at 5.7 per- cent, down from just over 6 percent last summer and from 10 per- cent at its peak in late 2009. The average pace of monthly job gains picked up from about 240,000 per month during the first half of last year to 280,000 per month during the second half, and employ- ment rose 260,000 in January. In addition, long-term unemploy- ment has declined substantially, fewer workers are reporting that VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 4 they can find only part-time work when they would prefer full-time employment, and the pace of quits—often regarded as a barometer of worker confidence in labor market opportunities—has recovered nearly to its prerecession level. However, the labor force participa- tion rate is lower than most estimates of its trend, and wage growth remains sluggish, suggesting that some cyclical weakness persists. In short, considerable progress has been achieved in the recovery of the labor market, though room for further improvement remains. At the same time that the labor market situation has improved, domestic spending and production have been increasing at a solid rate. Real gross domestic product is now estimated to have in- creased at a 33⁄ 4 percent annual rate during the second half of last year. While GDP growth is not anticipated to be sustained at that pace, it is expected to be strong enough to result in a further grad- ual decline in the unemployment rate. Consumer spending has been lifted by the improvement in the labor market as well as by the increase in household purchasing power resulting from the sharp drop in oil prices. However, housing construction continues to lag; activity remains well below levels we judge could be sup- ported in the longer run by population growth and the likely rate of household formation. Despite the overall improvement in the U.S. economy and the U.S. economic outlook, longer-term interest rates in the United States and other advanced economies have moved down signifi- cantly since the middle of last year; the declines have reflected, at least in part, disappointing foreign growth and changes in mone- tary policy abroad. Another notable development has been the plunge in oil prices. The bulk of this decline appears to reflect in- creased global supply rather than weaker global demand. While the drop in oil prices will have negative effects on energy producers and will probably result in job losses in this sector, causing hard- ship for affected workers and their families, it will likely be a sig- nificant overall plus, on net, for our economy. Primarily, that boost will arise from U.S. households having the wherewithal to increase their spending on other goods and services as they spend less on gasoline. Foreign economic developments, however, could pose risks to the U.S. economic outlook. Although the pace of growth abroad appears to have stepped up slightly in the second half of last year, foreign economies are confronting a number of challenges that could re- strain economic activity. In China, economic growth could slow more than anticipated as policymakers address financial vulnerabilities and manage the desired transition to less reliance on exports and investment as sources of growth. In the euro area, recovery remains slow, and inflation has fallen to very low levels; although highly accommodative monetary policy should help boost economic growth and inflation there, downside risks to economic activity in the region remain. The uncertainty surrounding the foreign outlook, however, does not exclusively reflect downside risks. We could see economic activ- ity respond to the policy stimulus now being provided by foreign central banks more strongly than we currently anticipate, and the VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 5 recent decline in world oil prices could boost overall global eco- nomic growth more than we expect. U.S. inflation continues to run below the Committee’s 2-percent objective. In large part, the recent softness in the all-items measure of inflation for personal consumption expenditures reflects the drop in oil prices. Indeed, the PCE price index edged down during the fourth quarter of last year and looks to be on track to register a more significant decline this quarter because of falling consumer energy prices. But core PCE inflation has also slowed since last summer, in part reflecting declines in the prices of many imported items and perhaps also some passthrough of lower energy costs into core consumer prices. Despite the very low recent readings on actual inflation, inflation expectations as measured in a range of surveys of households and professional forecasters have thus far remained stable. However, inflation compensation, as calculated from the yields of real and nominal Treasury securities, has declined. As best we can tell, the fall in inflation compensation mainly reflects factors other than a reduction in longer-term inflation expectations. The Committee ex- pects inflation to decline further in the near term before rising gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate, but we will continue to monitor inflation developments closely. I will now turn to monetary policy. The Federal Open Market Committee is committed to policies that promote maximum employ- ment and price stability, consistent with our mandate from the Congress. As my description of economic developments indicated, our economy has made important progress toward the objective of maximum employment, reflecting in part support from the highly accommodative stance of monetary policy in recent years. In light of the cumulative progress toward maximum employment and the substantial improvement in the outlook for labor market condi- tions—the stated objective of the Committee’s recent asset pur- chase program—the FOMC concluded that program at the end of October. Even so, the Committee judges that a high degree of policy ac- commodation remains appropriate to foster further improvement in labor market conditions and to promote a return of inflation toward 2 percent over the medium term. Accordingly, the FOMC has con- tinued to maintain the target range for the Federal funds rate at 0 to 1⁄ 4 percent and to keep the Federal Reserve’s holdings of longer-term securities at their current elevated level to help main- tain accommodative financial conditions. The FOMC is also pro- viding forward guidance that offers information about our policy outlook and expectations for the future path of the Federal funds rate. In that regard, the Committee judged, in December and Janu- ary, that it can be patient in beginning to raise the Federal funds rate. This judgment reflects the fact that inflation continues to run well below the Committee’s 2-percent objective and that room for sustainable improvements in labor market conditions still remains. The FOMC’s assessment that it can be patient in beginning to normalize policy means that the Committee considers it unlikely that economic conditions will warrant an increase in the target VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 6 range for the Federal funds rate for at least the next couple of FOMC meetings. If economic conditions continue to improve, as the Committee anticipates, the Committee will at some point begin considering an increase in the target range for the Federal funds rate on a meeting-by-meeting basis. Before then, the Committee will change its forward guidance. However, it is important to em- phasize that a modification of the forward guidance should not be read as indicating that the Committee will necessarily increase the target range in a couple of meetings. Instead the modification should be understood as reflecting the Committee’s judgment that conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting. Provided that labor market conditions continue to improve and further improvement is expected, the Committee anticipates that it will be appropriate to raise the target range for the Federal funds rate when, on the basis of incoming data, the Committee is reasonably confident that inflation will move back over the medium term toward our 2-percent objective. It continues to be the FOMC’s assessment that even after em- ployment and inflation are near levels consistent with our dual mandate, economic conditions may, for some time, warrant keeping the Federal funds rate below levels the Committee views as normal in the longer run. It is possible, for example, that it may be nec- essary for the Federal funds rate to run temporarily below its nor- mal longer-run level because the residual effects of the financial crisis may continue to weigh on economic activity. As such factors continue to dissipate, we would expect the Federal funds rate to move toward its longer-run normal level. In response to unforeseen developments, the Committee will adjust the target range for the Federal funds rate to best promote the achievement of maximum employment and 2-percent inflation. Let me now turn to the mechanics of how we intend to normalize the stance and conduct of monetary policy when a decision is even- tually made to raise the target range for the Federal funds rate. Last September, the FOMC issued its statement on Policy Normal- ization Principles and Plans. This statement provides information about the Committee’s likely approach to raising short-term inter- est rates and reducing the Federal Reserve’s securities holdings. As is always the case in setting policy, the Committee will determine the timing and pace of policy normalization so as to promote its statutory mandate to foster maximum employment and price sta- bility. The FOMC intends to adjust the stance of monetary policy dur- ing normalization primarily by changing its target range for the Federal funds rate and not by actively managing the Federal Re- serve’s balance sheet. The Committee is confident that it has the tools it needs to raise short-term interest rates when it becomes ap- propriate to do so and to maintain reasonable control of the level of short-term interest rates as policy continues to firm thereafter, even though the level of reserves held by depository institutions is likely to diminish only gradually. The primary means of raising the Federal funds rate will be to increase the rate of interest paid on excess reserves. The Committee also will use an overnight reverse repurchase agreement facility and other supplementary tools as VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 7 needed to help control the Federal funds rate. As economic and fi- nancial conditions evolve, the Committee will phaseout these sup- plementary tools when they are no longer needed. The Committee intends to reduce its securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal from securities held by the Federal Re- serve. It is the Committee’s intention to hold, in the longer run, no more securities than necessary for the efficient and effective imple- mentation of monetary policy and that these securities be primarily Treasury securities. In sum, since the July 2014 Monetary Policy Report, there has been important progress toward the FOMC’s objective of maximum employment. However, despite this improvement, too many Ameri- cans remain unemployed or underemployed, wage growth is still sluggish, and inflation remains well below our longer-run objective. As always, the Federal Reserve remains committed to employing its tools to best promote the attainment of its objectives of max- imum employment and price stability. Thank you. I would be pleased to take your questions. Chairman SHELBY. Madam Chair, I first would want to get into measures of inflation. You touched on that a little. The Federal Re- serve I understand currently uses an inflation measure of core per- sonal consumption expenditures, or PCE, which excludes volatile food and energy prices. Several alternative measures of inflation exist, including one called the ‘‘Trimmed Mean PCE,’’ which strips out a larger basket of volatile items from the calculation. I know you know all this. Do you think that the Federal Open Market Committee should incorporate alternative measures of inflation such as Trimmed Mean PCE? And could you explain to us the risk of not properly gauging inflation expectations? Ms. YELLEN. Thank you. So let me first say that the Federal Open Market Committee’s 2-percent objective refers to the in- crease, the annual increase in the total PCE price index that in- cludes food and energy. Food and energy are very important compo- nents of every household’s spending basket, and I do not think it would make a lot of sense or be acceptable to Americans to focus on a measure that strips out these important components of the consumer basket. So we focus on total consumer prices, including food and energy. But at the same time, we recognize that food and energy are par- ticularly volatile prices, and in order to get a better forecast some- times of the underlying trend in inflation, we do look at so-called core inflation that strips out these measures. And in trying to understand trends in inflation and the factors impacting inflation, we look at a broad variety of measures of infla- tion. Although our formal index is the so-called PCE price index, we look at the CPI, which is well known to most Americans, and also to these Trimmed Mean and other measures that you cited. Chairman SHELBY. You have opined on the use of monetary pol- icy rules such as the Taylor rule, which would provide the Fed with a systematic way to conduct policy in response to changes in eco- nomic conditions. I believe that would also give the public a greater understanding of and perhaps confidence in the Fed’s strategy. VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 8 You have stated, and I will quote: ‘‘Rules of the general sort pro- posed by Taylor capture well our statutory mandate to promote maximum employment and price stability.’’ You have expressed concerns, however, over the effectiveness of such rules in times of economic stress. Would you support the use of a monetary policy rule of the Fed’s choosing if the Fed had dis- cretion to modify it in times of economic disruption? Ms. YELLEN. I am not a proponent of chaining the Federal Open Market Committee in its decision making to any rule whatsoever. But monetary policy needs to take account of a wide range of fac- tors, some of which are unusual and require special attention, and that is true even outside times of financial crisis. In his original paper on this topic, John Taylor himself pointed to conditions such as the 1987 stock market crash that would have required a different response. I would say that it is useful for us to consult the recommendations of rules of the Taylor type and oth- ers, and we do so routinely, and they are an important input into what ultimately is a decision that requires sound judgment. Chairman SHELBY. Thank you. In a recent speech, Richard Fisher, the President of the Dallas Federal Reserve Bank, has suggested a reorganization of the Fed- eral Open Market Committee, specifically advocates for a rotating Vice Chairmanship of the Federal Open Market Committee, as well as a stronger role for regional banks on the Committee. Do you support any of Mr. Fisher’s proposals? And why, or why not? Ms. YELLEN. Well, Senator Shelby, I think the current structure of the Federal Open Market Committee and the voting structure was decided on by Congress a long time ago, after weighing a whole variety of considerations about the need for control in Wash- ington and the importance of regional representation. It is, of course, something that Congress could, if it wished, re- visit. But I would say that it has worked very well. We have a broad range of opinion that is represented at the table, and active debates. The decision to appoint the President of the New York Fed as Vice Chair reflected the reality that the New York Fed conducts open market operations on behalf of the system and has special and deep expertise pertaining to financial markets. And I think that has worked well and continues to be true, that there is special expertise in New York. Chairman SHELBY. A recent article written by two economists for the think tank e21 proposes reducing the number of Federal Re- serve districts from 12 to 5 and making the Presidents of all re- gional banks voting members of the Federal Open Market Com- mittee. The article states that this would preserve regional diver- sity while giving more authority over monetary policy to Reserve Banks that currently rotate as voting members. It also posits that it could allow for greater safety and soundness and remove the un- certainty created by 19 independent FOMC members. Do you oppose consolidation of Federal Reserve districts? Ms. YELLEN. Senator, again, this is a matter for Congress to de- cide. The structure of the Federal Reserve reflects choices that were hammered out 100 years ago, and I think the current struc- VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 9 ture works well, so I would not recommend changes. But, again, you know, the Federal Reserve Banks are—— Chairman SHELBY. It is up to Congress, is it not? Ms. YELLEN. ——play important roles in their communities, but, again, this is up to Congress to consider. Chairman SHELBY. My last question to you in this round: asset threshold for banks. A recent report by the Office of Financial Re- search shows a large disparity in systemic risk between the largest banks and those that are smaller and closer to $50 billion in assets. All banks above $50 billion are subject to enhanced prudential reg- ulation regardless of where they fall in this systemic important scale. Do you think the findings of the OFR, the Office of Financial Re- search, should be incorporated or considered in the determination of whether a bank is systemically significant? Ms. YELLEN. Well, Senator, we absolutely recognize in the Fed- eral Reserve that the largest banks and those closer to $50 billion are quite different in terms of their systemic footprint, and we have many different measures that help us decide on the systemic im- portance of an institution, and there obviously are large differences there. In Dodd-Frank, Congress gave us the flexibility to tailor our su- pervision and regulation to make it appropriate to the systemic im- portance and complexity and size of a bank, and to the maximum extent possible within that legislation, we have tried to use the powers that we have to appropriately tailor our supervision and regulation. So, for example, we recently proposed extra capital charges on the largest and most systemic institutions and higher leverage re- quirements, and those requirements would not apply to the smaller institutions. But there are many other examples as well. Chairman SHELBY. Do you know of any community or regional bank that has caused systemic risk to our economy? Ms. YELLEN. There may have been episodes in which there were bank failures of smaller banks that did threaten systemic con- sequences, but certainly it is the largest—— Chairman SHELBY. I believe you chose your words carefully. You said ‘‘may have been.’’ Do you know of any yourself and could you furnish any for the record where smaller banks, any of them, or re- gional banks have caused systemic risk to our economy or to our banking system? Would you furnish that for the record if you do? Ms. YELLEN. So I will certainly look into it and furnish it. I am trying to agree with you that it is—— Chairman SHELBY. That they do not—— Ms. YELLEN. By and large, that has not been the case. Chairman SHELBY. Thank you. Ms. YELLEN. Yes, I agree with that. Chairman SHELBY. Thank you, Madam Chair. Senator Brown. Senator BROWN. Thank you, Mr. Chairman. I have one comment about your answer to the last question of the Chairman’s about capital requirements that you have applied. I think there is no question, as reports have recently made pretty clear, that it has made for stronger banks and a more stable finan- VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 10 cial system, so thank you. And Senator Vitter on this Committee I know has had special interest, as has Senator Shelby, in strong capital standards. So thank you for that. Madam Chair, I mentioned in my opening statement that last October you gave a speech on income and wealth inequality. All of us agree the best way to address that is a more robust job-creating economy. What steps are you taking to incorporate your concerns about that into the monetary policy decisions? Ms. YELLEN. Well, Senator Brown, as you know, we are very committed to both parts of the dual mandate—price stability and maximum employment. We have been running a very accommoda- tive monetary policy in order to promote stronger conditions in the labor market. We have been monitoring a wide variety of indicators of labor market performance, not focusing on any single summary measure, and in particular, for example, the large magnitude of part-time involuntary employment workers who want full-time jobs, the decline in labor force participation, part of which we un- derstand to be or believe to be cyclical, these are things that we are monitoring very closely. We are also looking at wage growth, and the fact that wage growth has really not picked up very much during this recovery I take to be another signal that, although the labor market is im- proving, we have further to go, and we want to promote full recov- ery. Senator BROWN. Thank you. For much of our Nation’s economic history, productivity has tracked wages, but since the 1970s, as you know, this has changed; and productivity has continued, particu- larly in the last 15 years or so, to grow while wages have not. How do you explain this change? And what are the dangers of wages being uncoupled from productivity? Ms. YELLEN. Well, we have seen a significant increase in the share of the pie or GDP that accrues to capital as opposed to labor, and that occurs when the growth in inflation-adjusted or real wages fails to mirror the growth in productivity. So that has been occurring now for some time, and we have seen that occur during the recovery. Real wages tend to rise more rapidly in a strong labor market, so I interpret part of that phenomenon as a signal, a sign that the labor market is not yet fully recovered. But I should also say that there are longer-term structural factors that may also be affecting the shares of the pie that accrue to labor and capital. I think one of these factors, recent research points to the fact that many labor-intensive activities in the global production chain are being increasingly outsourced, and that phenomenon I think has tended to push down the share of income going to labor as op- posed to capital over the last decade or so. There is research on this topic, so I think it is a combination of structural factors, but also remaining cyclical weakness—— Senator BROWN. And that includes the organization of labor, of workers being organized? Ms. YELLEN. That certainly could include that as a factor. Senator BROWN. I appreciate the steps that you and your prede- cessor have made to bring greater transparency to the Fed. As you know, there is a proposal in the House and Senate to go one step VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 11 further and require the GAO to audit the Fed’s monetary policy de- liberations. What are your thoughts on that? Ms. YELLEN. I want to be completely clear that I strongly oppose ‘‘audit the Fed.’’ I believe the transparency and providing Congress and the public with adequate information to be able to understand our operations, our financial condition, the conduct of our meeting the responsibilities that Congress has assigned to us is essential. But ‘‘audit the Fed’’ is a bill that would politicize monetary policy, would bring short-term political pressures to bear on the Fed. In terms of openness about our financial accounts, we are exten- sively audited. I brought with me this volume which contains an independent outside auditor’s—Deloitte & Touche’s—audits of our financial statements. So in the normal sense in which people un- derstand what auditing is about, the Federal Reserve is extensively audited. What I think is really critically important is that the Fed be able to deliberate on the best way to meet the responsibilities that Congress has assigned to us, to achieve maximum employment and price stability, and that we be able to do so free of short-term political pressures. I would remind you that in the early 1970s, when inflation built and became an endemic problem in the U.S. economy, history sug- gests that there was political pressure on the Fed that interfered with its decision making. It was in the last 1970s that Congress put in place the current feature of law that exempts monetary pol- icy deliberations and decisions, the one area that is exempted from GAO audits. And I really wonder whether or not the Volcker Fed would have had the courage to take the hard decisions that were necessary to bring down inflation and get that finally under con- trol, something I think has been very important to the performance of the U.S. economy, I wonder if that would have happened with GAO reviews in real time of monetary policy decision making. So central bank independence in conducting monetary policy is considered a best practice for central banks around the world. We are one of many, many central banks that are independent, and academic studies I think establish beyond the shadow of a doubt that independent central banks perform better, the economies are more stable and have better performance in terms of inflation and macroeconomic stability. Senator BROWN. A last brief question, Madam Chair. You men- tioned your Community Advisory Council. What are you doing to encourage regional bank presidents to follow suit? Ms. YELLEN. Well, regional banks, most of the regional banks are actively involved with their communities. They have community de- velopment programs and are really trying to address the special needs of their communities. But in Washington, we also encourage and have oversight of those activities and strongly encourage simi- lar practices. Senator BROWN. Thank you. Thank you, Mr. Chairman. Chairman SHELBY. Senator Crapo. Senator CRAPO. Thank you, Mr. Chairman, and, Chair Yellen, I would like to use my time going over the EGRPRA process that we are in right now with you. VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 12 The first Economic Growth and Regulatory Paperwork Act, or EGRPRA, review submitted to Congress in 2007 states, ‘‘Besides reviewing all of our existing regulations in an effort to eliminate unnecessary burdens, the Federal banking agencies work together to minimize burdens resulting from new regulations and current policy statements as they were being adopted.’’ I think you know where I am headed here. The report submitted to Congress specifically discussed consumer financial protection issues, anti-money-laundering issues, and in- cluded recently adopted rules. However, included in the Federal Register put forward for this current 10-year EGRPRA process that we are now in, where we are supposed to be having our financial regulators by law look for outdated, unnecessary, and unduly bur- densome regulatory requirements in the system, there was, I think, a remarkable couple of footnotes included which basically said that the agencies engaged this time around are going to back off. They are basically not going to review new regulations that have gone into effect, not going to review regulations that are currently being considered and will go into effect during the EGRPRA process, and have clarified that the CFPB is not even going to be a part of the process. The entire Consumer Financial Protection Bureau will not be a part of the process. My question to you is going to be: Would you not agree that we should have a thorough EGRPRA process that reviews all rules and that the Consumer Financial Protection Bureau or the consumer regulatory system should be a part of the EGRPRA process? But before I put that question to you, I would just like to say we had a hearing last week which was dealing with community banks and credit unions and the regulatory burdens that they face. And I asked the witnesses, and every one of them said that in the set of rules and regulations that they feel are creating unnecessary and unduly burdensome pressures are rules and regulations coming from the consumer financial arena, coming from the anti-money- laundering arena, and coming from the Dodd-Frank legislation that is recently enacted which would be exempted from the current agency’s review. A couple of examples they gave were the qualified mortgage rule that needs to be reviewed, the Volcker rule that needs to be re- viewed, and yet all of this is apparently outside the scope of the entire EGRPRA process that the agencies are now undertaking. Could you respond, please? Ms. YELLEN. So in the rules that have gone into effect or are in the process under consideration and will go into effect related to Dodd-Frank, we had Federal Register notices, took public comment, an important part of designing those rules was considering the costs, the burdens, and what was the most effective and appro- priate way of designing regulations to meet Dodd-Frank objectives. So in a sense, what EGRPRA asks of the agencies is something that we have gone through very recently in the process of designing regulations in some cases that have not yet even gone into effect. Senator CRAPO. Would your answer be the same for the Con- sumer Financial Protection Bureau, because it is new that we do not need to review its rules and regulations? VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 13 Ms. YELLEN. I really cannot speak to—you know, we do not have that rulemaking authority, and, sir, I cannot speak to what role the CFPB is going to play. Senator CRAPO. Well, it seems to me—I understand the argu- ment. In fact, that is the argument we got from the regulators who were before us 2 weeks ago in one of our hearings. But it seems to me that that is not what EGRPRA says. EGRPRA does not say, ‘‘Let us review the rules and regulations that are old.’’ It says, ‘‘Let us review them all.’’ That is what the law was passed to do. And if you look at the Dodd-Frank legislation that you were just saying has recently been through the process, or many of its rules and reg- ulations have recently been through the process, the Dodd-Frank legislation itself was 848 pages long. But the page count of the reg- ulations required by Dodd-Frank has mushroomed to more than 15,000 pages so far, and they are not finished, and over 15 million words of regulatory text. And to say that the fact that they are new and the fact that the implementation process has just recently been completed on them I do not think is a satisfactory response to the requirement of EGRPRA that the agencies need to look at their regulations and identify those that are unnecessary or unduly bur- densome. Ms. YELLEN. Well, we are holding public hearings and will be taking extensive public comments. You mentioned community banks. We are very focused on trying to find ways to reduce the burdens on community banks, and during this process we will be very sensitive to looking for ways in which we can reduce the bur- den of regulation, and we will be reporting back to you. Senator CRAPO. Well, thank you. My time is up. But I would just encourage you and the other Federal regulators to focus on the full intent of EGRPRA and expand your review. Thank you. Ms. YELLEN. Thank you. Chairman SHELBY. Senator Reed. Senator REED. Well, thank you very much, Mr. Chairman, and, Madam Chair, welcome. The Federal Reserve has significant responsibilities in many areas. One is monetary policy, in which the Federal Reserve exer- cises a historic, customary independence. But one other area is reg- ulatory policy, actually supervising the operation of large financial institutions, which leads inevitably back to the New York Federal Reserve, which has a great deal of authority, and several of us have had proposals to help, we hope, improve this regulatory over- sight, which has been criticized in the past, I mean not only in the run-up to 2007 and 2008, but even recently. Can you please describe what you have done for greater account- ability from the New York Fed? Ms. YELLEN. So in the aftermath of the hearings that were held here and the allegations that were raised about the New York Fed, we have undertaken an internal review, and that is in process. Now, I should say that the question that we think is important that was raised there is—let me step back. We have a process for supervising the largest banks that is a systemwide process, in- volves systemwide committees, and is led by Washington, by the Board. VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 14 The Reserve Banks that are involved with the supervision of the institutions in that large bank portfolio take part in the process that is a groupwide and Board-led process. So the question we thought is important for us to look at is: Are we in that process, the Board and the group that supervises these banks and makes decisions, is the relevant information being fed up to the highest decision-making levels, including the Board of Governors? And to the extent that within a Reserve Bank supervision teams there may be divergent opinions, we want to make sure that dissident voices are heard and that dissident views can reach the highest levels for consideration. So that is the question that we have asked our internal team to look at. The review includes the New York Fed, but also other Re- serve Banks that are also involved in large bank supervision, be- cause avoiding group think and making sure that dissident views can be heard at the highest levels is really critical to sound super- vision. We have also asked our Inspector General to undertake his own independent review, and these are in process, and I expect them to be completed this year. Senator REED. And you anticipate that the Federal Reserve, the Board of Governors, will take specific action which is recognizable and transparent to the Congress and to the people that—— Ms. YELLEN. Yes. I mean, we expect to report to you on the find- ings of these investigations, and if the need and suggestions for im- provement are found, we expect to put those into effect. Senator REED. At this point do you anticipate that there will be needs to improve? I mean, that is what seems to strike most people when you look at some of the incidents that have taken place over the last several years, that some change has to happen. The ques- tion is: Will it be legislative or administrative? Ms. YELLEN. Well, we will certainly take any administrative changes that appear to be called for. You know, I would like to wait and see what the findings are of the reviews before deciding on the appropriate measures. Senator REED. Thank you, Madam Chair. My time has expired, but let me put one more issue on the table, and perhaps we could follow up with a question. We are all acutely sensitive to systemic risk, and in Dodd-Frank we tried to minimize that risk by intro- ducing the notion of clearinghouses that would take bilateral trans- actions, derivatives swaps, et cetera, and put them onto a platform. But that itself introduces a degree of risk in terms of the clearing- houses themselves, and I just want to obviously put on your screen, which I think already is, the sensitivity that we have to continued oversight of these clearinghouses, both our own and others across the globe, because of the potential systemic problem. So can I just put that on the table? Ms. YELLEN. Absolutely, and I want you to know that I am—we are very attuned to the need to be careful in our supervision that we have taken a step forward, I think, as you mentioned, in mov- ing a great deal of clearing to clearinghouses. Eight financial mar- ket utilities, including the most important central counterparties, have been designated by FSOC as systemically important financial market utilities, and they are being supervised by the Federal Re- VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 15 serve, those based in the United States, the Fed, the CFTC, and the SEC. There are a set of principles that have been put in place and agreed globally for what best practices are in terms of liquidity standards and other risk management standards for these financial market utilities, and it is extremely high priority for us to make sure that we vigorously enforce those standards, and we are in the process of doing so, because although these entities reduce risks that were previously present, they create their own risks if they are not appropriately managed. So I completely agree, this is important, and we are giving it a great deal of attention. Senator REED. Thank you very much. Thank you, Mr. Chairman. Chairman SHELBY. Senator Corker. Senator CORKER. Thank you, Mr. Chairman. And, Chair Yellen, thank you for being here today. There is a push right now to add a provision addressing currency manipulation in the Asian Pacific trade deal. Do you think trade negotiations are an appropriate place for these currency issues? And what if such an effort leads to the inclusion of an international arbitration panel under TPP’s enforcement procedures where com- panies or other Nations could challenge future monetary policy de- cisions by the Fed? Ms. YELLEN. So let me first say that I think currency manipula- tion that is undertaken in order to alter the competitive landscape and give one country an advantage in international trade is inap- propriate and needs to be addressed. But, that said, there are many factors that influence the value of currencies, including differences in economic growth and capital flows, and as you mentioned, monetary policy is a factor that can have an impact on currencies. So I would really be concerned about a regime that would intro- duce sanctions for currency manipulation into trade agreements when it could be the case that it would hamper or even hobble monetary policy. Monetary policies we have undertaken, the Fed- eral Reserve has undertaken over the last number of years, having designed for valid domestic objectives of price stability and max- imum employment. We have undertaken monetary policy in order to achieve those objectives, and that certainly is not currency ma- nipulation. But monetary policy affects the economy through many channels, perhaps most importantly through interest rates, but monetary policy may have impact on currency values. And so I would see that kind of direction as having the potential to perhaps hamper the conduct of monetary policy or even hobble the conduct of monetary policy. And I would really worry greatly about that ap- proach. Senator CORKER. So that is a long answer, but the answer I think you just said is you would have a significant problem with that being part of a trade deal. Is that correct? Ms. YELLEN. Yes, I would. Senator CORKER. OK. I want to follow the ‘‘audit the Fed’’ ques- tioning a little bit and walk through a series here, and if we could be a little briefer with our answers, that would be good. VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 16 The first is with respect to the Fed’s lending facilities and the discount window access during the financial crisis. There are legiti- mate questions about how these facilities were conducted, but to a large extent, Congress addressed this issue by adopting the Sand- ers amendment to Dodd-Frank. Can you speak to the impact of the Sanders amendment on GAO’s ability to audit crisis credit facili- ties? Ms. YELLEN. Well, in response to that amendment, the GAO con- ducted a complete review of the use of our 13(3) emergency lending authorities in all of the programs that were created and conducted an audit that was concluded I believe in mid-2011. In addition, the GAO has the ability to audit open market operations and discount window lending, and we now report regularly all the details—or the details of our open market operations and with a 2-year lag our discount window lending. Senator CORKER. So those are fully transparent and fully audited now. Is that correct? Ms. YELLEN. That is correct. Senator CORKER. The second concern I have heard raised by the ‘‘audit the Fed’’ advocates is the size and composition of the Fed’s current $4.5 trillion balance sheet. Does the Fed disclose the types of assets that make up that $4.5 trillion? Ms. YELLEN. Yes. We have audited financial statements which I have a copy of right here. We report on a security-by-security basis. All of the securities that are in that portfolio, they are reported on the New York Fed’s Web site. Senator CORKER. By CUSIP number, is that correct? Ms. YELLEN. By CUSIP number. And we have a weekly balance sheet that reports significant details of our balance sheet. Senator CORKER. So I hate to ask this question, but I have read some quotes lately, and I would just like for you—not by you but by ‘‘audit the Fed’’ advocates. While you may issue an updated bal- ance sheet each week, how do we know those securities actually exist? Ms. YELLEN. Well, we have an outside accounting firm, an inde- pendent auditor, currently Deloitte & Touche, that does a thorough review of our balance sheet, and that is what is contained in our annual report, both the Board and all of the Federal Reserve Banks and the consolidated Federal Reserve System. Senator CORKER. So they do exist? Ms. YELLEN. They do exist, Senator. Senator CORKER. Just my last point. It is obvious to me that the ‘‘audit the Fed’’ effort is to not address auditing the Fed, because the Fed is audited, and every day you publish the CUSIP numbers of the things that you own and the—— Ms. YELLEN. Correct. Senator CORKER. ——credit facilities that you put in place during an emergency, all of that is audited now. So to me, it is an attempt to allow Congress to be able to put pressure on Fed members rel- ative to monetary policy, and I would just advocate that that would not be a particularly good idea and it would cause us to put off tough decisions for the future, like we currently are doing with budgetary matters. Do you agree with that? VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 17 Ms. YELLEN. I strongly agree. As I indicated—well, let me say more generally, I think if you look around the globe in modern times and you consider every country that has gone through a pe- riod of chronic high inflation or hyperinflation, what you will find is a central bank that was pressured to print money by—— Senator CORKER. Politicians. Ms. YELLEN. By politicians who were unable to balance the budg- et. Senator CORKER. So I will close. I thank you, Mr. Chairman, for the little extra time. I do think one area that greater transparency could be utilized is in the regulatory area around things like CCAR and others. I think that that is an area where we should focus, and I hope that over the course of the next several months the Fed will work with us in a constructive manner so that we more fully un- derstand how you go about that process. It does seem like a black box now. It is something that I think should be far more trans- parent, and I hope you will work with us in that regard. Ms. YELLEN. We would be pleased to do so. Senator CORKER. Thank you. Chairman SHELBY. Thank you, Senator Corker. Senator Schumer. Senator SCHUMER. Thank you, Mr. Chairman. Thank you, Chair Yellen, for your testimony. Your hard work, your dedication, what I believe is your sound judgment and timely decision making have been a driving force behind the recovery. But I do not envy you your position. You and other members of the FOMC have impor- tant decisions to make in the coming months. Let me urge you to act with caution before raising rates. While there may be data points, positive signs of economic growth, let me be clear. I believe the Fed should remain committed to its current accommodative policy until it sees clear evidence that shows a con- sistent improvement in wages. In the current environment, wage growth needs to be a major factor, maybe even the lodestar, for the Fed when it is deciding whether to raise rates. As I have said over and over again, to me the single biggest prob- lem the country faces is the decline of middle-class incomes, and while economic progress has been seen in the past year—strong ex- pectations for growth of GDP, for instance—wage gains have re- mained sluggish through the recovery. Middle-class Americans have not yet seen the benefits of this growth in their take-home pay, and we all know the statistics of middle-class incomes declin- ing by 6.5 percent over the decade, $3,600 lower than when Presi- dent Bush took office in 2001. So I think the Fed must think long and hard before imple- menting a monetary policy that could reduce demand and hamper the growth of the economy. Wage growth not only serves to benefit middle-class workers who have been asked to do more with less for too long, but placing a priority on consistent wage growth prior to raising rates serves the dual role of fostering a rise in inflation to- ward the Fed’s 2-percent target, one that you have delineated. Overall growth is rightfully a key factor in the decision, but I firmly believe the Fed should not raise rates until wages are back on a steady trend, steady upward trend. VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 18 So as you begin to consider the path toward normalization of rates, I think the Fed must place a priority on seeing consistent real wage growth prior to any decision making. Those who are wor- ried about inflation—you always have to worry about it, but they should look at the last several years. There are few signs of incip- ient inflation, and, in fact, many economists believe that the chances of deflation are greater than worries of drastic rises in in- flation, and concerns of deflation are further precipitated by the prospect of the Fed raising rates too soon. So I think it is a prudent decision for our broader economy as well as middle-class families across the country to wait until wages really begin to rise. So, first, do you agree it is critical for the FOMC to see evidence of consistent wage growth prior to deciding to raise interest rates absent indicators that inflation is climbing well above or above the Fed’s 2-percent target? And if the FOMC does not wait, what are the potential consequences? Ms. YELLEN. Well, Senator, our objective is price stability, which we have defined as 2-percent inflation. And as I indicated, before beginning to raise rates, the Committee needs to be reasonably con- fident that over the medium term inflation will move up toward its 2-percent objective. I do not want to set down any single criterion that is necessary for that to occur. The Committee does look at wage growth. We have not yet seen—there are perhaps hints, but we have not yet seen any significant pick-up in wage growth. But there are a num- ber of different factors that affect the inflation outlook, and we will be considering carefully a range of evidence that pertains to the in- flation outlook and will determine the confidence that we feel in our—we forecast that inflation will move back up to 2 percent. Cer- tainly seeing continued improvement in the labor market adds to that confidence, and it would add to our confidence also that over time wages will pick up. But our objective is 2-percent inflation, and we will look at a wide range of evidence in deciding that. Senator SCHUMER. Do you feel that the worry of rampant infla- tion, above 2-percent inflation, is any greater than the worry of de- flation given the flatness of wages, 70 percent of the economy is wages, jobs, broadly defined? Ms. YELLEN. The Committee feels, I think anticipates that infla- tion is being held down by transitory factors, particularly the de- cline we have seen in oil prices. We have also had considerable slack in the labor market, and it is diminishing over time. Now wages tend to be a lagging indicator of improvement in the labor market. We have seen improvement, and if we continue to see im- provement, it would add to my confidence, especially as the impact of oil prices diminishes over time, that inflation will move back up. Senator SCHUMER. One final question. Do you see any real evi- dence of inflation heading above 2 percent right now given—— Ms. YELLEN. I do not see any evidence of that, but inflation—we need to be forward-looking. The Committee is forward-looking in setting monetary policy, and we do see that the labor market is im- proving, and we are getting closer to our goal of maximum employ- ment. VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 19 It is important to remember that monetary policy is highly ac- commodative. We have held the Federal funds rate at a 0 to 1⁄ 4 per- cent range and have a large balance sheet, and these policies have been in place for 6 years now. And we do have an economy that fortunately appears to be recovering, and we do have to be forward- looking in setting monetary policy. But I want to assure you we want to see that recovery continue. We do not feel the labor market is fully healed, and that is a process we want to go on. And we do not want to take policy actions that will hamper that, but monetary policy is very accommodative at the present—— Senator SCHUMER. Thank you. I urge caution. Chairman SHELBY. Senator Toomey. Senator TOOMEY. Thank you, Mr. Chairman. And thank you, Madam Chairman, for joining us today. Let me share a completely opposing point of view from that of the Senator from New York, which will not be a shock to Members of this Committee. I cannot help but observe what strikes me as a very obvious paradox here, and that is the financial and economic crisis is over. It has been over for years, at least 6 or 7 years. And yet we still maintain crisis-level interest rates. We have got no wave of defaults or massive bankruptcies going on. Unemployment has gone from 10 percent to sub-6 percent. GDP growth has been weak. I think that is easily explained by the avalanche of new reg- ulations, certainly not monetary policy, but it has been positive for years. Consumer sentiment is relatively high. The FOMC in Janu- ary described the economic recovery as solid. Walmart, interest- ingly, has made an announcement that suggests we might even be approaching NAIRU. The crisis has been over for a long time. And it is not as though there is no price to be paid by having this unbelievably accom- modative policy. Most immediately I see the problem incurred by my constituents, who may have spent a lifetime working hard, sac- rificing, saving, forgoing a vacation they might have taken, forgoing a splurge here and there, so that they could save for their retire- ment and buy a CD, have some money on deposit at a bank, and use that to supplement a modest pension or Social Security pay- ments. Of course, their reward now is they get nothing. Zero. That is what they earned on their savings year after year. Meanwhile, of course, we have all the risks associated with this: the risk of bubbles forming, I would argue the fixed income mar- kets probably are a huge bubble at the moment. We have the inhi- bition of price discovery in the financial sector. We facilitate exces- sive deficits because they look so manageable with zero interest rate environment. Credit is rationed. And what are the benefits of this? The benefits are, at best, a timing shift in economic activity. At best, we are moving economic activity that would otherwise occur in the future closer to the present. As we all know, if artifi- cially low interest rates led to strong economic growth, then every- one around the world would have zero interest rates and every- thing would be booming. And that is not the case. So, Madam Chairman, I know you and I disagree on this, but I would just suggest the crisis is clearly long over. I think the time for normalization is well overdue. I hope we get there soon. But I did want to ask you a specific question that is related, and that is, VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 20 you have said repeatedly that the goal of price stability is 2-percent inflation. Well, certainly there is a congressional mandate on price stability. But when the Fed decides that it is acceptable—in fact, that that is met by savers losing 2 percent of their purchasing power annually—and let me put that a different way. That means a 30-year-old woman who is saving, by the time she retires what she has saved at that point will have lost half of its value. Half of it is gone. How is that consistent with price stability? Ms. YELLEN. Well, the Federal Reserve is—the FOMC, in car- rying out Congress’ mandate, really does have to define how we un- derstand price stability operationally. Two-percent inflation is an inflation rate that we chose largely for two reasons: First of all, it is well known that price indices that we look at contain upward biases in part because their failure to adequately capture the benefits of new goods and quality improvement. So there are hard-to-measure but nevertheless upward biases in price indices. And, second of all, because deflation is so dangerous and because an environment of very low inflation and one of comparably ex- tremely low interest rates makes it difficult for monetary policy to respond to adverse shocks, we decided that in order to avoid dam- aging episodes of deflation, it is wise to have a small buffer that gives greater room for monetary policy to operate. Senator TOOMEY. Thank you. I am going to run out of time here, so I just want to get to my second question. I would just urge you to consider the impact of savers losing their purchasing power. Historically, of course, we have changed the level of accommoda- tion through open market activities, typically buying and selling se- curities to have corresponding changes in the level of cash. You have suggested, if I understand you correctly, that in the process of normalizing, assuming we will get to that process, you intend to achieve that principally by changing the target level of the Fed funds rate. Ms. YELLEN. Yes. Senator TOOMEY. And you will do that by increasing the interest on excess reserves. Ms. YELLEN. Correct. Senator TOOMEY. And my question is: Since that means over time in a normalizing environment the transfer of tens of billions of dollars from what would go to the taxpayers to big money center banks, why are you doing that instead of simply selling the bonds, which is a more conventional way to operate in the open market operation? Ms. YELLEN. Well, remember that, first of all, we will be paying banks rates that are comparable to those that they can earn in the marketplace, so those payments do not involve subsidies to banks. And, in addition, remember that we have—in expanding our provi- sion of reserves, we have acquired longer-term assets on the asset side of our balance sheet, and the spread above what we have been paying in terms of interest on excess reserves is quite large. So al- though that will diminish over time as monetary policy is normal- ized, the expansion of our balance sheet, even though we are even at present paying 25 basis points interest on reserves, we have had VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 21 record transfers to the Treasury close to $100 billion this past year and $500 billion since 2009. So there have been large transfers as- sociated with that policy. Senator TOOMEY. But that situation is likely to reverse if we get into a normalization mode. Ms. YELLEN. So it is very—it is likely that our transfers to, our remittances to the Treasury will decline as short-term rates rise. We nevertheless expect the remittances to remain positive. Senator TOOMEY. Thank you, Mr. Chairman. Chairman SHELBY. Senator Warner—Senator Menendez. I did not know he had come back. Thank you. Sorry. Senator MENENDEZ. Thank you, Mr. Chairman. I thank my col- league from Virginia. Madam Chair, thank you for your service. As you know, our economy continues to recover from the damage inflicted by the fi- nancial crisis and the Great Recession that followed. GDP is grow- ing. Employers are hiring. Unemployment is falling. So it is only natural that some are starting to look ahead to a time when the Federal Reserve can start withdrawing the monetary stimulus that has been so critical to our recovery. But in my view, we still face challenges. Most Americans are still waiting for the recovery to show up in meaningful income growth. Long-term unemployment, while down, is still high. Inflation con- tinues to run well below target, as it has now for an extended pe- riod of time. So from my perspective, it is critical that the Fed not put the cart before the horse and tighten too soon. You have said on multiple occasions that the Federal Reserve’s timetable for raising rates will depend on the data. There are some who say the Federal Reserve should tighten preemptively based on unemployment or wage growth or at the first hint of inflation, without waiting to find out if it is just a statistical blip. What would be the risks if the Fed raises rates too soon com- pared to the risks of waiting? Ms. YELLEN. Well, if the Fed were to raise rates too soon, Sen- ator, we would risk undermining a recovery that is really just tak- ing hold and is really succeeding, I think, in improving the labor market. As I said, I do not think we are back to attaining yet con- ditions I would associate with maximum employment or normal labor market conditions. Things have improved notably, but we are not there yet. And so we want to see a healthy recovery continue. In addition, as you mentioned, inflation is running well below our 2-percent objective, and while we think a significant reason for that is because of transitory factors, most importantly the decline we have seen in energy prices, we are committed to our 2-percent objective. And just as we do not want to overshoot 2 percent on the high side, we do not want to chronically undershoot 2 percent on the low side either. And so before raising rates, we will want to feel confident that the recovery will continue and that inflation is moving up over time. There are also, of course, risks of waiting too long to remove ac- commodation. We have a highly accommodative policy that has been in place for some time. We have to be forward-looking. As the labor market tightens, wage growth and inflation can pick up to VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 22 the point we would overshoot our inflation objective, and conceiv- ably there could be financial stability risks, and we want to be at- tentive to those as well. Senator MENENDEZ. Right. Ms. YELLEN. So this is a balancing of costs and risks that we are trying to make in a deliberate and thoughtful fashion. Senator MENENDEZ. Well, I appreciate that, and it is that bal- ance that I hope your wisdom and that of your fellow Board mem- bers can get just about right, because I could see entering and choking off recovery before middle-class families actually feel its gains and trapping a too-low inflation or deflation set of cir- cumstances, so I appreciate that. Let me ask you one other question. I have heard several com- mentators say that the interest rate increase by the Fed would sig- nal ‘‘confidence’’ to the market about the health of the U.S. econ- omy and have a stimulative effect. Do you agree with that theory? And if so, wouldn’t any so-called confident effect be more than off- set potentially by a contractionary impact of a rate increase? Ms. YELLEN. Well, I think it is fair to say that when we begin to raise our target for the Federal funds rate, it will be because we are confident about the recovery and we are reasonably confident that inflation will move back to our 2-percent objective over time. But that confidence will reside in real improvements that we see in the underlying condition of households and businesses where we would not be attempting to somehow boot-strap an improvement in the economy that is purely occurring from a confident effect that comes from our raising rates. There is reason, I think, to feel good about the economic outlook. Households have gone through major adjustments in their balance sheets and are in better financial condition than they were. The job situation is improving. And even though wages have not been ris- ing in real terms very rapidly, there are more hours of work and more jobs, so household income is improving. Lower oil prices are boosting household income. Housing prices have rebounded, and that has helped a lot of households, and busi- nesses are in—— Senator MENENDEZ. So, in essence, real confidence, not con- fidence that is spun. Ms. YELLEN. That is right. There is no spin here. Our confidence in the economy has improved, and when we raise rates, it will be a signal in our confidence in the underlying fundamentals. Senator MENENDEZ. Thank you. Thank you, Mr. Chairman. Chairman SHELBY. Senator Scott. Senator SCOTT. Thank you, Mr. Chairman. Chair Yellen, good morning. Ms. YELLEN. Good morning. Senator SCOTT. Thank you for being here this morning. Ms. YELLEN. Thank you. Senator SCOTT. I would like to change the conversation a little bit and talk about the insurance industry, the SIFIs, and its impact on places like South Carolina where we have about $354 billion of life insurance in place. As we think through the transferring of risk that the insurance industry provides, I think it is a very important VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 23 consideration. I am a bit prejudiced in this area because I have spent 25 years in the insurance industry, and I appreciate the fact that until the insurance company shows up, the ability to transfer risk is nonexistent. So the importance of how we impact the insur- ance industry to the Fed I think will reverberate throughout the economy. I take very specific interest in the impact that the Fed may have on regulating the insurance companies now that have been des- ignated ‘‘systemically important’’ by FSOC, and my thought is that last year, I believe it was, the President signed a law that clarifies the Fed need not impose bank-like capital standards on insurance companies under its supervision. I think this is for very obvious reasons. When you look at the activities of banks, loans and depos- its, compared to speaking to the long-term risk that most insurance companies are holding their assets for, it is important to have that delineation and take a very different approach to insurance compa- nies than we do other financial institutions. I know from experience that this is an important consideration, and I guess my question to you is: What expertise does the Fed have or plan to acquire as it begins to supervise insurance compa- nies? And how closely are you working with State insurance regu- lators? Ms. YELLEN. So my answer would be that we have acquired ex- pertise; we have hired individuals who have experience in the in- surance industry and are trying to build our expertise there. We consult closely with the NAIC and with State insurance regulators and the Federal Insurance Office. We are gaining experience be- cause we are now in our fourth annual supervision cycle of savings and loan holding companies, many of which are—some of which have significant insurance activities. And, of course, several insur- ance companies have been designated as SIFIs, and we are super- vising those as well. We are taking the time and doing the work that is necessary to understand their unique characteristics and fully plan to tailor our supervision and capital and liquidity requirements for those insur- ance companies to make our supervisory regime appropriate. There are very important differences between the risks faced by insur- ance companies and banking organizations. We have undertaken a quantitative impact study and are actively engaged in working with the firms we will be supervising to understand the unique characteristics of their operations before a promulgating super- vision regime. Senator SCOTT. Thank you. You answered my third question as well, so I will just go to the second question at this point then. Will the Fed issue an Advanced Notice of Proposed Rulemaking before issuing proposed rules on insurance capital standards then? Ms. YELLEN. Yes, we will issue proposed rules. We recently issued a proposed rule that pertains to our supervision of GE Cap- ital, and we would do the same with the other firms. Senator SCOTT. Thank you. On the issue of stress tests, I know that the Fed is—through the supervision of bank holding companies and other nonbank financial companies, the Fed conducts stress tests to determine how well the entity could withstand different levels of financial distress. The Fed VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 24 currently has on its balance sheet about $4.5 trillion as a result of the QE program, much larger, of course, than any of the financial entities it regulates. But it appears that nobody is stress-testing the Fed. The proverbial fox is guarding the henhouse, from my per- spective. So my question really is: As you begin to unwind the Fed’s mas- sive balance sheet, hopefully in the near future, what assurances can you give this Committee that the Fed will stress-test its own QE exit plan? Ms. YELLEN. Well, with respect to our balance sheet, let me say that we do stress-test it, and we have issued some reports and pa- pers where we describe what stress tests would look like when there are interest rate shocks that would affect our balance sheet and path of remittances. But it really is important to recognize that the Federal Reserve is not identical to an ordinary banking or- ganization. First of all, capital plays a very different role in a central bank than it does for a banking organization. Congress and the rules put in place regarding our capital were never intended to make our capital play the same role and it is not necessary for it to play the same role as in a banking organization. Importantly, unlike a bank, the Federal Reserve’s liabilities are mainly reserves to the banking system and currency, and these are not like the runnable deposits of an ordinary banking organization. So the risks that the Federal Reserve faces in our balance sheet are of a different character than those facing an ordinary bank. But, that said, we do look at the likely consequences for our bal- ance sheet of different interest rate scenarios. Senator SCOTT. Certainly very different scenarios between the Fed and the banks. Without any question, with $4.5 trillion and the way that you wind it down would have—would reverberate throughout the economy in a way that no other financial organiza- tion would have impacted. And the path forward is incredibly im- portant to the economy. Ms. YELLEN. Well, that is one reason that one of the principles of our normalization plans is that we want to wind down our bal- ance sheet in an orderly, gradual, and predictable way. And we have decided to use as our main tool of policy when the time comes for normalization something that is much more familiar both to us and to markets, and that is, variations in short-term interest rates. You know, of course, an alternative to that would be to say when the time comes to want to tighten monetary policy, we could begin to sell assets. That would be another way of going about doing business. But we have more experience and markets have much more experience with variations in short-term rates, and we want to proceed in that way that is familiar to us, familiar to market participants and the public, and to let our balance sheet play a pas- sive role to gradually diminish in size mainly through ending rein- vestment of maturing principal. Senator SCOTT. Thank you. Chairman SHELBY. Senator Warner, finally. Senator WARNER. Thank you, Mr. Chairman, and thank you, Chair Yellen. You are coming down to the home stretch here. I ap- preciate all your good work and this incredibly important balance VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 25 to get right as we start down a path of unwinding. But I, like many of my colleagues, share with inflation at such a low rate, trying to get this timing right is so critically important. One of the things we have talked a lot about, the statute of the U.S. economy, but I want to raise three quick points. One, after the January FOMC meeting, in your readouts one of the items you mentioned was international developments. Obvi- ously, disruption potentially in Europe, with the ongoing struggles with Greece, China’s slowing economy, can you rank—or how will these international developments affect the Fed’s decision on tim- ing on monetary policy? Ms. YELLEN. Well, there are a broad range of international devel- opments that we monitor, and they do affect the performance, the likely performance of the U.S. economy and factor both into our economic forecasts and our assessment of risks. Growth in Europe has been very slow. Growth in China is slow- ing. The huge decline we have seen in oil prices has had repercus- sions all over the global, in some areas positive, very positive, in other areas negative. It affects our outlook, these developments, both through trade flows and through developments in financial markets. The attempts of many central banks to add monetary policy ac- commodation is pushing down longer-run interest rates in many parts of the world, and that is, as I mentioned in my testimony, spilling over to the United States. So there are many channels through which these global developments affect the U.S. outlook in ways both positive and negative. All in all, so factoring all of those things into account, while there are risks—and, again, both positive and negative—stemming from global developments, we still think that the risks for the U.S. outlook are nearly balanced, that we have got sufficiently strong growth in domestic demand and in domestic spending by con- sumers and businesses, that the recovery looks to be on solid ground. We have just, as I mentioned in my testimony, had a very strong growth in the second half of the year and looking forward and analyzing the factors likely to impact domestic spending, we are seeing perhaps not as strong as we just had but nevertheless above-trend growth, and that really factors into account all of the global considerations—— Senator WARNER. But, obviously, these international factors will affect your decision—— Ms. YELLEN. They do affect our decision, yes. Senator WARNER. I also want to associate my comments with Senator Corker’s comments about I would like to make sure that we deal in a perfect world with currency manipulation, but cur- rency manipulation to one could appear as monetary policy to an- other. Ms. YELLEN. Yes. Senator WARNER. And as we have seen Japan and Europe move toward more monetary easing, obviously one of the effects of that has been strengthening of the dollar and it hurts our exports. Speak to that for a moment, and if you could, let me get a last 30 seconds in at the end, so if you could take—— VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 26 Ms. YELLEN. You bet. So, you know, I think we should be on guard against currency manipulation. The G7 in international fora have agreed, and I know our administration in dealing with foreign countries really tries to crack down on currency manipulation. Nevertheless, I think certainly it is a principle agreed in the G7 that monetary policy oriented toward domestic goals like price sta- bility or, in our case, price stability and maximum employment, this is a very valid use of a domestic tool for a domestic purpose. It is true that the use of that tool can have repercussions on ex- changes, but I really think it is not right to call that ‘‘currency ma- nipulation’’ and to put it in the same bucket as interventions in the exchange markets that are really geared toward changing the com- petitive landscape to the advantage of a country. Senator WARNER. Mr. Chairman, I would just in my last couple of seconds want to make the point that one of the things that has been absent from this discussion today has been—we have talked a lot about your work. We have not talked as much about our work and need to still address our own fiscal policies. I would simply point out that because of the extraordinary remittances from the Fed’s expanded balance sheet, we have seen north of $420 billion in net additional revenue that has diminished our deficit. But that is not something that can be projected on into the future. And as we talk about the times of raising interest rates and trying to get back to a normalized effort, I would simply point out again, you know, a 100-basis-point increase in interest rates adds $120 billion a year on debt service. Ms. YELLEN. Yes. Senator WARNER. And even CBO projections at this point will show that debt service with our current $18 trillion in debt will ex- ceed total defense spending or total domestic discretionary spend- ing in 10 years, and that is not a good business plan for our coun- try. Ms. YELLEN. All absolutely true. Senator WARNER. Thank you, Mr. Chairman. Chairman SHELBY. Senator Warren. Senator WARREN. Thank you, Mr. Chairman. Thank you for being here, Chair Yellen. You know, as you know, Wall Street banks could profit hand- somely if they knew about the Fed’s plans before the rest of the market found out, and that is why any leak of confidential informa- tion from the Fed results in serious penalties for the people who are responsible. But apparently there have been no consequences for the most re- cent leak. According to public reports, Scott Alvarez, the General Counsel of the Fed, was put in charge of investigating a leak from the September 2012 meeting of the Federal Open Market Com- mittee. Nearly 21⁄ 2 years later, the results of this investigation have not been made public, and no action has been taken. On February 5th, Congressman Cummings and I sent a letter to Mr. Alvarez requesting a briefing from him in advance of your ap- pearance here today, but so far we have not received one. Can you assure us that the Congressman and I will get a brief- ing soon? Ms. YELLEN. So if I might say by way of background—— VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 27 Senator WARREN. I just need a yes or no—— Ms. YELLEN. ——the answer is—— Senator WARREN. I just want to be able to get a briefing on what has happened that it has been 21⁄ 2 years and there has been no public report about what happened from a significant—— Ms. YELLEN. We are trying to work with your staff on a process to be responsive. Senator WARREN. I will take that as a yes? Ms. YELLEN. Yes. Senator WARREN. OK. Thank you. As you know, this past December, House Republicans success- fully blew a hole in Dodd-Frank protections by tacking the repeal of the swaps pushout rule to a must-pass Government spending bill. That repeal, which was written by Citigroup lobbyists, will allow the biggest banks in the country to continue to receive tax- payer protection for some of their riskiest derivatives and swaps. Now, a month before the repeal, Mr. Alvarez spoke at a con- ference at the American Bar Association, an organization that in- cludes many lawyers who represent the banks that are affected by the Fed’s enforcement of Dodd-Frank. Mr. Alvarez openly criticized the swaps pushout rule, saying, ‘‘You can tell it was written at 2:30 in the morning, and so it needs to be, I think, revisited just to make sense of it.’’ Mr. Alvarez also criticized the new rules Dodd-Frank put into place to address conflicts of interest at credit rating agencies, say- ing, ‘‘Restrictions on the agencies really did not work, and it does not work, and it is more constraining than I think is helpful.’’ So let me start by asking: Does Mr. Alvarez’s criticism of these two rules reflect your view or the view of the Federal Board of Gov- ernors? Ms. YELLEN. So let me just say that over the years we have had feedback that we have given on various aspects of Dodd-Frank, but we are—— Senator WARREN. I appreciate that, Chair. The question I am asking, though, is these are specific criticisms he has made of Dodd-Frank rules that govern the largest financial institutions in this country, and I am just asking: Do his criticisms reflect your criticisms or the criticisms of the Federal Board? Ms. YELLEN. I think we—I personally and the Board consider Dodd-Frank to be a very important piece of legislation that has provided a road map for us to put in place regulations—— Senator WARREN. I appreciate that, Madam Chairman, but I just need a yes or no here. Do his criticisms reflect your criticisms? Ms. YELLEN. I am certainly not seeking in any way to alter Dodd-Frank at this time. It is a framework that is—— Senator WARREN. Well, then, let me ask the question differently. Do you think it is appropriate that Mr. Alvarez took public posi- tions that do not evidently reflect the public position of the Fed’s Board, especially before an audience that has a direct financial in- terest in how the Fed enforces its rules? Ms. YELLEN. Well, I think the Fed’s position and my position is that we are able to work very constructively within the framework of Dodd-Frank to tailor rules that are appropriate for the institu- tions we supervise, and we are not seeking to change the—— VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 28 Senator WARREN. I appreciate that. You know, we know that the Fed staff plays a critical role in shaping Dodd-Frank rules and en- forcing them. In the case of the swaps pushout, Congress passed the law in 2010, but the Fed and the OCC delayed the effective date of the rule until 2016, giving Citigroup and other big banks time to get the rule repealed before it ever went into effect. Did Mr. Alvarez provide input into the Fed’s decision to delay the effective date of the pushout rule? Ms. YELLEN. I do not know. I mean, we usually have phase-ins for complicated rules that require adjustments by financial firms. This has been true of all of the Dodd-Frank rules that we have put into effect. Senator WARREN. Well, I think this might be worth looking into. You know, the Fed is our first line of defense against another fi- nancial crisis, and the Fed’s General Counsel or anyone at the Fed staff should not be picking and choosing which rules to enforce based on their personal views. So I urge you to carefully review this issue and to assess whether the leadership of the Fed staff is on the same page as the Federal Reserve Board. Thank you, Mr. Chairman. Chairman SHELBY. Thank you. Senator Heitkamp. Senator HEITKAMP. Mr. Chairman, thank you. Always last, hope- fully not least. Chair Yellen, I want to first thank you for your patience and your responsiveness, and I was tempted to ask one question, which was your definition of ‘‘patience.’’ But I will not do that today. Instead, I want to look to the future. I think Senator Warner really outlined one of the concerns that I have. We always seem to be fighting the last economic war in the U.S. Congress. You are a very astute and very respected student of the American economy. It is what you do every day. I am going to give you a chance—you have heard a lot of opinions and received a lot of advice from this panel. I am going to give you a chance to give us some advice. When you look at leading and lagging indicators, especially lead- ing indicators, what troubles you and what keeps you awake at night about the American economy in the next 10 to 15 years? And what advice would you give to the U.S. Congress in addressing those concerns that you have looking right now at those indicators? Ms. YELLEN. Well, I have said on a number of occasions that the rise we have see in inequality in the United States is a great con- cern to me. Senator HEITKAMP. We discussed this the last time you were here, and you offered no solutions toward that problem, you might recall. Ms. YELLEN. I think there are a variety of different things that the Congress could consider in policy measures that might be ap- propriate, but this really is a domain for Congress to consider. So that is one of the concerns that I have. Senator HEITKAMP. So no advice on the earned income tax credit or on tax rates or—— Ms. YELLEN. I am not going to weigh in on things that really are in your domain to evaluate. So I think that is important, and I would say something also in Congress’ domain is longer-run issues VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 29 with the Federal budget. I think Congress has made painful deci- sions that have now really stabilized, brought down the deficit very substantially and stabilized for a number of years the debt-to-GDP ratio. But eventually debt-to-GDP will begin to rise and deficits will increase again as the population ages and Medicare, Medicaid, and Social Security get to be a larger share of GDP under current programs. And there are a lot of ways in which—these are prob- lems we have known about for a long time. I also worry that if we were to again be hit by an adverse shock, there is not much scope to use fiscal policy. It was used in the early years after the financial crisis. We ran large deficits. But in the course of doing that, debt-to-GDP rose, and were another negative shock to come along, it is questionable how much scope we would now have to put in place even on an temporary, multiyear basis ex- pansionary fiscal policy. And I think it is important to deal with these issues, for the Congress to do so. Senator HEITKAMP. But your concern about scope does not lead you to believe that interest rates should be adjusted at this point to give you the flexibility to use interest rates should we receive another shock? Ms. YELLEN. Well, the Fed would, of course, use the tools that we have to try to achieve domestic ends, but I think having fiscal policy be available as a tool is important as well. Senator HEITKAMP. If we look today at the American economy and some of the challenges—and you and I have spoken privately about this—of the millennials and saving patterns and consump- tive patterns, the shared economy, what concerns you about the now 8 years of changed behavior in consumption? What concerns you about those issues? And do you see those changing long-term consumptive patterns that may present some interesting challenges for the American economy? Ms. YELLEN. Well, I think we are just beginning to understand how the millennials are behaving. They are certainly waiting longer to buy houses, to get married. They have a lot of student debt. They seem, you know, quite worried about housing as an in- vestment. They have had a tough time in the job market. And, as the economy strengthens, I expect more of them to form households of their own and buy homes. But we have yet to really see how this is going to affect that generation. Senator HEITKAMP. Or they may have experienced a change in consumptive patterns that will present some unique challenges, whether it is sharing automobiles, whether it is, in fact, not buying homes, doing the things that they have now done to accommodate their economic challenges in the long term. And I think that one of the things that we need to do much more carefully here in the U.S. Congress is begin to look at not just having a discussion with you about monetary policy, but looking at fiscal policy, whether it is tax reform or whether it is, in fact, taking a look at what we are doing with the mortgage market, to begin to develop an economy that the millennials will fully participate in. And I hope you con- tinue to think and provide us the advice that is extraordinarily val- uable. Thank you. Ms. YELLEN. Thank you. VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 30 Chairman SHELBY. Senator Donnelly. Senator DONNELLY. Thank you, Mr. Chairman. And, Madam Chair, thanks for your service. And I apologize. I have had to go in and out of some other committees, and I know this subject has been brought up, but the issue of wage stagnation that we have seen and the other piece of student debt. When we look at the student debt and the numbers are so high and, you know, it has been a long time, but when I graduated from college, you could basically work an entire summer and wind up paying off about half what your tuition was. How big a drag—and you may not have an exact measurement, but one of my great concerns has been in some areas of the coun- try, how do you buildup the housing market when the young people who want to buy a house—the money that I saved up for, at that time, that 20-percent downpayment is now in many cases being used to pay off a student loan, and it is a box you almost can never get out of. So how big a drag do you see that being on the economy? Ms. YELLEN. So it is a little bit hard to tell. I mean, the housing market has not recovered in the way that I would have anticipated. It has been very slowly improving, but household formation has been extremely low in the United States. It is hard to tell. You have many young people who are living with their families still. It is hard to tell whether that is because of student debt or because of a weak job market. My guess is that as the economy continues to improve, we will see an improvement in household formation, that we will see—now, many young people may decide that they prefer to rent rather than buy homes. But that will give rise to a boost to multifamily con- struction, even if not so much to single-family construction. But the housing market has been very depressed. Nevertheless, in spite of that, the economy as a whole and the job market has had sufficient strength to recover. Senator DONNELLY. My other concern in that area is when you see a young person who looks up and is dealing with $100,000 in student debt and they have this big chunk of money that goes off every month to pay that down, those dollars are dollars that are never used to go to a restaurant, never used to maybe buy a car, never used to travel somewhere. And so overall job-wise I think it hits or seems to hit—makes it more difficult in all those areas to continue job creation. Ms. YELLEN. It is true, but it also remains true that a higher education boosts income and is tremendously important. It is not always the case, not for every individual, that it is a good invest- ment, but certainly on average, it has been a very important and worthwhile investment. So I think to my mind that is the other side of it. Senator DONNELLY. I completely agree what a wonderful invest- ment it is. I just want to try to make sure that we can get that wonderful opportunity without basically saddling yourself for years and years as you look ahead. Ms. YELLEN. The debt loads are very large and have really in- creased a great deal. You are—— Senator DONNELLY. One other area I wanted to ask you about is cybersecurity, and I know that the Fed has certain things they VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 31 focus on on a constant basis. In the area of cybersecurity, though, it is, from all the financial organizations I talk to, one of the big- gest concerns they have, for the companies it is. How big a risk do you see that in the years moving forward? And how big an effect on the financial institutions do you see this being? Ms. YELLEN. Well, I think it is at the top of the list of concerns that we have about the financial system, about the problems facing financial organizations, and I would include the Federal Reserve in that, too. It is a top concern of our own given the importance of our own systems to the payment—the functioning of the payment sys- tem of the U.S. and global economy. Internally, we are paying a great deal of attention to make sure that we are addressing ever escalating threats to our own oper- ations. The banks that we supervise, we are very attentive and have experts who work with those banks to make sure that they are attentive. It is a larger problem, and this is one where coopera- tion is needed among card systems, retailers, and others involved in the financial system, and conceivably, legislation might be need- ed in this area. Senator DONNELLY. Thank you, and I will conclude with this: For the State I represent, Indiana, we for many years were hit very, very hard in the manufacturing sector because of currency manipu- lation, among many other areas. And I know this has been men- tioned, but I would like to make sure that you keep a close eye on this, because when we talk about manufacturing, the ability to be competitive—and all that was ever said to me by our manufactur- ers was, ‘‘If it is a fair field, we will do fine. But if the game is rigged, I do not know how we win that kind of game.’’ And I have always, you know, had the same feeling—and my Ranking Member, Sherrod Brown, right next to me in Ohio, has dealt with this a lot with his manufacturers as well—that if cur- rencies are fairly valued and we are not successful, our manufac- turers, they have always said to me, ‘‘If I cannot win a fair game, that is on me. But if I wind up in a situation where it is being ma- nipulated against my company, it makes it awful tough to keep those workers working and to keep our economy growing.’’ So I would just ask that you keep that in mind as you move for- ward, and thank you so much for your service. Ms. YELLEN. Thank you. Chairman SHELBY. Madam Chair, you mentioned that the cur- rent unemployment is listed at 5.7 percent. However, one alter- native measure that seems to fully capture a better sense of labor force participation is the U6 measure that lists total unemployed and underemployed at 11.3 percent as of January 2015. This meas- ure has not dipped below 10-percent unemployment since before the crisis. According to the Bureau of Labor Statistics data, there are now 12 million more Americans no longer participating in the workforce than in January 2009. Do you agree that the unemployment number that you cited, 5.7 percent, in your opening statement paints a rosy or a better picture of the true unemployment rate that I just cited? Ms. YELLEN. So, Senator, the U6 is a broader measure of unem- ployment. It includes marginally attached and discouraged workers and also an unusually large number of individuals who are work- VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 32 ing part-time who would like full-time jobs. So it is a much broader indicator of underemployment or unemployment in the U.S. econ- omy, and while it has come down—it was 12.1 percent a year ago. It has come down from there to 11.3 percent. It definitely shows a less rosy picture than U3 or the 5.7-percent number. And I did mention that we do not at this point, in spite of the fact the unem- ployment rate has come down, feel that we have achieved so-called maximum employment, in part for these very reasons. Labor force participation has come down, has been trending down. That is something that will continue for demographic reasons. I do not ex- pect it to move up over time, but I do think a portion of the de- pressed labor force participation does reflect cyclical weakness in that in a stronger job market more people would enter. Chairman SHELBY. But you basically concede that 11.3 percent of underemployed people, that is not good in this country, is it? Ms. YELLEN. That is an abnormally high level, and it signifies weakness that would be good to address. Chairman SHELBY. The Financial Stability Board, FSB, plays an important role, as you well know, in implementing financial re- forms, including completion of a capital framework that you al- luded to for banks. The Federal Reserve is a member of this FSB, the Financial Stability Board. Given that the Financial Stability Board is not accountable to Congress or to any branch of the U.S. Government, to my knowledge, where do these Financial Stability Board reforms fit in the U.S. regulatory system? My question is: Does the Federal Reserve treat them as mandated directives or suggestions or what? And what statutory basis does the Fed have to implement the Financial Stability Board’s reforms verbatim? Do you think further that the FSB decisions are important enough that they should be fully vetted by the FSOC before implemented in the U.S.? Ms. YELLEN. Well, a number of—— Chairman SHELBY. That is two or three questions, but they are all tied together. Ms. YELLEN. So a number of U.S. regulatory agencies participate in the FSB, including the administration and other regulators. Chairman SHELBY. Sure. Ms. YELLEN. Nothing that is decided in the FSB has effect in the United States unless the relevant agencies propose rules and those are publicly vetted through the normal public comment process and our rulemaking process. So those recommendations have no force in the United States unless we go through a rulemaking process. But there is a good reason for us to participate in these inter- national fora. Financial markets are global. If we take actions to stiffen supervision and regulation in the United States, and other major financial centers do not act in similar ways, we will just see activity move out of our borders to other parts of the world, and I do not think that will make for a safer global financial system. So we do want to be part of international discussions that lead all countries to work harmoniously together to try to raise stand- ards and maintain a level playing field, and that explains why we participate. And we can play and I think we do play a leadership role in this organization—— VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 33 Chairman SHELBY. But you do not need to accept that their rec- ommendations are verbatim, do you? Ms. YELLEN. No, we do not, and often we have put in place tougher standards than came out of those fora. Chairman SHELBY. Thank you. The Wall Street Journal recently reported that the Federal Re- serve surcharge for the largest banks is hurting U.S. banks be- cause it is not on par with what foreign regulators are applying to foreign banks. The article also indicated that the Fed’s proposal is going beyond an international standard, roughly doubling the sur- charge for big U.S. banks. We all want our banks well capitalized. I think that is very im- portant. But does the Fed’s proposal indicate its belief that foreign banks are not adequately capitalized? That has been said before, you know, that when they have stress tests, they are in deep stress, as we well know, probably a lot more than our banks are. Ms. YELLEN. Well, our proposal embodies our own analysis of the costs to our economy and our financial system of possible distress at the largest and most systemic organizations. We chose to pro- pose surcharges, capital surcharges, that rose above the level that were agreed internationally because we think this will make our fi- nancial system safer. There are other jurisdictions that have similarly put in effect a super equivalent regime. Switzerland is an example of that, and there are other countries that have gone a similar route. The pro- posal is out for comment, and we look forward to seeing what oth- ers say. But we do think it is important for the most systemic insti- tutions whose distress could lead to significant financial impact on the United States, we do think it is important for them to hold ap- propriate capital, and especially when in times of stress it is a com- petitive advantage and not a disadvantage for those firms. Chairman SHELBY. Madam Chair, some of the large foreign banks that do business in the U.S., do you hold them to the same capital standards that you do our banks? And if not, why not? Ms. YELLEN. Well, we have just put in place a rule pertaining to foreign banking organizations that would ask them, if they are suf- ficiently large, require them to form intermediate holding compa- nies that would contain their activities in the United States. And that is a way to subject them to the same capital and liquidity standards as U.S. firms doing business in our markets. Chairman SHELBY. But shouldn’t the standard—in other words, the foreign banks, as I understand what you are saying, they should not have an advantage with lower capital standards than our banks when they are doing business in this country. Ms. YELLEN. Well, to the extent that they are doing business in this country, we are going to subject them to the same standards as our banking organizations. Chairman SHELBY. Thank you. Senator Brown. Senator BROWN. Thank you, Mr. Chairman. Just a comment, then a couple of questions, and this side will wrap up. I understand, Madam Chair, your reluctance to weigh in on spe- cific policy issues that are the province of the Congress, such as the earned income tax credit. I appreciate your bringing attention to VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 34 those issues by which taxpayers/workers will benefit from the EITC. Trade, of course, is another one of those matters, and your prede- cessor had labeled currency manipulation ‘‘an effective subsidy,’’ his words. Ohio manufacturers, similar to Indiana manufacturers that Senator Donnelly mentioned, must compete against foreign competitors who are subsidized. I agree with your statement that this needs to be addressed. Two questions—first, about living wills. The FDIC last summer seemed positioned to declare the living wills of some of the Nation’s largest banks not sufficient. Instead, though, the FDIC stepped back, and together you and the FDIC asked for resubmissions in July. Two questions, a couple questions. A two-part question: Are you prepared to declare living wills submitted during this next round of submissions not credible if, in fact, they are not? And what actions will you take if the living wills are actually deemed insufficient? Ms. YELLEN. So we have worked, as you mentioned, closely with the FDIC to give guidance to the largest firms on what we want to see, what changes we want to see in their living wills in order to improve their resolvability. There are significant changes that we have asked for. Some pertain to their legal structure: the ability of critical operations that support an entire organization to remain available to the firm in a situation of distress, to simplify and make sure that they have a holding company structure that would be functional, to promote an orderly bankruptcy. We agreed with the FDIC on what we want to see. We are work- ing with the firms to make sure they understand what we expect. We expect to see resubmissions of these plans by July of 2015, July of this year, and we have not—— Senator BROWN. Let me interrupt there. Are you willing to—are you unwilling to accept any of these banks saying that ‘‘you have not given us enough information on what to do to comply by July’’? Are you unwilling—will you say, ‘‘We will not accept that answer’’? Ms. YELLEN. I feel we have given detailed feedback and adequate information, and if we do not see the progress we expect, we are fully prepared to declare the living wills to be not credible. Senator BROWN. OK. That is good to hear. One last question, Mr. Chairman. Earlier this month, the major story broke about a trove of HSBC account holder data that reveals that their Swiss banking arm col- laborated in efforts by some of its account holders to engage in tax evasion. On February 10th, I asked Ms. Hunter what steps her agency, the Fed, your agency, had taken with regard to these alle- gations. I gather that investigations of some individual U.S. ac- count holders have been undertaken by IRS. Last week, Geneva prosecutors raided the private bank offices of HSBC as part of a new money-laundering investigation. We know HSBC has a history of major U.S. sanctions, major money-laundering violations. They now face major new charges of facilitating tax evasion. I know you may be unable to address details of an ongoing inves- tigation, but summarize for this Committee, if you would, Madam Chair, what the Fed would normally do to pursue allegations like these regarding tax evasions by a major financial institution, how VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 35 long you would expect an investigation to take—again, not specifi- cally here if you are unwilling or unable to share that, but how you would normally do it, how long it takes, what steps you normally take with other Federal officials, with other countries’ regulators? Ms. YELLEN. Well, we would have some responsibility for this if it affected the operations of a bank in the United States. In this case, the information has been provided to the Justice Department. The Justice Department has primary enforcement responsibilities related to U.S. tax laws along with the IRS. And the Justice De- partment normally cooperates with us and provides information to us if they think that we would have jurisdiction if banking laws have been violated in the United States and that we should take action. In this case, the Justice Department has not provided us with information. Senator BROWN. Do you ask them, or must they make the first move? Ms. YELLEN. Well, we have not been privy to any of this informa- tion, and if they thought it appropriate, we would expect them to reach out to us. Senator BROWN. Don’t news reports suggest that there is no harm but perhaps reason for you to ask the Justice Department for some of this, any of this information that they might think impor- tant to this country’s financial system and to these banks and to you? Ms. YELLEN. Well, this is pretty recent news reports that we have learned about this. Senator BROWN. OK. Chairman SHELBY. Madam Chair, thank you for appearing again before the Committee. We look forward to further appearances, and this will conclude the hearing. Thank you. The Committee is adjourned. [Whereupon, at 12:17 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 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 36 PREPARED STATEMENT OF JANET L. YELLEN CHAIR, BOARDOFGOVERNORSOFTHEFEDERALRESERVESYSTEM FEBRUARY24, 2015 Chairman Shelby, Ranking Member Brown, and Members of the Committee, I am pleased to present the Federal Reserve’s semiannual Monetary Policy Report to the Congress. In my remarks today, I will discuss the current economic situation and outlook before turning to monetary policy. Current Economic Situation and Outlook Since my appearance before this Committee last July, the employment situation in the United States has been improving along many dimensions. The unemploy- ment rate now stands at 5.7 percent, down from just over 6 percent last summer and from 10 percent at its peak in late 2009. The average pace of monthly job gains picked up from about 240,000 per month during the first half of last year to 280,000 per month during the second half, and employment rose 260,000 in January. In ad- dition, long-term unemployment has declined substantially, fewer workers are re- porting that they can find only part-time work when they would prefer full-time em- ployment, and the pace of quits—often regarded as a barometer of worker con- fidence in labor market opportunities—has recovered nearly to its prerecession level. However, the labor force participation rate is lower than most estimates of its trend, and wage growth remains sluggish, suggesting that some cyclical weakness persists. In short, considerable progress has been achieved in the recovery of the labor mar- ket, though room for further improvement remains. At the same time that the labor market situation has improved, domestic spend- ing and production have been increasing at a solid rate. Real gross domestic product (GDP) is now estimated to have increased at a 33⁄4-percent annual rate during the second half of last year. While GDP growth is not anticipated to be sustained at that pace, it is expected to be strong enough to result in a further gradual decline in the unemployment rate. Consumer spending has been lifted by the improvement in the labor market as well as by the increase in household purchasing power re- sulting from the sharp drop in oil prices. However, housing construction continues to lag; activity remains well below levels we judge could be supported in the longer run by population growth and the likely rate of household formation. Despite the overall improvement in the U.S. economy and the U.S. economic out- look, longer-term interest rates in the United States and other advanced economies have moved down significantly since the middle of last year; the declines have re- flected, at least in part, disappointing foreign growth and changes in monetary pol- icy abroad. Another notable development has been the plunge in oil prices. The bulk of this decline appears to reflect increased global supply rather than weaker global demand. While the drop in oil prices will have negative effects on energy producers and will probably result in job losses in this sector, causing hardship for affected workers and their families, it will likely be a significant overall plus, on net, for our economy. Primarily, that boost will arise from U.S. households having the where- withal to increase their spending on other goods and services as they spend less on gasoline. Foreign economic developments, however, could pose risks to the outlook for U.S. economic growth. Although the pace of growth abroad appears to have stepped up slightly in the second half of last year, foreign economies are confronting a number of challenges that could restrain economic activity. In China, economic growth could slow more than anticipated as policymakers address financial vulnerabilities and manage the desired transition to less reliance on exports and investment as sources of growth. In the euro area, recovery remains slow, and inflation has fallen to very low levels; although highly accommodative monetary policy should help boost eco- nomic growth and inflation there, downside risks to economic activity in the region remain. The uncertainty surrounding the foreign outlook, however, does not exclu- sively reflect downside risks. We could see economic activity respond to the policy stimulus now being provided by foreign central banks more strongly than we cur- rently anticipate, and the recent decline in world oil prices could boost overall global economic growth more than we expect. U.S. inflation continues to run below the Committee’s 2-percent objective. In large part, the recent softness in the all-items measure of inflation for personal consump- tion expenditures (PCE) reflects the drop in oil prices. Indeed, the PCE price index edged down during the fourth quarter of last year and looks to be on track to reg- ister a more significant decline this quarter because of falling consumer energy prices. But core PCE inflation has also slowed since last summer, in part reflecting declines in the prices of many imported items and perhaps also some pass-through of lower energy costs into core consumer prices. VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00040 Fmt 6621 Sfmt 6621 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 37 Despite the very low recent readings on actual inflation, inflation expectations as measured in a range of surveys of households and professional forecasters have thus far remained stable. However, inflation compensation, as calculated from the yields of real and nominal Treasury securities, has declined. As best we can tell, the fall in inflation compensation mainly reflects factors other than a reduction in longer- term inflation expectations. The Committee expects inflation to decline further in the near term before rising gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate, but we will continue to monitor inflation developments closely. Monetary Policy I will now turn to monetary policy. The Federal Open Market Committee (FOMC) is committed to policies that promote maximum employment and price stability, con- sistent with our mandate from the Congress. As my description of economic develop- ments indicated, our economy has made important progress toward the objective of maximum employment, reflecting in part support from the highly accommodative stance of monetary policy in recent years. In light of the cumulative progress toward maximum employment and the substantial improvement in the outlook for labor market conditions—the stated objective of the Committee’s recent asset purchase program—the FOMC concluded that program at the end of October. Even so, the Committee judges that a high degree of policy accommodation re- mains appropriate to foster further improvement in labor market conditions and to promote a return of inflation toward 2 percent over the medium term. Accordingly, the FOMC has continued to maintain the target range for the Federal funds rate at 0 to 1⁄4 percent and to keep the Federal Reserve’s holdings of longer-term securi- ties at their current elevated level to help maintain accommodative financial condi- tions. The FOMC is also providing forward guidance that offers information about our policy outlook and expectations for the future path of the Federal funds rate. In that regard, the Committee judged, in December and January, that it can be pa- tient in beginning to raise the Federal funds rate. This judgment reflects the fact that inflation continues to run well below the Committee’s 2-percent objective, and that room for sustainable improvements in labor market conditions still remains. The FOMC’s assessment that it can be patient in beginning to normalize policy means that the Committee considers it unlikely that economic conditions will war- rant an increase in the target range for the Federal funds rate for at least the next couple of FOMC meetings. If economic conditions continue to improve, as the Com- mittee anticipates, the Committee will at some point begin considering an increase in the target range for the Federal funds rate on a meeting-by-meeting basis. Before then, the Committee will change its forward guidance. However, it is important to emphasize that a modification of the forward guidance should not be read as indi- cating that the Committee will necessarily increase the target range in a couple of meetings. Instead the modification should be understood as reflecting the Commit- tee’s judgment that conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting. Provided that labor market conditions continue to improve and further improvement is ex- pected, the Committee anticipates that it will be appropriate to raise the target range for the Federal funds rate when, on the basis of incoming data, the Com- mittee is reasonably confident that inflation will move back over the medium term toward our 2-percent objective. It continues to be the FOMC’s assessment that even after employment and infla- tion are near levels consistent with our dual mandate, economic conditions may, for some time, warrant keeping the Federal funds rate below levels the Committee views as normal in the longer run. It is possible, for example, that it may be nec- essary for the Federal funds rate to run temporarily below its normal longer-run level because the residual effects of the financial crisis may continue to weigh on economic activity. As such factors continue to dissipate, we would expect the Federal funds rate to move toward its longer-run normal level. In response to unforeseen developments, the Committee will adjust the target range for the Federal funds rate to best promote the achievement of maximum employment and 2-percent inflation. Policy Normalization Let me now turn to the mechanics of how we intend to normalize the stance and conduct of monetary policy when a decision is eventually made to raise the target range for the Federal funds rate. Last September, the FOMC issued its statement on Policy Normalization Principles and Plans. This statement provides information about the Committee’s likely approach to raising short-term interest rates and re- ducing the Federal Reserve’s securities holdings. As is always the case in setting VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00041 Fmt 6621 Sfmt 6621 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 38 policy, the Committee will determine the timing and pace of policy normalization so as to promote its statutory mandate to foster maximum employment and price stability. The FOMC intends to adjust the stance of monetary policy during normalization primarily by changing its target range for the Federal funds rate and not by actively managing the Federal Reserve’s balance sheet. The Committee is confident that it has the tools it needs to raise short-term interest rates when it becomes appropriate to do so and to maintain reasonable control of the level of short-term interest rates as policy continues to firm thereafter, even though the level of reserves held by de- pository institutions is likely to diminish only gradually. The primary means of rais- ing the Federal funds rate will be to increase the rate of interest paid on excess reserves. The Committee also will use an overnight reverse repurchase agreement facility and other supplementary tools as needed to help control the Federal funds rate. As economic and financial conditions evolve, the Committee will phase out these supplementary tools when they are no longer needed. The Committee intends to reduce its securities holdings in a gradual and predict- able manner primarily by ceasing to reinvest repayments of principal from securi- ties held by the Federal Reserve. It is the Committee’s intention to hold, in the longer run, no more securities than necessary for the efficient and effective imple- mentation of monetary policy, and that these securities be primarily Treasury secu- rities. Summary In sum, since the July 2014 Monetary Policy Report, there has been important progress toward the FOMC’s objective of maximum employment. However, despite this improvement, too many Americans remain unemployed or underemployed, wage growth is still sluggish, and inflation remains well below our longer-run objective. As always, the Federal Reserve remains committed to employing its tools to best promote the attainment of its objectives of maximum employment and price sta- bility. Thank you. I would be pleased to take your questions. VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00042 Fmt 6621 Sfmt 6621 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 39 RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN SHELBY FROM JANET L. YELLEN Q.1. The Financial Stability Board (FSB), of which the Federal Re- serve is a member, recently issued a proposal for a new long-term debt requirement for large financial institutions. The Federal Re- serve is expected to base its own long-term debt rule on the FSB’s proposal. However, the FSB is now conducting a quantitative im- pact study to assess costs and effects of its proposal. Because the comment period on the FSB proposal has already closed, the public will not be able to comment on the results of the FSB study. Do you think it is important for the public to be able to comment on the FSB study? Will the Fed do its own quantitative impact study before implementing the FSB rule? If not, why not and is it appro- priate to base a rule for U.S. banks on a study conducted by an international regulatory body? A.1. Since the financial crisis, U.S. authorities and foreign regu- lators have been working to identify and mitigate the obstacles to an orderly resolution or wind-down of a global systemically impor- tant bank (GSIB). To achieve this objective, a failed GSIB in reso- lution must have a sufficient amount of loss-absorbing resources so that shareholders and creditors—instead of taxpayers—will bear the costs of its failure. Accordingly, in November 2014, the FSB published for consultation a proposal for a common international standard on the total loss-absorbing capacity for GSIBs (TLAC pro- posal). The comment period for the FSB’s TLAC proposal closed in February 2015; the FSB received comments from a range of com- menters, including U.S. trade associations and public policy advo- cates. In connection with the TLAC proposal, the FSB is currently coordinating a comprehensive quantitative impact study to which the Federal Reserve and other U.S. authorities are contributing participants. Independently, the Federal Reserve has been developing a pro- posal that would require the largest, most complex U.S. banking firms to keep outstanding minimum amounts of long-term, unse- cured debt at the holding company level (U.S. long-term debt pro- posal). In proposing and adopting rules on long-term debt require- ments for U.S. banking firms, the Federal Reserve will seek public comment and comply fully with the Administrative Procedures Act and other applicable Federal law. To the extent that the FSB quan- titative impact study provides information that is relevant to the U.S. long-term debt proposal, the Federal Reserve will take that in- formation into account in preparing the materials that it publishes for public comment. As part of the rulemaking process, the Federal Reserve would consider all public comments as well as the public benefits and burdens associated with the proposed regulation. Q.2. During a hearing last June in connection with the Financial Stability Oversight Council’s (FSOC) Annual Report to Congress, Treasury Secretary Jack Lew responded to a question regarding the designation process for SIFI and G-SIFI institutions and the closely correlative timing by saying that, ‘‘ . . . the FSB does not make decisions for national authorities.’’ Both the Secretary of the Treasury and the Chair of the Federal Reserve are members of both FSOC and FSB. There have been instances of FSB desig- VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00043 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 40 nating certain U.S. companies as systemically important before the FSOC did so, and other instances where the FSB proposed rules that U.S. regulators then promulgated domestically. Do you believe it is appropriate for a Federal Reserve governor to vote on an FSB proposal or determination before the FSOC votes on the same issue? What specific processes and safeguards are in place that pre- vent FSB rules and decisions from being implemented in the U.S. through FSOC as a matter of formality and without due regard to the regulatory process and our existing regulatory framework? A.2. The FSOC’s process for designating nonbank firms as system- ically important assesses the potential harm that a firm’s distress or failure would cause to the economy of the United States. The methodology underlying this assessment process, including the quantitative metrics used to rule out smaller, less complex firms, has been made public.1 In addition, for the firms it ultimately votes to designate, the FSOC publishes a description of the basis for its finding. No part of this process is linked, mechanically or otherwise, with the deliberations or findings of agencies outside the United States, including the FSB. The leaders of the Group of 20 Nations, including the United States, charged the FSB with, in part, identifying firms whose dis- tress would threaten the global economy. The fact that both groups have examined the same firms, at times in close proximity, is to be expected given the limited number of firms which would reason- ably be large enough to be considered systemically important. How- ever, the specific designation frameworks and standards at the FSB and FSOC are materially different. As an example, the FSB’s process for identifying global system- ically important insurers (G-SIIs) is completely independent of the FSOC’s designation process. A designation by the FSB that an in- surer is systemically important would not logically require a simi- lar finding by the FSOC, even if the FSB and the FSOC agreed on the underlying facts. The methodology for identifying global systemically important in- surers (G-SIIs) was developed by the International Association of Insurance Supervisors (IAIS). The IAIS’ assessment methodology uses five categories to measure relative systemic importance: (1) nontraditional insurance and non-insurance (NTNI) activities, (2) interconnectedness, (3) substitutability, (4) size, and (5) global ac- tivity. Within these five categories, there are 20 indicators, includ- ing: intra financial assets and liabilities, gross notional amount of derivatives, Level 3 assets, non-policyholder liabilities and non-in- surance revenues, derivatives trading, short term funding, and variable insurance products with minimum guarantees. The FSOC considers a threat to the financial stability of the United States to exist if a nonbank financial company’s material fi- nancial distress or activities could be transmitted to, or otherwise affect, other firms or markets, thereby causing a broader impair- ment of financial intermediation or of financial market functioning. An impairment of financial intermediation and financial market functioning can occur through several channels, including through: 1http://www.treasury.gov/initiatives/fsoc/rulemaking/Documents/Authority to Require Su- pervision and Regulation of Certain Nonbank Financial Companies.pdf VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00044 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 41 (1) exposure of other financial market participants to the firm; (2) liquidation of its assets; or (3) failure of the firm to perform a crit- ical service or function that is relied upon by other market partici- pants. The FSOC’s analysis is based on a broad range of quan- titative and qualitative information available to the FSOC through existing public and regulatory sources and as submitted to FSOC by the firm under consideration. The analysis is tailored, as appro- priate, to address company-specific risk factors, including but not limited to, the nature, scope, size, scale, concentration, inter- connectedness, and mix of the activities of the firm. Any standards adopted by the FSB, including designation of an entity as a global systemically important financial institution (G- SIFI), are not binding on the Federal Reserve, the FSOC, or any other agency of the U.S. government, or any U.S. companies. Thus, FSB designation of an entity as a nonbank SIFI does not automati- cally result in the Federal Reserve Board becoming the entity’s prudential regulator. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), the FSOC is re- sponsible for deciding whether a nonbank financial company should be regulated and supervised by the Federal Reserve Board, based on its assessment of the extent to which the failure, material dis- tress, or ongoing activities of that entity could pose a risk to the U.S. financial system. Q.3. Governor Tarullo, the Federal Reserve’s representative to the FSB, stated that the Fed will be promulgating a rule to implement domestically the FSB’s proposal on minimum margin requirements for certain forms of securities financing deals. As the FSB has been criticized for lack of transparency and accountability by U.S. offi- cials and regulators, it is troubling that the Fed’s FSB representa- tive would indicate the rule’s quick adoption in the United States. Is the Federal Reserve going to undertake an analysis independent from the FSB before promulgating a similar rule domestically? Since securities financing regulation has traditionally been within the purview of the Securities and Exchange Commission (SEC), not the Federal Reserve, how does the Federal Reserve intend to pro- ceed with this rule and is the SEC going to be involved in that process? If not, why not? What expertise and knowledge does the Federal Reserve possess in this area? A.3. The Federal Reserve would adopt minimum margin require- ments for securities financing transactions only following a notice- and-comment rulemaking process supported by an independent as- sessment of the merits of such an approach. During that rule- making process, the Federal Reserve would consult with the SEC, as well as other stakeholders and experts. The Federal Reserve would also draw on its extensive knowledge of securities financing markets. This knowledge derives from multiple sources, including the Fed- eral Reserve’s supervision of financial institutions that are the dominant intermediaries in these markets, as well as the Federal Reserve’ s direct experience in securities financing markets related to the conduct of monetary policy. The FSB framework of minimum margin requirements has been developed through a multiyear process led by a working group that VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00045 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 42 includes representatives of the Federal Reserve and the SEC. There have been multiple opportunities for public input into the FSB process: • In April 2012, the FSB published an interim report provided an overview of the securities lending and repo markets, and identified financial stability issues in these markets. • In August 2013, the FSB published a policy framework for ad- dressing shadow banking risks in securities lending and repos, which included for public consultation the proposed regulatory framework of minimum margin requirements. • In October 2014, the FSB finalized minimum margin require- ments for transactions involving bank lenders and nonbank borrowers, and simultaneously proposed for public consultation the extension of the framework of minimum margin require- ments to transactions involving two nonbank entities. • In addition, the FSB conducted a multistage quantitative im- pact study to help gauge the impact of minimum margin re- quirements on market conditions. Q.4. The Federal Reserve is a participant in negotiations within the International Association of Insurance Supervisors, which is currently developing a global capital standard for international in- surance companies. How will these global capital standards for in- surers impact the development of insurance capital standards here in the United States? A.4. The Federal Reserve participates as a member to the IAIS along with our fellow U.S. members from the Federal Insurance Of- fice and National Association of Insurance Commissioners. Along with these organizations, we advocate for the development of inter- national standards that best meet the needs of the U.S. insurance market and U.S. consumers. The standards under development by the IAIS would only apply in the United States if adopted by the appropriate U.S. regulators in accordance with applicable domestic rulemaking procedures. Additionally, none of the standards are in- tended to replace the existing legal entity risk-based capital re- quirements that are already in place. The Federal Reserve continues to focus on constructing a domes- tic regulatory capital framework for our supervised insurance hold- ing companies that is well tailored to the business of insurance. The timeline for the development of our rulemaking is distinct from the activities of the IAIS. We are exercising great care as we ap- proach this challenging mandate. We are committed to following a transparent rulemaking processes to develop our insurance capital framework, which will allow for an open public comment period on a concrete proposal. We will continue to engage with interested parties as we move forward. Q.5. Over the last few years, the Federal Reserve has issued a se- ries of new rules on capital and liquidity requirements for banks. Although these rules are important to ensure that the banking sys- tem is adequately capitalized, the must also strike the right bal- ance to promote safety and soundness without eroding economic growth and job creation. Has the Federal Reserve conducted any cost-benefit analysis of the cumulative impact of its capital and li- VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00046 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 43 quidity rules on future economic growth and job creation? If yes, please share with this Committee the results of that study. If no, are you willing to conduct a cost-benefit analysis before finalizing the rules? A.5. As required by the Dodd-Frank Act, the Federal Reserve has adopted new risk-based capital and liquidity requirements through the rulemaking process to strengthen and enhance the safety and soundness of banking organizations and the U.S. banking system. To become informed about the benefits and burdens of any cap- ital and liquidity requirements, the Federal Reserve collected infor- mation directly from parties that we expect will be affected by the rulemaking through surveys and meetings. The Federal Reserve also participated in several international studies assessing the po- tential impact of changes to the regulatory capital and liquidity re- quirements, which found that stronger capital and liquidity re- quirements could help reduce the likelihood of banking crises while yielding positive net economic benefits.2 In the rulemaking process, the Federal Reserve specifically sought comment from the public on the burdens and benefits of the proposed approaches and on a vari- ety of alternative approaches to the proposal. The Federal Reserve carefully considered public comments received on every notice of proposed rulemaking, including information relevant to the impact of rulemakings provided by commenters. In adopting final rules on these topics, the Federal Reserve sought to adopt a regulatory al- ternative that faithfully reflected the statutory provisions and the intent of Congress, while minimizing regulatory burden. We also provided an analysis of the costs on small depository organizations of our rulemaking consistent with the Regulatory Flexibility Act and computed the anticipated cost of paperwork consistent with the Paperwork Reduction Act. The Federal Reserve performs an impact analysis with respect to each final rule pursuant to the Congres- sional Review Act.3 As part of the adoption of Regulation Q, the Federal banking agencies performed an analysis that showed that the vast majority of U.S. banking organizations, including community banks, would have already met the revised capital requirements plus the capital conservation buffer on a fully phased-in basis, which suggests that any negative impact stemming from the revised capital rule on credit availability should be small. 2Those studies included the Macroeconomic Assessment Group (MAG), a joint group of the Basel Committee on Banking Supervision (BCBS) and Financial Stability Board, (ii) the long- term economic impact working group of the BCBS, and (iii) the BCBS Quantitative Impact Study. See MAG, ‘‘Assessing the Macroeconomic Impact of the Transition to Stronger Capital and Liquidity Requirements’’ (MAG Analysis), available at: http://www.bis.org/publ/othpl2.pdf. See also BCBS ‘‘An Assessment of the Long-Term Economic Impact of Stronger Capital and Li- quidity Requirements’’ (LEI Analysis), also available at: http://www.bis.org/publ/bcbs173.pdf. See also ‘‘Results of the Comprehensive Quantitative Impact Study’’, also available at: http:// www.bis.org/publ/bcbs186.pdf. 3Before issuing any final rule, the Federal Reserve prepares an analysis under the CRA and provides the analysis to the Office and Management and Budget for its review. As part of this analysis, the Federal Reserve assesses whether the final rule is a ‘‘major rule,’’ meaning the rule could (i) have an annual effect on the economy of $100 million or more; (ii) increase or process for consumers, individual industries, Federal, States, or local government agencies, or geo- graphic regions; or (iii) have significant adverse effects on competition, employment, investment, productivity, or innovation. VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00047 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 44 RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM JANET L. YELLEN Q.1. Will the Federal Reserve follow a formal rulemaking process for insurance capital standards and not use an expedited process like imposing the standards by order? A.1. The Federal Reserve is committed a transparent rulemaking processes to develop our insurance capital framework. This will allow for an open public comment period on a concrete proposal. Q.2. Recognizing that there are two standard development tracks running at the same time—development of a domestic capital standard at the Federal Reserve, and development of an inter- national capital standard at the IAIS—could you explain how the Federal Reserve is coordinating these efforts? A.2. The Federal Reserve participates as a member to the Inter- national Association of Insurance Supervisors (IAIS) along with our fellow U.S. members from the Federal Insurance Office and Na- tional Association of Insurance Commissioners. Along with these organizations, we advocate for the development of international standards that best meet the needs of the United States insurance market. The standards under development by the IAIS would only apply in the United States if adopted by the appropriate U.S. regu- lators in accordance with applicable domestic rulemaking proce- dures. Additionally, none of the standards are intended to replace the existing legal entity risk-based capital requirements that are already in place. The Federal Reserve continues to focus on constructing a domes- tic regulatory capital framework for our supervised insurance hold- ing companies that is well tailored to the business of insurance. We are committed to a transparent rulemaking process and are engag- ing stakeholders at various levels. The timeline for the develop- ment of our rulemaking is distinct from the activities of the IAIS. We are exercising great care as we approach this challenging man- date. We will continue to engage with interested parties as we move forward. Q.3. The Basel Advanced Approaches regulation provides an ave- nue for companies to request a waiver from the rule. In effect, this would allow an institution to use the Basel Standardized Approach to calculate its capital ratios. How would the waiver process work? What are the types of criteria that would be considered? A.3. Under the banking agencies’ regulatory capital rules,1 inter- nationally active banking organizations (specifically, those with total consolidated assets of $250 billion or more or with consoli- dated total on-balance-sheet foreign exposure of $10 billion or more) must calculate risk-based capital using the advanced ap- proaches risk-based capital rules (the advanced approaches rule) in addition to the standardized approach. Section 100(b)(2) of the reg- ulatory capital rules provides that a banking organization subject to the advanced approaches rule shall remain subject to that rule until the primary Federal regulator determines that application of 112 CFR part 3 (national banks and Federal savings associations), 12 CFR part 217 (State member banks, bank holding companies, and savings and loan holding companies), and 12 CFR part 324 (State nonmember banks and State savings associations). VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00048 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 45 the advanced approaches rule is not appropriate in light of the banking organization’s size, level of complexity, risk profile, or scope of operations. In making such a determination, the primary Federal regulator must apply notice and response procedures. The primary Federal regulator may also set conditions on the granting of the waiver as appropriate, and any waiver granted must be con- sistent with safety and soundness. The capital adequacy of a bank- ing organization that meets the thresholds described above but has received a waiver from application of the advanced approaches rules would be addressed by standardized risk-based capital rules, leverage rules, and capital planning and supervisory stress-testing requirements. RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER FROM JANET L. YELLEN Q.1. Ms. Yellen, in 2013, Bloomberg View, looking at 2009 credit- rating date prices, placed the value on ‘‘too big to fail’’ subsidy at $83 billion. Another study by the International Monetary Fund re- leased in March, 2014 put the number somewhere between $16 bil- lion and $70 billion annually in 2011 and 2012 for the eight largest U.S. Banks. The GAO in a report released last summer then con- firmed the fact that Wall Street megabanks have not only received more support from Government bailout programs, but enjoy a tax- payer-funded advantage over community and regional banks that widens during times of economic crisis. Do you believe that megabanks, because creditors assume the Government can’t let them collapse, borrow for less than they oth- erwise would giving them an unfair advantage over regional and community banks? Do you think the supplemental leverage ratio should be strengthened further to offset this advantage? A.1. It is well documented that large banks generally fund them- selves at lower cost than smaller banks. Identifying a single, spe- cific reason for this funding differential, however, is challenging since large banks and small banks differ along many different di- mensions. At the same time, it is not unreasonable to assume that at least some of the observed funding differential owes to height- ened investor expectations of public support for large banks. Despite the fact that large banks may benefit to some degree from heightened investor expectations of Government support, it should be noted that the evidence in favor of such a ‘‘Too Big to Fail’’ (TBTF) subsidy has waned in recent years. In particular, the cited Government Accountability Office (GAO) study documents that the estimated size of the TBTF subsidy has declined signifi- cantly since the financial crisis. In addition, rating agencies have begun to remove their explicit rating uplift that was directly tied to expectations of Government support. This decline in the observed TBTF subsidy is not an accident. Rather, a number of coordinated policies are working in concert to improve the capital and liquidity position as well as the resolv- ability of our largest and most systemic banks which will reduce both the probability of any future insolvency as well the need to provide Government support in the event that a large bank fails in the future. More specifically, the capital position of our largest VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00049 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 46 banks has been improved with the finalization of Basel III and the recently proposed Systemically Important Financial Institution (SIFI) capital surcharges will further enhance the resiliency of our largest and most systemic banks. The new liquidity coverage re- quirement (LCR) will further help to ensure that large and sys- temic banks have the needed liquidity to manage through a period of financial stress. Finally, provisions of Dodd-Frank Wall Street Reform and Consumer Protection Act’s (Dodd-Frank Act) Title II were designed to ensure that a large and systemically important bank could be resolved in bankruptcy without requiring any tax- payer support. Accordingly, a number of policies that were put in place following the financial crisis have resulted in much tighter regulation of large and systemically important banks and are reducing any TBTF subsidy resulting from heightened investor expectations of Government support. Q.2. The Dodd-Frank Act arguably allows the assets of an insur- ance company affiliated with a failing depository institution to be used to cover the costs of resolving the depository institution. Such action could significantly harm the policyholders of the insurance company. Accordingly, do you support legislation clarifying that money held by insurance affiliates of failing depository institutions cannot be transferred without the consent of State insurance regulators? A.2. The Federal Reserve has long considered the source of strength doctrine, which was codified in the Dodd-Frank Act, to be an important component of reducing the likelihood of bank failures and protecting taxpayers against losses that might arise from bank failures. Section 616 of the Dodd-Frank Act requires all depository institution holding companies to serve as a source of financial strength to their subsidiary depository institutions, including bank holding companies, savings and loan holding companies, and any other company that controls an insured depository institution. Under section 5(g) of the Bank Holding Company Act, the ability of the Federal Reserve to require a bank holding company to pro- vide funds to a subsidiary insured depository institution may be blocked by a State insurance regulator if the funds would be pro- vided by a bank holding company or a subsidiary of the holding company that is an insurance company. We understand that legislation has been proposed which would extend the same treatment to insurance companies that are sav- ings and loan holding companies or are companies that otherwise control an insured depository institution. While this legislation would provide consistency of treatment between bank holding com- panies and other depository institution holding companies, it would weaken the ability of these companies to be a source of strength to their insured depository institutions. RESPONSES TO WRITTEN QUESTIONS OF SENATOR KIRK FROM JANET L. YELLEN Q.1. Chair Yellen, what is the appropriate response time for the Fed to respond to a written question by a Senator on the Banking Committee? VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00050 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 47 Would you agree that over 6 months is unacceptable? What is the average response time for the Fed to respond to Con- gress? What is the Federal Reserve Board process for responding to offi- cial Congressional correspondence? A.1. The Board recognizes the oversight function that the Com- mittee exercises over the Federal Reserve and has long and consist- ently cooperated to provide the Committee with information that it needs to conduct its oversight role. It is the custom and practice of the Federal Reserve to respond fully to requests for information from Congress, including responses to questions for the record fol- lowing hearings. As always, we endeavor to respond to requests fully and in as timely a manner as possible. Q.2. Now that the Federal Reserve oversees approximately 1⁄ 3 of the life insurance industry by premium volume, it is essential that the Federal Reserve has the proper person[ne]l and expertise to support proper insurance regulatory oversight. In addition to the hiring of former Connecticut Insurance Commissioner Tom Sul- livan, how many other individuals has the Board hired that have experience regulating insurance companies? A.2. The Federal Reserve is investing significant time and effort into enhancing our understanding of the insurance industry and firms we supervise, and we are committed to tailoring our super- visory framework to the specific business lines, risk profiles, and systemic footprints of the insurance holding companies we oversee. As part of this, we have hired a significant number of staff who have prior experience regulating insurance companies. Q.3. How does the Board assign examiners to insurance compa- nies? A.3. The Federal Reserve considers a number of factors when as- signing staff to supervisory teams in order to best meet our super- visory objectives of protecting the safety and soundness of consoli- dated firms and mitigating any risks to financial stability. These teams are combination of Federal Reserve staff with expertise in risk management, insurance, and specific areas of supervision. Q.4. How many examiners with insurance experience currently work for the Federal Reserve? A.4. The Federal Reserve employs approximately 70 people to su- pervise insurance holding companies. We will continue to evaluate our needs and increase our hiring as needed. Q.5. What policies and procedures has the Federal Reserve estab- lished for conducting supervision of insurance companies? A.5. After the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), the Federal Reserve moved quickly to develop a supervisory framework that is appro- priate for insurance holding companies that own depository institu- tions and promptly assigned supervisory teams to handle day-to- day supervision of those insurance holding companies. We also acted promptly to commence supervision of the three insurance holding companies designated by the Financial Stability Oversight Council for Federal Reserve supervision. While building our super- VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00051 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 48 visory regime for these firms, we have reached out to our col- leagues in the State insurance departments. Our supervisory ef- forts to date have focused on strengthening firms’ risk identifica- tion, measurement, and management; internal controls; and cor- porate governance. Our principal supervisory objectives for insur- ance holding companies are protecting the safety and soundness of the consolidated firms and their subsidiary depository institutions while mitigating any risks to financial stability. The supervisory program continues to be tailored to consider the unique character- istics of insurance operations and to rely on the work of the pri- mary functional regulator to the greatest extent possible. Q.6. The International Association of Insurance Supervisors (IAIS) is currently developing global insurance capital standards. This process is occurring at the same time the Fed is implementing the Insurance Capital Standards Clarification Act and authoring do- mestic insurance capital standards. The international standards have received a good amount of criticism here in the U.S. There is particular concern that the Fed may agree to IAIS standards before domestic standards are finalized. Does the Federal Reserve intend to precede these international efforts? A.6. The Federal Reserve participates as a member to the IAIS along with our fellow U.S. members from the Federal Insurance Of- fice (FIO) and National Association of Insurance Commissioners (NAIC). Along with these organizations, we advocate for the devel- opment of international standards that best meet the needs of the U.S. insurance market and U.S. consumers. The standards under development by the IAIS would only apply in the United States if adopted by the appropriate U.S. regulators in accordance with ap- plicable domestic rulemaking procedures. Additionally, none of the standards are intended to replace the existing legal entity risk- based capital requirements that are already in place. The Federal Reserve continues to focus on constructing a domes- tic regulatory capital framework for our supervised insurance hold- ing companies that is well tailored to the business of insurance. The timeline for the development of our rulemaking is distinct from the activities of the IAIS. We are exercising great care as we ap- proach this challenging mandate. We are committed to following a transparent rulemaking processes to develop our insurance capital framework, which will allow for an open public comment period on a concrete proposal. We will continue to engage with interested parties as we move forward. Q.7. Who represents the Federal Reserve Board at meetings of the IAIS? A.7. Since joining the IAIS in late 2013, the Federal Reserve has been an active participant in several key committees, working groups, and work streams. We currently hold a seat on the Finan- cial Stability Committee and the Technical Committee of the IAIS. Our participation in these activities is primarily overseen by Thom- as Sullivan, Associate Director, Division of Banking Supervision and Regulation, with support and participation of other staff of the Federal Reserve System at the direction and under the supervision of the Board of Governors which ultimately is responsible for our policy positions. VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00052 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 49 Q.8. Can you describe the process the U.S. uses to present a posi- tion during IAIS negotiations? A.8. The Federal Reserve has acted on the international insurance stage in an engaged partnership with our colleagues from the FIO, the State insurance commissioners, and the NAIC. We collaborate with one another both formally and informally on matters of import which are before the IAIS membership. Our multiparty dialogue, while respectful of each of our individual authorities, strives to de- velop a central ‘‘Team USA’’ position on the most critical matters of global insurance regulatory policy. RESPONSES TO WRITTEN QUESTIONS OF SENATOR HELLER FROM JANET L. YELLEN Q.1. Shortly after the Federal Reserve joined the International As- sociation of Insurance Supervisors (IAIS), the IAIS voted to shut out public observers including consumer groups from most of their meetings. How did the Federal Reserve representative vote on this issue? If the Federal Reserve is committed to being transparent in its operations, will you support allowing the public to observe the IAIS meetings in the same way Congress—and this Committee— does with its hearings and mark-ups? A.1. The Federal Reserve, along with our partners, the State insur- ance commissioners, the National Association of Insurance Com- missioners and the Federal Insurance Office have, and will con- tinue to actively seek out U.S. insurance stakeholders to ensure we are fully engaged and understanding of their perspectives as we ne- gotiate global insurance standards at IAIS. For instance, the U.S. delegation has hosted several meetings in recent months, where we invited in U.S. insurance stakeholders for open dialogue and active working sessions regarding matters of policy which are currently before the IAIS. This level of engagement will continue with U.S. interested parties. The Federal Reserve supports intervals and protocols for stake- holders to provide comment and input. We believe strongly in inde- pendence within the standard setting process and would also seek to mitigate any opportunity for regulatory capture within the pro- ceedings. The IAIS voted to revise its approach for industry partici- pation in standard setting. Under the new process, industry will no longer provide financial support to the IAIS or be day-to-day par- ticipants in the development of international supervisory standards for insurance. The industry and public will be able to provide input through stakeholder meetings as well as through comments on ex- posures of draft IAIS proposals. The Federal Reserve supports transparency in rulemaking and policy development and believes that it is critical that standard-setting bodies be fully independent of the regulated. Q.2. The Financial Stability Oversight Council (FSOC) recently adopted guidance on how it deals with entities it is considering for SIFI designation, however the Council’s actions did not address concerns about how it mitigates systemic risk. In particular, the Council did not create a process that would reduce potential threats to the financial system by allowing a company or its pri- VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00053 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 50 mary regulator to address identified risks before designation. Shouldn’t FSOC’s primary focus be to identify and ensure systemic risks are addressed rather than simply sending a nonbank entity to the Federal Reserve for undefined regulation? Why should the Federal Reserve regulate nonbank systemically important financial institutions as opposed to their primary regulator? A.2. The Dodd-Frank Act gives the FSOC authority to reduce sys- temic risks by requiring that systemically important financial insti- tutions be supervised by the Federal Reserve and subject to en- hanced prudential standards. Such enhanced prudential standards are designed to reduce systemic risk by ensuring that these firms maintain adequate capital and liquidity, and that they appro- priately plan for an orderly resolution in the event of their failure. In supervising systemically important financial institutions, the Federal Reserve’s role is not to replace the functional regulator, but rather to focus on consolidated supervision and systemic risk reduc- tion. The Federal Reserve is committed to tailoring its enhanced prudential standards for systemically important firms it supervises to the specific risks posed by each firm. The Dodd-Frank Act re- quires the FSOC to reevaluate each designation annually to con- sider whether the designation should be rescinded. This annual re- view process establishes a process for the FSOC to rescind a des- ignation if the company has taken steps to reduce the risk that the firm poses a threat to the financial stability of the United States. RESPONSES TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM JANET L. YELLEN Q.1. With Congress preparing to consider a budget in the near fu- ture, some members on the other side of the aisle are calling for severe, across-the-board funding cuts. In addition to being bad pol- icy for many of the priorities that could be cut, what would be the impact on the economy of a major fiscal tightening? How is the Fed taking into account the risk of new fiscal austerity in its timeline for tightening? If Congress were to impose severe fiscal cuts, would the Fed have to delay its timeline for tightening monetary policy to compensate for the contractionary effect? Given where monetary policy is with respect to the zero lower bound, wouldn’t it be better policy to allow monetary policy to normalize first, before considering severe budget cuts? A.1. The implications for the economy of a fiscal contraction would depend on many aspects of the situation. But in general, a fiscal contraction would generally be associated with slower GDP growth for a time, higher unemployment for a time, and somewhat lower inflation for a time, holding all other influences on the economy constant. As time passed, these effects would normally be expected to fade, as a result of the normal pursuit of monetary policy objec- tives, namely price stability and maximum employment. In other words, monetary would seek to restore the economy to its mandate- consistent performance, with labor fully employed and with infla- tion running at its mandate-consistent pace of 2 percent. As the Federal Open Market Committee (FOMC) assesses the best path for monetary policy to follow, the Committee attempts to VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00054 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 51 take into account the totality of factors affecting the pace of progress toward the Committee’s congressionally mandated policy objectives. Moreover, as I have noted many times, our policy deci- sions will evolve in light of the latest evidence concerning the posi- tion of the economy relative to our policy objectives. Specifically, if the sum total of factors restraining the pace of activity proves to be stronger than anticipated, then a more-accommodative monetary policy will be warranted to best promote attainment of the policy objectives. Conversely, if the factors restraining the pace of activity prove to be less potent than anticipated, then a less-accommodative monetary policy will be warranted, all else equal. Q.2. Long-term unemployment is coming down from its peak after the financial crisis, but the level is still high. As you know, Ameri- cans who have been hit with long-term unemployment face greater obstacles to returning to work, which, in addition to the human toll on these families, reduces our economy’s overall productive capac- ity. How can monetary policy help address the challenge of long- term unemployment? Is long-term unemployment a reason to let the economy run a little bit ‘‘hotter’’ for a little bit longer before tightening? A.2. The issue of long-term unemployment is very serious, as it has enormous implications in human terms for those most directly af- fected by it—first and foremost the workers themselves and their immediate families—but also for the overall performance of the economy. I would note that there are some reasonably encouraging signs that, as overall labor-market conditions have improved, the situation of the long-term unemployed has also improved. The best contribution that the Federal Reserve can make to the ongoing re- duction in long-term unemployment is to continue to pursue our congressionally mandated objectives of price stability and max- imum employment. A broad consensus agrees that by pursuing these objectives, the Federal Reserve provides the best possible backdrop for the economy to perform as well as possible. Q.3. As you may be aware, some of my colleagues on the other side of the aisle would like to throw sand in the gears of our financial regulators by tampering with the way agencies evaluate the bene- fits and costs of their actions. These proposals would impose a rigged version of cost-benefit analysis that would prevent the im- plementation of financial reform laws, create a nearly insurmount- able obstacle to action, and invite frivolous legal challenges at tax- payers’ expense. Can you elaborate on some of the problems with proposals such as these? A.3. The Federal Reserve takes quite seriously the importance of evaluating the benefits and burdens associated with our rule- making efforts. To become informed about these benefits and bur- dens, before we develop a regulatory proposal, we often collect in- formation directly from parties that we expect will be affected by the rulemaking. This helps us craft a proposal that is both effective and minimizes regulatory burden. In the rulemaking process, we also specifically seek comment from the public on the burdens and benefits of our proposed approach as well as on a variety of alter- native approaches to the proposal. In adopting a final rule, we seek to adopt a regulatory alternative that faithfully reflects the statu- VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00055 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 52 tory provisions and the intent of Congress while minimizing regu- latory burden. We also provide an analysis of the costs on small de- pository organizations of our rulemaking consistent with the Regu- latory Flexibility Act and compute the anticipated cost of paper- work consistent with the Paperwork Reduction Act. Imposing additional procedural steps and providing new avenues for legal challenge to the Federal Reserve’s rulemaking process would likely extend the amount of time it takes the Federal Re- serve to promulgate new regulations and to revise existing regula- tions. This could slow the pace at which the Federal Reserve imple- ments financial reform laws and could limit the Federal Reserve’s ability to respond promptly to situations where amendments to Board regulations are deemed to be necessary. Q.4. In the aftermath of the financial crisis, there was a clear con- sensus that the compensation practices of some financial companies created incentives for employees to chase profits by taking on large, inappropriate risks, where taxpayers could be stuck with the down- side if things went wrong. We’re now approaching 5 years after the passage of the 2010 Wall Street Reform law, and many of the com- pensation reforms have yet to be implemented. The Federal Reserve, with our other financial regulators, has re- sponsibility for implementing Section 956 of the Wall Street Re- form law, which prohibits compensation arrangements at financial companies that could drive inappropriate risk-taking. Can you please provide an update on the status of this rulemaking? A.4. Section 956 of the Dodd-Frank Wall Street Reform and Con- sumer Protection Act (Dodd-Frank Act) requires the Federal Re- serve, the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), the Securities and Exchange Commission, the National Credit Union Administration Board, and the Federal Housing Finance Agency (the Agencies) to jointly issue regulations or guidelines that would prohibit any types of incentive based payment arrangement, or any feature of any such arrangement, that regulators determine encourage inappro- priate risks by providing excessive compensation or that could lead to material financial loss to a covered financial institution. Section 956 helps address a critical safety and soundness issue that may have contributed to the financial crisis: poorly designed compensation structures that can misalign incentives and result in excessive risk-taking in financial organizations. The Agencies’ im- plementation of this and other sections of the Dodd-Frank Act, as Congress directed, is designed to address many of the systemic issues that contributed to the crisis. To that end, an interagency notice of proposed rulemaking to implement the provisions of sec- tion 956, titled Incentive-Based Compensation Arrangements, was published in the Federal Register on April 14, 2011. The Agencies received more than 11,000 comments on the proposal, many of which raised complex issues requiring additional research and analysis. The Agencies’ staffs are meeting regularly to work through the issues raised in the comments, which the Agencies will consider carefully before proceeding. The Federal Reserve expects that the Agencies will take further action to implement section 956 soon VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00056 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 53 and the Federal Reserve recognizes the importance of completing this rulemaking as expeditiously as possible. In the meantime, the Federal Reserve will continue its ongoing supervisory and regu- latory work addressing compensation-related issues at financial in- stitutions that it supervises. Currently this work is based on the Interagency Guidance on Sound Incentive Compensation Policies,1 enacted by the Federal Reserve, OCC and FDIC after being pro- posed by the Federal Reserve, as well as interagency guidelines adopted by the same agencies implementing the compensation-re- lated safety and soundness standards in section 39 of the Federal Deposit Insurance Act.2 Q.5. The Federal Reserve, OCC, and FDIC have on several occa- sions expressed concern about the risk management practices of regulated institutions with respect to leveraged lending. As regu- lators have required banks to reduce their risks in this area, how- ever, there have been reports that nonbank lenders are stepping in to fill the void. Even if regulated institutions reduce their direct ex- posure to leveraged loans, they still face risks from lending that oc- curs through the ‘‘shadow banking’’ sector—for example, if a regu- lated bank is lending money to a hedge fund or other entity that invests in risky loans, if a crisis occurs with nonbank lenders that could depresses bank asset values through a fire sale or destabilize credit availability marketwide, or through a cascade of defaults that could find its way back to a bank’s doorstep. How is the Federal Reserve working with other regulators, the Financial Stability Oversight Council, and the Office of Financial Research to monitor leveraged lending by institutions other than those it regulates? A.5. Within the Federal Reserve, staff regularly review marketwide information on underwriting trends as well as deals being made by lenders to assess the effects of supervisory actions to require banks to reduce their risks in leveraged lending. An important part of the analysis is the extent to which the origination of leveraged loans is migrating to nonbank institutions. Federal Reserve staff’s finan- cial stability analysis looks at various sources to assess this, includ- ing market data sources which provide information on the bookrunners, or main underwriters, for highly leveraged trans- action deals that have closed in the last quarter as well anecdotal evidence based on regular staff meetings with market participants. Federal Reserve staff have presented on the issue of leveraged lending to the principals of the Financial Stability Oversight Coun- cil.3 Q.6. How is the Fed monitoring the direct and indirect exposure of its regulated institutions to nonbank entities that are engaging in leveraged lending? A.6. The Federal Reserve studied extensively the exposures of the majority of its regulated institutions (specifically, about 80 percent of the banking sector) to a sudden reversal in conditions in lever- aged lending—alongside a severe recession—in the severely ad- 175 Federal Register 36395 (June 25, 2010). 212 U.S.C. §1831p-1(c); 12 CFR Part 208, Appendix D-1. 3See the readout from the January 21, 2015 meeting at http://www.treasury.gov/initiatives/ fsoc/council-meetings/Documents/January%2021,%202015.pdf. VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00057 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 54 verse scenario used in the recently completed stress test exercise. This exercise studied both direct exposures—including from loans held in the pipeline prior to sale to nonbank entities and holdings of securities issued by collateralized loan obligations—as well as in- direct exposures—including (as described in the scenario narrative) a sharp deterioration in the secondary market for leveraged loans and related assets consistent with the distress of a number of nonbank entities engaged in leveraged lending. Regular assessments of financial stability by Federal Reserve staff also consider other channels through which a deterioration in the leveraged lending market—and speculative debt markets more broadly—could create strains that could then indirectly feedback on the financial sector, including the institutions that the Federal Re- serve regulates. One such channel, which was highlighted in the February 24, 2015 Monetary Policy Report, is the growth in mutual funds and exchange-traded funds. These investors, which now hold a much higher fraction of the available stock of relatively less liq- uid assets (including leveraged loans), give the appearance of offer- ing greater liquidity than the markets in which they transact and, as a result, heighten the potential for forced sales in underlying markets. Q.7. What is the Fed’s assessment of the risks currently posed by leveraged lending outside of the institutions it regulates? A.7. Currently, the Federal Reserve sees little migration in the origination of leveraged loans as a result of supervisory actions, al- though staff are continuing to monitor closely this issue as de- scribed in the answer to Question 5. In terms of investors in lever- aged loans, however, and as described in the answer to Question 6, mutual funds’ and exchange-traded funds’ holdings of a higher fraction of the available stock of relatively less liquid assets (in- cluding leveraged loans) heightens the potential for forced sales in underlying markets. Q.8. What data can you provide regarding the share and relative riskiness of leveraged lending by nonbanks vs. regulated institu- tions, the exposure of regulated institutions to leveraged lending by nonbanks, and any systemic risk concerns relating to leveraged lending by nonbanks? A.8. As described earlier, the Federal Reserve relies on a variety of market data sources—which are broadly available—to assess the state of the speculative grade corporate debt market across a vari- ety of dimensions. Importantly, the Federal Reserve has high- lighted key trends in speculative-grade corporate debt markets, in- cluding issuance volume and important underwriting trends in re- cent Monetary Policy Reports. The Federal Reserve sees little migration in the origination of le- veraged loans as a result of supervisory actions. However, in the instances where nonbanks have increased their share of origina- tions of leveraged loans, often these transactions have been higher risk. The Federal Reserve’s views on leveraged lending are informed by the findings of ongoing supervisory examinations of practices at VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00058 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 55 banks. We publish the findings of an important part of this super- visory exercise, the Shared National Credits review.4 Q.9. In your remarks at the National Summit on Diversity in the Economics Profession on October 30, 2014, you highlighted the need for diversity in the economics profession—both at the Federal Reserve and elsewhere—and discussed how a diversity of perspec- tives can lead to more informed policy decisions and research that informs policy. What steps is the Federal Reserve taking to cul- tivate diversity among its economists and more broadly, and in par- ticular among its senior and mid-level leadership? How would you rate the Federal Reserve’s progress so far? What role does the Of- fice of Minority and Women Inclusion play in this process? A.9. I would reiterate the Federal Reserve’s commitment to diver- sity, and while we continue to work towards achieving a more di- verse workforce, we recognize that we need to do more. During the initial stages of appointing official staff, the Director of the Office of Minority and Women Inclusion (OMWI), who also is the Director of Office of Diversity and Inclusion (ODI), is consulted and is a member of the reviewing team that evaluates proposed official staff actions. This allows the ODI Director to better support inclusion and di- versity at the official staff level and to ensure that the Board’s leadership nomination criteria and process are inclusive. In 2014, the Federal Reserve hired 36 economists, of which 33 percent were minorities and 19 percent were women. Based on the 2010 Census civilian labor force data and subsequent updates, the availability of minority and female candidates in the economist job occupation remains low. To foster recruitment, the Federal Reserve continues to organize, oversee, and participate in the three pro- grams under the purview of the American Economic Association’s (AEA) Committee on the Status of Minority Groups in the Econom- ics Profession (CSMGEP): (1) the Summer Economics Fellow Pro- gram, (2) the Summer Training Program, and (3) the Mentoring Program. Also, through its participation in the Science Technology Engineering and Mathematics (STEM) Education Coalition and fi- nancial literacy programs, the Federal Reserve aims to stimulate an interest in economics and math among minorities and women. However, the Federal Reserve faces real challenges in hiring mi- norities in the economist job family as does the rest of the econom- ics profession. The Federal Reserve has addressed these challenges as an active member of the AEA’s CSMGEP, which was established by the AEA to increase the representation of minorities in the eco- nomics profession, primarily by broadening opportunities for a training of underrepresented minorities. The Board continues to be involved in the range of program (from undergraduate to post- Ph.D.) sponsored by CSMGEP including the following: • The Federal Reserve partnered with the AEA to host the Na- tional Summit on Diversity in the Economics Profession at the Federal Reserve on October 30, 2014, in Washington, DC. This conference brought together presidents and research directors 4See the results of the review at: http://www.federalreserve.gov/newsevents/press/bcreg/ 20141107a.htm. VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00059 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 56 of the Federal Reserve Banks and chairs of economics depart- ments from around the country to open a profession-wide dia- logue about diversity. Speakers and panelists discussed the state of diversity in the economics profession and examples of successful diversity initiatives in academia. A hallmark of the conference was the opportunity for collegial learning, discus- sion, and sharing among faculty peers to develop practical ideas about what can be accomplished to attract and retain di- versity in the economics profession. The proceedings of the con- ference are available on the Federal Reserve’s public Web site;5 • Board staff have been involved with the CSMGEP Summer Training Program since its inception in 1974. That program is designed to provide undergraduate students with a program of study and research opportunities that prepare then to enter doctoral level Ph.D. programs in economics. Board staff regu- larly participate as adjunct faculty in the Summer Training Program; • The Federal Reserve strives to encourage summer intern appli- cants from the CSMGEP Summer Fellows Program for the Board’s summer internship program and also focuses on matching minority advanced graduate students with research- oriented sponsoring institutions to work on their own research projects while participating in the research community at the Federal Reserve; and • Board staff have served as mentors through the CSMGEP Mentoring Program in which students are matched with a mentor who sees them through the critical junctures of their graduate program. In addition, the Federal Reserve has participated in or initiated other outreach efforts including the following: • The Federal Reserve has hosted the ‘‘Math x Econ’’ (math times econ) program for the past 3 years which is aimed at high-performing math students in minority-serving high schools in the Washington, DC, metropolitan area. Math x Econ brings math students to the Board for a one-day program that introduces them to the field of economics with the goal of encouraging them to explore economics when they begin their college educations. • A group of research assistants in our economics divisions as well as our supervision division continued with the fourth year of the Fed Ed Outreach program to present information on monetary policy, financial literacy, and the role of the Federal Reserve in the economy to local high school students. The pro- gram consists of hour-long presentations presented in high school classrooms or at the Board. This past school year, the program delivered 18 presentations to 11 schools and more than 500 students. 5http://www.federalreserve.gov/newsevents/conferences/national-summit-diversity-economics- profession-program.htm VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00060 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 57 Q.10. As you know, I worked during Wall Street Reform to include provisions in the law to create Offices of Minority and Women In- clusion, or OMWIs, at the Federal financial regulators, including the Federal Reserve. In 2013, the financial regulators jointly issued proposed interagency OMWI standards for assessing the diversity policies and practices of regulated entities, and it is my under- standing that the regulators intend to issue final joint standards later this year. Some community groups have expressed concerns that the proposal needs stronger standards and accountability measures in order to meet its objectives and improve workforce and supplier diversity for regulated institutions, such as mandating re- porting on employee and supplier diversity rather than proposing that regulated entities voluntarily submit self-assessments to the agencies. How is the Fed responding to these concerns, and what plans do the financial regulators have to ensure the final interagency stand- ards will be best designed to improve diversity and promote inclu- sion in recruiting, advancement, leadership, and contracting? What steps is the Fed taking to strengthen the final interagency stand- ards to ensure real progress in expanding the role of women, people of color, and other underrepresented groups in the financial sector? What is the expected timeline for adopting final standards? A.10. In 2013, an interagency working group comprising the OMWI directors from each of the financial agencies (the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comp- troller of the Currency, the National Credit Union Administration, the Consumer Financial Protection Bureau, and the Securities and Exchange Commission) published proposed standards for assessing the diversity policies and practices of entities regulated by each agency. The proposed standards were published in the Federal Reg- ister on October 25, 2013, for public comment; the comment period was later extended to February 7, 2014, to allow interested parties adequate time to respond. The standards seek to promote transparency and awareness of diversity policies and practices within regulated entities, and pro- vide a framework for assessing diversity in four major areas: • Organizational commitment to diversity and inclusion • Workforce profile and employment practices • Procurement and business practices and supplier diversity • Practices to promote transparency of organizational diversity and inclusion The agencies carefully considered over 200 comments received and on June 9, 2015, issued a joint press release announcing publi- cation in the Federal Register of the final policy statement that es- tablishes joint standards for assessing the diversity policies and practices of the entities they regulate. The final policy statement establishing joint standards is effective as of the date it is pub- lished in the Federal Register, June 10, 2015. The press release and policy statement are posted on our public Web site.6 The joint standards, which are generally similar to the proposed standards, provide a framework for regulated entities to create and 6http://www.federalreserve.gov/newsevents/press/bcreg/20150609a.htm VerDate Nov 24 2008 14:03 Jan 15, 2016 Jkt 046629 PO 00000 Frm 00061 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\02-24 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 58 strengthen their diversity policies and practices—including their organizational commitment to diversity, workforce and employment practices, procurement and business practices, and practices to pro- mote transparency of organizational diversity and inclusion within the entities’ U.S. operations. 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Janet L. Yellen (2015, February 23). Congressional Testimony. Testimony, Federal Reserve. https://whenthefedspeaks.com/doc/testimony_20150224_chair_federal_reserves_first_monetary_policy

@misc{wtfs_testimony_20150224_chair_federal_reserves_first_monetary_policy,
  author = {Janet L. Yellen},
  title = {Congressional Testimony},
  year = {2015},
  month = {Feb},
  howpublished = {Testimony, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/testimony_20150224_chair_federal_reserves_first_monetary_policy},
  note = {Retrieved via When the Fed Speaks corpus}
}