Congressional Testimony

S. HRG. 114–87 FEDERAL RESERVE’S SECOND 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 JULY 16, 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 97–176 PDF WASHINGTON : 2015 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 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 L:\HEARINGS 2015\07-16 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 DANA WADE, Deputy Staff Director JELENA MCWILLIAMS, Chief Counsel THOMAS HOGAN, Chief Economist 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 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00002 Fmt 0486 Sfmt 0486 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON C O N T E N T S THURSDAY, JULY 16, 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 .......................................................................................... 29 Responses to written questions of: Chairman Shelby ....................................................................................... 32 Senator Crapo ............................................................................................ 173 Senator Vitter ............................................................................................ 175 Senator Heller ........................................................................................... 175 Senator Sasse ............................................................................................ 176 Senator Menendez ..................................................................................... 183 Senator Donnelly ....................................................................................... 184 ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD Monetary Policy Report to the Congress dated July 15, 2015 ............................. 186 (III) VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON FEDERAL RESERVE’S SECOND MONETARY POLICY REPORT FOR 2015 THURSDAY, JULY 16, 2015 U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. The Committee met at 2:32 p.m., in room SD–538, Dirksen Sen- ate Office Building, Hon. Richard Shelby, Chairman of the Com- mittee, presiding. OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY Chairman SHELBY. The Committee will come to order. Today we will receive testimony from Federal Reserve Chair Janet Yellen. These semiannual hearings are an important part of the Committee’s oversight of the Fed and are among the few oppor- tunities that we have for public discussion with the Chair of the Federal Reserve. The Fed, as we all know, plays an important role in the overall economy, both in managing the supply of money and monitoring the health of the financial system. Through its quantitative easing and other special programs, the Fed’s balance sheet has expanded to an unprecedented size of $4.5 trillion. To put it in perspective, nearly 20 percent of all Treasury securi- ties—20 percent—are held on the Fed’s balance sheet. Further- more, rather than using the proceeds from matured mortgage- backed securities to reduce its balance sheet, the Federal Reserve continues to reinvest these proceeds into even more mortgage- backed securities. In addition, the Federal Reserve continues to hold down interest rates despite potential adverse effects on the U.S. economy, includ- ing the negative impact on household savings. Past announcements by the Federal Open Market Committee have stated that it would adjust its interest rate policy once unem- ployment fell to 5.6 percent. The Fed’s estimates, however, show an unemployment rate of 5.3 percent or lower for 2015, and yet inter- est rates remain unchanged. The Monetary Policy Report released yesterday states that the Fed will keep rates low, even though ‘‘the unemployment rate [will soon] be at or below its longer-run normal level’’—whatever that means. This is concerning to a lot of people because pushing the economy beyond its normal level can have negative effects, as we have seen with economic bubbles in recent history. (1) VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 2 More than ever, the financial markets have become heavily de- pendent on the Fed’s monetary policy decisions, which makes transparency I believe even more important. The Fed is often described by its own officials as the world’s most transparent central bank—or at least one of the most transparent. But it is worth noting that in several respects, Federal Open Mar- ket Committee monetary policy decisions are less transparent than at other central banks, including the European Central Bank and the Bank of England. For example, the Bank of England has more annual meetings and a shorter delay in publishing its minutes than the Federal Re- serve, and both banks issue more monetary reports per year. In ad- dition, the European Central Bank has twice the number of press conferences. So it seems that some aspects of the Fed’s trans- parency can be improved. Similar concerns exist regarding the Fed’s regulatory authority. The Federal Reserve’s Dodd-Frank and CCAR stress tests deter- mine the fate of U.S. banks, but the Fed does not reveal exactly how the banks will be tested or in what ways they have fallen short. Similarly, many banks have been forced to file and refile their living wills without a thorough explanation from the Fed on why the submissions failed. I believe the Federal Reserve must provide more complete explanations of its actions in order for the financial system and the U.S. economy to function effectively. Chair Yellen, we look forward to your testimony here today and your appearance and hope that you will be able to shed more light on some of the questions I have raised. Senator Brown. STATEMENT OF SENATOR SHERROD BROWN Senator BROWN. Thank you, Mr. Chairman, and welcome back to the Committee, Chair Yellen. Nice to see you again. Five years ago next week, July 21st, the Wall Street Reform Act became law. That anniversary serves as an important and ever present reminder of the costs of the financial crisis. The costs of the crisis were 9 million jobs lost, an unemployment rate that reached 10 percent, 5 million Americans who lost their homes, $13 trillion in household wealth erased. In Ohio alone, unemployment was over 10 percent, and half a million homes were foreclosed upon between 2006 and 2011. My wife and I live in Zip code 44105 in the city of Cleveland. In 2007, I believe, that Zip code had the highest number of foreclosures of any Zip code in the United States. My State suffered 14 years in a row of one foreclosure—my entire State, foreclosures more one year to the next year, every year an increased number of fore- closures for 14 years. As the Chair of the Federal Reserve, Ms. Janet Yellen, has said, the unemployed are more than just statistics. Behind each job loss, behind each foreclosure were painful conversations, parents telling their children they are going to have to share a house with their relatives, leaving their neighborhoods, schools, and friends, or that they could no longer afford their child’s education. Think what that would be like. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 3 The crisis took a devastating financial and psychological toll on a generation of workers and their families. We cannot forget that is why we passed the Wall Street reform law. Today’s hearing is a reminder how far we have come in 5 years. After unprecedented actions by the Government to stabilize the economy and the creation of a new regulatory framework to main- tain financial stability and protect consumers, the private sector has created almost 13 million new jobs; household wealth has grown by some $30 trillion, exceeding precrisis levels; and business lending has climbed over 30 percent. This hearing is also a reminder of how important it is that our financial system remains well regulated for financial stability, for consumer protection, and to prevent the next crisis. No one wants to return to the days of 2008 and 2009. Yet opponents of Wall Street reform continue to say that the law has not stabilized the economy and even that new regulations will cause—will bring on the next financial crisis. Wall Street reform did not ruin the economy. Wall Street gambling did, along with the failure of regulators to take away the punch bowl. Since Wall Street reform’s passage, the economy has strength- ened. We have made it less likely taxpayers will get stuck with a tab for another bailout. Polling released last week shows that Americans agree with that assessment. They overwhelmingly sup- port strong financial rules. Some of the behavior in the economy is the product of the ex- traordinary interest rate environment of the past 7 years. So it is no surprise that all eyes are on the Fed as it considers its first in- terest rate increase since 2008. There are real risks in tightening monetary policy too soon because although the economy has made progress since the crisis, we still have a ways to go. The recovery has been uneven. There are many groups of Ameri- cans who have not benefited from it. Premature rate increases could mean these people do not see new jobs, wage increases, or have access to credit. The current economic problems in Greece and China also remind us that any progress that our economy makes cannot be divorced from what is happening overseas. Our manufac- turers and our exporters are already contending with a very strong dollar. Chair Yellen, I look forward to your assessment of our Nation’s economy as well as your appraisal of the progress made from the enactment and the implementation of Wall Street reform. Thank you again for joining us. Chairman SHELBY. Madam Chair, welcome again to the Com- mittee. Your written statement will be made part of the record in its totality. You proceed as you wish. STATEMENT OF JANET L. YELLEN, CHAIR, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Ms. YELLEN. Thank you. 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. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 4 Since my appearance before this Committee in February, the economy has made further progress toward the Federal Reserve’s objective of maximum employment, while inflation has continued to run below the level that the Federal Open Market Committee judges to be most consistent over the longer run with the Federal Reserve’s statutory mandate to promote maximum employment and price stability. In the labor market, the unemployment rate now stands at 5.3 percent, slightly below its level at the end of last year and down more than 41⁄ 2 percentage points from its 10-percent peak in late 2009. Meanwhile, monthly gains in nonfarm payroll employment averaged about 210,000 over the first half of this year, somewhat less than the robust 260,000 average seen in 2014 but still suffi- cient to bring the total increase in employment since its trough to more than 12 million jobs. Other measures of job market health are also trending in the right direction, with noticeable declines over the past year in the number of people suffering long-term unemployment and in the numbers working part time who would prefer full-time employ- ment. However, these measures—as well as the unemployment rate—continue to indicate that there is still some slack in labor markets. For example, too many people are not searching for a job but would likely do so if the labor market was stronger. And al- though there are tentative signs that wage growth has picked up, it continues to be relatively subdued, consistent with other indica- tions of slack. Thus, while labor market conditions have improved substantially, they are, in the FOMC’s judgment, not yet consistent with maximum employment. Even as the labor market was improving, domestic spending and production softened notably during the first half of this year. Real GDP is now estimated to have been little changed in the first quar- ter after having risen at an average annual rate of 31⁄ 2 percent over the second half of last year, and industrial production has declined a bit, on balance, since the turn of the year. While these develop- ments bear watching, some of this sluggishness seems to be the re- sult of transitory factors, including unusually severe winter weath- er, labor disruptions at West Coast ports, and statistical noise. The available data suggest a moderate pace of GDP growth in the sec- ond quarter as these influences dissipate. Notably, consumer spending has picked up, and sales of motor vehicles in May and June were strong, suggesting that many households have both the wherewithal and the confidence to purchase big-ticket items. In ad- dition, homebuilding has picked up somewhat lately, although the demand for housing is still being restrained by limited availability of mortgage loans to many potential homebuyers. Business invest- ment has been soft this year, partly reflecting the plunge in oil drilling. And net exports are being held down by weak economic growth in several of our major trading partners and the apprecia- tion of the dollar. Looking forward, prospects are favorable for further improve- ment in the U.S. labor market and the economy more broadly. Low oil prices and ongoing employment gains should continue to bolster consumer spending, financial conditions generally remain sup- portive of growth, and the highly accommodative monetary policies VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 5 abroad should work to strengthen global growth. In addition, some of the headwinds restraining economic growth, including the effects of dollar appreciation on net exports and the effect of lower oil prices on capital spending, should diminish over time. As a result, the FOMC expects U.S. GDP growth to strengthen over the re- mainder of this year and the unemployment rate to decline gradu- ally. As always, however, there are some uncertainties in the eco- nomic outlook. Foreign developments, in particular, pose some risks to U.S. growth. Most notably, although the recovery in the euro area appears to have gained a firmer footing, the situation in Greece remains difficult. And China continues to grapple with the challenges posed by high debt, weak property markets, and volatile financial conditions. But economic growth abroad could also pick up more quickly than observers generally anticipate, providing addi- tional support for U.S. economic activity. The U.S. economy also might snap back more quickly as the transitory influences holding down first-half growth fade and the boost to consumer spending from low oil prices shows through more definitively. As I noted earlier, inflation continues to run below the Commit- tee’s 2-percent objective, with the personal consumption expendi- tures, or PCE, price index up only 1⁄ 4 percent over the 12 months ending in May and the core index, which excludes the volatile food and energy components, up only 11⁄ 4 percent over the same period. To a significant extent, the recent low readings on total PCE infla- tion reflect influences that are likely to be transitory, particularly the earlier steep declines in oil prices and in the prices of non-en- ergy imported goods. Indeed, energy prices appear to have sta- bilized recently. Although monthly inflation readings have firmed lately, the 12- month change in the PCE price index is likely to remain near its recent low level in the near term. My colleagues and I continue to expect that as the effects of these transitory factors dissipate and as the labor market improves further, inflation will move gradually back toward our 2-percent objective over the medium term. Mar- ket-based measures of inflation compensation remain low—al- though they have risen some from their levels earlier this year— and survey-based measures of longer-term inflation expectations have remained stable. The Committee will continue to monitor in- flation developments carefully. Regarding monetary policy, the FOMC conducts policy to pro- mote maximum employment and price stability, as required by our statutory mandate from the Congress. Given the economic situation that I just described, the Committee has judged that a high degree of monetary policy accommodation remains appropriate. Consistent with that assessment, we have continued to maintain the target range for the Federal funds rate at 0 to 1⁄ 4 percent and have kept the Federal Reserve’s holdings of longer-term securities at their current elevated level to help maintain accommodative financial conditions. In its most recent statement, the FOMC again noted that it judged it would be appropriate to raise the target range for the Federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 6 back to its 2-percent objective over the medium term. The Com- mittee will determine the timing of the initial increase in the Fed- eral funds rate on a meeting-by-meeting basis, depending on its as- sessment of realized and expected progress toward its objectives of maximum employment and 2-percent inflation. If the economy evolves as we expect, economic conditions likely would make it ap- propriate at some point this year to raise the Federal funds rate target, thereby beginning to normalize the stance of monetary pol- icy. Indeed, most participants in June projected that an increase in the Federal funds target range would likely become appropriate be- fore year-end. But let me emphasize again that these are projec- tions based on the anticipated path of the economy, not statements of intent to raise rates at any particular time. A decision by the Committee to raise its target range for the Fed- eral funds rate will signal how much progress the economy has made in healing from the trauma of the financial crisis. That said, the importance of the initial step to raise the Federal funds rate target should not be overemphasized. What matters for financial conditions and the broader economy is the entire expected path of interest rates, not any particular move, including the initial in- crease, in the Federal funds rate. Indeed, the stance of monetary policy will likely remain highly accommodative for quite some time after the first increase in the Federal funds rate in order to support continued progress toward our objectives of maximum employment and 2-percent inflation. In the projections prepared for our June meeting, most FOMC participants anticipated that economic condi- tions would evolve over time in a way that will warrant gradual increases in the Federal funds rate as the headwinds that still re- strain real activity continue to diminish and inflation rises. Of course, if the expansion proves to be more vigorous than currently anticipated and inflation moves higher than expected, then the ap- propriate path would likely follow a higher and steeper trajectory; conversely, if conditions were to prove weaker, then the appro- priate trajectory would be lower and less steep than currently pro- jected. As always, we will regularly reassess what level of the Fed- eral funds rate is consistent with achieving and maintaining the Committee’s dual mandate. I would also like to note that the Federal Reserve has continued to refine its operational plans pertaining to the deployment of our various policy tools when the Committee judges it appropriate to begin normalizing the stance of policy. Last fall, the Committee issued a detailed statement concerning its plans for policy normal- ization and, over the past few months, we have announced a num- ber of additional details regarding the approach the Committee in- tends to use when it decides to raise the target range for the Fed- eral funds rate. These statements pertaining to policy normalization constitute recent examples of the many steps the Federal Reserve has taken over the years to improve our public communications concerning monetary policy. As this Committee well knows, the Board has for many years delivered an extensive report on monetary policy and economic developments at its semiannual hearings such as this one. And the FOMC has long announced its monetary policy deci- sions by issuing statements shortly after its meetings, followed by VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 7 minutes of its meetings with a full account of policy discussions and, with an appropriate lag, complete meeting transcripts. Inno- vations in recent years have included quarterly press conferences and the quarterly release of FOMC participants’ projections for eco- nomic growth, unemployment, inflation, and the appropriate path for the Committee’s interest rate target. In addition, the Com- mittee adopted a statement in 2012 concerning its longer-run goals and monetary policy strategy that included a specific 2-percent longer-run objective for inflation and a commitment to follow a bal- anced approach in pursuing our mandated goals. Transparency concerning the Federal Reserve’s conduct of mone- tary policy is desirable because better public understanding en- hances the effectiveness of policy. More important, however, is that transparent communications reflect the Federal Reserve’s commit- ment to accountability within our democratic system of Govern- ment. Our various communications tools are important means of implementing monetary policy and have many technical elements. Each step forward in our communications practices has been taken with the goal of enhancing the effectiveness of monetary policy and avoiding unintended consequences. Effective communication is also crucial to ensuring that the Federal Reserve remains accountable, but measures that affect the ability of policymakers to make deci- sions about monetary policy free of short-term political pressure, in the name of transparency, should be avoided. The Federal Reserve ranks among the most transparent central banks. We publish a summary of our balance sheet every week. Our financial statements are audited annually by an outside audi- tor and made public. Every security we hold is listed on the Web site of the Federal Reserve Bank of New York. And, in conformance with the Dodd-Frank Act, transaction-level data on all of our lend- ing—including the identity of borrowers and the amounts bor- rowed—are published with a 2-year lag. Efforts to further increase transparency, no matter how well intentioned, must avoid unin- tended consequences that could undermine the Federal Reserve’s ability to make policy in the long-run best interest of American families and businesses. In sum, since the February 2015 Monetary Policy Report, we have seen, despite the soft patch in economic activity in the first quarter, that the labor market has continued to show progress to- ward our objective of maximum employment. Inflation has contin- ued to run below our longer-run objective, but we believe transitory factors have played a major role. We continue to anticipate that it will be appropriate to raise the target range for the Federal funds rate when the Committee has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2-percent objective over the medium term. As always, the Federal Reserve remains committed to employing its tools to best promote the attainment of its dual mandate. Thank you, and I would be pleased to take your questions. Chairman SHELBY. Thank you, Madam Chair. Madam Chair, recently some of us have raised concerns over a proposal to reduce the statutory dividend paid to member banks on the shares that they hold in their respective reserve banks to help VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 8 pay for a new transportation bill. Are you aware of some of these proposals? And do you have some concerns? Ms. YELLEN. Chair Shelby, I have heard about this proposal, and I guess I would say I would be concerned that reducing the divi- dend could have unintended consequences for banks’ willingness to be part of the Federal Reserve System, and this might particularly apply to smaller institutions. I would also say that this is a change that likely would be a sig- nificant concern to the many small banks that receive this divi- dend. So I suppose I would say that this is a change to the law that could conceivably have unintended consequences, and I think it de- serves some serious thought and analysis. Chairman SHELBY. I agree with you, and I do not see any nexus between the dividends coming from members of the Federal Re- serve System, which are a lot of small- and medium-size banks, and funding the highway or transportation system. I think that is a pretty far reach, but, you know, people look for money every- where they can get it. But that is something that I think we better be working together on, I hope. In another area, the impact of regulation on liquidity, the issue of liquidity in the fixed-income market has become a daily topic in the news and in the markets. Last month, Secretary Lew testified in the U.S. House that he does not—and I will quote him, he ‘‘does not believe that Federal regulation is a significant factor contrib- uting to any liquidity issues.’’ It is interesting. So you think that Federal regulation is a significant factor im- pacting market liquidity in any respect? And what work has the Federal Reserve done to determine the impact of regulation on li- quidity, if you have, in our markets? Ms. YELLEN. So I would say that we are studying this issue very carefully. We have certainly heard the market concerns on this topic. At this point I can give you a list of factors that may be caus- ing this phenomenon. Chairman SHELBY. OK. Ms. YELLEN. I should say you see this decline in liquidity in some measures but not in others. So the extent of the decline—— Chairman SHELBY. But isn’t the decline in liquidity an important issue to be watching? Ms. YELLEN. So there are a number of things that might be in- volved. First of all, there have been changes in the structure of the market. A larger share of bonds are held by buy-and-hold investors such as insurers and pension funds that may do less trading than leveraged firms that used to be more dominant in this market. We have had higher capital requirements and other regulatory changes, but firms are also changing their own risk management practices, in some cases in a more conservative direction. We have seen an increase in algorithmic and high-frequency trading, and that may be leading to changes in market trading practices. In addition, in the corporate bond market, there have been increased reporting requirements that may be reducing the desired sizes of trades. And I think all of these factors could poten- tially account for what is going on, but we have not really yet been VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 9 able to figure out what the contribution of each is or just how seri- ous. I think a concern is that while day-to-day in normal times most measures of liquidity seem to be roughly unchanged, there is a con- cern that in stress situations it may be, and we have seen some cases where it is less available. Chairman SHELBY. But in any market, you need risk and you need liquidity, do you not? Ms. YELLEN. Yes, you—— Chairman SHELBY. You do not have a market without it, do you? Ms. YELLEN. Well, we do need liquidity in markets. There may be changes, however, that precrisis it was leveraged, even highly leveraged banks that were exposed to providing liquidity and vul- nerable if liquidity were to be reduced. And now it seems like more of that risk has moved to unleveraged, low-leveraged investors, and that may be a safer situation. So there are two sides, I think, to this. Chairman SHELBY. In the area of reducing systemic risk, which we all are interested in, do you believe that having fewer system- ically risky financial institutions would be a good thing? Ms. YELLEN. Arguably, yes. Chairman SHELBY. OK. And should banks through regulation, like the Fed, be encouraged to reduce systemic risk everywhere they can? Ms. YELLEN. Well, we are certainly trying to put in place a set of incentives that will reduce the systemic footprint and risk of firms. I think higher capital requirements, we plan to impose sur- charges, capital surcharges on the most systemic firms, and other regulations that will diminish the risks, create incentives for their footprints to be reduced in ways that will reduce their systemic risk to the financial system. Chairman SHELBY. Senator Brown. Senator BROWN. Thank you, Mr. Chairman. Madam Chair, I continue to be concerned, as I know you are, that the economic recovery has not taken hold for all Americans, notably large numbers of women and in communities of color. I know that confirmation bias can be a problem in investing, and some might think it is a bit—it might exist on Capitol Hill, too, but I see lots of evidence of underemployment, unemployment, virtually no evidence of inflation, and lots of sources of headwinds for our economy. What are the risks of tightening monetary policy too soon? And once rates are increased, what would be the impact of the gradual rate increases on working Americans? Ms. YELLEN. So, of course, there are risks to the recovery of tightening too soon, and we have been highly focused on those risks. That is an important reason why we have left rates as low as they are for as long as they have been. Over 6 years they have been at effectively zero. We have had a recovery that has been slow to take hold. Growth has been slower than in most U.S. recoveries following a severe fi- nancial crisis. We have clearly made progress. I agree with you that there remain groups that are struggling in the labor market, and as we try to show in the Monetary Policy Report, arguably the VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 10 standard unemployment rate that we look at that is 5.3 percent may somewhat understate the real degree of slack that exists in the labor market. So we clearly want to see continued improvement in the labor market, and we want to do nothing that would threat- en that. On the other hand, the labor market is getting demonstrably closer, in my view, by almost any metric to a more normal state, and the degree of monetary accommodation has been sufficient over a long period of time to generate pretty significant improvement in the labor market. And as the headwinds that are holding the econ- omy diminish—and I believe they are diminishing—I think it does become appropriate to begin—we are not talking about tightening monetary policy. I think we are talking about slightly diminishing the very high degree of accommodation that we have in place. And, of course, we would not want to do so in a way or at a pace that would threaten continued progress in the labor market. At the same time, inflation is very low, and while we have indi- cated that a good share of that is for reasons we believe will be transitory and we expect inflation—headline inflation to rise to much closer to core levels, that is another reason why we can be patient in removing accommodation. But I think it is also impor- tant there are risks on both sides. Just as we do not want to tight- en too soon to threaten the recovery or to jeopardize the return of inflation back to our 2-percent target, we also want to be careful not to tighten too late because, if we do that, arguably we could overshoot both of our goals and be faced with a situation where we would then need to tighten monetary policy in a very sharp way that could be disruptive. My own preference would be to be able to proceed to tighten in a prudent and gradual manner, and there are many reasons why I would like to be able to do that. So I agree that there are cer- tainly risks to the recovery and to the labor market of tightening too soon, but there are risks on the other side as well. We are try- ing to balance those. Senator BROWN. Thank you. Some people have suggested re- cently that American workers need to be willing to work longer hours. I do not think many Americans work fewer hours by choice unless, of course, there are health issues or child care limitations or other responsibilities. I think most or at least many Americans working part time would like to work full time. This slack in the labor market seems to indicate we still have a ways to go. Discuss with us your concern about the number of workers who are only working part time but would like to be more in the labor force, if you would. Ms. YELLEN. Yes. Well, we have an unusually large share of the labor force—I believe it is around 4.5 percent—that report them- selves as working part time for economic reasons. That means they would like to be working more hours than they are able to work. And broader measures, the measure of the unemployment rate that we normally look at, it is referred to as the U–3 measure, that is 5.3 percent. But broader measures that capture that part time for economic reasons, a measure like U–6, we have a picture in the Monetary Policy Report, and we show how high that is. And we show that although, of course, it is always higher than the nar- VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 11 rower concept of unemployment, it is very much higher than you would expect historically given the narrower measure of unemploy- ment. So to my mind, this really suggests that our standard unemploy- ment rate does understate the degree of slack we still have in the labor market. Senator BROWN. Thank you. Thank you, Mr. Chairman. Chairman SHELBY. Senator Corker. Senator CORKER. Thank you, Mr. Chairman, Ranking Member. I appreciate it. Madam Chairman, thank you for being here. I spent a lot of time with you when you were getting ready to be confirmed, and I en- joyed that, and I appreciated talking about views on monetary pol- icy. And this is a not a pejorative statement, but I know as you were coming in, you were acclaimed to be the first ‘‘dove’’ coming in as head of the Federal Reserve. I know we had numbers of con- versations about that, and I know you supported all of the rate hikes, on the other hand, that took place as we were leading up. Ms. YELLEN. That is true. Senator CORKER. So I want to make sure everybody understands that. Ms. YELLEN. Thank you. Senator CORKER. But we did talk a lot about this moment in time we are in, and it seems that many are getting—let me put it this way—the impression, many who are spending their daily lives dealing with the stock market, that the Fed has become very af- fected by the market swings, and that much of that may actually be driving monetary policy, not just the stats. You know, we have had—this is the first—I guess we have had two other times in mod- ern history where we have had negative interest rates, or at least times that I am aware of, from 1974 to 1976, and 2002 to 2004. And so we have had this long period of time where, in essence, we have negative interest rates, and yet it seems the Fed continues to watch not just the stats, but is very affected by the markets and worried about disruptions in the stock market. I am wondering if you might address that. Ms. YELLEN. So I would push back against the notion that we are unduly affected by the ups and downs of the stock market. We are certainly very focused on the fundamentals and the economic sta- tistics that describe where the economy is and in terms of the labor market and inflation, which are the two goals assigned to us by Congress, and a lot of different kinds of economic information go into the forecasts that drive our decision making, our forecasts about where the labor market and inflation will be moving. But fi- nancial conditions broadly—and I am not talking about the stock market here uniquely, but a wide range of financial variables that I would say go into assessing financial conditions, the ease for households and businesses of borrowing that affect their spending patterns, whether it is consumer spending or investment or our ability, our competitive position in the global economy that affects our ability to export and the competitiveness of import competing goods. The state of financial, conditions broadly speaking, is one variable that does affect our forecast of the economy. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 12 So we cannot completely ignore what is happening in the mar- kets to housing prices, to equity prices, to longer-term interest rates, to credit spreads that influence borrowing costs, to the ex- change that affects the competitiveness of U.S. goods and services. All those factors feed into financial conditions, and they are rel- evant to forecasting the economy. So it is one element of our eval- uation, but I do not think we pay undue attention to it, and I do not think we should. Senator CORKER. Yes, I agree. Thank you. The living will process is something that—I know the Ranking Member alluded to Dodd-Frank, and Senator Warner and myself were assigned to work on those particular areas, Title 1 and Title 2, came to an agreement, and actually Senator Shelby, I think, of- fered an amendment on the floor that passed by 95 votes to make it even stronger, if I remember correctly. Or at least alter it to some degree, but certainly make sure it became law. We have had some questions about the living wills as they have come up. The last round, there was a little bit of concern, at least on my part and I think a few others, that there was a little regu- latory capture taking place, that really these living wills were way lacking in substance, and yet maybe the Fed really was not, you know, putting the pressure on these organizations to deliver as they should. I had a good meeting this week with Mr. Tarullo, and my under- standing is the substance of these living wills—I know you all have sent out some statements regarding what has happened. I think they are much better than they have been. But it is pretty clear these living wills have to be able to resolve an institution under bankruptcy, and I just wonder if you might speak to that for a mo- ment. Ms. YELLEN. I agree with you. We worked closely with the FDIC in this last round a year ago to set out a clear set of expectations for what we want to see in the current round of submissions. We have worked closely with the FDIC and the banking organizations to make sure that they have been very clear about what we expect in this round of submissions. We have instructed them to enhance their disclosure in the public part of the documents that they produce, and it looks like preliminary reads suggest they have made progress there, and we are going to be evaluating them in the coming months, and we indicated that if we continued to see shortcomings in the living wills, we will use our authority to deter- mine that these resolution plans do not meet Dodd-Frank require- ments. And that is where we stand, and that is what we are going to do. Senator CORKER. Thank you very much for your service. I appre- ciate it. Ms. YELLEN. Thank you. Senator CORKER. Thank you, Chairman. Chairman SHELBY. Senator Menendez. Senator MENENDEZ. Thank you, Mr. Chairman. Madam Chair, thank you for your service to our country. I appre- ciate the work you have been doing. Ms. YELLEN. Thank you. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 13 Senator MENENDEZ. As you know and have stated many times, the Fed’s dual mandate directs it to pursue maximum employment and stable prices. Now, how the Fed chooses to balance these goals has significant consequences for the quality of life of millions of Americans. On the first element, our labor market is improving, but most Americans feel like they have a lot of catching up to do from the deep hole the financial crisis put us in. They do not feel that their personal circumstances have certainly risen at all, and they feel enormous challenges. Meanwhile, inflation continues to run well below target, as it has for an extended period of time, so it would be a mistake in my view for the Fed to shift its focus away from jobs at this critical time. With interest rates near zero, the Fed has essentially no room for error if it tightens too soon. If it tightens too late, I think the risks are much lower, and the Fed has plenty of ammunition to keep in- flation anchored. So as a follow-up to Senator Brown’s question, I would like to know, in order to avoid choking off economic growth prematurely, will the Fed wait to raise interest rates until after it has seen signs of actual inflation rather than based on some intangible fear of fu- ture inflation, which may or may not ever actually materialize? Ms. YELLEN. So, Senator, I agree with your characterization of the risks that if there is a negative shock to the economy within interest rates pinned at zero, we do not have great scope to respond by loosening policy further; whereas, with a positive shock, of course, we can tighten monetary policy. We have the tools, and we know how to do that. That is a consideration that has been weigh- ing on our decision making for quite some time and has led us in part to hold interest rates at these very low levels for as long as we have. So that has been a factor we have been taking into account, and it partly explains the policy that we have been following. But there are lags in the effect of monetary policy. We need to be forward- looking. And on the other side, there are risks from waiting too long to act as well. We have to balance those risks. You asked me if we would likely raise rates before inflation has risen substantially, and there I would point you to Section 3 of the report that we gave to you where we show each summary of their forecast for the economy and for policy. And as I mentioned in my testimony, most participants, as of our June meeting, envisioned that economic developments would proceed in a way for the rest of this year that would, in their view for almost all of them, make it appropriate to begin the process of normalizing policy sometime this year. And if you look at their inflation forecasts, at the end of the year, on a year-over-year basis, most participants envisioned that total inflation would be running a little bit under 1 percent, so that is well below our 2-percent objective. And they envisioned core infla- tion, that is, for the year as a whole, at the end of 2015 as running in the neighborhood of 1.3 to 1.4 percent. So in that sense, you can see in their projections that they are envisioning its being appro- priate to begin tightening policy within inflation below our objec- tive. But what we have said is we want to have reasonable con- VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 14 fidence before we tighten that inflation over the medium term will move back to 2 percent. And what is going on here is that we think that there are transitory influences—namely, the marked decline in oil prices and the strengthening of the dollar—that are holding inflation down, and that underlying inflation, even with core infla- tion, that low import prices and declining import prices are a tran- sitory factor holding that down, that as we see the labor market improve and these transitory influences wash out, that we believe that inflation will move back to 2 percent. And so if we have that confidence, the Committee would be likely to begin before seeing inflation go back up to our target. Senator MENENDEZ. Now, normally in my experience here I would have interrupted you a long time ago because my time has expired. But because your response was so interesting and I am trying to grasp where your policy view is from it, I let it go. Let me, if I may, just make one very brief comment, Mr. Chair- man, and that is, from my—I listened to you intently. From my perspective, I think it is much less of a problem that inflation may run high a little bit—I did not say significant inflation, which you referenced—to run high for a little bit, for a short period of time until the Fed’s response to it takes effect than the alternative, which is cutting off much needed job growth and income growth, too, which would have been my second question, but I will submit that for the record. Ms. YELLEN. We do not want to cutoff job growth and income growth, and we do want to see inflation move up to 2 percent. We would not be pleased to see it linger indefinitely below 2 percent. Senator MENENDEZ. Thank you, Mr. Chairman. Chairman SHELBY. Senator Rounds. Senator ROUNDS. Thank you, Mr. Chairman. Madam Chair, recently the Senate Banking Committee held a hearing that examined the role of the Financial Stability Board in the U.S. regulatory framework. A lot of concern was expressed about international decision making on regulation overtaking U.S. decision making. I am just curious if you would agree that it is im- portant for the United States to set its own insurance capital and other regulatory standards before agreeing to any such standards internationally. Ms. YELLEN. Well, we are working on U.S. standards. Nothing applies to U.S. firms until we have gone through a formal rule- making process or process with orders in the United States. So no international discussion or agreement applies to U.S. firms unless they are consistent with U.S. law and we have gone through a full- blown rulemaking process. But discussions are taking place internationally about appro- priate standards. I think it is very important that we weigh in on those discussions so that the standards that other countries adopt work for our markets and for our firms, and that we end up with a playing field that is competitive for our own firms to compete in. So we participate in those international discussions, but within an understanding that nothing applies to U.S. firms until we have gone through a full rulemaking process here. Senator ROUNDS. Thank you. I would like to follow up just a lit- tle bit on what the Chairman was visiting with earlier, and that VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 15 is with regard to SIFI designations, literally in the spirit of reduc- ing systemic risk. Do you support giving designated firms a specific road map for de-designation, like an off ramp or an approach that would allow them to basically de-certify? Ms. YELLEN. So I think firms should have the ability to de-cer- tify, and the FSOC every year has to review designations to make sure that they remain appropriate. That is an annual procedure. Now, firms are given very detailed information and interact a great deal with FSOC during the process of designation, and they understand very clearly what it is about their business model and strategy that has caused them to be designated. So it is not a mys- tery to those firms what about their business activities is respon- sible for designation. I do not think it is appropriate for FSOC or for the regulators to try to run these businesses, to try to micromanage what these firms do. I do not think there is any single, appropriate off ramp. We should not be telling them exactly do the following list of things. They understand what they need to do to change their pro- file in a way that would change FSOC’s evaluation. And if they were seriously contemplating making those kinds of substantial changes, I am sure there would be many opportunities to interact with FSOC and staff to gain some perspective on whether or not the kinds of changes they were thinking of would significantly change their systemic footprint. Senator ROUNDS. Thank you. One last question. As you know, Madam Chair, when you talk, the markets clearly listen. As you work with the Federal Reserve’s Open Markets Committee, you look at a balanced approach, and you are looking at several goals. You have clearly defined that your goal is a 2-percent inflation rate. What about when we talk about maximum employment? Where do we go, and what do you lay out as the firms look at it in terms of what to expect from the Com- mittee? What is your goal in terms of the maximum employment? Ms. YELLEN. So as we say in our statement of longer-run goals and monetary policy strategies, there is something different about the two goals. We have a goal for inflation, 2 percent, and max- imum employment. A central bank can choose or determine what its inflation target should be. We chose 2 percent. We are in good company. That is what most advanced central banks have chosen. Maximum employment is different. We cannot just decide what do we want that to be in the long run. We think there is some nor- mal longer-run rate of unemployment or level of maximum employ- ment that is consistent with stable inflation, and for us it is not something we can say we would like it to be this or we would like it to be that. It is something we are trying to determine. It can change over time. It is not easy to know exactly what is possible given technology and demographics and the way the institutions of the labor market function. So we are trying to estimate it, not de- termine it. But participants in the Committee are asked every 3 months, when they submit their forecasts, to write down their own current views on the unemployment rate that corresponds to what they re- gard as normal in the longer run or consistent with maximum em- ployment. And most members of our Committee or participants VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 16 currently regard that as an unemployment rate in the neighbor- hood of 5.2 to 5.3. And that is something that can change over time. It has changed over time, and we report that publicly. Senator ROUNDS. Thank you. Thank you, Mr. Chairman. Chairman SHELBY. Thank you, Senator Rounds. Senator Donnelly. Senator DONNELLY. Thank you, Mr. Chairman, and thank you, Madam Chair. Madam Chair, I know you share my concerns with income in- equality and the continuing trend of middle-class wage stagnation. In your testimony, you said, ‘‘ . . . although there are tentative signs that wage growth has picked up, it continues to be relatively subdued . . . .’’ So as the economy improves, how do you expect middle-class wages to show substantial improvement? What are you looking at? Ms. YELLEN. Well, we look at several different measures of wage growth. Three aggregate measures that we look at are the Employ- ment Cost Index, hourly compensation, and average hourly earn- ings. They do not always tell exactly the same story. I think we have seen a meaningful pickup over the last year in the growth in the Employment Cost Index but less movement in the other two measures. So there are early indications or conflicting indications there. The levels of increase are still relatively low, and in real or infla- tion-adjusted terms, compensation or wages are increasing less rap- idly than productivity. Senator DONNELLY. What do you expect to see in the next year—— Ms. YELLEN. I would expect to see—— Senator DONNELLY. ——with regard to middle-class wages? Ms. YELLEN. ——a pickup in—so I am not going to say ‘‘middle- class wages’’ but aggregate wages in the economy. I would expect to see some further upward movement. Where they can go depends in part on productivity growth. For example, if productivity growth—and there is a lot of uncertainty about what it is, but if it were at a trend rate running, say, around 1.5 percent with a 2- percent inflation, we would expect to see wage growth—— Senator DONNELLY. And I guess the key to that is that there would actually be some correlation between productivity growth and the growth in wages as well. Ms. YELLEN. There tends to be over long periods of time, but it is not always true over shorter periods. So there is some uncer- tainty about this, and we have been through a period in which wages have been in real terms—— Senator DONNELLY. We have not seen a closer link—— Ms. YELLEN. ——growing less rapidly than productivity. I would expect to see a pickup. It is not a certainty here, but it is—and to my mind, it is evidence of some remaining slack in the labor mar- ket. So that is—my forecast is that we will see some pickup in wage growth. But it is important to remember that there has been increasing wage inequality in the United States over a long period of time, certainly going back to the mid-to-late 1970s, and that reflects a VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 17 deeper set of structural factors that the Federal Reserve does not have tools to combat. What we are looking for is an overall job market that is functioning in some sense well, but we see increas- ing gaps between the wages or compensation of more skilled and less skilled workers, and that has been holding down middle-class wage growth for a long time for other reasons. Senator DONNELLY. Let me ask you about a little bit different subject. You know, I voted for Dodd-Frank because I wanted to see safety and stability in the system. It was not a desire to load it up with regulations, but it was a desire to make sure we had safety and stability. But now what we have seen is a growing shadow banking system, which brings other concerns, and so as you look at this, since shadow banking entities are not subject to the same regulatory oversight, how concerned should we be with the poten- tial risk involved here? Because that is what we are trying to drive at in the first place with Dodd-Frank, was to eliminate some of the systemic risk. Ms. YELLEN. Well, I think you have put your finger on a very im- portant phenomenon, and we were well aware when we put these regulations in place in Dodd-Frank that wherever you draw the regulatory perimeter, there will be a tendency for activity to mi- grate beyond it to what we call ‘‘the shadow banking system.’’ So we clearly need to be very vigilant about monitoring risks that are migrating to that system, and certainly in the Federal Reserve, we have hugely ramped up our attention to the shadow banking sys- tem. The FSOC is focused on risks developing broadly through the fi- nancial system in shadow banking, and the Financial Stability Board has a large work program devoted to shadow banking. We are thinking about regulations that might address—like minimum margin requirements that would apply not only to banking organi- zations but more broadly, that might address some potential risks in the shadow banking system. Of course, we have seen some heightened attention to risks by the SEC in money market funds, which was an important piece of the shadow banking system where risks developed leading to the crisis. But you are absolutely right to focus on that, and we are at- tempting to address those risks as best we can. Senator DONNELLY. Thank you, Madam Chair. Thank you, Mr. Chairman. Chairman SHELBY. Senator Scott. Senator SCOTT. Thank you, Mr. Chairman. Chair Yellen, thank you for being here today. Ms. YELLEN. Thank you. Senator SCOTT. As I travel across South Carolina, people express concerns about America leading from behind, whether my conversa- tions with folks have been about the Administration’s failure to en- force their own red lines in Syria or more recently about the ill- advised nuclear deal with Iran, South Carolinians have the sense that our Nation is timid, that it is comfortable sitting back and taking cues from foreign actors rather than occupying our tradi- tional role a leader of the world. Now, I am certainly not suggesting that you somehow are in charge of military policy or Middle East diplomacy, but you are in VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 18 charge of our regulatory policy for some of our country’s most suc- cessful businesses. And sometimes it seems to me like our U.S. reg- ulators are leading from behind, especially when it comes to our in- volvement in international regulatory bodies like the Financial Sta- bility Board or the International Association of Insurance Super- visors. For example, the FSOC designated domestic insurers as SIFIs shortly after the FSB did, suggesting that the FSOC was happy to follow FSB’s lead. We saw something very similar happen with capital buffers for money market mutual funds. The FSOC and SEC seemed to take their cues from the FSB. Madam Chair, now that the Fed is writing a capital rule for in- surance companies, I would encourage you to break from the tradi- tion of leading from behind by developing a capital standard that first works for our domestic insurance companies rather than let- ting international standard-setting bodies like the ones I have men- tioned already write rules and export them back to our country. I would also encourage you in your capacity as a member of the IAIS to take the lead in that body in promoting activity-based regu- lations of insurers as the group reconsiders its G–SII designation methodology later this year. It appears that Governor Tarullo has committed the Fed to an activities-based approach for asset man- agers, but I have not yet heard him say that he would do the same for insurers. Can you commit today that the Fed will take the lead and follow these two courses of action both on insurance company capital standards and on promoting the replacement of entity-based regu- lation of insurance with activity-based regulation? I think Senator Rounds really was starting down this road when he was asking his question. It appears to me that the European regulators are con- cerned about the creditor protections. We at home are far more concerned about protecting the policy holders. The difference yields different capital philosophies. I would like a commitment to use our domestic approach and export it as opposed to importing their phil- osophical disposition on capital standards based on creditor protec- tions. Ms. YELLEN. So I guess all I can really say is that we are playing an active role internationally in insurance, which is why we joined the IAIS. We are participating jointly with the Federal Insurance Office and the State Insurance Commissioners. We are collabo- rating to think through what is an appropriate system of capital and liquidity standards for globally active firms. We have a strong interest in doing that, and it is important for us to have our voices heard in that process. So I do not think it is accurate to say we are sitting back and not trying to play a lead- ership role. I think we are. Domestically, we have been given increased flexibility through the Collins fix to design and tailor a set of insurance regulations, capital standards that we think are appropriate for our institu- tions. We want to carefully tailor them to the unique characteris- tics of the firms that we supervise, and we are taking the time and interacting with those firms to make sure we understand what an VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 19 appropriate insurance-centric, well-tailored set of capital standards would look like. Senator SCOTT. Thank you. I think at the end of the day all of the Washington regulators speak and sound pretty academic, but what it ultimately boils down to is a price that Americans will pay for their retirement. One of the things that we are trying to do is make sure that that price goes down and not up as we find our- selves, from my perspective, adopting international standards as opposed to taking ours and exporting them. Thank you. Chairman SHELBY. Senator Warren. Senator WARREN. Thank you, Mr. Chairman, and it is good to see you again, Chair Yellen. I want to follow up on Senator Corker’s question. As you know, Dodd-Frank requires big financial institutions to submit living wills, a plan for how they could be liquidated—and I want to quote the statute here—‘‘in a rapid and orderly fashion’’ in bankruptcy without bringing down the economy or needing a taxpayer bailout. Now, by law, the Fed and the FDIC are supposed to determine whether these plans are credible or not, and then if they are not credible, the agencies can order the institutions either to simplify their structures or eventually to sell off assets. So last August, the Fed and the FDIC identified significant prob- lems with the living wills submitted by 11 of the biggest banks in the country. The FDIC determine that these living wills were not credible. But the Fed did not. Instead, the Fed said that if the banks did not ‘‘take immediate action to improve their resolvability and reflect those improvements’’ in their new living wills, the Fed ‘‘expected’’ to find the new living wills were not credible. Now, the 11 banks submitted their new living wills at the begin- ning of this month, and I know you have not completed reviewing them yet. But I just want to make sure we are really clear on this point. Will the Fed find living wills not credible if the bank has not fixed each of the problems that the agencies identified last August? Ms. YELLEN. We are certainly prepared to make those determina- tions. We will work jointly with the FDIC, as we have been doing, to analyze the living wills and see whether or not we feel that the responses to the directions that we gave to these firms are satisfac- tory or not. And if we find that they are not, we are certainly pre- pared to say that they are not credible. Senator WARREN. OK. Good. I am glad to hear that. Two of the issues the agencies directed the banks to address were ‘‘establishing a rational and less complex legal structure and developing a holding company structure that supports resolv- ability.’’ Now, JPMorgan Chase, just to pick one example, has over 3,000 subsidiaries. It will take a lot of work to establish a rational struc- ture that permits JPMorgan to be resolved quickly as required by law. But to be clear again, the Fed will find JPMorgan’s living will not credible, and the living wills of the other 10 banks not credible, if they have not taken concrete steps to significantly simplify their structures and are not sleek enough to be resolved quickly? Ms. YELLEN. Well, we have given them those directions, and we will evaluate that. I would simply say that the regulatory reports VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 20 that we receive indicate that these firms since 2009 have reduced the number of legal entities in their structures by approximately a fifth. I guess we will be looking for—— Senator WARREN. You will note that number I gave you is not from 2009. It is over 3,000 subsidiaries at latest count that I have seen. So I just want to be clear that you are willing to say not cred- ible if they do not meet the legal standards that they could quickly be resolved, and that includes how complex their structure is. Ms. YELLEN. Well, agreed that they need to be less complex, and we have given them that direction. But I am not sure we can deter- mine exactly how complex they are by just counting the number of legal entities—— Senator WARREN. Fair enough. I am glad to have—— Ms. YELLEN. They are not all—— Senator WARREN. ——lots of ways you look at this. Ms. YELLEN. They are not all equal. Some are set up for very narrow purposes and would not represent serious impediments to resolving the firms. So I do not want to—— Senator WARREN. OK. But—— Ms. YELLEN. ——determine this by count of legal entities. Senator WARREN. Count by itself, I understand that. But we do remember that the statute says ‘‘rapid and orderly liquidation, and that goes to the question of complexity. I raise this because the liv- ing wills are one of the primary tools the Fed has to make sure that taxpayers will not be on the hook if one of these giant banks fails. It is critical that the Fed uses this authority, and like the FDIC has been willing to do, to make our financial system safer. I want to ask you one other question just quickly. In Dodd- Frank, Congress directed the Fed to impose some tougher rules on banks with more than $50 billion in assets. That covers roughly 40 of the biggest banks in the country, about one-half of 1 percent of the 6,500 banks that we have in the U.S. Together, this one-half of 1 percent holds more than $14 trillion in assets, about 95 per- cent of all the banking assets in this country—40 banks, 95 percent of all the assets. The tougher scrutiny is designed to direct regulator attention where serious risk is—in other words, concentrate regulatory scru- tiny on these 40 banks rather than on community banks and credit unions. Now, there have been proposals recently about exempting many of these banks from tougher rules by raising the $50 billion thresh- old to $100 billion, $250 billion, $500 billion. The argument I hear is that $50 billion banks just do not pose systemic risk. So I just want to ask a question on this one. We learned or should have learned in 2008 that in a crisis sev- eral banks can find themselves on the verge of failure at the same time. Do you think it could pose a systemic threat if two or three banks with about $50 billion in assets were on the verge of failure? Ms. YELLEN. Well, when a significant number of firms is at the risk of failure, often it is because they have highly correlated posi- tions. We always have to worry about that resulting in a drying up of credit to the economy, and, you know, during the Great Depres- sion, most of the banks that failed were small. They were a lot smaller than $50 billion or adjusted for that time. So when many VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 21 banks fail, of course, we have to be concerned as well, and that is one reason why for all institutions, even for community banks, Basel III regulatory capital requirements are higher. We want to see safety and soundness throughout the entire financial system, throughout the banking system, although the most systemic firms, as you pointed out, of course, need the greatest scrutiny. Senator WARREN. It is the top 40. So I just want to say there are two approaches to this issue. The first, which every Republican on this Committee supported, is to raise the threshold to $500 bil- lion—that is, cut loose about 30 or so of the biggest banks in this country, and just hope for the best. And if it does not work out, the taxpayers can pick up the tab again. The other approach is to play it safe. Keep the threshold where it is and rely on the Fed to tailor the rules to fit the risks posed by these different banks. That is the approach I support, and since the American taxpayers are on the hook when the economy starts to implode, I suspect most of them would prefer that Congress be careful, too. Thank you, Madam Chair. Thank you, Mr. Chairman. Chairman SHELBY. Madam Chair, some people have proposed that we do not have any threshold. You have seen some of that. But the regulator having the power to do their job properly, you have seen some of that, I am sure. Senator Crapo. Senator CRAPO. Thank you very much, Mr. Chairman, and I want to follow up on exactly the same question that Senator War- ren just finished on. Last September, I asked Federal Reserve Governor Tarullo about legislatively raising the trigger when a bank is systemically impor- tant from the $50 billion level. In hearings, we have heard that the asset threshold should be raised or changed because it is arbitrary, includes institutions that are not systemically important, focuses only on size, and produces undesirable incentives. Governor Tarullo said that several years of testing and assessment have given regu- lators a better understanding of the designation threshold. Given the intensity and complexity of work around stress testing, he said that regulators have not felt that the additional safety and sound- ness benefits of SIFI regulation are really substantial enough to warrant the kinds of compliance and resource expenditures re- quired of banks that are above $50 billion in assets, but well below the largest systemically important institutions. And so I guess my question to you, which is sort of another way of asking the same question that Senator Warren just asked, is: Do you agree with Governor Tarullo’s analysis that there would be a benefit if Congress changed the current threshold and focused more on substantive evaluations of true risk rather than on an arbitrary number? Ms. YELLEN. So like Governor Tarullo, I would be open to a mod- est increase in the threshold. And I guess the reason that I would be open to it is, as he indicated and as you just stated, we do have some smaller institutions that under Section 165 are required to do, for example, supervisory stress testing and resolution planning. And for some of those institutions, it does look from our experience like the costs exceed the benefits. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 22 But if there were to be a modest increase in the threshold, I think what is essential is that the Federal Reserve retain the dis- cretionary to subject an institution that might fall below the new threshold to higher supervisory requires, for example, that we would be able to insist that it perform supervisory stress testing if, in our view, the risk profile of that firm, in spite of its size, led us to believe that it had systemic import that made us think it was appropriate, and that is possible that we might feel we would need that discretion. But at present, every firm over $50 billion has to do things like supervisory stress testing, and I think what we have found is in some cases the burden associated with that for many of those firms really exceeds the benefit to systemic stability. But retaining the discretion to, as supervisors require them to, do that if we thought it appropriate, that would be very important for me to support that change. Senator CRAPO. Thank you. I appreciate your openness to in- creasing the threshold and focusing on the flexibility that we need there. What I am hearing you say—well, let me put this differently. It seems to me that a principle we should follow is that banks with similar risk profiles should not be subject to different regulatory standards, and that applies on both sides of any arbitrary number which we might pick. The question that I—what I think I heard you say was that the real issue is the risk profile, and that the reg- ulators should have the authority to evaluate the risk profile of our financial institutions and regulate them appropriately. Did I hear you correctly? Ms. YELLEN. I think that is a fair summary. Senator CRAPO. Thank you. And the last question I have is: The Office of Financial Research recently published a study this past February that uses a multifactored approach to grading the sys- temic risk of each of the institutions subjected to Section 165 of Dodd-Frank. Are you familiar with that study? Do you know what I am referring to? Ms. YELLEN. I am sorry. I have not really had a chance to review the study. I apologize. Senator CRAPO. Fair enough. I get asked by reporters all the time about things, and I have learned, if I do not know about it, to tell them, and I appreciate that. The point is this study showed that different banks who are sub- ject to the $50 billion—who are on the upside of the $50 billion trigger have vastly different risk profiles. And I guess the question I was going to ask you is whether this study has validity in show- ing that there are vastly different risk profiles among the different banks who are above the $50 billion trigger. So let me ask that question without referencing the study. Isn’t it correct that there are very, very different risk profiles in this pool of banks that are above the $50 billion trigger? Ms. YELLEN. Yes, they have very different risk profiles. Some are essentially large community banks that are not especially risky. But, on the other hand, we have a couple of U.S. firms that are designated as G–SIBs now. They are a lot above 50, but they are certainly a lot smaller than the largest U.S. firms. But they have business models that make their activities systemically important. And so firms of the same size can have very different risk profiles VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 23 and the appropriate supervision of those firms can be quite dif- ferent. Senator CRAPO. Well, thank you. And this is not a question. I will just conclude with this comment, and that is, I think we would be much better served if our regulatory system allowed our regu- lators to focus on risk and regulate to that rather than forcing them to utilize arbitrary numbers. Chairman SHELBY. Thank you, Senator Crapo. Senator Reed. Senator REED. Well, thank you very much, Mr. Chairman. Just quickly, because I have had the opportunity to listen to these ques- tions, your position would be that a threshold is appropriate, but then discretion to look at different banks over that threshold dif- ferently is what really you think is the ideal? Ms. YELLEN. Well, within limits, we can tailor our supervision to the profiles of the firms. I guess I would be concerned if the thresh- old is raised, we are now saying that banks that used to be above the threshold now fall below the new threshold. They are no longer automatically subject to a number of requirements. Senator REED. And they might be engaged in risky behaviors that—— Ms. YELLEN. Yeah, and we might want to, as supervisors, say no, no, no. But those two firms, they really need to continue doing that. We know they are now below the threshold, but we want to subject them to it anyhow because it is right for them. Now, there may be many other firms that have now been re- lieved from what was a burden that is not appropriate for them. Senator REED. So just to be clear, this issue of threshold is not to essentially if you get below a threshold, you do not have any re- sponsibility. What you want to be able is to follow risk even if it is below the threshold. Ms. YELLEN. That is right. But we have observed that, for exam- ple, quite a number of firms that are just above the $50 billion threshold, we are really imposing some burdens on them that it is not clear that the benefits exceed the costs there. Senator REED. Just a final point. There is sort of a functional value of having a threshold. Ms. YELLEN. Yes. Senator REED. However you want to characterize it, because if you do not, then you have to have sort of a contest with each insti- tution about whether they fit within your criteria, whether they truly have risk, and you do not have the entree you need to basi- cally make your valuation. You know, you have to fight your way through the door. Is that correct? Ms. YELLEN. That is right. And I used the words ‘‘modest in- crease in the threshold.’’ Senator REED. All right. Thank you. My real question is with the now ubiquitous issue of cybersecu- rity. First, a two-pronged question. One is the cybersecurity of the Federal Reserve, and then as importantly, maybe more impor- tantly, how effective you are in ensuring that your regulated insti- tutions have cybersecurity protections that are effective, because this is the issue of the moment and of the next decade or more— millennium maybe. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 24 Ms. YELLEN. Absolutely agreed. We internally are highly focused on cybersecurity. I believe we have a robust and comprehensive cy- bersecurity system in place. We realize that the nature of the threats we face are constantly evolving. We are routinely doing self-evaluations of our vulnerabilities and engaging third parties to review what we are doing. We have a National Incident Response Team that is constantly 24/7 responsible for looking at intrusion detection, incident re- sponse, vulnerable assessments, trying to do their own penetration tests to see how secure we are. We have business continuity plans for all of our business lines, including our most systemically impor- tant payment systems like Fedwire and for our open market oper- ations. If the primary operators of these systems were to suffer an attack, we have backup facilities that could take over the oper- ations. So that is sort of a—— Senator REED. Madam Chair, switching to your regulated indus- try, are you testing them as hard? Are you going in with teams to assess? Are you trying to sort of break in—I mean, in terms of as a regulator looking to see if they are conducting operations appro- priately? Ms. YELLEN. So I do not think we are breaking in and doing our own detection tests. But it is an important aspect of our super- vision to ensure financial institutions have appropriate measures in place. We have specialized teams of supervisors that are trained in IT security who examine the institutions to make sure that they are appropriately—taking the appropriate steps, and we work joint- ly with other regulators through the FFIEC for the financial sector more broadly under the leadership of Treasury. And we support ef- forts throughout the Government to make sure that we are ad- dressing these threats. Senator REED. Thank you very much. I think the nature of the threat is we will be having this conversation for a long time. Ms. YELLEN. We will. Chairman SHELBY. Senator Warner, finally. Senator WARNER. Thank you, Mr. Chairman. I will go ahead and start. Chairman SHELBY. I am sorry. If I could, Senator Schumer came back. Senator SCHUMER. I will let Senator Warner go. Chairman SHELBY. He was here earlier. He came back. Senator WARNER. Senator Schumer was hoping to learn from some of my comments, and then he can follow up on them. Chairman SHELBY. He yielded to you, so maybe we will—— Senator SCHUMER. Mark, do not mess with me. [Laughter.] Senator WARNER. I want to start by complimenting the Chair- man on one of his first questions to Chair Yellen about the notion of taking some of these funds that are used to shore up the finan- cial system and using them for purposes not related to the financial system, the way I believe some people have proposed related to highways. This is what happens when you skip the line in the hierarchy on the Democratic side. [Laughter.] VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 25 Senator SCHUMER. Those are the big banks. Senator WARNER. Although I would acknowledge that while I have great sympathy, you know, for the fact that our community- based banks, close to 7,000 of them, are buying into this, getting the 6-percent return, you know, some of the money market funds that can access the emergency window at 50, 60, 70, 80 basis points, if they have to then get this ability to invest at 6 percent, that is a pretty good trade for the money center banks that the community banks do not have—— Senator SCHUMER. I am going to forgo my line of questioning. [Laughter.] Senator WARNER. The one thing I know that I think Senator Warren and probably Senator Brown offered, I actually do believe on the resolution plans that we have made progress and that we are seeing plans with greater rigor and, candidly, even some of the plans in terms of the capital standards that are being put in place might even get close to meeting Senator Brown and Senator Vitter’s requirements. The one area that we still do not have the regs out on, though, is the regs on the long-term debt and how we have got to make sure that that long-term debt is clear, that it could be convertible in the event of a challenge so that we can use bankruptcy, so that we can meet the goals that Senator Brown so carefully articulated. I think what I would love to just hear is some assurance that we are going to see those final regs by the end of the year so that we can have this full guidance out about these resolution plans. Ms. YELLEN. So I cannot give you a specific date, but I want to assure you it is a very high priority item for us. We have not—— Senator WARNER. Chair Yellen, I did not say specific date. I am just saying end of the year. You know, that gives you half the year. Ms. YELLEN. I am loath to promise a date. This is really impor- tant to us. This is not something that we are just letting slip. It is right at the top of our agenda—— Senator WARNER. But when we look at—— Ms. YELLEN. ——to get this done. Senator WARNER. ——the capital structures and the kind of in- creased ability for these large banks to withstand trauma, having those rules out on the long-term debt and that conversion compo- nent really, you know—— Ms. YELLEN. Agreed. I totally agree. Senator WARNER. Because I really want to be able to respond to Senator Brown in an artful and complete way that his approach maybe has been solved by those of us who thought Title 1 and Title 2 got at this issue. Ms. YELLEN. So we completely agree. It is very important for there to be a long-term debt requirement. Most of these firms in their living wills propose a resolution strategy that is similar to the FDIC’s single point of entry strategy that they would use under Title 2. Senator WARNER. Right. Ms. YELLEN. In either case, it requires adequate long-term debt. We are working jointly with the FDIC trying to figure out the right parameters. We are working through the FSB. There is a TLAC VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 26 agreement. We want to see this globally. I promise to get it done just as soon as we can. I am not going to let it—— Senator WARNER. It sounds like—end of the year sounds like a great time. But let me—— Ms. YELLEN. I promise to make every effort to do so. Senator SCHUMER. He has spoken. [Laughter.] Senator WARNER. You know, one of the things that we have seen—let us switch to kind of world monetary policy for a moment. You know, as we see the Bank of Japan and the ECB continue to deal with their currencies, which indirectly obviously makes their products cheaper, our products more expensive, do you worry at all that the actions of these other central banks are putting even more undue pressure on America to be the engine that drives and affects the whole world’s economy because of their monetary policy ac- tions? Ms. YELLEN. Well, monetary policy for domestic purposes often has some impact on a country’s exchange rate. So the fact that we have a stronger economy, are likely to raise rates sooner, and they are continuing to ease monetary policy, those factors have tended to push up the dollar. That has tended to create a drag for net ex- ports and to diminish our growth prospects, and that is something that affects the stance and appropriate future stance of monetary policy. Now, even taking all of that into account, the very significant ap- preciation we have seen of the dollar, we need to put that in the context of the overall strength in domestic spending in the U.S. economy. Our committee concluded that even taking that into ac- count, the continuing drag there, we still think the U.S. economy is going to grow and will probably remain appropriate. Senator WARNER. But this will be a factor—and my time is up. Ms. YELLEN. It is a factor—— Senator WARNER. This will be a factor the FOMC will look at since—— Ms. YELLEN. Absolutely, always looking at—— Senator WARNER. ——in effect, they are continuing to put all these burdens on our country’s economy to kind of carry the whole world forward. Ms. YELLEN. It is a factor. We are constantly looking at it. That is essentially what is happening. Chairman SHELBY. Before I recognize Senator Schumer, I would like to clarify the record. The bill that was reported out of here, our banking legislation, back in May does not raise the threshold in Section 165 of Dodd-Frank to $500 billion, as a lot of people think. In fact, the legislation keeps the $50 billion threshold in place for all institutions to be considered for enhanced prudential regulation and gives the regulators—the Fed, generally—the discretion to de- termine what institutions above $50 billion should be subject to it. Banks above $500 billion would receive no such discretion. I just wanted to clear the record on this. Senator Schumer. Senator SCHUMER. Thank you, Mr. Chairman—— Senator BROWN. Could I speak for a moment? Chairman SHELBY. Yes, sir, Senator Brown. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 27 Senator BROWN. While the Chairman technically is correct, the difficulty for FSOC designation was made much greater, so the— I believe that what Senator Warren said is correct, that it does not protect the safety and soundness of our—that legislation can threaten the safety and soundness of our banking system. I will leave it at that, and we can debate this for a long time. Chairman SHELBY. We will. [Laughter.] Chairman SHELBY. Senator Schumer. Senator SCHUMER. Thank you, Mr. Chairman. Chairman SHELBY. Thank you for your—— Senator SCHUMER. No problem. Thank you. And thank you, Chairman. As you stated in your testimony, the FOMC will likely look to raise the Federal funds rate at some point before the end of the year, and you and the others on the FOMC must ultimately make this decision, weighing all the information at your disposal. I un- derstand that. But as we have discussed previously, I am still troubled by slug- gish wage growth in America. Along with tepid wage growth, we continue to see depressed labor force participation, inflation con- tinues to run well below the 2-percent target. So I am left to ques- tion whether there is still significant slack in the labor market. Views may differ here. I have heard from experts on both sides. But I refuse to let the loud voices of those screaming for the Fed to act to drown out the voices of middle-class working families who continue to wait quietly for economic recovery to show up in their take-home pay. And so the question of when the Fed will raise rates has received a lot of attention, but as I have said before, I believe the single biggest problem facing this country is the decline of middle-class income. And as you know, middle-class incomes have decreased by 6.5 percent. Median income adjusted for infla- tion is $3,600 lower than when President Bush took office. So my question is a simple one: What more can be done? How can we create better individuals to increase productivity? What do you see as critical catalysts for stronger wage growth? Because it almost seems we are pushing on a wet noodle? Ms. YELLEN. Well, we have seen structural forces over a long pe- riod of time push down on middle-class wages, and the economic research that has been done suggests a continuing high demand for skilled labor and declining demand for less skilled labor. We see an increasing wage gap between those who are more skilled and less skilled, partly reflecting the nature of technological change and globalization. And productivity growth, as you mentioned, has cer- tainly slowed down since 2007. We point this out in the Monetary Policy Report. It has been decidedly slower than before that. And I think it is important to focus on policies that would improve pro- ductivity growth. They have to do with making sure that every American child is able to get a really world-class education and is really able to succeed in this economy, and that we take actions to promote innovation and entrepreneurship and capital investment, both public and private, that are necessary to drive innovation. I think those are the kinds of policies that Congress and the pub- lic need to consider to address these. These are deeper structural VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 28 trends that are not just related to the cyclical state of the economy, and they have been around for a long time, and it is appro- priate—— Senator SCHUMER. And there is certainly a limit what monetary policy—— Ms. YELLEN. There is. Senator SCHUMER. We understand that. But here we are facing sequestration here in the Congress, and current spending bills pro- posed by my colleagues on the other side of the aisle would slash funding for key resources—supplemental opportunity grants, Pell grants, $300 million from employment and job training programs, cuts to education. These are the kinds of programs you mentioned in part as catalysts to stronger wage growth. So I do not want you to weigh in on specific programs. Obviously, that is not your job. But let me ask you this: As we look toward the end of the year, can you talk about the broader impact to our economic recovery that drastic, automatically triggered budget cuts may have as well as the potential for a Government shutdown and the uncertainty surrounding the debt ceiling? Do you believe these events could cre- ate fiscal headwinds for our recovery? Ms. YELLEN. Well, in recent years, fiscal policy has gone from creating a significant drag on the economy to being roughly neu- tral, and that shift in a favorable direction I think has helped to promote economic recovery. So I would be concerned about some- thing that was a large fiscal shift. I do not know whether or not this would be. But policies or governmental actions that create un- certainty, whether it is a Government shutdown or running up against the debt ceiling, that reduce the confidence of households and businesses on the ability of their Government to function in an effective way and create fear and loss of confidence obviously are not helpful to recovery. Senator SCHUMER. And just getting to the wage growth conun- drum, wouldn’t cutting education and cutting training programs that make workers more able to be productive be counter to that? Ms. YELLEN. So I do not want to, as you indicated, weigh in on specific programs, but I do think that education programs, pro- grams to promote training and skills acquisition are very critical in addressing wage inequality. Senator SCHUMER. Thank you. Thank you, Mr. Chairman. Chairman SHELBY. Madam Chair, we thank you again for your appearance and your willingness to come, and we hope we can work with you on some of the proposed legislation because I think there are some misperceptions of what we are trying to do. We are trying to give you a lot of power—you already have a lot of power— and some discretion, but none of us wants to weaken the banking system. Thank you. Ms. YELLEN. Thank you, Chair Shelby. I look forward to working with you and the Committee. Chairman SHELBY. Thank you. This hearing is adjourned. [Prepared statements, responses to written questions, and addi- tional material supplied for the record follow:] VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 29 PREPARED STATEMENT OF JANET L. YELLEN CHAIR, BOARDOFGOVERNORSOFTHEFEDERALRESERVESYSTEM JULY16, 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 in February, the economy has made further progress toward the Federal Reserve’s objective of maximum employment, while inflation has continued to run below the level that the Federal Open Market Committee (FOMC) judges to be most consistent over the longer run with the Fed- eral Reserve’s statutory mandate to promote maximum employment and price sta- bility. In the labor market, the unemployment rate now stands at 5.3 percent, slightly below its level at the end of last year and down more than 41⁄2 percentage points from its 10 percent peak in late 2009. Meanwhile, monthly gains in nonfarm payroll employment averaged about 210,000 over the first half of this year, somewhat less than the robust 260,000 average seen in 2014 but still sufficient to bring the total increase in employment since its trough to more than 12 million jobs. Other meas- ures of job market health are also trending in the right direction, with noticeable declines over the past year in the number of people suffering long-term unemploy- ment and in the numbers working part time who would prefer full-time employ- ment. However, these measures—as well as the unemployment rate—continue to in- dicate that there is still some slack in labor markets. For example, too many people are not searching for a job but would likely do so if the labor market was stronger. And, although there are tentative signs that wage growth has picked up, it con- tinues to be relatively subdued, consistent with other indications of slack. Thus, while labor market conditions have improved substantially, they are, in the FOMC’s judgment, not yet consistent with maximum employment. Even as the labor market was improving, domestic spending and production soft- ened notably during the first half of this year. Real gross domestic product (GDP) is now estimated to have been little changed in the first quarter after having risen at an average annual rate of 31⁄2 percent over the second half of last year, and in- dustrial production has declined a bit, on balance, since the turn of the year. While these developments bear watching, some of this sluggishness seems to be the result of transitory factors, including unusually severe winter weather, labor disruptions at West Coast ports, and statistical noise. The available data suggest a moderate pace of GDP growth in the second quarter as these influences dissipate. Notably, consumer spending has picked up, and sales of motor vehicles in May and June were strong, suggesting that many households have both the wherewithal and the confidence to purchase big-ticket items. In addition, homebuilding has picked up somewhat lately, although the demand for housing is still being restrained by lim- ited availability of mortgage loans to many potential homebuyers. Business invest- ment has been soft this year, partly reflecting the plunge in oil drilling. And net exports are being held down by weak economic growth in several of our major trad- ing partners and the appreciation of the dollar. Looking forward, prospects are favorable for further improvement in the U.S. labor market and the economy more broadly. Low oil prices and ongoing employ- ment gains should continue to bolster consumer spending, financial conditions gen- erally remain supportive of growth, and the highly accommodative monetary policies abroad should work to strengthen global growth. In addition, some of the headwinds restraining economic growth, including the effects of dollar appreciation on net ex- ports and the effect of lower oil prices on capital spending, should diminish over time. As a result, the FOMC expects U.S. GDP growth to strengthen over the re- mainder of this year and the unemployment rate to decline gradually. As always, however, there are some uncertainties in the economic outlook. For- eign developments, in particular, pose some risks to U.S. growth. Most notably, al- though the recovery in the euro area appears to have gained a firmer footing, the situation in Greece remains difficult. And China continues to grapple with the chal- lenges posed by high debt, weak property markets, and volatile financial conditions. But economic growth abroad could also pick up more quickly than observers gen- erally anticipate, providing additional support for U.S. economic activity. The U.S. economy also might snap back more quickly as the transitory influences holding down first-half growth fade and the boost to consumer spending from low oil prices shows through more definitively. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00033 Fmt 6621 Sfmt 6621 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 30 As I noted earlier, inflation continues to run below the Committee’s 2-percent ob- jective, with the personal consumption expenditures (PCE) price index up only 1⁄4 percent over the 12 months ending in May and the core index, which excludes the volatile food and energy components, up only 11⁄4 percent over the same period. To a significant extent, the recent low readings on total PCE inflation reflect influences that are likely to be transitory, particularly the earlier steep declines in oil prices and in the prices of non-energy imported goods. Indeed, energy prices appear to have stabilized recently. Although monthly inflation readings have firmed lately, the 12-month change in the PCE price index is likely to remain near its recent low level in the near term. My colleagues and I continue to expect that as the effects of these transitory factors dissipate and as the labor market improves further, inflation will move gradually back toward our 2-percent objective over the medium term. Market-based measures of inflation compensation remain low—although they have risen some from their levels earlier this year—and survey-based measures of longer-term inflation expec- tations have remained stable. The Committee will continue to monitor inflation de- velopments carefully. Monetary Policy Regarding monetary policy, the FOMC conducts policy to promote maximum em- ployment and price stability, as required by our statutory mandate from the Con- gress. Given the economic situation that I just described, the Committee has judged that a high degree of monetary policy accommodation remains appropriate. Con- sistent with that assessment, we have continued to maintain the target range for the Federal funds rate at 0 to 1⁄4percent and have kept the Federal Reserve’s hold- ings of longer-term securities at their current elevated level to help maintain accom- modative financial conditions. In its most recent statement, the FOMC again noted that it judged it would be appropriate to raise the target range for the Federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2-percent objective over the medium term. The Committee will determine the timing of the initial increase in the Federal funds rate on a meeting- by-meeting basis, depending on its assessment of realized and expected progress to- ward its objectives of maximum employment and 2-percent inflation. If the economy evolves as we expect, economic conditions likely would make it appropriate at some point this year to raise the Federal funds rate target, thereby beginning to nor- malize the stance of monetary policy. Indeed, most participants in June projected that an increase in the Federal funds target range would likely become appropriate before year-end. But let me emphasize again that these are projections based on the anticipated path of the economy, not statements of intent to raise rates at any par- ticular time. A decision by the Committee to raise its target range for the Federal funds rate will signal how much progress the economy has made in healing from the trauma of the financial crisis. That said, the importance of the initial step to raise the Fed- eral funds rate target should not be overemphasized. What matters for financial conditions and the broader economy is the entire expected path of interest rates, not any particular move, including the initial increase, in the Federal funds rate. In- deed, the stance of monetary policy will likely remain highly accommodative for quite some time after the first increase in the Federal funds rate in order to support continued progress toward our objectives of maximum employment and 2-percent in- flation. In the projections prepared for our June meeting, most FOMC participants anticipated that economic conditions would evolve over time in a way that will war- rant gradual increases in the Federal funds rate as the headwinds that still restrain real activity continue to diminish and inflation rises. Of course, if the expansion proves to be more vigorous than currently anticipated and inflation moves higher than expected, then the appropriate path would likely follow a higher and steeper trajectory; conversely, if conditions were to prove weaker, then the appropriate tra- jectory would be lower and less steep than currently projected. As always, we will regularly reassess what level of the Federal funds rate is consistent with achieving and maintaining the Committee’s dual mandate. I would also like to note that the Federal Reserve has continued to refine its oper- ational plans pertaining to the deployment of our various policy tools when the Committee judges it appropriate to begin normalizing the stance of policy. Last fall, the Committee issued a detailed statement concerning its plans for policy normal- ization and, over the past few months, we have announced a number of additional details regarding the approach the Committee intends to use when it decides to raise the target range for the Federal funds rate. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00034 Fmt 6621 Sfmt 6621 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 31 Federal Reserve Transparency and Accountability These statements pertaining to policy normalization constitute recent examples of the many steps the Federal Reserve has taken over the years to improve our public communications concerning monetary policy. As this Committee well knows, the Board has for many years delivered an extensive report on monetary policy and eco- nomic developments at semiannual hearings such as this one. And the FOMC has long announced its monetary policy decisions by issuing statements shortly after its meetings, followed by minutes of its meetings with a full account of policy discus- sions and, with an appropriate lag, complete meeting transcripts. Innovations in re- cent years have included quarterly press conferences and the quarterly release of FOMC participants’ projections for economic growth, unemployment, inflation, and the appropriate path for the Committee’s interest rate target. In addition, the Com- mittee adopted a statement in 2012 concerning its longer-run goals and monetary policy strategy that included a specific 2-percent longer-run objective for inflation and a commitment to follow a balanced approach in pursuing our mandated goals. Transparency concerning the Federal Reserve’s conduct of monetary policy is de- sirable because better public understanding enhances the effectiveness of policy. More important, however, is that transparent communications reflect the Federal Reserve’s commitment to accountability within our democratic system of Govern- ment. Our various communications tools are important means of implementing mon- etary policy and have many technical elements. Each step forward in our commu- nications practices has been taken with the goal of enhancing the effectiveness of monetary policy and avoiding unintended consequences. Effective communication is also crucial to ensuring that the Federal Reserve remains accountable, but measures that affect the ability of policymakers to make decisions about monetary policy free of short-term political pressure, in the name of transparency, should be avoided. The Federal Reserve ranks among the most transparent central banks. We pub- lish a summary of our balance sheet every week. Our financial statements are au- dited annually by an outside auditor and made public. Every security we hold is list- ed on the Web site of the Federal Reserve Bank of New York. And, in conformance with the Dodd-Frank Act, transaction-level data on all of our lending—including the identity of borrowers and the amounts borrowed—are published with a 2-year lag. Efforts to further increase transparency, no matter how well intentioned, must avoid unintended consequences that could undermine the Federal Reserve’s ability to make policy in the long-run best interest of American families and businesses. Summary In sum, since the February 2015 Monetary Policy Report, we have seen, despite the soft patch in economic activity in the first quarter, that the labor market has continued to show progress toward our objective of maximum employment. Inflation has continued to run below our longer-run objective, but we believe transitory fac- tors have played a major role. We continue to anticipate that it will be appropriate to raise the target range for the Federal funds rate when the Committee has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2-percent objective over the medium term. As always, the Fed- eral Reserve remains committed to employing its tools to best promote the attain- ment of its dual mandate. Thank you. I would be pleased to take your questions. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00035 Fmt 6621 Sfmt 6621 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 32 RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN SHELBY FROM JANET L. YELLEN Q.1. Many economists have proposed that the Federal Reserve should adopt a strategy of targeting the growth rate of nominal GDP, which would create a countercyclical monetary policy to offset booms and downturns in the economy while also reducing uncer- tainty. Does the Federal Open Market Committee (FOMC) consider the rate of nominal GDP growth as a priority in its monetary policy de- cisions? A.1. The Federal Reserve’s mandate, as established by Congress in the Federal Reserve Act, is ‘‘to promote effectively the goals of max- imum employment, stable prices, and moderate long-term interest rates.’’1 To assess progress toward these statutory objectives, the FOMC considers information about a wide range of variables, in- cluding the rate of nominal GDP growth. This information encom- passes indicators of inflation pressures, measures of labor market conditions and real economic activity, and readings on financial and international developments. Nominal GDP growth, by itself, does not give a complete picture of the economy’s performance; moderate nominal GDP growth could reflect, for example, strong growth of real economic activity with low inflation, or weak eco- nomic growth with high inflation. Q.2. Could the FOMC adopt a strategy of targeting nominal GDP? A.2. While, conceptually, the FOMC could adopt a strategy of tar- geting nominal GDP, there are a number considerations regarding the satisfaction of the Federal Reserve’s statutory objectives and the balance of prospective benefits and costs that such strategy would entail relative to other policy frameworks. The expression ‘‘nominal GDP targeting’’ has been used to refer to two distinct policy strategies. First, a central bank could target the growth rate of nominal GDP.2 As pointed out by Bernanke and Mishkin (1997), and as illustrated by the international experience, modern inflation targeting frameworks generally allow policy- makers ample flexibility to stabilize economic activity in the near term or to look beyond transitory movements in inflation due to swings in global energy and trade prices. The research literature suggests that the macroeconomic outcomes achieved by central banks pursuing an inflation objective tend to be similar to those they would have achieved had they targeted the growth rate of nominal GDP.3 Second, nominal GDP targeting can be understood 1The FOMC judges that moderate longer-term interest rates would follow if the Federal Re- serve achieves its objectives of maximum employment and stable prices; hence the FOMC often refers to its statutory objectives as the ‘‘dual mandate.’’ The FOMC also judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal con- sumption expenditures, is most consistent over the longer run with the Federal Reserve’s statu- tory mandate. In setting monetary policy, the FOMC seeks to mitigate deviations of inflation from this 2 percent longer-run goal and deviations of employment from the committee’s assess- ments of its maximum level. See Board of Governors (2015), ‘‘Statement on Longer-Run Goals and Monetary Policy Strategy’’, press release, January 27, http://www.federalreserve.gov/ monetarypolicy/files/FOMClLongerRunGoals.pdf. 2For early arguments in favor of targeting the growth rate of nominal GDP, see Taylor (1985), ‘‘What Would Nominal GDP Targeting Do to the Business Cycle?’’ Carnegie-Rochester Conference Series on Public Policy, Amsterdam: North-Holland, vol. 22, pp. 61–84. 3See Ben S. Bernanke and Frederic S. Mishkin (1997), ‘‘Inflation Targeting: A New Frame- work for Monetary Policy?’’ Journal of Economic Perspectives, vol. 11(2), pp. 97–116. For argu- ments that policymakers under inflation targeting regimes afforded considerable flexibility to re- VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00036 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 33 as a monetary policy strategy in which the central bank seeks to stabilize the level of nominal GDP around a preannounced trend path in order to achieve its longer-run statutory objectives. Because the difference between nominal GDP and its targeted value can be expressed as the sum of a price gap and a real activity gap, nominal GDP targeting recognizes, albeit imperfectly, ele- ments on both sides of the FOMC’s dual mandate.4 At least in the- ory, monetary policy that targets nominal GDP can help correct the effects of aggregate demand shocks on both real GDP and the price level. For instance, under nominal GDP level targeting, the central bank would respond to a shortfall in the level of nominal GDP by easing monetary policy to generate a period of above-trend nominal GDP growth in order to bring nominal GDP back to the original trend path; that policy easing would increase both real activity and the price level. A credible expectation that monetary policy will be accommodative in the future, in turn, helps to mitigate the initial fall in output and inflation. The theoretical benefits of targeting the level of nominal GDP hinge on the credibility of the promise to stimulate the economy down the road, the public’s ability to form accurate expectations of the policy response and its effects, and, more generally, the public’s understanding of the way the economy operates and interacts with monetary policy. There are, however, some important practical considerations with the pursuit of nominal GDP targeting. First, when faced with a very large fall in nominal GDP, as occurred during the 2008–2009 recession, a central bank committed to a nominal GDP target would promise to eventually lower the unemployment rate well below the natural rate of unemployment and to raise inflation above its longer-run average for some time in order to lift nominal GDP back to its targeted level. When that promise comes due, it is not obvious that the central bank and the public would judge that running the economy that hot—possibly over a period of sev- eral years after the initial shock has come to pass—is desirable.5 Second, if the central bank is intent on delivering the promised period of very low unemployment and temporarily high inflation, there can be risks to the potency and credibility of monetary policy from adverse movements in expectations. Once resource slack has been reabsorbed, the maintenance of monetary conditions that are sufficiently accommodative to lift inflation above the longer-run ob- jective could be misinterpreted by the public as evidence that the central bank is not committed to its price stability mandate, thus heightening the risk that longer-run inflation expectations could become unanchored. Third, data on nominal GDP are not available as timely and fre- quently as, say, data on inflation and the unemployment rate. Moreover, nominal GDP data are subject to revisions, which can be spond to the slump in output during the financial crisis, see Ben S. Bernanke (2011), ‘‘The Ef- fects of the Great Recession on Central Bank Doctrine and Practice’’, speech delivered at Federal Reserve Bank of Boston 56th Economic Conference, Boston, Massachusetts, October 18. 4Output prices cover a broader set of goods and services prices than the index of personal consumption expenditures that the FOMC uses to assess progress toward its longer-run inflation objective. Moreover, the real activity gap is only imperfectly related to the gap between employ- ment and the statutory goal of maximum employment. 5This phenomenon is known as the time-consistency problem. It arises because the benefits of nominal GDP targeting are frontloaded whereas the costs are postponed and can be avoided by reneging on the promise. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00037 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 34 large and occur several quarters or even years after the release of the initial estimates. These revisions directly alter the size of the gap between current nominal GDP and its targeted level, and so might call for a change in the stance of monetary policy even if the public perceives economic conditions as unchanged. Furthermore, nominal GDP is influenced by a number of nonmonetary factors such as population growth, the labor force participation rate, the pace of technological advances, and measurement issues such as price adjustments for quality changes. Innovations to these non- monetary factors affect the price level or inflation rate that is con- sistent with the achievement of a given nominal GDP target.6 For all these reasons, the demands on the public’s attention and com- prehension imposed by nominal GDP targeting are arguably non- trivial. Q.3. A recent report from the Bank of International Settlements (BIS) found that the prolonged period of low interest rates is dam- aging the U.S. economy, resulting in ‘‘too much debt and too little growth.’’ In addition, the report states that ‘‘low rates may in part have contributed to . . . costly financial booms and busts.’’ Do you agree with the BIS that persistently low interest rates can have negative effects on the U.S. economy? Please explain. A.3. The accommodative monetary policy of the Federal Reserve is designed to fulfill the dual mandates of maximum employment and price stability set for us by the Congress. In particular, low interest rates are currently needed to provide support for a return to full employment and for inflation to return to the FOMC’s longer run objective over time. When the economy has strengthened, interest rates will rise in a sustainable way. In particular, the FOMC has indicated that it anticipates that it will be appropriate to raise the target range for the Federal funds rate when it has seen some fur- ther improvement in the labor market and is reasonably confident that inflation will move back to its 2-percent objective over the me- dium term. However, the Federal Reserve is also mindful that a prolonged period of low rates could encourage imprudent risk taking by some investors and eventually undermine financial stability, with nega- tive effects on the U.S. economy. For this reason, the Federal Re- serve, on its own and with other domestic and international regu- lators, has taken steps to boost the resilience of the financial sys- tem and has increased its efforts to comprehensively monitor the financial system for building vulnerabilities and to guide actions to mitigate those risks. Q.4. In your previous testimony before this Committee on February 24th, you stated that in the FOMC’s monetary policy decision- making process, ‘‘it is useful for us to consult the recommendations of rules of the Taylor type. We do so routinely, and they are an im- portant input into what ultimately is a decision that requires sound judgment.’’ 6Given a fixed nominal GDP target, volatility in these nonmonetary factors thus directly translates into volatility in the level of inflation consistent with achieving the target. This vola- tility could conflict with the Federal Reserve’s statutory mandate of promoting ‘‘stable prices.’’ To be sure, the FOMC could offset the effects on inflation of movements in these nonmonetary factors by adjusting the nominal GDP target. However, occasional adjustments to the target could create some communication challenges. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00038 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 35 Which monetary policy rules are used by the FOMC? A.4. The FOMC treats the prescriptions of monetary policy rules as useful benchmarks for setting the Federal funds rate. Accordingly, ahead of every FOMC meeting, Federal Reserve staff prepare a dis- cussion of policy prescriptions from several policy rules for the com- mittee’s consideration. For example, the most recent staff briefing materials that are available to the public, which cover FOMC meet- ings in 2009, considered prescriptions from the following five sim- ple rules: the canonical Taylor (1993) rule, the Taylor (1999) rule, a first-difference rule, an empirical rule approximating past FOMC behavior, and an estimated forecast-based rule. Those materials also discussed ‘‘optimal control’’ policy prescriptions, which are sim- ulations of the path for the Federal funds rate that delivers the best macroeconomic outcomes given the Federal Reserve staffs baseline economic outlook and a ‘‘loss function’’ that considers larg- er deviations of real GDP from the level consistent with full em- ployment to be appreciably more costly than smaller deviations, and similarly for deviations of inflation from the longer-run objec- tive and for volatility in the Federal funds rate.7 In addition, FOMC discussion of monetary policy rules is informed by in-depth technical memos and working papers that are periodically prepared by Federal Reserve staff, as well as by contributions from the aca- demic literature.8 The FOMC considers the prescriptions of a variety of monetary policy rules because no single rule has been shown to be fully satis- factory given the complexity of the economy and constantly evolv- ing economic relationships. Many studies have shown that in nor- mal times, when the economy is buffeted by typical shocks, simple rules can deliver outcomes that are close to those under optimal policies. However, the simple rules that perform well under ordi- nary circumstances may disappoint during periods of, say, persist- ently strong headwinds restraining recovery.9 Moreover, simple rules that perform well in some economic environments may per- form poorly when economic relationships are unstable, because such rules do not quickly adapt to changes in potential output growth or fail to incorporate financial stability concerns in times of crisis.10 Q.5. Please submit to us a list of each rule discussed by the FOMC at its most recent meeting. 7For an example of policy prescriptions from simple rules and optimal control exercises, along with a discussion of how they inform policy, see Janet Yellen (2012), ‘‘Perspectives on Monetary Policy’’, speech delivered at the Boston Economic Club Dinner, Boston, Massachusetts, June 6. Complete model code of the Federal Reserve’s FRB/US model and illustrative simulation pro- grams, including sample code for optimal control policy, are publicly available on the Federal Reserve’s Web site. 8Some of the staff’s technical analysis reviewed by FOMC participants may be made public in the form of technical working papers, staff notes, and publications in academic journals. For an illustration of in-depth staff analysis using simple policy rules, including nominal GDP tar- geting rules, see William B. English, David Lopez-Salido, and Robert J. Tetlow, ‘‘The Federal Reserve’s Framework for Monetary Policy: Recent Changes and New Questions’’, IMF Economic Review, vol. 63(1), pp. 22–70. 9For a discussion and an illustration of the shortcomings of simple Taylor-type rules in the wake of the Great Recession, see Janet Yellen (2012), ‘‘Revolution and Evolution in Central Bank Communications’’, speech delivered at the Haas School of Business, University of Cali- fornia, Berkeley, Berkeley, California, November 13. 10For studies of rule robustness, see, among others, John B. Taylor and John C. William (2011), ‘‘Simple and Robust Rules for Monetary Policy’’, in John C. Williams, Benjamin Fried- man, and Michael Woodford (Eds.), Handbook of Monetary Economics, vol. 3, pp. 829–859. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00039 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 36 A.5. Please see response to Question 4. Q.6. Federal Reserve officials have stated that the Federal Re- serve’s practice of paying interest on banks’ reserve balances has become an important tool of monetary policy. If that is the case, should this rate be set by the FOMC, which is responsible for mon- etary policy, rather than by the Federal Reserve Board of Gov- ernors? Please explain. A.6. By statute, both the Federal Reserve and FOMC play impor- tant roles in the conduct of monetary policy, with the Federal Re- serve being responsible for some policy tools and the FOMC being responsible for the others. The Federal Reserve and FOMC have worked collaboratively for decades to employ these policy tools in concert to effectively promote the Federal Reserve’s long-run goals of maximum employment and stable prices. Under the Federal Reserve Act, the Federal Reserve has author- ity over changes in reserve requirements and on interest on re- serves. In addition, any change in the discount rate initiated by a Federal Reserve Bank is subject to review and determination by the Federal Reserve. Reserve requirements and the discount rate have been employed for many years as key elements of the frame- work that the FOMC has relied upon in managing the level of the Federal funds rate. The interest rate paid on banks’ reserve balances is an important new tool of monetary policy that is determined by the Federal Re- serve. Following the examples of the discount rate and reserve re- quirements, the Federal Reserve has indicated that the interest on excess reserves rate will be set in a way to keep the Federal funds rate in the range established by the FOMC. Indeed, the FOMC noted in its September 2014 Policy Normalization Principles and Plans that the Federal Reserve intends to move the Federal funds rate into the target range set by the FOMC primarily by adjusting the interest rate it pays on excess reserve balances. The collabo- rative approach to monetary policy implementation to achieve over- all monetary policy objectives was reiterated in the June 2015 FOMC meeting minutes, which noted that operational decisions re- garding policy tools will be made in concert by the Federal Reserve and the FOMC. Q.7. A Federal judge recently ruled in Starr International Co. v. U.S. that the actions in the bailout of AIG were beyond the author- ity of the Federal Reserve since ‘‘Section 13(3) did not authorize the Federal Reserve Bank to acquire a borrower’s equity as consider- ation for the loan.’’ The Board of Governors responded in a press release that its ‘‘actions in the AIG rescue during the height of the financial crisis in 2008 were legal, proper and effective.’’ Did the Federal Reserve conduct a legal analysis to reach this conclusion? A.7. A comprehensive legal analysis supporting the conclusion that the Federal Reserve’s actions in the American International Group (AIG) rescue were consistent with all applicable laws can be found in the United States’ Post-Trial Brief in the Starr International court case, filed on March 23, 2015. Starr International Co. v. U.S., No. 11-779C, U.S. Court of Federal Claims (Docket No. 434, pages 6–19). Attached is a copy of that brief, along with two internal Fed- VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00040 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 37 eral Reserve memoranda cited in it that relate to the issue of au- thority (JX–13 and DX–484). Some other publicly available filings in this case that also address the authority issue are Docket Nos. 55, 63, 248-1, 279, and 426; these can be found through the Federal Judiciary’s system, ‘‘Public Access to Court’s Electronic Records’’ or PACER, at www.pacer.gov. As you may be aware, the Department of Justice has cross-appealed the Court of Federal Claims decision in Starr, and we expect that the issue of the Federal Reserve’ s au- thority will be addressed by the Federal Circuit. Q.8. Please provide a copy of this analysis and all memoranda and related documents. A.8. Please see response to question 5a. Q.9. Market-based indicators of future economic activity are often more accurate than research-based predictions. Does the FOMC use any market-based indicators (such as TIPS spreads) in its monetary policy decisions? A.9. The FOMC is firmly committed to fulfilling its statutory man- date of promoting maximum employment and stable prices. The FOMC recognizes that the inflation expectations of those who set prices in the economy are an important determinant of the behav- ior of actual inflation. Consequently, the FOMC monitors both in- flation expectations and the actual inflation rate in setting mone- tary policy. The FOMC follows various measures of inflation expectations. One set of measures is based on financial instruments whose pay- outs are linked to inflation. For example, Treasury inflation protec- tion securities (TIPS)—implied inflation compensation (or the TIPS break even inflation rate) is defined as the difference at comparable maturities between yields on nominal Treasury securities and yields on Treasury securities that are indexed to headline CPI in- flation (or TIPS). Inflation swaps—contracts in which one party pays a certain fixed amount in exchange—for cash flows that are indexed to cumulative CPI inflation over some horizon—provide al- ternative measures of inflation compensation. These market-based measures provide information about market participants’ expecta- tions of inflation. However, extracting that information generally requires the application of economic theory and statistical models because these market-based measures reflect not only expected in- flation, but also an inflation risk premium—the compensation that holders of nominal securities demand for bearing inflation risk—as well as other premiums driven by liquidity differences and shifts in the relative supply and demand of nominal versus inflation-in- dexed securities. Staff in the Federal Reserve System maintain sev- eral term structure models aimed at providing estimates of the in- flation expectations and risk premiums that make up inflation com- pensation but results from those decompositions are sensitive to model specification. In addition, the FOMC monitors measures of inflation expecta- tions that are based on surveys of households, market participants, and professional forecasters. These measures elicit respondents’ in- flation expectations directly, although survey participants are not necessarily the price setters in the economy. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00041 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 38 As none of available measures of inflation expectations is perfect, staff in the Federal Reserve System keep track of a wide array of such measures and continue their efforts to develop deeper under- standing of the measures’ behavior. Q.10. Does the Federal Reserve have the authority to create a pre- diction market for economic indicators to help inform its monetary policy decisions? A.10. A predictions market is a market where investors purchase financial contracts—futures or options for example—with real funds and the contract payoffs depend on the outcome of events, such as economic data releases or events. The Federal Reserve Act does not expressly provide the Federal Reserve with authority to establish and operate a predictions market. The Federal Reserve has not considered whether it has inherent authority or authority under other more general provisions of law to establish and operate a predictions market. From time to time, there have been private sector efforts to cre- ate prediction markets for economic variables but they have not at- tracted widespread interest from investors. Indeed, some financial firms have experimented with running prediction markets for major economic releases. This information was useful in gauging market expectations ahead of economic releases but those markets are no longer active. More broadly, the Federal Reserve regularly reviews information from financial markets to gauge market expectations about eco- nomic variables such as inflation or the Federal funds rate. Q.11. If not, what clarification or authorization would be necessary from Congress to assure the Federal Reserve that predictions mar- kets are an authorized tool for its economic research? A.11. As noted above, the Federal Reserve regularly reviews finan- cial data to gauge market participants’ outlook for economic vari- ables such as inflation or the Federal funds rate. If there were ac- tively traded instruments based on other economic variables, the Federal Reserve would use that information for economic research and policy analysis as well. The Federal Reserve is not requesting specific authority to establish and operate a predictions market. In effect, establishing a predictions market would amount to estab- lishing a futures and options exchange for special types of deriva- tives contracts. This is an undertaking that would involve many important operational and policy challenges for the Federal Re- serve. Perhaps more importantly, the fact that existing futures and options exchanges and other large financial institutions have been unable to launch successful financial contracts of this type suggests that investor interest in such instruments is limited. Q.12. On July 20, 2015, the Federal Reserve finalized the G–SIB surcharge proposal. The final rule adopts the proposed rule’s meth- odology to identify whether a bank holding company is a G–SIB by considering the institution’s size, interconnectedness, substitut- ability, complexity, and cross-jurisdictional activity. The final rule states that there ‘‘is general global consensus that each category in- cluded in the BCBS framework is a contributor to the risk a bank- ing organization poses to financial stability.’’ Please explain why VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00042 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 39 the Federal Reserve believes that this multifactor approach is an appropriate way to measure systemic importance. A.12. The Federal Reserve believes that the multifactor approach used in the final G–SIB surcharge rule (final rule) is appropriate because it closely aligns with the considerations that the Federal Reserve may consider under section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Sec- tion 165 of the Dodd-Frank Act (12 U.S.C. §5365) directs the Fed- eral Reserve to implement enhanced prudential standards for cer- tain bank holdings companies and nonbank financial companies. In prescribing more stringent prudential standards, the Federal Re- serve may differentiate among companies on an individual basis or by category, capital structure, riskiness, complexity, financial ac- tivities (including the financial activities of their subsidiaries), size, and any other risk-related factors that the Federal Reserve deems appropriate.11 Similarly, the final rule takes into account leverage, off-balance sheet exposures, interconnectedness with significant fi- nancial counterparties, the nature, scope, size, scale and mix of ac- tivities, degree of regulation, and liabilities. Consistent with that requirement, under the final rule, a firm’s method 1 and method 2 scores are calculated using a measure of each firm’s nature, scope, size, scale, concentration, interconnectedness, and mix of the activities. Global systemically important bank holding company (G– SIB) capital surcharges are established using these scores, and G– SIBs with higher scores are subject to higher G–SIB capital sur- charges. In addition, the Federal Reserve, along with other central banks, informed and contributed to the preparation of the 2009 Report to the G20 Finance Ministers and Central Bank Governors, titled ‘‘Guidance to Assess the Systemic Importance of Financial Institu- tions, Markets and Instruments: Initial Considerations—Back- ground Paper’’ (available at http://www.bis.org/publ/othp07b.pdf) by participating in a comprehensive survey on what factors con- tribute to the classification of systemic importance. This report identified size, interconnectedness, substitutability, complexity, and cross-jurisdictional activity as trends in countries’ assessments of systemic importance. Q.13. It is my understanding that custodial banks have faced in- creasing difficulty in accepting cash deposits from their clients such as investment funds and institutional investors, in part due to reg- ulatory requirements that provide disincentive for custodial banks to hold cash. Nonetheless, custodial banks play an important role of handling cash for investment funds and now face a multitude of regulations that inhibit their core activities. Please provide a copy of any analysis the Federal Reserve has conducted to evaluate the impact of new regulations on custody banks’ ability to accept cash deposits. Please provide a copy of each analysis conducted by the Federal Reserve which considers the impact that such regulations would have on a custody bank during times of financial stress. Please explain policy rationale for disincentivizing cash holdings by custodial banks. 1112 U.S.C. §5365(a)(2)(A). VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00043 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 40 A.13. I will first respond to your last inquiry, then to the first two. With regards to part (c), regulatory requirements that have been established by the Federal Reserve since the financial crisis are meant to address risks to which banking organizations are exposed, including the risks associated with funding in the form of cash de- posits. The requirements were designed to increase the resiliency of banking organizations, enabling them to continue serving as fi- nancial intermediaries for the U.S. financial system and as sources of credit to households, businesses, State governments, and low-in- come, minority, or underserved communities during times of stress. The supplementary leverage ratio rule (SLR rule), which requires internationally active banking organizations to hold at least 3 per- cent of total leverage exposure in tier 1 capital, calculates total le- verage exposure as the sum of certain off-balance sheet items and all on-balance sheet assets.12 The on-balance sheet portion does not take into account the level of risk of each type of exposure and includes cash. As designed, the SLR rule requires a banking orga- nization to hold a minimum amount of capital against on-balance sheet assets and off-balance sheet exposures, regardless of the risk associated with the individual exposures. This leverage require- ment is designed to recognize that the risk a banking organization poses to the financial system is a factor of its size as well as the composition of its assets. Excluding select categories of on-balance sheet assets, such as cash, from the total leverage exposure would generally be inconsistent with this principle. Moreover, in some instances the regulatory requirements regard- ing liquidity and liquidity risk management provide a favorable treatment to specific types of cash deposits. For example, the out- flow rates for deposits under the Liquidity Coverage Ratio: Liquid- ity Risk Management Standards rule (LCR rule) are based on fac- tors such as counterparty type and tenor.13 Relevant to the activi- ties of custodial banks, the LCR rule provides favorable outflow treatment to operational deposits because the LCR rule acknowl- edges that these types of deposits exhibit a more stable funding profile than non-operational funding.14 To be afforded this favor- able treatment, the deposits must meet a set of specific criteria as- sociated with such increased stability.15 In this way, the LCR rule takes into account the risk that is inherent in the particular type of deposit held at the bank. With regard to parts (a) and (b) of Question 13, as part of several rulemakings that are applicable to U.S. banking organizations identified as global systemically important banking organizations (G–SIBs), which includes the largest U.S. custodial banking organi- zations, Federal Reserve staff estimated the impact that such rulemakings would have on these firms’ regulatory capital ratios, including on the leverage ratio. 12See 79 FR 57725 (September 26, 2014), available at http://www.gpo.gov/fdsys/pkg/FR- 2014-09-26/pdf/2014-22083.pdf. 13See 79 FR 61440 (October 10, 2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014- 10-10/pdf/201422520.pdf. 14See page 61502 of 79 FR 61440 (October 10, 2014), available at http://www.gpo.gov/fdsys/ pkg/FR-2014-1010/pdf/2014-22520.pdf. 15See page 61498 of 79 FR 61440 (October 10, 2014), available at: http://www.gpo.gov/fdsys/ pkg/FR-2014-1010/pdf/2014-22520.pdf. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00044 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 41 For example, in April 2014, the Federal Reserve issued a final rule that would require U.S. top-tier bank holding companies iden- tified as G–SIBs to maintain an SLR of more than 5 percent to avoid restrictions on capital distributions and discretionary bonus payments to executive officers.16 Insured depository institutions of these BHCs must maintain at least a 6 percent SLR to be ‘‘well- capitalized’’ under the Federal banking agencies’ prompt corrective action framework. Prior to finalizing these requirements, the staff of the Federal banking agencies, including the Federal Reserve, analyzed regulatory and confidential supervisory data to determine the quantitative impact of these rules on subject firms. Federal Re- serve staff estimated a tier 1 capital shortfall across U.S. G–SIBs of approximately $68 billion to meet a 5 percent SLR, but all inter- nationally active banking organizations firms were estimated to al- ready meet the minimum 3 percent SLR requirement.17 The SLR rule requires public disclosures beginning in 2015, and provides a transitional period until January 1, 2018, for firms to comply with these standards. According to their public disclosures, U.S. G–SIBs have made significant progress in complying with the enhanced SLR standards that take effect in 2018. As another example, more recently, in July 2015, the Federal Re- serve finalized a rule that would implement risk-based capital sur- charges for U.S. G–SIBs.18 Federal Reserve staff estimated the capital surcharges that would apply to the eight U.S. bank holding companies identified as G–SIBs under the final rule. Based upon these estimates, seven of the eight G–SIBs already meet their G– SIB surcharges on a fully phased-in basis, and all such firms are on their way to meeting their surcharges over the 3-year phase-in period from January 1, 2016, to fully phased in on January 1, 2019. Therefore, it is likely that the immediate costs of the final rule on individual institutions are significantly mitigated by the implemen- tation timeframe.19 16See 79 FR 24528 (May 1, 2014), available athttp://www.gpo.gov/fdsys/pkg/FR-2014-05-0l/ pdf/2014-09367.pdf. 17See Staff memo to the Board ‘‘Draft Final Rule on Enhanced Supplementary Leverage Ratio (SLR) Standards’’; p. 2, available at http://www.federalreserve.gov/aboutthefed/boardmeetings/ 20140408openmaterials.htm. 18See 80 FR 49107 (August 14, 2015), available at http://www.gpo.gov/fdsys/pkg/FR-2015- 08-14/pdf/201518702.pdf. 19See Staff memo to the Board ‘‘Draft Final Rule Regarding Risk-Based Capital Surcharges for Systemically Important U.S. Bank Holding Companies’’; p. 9, available at http:// www.federalreserve.gov/aboutthefed/boardmeetings/board-memo-gsib-20150720.pdf. 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YELLEN Q.1. I submitted a question for the record at your last hearing that focuses on the Federal Reserve’s waiver authority under the ad- vanced approaches regulation. In the response, you noted there were five criteria against which the Federal Reserve would judge a waiver application. Please provide information on how you define those criteria and how you would apply them. A.1. As set forth in the advanced approaches risk-based capital rule (the advanced approaches rule), the Board of Governors of the Federal Reserve System (Board) may determine that the applica- tion of the advanced approaches rule to a particular firm is not ap- propriate in light of the firm’s asset size, level of complexity, risk profile, or scope of operations.1 Based on these criteria, the Board has exempted from, or determined not to apply, the advanced ap- proaches rule to two State member banks, certain U.S. subsidiaries of foreign banking organizations, and GE Capital Corporation (GECC). Exemption for Two State Member Banks The Board has exempted from the advanced approaches rule two special purpose State member banks that were subsidiaries of bank holding companies.2 In each case, the State member bank was sub- ject to the advanced approaches rule because the parent bank hold- ing company was subject to the advanced approaches rule. Each of the banks had limited credit risk because each engaged in a narrow range of deposit, loan, and other banking services. One of the banks was a limited purpose trust bank with no FDIC-insured de- posits. The other bank engaged primarily in back-office operations and maintained very high capital levels. In addition, each bank’s total assets represented less than 1 percent of the total consoli- dated assets of its bank holding company. In exempting these banks from the advanced approaches rule, the Board considered the limited activities and operations of the banks, risks posed by the banks to the overall banking organiza- tion, and the enterprise-wide risk-management practices and ongo- ing implementation of the advanced approaches rule by the holding company. After the Board granted the exemptions, each of the bank holding companies continued to be required to capture the risks of its subsidiary bank in its advanced systems and to hold capital at the consolidated level against these risks. Certain U.S. Subsidiaries of Foreign Banking Organizations The Board also has exempted certain U.S. subsidiaries of foreign banking organizations from the requirements of the advanced ap- proaches rule. Under the enhanced prudential standards regulation (Regulation YY, 12 CFR part 252), a foreign banking organization with U.S. nonbranch assets of $50 billion or more is required to form or designate a U.S. intermediate holding company (IHC) to 112 CFR 217.100(b)(2). 2The advanced approaches rule applies to a State member bank that has total consolidated assets equal to $250 billion or more, that has consolidated total on-balance sheet foreign expo- sure equal to $10 billion or more, or that is a subsidiary of a holding company or depository institution that is subject to the advanced approaches rule. See 12 CFR 217.100(b)(1)(ii). VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00177 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 174 hold its interests in its U.S. subsidiaries.3 While an IHC is gen- erally subject to the same risk-based and leverage capital rules that apply to a bank holding company, the IHC is not required to comply with the Board’s advanced approaches rule.4 Prior to IHC formation, a bank holding company that is a subsidiary of a foreign banking organization and that currently is subject to the advanced approaches rules may, with the Board’s prior written approval, elect not to comply with the advanced approaches rule.5 As with the exemptions for the two limited purpose State mem- ber banks, the risks of the IHCs are captured in the consolidated capital requirements and risk management systems of its parent foreign banking organization. In addition, each IHC will remain subject to the Board’s standardized risk-based capital rules, lever- age capital rules, and capital planning and supervisory stress test- ing requirements. GECC Section 165 of the Dodd-Frank Wall Street Reform and Con- sumer Protection Act generally requires the Board to apply en- hanced prudential standards, including risk-based capital require- ments, to nonbank financial companies supervised by the Board.6 In the case of GECC, the Board applied the same risk-based capital requirements that apply to bank holding companies, except for the advanced approaches rule.7 In particular, as noted in the Board’s draft order applying enhanced prudential standards to GECC, the advanced approaches rule requires the development of models for calculating advanced approaches risk-weighted assets, and can re- quire a lengthy parallel run period of no less than four consecutive calendar quarters during which the firm must submit its models for supervisory approval.8 While GECC exceeds the threshold for application of the requirements that apply to advanced approaches banking organizations, GECC had not previously been subject to regulatory capital requirements and had not developed the infra- structure and systems required to begin calculating its capital ra- tios under the advanced approaches rule.9 Moreover, GECC is un- dergoing a substantial reorganization. The Board determined to apply to GECC the same minimum capital requirements that apply to all bank holding companies under the Board’s Regulation Q (12 CFR part 217) through December 31, 2017, and the Board’s regu- latory capital framework applicable to advanced approaches bank- ing organizations, except for the advanced approaches rule, there- after unless GECC is no longer designated for Board supervision at that time.10 Other Firms In determining whether to apply the advanced approaches rule to other firms, the Board would, in each case, make a determina- 3See 12 CFR 252.153. 412 CFR 252.153(e)(2)(i)(A). 512 CFR 252.153(e)(2)(i)(C). 612 U.S.C. §5365. 779 FR 71768, 71772 (Dec. 3, 2014). 8Id. The Board referenced these considerations in the final order applying enhanced pruden- tial standards to GECC. See 80 FR 44111, 44117 (July 24, 2015). 979 FR at 71772. 10See 80 FR at 44125. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00178 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 175 tion based on the relevant facts and circumstances, consistent with the safety and soundness of the firm. As shown in these examples, this would include, among other things, consideration of the firm’s size, complexity, risk profile, and scope of operations, including its capacity to implement the advanced approaches rule; a balancing of the cost to implement advanced approaches systems against the added risk management value; whether the firm’s risks are cap- tured by a parent banking organization’s systems; and other rel- evant facts. RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER FROM JANET L. YELLEN Q.1. Ms. Yellen, is the Federal Reserve Board involved in negoti- ating international insurance standards for entities beyond those you supervise? A.1. The Federal Reserve participates in the International Associa- tion of lnsurance Supervisors (IAIS) as the supervisor of nonbank systemically important financial institutions and savings and loan holding companies with significant insurance activities. Along with members from the Federal Insurance Office and the National Asso- ciation of lnsurance Commissioners, we advocate for the develop- ment of international standards at the IAIS that meet the needs of the our domestic insurance market and consumers. Standards developed at the IAIS are not self-executing, or binding on the U.S. insurance companies unless adopted by the appropriate U.S. regu- lators in accordance with applicable domestic laws and rulemaking procedures. The IAIS standards could apply to entities that we do not supervise if they were adopted as law or regulation by the ap- propriate authorities in a particular jurisdiction. This is true of all supervisors who participate at the IAIS since no insurance super- visor has global authority. RESPONSES TO WRITTEN QUESTIONS OF SENATOR HELLER FROM JANET L. YELLEN Q.1. During your July 15, 2015, testimony in the House Committee on Financial Services you briefly indicated some vagueness on the path forward regarding the development of domestic insurance cap- ital standards for companies in the United States. On April 1, 2015, you wrote a letter to me stating: ‘‘we are committed to invit- ing public comment on a draft proposal through a formal rule- making process.’’ I request your confirmation that it is your final decision to develop domestic insurance capital standards through formal rulemaking and public comment and not by an order. A.1. Thank you for the opportunity to clarify. The response pro- vided to you in my letter dated April 1, 2015, is accurate. We are committed to a formal rulemaking process in the development of a domestic insurance capital standard. Issuance of a final rule will commence after we assess the feedback given during the Notice of Proposed Rulemaking. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00179 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 176 RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE FROM JANET L. YELLEN Q.1. In 2013, Senator Crapo asked then Chairman Bernanke to list bipartisan financial regulatory reforms that Congress should con- sider enacting. Bernanke responded by mentioning end-user issues, the swaps push out, and regulatory relief for small financial insti- tutions. Certainly everyone can agree that Dodd-Frank is not per- fect. Can you list bipartisan financial regulatory reforms that you believe Congress should enact? A.1. The core Dodd-Frank Act and Basel III reforms have made the global and U.S. financial systems more resilient. These core re- forms include much stronger capital requirements and stress test- ing for large banking firms; strong liquidity requirements for large banking firms; a new resolution regime for systemically important financial institutions (SIFIs) and improvements to the resolvability of SIFIs; central clearing and margin requirements for over-the- counter derivatives; and the creation of the Financial Stability Oversight Council. I believe these reforms have made the financial system signifi- cantly more stable, but we have more work to do. Some of the re- maining steps include: (i) finalization of a few remaining Dodd- Frank Act reforms, such as swap margin rules and single- counterparty credit limits for large bank holding companies; imple- mentation of the Net Stable Funding Ratio (NSFR) in the United States to reduce risks from short-term wholesale funding in our banking system; and continued improvements to the resolvability of our largest and most complex firms, including through issuance by the Board of a long-term debt proposal and continuing work by the Board and the FDIC to improve resolution planning by these firms. The Board has supported targeted financial regulatory reforms in the past few years, including amendments to the Dodd-Frank Act provisions that address treatment of end users in the swap margin rules and changes to the Collins Amendment of the Dodd-Frank Act to better enable the Board to design capital requirements for insurance holding companies as well as provisions to expand the scope of coverage of our Small Bank Holding Company Policy Statement. The Board continues to support additional targeted re- lief for small banking organizations, such as exempting banking firms with less than $10 billion in assets from the Volcker rule and the incentive compensation provisions of the Dodd-Frank Act. As I have previously stated, I would also support a modest increase in the $50 billion threshold in section 165 of the Dodd-Frank Act, so long as such modest increase did not reduce the Board’s authority to apply an appropriate set of prudential standards on any firms that fell below the new threshold. Q.2. I’m very concerned about the troubling developments in Greece, including their inability to keep their fiscal house in order. Over the long-term horizon, are there parallels that exist now or that could develop between the United States and Greece that would trouble you? What steps could we take now to prevent these parallels from developing? VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00180 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 177 A.2. Greece’s current fiscal and economic situations are difficult. However, there are no real parallels between Greece and the United States. Greece’s precarious fiscal position prior to the crisis left it ill-equipped to use fiscal policy to buffer the effects of the re- cession, which was particularly problematic as Greece could not avail itself of its own monetary policy because it is a member of the euro area. In addition, its access to financial markets was ham- pered by a lack of trust in Greek fiscal institutions. It is important to note that Greece’s troubles reflect much more than just its fiscal position. In sum, the events in underscore the value of sound struc- tural policies, Government finances, and macroeconomic institu- tions. Q.3. My understanding is that the Financial Stability Board’s pro- posed methodologies for designating asset manager companies and mutual funds as G–SIFIs, as proposed in the FSB’s March 2015 re- port, ‘‘Assessment Methodologies for Identifying Non-Bank Non- Insurer Global Systemically Important Financial Institutions’’ uses size thresholds that singles out only U.S. entities. Is this true and is there a risk that designating only U.S. entities would create com- petitiveness concerns for the U.S.? A.3. Under the March 2015 report of the Financial Stability Board (FSB), materiality thresholds would be used to provide an initial filter of nonbank, non-insurance (NBNI) entities that would be sub- ject to further analysis to determine whether such entities should be designated as NBNI global systemically important financial in- stitutions (NBNI G–SIFls). Thus, while NBNI entities that exceed the thresholds would be subject to further analysis, they would not necessarily be designated as NBNI G–SIFIs. It is important to note that none of the thresholds are tied to a firm’s place of domicile or incorporation; an entity from any jurisdiction could qualify for fur- ther analysis. The March 2015 proposal described two possible materiality thresholds that could be used exclusively or in combination to evaluate asset management companies. Under the first option, an asset manager would be subject to further assessment if its balance sheet exceeded a particular threshold (e.g., $100 billion). Under the second option, an asset manager would be subject to further assess- ment if it had more than a particular amount of assets under man- agement (e.g., $1 trillion). Two possible materiality thresholders were also proposed for tra- ditional investment funds. Under the first option, a traditional in- vestment fund would be subject to further assessment if (1) its net asset value (NAV) exceeded $30 billion and it had balance sheet le- verage of three times NAV or (2) the assets under management of the fund exceeded $100 billion. Under the second option, a tradi- tional investment fund would be subject to further analysis if its gross assets under management exceeded $200 billion, unless it can be demonstrated that the fund is not a dominant player in rel- evant markets. On July 30, 2015, the FSB announced that it will wait to finalize the assessment methodologies for NBNI G–SIFIs until further work on financial stability risks from asset management activities is completed. This will allow further analysis of potential financial VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00181 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 178 stability issues associated with asset management entities and ac- tivities to inform the revised NBNI methodology. Q.4. I am concerned that international regulators do not under- stand the unique aspects of our financial system. For example, Basel III’s capital framework severely limits the amount of mort- gage servicing asset banks can hold without paying a significant capital charge. Many think it doesn’t make sense to draw such an arbitrary line, especially when it comes at such a cost to commu- nity banks. Banks in my State tell me that the Basel III nego- tiators ignored or failed to understand the important role of com- munity banks in the United States financial system. That’s cause for deep concern. Are there areas where you believe the FSB has ignored or failed to understand aspects of our U.S. financial sys- tem, for example in Basel III’s treatment of community banks? A.4. The Federal Reserve recognizes the critical role community banking organizations play in the U.S. economy, and the revised regulatory capital rule (rule) puts in place a regulatory regime that takes into account their business model and economic function, as well as the reduced risks to U.S. financial stability presented by community banks. Prior to issuing the final rule, the agencies conducted a pro forma impact analysis as of March 31, 2012. The analysis, which incorporated the rule’s revised treatment of mortgage servicing as- sets (MSAs), indicated that more than 90 percent of bank holding companies with assets under $10 billion that met the existing cap- ital requirements at the time would meet the minimum common equity tier 1 (CET1) capital ratio of 41⁄ 2 percent and that more than 80 percent of such bank holding companies would meet the fully phased-in common equity plus capital conservation buffer level of 7 percent.1 Based on data publicly reported from these in- stitutions on the Consolidated Financial Statements for Holding Companies (FR Y-9C), as of July 31, 2015, more than 95 percent of these bank holding companies would exceed a 7 percent CET1 capital ratio.2 With regard to MSAs in particular, as noted in the preamble to the final rule, the Federal banking agencies’ capital rules have long limited the inclusion of MSAs and other intangible assets in regu- latory capital. This is because of the high level of uncertainty re- garding the ability of banking organizations to realize value from these assets, especially under adverse financial conditions. Under the final rule, certain deferred tax assets (DTAs) arising from temporary differences, MSAs, and significant investments in the capital of unconsolidated financial institutions in the form of common stock are each subject to an individual limit of 10 percent of CET1 capital elements and are subject to an aggregate limit of 15 percent of CET1 capital elements. The amount of these items in excess of the 10 and 15 percent thresholds are to be deducted from 1See Attachment A ‘‘FRB Impact, Methodology, and Assumptions’’ to Michael S. Gibson’s tes- timony on Basel III before the Committee on Banking, Housing, and Urban Affairs on November 14, 2012, available at http://www.federalreserve.gov/newsevents/testimony/ gibson20121l14a2.pdf. The final rule implementing the Regulatory Capital Rules, 78 FR 62018 (October 11, 2013) is available at: http://www.gpo.gov/fdsys/pkg/FR2013-11-29/pdf/2013- 27082.pdf. 2FR Y-9C data is publicly available from the National Information Center, available at: http://www.ffiec.gov/nicpubweb/nicweb/nichome.aspx. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00182 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 179 CET1 capital. Amounts of MSAs, DTAs, and significant invest- ments in unconsolidated financial institutions that are not de- ducted due to the aforementioned 10 and 15 percent thresholds must be assigned to the 250 percent risk weight.3 The rule’s treatment of MSAs contributes to the safety and soundness of banking organizations by mitigating against MSA market value fluctuations that may adversely affect banking orga- nizations’ regulatory capital base. Moreover, the financial crisis demonstrated that the liquidity— in the form of sales, exchanges, or transfers—of MSAs may become unreliable at a time when banking organizations are especially in need of such liquidity. Furthermore, the Federal Deposit Insurance Corporation, as receiver of failed insured depository institutions, has generally found MSAs to be unmarketable during periods of adverse economic and financial conditions for a variety of reasons related to the size of the mortgage portfolio and contingent liabil- ities arising from selling representations and warranties associated with MSAs.4 The Federal Reserve is mindful of community banking organiza- tions’ concerns about aggregate regulatory burden, including both safety and soundness and consumer regulation. In that regard, sev- eral elements of the revised capital rule only apply to large bank- ing organizations and do not apply to community banking organiza- tions. Specifically, banking organizations that qualify as advanced approaches Board-regulated institutions (those with $250 billion or more in consolidated total assets or $10 billion or more in consoli- dated total on-balance-sheet foreign exposures) are subject to the countercyclical capital buffer, supplementary leverage ratio, capital requirements for credit valuation adjustments, and disclosure re- quirements.5 Banking organizations with trading assets and liabil- ities of at least $1 billion or 10 percent of its total assets are sub- ject to market risk capital requirements.6 Community banking or- ganizations also are not subject to the enhanced standards that larger bank holding companies face related to capital plans, stress testing, liquidity and risk management requirements, and the glob- al systemically important banking organization surcharge. In addi- tion, consistent with recent statutory changes, the Federal Reserve expanded the applicability of its Small Bank Holding Company Pol- icy Statement, which has the effect of exempting virtually all bank holding companies and savings and loan holding companies with less than $1 billion in total consolidated assets from the Federal Reserve’s regulatory capital rules.7 Q.5. Securities and Exchange Commissioner Dan Gallagher re- cently argued that ‘‘it remains the height of regulatory hubris to assume that not only is there a single regulatory solution to any 3See 79 FR 62018 (October 11, 2013), available at http://www.gpo.gov/fdsys/pkg/FR-2013- 11-29/pdf/201327082.pdf. See also ‘‘Final Rule on Enhanced Regulatory Capital Standards— Implications for Community Banking Organizations’’, available at http://www.gpo.gov/fdsys/ pkg/FR-2013-11-29/pdf/2013-27082.pdf. 4See 79 FR 62018 (October 11, 2013), available at http://www.gpo.gov/fdsys/pkg/FR-2013- 11-29/pdf/201327082.pdf. 5Id. 6See 78 FR 76521 (December 18, 2013), available at http://www.gpo.gov/fdsys/pkg/FR- 2013-12-18/pdf/201329785.pdf. 7See 80 FR 20153 (April 15, 2015) available at: http://www.gpo.gov/fdsys/pkg/FR-2015-04- 15/pdf/201508513.pdf. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00183 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 180 given problem facing our markets, but that a handful of mandarins working in an opaque international forum can find those perfect so- lutions.’’ He argues that when regulators get things wrong, they risk things going wrong everywhere because of the regulatory international cooperation. He cites Basel’s classification of residen- tial mortgage backed securities as lower-risk as an example, which partially led to the housing bubble and subsequent financial crisis. Given this example, is there a risk that increasing international regulations actually increases systemic risk by creating a firm ho- mogeneity that’s shaped by regulation? If firms are all subjected to similar regulatory standards—a ‘‘one- size-fits-all approach’’—won’t their balance sheets end up looking the same, and thus subject to the same risk? A.5. It is important for financial regulation to be tailored to the business mix, risk profile, size, and systemic footprint of individual financial firms. The Federal Reserve is a strong supporter of gradating the strin- gency of supervision and regulation to the size and systemic foot- print of individual banking firms. And we have been doing what we can with our existing legal authority to do that kind of tailoring, including with respect to the enhanced prudential standards for large bank holding companies in section 165 of the Dodd-Frank Act. We have already done quite a bit of tailoring in this area to make sure that the most systemic banking firms are subject to a much tougher regulatory and supervisory framework than regional banking firms, and we are analyzing whether there is more that we can do. The Federal Reserve’s commitment to regulatory tailoring is also manifest in our support of Congressional efforts to modify the Col- lins Amendment in the Dodd-Frank Act to better enable us to de- sign a regulatory framework for insurance holding companies that is appropriately tailored to the business of insurance. We appre- ciate the work of Congress to give us this flexibility through the passage of The Insurance Capital Standards Clarification Act of 2014. Similarly, we would not support any international insurance capital standard that is not appropriately tailored to the business of insurance. The Federal Reserve participates in various international stand- ard setting and policymaking bodies—including the Basel Com- mittee on Banking Supervision (BCBS), the Financial Stability Board (FSB), and the International Association of Insurance Super- visors (IAIS). Our work in these organizations is designed in sig- nificant part to achieve greater comparability across jurisdictions in the core prudential supervisory and regulatory frameworks that apply to internationally active financial firms. Well-designed inter- national prudential frameworks for large, globally active financial firms should promote global and U.S. financial stability, provide a more level playing field for internationally active U.S. financial firms, and enhance supervisory cooperation and coordination among global supervisors. The Federal Reserve is committed in its international regulatory work to ensure that any global standards work well for U.S. financial firms and U.S. financial markets. Moreover, no global standard has binding effect in the United VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00184 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 181 States unless and until a U.S. regulatory authority goes through appropriate domestic notice-and-comment processes. Q.6. Capital regulations for insurance companies is an important issue that has a significant impact on insurance policyholders in my State. This April, Mark Van Der Weide, Deputy Director for the Fed- eral Reserve’s Division of Banking Supervision and Regulation, ex- plained that the Federal Reserve supports developing an Inter- national Capital Standard (JCS) because it can promote financial stability and ‘‘help provide a level playing field for global financial institutions.’’ I’m concerned that efforts to ‘‘level the playing field,’’ will ‘‘level’’ the field by hurting U.S. insurance companies and their policy- holders, by forcing them to comply with Europe’s overly stringent insurance regulations. As Dr. Adam Posen recently argued at a hearing with the Senate Banking Committee, the FSB’s efforts to ‘‘extend Solvency II, the European Commission’s regulation for in- surance firms, to global application’’ will be harmful for U.S. insur- ance policyholders, because it ‘‘tries to add on capital holding re- quirements of Government bonds and short-term assets akin to what is (rightly) required for banks.’’ He goes on to argue that Eu- ropean insurers are now ‘‘using the FSB to impose it on the U.S., Japanese, and other competing insurers.’’ Are there aspects of Solvency II would be harmful if they were imposed on U.S. insurers? Are there other areas where you believe the FSB has ignored or failed to understand aspects of our State-based insurance regu- latory system? What is the Federal Reserve doing to ensure that international insurance standards do not encroach on the U.S. State-based insur- ance system and that other countries don’t use the FSB and the IAIS to impose stringent and senseless regulations on U.S.-based insurers? A.6. The Federal Reserve participates as a member of the Financial Stability Board (FSB) and International Association of Insurance Supervisors (IAIS). Along with other organizations from the United States including the Federal Insurance Office and the National As- sociation of Insurance Commissioners, the Federal Reserve advo- cates for the development of international standards that best meet the needs of the U.S. insurance market. The details of these inter- national standards are still being determined. The FSB’s work to date has primarily focused on the identification and development of policy measures for Globally Systemically Important Insurers (G–SIIs) including through the adoption of an assessment method- ology built by the IAIS. The IAIS continues to work on developing policy measures to be applied to G–SIIs. The Federal Reserve would not support any international insur- ance standard that is not appropriately tailored to the business of insurance and in the best interest of the United States insurance market. Aspects of Solvency II that could be problematic include its reliance on models built by the regulated companies and its ac- counting systems market value basis. VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00185 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 182 The international insurance standards currently under develop- ment at the IAIS are not self-executing or binding on the U.S., ei- ther at the State or the Federal level. They would only apply in the U.S. if adopted by the appropriate U.S. regulators in accordance with applicable domestic rulemaking procedures. The Federal Re- serve is working to ensure that any standard adopted allows for the equitable treatment of U.S.-based insurers operating abroad. None of the standards are intended to replace the existing legal en- tity risk-based capital requirements that are already in place with- in the State-based regulatory regime. Q.7. Insurance experts have levied a number of criticisms against the Financial Stability Board as it relates to the international regu- latory process. This includes that the FSB designates insurance companies as globally systemically important before the FSOC des- ignates them as systemically important, concerns about the unac- countable process by which the FSB arrives at its decision to label global systemically important insurers, the lack of a clear ‘‘off- ramp’’ for companies to lose their designation, and the risk that international regulations undermine our State-based regulatory system. What FSOC or FSB reforms are you prepared to support on these issues? A.7. The IAIS, in coordination with the FSB, developed a proposed methodology and framework for measuring the systemic footprint of global insurers. IAIS made public its proposed designation framework and methodology for global systemically important in- surers (G–SIIs) multiple times for public comment. Any insurance company, and any member of the public, had the opportunity to comment on the proposal. The Federal Reserve strongly supports public transparency in the methods and processes that inter- national organizations use to identify systemically important finan- cial firms. Importantly, IAIS and FSB decisions about the identification of global systemically important insurers are not binding on the United States. FSOC makes its own independent decisions on des- ignating nonbank financial firms, using the statutory standards set forth in the Dodd-Frank Act. I would note that the IAIS and FSB use a somewhat different standard to make designation decisions than does the FSOC. The international organizations focus on a firm’s global systemic footprint and primarily use an algorithm to make their decisions, whereas the FSOC focuses on impact on U.S. financial stability and uses a more judgment-based, firm-specific approach. With respect to the FSOC, I am firmly committed to promoting transparency and accountability in connection with the FSOC’s ac- tivities. To implement its designation authority, FSOC initially de- veloped a framework and criteria and sought public comments twice on the framework. After publishing guidance, FSOC began the process of assessing individual companies from a list of compa- nies that met the quantitative criteria set out in the guidance. Throughout the fall of 2014, FSOC engaged in outreach to stake- holders regarding the designations process. Based on that outreach, FSOC identified changes to the designations process that would en- VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00186 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 183 able earlier engagement with companies under review and increase transparency to the public, without compromising the FSOC’s abil- ity to conduct its work and protect confidential company informa- tion. These new processes went into effect in February. We will continue to work with the FSOC and the Congress to ensure that the process for designations is transparent and accountable. The FSOC’s designation of a nonbank financial firm is not in- tended to be permanent. Dodd-Frank Act provides that FSOC an- nually review designations to make sure that they remain appro- priate, and take into account significant changes at the firms. At the time of designation, firms are given a detailed explanation as to the specific factors that led to their designation. Firms can use that information, as well as the public criteria set forth by FSOC, to guide their efforts to reduce their systemic footprint. RESPONSES TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM JANET L. YELLEN Q.1. Before the financial crisis under President Bush, our country saw policies of ‘‘trickle-down economics,’’ focused on tax benefits for individuals at the top of the distribution and budget cuts for every- one else. The results were predictable—incomes grew at the very top, but stagnated for everyone else. Then, during the crisis and recession, families in the middle and at the bottom were hit particularly hard. So for the vast majority of families, it’s been a long time since they’ve seen a meaningful raise. Now, our economy is recovering, but we haven’t reached the point yet where growth feels truly broad-based. Like most Americans, I don’t begrudge financial success, but I’m concerned when the vast majority of people in our country feel they are not sharing in economic growth, and when widening disparity makes it harder for ordinary working families to move up the lad- der. In balancing the Fed’s dual mandate of creating jobs and fighting inflation, how does the Fed account for the very different ways Americans are experiencing the same economy, depending on where they are on the income and wealth spectrum? A.1. The Congress has instructed the Federal Reserve to pursue a dual mandate, which involves promoting both maximum employ- ment and price stability. Generally speaking, these objectives per- tain to the overall national situation. The Federal Reserve will aim, to the best of its ability, to deliver the strongest labor market con- sistent with its 2 percent inflation objective. In doing so, we will be setting the best possible macroeconomic backdrop for all groups to attain the greatest prosperity that can be sustained. To be sure, a range of other policy steps outside the realm of monetary policy may be appropriate to achieve additional objectives, but such policy steps are not within the remit of the Federal Reserve. Q.2. How does the Fed factor in wage history when looking for signs of when to tighten? Meaning, if average working families have gone a long period without real wage growth, would that call for waiting longer to tighten instead of raising rates at the first sign of an increase? VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00187 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 184 A.2. Wage data are one of many sets of indicators that we consult in determining the appropriate stance of monetary policy. In prin- ciple, wage behavior can be informative about both aspects of our dual mandate—price stability and maximum employment. If wage growth is weak, that may be a sign both that labor markets are in a relatively slack condition, and thus that the maximum employ- ment aspect of our mandate is not fulfilled; and it may be a sign that inflation pressures will be less intense. The symmetric state- ments could be made if wage growth were strong. That said, many factors affect wages, including productivity growth, global competi- tion, the nature of technological change, and trends in unioniza- tion, that are outside of the Federal Reserve’s control. For such rea- sons, wages are but one of many indicators that policymakers con- sult for evidence of how close or far we are from achieving our dual mandate. RESPONSES TO WRITTEN QUESTIONS OF SENATOR DONNELLY FROM JANET L. YELLEN Q.1. Chair Yellen, in addition to your comments about the shadow banking system, are there other developments in the global or do- mestic economy that you are monitoring for potential risks to fi- nancial stability? Many people are rightly focused on Greece and China, but I worry about the economic obstacles we do not see coming. Should we be worried about increasing corporate debt, a liquidity crisis, or is it something else entirely? In other words, what are the less ob- vious threats to economic and financial stability that you are watching closely? A.1. As you know, since the financial crisis and recession of 2007– 2009, we have put in place a comprehensive system to monitor the financial system for building vulnerabilities. The financial system and the broader economy will always be buffeted by shocks that are unexpected or that cannot be mitigated by policymakers, in- cluding, as you point out, events abroad. However, the potential for these shocks to grow and spread is greater when the financial sys- tem is more vulnerable. This effect was on full display during the last recession, when losses on risky mortgages led to problems in the financial system that ultimately impeded the ability of credit- worthy businesses and households to finance investments. We judge that financial vulnerabilities in the U.S. financial sys- tem overall continue to be about where they have been for the past 6 months—at a moderate level. Factors suggesting that the finan- cial system remains robust include the extremely strong capital and liquidity positions of the largest banking organizations relative to recent history and modest debt growth among households. Among factors suggesting increasing vulnerabilities are, as you pointed out, the continued rapid clip of borrowing by lower-rated businesses and stretched valuations among a number of assets, in- cluding commercial real estate. Liquidity has indeed been an issue raised by policymakers, mar- ket participants, academics and others. In particular, the concern is that liquidity, especially in fixed-income markets, is now more likely to deteriorate significantly even under moderate stress. How- VerDate Nov 24 2008 11:53 Oct 29, 2015 Jkt 046629 PO 00000 Frm 00188 Fmt 6602 Sfmt 6602 L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 185 ever, a variety of metrics do not suggest a deterioration in day-to- day liquidity, with some mixed evidence that may point to less re- silient liquidity. This evidence is described in greater detail in July’s Monetary Policy Report.1 In addition, on July 13, 2015, the Federal Reserve, together with the Commodity Futures Trading Commission, the Securities and Exchange Commission, and the De- partment of Treasury published a joint report examining the events in the Treasury market on October 15, 2014—an episode when Treasury yields moved dramatically over a brief span of time.2 The Federal Reserve, together with other financial regulatory agencies, is continuing to study and monitor developments in market liquid- ity. 1See http://www.federalreserve.gov/monetarypolicy/files/20150715lmprfullreport.pdf. 2See http://www.treasury.gov/press-center/press-releases/Documents/ JointlStafflReportlTreasuryl10-15-2015.pdf. 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Janet L. Yellen (2015, July 15). Congressional Testimony. Testimony, Federal Reserve. https://whenthefedspeaks.com/doc/testimony_20150716_chair_federal_reserves_second_monetary_policy

@misc{wtfs_testimony_20150716_chair_federal_reserves_second_monetary_policy,
  author = {Janet L. Yellen},
  title = {Congressional Testimony},
  year = {2015},
  month = {Jul},
  howpublished = {Testimony, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/testimony_20150716_chair_federal_reserves_second_monetary_policy},
  note = {Retrieved via When the Fed Speaks corpus}
}