Congressional Testimony

MONETARY POLICY AND THE STATE OF THE ECONOMY HEARING BEFORETHE COMMITTEE ON FINANCIAL SERVICES U.S. HOUSE OF REPRESENTATIVES ONE HUNDRED FOURTEENTH CONGRESS SECOND SESSION FEBRUARY 10, 2016 Printed for the use of the Committee on Financial Services Serial No. 114–71 ( U.S. GOVERNMENT PUBLISHING OFFICE 23–566 PDF WASHINGTON : 2017 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 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 K:\DOCS\23566.TXT TERI HOUSE COMMITTEE ON FINANCIAL SERVICES JEB HENSARLING, Texas, Chairman PATRICK T. MCHENRY, North Carolina, MAXINE WATERS, California, Ranking Vice Chairman Member PETER T. KING, New York CAROLYN B. MALONEY, New York EDWARD R. ROYCE, California NYDIA M. VELA´ZQUEZ, New York FRANK D. LUCAS, Oklahoma BRAD SHERMAN, California SCOTT GARRETT, New Jersey GREGORY W. MEEKS, New York RANDY NEUGEBAUER, Texas MICHAEL E. CAPUANO, Massachusetts STEVAN PEARCE, New Mexico RUBE´N HINOJOSA, Texas BILL POSEY, Florida WM. LACY CLAY, Missouri MICHAEL G. FITZPATRICK, Pennsylvania STEPHEN F. LYNCH, Massachusetts LYNN A. WESTMORELAND, Georgia DAVID SCOTT, Georgia BLAINE LUETKEMEYER, Missouri AL GREEN, Texas BILL HUIZENGA, Michigan EMANUEL CLEAVER, Missouri SEAN P. DUFFY, Wisconsin GWEN MOORE, Wisconsin ROBERT HURT, Virginia KEITH ELLISON, Minnesota STEVE STIVERS, Ohio ED PERLMUTTER, Colorado STEPHEN LEE FINCHER, Tennessee JAMES A. HIMES, Connecticut MARLIN A. STUTZMAN, Indiana JOHN C. CARNEY, JR., Delaware MICK MULVANEY, South Carolina TERRI A. SEWELL, Alabama RANDY HULTGREN, Illinois BILL FOSTER, Illinois DENNIS A. ROSS, Florida DANIEL T. KILDEE, Michigan ROBERT PITTENGER, North Carolina PATRICK MURPHY, Florida ANN WAGNER, Missouri JOHN K. DELANEY, Maryland ANDY BARR, Kentucky KYRSTEN SINEMA, Arizona KEITH J. ROTHFUS, Pennsylvania JOYCE BEATTY, Ohio LUKE MESSER, Indiana DENNY HECK, Washington DAVID SCHWEIKERT, Arizona JUAN VARGAS, California FRANK GUINTA, New Hampshire SCOTT TIPTON, Colorado ROGER WILLIAMS, Texas BRUCE POLIQUIN, Maine MIA LOVE, Utah FRENCH HILL, Arkansas TOM EMMER, Minnesota SHANNON MCGAHN, Staff Director JAMES H. CLINGER, Chief Counsel (II) VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00002 Fmt 5904 Sfmt 5904 K:\DOCS\23566.TXT TERI C O N T E N T S Page Hearing held on: February 10, 2016 ............................................................................................ 1 Appendix: February 10, 2016 ............................................................................................ 55 WITNESSES WEDNESDAY, FEBRUARY 10, 2016 Yellen, Hon. Janet L., Chair, Board of Governors of the Federal Reserve System ................................................................................................................... 5 APPENDIX Prepared statements: Yellen, Hon. Janet L. ....................................................................................... 56 ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD Yellen, Hon. Janet L.: Monetary Policy Report of the Board of Governors of the Federal Reserve System, dated February 10, 2016 ................................................................ 64 Written responses to questions for the record submitted by Representa- tive Fincher ................................................................................................... 116 Written responses to questions for the record submitted by Representa- tive Hill .......................................................................................................... 118 Written responses to questions for the record submitted by Representa- tive Hultgren ................................................................................................. 120 Written responses to questions for the record submitted by Representa- tive Luetkemeyer .......................................................................................... 124 Written responses to questions for the record submitted by Representa- tive Lynch ...................................................................................................... 128 Written responses to questions for the record submitted by Representa- tive Messer .................................................................................................... 130 Written responses to questions for the record submitted by Representa- tive Mulvaney ................................................................................................ 131 Written responses to questions for the record submitted by Representa- tive Murphy ................................................................................................... 134 Written responses to questions for the record submitted by Representa- tive Sherman ................................................................................................. 135 Written responses to questions for the record submitted by Representa- tive Tipton ..................................................................................................... 137 Written responses to questions for the record submitted by Representa- tive Waters .................................................................................................... 139 (III) VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 K:\DOCS\23566.TXT TERI VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 K:\DOCS\23566.TXT TERI MONETARY POLICY AND THE STATE OF THE ECONOMY Wednesday, February 10, 2016 U.S. HOUSE OF REPRESENTATIVES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. The committee met, pursuant to notice, at 10:02 a.m., in room 2128, Rayburn House Office Building, Hon. Jeb Hensarling [chair- man of the committee] presiding. Members present: Representatives Hensarling, Royce, Lucas, Garrett, Neugebauer, McHenry, Pearce, Posey, Fitzpatrick, Luetke- meyer, Duffy, Hurt, Stivers, Stutzman, Mulvaney, Hultgren, Ross, Pittenger, Wagner, Barr, Rothfus, Messer, Schweikert, Guinta, Tip- ton, Williams, Poliquin, Love, Hill, Emmer; Waters, Maloney, Velazquez, Sherman, Meeks, Hinojosa, Clay, Lynch, Scott, Green, Cleaver, Moore, Ellison, Perlmutter, Himes, Carney, Sewell, Foster, Murphy, Delaney, Sinema, Beatty, Heck, and Vargas. Chairman HENSARLING. The Financial Services Committee will come to order. Without objection, the Chair is authorized to declare a recess of the committee at any time. This hearing is for the purpose of receiving the semiannual testi- mony of the Chair of the Board of Governors of the Federal Reserve System on the conduct of monetary policy and the state of the econ- omy. I now recognize myself for 3 minutes for an opening state- ment. Last month, we all heard President Obama attempt to take an economic victory lap in his State of the Union speech, but the American people are having none of it. They are tired of hearing from the out-of-touch ruling class in Washington just how good things are when their realities are vastly different. So, Chair Yellen, notwithstanding the fact that you are a Presi- dential appointee, I hope you do not follow suit this morning. The reality is, since the President was elected and the Fed em- barked upon its unprecedented quantitative easing in zero real in- terest rate policies, working families’ paychecks have declined. Their net worth has declined. The real unemployment rate continues to hover around 10 per- cent. Approximately one in six is on food stamps and almost 15 percent live in poverty. There hasn’t been a single year when eco- nomic growth has reached 3 percent. As one published report on this failure noted, ‘‘There is no par- allel for this since the end of World War II, maybe not since the beginning of the Republic.’’ Last year’s less than 1 percent GDP growth just punctuates the matter for struggling working families. (1) VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 2 I will not use this hearing to either praise or condemn the Fed’s decision to raise by 25 basis points interest rates in December, nor do I think it appropriate to advise the FOMC on how to vote during its next meeting. But, given that Article I, Section 8 of the Con- stitution gives Congress the power to coin money and regulate the value thereof, I do feel compelled to demand that the Fed adopt a monetary policy course that is predictable, transparent, sustain- able, and, barring terribly exigent circumstances, to stick with it. This is part of the rationale underlying the House-passed Fed Oversight Reform and Modernization Act, known as the FORM Act. To use Austrian economist Friedrich Hayek’s phrase: ‘‘It is fatal conceit to believe that the Fed is capable of micromanaging our economy to some state of economic nirvana.’’ We now have at least 8 years of recent history to prove otherwise. Most importantly, no amount of monetary policy can substitute for sound fiscal policy. Unless and until the crushing regulatory on- slaught of Obamacare, the Dodd-Frank Act, and the EPA is re- placed with greater opportunity, competition, and innovation, the Fed cannot substantially help our economy; it can only hurt it. It can hurt it by continuing to serve as the financier and facilitator or our unsustainable Federal debt. Just last month, the Congressional Budget Office yet again warned of our unsustainable debt in its latest baseline release, which references the debt 199 times. The Fed can hurt our economy by continuing to force investors to chase yield, thus inflating dangerous asset bubbles, the deflating of which we are likely seeing in our turbulent equity markets today. The Fed can continue to hurt our economy by failing to unwind its unprecedented balance sheet. By growing at almost 500 percent, the Fed itself has become one of our largest sources of systemic risk. Finally, separate and apart from monetary policy, alarmingly, the Fed, under Dodd-Frank, can now functionally control virtually every major corner of the financial services sector of our economy. It does so with almost no accountability or transparency. Not only does this harm economic growth, it is an affront to due process, checks and balances, and the rule of law. The American people should again be duly alarmed that they may wake up one day to discover that our central bankers have be- come our central planners. The Chair recognizes the ranking member of the committee, Ms. Waters, for 3 minutes for an opening statement. Ms. WATERS. Thank you, Mr. Chairman, for this meeting here today. But I would really like to thank Chair Yellen for being here with us today to discuss the state of the economy and your role in ensur- ing that a full recovery is achieved for all. As a result of your Her- culean efforts, the efforts of Democrats in Congress, and the Obama Administration, we have truly made tremendous progress since the darkest days of the financial crisis. Over the past 71 consecutive months, our economy has added more than 14 million private sector jobs, and the unemployment VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 3 rate has fallen by more than half. But despite this commendable progress, significant work remains. Wages have yet to see real gains: 7.8 million workers remain job- less; 6 million workers are involuntarily working part-time jobs; and another 2 million Americans indicate they would join the work- force if only the economy was strong enough to support them. With inflation consistently running below target, I wonder whether the expected path for further raising rates over the course of 2016 may overemphasize concerns about inflation and underesti- mate the weakness in our labor market. I look forward to your comments on this issue. Absent a full recovery, I fear that further raising rates may be a step that takes us further away from what is needed to ensure that the needs of vulnerable populations are met. At today’s hear- ing, I also hope we can explore the ramifications of an exit strategy that relies heavily on paying private sector banks not to lend the funds they hold in reserve and to discuss reasonable alternatives that may exist that do not involve a massive transfer of wealth from the Federal Reserve to private sector banks. I just wonder if it is possible for these funds to be used for work- ers who are really worried about whether or not they are going to have a pension, or if there can be some social responsibility invest- ment with these funds to help workers in vulnerable populations? Finally, many of us have been very patient about the implemen- tation of the living wills. As you know, this is a requirement in the Dodd-Frank Act, and it is designed to end too-big-to-fail. And I know that you have to give careful consideration to all of this, but after not one, not two, but five submissions, the Federal Reserve has yet to impose consequences for living wills that are not credible. What can we do about this? It is time we understand that we have given a lot of opportunities to the banks to get it right and they haven’t done that. Chair Yellen, I look forward to hearing your views on the econ- omy and I welcome the opportunity to discuss how we can more ef- fectively elevate the needs of the most vulnerable populations and promote a safe and sound financial system. And I want you to know that our audience today is made up of workers who really want to hear you talk about this, so I would welcome opportunities to address some of their concerns. I yield back the balance of my time. Chairman HENSARLING. The Chair now recognizes the gentleman from South Carolina, Mr. Mulvaney, the vice chairman of our Mon- etary Policy and Trade Subcommittee, for 2 minutes. Mr. MULVANEY. Chair Yellen, when I sat down last night to get ready for this hearing, it occurred to me that I could ask you about a bunch of things today. I could ask you about your plans on interest rates and how you arrived at the decisions that you are going to make, what you used to arrive at those decisions. I could ask about your role at the Fed in regulating financial institutions. Dodd-Frank, for example, has now given you regulatory powers over banks, nonbanks, clearing- houses, and thrift holding companies. It also struck me I could even ask you about the role of the Fed, and more specifically the New York branch, in the possibly mis- VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 4 leading statements that I believe Secretary Lew made to two con- gressional committees regarding the Fed and the Treasury’s role in intentionally withholding information from Congress about plans to prioritize debt payments during the last government shutdown. And then, I realized that is too much. That is too much not just to ask you in the few minutes that we are going to have today; it is just too much for you to be doing. The Fed has, like so many other parts of our government, grown way beyond its original in- tended scope. When Congress chartered the Bank in 1913, we asked it to do one thing: keep the financial system, and primarily currency, sta- ble. Today, the Fed is involved in everything from how much pur- chasing power these people have, to where they can bank, how they can invest and save, and, to believe some, whether or not they even have a job. Maybe you shouldn’t be involved in trying to get us to full em- ployment, something that your own economics orthodoxy teaches us you don’t have the ability to do, but only fiscal policy can do. Maybe you shouldn’t be involved with regulating mortgages and credit cards. And you certainly shouldn’t be involved in political de- cisions to intentionally keep Congress in the dark about how this country is going to pay back its principal and its interest on the debt. So I hope today we get a chance to talk about a lot of things— sound money, the dual mandate, full employment, regulations, the debt ceiling, community banks, the impact of zero rates on retirees, asset bubbles—in the hopes that at the end we discover that per- haps the time has come to get back to basics, and one and one thing only, which is long-term price stability. Chairman HENSARLING. The time of the gentleman has expired. The Chair now recognizes the gentlelady from Wisconsin, Ms. Moore, the ranking member of our Monetary Policy and Trade Sub- committee, for 2 minutes. Ms. MOORE. Thank you so much, Mr. Chairman, and welcome back, Chair Yellen. As you can tell from the opening statements, there is plenty to discuss since your last appearance before this committee. I sup- ported your rate increase in December. I still do. And I think you are providing a lot of credibility to markets with your leadership. However, these seem to be economic times that are destined to be interesting. Since December we have witnessed a lot of global economic turmoil, and now it is turning up in the United States, as reflected in our stock market. Foreign central banks are moving to ease rates even as we are moving to try to tighten them. And I am not saying that we need to harmonize our monetary policy, but I am very interested in hearing how you and the Fed are working with foreign central banks to get in front of these ominous trends. As you have stated so many times before, monetary policy is a limited tool. But if we are going to grow our economy and keep on track, and as I look at the folk in green in the audience, it causes me to realize that Members of Congress have to do their part, too, and not just throw it in all in the lap of the Fed. We have to em- brace proven growth strategies like tackling poverty, especially VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 5 among women, by providing vocational training so that they can qualify and compete for sustainable jobs with living wages. And with that, I yield back the balance of my time. Chairman HENSARLING. The gentlelady yields back. Today, we welcome the testimony of the Honorable Janet Yellen, Chair of the Federal Reserve. Chair Yellen has previously testified before this committee so I believe she needs no further introduc- tion. Without objection, Chair Yellen, your written statement will be made a part of the record. You are now recognized for 5 minutes to give an oral presentation of your testimony. Thank you. STATEMENT OF THE HONORABLE JANET L. YELLEN, CHAIR, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Mrs. YELLEN. Thank you. Chairman Hensarling, Ranking Mem- ber Waters, 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 situa- tion and outlook before turning to monetary policy. Since my appearance before this committee last July, the econ- omy has made further progress toward the Federal Reserve’s objec- tive of maximum employment. And while inflation is expected to remain low in the near term, in part because of further declines in energy prices, the Federal Open Market Committee (FOMC) ex- pects that inflation will rise to its 2 percent objective over the me- dium term. In the labor market, the number of payroll jobs rose 2.7 million in 2015, and posted a further gain of 150,000 in January of this year. The cumulative increase in employment since its trough in early 2010 is now more than 13 million jobs. Meanwhile, the unemployment rate fell to 4.9 percent in Janu- ary, 0.8 of a percentage point below its level a year ago and in line with the median of FOMC participants’ most recent estimates of its longer-run normal level. Other measures of labor market conditions have also shown solid improvement, with noticeable declines over the past year in the number of individuals who want to work, and are available to work, but have not actively searched recently, and in the number of people who are working part-time but would rather work full- time. However, these measures remain above the levels seen prior to the recession, suggesting that some slack in labor markets re- mains. Thus, while labor market conditions have improved sub- stantially, there is still room for further sustainable improvement. The strong gains in the job market last year were accompanied by a continued moderate expansion in economic activity. U.S. real gross domestic product is estimated to have increased about 1.75 percent in 2015. Over the course of the year, subdued foreign growth and the ap- preciation of the dollar restrains net exports. In the fourth quarter of last year, growth in the gross domestic product is reported to have slowed more sharply, to an annual rate of just 0.75 percent. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 6 Again, growth was held back by weak net exports as well as by a negative contribution from inventory investment. Although private domestic final demand appears to have slowed somewhat in the fourth quarter, it has continued to advance. Household spending has been supported by steady job gains and solid growth in real disposable income, aided in part by the de- clines in oil prices. One area of particular strength has been purchases of cars and light trucks. Sales of these vehicles in 2015 reached their highest level ever. In the drilling and mining sector, lower oil prices have caused companies to slash jobs and sharply cut capital outlays. But in most other sectors, business investment rose over the sec- ond half of last year, and home-building activity has continued to move up on balance, although the level of new construction re- mains well below the longer-run levels implied by demographic trends. Financial conditions in the United States have recently become less supportive of growth, with declines in broad measures of eq- uity prices, higher borrowing rates for riskier borrowers, and a fur- ther appreciation of the dollar. These developments, if they prove persistent, could weigh on the outlook for economic activity in the labor market, although declines in longer-term interest rates and oil prices provide some offset. Still, ongoing employment gains and faster wage growth should support the growth of real incomes and, therefore, consumer spend- ing. And global economic growth should pick up over time, sup- ported by highly accommodative monetary policies abroad. Against this backdrop, the Committee expects that with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the coming years, and that labor market indicators will continue to strengthen. As is always the case, the economic outlook is uncertain. Foreign economic developments in particular pose risks to U.S. economic growth. Most notably, although recent economic indicators do not suggest a sharp slowdown in Chinese growth, declines in the for- eign exchange value of the renminbi have intensified uncertainty about China’s exchange rate policy and the prospects for its econ- omy. This uncertainty led to increased volatility in global financial markets and, against the backdrop of persistent weakness abroad, exacerbated concerns about the outlook for global growth. These growth concerns, along with strong supply conditions and high in- ventories, contributed to the recent fall in the prices of oil and other commodities. In turn, low commodity prices could trigger financial stresses in commodity-exporting economies, particularly in vulnerable emerg- ing market economies and for commodity-producing firms in many countries. Should any of these downside risks materialize, foreign activity and demand for U.S. exports could weaken, and financial market conditions could tighten further. Of course, economic growth could also exceed our projections for a number of reasons, including the VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 7 possibility that low oil prices will boost U.S. economic growth more than we expect. At present, the Committee is closely monitoring global economic and financial developments as well as assessing their implications for the labor market and inflation and the balance of risk to the outlook. As I noted earlier, inflation continues to run below the Commit- tee’s 2-percent objective. Overall, consumer prices, as measured by the price index for personal consumption expenditures, increased just 0.5 percent over the 12 months of 2015. To a large extent, the low average pace of inflation last year can be traced to the earlier steep declines in oil prices and the prices of other imported goods. And, given the recent further decline from the prices of oil and other commodities as well as the further ap- preciation of the dollar, the Committee expects inflation to remain low in the near term. However, once oil and import prices stop falling, the downward pressure on domestic inflation from those sources should wane. And as the labor market strengthens further, inflation is expected to rise gradually to 2 percent over the median term. In light of the current shortfall of inflation from 2 percent, the Committee is carefully monitoring actual and expected progress to- ward its inflation goal. Of course, inflation expectations play an im- portant role in the inflation process, and the Committee’s con- fidence in the inflation outlook depends importantly on the degree to which longer-run inflation expectations remain anchored. It is worth noting in this regard that market-based measures of inflation compensation have moved down to historically low levels. Our analysis suggests that changes in risk and liquidity premiums over the past year-and-a-half contributed significantly to these de- clines. Some survey measures of longer-run inflation expectations are also at the low end of their recent rages. Overall, however, they have been reasonably stable. Turning to monetary policy, the FOMC conducts policy to pro- mote maximum employment and price stability, as required by our statutory mandate from the Congress. Last March, the Committee stated that it would be appropriate to raise the target range for the Federal funds rate when it had seen further improvement in the labor market and was reasonably confident that inflation would move back to its 2 percent objective over the medium term. In December, the Committee judged that these two criteria had been satisfied and decided to raise the target range for the Federal funds rate 0.25 percentage point to between 0.25 and 0.5 percent. This increase marked the end of the 7-year period during which the Federal funds rate was held near zero. The Committee did not ad- just the target range in January. The decision in December to raise the Federal funds rate re- flected the Committee’s assessment that even after a modest reduc- tion in policy accommodation, economic activity would continue to expand at a moderate pace and labor market indicators would con- tinue to strengthen. Although inflation was running below the Committee’s longer-run objective, the FOMC judged that much of the softness in inflation was attributable to transitory factors that VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 8 are likely to abate over time, and the diminishing slack in labor and product markets would help move inflation toward 2 percent. In addition, the Committee recognized that it takes time for mon- etary policy actions to affect economic conditions. If the FOMC de- layed the start of policy normalization for too long it might have to tighten policy relatively abruptly in the future to keep the econ- omy from overheating and inflation from significantly overshooting its objective. Such an abrupt tightening could increase the risk of pushing the economy into recession. It is important to note that even after this increase, the stance of monetary policy remains accommodative. The FOMC anticipates that economic conditions will evolve in a manner that will warrant only gradual increases in the Federal funds rate. In addition, the Committee expects that the Federal funds rate is likely to remain for some time below the levels that are expected to prevail in the longer run. This expectation is consistent with the view that the neutral, nominal Federal funds rate, defined as the value of the Federal funds rate that would be neither expansionary nor contractionary if the economy was operating near potential, is currently low by historical standards and is likely to rise only gradually over time. The low level of the neutral Federal funds rate may be partly at- tributable to a range of persistent economic headwinds, such as limited access to credit for some borrowers, weak growth abroad, and the significant appreciation of the dollar that have weighed on aggregate demand. Of course, monetary policy is by no means on a preset course. The actual path of the Federal funds rate will depend on what in- coming data tell us about the economic outlook, and we will regu- larly reassess what level of the Federal funds rate is consistent with achieving and maintaining maximum employment and 2 per- cent inflation. In doing so, we will take into account a wide range of informa- tion, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on fi- nancial and international developments. In particular, stronger growth or a more rapid increase in inflation than the Committee currently anticipates would suggest that the neutral Federal funds rate was rising more quickly than expected, making it appropriate to raise the Federal funds rate more quickly as well. Conversely, if the economy were to disappoint, a lower path of the Federal funds rate would be appropriate. We are committed to our dual objectives and we will adjust policy as appropriate to fos- ter financial conditions consistent with their attainment over time. Consistent with its previous communications, the Federal Re- serve used interest on excess reserves and overnight reversed re- purchase (RRP) operations to move the Federal funds rate into the new target range. The adjustment to the interest rate on excess re- serves (IOER) rate has been particularly important in raising the Federal funds rate and short-term interest rates more generally in an environment of abundant bank reserves. Meanwhile, overnight RRP operations complement the IOER rate by establishing a soft floor on money market interest rates. The IOER rate and the overnight RRP operations allowed the FOMC to VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 9 control the Federal funds rate effectively without having to first shrink its balance sheet by selling a large part of its holdings of longer-term securities. The Committee judged that removing monetary policy accommo- dation by the traditional approach of raising short-term interest rates is preferable to selling longer-term assets because such sales could be difficult to calibrate and could generate unexpected finan- cial market reactions. The Committee is continuing its policy of re- investing proceeds from maturing Treasury securities and principal payments from agency debt and mortgage-backed securities. As highlighted in the December statement, the FOMC anticipates con- tinuing this policy until normalization of the level of the Federal funds rate is well under way. Maintaining our sizable holdings of longer-term securities should help maintain accommodative financial conditions and reduce the risk that we might need to return the Federal funds rate target to the effective lower bound in response to future adverse shocks. Thank you. I will be pleased to take your questions. [The prepared statement of Chair Yellen can be found on page 56 of the appendix.] Chairman HENSARLING. The Chair now recognizes himself for 5 minutes for questions. Chair Yellen, I know you are familiar with the Fed Oversight Re- form and Modernization Act, known as the FORM Act, which was passed by the House in November. It is designed to bring about greater transparency and accountability at the Fed, to respect the Fed’s independence but also ensure that the Fed lets the rest of us know the variables that are used in monetary policy and their reac- tion functions so that working families can plan out their family economies. I know that you are not a fan of the FORM Act, because I have a letter dated November 16th that you sent to the Speaker. In that letter, you called the Act ‘‘a grave mistake.’’ I have another letter that describes it as an important reform. Your letter mentions, or complains that monetary policy would be forced to be strictly adhered to by the prescriptions of a simple rule. My letter says the legislation does not chain the Fed to any rule, and certainly not a mechanical rule. Your letter says that the Act would undermine the independence of the Fed. My letter says in no way would the legislation com- promise the Fed’s independence. On the contrary, publicly report- ing a strategy helps prevent policymakers from bending under pressure and sacrificing independence. Your letter states that the FORM Act would ‘‘severely damage the U.S. economy were it to become law.’’ My letter says the new legislation would improve economic performance. By definition, your letter is signed by you. My letter is signed by Dr. Lars Hansen of the University of Chicago, Nobel laureate in ec- onomics. It is also signed by Robert Lucas, University of Chicago, Nobel laureate in economics; Edward Prescott, Arizona State University, Nobel laureate in economics; George Shultz, former Secretary of the Treasury; Robert Heller, former Federal Reserve Governor; Jerry Jordan, former President of the Cleveland Federal Reserve VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 10 Bank; William Poole, former President of the St. Louis Federal Re- serve Bank, and former member of the Council of Economic Advis- ers; Michael Boskin, Stanford University, former Chairman of the President’s Council of Economic Advisers; Charles Calomiris, Co- lumbia University, former consultant, Federal Reserve Board of Governors; Marvin Goodfriend, Carnegie Mellon, former Research Director for the Federal Reserve Board of Richmond; Allan Meltzer, Carnegie Mellon; and John Taylor of Stanford University, former Under Secretary of the Treasury, member of the Council of Eco- nomic Advisers, and author of the Taylor Rule. And there are about 15 other signatories to the letter. So, Chair Yellen, we have three Nobel prizewinners in economics, a host of former Federal Reserve officials, and some of the most re- nowned and respected economists in the country who pretty much disagree with everything that you asserted in your three-page mis- sive against the FORM Act. I know you are not a fan, but I would just caution you, Chair Yellen, that when you use such apocalyptic and hyperbolic language, you might consider whether or not this undercuts your credibility as Fed Chair. I have one question. In your testimony, Chair Yellen, in charac- terizing the Fed strategy to increase policy rates, you testified that, ‘‘removing monetary policy accommodation by the traditional ap- proach is preferable to shrinking the Fed’s balance sheet,’’ which now holds almost as much in Treasuries as China and Japan do combined. I am trying to figure out what precisely is ‘‘traditional’’ about this current approach where the Fed—and the ranking member, I think, brought this up in her opening statement—subsidizes de- posit rates for some of the biggest banks in our country, which can distort, as you well know, real asset allocation and constrain eco- nomic opportunity. And the last time I checked, as we speak, the Fed’s fund rate is just above 30 basis points. You are paying banks 50 basis points for excess reserves, which would seem to be above the market rate. You have previously testified that this does not involve a subsidy to the banks. It appears to be a subsidy, and it appears to distort real asset allocation. So what is traditional about this approach? Mrs. YELLEN. The tools that we have used to raise our target for short-term interest rates, namely our key tool being interest on ex- cess reserves, is widely used by central banks as a key tool of mon- etary policy. And it is the critical tool that we need to rely on in order to adjust the level of short-term rates to what we regard as the appropriate stance to achieve congressionally-mandated goals. I would point out that although we are paying interest to banks on reserves, those reserves are financing our holdings, a large port- folio of holdings of longer-term Treasury securities and mortgage- backed securities on which we earn substantially greater interest. And because of that large balance sheet, this past year the Fed transferred back to the Treasury and to the American taxpayers $100 billion. Chairman HENSARLING. But it is true, Chair Yellen, is it not, that you are paying 50 basis points when the Fed funds rate is 30 basis points? VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 11 Mrs. YELLEN. It is necessary for us to raise benchmark rates in order for a whole host of short-term interest rates— Chairman HENSARLING. That would seem to imply a subsidy to the largest banks. My time has long since expired. The Chair now recognizes the ranking member for 5 minutes. Ms. WATERS. Thank you, Mr. Chairman. Chair Yellen, continuing on the discussion that was just initiated by the Chairman, as you continue to embark on the path of raising rates I want to explore the alternative approaches that may exist for the Federal Reserve to do so in a manner that does not rely so heavily on paying massive sums to private sector banks to hold onto the reserves they maintain at the Fed. While the Fed paid close to $7 billion on reserves in 2015, as the economy strengthens and rates are further increased, the amounts paid could increase dramatically into the tens of billions of dollars. Can you expand on why you believe that paying interest on excess reserves is particularly important for raising rates in the current environment and discuss possible alternative approaches that may exist? And if you talk about what you believe is the mandate of Con- gress and how you don’t have the authority for alternatives, I want to hear more about that and what you do have the authority to do. Mrs. YELLEN. Prior to the financial crisis, the Fed adjusted the level of short-term interest rates through small variations in the supply of reserves to the banking system. Following the financial crisis, as our balance sheet expanded, reserves became abundant, and the traditional old-fashioned approach was no longer feasible. Congress had debated the wisdom of giving us the tool of paying interest on reserves for many years and decided to do so in 2006, and then speeded up implementation in 2008. The knowledge that we had that tool and would be able to use it when we deemed it appropriate to begin to raise the short-term level of interest rates, as we did in December—the knowledge that that tool was avail- able, as I just mentioned, the tool that is critical to our control of short-term rates and widely used globally, that was an important fact when we considered all the actions that we took—the uncon- ventional actions that we took—to produce the decline in the unem- ployment rate and improvement in the labor market that we have achieved. So if we were denied that tool at the present time, we would not be able to easily raise the level of short-term rates. Until we— Ms. WATERS. However, if I may interrupt you for a moment, are you saying that you are limited only to that action? Or do you have the authority to make some other decisions relative to what the in- terest is that you are paying to big banks? Do you have some flexi- bility here? Mrs. YELLEN. We would likely, to regain effective control of short-term interest rates, need to shrink our portfolio from its cur- rent large level back to the kinds of levels we had before the crisis. And we have set out over several years a plan for how we would normalize policy that relies not on selling long-term assets but on adjusting short-term interest rates. I believe that if we were to follow the plan of selling off long-term assets, it could prove very disruptive to the expansion. It is a strat- VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 12 egy that I think could harm the economic recovery, and it certainly is not what we have set out to the public. We said we would shrink our balance sheet in a gradual and predictable way so as to not be disruptive. Ms. WATERS. So if I may interrupt you again, you are saying it was Congress, starting in 2006, who would have to design this ap- proach, and Congress could, if it decided to, take it away as an ap- proach that you would use even though you do not think it would be helpful? Mrs. YELLEN. I think it would be very disruptive to the economy and I really—I want to point out several things about this. First of all, although the banks are earning this interest on the excess— on the reserves that they hold, as the level of short-term rates rises, first of all, on their wholesale funding that many of the banks rely on, they are also paying more to gain that funding. Eventually this will be the mechanism that would lead, as well, to higher deposit rates to reward savers. And finally, I really want to emphasize that from the taxpayers’ point of view, the Federal Reserve has transferred, since 2008 through 2015, roughly $600 billion back to Congress, to the tax- payers, to the Treasury, funds that have contributed importantly to financing the government, and that has only been possible because we have a larger stock of reserves in the banking system and, cor- respondingly, hold a far larger stock of interest-bearing assets that pay in larger amounts. Prior to the crisis, a typical level of transfers from the Fed to the Treasury was in the order of $20 billion. For the past 2 years, we have transferred $100 billion a year. Ms. WATERS. Thank you very much. We need to talk about this some more. I yield back the balance of my time. Chairman HENSARLING. The Chair now recognizes the gentleman from South Carolina, Mr. Mulvaney, the vice chairman of our Mon- etary Policy and Trade Subcommittee. Mr. MULVANEY. I thank the Chairman. A quick follow up, Chair Yellen, on the Chairman’s question: You mentioned that using the IOER or the RRP were traditional tools, and then you mentioned that other central banks used them before. Have you ever used them? Mrs. YELLEN. No. Mr. MULVANEY. Has the Federal funds rate, which I understand now is trading on the market at about 30 basis points, ever been— ever—below the IOER, which is now set at 50 basis points? Mrs. YELLEN. Has it ever been below? Mr. MULVANEY. Yes, ma’am. It is since we set the—when we were first given the power to pay interest on reserves, we set it at 25 basis points, and the Fed funds rate traded below it. And when we raised it to 50, the Fed funds rate moved up by 25 basis points, the amount of the increase in IOER that continues to trade below it. Mr. MULVANEY. All right. So your testimony is that those are tra- ditional tools. So let’s move then to a different discussion with that as a background. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 13 You have in the past been a proponent, though a reserved pro- ponent, of a rules-based system. Back in 2012, you gave a speech where you said, ‘‘Why shouldn’t the FOMC adopt such a rule as a guidepost?’’ The answer is that times are by no means normal now and that simple rules that perform well under ordinary circumstances just won’t perform well. Two years ago, you said something similar to this committee. In response to a question about rules you said, ‘‘The conditions facing the economy are extremely unusual. I have tried to argue and be- lieve strongly that while a Taylor Rule, or something like it, pro- vides a sensible approach in normal times, like the Great Modera- tion, under current situations it is not appropriate.’’ So, that was your testimony in 2014. You gave a speech in 2012. Here we are in 2016. You, by your own testimony, are using tra- ditional tools of monetary policy. Your written testimony begins by saying that the economy has made further progress towards the Federal Reserve’s objective of maximum employment. You go on to say that inflation is low in the near-term but it will rise to its 2 percent objective over the median term. Are we in normal times? Mrs. YELLEN. The economy is in many ways close to normal in the sense that the unemployment rate has declined to levels that most of my colleagues believe are consistent with full employment in the longer run. And inflation, while it is below 2 percent, I do think there is a good reason to think it will move up over time. And in that sense things are normal. But what is not normal is that the so-called neutral level of the Federal funds rate that I referred to in my testimony and we dis- cuss in the report is by no means normal. In other words, we have needed for 7 years to hold the Federal funds rate and—both in nominal and inflation in real terms—inflation adjusted or real terms—at exceptionally low levels to achieve growth averaging 2 percent or a little bit above. Mr. MULVANEY. I am sorry to interrupt, but I do want to get— Mrs. YELLEN. And in that sense, it is not normal. The economy is being held back by headwinds. I would point out that a tenet of the Taylor Rule is that it takes—it assumes and embodies in it an assumption that the equi- librium level of the Fed funds rate with the 2 percent objective is 4 percent, or that the real equilibrium Fed funds rate is 2 percent. And that simply isn’t the case. Mr. MULVANEY. Madam Chair, I am not actually, surprisingly, not pushing the Taylor Rule. I am simply asking about a general rule-based system because you have shown some support for it in the past. And I guess my question is this: What does the world have to look like? Because I think admittedly, employment is bet- ter. Inflation, it seems to be under control. Yes, you say that the Fed funds rate is extraordinarily low, which it is, but that is some- thing under your control. What does the world have to look like in order for the Federal Reserve to start considering transitioning to a rule-based system? Mrs. YELLEN. I think the benefit of a rule-based system is it is systematic and understandable. And the Federal Reserve has at- VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 14 tempted to engage in the systematic policy. It takes a different form. Mr. MULVANEY. I get that, but what does the world have to look like? When you come back next year, what should the world look like for you to be saying, you know what, we are considering a rules-based system? What has to change? Mrs. YELLEN. The Committee looks at guidelines from rules as useful benchmarks as it considers the appropriate stance of policy, but I believe, and I think most of my colleagues would agree, that we shouldn’t mechanically follow that rule or any other rule, but that we need to take into account a large set of indicators of how the economy is performing. Chairman HENSARLING. The time of the gentleman has expired. The Chair now recognizes the gentlelady from Wisconsin, Ms. Moore, ranking member of our Monetary Policy and Trade Sub- committee. Ms. MOORE. Thank you so much, Mr. Chairman. And again, welcome, Chair Yellen. I want to take us in a little different direction. Many of us here on both sides of the aisle are really concerned about what is hap- pening with our smaller banks. And we understand that because of Basel III and we had a lot of concerns when we debated Dodd- Frank, including provisions like Volcker and FSOC. They were driven by the concerns of the large banks in active capital markets. And I know that the Fed is not the only regulator overseeing implementation of Dodd-Frank, but I would like your thoughts on how the rules may have been tailored, or should have been tailored, for small and community banks? The stress tests and the capital standards are killing our small banks, compliance officers that—where they don’t have the addi- tional staff. Just your thoughts on what should have been done or how has it been tailored? Mrs. YELLEN. Let me say that I think community banks and their vitality is exceptionally important. They provide enormous benefits to the country and to the economy. I recognize that the regulatory burden on community banks is intense. Ms. MOORE. They are shutting down. Mrs. YELLEN. For our part, we are focused on doing everything that we conceivably can to minimize and reduce the burden on these banking organizations. We have been conducting an EGRPRA review to identify poten- tial burdens that our regulations impose on these banks, and we will do everything that we can to respond to the concerns that are identified there to reduce burden. We are looking for many ways. First of all, we have tried to tai- lor our regulations to the size and complexity of institutions. The smaller community banks are not subject to stress-testing require- ments. Many aspects of Basel III capital requirements and liquidity rules do not apply to those banking organizations. We have tried to simplify those requirements. We are, in addition to that, trying to reduce the duration of the time that we spend reviewing banks during exams; we are trying to simplify and be more targeted in our requests for documentation. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 15 We try to identify for community bankers what is relevant to them and what they can safely ignore. And we are looking for ways to conduct exams that are more focused on the actual risks that are relevant to a particular organization. So I recognize that the burdens on those banks have been very intense and I pledge that we are doing and will continue to do all we can to reduce burdens on them. Ms. MOORE. Thank you, Madam Chair. On this committee, we spend a lot of time talking about moral hazard, and so I guess I would like your view on whether or not you think there is any moral hazard on not a single person in- volved in the 2008 crash having gone to jail. They get fines, they get sort of compliance letters where they can clean up their act and avoid prosecution, and I am wondering if you think that it is im- portant for us to seek—so what? You pay a fine. That doesn’t stop anyone from doing the next crime, unlike other of our criminal laws. Mrs. YELLEN. I agree with you. I do not think that individuals who are guilty of wrongdoing should escape paying appropriate penalties. For our own part, we are not allowed, obviously, to put in place criminal penalties. That is a matter for the Department of Justice. For our part, we can, when we find individuals to be responsible for wrongdoing, make sure that they are not allowed to work at the banking organizations where they committed misdeeds. And in many cases, we can make sure that they are banned from the busi- ness of banking. And when we have been able to identify individuals who are re- sponsible, we have put in place those sanctions and will continue to do so. And we always cooperate with the Department of Justice in their investigations. Chairman HENSARLING. The time of the gentlelady has expired. The Chair now recognizes the gentleman from North Carolina, Mr. McHenry, vice chairman of the committee. Mr. MCHENRY. Thank you, Chair Yellen. So, does the Federal Reserve have the legal authority to imple- ment negative rates? Mrs. YELLEN. I’m sorry, do we have the legal authority to— Mr. MCHENRY. Implement negative rates. Mrs. YELLEN. This is a matter that the Federal Open Market Committee considered around 2010, and we didn’t fully—as we were exploring our options to provide accommodation we decided not to lower interest rates, either IOER to zero or into negative ter- ritory, and we didn’t fully look at the legal issues around that. I would say that remains a question that we still would need to investigate more thoroughly. Mr. MCHENRY. And one of our document requests, that 2010 memo that I assume is connected to that policy discussion— Mrs. YELLEN. That is right. Mr. MCHENRY. —raised significant doubts about the Fed’s au- thority that they currently have to charge—to pay interest on ex- cessive—on excess reserves and whether or not that same authority would allow you to demand payment for that. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 16 Mrs. YELLEN. Congressman, I don’t know of any restriction that would prevent us from doing that. That memo indicated—was in- tended to indicate that the legal issues had not been seriously con- sidered in the time that went to the FOMC. Mr. MCHENRY. Have they been seriously considered since 2010? Mrs. YELLEN. In the spirit of prudent planning, we always try to look at what options we would have available to us, either if we need to tighten policy more rapidly than we expect or the opposite, to loosen policy. Mr. MCHENRY. Do you— Mrs. YELLEN. So, we would take a look at it. But the legal issues I am not prepared to tell you have been thoroughly examined at this point. Mr. MCHENRY. So at this point it is unclear whether or not the Fed does have the legal authority to implement negative rates? Mrs. YELLEN. I am not aware of anything that would prevent us from doing it, but I am saying that we have not fully investigated the legal issues. That still needs to be done. Mr. MCHENRY. So let’s move to regulation. You run the largest regulatory organization in the United States of America, perhaps on the globe—likely on the globe. And as such, I believe in the independence of the Fed to make monetary policy, but as a regulator, Congress should have signifi- cant oversight of your regulatory action, should they not? Mrs. YELLEN. Yes. Mr. MCHENRY. Okay. And as such, as a matter of regulation— the Chairman raised this question with you the last time you were here about Federal Reserve regulators, bank examiners demanding to be a part of board of director meetings at member banks. And you have exchanged multiple letters on this matter. We still hear that this is, in fact, taking place. Would you pledge to this committee that you would direct your bank examiners and regional bank examiners to stop this practice? Mrs. YELLEN. I will look into— Mr. MCHENRY. You have already looked into it, and you have ex- changed letters and you gave the Chairman the assurance last time that you are not aware of it. I assume you are now aware of whether or not this is taking place, are you not? Mrs. YELLEN. I think there are occasional situations in which that occurs. Mr. MCHENRY. Do you believe that is appropriate? Mrs. YELLEN. I am not certain that it is inappropriate. I want to get back to you on that. Mr. MCHENRY. This was raised about 6 months ago by the Chair- man; you have exchanged multiple letters. I would like to have some greater assurance. This is not meant to be a ‘‘gotcha;’’ this is a well-worn question. And we are hearing—and in fact, there is a press report that the Fed directed one of your member banks to incorporate two addi- tional members of the board of directors. And the Fed directing a private enterprise to change their board of directors seems some- what perplexing. Do you believe that is appropriate authority for the Fed? VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 17 Mrs. YELLEN. I think it is appropriate as a matter of supervision to— Mr. MCHENRY. To direct? Mrs. YELLEN. —ensure that a board of directors of a financial company that we supervise is appropriately constituted in fulfilling its corporate governance functions. That is a part of supervision. Mr. MCHENRY. My time has expired. Chairman HENSARLING. The time of the gentleman has expired. The Chair now recognizes the gentlelady from New York, Mrs. Maloney, ranking member of our Capital Markets Subcommittee. Mrs. MALONEY. Chair Yellen, you raised interest rates in Decem- ber and said that any future interest rate increases, if they hap- pened, would be gradual. I would like to ask you about the recent turmoil in global markets. As you know, equity markets around the world, led by China, have plunged since the beginning of the year as global economic growth has weakened. And the United States has not been im- mune. U.S. stock markets have fallen over 9 percent since the be- ginning of the year and Treasury yields have plunged 23 percent. So my question is, has the turmoil in global markets changed your view about the appropriate pace of interest rate increases and hikes, or will you wait to see how global market turmoil affects the U.S. economy before raising rates again? Mrs. YELLEN. We are watching very carefully what is happening in global financial markets. It would appear that stresses that we have seen since the turn of the year relate to uncertainties regard- ing Chinese exchange rate policy. There are uncertainties around the price of oil. We have not seen shifts in—that seem significant enough to have driven the sharp moves we have seen in markets. There would seem to be increased fears of recession risk that is resulting in rises in risk premium. We have not yet seen a sharp drop-off in growth, either globally or in the United States, but we certainly recognize that global market developments bear close watching. As I mentioned, the financial conditions have become less supportive to growth and we recognize that these develop- ments may have implications for the outlook, which we are in the process of assessing. And I want to make clear that monetary policy is not on a preset course and so our evaluation of the likely impact of those develop- ments on the economic outlook and our ability to meet both our employment and inflation objectives, those are the factors that will govern the future stance of monetary policy. It is not on a preset course. Mrs. MALONEY. And given the turmoil in global markets and the slowing U.S. economy, some analysts are now talking about the United States possibly falling into a recession this year. What would it take for you to consider cutting interest rates again? A se- vere downturn in the economy or just stubbornly low inflation? Mrs. YELLEN. Our commitment is to achieve our congressionally mandated goals of maximum employment and price stability. I do not expect that the FOMC is going to be soon in this situation where it is necessary to cut rates. Let’s remember that the labor market is continuing to perform well, to improve. I continue to VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 18 think that many of the factors holding down inflation are transi- tory. While there is always some risk of recession, and I recognize and have just stated that global financial developments could produce a slowing in the economy, I think we want to be careful not to jump to a premature conclusion about what is in store for the U.S. economy. So I don’t think it is going to be necessary to cut rates, but that said, monetary policy, as I said, is not on a preset course. And if it turned out that would be necessary, obviously the FOMC would do what is needed to achieve our—the goals that Congress has as- signed to us. Mrs. MALONEY. You said in December that you were surprised by how far oil prices had fallen and that you expected inflation to in- crease once oil prices stabilized. Since the Fed’s December meeting, oil prices have fallen even further. They are down about 25 percent since the December meeting and they have fallen 7 percent since Friday. At the same time, we have also seen inflation expectations fall since the December meeting to the lowest levels in quite some time. Has this caused you to rethink your inflation projections at all? Mrs. YELLEN. We indicated in our statement in January that these developments led us to conclude that inflation will stay low for a while longer as these developments work through. Clearly, we are watching inflation expectations and, as I mentioned, market- based measures of inflation compensation have moved down now to historically low levels. And that is something we are evaluating carefully. In December when we raised rates, we indicated that with infla- tion so far below our objective, we would carefully watch incoming data and revise our expectations. So I don’t want to jump to a pre- mature conclusion. My colleagues and I will issue in March updated projections for inflation taking all the evidence we have at hand into account, but— Chairman HENSARLING. The time of the gentlelady has expired. The Chair recognizes the gentleman from New Jersey, Mr. Gar- rett, chairman of our Capital Markets Subcommittee. Mr. GARRETT. I thank the Chair. Chair Yellen, thank you for being here. I would like to talk a little bit—begin on emergency lending under Section 13(3). It was about a year-and-a-half ago that Sen- ator Elizabeth Warren and myself and Mr. Capuano joined to- gether, and Senator Vitter as well, and sent you a letter expressing our deep concern with what you were doing with regard to imple- menting the limiting language in Dodd-Frank at that time. And of course, you have come out now with a rule, despite our admonition and questions in that letter, a rule that would basically allow the Fed to drive a Mack truck through the various loopholes in it, and also, once again, as is typical with the Fed, lacking in clarity and transparency. That being said, the Fed is not always not clear in what they want to do, and the regulators are not always clear in what they want to do. For example, they came up with the Volcker Rule, and VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 19 in the Volcker Rule the Fed was not shy about elaborating on con- cepts in that statute. In fact, it went so far as to adopt prohibitions in trading assets that were clearly never intended by the statute. So the Fed and other regulators came up with this part of the Volcker Rule dealing with defining just what the words ‘‘propri- etary trading’’ mean. Over 800 pages to make some definitional clarity in the area of Volcker and proprietary trading. Compare that to what you did with—under the limitations that should be in place under Dodd-Frank of 13(3)—47 pages of definition and a lack of clarity throughout it. So the first question is why in one area can you be exact and pre- cise in precision when you are trying to limit what the private mar- ket is doing, but when Congress tells you to put limitations on yourself, you lack that clarity and give it a broad brush? Mrs. YELLEN. I think we tried in the rule to be as clear as we possibly could. We— Mr. GARRETT. Let’s take a look at that then. Mrs. YELLEN. —took a—we, for example— Mr. GARRETT. Now, let me give you an example. The Fed claims that it establishes a penalty rate under 13(3), but then you failed to provide any specifics whatsoever of what that rate would be. Compare that to what Congress did. This committee passed a bill that would establish a penalty rate that would be commensurate with ‘‘a distressed borrower.’’ So why wouldn’t the Fed be clear on this? What are the rates going to be? Mrs. YELLEN. Because what a penalty rate is depends on the spe- cifics of a particular situation. Mr. GARRETT. But can’t— Mrs. YELLEN. A penalty rate is a rate that when conditions nor- malize— Mr. GARRETT. But we know what a distressed borrower is and what the markets are. That is clear. Why didn’t you define it that way, compare it to the regular markets so that a distressed bor- rower in the markets would be charged the same if they are bor- rowing from the Fed— Mrs. YELLEN. Well, in the— Mr. GARRETT. —or related to it? Mrs. YELLEN. In the type of situation that we found ourselves in— Mr. GARRETT. Yes. Mrs. YELLEN. —during the financial crisis, market rates had shot up to extraordinary levels because liquidity had dried up in the fi- nancial— Mr. GARRETT. I understand what the history of the market was at that time, but you could have provided clarity in here. So basically what you are telling us is once again, the Fed is going to be in the position of picking winners and losers. By your prior answer, it seems like you are saying that you could charge borrower A one rate and borrower B another rate under similarly situated circumstances. Is that not correct? VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 20 Mrs. YELLEN. I think what is an appropriate rate does depend on the circumstances. Financial crises, which is when we would be using this authority— Mr. GARRETT. But that is— Mrs. YELLEN. —to set up a broad-based program, are always very unique. And— Mr. GARRETT. Right. And I think that basically what you are tell- ing us is that nothing really has changed despite the admonition and the law in Dodd-Frank to put a limitation. And it is not just me saying that, by the way. It is interesting that while you are here testifying today, Governor Fisher is also making public statements as you speak. We just got part of his statement, and he seems to be saying ex- actly what you are, that you have not limited 13(3). He said, ‘‘But in simple language, strengthening fire prevention regulation does not imply that the fire brigade should be disbanded.’’ He goes on basically to say in his comments today that we are not seeing the limitations, that you are going to be able to do simi- lar things to what you did back in, or that—before you were here, that the Fed did the last time around. Mrs. YELLEN. I want to make clear that I think our 13(3) powers and ability to lend to keep credit flowing in the economy during a financial crisis is a critical power. It played a critical role during the financial crisis. Mr. GARRETT. So is he wrong when he says that nothing—my in- terpretation—has really changed? Your powers are the same as they were before? Mrs. YELLEN. No, a lot has changed. Congress put in place a se- ries of restrictions that they intended— Mr. GARRETT. But your rule does not implement those, does it? Mrs. YELLEN. Yes, it does. Our rule does implement those restric- tions. We cannot lend to an insolvent borrower; we cannot lend to help one or more failing firms. We can only put in place broad-based programs, and we have defined pretty clearly in that rule what constitutes a broad-based program. So Congress clearly changed what the Fed can do. Mr. GARRETT. But it does not— Mrs. YELLEN. It also gave—provided— Mr. GARRETT. Governor Fisher is saying we have likely reduced the probability that lender of last resort will be needed, but we have not reduced that probability to zero. So it appears that, in his opinion at least, some of those problems remain. Chairman HENSARLING. The time of the gentleman has expired. The Chair now recognizes the gentlelady from New York, Ms. Velazquez. Ms. VELAZQUEZ. Thank you, Mr. Chairman. Chair Yellen, the unemployment rate is down to under 5 percent for the first time in 8 years. However, I remain concerned that un- employment rates remain elevated in the Hispanic and African- American communities. Does the Fed specifically take unemployment within these groups into consideration when making policy decisions sur- rounding the Fed fund rate? VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 21 Mrs. YELLEN. We track very carefully the unemployment rates and experiences of different demographic groups, and we make a very careful assessment about whether or not the economy is meet- ing the objective of maximum sustainable employment, which in- volves taking account of factors like, are particular groups being discouraged from even participating in the labor force because of conditions? But it is important to recognize that our powers, which involve setting interest rates, affecting financial conditions, are not tar- geted and can’t be targeted at the experience of particular groups. I think it always has been true and continues to be true that when the labor market improves, the experience of all groups does im- prove. Roughly now, the unemployment rate in the United States is close to where it was in the fourth quarter of 2007. Now, African- Americans and Hispanics at that time back in 2007 had higher un- employment rates than the population as a whole. Regrettably, be- cause of the disadvantages that these groups face in the labor mar- ket, they have historically tended to have higher unemployment rates. But as the economy has improved and unemployment has come down, the unemployment rates for those groups, for Hispanics and African-Americans, has come down. They have fallen to roughly the same levels that they were in at the end of 2007 while, again, re- maining higher. Ms. VELAZQUEZ. So you— Mrs. YELLEN. We do look at that, but we don’t have tools to tar- get particular groups— Ms. VELAZQUEZ. I understand that. Mrs. YELLEN. —rather than others. Ms. VELAZQUEZ. Do you consider an 8.8 percent unemployment rate among African-Americans today too high? Mrs. YELLEN. I do consider it too high, and I think there are any number of reasons for that. And I think that the reasons for it are ones that Congress should be considering broadly in designing a wide range of policies. It is something that we want to see a strong labor market, we want to see continued progress, and we will put in place policies that achieve that. But we cannot target the unemployment rate for a particular group. Ms. VELAZQUEZ. I heard you. As you know, Chair Yellen, U.S. employers have created 14 mil- lion jobs during President Obama’s tenure. However, the labor force participation rate remains low and discouraged people who want to work have stopped looking. How much of the decline in the rate can be explained by the trend of flat or declining wages for many American workers? Mrs. YELLEN. For the country as a whole, an important reason that labor force participation has fallen and will continue to fall is because of the aging of the population. So that is not going to change and the trend is downward. But it is also true that for certain subgroups in the population— for example, prime age but less educated men—the trend down- ward has been particularly steep. And there is a lot of economic re- VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 22 search that tries to understand why men have—their labor force participation has declined, and it wouldn’t surprise me if wage trends are part of the reason for that. Ms. VELAZQUEZ. Right. Mrs. YELLEN. So my guess is that they have played a role in dis- couraging labor force participation. Ms. VELAZQUEZ. As wages begin to increase, do you anticipate the participation rate to increase as well? Mrs. YELLEN. Yes, I anticipate that wage growth will move up somewhat. And I do think that labor force participation is some- what depressed relative to where it will be in a really full employ- ment economy. That is why I say I think there does remain some slack in the labor market even though the aggregate unemployment rate is at 4.9 percent. So I do hope that— Chairman HENSARLING. The time of the gentlelady has expired. The Chair now recognizes the gentleman from Texas, Mr. Neuge- bauer, chairman of our Financial Institutions Subcommittee. Mr. NEUGEBAUER. Thank you, Mr. Chairman. And thank you, Chair Yellen, for being here as well. Part of your remarks were about the state of the economy, and I think you are trying to paint a little bit rosier picture, and maybe there is a little bit of a rosier picture, but it is not a good picture. I am looking at some stats here that we still have 16 million American citizens who are unemployed. In fact, the number of long-term unemployed Americans is 761,000 higher than it was at the start of the recession. We have 94 million Americans over the age of 17 who have aban- doned the job market. Real disposable income is a paltry annual rate at 1.2 percent. The real GDP is growing just under 2.2 percent. We have more Americans living in poverty than ever before—46.7 million people. And we have 45 million people on SNAP. I could read more and more. I think the issue that I have been thinking about this week is that when you look at the original purpose the Fed was formed for, and what the Fed looks like today, and I think my good friend Mr. Mulvaney pointed this out, is that basically we have a Fed that is in charge of monetary policy, some other things have been added to that, and then we have a Fed that is the biggest and largest reg- ulator and regulates more assets than any other financial institu- tion in the world. And it kind of reminds me that while you all are working on one side of the Fed to stabilize employment, keep inflation in check, then on the other side of the Fed you have this huge regulatory structure that has grown substantially and continues to issue very complicated, and some people think that you have become a micro- manager of these financial institutions with the regulations. So it reminds me of that statement, ‘‘We have met the enemy and it is us.’’ Is it counterproductive that you have the—a Fed working on one side to create jobs, and you have a Fed on the other side of the building that is doing things that a lot of people think are killing jobs: micromanaging the financial markets; increasing the cost of capital; and reducing the availability of capital, which VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 23 has stymied the ability of this economy to grow? Isn’t that self-de- feating? Mrs. YELLEN. I think we have to remember that financial crises are immensely costly to well-being. And it is important to make sure that we do everything—almost everything we can to reduce the odds of another devastating financial crisis. So we are working hard. We have worked hard in the aftermath of the crisis to make sure that we have a financial system that is safer, sounder, has more capital, higher quality capital, more li- quidity, and is less crisis-prone than the financial system that we had that caused this financial crisis. Mr. NEUGEBAUER. The time is short. You mentioned the word ‘‘li- quidity,’’ and I think a lot of people think some of the things that the Fed has done and some of the regulations have actually re- duced liquidity in a number of markets. And in fact, you and I have had a conversation about the fact that you all have shown some concern about liquidity. I wanted to see if you knew that the European Commission has initiated a review process. They said after 5 years of instituting all of these regulations and additional capital requirements, and kind of just piling on of regulation and capital, more capital and regula- tion—and I am not against having adequate capital, but the prob- lem is that we seem to have an add-on game here and the addi- tional capital also comes with additional regulations. And so the European Commission has initiated a review process that said, ‘‘You know what? Time out here; let’s go back and look. We know what we have asked these entities to do; we know what we have impounded them with.’’ But the question is, how are the markets responding to this and how have—basically, it is a cost-benefit analysis of all of the poli- cies that have been in place. Has the Fed thought about, hey, maybe we should stop and ana- lyze what we have done here and see if it is positive? Mrs. YELLEN. We have a few things we still need to finalize to put in place the Dodd-Frank regulations that were called for, and we hope to complete that work soon. And it certainly is appropriate to evaluate how the system is working. And we do that on an ongo- ing basis, and I think it is, of course, appropriate to see whether or not there are ways in which we can improve or simplify regula- tions. And we are in the process of doing that in some very impor- tant areas. Chairman HENSARLING. The time of the gentleman has expired. The Chair now recognizes the gentleman from California, Mr. Sherman. Mr. SHERMAN. Mr. Chairman, I feel like I am at a ballroom dance on the deck of the Titanic. The faith of the American people in our government and institutions is at an all-time low. I have been sitting in this room for 20 years and the room has the feel that it had 20 years ago, except we don’t have Alan Greenspan in front of us. Government institutions work better if they listen to the Amer- ican people, first, because the American people will then accept the decisions, and second, because we get better decisions. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 24 Yesterday, in a small State that is doing better than most of the country, two-thirds of the people went out in a very, I think, record-setting turnout with inclement weather to say that they are mad as hell, particularly at the financial institutions that this com- mittee deals with. And two-thirds of them voted for the most angry candidate they could find. Too-big-to-fail should be too-big-to-exist. Madam Chair, in re- sponse to the gentlelady from Wisconsin, you said it was basically the Department of Justice’s failure to have a single criminal pros- ecution of those who had robbed the banks and, more importantly, robbed the American people. And I wonder whether you can really just put that at the feet of the Department of Justice? Because we have learned institutions can get so big that they are too-big-to-fail. Your predecessor was in this room demanding that we bail them out. And, God forbid, you will be again if you allow these too-big-to-fail institutions to continue to exist. They are too-big-to-jail. And as you point out, you may bar some- body from the banking world, but, gee whiz, in a country with more people incarcerated than any other country in the world, is it really adequate to those who steal hundreds of millions and billions to say, ‘‘Well, you can’t go back into the banking world?’’ So I will ask you as a member of FSOC, we need moral hazard to make sure that major economic decisions made by the giant banks are made correctly. They don’t have a moral hazard in the sense of not being able to get capital. People are flooding them with capital at rates that are said to be up to 80 basis points less than they would pay if there wasn’t a belief that we would bail them out. So the too-big-to-fail won’t be allowed to fail. As you point out, DOJ won’t put anybody in jail. The solution is, use your power under FSOC to break them up. Are you going to break up the too-big-to-fail institutions? I have asked you that before, and I will ask you it again. I think I know the answer. Mrs. YELLEN. The answer I will give you is that we are using our powers to make sure that a systemically important institution could fail and it would have systemic consequences for the country. We are doing that in a whole variety of ways. First of all, we have done many things to diminish the odds that they would fail. We are trying to make them, and I think I can enumerate all the things we have done— Mr. SHERMAN. Are you willing to call the attorney general and say, ‘‘We have this thing handled so well that you can start crimi- nal prosecutions because they are not too-big-to-jail anymore?’’ Mrs. YELLEN. I said that I am in favor of going after individuals who are guilty of wrongdoing. Mr. SHERMAN. With such penalties as barring them from the banking system. Mrs. YELLEN. Well, — Mr. SHERMAN. I want to move on— Mrs. YELLEN. —what I said is those are the sanctions that the Federal Reserve can impose. Mr. SHERMAN. I need to move on to another question. You are a governmental entity, but it is—in some parts of the en- tity it is one bank, one vote. It is the only part of our constitutional VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 25 system that puts governmental power in the hands of one bank, one vote. Are you going to use your considerable power to oppose legisla- tive efforts to try to make the regional bank governors appointed exclusively by the President and to try to make the regional banks subject to the Freedom of Information Act? Mrs. YELLEN. Congressman, I think the current structure of the Fed is something that Congress decided after a long debate and weighing of a whole variety of considerations. I would say I think it has worked pretty well, but it is certainly something— Mr. SHERMAN. Wait, excuse me, Madam Chair. Are you saying that the Fed, having just lived through 2008, with people not get- ting raises, that this whole system has worked well? Mrs. YELLEN. I’m sorry. I thought you were asking about our governance. Mr. SHERMAN. Your governance has led to the decisions that have nearly brought this country to its knees. I yield back. Chairman HENSARLING. The time of the gentleman has expired. The Chair now recognizes the gentleman from Missouri, Mr. Luetkemeyer, chairman of our Housing and Insurance Sub- committee. Mr. LUETKEMEYER. Thank you, Mr. Chairman. And welcome, Madam Chair. It is kind of interesting, as you discuss all the questions that have been asked you here with regards to your ability to micro- manage the economy, and as you make the decisions at the Federal Reserve to try and do something about unemployment and try and do something about the inflation rate, I look at some of these things and I am just kind of stunned. Let’s start off first with what happens if we have a downturn and you already have $4 trillion on your balance sheet? What levers are still allowed or are available to you to do something? Mrs. YELLEN. The Fed has an array of tools. Mr. LUETKEMEYER. Which are? Mrs. YELLEN. Most importantly, the path of the short-term inter- est rates. Mr. LUETKEMEYER. Madam Chair, they are already down to al- most nothing. How is lowering the rates going to help when they are almost nothing right now? Mrs. YELLEN. One of the ways in which markets work is that they form expectations about what the likely path of the Fed funds rate will be over time. Those expectations influence longer-term rates in the market. And when the economy weakens, market participants naturally expect the Fed, in pursuing our mandate, to follow a shallower path of interest rate increases, and that shift in expectations moves longer-term rates. I think you can see that just over the last several weeks, as I mentioned, longer-term Treasury yields have come down as market participants have become more fearful about a recession. And their— VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 26 Mr. LUETKEMEYER. Forgive me for intruding, but I have more questions here. So are you saying that this is a good time, then, to start to reduce your balance sheet? Mrs. YELLEN. We— Mr. LUETKEMEYER. Lower interest rates, it would be a nice time to short-shift that, wouldn’t it? Are you intending to do that? Mrs. YELLEN. We have indicated that we want to make sure that normalization is well under way before we begin to shrink our bal- ance sheet. And our decision to do that reflects the fact that we feel that moving short-term rates is a more reliable and understandable and predictable way to manage the economy. Mr. LUETKEMEYER. Okay. Mrs. YELLEN. And so we are going to wait to shrink our balance sheet until a point when short-term interest rates are somewhat higher. Mr. LUETKEMEYER. So we may never get there, is what you are saying? Because there is not much room to go down. So, let’s— Mrs. YELLEN. We will have to see. Mr. LUETKEMEYER. But let me also go into your decision-making process, here. We have a labor market that continues to—the labor force par- ticipation rate continues to go down, and yet, according to your re- port here, the hourly rate of employees went up. There should be more incentive for people to work, yet they are becoming less. And you use the demographics of our country to indicate that. So I am concerned that if you look at those numbers, that there is minimal ability of your—the way you explained the answer to Ms. Velazquez a while ago, of you guys to be able to manipulate this. The second thing is, I am concerned—what other factors do you take into consideration when you look at your rates? For instance, do you look at what the Congress is proposing? Do you look at the court decisions? Because we had—and there has been a big discussion about try- ing to stop the inversion, the ability of our companies to go over- seas and be able to take advantage of those tax rates. So the dis- cussion is to try and cut corporate tax rates to bring those dollars home. Do you ever think about those sorts of implications about when- ever you make decisions on your rates? Yesterday, we had a dramatic historic decision by the courts with regards to an EPA ruling that would have dramatically changed the way that we—the cost of energy in this country. Do you take those things into consideration when you make your rates? Because those are dramatic—they will have dramatic in- creases or significant impact on our economy. Mrs. YELLEN. We try to take into account in making our deci- sions any factor that we regard is important in— Mr. LUETKEMEYER. But do you have in place right now some modeling with regards to the EPA rule? Mrs. YELLEN. Not that I know of. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 27 Mr. LUETKEMEYER. Do you have in place any modeling with re- gards to potential tax cut for bringing dollars home? Or for corpora- tions? Mrs. YELLEN. We routinely look at the stance of fiscal policy— Mr. LUETKEMEYER. Do you have a model in place right now, if we cut corporate tax rates, that would allow you to make a decision on that issue? Mrs. YELLEN. If you were to decide that, our staff would attempt to evaluate— Mr. LUETKEMEYER. But you don’t have one in place right now, is what you just said? Mrs. YELLEN. Not to the best of my knowledge. Mr. LUETKEMEYER. Okay. Thank you very much. I yield back. Chairman HENSARLING. The time of the gentleman has expired. The Chair recognizes the gentleman from New York, Mr. Meeks. Mr. MEEKS. Thank you, Mr. Chairman And welcome, Chair Yellen. Some of my colleagues may not have been here 9 years ago, 8 years ago, but I have to tell you, I feel better today than when I sat here 8 or 9 years ago. I feel much better today than I did then. I can remember some of what was taking place then, and the panic that was going on, and the pressure that this government was under. And though we have not completely done what we need to do, because we do need to let wages grow, we do need to make sure we create more jobs, the position that we are in today, would you agree, is much stronger than the position we were in 2007 and 2008? Mrs. YELLEN. I believe it is. I believe we have made a lot of progress, while recognizing at the same time that there are many households that are suffering and that there are a lot of challenges that people face and structural— Mr. MEEKS. Which, and I think it is important to acknowledge that, that—how far we have come. And then, I would hope that we would also focus then on what else needs to be done, because we do need to make sure that—especially those individuals who were victimized by the financial crises. For example, if you look at areas in—and I think Ms. Velazquez talked about it particularly in African-American and Latino com- munities, they lost a great amount of wealth. Many of them lost their homes; they lost their jobs. And so, they need something so that they can get back, and that is why you see this disparity that is very high right now. My focus then is we had, and I guess because of what took place in the past, in 1977 we passed the Community Reinvestment Act (CRA). Now, the Fed is in charge of CRA and can enforce it. And today, one of the—what we find still is that individuals in commu- nities that were deeply affected, there is no investment going in, there is no job creation there, there is no access to credit. They don’t have credit because of, primarily, the crisis. So I was wondering, since the Fed oversees and can enforce CRA, what is the Fed doing in helping to implement CRA, compelling some of the large banks to make these investments in these com- munities as well as into CDFIs, who are focused on trying to make VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 28 sure that the kind of investments are there to create jobs, to grow wages in communities that were devastated by the recession? Mrs. YELLEN. I think CRA is extremely important in making sure that financial institutions, depository institutions serve the needs of their communities, and particularly underserved commu- nities. We take our enforcement and evaluation of banks’ CRA perform- ance very seriously. We have a whole variety of community devel- opment activities and programs that are focused on working, using our convening power and their CRA obligations to try to under- stand and identify what the needs are in particular communities and to try to tell banks what works, what kind of programs are worth supporting that really seem to make a difference in terms of alleviating distress in low- and moderate-income communities. Mr. MEEKS. One of the things I think is important, because I want to know, and maybe you have the answers, is to show where the banks are making these investments in compliance with CRA. Because I have found that those numbers have surely sunk, and then when I look at access to capital in these communities, you have about 70 million people now who are underbanked or unbanked in these communities, and so CRA could definitely help there. I would love to follow up with you to find out exactly where the enforcement—who is, in fact, complying and giving and who is not, because there has to be some accountability therein. Lastly, let me just, in the few seconds I have, because the other thing that I think that is important to look at in some of these communities, because—and today as well, access to credit is abso- lutely key and essential. And sometimes, in the way credit is looked at, are there alternative systems? For example, you find some people who pay their rent every month on time, and that is not to be considered when referenced to credit scoring models. So are there other models that you are looking at with reference to how credit scores are considered that the Fed could advocate? Mrs. YELLEN. I am not sure about credit scores. We would be glad to get back to you on that. Chairman HENSARLING. The time of the gentleman has expired. The Chair now recognizes the gentleman from Wisconsin, Mr. Duffy, chairman of our Oversight and Investigations Subcommittee. Mr. DUFFY. Thank you, Mr. Chairman. And welcome, Chair Yellen. I want to take a trip down memory lane, because I think there is some rewriting of what happened in the crisis. There are a lot of people who bought homes, and for lower-in- come folks, that is their investment. And a lot of them lost their investment walking into the crisis, devastating families. I know we want to look to Wall Street and there is blame there. But I think there is a little bit of revisionist history when we say, you know what, Fannie Mae and Freddie Mac didn’t have anything to do with the crisis. Fannie and Freddie allowed no-doc loans, no income verification, allowing folks to buy homes they couldn’t af- ford. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 29 And in Dodd-Frank, that was passed by my friends across the aisle, Fannie and Freddie weren’t touched at all. Fannie and Freddie were the ones that were allowing folks in this room to get homes they couldn’t afford and they were hurt. It didn’t touch them. The regulators had wild authority and power. They failed. And instead of taking a look at the regulation and the regulators, we have re-empowered regulators. And it’s no wonder that big banks after Dodd-Frank haven’t got- ten smaller. Big banks have gotten bigger. And the small commu- nity banks that I am sure service a lot of the folks in this room, and service folks in my community, are going away. That’s a big problem. I just had to get it off my chest. So there are a lot of exciting things to chat about with you, Chair Yellen. But as the chairman of the Oversight Subcommittee, I do have some concerns about your willingness to comply with our re- quests. We sent a letter in the Medley investigation in our oversight of the Fed asking you for information regarding communication. No compliance. Then, we sent you a subpoena in May. You did not comply with that. We had partial compliance in October. We are now a year after my initial letter. I have asked you for excerpts of the FOMC transcripts in regard to the discussion—in regard to the internal investigation on Medley. You have not pro- vided those to me. Is it your intent today to promise that I will have those if not this afternoon, then tomorrow? Mrs. YELLEN. Congressman, I discussed this matter with Chair- man Hensarling and indicated we have some concern about pro- viding these transcripts. Mr. DUFFY. Finding the transcripts? Mrs. YELLEN. I said with providing transcripts, given their im- portance in monetary policy. Mr. DUFFY. So let me just— Mrs. YELLEN. And I received a note back from Chairman Hen- sarling last night quite late indicating your response to that. And we will consider it and get back to you as soon as we can. Mr. DUFFY. Oh no, no. I don’t want you to consider it. And I think the Chairman would agree with me that this is a conversa- tion not about monetary policy; this is not market-moving stuff. This is about the investigation and the conversation of a leak in- side of your organization. This institution is entitled to those documents. Would you agree? Mrs. YELLEN. I will get back to you with the formal answer. Mr. DUFFY. No, no, listen. Mrs. YELLEN. I believe that we have provided you with all the relevant information. Mr. DUFFY. That is not my question for you, Chair Yellen. If I am not entitled to it, can you give me the privilege that you are going to exert that is going to let me know why I am not entitled to those documents? VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 30 Mrs. YELLEN. I said we received well after the close of business yesterday a letter explaining your reasoning, and I will need some time to discuss this matter with my staff— Mr. DUFFY. No, I don’t want— Mrs. YELLEN. —before I give you a final answer. Mr. DUFFY. I don’t want—listen. I sent you a letter a year ago, on February 5th. I had to send you a subpoena. You knew that I was looking for these documents; you knew I was going to ask you about this today. So if you are not going to give me the documents, exert your privilege. Tell me your legal au- thority why you are not going to provide this to us. If this is market-moving, I would be sensitive to that. This is not monetary policy conversations; this is about the internal workings of the Fed. And I am not asking for all the transcripts; I am just asking for the excerpts specific to our investigation and oversight of the Fed. Let me ask you this: You get to oversee banks. If you made a re- quest to a bank for information a year ago and they said, ‘‘Let me review with my board. Let me talk about it,’’ but they never comply with your request for documents or information, what would the Fed do? Mrs. YELLEN. I think we have complied very fully with the re- quests that you have made. Mr. DUFFY. I am asking, what would you do if you made that kind of a request to a bank that you oversee? What would you do? Mrs. YELLEN. We work with banks to make sure we have access to the information. Mr. DUFFY. If they didn’t, I can’t imagine what the Fed would do if someone didn’t comply with your request. And guess what, we are entitled to the documents. We expect to get them unless you exert a privilege, and there is no privilege that you have. So I ex- pect they will come over. I yield back. Ms. WATERS. Mr. Chairman? Chairman HENSARLING. The time of the gentleman has—for what purpose is the ranking member seeking recognition? Ms. WATERS. Is it appropriate to ask for unanimous consent for clarification on a point of information that was just given by the gentleman? Chairman HENSARLING. Does the lady have a parliamentary in- quiry? Ms. WATERS. The inquiry could be considered parliamentary. I understand the gentleman to say that they subpoenaed the Fed and it was ignored. Is that what he meant? Chairman HENSARLING. The gentlelady is not stating a par- liamentary inquiry, and as I think the ranking member knows, the time of the Chair is limited. If other members wish to pursue that in their questioning, they may pursue it in their questioning. The Chair now recognizes the gentleman from Texas, Mr. Hino- josa. Mr. HINOJOSA. Thank you, Chairman Hensarling and Ranking Member Waters, for holding this hearing today. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 31 Chair Yellen, I thank you for meeting with our committee today and for your steadfast leadership at the Federal Reserve. America has made great progress since the financial crisis of 2008. Our recovery includes 70 consecutive months of job growth, the longest streak in our Nation’s history, resulting in an astounding 14 million private-sector jobs created. And an unemployment rate now standing below 5 percent. However, we continue to feel the hangover from the financial cri- sis started during President George W. Bush’s second term. Today, the slower-than-average economic growth rate is fueling anxiety and weakening confidence in our Nation’s economic growth pros- pects. Additionally, our economy appears to be sailing into strong headwinds caused by slowing growth in the developing world, stag- nant growth in Europe, the dual effects of plunging oil prices and a strong dollar negatively affecting our manufacturing and export industries. Addressing those challenges also requires us to answer questions regarding the sustainability of our national debt and of the ability of Congress and the Federal Reserve to act effectively to stimulate the economy. Despite that market turmoil and economic uncertainty, however, I will note that our Nation’s confidence in the safety and soundness of our financial system has not been shaken. Indeed, we can at- tribute a much stronger and more resilient financial system in large part to the protections and improvements of the market over- sight under the Dodd-Frank Act. My first question, Chair Yellen: What else should our Nation be doing to help us return to normal growth rates? Mrs. YELLEN. One of the distressing aspects of the recovery we have seen—I agree with you that we have made progress in the labor market, created a lot of jobs and the unemployment rate is low. But the growth in the economy that has been consistent with that has been quite disappointing. So another way of saying what that implies is when output is growing at a very weak pace and you have a lot of job growth, that means that productivity growth has been very disappointing since the financial crisis, and ultimately that determines living stand- ards. Mr. HINOJOSA. Chair Yellen, do you think we are dragging down the potential growth rate of our economy and doing a disservice to our young men and women by saddling them with debt just as they are setting out to become full contributing members of our work- force and economic engine? Mrs. YELLEN. I think the debt situation that faces this country over the longer term is something that Congress certainly needs to address. While at this point the debt-to-GDP ratio looks like it should be sustainable at present levels for a number of years, as the population ages, it will—this is evident from CBO projections— be on an unsustainable upward course, and this is something Con- gress has known about for decades and it is important to address. Mr. HINOJOSA. It seems to me that while Congress must do its part to raise the minimum wage, expand the Social Security safety net, and provide a more progressive tax code, what steps are you VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 32 taking at the Federal Reserve to address the historic level of in- equality in the United States? Mrs. YELLEN. Congressman, the main contribution that the Fed can make to inequality, given that we don’t have policies that tar- get particular groups in the labor force, is to make sure that the labor market is performing well, that we attain Congress’ max- imum employment objective. I am pleased with the progress we have made, but there is fur- ther to go, and we are committed to making sure that we stay on that course of further improvement in the labor market. And it won’t right every disadvantage that workers face, but it has resulted and will continue to result in broad-based gains for all groups in the workforce. Mr. HINOJOSA. My time has run out, and I yield back. Chairman HENSARLING. The time of the gentleman has expired. The Chair now recognizes the gentleman from California, Mr. Royce, Chairman of the House Foreign Affairs Committee. Mr. ROYCE. Thank you, Mr. Chairman. Chair Yellen, it’s good to see you. Thank you for being here. The latest stress-test scenario that was published by the Fed in- cludes this scenario where the rate on 3-month U.S. Treasuries drops below zero from the second quarter of 2016 through 2019. And I recognize that this in no way predicts any future action here. As a matter of fact, CCAR announced specifically in the docu- ment there that this scenario does not represent a forecast for the Federal Reserve. Nonetheless, this timing is interesting because it comes at a time when the European Central Bank and the Bank of Japan have both instituted these negative interest rate policies. So the question I was going to ask you—and let me make one other point. It may suggest that the Federal Reserve is not opposed to reducing its target rate below zero, should economic conditions warrant, and may be employing the stress-test process as a tool to consider its possible impacts. That strikes me as maybe the reason you deployed it in the scenario. You told the committee in November that if the economy were to deteriorate in a significant way, potentially anything, including negative interest rates, would be on the table. And I remember those remarks were echoed in January by New York Fed President Bill Dudley. So assuming for a minute that the Fed figures out this question about the legal authority, do you still believe that negative rates are a tool in the toolbox? And can we assume that the Federal Re- serve would not include this scenario in a stress test if, in fact, it were not a potential future action? Mrs. YELLEN. Let me say that was not what motivated the inclu- sion of this scenario in the stress test. We are in an environment where, as you pointed out, a number of the ECB, other European central banks, and the Bank of Japan, have gone to negative rates. Through much of Europe, and in Japan, interest rates are nega- tive way at the yield curve. And we have had periods of market stress, where we see a flight into U.S. Treasuries as a safe haven, and the scenario that we ask banks to look at is one in which Treasury bill yields go negative. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 33 This is something that could potentially happen without the Fed actually setting negative interest rates. It is something that could happen, and we have seen it happen for limited periods of time in stressful situations. Mr. ROYCE. Let me ask a clarifying point— Mrs. YELLEN. But— Mr. ROYCE. —because it has been kicked around since 2010, the possibility of the Fed maybe setting negative interest rates. Right? Mrs. YELLEN. Well, yes. Mr. ROYCE. Quick question on looking at the Fed authority, you haven’t taken a serious look at the Fed authority until now, while it was kicked around then and you do the scenario in the interim? Mrs. YELLEN. Back in 2010 when we were looking for ways to consider—to add accommodation, to have a toolkit available, it is something we looked at. We got only to the point of thinking that it wasn’t a preferred tool. Mr. ROYCE. Right. Mrs. YELLEN. We were concerned about the impacts it would have on money markets. We were worried that it wouldn’t work in our institutional environment. And we thought that zero was really the effective or very— Mr. ROYCE. I got it. Mrs. YELLEN. —just very little was—could be gained. Mr. ROYCE. Let me ask you, then, really quickly— Mrs. YELLEN. We would—in the spirit of prudent planning— Mr. ROYCE. —right. Yes. Mrs. YELLEN. —it is something that, in light of European experi- ence, we will look at, we should look at, not because we think there is any reason to use it but to know what could potentially be avail- able. And it isn’t just a question of legal authority. It is also a question of, could the plumbing of the payment system in the United States handle it? Is our institutional structure of our money markets com- patible with it? We have not determined that. Mr. ROYCE. Let me just say that I think that the central banks in Japan and Europe are trying to overcompensate for irresponsible fiscal policy. I think that is what put them in this position. Can we avoid the same mistake here in the United States if we get our fiscal house in order? In other words, do you agree that if we address the long-term structural problems with soaring manda- tory spending, we would decrease the potential need for monetary policy actions that reverse course on interest rates? Mrs. YELLEN. I think it is certainly desirable and important for the long-run stability and growth of this country to take the meas- ures that you have suggested and evaluating the stance of fiscal policy. It is something that affects our monetary policy options. Mr. ROYCE. Thank you, Chair Yellen. Thank you very much. Chairman HENSARLING. The time of the gentleman has expired. The Chair now recognizes the gentleman from Georgia, Mr. Scott. Mr. SCOTT. Chair Yellen, thank you for being here. Chair Yellen, you know I have a lot of respect for you. Mrs. YELLEN. Thank you. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 34 Mr. SCOTT. But I very vehemently disagree with you when you say that you can’t target unemployment. Let me just say this: It is very important for everyone to know that you have an equal mission. Part of that mission, one half of it, is to curb inflation. But the other half is unemployment. And so just as surely as you go and you target inflation with movement of your interest rates, surely you have to understand that you have the same authority to deal with the unemployment. Now, let me tell you why this is important, Mrs. Yellen: Nobody is suffering from unemployment like the African-American commu- nity. And they are suffering from that because of the very laissez- faire attitude that the Fed historically has dealt with just employ- ment or unemployment altogether. When you look—yes, we can crow about a 4.5 unemployment rate. Do you know what the unemployment rate is for African- American men between the ages of 18 and 37? It is 36.5 percent unemployment. And in some communities like Chicago, Baltimore, Atlanta, Houston, any of these big cities, it is hovering at 50 per- cent. When you have this devastating situation, there is nobody else— there is no other agency that has the mandate to deal with it as the Fed. Now, in order to deal with it, you have to look at the econ- omy like it is a wheel. The economy is a wheel. And why is it that we have this high unemployment rate among African-American young men? And African-American women in that same age group is 26 percent. So why is it that we can’t? And a part of that reason is because the Fed has historically downplayed unemployment. Never in the history of the Fed have you even seen fit to have an African-American president of a regional Federal bank for the Federal Reserve. That is a part of the reason. We are not even a part of the conversation. So my whole point is that I want the Fed—nobody is better equipped to handle this rigid unemployment facing the African- American community in that most pliable age group. That is the child-producing age group, 18 to 37. Can you imagine if that was the employment rate of 37.6 percent of white young men in that age group? All hell would be breaking loose right now to do something about it. We need that same compassion from you. When you look at the sectors of the economy that are growing—transportation, energy, agriculture business, health care, construction, rebuilding the in- frastructure, manufacturing—we need an advocacy from you to say automatically, there must be on-the-job training programs for Afri- can-Americans in this hard group to go into these areas and earn as they learn. In agro-business, we have 1890s colleges, 19 of them, whose au- thority and mandate through the Farm Bill is to take the money that we give them through the Farm Bill and spend in teaching, research, and extension. Why not create the other spending cat- egory for scholarships and loan forgiveness, students who will go in and take advantage of these job openings in agriculture and business? VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 35 All I am saying is that, please, we have to get the Fed to get off the dime and put the issue of African-American unemployment on the front burner. That is the core of all of the domestic issues that we are facing. And that is the child-bearing group. What are these fathers to do? What is there for them? That is why we have so many of the situations in Baltimore, in Chicago, and in other places, and it leads to a straight pipeline to why we have 1.2 million of them sitting in the prisons. Would you help us with that? Mrs. YELLEN. Congressman, I— Mr. SCOTT. I would love to work with you on it. Mrs. YELLEN. —want to assure you that we recognize how seri- ous the problems are that you have discussed, and we take our em- ployment mandate extremely seriously and have been doing every- thing that we can to promote a stronger labor market that will ben- efit African-Americans. Mr. SCOTT. Would you really consider getting an African-Amer- ican, for the first time in history, to be a regional president of a Federal Reserve bank for the first time in history? Mrs. YELLEN. Absolutely. It is our job to make sure that every search for those jobs assembles a broad and diverse group of can- didates, and I regret that there hasn’t been an appointment of an— Mr. SCOTT. Thank you, Mrs. Yellen. Chairman HENSARLING. The time of the gentleman has expired. Mr. SCOTT. Thank you, Mr. Chairman. Chairman HENSARLING. The Chair now recognizes the gentleman from Florida, Mr. Posey. Mr. POSEY. Thank you, Mr. Chairman. Madam Chair, the number one thing I hear from my local com- munity banks and credit unions is the need for regulatory release. That is not news to you, obviously, either. And these financial insti- tutions provide critical services to our communities, and they are worried that the overregulation is hurting not only their ability to provide those services, but eventually is clearly leading to in- creased industry consolidation. What do you consider to be the negative consequences, if any, that result from consolidation, and the effects on the local and na- tional economy? Mrs. YELLEN. I think community banks play a vital role in sup- plying credit to groups of borrowers whom larger banks often would not be able to serve. And that is a vital role in all communities throughout the country, so we want to see those banks thrive, and are very focused on ways that we can reduce the burden on those banks. I mentioned earlier some of the things that we have tried to do to reduce the burden, and we will continue looking through the EGRPRA process, and by the regular meetings and contact that we have with community bankers, to address the burdens that they face and look for ways to simplify regulation and reduce burden. Mr. POSEY. Madam Chair, do you think that relationship lending is important? Mrs. YELLEN. It has been very important often for community banks in the kind of business that they do, so yes. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 36 Mr. POSEY. Just a quick follow up: Can you identify some areas of priority at the Fed for reducing regulatory burdens on commu- nity banks? Mrs. YELLEN. Yes. We have been focusing, for example, on the duration of our on-site reviews and looking for ways to have our examiners spend less time on bank premises. We have been looking at ways and have simplified and tried to tailor our pre-examination requests for documentation. We have been conducting extensive training for examiners to make sure that our guidance is properly interpreted and applied in ways that are consistent. We have a number of fora in which we try to help community bankers understand what new regulations or proposals are relevant to them and which ones are not intended at all for their organizations. As I mentioned, the EGRPRA process is ongoing, and we have been holding fora around the country to hear the concerns of banks with regulatory burden and will take all of the steps that we pos- sibly can to address the concerns that surface. We meet regularly with community bankers through an organi- zation called CDIAC, which is composed of representatives from each of the 12 Federal Reserve districts. They come to the Board and we meet with them twice a year, the full Board of Governors, to discuss their concerns, and we follow up on what we hear. Mr. POSEY. Thank you. Finally, this week the House is considering legislation that would require the Administration to put forth a detailed plan to reduce the national debt whenever the debt limit is increased—a common- sense concept, I believe. We also just received the President’s budg- et request, which would, in the face of a $19 trillion—we just passed the $19 trillion mark in the debt clock—increase spending by $2.5 trillion. When the President took office, the national debt was roughly $10 trillion. When he leaves office, the debt is expected to have doubled to about $20 trillion. You have also voiced your concerns about the impact of failing to raise the debt limit, failing to pay our bills, citing the impact it would have on the economy. I don’t disagree, but I am curious, do you have similar concerns about the impact on the economy of failing to address our national debt? How much debt do you think is too much? Mrs. YELLEN. I think if you look at the path that the U.S. Fed is on under current policies, it will rise from the present level to levels well above 100 percent of GDP and continue rising more or less indefinitely. And wherever you draw the line, you have to con- clude that is an unsustainable economic situation. So I think it is essential that Congress address this longer-run budget deficit issue. Chairman HENSARLING. The time of the gentleman has expired. The Chair now recognizes the gentleman from Texas, Mr. Green, the ranking member of our Oversight and Investigations Sub- committee. Mr. GREEN. Thank you, Mr. Chairman. I thank Chair Yellen for appearing today, as well. Mr. Chairman, Chair Yellen and, of course, Ranking Member Waters, I want you to know that there has not been some sort of VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 37 conspiracy among Congressional Black Caucus members to bring up this issue of black unemployment, although I think we do talk about it among ourselves quite regularly. But I do believe that a basic premise that may be of help to us is the notion that, ‘‘In the beginning was the Word.’’ And not enough talk takes place among those who have the power to influ- ence public policy with reference to African-American unemploy- ment. To this end, I am concerned, and would ask if you have, in your statement, given a specific reference to African-American un- employment in the statement that you made today? I apologize if I missed it, but was there a specific reference to Af- rican-American unemployment? Mrs. YELLEN. I referenced in the answer to a previous question the very high rates of unemployment of African-Americans that persist even with the current aggregate unemployment rate. Mr. GREEN. If I may, let me share this thought with you: If it is—and I believe you are in agreement that it is a serious prob- lem—not just a problem, a serious problem. Mrs. YELLEN. I certainly agree with that. Mr. GREEN. If it is a serious problem, I would ask that you make it a part of your actual statement that you present, and that you publish it, and that you continue to say to those of us who can make a difference—and we should be able to make the difference here in Congress; we have responsibilities here to focus as well— but if you would make it a part of your statement, and if you would publish this, I think it can have a meaningful impact on policy- makers up and down the line. So just a small request, but I think it can make a really big dif- ference, so I am going to ask that you do this. Mrs. YELLEN. I am certainly open to doing so. I will certainly— Mr. GREEN. Thank you. Now, let’s move to the Taylor Rule for just a moment. You have indicated that the Taylor Rule would be a grave mistake and that it would be detrimental to the economy and the American people. Could you, in about 1 minute, give some examples or an example of how it would be detrimental to the economy? That is a sort of a nebulous term and I think you should provide some clarity. Mrs. YELLEN. Sometimes, it provides recommendations for what monetary policy should be that clearly overlook important cir- cumstances, and— Mr. GREEN. If I may, Madam Chair, would you kindly explain the impact that it will have on the economy? What would the im- pact be if it causes us to do something inappropriate? And I will let you decide what is inappropriate. Mrs. YELLEN. Either it would have us set a monetary policy that would result in much higher unemployment than would be desir- able or, alternatively, there could be circumstances in which it would recommend an accommodative policy that would result in ex- tremely high inflation. Now, I would say right now, as an example, the Taylor Rule would recommend an overnight short-term interest rate that would be close to 2.5 percent, and I think in light of the slow growth in the U.S. economy and the fact that we have needed to hold the Federal funds rate for almost 7 years—for 7 years at zero to VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00041 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 38 achieve the progress that we have made, that setting it at the level that it would now recommend would be highly damaging to the eco- nomic situation. And we tried to provide some analysis in the monetary policy re- port we submitted about what—why that is, and in particular this idea that the neutral Fed funds rate, because of the damage from the financial crisis— Mr. GREEN. I regret that I must reclaim my time because I have one additional thing that I must say. I appreciate your commentary and I think that a good many people have the point. But I want to say this: We have some people who are visiting today. I don’t want any response from them, but I want to acknowl- edge their presence because they are concerned about these wages. Now, they are concerned about wages across-the-board, especially as they impact working people, people who are on salaries, people who make minimum wage. And it is our desire to see policies that will have greater employ- ment, greater opportunities, but also policies that will target those who are hurt the most. I thank you, Mr. Chairman. I yield back. Mr. MESSER [presiding]. The gentleman’s time has expired. The Chair now recognizes the gentleman from Pennsylvania, Mr. Rothfus, for 5 minutes. Mr. ROTHFUS. Thank you, Mr. Chairman. Welcome, Chair Yellen. I want to talk briefly about custody banks, which you know fol- low a different business model from other financial institutions. Custodians do not make consumer loans or engage in investment banking, and for these reasons pose relatively little credit risk. I understand that custody banks, whose customers would include, for example, pension funds with millions of beneficiaries, are finding it increasingly difficult to provide their core custody services, espe- cially accepting large cash deposits. And this could worsen under a period of stress. One of the main reasons for this appears to be recent regulatory reform, such as the supplementary leverage ratio known as SLR. Custody banks typically place cash received on deposit with the Federal Reserve. This is cash that comes from pension funds, en- dowments, municipalities, and other clients. However, the Federal Reserve’s supplementary leverage ratio does not recognize the essentially riskless nature of Fed deposits or the necessity of these placements by custodians. This may cause the leading custody banks to reject a customer cash deposit. My question is: Is the Federal Reserve aware of the impact that this may be having on custody banks? And if so, what do you pro- pose to do about it? Mrs. YELLEN. This is something that was considered, what is the appropriate treatment of central bank deposits, when the supple- mentary leverage ratio was adopted. And the decision was made at the time that the leverage ratio is not our main capital tool, but a backup capital tool that is intended to, in a crude kind of way, base capital requirements on the overall size of a firm’s balance sheet, and that for that reason it should be included. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00042 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 39 We have more recently put in place capital surcharges that apply to the eight largest U.S. banking organizations, including two cus- tody banks. And it is likely that once those are in place, they will become the binding capital requirement. But— Mr. ROTHFUS. I would encourage you to take a look at it because it is an issue for the banks. Mrs. YELLEN. We have heard of the problem, and I will address it. Mr. ROTHFUS. As you know, Chair Yellen, the Bank of Japan re- cently announced that it would implement a negative interest rate policy in an effort to increase spending and investment and spur growth. The decision follows close on the heels of the European Central Bank’s announcement that it would also launch additional monetary stimulus in March, and economists have predicted that Sweden, Denmark, Norway, Canada, Australia, and China may fol- low suit. In a recent editorial in The Wall Street Journal, William Poole, the former president of the Federal Reserve Bank of St. Louis, ar- gued that these sorts of monetary policy gimmicks will not create their intended effects and instead they will only serve to divert at- tention from the actual structural problems that have plagued growth in the United States and around the world over the last decades, namely regulatory burdens and tax policies that serve to constrain business investment and long-term growth. What do you say in response to Mr. Poole? Mrs. YELLEN. I agree that there are structural factors that have restrained U.S. growth and also been responsible for rising inequal- ity in the labor market. And it is important to take steps to ad- dress those problems. They are steps that are in the domain of Congress. But it is important for the Fed to try to achieve its mandate of ensuring a state of the labor market where people who want to work are able to find jobs, where there are a sufficient number of them. And, given the stressed situations that exist in Europe where there remains very high unemployment, and in Japan where infla- tion has for well over a decade undershot their inflation objective, it is a tool that has proven useful to them. Mr. ROTHFUS. I want to talk a little bit—you testified earlier that over the past number of years, the Fed kept the Federal funds rate at exceptionally low levels. You testified that even with this ‘‘excep- tional’’ strategy, the economy achieved only 2 percent growth. And you added that ‘‘The economy is being held back by headwinds.’’ I am wondering if any of these headwinds are manmade, or, to borrow a phrase, anthropogenic here in the United States? And I could identify some: the Affordable Care Act; a Wall Street reform bill that missed the mark, frankly; EPA regulations. And these headwinds have hit folks in my district, like a mom who now has to pay $400 for allergy medicine for her kid when she used to pay $10; or the coal miner I talked to last week who is tak- ing care of a 5-year-old, a 3-year-old, and a 1-year-old and won’t be able to pay for his mortgage. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00043 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 40 And I just wonder, when the economic history of this decade is written, are they going to say that the Fed tried to do with mone- tary policy what should have been done with fiscal policy? I yield back. Mrs. YELLEN. I think it is also important for Congress to address structural factors that are holding down growth. Chairman HENSARLING. The time of the gentleman has expired. The Chair now recognizes the gentleman from Missouri, Mr. Cleaver, ranking member of our Housing and Insurance Sub- committee. Mr. CLEAVER. Thank you, Mr. Chairman. Thank you for being here, Madam Chair. Following through on some things that were said earlier, I have a bad knee and I have had it operated on 11 times, but the weird thing is that whenever I go to the hospital for another surgery, they never operate on my shoulder or my fingers. For some strange reason, they always operate on the same knee that has been hurt. And I know that is weird. The issue is we can’t address unemployment in a certain sector by saying we are going to operate on the whole body and it gets better. That has never been true. Now, I differ a little from my colleagues in that I don’t think it is your responsibility. I don’t think the Fed has the responsibility even with the dual mandate. I think it is to be handled legisla- tively, and I don’t think we are going to get that done. The other thing I have to say is that—and it is been said, and every time you come I have to say it because I have to just get it off my chest, because I do think that we are declaring minority un- employment to be too-big-to-curtail, and that is somewhat trouble- some. But Wall Street and the big six banks are too-big-to-jail. If you rob a convenience store, you go to jail. If you rob 300 million Amer- icans, you get a cocktail. And I think that is what is creating all this anger around the country. I know you don’t run the Justice Department, and I know you don’t vote on legislation that could address some of these other issues. But I think we have to say it as much as we can because I don’t think the world is hearing us. Now, I would like to yield the remainder of my time to the rank- ing member of the Financial Services Committee. Ms. WATERS. Thank you very much, Mr. Cleaver. As you know, originally I was thinking about dealing with the question of the subpoena, et cetera. Except if you don’t mind, I am so focused on all of this money that goes to these too-big-to-fail banks and trying to understand, number one, not only the fact that Goldman Sachs got $121 million, JPMorgan $910 million, and that with the rise in interest rates from 0.25 percent to 0.5 percent, this will double. And this money keeps—it is going to the big banks. It is a sub- sidy to keep them from lending money, and we have this big need that has been discussed by my colleagues about this high unem- ployment rate and the lack of creativity and thinking about how we can deal with this. And these banks, too-big-to-fail, who we are VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 41 finding every day because of the predatory lending, et cetera, are getting support from the Feds. Please, please explain that. Mrs. YELLEN. It is an essential tool that we need to adjust the level of short-term interest rates. And from the standpoint of the taxpayer, our payment of those interest on reserves—we have very large reserve balances. We have $2.5 trillion, roughly, of reserves in the banking system, as compared with $20 billion or $30 billion prior to the crisis. The counterpart of that on our balance sheet is that we hold a very large stock of assets on which we are earning a substantially higher rate of return than we are paying to the banks. And that differential between what we earn on our holdings of long-term Treasuries and mortgage-backed securities and the 25 or 50 basis points we pay to the banks, that differential all shows up in the taxpayers’ pocket. It is money that Congress can use to address all of the problems that you have discussed. Over the last year, we transferred $100 billion because of that. Now, if we don’t pay interest on reserves and must use another technique to adjust short-term interest rates, likely we will be forced to greatly shrink our balance sheet in a rapid fashion, and the total amount of money going from the Federal Reserve to Con- gress will be significantly diminished. In addition to that, it would have very adverse effects on the economy. Ms. WATERS. I want you to know that not only am I concerned, it looks like we are about to have some bipartisan concern on this issue. Mrs. YELLEN. I hear that. Ms. WATERS. And while I understand the argument that you are making about the big banks, we cannot feel sorry for them in terms of the amount of interest rates that they are getting or not getting, et cetera. We really do have to deal with this issue. I understand what you are trying to explain by short-term inter- est rates, but if I may, Madam Chair, let me just say this, that we have an opportunity with the discount window to allow for loans from some of these small community banks that they are not get- ting. And if that money went into the small community banks, they would be able to do job creation and to support small businesses, et cetera. And we just don’t get why they are precluded from doing this, and increasing the job opportunities in the community, while we have given the subsidy to the big banks. We just don’t get it. Chairman HENSARLING. Although I agree with much of what the ranking member has said, she has long since spent her time. The Chair now recognizes the gentlelady from Utah, Mrs. Love. Mrs. LOVE. Thank you, Mr. Chairman. Thank you, Chair Yellen, for being here today. Chair Yellen, I am increasingly concerned about the impact of Dodd-Frank regula- tions on real economy, economic growth, and especially job cre- ation, which I wouldd like to just ask you a few questions about. If you look beyond the headlines, the headline numbers from last Friday’s job numbers, and include discouraged workers and the underemployment, real unemployment remains high, nearly 10 percent. In addition, millions of people have stopped looking for VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00045 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 42 jobs. They have dropped out of the workforce, and it is a dynamic that is driving the Nation’s workforce participation rate to an all- time low at 62.7 percent. And I want you to know that I agree with my colleague on the other side of the aisle, Representative Scott, when he talks about the large number of unemployment with our young Black Ameri- cans. Meanwhile, economic growth slowed to just 0.7 percent in the fourth quarter. I am concerned the Fed and other financial regulators may not have a firm grip on the cumulative impact on the real economy of thousands of pages of the new Dodd-Frank regulations, especially new capital and liquidity rules. I am wondering if you share some of those concerns? Mrs. YELLEN. I recognize that some of the new concerns are bur- densome and do raise banks’ cost of financial intermediation. In de- signing those regulations, we are always trying to achieve a bal- ance between the benefits of creating a sounder and more resilient financial system that is less likely to be subject to the kind of dev- astating financial crisis that we had. We are balancing that against burdens that can raise the cost of capital or diminish financial intermediation. And we have tried to strike a reasonable balance, remembering that nothing resulted in more harm for a longer period of time than the financial crisis that we lived through, and I think we now have a much safer and sounder financial system. Mrs. LOVE. Okay, so another study by the American Action Forum found that consumer credit availability deteriorated 12 per- cent to 14 percent since the passage of Dodd-Frank. I am also con- cerned about the growing number of borrowers unable to access af- fordable banking—including a lot of borrowers from low-income areas in my district, which is Sigurd, West Valley. These are hard- working Americans who are turning to high cost and unregulated online lenders to be able to get the access to the credit that they need, whether it is for purchasing a car or even starting a small business. They are finding that their ability to access this type of credit is unavailable to them. And so I am wondering if you also share some of my concerns about credit availability and the higher-cost alternatives? Mrs. YELLEN. I do share your concerns about credit availability. And I think it is clear that credit availability has, in particular seg- ments, been diminished. Home loans, mortgages, for example, for individuals without pristine credit ratings is really difficult, re- mains difficult to obtain. In part, we have regulations that are meant to address harms. I think lending standards were too easy prior to the financial crisis. We don’t want to go back to lending standards that are so loose that they lead to the kinds of predatory lending and harms that we had that took a toll on the economy and on low-income households in communities. We need to achieve a reasonable balance, and we are searching for that. Mrs. LOVE. Being on the Subcommittee on Monetary Policy, I wanted to ask you just a quick question on monetary policy and what is happening in Europe and what are the implications. I may have stepped out of the room; I don’t know if you have addressed VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 43 this. But very quickly, what are the implications of the Federal Re- serve and the ECB pursuing divergent monetary policy? Mrs. YELLEN. The ECB has been addressing high unemployment and inflation that has slipped very meaningfully below their 2-per- cent goal by putting in place negative interest rates and large-scale asset purchase programs. The United States has done better. We are, among advanced economies, about the strongest, so we have divergent monetary policies. It has put upward pressure on the dollar over a long period of time, which has harmed manufacturing and net exports. And so, it has resulted in negative influences on the part of our economy. Chairman HENSARLING. The time of the gentlelady has expired. The Chair now recognizes the gentleman from Missouri, Mr. Clay, ranking member of our Financial Institutions Subcommittee. Mr. CLAY. Thank you, Mr. Chairman. And thank you for being here, Chair Yellen. The Federal Reserve has a congressional dual mandate to seek maximum employment while limiting inflation. To limit inflation, the Federal Reserve raises interest rates, which slows the economy by discouraging people from borrowing to buy homes and cars, and discouraging businesses from investing. With this reduced demand, businesses will hire fewer workers. And as a result, workers will have less bargaining power, meaning they will be less likely to get pay increases. The decision to raise interest rates is based on the assessment of the Federal Open Mar- ket Committee of the Federal Reserve about whether inflation or unemployment poses a greater threat to the American economy. Unfortunately, the members of the FOMC largely come from the financial industry and, as a result, tend to be more concerned about inflation than the population as a whole, and less concerned about unemployment. So how do we square that, Madam Chair? Mrs. YELLEN. First of all, I want to say that the committee is deeply focused on unemployment. We have two objectives, not one: maximum employment; and price stability, which we have inter- preted as a 2 percent inflation objective. And I would really take issue with the idea that we are not fo- cused on achieving our maximum employment objective. We are. Monetary policy has been highly accommodative. The Fed funds rate was at zero for 7 years. And we also have a large balance sheet that has provided a lot of additional accommodation. So we are not talking about tightening monetary policy, or a tight monetary policy. We have an economy that now has made substantial progress, creating 13 million jobs with the unemploy- ment rate down to 4.9 percent. We took one small step to raise short-term interest rates but con- tinue to have an accommodative monetary policy, which we see as consistent with further progress in the labor market. So it is not that we are trying to reverse progress. We continue to see, even with modest increases and interest rates, further progress, and we want to achieve it precisely because we think that although the un- employment rate is at levels that are probably normal in the longer run, there remains slack in the labor market. We want to see more progress. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00047 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 44 Mr. CLAY. Although—not to cut you off—we could get to 4 per- cent unemployment. But, look, while we are pleased to see that new jobs are continuing to be created in our economy and to learn that the unemployment rate last month fell below 5 percent broad- ly, these positive signs may lead some to ignore the persistent eco- nomic challenges faced by African-Americans in this country. The current unemployment rate for African-Americans, for exam- ple, remains at nearly 9 percent. It is a commonly accepted view that access to gainful employment is one of the most important fac- tors in supporting economic mobility and improving health out- comes. It is also widely known that in areas with higher rates of unemployment, there is a lack of consumption, increased crime rates, reduced school funding, and reduced political influence. Please discuss with us any specific actions that you have person- ally taken or directed your staff to take to identify solutions to help remedy the historical and continued racial disparity between em- ployment opportunity for African-Americans and Whites. Mrs. YELLEN. Our staff produces statistics that are among the most important in documenting and highlighting disparities in the economic situations in terms of assets and income by demographic groups. And I have personally given speeches highlighting those statistics. So our staff certainly looks at and does work to document those disparities. And in our community-development programs and work we dis- cussed earlier that relates to the CRA, that is an area in which we have the capacity to try to identify particular programs that will be helpful in low- and moderate-income communities that suffer from special disadvantage in the labor market, and to try to iden- tify programs that work that we encourage to be adopted on a broader scale— Chairman HENSARLING. The time of the gentleman has expired. Mr. CLAY. I would like to work more with you in that area. Chairman HENSARLING. The Chair now recognizes the gentleman from North Carolina, Mr. Pittenger. Mr. PITTENGER. Thank you, Mr. Chairman. I would like to just welcome those who have come today with your T-shirts on: ‘‘What recovery?’’ ‘‘Let our wages grow.’’ ‘‘Whose recovery?’’ These are very pointed and clear statements, and I real- ly commend you for being here and seeing this process. Yes, the reality is that this recovery is the most dismal, slow, tepid recovery we have ever had from a recession in recorded his- tory. And we look at the realities of this recovery. This last report of new jobs was only 150,000 new jobs. We have a 2 percent dismal economic growth. Frankly, the demographic group that is the lowest recovery is the low-income, minority people in this country. That demographic group has moved up the ladder less than any other group, albeit an intense effort, well-intended, I am sure, by the Obama Adminis- tration, by Chair Yellen. But through it, what we have seen is very accommodative mone- tary policy; we have seen a high regulatory environment; we have seen Obamacare; we have seen the highest corporate tax rates in the industrialized world. All of this has achieved this dismal recov- ery. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00048 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 45 And I would say to you that the contrast is back in the 1970s, we had the same type of dismal economic outlook—high inflation, high unemployment. And yet, what happened? We reduced the reg- ulatory environment, we reduced the tax burden, and the economy took off. We were creating 300,000, 400,000, 500,000 jobs a month. One month, a million jobs. We were growing up to 6 percent. It seems to me that—logic may come in—perhaps well-intended policies have had an adverse outcome of what was ever intended. And, Chair Yellen, I commend you for your work and what you have sought to do. But it seems to me that these accommodative policies have contributed to where we are today. I would say, Chair Yellen, I would like to thank you in your re- marks that you made reference to the fact that there are those who are available to work but not actively searching for work. You have also made reference to those who are working part-time and can’t get full-time jobs. Now, these numbers are not included in the current unemploy- ment rate of 4.9 percent. So in reality, we are really talking around 10, 11, 12 percent are the stats that I have seen of real unemploy- ment. Would that not be correct, Chair Yellen? Mrs. YELLEN. Broader measures of unemployment are signifi- cantly higher. For example, a definition that the BLS refers to as U-6 that includes both of the groups you mentioned—involuntary part-time— Mr. PITTENGER. The point I want to make is— Mrs. YELLEN. —and discouraged— Mr. PITTENGER. —the real numbers are much higher than 4.9 percent. So it is really disingenuous to say to the American people that these policies have contributed toward 4.9 percent unemploy- ment. In the real world, where people are living—and we have some of them here today—it is far less. And I think that should be under- stood and absorbed by these wonderful people who have come, that the types of policies that have been enacted, been enforced this last 7 years, have worked against your interests. What grew the American economy were small businesses who could go get loans. That entrepreneur who has been the lifeblood of our economy can’t go to a bank today to get that new loan be- cause of compliance requirements. They are the people who create those new jobs. And on top of that, you have the burden of the obligations of Obamacare. In small business, what are they doing? They are cut- ting jobs so they don’t have to comply. What will grow your economy, what will create the jobs that you earnestly want, is an open market where companies can grow and not have this intense regulatory environment, whether it is through monetary accommodative policy or through onerous regu- latory environments placed upon them. So I want to encourage you with that reality, that we can find that type of opportunity econ- omy. I would say to you, Chair Yellen, that the regulatory rulebook— it has been in a constant state of revision for the last 6 years. Can VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00049 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 46 you see the benefit, then, as a result of what we discussed, in paus- ing this process in order to assess the cumulative impact that these regulations are having on the economy before we proceed further? Mrs. YELLEN. We have several regulations that we intend to put out during this coming year. And in terms of the list of what was mandated by Dodd-Frank, we have made substantial progress. Mr. PITTENGER. Consider that outcome. We are saying that we think it needs to be done. Chairman HENSARLING. The time of the gentleman has expired. The Chair wishes to remind Members that we expect to excuse the witness as close to 1:00 p.m. as possible. The Chair anticipates getting through perhaps four more Members. The Chair now recognizes the gentleman from the Super Bowl champion Denver Broncos, Mr. Perlmutter. Mr. PERLMUTTER. Thanks, Mr. Chairman. And, Chair Yellen, thank you, as always, for being here today. I was going to go a little off topic with my first question, to say, how about those Broncos, but— Mrs. YELLEN. Way to go. Mr. PERLMUTTER. —the Chair already beat me to the punch. But I do want to talk about the overall conversation today, and I want to thank you and I want to thank the Federal Reserve. I want to start with the chart that we have on the board, which shows what happened at the end of the Bush Administration, when we went to 10 percent unemployment, and under Obama, we are down to less than half of that. Okay? So that is your chart number two in your monetary report. And all the Republicans don’t want to let the facts get in the way of their rhetoric because then chart number four shows that after some time—and that is on page five, Chair—wages are beginning to move up after we started getting people back into the job mar- ket. Chart six, oil prices way down. Chart seven, inflation even. Chart 13, wealth-to-income—disposable income up ‘‘a robust 3.5 percent.’’ Chart 15, household debt service, way down. Chart 20, mortgage rates, down. Figure one on page 37, unemployment down looking at the long-term, and core price inflation, even. Those are your charts. Those are the facts. Now, have wages gone up as much as we would like to see? No. But we had to get a lot of people back working. Now, we are start- ing to see them move. So the Chair went through a whole list of economists, because obviously he didn’t have a lot of questions; he wanted to list a lot of names. And there were a couple of guys there with the Hoover Institute. So Herbert Hoover, grand old Republican President who led us into the Great Depression. Not the kind of economy I would like to see, all right? George Bush, we go from 5 percent unemployment to 10 percent unemployment. We lose millions of jobs. Under Barack Obama, back down to 4.9 percent. In Colorado, we are at 3.5 percent. So I just want to thank you, and I want to thank the Administra- tion for getting this economy back on track. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00050 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 47 Now, can we do better? You bet. So how would you suggest that we do better? How can this econ- omy get moving so that the folks here can see some real growth in wages, which I think are beginning to appear, but what would you suggest? Mrs. YELLEN. Our objective in terms of what we can do is to try to make sure that the picture that you have put up here shows con- tinuing improvement in the labor market. I agree with you, I would say the signs of wage growth increas- ing—they are tentative at this point. There are some hopeful signs, but I think if the labor market continues to progress we are very hopeful we will see faster progress on wages. And we will try to keep that progress going. That is our objec- tive. Inflation is running under our 2-percent objective. I expect that will move up over time, as well, with appropriate policy. But I appreciate your saying that some of the burden should also be on Congress and others, because there are so many problems in the labor market and particular groups—we have talked a lot about African-Americans and the problems they face. The Fed, of course, has a role to play, but job training, edu- cational programs, programs that address other barriers in the labor market, I think this is Congress’ job to address. Productivity growth is very low. I think Congress has always had a role in supporting basic research, making sure that the infra- structure of our country is adequate and putting in place programs that make sure that training and education are widely available. Mr. PERLMUTTER. All right. Let me move to a soft spot that I think exists in the economy, and you and I have talked about it be- fore, and that is on oil and gas and the fact that the Saudi Ara- bians are pumping like crazy into what appears to be an over- supplied market, causing the price to drop a lot, which in some ways is very good for all of us because saves us $10, $15, $20 a week or a month in our price at the pump. But it also is causing some job losses in the manufacturing sec- tors, the oil and gas, obviously, transportation. Can you comment on what the Fed is doing or reviewing when it comes to oil and gas production? Mrs. YELLEN. We are taking account, as you said, of the fact that the energy sector is very hard-hit. We are losing jobs there. But with respect to employment, it is—although there really are very severe losses, it is a pretty small sector of the workforce overall. We are seeing massive cutbacks in drilling activity, and that is rippling through to manufacturing generally, where output is de- pressed. So, it is having negative consequences. On the other hand, if you look at the difference in oil prices now relative to 2014, for the average American household, we are look- ing at a savings of $1,000 a year. And that is boosting consumer spending. And we have these two: a negative force, positive forces. We are trying to factor all of that in as— Chairman HENSARLING. The time of the gentleman has expired. The Chair now recognizes the gentleman from Illinois, Mr. Hultgren. Mr. HULTGREN. Thank you, Mr. Chairman. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00051 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 48 Thank you, Chair Yellen, so much, for being with us today. As you may know, the Financial Crimes Enforcement Network, or FinCEN, is in the process of finalizing some new requirements to prevent terrorism financing and money laundering under its beneficial ownership rules. While I fully support efforts to curb terrorism financing, it seems the application of FinCEN’s rule to certain non-bank subsidiaries, such as premium finance companies, may not be appropriate. I understand that my staff is already talking with the Fed about this issue, but wondered if I could get a commitment from you today about trying to find clarification for if these rules apply to premium finance companies that are subsidiaries of banks? Mrs. YELLEN. We would be happy to work with you on that. Mr. HULTGREN. Thank you so much. When you testified before the committee back on November 4th of 2015, we discussed the impact of the supplementary leverage ratio on custody banks. At that time, you described it as a kind of backup ratio that works as a backup to risk-based capital stand- ards. When responding to questions from Congressman Rothfus earlier today, you stated that, ‘‘When the supplementary leverage ratio be- comes effective, that it will likely become the binding capital re- quirement for some custody banks.’’ I understand some of these custody banks already feel they must discourage customer cash deposits. As you know, these institutions have highly liquid, low-risk balance sheets that support client needs. In light of this concern, will the Fed consider adjusting the capital requirements for excess cash deposits held with the Federal Reserve? Mrs. YELLEN. I am not sure if they will become the—if the sup- plementary leverage ratio will become the binding constraint or not. I didn’t intend to say that it is the binding constraint. There will also be so-called SIFI capital surcharges that will come into ef- fect that may make those binding constraint. This is a matter that I understand what the issue is. We can look at it and discuss it. It was debated at the time. There were consid- erations on both sides and a decision was made to include Fed de- posits. It is something we can look at, but it was considered. Mr. HULTGREN. I hope we are able to discuss that and also look and see if it is necessary for us to have congressional intervention, as far as legislation, to change the rule. Let me move on. I am pleased by the news that the Federal Re- serve has been engaged with the insurance industry on capital roles appropriate for the business of insurance. What are your thoughts on how that process is proceeding, and when might we suspect to see proposed rules from the Federal Re- serve released for public comment? Mrs. YELLEN. We are working very hard on that. I don’t have an exact timetable but we are expecting to go out with, for each of the firms, a notice of proposed rulemaking, so the public can react to these rules. The staff is fairly far along in developing these, so my hope is that it won’t be too much longer. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00052 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 49 We have worked hard to have the appropriate interactions with the firms and other regulators to do this right. Mr. HULTGREN. I appreciate your work on that. From Illinois, in- surance is important. We have some wonderful companies there, but I know they have questions, and I appreciate the iteration and hopefully the resolution relatively quickly. One last question: Will the Federal Reserve issue one proposed capital rule for all insurers it supervises? And if you could explain why or why not? Mrs. YELLEN. I am not positive. I think for the particular SIFIs that have been designated—Prudential, AIG, and MetLife—they are likely to be firm-specific rules, but I am not positive. Let me get back to you on that. Mr. HULTGREN. That would be great. Thank you. Thanks, Chair Yellen. Mr. Chairman, I have an additional minute. I would yield that back to the Chairman, if the Chairman wants it. Otherwise, I yield back. Chairman HENSARLING. The gentleman yields back. The Chair now recognizes the gentleman from Minnesota, Mr. Ellison. Mr. ELLISON. Thank you, Mr. Chairman, and Ranking Member Waters. As we start out, I also want to thank some of the folks who have joined us for the hearing today. My good friend, Ron Harris, is here from Minneapolis. It’s good to see you, Ron. And I just want to let you know that this active citizenship of coming to these hearings, watching things, is exactly what is need- ed in order for this government to function properly. In my view, this is what democracy looks like. Thank you all for being here. Chair Yellen, let me point your attention to the words of Mr. Narayana Kocherlakota, who was a former Minneapolis Fed chair, outgoing President of the Federal Reserve Bank in Minneapolis. On Martin Luther King Day, he wrote a blog and here is what he said in part: ‘‘There is one key source of economic difference in Amer- ican life that is likely underemphasized in the FOMC delibera- tions—race.’’ He went on to say that for the year—he went on to say that he searched through the transcripts of the FOMC meetings for the year 2010, his first year on the committee, and a dire year for Afri- can-Americans in our labor market, and in that year our total un- employment rate exceeded 9.25 percent every quarter, but for Afri- can-Americans, it exceeded 15.5 percent. Today, now, White unemployment in Minnesota is 2.9 percent as of December 2015, but Black unemployment is 14.1 percent. And in Minneapolis, overall White unemployment is 4 percent, but Black unemployment is a shocking 18.9 percent. So I say that because this is something that I think needs the attention of the Chair. I don’t know what constraints you believe are out there, but race matters when it comes to how people experi- ence our economy. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00053 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 50 And if we don’t discuss it, talk about it, then we won’t ever get to the heart of the matter as to how to fix it to make equal justice for all. I will quote one Kocherlakota one more time. He said, ‘‘As we all know too well, race matters. The average African-American’s expe- rience with the U.S. economy is different from that of the average White person’s.’’ So, my question is, what do you make of the commentary from the previous Minneapolis Fed president? In your view, is there ade- quate discussion, attention of the economic situation of African- American workers within FOMC deliberations? And if there is not—and I suspect you will say there is not— what can we do about it? How can we at least focus the commit- tee’s attention on this segment of our fellow Americans? Mrs. YELLEN. It is, of course, important that we look at different groups, and particularly those who are suffering the most in the labor market. And I am surprised that there was no specific men- tion of race. In 2010, the unemployment rate was substantially higher than it was. The committee was very focused at the time on what we could do to promote a stronger labor market. And I suppose be- cause our tools are not ones that can be targeted at particular groups in the labor market, it was clear what we needed to do, and that was to support a stronger labor market more generally. Mr. ELLISON. But, Chair Yellen, forgive me for the interruption. I definitely think that—I get that part. But I would rather talk pro- spectively, because the past is what happened and there is no changing it. How can the Fed Chair get the FOMC to say, ‘‘Wait a minute, not all Americans, particularly African-Americans, are experiencing this upsurge in economic activity?’’ For Black Americans, we are still in the midst of a very serious depression-recession. What can we do about it, and what—and again, I am not here to say—to wag my finger about what hap- pened. We know what happened and it wasn’t right. But in terms of what is happening now and what can happen, what can you tell me? Mrs. YELLEN. I think you are right that we should pay adequate attention to how different groups are faring in the labor market. We have made clear that we don’t focus on any single statistic, that the unemployment rate is only one measure of what is happening in the labor market, and it is appropriate for us to really try to do a much more detailed assessment of where things stand and what we should be aiming for. Chairman HENSARLING. The time of the gentleman has expired. The Chair anticipates calling upon two more Members, Mr. Barr and Mr. Delaney, and then excusing the witness. The Chair now recognizes the gentleman from Kentucky, Mr. Barr. Mr. BARR. Thank you, Mr. Chairman. And, Chair Yellen, thanks for being back before us. The last time you were here, we talked about a qualified CLO concept, and you were kind enough to respond to that question in writing. I want to thank you for that, and I want to particularly VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00054 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 51 thank you for recognizing that the qualified CLO concept could be considered a positive development in the market. And I would like to continue our discussion about the role that regulation could very well play in terms of being a source of eco- nomic instability, particularly in our capital markets. The Basel Committee recently finished a rule in January that in- creases the capital held against securitization exposures in a bank trading book by up to 5 times the amount already required under Basel III, as well as the final TLAC rules. One industry study suggests that trading in U.S. asset-backed securities will become uneconomical if the rule is not tailored to fit the U.S. marketplace. If it is uneconomical to act as a market-maker for commercial mortgage-backed securities or residential mortgage-backed securi- ties, auto loans, credit cards, collateralized loan obligations, then banks will pull out of the ABS market, which represents a $1.6 bil- lion source of consumer lending, or 30 percent of all lending to U.S. consumers. So my question to you, Chair Yellen, is how will the Fed ensure that the final rule will be tailored to fit the U.S. market, which is the most liquid ABS market in the entire world? Mrs. YELLEN. I will have a careful look at that. I am not familiar with all of the details of the Basel proposal. But anything we implement in the United States—there is noth- ing automatic that is implemented in the United States, and we will have a careful look at what the impact would be. Mr. BARR. I appreciate you doing that. And I continue to urge the Fed, and you in particular, as a member of FSOC, to look at gov- ernment regulation as a source of economic instability. To that end, we are told by many of the regulated bank holding companies that there is no updated organizational chart within the Fed. And so my question would be, can you share with us—or can your staff share with us—a detailed organizational chart with the names and titles of the Bank Supervision and Regulation Division’s full professional staff? Mrs. YELLEN. I think so. Mr. BARR. I am told that whatever organizational chart you have is very dated, and so— Mrs. YELLEN. Yes— Mr. BARR. —we can’t even—many of the folks can’t even ask you questions. Mrs. YELLEN. —yes. I don’t see any reason we can’t— Mr. BARR. I appreciate you doing that. Switching gears really quickly to the Consumer Financial Protec- tion Bureau and their funding source, which, as you know, accord- ing to the budget overview that the Bureau makes public, transfers from the Federal Reserve System are capped at $618 million for Fiscal Year 2015, and the transfer cap is estimated to be $631 mil- lion for Fiscal Year 2016. Given that my time is scarce, if you could just answer the fol- lowing in yes-or-no responses, that would be greatly appreciated. Does the Fed approve the Bureau’s budget? Mrs. YELLEN. We fund the Bureau’s budget. Mr. BARR. You fund it, but do you approve the budget? VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00055 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 52 Mrs. YELLEN. I think the answer is no, but— Mr. BARR. Right. Can you veto specific allocations requested? No. Mrs. YELLEN. I don’t think so. Mr. BARR. Okay. And does the Fed have protocols if the bureau seeks to transfer more than the cap on its transfers under the for- mula? Do you have a protocol in place to prevent that? Mrs. YELLEN. We abide by the law. I need to look at the details of what our obligations and limits are. I need to look at that more fully. Mr. BARR. We would like to know if the— Mrs. YELLEN. But we certainly have protocols to abide by what Congress set out. Mr. BARR. This is the problem we have is that we don’t have ap- propriations control over the Bureau. And so, they get their fund- ing from you. We would hope that they would at least be account- able to you as the funding source. Is there any direct oversight of the implementation of the Bu- reau’s budget by the Fed? Mrs. YELLEN. No. Our Inspector General has authority both for the Fed and the Bureau, but the Fed does not have authority over the budget and spending of the— Mr. BARR. Thank you. In my last 10 seconds, you have talked a little bit about the need for Congress to address our long-term debt and deficit crisis. This seems to me a five-alarm fire. Given that mandatory spending is 70 percent of the Federal budget, why isn’t the Fed more aggressively warning Congress that it must reform mandatory entitlement spending? Mrs. YELLEN. Every Fed Chair that I can remember has come and told Congress that this is a looming problem with serious eco- nomic consequences. I know my predecessor has; I have on many occasions; and I certainly remember that Chairman Greenspan dis- cussed with Congress the importance of addressing this. Mr. BARR. Thank you. Chairman HENSARLING. The time of the gentleman has expired. The Chair now recognizes the gentleman from Maryland, Mr. Delaney. Mr. DELANEY. Thank you, Mr. Chairman. And I want to thank you, Chair Yellen, for not only your leader- ship in general, but also your participation and patience at this hearing. I also want to welcome our visitors and guests here today and thank you for bringing your important message. We do talk about how our unemployment rate has gone down substantially, which it has—below 5 percent now. But we all know that when you get behind those numbers there are really only two types of jobs being created right now in this country: high-skilled, high-paid jobs, where you need very, very specific skills and ad- vanced educations to get them; and low-skilled, low-paid jobs. And what we are not creating is middle-skilled, middle-class jobs, the kind of jobs that have been the backbone of this country for a long time and allowed wages to grow and people to raise their fam- ilies with one job. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00056 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 53 The Chair touched on something very important, which is infra- structure, because there is nothing we can do as a country to help address that problem more than rebuilding our country. So if I could ever edit your T-shirts I would say, ‘‘Let our wages grow, rebuild our country,’’ because I do think it would really make a difference in raising wages. But my question for the Chair is—and again, thank you for your patience—in December, when the decision was made to raise the Federal fund rates, in your testimony you said that was in part based on a view that economic activity would continue to expand at a moderate pace and labor market indicators would continue to strengthen. And certainly, based on the top-line data from 2015 and 2014, where we saw decent GDP growth, improvement in the residential market, business investments at a decent level—not where we would like them, but at a decent level—increases in R&D invest- ments, et cetera, but even when you take into consideration the negatives from the oil and gas sector, the outlook for economic growth was reasonably solid, and the labor market data that you were looking at, at the time, must have been good because the Jan- uary numbers were actually encouraging, not only in terms of un- employment but some of the wage data, as you talked about. So I guess my question is, a lot has happened since that decision in the markets, and that tends to change behavior. When you look at the same data you looked at when you made that decision in De- cember, if you look at that data now, does it change your view as to your perspective on economic activity, economic growth, and gen- eral labor market trends? Mrs. YELLEN. I think the answer is ‘‘maybe,’’ but the jury is out. We have continued to see progress in the labor market. Over the last 3 months, there have been 230,000 jobs per month, averaging through. GDP growth clearly slowed a lot in the fourth quarter. My expec- tation is that it will pick up this quarter. But on the other hand, financial conditions have tightened con- siderably, and that can have implications for the outlook. And what the Committee said in January—we had previously said that we regarded the risks to the outlook for economic activity and the labor market as balanced. Mr. DELANEY. Right. Mrs. YELLEN. What we said in January is that we are evaluating and assessing the impact of these developments on the outlook for both the labor market and activity for inflation and the balance of risks. And that is what we are doing at this point. Mr. DELANEY. And when you look, Chair Yellen, at recent data that you get better than anyone about credit formation and bor- rowing activities in the markets, are you concerned that there has been a significant contraction in credit availability based on recent market activities? And how much does that factor in to your— Mrs. YELLEN. That is an important factor. Mr. DELANEY. And have you seen it? Mrs. YELLEN. Not really at this stage. But what we do see is that spreads, especially on lower-graded bonds, have widened consider- ably. Borrowing rates have widened. VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00057 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI 54 Mr. DELANEY. What about bank lending? Mrs. YELLEN. And it is not just energy. In our most recent survey of banks on their lending standards, we have seen a tightening that is reported in C&I loans, in CRE loans, and that certainly those loans continue to grow but that is something that bears watching. It is really those kinds of trends that we need to evalu- ate— Mr. DELANEY. And very quickly, as you weigh your decisions, ob- viously inflation and labor-market participation are critical, overall, the economic activity is critical. This subcomponent, in other words, what is happening with credit availability—how important is that in your decision-making process? Mrs. YELLEN. What we are trying to do is forecast spending in the economy. Investment spending and housing are two important forms of spending. And credit availability factors into our forecast for both of those portions of the economy. They are not the only fac- tors that matter, but they are a factor that is important, and so we will be considering those. And there are a number of weeks before we meet again in March. There is quite a bit of additional data we will want to look at. But you have pinpointed exactly the kinds of considerations that will bear on our thinking. Mr. DELANEY. Thank you again. Chairman HENSARLING. The time of the gentleman has expired. The ranking member is recognized for a unanimous consent re- quest. Ms. WATERS. I ask unanimous consent to insert into the record the statement from Financial Innovation Now (FIN) that highlights the very important work the Federal Reserve Board is doing through the Faster Payments Task Force, of which FIN is a mem- ber. Chairman HENSARLING. Without objection, it is so ordered. Chair Yellen, I thank you for your testimony today. The Chair notes that some Members may have additional ques- tions for this witness, which they may wish to submit in writing. Without objection, the hearing record will remain open for 5 legis- lative days for Members to submit written questions to this witness and to place her responses in the record. Also, without objection, Members will have 5 legislative days to submit extraneous mate- rials to the Chair for inclusion in the record. I ask Chair Yellen to please respond promptly. This hearing stands adjourned. [Whereupon, at 1:12 p.m., the hearing was adjourned.] VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00058 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI A P P E N D I X February 10, 2016 (55) VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00059 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 56 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00060 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 100.66532 For release at 8:30 a.m. EST February 10,2016 Statement by Janet L. Yellen Chair Board of Governors of the Federal Reserve System before the Committee on Financial Services U.S. House of Representatives February 10,2016 57 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00061 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 200.66532 Chairman Hensarling, Ranking Member Waters, and other members of the Committee, I am pleased to present the Federal Reserve's semiannual Monetary Policy Report to the Congress. In my remarks today, I will discuss the current economic situation and outlook before turning to monetary policy. Current Economic Situation and Outlook Since my appearance before this Committee last July, the economy has made further progress toward the Federal Reserve's objective of maximum emplo;ment. And while inflation is expected to remain low in the near term, in part because of the further declines in energy prices, the Federal Open Market Committee (FOMC) expects that inflation will rise to its 2 percent objective over the medium term. In the labor market, the number of nonfarm payroll jobs rose 2.7 million in2015, and posted a further gain of 150,000 in January of this year. The cumulative increase in employment since its trough in early 20 I 0, is now more than 13 million jobs. Meanwhile, the unemployment mte fell to 4.9 percent in January, 0.8 percentage point below its level a year ago and in line with the median ofFOMC participants' most recent estimates of its longer-run normal level. Other measures oflabor market conditions have also shown solid improvement, with noticeable declines over the past year in the number of individuals who want and are available to work but have not actively searched recently, and in the number of people who are working part time but would rather work full time. However, these measures remain above the levels seen prior to the recession, suggesting that some slack in labor markets remains. Thus, while labor market conditions have improved substantially, there is still room for further sustainable improvement. The strong gains in the job market last year were accompanied by a continued moderate expansion in economic activity. U.S. real gross domestic product is estimated to have increased 58 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00062 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 300.66532 -2 - about 1-3/4 percent in 2015. Over the course of the year, subdued foreign growth and the appreciation of the dollar restrained net exports. In the fourth quarter of last year, growth in the gross domestic product is reported to have slowed more sharply, to an annual rate of just 3/4 percent; again, growth was held back by weak net exports as well as by a negative contribution from inventory investment. Although private domestic final demand appears to have slowed somewhat in the fourth quarter, it has continued to advance. Household spending has been supported by steady job gains and solid growth in real disposable income--aided in part by the declines in oil prices. One area of particular strength has been purchases of cars and light trucks; sales of these vehicles in 2015, reached their highest level ever. In the drilling and mining sector, lower oil prices have caused companies to slash jobs and sharply cut capital outlays, but in most other sectors, business investment rose over the second half of last year. And homebuilding activity has continued to move up, on balance, although the level of new construction remains well below the longer-run levels implied by demographic trends. Financial conditions in the United States have recently become less supportive of growth, with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers, and a further appreciation of the dollar. These developments, if they prove persistent, could weigh on the outlook for economic activity and the labor market, although declines in longer term interest rates and oil prices provide some offset. Still, ongoing employment gains and faster wage growth should support the growth of real incomes and therefore consumer spending, and global economic grov.1h should pick up over time. supported by highly accommodative monetary policies abroad. Against this backdrop, the Committee expects that with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in coming years and that labor market indicators will continue to strengthen. 59 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00063 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 400.66532 -3 As is always the case, the economic outlook is uncertain. Foreign economic developments, in particular, pose risks to U.S. economic growth. Most notably, although recent economic indicators do not suggest a sharp slowdown in Chinese growth, declines in the foreign exchange value of the renminbi have intensified uncertainty about China's exchange rate policy and the prospects for its economy. This uncertainty led to increased volatility in global financial markets and, against the background of persistent weakness abroad, exacerbated concerns about the outlook for global growth. These growth concerns, along with strong supply conditions and high inventories, contributed to the recent fall in the prices of oil and other commodities. In turn, low commodity prices could trigger financial stresses in commodity-exporting economics, particularly in vulnerable emerging market economies, and for commodity-producing firms in many countries. Should any of these downside risks materialize, foreign activity and demand for U.S. exports could weaken and financial market conditions could tighten further. Of course, economic growth could also exceed our projections for a number of reasons, including the possibility that low oil prices will boost U.S. economic growth more than we expect. At present, the Committee is closely monitoring global economic and financial developments, as well as assessing their implications for the labor market and inflation and the balance of risks to the outlook. As Tn oted earlier, inflation continues to run below the Committee's 2 percent objective. Overall consumer prices, as measured by the price index for personal consumption expenditures, increased just 1/2 percent over the 12 months of 2015. To a large extent, the low average pace of inflation last year can be traced to the earlier steep declines in oil prices and in the prices of other imported goods. And, given the recent further declines in the prices of oil and other commodities, as well as the further appreciation of the dollar, the Committee expects inflation to 60 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00064 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 500.66532 -4- remain low in the near tenn. However, once oil and impmi prices stop falling, the downward pressure on domestic inflation from those sources should wane, and as the labor market strengthens further, inflation is expected to rise gradually to 2 percent over the medium term. In light of the current shortfall of inflation from 2 percent, the Committee is carefully monitoring actual and expected progress toward its inflation goal. Of course, inflation expectations play an important role in the inflation process, and the Committee's confidence in the inflation outlook depends importantly on the degree to which longer-run inflation expectations remain well anchored. It is worth noting, in this regard, that market-based measures of inflation compensation have moved down to historically low levels; our analysis suggests that changes in risk and liquidity premiums over the past year and a half contributed significantly to these declines. Some survey measures of longer-run inflation expectations are also at the low end of their recent ranges; overall, however, they have been reasonably stable. Monetary Policy Turning to monetary policy, the FOMC conducts policy to promote maximum employment and price stability, as required by our statutory mandate from the Congress. Last March, the Committee stated that it would be appropriate to raise the target range for the federal funds rate when it had seen fltrther improvement in the labor market and was reasonably confident that inflation would move back to its 2 percent objective over the medium term. In December, the Committee judged that these two criteria had been satisfied and decided to raise the target range for the federal funds rate 1/4 percentage point, to between 1/4 and 1/2 percent. This increase marked the end of a seven-year period during which the federal funds rate was held near zero. The Committee did not adjust the target range in January. 61 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00065 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 600.66532 -5 - The decision in December to raise the federal funds rate reflected the Committee's assessment that, even after a modest reduction in policy accommodation, economic activity would continue to expand at a moderate pace and labor market indicators would continue to strengthen. Although inflation was running below the Committee's longer-run objective, the FOMC judged that much of the softness in inflation was attributable to transitory factors that are likely to abate over time, and that diminishing slack in labor and product markets would help move inflation toward 2 percent. In addition, the Committee recognized that it takes time for monetary policy actions to affect economic conditions. If the FOMC delayed the start of policy nonnalization for too long, it might have to tighten policy relatively abruptly in the future to keep the economy from overheating and inflation from significantly overshooting its objective. Such an abrupt tightening could increase the risk of pushing the economy into recession. It is important to note that even after this increase, the stance of monetary policy remains accommodative. The FOMC anticipates that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate. In addition, the Committee expects that the federal funds rate is likely to remain, for some time, below the levels that are expected to prevail in the longer run. This expectation is consistent with the view that the neutral nominal federal funds rate--defined as the value of the federal funds rate that would be neither expansionary nor contractionary if the economy was operating near potential--is currently low by historical standards and is likely to rise only gradually over time. The low level of the neutral federal funds rate may be partially attributable to a range of persistent economic headwinds- such as limited access to credit for some borrowers, weak growth abroad, and a significant appreciation of the dollar--that have weighed on aggregate demand. 62 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00066 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 700.66532 -6- Of course, monetary policy is by no means on a preset course. The actual path of the federal funds rate will depend on what incoming data tell us about the economic outlook, and we will regularly reassess what level of the federal funds rate is consistent with achieving and maintaining maximum employment and 2 percent inflation. In doing so, we will take into account a wide range of infonnation, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In particular, stronger growth or a more rapid increase in inflation than the Committee currently anticipates would suggest that the neutral federal funds rate was rising more quickly than expected, making it appropriate to raise the federal funds rate more quickly as welL Conversely, if the economy were to disappoint, a lower path of the federal funds rate would be appropriate. We are committed to our dual objectives, and we will adjust policy as appropriate to foster financial conditions consistent with the attainment of our objectives over time. Consistent with its previous communications, the Federal Reserve used interest on excess reserves (IOER) and overnight reverse repurchase (RRP) operations to move the federal funds rate into the new target range. The adjustment to the IOER rate has been particularly important in raising the federal funds rate and short-tenn interest rates more generally in an environment of abundant bank reserves. Meanwhile, overnight RRP operations complement the IOER rate by establishing a soft floor on money market interest rates. The IOER rate and the overnight RRP operations allowed the FOMC to control the federal funds rate effectively without having to first shrink its balance sheet by selling a large part of its holdings of longer-tenn securities. The Committee judged that removing monetary policy accommodation by the traditional approach of raising short-tenn interest rates is preferable to selling longer-tenn assets because such sales could be difiieult to calibrate and could generate unexpected financial market reactions. 63 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00067 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 800.66532 -7- The Committee is continuing its policy of reinvesting proceeds from maturing Treasury securities and principal payments from agency debt and mortgage-backed securities. As highlighted in the December statement, the FOMC anticipates continuing this policy "until normalization of the level oftbe federal funds rate is well under way." Maintaining our sizable holdings of longer-tenn securities should help maintain accommodative financial conditions and reduce the risk that we might need to return the federal funds rate target to the effective lower bound in response to future adverse shocks. Thank you. I would be pleased to take your questions. 64 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00068 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 900.66532 hlr\Jseat8:30a.m. r-:,1 february 10, l016 MoNETARY Poucv REPORT February 10, 2016 Board of Governors of the Federal Reserve System 65 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00069 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 010.66532 LETTER OF TRANSMITTAL BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Washington, D.C., February 10, 2016 THE PRESIDENT OF THE SENATE THE SPEAKER OF THE HOUSE OF REPRESENTATIVES The Board of Governors is pleased to submit its Monetary Policy Report pursuant to section 2B of the Federal Reserve Act. Janet L. Yellen, Chair 66 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00070 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 110.66532 STATEMENT ON LoNGER-RuN GoALS AND MoNETARY PoucY STRATEGY /\doptf~d effective /dnuary The Federal Open Market Committee (FOMC) is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decisionmaking by households and businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary policy, and enhances transparency and accountability, which are essential in a democratic society. Inflation, employment, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Moreover, monetary policy actions tend to influence economic activity and prices with a lag. Therefore, the Committee's policy decisions reflect its longer-run goals, its medium term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the Committee's goals. The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer rnn with the Federal Reserve's statutory mandate. The Committee would be concerned if inflation were running persistently above or below this objective. Communicating this symmetric inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee's ability to promote maximum employment in the face of signilicant economic disturbances. The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a ftxed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision. The Committee considers a wide range of indicators in making these assessments. Information about Committee participants' estimates of the longer-run normal rates of outpnt growth and unemployment is published four times per year in the FOMC's Summary of Economic Projections. for example, in the most recent projections, the median of FOMC participants' estimates of the longer-run normal rate of unemployment was 4.9 percent. In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee's assessments of its maximum level. These objectives are generally complementary. However, nnder circumstances in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into account the magnitude of the deviations and the potentially ditTerent time horizons over which employment and inflation are projected to return to levels jndged consistent with its mandate. The Committee intends to reaffirm these principles and to make adjustments as appropriate at its annual organizational meeting each January. 67 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00071 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 210.66532 CONTENTS Summary ................................................................ 1 Part 1 : Recent Economic and Financial Developments ..................... 3 Domestic Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Financial Developments .................................................. 16 International Developments ............................................... 22 Part 2: Monetary Policy .................................................. 29 Part 3: Summary of Economic Projections ................................ 35 The Outlook for Economic Activity ......................................... 36 The Outlook for Inflation .................................................. 38 Appropriate Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Uncertainty and Risks . . . . . . . ............................................ 45 Abbreviations ........................................................... 49 List of Boxes Effects of Movements in Oil Prices and the Dollar on Inflation .................... 8 Developments Related to Financial Stability .................................. 20 Monetary Policy Divergence in the Advanced Economies ....................... 24 The Neutral Federal Funds Rate in the Longer Run ............................. 32 Monetary Policy Implementation following the December 2015 FOMC Meeting ... 34 Forecast Uncertainty ..................................................... 47 NoTE: Unless stated otherwise, the time series in the extend through, for daily data, February 4, 2016; for monthly data, january 20! b; and, for quarterly data, 2015:Q4. In bar exct>t}t dS noted, the ch;mge for a given period is measured to its final quarter from the final quarter of the preceding period. For figures 32 and 36, note that the Dow Jones Bank Index and the S&P 500 Index ("Indexes") are a Oow jom•s !ndic('S I LC and/or its affiliates and have been licensed for use by the Board. Copyright© 2016 S&P Indices lLC, a subsidiary o{ the McGraw Hill Financial inc., and/or its affiliates. AI! rights rf'servf'd. Redistribution, reproduction and/or photocopying in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indic-es LLC's indices please visit www.spdji.com. S&P® is a registered trademark of Standard & Poor's Financial Services LLC and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow jones Indices LLC, Dow jones Tradem<Jrk !-!ofdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately reprPsent the asset class or market sector that it purports to represent and nell her S&P Dow jones tndices LLC Dow jones Trademark Holdings LLC, their affiliates nor their third party !icmsors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein. 68 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00072 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 310.66532 SuMMARY Labor market conditions continued to demand, supported by ongoing job gains and improve during the second half of 2015 and accommodative monetary policy. Government into early 2016. Payroll employment has purchases rose modestly. By contrast, the rise increased at a solid average pace of 225,000 in the foreign exchange value of the dollar over per month since June. The unemployment the past year and a half and the sluggish pace rate, which had reached a high of 10 percent of economic activity abroad have continued in late 2009, declined from 5.3 percent last to weigh on exports. In addition. the pace of June to 4.9 percent in January. Although the inventory accumulation slowed markedly from unemployment rate now equals the median of its elevated first-half pace, thereby reducing Federal Open Market Committee (FOMC) overall GDP growth in the second half of 2015. participants' estimates of its longer-run normal level, other considerations suggest Domestic financial conditions have become that some further improvement in labor somewhat less supportive of economic growth market conditions is needed to achieve the since mid-2015. Recent months have been Committee's maximum employment mandate. marked by bouts of turbulence in financial The labor force participation rate remains markets that largely reflected concerns somewhat below most assessments of its trend, about the global economic outlook and and an unusually large number of people developments in oil markets. Broad measures continue to work part time when they would of U.S. equity prices have declined, on net, prefer full-time employment. roughly returning these indexes to levels that prevailed during the first half of 2014. And the Inflation remains below the FOMC's longer dollar has strengthened further, on balance, run goal of 2 percent: The price index for since the summer of 2015. Corporate risk personal consumption expenditures (PCE) spreads have widened, particularly for lower rose only 'h percent over the 12 months ending rated issuers. Nonetheless, interest rates for in December. The PCE price index excluding investment-grade issuers are generally still food and energy items, which often provides low, reflecting declines in yields on longer a better indication of future inflation, also term Treasury securities. Moreover, although remained subdued, rising 1Y , percent over debt issuance by lower-rated firms bas slowed, that period. Inflation has been held down credit flows to nonfinancial businesses have substantially by the drop in energy prices; remained solid since the middle of last year, declines in the prices of non-oil imported supported by continued strong bond issuance goods have contributed as well. Meanwhile, of higher-rated firms and by bank lending. survey-based measures of longer-run inflation Household access to credit was mixed, with expectations have drifted down a little mortgages and credit cards still difficult to since the middle of last year and generally access for some borrowers while student stand near the lower ends of their historical and auto loans remained broadly available, ranges; market-based measures of inflation even to borrowers with lower credit scores. compensation have fallen and arc at low levels. Overall, debt growth in the household sector has remained modest and continues to be Real gross domestic product (GDP) is concentrated among borrowers with strong reported to have increased at an annual rate credit histories. of about l Y. percent over the second half of the year, slower than the first-half pace. The The U.S. financial system overall has been expansion in economic activity reflected resilient to the stresses that have emerged continued increases in private domestic final since mid-2015, and financial vulnerabilities 69 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00073 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 410.66532 2 SUMMARY remain moderate. Regulatory capital ratios gradually over time, as headwinds to economic and holdings of liquid assets at large banking growth dissipate slowly and as inflation rises firms arc at historically high levels. Usage toward the Committee's goal of 2 percent. of short-term wholesale funding in the Consistent with this outlook, in the most 11nancial system is relatively low, and the usc recent Summary of Economic Projections of leverage to finance securities purchases has (SEP), which was compiled at the time of the declined somewhat. The ratio of aggregate December FOMC meeting, FOMC partic private nonfinancial credit to GDP is below ipants projected that the appropriate level most estimates of its long-run trend, although of the federal funds rate would be below its leverage of speculative-grade nonfinancial longer-run level through 2018. (The December corporations has risen further since the SEP is included as Part3 of this report.) middle of last year and is relatively high. Risk premiums for many asset classes have With respect to its securities holdings, the increased. For instance, the rise in spreads on Committee will continue to reinvest principal corporate debt has been larger than would payments from its securities portfolio, and it be expected given the evolution of expected expects to maintain this reinvestment policy defaults. The direct exposures of the largest until normalization of the level of the federal U.S. banking firms to the oil sector and to funds rate is well under way. This policy, by emerging market economies are limited. If keeping the Committee's holdings of longer conditions in those sectors worsen, however, term securities at sizable levels, should help wider stresses could emerge and be transmitted maintain accommodative financial conditions. to the United States through indirect global financial linkages. The Committee has emphasized that the actual path of monetary policy will depend on how In December, after holding the federal funds incoming data affect the economic outlook. rate near zero for seven years, the FOMC In determining the timing and size of future raised the target range for that rate to '/. to adjustments to the target range of the federal Y, percent. The decision to increase the funds rate, the Committee will assess realized federal funds rate reflected the Committee's and expected economic conditions relative to assessment that there had been considerable its objectives of maximum employment and improvement in the labor market last year and 2 percent inflation. Stronger growth or a more that the Committee was reasonably confident rapid increase in inflation than the Committee that inflation would move back to 2 percent currently anticipates would likely call for faster over the medium term; thus, the criteria set increases in the federal funds rate; conversely, out by the Committee in March 2015 had if conditions prove weaker, a lower path of the been met. federal funds rate would likely be appropriate. The Committee anticipates that economic To move the federal funds rate into the new conditions will evolve in a manner that will target range announced in December, the warrant only gradual increases in the federal Federal Reserve raised the rate of interest paid funds rate. This expectation is consistent with on required and excess reserve balances and the view that the neutral nominal federal funds also employed an overnight reverse repurchase rate-defined as the value of the federal funds agreement facility. The effective federal funds rate that would be neither expansionary nor rate was moved successfnlly into the increased contraetionary if the economy was operating target range. The FOMC remains confident at its productive potential-is currently low by that it has the tools it needs to adjust short historical standards and is likely to rise only term interest rates as appropriate. 70 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00074 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 510.66532 3 1 PART RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS The labor market continued to improve during the second half of last year and early this year. Payroll employment has increased 225,000 per month, on average, since june. The unemployment rate fell from 5.3 percent in june to 4.9 percent in january and thus has reached the median estimate among Federal Open Market Committee ( FOMC) participants of the level of unemployment that is considered to be normal in the longer run. Even so, the relatively low labor force participation rate and the unusually large number of people working part time who would prefer full-time employment suggest that some cyclical weakness is still present in the labor market. Since mid-2014, a steep drop in crude oil prices has exerted significant downward pressure on overall inflation, and declines in the prices of non-oil imported goods have held down inflation as well. The price index for personal consumption expenditures (PCE) increased only 'h percent during the 12 months ending in December, a rate that is well below the FOMCs longeNun objective of 2 percent; the index excluding food and energy prices rose 1' h percent over the same period. Both survey-and market-based measures of inflation expectations have moved down since June. Meanwhile, real gross domestic product (COP) increased at an annual rate of 1' 4 percent over the second half of 20 15, slower than in the first half. The growth in COP has been supported by accommodative monetary policy, favorable consumer confidence, and the boost to household purchasing power from lower oil prices. However, lower oil prices have also exerted downward pressure on domestic investment in the energy sector. In addition, sluggish growth abroad and the higher foreign exchange value of the dollar have weighed on exports, and financial conditions more generally have become somewhat less supportive of economic growth. Concerns about economic conditions abroad and the energy sector have contributed to lower equity prices and higher borrowing rates for some businesses. Domestic Developments The labor market has continued to improve ... Labor market conditions strengthened I. Net change in payroll employment further across a variety of dimensions over the second half of 2015 and early this year. --3--m-o-m-h-r-n-ov-w-g-<-l-ve-r·a-g-es --- Th - o - us - a - nd - s - of - Jo - b - s Payroll employment gains remained robust, --- 400 averaging about 235,000 per month over the P1ivatc second half of last year, similar to the gains 200 over the first half; factoring in the January increase of about 150,000, monthly gains since 200 June have averaged about 225,000 (figure !). 400 The increase in 2015 followed an even faster pace of job gains in 2014, and, in total, some 600 5'14 million jobs were added over the two years. 800 In addition, the unemployment rate-which had reached I 0 percent in late 2009----declined from 5.3 percent in June 2015 to 4.9 percent in SouRCE Department of Labor, Bureau of Labor Statlsttcs January of this year; this level is '14 percentage point lower than a year earlier and is equal to 71 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00075 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 610.66532 4 PART 1: RECENT ECONOMIC AND FINANCIAL DEVEl OPMFNTS 2. Measures oflabor underutilization Percem 16 !J-4 14 12 10 ~__j_ ______ L_ __j__ __ l_ _ ___l_ _ __j___ _L__j_J 2010 2012 2014 2016 NoTE U-4 measures total unemployed plus dlSCOuraged workers, as a percent of the labor force plus discouraged workers. Discouraged workers are a subset of marginally attached workers who are not currently looking for work b(X:ause they believe no jobs are available for them. U-5 measures total unemployed plus aH marginally attached to the labor force, as a percent of the labor force plus persons margmally attached to the labor force. Marginally attached workers are not in the labor force, want and are available for work, and have looked for a JOb m the past 12 months. U-6 measures total unemployed plus aH marginally attached workers plus total employed part time for <..-conomic rea<;ons, as a percent of the labor force plus all marginally attached workers. The shaded bar md1cates a penod of business recession as defined by the National Bureau of Econom1c Research_ SouRcE: Department of Labor, Bureau of Labor Statistics. the median of FOMC participants' estimates of its longer-run normal level (figure 2). Broader measures of labor underutilization, such as those including individuals who are classified as marginally attached to the labor force, declined by similar amounts_ (A "marginally attached" individual is defined as 3. Labor force participation rate and someone who is not looking for work currently empJoyment~to~population ratio and therefore treated as not in the labor force, but who wants and is available for work and Monthly has looked for a job in the past 12 months_) 68 ... though some labor market slack likely 66 remains ... 64 While payroll employment and the unemployment rate have improved further 62 since mid-2015, the labor force participation 60 rate fell from an average of 62.7 percent of the working-age population during the second 58 EmploymcnHo-popula!!On !Dl!O quarter of 2015 to 62.5 percent in the fourth L_LLLLl.J_J_ _ _j_ L.L_l ___ LLLLLLLJ quarter; the participation rate moved back np 2000 2002 2004 2006 2008 2010 2012 2014 ~016 to 62.7 percent in January (figure 3)_ Changing Both series are a percent of the population aged 16 and over. Department of Labor, Bureau of Labor Statistics demographics-most notably the increasing 72 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00076 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 710.66532 MONETARY POLICY REPORT: FEBRUARY 2016 5 share of older people in the population, who are less likely to be in the labor force--and other longer-run structural changes in the labor market have continued to push down the participation rate even as cyclical forces have been pushing it up. That said, labor force participation appears to remain a little weaker than can be explained by structural factors alone, pointing to the likelihood that some slack remains in this dimension of labor utilization. In addition, although the share of workers who arc employed part time but would like to work full time has fallen noticeably since June, it is still relatively high, indicating some scope for improvement on this dimension as well. ... while labor compensation has shown some tentative signs of accelerating ... 4. Measures of change in hourly compensation As the labor market has continued to improve, the rates of increase in some measures of ___P _o_rcentchange from~earearher hourly labor compensation have begun to pick up while others remain relatively subdued. Com b p u en si s n a e t s io s n s e p c e t r o r h our, .For example, average hourly earnings for all employees increased 2'h percent over the 12 months ending in January, above the 2 percent pace seen throughout most of the recovery (tlgurc 4). In addition, compensation per hour in the business sector-a volatile measure derived from the labor compensation data in the national income and product accounts, or NJPA-is reported to have increased more quickly in 2015 than its Non: The average hourly eaminp.s data series begins in March 2007 and average pace throughout most of the recovery. extends through January 2016. The compensatiOn per hour and employment cost index data extend through 20t5:Q4. For busmess~sector compensation, In contrast, the employment cost index for change 1s over four quarters; for the employmem cost index, change is over private industry workers, which measures both e th a e n 1 1 in 2 g m s, o c n h t a h n s g e e n i d s i ! n T g o m m 1 t 2 h e m l o a n s t t h m s e o a n r t l h i e o r f each quarter; fOr average hourly wages and the cost to employers of providing SOURCE, Departrnent ofl.abor, Bureau of Labor Statistics benefits, increased about 2 percent over the 12 months ending in December, similar to the pace seen throughout most of the recovery. All of these measures of compensation are increasing at slower rates than those seen prior to the recession. This deceleration probably reflects a variety of factors, including the slower growth of productivity, the slower pace of inflation, and perhaps some remaining slack in the labor market. Despite the continued relatively small increases in nominal wages, the recent very low inflation led to a noticeably 73 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00077 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 810.66532 6 PART 1 o RECENT ECONOMIC AND fiNANCIAL DEVELOPMENTS larger wage gain last year on a purchasing power-adjusted (or so-called real) basis than had been evident earlier in the expansion_ ... and productivity growth has been 5, Change in business sector output per hour lackluster .Percent_ annual rate Over time, increases in productivity are a key ---~----- determinant of the rise in real wages and living -- 4 standards. Labor productivity in the business sector increased at an annual rate of just '/,percent in 2015 and at an average annual rate of just 1 percent since tbe last business cycle peak in 2007 (figure 5). The average pace since 2007 is a little below the 1974-95 average and well below the pace during the period from the mid-1990s to 2007_ The reasons behind the slower productivity performance in 1 7 9 3 4 8" 1 9 9 5 7 4- 2 1 0 99 0 6 0 - - 2 0 0 7 0 1- 20 1 0 5 8 recent years arc not well understood, but one factor seems to be the slower pace of capital Non:: Changes are measured from Q4 of the year immediately preceding the period through Q4 of the fmal year of the penod accumulation_ SouRCE: Department of Labor, Bureau of Labor Statistics. Falling oil prices continue to hold down overall consumer prices ... Consumer price increases have remained muted and below the FOMC's longer-run objective of 2 percent. As discussed in the box "Effects of Movements in Oil Prices and the Dollar on Inflation," crude oil prices have plummeted since June 2014, and the dollar has moved appreciably higher; both factors have 6. Brent spot and futures prices contributed importantly to the low inflation Weekl) ·--flo-!lar-spo-.'<l-lms-rel- readings of the past year- -------~ DO 120 Since July, the price of crude oil has fallen 110 appreciably further, on net, with the spot price 100 of Brent crude oil dropping below $35 per 90 barrel, a level last seen more than a decade ago 80 (the blue line in figure 6). Futures prices have 70 60 also dropped significantly and indicate that 50 market participants expect only modest price 40 increases over the next few years_ Although 30 concerns about global growth have contributed to the fall in prices, much of the recent decline can be attributed to the abundance of global supply_ Reductions in US_ production have been slower and smaller than expected, and OPEC has abandoned its official production target in favor of maintaining robust production despite declining prices and the 74 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00078 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 910.66532 MONETARY POLICY RFPORT: FEBRUARY 2016 7 likely increase in Iranian oil exports in the coming months. The drop in crude oil prices continues to pass through to gasoline prices: The national average of retail gasoline prices (on a seasonally adjusted basis) moved down from more than $2.50 per gallon in June to about $2.00 per gallon in January. Largely because of the decline in energy prices, overall consumer price inflation, as 7. Change in the price index for personal consumption expenditures measured by the PCE price index, was running at just Y. percent for the 12 months ending Month I~ ---!2--mom-hperce-ntcha-nge in June 2015; the 12-month change remained near that pace until year-end, when it edged up to 1;2 percent as some of the sharpest declines from a year earlier fell out of the 12-month calculation (figure 7). Food prices were little changed over the past six months after edging down during the first half of 2015. Consumer food prices were held down in 2015 by falling food commodity prices, but futures markets suggest that these commodity prices will flatten out, implying that this source of downward pressure on consumer food price inflation is likely to wane . . . . but even outside of the energy and food inflalion has remained subdued As is also discussed in the box "Effects of Movements in Oil Prices and the Dollar on Inflation," another important factor holding down inflation has been the behavior of import 8. Non-oil import prices and U.S. dollar exchange rate prices. After declining sharply in the first half of 2015, non-oil import prices continued to Month!~ fall in the second half, albeit at a slightly more 20 modest pace; the further declines in the second 16 half rcllected lower commodity prices as well 12 as additional increases in the foreign exchange value of the dollar (figure 8). In addition, slack in labor and product markets likely placed downward pressure on inflation, although this factor has probably waned signilicantly. For all of these reasons, inflation for items other 12 than food and energy (so-called core inflation) ~oo9 201~4"'zo::cl5c-'-:-:2o,.,-J6,-L--J remained modest. Core PCE prices rose about 2010 20ll 2012 1' h. percent over the 12 months ending in Nm&. The data for non-oilnnpon pnces extend 1hrough D<X:ember 2015 December, similar to the increase in 2014. Bo S a o r u d R , C S E ta . ti D sti e c p a a l r t R m e e le n a t s o e f H L . a J b O o , r " , F B o u re re ig au n o E f x L ch ab an o g r e S t R a a ti t s e ti s c · s · : Federal Reserve 75 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00079 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 020.66532 8 PART 1, RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS Effects of Movements in Oil Prices and the Dollar on Inflation Over the past year, inflation has continued to run declines in energy prices since the middle of 2014 well below the Federal Open Market Committee's have likely been holding down core consumer price longer-run objective of 2 percent (text figure 7). inflation somewhat. The 12-month change in the personal consumption The broad dollar has appreciated more than expenditures (PCE) price index, which was about 20 percent since the middle of 2014, reflecting both lf2 percent in 2015, was held down most clearly by heightened concerns about the global outlook, which falling prices for oil and farm commodities. Falling have resulted in safe-haven flows toward dollar assets, prices for other commodities and lhe rise in the and diverging expectations regarding domestic and foreign exchange value of the dollar have also foreign monetary policy (iigure A). A stronger dollar contributed importantly to continued low rates of makes foreign goods cheaperfor U.S. consumers. An inflation. Indeed, reflecting these influences, inflation extensive literature, however, has found that the pass for items other than food and energy remained through of exchange rate changes to U.S. import prices relatively low, with core PCE price inflation at slightly is incomplete-that is, less than proportionate-as under 1111 percent last year. foreign exporters prefer to absorb part of the exchange Since the middle of 2014, crude oil prices have rate change by narrowing profit margins. For example, tumbled, with the spot price of the global benchmark a typical estimate is that a 10 percent appreciation Brent crude oil falling from over $115 per barrel to under $35 per barrel in recent weeks; prices for a A. U.S. dollar exchange rate: Broad nominal dollar wide variety of other commodities have also declined C(>nsiderably. The pass~through of falling oil prices into Jrumal) 3.2005 lower gasoline prices is typically relatively rapid, and the drop in consumer energy prices held down overall 120 PCE inilation directly by more than 'h percentage 1!5 point in 2015. Falling farm commodity prices also Ito reduced consumer food price inflation over the past year, although the pass-through oi these commodity 105 price changes into overall PCE inflation tends to be JOO somewhat smaller and more gradual than with oil prices. Additionally, the sustained reduction in both oil 95 and non-oil commodity prices has likely lowered core 90 inflation somewhat by holding down firms' prorluction 85 and distribution costs. rmpirical estimates of the pass through of energy costs into core inflation are generally quite small, with long and variable tags. Nonetheless, SOURCE: Federal Reserve Board. Statistical Release H. 10, ''Foreign even with a small degree of pass-through, the very large Exchange Rates " 76 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00080 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 120.66532 MONETARY POLICY REPORT: FEBRUARY 2016 9 of the dollar causes the prices of non-oil imported this exercise suggests that the stronger dollar has played goods to decline about 3 percent after one year, 1 a material role in holding down PCE inflation. Roughly one-third of this effect occurs through the Although further declines in energy prices or a effect on imported commodities, as an increase in the further rise in the exchange value of the dollar are value of the dollar tends to lower commodity prices certainly possible, those movements will eventually proportionately. stop. As these prices stabilize, the drag on consumer Because imported goods and services make up price inflation from oil and import prices will dissipate. only a modest share of lJ .S. consumption, a given Moreover, with margins of resource utilization having percentage decline in import prices causes a much already diminished appreciably and longer-run inflation smaller percentage reduction in core PCE prices. expectations reasonably stable, both core and overall Figure B uses a simple econometric model to illustrate inflation are likely to rise gradually toward 2 percent how a 1 0 percent appreciation of the do! far might affect over the medium term as these transitory factors fade core PCE inflation through this channeL' According to and the labor market improves further. this model, core PCE inflation dips in the two quarters following the appreciation before gradually returning to B. Effect of 10 percent appreciation on core PCE inflation the baseline, leading to a four-quarter decline in core t P h C e E b i a n s f e la li t n io e n in o f t h a e b o fi u rs t t 1/ y 4 e p a e r r f c o e l n lo ta w g i e n g p o th in e t s r h e o la c t k iv . e G t i o v en - Q · ua - rte - rs - aft - er - sho - ck - -~-· D emiiJOn from baselme (percen _. t _ a ge .. J ~ X H ~ I'lL · ~). - an - nu - al r - ;~.t - e + the size of the dollar's appreciation since the middle ------~"··~·-----=:::::::==~-0.0 of 2014, this model suggests that falling import prices depressed core PCE inflation about 1h percentage point -0.1 last year. Although the exact magnitude of the dollar's 0.2 effect on infbtion depends on the specific model used, 0.3 1. r'<>r more detail, see Joseph Gruber, Andrew McCallum, and Robert J. Vigfusson (2016), "The Dollar in the US 0.4 International Transactions (USlT) Model," IFDP Notes (Washington; Board of Governors of the Federal Reserve -05 System, FebruJry 8), wwwJederalreserve.gov/econresdata/ notes/ifdp-notes/2016/the-dollar-in-the-us-internation<~l­ transactions-mode!-20 160208. htm!. 2. This model was discussed in a recent speech by Chair Nor.E: TI1e x·axis represents the quarters followmg the 10 percent Yellen and is described in its appendix. See janet L Yellen appreciation shock "lni!arion Dynamics and Monetary Policy," SouRct: Federal Reserve Board staff calculattons based on an econometric the Philip Gamble Memorial lecture, m Dy o n d a e r l m d c e s sc a n n b d e d M o in n et t a h r e y a P p o p l e ic n y d , i " x s t p o e e J c a h n e d t e l L iv er Y ed el l a e t n th (2 e 0 1 P 5 h ) i , l ip " I G nf a la m ti b O l n e Massa<chusetts, Amherst, Mass., September 24, www. Memorial Lecture, University of Massachusetts. Amherst, Mass., September fcdera!reserve.gov/newseventslspeech/ye!len20150924a.htm. 24, www.federalreserve gov/ncwsevcn1slspeedv'ydlcn20 l50924a.h!m. 77 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00081 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 220.66532 1 0 PART 1 o RECENT fCONOMIC AND fiNANCIAl DEVELOPMENTS 9, Median inflation expectations Survey-and market-based measures of inflation expectations have moved down since june Wage-and price-setting decisions arc likely influenced by expectations for inflation" Survey measures of longer-term inflation expectations -~ have been quite stable over the past 15 years but appear to have moved down some lately, ~ including over the past 6 months, to the lower SPF expectatiOns for next 10 years end of their historical ranges" This decline has occurred both for the measure of inflation expectations over the next 5 to I 0 years as reported in the University of Michigan 2002 2004 2006 2008 2010 2012 2014 2016 Surveys of Consumers and for the median NoTE: lbe Mlch1gan survey data are monthly The SPF data for inflation expectattons for personal consumpuon expenditures are quarterly and extend expectation for the annual rate of increase in IJom 2007.Ql through 2015.Q4 SoURCE: University of Michigan Surveys of Consumers; Federal Reserve the PCE price index over the next I 0 years Bank of Philadelphm, Survey of Professional Forecasters (SPF) from the Survey of Professional Forecasters, lO. 5-to-10-year-forward inflation compensation conducted by the Federal Reserve Bank of Philadelphia (figure 9)" Market -based measures Week!;.------- ----- of medium-(5-year) and longer-term (5-to- 10-year-ahead) inflation compensation derived 4"0 from the difference between yields on nominal 3,5 Treasury securities and Treasury Inflation Protected Securities moved down further, on 30 net, over the second half of the year after 25 having declined notably between mid-2014 and mid-2015 (figure 10)" Although changes in 2.0 inflation compensation could reflect changes 1.5 in expected inllation, they also may reflect a variety of other considerations, including an inflation risk premium, liquidity premiums, Non:· lbe data are weekly averages of daily data and extend tlu·ough and other factors"' February 3, 2016, for inflat10n swaps, and February 4, 2016, for TIPS breakevens. TIPS is Tre.'lsury inflation-Protected Secunties SOURcE: Federal Reserve Bank of New York; Hardays, Fctkral Reserve Economic activity expanded at a Board staff estimates . moderate pace in the second half of 2015 11. Change in real gross domestic product, gross domestic income, and private domestic final purcha,;;es Real GDP is reported to have increased at an annual rate of IV. percent in the second half _______l'erce nt.aunualmhJ of last year, slower than the first-half pace • Gross domestJC product (figure II)" As in the first half of the year, Ill Gross domestic income Private domestic final purchases economic activity during the second half was supported by solid gains in private I. For further discussion of inferring inflation expectations from market-based measures, sec the box "Challenges in Interpreting Measures of Longer-Term Inflation Expectations." in Board of Governors of the Federal Reserve System (2015), Monetary Polhy Report (Washington: Board of Governors. February), www. L-l _"""-L"--" _t" fcdcralreservc"gov/monctarypo1icylmpr_20 15 0224 __ part 1" htm 2009 2010 * Gross domestic income is not yet avai!ahlc for 20 15·H2 SouRcE: Depa1tmenl of Commerce. Bureau ofEconom1c Analysis 78 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00082 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 320.66532 MONETARY POLICY REPORT: FEBRUARY 2016 11 domestic final purchases-that is, final 12. Change in real personal consumption expenditures purchases by households and businesses--- and disposable personal income and by modest increases in government purchases of goods and services. By contrast, 11 Personal consumption expenditures aggregate demand continued to be held down Disposable persona! income by weak export performance, reflecting the rise in the foreign exchange value of the dollar Hl H2~ 4 and sluggish foreign economic growth. In addition, inventory investment slowed markedly from its elevated first-half pace, thereby reducing overall GDP growth in the second half of 2015. Gains in income and wealth arc ._L___,-L___,_l I _____ __! __L _L.J 2009 2010 2011 2012 2013 2014 2015 supporting consumer spending ... SouRcE· Department of Commerce, Bureau ofEconom1c Analysis Real personal consumption expenditures rose 13. Wealth-to-income ratio at an annual rate of 2'1, percent in the second half of 2015, about the same as the first-half Q""'_"'-'---- pace (figure 12). These increases have been supported by income gains from the improving -- 6.5 labor market as well as the fall in gasoline and other energy prices, which has bolstered 6.0 consumers' purchasing power. As a result, real disposable income-that is, income after taxes 5.5 and adjusted for price changes--rose a robust 31/z percent in 2015 after a similar gain in 2014. 5.0 Consumer spending last year was also likely LLLLL U_l_LLLLLLLLI supported by further increases in household 1995 1999 2003 2007 2011 2015 net worth. Although the value of corporate Norc· The data extend through 2015.Q3. lhc series is the ratiO of equities edged down last year, prices of household n F et o r w n o e rt t h w to o r d t i h s , p o F s e a d b e le ra p l e R rs e o s n e a rv l e in c B o o m ar e d , Statistical Release Z L houses----which are owned much more widely Accounts of tl1e United States". for mcome, Department of Commerce, Bureau of Economic Analysis than are corporate equities-posted significant gains, and the wealth-to-income ratio remained 14. Nominal house prices and price-rent ratio elevated relative to its historical average !'.101lth!y Index (figure 13). In nominal terms, national house 200 price indexes are now close to their peaks of 190 the mid-2000s, but relative to rents, house price 180 170 valuations are much lower than a decade ago 160 (figure 14). 150 130 Coupled with low interest rates, the rise in 120 110 incomes has lowered debt payment burdens for 100 many households. The household debt service 90 RO burden-the ratio of required principal and 70 interest payments on outstanding household debt to disposable income, measured for the Noll'.. lhe data e:-;;tend thmugh December 2015. ll1c Corclogic price household sector as a whole-has remained index is seas.onaHy adjusted by Federal Reserve Board staff. l11e pricc"rent at a very low level by historical standards o ra f t i p o r i i m s a th ry e r r e a s ti i o d e o n f c e n . o l m h i e na d l a h ta o u a s re e i p n n d c e c x s e d to t o th ! e 0 c 0 o m ns J u a m n e u r a r p y r i 2 ce 0 0 i 0 n dex of rent SoVRCf.: For prices, C'oreLogic; for rents, Department of labor, Bureau of Labor Statistics. 79 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00083 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 420.66532 1 2 PART 1: RECENT ECONOMIC AND FINANCIAl DEVElOPMENTS 15. Household debt service (figure 15). As interest rates rise, the debt burden will move up only gradually, as most _<l<>_:_""_"c..''-----------'-"-""_tofd!sposab!emcome household debt is in fixed-interest products. 14 ... as is credit availability 13 Consumer credit continued to expand moderately through late 2015, as lending 12 standards for both auto lending and student loans remained accommodative (figure 16). ll In addition, credit card lending has been 10 rebounding since early last year. Standards and terms on credit cards are still relatively LllLLLLLU_LI II 111111!!! 111!11111! I II!! I tight for riskier borrowers, although there 1983 1987 J9t)J 1995 1999 2003 2007 2011 2015 has been some modest increase in access for Norr. 'l"he data extend through 20 l5:Q3. Debt scrv1ce payments consist of estimated required payments on outstanding mortgage and consumer debt borrowers with subprime credit histories. Se S r O vi U c R e C a E n : d F F e i d n e an ra c l 1 a R l O es b e l r i v g e a ti B on o s a r R d, a ti S o t s a . t " i stical Release, "Household Debt Delinquencies on credit card and auto loans are still near historical lows, in part due to the 16. Changes in household debt tight standards. Bllll<msofdollars . .annualrate Consumer confidence remains high Mortgages B Consumer credit 1,000 -Sum 800 Household spending has also been supported by favorable consumer sentiment. For the 600 past year or so, the overall index of consumer 400 sentiment from the University of Michigan 200 Surveys of Consumers has registered levels comparable to those that prevailed before 200 the recession (figure 17). Rising real incomes. 400 partly driven by falling energy prices and 600 L_i_~L~-L __ j improvements in the labor market, have likely 2007 2008 2009 2010 2011 2012 20!3 2014 2015 driven up consumer confidence. These same Nor"E. Changes are calculated from year~end to year-end, except 2015 factors are probably behind the more upbeat changes, which are calculated from Q3 to Q3 SouRCE: Federal Reserve Board, Statisucal Release Z.l, "Financial expectations that households report for real AccOlmt~ of the !Jnited States,. income changes over the next year or lwo, 17_ Indexes of consmner sentiment and income expectations which are now near pre-recession levels. 01ffuSn:mmde.' lm!e't Residential construction has improved modestly 100 110 ·-- 100 The gradual recovery in residential 9() construction activity continued over the second 90 80 half of last year. Both single-and multifamily 80 housing starts registered moderate increases 70 70 in 2015 (figure 18). Sales of new and existing 60 60 homes also rose moderately, abstracting from the temporary plunge in existing home sales 50 50 in November, which reportedly rcllected a lengthening in closing times due to new N01 E: The data are three-month movmg averages and extend through mortgage disclosure rules (figure 19). But January 2016 Consumer sentiment is indexed to 100 in 1%6. Rea! income while multifamily starts have recovered to their expectations arc calculated as the net percent of survey respondents ex"{)ectmg family inwme to go up more than prices dunng the next year or two SOURCE: University of\11chigan Surveys of Consumers 80 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00084 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 520.66532 MONETARY POLICY REPORT: FEBRUARY 2016 13 pre-recession level, single-family construction 18. Private housing starts and pem1its continues to be well below its earlier pace. The level of housing starts is still being held down Month!~ M!lhonsoftnuts.armualrate by a meager pace of household formation, tighter-than-average mortgage credit supply, 18 and shortages of skilled labor and other inputs 14 in the construction sector. 1.0 Although the October 2015 and January 2016 Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) reports suggest that a gradual easing of bank lending standards has continued over the past six months, mortgage credit is still difficult to access for borrowers with low credit scores, undocumented income, or high debt-to income ratios2 For borrowers who can obtain 19. New and existing home sales credit, interest rates on mortgages remain near Mdhons.arumalrate M!lhons.annualrate their historical lows, although they inched up, on net, over the second half of the year 7.5 I 8 (figure 20). In 2015, outstanding mortgage 7.0 16 debt rose for the first time since the recession 6.5 Exi~!ing bnme sales I 4 as mortgage originations for home purchases 6.0 L2 increased and write-downs of mortgage debt 55 1.0 continued to ebb. 5.0 45 Overall business investment has slowed 40 as a result of a sharp drop in investment 3.5 in the energy sector Business investment (private nonresidential NOTE 'flle data extend through December 2015. "Ex1stmg home sales" fixed investment) rose at an annual rate of includes single-family, condo, townhome, and co .. op sales SoURCE: For new single-fam1ly home sales, Census Bureau; for existmg only Yi percent during the second half of 2015 bome sales, National As.socJation of Realtors after increasing at a 3 percent pace during the 20. Mortgage rates and housing affordability first half of the year (figure 21). Spending on equipment rose modestly, and a bit faster than lnde~ during the first half of 2015, but spending on intangibles, such as research and development, :\1ortgag_cratcs 205 and investment in structures outside of 185 drilling and mining flattened out after posting 165 strong gains during the first half of the year. Investment in structures used in the energy 145 sector continued to fall precipitously, as the 125 drop in oil prices has scuttled investment in 105 higher-cost oil and gas wells. For the year as a 85 whole, the pace of overall business investment 2006 2008 2010 2012 2014 2016 NoTE· The housmg affordab1hty mdex data are monihly lhrough 2. The SLOOS is available on the Board's website at November 2015 and t11e mortgage rate data are weekly through Febmary .'L 2016. At an index value of 100, a median-income family has exactly enough www.fcderalreserve.gov/boarddocs/snloansurvey. income to qualify for a median-priced home mortgage. Housing a!Tordablhty is seasonally adjusted by Board staff SOURCE For housmg aiTordabihty index, Nat!OIJal AssociatJon of Realtors; lOr mortgage rates, Freddie Mac Pnmary Mortgage Market Survey 81 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00085 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 620.66532 14 PART 1; RECENT ECONOMIC AND fiNANCIAl DEVElOPMENTS 21. Change in real private nonresidential fixed investment slowed compared with 2014, mostly as a result of the drop in the energy sector. Investment -----------P-erc-enL-ann-ual-rate- has been supported by low interest rates and 113 Structures financing conditions that are still generally II Equipment and intangible capital 16 accommodative, though somewhat less so than earlier. Corporate financing conditions have become somewhat less supportive Domestic financial conditions for nonfinancial firms have become somewhat less supportive 32 of growth since last June, particularly for non-investment-grade firms. Equity prices have declined and bond spreads have widened amid SouRCE' Department of Commerce, Bureau of Ewnomic Analysis concerns about the global economic outlook and oil prices. Downgrades of bonds issued by 22. Selected components of net financing for nonfinancial nonfinancial companies have increased, and businesses the leverage of these companies is near the Bt!honsofdo!lars,month!)·rate top end of its range over the past few decades. Ill Commercial paper Nonetheless, profitability has remained high fiR Bonds 80 outside the energy sector. Against a backdrop II Bank loans HI -Sum 60 of low interest rates, investment-grade nonfinancial businesses have continued to raise 40 substantial amounts of funds in bond and 20 loan markets since last June, in part to finance mergers and acquisitions activity (figure 22). 20 Speculative-grade bond issuance also was solid for much of 2015 but diminished toward the 40 end of the year as spreads widened notably, particularly for firms in the energy sector Norr: The da1a for the components except bonds are seasonally adjusted (figure 23). SouRCE Federal Reserve Board, Statistical Release Z.l, ''Financial Accow1ts of the United States·· Loan demand remained strong across most major categories through the end of 2015. 23. Corporate bond yields, by securities rating Of note, demand for commercial real estate (CRE) loans strengthened further and Perccntagepomt~ issuance of commercial mortgage-backed 20 securities (CMBS) remained robust Credit !8 conditions tightened for this sector as concerns !6 !4 about credit quality led to wider spreads !2 on CMBS and, according to the results of 10 the October and January SLOOS reports, a 8 moderate number of banks had tightened lending standards for CRE loans, particularly for construction and land development A modest fraction of banks also reported having [_LLLLLLLLLLLLLLLLLLLLLJ tightened lending standards for commercial 1998 2001 2004 2007 2010 20l3 2016 and industrial loans to firms of all sizes since S N o o \ n JR :. (E T h B e o y f 1 A e ld M s e s r h r o il w l L n y a n re c h y 1 G e l l o d b s a o l n R 1 e 0 s - e y a c rc a h r . b u o s n e d d s w1tb. penmssJOU the second quarter. 82 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00086 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 720.66532 MONETARY POliCY REPORT: FEBRUARY 2016 15 The from federal fiscal policy has 24. Change in real government expenditures on ended ... consumption and investment After being a drag on aggregate demand Perceot.mmualrale during much of the expansion, federal fiscal Federal Ill State and local policy has shifted to a more neutral stance as fiscal consolidation efforts have abated. During 2015, policy actions had little effect on taxes and transfers, and real federal purchases of goods and services edged up (figure 24). The federal budget deficit narrowed further in fiscal year 2015 to 2'h percent of GOP, largely reflecting the increase in tax receipts owing to the ongoing economic expansion as well as the 2010 20li 2012 2013 2014 modest increase in purchases (figure 25). A So\JRCE Department of Commerce, Bureau of EconomiC AnalySIS deficit of this size is small enough to stabilize 25. Federal receipts and expenditures the ratio of the debt held by the public to nominal GOP; that said, the current level of Anmci Percentofnomma!GDP that ratio is elevated relative to its average over the post-World War II period (figure 26). Expenditures 26 The Congressional Budget Office projects the 24 deficit to move up to about 3 percent of GOP 22 in Jisca12016. Receipts 20 ... and state and local government /\_/ 18 expenditures are rising moderately 16 Fiscal conditions of most state and local 14 governments continue to improve gradually. Tax revenues have been rising moderately, supported by the expansion of economic NoTE. The recc1pts and expenditures data are on a unified~budget baSIS and arc for fiscal years (October through September); gross domestic product activity and increasing house prices. These (GOP) data are for the four quarters ending in Q3 governments boosted spending at a moderate SouRn:: Office of Management and Budget. rate in 2015. In particular, real state and 26. Federal government debt held by the public local purchases of goods and services rose 1 y, percent last year, as employment posted Quarterly another modest gain and real construction 90 spending rose markedly for the first time since 80 the recession (figure 27). 70 In contrast, net exports still held down 60 growth in gross domestic product slightly 40 Exports held about flat in the second half of 2015, weighed down by the appreciation of the 30 dollar and by soft foreign economic growth 20 (figure 28). Although the stronger dollar made imports more affordable, import growth was Non, The data extend through 2015:Q3. The data fOr gross domestic also relatively subdued. Imports for inputs prodttct (GDP) are at an annual rate Federal debt held by the pubhc equals related to oil exploration and production federal debt less Treas<uy secunties held in federal employee defined benefit retirement accounts, evaluated at the end of the quaner. SouRcE. For GOP, Department of Commerce, Bureau of Econom1c Analysts; for federal debt, Federal Reserve Board, Statisllcal Release Z.l, "Ftnancial Accounts oftl1e United States" 83 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00087 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 820.66532 16 PART 1: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 27. State and local employment and structures investment were particularly weak, consistent with steep declines in that industry. In all, real net trade B•llums of chamed (2009) dollars, ~ llru - lua - J ra! - e ----- E-mp-lov-«.>-s m- m-!l!w-os- continued to be a drag on real GDP growth in the second half of 2015. Although the 320 --·l9.8 real trade balance deteriorated, the nominal 300 trade balance was little changed in 2015 in -!9.6 part because the value of imports declined, 280 --·19.4 largely because of the decline in oil prices. ?60 Still, the current account deficit widened a bit -19.2 to ncar 3 percent of nominal GDP as U.S. net 240 investment income declined (figure 29). 220 --19.0 Financial Developments Non;: The employment data are monthly, and the structures <lata are The expected path for the federal funds q11arter!y SoVRCF.: For employment data, Department of Labor, Bureau of Labor rate over the next several years declined S!atJstics; for structures data, DepartnH."'tt of Commerce, Bureau of Economic Analysis. Despite further strengthening in labor market conditions and a range of other indicators 28. Change in real imports and exports of goods and services that market participants viewed as consistent with continued expansion in the U.S. economy, Percenl.annualrate market -based measures of the expected path II Imports !5 of the federal funds rate over the next several Exports 12 years have moved down, on balance, since the middle of last year. Contributing to this shift HI were concerns abont the foreign economic outlook and global disinllationary pressures, as well as Federal Reserve communications anticipating that economic conditions will warrant only gradual increases in the federal funds rate. Survey-based measures of the expected path of policy also moved down. According to the results of the most recent SouRCE: Department of Commerce, Bureau of Economic Analysis Survey of Primary Dealers, conducted by the Federal Reserve Bank of New York just prior 29. U.S. trade and current account balances to the January FOMC meeting, respondents' Quancdy Pcrccrl!ofnomma!GOP expectations for the federal funds rate target at the end of this year and next year were lower than those reported last June. Market based measures of uncertainty about the policy rate approximately one to two years ahead declined, on balance, from their mid- 20 15 levels. Longer-term Treasury yields decreased ('uJTentaccount Yields on longer-term nominal Treasury securities have declined since the middle of last year on net (figure 30). The decreases in nominal yields largely reflected reductions 84 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00088 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 920.66532 MONETARY POliCY REPORT: FEBRUARY 2016 17 in inflation compensation; yields on long- 30. Yields on nominal Treasury securities term inflation-protected Treasury securities were little changed. Participants in the U.S. Treasury market reportedly were particularly attentive to developments abroad, especially turbulence in Chinese financial markets, and to fluctuations in oil prices. Consistent with the changes in yields on Treasury securities, yields on 30-year agency mortgage-backed securities (MBS)--an important determinant of mortgage interest rates----decreased, on balance, over the second half of 2015 and early 2016 (figure 31). Broad equity price indexes decreased ... NoTE" The Treaswy ceased pubhcation of the 30-year constant maturity series on Febmary 18, 2002, and resumed that series on February 9, 2006 SoURcE: Department of the Treasury. Since the middle of last year, amid considerable volatility, broad measures of 31. Yield and spread on agency mortgage~ backed U.S. equity prices have decreased notably, on securities net, as concerns about the foreign economic outlook appeared to weigh on risk sentiment _P_cr_ooo_'- ---------·------Bam points and the outlook for corporate earnings growth 400 (figure 32). Stock prices for companies in the 350 energy and basic materials sectors dropped 300 sharply, reflecting the continued fall in oil and 250 other commodity prices. Implied volatility for --- 200 the overall S&P 500 index, as calculated from 150 options prices, increased, on balance, since JOO the middle of last year; at times, its movement 50 was notable. . . . and risk spreads on speculative-grade corporate bonds moved up substantially, Nou:_ The data are daily. Y1eld shov.n is for the Fannie Mae 30~ycar current coupon, the coupon rate at which nevt mortgage-backed secuntws particularly for firms in lne energy sector would be priced at par, or face, value. Spread shown is to the average of the 5-and 10-year nominal Treasury yields Credit spreads in the corporate sector have SoURce: Department of the Treasury; Bardays widened across the credit spectrum. The 32. Equity prices spread of yields on investment-grade corporate ---------------D-ecember3L2001"" 100 bonds to yields on Treasury securities of comparable maturity rose moderately, and 160 credit spreads on speculative-grade bonds 140 widened substantially. Spreads for firms in the 120 energy sector increased particularly sharply, 100 reflecting the further drops in the price of so oil since late June. Mutual funds investing in speculative-grade bonds experienced significant 60 outflows over the second half of 2015 and 40 early 2016, and, in December, redemptions 20 from one such fund were suspended. During the second half of last year, the respondents NoTE: For Dow Jones Indices licensing informatiOn, sec lhe note on the Contents page SouRcE The Dow Jones Bank Index and the S&P 500 Index are a product of S&P Dow Jones Indices LLC and/or its affiliates 85 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00089 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 030.66532 18 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS to the Senior Credit Officer Opinion Survey on Dealer Financing Terms reported a moderate deterioration in liquidity and market functioning in speculative-grade corporate bonds and some tightening of the terms under which dealers were willing to provide financing to clients against such bonds.' In addition, some metrics of corporate bond market liquidity suggest a slight deterioration over the second half of 2015 and early 2016, though most indicators remain at levels comparable with those seen prior to the crisis. For further discussion of corporate bond markets and other financial stability issues, see the box "Developments Related to Financial Stability." Short-term funding markets continued to function well Short-term dollar funding markets have functioned smoothly during the second half of 2015 and early 2016. Markets for unsecured offshore dollar funding and repurchase agreements, or repos, generally did not exhibit signs of stress. Year-end funding pressures were modest. Money market participants continued to focus on the Federal Reserve's use of its monetary policy tools. These tools proved elfective in raising the federal funds rate following the FO M C's decision to increase the target range in December, while other money market rates also moved up broadly in line with the increase in the federal funds target range. For a detailed discussion, see the box "Monetary Policy Implementation following the December 2015 FOMC Meeting" in Part 2. Treasury market functioning and liquidity conditions in the mortgage-backed securities market were generally stable Indicators of Treasury market functioning have remained broadly stable over the second half of 2015 and early 2016. A variety of 3. More information on the Senior Credit Officer Opinion Survey on Dealer Financing Terms is available on the Board's website at www.federalreservc.gov/ econresdata/rcleases/scoos.htm. 86 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00090 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 130.66532 MONETARY POLICY REPORTc FEBRUARY 2016 ] 9 liquidity metrics-including bid-asked spreads and bid sizes-have displayed no notable signs of liquidity pressures over the same period. In addition, Treasury auctions generally continued to be well received by investors. Liquidity conditions in the agency MBS market were also generally stable. Dollar roll-implied financing rates for production coupon MBS-an indicator of the scarcity of agency MBS for settlement--suggested limited 33. Ratio of total commercial bank credit to nominal gross settlement pressures over the second half of domestic product 2015 and early 2016. Quarter!~._·- --- Percent Bank credit has continued to expand and ban!< rose further 75 Aggregate credit provided by commercial 70 banks increased at a solid pace in the second half of 2015 (figure 33). The expansion in bank -~ 65 credit was mainly driven by strong growth in loans coupled with an increase in banks' 60 holdings of agency MBS. The growth of loans 55 on banks' books was generally consistent with the SLOOS reports of increased loan demand I l!!!l!!!l!!II.Utl!!!ll!!l!!!l!I!!Jt!!t!!l!!ll ! 2005 2007 2009 20ll 2013 2015 for many loan categories. SouRcE: federal Rest'fVe Board, Statistical Release H.R, "Assel~ and Liabilines of Commercial Banks in the United States''; DepartmeJJt of Measures of bank profitability remained Commerce, Bureau ofF..(;()nomic Analysis below their historical averages but improved slightly during the third quarter of 2015 (the latest available data), supported by lower 34. Profitability of bank holding companies nonintcrest expenses (figure 34). Net interest P..rcenf.annualrate l'ercent,ann!.lalrate margins were about unchanged, on average, Retumonassets during the third quarter. Delinquency and L5 -- 20 charge-otl rates for most major loan types were generally stable, near or at their lowest TO levels since the financial crisis. Among large bank holding companies (BHCs), despite generally positive third-and fourth 10 I 0 quarter earnings reports, equity prices have 20 decreased markedly, on balance, since the middle of last year. The decline in bank equity prices likely reflected concerns about global growth, the etlccts of a flatter yield curve on the outlook for bank profitability, and Reserve Board, FR Y-9C, Consolidated Financial Statements !Or Bank Holding Compames potential losses due to the decrease in energy prices. Credit default swap (CDS) spreads for large BHCs increased on net. 87 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00091 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 230.66532 20 PART 1: RECENT ECONOMIC AND FINANCIAl DEVELOPMENTS Developments Related to Financial Stability Financial vulnerabilities in the U.S. financial system A. Corporate bond spreads to similar-maturity Treasury overall have continued to be moderate since mid-2015. securities Regulatory capital and liquidity ratios at large banking firms are at historically high levels, and the use of Month!\' Percent short-term wholesale funding remains relatively !ow. Debt growth in the household sector continues to be !5 modest and concentrated among borrowers with strong 13 credit histories. Some areas where valuation pressures were a concern have cooled recently; in particular, High·yield spread II risk premiums for below-investment-grade debt have widened. However, high leverage of nonfinancial corporations makes some firms highly vulnerable to adverse developments, such as lower oil prices or slowing global growth, Vulnerabilities owing to leverage and maturity transformation in the financial sector remain low. Regulatory capital ratios at U.S, banking firms increased further in the third quarter of 2015, and NOTE. The spread is the I O·year yield for corporate bonds less the 10 -year holdings of high-quality liquid assets at banking firms Treasury yield; bond yields are estimated from a smoothed curve fit to OOnd also remain at very high levels. In addition, some of the y o i f e f· l t d lJ s e . -r a u n n d T T re r a e s a u s r u y r y s e y c i u el r d it . i ~ e s a re estimated from a smoothed curve fit to largest domestic banks have reduced their reliance on SOURCE: Department of the Treasury; SofA Merrill Lynch Global potentially less stable types of short-term funding. The Research, used with perm1ssion. aggregate delinquency rate on bank loans declined to of speculative-grade bonds and leveraged loans has its lowest level since 2006, though delinquency rates slowed significantly, which also could reflect, in on loans to the oil and gas industry, which account for part, an increase in investors' risk aversion. Despite a small share of most banks' portfolios, have increased. the volatility, most indicators of liquidity conditions Bank underwriting practices in the leveraged loan in corporate bond markets, such as trading volumes market have improved, on balance, over the past and bid-asked spreads, deteriorated only slightly. year but occasionally still fall short of supervisory Nonetheless, the suspension of redemptions in expectations. Moreover, domestic banking firms have December by a high-yield hond mutual fund that only limited exposure to emerging market economies. had a high concentration of very low-rated debt and However, developments in foreign economies and had experienced persistent outflows high lighted a financial markets, particularly an escalation of recent vulnerability at open-end mutual funds that offer volatility or a worsening of the outlook for China, could daily redemptions to investors while holding transmit risks through indirect financial linkages. Jess-liquid assets. Net secured borrowing by dealers, primarily used Commercia! real estate prices continued to rise, to finance their own portfolios of securities, continued supported in part by improved fundamentals, and to decrease and is near historical lows, while securities commercial real estate lending by banks accelerated financing activities aimed at facilitating clients' in recent quarters. However, spreads on securities transactions also remain at low levels. The fatter is backed by commercial mortgages widened further consistent with reports that dealers have tightened and bank lending standards reportedly have tightened price terms for securities financing and derivatives. The since july, suggesting that financing conditions have volume of margin loans outstanding-an important become-a little less accommodative. In addition, late component of overall leverage used by hedge funds last year, federal banking regulators issued a joint appears to have moderated. Short-term funding statement reinforcing existing guidance for prudent risk levels remain relatively low, though reforms aimed at management in that sector. 1 Residential home prices reducing structural vulnerabilities in those markets are also continued to increase. However, price-to-rent still being implemented. ratios do not suggest that valuations are notably above Overall asset valuation pressures have eased. Corporate bond spreads increased notably and are 1 _ See Board of Governors of the Federal Reserve System, now above their historical norms (figure A). Those Federal Deposit and Office of the spreads appear to have risen by more than the o C n o m Pr p u t d ro e l n le t r R o is f k t h M e a C n u a r e r , e em nc e y n t compensation required for higher expected losses, suggesting risk premiums have also increased. Issuance 88 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00092 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 330.66532 MONETARY POLICY REPORT: FEBRUARY 2016 21 historical norms, and residential mortgage debt growth buffer is a macroprudential tool that can be used remains minimal. to increase the resilience of the financial system by Broad equity indexes have declined significantly raising capital requirements on internationally active since July 2015, and forward price-to-earnings ratios banking organizations when there is an elevated risk have fallen to a level closer to their averages of the past of above-normal losses in the future. The CCyB would three decades. Yields on longer-term Treasury securities then be available to help those banking organizations decreased over that period, and estimates of term absorb shocks associated with worsening credit premiums remained low. Because many assets are priced conditions, and it may also help moderate fluctuations based on Treasury yields, their low level continues to in the supply of credit. In releasing the framework pose a risk to valuations of assets that have lower-than for comment, the Board consulted with the Federal average earnings yields. However, in December, the Deposit Insurance Corporation and the Office of the Federal Reserve's increase in the target range for the Comptroller of the Currency. Should the Board decide federal funds rate did not result in significant changes in to increase the CCyB amount in the future, banking longer-term interest rates or their volatility. organizations would have 12 months before the change The ratio of private nonfinancial sector credit to became effective, unless the Board established an gross domestic product remains below estimates of earlier effective date. its long-term upward trend, reflecting subdued levels Third, the Board issued for public comment a proposed of household debt. Debt growth in the nonfinancial rule that would impose total loss-absorbing capacity and business sector has slowed in recent months, long-term debt requirements on U.S. G-S!Bs and on the particularly among speculative-grade and unrated firms. U.S. operations of certain foreign G-SIBs.' The proposal However, leverage of such firms has risen to historical would require each covered firm to maintain a minimum highs, especially among those in the oil industry, a amount of unsecured long-term debt that could be development that points to somewhat elevated risks of converted into equity in a resolution of the firm, thereby distress for some business borrowers. recapitalizing the finn without putting public money at As part of its effort to improve the resilience of risk. The proposal would diminish the threat that a G-SIB's financial institutions and overall financial stability, failure would pose to financial stability and is an important the Federal Reserve Board has taken several further step in addressing the perception that certain institutions regulatory steps. First, the Board finalized a rule that are "too big to fail." increases risk-based capital requirements for U.S. Finally, the Board, acting in conjunction with global systemically important bank holding companies other federal regulatory agencies, issued a final (G-SIBs)-' The applicable surcharges are calibrated rule imposing minimum margin requirements on based on the systemic footprint of each U.S. G-SIB so certain derivatives transactions that are not centrally that the amount of additional capita! a firm must hold deared.5 The swap margin rule will reduce the risk increases with the costs that its failure would impose that derivatives transactions would act as a channel for in terms of U.S. financial stability. The G-SIB surcharge fin;mcia! contagion and, by imposing higher margin rule is designed to ensure that U.S. G-SIBs either hold requirements on uncleared swaps than apply to cleared substantially more capital, reducing the likelihood swaps, will incentivize market participants to shift that they will fail, or choose to shrink their systemic derivatives activity to central clearinghouses. footprint, reducing the harm that their failure would do to the financial system. Second, the Board announced that it is seeking Proposed Polley Statement Detailing the Framework the Board public comment on its proposed framework for Would r-ollow in Setting the Countercyclical Capital Buffer setting the Countercyclical Capital Buffer (CCyB) ( n C e C w y s B f.' ) v ," e n p t r s e / s p s re r s d sA ea x s re e g , / D 20 e 1 c . e '> m 1 b 22 e 1 r 2 b 1 .h , tm ww . w.federalreserve.gov/ and voted to affirm the CCyB amount at the current 4. See Board of Governors of the Federal Reserve System level of 0 percent--consistent with the continued (2015), "Federal Reserve Board Proposes New Rule to moderate level of financial vu!nerabi!ities.3 The Strengthen the Ability of largest Domestic and Foreign Banks Operating in the United States to Be Resolved without Extraordinary Government Support or Taxpayer Assistance," 2. See Board of Governors of the Federal Reserve System press release, October 30, www.federalreserve.gov/ (2015}, "f-ederal Reserve Board Approves Final Rule Requiring newsevents/presslbcreg/20151 030a.htm. the largest, Most Systemically Important U.S. Bank Holding 5. See Board of Governors of the Federal Reserve System, Companies to Further Strengthen 1heir Capita! Positions;' press redera! Deposit Insurance Corporation, Office of the release, July 20, www.federalreserve.gov/newsevents/press/ Comptroller of th(• Currency, Farm Credit Administr<Jtion, and bcregl20150720a.htm. Federal Housing Finance Agency (2015), "Agencies Finalize 3. See Board of Governors of the Federal Reserve System Swap Margin Rule," joint press release, October 30, www. (2015}, "FederJ! Res~rv{> Board SE''€ks Public Comment on federa!reserve.gov/newsevents/press/bcreg/20 151 030b.htm. 89 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00093 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 430.66532 22 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS The M2 measure of the money stock has increased at an average annualized rate of about 6 percent since last June, about the same pace registered in the first half of 2015 and faster than nominal GDP growth. Demand for liquid deposits has continued to boost M2 growth. Municipal bond markets functioned smoothly, but some issuers remained strained Credit conditions in municipal bond markets have generally remained stable since the middle of last year. Over that period, the MCDX · an index of CDS spreads for a broad portfolio of municipal bonds-and ratios of yields on 20-year general obligation municipal bonds to those on longer-term Treasury securities edged up on net. Nevertheless, significant financial strains were still evident for some issuers. In particular, Puerto Rico, which continued to face challenges from subdued economic performance, severe indebtedness, and other fiscal pressures, defaulted on some bond issues not backed by guarantees from the commonwealth and is seeking to restructure its debt. International Developments 35. U.S. dollar exchange rate indexes The dollar continued to strengthen ... The foreign exchange value of the dollar rose further, on net, since the middle of 130 last year, bringing its increase since mid- 125 2014, when the most recent run-up began, 120 to over 20 percent by the beginning of 2016 115 (figure 35). Expectations that the Federal 110 Reserve would soon start increasing its policy interest rates, even while most foreign central 105 banks maintained or expanded monetary 100 policy accommodation, boosted the value 95 of the dollar. (For more discussion, see the box "Monetary Policy Divergence in the Advanced Economies.") The dollar has also Nmc: The data, which are m fore1gn currency units per dollar, arc weekly averages of datly data and extend through Febmary 4, 2016 appreciated against the renminbi since last Federal Reserve Board. Statistical Release H.IO, "Foreign summer, when the People's Bank of China 90 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00094 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 530.66532 MONETARY POLICY REPORT: FEBRUARY 201 & 23 (PBOC) announced it was changing its policy to allow market forces to play a greater role in determining the renminbi's exchange rate. The PBOC allowed the renminbi to depreciate 3 percent against the dollar in August and another 1 y, percent after the turn of the year. These developments, which contributed to intensified uncertainty about China's exchange rate policy and the prospects for its economy, fostered episodes of global market turbulence that further boosted the dollar. Investors became more focused on downside 36. Equity indexes for selected foreign economies risks to prospects for growth in China and, by implication, global growth. These concerns Week!~ Januarv4,2{)13~JOO about growth, along with still-strong oil 240 production and high inventories, contributed 220 to a sharp drop in commodity prices, which 200 in turn weighed on the currencies of several ISO commodity-exporting countries. !60 140 ... while equity prices and foreign I20 sovereign bond yields have declined 100 80 Triggered in part by the unexpected 60 devaluation of the renminbi and an ensuing increase in concerns about global economic No1E: The data are weekly averages of daily data and extend through growth, equity indexes have dropped, on net, February 4, 2016. For Dow Jones Indices licensmg informatiOn, see the note in most emerging market economies (EMEs) on S t O h "L e " R C C o E n : te F n o t r s J p a a p g a e n . , Tokyo Stock Price Index (TOPIX): for the euro area, and advanced foreign economies (AFEs) Dow Jones Euro STOA'X Index; for China, Shanghai Composite Index: ti:x emerging markets, Morgan Stanley Emergmg Markets MXEF Capital Index: since the beginning of the summer (figure 36). all vm Bloomberg In particular, Chinese stock prices tumbled more than 40 percent despite official interventions, including circuit breakers and 37. 10 -year nominal benchmark yields in selected bans on stock sales, that were intended to mute advanced economies some of the downward pressure. The fall in Weekly Brazilian stock prices was also very sharp, as global market turbulence as well as domestic 3.0 developments, including a corruption scandal, 2.5 declining output, and persistent high inflation, 2.0 prompted stock prices to fall nearly 25 percent since last summer. ]5 I 0 As in the United States, I 0-year sovereign yields declined in most AFEs, likely in part because of increasing concerns about potential deflationary pressure amid falling commodity prices (figure 37). In the euro area, Greek sovereign yields, which had risen sharply in the first half of the year, declined substantially 91 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00095 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 630.66532 2 4 PART 1o RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS Monetary Policy Divergence in the Advanced Economies As recovery has gradually taken hold in the U.S. A. Two-year overnight index swap rates in selected economy over the past few years, both activity and advanced economies inflation in the advanced foreign economies {AFEs) have remained persistently weak. This divergence in the Percent economic outlooks for the United States and the AFEs has led to expectations of divergence in their monetary United Kingdom 1.2 policies. Although the Federal Reserve raised its target for the federal funds rate in December, policy rates - .8 in most AFfs are near zero (and negative for several economies) and are expected to remain low for several .4 years. Furthermore, the European Central Bank (ECB) and Bank of Japan are providing further monetary accommodation through sizable asset purchase programs, and both of these central banks have .4 indicated that asset purchases will continue, given that inflation remains well below target. Given this ongoing monetary easing, the average policy rate expected by market participants over the next 24 months has SoURcE: Bloomberg. declined in the euro area and Japan since 2014, while are observed between U.S. and German yields on that of the federal funds rate gradually increased over days when the Federal Reserve has made policy this period as "liftoff" approached (figure A). announcements. In the context of economic and policy Two effects of these policy divergences that operate divergences, these monetary policy spillovers may through financial markets have important consequences alter financial conditions in other countries in ways for the economies invo!ved.1 First, and most obviously, that are not necessarily consistent with their cyclical monetary policy divergences have given rise to changes stabilization needs. For example, recent monetary in exchange rates: Portfolio rebalancing by international easing abroad likely has had a tempering effect on investors toward economies and currencies with higher longer-term U.S. interest rates that partially offsets the interest rates has put downward pressure on AFE effect of our own policy normalization. Analogously, currencies, and the dollar has appreciated significantly reduced monetary accommodation in the United States against these currencies since mid-2014 (text figure 35). likely will partially offset the effect of greater monetary This dollar appreciation has contributed to the drag accommodation abroad. However, the implications that U.S. net exports have exerted on U.S. economic of current policy divergences for monetary spillovers growth in recent quarters, but the stronger dollar also should not be exaggerated: U.S. policy remains has contributed to cyclical stabilization abroad as accommodative and, on net, likely continues to expenditures have shifted toward weaker economies. contribute to accommodative conditions abroad. This effect on international trade is also a consideration for U.S. and foreign monetary policies: All else being equal, a smaller contribution to the U.S. economy B. One-day changes in U.S. and Gennan 10-year yields from the external sector likely points to a more gradual on ECB policy announcement days, 1999·-2015 pace of policy normalization in the United States. By the same token, the economic stimulus from more --.Bas!spoints,l...tayctm · n - g · es - -·~~- .. US JQ.yearymldcbanges depreciated currencies abroad may allow AFE central 25 banks to provide less monetary accommodation~-or Correlation '"' 0.58 -20 to start removing it earlier-than would otherwise be L' the case. 10 Second, the effect of monetary policy actions on financial conditions may spill over to interest rates in other countries. For example, on ECB policy announcement days, changes in U.S. and German long-term sovereign yields historically have been highly correlated (figure B); similarly large correlations 1. for more detail, see John Ammer, Michiel De Pooter, Christopher Erceg, and Steven Kamin (2016), "International Spillovers of Monetary Policy," I FOP Notes (Washington: Board of Governors of the Federal Reserve System, NoTE" Each point represents the one-day change in Februmy 8), www.federalreserve.gov/econresdataJnotcsf 1 to E ) - < y )9 e a an r d y i A el p d r s il o 2 n 0 1 t 5 h . e 1 1 d 1 a e y !m of e a in n di E c C at B e s p t O h i e i\ .- l . i ) n ' e a n o n f o b u e n s c t e f m it ent lfdp-notes/2016/inteniationa!-spillovers-of-monetary SOURL'E: For U.S. y1elds, Department of the Treasury: for German yields, policy-20160208.html. Bf<mmberg; for announcement dates, European Central Bank 92 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00096 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 730.66532 MONFTARY POLICY REPORT: FEBRUARY 2016 2 5 as an agreement was reached last summer between the European Union and Greece. In contrast, bond spreads in a number of EMEs rose modestly, on net, in the second half of the year before moving up more steeply after the start of 2016 amid a widespread increase in risk aversion. 38. Real gross domestic product growth in selected emerging market economies Growth in the emerging market Quarterly Percent, annual rate economies moved back up from earlier in II. China 2015 ... ~Korea 15 • Mexico Following weak growth in the first half Brazil of 2015, economic activity in the EMEs improved in the second half, as the pace of growth picked up in Asia and Latin America (figure 38). However, growth has been held back in part by exports from EMEs, which declined appreciably early in 2015 and remain subdued on average. Economic activity in most of emerging Asia, • Gross domestic product of Brazil is not yet available for 201 5:Q4 Non:.: The data for Mexico incorporate the flash: estimate for 20I5·Q4 which had been restrained in the first half of ·nlC data for China are seasonally adjusted by staff The data for Mexico, the year by soft external demand and by the a B g r e u n n c i 1 , e s a . n d Korea are seasonally adjusted by their respective government outbreak of MERS (Middle East Respiratory SOURCE: For Ch:ina, China Natioool Bureau ofStatJstics; for Korea, Bank of Korea; for Mexico, Instttuto Nacional de Estadistica Geografia e Syndrome) in South Korea, picked up in the Informatica; for Braz1l, Instituto Brasileiro de Geografia e Estadistica; all via second half, as the drag from these pressures Haver Analyncs subsided. In China, GDP growth is reported to have held steady around 7 percent in the second half of the year, boosted in part by relatively strong growth in services. However, weak manufacturing, as well as the financial market volatility noted previously, Jed to a pronounced heightening of concerns about the economy during the second half of the year. In Latin America, the decline in commodity prices, along with other macroeconomic challenges, continued to weigh on the economic activity of several countries. In Mexico, the economy continued to grow at a moderate pace in the second half of 2015, supported by improving household demand. However, low oil prices have pressured public finances, and manufacturing exports faltered toward the end of the year. In Brazil, the economy is undergoing its most severe recession in decades. Tight monetary policy in response to high inflation, low commodity 93 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00097 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 830.66532 2 6 PART 1: RECENT ECONOMIC AND FINANCIAl DEVELOPMENTS prices, and the fallout from a high-profile corruption scandal eroded business confidence and contributed to a collapse in investment. Inflation remained subdued in many EMEs, as the continuing decline in commodity prices contributed to a moderation of headline inflation. Consequently, some central banks, including those of Korea and India, loosened monetary policy to support growth. In China, the PBOC also lowered its benchmark rate and cut the reserve requirement ratio in August and October to address weakness in the economy. In contrast, faced with inflationary pressures stemming partly from their depreciating currencies, Brazil, Chile, and Colombia raised their policy rates in the second half of 2015 . . . . and in the advanced foreign economies, economic activity expanded at a moderate pace In Canada, where low oil prices induced a mild contraction earlier in the year, economic activity rebounded in the third quarter as exports recovered and business-sector investment contracted at a slower pace. 39. Real gross domestic product gwwth in selected advanced t{>reign economies That said, more recent indicators of growth weakened markedly during the fourth quarter. Percem,mmualrate In contrast, in the euro area, Japan, and the W 8 il l J U a m pa te n d Kingdom __ , 4 United Kingdom, economic activity grew - II li't , moderately in the third quarter, and recent ~~::~ ~ indicators for fourth-quarter growth, such as purchasing managers indexes, have largely held ::__u_ I ~L steady (figure 39). - I -, As in the United States, inflation remained low in most advanced foreign economies. Further -2 declines in commodity prices weighed on in11ation in the AFEs; in the euro area, Japan, and the United Kingdom, consumer prices changed little in 2015. Over the same period, consumer prices rose about l Y2 percent in Canada, reflecting the boost to import prices from the sharp depreciation of the Canadian dollar over the past year. 94 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00098 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 930.66532 MONETARY POLICY REPORT: FEBRUARY 201 n 2 7 With inflation low, AFE central banks as necessary. The Bank of England announced maintained highly accommodative monetary that it will start shrinking its balance sheet policies, and some signaled their intention only after its policy rate rises to about to maintain large balance sheets well in to 2 percent from its current level of 'h percent. the future. The European Central Bank, in Meanwhile, in response to weak economic addition to lowering its deposit rate further performance earlier in 2015, the Bank of into negative territory, announced an extension Canada cut its policy rate further. More of the intended duration of its asset purchase recently, the Bank of Japan cut the interest program through at least March 2017 and that rate that it pays on a portion of banks' current it would reinvest principal payments for as long account deposits to negative 0.1 percent. 95 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00099 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 040.66532 29 2 PART MoNETARY Poucy In December, the f"ederal Open Market Committee (FOMC) raised the target range for the federal funds rate by '14 percentage point after seven years in which that rate had been held near zero. The FOMCs decision reflected the considerable improvement in the labor market last year and the Committee's assessment that, even with the modest reduction in policy accommodation, the labor market would continue to strengthen and inflation would return over the medium term to the f"OMCs 2 percent objective. Monetary policy remains accommodative, and the Committee expects that economic conditions will warrant only gradual increases in the federal funds rate. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data. The FOMC raised the federal funds rate The Committee's decision to raise the federal target range in December ... funds rate recognized the time it takes for policy actions to affect future economic Since last March, the FOMC had anticipated outcomes; if the FOMC delayed the start of that it would be appropriate to increase the policy normalization for too long, a relatively federal funds rate when it had seen further abrupt tightening of policy might eventually be improvement in the labor market and was needed to keep the economy from overheating reasonably confident that inflation would and inflation from significantly overshooting move back to 2 percent over the medium term. the Committee's 2 percent objective. Such In December, the FOMC,judging that these an abrupt tightening cDuld disrupt financial criteria had been met, raised the target range markets and perhaps even inadvertently push for the federal funds rate to '14 to y, percent the economy into recession. (figure 40)4 ... but monetary policy remains 4. See Board of Governors of the Federal Reserve Sys accommodative tem (2015), "Federal Reserve Issues FOMC Statement," press release, December 16, www.federa1reserve.gov/news Even after the increase in the federal funds events/press/monctary/20 151216a.htm. rate late last year, the stance of monetary 40. Selected interest rates Dmty Percent 1130 4130 815 !0/~9 !/28 4/29 &ll2 !114 1127 4128 \'.lltl ll/3 !/26 4127 8N 11/2 !125 4115 ~fl !(1114 t!JO Vl 7!}1 1013() 1129 4/30 7130 10/29!/)8 4/2Q 7/2Q J0/28 J/27 3fll\ 61259!16 121163/18 6124 WlJ121J63!!6 6123 Q/11121!43/15 6!'11 «11112!133.!13 6!20 91!312/12 3120 6/JQ 9/l& 1211:0!!9 6Jl8 9117 !21!73/18 6!!7 9/1712116 2008 2009 2010 2011 2012 20l3 2014 2015 2016 NOIE. 'l11e 2~year and I 0-year Treasury rates arc the constant-maturity yJCids based on the most ac!Jve!y traded securities. The dates on the honzontal axis are those of regularly scheduled Federal Open Market Committee meetmgs. SOURCE: Deparimenl of the T rcasury, Federal Reserve Board 96 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00100 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 140.66532 30 PART 2: MONETARY POLICY policy remains accommodative. The FOMC economic growth, and employment than to anticipates that economic conditions will downside shocks. This asymmetry suggests evolve in a manner that will warrant only that it is appropriate to be more cautious in gradual increases in the federal funds rate, normalizing the stance of monetary policy and that the federal funds rate is likely to than would be the case if short-term nominal remain, for some time, below the levels that are interest rates were appreciably above zero. expected to prevail in the longer run. In part reflecting this concern, the FOMC This expectation is consistent with the view continued to reinvest principal payments from that the neutral nominal federal funds rate its securities portfolio, and the Committee defined as the value of the federal funds expects that this reinvestment policy will be rate that would be neither expansionary nor maintained until normalization of the level contractionary if the economy was operating of the federal funds rate is well under way. at its productive potential-is currently low by Maintaining sizable holdings of longer-term historical standards and is likely to rise only securities should help support accommodative gradually over time. One indication that the financial conditions and reduce the risk that neutral federal funds rate is low is that U.S. the Committee would not be able to deliver economic growth has been only moderate in sufficient accommodation by lowering the recent years despite the very low level of the federal funds rate in the event of future federal funds rate and the Federal Reserve's adverse shocks. very large holdings of longer-term securities. Had the neutral rate been running closer to The FOMC expects that, supported by an the average level estimated to have prevailed in accommodative monetary policy, economic recent decades, these policy actions would have activity will continue to expand at a moderate been expected to foster a much more rapid pace and the labor market will continue to economic expansion. strengthen. Inflation is expected to remain low in the near term, in part because of recent An array of persistent economic headwinds further declines in energy prices, but to rise have weighed on aggregate demand since the to 2 percent over the medium term as the financial crisis; these headwinds included, at transitory effects of declines in energy and various times, limited access to credit for some import prices dissipate and the labor market borrowers, contractionary fiscal policy, and strengthens further. ln light of the current weak growth abroad coupled with a significant shortfall of inflation from 2 percent, the appreciation of the dollar. Although the Committee is carefully monitoring actual and overall restraint imposed by such headwinds expected progress toward its intlation goal. has declined over the past few years, the effects of some headwinds have remained significant. The FOMC's policy decisions will As these effects abate further, the neutral continue to be data dependent federal funds rate should gradually move higher over time. (for a discussion of how the Although the Committee expects that neutral federal funds rate is likely to evolve economic conditions will warrant only over time, see the box "The Neutral Federal gradual increases in the federal funds rate, Funds Rate in the Longer Run.") the Committee has emphasized that the actual path of monetary policy will depend Another reason that the Committee expects on how incoming data affect the economic only a gradual increase in the federal funds outlook. In determining the timing and rate will be warranted is that, with the federal size of future adjustments to the target funds rate near zero, the FOMC can respond range, the Committee will assess realized more readily to upside surprises to inflation, and expected economic conditions relative 97 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00101 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 240.66532 MONETARY POLICY REPORT: ffBRUARY 2016 31 to its objectives of maximum employment mortgage-backed securities at approximately and 2 percent inflation. Stronger growth or $1.8 trillion. Consequently, total liabilities a more rapid increase in inflation than the on the Federal Reserve's balance sheet were Committee currently anticipates would likely largely unchanged. call for faster increases in the federal funds rate; conversely. if conditions prove weaker, Given the Federal Reserve's large securities a lower path of the federal funds rate would holdings, interest income on the SOMA likely be appropriate. Similarly, the timing portfolio has continued to support substantial of a change in the reinvestment policy will remittances to the U.S. Treasury Department. depend on economic developments and their Preliminary results indicate that the Reserve implications for progress toward the FOMC's Banks provided for payments of $97.7 billion goals of maximum employment and price of their estimated 2015 net income to the stability. In assessing realized changes in Treasury. In addition, the Reserve Banks economic conditions and forming its outlook, transferred to the Treasury $19.3 billion the Committee will take into account a from their capital surplus as required by wide range of measures, including measures an amendment to the Federal Reserve Act of labor market conditions, indicators of contained in the Fixing America's Surface inflation pressures and inflation expectations, Transportation Act of 2015. Remittances from and readings on financial and international 2008 through 2015 total about $600 billion developments. on a cumulative basis-an average of about $75 billion a year, compared with about The size of the Federal Reserve's balance $25 billion a year, on average, over the decade sheet has remained stable prior to 2008. With the continuation of the Committee's The Committee continued to focus on the reinvestment policy, the Federal Reserve's total implementation of monetary policy assets have held steady at around $4.5 trillion (figure 41 ). Holdings of U.S. Treasury Consistent with the FOMC's Policy securities in the System Open Market Account Normalization Principles and Plans published (SOMA) have remained at $2.5 trillion, on September 17, 2014, the Federal Reserve and holdings of agency debt and agency used interest paid on reserve balances 4l Federal Reserve assets and liabilities Week!"-'--------- Tn!!u:msofdollars -45 -Assets 4.0 Other assets -3.5 3.0 2.5 -2.0 -L5 I '0 -- 0 5 ·-· 1.0 -1.5 -20 2.5 -3.0 -3.5 --4 0 4.5 Non:. "Credit and hquidity facilities". cons is~ of J?fllUaJY, second~, and seasonal cr~dit, tc_rm auction credit; central bank hq0 d1ty swaps; support for !\1aiden Lane, Bear_ Steams. ~nd AlG; and oth?r credit facilttJcs, mc_!uding the Primary Dealer Crcd1t Fac1!ity. the Asset~-!3acked Commcn;Jal_Papcr Money M~rkct Mutual Fund Ll(jULdJty Facthty, ~e C'onunercJal Paper ~undin~t Fac1liry, -~d the_ Tcnn Asset-Backed Securitws Loan Fac1hty. "Other assets" mdudes unamortJ;r..ed premitmts and discmmts on scct~nttes held outright. "Cap1tal and other habd!tles" mcludes reverse repurchase agreements, the US. Treastuy Genera! Accmmt, and rhe US Treasury Supplementary Fmancing AccoWlt. The data extend through February 3. 2016 Somwr Federal Reserve Board, Statistical Release H.4.l, '·Factors Atfectmg Reserve Balances" 98 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00102 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 340.66532 32 PART L MONETARY POLICY The Neutral Federal Funds Rate in the longer Run As discussed in the main text, t.."Conomic growth Economic Projections has fallen from 4.25 percent to has been only moderate in recent years despite 3.50 percent.2 In addition, several econometric studies the very low level of the federal funds rate and the have estimated a decline in the longer-run value of the Federal Reserve's large-scale purchases of longer-term neutral rate by statistically modeling the co-movements securities. This observation suggests that headwinds between variables like inflation, interest rates, output, have lowered the "neutral" federal funds rate-<Jefined and unemployment.3 Figure A shows estimates from as the value of the federal funds rate that would be neither expansionary nor contractionary if the economy was operating at its productive potential-to historically 2. See the December 2015 Summary of Economic low levels. Projections, which appeared as an addendum to the minutes As economic disturbances dissipate, the neutral of the December 1 5·-16, 2015, meeting of the Federal Open Market Committee and is included as Part 3 of this report. federal funds rate should rise to its expected longer-run 3. See, for example, Benjamin K. Johannsen and Elmar level. This longer-run value of the neutral rate plays an Mertens (forthcoming), "The Expected Real Interest Rate in important role in monetary policy analysis: It is a key the long Run: Time Series Evidence with the Effective lower determinant of the longer-run level of the federal funds Bound," FEDS Notes {Washington: Board of Governors of the federal Reserve System); Michael T. Klley (2015), 'What rate and other nominal interest rates. When expressed Can the Data Tel! Us about the Equilibrium Real Interest on a real basis, it also corresponds to the intercept Rate?" Finance and Economics Discussion Series 2015-077 of simple policy rules such as those studied in Taylor (Washington: Board of Governors of the Federal Reserve (1993).' Like the current neutral rate, the longer- System, August), www.federalreserve.gov/econresdata/ run value of the neutral rate is not directly observed W fed i! s H /2 a 0 m 1 s S ( / 2 fi 0 !e 1 s 5 / ) 2 , D " 1 M 5 e 0 a 7 s 7 u p r a in p g .p t d h f e ; T N h a o t m ur a a s l R La a u te b a o c f h In a te n r d e s J t o hn and must be estimated using the available data and Redux," Hutchins Center Working Papers 15 (Washington: potentially imperfect models of the economy. Brookings Institution, November), www.brookings.edu/-/ Since 2012, the median of the projections of media/Research/Fi!es/Papers/2015/l 0/30-laubach~wil!iams/ the longer-run level of the federal funds rate in the WP15~lauhach-Wi!liams-natural~interest~rate-redux-2. pdf?!a=en; and Thomas A lubik and Christian Matthes {2015), Federal Open Market Comminee's Summary of "Calculating the Natural Rate of Interest: A Comparison of Two Alternative Approaches," Economic Brief 15~ 10 (Richmond: 1. See-john B. Taylor (1993), "Discretion versus Policy Rules Federal Reserve Bank of Richmond, October), https://www. ln Practice," Carnegie-Rochester Conference Series on Public r!chmondfed.orgl-/mt"dialrlchmondfedorglpub!ications/ Policy, vol. 39 (December), pp. 195~214. rese<uch/economic~brief/2015/pdf/eh_lS-1 O.pdf. In these and also employed an overnigbt reverse Implementation following the December 2015 repurchase agreement (ON RRP) facility FOMC Meeting.") In addition, the Board to implement its decision in December to of Governors approved an increase in the raise the target range for the federal funds discount rate (the primary credit rate) to rate.' Specifically, the Board of Governors I percent. raised the interest rate paid on required and excess reserve balances to y, percent, while Along with the decision to increase the target the FOMC authorized ON RRP operations range for the federal funds rate, the FOMC at an o(fering rate of Y. percent. (For further also temporarily suspended the aggregate information, sec the box "Monetary Policy cap on ON RRP transactions, indicating that ON RRP operations would be undertaken in amounts limited only by the value of Treasury 5. See Board of Governors of the Federal Reserve securities held outright in the SOMA that System (2014), "Federal Reserve Issues FOMC are available for such operations and by a Statement on Policy Normalization Principles and Plans," press release, September 17, www.federalreserve. per-counterparty limit of $30 billion per gov/ncwsevents/prcss/monctary/20 l40917c.h tm. day. Nonetheless, total reverse repurchase 99 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00103 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 440.66532 MONETARY POLICY REPORT: FEBRUARY 2016 33 two time-series models of the longer-run value of the A Estimates of the neutral real rate in the longer run neutral rate, expressed on a real basis. One is from Johannsen and Mertens (forthcoming), and the other is from Laubach and Williams (2015).' The figure includes the uncertainty bands for the Johannsen and Mertens estimates, which indicate that the uncertainty surrounding the longer-run value of the neutral rate is substantial (as it is in other model frameworks). Uncertainty about the longer-run value of the neutral rate implies uncertainty about the expected cumulative rise in policy rates during the policy normalization process. The risk that the longer-run value of the neutral rate going forward could be lower than currently estimated is especially pertinent, because such a scenario would likely increase the probability that monetary policy will be constrained by the effective lower bound on nominal interest Non::: The data extend through 20l5:Q3. For the Johannsen-Mertens model, at each date, the parameters of the model and the longer-nm rates in the future 1 with adverse consequences for equilibrium real rate are JOintly estimated u..<>ing data up to that date. For the macroeconomic outcomes. Laubach-Williams model, the parameters are estimated on the enttre data sample, bllt estimates of the longer-run equilibrium rca! rate use data only up to the: date of interest Shaded regions are 50 and 90 percent uncertainty bands from the Johannsen-Mcrtens mode!. The shaded bars indicate periods of busmess recession as defined by the National Bureau of Economic Research. SOURCE; Benjamin K. Johannsen and Elmar Mertens (forthcoming), "The studies, the longer-run value of the neutral rate is sometimes Expected Real Interest Rate in the Long. Run: Time Series Evidence with the referred to as the longer-run value of the "natural" rate or the EffectJVe Lower Bound," FEDS Notes (Washington: Board of Governors of longer-run "equilibrium" federal funds rate. the Federal Reserve System). and Thomas Laubach and Jolm Williams 4. The estimates from the Johannsen-Mertens and laubach (20 15), "Measuring the Natural Rate of Interest R<..-dux," Hutchins Center Wil!iams models are not the same because the models use W ww o w rk . m br g o ok P i a n p g e s r s e du 1 / 5 -/ m { e W dia as !R hi e n s g e t a o r n c : h/F B i r l o es o ! k P in a g p s e rsn lm o t 1 i 5 t 1 u 1 t i 0 o / n 30 , -J N au o h v a e c m h ber). different data to infer slack in the economy and because the wiHiams!WPJ5-Laubach-Williams-natural-interest-rate-redux-2.pdf?la=en model restrictions and estimation methods are different. agreement transactions with the Federal tools. Three Term Deposit Facility operations Reserve have remained near levels observed were conducted in the second half of 2015. prior to the increase in the target range for The operations offered either 7-or 14-day the federal funds rate and the suspension of deposits at a floating rate of l basis point over the aggregate cap. The Committee intends the interest rate on excess reserves. In these to phase out this facility when it is no longer operations, deposit volumes declined slightly needed to help control the federal funds rate. from previous tests with similar parameters. The Federal Reserve also continued to test the operational readiness of other policy 100 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00104 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 540.66532 34 PART 2: MONETARY POLICY Monetary Policy Implementation following the December 2015 FOMC Meeting At its December 2015 meeting, the Federal Open The effective federal funds rate rose to 0.37 percent Market Committee (FOMC) increased the target range at the time of the change to the target range lor the for the federal funds rate from between 0 and 1/4 percent federal funds rate amid orderly trading conditions in to between v.~ and 112 percent, effective December 17.1 money markets (figure A}. Since the increase in the In order to implement the monetary policy stance target range, the effective federal funds rate has traded announced in December, the Board of Governors also in a relatively narrow range of 0.35 to 0.38 percent, voted to raise the interest rate paid on required and with !he exception of month-ends, when the rate fell excess reserve balances to 0.50 percent Moreover, the temporarily in typical fashion. Increases in interest rates fOMC authorized an increase in the overnight reverse in other money markets were similar to the rise in the repurchase agreement (ON RRP) facility offering rate to federal funds rate following the December meeting, 0.25 percent and indicated that the aggregate amount with overnight Eurodollar rates closely tracking the of the ON RRP operations would be constrained only effective federal funds rate and the general collateral by the value of Treasury securities held outright in repurchase agreement (or repo) rate maintaining the System Open Market Account that are available spreads to unsecured rates similar to those observed for such operations.2 Each of these monetary policy before the December meeting. decisions is consistent with the guidance provided in Total volume in the ON RRP facility was virtually the Policy Normalization Principles and Plans outlined unchanged on the day after the December meeting in the july 2015 Monetary Policy Report.3 (figure B). In the weeks following the December meeting, the total amount of Federal Reserve reverse Federal Reserve System repurchase agreement {RRP) operations reflected Reserve Issues FOMC Statement," press typical calendar-related effects. On year-end, volume December 16, www.federa!reserve.gov/newsevents! in the ON RRP facility was nearly $475 billion, roughly press/monetary/20151216a.htm. 2. In a related action, the Board of Governors voted to in line with aggregate RRP operations seen on recent approve a lf4 percentage point increase in the discount rate to quarter-ends. Following year-end, usage of the ON RRP 1 percent facility rapidly returned to--and has remained at- 3. See the box "Policy Normalization Principles and Plans: levels that prevailed before year-end, consistent with Additional Details" in Board of Governors of the Federal Reserve System (2015), Monetary Policy Report (Washington: recent quarter-end patterns. Board of Governors, July), p. 35, www.federalreserve.gov/ monetarypolicy/iiles/20 150715_mprfu!!report.pdf. A Effective federal funds rate B. Reverse repurchase agreement operations Daily Bas1spmnts Target federal f1mds rate 120 feon RRP - Effective federal funds rate 110 II ONRRP 75 !00 - Participants 360 320 280 240 200 160 !20 80 l\OTE ON RRP IS overnight reverse repm.:hase agreement, 1crm RRP is to."lm reverse repurclmse agn.:ement. Dat."' arc daily Sm:RcE; Federal Reserve Bank of New York. 101 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00105 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 640.66532 35 3 PART SuMMARY oF EcoNOMIC PROJECTIONS The following material appeared as an addendum to the minutes of the December 15-16,2015, meeting of the Federal Open Market Committee. In conjunction with the Federal Open 2018 the unemployment rate would remain Market Committee (FOMC) meeting held on somewhat below their individual judgments December 15-16,2015, meeting participants of its longer-run normal rate. Participants submitted their projections of the most projected that inflation, as measured by the likely outcomes lor real output growth, the four-quarter change in the price index for unemployment rate, inflation, and the federal personal consumption expenditures (PCE), funds rate for each year from 2015 to 2018 would pick up in 2016 and 2017 from the very and over the longer run6 Each participant's low rate seen in 2015. Almost all participants projection was based on information available projected inflation in 2018 to be at or very near at the time of the meeting, together with his the Committee's 2 percent objective. or her assessment of appropriate monetary policy and assumptions about the factors likely As shown in figure 2, all but two participants to affect economic outcomes. The longer- thought that it would be appropriate to raise run projections represent each participant's the target range for the federal funds rate assessment of the value to which each variable before the end of 2015. Most participants would be expected to converge, over time, expected that it would be appropriate to under appropriate monetary policy and in the raise the target range for the federal funds absence of further shocks to the economy. rate gradually over the projection period as "Appropriate monetary policy" is defined as headwinds to economic growth dissipate the future path of policy that each participant slowly over time and as inflation rises toward deems most likely to foster outcomes for the Committee's goal of 2 percent. Consistent economic activity and inflation that best with this outlook, most participants projected satisfy his or her individual interpretation of that the appropriate level of the federal funds the Federal Reserve's objectives of maximum rate wonld be below its longer-run level employment and stable prices. through 2018. FOMC participants generally expected that, Almost all participants viewed the levels of under appropriate monetary policy, real gross uncertainty associated with their outlooks for domestic product (GOP) growth in 2016 economic growth and the unemployment rate and 2017 would be at or somewhat above as broadly similar to the norms of the previous their individual estimates of the longer-run 20 years. Nearly all also viewed the levels of growth rate and would converge toward uncertainty associated with their inflation its longer-run rate in 2018 (table 1 and forecasts as broadly similar to historical figure !). All participants projected that the norms. Most participants saw the risks to unemployment rate would decline further their outlooks for real GOP growth and the in 2016. Most participants expected that in unemployment rate as broadly balanced. A majority viewed the risks attending their 6. The president of the Federal Reserve Bank of projections for both PCE and core PCE Minneapolis did not participate in this FOMC meeting, inflation as broadly balanced, but many nnd the incoming president is scheduled to assume office saw these risks as weighted to the downside. on January I, 2016. James M. Lyon. First Vice President Among those who saw the risks to their of the Federal Reserve Bank of Minneapolis, submitted economic projections. inflation outlook as tilted to the downside, 102 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00106 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 740.66532 3 6 PART 3, SUMMARY OF ECONOMIC PROJECTIONS Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, under their individual assessments of projected appropriate monetary policy, December 2015 Percent Median1 Centra! tendcncy2 Range' Variable 201s 1 2016 1 2011 1 201s Longer ChangeinrealGDP ... 2.1 2.4 2.2 2.0 2.0 2.1 2.3-25 2.0--2.3 LS-2.2: 1.8--2.2 2.0-2.2 2.0-2.7 l.S-2.5 1.7-2.4 1.8-23 September projection .. . :u 2.3 2.2 2.0 2.0 2.0--23 2.2-2.6 2.0-2.4 L8-2.2l LS-2.2 1.9--2.5 2.1-2.8 1.9-2.6 L6--2.4 1.8-2.7 Unemployment rate .... 5.0 4.7 4.7 4.7 4.9 5.0 4.Cr-4.8 4.6-4.8 4.6-..5.0 i 4.8-5.0 5.0 4.3-4.9 4.5--5.0 4.5-5.3 4.7-5.8 September proj~Xtion .. 5.0 4.8 4.8 4.8 4.9 5.0--SJ 4.7-4.9 4.7-4.9 4.7-5.0 j 4.9-5.2 4.9-5.2 4.5-5.0 4.5-5.0 4.6--5.3 4. 7-5.8 PC£ inflation ... 0.4 1.6 1.9 2.0 2.0 0_4 1.2--1.7 1.8-2.0 1.9-2.0 ; 2.0 0.3·..0.5 1.2-2.1 1.7-2.0 1.7-·2.1 2.0 September projection .... 0.4 L7 1.9 2.0 2.0 0.3-05 LS~I.8 1.8~2.0 2.0 j 2.0 Q.J.J.O l.S-2.4 1.7-2.2 1.8-2.1 2.0 Co S r e e p t P e C m E b e in r f p l r a o ti j o e n ct 4 i • o • n .. 1 L . 3 4 1 1 . . 6 7 1 1. . 9 9 2 2. . 0 0 L3 L - 3 1 .4 1 1. .5 5 - ~ - 1 1 . .7 8 1 1. . 7 8 - - - 2 2 . . 0 0 1 1 . . 9 9 - - 2 2 . . 0 0 l : 1 L . 2 2 - -1 L . 7 4 1 1. . 5 4 - - - 2 -2 . . 1 4 1 1. .7 6 - - 2 2 . . 2 0 1 1 . . 7 8 - - - 2 2 . . 1 1 Memo: Projected appropriate policy path Federal funds rate .. 0.4 !.4 2.4 3.3 ! 3.5 0.4 0.9~1.4 1.9-3.0 2.9-3.5:3.3-3.5 0.1-0.4 0.9-2.1 1.9-3.4 2.1-3.9 J.G·-4.0 September projection . 0.4 1.4 2.6 3.4 1 3.5 0.1-0.6 l.i-2.1 2.1-·3.4 3.0--3.6; 3.3-·3.8 -0.1-0.9 -0.1-2.9 l.0-3.9 2.9-3.9 3.0-4.0 r.;oT£. PmJectlons of change m real gross domestiC product (GOP) and projections tor both measures ot mflauon arc percent changes trom the founh quarter ot the pn::vJ<::~us y~r to the tOunh quarter <'I the year indicated. PCE inflation and core PC'E inflation are the percentage rates M change in, n:spectively, the price index for personal consumptwn expenditures {PCE) and the price index: for PCE ex:dudmg food and energy ProJe<:llons for the unemployment rate are for the avNage civilmn unemployment rate in the JOurth quarter of the year indicated. Each participant's projections are based on his or her assessment of appropriate monetary policy. Longer·ruo projecuom. represent each participant's asse;sment of the rate to which each vanabk would be expec!ed to converge under 11ppropriate monetary policy and in thl." absence of further shocks to the economy The projections for the federal fund'> rate are the value of the midpomt of the projected appropnate target range for the federal fllllds rate or the projected appropriate target level for the federal funds rate at !hi." end of the specified calendar year or over the longer run. The September projections were made in conjunction with the meeting of the Federal Open Market Com mince nn September 16-17,2015 I. For each period, the median is the middle projection when the projections are arranged from lowest to highl'St. When the number of projections is even, the median is the average ofthctwomJddleproJeclions """"" hi,hw'"""'" '"~" several highlighted the continued strength Compared with their contributions to the of the dollar and some recent indications Summary of Economic Projections (SEP) that inflation expectations had declined as in September, participants' projections of contributing to those risks. real GDP growth from 2016 to 2018 were generally little changed. The median value of The Outlook for Economic Activity participants' projections for real GDP growth in 2016 was revised up slightly to 2.4 percent; Participants generally projected that, some participants cited the Bipartisan Budget conditional on their individual assumptions Act of 2015, which was passed in late October, about appropriate monetary policy, real GDP as adding support to economic growth in the would increase in 2016 and 2017 at a pace near term. Very few participants changed their somewhat above their estimates of its longer for~-casts for real GDP growth in the longer run rate. Real GDP growth would then slow run, resulting in an unchanged median. in 2018 to a rate at or near their individual estimates of the longer-run normal rate. All participants projected that the Participants pointed to a number of factors unemployment rate would be at or below their that they expect will contribute to moderate individual judgments of its longer-run normal output growth over the next few years, level from 2016 through 2018. Compared including labor market conditions that are with the September SEP, most participants' supportive of economic expansion, household projected paths for the unemployment rate and business balance sheets that had improved were revised down a little over those three significantly since the financial crisis, and a years, with the median of the projections in stance of monetary policy that was expected to the fourth quarter of each year at 4.7 percent. remain accommodative. Many also revised down slightly their 103 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00107 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 840.66532 MONETARY POLICY REPORT: FEBRUARY 2016 37 Figure I. Medians, central tendencies, and ranges of economic projections, 2015 ~18 and over the longer run Percent Change in real GDP - -Median of projections 4 • Centra! tendency of projections I Range of projections ~ ;;;;;;;;e; ~ Actual - 1 + - 0 2010 2011 2012 2013 2014 2018 Longer run Percent _ Unemployment rate -10 - 7 - 5 ~ ~ - 4 2010 2011 2012 2013 2014 2015 2016 2017 2018 Longer run Percent PCE inflation - 3 ~ - l 20!0 2011 2012 2013 2014 2015 2016 2017 2018 Longer run Percent Core PCE inflation - 3 ~ 20!0 2011 2012 2013 2014 2015 2016 2017 2018 Longer run NoTE: Definitions of variables are in the general note to table l. The data for the actual values of the variables are annuaL 104 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00108 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 940.66532 38 PART 3: SUMMARY OF ECONOMIC PROJECTIONS Figure 2. FOMC participants' assessments of appropriate monetary policy: Midpoint of target range or target level for the federal funds rate Percent ··-4.5 ···>!~ ·········t· ......................_ 2.5 ' ········- 1.5 ' •. ·--" .. ·-... " J .•• ···-0.5 ············'· · 2015 2016 2017 2018 Longer run NorE: Each shaded circle indicates the value (rounded to the nearest 1h percentage point) of an individual participant's judgment of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run. estimates of the longer-run normal rate of in their individual assessments of the size unemployment, although the median forecast and persistence of the effects of lower energy of 4.9 percent was unchanged since September. prices and a stronger dollar on real activity; Participants generally cited stronger-than the time it would take for the headwinds expected labor market data in recent months that have been restraining the pace of the as a factor explaining the downward revisions economic expansion, such as financial and to their unemployment rate forecasts. economic conditions abroad, to dissipate; and the appropriate path of monetary policy. Figures 3.A and 3.B show the distribution With regard to the unemployment rate, the of participants' views regarding the likely distributions of projections over the next three outcomes for real GDP growth and the years shifted modestly to lower values since unemployment rate through 2018 and in September. the longer run. The distributions of the projections for real GDP growth over the next The Outlook for Inflation several years and in the longer run narrowed some since the September SEP. The diversity Nearly all participants saw PCE price inflation of views across participants on the outlook picking up in 2016, rising further in 2017, for GDP growth retlected, in part, differences and then reaching a rate in 2018 at or very 105 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00109 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 050.66532 MONETARY POLICY REPORT: FEBRUARY 2016 3 9 Figure 3.A. Distribution of participants' projections for the change in real GDP, 2015-18 and over the longer run Number of participants 2 0 0 15 S D e e p c t e e m m b b e e r r p p r r o o j j e t" c C ti t o io n n s s - - - 1 1 1 8 6 4 -12 -10 8 6 4 2 2.2"' :!.8- 2.1 2.3 2.5 2.9 Percent range Number of participants 2016 -18 -16 -14 -12 -10 8 6 4 ~~iil;i=--=~:...:..t..:J 2 1.7 1.9 2.1 2.3 2.5 2.7 2.9 Percent range Number of participants 2017 -18 -16 -14 -12 -10 8 6 4 ' 1.7 1.9 2.3 25 2.7 :t9 Percent range Number of participants 20!8 -18 16 14 -12 -JO 8 6 4 2 2.4- 2.8- 1.9 21 23 2.5 2.7 2.9 Percent range Number of participants Longer run -18 -16 -14 12 10 8 6 4 ,.. 2 2.8 2.7 2.9 NoTE: Defmitions of variables are in the general note to table l. 106 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00110 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 150.66532 40 PART 3: SUMMARY OF ECONOMIC PROJECTIONS Figure 3.B. Distribution of participants' projections for the unemployment rate, 2015-18 and over the longer run Number of participants 2 0 0 15 S D e e p c t e e m m b b e e r r p p r r o o j j e e c c t t i i o o n n s s -18 1 1 6 4 -12 -- - 10 6 8 4 2 42· 4k 46- 4.8- 5.~ 54 5& 4.3 4.5 4.7 49 5.3 55 5.7 5.9 Percent range Number of participants 2016 -18 -16 14 12 -10 8 6 4 2 s.z. 5.4 5.6- 5.& 4.5 5.3 5.5 5.7 5.9 Percent range Number of participants 2017 18 -16 -)4 -12 10 8 6 L. 4 2 4.2- 4.4- 5.~ 5.2- 5.4 5.& 5.& 43 45 51 53 5.5 5.7 5.9 Percent range Number of participants 2018 -18 -16 -14 12 10 8 6 4 2 43 4.9 51 53 5.5 57 5.9 Percent range Number of participants Longer run -18 16 14 -12 -10 8 6 4 2 4,2- 4.4- 4.& 5.4-- 5.& 5.& 43 45 4.7 5.5 57 59 Percent range NOTE: Definitions of variables are in the general note to table I. 107 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00111 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 250.66532 MONETARY POLICY REPORT: FEBRUARY 2016 41 close to the Committee's 2 percent longer-run levels of the federal funds rate over the next objective. However, relative to the September three years generally shifted to lower values. SEP, almost all participants marked down The median projection for next year was their projections for PCE price inflation in unchanged, but the medians for 2017 and 2016, observing that recent declines in energy 2018 declined slightly. The median projection prices and the continued strength in the dollar now stands at 1.4 percent at the end of 2016, could exert additional downward pressure 2.4 percent at the end of 2017, and 3.3 percent on inflation in the near term. Revisions to at the end of 2018. Given their expectations participants' inflation forecasts in 2017 were that economic headwinds will persist and more mixed, while the projections for inflation that inflation will rise gradually to 2 percent in 2018 were little changed. Most participants over the next three years, most participants also marked down their projections for core judged that it would be appropriate for PCE price inflation in 2016, although almost the federal funds rate to remain below its all still expected core inflation to rise gradually longer-run normal level from 2016 to 2018. over the projection period and to be at or very Participants projected that a gradual rise in the close to 2 percent by 2018. Factors cited by federal funds rate over that period would be participants as contributing to their outlook appropriate as some of those headwinds, such that inflation will rise over the medium term as sluggish foreign economic growth, diminish included recent signs of a pickup in wage and the temporary factors holding down growth, their expectation of tighter resource inflation dissipate. Some participants noted utilization, their expectation that the effects of that a gradual increase in the federal funds rate recent appreciation in the dollar and declines would be consistent with their expectation that in oil prices on inflation will fade, their the neutral short-term real interest rate will rise anticipation that inflation expectations will slowly over the next few years. remain at levels consistent with the FOMC's longer-run objective, and still-accommodative Both the median and the range of participants' monetary policy. projections of the federal funds rate in the longer run, at 3.5 percent and 3 to 4 percent, Figures 3.C and 3.D provide information on respectively, were unchanged since September. the distribution of participants' views about However, several participants revised their the outlook for inflation. The distribution projections for the longer-run federal funds of participants' projections for PCE price rate slightly lower. All participants judged intlation in 2016 and 2017 shifted to the left that inflation in the longer run would be equal compared with the September SEP, while to the Committee's objective of 2 percent, the distributions of projections for 20 I 8 and implying that their individual judgments in the longer run were little changed. The regarding the appropriate longer-run level of distributions of projections for core PCE the real federal funds rate, in the absence of price inflation moved lower for 2016 and 2017 further shocks to the economy, ranged from compared with September but did not change I to 2 percent, the same as in September. for 2018. Participants' views of the appropriate path Appropriate Monetary Policy for monetary policy were informed by their judgments about the state of the economy Figure 3.E provides the distribution of and the outlook for labor markets and participants' judgments regarding the inflation. One important consideration for appropriate level of the target federal funds many participants was their estimate of rate at the end of each calendar year from 2015 the extent of slack remaining in the labor to 2018 and over the longer run. Relative to market, as informed by the incoming data September, the projections of the appropriate on various labor market indicators. Another 108 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00112 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 350.66532 42 PART 3: SUMMARY OF ECONOMIC PROJECTIONS Figure 3.C. Distribution of participants' projections for PCE inflation, 20 15~ 18 and over the longer run Number of participants 2015 0 December projections -IS September projections -10 1.1- 1.3- L5- L7- 1.9- 21 2.3· 1.2 14 1.6 1.8 2.0 22 2.4 Percent range Number of participants 2016 - lS - - - - - " JQ I 8 04 0,6 0,8 1.0 1.2 lA 1.6 L8 2,0 2.2 24 Percent range Number of participants 2017 - " 21- 2.3- 04 0,6 LO lA 1.6 2.0 2.2 2.4 Percent range Number of participants 2018 12 10 Percent range Number of participants Longer run 0,3 0.5 0.9·- II 1.3- 1.5· 1.7- 1.9 2.1- 2.3- 04 06 1.0 L2 14 16 18 20 22 2A Percent range NOTE: Definitions of variables arc in the general note to table I. 109 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00113 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 450.66532 MONETARY POLICY REPORT: FEBRUARY 2016 43 Figure 3.D. Distribution of participants' projections for core PCE inflation, 2015-18 Number of participants 2015 D December projections September projections 11- 1.7- 1.9 2.1- 2.3- 12 1.8 2.0 2.2 24 Percent range Number of participants 20!6 _, -ll 1.9·- 2.1 2.3- 1.2 2.0 2.2 2.4 Percent range Number of participants 20!7 - " - 16 ,.. - - - -. - ' - 6 L!- 1.3- 1.5 2.1- L2 " Percent range Number of participants 2018 -ll 13- 1.5- n 14 1.6 18 2.0 2.2 Percent range NoTE: Definitions of variables arc in the general note to table L 110 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00114 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 550.66532 44 PART 3: SUMMARY OF ECONOMIC PROJECTIONS Figure 3.E. Distribution of participants' judgments of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate, 2015-18 and over the longer run Number of participants 2015 a S D e e p c t e e m m b b e e r r p p r r o o j j e e c c t t i i o o n n s s " 1 1 6 4 12 10 8 6 4 2 Percent range Number of participants 2016 -IS 16 14 12 10 8 6 4 2 3.13- 3.38- H3· 3.88~ 3.37 3.62 3.87 4.12 Number of participants 2017 18 -16 -14 -12 _JO 8 6 4 2 Percent range Number of participants 2018 -IS 16 14 12 _]t) 8 6 4 2 Number of participants Longer run " !6 -14 -12 -10 ' 6 4 2 -0.37--012- 013- 0.38- 0.63- 0.88- 1.13- !.38- J.6J- 1.88- 2.13- 2.38- 2-63- ·-0.13 0.12 0.37 0.62 0.87 1.12 1.37 !.62 L87 2.12 237 2.62 2.87 Percent range NoTE: I'hc midpoint<; of the target ranges for the federal funds rate and the target levels for the federal funds rate arc measured at the end of the spet.:iiicd calendar year or over the longer run. 111 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00115 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 650.66532 MONETARY POLICY REPORT' FEBRUARY 2016 45 was prospects for inflation to return to Table 2. Average historical projection error ranges the Committee's objective of 2 percent; Percentage points in making such assessments, participants Variable 2015 2018 considered a range of factors, including Change in real GDP1 ••.• ±0.9 ±1.8 ±2.1 ±2.1 measures of inflation compensation and Unemployment rate1 •••• ±0.1 ±0.8 ±1.4 ±1.8 longer-run inflation expectations as well as TOtal consumer prices2 •• +0.2 +t.O ±LO +J.O the likely persistence and size of the effects err N o O r " o l f ~ p E ro rr j o ec r t r i a o n n g s e f s o s r h ! o 9 w 95 n t a h r r e o m u e g a. h ~ 2 u 0 :r 1 e 4 d t a h .~ a p t l w us e r o e r r m el i e n a u se s d t h in e r th o e o t w m in e t a e n r s b q y u ared from low energy prices and the strong dollar. various pnvate and government forecasten;. A~ described in the bo;~; "Forecast IJnccrtaimy,"" und.:r certain assumptions. there is about a 70 pt.'Tttrlt prohabihty Participants also emphasized the potential for that actual outcomes for real GDP, unemployment, and consumer pn<:es will be in ranges implied by the average size of projectJon errors made in the past. For international developments to continue to have more information, see David Reifschneider and Peter Tulip (2007). '"Gauging the Uncertainty of the EconomK Outlook from Historical Forecastmg Errors.'" Finance important implications for domestic economic and Economics Discussion Senes 2007-60 (Washington: Board of Governot:S of the Federal Reserve System. November), avallable at www.fcdcralreservc.gov/pubsJ activity and inflation and thus for appropriate fedsi2007/200760!200760abs.html; and Board of Governors of the Federal Reserve monetary policy. Several participants S E y rr s o te rs m ." . m Di e v m is o io ra n n o d f u R m e , s A ea p K ri h l 9 a , n w d w S w ta . t f i e s d ti e c r s a l ( r 2 e 0 se 1 r 4 v ) e , . " _ U go p v d /J a ( t H ed al t H i! J e s J t 2 o 0 r 1 ic 4 a 0 \ 4 f 0 O 9 r - e h c is a t s o t r ical discussed potential interactions between policy for I e . c D as e t- f e i r n r i o t r i s o .p n d s f o . fvariablesareinthegeneralnotetotabk !. normalization and risks to financial stability. 2. Measure is the overall consumer price index. the price measure that has been moM WJdely used m government and private economic forecasts. Projection is In addition, given the continued proximity of pen:;ent change. fourth quarter of the previous year to the fourth quarter of the year indicated. short-term interest rates to their effective lower bound, asymmetric risks around the outlook for employment and inflation were noted as risks to economic growth as weighted to the one reason why a gradual approach to raising downside and the risks to the unemployment the federal funds rate may be appropriate. rate as weighted to the upside fell appreciably since September. Diminished risks to domestic Uncertainty and Risks economic activity from developments abroad and the strength of recent labor market data As in the September SEP, nearly all were among the reasons noted for the more participants continued to judge the levels of upbeat assessment of risks. uncertainty around their projections for real GDP growth and the unemployment rate as As in the September SEP, participants broadly similar to the average level of the past generally agreed that the levels of uncertainty 20 years (figure 4)7 Most participants saw the associated with their inflation forecasts were risks to their outlooks for real GDP growth broadly similar to the average level over the and unemployment as broadly balanced, as past 20 years. The number of participants who the number of participants who viewed the viewed the risks to their inflation forecasts as weighted to the downside declined slightly since September, and a majority now viewed 7. Table 2 provides estimates of the forecast uncertainty for the change in real GDP~ the the risks to both PCE and core PCE inflation unemployment rate, and total consumer price inflation as broadly balanced. Among those who saw over the period from 1995 through 2014. At the end risks to inflation as tilted to the downside, of this summary, the box "Forecast Uncertainty" several highlighted the continued strength discusses the sources and interpretation of uncertainty of the dollar and some recent indications in the economic forecasts and explains the approach used to assess the uncertainty and risks attending the that inflation expectations had declined as participants' projections. contributing to their perception of those risks. 112 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00116 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 750.66532 46 PART 3: SUMMARY OF ECONOMIC PROJECTIONS Figure 4. Uncertainty and risks in economic projections Number of participants Number of participants Uncertainty about GDP growth Risks to GDP growth [] December projections C December projections September projections "' "' September pm_iections Lower Broadly Higher Weighted to Broadly Weighted to similar downside balanced upside Number of participants Number of participants Uncertainty about the unemployment rate Risks to the unemployment rate -18 -16 -14 -12 -10 - 8 0 4 2 Lower Broadly Higher Weighted to Broadly Weighted to similar downside balanced upside Number of participants Number of participants Uncertainty about PCE inflation Risks to PCE inflation -18 -IS -16 -16 -14 -14 -12 -12 -10 -IO - 8 - 8 - 6 - 0 4 - 4 2 Lower Broadly Higher Weighted to Broadly Weighted to similar downside balanced upside Number of participants Number of participants Uncertainty about core PCE inllation Risks to eMe PCE inflation -18 -18 16 -16 -14 -14 -12 -10 8 - 6 - 4 L__ ___~ ~~_E~~~2 Lower Broadly Higher Weighted to Broadly Weighted to similar downside balanced upside Non:; For definitions of uncertainty and risks in economic projections, see the box "Forecast Uncertainty.'' Definitions of variables are in the general note to table 1. 113 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00117 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 850.66532 MONETARY POLICY REPORTo FEBRUARY 2016 47 Forecast Uncertainty The economic projections provided by the members 4.8 percent in the second year, and 0.9 to 5.1 percent of the Board of Governors and the presidents of in the third and fourth years. The corresponding 70 per the Federal Reserve Banks inform discussions of cent confidence intervals for overall inflation would monetary policy among policymakers and can aid be 1.8 to 2.2 percent in the current year, and 1.0 to public understanding of the basis for policy actions. 3.0 percent in the second, third, and fourth years. Considerable uncertainty attends these projections, Because current conditions may differ from those however. The economic and statistical models and tllat prevailed, on average, over history, participants relationships used to help produce economic forecasts provide judgments as to whether the uncertainty are necessarily imperfect descriptions of the real world, attached to their projections of each variable is greater and the future path of the economy can be affected than. smaller than, or broadly similar to typical levels by myriad unforeseen developments and events. Thus, of forecast uncertainty in the past, as shown in table 2. in setting the stance of monetary policy, participants Participants also provide judgments as to whether the consider not only what appears to be the most likely risks to their projections are weighted to the upside, economic outcome as embodied in their projections, are weighted to the downside, or are broadly balanced. but also the range of alternative possibilities, the That is, participants judge whether each variable is likelihood of their occurring, and the potential costs to more likely to be above or below their projections the economy should they occur. of the most likely outcome. These judgments Table 2 summarizes the average historical accuracy about the uncertainty and tile risks attending each of a range of forecasts, including those reported in participant's projections are distinct from tile diversity past Monetary Policy Reports and those prepared of participants' views about the most likely outcomes. by the Federal Reserve Board's staff in advance of Forecast uncertainty is concerned with the risks meetings of the Federal Open Market Committee. associated with a particular projection rather than with The projection error ranges shown in the table divergences across a number of different projections. illustrate the considerable uncertainty associated As with real activity and inflation, the outlook with economic forecasts. for example, suppose a for the future path of the federal funds rate is subject participant projects that real gross domestic product to considerable uncertainty. This uncertainty arises (GOP) and total consumer prices will rise steadily at primarily because eacll participant's assessment of annual rates of, respectively, 3 percent and 2 percent. the appropriate stance of monetary policy depends If the uncertainty attending those projections is similar importantly on the evolution of real activity and to that experienced in the past and the risks around inflation over time. If economic conditions evolve the projections are broadly balanced, the numbers in an unexpected manner, then assessments of the reported in table 2 would imply a probability of about appropriate setting of the federal funds rate would 70 percent that actual COP would expand within a change from that point forward. range of 2.1 to 3.9 percent in the current year, 1.2 to 114 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00118 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 950.66532 49 ABBREVIATIONS AFE advanced foreign economy BHC bank holding company CDS credit default swap CMBS commercial mortgage-backed securities CRE commercial real estate EME emerging market economy FOMC Federal Open Market Committee; also, the Committee GOP gross domestic product MBS mortgage-backed securities ONRRP overnight reverse repurchase agreement OPEC Organization of the Petroleum Exporting Countries PBOC People's Bank of China PCE personal consumption expenditures SEP Summary of Economic Projections SLOOS Senior Loan Officer Opinion Survey on Bank Lending Practices SOMA System Open Market Account 115 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00119 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 060.66532 116 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00120 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 160.66532 Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System from Representative Fincher: 1. The Basel Committee just finalized new trading book capital rules in January. I understand these rules were never intended to increase or decrease capital requirements, yet the fmal rule you endorsed last month will result in a 40% increase in capital requirements. I understand the Basel Committee conducted a number of impact studies, but can you commit that the Fed will conduct its own impact study with cost-benefit analysis and share the results with this committee prior to implementing it in the United States? Will the Fed consider recalibrating or deviating from this international agreement in any way if your own results demonstrate the rule's costs exceeds any incremental benefit it provides to financial stability or the safety and soundness of individual institutions? Given large trading losses some banks sustained during the fmancial crisis, the Basel Committee issued revised standards in 2009 to raise capital requirements for market risks. These revised standards, supplemented in 2010, roughly tripled the capital of banks that used internal models held against market risk, but did not change the basic framework of the market risk capital rules. The Basel Committee on Banking Supervision (BCBS) began the Fundamental Review of the Trading Book (FRTB) in 2011 to address some of the shortcomings in the structure of the market risk capital rules. Last year the industry commented about the calibration of certain aspects of the revised market risk capital rules. The BCBS addressed outstanding issues on calibration before publication of the final rule in January. The BCBS will be monitoring any undesired increase in capital that could impact market liquidity during the implementation period. The 40 percent figure cited is the weighted average increase in total capital across all banks under the revised market risk rule. The final decisions on the calibration, however, were not based on this figure. Rather they were based on an estimated increase in these capital requirements of20 percent for the median large global trading bank. The overall increase in capital for U.S. banks was estimated to be considerably less than the weighted average increase. Estimating the impact of the new standards entailed an extensive data collection from banks on a voluntary basis that tested proposed standards set forth in a consultative document. The data quality varied considerably among the banks' submissions and there were clear outliers. For this reason, the median was viewed as a more appropriate metric than the weighted average. Moreover, given the data quality issues, supervisors felt some increase in capital was appropriate to ensure the new standards were calibrated to a prudential level. In addition, the new standards for modeled market risk require that a bank's measure of risk exposure against which capital is held includes risk factors that a bank does not model well. In most countries, current standards do not require such a formal inclusion, but rather a supervisory assessment. The requirement for a formal inclusion under the new standard played a significant role in the increase of capital requirements for a number of banks. It is important to bear in mind that an increase in weighted average capital requirements does not translate into an increase for any particular bank. Some banks showed an increase in capital requirements, while others showed a decrease. The variability in outcomes underscores the lack 117 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00121 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 260.66532 -2- of precision of the capital change estimates collected in Basel quantitative impact studies arising in part from differences in the capability of various banks' systems to capture the necessary data. Before adopting a standard for revised trading book capital requirements, the Federal Reserve, Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation will issue a domestic Notice of Proposed Rulemaking for public comment. That notice will describe the costs and benefits of the proposed rules and identifY areas where these considerations may not be balanced for U.S. banks. We recognize that bank holdings of capital market instruments can be very sensitive to regulatory capital requirements and that it is important to maintain market liquidity as we promote financial stability. We are committed to ensuring that the new framework will not unduly disrupt smooth functioning of the capital markets. And we would not adopt any changes to the Fed's rules on market risk capital requirements without going through the U.S. comment process. 118 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00122 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 360.66532 Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System from Representative Hill: 1. In your testimony, you referenced "a range of persistent economic headwinds-such as limited access to credit for some borrowers, weak growth abroad, and a significant appreciation of the dollar." Further, we have had seven years of unprecedented low interest rates and exceptional monetary accommodation. The benefits of this "zero interest rate" environment have run their course. The long-term negative consequences are clear: wealth inequality increasing, asset prices driven up, misallocation of resources, Jack of a dependable market risk indicator, punishing of families trying to live on modest savings and social security. In short, we have sustained poor growth. Recently Dr. William Poole, former President of the Federal Reserve Bank of St. Louis, wrote a thoughtful piece in The Wall Street Journal, and his premise echoed the questions in this hearing in exploring the topic "persistent economic headwinds." In my view, the U.S. economy is facing substantial, non-monetary structural impediments to accelerated economic growth. Dr. Poole makes the suggestion that these non-monetary policy, structural impediments should be studied by the Federal Reserve stafi. Has the Federal Reserve formally studied these non-monetary policy structural impediments? If not, could you commit to such a study that considers such factors including the level of federal debt (to GDP and the current and potential impact of "crowding out"), tax policy, the level of federal intervention in the capital markets (impacts of Dodd-Frank provisions, Basel Ill regulations, and the Volcker Rule), the level of federal intervention in the labor markets (impacts of the Department of Labor rulings on compensation, benefits, overtime, etc. and Affordable Care Act mandates)? The United States has come much further in recovering from the Great Recession than have many other countries, and the evidence overwhelmingly indicates that the Federal Reserve's accommodative monetary policy during the past several years has been an essential force supporting this recovery. Today, the unemployment rate in the United States, at 4.9 percent, is roughly half of what it was during the worst of the Great Recession. For sure, some sectors of the economy and regions of the country have yet to fully recuperate, and many families still have not felt the benefits of a strong recovery. But the Congress has charged the Federal Reserve with promoting the overall macroeconomic health of the U.S. economy, and our monetary policy since the fmancial crisis has been effective in promoting a stronger labor market that is benefiting all population groups. Structural impediments to growth are relevant for the long-term performance of the economy, and they may play a role in explaining why the growth of gross domestic product has been as sluggish as it has been since the onset of the financial crisis. In addition, we do consider many of the factors you listed in judging the longer run sustainable growth rate of the economy through their effects on labor market perfom1ance, productivity and business investment. But our monetary policy mandate, as given to us by the Congress, is to pursue maximun1 employment and price stability. The labor market is much closer now to fulfilling the condition of maximum employment than it has been in years. The Federal Open Market Committee (FOMC) has 119 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00123 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 460.66532 -2- interpreted "price stability" as corresponding to 2 percent inflation as measured by the price index for personal consumption expenditures. As I mentioned in my testimony, inflation has. fallen short of the Federal Reserve's 2 percent objective, on average, in recent years; but the FOMC judged, in December 201 S when it frrst raised the federal funds rate above from the range that it had occupied for several years, that the Committee was "reasonably confident that inflation will rise, over the medium term, to its 2 percent objective." Essentially by definition, structural impediments to growth are most relevant to the secular or trend growth of the economy over longer periods of time. In conducting monetary policy, the job of the Federal Reserve is to focus, frrst and foremost, on the cyclical fluctuations in economic output around its trend, and on the fluctuations in inflation around its 2 percent objective. That strategy is proven quite successful in helping to promote the economic recovery in a context of price stability. 120 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00124 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 560.66532 Questions for The Honorable .Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System from Representative Hultgren: 1. I have expressed concern with the supplementary leverage ratio's treatment of federal reserve deposits. You have described it as a "back-up" ratio in your testimony before the House Financial Services Committee, but that does not appear to be how the rule functions in the real world. You committed to both Congressman Rothfus and I that our concerns at minimum deserve further consideration by the Federal Reserve. During a February 10,2016, hearing of the House Financial Services Committee you stated, "We have heard of the problem and I will address it," and "You know, it's something we can look at, but it was considered." While you have described the Supplementary Leverage Ratio as the "back-up ratio", this and the standardized leverage ratio have or are becoming binding capital constraints for custody banks, due to their highly liquid, low risk balance sheets that support client needs. In light of your commitment to address these concerns, will the Federal Reserve Board consider adjusting the capital requirements for excess cash deposits held with the Federal Reserve? What opportunity will there be for input from the public? The supplementary leverage ratio rule (SLR rule) adopted by the Federal Reserve, the Offiee of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (the Agencies), requires internationally-active banking organizations to hold at least 3 percent of total leverage exposure in tier 1 capital. The rule calculates total leverage exposure as the sum of certain off balance sheet items and all on-balance sheet assets.1 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 organization 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 requirement is designed to recognize that the risk a banking organization poses to the fmancial 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 totallevcrage exposure would generally be inconsistent with this principle. The Agencies understand the concern that certain custody banks, which act as intermediaries in high-volume, low-risk, low-return financial activities, may experience increases in assets as a result of macroeconomic factors and monetary policy decisions, particularly during periods of financial market stress2 Because the SLR rule is not a risk-based measure, it is possible banking organizations' costs of holding low-risk, low-return assets, such as deposits, could increase if such ratio were to become the binding regulatory capital constraint. However, when choosing an appropriate asset profile, banking organizations consider many factors in addition to regulatory capital requirements, such as yields available relative to the overall cost of funds, the need to 1 See 79 Fed. Reg. 57725 (September 26, 2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-09- 26/pdfi'2014-220&3.pdf. 2 The agencies have reserved authority under the capital rule to require a banking organization to use a different asset amount for an exposure included in the SLR to address extraordinary situations. See 12 CFR 3.l(d)(4) (OCC); 12 CFR 217.l(d)(4) (Federal Reserve); 12 CFR 324.l(d)(4) (FDIC). 121 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00125 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 660.66532 -2 preserve financial flexibility and liquidity, revenue generation, the maintenance of market share and business relationships, and the likelihood that principal will be repaid. Regulatory requirements 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 deposits. The requirements are designed to increase the resiliency of banking organizations, enabling them to continue serving as fmancial intermediaries for the U.S. fmancial system and as sources of credit to household and businesses during times of stress. The SLR requirement and the enhanced SLR standards do not become effective until January 1, 2018. According to public disclosures of firms subject to these requirements, the custody banks and other global systemically important banks have made significant progress in complying with the enhanced SLR requirements. Federal Reserve Board (Board) staff have held meetings with and reviewed materials prepared by the custody banks in connection with the implementation of the SLR rule. The Board continuously considers potential improvements to its regulations based on feedback from affected parties and the general public, but is not actively considering making any modifications to the SLR rule at this time. Any future changes to the Board's regulations would take public comments into account in a marmer consistent with U.S. law and the administrative rulemaking process. 2. I understand the Federal Reserve already applies existing Customer Identification Program (CIP) requirements to all subsidiaries of the banks they supervise, including premium finance companies. Would a more nuanced approach for application ofthese requirements be appropriate for subsidiaries that pose little risk for money laundering or terrorism financing? What risk is posed, if any, by bank-owned premium finance companies? Will the Federal Reserve confirm that it will not apply further CIP requirements (if such rules become final) to the insurance premium finance industry until the Federal Reserve and the Financial Crimes Enforcement Network (FinCEN) demonstrate they will prevent terrorism financing and money laundering? Absent such confirmation, please explain the rational, if any, for application of incremental CIP requirements to bank-owned insurance premium finance companies. We understand the concerns that have been raised by some in the insurance premium fmance industry regarding the requirement to collect customer identification information under the Bank Secrecy Act (BSA). In 2003, the Financial Crimes Enforcement Network (FinCEN) and the federal banking agencies issued an interagency Customer Identification Program (CIP) rule implementing section 326 of the USA PATRIOT Act. The CIP rule requires banks and other financial institutions to form a reasonable belief regarding a customer's identity when opening an account.3 The CIP rule applies to any "formal banking relationship established to provide or engage in services, dealings, or other financial transactions including a deposit account, a transaction or asset account, a credit account, or other extension of credit."4 Importantly, the CIP 3 31 CFR §1020.100(c), (a). 4 31 CFR § 103.12l(a)(i). 122 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00126 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 760.66532 -3- rule does not exempt accounts established for the purpose of insurance premium financing. The CIP rule applies equally to banks and their subsidiaries when opening an account within the meaning of the rule.5 The requirements of the CIP rule are typically satisfied by adopting risk- based procedures at account opening that enable the bank to verify the customer's identity to the extent reasonable and practicable. First, a bank's CIP must obtain a name, date of birth, address, and identification number from a customer who is an individual.6 Second, the bank must adopt identity verification procedures that describe when and how the bank will verify the customer's identity using documentary or non-documentary methods. 7 Finally, the CIP rule has specific account recordkeeping and notice requirements.8 The procedures used by the Federal Reserve and other banking agencies to examine a bank's compliance with the CIP rule are identified in the BSA/Anti-Money Laundering (AML) manual published by the Federal Financial Institutions Examination Council (FFIEC) member agencies.9 In 2014, separate from the CIP rule, FinCEN issued a proposed rule that establishes customer due diligence (CDD) requirements for banks and other financial institutions with obligations under the BSA. As proposed, the CDD rule requires banks to identify the beneficial owner(s) of any legal entity customer who opens an "account" within the meaning of the CIP rule. Although the proposed CDD rule exempts certain customers, these exemptions do not extend to customers who establish an insurance premium financing relationship with a bank or its subsidiary. The Federal Reserve does not have the authority to exempt insurance premium finance companies from any increased costs associated with FinCEN's proposed CDD rule. The Federal Reserve's responsibility is limited to examining banks under its supervision for compliance with the CDD rule once FinCEN reaches its fmal determination. Indeed, only FinCEN retains the authority to determine whether the final CDD rule will apply to the insurance premium financing industry. 3. On November 5, 2015, FDIC Vice Chairman Thomas Hoenig provided remarks to the 18th Annual International Banking Conference at the Federal Reserve Bank of Chicago. During his prepared remarks, entitled "Post-Crisis Risks and Bank Equity Capital," Mr. Hoenig stated, regarding the Federal Reserve's proposal to increase minimum debt requirements, "A question we must ask, then, is whether the effect of such a requirement that is designed to make a firm more resolvable once that firm has failed, could --prior to failure--increase the firm's leverage and thereby its likelihood to default. Our goal to prevent failure should be every bit as important as resolving failed firms." Taking into account Mr. Hoenig's statement as well as the long term debt requirements under the Federal Reserve's recently proposed Total Loss Absorbing Capacity rules, do 5 Interagency Interpretive Guidance on Customer Identification Program Requirements under section 326 of the USA PATRIOT Act, F AQs Final CIP Rule (April28, 2005). 6 31 CFR § 1020.220(a)(2)(i). 7 31 CFR § 1020.220(a)(2)(ii). 8 31 CFR § 1020.220(a)(3) and (a)(5). 9 See generally, FFIEC, BSA/AML Examination Manual (2014) (available at: https://www.ffiec.gov/bsa_a ml_infobase/pages_ manual/manual_o nline.htm). The FFIEC member agencies include the Federal Deposit Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency, and the Consumer Financial Protection Bureau, as well as the Federal Reserve Board. 123 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00127 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 860.66532 4- you believe that the Fed has overlooked the "prevention of failure" as described by Mr. Hoenig and is instead placing unnecessary stress on financial institutions that could in fact lead to failure itself? Can you let the committee know what steps the FRB is taking in light of Mr. Hoenig's concerns? The Federal Reserve is committed to improving the resolvability and resiliency of global systemically important banks (GSIBs) and to limiting the systemic damage that would result if a large financial institution were to faiL GSIBs are central intermediaries in the U.S. financial market, and their failure or distress would thus likely cause the most harm to the financial system. The preamble to the Federal Reserve's Total Loss-Absorbing Capacity (TLAC) proposal acknowledges the importance of each of these two complementary objectives to the Dodd-Frank Wall Street Reform and Consumer Protection Act's broader goal of protecting U.S. financial stability and ending "too big to faiL" See 80 FR 74926, 74926-74928. The TLAC proposal's long-term debt requirement should not increase the likelihood that a banking organization that is subject to the proposed rule would fail. First, the Federal Reserve expects that the GSIBs would generally come into compliance with the long-term debt requirement without increasing their leverage or the size of their balance sheets, mostly by moving long-term debt that is currently outstanding from the GSIBs' bank subsidiaries to their holding companies, and by extending the maturity of existing debt. Second, the Federal Reserve has in place robust risk-based and leverage capital requirements, including a risk-based capital surcharge for the U.S. GSIBs, that are intended to keep the likelihood that a GSIB will fail at a very low leveL 10 The TLAC proposal would not weaken or override any of these important capital requirement~. Indeed, the TLAC proposal's long-term debt requirement should increase the resilience of the covered firms and thus decrease the likelihood that one of them would fail. Each covered firm would be required to maintain outstanding a substantial amount of eligible long-term debt, and the holders of that debt--rather than the short-term unsecured creditors of the covered firm's operating subsidiaries--would absorb the banking organization's losses in resolution. This requirement would give the entities that invest in a firm's eligible long-term debt strong incentives to impose market discipline on the firm, deterring it from taking excessive risks that could lead to failure. The requirement would also reduce the risk that the covered firm would experience a destabilizing run, because the holders of the long-term debt (which is not runnable) would absorb losses ahead of the operating subsidiaries' runnable short-term creditors, meaning that those short-term creditors would have diminished incentives to run in the first place. Thus, the TLAC proposal advances the goal of improving the resolvability and resiliency of GSIBs as well as the goal of reducing the harm that a GSIB failure would do to U.S. financial stability. The periodJor public comment on the TLAC proposal has now closed, and the Federal Reserve is carefully considering all of the conunents that have been submitted. As the Federal Reserve considers these comments and determines how to move forward with the proposal, it will continue to place great weight on ensuring the safety and soundness of the U.S. financial system. 10 See 80 FR49082; Board of Governors of the Federal Reserve System, "Calibrating the GSIB Surcharge" (July 20, 2015), available at www.federalreserve.gov/aboutthefed/boardmeetingslgsib-methodology-paper- 20150720.pdf. 124 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00128 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 960.66532 Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System from Representative Luetkemeyer: 1. The Fed's criteria for applying the Basel Advanced Approaches Capital requirements and the Liquidity Coverage Ratio (LCR) is $250 billion or more in assets or $10 billion or more in foreign exposures. These criteria were devised as part of Basel II in 2005, more than 10 years ago. As a result, the Advanced Approaches and the LCR apply to an entirely different group of institutions than the criteria originally captured. Has the Fed undertaken any assessment to determine if the $250 billion and $10 billion criteria are appropriate for the Advanced Approaches and the LCR, either on an individual firm basis or revising the thresholds entirely? The Federal Reserve Board (Board) is committed to ensuring that our regulations are appropriately tailored to the size and risk profile of regulated institutions. The Board has assessed the thresholds used to determine the scope of applicability of its regulations, including the advanced approaches capital requirements and the Liquidity Coverage Ratio (LCR) rule, to be appropriate for the idiosyncratic and systemic risks those regulations are meant to address. The thresholds of $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposure capture those banking organizations that are the largest and most complex in the U.S. fmancial system and thus, those that pose the most systemic risk. The fact that the thresholds capture different firms than in 2005 reflects changes in the profiles of those firms. The Board continues to monitor the scope of applicability of the advanced approaches capital requirements, LCR rule, and its other regulations. 125 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00129 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 070.66532 Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System from Representative Luetkemeyer: 2. With respect to the Basel Advanced Approaches Capital requirements, would you support the Fed providing exempt relief for companies where their cost of compliance greatly exceeds their benefits? If so, how would you make that determination? Under the regulatory capital rules, promulgated by the Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (the Agencies), internationally active banking organizations (specifically, those with total consolidated assets of $250 billion or more, or with consolidated total on-balance-sheet foreign exposure of $10 billion or more) must calculate risk-based capital using the advanced approaches risk-based capital rules (the advanced approaches rule) in addition to the standardized approach. Section IOO(b)(2) of the regulatory capital rules provides that a banking organization subject to the advanced approaches rule shall remain subject to that rule until the primary federal regulator determines that application of the advanced approaches rule is not appropriate in light of the banking organization's size, level of complexity, risk profile, or scope of operations. In making such a determination, the primary federal regulator must apply notice and response procedures. 1 The primary federal regulator may also set conditions on the granting of the waiver as appropriate, and any waiver granted must be consistent with safety and soundness. The capital adequacy of a banking organization that meets the thresholds described above, but has received a waiver from application of the advanced approaches rules would be addressed by standardized risk-based capital rules, leverage rules, and capital planning and supervisory stress-testing requirements. 3. While the Federal Reserve Board has described the Supplementary Leverage Ratio as the "back-up ratio", this and the standardized leverage ratio have or are becoming binding capital constraints for custody banks, due to their highly liquid, low risk balance sheets that support client needs. In light of this concern, will the Federal Reserve Board consider adjusting the capital requirements for excess cash deposits held with the Federal Reserve? The supplementary leverage ratio rule (SLR rule) adopted by the Agencies, requires internationally-active banking organizations to hold at least 3 percent of total leverage exposure in tier 1 capital. The rule calculates total leverage exposure as the sum of certain off-balance sheet items and all on-balance sheet assets.z 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 organization 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 requirement 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 total leverage exposure would generally be inconsistent with this principle. 1 12 CFR 3.404 (Office of the Comptroller of the Currency), 12 CFR 263.202 (Federal Reserve), and 12 CFR 324.5 (Federal Deposit Insurance Corporation). 2 See 79 Fed. Reg, 57725 (September26, 2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-09- 26/pd1J2014-22083.pdf. 126 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00130 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 170.66532 -2- The Agencies understand the concern that certain custody banks, which act as intermediaries in high-volume, low-risk, low-return financial activities, may experience increases in assets as a result of macroeconomic factors and monetary policy decisions, particularly during periods of fmancial market stress. 3 Because the SLR rule is not a risk -based measure, it is possible banking organizations' costs of holding low-risk, low-return assets, such as deposits, could increase if such ratio were to become the binding regulatory capital constraint. However, when choosing an appropriate asset profile, banking organizations consider many factors in addition to regulatory capital requirements, such as yields available relative to the overall cost of funds, the need to preserve financial flexibility and liquidity, revenue generation, the maintenance of market share and business relationships, and the likelihood that principal will be repaid. Regulatory requirements established by the Federal Reserve since the fmancial crisis are meant to address risks to which banking organizations are exposed, including the risks associated with funding in the form of cash deposits. The requirements are designed to ·increase the resiliency of banking organizations, enabling them to continue serving as financial intermediaries for the U.S. financial system and as sources of credit to household and businesses during times of stress. The SLR requirement and the enhanced SLR standards do not become effective until January 1, 2018. According to public disclosures of firms subject to these requirements, the custody banks and other global systemically important banks have made significant progress in complying with the enhanced SLR requirements. Federal Reserve Board (Board) staff have held meetings with and reviewed materials prepared by the custody banks in connection with the implementation of the SLR rule. The Board continuously considers potential improvements to its regulations based on feedback from affected parties and the general public, but is not actively considering making any modifications to the SLR rule at this time. Any future changes to the Board's regulations would take public comments into account in a manner consistent with U.S. law and the administrative rulemaking process. 4. In a recent written response to Congress on the insurance capital issue, you wrote that the Federal Reserve Board will consider a congressional suggestion regarding a baseline approach that would rely in part on the state risk-based capital framework. You also wrote that the Board now has the authority to exclude insurance operations from its consolidated capital requirements pursuant to the Collins Amendment. Will you please be more specific about your plans to rely on the state risk-based capital framework for insurance companies? How fully will you rely on the state regime for the insurance operations of federally supervised insurers? You are correct to note that, in developing our domestic insurance regulatory capital requirements, the Board has greater flexibility to tailor these requirements to the business of insurance through the Insurance Capital Standards Clarification Act of2014, which gave the Board the authority to exclude regulated insurance companies when establishing minimum consolidated risk-based capital requirements for supervised insurance savings and loan holding companies and nonbank financial companies. 3 The Agencies have reserved authority under the capital rule to require a banking organization to use a different asset amount for an exposure included in the SLR to address extraordinary situations. See 12 CPR 3.1(d)(4) (OCC); 12 CFR 217J(d)(4)(Pederal Reserve); 12 CFR 324J(d)(4) (FDIC). 127 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00131 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 270.66532 -3 - We leverage the work of state insurance regulators where possible. The Federal Reserve's consolidated supervision supplements existing state based legal-entity supervision, which focuses on policyholder protection, with a perspective that considers the risks across the entire firm. It would be premature for me to comment on how we will treat the unique risks of certain insurance lines, mix of business and the like, before the Board has fully considered its potential options for consolidated capital frameworks, and we are in the process of doing just that through careful deliberations. To that end, in our consolidated supervision of insurance firms, the Board remains committed to tailoring our supervisory approach, including a domestic regulatory capital framework and other insurance prudential standards, to the business of insurance, reflecting insurers' different business models and systemic importance compared to other frrms supervised by the Board. Moreover, we are committed to a formal rulemaking process in the development of insurance capital requirements. 5. You have indicated that you were not positive as to whether or not one capital rnle would apply to all insurance companies subject to supervision by the Federal Reserve Board. You suggested that firm-specific rules might apply to those insurers designated as nonbank SIFis. Please clarify the Federal Reserve Board's plan in this regard. What sort of firm-specific rules will nonbank SIFI insurers face and how will those rules be applied? Without going into specifics as to the Board's plans for each firm, what issues will the rules address, e.g., capital and/or stress testing? Will any firm-specific rules be imposed by order exposed for public comment rather than traditional rulemaking? As I have noted, it would be premature for me to comment on how we will treat insurers' unique risks, in the development of consolidated capital requirements for supervised insurance nonbank financial companies, before the Board has fully considered its potential options. The Board's consolidated supervision supplements existing legal-entity supervision with a perspective that considers the risks across the entire firm. The Board's role in monitoring and mitigating risks to financial stability seeks to ensure, as appropriate, that supervised insurance firms remain solvent as going concerns, maintain their positions as financial intermediaries even in times of stress, and are resolvable in a manner that is not destabilizing to the financial system if resolution is required. Together with the capital framework that the Board determines for supervised insurance nonbank financial companies, the Board intends to conduct stress tests, as prescribed under the Dodd-Frank Wall Street·Reforrn and Consumer Protection Act (Dodd-Frank Act), which will be appropriately tailored to the business of insurance and the insurance companies' solvency under stress conditions. These will be designed in coordination with the Federal Insurance Office as specified under the Dodd-Frank Act. As we develop the stress testing framework, we will determine the appropriate treatment of circumstances concerning the individual company and the financial system. Moreover, with regard to the insurance capital rules that the Board develops and applies, we are committed to a formal rulemaking process. 128 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00132 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 370.66532 Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System from Representative Lynch: 1. As you know, last year I, along with Congressman Capuano and most of the Massachusetts Delegation, wrote to the Fed, the OCC and the FDIC on the regulation that requires custody banks to maintain a 6 percent enhanced supplemental leverage ratio to be considered well capitalized, even on custody cash funds deposited with the Federal Reserve banks. In your response letter dated December 21, 2015, The Fed and the other two agencies said: "The agencies understand the concern that certain custody banks, which act as intermediaries in certain high-volume, low-risk, low-return financial activities may experience increases in assets as a result of macroeconomic factors and monetary policy decisions, particularly during times of financial market stress. Because the SLR is not a risk-based measure, it is possible that banking organizations' cost of holding low-risk low return assets such as deposits could increase if this ratio were to become the binding regulatory capital constraint". The custody banks are telling me the leverage ratio has become the binding capital constraint for custody banks, due to their highly liquid, low risk balance sheets. Can you assure me the Fed will work with the other regulatory bodies and the custody banks to alleviate this concern? I don't think anyone wants to experience a crisis scenario where custody banks cannot accept their clients cash deposits, cash that would be deposited in the federal reserve system. The supplementary leverage ratio rule (SLR rule) adopted by the Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (the Agencies), requires internationally-active banking organizations to hold at least 3 percent oftotalleverage exposure in tier 1 capitaL The rule calculates total leverage exposure as the sum of certain off balance sheet items and all on-balance sheet assets.1 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 organization 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 requirement 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 total leverage exposure would generally be inconsistent with this principle. The Agencies understand the concern that certain custody banks, which act as intermediaries in high-volume, low-risk, low-return financial activities, may experience increases in assets as a result of macroeconomic factors and monetary policy decisions, particularly during periods of financial market stress.2 Because the SLR rule is not a risk-based measure, it is possible banking organizations' costs of holding low-risk, low-retum assets, such as deposits, could increase if such ratio were to become the binding regulatory capital constraint. However, when choosing an appropriate asset profile, banking organizations consider many factors in addition to regulatory capital requirements, such as yields available relative to the overall cost of funds, the need to 1 See 79 Fed. Reg. 57725 (September 26, 2014), available at http://www.gpo.gov/fdsys/pkg!FR-2014-09- 26/pd£'2014-22083.pdf. 2 The agencies have reserved authority under the capital rule to require a banking organization to use a different asset amount for an exposure included in the SLR to address extraordinary situations. See 12 CFR 3.l(d)(4)(0CC); 12 CFR 217.l(d)(4) (Federal Reserve); 12 CFR 324.1(d)(4) (FDIC). 129 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00133 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 470.66532 2- preserve financial flexibility and liquidity, revenue generation, the maintenance of market share and business relationships, and the likelihood that principal will be repaid. Regulatory requirements 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 deposits. The requirements are designed to increase the resiliency of banking organizations, enabling them to continue serving as financial intermediaries for the U.S. financial system and as sources of credit to household and businesses during times of stress. The SLR requirement and the enhanced SLR standards do not become effective until January 1, 2018. According to public disclosures of firms subject to these requirements, the custody banks and other global systemically important banks have made significant progress in complying with the enhanced SLR requirements. Federal Reserve Board (Board) staff have held meetings with and reviewed materials prepared by the custody banks in connection with the implementation of the SLR rule. The Board continuously considers potential improvements to its regulations based on feedback from affected parties and the general public, but is not actively considering making any modifications to the SLR rule at this time. Any future changes to the Board's regulations would take public comments into account in a manner consistent with U.S. law and the administrative rulemaking process. 130 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00134 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 570.66532 Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System from Representative Messer: 1. Chair Yellen, In November, you claimed before this committee that the Fed is studying the consequences of all the new regulations on the economy "very closely" including the impact on market liquidity. Now European regulators are actually doing a formal review. Given that many of our own rules have gone farther than international standards, isn't it time for a formal review of the cumulative impact of the new rules here in the United States? The Federal Reserve conducts a variety of economic analyses and assessments to support the rulemaking process. For instance, the Federal Reserve included economic cost and impact assessments in its margin trading and Total Loss-Absorbing Capacity proposals. As these proposals relate to a specific regulation or requirement, the impact analyses naturally focus on the impact of the specific regulation in question, though impact and cost estimates can generally be aggregated across different regulatory initiatives. More broadly, the Federal Reserve engages in a regular quantitative impact assessment and monitoring program that is coordinated with other global regulators through the Basel Committee on Banking Supervision (BCBS) to assess the overall impact of prudential capital and liquidity requirements. This impact assessment has been conducted and made public regularly since 2012, and it continues to inform the Federal Reserve's understanding of the cost and impact of capital and liquidity regulation. Additionally, the Federal Reserve participates in a global effort through its participation on the Financial Stability Board and the BCBS's Macroeconomic Assessment Group. The Macroeconomic Assessment Group published a study in 2010 that assessed the overall macroeconomic impact of stronger capital and liquidity requirements. The Federal Reserve seriously considers the overall cost and benefit of all of the regulations it promulgates. The overarching goal of the Federal Reserve's regulatory program is to enhance financial stability while at the same time not creating any undue costs or burdens for the rest of the economy. The Federal Reserve is committed to engaging in an ongoing assessment program to better understand how post-crisis reform is influencing financial stability as well as the potential economic costs of enhanced regulation. 131 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00135 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 670.66532 Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System from Representative Mulvaney: 1. I would like to follow up on our discussion concerning rules-based monetary policy and economic normalization. During the hearing, you testified that "the economy is in many ways close to normal," that unemployment rates are at a point "most of my colleagues believe are consistent with full employment in the longer rnn," and that you had good reason to believe inflation "will move up over time." In fact, you testified, "in a sense, things are normal." While you mentioned some concerns with the neutral level of the Federal Funds Rate and some other headwinds, you testified that the Taylor Rule wouldn't be appropriate due to its underlying assumptions. You testified that the Federal Reserve follows systematic policy, but not in the form of a rule. However, at the end of our conversation, I was still left wondering what the world would have to look like before the Federal Reserve would be willing to employ a rules based system? I recognize that the Federal Reserve can still deviate from a rule to consider large sets of indicators about the economy's performance, and that employing a rule isn't mechanic, but I do expect to know what would be required before the Federal Reserve will consent to using rule based policy. It is essential that Congress and the public understand the methods employed by the Fed when making monetary policy decisions, and have some ability to predict future economic outcomes based on economic conditions (recognizing these change in extraordinary circumstances). A rule based policy provides us both the oversight and understanding that is essential during normal economic times. Chair Yellen, I'd like to provide you another opportunity to answer this question, directly: What must the world look like before the Federal Reserve will employ and follow a rules based system of monetary policy? What must the employment rate be? What must the inflation rate be? What must the Federal Funds rate be? What other factors must change from the state of the economy today before you will follow a monetary policy rule-any rule, not just the Taylor rule-of your choosing? Please answer each question specifically, including with specific rates and levels. My judgment, based on my reading of the research literature on policy rules and my experience as a policymaker, is that simple policy rules are a useful input into monetary policy decisions but that it is unlikely to ever be appropriate to follow the prescriptions of any simple policy rule. The economic research literature on monetary policy rules indicates that it is possible to identify optimal policy rules within the context of specific models of the structure and dynamics of an economy, but that the optimal rule is not the same in all models. The actual U.S. economy is much more complex than any of the extant models of the economy that economists have developed, so we cannot say that any particular rule is the right rule. The research literature also indicates that the optimal rule changes as the structure or dynamics of the economy changes. We know that the structure of the U.S. economy changes over time, but we cannot track those changes with any mathematical precision in real time. Moreover, even in the context of a given model of the U.S. economy, a rule that produces good outcomes on average does not do so in 132 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00136 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 770.66532 -2- response to all shocks to the economy. For those reasons, my Federal Reserve colleagues and I monitor the prescriptions of a range of policy rules and use them as inputs to our deliberations but do not necessarily implement the prescriptions of any rule. To the extent that the factors restraining growth in U.S. economic activity (headwinds) are stronger now than during the historical period over which any particular policy rule has been estimated to work well, the implication is that the federal funds rate needs to be lower, while those headwinds persist, than prescribed by the rule. I would note that the economy has continued to make gradual progress toward maximum employment over the past couple of years, and inflation has been low (even after adjusting for the effects of falling oil prices on reported inflation), even as the Federal Open Market Committee (FOMC) kept the federal funds rate near zero rather than raising it to the appreciably higher levels suggested by the Taylor rule. Those economic outcomes indicate that monetary policy was not too easy even though it was more accommodative than the prescriptions of the Taylor rule. Nonetheless, I would not rule out the possibility that, as headwinds diminish over time, it could prove appropriate for the FOMC to gradually raise the federal funds rate to the level prescribed by the Taylor rule. I agree that it is essential that Congress and the public understand the methods employed by the Fed when making monetary policy decisions, and that they have some ability to predict future monetary policy decisions based on economic conditions. That is what I mean by a "systematic policy." A systematic policy is one that responds in a predictable and consistent manner to changes in economic conditions and the economic outlook. In practice, market expectations about future monetary policy, as indicated by market prices of federal funds futures contracts and some other financial instruments, do move in response to economic data that turns out to be stronger or weaker than expected; these movements offer evidence that investors understand how monetary policy will respond to an accumulation of data that indicates a need for a higher or lower path of the federal funds rate to foster maximum employment and price stability. That said, market participants, like policymakers, do not always agree about the implications of incoming data for the economic outlook, so they do not always agree about the implications of incoming data for future monetary policy. That would be true even if policymakers mechanically followed a particular rule: to predict future policy actions, investors would need to be able to predict the future values of the economic variables that enter the rule. 2. When making monetary policy decisions, what weight do you place on equity market movements in your decision making? Of asset prices, stocks are one of the most closely watched and highly sensitive to economic conditions. With respect to monetary policy decisions, it should be the case that anticipated changes in policy are already discounted by market investors and are unlikely to affect equity prices when announced. However, any time a monetary policy decision is not aligned with market expectations, it would flow that there would be a greater impact on the markets. Have yon found that to be the case as well? Do you find equity market prices to transmit the effects of monetary policy, or are monetary policy decisions made in response to equity market activities? Are these two factors countercyclical? Do you see a greater impact in some types of funds, like exchange traded funds, compared to others, and what weight to you give those fluctuations compared to the overall market when making monetary policy decisions? 133 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00137 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 870.66532 -3- Research clearly indicates that widely expected news, whether about monetary policy or fiscal policy or economic data releases, has smaller effects on asset prices than does unexpected news. The reason, of course, is that a widely anticipated policy decision or data release had its effect on asset prices when investors came to anticipate the decision or data. It is worth noting, however, that investors are unlikely to all share the same expectation about any policy decision, so it is rare for there to be absolutely no market response to the FOMC's decisions. The effects of monetary policy actions on equity prices, like the effects of monetary policy actions on interest rates and exchange rates, are part of the transmission mechanism through which monetary policy affects the economy. For example, when the economy slows and unemployment rises, the FOMC typically reduces its target for the federal funds rate. That action, plus expectations of further such actions, tends to result in higher equity prices and thus higher net worth-and lower interest rates for households and businesses (relative to what they would be otherwise). Higher net worth and lower interest rates both tend to foster additional consumer spending and business investment spending; that additional spending, in tum, gives firms an incentive to increase production and employment. While equity prices and other asset prices help transmit the effects of changes in monetary policy to the economy, the Federal Reserve does not target any particular level of equity prices or other asset prices. Neither does it target a particular level of interest rates other than the federal funds rate. Asset prices and interest rates vary in response to many factors other than monetary policy; the Federal Reserve does not seek to prevent such variations. However, because asset prices and interest rates affect household and business decisions about how much to spend and save, the FOMC necessarily takes asset prices and interest rates other than the federal funds rate into account when it considers how the economy is likely to evolve and what adjustments in monetary policy may be appropriate to foster maximum employment and price stability. In a rough sense, broad equity price indexes tend to move with the business cycle, rising during economic expansions and declining during economic contractions. But there also appears to be a good deal of variation in equity prices-even in broad equity price indexes·-that is not associated with the business cycle. Accordingly, the FOMC does not focus on day-to day ups and downs in equity prices or other asset prices. I am not aware of evidence that there is a systematic difference in the covariation between various types of equity funds and economic conditions that would warrant using prices of exchange-traded funds rather than broad equity price indexes as an input into an assessment of fmancial conditions and their implications for the economic outlook. 134 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00138 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 970.66532 Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System from Representative Murphy: 1. While we've started to see signs of positive growth recently, do you agree that the lack of meaningful and sustained wage growth is an indication that our economy has not yet reached an acceptable deimition of full employment? What type of progress on rising wages for working families do you see as a pre-requisite of any further rate increases? We consider a number of indicators when evaluating whether we are on a path to meeting our dual mandate such as changes in the labor market, spending growth, and inflation. Hence, no single indicator provides a comprehensive view of whether we are on a path to meet our dual mandate. That said, wage growth does provide a signal of both the outlook for inflation and how much slack there is in the labor market, and so it is an indicator that we follow closely. It is our assessment that there remains at least a small amount of slack in the economy and that there is scope for wage growth to strengthen consistent with achieving our 2 percent inflation objective. 2. What efforts are you making to weigh the impact of further rate increases on the most vnlnerable populations? How in your view will raising interest rates impact working families, including in traditionally underserved and minority communities? I appreciate that the U.S. economic recovery, which has been substantial overall, has been uneven across communities, including some low-and moderate-income (LMI) communities, and I am troubled that some LMI communities have experienced long-term declines in economic opportunity. The Federal Reserve is limited in the extent to which its macroeconomic tools can specifically target those communities where further progress is needed. That said, our efforts to promote a strong economy, robust labor market, and stable financial institutions particularly benefit LMI communities, who tend to be harder hit when the economy falters. Given that monetary policy is blunt tool, the best way that we can promote the economic health ofLMI communities is to promote a sound economy. Monetary policy is currently accommodative, and in my view, assuming that labor markets continue to tighten and we are reasonably assured that inflation will return to our target, we will be most able to engender a sustainable expansion with a gradual removal of monetary accommodation. That said, as our decision not to raise rates in March shows, the path of monetary policy is dependent on the evolution of the economy. 135 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00139 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 080.66532 Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System from Representative Sherman: 1. What are the Federal Open Market Committee's (FOMC) plans in in the event of another economic downturn? Specifically, has the FOMC determined whether it has legal authority to implement the following tools: Negative interest rates; Assistance to states, municipalities, and territories in fiscal distress (e.g., Chicago's Public School System, the city of Detroit, and Puerto Rico); An emergency lending program using the Federal Reserve Act Section 14 (12 U.S.C. § 355) authority to make short-term public investments; Under what contingencies would the FQMC consider utilizing the tools listed above? Under what circumstances would the FOMC initiate a fourth round of quantitative easing? Under what circumstances would the FOMC formulate a target (e.g., 1.0%) for the five year Treasury rate? The Federal Reserve's response to economic conditions, including any future financial crisis, very much depends on the circumstances. It is important to note that there have been many periods of economic downturn coupled with severe strains in fmancial markets that did not require the use of emergency lending programs, innovative monetary policy tools, or other extraordinary tools. Indeed, prior to the fmancial crisis in 2007-2009, the Federal Reserve had not utilized its emergency lending authorities since the Great Depression. It simply is not possible to predict the circumstances in which it might be appropriate to implement particular policies, such as conducting additional quantitative easing or formulating targets for longer-term rates. As the FOMC has noted in recent statements, we expect that the economy will continue to strengthen and that inflation will return to our 2 percent goal over time. Consistent with that outlook, the FOMC has noted that it believes the economic outlook will evolve in way that will warrant a gradual increase in the target federal funds rate. Of course, if the economic outlook evolves in an unexpected way, the Federal Reserve will adjust the stance ofpoliey-appropriately to foster progress toward-its long-run goals of maximum employment and stable prices. The policy tools available to the Federal Reserve are provided by statute. The Federal Reserve's authority to purchase obligations issued by municipalities is limited to very specific types of obligations and may be done only in the open market. The Federal Reserve's authority to provide emergency credit to non-depository institutions is limited to programs with broad-based eligibility aimed at supporting the flow of credit to households and businesses; under these provisions, the Federal Reserve does not have the legal authority to lend to a specific borrower, including a municipality, that is failing or seeking to avoid resolution. More generally, providing assistance to municipalities inherently involves political judgments. As a result, as the Federal Reserve has noted previously, any program designed to provide assistance to municipal governments is a matter for tl1e Congress and the Administration to address. Negative interest rates are a tool employed by countries in Europe and elsewhere. By some accounts, these policies appear to have provided additional policy accommodation. As I have 136 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00140 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 180.66532 -2- noted previously, we certainly are trying to learn as much as we can from the experience of other countries. That said, while I would not completely rule out the use of negative interest rates in some future very adverse scenario, policymakers would need to consider a wide range of issues before employing this tool in the United States, including the potential for unintended consequences. 137 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00141 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 280.66532 Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System from Representative Tipton: 1. Chair Yellen, I appreciate the recent discussion from regulators acknowledging that regulation can be over burdensome. For instance, last month FDIC Vice Chair Thomas Hoenig expressed concern that the Fed's TLAC proposal, meant to strengthen supervision of systemically important fmancial institutions in the U.S., may not be tailored enough. As you are likely aware, the Committee has several pieces of legislation pending, including my bill H.R. 2896, that would call ou regulators to be more tailored in their approach to prudential regulation. With regard to the TLAC rule, what criteria does the Fed use to determine its calibration for applying TLAC? There is a concern that it is not sensitive enough to the relative risk posed by individual institutions and I'd like to know what more can be done to ensure the level of regulation appropriately matches the risk posed by individual firms to the broader US Financial System. The Federal Reserve Board (Board) designed its total loss-absorbing capacity (TLAC) proposal to be closely tailored to the risks to financial stability posed by each covered entity. This tailoring can be seen both in the selection of the firms to which the proposed TLAC and long-term debt requirements would apply and in the calibration of those requirements, which would vary from finn to firm based on the Board's assessment of each covered firm's systemic footprint. First, the proposed TLAC and long-term debt requirements would apply only to the eight United States bank holding companies that meet the Board's criteria for "global systemically important banking organizations" (GSIBs), and to the U.S. intermediate holding companies of foreign GSIBs. As the preamble to the TLAC proposal discusses in greater detail, the criteria used to identify GSIBs are tailored to select those banking organizations that pose elevated risks to the financial system, and the criteria used to determine which foreign banking organizations must form U.S. intermediate holding companies are tailored to identifY the foreign banking organizations with substantial operations in the U.S. Second, the proposed external TLAC requirements include an "external TLAC buffer" whose size is scaled based on the systemic footprint of each U.S. GSIB. This scaling results from the fact that the external TLAC buffer for each U.S. GSIB includes the surcharge applicable to that firm under the first method of the Board's rule imposing risk-based capital surcharges on GSIBs (GSIB surcharge rule). See 80 FR, at 74933-74934. The materials issued along with the Board's GSIB surcharge rule discuss in detail how the GSIB surcharge applicable to each U.S. GSIB was calibrated on the basis of that firm's systemic footprint--that is, the damage that the firm's failure would be expected to do to the financial stability of the United States. Third, the proposed external long-term debt requirements also incorporate each U.S. GSIB's GSIB surcharge, in that the risk-weighted assets component of each U.S. GSIB's external long term debt requirement would be 6 percent of risk-weighted assets plus the surcharge applicable to that firm under the GSIB surcharge rule. Again, the GSIB surcharges are scaled based on the systemic footprint of each U.S. GSIB. 138 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00142 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 380.66532 -2- Finally, under the TLAC proposal, each covered fum's TLAC and long-term debt requirements would include a risk-weighted assets component, which sets the dollar amount of the requirement on the basis of the level of risk posed by the assets on each individual finn's balance sheet. This component tailors the requirements to each firm's probability offailnre, and therefore to a key indicator of the risk that the firm poses to the financial stability of the United States. Thus, if two firms have balance sheets of the same absolute size but one of them is invested more heavily in relatively risky assets, then the firm with the riskier assets would be subject to higher requirements under the risk-weighted assets components of the proposed TLAC and long-term debt requirements. 139 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00143 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 480.66532 Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System from Ranking Member Waters: 1. It's estimated that more than $500 billion in checks are cashed annually, as opposed to deposited, and it's largely because of the time it takes for an average check to "clear." Would you agree that faster or same-day payments would reduce the need to cash checks? 2. An FDIC study showed that 60% of people who already have an account with either a bank or a credit union want instant access to their money, so much so that they are willing to pay exorbitant fees in check-cashing or small dollar loans. What specifically is the Federal Reserve doing to address this? 3. Are you aware that roughly 69% of first-time users of short-term loans said they used the loans to cover a recurring expense, such as paying rent or their electric bill? Do you agree that same day payments in the U.S. would help meet these daily cash-flow problems that so many families and young adults face? Response to questions 1 through 3: Several of the Federal Reserve's strategies in the payments system realm could help to make banking services more responsive to consumers including the unbanked and under banked population. The Federal Reserve has undertaken a variety of actions to speed the clearing of payments and the availability of funds. These payments system improvements should help low income Americans who face challenges managing their daily cash flow. With regards to check clearing, the Federal Reserve has led the effort to make the nation's check clearing system faster and more efficient, beginning with the initial development of the Check Clearing for the 21st Century Act (Check 21), which took effect in 2004, and the provision of new services that leverage the Check 21 statutory authorities. Instead of physically moving paper checks from one bank to another, Check 21 has enabled banks to collect checks electronically. As a result of Check 21 and other check-system improvements, checks are almost always delivered to the paying bank within one business day of being deposited in the banking system. Also, given the Federal Reserve's restructuring of its check collection service, banks generally must make the proceeds of checks available for withdrawal no later than two business days following deposit, giving consumers faster guaranteed availability of funds than previously was the case. The Federal Reserve has offered a voluntary same-day Automated Clearing House (ACH) service for several years. This experience has demonstrated that a same-day ACH service can only succeed if it is mandatory (that is, require all receiving banks to post same-day ACH transactions in a timely manner and make the funds available to the recipient on the day the transaction is received). Consistent with actions recently taken by the National Automated Clearing House Association or NACHA, the Federal Reserve Banks will introduce an enhanced, mandatory same-day ACH service later this year. This service will enable employers to pay their hourly workers via direct deposit, rather than by check, which is commonplace today. Employers will have more time to accurately determine the amount each hourly employee is due and create the ACH file in time to meet the processing deadlines for the current next-day ACH 140 VerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00144 Fmt 6601 Sfmt 6601 K:\DOCS\23566.TXT TERI 580.66532 -2- service. The service will also enable banks to provide individuals an easy option to pay bills on a same-day basis. The Reserve Banks will encourage the banking industry to use same-day ACH for these and other potential use cases. Additionally, the Federal Reserve has been leading an effort, together with a broad group of interested stakeholders, to evaluate designs for new safe, ubiquitous, faster payment capabilities in the United States. With such capabilities, payments could be made in seconds or minutes, with the recipient of the payment having prompt access to the funds. This system could help consumers manage their money in near real time. We believe that more than a quarter of current check payments could migrate to faster payments capabilities. More information on this effort can be found at https://fedpaymentsimprovement.org/. Among the criteria that will be used to evaluate the various potential faster payments system designs are the speed in which transactions would be cleared, how fast funds would be made available to the payee, and importantly, how effectively the solution addresses the needs ofthe unbanked or underbanked to affordably send or receive payments. 4. To what extent is lmancial inclusion of nnderserved communities a focus of the Federal Reserve's Faster Payments Taskforce? The Federal Reserve recognizes that faster payment capabilities have the potential to draw more of the unbanked and underbanked population into the financial mainstream. As noted above, one of the faster payments effectiveness criteria developed by the Faster Payments Task Force is how effectively a faster payments solution addresses the needs of the unbanked or underbanked to affordably send or receive payments (for example, by supporting the ability to make payments to and/or from a regulated nonbank provider and/or explicitly promoting financial inclusion in the payments solution). An important aspect of the Faster Payments Task Force's work is bringing together organizations with a wide range of views so that these views can be discussed and analyzed. To that end, the Federal Reserve has encouraged the Consumer Financial Protection Bureau (CFPB) and other consumer organizations to actively participate in the Faster Payments Task Force. Presently, representatives from Consumers Union and The Pew Charitable Trusts sit on the Faster Payments Task Force Steering Committee as well as a representative from the CFPB. Additionally, several other consmner advocacy organizations participate on the Faster Payments Task Foree. 0

Janet L. Yellen (2016, February 9). Congressional Testimony. Testimony, Federal Reserve. https://whenthefedspeaks.com/doc/testimony_20160210_chair_monetary_policy_and_the_state_of_the

@misc{wtfs_testimony_20160210_chair_monetary_policy_and_the_state_of_the,
  author = {Janet L. Yellen},
  title = {Congressional Testimony},
  year = {2016},
  month = {Feb},
  howpublished = {Testimony, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/testimony_20160210_chair_monetary_policy_and_the_state_of_the},
  note = {Retrieved via When the Fed Speaks corpus}
}