Congressional Testimony

S. HRG. 114–231 FEDERAL RESERVE’S FIRST MONETARY POLICY REPORT FOR 2016 HEARING BEFORETHE COMMITTEE ON BANKING, HOUSING, ANDURBANAFFAIRS UNITED STATES SENATE ONE HUNDRED FOURTEENTH CONGRESS SECOND SESSION ON OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU- ANTTOTHEFULLEMPLOYMENTANDBALANCEDGROWTHACTOF1978 FEBRUARY 11, 2016 Printed for the use of the Committee on Banking, Housing, and Urban Affairs ( Available at: http://www.fdsys.gov/ U.S. GOVERNMENT PUBLISHING OFFICE 99–726 PDF WASHINGTON : 2016 For sale by the Superintendent of Documents, U.S. Government Publishing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800 Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001 VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS RICHARD C. SHELBY, Alabama, Chairman MIKE CRAPO, Idaho SHERROD BROWN, Ohio BOB CORKER, Tennessee JACK REED, Rhode Island DAVID VITTER, Louisiana CHARLES E. SCHUMER, New York PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey MARK KIRK, Illinois JON TESTER, Montana DEAN HELLER, Nevada MARK R. WARNER, Virginia TIM SCOTT, South Carolina JEFF MERKLEY, Oregon BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana JERRY MORAN, Kansas WILLIAM D. DUHNKE III, Staff Director and Counsel MARK POWDEN, Democratic Staff Director DANA WADE, Deputy Staff Director JELENA MCWILLIAMS, Chief Counsel THOMAS HOGAN, Chief Economist SHELBY BEGANY, Professional Staff Member LAURA SWANSON, Democratic Deputy Staff Director GRAHAM STEELE, Democratic Chief Counsel PHIL RUDD, Democratic Legislative Assistant DAWN RATLIFF, Chief Clerk TROY CORNELL, Hearing Clerk SHELVIN SIMMONS, IT Director JIM CROWELL, Editor (II) VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00002 Fmt 0486 Sfmt 0486 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON C O N T E N T S THURSDAY, FEBRUARY 11, 2016 Page Opening statement of Chairman Shelby ................................................................ 1 Opening statements, comments, or prepared statements of: Senator Brown .................................................................................................. 3 WITNESS Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System ...... 5 Prepared statement .......................................................................................... 47 Responses to written questions of: Chairman Shelby ....................................................................................... 50 Senator Toomey ......................................................................................... 54 Senator Kirk .............................................................................................. 62 Senator Heller ........................................................................................... 64 Senator Sasse ............................................................................................ 70 Senator Cotton ........................................................................................... 80 Senator Rounds ......................................................................................... 83 Senator Moran ........................................................................................... 86 Senator Menendez ..................................................................................... 90 ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD Monetary Policy Report to the Congress dated February 10, 2016 ..................... 96 ‘‘Reducing the IOER Rate: An Analysis of Options’’ Memo submitted by Sen- ator Toomey .......................................................................................................... 148 Statement of the Financial Innovation Now Coalition submitted by Senator Brown .................................................................................................................... 159 (III) VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON FEDERAL RESERVE’S FIRST MONETARY POLICY REPORT FOR 2016 THURSDAY, FEBRUARY 11, 2016 U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. The Committee met at 10:01 a.m., in room SD–538, Dirksen Sen- ate Office Building, Hon. Richard C. Shelby, Chairman of the Com- mittee, presiding. OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY Chairman SHELBY. The Committee will come to order. Today we will receive testimony from Federal Reserve Chair Janet Yellen. The semiannual Monetary Policy Report to the Con- gress is an important statutory tool for oversight of the Federal Re- serve, which was created by Congress over 100 years ago as part of the Federal Reserve Act. The act grants the Fed a certain degree of independence, but in no way does it preclude congressional oversight or accountability to the American people. There is broad consensus that the Fed should communicate in a manner that helps Congress and the public un- derstand its monetary policy decision making. How the Federal Open Market Committee makes its decisions re- mains a point of contention, however. Some argue for unfettered discretion, while others advocate a rule-based construct. Recently, a statement released by 24 distinguished economists and other officials, including John Taylor, George Shultz, Allan Meltzer, and three Nobel Prize winners, disputes the idea that ad- herence to a clearer, more predictable rule or strategy would re- duce Fed independence. In fact, their statement argues, and I will quote, that ‘‘publicly reporting a strategy helps prevent policymakers from bending under pressure and sacrificing independence.’’ Last year, this Committee favorably reported the Financial Regu- latory Improvement Act, which included a provision that would not establish a rule but, rather, require the Fed to disclose to Congress any rule it may happen to use in its decision making process. I believe this represents a reasonable step toward increased transparency and accountability. It is my hope that this year we will be able to reach some kind of agreement on this and other banking reforms. Never before has it been more important for Congress to consider ways to strengthen Fed transparency and accountability. Since the (1) VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 2 financial crisis, the Fed has expanded its monetary policy actions to an extent that would have been unthinkable 10 years ago. As former Fed Chairman Paul Volcker described, during the cri- sis, the Fed took, and I will quote him, ‘‘actions that extend the very edge of its lawful and implied powers, transcending certain long-embedded principles and practices.’’ We are all too familiar with the successive rounds of quantitative easing that brought the Fed’s balance sheet to over $4 trillion, with no wind-down in sight. I think it begs the question: How will the Fed shrink a balance sheet that exceeds 20 percent of the entire U.S. economy? Some also worry that the Fed may have assumed economic re- sponsibilities beyond its statutory mandates of price stability and full employment. To the extent that the Federal Reserve has done so, it should be disclosed and justified. While I agree that the Fed should be free to make independent decisions, it should not be completely shielded from explaining its decisions and the factors that it uses to guide them. At times, it seems that Federal Reserve officials resist even sensible reforms designed to improve economic performance, congressional over- sight, or public understanding of the Federal Reserve’s actions. The need to preserve Fed independence is very real, but surely it does not justify objection to any reform. Independence and ac- countability should not be viewed as mutually exclusive concepts. In fact, accountability is even more crucial given the Federal Re- serve’s role as a financial regulator. Never before has a single enti- ty held so much power over the direction of our financial system. Notably, Dodd-Frank expanded the Fed’s regulatory authority over large sectors of the economy, including insurance companies and other nonbank financial institutions. Such regulatory authority and the rulemakings issued as a result of it raise significant ques- tions. Recently, the Federal Reserve has issued a number of new regu- lations stemming from the Basel III bank capital rules, such as total loss-absorbing capital, the liquidity coverage ratio, and high- quality liquid asset ratings. These rulemakings are based on the requirements set by the Bank for International Settlements and its Basel Committee on Banking Supervision. But instead of allowing international bodies to serve as de facto U.S. regulators, the Fed should appropriately vet these rules and answer important questions. For example, are those international requirements appropriately tailored for our domestic financial institutions? Are they even nec- essary given existing rules? Are they harming our economy or plac- ing U.S. firms at a disadvantage? I continue to encourage the Federal Reserve to further exercise its regulatory discretion to tailor enhanced prudential standards according to the systemic risk profile of each institution, not arbi- trary factors. And where it does not have the authority to do so, Congress should step in with legislative changes. None of the Fed- eral Reserve’s authorities are immune from reform, and many of us believe that reform is long overdue. Madam Chairman, I look forward to your testimony today and your thoughts on these important issues. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 3 Senator Brown. STATEMENT OF SENATOR SHERROD BROWN Senator BROWN. Thank you, Mr. Chairman. Thank you, Madam Chair. It is so nice to have you back here. It is good to see everyone back in this hearing room. This is our first gathering since October, and I welcome all of you back. I cannot help but think back to February 2009 when then-Chair Ben Bernanke told this Committee that our economy was suffering a severe contraction. President Obama had just taken the reins in the middle of a financial crisis that would become the worst since the Great Depression. American taxpayers had just rescued the banking and auto industries. By the time we hit bottom, 9 million jobs had disappeared. The unemployment rate soared to 10 percent. In some places that we all represent it was higher. Five million families lost their home to foreclosure. I mentioned to Chair Yellen that my wife and I live in Zip code 44105 in Cleveland, which had more foreclosures in the first half of 2007 than any Zip code in the United States. Thirteen trillion dollars in household wealth was wiped out. It was one of the darkest periods in our Nation’s eco- nomic history. Seven years later, it is clear we have come a long way since the financial crisis. Our economy has added 13 million jobs since 2010. We have had 71 consecutive months—that is almost 6 years—of job growth. The unemployment rate has dropped to below 5 percent, the lowest level since 2008. Average hourly earnings are up 0.5 percent since December, the second strongest monthly gain since the crisis, up 2.5 percent in the last year. And the Fed, as we know, increased rates for the first time in a decade. That is the good news. But we still face severe challenges. Wages have been too flat for too long. Too many workers are still looking for jobs. Those that have one are not making as much as they should be, and some are benefiting from the recovery. Mostly the top 5 percent are bene- fiting from the recovery far more than average workers. International economies are slowing. American exports are chal- lenged by the strong dollar. Oil prices are at all-time lows, though they have not provided the economic boost that many analysts ex- pected. Inflation remains very low. The slow and steady progress of the economy has given rise to what I fear—and I see that in this room—what I fear is a collective amnesia for many on Wall Street and many in Congress, as if they forgot what happened in 2006, 2007, and 2008, as if they did not know about the human suffering in every one of our States, the lost wealth, the lost jobs, the foreclosed homes. I think that few of us, and none of us enough, spend time talking to people who have lost their homes and have to explain to their child that they are going to have to move to a new neighborhood in a less nice house and go to a different school, and the pain that caused to the millions of people who have seen their homes fore- closed on. They seem to have forgotten—this collective amnesia suggests that far too many people that sit on this side of this dais have for- gotten just how devastating the crisis was for an entire generation VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 4 of working and middle-class Americans. Instead of working to strengthen our economy and to bolster the financial system safe- guards, some Republicans want to unleash the forces that almost destroyed the economy in the first place. They want to go back to business as usual with Wall Street. Instead of conducting oversight hearings to push for implementa- tion of the Wall Street Reform Act, we all remember when Presi- dent Obama signed Dodd-Frank that chief financial services lobby- ists in this town said, ‘‘Now it is half-time,’’ meaning they were going to go to work to try to stop the Fed and weaken the FDIC rules and do whatever they could do on behalf of Wall Street. So instead of conducting hearings to push for implementation of Wall Street reform, this Committee instead has been holding hearings on weakening the law for banks and nonbanks and how to make it impossible for regulators to finalize their rules. The Banking Committee has not in 13 months held a single hearing on strengthening consumer protections. We have not talked about improving credit reporting and debt collection. We have not examined how to curtail payday lending or make rental housing more accessible, affordable, and safe. There is a lot of work to do to ensure we do not repeat the mis- takes that led to the Great Recession. I sent a letter to Chair Yellen this week urging the Federal Reserve to do more to reduce the risks posed by big banks’ involvement in the commodities busi- ness. The Fed and the FDIC need to make public determinations if individual firms have not provided credible living wills that dem- onstrate that they could go out of business without wrecking the financial system. This is one of the ways we determine if too big to fail still actually exists. The regulators should finish rules relating to compensation in- centives on Wall Street, understanding when Americans who have not had a raise for years are just barely making it when they see this kind of compensation on Wall Street and these kinds of bo- nuses for executives in many cases who helped to get us into the bad situation we are in. If we have learned anything from the crisis, it is that Wall Street encouraged behavior that caused the crisis at a steep price to American homeowners and American renters. The Fed still has work remaining on its regulatory framework for the nonbanks that it supervises as well as insurance companies that own savings and loan holding companies, and I hope you will pay close attention, Madam Chair, to those business models. And while regulators have taken important steps to rein in risks in money market mutual funds and the tri-party repo market, pol- icymakers should continue to examine these and other potential threats in the nonbank sector. To those that say that the reforms that have taken place in the U.S. will put us at a competitive disadvantage, this week has shown us that they actually benefit our financial system. It is clear to me that as a result of the new regulations, U.S. financial institu- tions are more resilient than their counterparts in other parts of the world. Chair Yellen, I look forward to your assessment of both the econ- omy and where we are with efforts to strengthen and more sta- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 5 bilize our financial system. All of us must do the necessary work to promote financial stability, to protect consumers, to help prevent what could be the next crisis. There is far too much at stake for American families to do otherwise. Thank you. Chairman SHELBY. Madam Chair, your written testimony will be made part of the record in its entirety. You proceed as you wish. Welcome to the Committee again. STATEMENT OF JANET L. YELLEN, CHAIR, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Ms. YELLEN. Thank you. Chairman Shelby, Ranking Member Brown, 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. 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 the further de- clines in energy prices, the Federal Open Market Committee ex- pects that inflation will rise to its 2-percent objective over the me- dium term. In the labor market, the number of nonfarm 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 un- employment rate fell to 4.9 percent in January, 0.8 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 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. How- ever, these measures remain above the levels seen prior to the re- cession, 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 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 prod- uct is reported to have slowed more sharply, to an annual rate of just 3⁄ 4 of a percent; again, growth was held back by weak net ex- ports as well as by a negative contribution from inventory invest- ment. Although private domestic final demand appears to have slowed somewhat in the fourth quarter, it has continued to ad- vance. 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 pur- chases of cars and light trucks; sales of these vehicles in 2015 VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 6 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 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 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 growth 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, eco- nomic activity will expand at a moderate pace in 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 has led to increased volatility in global fi- nancial markets and, against the background of persistent weak- ness abroad, exacerbated concerns about the outlook for global growth. These growth concerns, along with strong supply condi- tions 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 economies, 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 tight- en 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 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 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 remain low in the near term. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 7 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 medium term. In light of the current shortfall of inflation from 2 percent, the Committee is care- fully monitoring actual and expected progress toward its inflation goal. Of course, inflation expectations play an important role in the in- flation process, and the Committee’s confidence in the inflation out- look depends importantly on the degree to which longer-run infla- tion 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 meas- ures of longer-run inflation expectations are also at the low end of their recent ranges; overall, however, they seem 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 Congress. Last March, the Committee stat- ed 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 De- cember, the Committee judged that these two criteria had been sat- isfied 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 in- crease marked the end of a 7-year period during which the Federal funds rate was held near zero. The Committee did not adjust 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 re- duction 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 mone- tary 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 VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 8 Federal funds rate that would be neither expansionary nor contractionary if the economy was operating near potential—is cur- rently low by historical standards and is likely to rise only gradu- ally 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. 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 information, including measures of labor market conditions, indi- cators of inflation pressures and inflation expectations, and read- ings 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. But, 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, or IOER, and overnight re- verse repurchase, or 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-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 oper- ations allowed the FOMC to control the Federal funds rate effec- tively 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 accommodation by the tradi- tional 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 financial market reactions. 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 of the Federal funds rate is well under way.’’ Maintaining our sizable holdings of longer-term securi- ties 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 ad- verse shocks. Thank you. I would be pleased to take your questions. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 9 Chairman SHELBY. Madam Chair, we have talked about this pri- vately before, but does the Fed still use the Phillips rule in a lot of its deliberations? Ms. YELLEN. Well, the—— Chairman SHELBY. Is that an important tool? Or is it just one of many tools? Ms. YELLEN. It is essentially a theory that fits reasonably, but certainly not perfect, explaining the inflation process. And it is a theory that says first that inflation expectations play a key role in determining inflation; second, that various supply shocks, such as movements in the price of oil or commodities or import prices, also play an important role; and, third, that the degree of slack in the labor market or the degree more generally of pressure on resources in the economy as a whole exert an influence on inflation as well; and that theory underlines the kind of statement that I have made that, if inflation expectations remain well anchored and the transi- tory influence of energy prices and the dollar fade over time, that in a tightening labor market with higher resource utilization, I ex- pect inflation to move back up to 2 percent. It is consistent with that Phillips curve theory. So, in essence, yes, I want to make clear that all of those ele- ments play a role. And, of course, there can be other factors, idio- syncratic factors or other factors not captured by that model that make a difference. So that model in part underlies an expectation inflation will return to 2 percent. But in our statement in Decem- ber and January, the Committee indicated that we will continue to assess actual developments with inflation and see whether they are in alignment with our expectations because, after all, this is not a theory that is perfect. Chairman SHELBY. Would you say today that the precipitous de- cline in the price of oil and gas plus the rise of the dollar has sur- prised the Fed to some extent? Or could you have predicted all of this? Ms. YELLEN. So I think we have been—markets have been and we have been quite surprised by movements in oil prices. I think in part they reflect supply influences, but demand may also play a role. The stronger dollar is partly something that we anticipated be- cause the U.S. economy has been performing more strongly than many foreign economies, and we have a divergence in the stance of monetary policy that influences capital flows in the dollar. Nev- ertheless, the strength of the dollar and the extent to which it has moved up since mid-2014 is not something that we anticipated. So, yes, we have been surprised in part by those developments, and they have played a significant role in holding down inflation. Chairman SHELBY. Do you believe this economy, although it is a number of years old, as you would say, has peaked or is near peak- ing or will start declining and put us into a recession of some type? Or you just do not know, it is something you are watching? Ms. YELLEN. Well, we are watching developments very carefully. I would say there is always some chance of a recession in any year, but the evidence suggests that expansions do not die of old age. We are, as I mentioned in my testimony, looking very carefully at glob- al financial market and economic developments that create risks to VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 10 the economy, and we are evaluating them, recognizing that these factors may well influence the balance of risks or the trajectory of the economy, and thereby might affect the appropriate stance of monetary policy. But at this point I think it is premature to make a judgment. We will meet in March, and our Committee will care- fully deliberate about what impact these developments have had. Today I think it is premature to render a judgment on that. Chairman SHELBY. Are you saying basically the Fed will be care- ful, looking at every aspect of the economy and the international economy, before it raises the Federal funds rate? Is that what you are saying? Ms. YELLEN. Yes, certainly, we will. We will evaluate the out- look, certainly taking these developments into account, and I want to emphasize that, as I said, monetary policy is not on a preset course. We want to set the path of policy that will achieve the ob- jectives that Congress has assigned to us, and that certainly entails doing what we can to make sure that the expansion continues. Chairman SHELBY. Could you just take a couple of minutes and share with us your view as to the strength of our banking system today if we were to—we hope we will not go into a recession, but we do have cycles, and we know that. What is the condition of our banking system? Do you feel comfortable about our banking sys- tem? Or is it work you are working every day on? Ms. YELLEN. I think the steps that we have taken over the last 7 years have had very substantial payoffs in the form of a much more resilient and stronger, better capitalized, more liquid banking system. We have not only raised capital and liquidity standards, in- cluding especially ramping those up for the most systemic firms; we have also used stress test methodology to see whether we think those firms—and we do think that they can—continue to support the credit needs of our economy, even in this scenario of very sig- nificant stress. So I think we do have a strong banking system, and we have seen marked improvement. Chairman SHELBY. Senator Brown. Senator BROWN. Thank you, Mr. Chairman. You said in your testimony and in your response to Chairman Shelby, Madam Chair, you said that in regards to monetary policy the Committee is by no means on a preset course, and then you later said if the economy were to disappoint that you would—you suggested it would be less likely to raise interest rates. And I want to make just one comment, and then I have three questions—or a couple questions about wages, that the dual mandate is so impor- tant, I so appreciate your emphasis always on it, on, of course, re- straining inflation, but also equally importantly, and to many of our constituents, I think maybe even more importantly, the impor- tance of job growth. And I also appreciate the importance to you of wage growth as you deliberate on these questions of raising in- terest rates. And while job growth has been better than some might have expected with 71 consecutive months, wage growth has not, as you know, and with some good signs recently but not enough. Data released earlier this month show average hourly earnings increased in 2015. My questions are these: Are other wage growth—and just three questions, and answer them together, if you would. Are other wage VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 11 growth indicators showing the same increases? Are wage increases occurring across race and gender and across economic sectors, or are certain groups doing better than others in that wage growth? And, finally, can the economy reach full employment without labor force participation increases for women and minorities and have widespread wage growth? So if you would sort of pull those to- gether and answer, Madam Chair. Ms. YELLEN. So you asked about other wage indicators. As you indicated, average hourly earnings have picked up, but it is a se- ries that is volatile. And while I think we see some evidence of fast- er wage growth there, I would still refer to that evidence as ten- tative. In compensation per hour, we also see a somewhat slightly high- er pace over the last 12 months in its growth, but, again, this is a very volatile series. And in terms of the employment cost index, compensation growth has really not shown any sustained pickup, and that is a signifi- cant series. So at best, I would say the evidence of a pickup is tentative. I do continue to envision that if the labor market continues to im- prove, as we certainly hope it will, that there is scope and we will likely see some further pickup in wage growth. In terms of particular groups in the economy, I cannot give you recent evidence on developments by—I think you asked for race and gender, but—— Senator BROWN. And sector. Ms. YELLEN. So I do not have that data at my fingertips, but, we know that in the U.S. we have had a longstanding trend toward rising inequality, rising wage inequality in this country, and that more educated people have seen faster wage growth than those in the middle and at the bottom, and I believe that trend continues. A lot of jobs during the downturn, middle-income jobs, were lost. And although jobs across the occupational distribution have been created, job creation has perhaps been more heavily skewed toward sectors that have lower pay. And I think that there are deeper structural reasons that these trends continue. They predate the downturn in the economy, but the downturn probably accelerated those trends that perhaps relate to globalization and technological change that are demanding increased skill. Senator BROWN. Thank you, and I think you cannot—and I just have one comment. I think we cannot be satisfied that we have full employment without full employment across demographic lines, meaning women and minorities, especially. We do not really have full employment until it is full for them also, and I know that you recognize that. Let me shift—and I know we do not have a lot of time because there is a vote called—to a question on living wills. We have dis- cussed that process. Last year, you said you felt that the Fed and FDIC have provided companies with clear feedback on the defi- ciencies in the submissions to you, and that you would be willing to make formal determinations that certain plans are not credible. Three questions. When do you anticipate providing feedback on last year’s submissions? Are you still committed to making formal determinations about insufficient plans? And will you differentiate VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 12 between and among firms when you provide feedback or make de- terminations? Ms. YELLEN. So, when, we are actively engaged and far along in evaluating these plans. The Board has met regularly since August. I believe we have had seven Board meetings to discuss these plans. We have worked closely with the FDIC. We have not made final determinations, so it is premature for me to give you a definite time, but we will make these determinations in the not too distant future. We are very actively engaged. And, yes, we are still committed, as I indicated, to finding that plans that do not meet the specifications we outlined, we are cer- tainly prepared to find them deficient and to specify what those de- ficiencies are. Senator BROWN. And one more quick one. Does an aggressive, thorough living will process answer the question of too big to fail? Ms. YELLEN. It certainly helps. We have also put in place re- quirements for adequate—our so-called TLAC rules for adequate loss absorbency. We certainly are requiring that firms have work- able plans for how they would be resolved under bankruptcy. And Dodd-Frank—so we want to make sure that there is a way that they could be resolvable under bankruptcy, and that the resources are there so that the taxpayer would not be at risk. And Dodd- Frank provided as a backup authority Title 2, which would be, if it is necessary, an additional tool that we can use. So I think it is premature to say we have solved too big to fail, but I do think we have made very substantial strides toward deal- ing with it, toward addressing it. Chairman SHELBY. Thank you. Senator Crapo. Senator CRAPO. Thank you, Mr. Chairman. Chair Yellen, I appreciated your comments at our last Hum- phrey-Hawkins hearing when we discussed the $50 billion trigger being used to determine when a bank is systemically important and your openness to increasing the threshold and focusing on the flexibility that we need there. While Congress continues to make progress on this effort—and hopefully we will make some progress soon—you have previously noted that the Federal Reserve has the authority and discretion on its own to tailor the application of these rules as they apply to sys- temically important designated banks, those covered by Section 165 of Dodd-Frank. My question is: Can you give us some specific examples of the kind of tailoring that might be in the works as the Federal Reserve works on this? And will there be relief on stress testing and resolu- tion planning? Ms. YELLEN. So we are, for example, actively engaged in review- ing our stress test testing and capital planning framework for the bank holding companies above $50 billion, and we are considering ways in which we can make that less burdensome for the bank holding companies that are close to the $50 billion asset line. Along with that, we might make it somewhat stricter for some of the GCIBs. We are considering that as well, and I think that would be tailoring appropriately, I think—at both ends of the spec- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 13 trum. We are paying close attention to the costs and benefits of particular changes, how they affect those institutions. So we have not made final decisions, but that is certainly some- thing on the drawing board where I hope we can make progress. Senator CRAPO. Do you believe we will see any of that tailoring announced soon or applied soon? Ms. YELLEN. Certainly this year, but I think if we were to make changes, they would not take effect until the 2017 cycle of stress testing. Senator CRAPO. Thank you. And shifting topics, because of the li- quidity issues that occurred on October 15, 2014, in the Treasury market, there has been a lot of effort by the Federal Reserve and others to better understand the factors that impact the liquidity of the Treasury market, especially during stressed market conditions. The concern that I heard is that several factors, including new regulations, may have reduced market-making capacity in the mar- ket, and that during stressed market conditions, liquidity may be more prone to disappearing at times when it is most needed, as it seemed to do on October 15th. Are you concerned that liquidity in the bond markets may be less available in stressed market conditions and that we need to better understand and analyze all the factors, including the impact of reg- ulations on this? Ms. YELLEN. Senator, yes, I agree with what you said. You know, normal metrics, the ones we typically monitor on liquidity condi- tions in these markets, have not changed that much, but the per- ception and, of course, some experiences, as you cited, suggest that under stressed conditions liquidity may disappear when it is most needed. So we are looking very carefully at that and at all of the factors that may be involved. Regulation is on the list, but there are other things as well. The prevalence of high-frequency trading has increased. Broker-dealers have reconsidered in the aftermath of the crisis the appropriate models they want to use to run their businesses. There have been changes in disclosure that affect cor- porate bond markets, and we want to recently to disentangle the impact of all of those different influences. Senator CRAPO. Well, thank you. And one last question. There have been several hearings on the Financial Stability Oversight Council that focused on ways to improve transparency, account- ability, and communications. In the April Subcommittee hearing that Senator Warner and I held, the witnesses agreed that the Fi- nancial Stability Oversight Council needed to provide actionable guidance to designated systemically important financial institu- tions on how they could de-risk and ultimately shed their designa- tion label. What has been done—this has been referred to as an ‘‘off ramp.’’ Do you agree that further progress in this area is appropriate? And wouldn’t our financial system be safer if companies knew what they could do to address the risks and had an incentive to become less systemically risky? Ms. YELLEN. So I would certainly agree with you, it would be good if they became less systemically risky, and designation is not intended to be permanent. The FSOC reviews these designations every year, and it is, of course, important for firms to understand VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 14 the kinds of steps that they could take to shed their designation and to become less risky. But I think the FSOC needs to be very careful not to micro- manage these firms and to try to tell them exactly what their busi- ness models ought to be. Those firms know exactly why they were designated. They have received detailed letters and analysis ex- plaining what the factors were about their businesses that would give rise to systemic risk in the event of their failure. So they do understand why they have been designated and the things that they would need to address. So designation is not intended to be permanent. We do have reg- ular reviews, and I think those firms do have an understanding of the kinds of things they would need to be prepared to do. So I just do not think it is appropriate for the FSOC to say, ‘‘We want you to do the following business plans.’’ There are a lot of different ways in which a firm might decide to address those issues. Senator CRAPO. Thank you. My time has expired. I would like to discuss this with you further. Thank you. Ms. YELLEN. Certainly. Senator CORKER. [Presiding.] Senator Tester. Senator TESTER. Thank you, Senator Corker. Thank you, Chairman Yellen, for being here today. I want to fol- low up with Senator Crapo’s questions a little bit because there is some new information that you just gave that I was not aware of, and that is that—and correct me if I am wrong—you just said that the companies understand why they are designated as a SIFI and, therefore, they understand what they have to do to get undesig- nated. Is that what you just said? Because that is new information for me. Ms. YELLEN. Well, in the sense that they have been given very detailed explanations of what aspects of their business give rise to the systemic risks that have caused them to be designated. Senator TESTER. And so is that information given as the process goes on or after the process of designation is done? Ms. YELLEN. Well, there is a three-stage process. Senator TESTER. Yeah. Ms. YELLEN. And there is a great deal of interaction with FSOC during that process. Senator TESTER. OK. Ms. YELLEN. So I believe before they are designated, there is a sufficient amount of interaction that they well understand the as- pects—— Senator TESTER. Why they are being designated? Ms. YELLEN. ——that are leading them to be designated, and then they are given a very detailed—— Senator TESTER. Would they have the opportunity as that proc- ess goes on to make changes so they would change the direction the FSOC is going? If that information is—what I am getting at is if that information is being given out early enough so the company can say, well, we are going to make some changes—not changes that the FSOC demands of them to make, but they have chosen to make some changes to stop the designation, do you believe they have time to do that before the designation is made? VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 15 Ms. YELLEN. So they certainly have lots of opportunities to inter- act with FSOC and to explain—— Senator TESTER. OK. Ms. YELLEN. ——their business model and the direction it is going. Senator TESTER. I think that is good. Thank you, Chairman. I want to talk a little bit about the housing sector just very, very briefly. Could you give us your perspective on what the Fed is see- ing in the housing sector right now and what a hiccup in that sec- tor would mean for the American taxpayer? Ms. YELLEN. So we are seeing a recovery, I would say, in hous- ing. It has gone on now for a number of years, but it is very, very gradual. Senator TESTER. Yeah. Ms. YELLEN. House prices are recovering. They have increased quite a bit, and I think that is helping the financial situation of many households. Senator TESTER. Yeah. Ms. YELLEN. The level of new construction of residential invest- ment remains quite low relative to underlying demographic trends. So it seems to me there is quite a significant way for housing to go before we could say it is at levels consistent with demographic trends. So I think it will continue to improve. Senator TESTER. OK. Ms. YELLEN. And it is a support to the economy. Senator TESTER. All right. And a hiccup in the housing industry, what would that mean for the taxpayer right now? Ms. YELLEN. For the taxpayer. Senator TESTER. The American taxpayer, what would a housing slowdown or perhaps not a collapse but a decrease in their growth mean to the American taxpayer vis-a-vis Fannie Mae and Freddie Mac? Ms. YELLEN. Oh, vis-a-vis Fannie Mae and Freddie Mac? Senator TESTER. Yeah. Ms. YELLEN. So I am not—— Senator TESTER. OK. Ms. YELLEN. I do not have—— Senator TESTER. We are probably going down a line that we—— Ms. YELLEN. I am sorry. I do not have numbers on—— Senator TESTER. Tell me, can you give me a sense of what the Fed is doing to ensure that we are protecting consumers while at the same time differentiating between community banks and the big banks—— Ms. YELLEN. Well, when you say that we are protecting con- sumers—— Senator TESTER. Yes, while at the same time differentiating the regulations that impact the small banks versus the big guys. Ms. YELLEN. So consumer protection is a very important part of our supervision, and the CFPB examines the larger banks in terms of their consumer compliance, and our responsibility is now with the smaller banks in community banks where we have consumer protection enforcement. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 16 We try to tailor our examinations, our consumer exams of the community banks so that they are not too burdensome and they are focused on real risks. Senator TESTER. Do you feel you have been successful in that tai- loring from a community bank standpoint? Ms. YELLEN. We are very focused on regulatory burden on com- munity banks, and we are trying to do both in the safety and soundness side and on the consumer compliance side everything that we can to reduce burden while still making sure that banks abide by consumer protection. Senator TESTER. OK. If I might, Mr. Chair, just very quickly, we are seeing consolidation in banks in Montana pretty rapid. Is that true throughout the country? And are you concerned about that? Ms. YELLEN. Well, there has been consolidation. We are con- cerned about the burdens on community banks and trying to re- lieve that. In a low-interest-rate environment, net interest margins are also squeezed for many of these banks, and that is a factor also here. Senator TESTER. Thank, Mr. Chairman. Thank you, Janet. Senator CORKER. Thank you. Madam Chairman, thank you for being here. I know when we went through our confirmation hearings, I noted that you were the first avowed dove to head the Fed, and yet you honored the state- ments you made, which were at the time that if the data showed that you needed to raise interest rates, you were going to do so, and you just did that recently. And I noticed during this hearing you were talking about 2 percent inflation and full employment. I think the question by many is: Are there any other rules at the Fed other than 2 percent inflation and full employment as you look at data that guide where you are going? I would like not a particu- larly long answer to that. Ms. YELLEN. Well, those are—— Senator CORKER. I think there has been—as you know, there have been criticisms about whether there really is a rule-based sys- tem that people understand so that it is not like the Fed is the Wizard of Oz and no one really knows what is going to happen. And, you know, markets have fallen 500 points, which is unusual, in the last couple days after testimony, which I thought was good yesterday. But is there some other rule-based system that those of us who care about these kind of things could count on relative to what the Fed’s actions are? Ms. YELLEN. So, Senator, if I might, I would like to distinguish between a systematic approach to monetary policy, which I believe we have put in place, and a system that we use that is in line with what other advanced central banks do and a mechanical, mathe- matical rule-based approach, which I do not support and no central bank that I am aware of follows. We have articulated in a clear statement what our objectives are: 2 percent inflation and our interpretation of maximum employ- ment. Every 3 months, all members, all participants in the FOMC set out their explicit projections for key variables and also the mon- etary policy path that they regard as appropriate to achieve those variables, and we publish these projections. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 17 Now, it is not a single Committee-endorsed view, but it does show the range of forecasts and assessments of what appropriate policy would be in line with those forecasts, and we update those projections every 3 months in line with incoming data. And I would regard that as quite a bit of information and a systematic ap- proach. We are telling the public what the range of opinion is about appropriate policy and the associated path for the economy. And, of course, there is uncertainty. So policy is not on—— Senator CORKER. I got it. Ms. YELLEN. ——a preset path. We update those projections, but we are showing what we think in a systematic way. Senator CORKER. I would think—we had a nice conversation the other day at length, and I think that one of the things the Fed could do—you asked me questions along those lines—would be to maybe come in here in an off-the-record meeting and lay that out, and then contrast that with a rule-based system. I think that would be very helpful to the Fed and I think very helpful to the Committee Members here. Let me ask you this: Just briefly on the $4.5 trillion balance sheet that the Fed now has, as we look at where we are today, has there been any thought, looking in the rearview mirror, that it might have been good to unload some of that earlier so there was additional ammunition should that be needed in the future? Ms. YELLEN. Well, so I think the thinking about additional am- munition is that the best ammunition we have and the single most reliable and predictable tool for affecting the stance of monetary policy is variations in short-term interest rates. So as the economy has now gotten to a point where we are slowly reducing accommo- dation, we have a choice between selling off assets or raising short- term interest rates. Senator CORKER. I am talking about as the economy goes the other direction, and I guess the question then is—so you have got a pretty loaded up balance sheet, and I think people are beginning to observe that the Fed is probably out of ammunition, unless you decided to go to negative rates. And if you could, briefly—I am not proposing this. I am just observing what is happening around the world and what is happening here in our own country. I think peo- ple are waking up and realizing that the Fed really has no real am- munition left. You alluded to this some yesterday, but—and I have one more question, so I do not want this to be too long. But are you considering if things go south, which none of us hope do, are you considering negative rates? I know you had that question yes- terday. Yes or no? Ms. YELLEN. So the answer is that we had previously considered them and decided that they would not work well to foster accommo- dation back in 2010. In light of the experience of European coun- tries and others that have gone to negative rates, we are taking a look at them again because we would want to be prepared in the event that we needed to add accommodation. We have not finished that evaluation. We need to consider the U.S. institutional context and whether they would work well here. It is not automatic. Senator CORKER. Yeah. Ms. YELLEN. There are a number of things to consider. We have not—— VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 18 Senator CORKER. I got it. Ms. YELLEN. So I would not take those off the table, but we would have work to do to judge whether they would be workable here. And I would say we have—— Senator CORKER. I would have thought that where we would be is that we were out of ammunition. And it would be good for the markets to understand that we are out of ammunition, and now it is up to other factors. But now, as I hear it, potentially negative rates are something that could affect things over time. If I could just go down one more path, productivity. You have talked about that as the greatest driver for wage increases. And I appreciated some of Senator Brown’s opening comments, and I want to say that, you know, the concern that we all have is the most vulnerable in our society are the ones that are hurt most when we have downturns and the slowest to regain, and there is no question there is a wealth gap in our country. The question is: What do we do about it? You have mentioned the most important factor determining pro- ductivity in advances in living—advances in living standards is productivity growth, defined as the rate of increase on how much a worker can produce in an hour of work. Over time, sustained in- creases in productivity are necessary to support rising household incomes. And then later on, we do know that productivity ulti- mately depends upon many factors, including our workforce knowl- edge and skills. By the way, does monetary policy affect knowledge or skills? The answer is no. Does the quality of capital equipment—monetary policy does not affect that. Is that correct? Ms. YELLEN. Well, the only qualification I would make is that during a long, deep downturn like we had, capital investment, in part because it was not needed, was very slow. And that leaves a legacy that has a negative impact. And when people are out of work for a long period of time, their skills can erode to the point where it becomes difficult for them—— Senator CORKER. I am trying to help you here. The teacher has now showed up, and he is going to reprimand me for going over. So is there anything about monetary policy that—— Chairman SHELBY. Senator Corker knows that would not be in order. Senator CORKER. Does monetary policy affect infrastructure in- vestment? Ms. YELLEN. No. Senator CORKER. OK. So the point is productivity is sort of on this side of the dais. Is that correct? Ms. YELLEN. Yes. Senator CORKER. And when people try to look at the Fed through monetary policy to increase productivity, it is a ridiculous notion, is it not? Ms. YELLEN. Fundamentally, it is not something we control. Senator CORKER. And that is our job, and we are not doing our job. Let me just ask one last question, and the Chairman has been very nice. He came in today in a very good mood. [Laughter.] VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 19 Senator CORKER. Last year, in a budget meeting, the head of— Doug Elmendorf came in and said that because Federal borrowing reduces total saving in the economy over time, the Nation’s capital stock would ultimately be smaller than it would be if debt was smaller, and productivity and total wages would be lower. So as we accumulate debt, we are actually hurting many of the people in this room that came today because they care about this, because we are really hurting productivity. Is that a true statement? Ms. YELLEN. Well, over long periods of time, yes, I would agree with that. Senator CORKER. Thank, Madam Chairman. Thank you, Chairman. Chairman SHELBY. Senator Menendez. Senator MENENDEZ. Thank you, Mr. Chairman. Madam Chairman, let me talk about the challenges of families who still, notwithstanding the numbers, do not see their incomes rising. I know that in some respects the numbers are indisputable. The unemployment rate is at 4.9 percent, the lowest since we have seen since February 2008, less than half of what it was at the peak in October 2010, 14 million jobs over 71 straight months. But those numbers in my mind do not tell the whole story. Long-term unem- ployment persists with people unemployed for 27 weeks or longer, compromising more than a quarter of all of the total number of job- less individuals. Hardworking families throughout the country have been waiting too long for income increases to materialize. And those the economy has partially healed and hopefully will continue to heal, to me there is a clear indicator of how much harm was in- flicted by the financial crisis. Many employers due to market conditions are paying low wages and offering limited benefits to their employees with little concern that these employees will leave because of the slack in the job mar- ket. Employers have a sea of prospects every time an employee jumps ship. So talk to me about what needs to be done at the Fed and else- where to address long-term unemployment and to foster policies that transform economic growth into growth for hardworking fami- lies. Ms. YELLEN. Well, I think what we are trying to do to contribute to the solution of that problem is to keep the economy growing at a steady pace, to keep the labor market improving in the hope and expectation that a stronger labor market will improve the status of all groups in the labor market and begin to bring down long-term unemployment, involuntary part-time employment, and we have seen that. So unemployment rates have come down for almost all demo- graphic groups. As high as it is, the incidence of long-term unem- ployment has declined. Involuntary part-time unemployment has also declined as the economy has improved. But these are long- standing adverse trends, including structural factors like globalization, the very slow growth in middle-income jobs, techno- logical trends that have favored higher-skilled workers. I mean, I think for Congress there are any number of things that you might consider and might do that would be helpful in addressing these trends. Some of them, many of them would be related to training, VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 20 education, increasing opportunity to make sure that those skills can be more readily acquired. Senator MENENDEZ. Let me ask you, just before I turn to another subject, how can the Fed better account for full employment and, thus, enhanced efficiency and production in its analysis and plan- ning? Ms. YELLEN. Well, from my point of view, and I think from the point of view of the FOMC, more jobs are always good, employment is good. And when we think about maximum employment, we are really considering is there a point at which pursuing that goal would lead to higher inflation and inflation above our 2-percent ob- jective. So we try to estimate, and, in fact, all participants in the FOMC every 3 months write down their estimate of the unemployment rate in the economy that would be sustainable and consistent with our inflation objective. At the moment the median of those esti- mates is 4.9 percent, but most of us recognize that there are addi- tional forms of slack that we would certainly like to see diminished. Senator MENENDEZ. Well, as a corollary, and a final point I would like to hear from you on, context matters. When I sit on the Senate Foreign Relations Committee and I see what is happening with China and other places in the world, context matters. And here in the United States and in Europe and Asia, we have seen the combination of fiscal austerity and tight monetary policy can be toxic for an economy that is recovering. And so I know that there is this sense among—I think there is a sense among Fed policy- makers that they are eager to reach the point in the economy where we can ‘‘normalize’’ monetary policy by raising rates. But can you describe the risks to the economy—and this is always a calibration, I understand—of tightening too soon? And do you take this global context into consideration when you are looking at that? Ms. YELLEN. We absolutely take the global context into consider- ation, and normalization is not something we want to pursue and accomplish for its own sake. We only want to move to more normal levels of interest rates if it is consistent with achieving our objec- tives of 2 percent inflation and maximum employment. We want to and intend to put in place the monetary policy that is consistent with achieving those objectives. In an economy that has been recovering, the Committee felt that it could be on a path and would likely be on a path where short- term rates would gradually rise over time consistent with that ob- jective. But I want to emphasize that monetary policy is not on some preset course. Monetary policy will be set and calibrated to do the best we can to achieve our congressionally mandated objec- tives. Senator MENENDEZ. All right. Thank you, Mr. Chairman. Chairman SHELBY. Senator Toomey. Senator TOOMEY. Thank you, Mr. Chairman. And, Madam Chair- man, thanks for joining us again. I want to follow up on the line of discussion that Senator Corker was discussing, and, Madam Chairman, we have had this conversa- tion before. You may recall I have been advocating that the Fed normalize interest rates for a long time now. One of my deep con- cerns is that central banks around the world, very much including VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 21 our own, seem to be trying to compensate for an inability of the po- litical class around the world to address what is really holding back economic growth, which are fiscally unsustainable budgets, in our case and I would argue in much of the rest of the world, an ava- lanche of new regulations that is holding back economic growth, high marginal tax rates that discourage savings, work, investment. And the fact is central banks’ monetary policy cannot make up for those problems. In fact, you could argue in some cases they can make it worse. Now we see the markets as of this morning appear to be pricing in an expectation that there will be no further increases in the in- terest rates that the central bank controls. They may be right, they may be wrong, but that is the expectation now. And there is this discussion, since the rest of the world is pursuing ever further this new chapter in radical monetary policy, we have this discussion about negative interest rates. And I appreciate the fact that you in your discussion with Senator Corker pointed out that there might be some serious concerns. I find it very, very disturbing to even seriously consider moving in that direction, and I hope we could talk about some of the poten- tial risks of negative interest rates, because I think there is a qual- itative difference, and I would like to get your thought on this be- tween, say, a 25-basis-point movement in Fed-controlled rates, a movement that takes you from a low-positive rate to another low- positive rate, versus one that crosses the threshold into the nega- tive. Above and beyond the psychological effect—I think most of us have grown up our entire life with the expectation that there is an absolute floor to interest rates. That would be shattered, and that might have unanticipated consequences. But there are practical consequences, too, and I am hoping you could comment on some. For instance, it would seem that it would crush net interest mar- gins for banks and perhaps dramatically diminish their ability to provide capital. I do not know how a money market business sur- vives at all if there is a sustained period of negative interest rates. I could see an adverse effect on business investments. Investors would be pressured to move further out the risk curve, even further than they have already been pressured. It would put the U.S. deep in the midst of a global currency war, which is won by he who de- bases his currency the most. And I would suggest that the results where it has been tried have not gone so well. Sweden has had negative interest rates since 2009. They have got a massive property bubble. The eurozone area generally has had negative interest rates since June of 2014. GDP growth has been very, very weak. Japan recently instituted negative interest rates, and as you saw, among other problems, they recently had a completely failed auction. They had to give up on auctioning off JGBs, so I guess we just monetize the debt. It seems to me there are a lot of potential problems, and I won- der if you could, first, confirm that, for a layman, when we talk about negative interest rates, if that is imposed on savers, we are talking about savers having to pay a bank in order to take their money on deposit. Isn’t that equivalent to a tax on savings? And could you just comment on some of these other problems? VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 22 Ms. YELLEN. So in the European countries that have taken rates to negative territory, while I will say I was surprised that it was possible to move rates as negative as some countries have done, I think we have not in those countries seen actual fees levied on de- positors. I may be wrong about—there may be some experiences there that I am not aware of, but I do not think there has been broad-based passthrough of negative rates to at least small deposi- tors. But—— Senator TOOMEY. And if banks resist that, then that just means their margins are crushed. Ms. YELLEN. Their margins have been squeezed. A low interest rate environment generally tends to push down net Internet mar- gins. Now, they adopted it because they were concerned about infla- tion running very much below their objectives and wanted to stim- ulate the economy in order to achieve those objectives, so there were reasons that they adopted it. In our own context, when we considered this in 2010, we were concerned about potential impacts on money market functioning and did not really think it was be possible to bring them to very negative levels. And before we were to take a step like that, we would have to think through all of the institutional details and how they would work in the U.S. context. I think as a matter of due diligence and preparedness, these are things we need to work through, but we do not even know if pay- ments and clearing and settlement systems in our context would be able to easily handle negative rates. So we have not studied that. Senator TOOMEY. And just a very quick follow-up, Mr. Chairman, and I will be finished, but isn’t it also true that there is an internal memo at the Fed from, I think it was, August of 2010 that raises doubts about whether the Fed has the legal authority to impose negative interest rates? Ms. YELLEN. No. So there is a memo from 2010, and what it real- ly said is that the legal issues have not been studied. It was silent on the legality. It was a memo that discussed market functioning and economic issues connected with it, and the legal issues had not been vetted. I am not aware of any legal restriction that would mean that we could not establish negative rates, but I will say that we have not looked carefully at the legal side of this. Senator TOOMEY. I would like to submit that memo to the record, Mr. Chairman, and just quote very briefly from—— Chairman SHELBY. Without objection, it will be made part of the record. Senator TOOMEY. Thank you, Mr. Chairman. Among other things, the memo does say, and I quote, ‘‘There are several poten- tially substantial legal and practical constraints.’’ In another part of the letter it says, and I quote, ‘‘It is not at all clear that the Fed- eral Reserve Act permits negative IOER rates.’’ So, obviously, there was a question in somebody’s mind. Ms. YELLEN. Right. It had not been seriously studied, and at this point I am not aware of a legal constraint. But, again, we have not run that through a careful legal analysis. Senator TOOMEY. Thank you very much. Chairman SHELBY. Thank you. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 23 Senator Warner. Senator WARNER. Thank you, Mr. Chairman. Chairwoman Yellen, it is great to see you, and thank you for your service. As we kind of go back and forth about effects of mone- tary policy or not—and I share some of Senator Toomey’s concerns about negative interest rates—I would, a little tongue in cheek, make mention of one of your comments in reply earlier to Senator Menendez, which I think would actually have 100 percent approval on this panel, where you said more jobs are good for the economy. How we get those more jobs is some question, and we can debate monetary policy or not. But one of the things—and we were talking about productivity, and, again, I share your views on productivity. Productivity gains often are driven by knowledge and skills, and I think one of the things that we have talked about before, but un- fortunately this Congress has not fully addressed, is the rising challenge around student debt, now at $1.3 trillion and rising, greater than credit card debt, and the ripple effect that has across our whole economy, not just to those individual students or recent graduates and their families, but I would like you to comment upon that kind of wage box you are caught in with rents, student debts, not enough rising wages, and the effect that has both on startups, as someone—we all know 80 percent of our net new jobs have been created by startups over the last 30 years. Startup entrepreneur numbers are down, a lot of that, I believe, due to student debt. First-time home buyers are down, often times due to student debt. I know you and other regulatory entities have looked at this, but I would like you to comment on the effect if we continue to have this number grow and do not take a more comprehensive approach to student debt, what kind of drag that will be on the economy, be- cause, again, echoing your comments that more jobs are better for the economy, driving down that student debt I believe would lead to further growth in the housing market and further growth in en- trepreneurial activities. Ms. YELLEN. So, on the one hand, taking on that student debt, to the extent it is successful in building skills that put people in higher-wage jobs and qualify them for better work is really critical to their getting ahead. You know, on the other hand, there is a lot to worry about with student debt, with people attending colleges or gaining education where they do not finish, the reward is not there, to me a major concern is that people may not be well-informed about what the benefits are of what they are taking on. And if an individual finds themselves in difficult financial straits for any reason, that debt, because it is not dischargeable in bankruptcy, can be a very severe burden that really holds people back. In terms of studies, there has been, it would appear, a decline in new business formation. I have not seen anything myself, but I might not be aware of studies that link it to student debt. I have not seen that. It is certainly possible, but I am not aware of that. With respect to housing, some economists at the Fed have tried to look at that, and others have, and I think the results are mixed. It is not clear that student debt is a major factor responsible for inability to buy homes or get ahead in the housing market, al- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 24 though I understand it is quite logical that a heavy student debt burden would make it difficult—— Senator WARNER. I would simply note that home builders across all sectors are indicating particularly the weakest part of the hous- ing market is first-time home buyers, oftentimes people who, be- cause they are otherwise burdened with student debt, do not make those investments. And I think I would just urge my colleagues there are com- prehensive approaches that Senator Warren and others have sug- gested in terms of total refinancing. But there are other steps that can be taken, whether it is better transparency—we all know high- er education next to buying a house may be your most expensive item you purchase. Better transparency about outcomes, that would force higher education to come clean a little more. Clearly, the problem of not finishing is a huge issue. But we do not have very much transparency in higher education. On top of that, in- come-based repayment, the Administration has made some move- ments there. I think there are more. I mean, there is low-hanging fruit. Ms. YELLEN. Yes. Senator WARNER. Businesses already can provide ongoing edu- cation to employees on a pre-tax basis. I scratch my head, and I have got bipartisan legislation that would say if you can go ahead and continue your education on a pre-tax basis, why shouldn’t an employer be able, in concert with an employee, to use pre-tax dol- lars to pay down student debt on both sides of the balance sheet? Good for retention, good obviously for the employees as well. I will not go ahead and take the additional 3 or 4 minutes that most of my colleagues have had beyond the timeline in respect to my other colleagues, but I would like to submit for the record a couple of questions about what happens as we draw down this cap- ital surplus account, and obviously the Fed has kicked in about $517 billion over the last 6 years. As you wind down that portfolio, we could see, obviously, those dollars go down. And I know that you share some of the concerns. As we unwind that $4 trillion bal- ance sheet, how much cushion does the central banking system need, particularly when Congress most recently has raided part of that cushion, and I would take that for the record. Thank you, Mr. Chairman. Chairman SHELBY. Thank you. Senator Cotton. Senator COTTON. Thank you. Since Senator Warner graciously yielded back his extra 3 or 4 minutes, I will just add that to my extra 3 or 4 minutes to get 8 or 9 extra minutes maybe. [Laughter.] Chairman SHELBY. Chair Yellen is not up here every day. Senator COTTON. I will try to be brief. Madam Chair, welcome back. Throughout much of history, the Federal Reserve has raised interest rates when economic growth is strong and accompanying inflation is growing—hence, the cliche that the Federal Reserve takes the punch bowl away right as the party is getting going. In December, we were in the middle of a quarter with seven- tenths of a percent economic growth and inflation was below the VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 25 stated target. The Open Market Committee raised interest rates. Could you explain why this historical anomaly occurred? Ms. YELLEN. Well, our focus is on the labor market and the path that it is on and the fact that economic growth has been very slow and this has been true for quite some time and yet the labor mar- ket has made more or less continuous improvements is a reflection of slow pace of productivity growth, I would say. So we saw a labor market where jobs were being created at a pace of around 225,000 or so a month. The unemployment rate had fell to very close to lev- els we would regard as sustainable in the longer run, although in my view there remains slack. There did and still remains some slack in the labor market. Monetary policy was highly accommodative. The funds rate had been at zero for 7 years, and we had a large balance sheet, so we were not talking about moving to a restrictive stance of policies simply diminishing accommodation by a modest amount. And while inflation was running below our 2-percent objective, the Committee judged that transitory factors, particularly energy prices and the appreciation of the dollar, were placing significant downward pres- sure, that that would ebb over time, and as the labor market con- tinued to improve, that inflation would move back up to 2 percent. And we want to make sure, given the lags in monetary policy, that we do not wait so long to begin the process of modest adjustments in the Fed funds rate that we end up significantly overshooting both of our objectives and allowing inflation to rise to the point where we would have to tighten policy in a more precipitate man- ner, which could potentially place ongoing sustainable economic growth and improvement in the labor market in jeopardy. So we wanted to be able to move in a very gradual way and to make sure that the economy remained on a sustainable course of improvement. Senator COTTON. Thank you. You used a term there, ‘‘transitory factors,’’ that you also cite on page 5 of your testimony where you say the Committee ‘‘judged that much of the softness in inflation was attributable to transitory factors that are likely to abate over time,’’ without specifying in the written testimony, you just cited energy prices and appreciation of the dollar. Are there any other transitory factors that you—— Ms. YELLEN. Those are the main ones, and, you know, of course, energy prices have continued to move down. Senator COTTON. So now 2 months on, do you still expect that energy prices and the appreciation of the dollar will halt or even turn around on their current trajectory? Ms. YELLEN. So, you know, energy prices have continued to move down. I feel eventually they will stop moving down and stabilize. Exactly when that will be, when that happens, when that eventu- ally happens and the dollar stabilizes, inflation will begin to move up, it is hard to predict exactly when that will be, and there can be and have been surprises. Senator COTTON. Thank you. I want to turn briefly to wages. Several Members of this Com- mittee have expressed their concern about stagnant wages, espe- cially for working-class men and women in this country. I share VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 26 that concern, as do apparently many people in the audience, judg- ing by their T-shirts. One point we have not touched upon is immigration, and here I do not mean illegal immigration but legal immigration. We are now at record-high levels of foreign-born residents in this country. Something like one-seventh of all American residents were born in a foreign country. Do you think that that level of mass legal immi- gration has put downward pressure on the wages of working men and women in this country, native-born Americans? Ms. YELLEN. I am not aware of evidence that suggests it has, but I would need to look into it. I am not aware of evidence on that. Senator COTTON. OK. Thank you. Chairman SHELBY. Senator Warren. Senator WARREN. Thank you, Mr. Chairman. And it is good to see you again here, Chair Yellen. And it is also good to see people here from across the country, people who are fed up. I know that as Chair you have done a lot of outreach, but seeing people here who have come in from a lot of different places is a strong reminder that every Fed decision affects every person in this country. And the Fed has plenty of opportunities to hear from giant banks. It is good to hear from real people and get that reminder, so thank you. Now, I want to go back to another question here. As you know, Dodd-Frank requires giant financial institutions to submit living wills. These are the documents that describe how these banks could be liquidated in a rapid and orderly fashion in bankruptcy without either bringing down the economy or needing a taxpayer bailout. If the Fed and the FDIC find that those living wills are not cred- ible, the agencies can take steps to reduce the risks poses by these banks by imposing higher capital standards, by lowering leverage ratios, or by breaking up the banks by forcing them to sell off as- sets. A year-and-a-half ago, in August of 2014, the Fed and the FDIC identified several problems with the living wills submitted by 11 of the biggest banks in this country. The FDIC found that all 11 of those wills were not credible, while the Fed agreed about the prob- lems but then refused to make any determination about whether the wills met the legal standard about credibility. In other words, the Fed did not say they were credible, but the Fed did not say they were not credible either. Now, that mattered a lot because it is only a joint determination by the agencies that has any legal force. The Fed’s refusal to call the plans ‘‘not credible’’ meant the agencies could not use statutory tools to push these risky banks in the right direction. So I want to start by looking back at that decision by the Fed. The FDIC stands behind insured deposits, so its main mission is to stop bank failures before they happen so taxpayers will not be on the hook for some kind of bank failure. Of all the regulators, the FDIC has the most expertise in liquidating failed banks. So if the FDIC found that the banks’ liquidation plans were not credible and the Fed agreed with the FDIC on the basic problems with each of these plans, why did the Fed refuse to join the FDIC and designate these plans as not credible? VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 27 Ms. YELLEN. Well, looking back to the decision we made last year, we had set out in the guidance pertaining to these living wills that we expected to go through a few rounds of submissions to clar- ify. It is a completely new process, and we felt the banks needed to understand what expectations were in terms of what we wanted to see, and we felt that we had not given sufficiently clear guidance to make the decision at that time. We worked very closely with the FDIC. As you noted, we have given detailed guidance to these firms about what we want to see in this round of living wills. We are spending a great deal of time, we have had seven full Board meetings so far since August to dis- cuss and work through these living wills. We are working closely with the FDIC in evaluating them, and we did make clear and it continues to be the case that if a living will does not satisfactorily address the shortcomings that we identified last year, that we are prepared to make findings that a living will is deficient. Senator WARREN. OK. So let me go then to where you are going here. The FDIC already thought that the facts established that the plans were not credible for 11 of the largest financial institutions. In August of 2014, the Fed and the FDIC required those 11 firms to resubmit living wills that addressed the problems they had iden- tified, and the firms resubmitted their plans last July. And as you say, it is my understanding that you are just about finished review- ing those plans. So once again I want to underline only joint deter- minations by both the FDIC and the Fed will carry the force of law. So can you say today that you will work with the FDIC to ensure that the agencies issue joint determinations of credibility on each of the 11 living wills that were resubmitted? Ms. YELLEN. We are working very closely with them to evaluate these living wills, and—— Senator WARREN. Well, I assume you did that last time, that you worked closely with them. I think that is what you said in your tes- timony. Ms. YELLEN. We did, and we wrote joint letters to these firms, and we will certainly try to do that again to identify shortcomings that the living wills have and further steps that we want to see. Each member of the Board of Governors and members of the FDIC Board are charged with arriving at our own individual judgments as to whether or not these living wills are credible or facilitate res- olution, and I cannot guarantee you that we will arrive at identical conclusions. Senator WARREN. OK. Fair—— Ms. YELLEN. ——we have each been vested by Congress into making a judgment based on the merits. Senator WARREN. OK. If you cannot ensure that the agencies will issue joint determinations, which is how we get to the effect of the law, let me ask if you will make another commitment, and that is, will you at least commit that if the Fed finds a living will credible and the FDIC does not find a living will credible, that the Fed will issue a written public explanation for why it is reaching a different conclusion? It seems like that is the least that the Fed can do to help the public understand its position. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 28 Ms. YELLEN. Well, my expectation is that we will release the let- ters that we send to the firms giving our evaluations of their living will. Senator WARREN. So you will be explaining—if there is a dif- ference between the Fed and the FDIC, you will be issuing a writ- ten statement about why the Fed decided something was credible that the FDIC found was not credible? Ms. YELLEN. Well, I want to be careful exactly what I say about this. Senator WARREN. Good. Ms. YELLEN. We expect to send letters; hopefully they will be joint letters; hopefully we will be able to agree on what the short- comings are of the living wills and if either agency finds that they are not credible, we need to identify specific deficiencies that we wish to see remedied. And my strong hope and expectation is that we will arrive at joint agreement with the FDIC on those defi- ciencies and release letters that explain what we find them to be. Senator WARREN. Well, I very much hope that the Fed and the FDIC are on the same page. That is the only way we get the im- pact of this law. Living wills are one of the primary tools that Con- gress gave to regulators to make sure that the taxpayers will not be on the hook if another giant bank fails, and it is critical that the Fed use this authority, like the FDIC has been willing to do, to make sure our financial system safer. Thank you. Ms. YELLEN. I agree with you on that, and we have been working with them all along through our supervisory process as well, which is separate, but we are also emphasizing recovery planning and resolution through our supervision. Senator WARREN. Thank you. Thank you, Mr. Chairman. Chairman SHELBY. Thank you, Senator Warren. Senator Rounds. Senator ROUNDS. Thank you, Mr. Chairman. And welcome. I sus- pect now that you have had more than 60 different individuals ask- ing questions. Most of them perhaps have been asked. In looking at today’s testimony, I think a lot of attention was paid to the discussion on negative interest rates, and I noted that there were a couple of items that I suspect, as you have shared, you have indicated that while you would be looking at negative rates, the analysis is not yet done, and that it is not off the table. But you have also indicated that the variations in short-term inter- est rates is one of the key tools that you have. Would it be fair, though, to say that today, as you have answered these questions, the current discussion and the current focus is not so much on reducing the interest rates that we have in effect today but, rather, whether they should remain stable or move up? Ms. YELLEN. Well, yes. We certainly felt in December when we made our decision to raise rates that the economy was recovering, that inflation would move up, and it would likely be appropriate to gradually continue to raise rates, not to cut them. A lot has happened since then. As I have indicated, global eco- nomic and financial developments impinge on the outlook. We are in the process of evaluating how those developments should affect VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 29 our outlook or our assessment of the balance of risks. We will meet in March and provide a new set of projections that will sort of up- date markets on our thinking on the outlook and the risks. But I have not thought that a downturn sufficient to cause the next move to be a cut was a likely possibility. And we have not yet seen, I would say, a shift in the economic outlook that is sufficient to make that highly likely. But in saying that, I also want to make clear that policy is not on a preset course, and if our perception of the risks and the outlook changes in a manner that did make that ap- propriate, certainly that is something the Committee would have to take into account in order to meet its objectives. It is not what I think is the most likely scenario. Senator ROUNDS. Very good. Let me just change focus a little bit and move into basically the regulatory side of the responsibilities which you carry. When the Federal Reserve writes its rules, I think it is important for the Board to do a thorough cost-benefit analysis before it cre- ates any new red tape or negotiates international agreements like insurance capital standards. We talked a little bit in here about the fact that there is a regulatory impact on productivity, and the one thing that on our side of the dais we talk about is what we can do most certainly to provide opportunity for productivity to increase within our economy. There are some areas in which you do have on the regulatory side an impact as well. With regard to the issue of international agreements, specifically on insurance capital standards, is the Fed currently working on any cost-benefit analysis related to the insurance industry either in the context of regulation or for international agreements? Ms. YELLEN. So we are very carefully considering what capital standards we should impose on the designated firms that we need to create standards for or S&L holding companies that are pri- marily insurance-focused. Senator ROUNDS. But will you do a cost-benefit analysis to those rules? Ms. YELLEN. We are charged with putting in place appropriate standards to mitigate systemic risk in the event that one of those firms would have failed, to make it operate in a safer and sounder way, and that is our charge. We will put rules out for comment. We will consider regulatory burden. And we will consider various ways of designing rules which might be least burdensome, and—— Senator ROUNDS. But would that mean that you would consider then doing a cost-benefit analysis and the burden that these may place on the individual entities that you are regulating? Ms. YELLEN. Well, we will certainly put out a Notice of Proposed Rulemaking and consider comments on it, including those that per- tain to costs. Senator ROUNDS. So the answer is, ‘‘I would rather not answer the question on whether or not there is a cost-benefit analysis in- cluded’’? Ms. YELLEN. Well, I am not going to commit to a cost-benefit analysis of those rules. Senator ROUNDS. OK. Very good. One of the major concerns about the current insurance SIFIs designation process is that there is no real comparison with banks to determine systemic risk be- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 30 cause—I would suspect that we are in rather uncharted waters with regard to adding the insurance companies in with the banks and considering them as SIFIs. I am concerned that we may not have the reliable data to compare banks to insurance companies in this regard. What has either the Federal Reserve or the FSOC done compare the systemic risk of bank SIFIs and nonbank companies against each other? Has there been an analysis? Ms. YELLEN. So in the case of each of those designations, a very detailed analysis was done asking what would be the systemic con- sequences of the failure of that organization. And in the case of the insurance companies that were designated—MetLife, Prudential, and AIG—the FSOC did determine and judge with very careful work done that the failure of those organizations would potentially have systemic consequences that needed to be addressed. Senator ROUNDS. Are those publicly available analyses? Ms. YELLEN. They are on the FSOC Web site. You can find the analysis, and they do not include confidential firm information. The firms themselves were provided with greater detail than what is on the Web site, but there is detailed information available. Senator ROUNDS. Thank you. Thank you, Mr. Chairman. Chairman SHELBY. Senator Donnelly. Senator DONNELLY. Thank you, Mr. Chairman. Madam Chair, thank you. Yesterday was a really bad day for my home State of Indiana. We had over 2,100 workers who were given pink slips yesterday. They lost their jobs at a company that had been in Indiana since the early 1950s. Carrier’s Indianapolis plant will be closing, and UTEC is moving their manufacturing department from Hun- tington, Indiana, both part of United Technologies, over 2,100 jobs. All of those jobs are being shipped to Mexico. Last year, Carrier had $58 billion in sales and $6.1 billion in earnings. So we have 2,100 people who have lost their jobs because apparently $6.1 billion in earnings is not enough. Now, the promise of America has always been you work hard, you do your job, you help your company be profitable. And then in return you hope to have a decent retirement, to be able to maybe get a fishing boat, see your kids go to school. So how do we tell workers who have put their whole heart and soul into a company, who have provided them with over $6.1 billion in sales, that that is not enough? I mean, the reasons folks are here is because there has always been a promise if you work hard that the company in return will stand up and do right by you. So how is doing right having $6.1 billion in earnings and shipping 2,100 Indiana jobs off to Mexico when we also in Indiana have said you have one of the best busi- ness climates in America? And these same folks said if we put in tax extenders, things like bonus depreciation, research credit, Eximbank—I sat here and fought for Eximbank because these folks came and said this will help American jobs stay in America. So how do you provide the confidence to these workers and oth- ers that this compact even exists anymore? VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 31 Ms. YELLEN. A great deal has changed in the job market, and many families during the downturn particularly but on a longer- term basis have faced the kind of miserable situation that you have described of losing a job that they held for the better part of their career and expected would provide them a secure retirement. And this is a miserable and burdensome situation that many house- holds have faced. For our part, what we are trying to do and have tried to do is make sure that there are enough jobs overall in the economy that those workers can find another job. And, of course, we know—— Senator DONNELLY. I understand, but I am just asking you—and maybe this is not as the Fed Chair. Why should they have to find another job when they produced over $6.1 billion in earnings for a company that is doing extraordinarily well but it is still not enough? ‘‘We are going to ship your job to Mexico because you cre- ated huge profits for us. You created incredible success for us. You created the opportunity for this company to grow and for our share- holders to do really, really well, but we just do not have room for you as the worker anymore.’’ Ms. YELLEN. Many firms have made that decision, that moving their activities elsewhere is a profitable course and have made those decisions. Senator DONNELLY. And the question becomes: Profitable for who? For an America that we have forever had the promise that you do your job, like I said, you work hard—I mean, that is what my dad did every day. He took the train to work every day so he could feed us kids. I was the fifth of five. But his company never told him, ‘‘Sorry. You made a ton of dough for us. We are moving to Mexico.’’ And if they did, I do not know what we would have done. And now we are facing the same thing in the steel industry as well. We have been facing it for a while, and you have probably heard there are actually questions about the ongoing viability of a number of the American steel companies. And a big part of that is currency manipulation, illegal dumping, all of these kind of things. And so, you know, as we look at this, I know the Treasury De- partment monitors currency manipulation. Other agencies monitor illegal trade activities. But as head of the Fed, are you concerned that the United States tries to play by the rules while other coun- tries dump steel here, dump other products here, manipulate cur- rency, and we seem to be unable to provide our companies who are doing with a level playing field? Ms. YELLEN. Well, U.S. policymakers—the Treasury has prime responsibility for exchange rate policy, but they have made clear and the G7 has made very clear that currency manipulation to at- tempt to gain advantage for a country’s products in global markets and to shift the playing field through currency manipulation is un- acceptable policy. And I know that the Treasury Department in their conversations with foreign officials in other countries is vigi- lant about looking for and addressing currency manipulation. On the other hand, we all recognize that countries should be al- lowed to use tools of domestic policy like monetary policy to stimu- late domestic demand in situations where inflation is running well below a country’s inflation objective or domestic spending, unem- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 32 ployment is high and domestic spending is weak. We have used monetary policy for this purpose. Other countries have done the same. And there is some impact of monetary policies on exchange rates. We recognize that. But it also works through other channels that tend to have broadly shared benefits. Senator DONNELLY. Well, as Fed Chair, I hope you keep in mind, as you set rates, as you set other things, the importance to our families of the chance to go to work. And I feel in particular very burned today, after having fought so hard for the Eximbank, that some of the very same folks who told me it was critical for jobs in the United States, to be there when they needed something, and then to walk away now. Thank you, Madam Chair. Thank you, Mr. Chairman. Chairman SHELBY. Senator Heller. Senator HELLER. Mr. Chairman, thank you, and thanks for hold- ing this hearing. I want to thank the Chairwoman for being here also and taking the time. I want to raise some questions about how the Fed communicates with the general public, specifically their policies and specifically how you communicate those. Let me give you an example here, and it led up to the increase of the interest rates back in December. You had people from the Fed like the head of the San Francisco Fed saying that they were pretty hawkish that interest rates were going to be increased and that those increases were coming, and the market reacted to it. Then there were others like the head of the Chicago Fed calling for rates to stay near zero, and the markets reacted to it. Then we had some Fed officials implying that any rate increases would be data-driven, and the markets responded to that. And then we had some saying there was no formula. Even today, we seem to have a new person each day giving their thoughts about future rates. Now, I do not have a problem with broad questions and a variety of viewpoints coming from Fed members, but what it is causing, though, is confusion and instability in the markets today every time someone has something to say, feeling like they have got to walk in front of a mic and make a comment. My question to you is: Do you think there is a problem here and how these markets are reflecting every time one of these Fed mem- bers opens their mouth by hundreds of points? Hundreds of points. And, in general, I am not sure most of them know what they are talking about. Ms. YELLEN. So I would say that Congress purposely created a system with a large monetary policymaking committee where there would be a diversity of views so that we did not fall into a group think type of mentality, and we do have at the moment 17 mem- bers who come to the table with a range of views. They—— Senator HELLER. So you are comfortable? You are comfortable where we are today? Ms. YELLEN. We have guidelines for communications because it is important to explain to the public what our policy is about. Senator HELLER. Could I see a copy of that guideline? I would sure like that. Ms. YELLEN. Yes, I would be glad to—— VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 33 Senator HELLER. OK. Ms. YELLEN. First of all, the guideline says that everyone shares a joint objective of explaining the Committee’s decisions. They can explain their own views, but should be explaining that they are not speaking for the Committee, that they are speaking for themselves. And the person who speaks—— Senator HELLER. But they do have an official capacity, and—— Ms. YELLEN. ——for the Committee is the Chair. Senator HELLER. ——it clearly carries water. It carries water. You raised rates on December 16th by a quarter of a point. At that time the markets closed—the S&P 500 closed at 2,073. Yesterday, it closed at 1,851, and I think it is down another 34 or 35-plus points today. Do you feel that you or the Fed is responsible for this decline? Ms. YELLEN. Well, the immediate market response, and for a number of weeks, to the Fed decision was quite tranquil. It was a decision that I believe had been well communicated and was ex- pected, and there was very little market reaction. Around the turn of the year, we began to see more volatility in financial markets. Some of the precipitating factors seemed to be the movement in Chinese currency and the downward move in oil prices. I think those things have been the drivers and have been associated with broader fears that have developed in the market about the potential for weakening global growth—— Senator HELLER. OK. Let me—— Ms. YELLEN. ——with spillovers to inflation—— Senator HELLER. Thank you. Ms. YELLEN. ——so I do not think it is mainly our policy. Senator HELLER. Let us go back to oil prices again since it is not your policies that are causing the market decline. You told us last year here in this meeting that a drop in oil prices was a good thing for the economy and for the consumer. That is what you said a year ago. And yet since then we have seen thousands of jobs lost. We see oil companies in bankruptcy and consumers that are not spend- ing their gas savings. Do you still feel the same way about oil prices? Ms. YELLEN. Well, clearly, declining oil prices have had some negative consequences. There have been sharp job cuts and cutback in drilling activity and capital spending, and that has been—— Senator HELLER. Do you think you made a mistake? Do you think you made a mistake a year ago when you said it would be good for the economy and good for the consumers? Ms. YELLEN. On balance, I would say it is still true for the United States. We are net importer of oil, in spite of our large pro- duction, and the gains to households from lower oil prices, they av- erage about $1,000 per household. Now, whether they spend or do not spend those gains, those are substantial gains. From the standpoint of growth, what has been dominant so far I would say is the negative consequences on spend- ing from—— Senator HELLER. OK. Ms. YELLEN. ——the cutback in drilling activity. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 34 Senator HELLER. Let me get your feeling on a question. Do you think that banks here in America are overregulated or underregu- lated? Ms. YELLEN. I recognize that regulatory burden is a significant issue for many banks, and it is something we will do our very best and have been working to mitigate, particularly for community banks that are vital to the health of their communities. But I do think for the larger banks whose failure would have systemic con- sequences, it is critically important to make sure that they hold more capital liquidity, are held to higher standards to address the threats that they pose to the financial stability of our country and the global economy. Senator HELLER. So is it fair for me to say that you believe smaller banks are overregulated, large banks are underregulated? Ms. YELLEN. I do not want to say as a blanket matter that com- munity banks are overregulated. What I do think is that we need to do everything in our power to look for ways to simplify and con- trol regulatory burdens for them. Senator HELLER. One more question. Chairman SHELBY. Go ahead. Senator HELLER. One more question. Thank you for being—— Chairman SHELBY. We have got a vote, but go ahead. Let him ask the question. Senator HELLER. One more question. In a recent Wall Street Journal survey, the odds of a recession in the next 12 months have climbed to 21 percent, and that is double what it was a year ago. What are your thoughts on that? Ms. YELLEN. Well, as I mentioned in my testimony and in my an- swers this morning, we have seen global economic and financial de- velopments that may well affect the U.S. outlook. Financial condi- tions have tightened, and that can have consequences for the out- look. I think it is premature at this point to decide exactly what the consequences of those shocks will be, and it depends in part on whether they persist. And that is something we will be looking at closely going forward. Senator HELLER. Madam Chairwoman, thank you very much for being here. And, Mr. Chairman, thanks for the time. Chairman SHELBY. Thank you. Senator Schumer. Senator SCHUMER. Thank you, Mr. Chairman. Thank you, Madam Chair, for the good job you do. And now that Brooklyn is in the news, I am glad we have another daughter of Brooklyn doing well. I see that we have some people in the audience from a group called ‘‘Fed Up’’, many from New York, and I welcome them, al- though it was just my luck the people wearing New York City beanies left just before I spoke. Tell them hello. And I see that some of the shirts say, ‘‘Let our wages grow’’, and that is apropos, and that relates to my first question. I was pleased to see that wages rose 0.5 percent—oh, they came back. Hi, New York City people. I believe I saw that wages grew 0.5 percent in the month of January. I hope recent data we have seen is a sign that middle class incomes and people trying to be VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 35 in the middle class, their incomes are growing again, because wages have been stagnant for too long. But I have to be honest with you. Given the fact we are in a de- flationary environment globally and our own inflation rate is con- tinuing to run well below the Fed’s 2-percent target, I am con- cerned that further movement by the Fed to raise rates in the near term could snuff out the embers of real wage growth before they are even given a chance to catch fire. If you believe that the flattening and decline of wages is the number one problem our economy faces, that it is harder to stay in the middle class, it is harder to get to the middle class than it has been in a very long time, you make that a very high priority— which I do and I know you do. So going forward, do you still believe that, given the room for growth in the labor market, considerable evidence of consistent wage growth is still important for you to see before the Fed con- siders raising rates further? And, second, will the FOMC be par- ticularly cautious in its decision making so as to protect against the prospect of stifling wage growth before it even gets going? Ms. YELLEN. So Congress has assigned us maximum employment and price stability as objectives. Our focus is on inflation and try- ing to achieve a 2-percent objective for inflation. The behavior of wages—so, first of all, we have seen substantial improvement in the labor market, and we, at the time we raised rates, expected that improvement to continue, fully expected as that occurred that wages would move up at a somewhat faster pace. Senator SCHUMER. We have just begun to see it. I mean, it is hardly sufficient. Would you not agree? We have not made up for the loss in wage growth over the last decade yet. Ms. YELLEN. Well, productivity growth has been extremely slow, and the state of the labor market and the pace of inflation are not the only factors feeding into wage growth. For the last eight quar- ters, productivity in the nonfarm business sector has barely grown at a quarter of a percent, and that is a substantial drag on wages as well. So I would not say that wage growth is a litmus test for changes in monetary policy. But it is something that is indicative both of likely inflationary pressure going forward. It is not a sure sign of it, but it is relevant, and it is also relevant in assessing whether or not we are at maximum employment. Senator SCHUMER. Well, yeah, but I see it just the other way, that I am less worried about inflation and more worried about slow wage growth, which has picked up a little bit late. But if you look at the last decade or even the last three decades, productivity is considerably further up than wage growth is. And one of our great challenges is tying the two together. So I will just say I hope that you and the FOMC will look at growth in wages—it may not be the only issue, for sure, but it is a very important issue. But I am going to move on here, and you can comment further on what I said if you want. But it is related. Now, another thing that is going on is the strength of the dollar, and it has been critical in the interplay, so I want to get your spe- cific thoughts. Given the strength of the dollar and the influence of the global deflationary environment, couldn’t one argue that the VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 36 dollar’s strength has essentially served as another increase to the Federal funds rate? If you look at manufacturing, it is not doing well because of all of those issues. And, again, it seems to me that efforts by the Fed to raise rates further could end up being a dou- ble whammy to our economy because here you have the strength of the dollar hurting our export businesses, which are still vital to us, and another wage rate—wages added onto that. So have you seen that the strength of the dollar has influence on whether you should raise rates further? Ms. YELLEN. The strength of the dollar is certainly something we take account of in deciding on monetary policy. I agree with you net exports have declined. It has been a drag on the economy and for that reason does factor into our thinking. It is one of the rea- sons we think that the so-called neutral level of the Fed funds rate is low at the moment, but remember that in spite of that drag and the impact it is having on manufacturing, the economy has contin- ued to create jobs at a pace of 220,000 or some a month. And so we cannot just look at sectoral impacts. We have to look at the overall performance of the labor market. But certainly the dollar and the drag that it implies—it is a symptom and in part a signal of the strength of the U.S. economy in comparison with many oth- ers. Senator SCHUMER. And a drag on the U.S. economy. Ms. YELLEN. It is both. Senator SCHUMER. Which possibly could make things worse. Ms. YELLEN. It is both things. Senator SCHUMER. Thank you, Mr. Chairman. Chairman SHELBY. Senator Reed. Senator REED. Well, thank you very much, Mr. Chairman. And thank you, Madam Chairman, and thank you for your leadership and your endurance. We expect nothing less from a Brown grad- uate, so I am not at all surprised. One of human phenomenon is sometimes when you try to fix a problem, you unwittingly create other problems. I know in Dodd- Frank we were concerned about the bilateral nature of derivatives, and so we have now required them to be on a clearing platform, which creates not a bilateral issue but a multilateral issue. But that in itself introduces the possibility of systemic risk. And, frank- ly, one of the lessons of the crisis was always be on watch for the next fault line and take proactive steps to prevent it. In that context, the Financial Stability Oversight Council noted that there are still a number of central clearinghouse platform issues. Can you give us your comments now about how close you are watching? Is there any developments that concern you? And is this going to be a constant area of emphasis and investigation? Ms. YELLEN. So I completely agree with you. Creating those cen- tral clearing platforms has importantly diminished risk in the fi- nancial system, but they are a source of risk. FSOC has pointed out that this is making sure that they are appropriately supervised and operate subject to very high standards because they are plat- forms that concentrate risk. This is a very high priority for us. We are very focused on it. These platforms are now supervised. The SEC and CFTC have significant authority here. We have backup authority. Globally, there is a focus on ensuring comprehensive and VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 37 strong supervision of these platforms. So, you know, we are not ready to rest and say everything is done, but we are very focused on it, and it—— Senator REED. Let me underscore the issue the international is very important because of the ability and willingness of entities to arbitrage sort of regulatory environments, moving from here to someplace that does not have quite the same oversight. Ms. YELLEN. That is right. Senator REED. And you are trying, I believe in many ways, in- cluding margin requirements, to level the playing field internation- ally. Ms. YELLEN. That is exactly right. Senator REED. Thank you very much, Madam Chairman. The issue of Federal Reserve Bank Presidents, we have talked about this. I know you have got 12 that are due for reassignment or change at the end of February of 2016, a few weeks from now. They will be elected by the Class B Directors, who are elected by local financial institutions to represent the public, and then the Class C Directors appointed by the Board. A general issue is how do you ensure that there is real public participation in this process. One of the impressions that we had in 2008 and 2009 crafting Dodd-Frank was this sort of is an inside game in which, in fact, the Class A Directors appointed by the banks were influential. How do you ensure that there is a real pub- lic purpose and public scrutiny of these Directors? Ms. YELLEN. So the governance around this was established in the Federal Reserve Act, and we tried to make sure that the Re- serve Banks and the Board adhered to that. We tried to make sure that the Class C Directors that are appointed by the Board are broadly representative of the public and all sectors mentioned in the Federal Reserve Act. I think we have among Federal Reserve Bank Directors—— Senator REED. I must—I have been rightly corrected by my very intelligent staff. Presidents. Ms. YELLEN. Presidents. Senator REED. The Presidents of the Federal Reserve Banks. That is the focus of my question. Ms. YELLEN. Yes. So the presidents are appointed by the Class B and C Directors. We try to make sure that those Class Cs and that the Directors more broadly represent not only business inter- ests but also community interests, that there is sufficient diversity. The Board is constantly attentive in its oversight of the Reserve Banks to the issue of diversity of representation on those boards, and it has improved considerably. At the moment I believe some- thing like 45 percent of Bank Directors are either women or mi- norities. Now, they are charged with making recommendations about ap- pointment and reappointment of Reserve Bank Presidents, and the Board of Governors is charged with reviewing those recommenda- tions and deciding. And we will take that obligation seriously. We have a regular process, an annual process in which the Board through its Oversight Committee. We review each Reserve Bank every year and, in particular, the performance of the president. And the Members of this Committee discuss with the boards of di- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00041 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 38 rectors, the chair, and deputy chair the performance of the presi- dent. So there is ongoing monitoring of the performance of the presi- dent. There is feedback to the Boards of Directors on it. When we come up to the 5-year point to review these appointments, we will act on the recommendations of the Boards of Directors, but it is not as though we are just looking at that for the first time when we make those decisions. Senator REED. Thank you, Madam Chairman. Thank you, Mr. Chairman. Chairman SHELBY. Senator Heitkamp. Senator HEITKAMP. I do not know if they save the best for last, but, you know, we are hanging in there. The first thing I want to say—and it troubles me every time this happens. In your exchange with Senator Warner, Chair Yellen, when you talk about working people, you know, the answer is al- ways, ‘‘Let us improve their job skills. Let us get them more train- ing, and then they will get a better job.’’ Someone has to be a CNA; someone has to drive a garbage truck. And they are well trained for those jobs. But those jobs do not pay a living wage, and that is why so many people are frustrated, be- cause these jobs are not going to go away. These jobs are essential, whether it is being wait staff in a restaurant or whether it is being a CNA in a nursing home or whether it is, in fact, you know, deliv- ering pizza. And so, we need to be really careful when the response to wage inequality or income inequality is more skills for the workers, be- cause I think it does not focus the attention on the value of work and what we need to do to improve the opportunities for people who work every day. And I know you do not intend that, but I just felt like I had to get that off my chest. The challenge that I have in North Dakota is we are counter- cyclical. As you know, we are fundamentally a commodity-driven State. Commodity prices have taken a toll, whether it is in our ag- ricultural sector or whether it is in the energy sector, and that has been exacerbated by a high dollar value. I had a gentleman once ask me, said, ‘‘I just cannot figure out in North Dakota if a high dollar value is good or bad.’’ I said, ‘‘Let me help you with that. It is bad,’’ because we are fundamentally an export State. But I will tell you, we are deeply concerned about currency ma- nipulation. We are deeply concerned about the challenges of having to compete against other currencies in other markets, and that has national and, I think, international ramifications. But I also want to point out that in production—oil production, gas production—we have lost probably globally about 250,000 and about 100,000 jobs in this country. That is a huge hit. And it really was that production sector, whether we are talking about agri- culture or whether we are talking about oil and gas, that buoyed this economy during the tough times. There has been so little attention to the challenges of commodity producers, not just, you know, people who invest in commodities but the challenge of commodity producers. What is the Fed doing to analyze the challenges for commodity producers and to analyze VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00042 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 39 what the increase in dollar value and potential currency manipula- tion means going forward to production of commodities in this country? Ms. YELLEN. Well, we are looking critically—commodities, their prices, and trends are a huge global driver and driver for the United States. We look carefully at the factors that are resulting in low commodity prices and trying to understand the extent to which low prices reflect supply or shifts in demand in various emerging markets. Senator HEITKAMP. What impact do you believe the dollar value has had on profitability of commodity production in this country? Ms. YELLEN. When the dollar appreciates, it typically tends to push down oil prices. So the link that you are suggesting is cer- tainly there. We have a global economy in which there is consider- able weakness in many parts of the world, including Europe and Japan. Countries are adopting expansionary monetary policies in order to bring inflation up to their desired target levels and to ad- dress weakness in their own economies. The U.S., with a 4.9 per- cent unemployment rate, is far more advanced in that process of recovery, and the different cyclical positions of our different econo- mies, are a factor that is pushing up the dollar. The dollar in part reflects disproportionate strength in the U.S. economy, and that is a natural response to it. The U.S. Treasury is responsible for currency policy, and cur- rency manipulation is something that they would not sanction. The G7 has spoken out against it. But we do believe that countries should be able to use tools of policy like monetary policy for domes- tic ends. Senator HEITKAMP. And, obviously, one person’s monetary policy is another person’s currency manipulation, and I think we need to be very cautious in how we characterize monetary policy in other countries lest we not limit our access to tools that we may need. Ms. YELLEN. I think that is very important, and we have used—— Senator HEITKAMP. I get that. In the time that I have remain- ing—and I want to thank you for your patience, and you sat through a lot of hours here. I want to talk about something that I have been working on that has caused some concern within the Fed organization, and that is cost-benefit analysis and review of cost-benefit analysis of independent agencies. Senators Warner and Portman have pursued a bill for a number of years which, in fact, asks that there be an independent review of cost-benefit analysis of independent agencies. You have been subject to an Executive order that really is advisory, as near as I can tell, and we are trying to figure out how we can get a second opinion on your cost-benefit analysis. And I think that is an essen- tial piece of this if we are going to do the appropriate oversight. So I would just like a commitment that the Fed will work with us to try and understand your need for independent, but to please appreciate and understand our need for legitimate oversight and tools that help us with legitimate oversight. Ms. YELLEN. I am certainly willing to work with you on that, but as your comment indicated, you recognize the importance of inde- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00043 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 40 pendence for regulatory agencies that we not be subject to execu- tive branch review. Senator HEITKAMP. And we have worked to try and figure out how we replace OIRA as the reviewing agency, how we engage even to the point we contract with independent economists to actu- ally look at this analysis and get a second opinion. And I think, you know, you are kind of caught in the middle here, people who do not think you do enough and people who think you do too much. And one of the ways that I think we can broaden support for the Fed is broaden transparency. You know, to Elizabeth’s point, tell us why you are making a de- cision if you believe that the living will is appropriate. Tell us why you made this decision on cost-benefit. And I know, Chair Yellen, you have been very interested in being more transparent without being disruptive to markets. I appreciate the difficulty of the lane that you are in, but we need these tools in order to do our over- sight, and we need these tools kind of going forward. So I look forward to working with you. This is not an idea that is going to go away. It is an idea that has been introduced over and over again, and we would appreciate any input so that we can ac- complish what we want, which is to not set monetary policy but give us the tools that we need to review what decisions you make. So thank you, Mr. Chairman, and I am done. Senator BROWN. [Presiding.] Thank you. Senator Shelby, the Chairman, will return in a moment. He has three or four questions in the second round. I will ask a couple of questions now, and then I think we can dismiss you, Madam Chair. I want to ask a question about Senator Heitkamp’s views on cost- benefit. A lot of us are very concerned about these efforts on cost- benefit analysis and where it could take us as a Nation. I recall, as you do—and we have talked about this before—when the Presi- dent signed Dodd-Frank, the leading financial services lobbyists said, ‘‘It is halftime.’’ And that was a call, that sounded an alarm to a lot of us that we knew that they were going to do—Wall Street was going to do everything possible to slow walk and delay and lobby and push back against any of the Dodd-Frank implementa- tion that we all cared about and the reason we passed Dodd-Frank. And this whole cost-benefit analysis idea, frankly, is—I am not questioning anybody’s motives, particularly Senator Heitkamp’s, but it is, you know, the best way to weaken Dodd-Frank, and it is really kind of the dream of Wall Street to keep this slow walk going and slow it down even more. It is not just financial regula- tion, and you have done good work at the Fed. I wish the Fed in the past had done more, but generally, regulators are trying but this will undercut your efforts, this cost-benefit analysis bill, and ultimately lead to weakening health and safety rules, which has been the long-time battle in this institution. Emerson would talk about the battle between the conservators and the innovators, and the conservators wanted to preserve their privilege and power, and the innovators wanted to move the country forward. And cost-ben- efit analysis just helps the powerful people in this town resist any kind of regulation that makes people’s lives better, whether it is health, whether it is safety, whether it is safety and soundness of the financial system. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 41 So I want to ask a question about that and about your letter. Senator Rounds also asked you a question earlier about cost-ben- efit. It sounds like a good idea. How can you be against regulatory reform? How can you be against cost-benefit analysis? But it is ob- viously how do you calculate the benefit of a rule that contributes to safety and soundness? It is so much harder to quantify the bene- fits than it is the cost. That is not even counting the slow walk that this will require and how easy it is to delay things by the cost-ben- efit analysis. So you sent a letter out signed by many other agency heads. Just explain why you sent that letter and kind of make your case for why that is so important. Ms. YELLEN. Well, we were very concerned that the bill under consideration, first of all, would have a severe impact on the inde- pendent agencies’ ability to put out rules that would involve execu- tive branch, Presidential involvement. I agree with you, it would cause very significant delays in implementing regulations and probably result in unnecessary and unwarranted litigation in con- nection with our rules. We are putting our rules very often in situations where Congress has decided there is a safety and soundness issue they want us to address by imposing safeguards in a particular area, and our job is to figure out how to do that where Congress has already judged that the benefits are worthwhile. As you said, the financial crisis took a huge toll, an amazing economic cost to the country and the global economy. And you have directed us—— Senator BROWN. And I assume there would have been—— Ms. YELLEN. ——to try to create a safer and sounder financial system when we have done—for example, capital rules, there has been cost-benefit analysis. While there are some costs, the benefits of reducing the probability of a financial crisis overwhelm those costs. So our job is to find the least burdensome way of putting out rules to implement what Congress has told us to do. We publish Advance Notices of Proposed Rulemaking, Notices of Proposed Rulemaking, take comments, look for and discuss alternative ways that we might approach promulgating a rule to reduce burden and take comments into account. So it is not as though there is no a weighing of benefits and costs that are involved already in what we do. Senator BROWN. How long typically is that process? Ms. YELLEN. The process can take years, and especially when there are multi-agency rules that have to be put in place. We are coming close to completing the Dodd-Frank agenda of rulemaking, but it has taken a very long time, and we have been very actively engaged in trying to do this as rapidly as we possibly can. Senator BROWN. So if it has taken half a decade for the regu- lators, you and the FDIC and the OCC and others, if it has taken half a decade plus to do Dodd-Frank—— Ms. YELLEN. That is right. Senator BROWN. ——rulemaking, what would it—can you guess what it would have taken if there had been a cost-benefit analysis like this? Ms. YELLEN. Well, clearly, it would be much more burdensome and take much longer. There is no doubt about it. I cannot give you VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00045 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 42 a guess, but as you indicated, attempting to quantify the benefits of safety and soundness regulation is very difficult. Senator BROWN. Well, who would have wanted this to take longer? Ms. YELLEN. You indicated that those who were regulated—— Senator BROWN. Well, what do you think? Do not say what I in- dicated. But who in this town, who in this country would have wanted these regulations to have taken longer? Ms. YELLEN. Well, we know that banking organizations are con- cerned with regulations and the burdens that they impose. Senator BROWN. OK. Let me shift to another question. I think Senator Shelby will be back within a couple of minutes. I want to talk about interest on excess reserves. Some have sug- gested repealing or limiting the Fed’s authority to pay interest on excess reserves. I am concerned this is an attempt by those opposed to the unconventional steps the Fed took during the crisis to limit the Fed’s monetary policy tools. What are the implications of re- pealing or limiting interest on reserves? Ms. YELLEN. It is the most critical tool that we have for mone- tary policy to adjust the level of short-term interest rates and the stance of monetary policy. First let me say that our knowledge that we had that tool when the time came to raise interest rates was critical to the decisions we made throughout the financial crisis and thereafter to undertake unconventional policies, including large-scale lending programs, and then quantitative easing or large-scale asset purchases. The knowledge that we, when the time came, would be able to use interest on excess reserves to raise the level of short-term interest rates was critical in the decisions that we made that I believe provided great support to the economy and caused us to recover more rapidly. Now, if Congress were to repeal our ability to pay interest on re- serves, we would not be able to control short-term interest rates in the way we did before the crisis. So we would be forced to con- template shrinking our balance sheet perhaps rapidly, and I would be greatly concerned about the impact that that could have on the economy, on the economic recovery. For example, selling of mortgage-backed securities could raise mortgage rates and have a very adverse impact on the housing market, and we purposely decided that we will shrink our balance sheet in a predictable and gradual manner through diminishing or ceasing reinvestment to avoid the kind of unpredictable impacts on financial conditions that could come from rapidly selling off our portfolio. But without the ability to control short-term interest rates through using interest on excess reserves, we would be forced to contemplate those steps, and I would worry about their con- sequences. And, finally, if I could just take another second, I would like to point out that although we are paying banks interest on their ac- counts with us, the counterpart of those reserves is large asset holdings that we have on our balance sheet on which we earn con- siderably more interest income than we are paying to the banks, and that differential has resulted in 2015 in transfers from the Fed to the Treasury and the American taxpayers of $100 billion for the last 2 years, $600 billion since 2008. If our balance sheet had to VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 43 shrink rapidly, those transfers would clearly diminish to the far lower levels that were typical before the crisis. So this is not something that would be a financial winner. Our goal is economic performance. I think our top concern should be what would be the impact on the economy, which would be very negative. But even in the financial sense for the taxpayer, it would not be a positive. Senator BROWN. Good. Thank you, Mr. Chairman. Thanks. Chairman SHELBY. [Presiding.] Thank you, Senator Brown. Madam Chair, I have several questions. I know it has been a long morning, and we are in the afternoon now. Recently, a House- passed bill would force the Federal Reserve and other regulators to consider what you call ‘‘liquid and readily marketable municipal bonds’’ as Level 2 assets in the calculation of the bank’s liquidity coverage ratio. The Level 2A category, it is my understanding, cur- rently includes GSE securities, which are considered very liquid and uniform in structure. In addition, the Fed has proposed treat- ing eligible municipal bonds as Level 2B assets for liquidity pur- poses. My question: Do you support the House bill to treat municipal bonds as Level 2 assets? And why or why not? Ms. YELLEN. So I would not support the legislation to treat them as Level 2A assets. Chairman SHELBY. And explain why. Ms. YELLEN. Yes. Because this is a liquidity requirement to make sure that banks have sufficient liquid assets to cover the kinds of outflows they could see—— Chairman SHELBY. You are in stressful times. Ms. YELLEN. In a stressful situation. So the most liquid assets are cash and U.S. Treasuries. Mortgage-backed securities, Fannie and Freddie mortgage-backed securities and Level 2A assets are quite liquid but not as liquid as cash or Treasuries, which is why we have downgraded them. And while we have proposed to include some more liquid municipal securities, they are not as liquid as those included in 2A, and we have tried to recognize that while municipal securities generally are not very liquid, some are suffi- ciently liquid to include them in limited amounts but in Category 2B. And I think that this bill would interfere with our supervisory judgments about what constitutes adequate liquidity. Chairman SHELBY. Are there two things—we talked about this up here many times, and you have talked about it. There are two things banks need, capital and they have to have liquidity, because you could have capital and no liquidity, and in a stressful environ- ment you could be in trouble, could you not? Ms. YELLEN. Yes. Chairman SHELBY. So your statement is dealing with liquidity. You do not want to weaken the banking system. You want to strengthen it. Is that your basic premise? Ms. YELLEN. Absolutely, yes. Chairman SHELBY. OK. In the area of reforming the Federal Re- serve that I talked about in my opening statement, currently mem- bers of the Board of Governors do not have the ability to employ their own staff, instead relying on a shared staff of the Board, which you head up. I understand that you oppose a policy that VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00047 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 44 would allow a specific member of the Board of Governors of the Federal Reserve to employ even a single person to work exclusively for them. What are your reasons for opposing this policy? Is it control or is it—what? What is it? Ms. YELLEN. Well, I want to be careful. I think that Governors certainly are entitled—they have substantial responsibilities—— Chairman SHELBY. They do. Ms. YELLEN. ——and are entitled to adequate support. And as Chair, I have worked to make sure—and I think this is true that each of the Governors has somebody—— Chairman SHELBY. Well, you were a member of the Board of Governors before you were Chair. Ms. YELLEN. Yes, and it was important to me when I was a member and Vice Chair, and I took on a staff—it was a staff mem- ber, not someone I hired from the outside but a staff member who was assigned to work primarily with me to help me with my par- ticular work. And most of the Governors now have staff members who were working primarily or exclusively with them to help them undertake their particular job responsibilities. And I am not op- posed to that. I have tried to foster it. We have pretty complicated agendas and a lot of work to do, and we do need help. Chairman SHELBY. But if you were a member of the Board of Governors and you had really no support staff, then there is not a heck of a lot you could add to a debate like within the Fed at a crucial time. But if you had support, you know, there are many voices down there; there should not be just one voice. There should be a healthy debate even inside the Federal Reserve, should there not? Ms. YELLEN. Yes, of course there should be, and Board staff pro- vides support to all of the Governors, including their individualized needs. But it is certainly appropriate for Governors who want to have staff specially work with them to have that ability. I am not opposed to that. Chairman SHELBY. In the area of Fed transparency and tran- script release, you said before that the Fed, and I will quote, ‘‘is one of the most transparent central banks in the world.’’ But, also—and these are your words, too—‘‘there is always room for fur- ther improvement.’’ I understand that you oppose a policy that would improve Fed transparency by shortening the delay in the release of Federal Open Market Committee transcripts from 5 years to 3 years. Now, 5 years to 3, that is not—— Ms. YELLEN. I believe—— Chairman SHELBY. Go ahead. Ms. YELLEN. Only a few central banks release transcripts at all, and we are the shortest lag. I believe the next shortest lag is 8 years. When transcripts were first released, it was debated what the lag should be, and even with a 5-year lag, I think the experi- ence was that fewer people were willing to engage actively with others in meetings, expressing their views rather than read from prepared remarks. And while I would say we have a reasonable de- gree of interaction in the meetings, the knowledge that we will be VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00048 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 45 releasing transcripts in 5 years does lead to less interaction in the meetings. We really need to be able to engage with one another with give- and-take where people feel protected that their unvarnished views and exchanges with their colleagues will not quickly be exposed to the public. We, after all, release very detailed minutes of those dis- cussions within 3 weeks. I would simply fear that moving up the release, the timing of the release of verbatim transcripts actually would not add very much, if anything, to what the public already knows about our policies from detailed minutes of the discussions, statements, reports, that actually there would not be much addi- tional information and it would stifle the level of interaction that we have. Clearly, that is a balancing act, but that is my concern. Chairman SHELBY. Well, I could see how a release of transcripts in 5 months or 3 months could cause problems in the economy, you know, the monetary policy and everything else. But 5 years, 3 years, I do not buy that. I believe that although—and I have said this to you privately and publicly here. I believe the Fed should be independent, but I do not think that you are totally independent, but we ought to know—we should not be a member of the Board of Governors. I do not want to be a member of the Board of Gov- ernors. But, on the other hand, we should know what you are doing and why you are doing it. Now, do we need to know that immediately? Probably not, for a lot of reasons, sometimes. But we do need to know, and to move it the transcript release from 5 years to 3 years seems overly gen- erous to me. That is my view. Reforming the Fed structure in the area there, we have talked about this, too, Madam Chairman. When asked yesterday, I believe it was in the House, about the structure of the Federal Reserve System, you said, and I will quote, ‘‘The current structure of the Fed is something Congress decided after a long debate and weigh- ing of a whole variety of considerations’’—that is true, like any im- portant—‘‘and while this may be the case, I believe the Federal Re- serve System was established by Congress,’’ as we have talked, ‘‘over 100 years ago.’’ Since then, the country has changed dramati- cally. Our economy has changed dramatically. And as you are aware, the San Francisco Federal District now includes approxi- mately 65 million people—this is the Fed District—while the Min- neapolis Fed District includes just 9 million people. Why, Madam Chair, do you oppose instituting any type of review of the structure of the Fed, an outside, healthy study? Why do you do that knowing that things are evolving all the time, as I pointed out? Ms. YELLEN. It is, of course, up to Congress to consider what the appropriate structure is of the Fed, and I am well aware of the fact that history plays a great role in deciding what the Fed would be. Probably if we were starting from scratch, you would not have the 12th District with 65 million people, I think 20 percent of the U.S. economy having one Federal Reserve Bank. And Congress can, of course, reconsider the appropriate structure. I simply mean to say I do not regard the structure as broken in the sense that it is failing to put in place good monetary policies, failing to collect the information we need about what is happening VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00049 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 46 in the economy to craft good policies. We do have, as Congress in- tended, independent-minded people sitting around the table crafting policies. Of course, the structure could be something different, and it is up to Congress to decide that. I certainly respect that. I simply mean to say I do not think it is broken the way it is. Senator BROWN. Mr. Chairman, if I could add—— Chairman SHELBY. Go ahead. Senator BROWN. The San Francisco Fed has a really, really good president for a number of years. Ms. YELLEN. Oh, yes. Thank you. Chairman SHELBY. Well, we understand that. But the fact re- mains that since 1913—just since 1950, you have seen greater pop- ulation changes in this country. Ms. YELLEN. Of course. Chairman SHELBY. For example, in the South, where I come from, from Virginia to Texas and the border States, that is the most heavily populated area of the United States, and it is slated to grow even more dense. Is that correct? Ms. YELLEN. Yes, and, you know, when I was in San Fran- cisco—— Chairman SHELBY. The same thing in the West. Look at the West growth since—— Ms. YELLEN. Of course. You know, we had places like Las Vegas or San Diego—— Chairman SHELBY. That is right. Ms. YELLEN. ——that had no Fed branch or Reserve Bank rep- resentation that are growing faster and far larger than many places that do have branches. So, yes, there is a historical legacy that has left the Federal Reserve System in place where geographi- cally it no longer represents the distribution of economic activity in the country. I would not argue with that. Chairman SHELBY. And when things change, do you not think we should be aware of that to change with it? Ms. YELLEN. So it is up to Congress to decide—— Chairman SHELBY. That is right. Ms. YELLEN. ——if changes are necessary. I only mean to say that, for example, when I was the president in the 12th District, I was highly attentive to making sure, even though we have a very large district, that I was aware of developments all around our re- gion and made a big effort to collect information from the various parts, very diverse parts of our district. And I think my colleagues do that as well. Chairman SHELBY. Thank you. Madam Chair, thank you for your patience this morning. Ms. YELLEN. No problem. Chairman SHELBY. We appreciate your time today. Thank you very much. Ms. YELLEN. Thank you for having me. Chairman SHELBY. This hearing is adjourned. [Whereupon, at 12:53 p.m., the hearing was adjourned.] [Prepared statements, responses to written questions, and addi- tional material supplied for the record follow:] VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00050 Fmt 6633 Sfmt 6633 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 47 PREPARED STATEMENT OF JANET L. YELLEN CHAIR, BOARDOFGOVERNORSOFTHEFEDERALRESERVESYSTEM FEBRUARY11, 2016 Chairman Shelby, Ranking Member Brown, 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 fur- ther progress toward the Federal Reserve’s objective of maximum employment. 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) ex- pects 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 in 2015, and posted a further gain of 150,000 in January of this year. The cumulative in- crease 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 January, 0.8 percent- age point below its level a year ago and in line with the median of FOMC partici- pants’ 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 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 esti- mated to have increased about 13⁄4 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 inven- tory 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 activ- ity 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 growth should pick up over time, supported by highly accommodative monetary poli- cies abroad. Against this backdrop, the Committee expects that with gradual adjust- ments 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. As is always the case, the economic outlook is uncertain. Foreign economic devel- opments, in particular, pose risks to U.S. economic growth. Most notably, although recent economic indicators do not suggest a sharp slowdown in Chinese growth, de- clines in the foreign exchange value of the renminbi have intensified uncertainty about China’s exchange rate policy and the prospects for its economy. This uncer- tainty led to increased volatility in global financial markets and, against the back- ground 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-export- ing economies, particularly in vulnerable emerging market economies, and for com- modity-producing firms in many countries. Should any of these downside risks ma- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00051 Fmt 6621 Sfmt 6621 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 48 terialize, 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 rea- sons, 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 eco- nomic and financial developments, as well as assessing their implications for the labor market and inflation and the balance of risks to the outlook. As I noted earlier, inflation continues to run below the Committee’s 2 percent ob- jective. Overall consumer prices, as measured by the price index for personal con- sumption 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 remain low in the near term. However, once oil and import prices stop falling, the downward pres- sure 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 me- dium term. In light of the current shortfall of inflation from 2 percent, the Com- mittee 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 em- ployment and price stability, as required by our statutory mandate from the Con- gress. 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 1⁄4 percentage point, to between 1⁄4 and 1⁄2 percent. This in- crease marked the end of a 7-year period during which the Federal funds rate was held near zero. The Committee did not adjust the target range in January. The decision in December to raise the Federal funds rate reflected the Commit- tee’s assessment that, even after a modest reduction in policy accommodation, eco- nomic activity would continue to expand at a moderate pace and labor market indi- cators would continue to strengthen. Although inflation was running below the Committee’s longer-run objective, the FOMC judged that much of the softness in in- flation 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 to- ward 2 percent. In addition, the Committee recognized that it takes time for mone- tary policy actions to affect economic conditions. If the FOMC delayed the start of policy normalization 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 ex- pectation 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. 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 eco- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00052 Fmt 6621 Sfmt 6621 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 49 nomic 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 information, includ- ing measures of labor market conditions, indicators of inflation pressures and infla- tion expectations, and readings on financial and international developments. In par- ticular, 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 objec- tives, and we will adjust policy as appropriate to foster financial conditions con- sistent 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- 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 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 accom- modation by the traditional approach of raising short-term interest rates is pref- erable to selling longer-term assets because such sales could be difficult to calibrate and could generate unexpected financial market reactions. 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 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 would be pleased to take your questions. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00053 Fmt 6621 Sfmt 6621 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 50 RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN SHELBY FROM JANET L. YELLEN Q.1. At a hearing before the House Financial Services Committee on November 4, you stated, ‘‘we are looking at further ways in which we can tailor our supervisory approach, in particular, the CCAR process . . . We have some ideas about how we might tailor it, particularly [as it applies] to smaller firms.’’ On December 18, the Federal Reserve Board released CCAR guidance that clarified existing practices, and did not introduce new tailoring, according to a briefing by Federal Reserve Board staff. Will the Board tailor CCAR expectations in a meaningful way that reflects the relative systemic risk of financial institutions? If so, when do you anticipate commencing and finalizing that effort? A.1. The Federal Reserve’s capital plan rule and related Com- prehensive Capital Analysis and Review (CCAR) apply only to bank holding companies (BHCs) with total consolidated assets greater than $50 billion, not small- to mid-size banking organizations. As you note, on December 18, 2016, the Federal Reserve pub- lished two supervisory guidance letters that set forth supervisory expectations for large BHCs’ capital planning processes. SR letter 15-18 (Federal Reserve Supervisory Assessment of Capital Plan- ning and Positions for Large Institution Supervision Coordination Committee (LIS CC) Firms and Large and Complex Firms) sets forth supervisory expectations for capital planning for firms subject to the Federal Reserve’s LISCC framework and other large and complex firms, and SR letter 15-19 (Federal Reserve Supervisory Assessment of Capital Planning and Positions for Large and Non- complex Firms) details the supervisory expectations for capital planning for firms with total consolidated assets of $50 billion or more that are not large and complex.1 The guidance consolidated supervisory expectations that were previously communicated to the industry, and it formalizes the differences in expectations for firms of different size and complexity. Supervisory expectations applica- ble to SR 15-19 firms are less intensive than those applicable to SR 15-18 firms, particularly in the expectations for model use and con- trols, scenario design, and governance. Currently, the Board is considering a broad range of issues re- lated to the capital plan and stress testing rules and whether any modifications may be appropriate, including any modifications to the rules to reduce burden on firms that pose less systemic risk. The Board would publish a notice of proposed rulemaking for pub- lic comment in connection with any proposed change to the capital plan or stress testing rules. Q.2. You have stated in the past that the Federal Reserve Board has limited ability to tailor certain requirements under Section 165 of Dodd-Frank. However, Section 165(a)(2) states that the Board may ‘‘differentiate among companies on an individual basis or by category,’’ taking various factors into consideration. Has the Board 1Large and complex firms are U.S. BHCs and intermediate holding companies of foreign banking organizations that are either (i) subject to the Federal Reserve’s LISCC framework or (ii) have total consolidated assets of $250 billion or more or consolidated total on-balance sheet foreign exposure of $10 billion or more. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00054 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 51 done all it can do under the statute to appropriately tailor its regu- lations? A.2. Under section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Board is authorized to tailor the ap- plication of enhanced prudential standards.2 In implementing sec- tion 165, the Federal Reserve has identified three categories of bank holding companies with $50 billion or more in total consoli- dated assets based not only on their size but also based on com- plexity and other indicators of systemic risk. Specifically, all bank holding companies with $50 billion or more in consolidated assets are subject to certain enhanced prudential standards, including risk-based and leverage capital requirements,3 company-run and supervisory stress tests,4 liquidity riskmanagement requirements,5 resolution plan requirements,6 and risk management require- ments.7 Bank holding companies with $250 billion or more in total consolidated assets or $10 billion or more in on-balance-sheet for- eign assets are also subject to the advanced approaches risk-based capital requirements,8 a supplementary leverage ratio,9 more stringent liquidity requirements,10 and a countercyclical capital buffer.11 In identifying global systemically important banks, the Federal Reserve considers measures of size, interconnectedness, cross-jurisdictional activity, substitutability, complexity, and short- term wholesale funding. The eight U.S. firms identified as global systemically important banks (GSIBs) are subject to additional re- quirements including risk-based capital surcharges,12 enhanced supplementary leverage ratio standards,13 and more specific recov- ery planning guidance.14 Q.3. The Federal Reserve recently introduced and enhanced a vari- ety of regulations including: more detailed Basel III capital require- ments, a minimum Liquidity Coverage Ratio, margin trading rules, and Total Loss-Absorbing Capital requirements. While the stated goals of these rules are to ensure that banks have sufficient capital and liquidity cushions, it is not clear what the combined impact of such rules is on the economy. Has the Board conducted any studies to estimate the cumulative impact of these regulations? If not, do you believe that the Board should be doing so? A.3. The Federal Reserve conducts a variety of economic analyses and assessments to support the rulemaking process. In the context of rulemakings that have been specifically referenced, the Federal Reserve included economic cost and impact assessments in its mar- gin trading and Total Loss-Absorbing Capacity (TLAC) proposals. As these proposals relate to a specific regulation or requirement, 212 U.S.C. 5365(a)(2). 312 CFR 252.32. 412 CFR part 252, subparts E and F. 512 CFR part 252.34. 612 CFR part 243. 712 CFR 252.33. 812 CFR part 217, subpart E. 912 CFR 217.10(c)(4). 10See 12 CFR part 249. 1112 CFR 217.11(b). 1212 CFR part 217, subpart H. 1312 CFR 217.11(a)(2)(v), (a)(2)(vi), and (c) (effective January 1, 2018). 14Federal Reserve supervisory letter 14-8, available at http://www.federalreserve.gov/ bankinforeg/srletters/sr1408.htm. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00055 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 52 the impact analyses naturally focus on the impact of the specific regulation in question, though impact and cost estimates can gen- erally be aggregated across different regulatory initiatives. More broadly, the Federal Reserve engages in a regular quantitative im- pact assessment and monitoring program that is coordinated with other global regulators through the Basel Committee on Banking Supervision to assess the overall impact of prudential capital and liquidity requirements. This impact assessment has been conducted and made public regularly since 2012, and continues to inform the Federal Reserve’s understanding of the cost and impact of capital and liquidity regulation. More broadly, the Federal Reserve participates in a global effort through its participation on the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision’s Macroeconomic Assessment Group. The group published a study in 2010 that as- sessed the overall macroeconomic impact of stronger capital and li- quidity requirements. The Federal Reserve seriously considers the overall costs and benefits of all of the regulations it promulgates. The overarching goal of the Federal Reserve’s regulatory program is to enhance fi- nancial 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 bet- ter understand how post-crisis reform is influencing financial sta- bility as well as the economic costs of enhanced regulation. Q.4. Members of this Committee have raised concerns that U.S. regulators at the Financial Stability Board (FSB) and the Inter- national Association of Insurance Supervisors (IAIS) are not rep- resenting the United States in a coordinated, cohesive and central- ized manner. Have you ever represented the Federal Reserve at an FSB or IAIS meeting? If not you, then who represents the Federal Reserve at these meetings? Have you had any meetings with the Treasury Secretary or the SEC Chair in advance of these meetings to develop a cohesive and unified strategy? A.4. As members of the FSB and International Association of In- surance Supervisors (IAIS), participation in these for a require cer- tain commitments of staff and resources. Governor Daniel Tarullo or senior employees of the Federal Reserve, such as Mark Van Der Weide and Thomas Sullivan, represent the Federal Reserve at meetings of the FSB and IAIS. The Federal Reserve’s representa- tives are supported by various staff members. The Federal Reserve confers with other agencies regularly on many FSB and IAIS topics. With regards to U.S. representation at the FSB and IAIS, several U.S. agencies participate in the work of the FSB and the IAIS, and provide input that considers implica- tions for U.S. domiciled firms that we supervise. The Federal Re- serve, the U.S. Securities and Exchange Commission, and the U.S. Department of Treasury are all members of the FSB and engage in the FSB’s global financial stability work. Related to the work of the IAIS, the Federal Reserve is participating alongside the Fed- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00056 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 53 eral Insurance Office (FIO), the National Association of Insurance Commissioners (NAIC), and State insurance regulators in the de- velopment of international insurance standards that best meet the needs of the U.S. insurance market and consumers. The Federal Reserve, along with other members of the U.S. delegation at the FIO and the NAIC, actively engage U.S. interested parties on issues being considered by the IAIS. Additionally, the FSB and the IAIS have public consultation processes designed to facilitate stakeholder participation and solicit industry and public views on key issues. The U.S. agencies ensure that U.S. comments are considered in the final deliberation process on such issues. However, it is important to note that neither the FSB, nor the IAIS, has the ability to impose requirements in any national jurisdiction. Implementation in the United States would have to be consistent with U.S. law and comply with the U.S. ad- ministrative rulemaking process, which would include issuing pro- posed rules for public comment. Q.5. A recent report by the Office of Financial Research discussed the risk of a downturn in the credit markets, noting that ‘‘non- financial corporate balance sheet leverage is close to peak levels . . . and weak underwriting standards have persisted.’’ In your opinion, has the low interest rate environment contributed to in- creased leverage and reductions in credit quality? What other fac- tors are involved? A.5. Corporate bond yields have been very low in recent years by historical standards, which has made borrowing through debt mar- kets more attractive for corporations and has likely contributed to the notable increase in corporate borrowing. A substantial amount of the recent debt issuance has been used by firms to refinance ex- isting debt into lower rates and longer maturities. In addition though, outstanding debt has grown and aggregate leverage ratios for the corporate sector have increased noticeably over the past few years and are now close to the top of their range during previous economic expansions. Even so, cash flow coverage ratios for the nonfinancial corporate sector remain fairly moderate. A large part of the deterioration in credit quality in the corporate sector can be attributed to the steep downturn in oil prices and the resultant outlook for the energy sector, which had borrowed heavily from debt markets before the sharp drop in oil prices since mid- 2014. Indeed, rating downgrades on corporate bonds over the past year have been particularly concentrated in the energy sector. Signs of some deterioration in credit quality in other industries are also apparent but notably smaller. Q.6. The Federal Reserve Board’s Total Loss Absorbing Capacity (TLAC) rule would require U.S. subsidiaries of foreign banks to in- clude certain contractual provisions in their long-term debt instru- ments, including a contractual clause providing that the Federal Reserve can convert the debt into equity of the bank or cancel the debt, even if the bank is not in resolution proceedings. It is unclear if such long-term debt will be treated as debt or equity for tax pur- poses. Is the intended outcome of the Federal Reserve’s proposal that long-term debt should be treated as equity for tax purposes? VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00057 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 54 If so, does the Board intend to take the same approach for U.S. banks? Has the Board consulted with the Treasury Department on this issue? A.6. With regard to the Federal Reserve’s proposed TLAC rule, the purpose of the proposed internal long-term debt requirement is generally to protect the financial stability of the United States and, if applicable, to facilitate the single-point-of-entry resolution of the foreign GSIB parent of a given U.S. intermediate holding company. To accomplish these goals, it is important that the U.S. inter- mediate holding company be recapitalized (if necessary) on a going- concern basis, without entering a resolution proceeding and with- out disruption to the foreign GSIB’s U.S. operations. To make such a going-concern recapitalization possible, the proposed rule would require the U.S. intermediate holding companies of foreign GSIBs to issue to a foreign parent entity a minimum amount of long-term debt instruments with a contractual provision providing for the Federal Reserve to convert that long-term debt into equity under specified conditions. Under the proposal, one of the required pre- conditions for conversion would be a determination by the Federal Reserve that the U.S. intermediate holding company is in default or in danger of default. By contrast, the TLAC proposal does not seek to provide for the recapitalization of the top-tier holding company of a U.S. GSIB on a going-concern basis. Rather, the proposed rule would require those entities to issue plain vanilla15 long-term debt, with no pro- vision for conversion to equity. The recapitalization of a U.S. GSIB would be effected only through the top-tier parent holding com- pany’s entry into a resolution proceeding, during which the entity’s long-term debt would be subject to write-down. The period for public comment on the TLAC proposal has ended, and the Federal Reserve is now reviewing the comments that it has received. Some of these comments address the potential tax treat- ment of long-term debt instruments that the proposed rule would require covered entities to issue. The Federal Reserve will give careful consideration to all comments as it moves towards the issuance of a final rule. RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY FROM JANET L. YELLEN Q.1. As part of the policy tools it is using to normalize interest rates, the Federal Reserve has set up reverse repurchase facilities. It is my understanding that there are two such RRP facilities at the Federal Reserve Bank of New York (FRBNY)—one for domestic participants (with a regularly updated list of counterparties posted on the FRBNY’s Web site) and one for foreign central banks (where a list of counterparties does not appear to be publicly available). I have several questions regarding these facilities. Which entities or committees set the policy which the foreign RRP facility abides by? Is it the FOMC? The Board of Governors? The FRBNY? 1580 Federal Register 74929 (November 30, 2015). VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00058 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 55 A.1. The Federal Open Market Committee (FOMC) authorizes the operation of the foreign repurchase (RP) pool for foreign central bank and international accounts. The most recent authorization language can be found in the Committee’s Authorization for Do- mestic Market Operations (ADMO) from January of this year.1 Q.2. How is pricing set for the foreign RRP facility? How does the policy and process compare to that which is applied to the domestic RRP facility? A.2. Pricing for the foreign RP pool is ‘‘undertaken on terms com- parable to those available in the open market.’’2 In fact, the rate on the pool has averaged about one basis point below the overnight tri-party repo rate and has moved very closely over time with mar- ket rates.3 This policy toward pricing for the foreign RP pool has not varied with changes in the setting of monetary policy by the FOMC. By contrast, the offering rate on the domestic reverse repurchase (RRP) facility is set by the FOMC to help maintain the Federal funds rate at the FOMC’s monetary policy target. As such, the FOMC is using the domestic RRP rate as a monetary policy tool, which is distinct from the way it uses the foreign RP pool, which is as an investment service to foreign central banks and other offi- cial account holders. Q.3. Why is the foreign RRP rate, beginning in 2015, relatively high given the trend? Why did the Fed feel it was necessary to price foreign RRP rates higher than 6-month Treasury bill rates? A.3. The rate offered on the foreign RP pool is tied to a com- parable-maturity, market-based Treasury repo rate. As such, any change in the relation between the rate on the foreign RP pool and the rate on 6-month Treasury bills is the result of changes in mar- ket conditions in the repo and Treasury markets and not the result of a change in Federal Reserve policy with respect to the foreign RP pool. Q.4. As expected, foreigners rotated tens of billions of dollars out of Treasury bills and instead increased their usage of the foreign RRP facility. Was this an intended and anticipated effect by the Fed? A.4. Foreign official holdings of Treasury bills were little changed on net in 2015—at $335.3 billion in December 2014 and $336.7 bil- lion in December 2015.4 Thus, it is not apparent that foreign offi- cial holders of Treasury bills did reduce their holdings. However, usage of the foreign RP pool has increased following a relaxation in restrictions on the size of investments in the pool. Of- ficial investors have for some time wanted to increase their posi- tions in the pool, but, prior to 2008, participation was restricted be- 1See http://www.federalreserve.gov/monetarypolicy/files/FOMClDomesticAuthorization.pdf. 2See ADMO, paragraph 4. 3See figure 16 from Simon Potter’s presentation, ‘‘Money Markets After Liftoff: Assessment to Date and the Road Ahead’’, February 22, 2016. https://www.newyorkfed.org/newsevents/ speeches/2016/pot160222. The accompanying figures and data are available at https:// www.newyorkfed.org/medialibrary/media/newsevents/speeches/2016/pot160222/full-presen- tation.pdf and https://www.newyorkfed.org/medialibrary/media/newsevents/speeches/2016/ pot160222/data-r.xlsx. 4From Treasury International Capital System, Major Foreign Holders of U.S. Treasury Secu- rities, http://ticdata.treasury.gov/Publish/mfhhis01.txt. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00059 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 56 cause movements in the pool affected market interest rates, which could have interfered with the implementation of monetary policy. Since 2008, however, in the environment of reserve abundance, movements in the repo pool have had little to no impact on market rates. Accordingly, to accommodate the demands of account hold- ers, the Federal Reserve eased the constraints on the permitted size of the investments in the pool. The Federal Reserve was not seeking to increase pool investments, but given the previous inter- est expressed by account holders, it was no surprise that invest- ments increased when these constraints were lifted. Q.5. To what extent was the Fed motivated by a desire to sub- stitute the use of deposits at U.S. banks with cash pools (and the accompanying need for short-term risk-free Treasury instruments)? A.5. As noted above, the Federal Reserve was not seeking to in- crease the size of the pool, nor was it seeking to induce official ac- count holders to substitute one type of asset for another. Demand for investments in the foreign RP pool has been driven solely by the interests of the foreign official account holders. Q.6. It would seem to me that this policy is encouraging foreigners to use the Fed’s foreign RRP facility rather than making use of U.S. money market funds, the largest of which are counterparties to the Fed through the domestic RRP facility. Was this an intended and anticipated effect by the Fed? Additionally, to what extent is the Fed concerned that pursuing this policy undermines the health and depth of money market funds? A.6. The foreign RP pool is a long-standing service that the Federal Reserve has provided to foreign central banks, foreign Govern- ments, and official international institutions, and the way in which the interest rate for the pool is calculated has not changed. Al- though the restrictions on the size of investments have changed re- cently, the resulting changes in the overall size of the foreign RP pool have had no noticeable effect on market interest rates because of the large volume of reserves now in the system.5 Finally, these account holders generally do not hold significant balances with money market funds, so shifts into the foreign RP pool are not di- rectly affecting the assets under management at money market funds.6 Q.7. The Fed has expressed some reluctance to allow too much usage of the domestic RRP facility, fearing that the market would become too used to the Fed as a counterparty. Additionally, there is concern that the Fed could increase systemic risk by creating a single point-of-failure for cash markets, rather than a diffused sys- tem that has traditionally been in place through the interbank market. Does the Fed share these concerns as it relates to the for- eign RRP facility? A.7. The Federal Reserve closely monitors the impact of its oper- ations to determine whether they are having any unintended or un- 5See Simon Potter’s presentation, p.11, for a discussion of this point. 6As of the fourth quarter of 2015, total foreign holdings of money market mutual fund shares, which includes holdings by official foreigners, were $114.5 billion, compared to total money mar- ket mutual fund assets of $2,715.7 billion. See L.206 Money Market Mutual Fund Shares, Board of Governors, http://www.federalreserve.gov/apps/fof/DisplayTable.aspx?t=1.206. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00060 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 57 desirable impact. If such impact were to be observed, the FOMC could then take appropriate action to ameliorate it. The Federal Reserve maintains the right to limit the size of the RP pool at any time. Q.8. On October 30, 2015, the Federal Reserve Board proposed its Total Loss-Absorbing Capacity (TLAC) rule. As I have written to you in the past, I support a strong and workable TLAC with the goal of making the failure and resolution of large financial institu- tions more manageable and without taxpayer bailouts. However, I have a few questions that I would like addressed. As I read the rule, bank holding companies (BHCs) designated as a global systemically important bank (GSIB), or the bridge com- panies that succeed them, would be prohibited from obtaining se- cured liquidity from the private sector, such as debtor-in-possession (DIP) financing, as part of a resolution under Title I under Dodd- Frank. Did the Fed intend to restrict access to DIP financing? Doesn’t this contradict Dodd-Frank’s stated goal of using Title I resolution as a first option if mechanically the BHC would find bankruptcy unworkable without short-term liquidity provided with- out taxpayer support? Will you commit to explicitly allowing these firms to access DIP financing during bankruptcy proceedings? A.8. The proposed total loss-absorbing capacity (TLAC) rule would prohibit global systemically important banking organization (GSIB) top-tier holding companies from issuing debt instruments with an original maturity of less than one year to a third party. The gen- eral purpose of this prohibition is to mitigate the risk posed to the financial stability of the United States by potentially destabilizing short-term funding runs on those holding companies. The proposed prohibition generally should not prevent a GSIB from obtaining needed liquidity, including during resolution. This is because the proposed TLAC rule would generally require that a GSIB’s operations be engaged in by its subsidiary legal entities rather than by its top-tier holding company, and it would place no restriction on the ability of those operating subsidiaries to obtain liquidity themselves (including both secured and unsecured and long-term and short-term liquidity). As discussed in the preamble to the proposed TLAC rule, the proposal is intended to mitigate the risk of liquidity runs on those subsidiary entities by facilitating sin- gle-point-of-entry (SPOE) resolution, pursuant to which only the top-tier holding company would enter resolution while its operating subsidiaries would continue normal operations. By enhancing the credibility of SPOE resolution, in which losses would be borne by the equity holders and creditors of the top-tier holding company, the proposal should increase the confidence of the creditors of GSIB operating subsidiaries and reduce their incentive to run if the GSIB experiences financial distress. We are committed to making the GSIBs more resolvable under the U.S. Bankruptcy Code, consistent with Title I of the Dodd- Frank Wall Street Reform and Consumer Protection Act (Dodd- Frank Act), as well as under the orderly liquidation authority (OLA) provided by Title II of the Dodd-Frank Act, and the provi- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00061 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 58 sions discussed above are intended to facilitate orderly resolution under both of those frameworks. As we move forward with the process of considering comments and finalizing the proposed TLAC rule, we will consider how to address issues related to debtor-in- possession funding during a resolution under the U.S. Bankruptcy Code. Q.9. Similarly, provisions restricting the issuance of short-term debt by intermediate holding companies (IHCs) would preclude JHCs from obtaining DIP financing in bankruptcy. Was this intended? Would the Fed consider making it explicit that IHCs would be able to obtain DIP financing if they were to file for bankruptcy? A.9. Similarly, the identical restrictions on the issuance of short- term debt by the U.S. intermediate holding companies (IHCs) of foreign GSIBs were intended to promote resolvability under both the U.S. Bankruptcy Code and the OLA, as well as SPOE resolu- tion of the foreign GSIB parent entity in its home jurisdiction. As we move forward, we will consider how to address issues related to debtor-in-possession funding with respect to foreign GSIB IHCs as well as U.S. GSIBs. Q.10. It seems very clear that the Fed is heavily restricting the use of convertible features in the debt instruments allowed. Is this to maintain flexibility under Title II Orderly Resolution Authority? In effect, is this preserving a regulator’s ability to de- cide when to place a firm into resolution and how to structure the capital stack? Wouldn’t markets be better at signaling when a firm needs to be resolved and wouldn’t convertible features strengthen the value of that signal? Wouldn’t having convertible features as an option allow BHCs and investors the ability to be explicit and clear of creditor rights going in to a resolution? A.10. The proposed TLAC rule would restrict the use of convertible features in eligible long-term debt instruments in order to safe- guard the fundamental objective of the proposal’s standalone long- term debt requirement: ensuring that a failed GSIB will have at least a fixed minimum amount of loss-absorbing capacity available to absorb losses at the time that its holding company enters resolu- tion. This objective is equally important for increasing the pros- pects for orderly GSIB resolution under both the U.S. Bankruptcy Code and the OLA. Debt instruments with features that would cause conversion into or exchange for equity prior to the holding company’s entry into resolution would not serve this goal, since the instruments could convert into equity—which absorbs losses on a going-concern basis—before the firm enters resolution and could then be depleted prior to failure, leaving the firm with insufficient loss-absorbing capacity for orderly resolution at the point of failure. Thus, while convertible debt, like equity, could reduce a GSIB’s probability of failure, it would do little to achieve the proposal’s principal goal of reducing the harm that a GSIB’s failure would do to the financial stability of the United States. The proposed TLAC rule is intended to promote clarity about the consequences of a GSIB’s failure for various classes of creditors, in VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00062 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 59 particular, by making clear that losses will generally be absorbed first by the holding company’s TLAC holders, and thereby to in- crease the role of market discipline played by the entities that hold the holding company’s equity and unsecured long-term debt. Question 12 of the preamble to the proposed TLAC rule invites comment on whether eligible long-term debt instruments should be permitted to have any of the features that would be prohibited under the proposal (which include provisions for conversion). As we move toward finalization, we will consider whether allowing eligi- ble long-term debt instruments to include any conversion features would be appropriate in light of the objectives of the proposed rule. Q.11. The rule proposes a requirement that internal TLAC be issued to a foreign parent. Would this outright prohibit a foreign parent’s ability to use its receivables on internal TLAC to recapitalize a foreign affiliate of the IHC? If this is an attempt to ring-fence internal TLAC, wouldn’t this make the preferred single-point-of-entry (SPOE) strategy for reso- lution through bankruptcy or OLA unworkable should foreign juris- dictions take the same approach? A.11. The proposed TLAC rule would require that a foreign GSIB IHC’s cross-border internal TLAC instruments be issued to a for- eign parent entity that controls the IHC. The primary purpose of including this restriction, rather than permitting internal TLAC to be issued to another foreign entity within the foreign GSIB or to a third party, is to prevent the conversion of internal TLAC into equity from effecting a change in control over the IHC. A change in control could create additional regulatory and management com- plexity that would be undesirable and potentially disruptive during resolution. Ensuring that internal long-term debt instruments are held by a foreign parent entity also safeguards the financial sta- bility of the United States by ensuring that losses incurred by a foreign GSIB IHC will be passed out of the U.S. economy during resolution and by ensuring that the foreign GSIB has sufficient skin in the game to encourage it to support the IHC rather than simply allowing it to fail if its equity stake is depleted. Question 32 of the preamble to the proposed TLAC rule invites comment on the definition of eligible internal TLAC instruments (which includes the requirement that such instruments be issued to a foreign parent that controls the IHC). We are committed to fa- cilitating GSIB resolution and will consider whether a modification to this element of the internal TLAC proposal would be appropriate in light of the considerations discussed above and the objectives of the proposed rule. Q.12. In 2014, I wrote a letter to you on the Supplementary Lever- age Ratio (SLR) expressing concern that the rule, at least as ap- plied to custody banks, did not reflect their unique business model and risks they presented to the financial system. At the time I raised concerns that this would harm their customers, because cus- tody banks would find it economically unattractive to accept cash deposits during times of stress. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00063 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 60 Since the rule’s adoption and given the state of play in short- term markets, have you evaluated the extent to which it should be revisited? A.12. The Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (the Agencies) finalized he supplementary leverage ratio rule (SLR rule) in September 2014, which requires internationally active banking organizations to hold at least 3 percent of total leverage exposure in tier 1 capital, 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 indi- vidual exposures. This leverage requirement is designed to recog- nize that the risk a banking organization poses to the financial sys- tem 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. We understand the concern that certain custody banks, which act as intermediaries in high volume, low-risk, low-return financial ac- tivities, may experience increases in assets as a result of macro- economic factors and monetary policy decisions, particularly during periods of financial market stress.2 Because the SLR is not a risk- based measure, it is possible that increases in banking organiza- tions’ holdings of low-risk, low-return assets, such as deposits, could cause this ratio to become the binding regulatory capital con- straint. However, when choosing an appropriate asset profile, banking organizations consider many factors in addition to regu- latory 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 re- paid. Federal Reserve staff has held meetings with and reviewed mate- rials prepared by the custody banks in connection with the imple- mentation of the SLR. The Federal Reserve continuously considers potential improvements to its regulations based on feedback from affected parties and the general public but is not considering mak- ing any modifications to the SLR at this time. The SLR require- ment and the enhanced SLR requirements do not become effective until January 1, 2018. According to public disclosures of firms sub- ject to these requirements, the GSIBs have made significant progress in complying with the enhanced SLR requirements. Q.13. It is my understanding that custody banks have been in to meet with the Fed on the problems created by the SLR in times 1See 79 Fed. Reg. 57725 (September 26, 2014), available at http://www.gpo.gov/fdsys/pkg/ FR-2014-09-26/pdfl2014-22083.pdf. 2The Agencies have reserved authority under the capital rule to require a banking organiza- tion to use a different asset amount for an exposure included in the SLR to address extraor- dinary situations. See 12 CFR 3.l(d)(4) (OCC); 12 CFR 217.1(d)(4) (Federal Reserve); 12 CFR 324.1(d)(4) (FDIC). VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00064 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 61 of stress. What has your response to them been? Where do you an- ticipate their clients placing their cash if custody banks are penal- ized for taking it in on deposit? A.13. Please see response to Question 12. Q.14. I remain concerned that despite Congress expressing a desire for the Fed and other regulators to reevaluate and recalibrate the treatment different-sized banks receive under rules promulgated in accordance with Basel III, there has been no meaningful improve- ment. As a result, consumers and small business-owners find it harder and more expensive to borrow. Given that the asset and foreign activity thresholds used to im- plement Basel are woefully outdated and pre-date the 2008 Finan- cial Crisis, wouldn’t it be better for the Fed to abandon these standards in favor of those which more closely reflect the current banking landscape and the risks posed by today’s institutions? A.14. The financial crisis showed there was a need for higher quan- tities of higher quality capital for banks of all sizes so that they could continue operating and lending to their communities during periods of stress. To this end, the revised regulatory capital rules adopted by the Agencies strengthen the quantity and quality of banking organizations’ capital, thus enhancing their ability to con- tinue functioning as financial intermediaries during stressful peri- ods, reducing risks to the deposit insurance fund and the chances of taxpayer bailouts, and improving the overall resilience of the U.S. financial system.3 Consistent with section 171 of the Dodd- Frank Act, the Agencies’ capital rules apply to all insured deposi- tory institutions and depository institution holding companies that have $1 billion or more in total consolidated assets or that engage in significant nonbanking activities.4 In addition, the Agencies have tailored the application of certain components of the capital rules. Certain large and more complex banking organizations are subject to additional capital require- ments in light of their size and increased risk profile. For example, banking organizations that have $250 billion in total consolidated assets or total consolidated on-balance sheet foreign exposure of $10 billion or more are subject to the advanced approaches capital rules, a supplementary leverage ratio requirement, and the re- quirement to recognize most elements of accumulated other com- prehensive income in regulatory capital.5 In addition, the eight U.S. firms identified as global systemically important banks (GSIBs) are subject to risk-based capital surcharges,6 enhanced supplementary leverage ratio standards,7 and more specific recov- ery planning guidance.8 Underlying this tailoring was the principle that progressively more stringent regulation should apply to the different firms based on their relative importance to the financial system, and thus the harm that could be expected to the system if they failed. The Fed- 3 See, for example, 12 CFR part 217 (Federal Reserve). 412 U.S.C. 5371. 512 CFR part 217, subpart E. 612 CFR part 217, subpart H. 712 CFR 217.11(a)(2)(v), (a)(2)(vi), and (c) (effective January 1, 2018). 8Federal Reserve supervisory letter 14-8, available at http://www.federalreserve.gov/ bankinforeg/srletters/sr1408.htm. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00065 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 62 eral Reserve continues to consider ways to further tailor the capital standards and related requirements to reflect differences in risk among firms. Q.15. Has the Fed considered using the Fed’s own systemic indi- cator approach? Currently the systemic indicator approach is ap- plied for some rules but not for others. A.15. As indicated in the response to Question 14, the Federal Re- serve has established tailored regulatory requirements and super- visory expectations since the recent financial crisis for the large banking organizations that take into account macroprudential con- siderations and systemic risk. These include various enhanced pru- dential standards under section 165 of the Dodd-Frank Act.9 Q.16. Would you agree that a more holistic approach, such as that guided by the Fed’s systemic indicators, would assist in better cali- brating rules, such as the LCR, than simple asset thresholds? A.16. As I have stated in the past, one-size-fits-all should not be the model for regulation. The Federal Reserve has made it a top priority to ensure that we appropriately tailor our regulation and supervision of banks to their size, complexity, and risk. As indi- cated in the responses to Questions 14 and 15, the Federal Reserve has used a variety of measures to tailor its prudential require- ments. The Federal Reserve continues to consider ways to further tailor the standards to reflect differences in risk among firms. RESPONSES TO WRITTEN QUESTIONS OF SENATOR KIRK FROM JANET L. YELLEN Q.1. In 2009, the Federal Reserve expressly recognized that the in- surance premium finance industry was an essential source of credit to the Nation’s small business community and vital to the restora- tion of the Nation’s economy when it designated insurance pre- mium finance loans as one of the select categories of collateral eli- gible for its Term Asset Backed Securities Loan Facility (TALF). Today, the insurance premium finance industry provides loans to finance the purchase of commercial insurance coverage worth more than $40–45 billion in annual premiums. I am writing specifically to ask how the Fed intends to enforce a forthcoming final rule, entitled ‘‘Customer Due Diligence Require- ments for Financial Institutions’’, that is to be issued by the De- partment of the Treasury and the Financial Crimes Enforcement Network (FinCEN) imminently. I am concerned that this rule could adversely affect the ability of bank-owned insurance premium fi- nance companies to provide financing for small businesses that is critical to their day-to-day operations. The Fed should work closely with Treasury and FinCEN when the rule comes out to avoid any unintended consequences of implementation. In light of the Fed’s recognition of this industry’s significance as a source of affordable, essential credit to small businesses, I would respectfully ask the following: FinCEN long ago determined that purchases of property and cas- ualty insurance policies by insureds from insurance companies in 912 U.S.C. 5365. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00066 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 63 and of themselves do not present any appreciable risk of money laundering or other financial crimes and have therefore been ex- cluded from applicable FinCEN regulations. Accordingly, there does not appear to be any appreciable risk that insurance premium fi- nancing will be used to launder money or fund terrorism. What is the basis for the Fed applying CIP requirements to premium fi- nance companies and when specifically can we expect to hear spe- cific guidelines on how Fed enforcement will look? A.1. We understand the concerns that have been raised by some in the insurance premium finance industry regarding the requirement to collect customer identification information under the Bank Se- crecy Act (BSA). In 2003, 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.1 The CIP rule ap- plies to any ‘‘formal banking relationship established to provide or engage in services, dealings, or other financial transactions includ- ing a deposit account, a transaction or asset account, a credit ac- count, or other extension of credit.’’2 The CIP rule does not exempt accounts established for the purpose of insurance premium financ- ing. The CIP rule applies equally to banks and their subsidiaries when opening an account within the meaning of the rule.3 The requirements of the CIP rule are typically satisfied by adopt- ing risk-based procedures at account opening that enable the bank to verify the customer’s identity to the extent reasonable and prac- ticable. First, a bank’s CIP must obtain a name, date of birth, ad- dress, and identification number from a customer who is an indi- vidual.4 Second, the bank must adopt identity verification proce- dures that describe when and how the bank will verify the cus- tomer’s identity using documentary or nondocumentary methods.5 Finally, the CIP rule has specific account record keeping and notice requirements.6 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 Bank Secrecy Act/Anti-Money Laun- dering (BSA/AML) manual published by the Federal Financial In- stitutions Examination Council member agencies.7 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 BSA. As proposed, the CDD rule requires banks to identify the ben- eficial owner(s) of any legal entity customer who opens an ‘‘ac- count’’ within the meaning of the CIP rule. Although the proposed 131 CFR §1020.100(c), (a). 231 CFR §103.121(a)(i). 3Interagency Interpretive Guidance on Customer Identification Program Requirements Under Section 326 of the USA PATRIOT Act, FAQs Final CIP Rule (April 28, 2005). 431 CFR §1020.220(a)(2)(i). 531 CFR §1020.220(a)(2)(ii). 631 CFR §1020.220(a)(3) and (a)(5). 7See generally, Federal Financial Institution Examination Counsel, Bank Secrecy Act/Anti- Money Laundering Examination Manual (2014) (available at: https://www.ffiec.gov/bsa—am1— infobase/pages—manual/manual—online.htm). The FFIEC member agencies include the Fed- eral Deposit Insurance Corporation, National Credit Union Administration, Office of the Comp- troller of the Currency, and the Consumer Financial Protection Bureau, as well as the Federal Reserve Board. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00067 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 64 CDD rule exempts certain customers, these exemptions do not ex- tend 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 pro- posed 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 final determination. Indeed, only FinCEN retains the authority to determine whether the final CDD rule will apply to the insurance premium financing industry. Q.2. I am concerned that the Fed’s application of CIP require- ments, once the rule is finalized, to bank-owned premium finance companies will result in higher costs to small businesses that de- pend on affordable premium financing to operate. How would the Fed propose to address this presumably unintended consequence of applying CIP requirements to bank-owned premium finance lend- ers? A.2. Please see response to Question 1. Q.3. Since it is not clear that even the existing CIP requirements should apply to the premium finance industry, will you please con- firm that the Fed will not apply the proposed incremental CIP re- quirements (if such rules become final) to the insurance premium finance industry? Absent such confirmation, please explain the ra- tionale for application of incremental CIP requirements to bank- owned insurance premium finance companies. A.3. Please see response to Question 1. RESPONSES TO WRITTEN QUESTIONS OF SENATOR HELLER FROM JANET L. YELLEN Q.1. Through our previous correspondence you have stated that, ‘‘we are committed to a formal rulemaking process in the develop- ment of a domestic insurance capital standard. Issuance of a final rule will commence after we assess the feedback given during the Notice of Proposed Rulemaking.’’ Do you expect that proposed rulemaking will be issued in 2016, and if so when? A.1. The Federal Reserve remains committed to tailoring its ap- proach to consolidated supervision of insurance firms, including the development and application of a domestic regulatory capital framework and other insurance prudential standards, to the busi- ness of insurance, reflecting insurers’ different business models and systemic importance compared to other firms supervised by the Federal Reserve. Moreover, as you note, we are committed to a for- mal rulemaking process in the development of a domestic insur- ance capital standard. We are approaching our mandate carefully and are engaged in a deliberative process. We are committed to fol- lowing a transparent rulemaking process that will include a public comment period on a concrete proposal. Q.2. You have stated that the Board is committed to a capital ap- proach that is tailored to the unique risks of insurers and one that is appropriate for the U.S. market, insurers, and consumers. Please VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00068 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 65 provide specific decisions that have been made on how the Board may tailor regulations to account for the difference between insur- ance businesses and the banking sector. A.2. As stated in the answer above, in our consolidated supervision of insurance firms, the Federal Reserve remains committed to tai- loring its 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 firms supervised by the Federal Reserve. The Federal Reserve appreciates that insurance involves unique risks among financial institutions, encompassing both liabilities and assets, and it is important to keep in mind the liability structure of firms in determining capital requirements for insurance companies, particularly with regard to the mix of the in- surers’ activities. It would be premature to comment on how the Federal Reserve may treat the unique risks of certain insurance lines, mix of business and the like, before we have fully evaluated the potential options and complicated our deliberations. We are, however, approaching our mandate carefully and with proper delib- eration. In our development of domestic standards, we continue to solicit views from external parties and engage in internal delibera- tion as we develop the domestic capital frameworks as well as rule- making regarding other aspects of the Federal Reserve’s mandate and authority as set out in the Dodd-Frank Wall Street Reform and Consumer Protection Act. Moreover, The Insurance Capital Stand- ards Clarification Act of 2014 gave the Federal Reserve further flexibility to tailor a capital standard to the business of insurance. Q.3. Will the Board issue one proposed domestic capital rule for all insurers it supervises? If the Board is currently exploring multiple domestic capital standards what are the possible benefits and det- riments to this approach based on the Board’s evaluations so far? A.3. The Federal Reserve is considering a variety of options for the domestic capital standards that reflect the unique risks of certain insurance lines, mix of business, and other factors. However, the Federal Reserve has not fully evaluated these options and has not completed its deliberations, so it would be premature to comment on these matters. In our consolidated supervision of insurance firms, the Federal Reserve remains committed to tailoring its su- pervisory approach, including a domestic regulatory capital frame- work and other insurance prudential standards, to the business of insurance, reflecting insurers’ different business models and sys- temic importance compared to other firms supervised by the Fed- eral Reserve. Moreover, we are committed to a formal rulemaking process in the development of insurance prudential standards. Q.4. As a member of the Financial Stability Oversight Council what information does the Board provide to systemically important financial institutions on how they can de-risk and de-designate? Do you support providing a clear roadmap or analysis on actions a company can take to be less of a potential risk to the financial sys- tem? A.4. The Federal Reserve Board’s (Board) regulations and super- visory guidance applicable to the largest U.S. bank holding compa- nies and nonbank financial companies that are designated by the VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00069 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 66 Financial Stability Oversight Council (FSOC) are intended to re- duce the threat that could be posed to U.S. financial stability by the material financial distress or failure of these organizations and promote their safe and sound operations. Such regulations are de- signed to increase the resilience of systemically important financial institutions and foster such firms’ ability to provide credit and other financial services in times of financial stress. Through speeches and testimony, the Board and its staff also provide infor- mation on how financial institutions, both banks and nonbanks, can reduce the risk they could pose to U.S. financial stability. FSOC designation of nonbanks is not intended to be permanent. The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) provides that the FSOC annually review designa- tions to make sure that they remain appropriate and take into ac- count significant changes at the firms that materially affect the FSOC’s determination. At the time of designation, nonbank finan- cial companies are given a detailed basis for the determination that a nonbank financial company should be subject to supervision by the Board. Factors include the extent of short-term funding activi- ties at those organizations, the firms’ products and associated short-term liabilities, their capital markets activities, securities lending, over the counter derivatives, and interconnectedness with the rest of the financial system. Firms can use that information, as well as factors the FSOC is required to consider under the Dodd- Frank Act, to guide their efforts to reduce their systemic footprint. Q.5. During your testimony you stated to me that you recognize that regulatory burden is a significant issue for many banks and it is something the Board will do its best to mitigate particularly for community banks. You also stated the Board will do everything in its power to look for ways to simplify and control regulatory bur- dens for community banks. What specific actions will the Board take to tailor or simplify regulations specifically for community lenders this year? A.5. The Federal Reserve has long maintained that our regulatory efforts should be designed to minimize regulatory burden con- sistent with the effective implementation of our statutory respon- sibilities. In addition, the Federal Reserve and the other banking agencies have developed a number of compliance guides that are specifically designed to assist community banks’ understanding of applicable regulatory requirements. Generally, the Federal Reserve strives to balance efforts to en- sure that supervision and regulation are calibrated appropriately for smaller and less risky institutions with our responsibility to en- sure that consumer financial transactions are fair and transparent, regardless of the size and type of supervised institutions involved. The Federal Reserve has worked to minimize regulatory burdens for community banks, by fashioning simpler compliance require- ments and clearly identifying which provisions of new regulations are of relevance to smaller banks. In February, the Federal Reserve, Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency (the Agencies) increased the number of small banks and savings asso- ciations eligible for an 18-month examination cycle rather than a VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00070 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 67 12-month exam cycle. Upon authorization provided in the Fixing America’s Surface Transportation Act, enacted on December 14, 2015, the Agencies moved quickly to raise the asset threshold from $500 million to $1 billion in total assets for banks and savings as- sociations that are well-capitalized and well-managed to be eligible for an 18-month examination cycle. In April, the Board implemented new procedures for examiners to conduct off-site loan reviews for community and small regional banks. State member banks and U.S. branches and agencies for foreign banking organizations with less than $50 billion in total as- sets can opt to allow Federal Reserve examiners to review loan files off-site, so long as loan documents can be sent securely and with the required information. Banks may still select to have on-site loan reviews if they prefer. Continued efforts to reduce burden include a new consumer com- pliance examination framework for community banks instituted by the Board that more explicitly bases examination intensity on the individual bank’s risk profile, weighted against the effectiveness of the bank’s compliance controls. The Board also revised its con- sumer compliance examination frequency policy to lengthen the time between on-site consumer compliance and Community Rein- vestment Act examinations for many community banks with less than $1 billion in total consolidated assets. Also in April, the Board approved a final rule raising the asset threshold of the Board’s Small Bank Holding Company and Sav- ings and Loan Holding Company Policy Statement (Policy State- ment) from $500 million to $1 billion and expanding its application to savings and loan holding companies. As a result of this action, 89 percent of all bank holding companies and 81 percent of all sav- ings and loan holding companies are now covered under the scope of the Policy Statement. The Policy Statement reduces regulatory burden by excluding these small organizations from certain consoli- dated capital requirements. In addition to reducing capital burden, the action significantly reduced the reporting burden associated with capital requirements by eliminating the more complex quar- terly consolidated financial reporting requirements and replacing them with semiannual parent-only financial statements for 470 in- stitutions. In addition, raising the asset threshold allowed more bank holding companies to take advantage of expedited applica- tions processing procedures. To deepen its understanding of community banks and the specific challenges facing these institutions, the Board meets twice a year with the Community Depository Institutions Advisory Council (CDIAC) to discuss the economic conditions and issues that are of greatest concern to community institutions. The CDIAC members are selected from representatives of community banks, thrift insti- tutions, and credit unions who serve on local advisory councils at the 12 Federal Reserve Banks. The Board also has launched a number of outreach initiatives, including the establishment of its ‘‘Community Banking Connections’’ program, which is designed to enhance the dialogue between the Board and community banks. In addition, this program highlights key elements of the Board’s su- pervisory process for community banks and provides clarity on su- pervisory expectations. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00071 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 68 Under the auspices of the Federal Financial Institution Exam- ination Council (FFIEC), the Board is participating in the decen- nial review of regulations as required by the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA). Four Fed- eral Register notices have been released requesting comments on the regulations that are applicable to insured depository institu- tions and their holding companies in 12 substantive categories: Ap- plications and Reporting; Powers and Activities; International Op- erations; Banking Operations; Capital; the Community Reinvest- ment Act; Consumer Protection; Directors, Officers and Employees; Money Laundering; Rules of Procedure; Safety and Soundness; and Securities. The final comment period closed on March 22, 2016, and produced over 160 written comment letters. Additionally, the Fed- eral Reserve participated in six outreach events across the country with over 1,030 participants attending in person, by telephone, or via live stream. The member agencies of the FFIEC are carefully reviewing the comments and a final report will be provided to Con- gress later in the year. Additionally, under the auspices of the FFIEC, public notice was issued in September 2015 that established a multistep process for streamlining Call Report requirements. The notice included pro- posals to eliminate or revise several Call Report data items, an- nounced an accelerated start of a statutorily required review of the Call Report, and began an assessment of the feasibility of creating a streamlined community bank Call Report. In addition to the for- mal EGRPRA process, efforts continue for engaging in industry dia- logue and outreach, to better understand significant sources of Call Report burden. Q.6. Coming from a State where we have lost many community lenders, are you worried about credit availability? Will the Board do any specific research on how regulations are impacting credit availability in our economy? A.6. The Board recognizes the unique and important role that com- munity banks play, particularly by lending to small- and medium- sized businesses in local economies. The Board is committed to es- tablishing a deep understanding of the role of community banks in providing credit, and of the impact of economic conditions and reg- ulation on community bank activity. As part of our surveillance function, the Board produces regular reports on profitability, risks, and lending activity for each of its supervisory portfolios, including Community Banking Organiza- tions. There is a challenge to monitoring community banks, in that the Board must strike a balance between the desire for more infor- mation and the burden of increased regulatory reporting for the banks. As mandated by the EGRPRA, the Board submits a report to Congress every 5 years on the availability of credit to small busi- nesses. The last such report was submitted in 2012, and detailed the substantial changes in credit conditions during the financial crisis of 2007–2008, as well as the improvements in credit avail- ability that had occurred as of 2012. The next report on small busi- ness credit availability will be submitted in 2017. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00072 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 69 Since 2013, the Board, in partnership with the Conference of State Bank Supervisors (CSBS), has hosted an annual conference on community banking research and policy. The conference brings together researchers from the Board and academic institutions, and consists of 2 days of research presentations and panels. Governor Brainard and I provided keynote addresses to the 2015 event. Coinciding with the conference, the Board and CSBS have issued an annual report on community banking.1 The report is based largely on a survey conducted by the CSBS and State regulators. The survey seeks to provide an understanding of the profile of com- munity banks, including their product and customer mix, as well as a view of bankers’ impressions on key issues facing the industry, including the cost impact of regulatory compliance. The Board also recognizes that regulatory compliance often rep- resents a fixed cost, and as such community banks can be at a dis- advantage to their larger counterparts in shouldering the burden of compliance. For this and other reasons, the Board is convinced committed to tailoring banking supervision and regulation based on the size and complexities of firms. Among our efforts to reduce reg- ulatory burden for small banks, the Board is currently partici- pating in the decennial review under EGRPRA, as previously noted. The review has included numerous public comments and outreach sessions, and has helped identify a number of themes on which the Board and other agencies have already taken action. In addition, the Board is acting along with other regulators to reduce the burden of various examinations for small banks. Q.7. Specifically, what is the Board’s plan to unwind the Federal Reserve’s nearly $4.5 trillion dollar balance sheet and when will that happen? A.7. The size and composition of the Federal Reserve’s balance sheet reflects the policy actions the Federal Open Market Com- mittee (FOMC) has taken over recent years to achieve its statutory objectives for monetary policy—maximum employment and stable prices. In September 2014, as part of prudent planning, the FOMC released Policy Normalization Principles and Plans2 (Principles and Plans) that provided information regarding its strategy to re- duce the size of the Federal Reserve’s securities holdings once it began normalizing the stance of monetary policy. As stated in the Principles and Plans, the FOMC intends to re- duce the Federal Reserve’s securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal on securities holdings. In its most recent statement, the FOMC again noted that it is maintaining its existing policy of rein- vesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed se- curities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the Federal funds rate is well under way. The FOMC also noted in the Principles and Plans that it cur- rently does not anticipate selling agency mortgage-backed securi- 1See ‘‘Community Banking in the 21st Century: Policy and Research Conference’’, Sept. 31– Oct. 1, 2015, https://www.csbs.org/news/press-releases/pr2015/Pages/PR-100115b.aspx. 2https://www.federalreserve.gov/newsevents/press/monetary/20140917c.htm VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00073 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 70 ties as part of the normalization process, although limited sales might be warranted in the longer run to reduce or eliminate resid- ual holdings. In addition, the timing and pace of any sales would be communicated to the public in advance. Of course, all of these balance sheet plans can be adjusted in light of economic and finan- cial developments. Q.8. During your testimony you responded to Senator Crapo’s ques- tion regarding liquidity conditions and stated that you are looking very carefully at that the factors that may be affecting liquidity in the markets. Will you please further elaborate on what specific studies or evaluations are currently being conducted by the Federal Reserve regarding liquidity conditions in the fixed income market? A.8. Federal Reserve staff have been involved in several projects on market liquidity both internally and with other U.S. Government agencies. Internally, staff have studied and are continuing to study whether there has been a decline in secondary market liquidity in the fixed income markets. Although we have not found strong evi- dence of a significant deterioration in day-to-day liquidity, it is pos- sible that changes in the structure of markets have made liquidity less resilient. This is more difficult to analyze because it involves the study of relatively infrequent events. Among the factors we have looked at, algorithmic traders have become more prevalent in the Treasury market, and the share of bond holdings held by open- end mutual funds, some of which provide significant liquidity transformation, has grown significantly in the postcrisis period. We have explored the importance of these factors, and focused on changes in the broker dealer business model and on the potential impact of regulatory changes on market liquidity. We note that staff at the Federal Reserve Bank of New York have also done a number of studies on market liquidity and have recently published some of this work online.3 Federal Reserve staff have also played a key role in the inter- agency work on the events of October 15, 2014, when fixed income markets experienced a sudden and extreme increase in market vol- atility.4 Staff also continue to engage actively with the U.S. Treas- ury, the Commodity Futures Trading Commission, and the Securi- ties and Exchange Commission on work examining longer term changes in fixed income market structure and their potential im- pact on market liquidity. RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE FROM JANET L. YELLEN Q.1. State of the Economy—I’d like you to elaborate on your state- ment during the February 11, 2016, Senate Banking Committee hearing that ‘‘job creation has perhaps been more heavily skewed toward sectors that have lower pay,’’ and that ‘‘the downturn prob- ably accelerated those trends that perhaps relate to globalization and technological change that are demanding increased skill.’’ This is an important concept to grapple with because our economy is fac- 3http://libertystreeteconomics.newyorkfed.org/2016/02/continuing-the-conversation-on-liquid- ity.html#.Vs3HdXIUWmR 4http://www.federalreserve.gov/newsevents/press/other/20150713a.htm VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00074 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 71 ing a crisis in the nature of work. If we think about the history of economics, we had the ‘‘old economy,’’ which evolved from hunter gatherers, to settled farmers and big tool manufacturing economies. Now we’re entering into a ‘‘new economy’’ which exists within a global economy and a fast, technology-based, information age. With this old and new economy framework in mind, in what sec- tors do you find the unemployment rate is lower? Where is it in- creasing or decreasing more quickly? A.1. The Bureau of Labor Statistics collects data on the previous industry and occupation of people who are unemployed. These data indicate that the unemployment rates of highly skilled workers, in- cluding managers and professionals (around 2 to 3 percent) are lower than the unemployment rates for lower-skilled service work- ers and workers in goods producing industries (typically around 41⁄ 2 to 61⁄ 2 percent). By sector, the unemployment rates for workers in the information and professional, and business services indus- tries are lower than for workers in the construction and leisure and hospitality industries. These findings are indicative of the patterns of job creation that I mentioned in my remarks. However, the unemployment rate data can be difficult to inter- pret, because they reflect not only the long-term changes in the de- mand for certain types of workers that you mentioned, but also the state of the business cycle and transitory sector-specific factors. For instance, unemployment rates for those in lower-skilled occupations have been falling, likely reflecting the further progress in cyclical recovery. And while the unemployment rate is high among former construction workers, this is likely a holdover from the housing market collapse and subsequent slow recovery in residential invest- ment. Similarly the high (and rising) unemployment rate among workers in the mining industry is largely the result of the contrac- tion in oil extraction due to the decline in oil prices, rather than longer run trends. Another way to appreciate the shift in job creation that I men- tioned is to look at an occupation’s share of civilian employment. For instance, the share of total employment made up by managers, professionals, and related workers has risen from less than 30 per- cent in the mid-1980s to nearly 40 percent. In contrast, the share of employment constituted by office and administrative workers has fallen from 16 percent to 12 percent over that same time pe- riod, while the production worker share of employment has fallen from 9 percent to less than 6 percent. Q.2. In what sectors are wages higher? Where are they increasing more and less quickly? A.2. Data from the Bureau of Labor Statistics’ Employer Costs for Employee Compensation survey indicate that compensation is high- er for workers in industries, such as professional and business services, financial activities, educational services and information, that could be thought to have many high-skilled workers (com- pensation at $40 per hour or more, on average). Industries such as manufacturing and transportation and warehousing also pay their workers relatively well (compensation between $35 and $40 per hour, on average). Low-paying industries include leisure and hospi- tality and retail trade (compensation under $20 per hour). One VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00075 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 72 thing to note is that all these industries include workers with vary- ing skill levels. It is difficult to discern trends in wages over short periods of time, since these movements can be dominated by cyclical forces and idiosyncratic shocks. Looking at the Bureau of Labor Statistics’ Employment Cost Index, over the past decade, compensation growth for most industries has averaged around 21⁄ 2 percent. How- ever, if you look over longer time periods, workers with higher skills, for instance, as measured by higher levels of education, have experienced greater wage gains than other workers. Q.3. In what sectors, if any, have workers stopped looking for jobs? A.3. Useful data on this topic come from the Bureau of Labor Sta- tistics’ Displaced Workers’ Survey, which surveys workers who had been in their jobs for at least 3 years and who ‘‘lost or left jobs be- cause their plant or company closed or moved, there was insuffi- cient work for them to do, or their position or shift was abol- ished.’’1 In interpreting these data, it is useful to keep in mind that these job losses and any labor force exits could be due to cyclical as well as structural factors. Over the period from 2011 to 2013, former workers in some man- ufacturing industries, including transportation equipment and many nondurable manufacturing industries, were more likely than average to have left the labor force, as were former workers in re- tail trade, finance and insurance, and management, administrative, and waste services. Looking by occupation, according to the most recent data, former workers in the production, transportation, and material moving occupations were the most likely to have left the labor force, followed by individuals leaving sales and office occupa- tions. Workers in occupations requiring higher skills were less like- ly to exit the labor force. Q.4. How do observations about unemployment and labor force par- ticipation in the old and new economy affect the Fed’s interest rate policy decisions? A.4. One of the Federal Reserve’s mandates from the Congress is to conduct monetary policy so as to promote the maximum level of employment that can be sustained without leading to higher infla- tion. In assessing its employment objective, policymakers must evaluate how changes in the economy, such as globalization and technological change, affect the types of jobs and skills needed in the workforce. In addition, policymakers need to consider how trends in the size and makeup of the labor force—for example, its composition by age, education, and skills—affect the longer-run normal rate of unemployment and the maximum sustainable level of employment. Because of the factors influencing the demand and supply of labor evolve over time, the Federal Open Market Com- mittee (FOMC) cannot specify a fixed longer-run goal for employ- ment or the unemployment rate. Policymakers update their assess- ments of the longer-run economic outlook regularly using a wide range of information and present their views four times each year in their Summary of Economic Projections (SEP). In the SEP pro- jections prepared in connection with the March 2016 meeting, 1http://www.bls.gov/news.release/disp.nr0.htm VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00076 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 73 FOMC participants reported estimates of the longer-run normal rate of unemployment that ranged from 4.7 to 5.8 percent, with a median estimate of 4.8 percent. Conditional on appropriate mone- tary policy, participants projected that the unemployment rate would be at or below their individual estimates of the longer-run normal rate from 2016 to 2018, and that inflation would gradually rise over that period, reaching a level at or close to the FOMC’s longer-run objective in 2018. Q.5. I’d like to briefly turn to Iran, which recently demanded that Iranian oil purchasers transact in euros instead of dollars. What volume—if any—of oil transactions would have to be denominated in euros instead of dollars for such a shift to impact the Federal Reserve’s monetary policy or macroeconomic projections? A.5. Iran currently exports about 1.6 million barrels of oil per day, which is higher than the roughly 1 million barrels per day aver- aged over 2014 to 2015, but still below the 2.2 million barrels per day pace before the limited States and the European Union tight- ened sanctions targeting Iran’s oil sector in 2012.2 However, even if Iranian exports were to move back up to pre-sanction levels and oil prices to rise to $50 a barrel, their share of global oil trade would only be around 3 percent and of overall global trade only about 0.2 percent.3 Most oil prices are quoted in dollars, and would continue to be, as having a common currency likely facilitates transparency and communication. Moreover, many of the benefits that are said to ac- crue to the United States because of dollar invoicing, such as the stability of prices in the face of exchange rate movements, are less relevant for oil markets because oil prices are very responsive to market conditions, including exchange rate changes. Q.6. Entitlement Spending—I’d like you to elaborate on your state- ment to Representative Andy Barr that ‘‘Every Fed chair that I can remember has come and told Congress that [mandatory entitle- ment spending] is a looming problem with serious economic con- sequences.’’ In July of 2015, former Federal Reserve Chairman Alan Green- span said that the ‘‘extraordinary rise in entitlements’’ is ‘‘ex- tremely dangerous.’’ Do you agree with this sentiment? Why? A.6. As do most economists, I agree with the assessment that the Federal Government budget is on an unsustainable path, given cur- rent fiscal policies. The Congressional Budget Office (CBO) projects that Federal budget deficits and Federal Government debt will be increasing, relative to the size of the economy, over the next decade and in the longer run.4 In the CBO’s projections, growth in Federal spending—particularly for mandatory entitlement programs and interest payments on Federal debt—outpaces growth in revenues in the coming years. The increases in entitlement programs, such as Social Security and programs providing health care, are mainly at- 2According to the International Energy Agency’s March estimate. 3Total world trade is about $19 trillion dollars. At least 40 percent of world trade is denomi- nated in dollars, which is about 4 times greater than the U.S. share of global exports and im- ports. Total global exports of oil are about 64 million barrels per day. 4Congressional Budget Office, ‘‘The Budget and Economic Outlook: 2016 to 2026’’, January 2016, and ‘‘The 2015 Long-Term Budget Outlook’’, June 2015. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00077 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 74 tributable to the aging of the population and rising health care costs per person. For fiscal sustainability to be achieved, whatever level of spending is chosen, revenues must be sufficient to sustain that spending in the long run. Q.7. Please describe the ‘‘serious economic consequences’’ of failing to address entitlement spending. A.7. I believe the CBO appropriately describes several reasons why high and rising Federal Government debt would have serious nega- tive consequences for the economy.5 First, because Federal bor- rowing reduces total saving in the economy over time, the Nation’s capital stock would ultimately be smaller than it would be if debt was lower; as a result, productivity and overall economic growth would be slower. Second, fiscal policymakers would have less flexi- bility to use tax and spending policies to respond to unexpected negative shocks to the economy. Third, the likelihood of a fiscal cri- sis in the United States would increase. Q.8. How soon does the United States need to address our entitle- ment spending, before there are, as you put it, ‘‘serious economic consequences’’? A.8. Neither experience nor economic theory clearly indicate the threshold at which Government debt would begin to impose sub- stantial costs on the U.S. economy.6 But given the significant costs and risks associated with a rapidly rising Federal debt, fiscal pol- icymakers should soon put in place a credible plan for reducing deficits to sustainable levels over time. Doing so earlier rather than later would ultimately prove less costly by avoiding abrupt shifts in policy and by giving those affected by budget changes more time to adapt. Q.9. How would a failure to address entitlement spending affect the way in which the Federal Reserve conducts monetary policy? A.9. The Federal Reserve adjusts monetary policy as appropriate to maintain or to make progress toward our statutory goals of max- imum employment and price stability; both the direction and size of those adjustments could depend on the implications of a failure to address entitlement spending for the economic outlook. For ex- ample, it is possible that a failure to put entitlement programs on a sustainable longer-term path could result in an increase in the yields that investors demand on longer-term U.S. Treasury securi- ties. To the extent those increased yields pass through into higher interest rates on corporate bonds, mortgages, and bank loans, the increase in rates would tend to restrain economic activity in the United States and could require the Federal Reserve to ease policy to achieve its economic objectives. In other scenarios, concerns that entitlement programs were not on a sustainable course could con- tribute to inflationary pressures that could require the Federal Re- serve to tighten policy to achieve its objectives. Of course, these are not the only possible outcomes. In judging the appropriate stance of monetary policy, the Federal Reserve constantly assesses incom- 5Congressional Budget Office, ‘‘The Budget and Economic Outlook: 2016 to 2026’’, January 2016. 6See, for example, Congressional Budget Office, ‘‘Federal Debt and the Risk of a Fiscal Cri- sis’’, July 27, 2010. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00078 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 75 ing economic and financial data and their implications for the eco- nomic outlook. Q.10. How would a failure to act affect the amount of interest the Federal Government pays on the debt? How early could we start to see this affect? A.10. With a high level of Federal debt and a forecast of increasing budget deficits, as interest rates rise from their current levels to more typical ones, the CBO projects that Federal spending on in- terest payments will soon begin to rise considerably.7 Q.11. Could a failure to address entitlement spending ever affect the dollar’s status as a reserve currency? A.11. The U.S. dollar has been considered the world’s reserve cur- rency on a consistent basis for quite a while, and projections show- ing that the Federal budget is unsustainable over the long run have also been known for some time. Thus, it is uncertain what cir- cumstances could change that status. There is no way to predict with any confidence whether and when such a change might occur; in particular, there is no identifiable level of Federal debt, relative to the size of the economy, indicating that this would be likely or imminent. Q.12. Could a failure to address entitlement spending ever cause markets to significantly question the Treasury bill’s status as a risk-free instrument? What would the consequences be if this were to occur? A.12. U.S. Treasury securities have generally been considered risk- free because of the size and strength of our economy. And as I stat- ed in my response above, at the same time, projections showing that the Federal budget is unsustainable over the long run have been known for some time. Similarly, there is no way to predict with any confidence whether and when a change in the risk-free status of Treasury securities might occur. In particular, there is no threshold level of debt, relative to the size of the economy, indi- cating that investors would become unwilling to finance all of the Federal Government’s borrowing needs unless they were com- pensated with very high interest rates. But all else being equal, the higher the ratio of Federal debt to GDP, the greater the risk of this happening.8 Q.13. Regional Banks—I’d like to ask about the Federal Reserve’s implementation of Section 165 of Dodd-Frank, which provides for enhanced prudential standards for banks with $50 billion in assets or higher. As you know, these standards include stress tests, which require banks to evaluate how they would fare under unfavorable economic conditions, and resolution plans, which require banks to provide a plan for winding down during a crisis. I’m concerned about the unnecessary damage that these prudential standards could have on regional banks, which play a key role in expanding capital to small- and medium-size businesses. 7Congressional Budget Office, ‘‘The Budget and Economic Outlook: 2016 to 2026’’, January 2016. 8See, for example, Congressional Budget Office, ‘‘Federal Debt and the Risk of a Fiscal Cri- sis’’, July 27, 2010. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00079 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 76 Do regional banks pose the same risk as large banks with a tril- lion or more in assets? A.13. As I have stated in the past, one-size-fits-all should not be the model for regulation. The Federal Reserve has made it a top priority to ensure that we appropriately tailor our regulation and supervision of banks to their size, complexity, and risk. By statute, all banking organizations above $50 billion in assets are subject to enhanced prudential standards. However, the Federal Reserve rec- ognizes that very large, complex firms pose a greater risk to the fi- nancial system than smaller, noncomplex firms, and we have dif- ferentiated our implementation of the enhanced prudential stand- ards as a result. The eight globally systemic banks are overseen by the Large Institution Supervision Coordinating Committee (LISCC) and are subject to the highest supervisory standards relative to firms outside this portfolio.9 LISCC firms are subject to additional capital and leverage surcharges and more stringent liquidity re- quirements. In addition, the LISCC firms are subject to the highest supervisory standards across all assessment areas to include gov- ernance, risk management, internal controls, capital policy, sce- nario design, and the use of models. The Federal Reserve has further differentiated between large, complex super-regional institutions and other large banking organi- zations with smaller regional footprints. The large, complex firms while subject to tailored expectations as opposed to the LISCC firms, are subject to heightened standards relative to the smaller, noncomplex firms. This distinction was outlined in the publication of guidance10 in which the Federal Reserve set expectations for capital planning for LISCC Firms and Large and Complex Firms (with assets in excess of $250 billion and onbalance sheet foreign exposure in excess of $10 billion) that are higher than the expecta- tions for their smaller counterparts. In addition to tailoring guidance, the Federal Reserve continues to explore ways to improve our supervision process around capital planning to ensure that our supervisory approaches and methodolo- gies are appropriate and consistent as possible for similar sized in- stitutions. Q.14. I’m concerned that our Federal banking regulatory regime arbitrarily relies upon asset thresholds to impose prudential regu- lations, instead of independently analyzing the risk profile of finan- cial institutions. Should a bank’s asset size be dispositive in assess- ing a bank’s risk profile for the purposes of imposing prudential regulations? For example, would a bank with less than a half-tril- lion in assets typically have the same complexity and conduct the same kind of financial activities as a bank with over $2 trillion in assets? A.14. Under section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), the Federal Reserve is 9The eight domestic banks classified as global systemically important financial institutions supervised by LISCC are: Bank of America Corporation, The Bank of New York Mellon Corpora- tion, Citigroup Inc., The Goldman Sachs Group, Inc., JP Morgan Chase & Co., Morgan Stanley, State Street Corporation, and Wells Fargo & Company. 10SR Letter 15-18 (Federal Reserve Supervisory Assessment of Capital Planning and Posi- tions for LISCC Firms and Large and Complex Firms) and SR Letter 15-19 (Federal Reserve Supervisory Assessment of Capital Planning and Positions for Large and Noncomplex Firms). VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00080 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 77 authorized to tailor the application of enhanced prudential stand- ards. In implementing section 165, the Federal Reserve has identi- fied three categories of bank holding companies with $50 billion or more in total consolidated assets based not only on their size, but also based on complexity and other indicators of systemic risk. Spe- cifically, all such bank holding companies are subject to certain en- hanced prudential standards, including risk-based and leverage capital requirements, company-run and supervisory stress tests, li- quidity risk-management requirements, resolution plan require- ments, and risk management requirements. Bank holding compa- nies with $250 billion or more in total consolidated assets or $10 billion or more in on-balance-sheet foreign assets are also subject to the advanced approaches risk-based capital requirements, a sup- plementary leverage ratio, more stringent liquidity requirements, and a countercyclical capital buffer. In identifying global systemically important banks, the Federal Reserve considers measures of size, interconnectedness, cross-juris- dictional activity, substitutability, complexity, and short-term wholesale funding. The eight U.S. firms identified as global system- ically important banks (GSIBs) are subject to risk-based capital surcharges, an enhanced supplementary leverage ratio, and more specific recovery planning guidance. In addition, the Federal Reserve tailored the application of the enhanced prudential standards required under section 165 to Gen- eral Electric Capital Corporation (GECC), a nonbank financial com- pany designated by the Financial Stability Oversight Council (FSOC) for supervision by the Federal Reserve. Because of the sub- stantial similarity of GECC’s current activities and risk profile to that of a large bank holding company, the enhanced prudential standards that would be applied to GECC are similar to those that apply to large bank holding companies, but they are tailored to re- flect the unique characteristics of GECC. The standards include (1) capital requirements; (2) capital-planning and stress-testing re- quirements; (3) liquidity requirements; and (4) risk-management and risk-committee requirements. Q.15. Please describe in detail how the Federal Reserve will mean- ingfully tailor Section 165 prudential standards to match a par- ticular bank’s ‘‘capital structure, riskiness, complexity, financial ac- tivities . . . [and] size,’’ as allowed for under Section 165, including with regards to stress testing and resolution planning? A.15. The Federal Reserve has tailored resolution planning re- quirements for firms subject to section 165 of the Dodd-Frank Act where it has permitted firms with limited nonbanking operations to file a tailored plan that exempts it from many informational re- quirements. Additionally, the Federal Reserve and the Federal De- posit Insurance Corporation have exempted 90 firms with limited U.S. operations from most plan requirements. These firms may file plans that focus on material changes to their initial resolution plan filed in 2014, actions taken to strengthen the effectiveness of those plans, and, where applicable, actions to ensure any subsidiary in- sured depository institution is adequately protected from the risk arising from the activities of nonbank affiliates of the firm. The VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00081 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 78 Federal Reserve’s recovery planning guidance focuses only on the eight U.S. GSIBs. Bank holding companies with more than $50 billion in total con- solidated assets are subject to the Federal Reserve’s Comprehen- sive Capital Analysis and Review (CCAR), which evaluates the cap- ital planning processes and capital adequacy of the largest U.S.- based bank holding companies, including the firms’ planned capital actions such as dividend payments and share buybacks and issuances. Strong capital levels absorb losses and help ensure that banking organizations have the ability to lend to households and businesses even in times of financial and economic stress. In De- cember 2015, the Federal Reserve released guidance to its exam- iners and banking institutions that consolidates the capital plan- ning expectations for all large financial institutions and clarifies differences in those expectations based on firm size and complexity. The guidance is designed to tailor the Federal Reserve’s expecta- tions for large financial institutions. For the largest and most complex firms, the guidance clarifies ex- pectations that have been previously communicated to firms, in- cluding through past CCAR exercises and related supervisory re- views. These firms are bank holding companies and intermediate holding companies of foreign banks subject to the Federal Reserve’s LISCC framework, or firms with $250 billion or more in total con- solidated assets or $10 billion or more in foreign exposures. For firms with more than $50 billion, but less than $250 billion in total consolidated assets, as well as less than $10 billion in for- eign exposures, the guidance clarifies the supervisory expectations to be applied for the firms’ capital planning processes. In general, the guidance is tailored to reflect the lower systemic risk profile and less complex operations of these firms, as compared to the largest and most complex firms. Q.16. In testimony to the Senate Banking Committee, you noted that the Federal Reserve is ‘‘actively engaged in reviewing our stress-test testing in capital planning framework’’ and that the Federal Reserve is ‘‘considering ways in which we can make that less burdensome for the bank holding companies that are close to the $50 billion asset line.’’ How close to $50 billion in assets must a bank be for the Federal Reserve to consider tailoring the stress test regime? A.16. Please see response to Question 13. Q.17. Is the Federal Reserve considering tailoring Section 165 pru- dential standards for banks with assets that are not merely ‘‘close’’ to $50 billion in assets? For instance, according to Basel Systemic Risk Indicators from 2013, the systemic risk score of almost every bank with less than $500 billion in assets is 4 times less than every bank with more than $500 billion in assets. A.17. As indicated in the responses to Questions 14 and 15, the Federal Reserve has tailored meaningfully the application of the enhanced prudential standards under section 165 to both bank holding companies and GECC. Underlying this tailoring was the principle that progressively more stringent regulation should apply to firms based on their relative importance to the financial system, and thus the harm that could be expected to the system if they VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00082 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 79 failed. The Federal Reserve continues to consider ways to further tailor the enhanced prudential standards to reflect differences in risk among firms. Q.18. Insurance—I’d like to ask about the Federal Reserve’s devel- opment of insurance capital standards. What steps has the Federal Reserve taken to ensure that the minimum capital standards are tailored to the business of insur- ance? A.18. The Federal Reserve is committed to developing capital standards in accordance with its statutory mandate and authority in a way that is appropriate and tailored to the insurance industry. The Federal Reserve appreciates that insurance involves unique risks among financial institutions, encompassing both liabilities and assets, and it is important to keep in mind the liability struc- ture of firms in determining capital requirements for insurance companies, particularly with regard to the mix of the insurers’ ac- tivities. We are approaching our mandate carefully and with proper deliberation. In our development of domestic standards, we are con- sulting with the industry, State commissioners and other key exter- nal parties on several aspects of the standards to achieve the Fed- eral Reserve’s mandate under the authority as set out in the Dodd- Frank Act. Moreover, the Federal Reserve intends to make full use of the flexibility provided by the Insurance Capital Standards Clar- ification Act of 2014 to tailor the capital standards to the business of insurance. Q.19. How much deference will the Federal Reserve give to State insurance regulators in developing these insurance standards? Will State insurance standards provide the broad basis for the Federal Reserve’s new regulations? Why or why not? A.19. With the enactment of the Dodd-Frank Act, the Federal Re- serve was assigned responsibility as the consolidated supervisor of insurance holding companies that own thrifts, as well as insurance companies designated by the FSOC. The Federal Reserve’s prin- cipal supervisory objectives for the insurance firms that it oversees include protecting the safety and soundness of the consolidated firms, as well as mitigating risks to financial stability. The Federal Reserve continues to engage extensively with State insurance regu- lators, the National Association of Insurance Commissioners, and other interested stakeholders to solicit feedback on insurance pru- dential standards that would comport with the Federal Reserve’s statutory authority. The Federal Reserve’s consolidated supervision supplements ex- isting State based legal-entity supervision, which focuses on policy- holder protection, with a perspective that considers the risks across the entire firm. Moreover, the Federal Reserve’s insurance pruden- tial standards will not alter or replace the existing State-based framework, including capital requirements at the legal entity level, that are already in place. We continue to coordinate with State in- surance regulators in their protection of policyholders and aim to avoid duplications of their supervision. We leverage the work of State insurance regulators where possible and continue to look for opportunities to further coordinate with them. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00083 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 80 It would be premature to comment on how the Federal Reserve will treat the unique risks of certain insurance lines, mix of busi- ness and the like, before we have fully evaluated the potential op- tions for insurance prudential standards, including those that rely, in part, on the State-based capital requirements of regulated insur- ance companies. In our supervision of insurance firms, the Federal Reserve remains committed to tailoring our supervisory approach, including a domestic regulatory capital framework and other insur- ance prudential standards, to the business of insurance, reflecting insurers’ different business models and systemic importance com- pared to other firms supervised by the Federal Reserve. Moreover, we are committed to a formal rulemaking process in the develop- ment of insurance prudential standards. Q.20. Has the Federal Reserve conducted cost benefit analysis to develop these insurance standards? If not, why? If so, please share the results of these studies? A.20. With respect to the insurance standards and all other rulemakings, the Federal Reserve follows the Administrative Proce- dures Act and other applicable administrative laws that govern the various aspects of rulemakings, including the consideration of costs and benefits. The Federal Reserve regularly conducts economic analyses in connection with rulemakings, including considering the potential economic impact of a rule on small depository institutions consistent with the Regulatory Flexibility Act, and considering the anticipated cost of paperwork consistent with the Economic Growth and Regulatory Paperwork Reduction Act. To inform our rule- making, in 2014, the Federal Reserve conducted an extensive quan- titative impact study. The data we collected helps us to understand the insurance risks of the firms that participated in the study. To the extent possible, the Federal Reserve attempts to minimize regulatory burden in its rulemakings consistent with the effective implementation of our statutory responsibilities. The Federal Re- serve is charged by Congress to promulgate rules largely designed to improve the safe and sound operation of financial organizations and safeguard financial stability. As part of the rulemaking proc- ess, the Federal Reserve specifically seeks comment from the public on the burdens and benefits of our proposed approach as well as on alternative approaches and, in adopting final rules, the Federal Reserve seeks to adopt a regulatory alternative that faithfully im- plements the statutory provisions while minimizing regulatory bur- den. It would be premature for the Federal Reserve to disclose the cost benefit analysis of the insurance standards rulemaking since it is still in the development stage and we have yet to conclude our deliberations. RESPONSES TO WRITTEN QUESTIONS OF SENATOR COTTON FROM JANET L. YELLEN Q.1. You testified at your confirmation hearing that even a positive rate close to zero could disrupt money markets that help fund fi- nancial institutions. By extension, isn’t it logical to conclude that a negative interest rate would be even more disruptive? VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00084 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 81 A.1. As noted in its most recent statement, the FOMC anticipates further improvement in labor market conditions with inflation re- turning to 2 percent over the medium term. This economic outlook is expected to be associated with gradual increases in the Federal funds rate. That said, if the economic outlook weakened appre- ciably, the FOMC would need to consider actions to provide addi- tional policy accommodation to foster progress toward its statutory objectives of maximum employment and price stability. The experi- ence of foreign countries suggests that negative interest rates have provided additional monetary policy accommodation in those coun- tries without significant disruptions in money markets. However, it is unclear whether the same would be true for the United States. At a minimum, any consideration of negative interest rates in the United States would require careful study of the implications of negative rates for U.S. financial markets and institutions and U.S. households and businesses along with the potential for unintended consequences. Q.2. How long can the wholesale banking system withstand a glob- al environment of negative interest rate policies from the major central banks? A.2. The long-run effects of negative interest rate policies on banks’ profitability are uncertain. In a number of economies where the policy has been introduced, banks’ profits have been reduced by lower interest income, but have been supported by lower funding costs, capital gains on bond holdings, and lower provisions for loan losses. At the same time, negative interest rate policies may be pro- viding economic stimulus, and that stimulus may ultimately im- prove the overall economy and subsequently bank’s income. Q.3. What incentive effect would you expect negative interest rates to have on fiscal consolidation? A.3. During the most recent recession and financial crisis, the Fed- eral Reserve did not respond with a monetary policy that included a target for the Federal funds rate that was negative. As a result, without the experience of using a negative policy rate, it is difficult and speculative to describe the effects that it might have on the U.S. economy and the Federal Government budget. That said, if economic conditions were such that the Federal Reserve decided that it was appropriate to implement a negative policy rate, then the effects on the economy and the Federal Government budget could be qualitatively similar to the effects of our traditional mone- tary policy response of lowering the target for the Federal funds rate when the economy goes into a downturn. To the degree that a negative rate policy helped reduce long-term borrowing costs for households and businesses that, in turn, boosted economic activity and employment above where it otherwise would have been, the Federal Government budget would also be in a better position. If a stronger economy was the result of such a policy, then tax reve- nues would be higher and there would be less Government spend- ing for income-support programs, such as unemployment insurance benefits. Q.4. What would a further drop in discount rates, driven by NIRP, do to unfunded pension liabilities in the public and private sectors? VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00085 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 82 A.4. In general, lower discount rates mechanically increase the present value calculation for future pension liabilities. However, pension funding status is heavily dependent on the rate of return on pension assets, as well as the calculation of liabilities. As a re- sult, the effect of monetary policy on pension funding status is dif- ficult to ascertain, because monetary policy likely affects the rate of return on pension assets as well as the calculation of the liabil- ities. In addition, there is not a direct connection between mone- tary policy and the discount rate used by pension systems to cal- culate their liabilities. For example, the median discount rate being used by State and local retirement systems in their financial re- ports, as reported in ‘‘Wilshire Consulting’s 2016 Report on State Retirement Systems’’, was 7.5 percent, well above the Federal Open Market Committee’s Federal funds rate target range of 0.25–0.50 percent. Q.5. Last year, an official from the Bank of International Settle- ments said: For central banks, [NIRP] policies raise the risk of fi- nancial dominance, exchange rate dominance, and fiscal domi- nance—that is, the danger that monetary policy becomes subordi- nated to the demands of propping up financial markets, massaging the exchange rate downwards, and keeping public refinancing costs low in the face of unprecedented public debt burdens. Do you dis- agree? If you believe this might be a risk worth taking for the Fed that implies some temporal trade-off. But, as you know, pulling growth forward is not sustainable. How long would you expect a hypo- thetical NIRP environment to take to generate the real economic growth necessary to meet the Fed’s dual mandate? A.5. The Congress established the Federal Reserve as an inde- pendent central bank tasked with conducting policy to promote progress toward the statutory goals of maximum employment and stable prices. As part of this framework, the Federal Reserve is ac- countable to the Congress and the American people for its actions. The Federal Reserve supports appropriate accountability through many steps that foster a transparent monetary policy process. For example, the Federal Reserve regularly reports detailed descrip- tions of its analysis of economic and financial developments, the policy outlook, and policy deliberations in the minutes of every FOMC meeting. Additionally, I formally report to Congress twice each year on the economic and monetary policy outlook and typi- cally testify on many other occasions as well. These and many other steps ensure that monetary policy actions undertaken by the Federal Reserve can be understood and scrutinized by the public. That process, in turn, ensures that monetary policy is directed sole- ly at achieving the Federal Reserve’s statutory objectives of max- imum employment and stable prices. The current stance of monetary policy remains very accommoda- tive and, as noted in the answer to Question 1 above, the Federal Reserve anticipates that economic conditions will warrant gradual increases in the Federal funds rate over time. Regarding hypo- thetical situations in which additional policy accommodation could be needed, recent foreign experience suggests that negative interest rates have provided additional policy accommodation in those coun- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00086 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 83 tries. However, it is unclear whether the same would be the case in the United States. Any consideration of the use of negative rates in the United States to provide additional policy accommodation would require careful study of many complicated issues. RESPONSES TO WRITTEN QUESTIONS OF SENATOR ROUNDS FROM JANET L. YELLEN Q.1. The purpose of the Systemically Important Financial Institu- tion designation process is to reduce risk, but I am concerned that it’s a lot easier for firms to become designated a SIFI than it is for firms to de-risk and de-designate. What has the Federal Reserve done and what do can the Federal Reserve do going forward to make it easier for firms to de-designate? A.1. The Federal Reserve Board’s (Board) regulations and super- visory guidance applicable to the largest U.S. bank-holding compa- nies and nonbank financial companies that are designated by the Financial Stability Oversight Council (FSOC) are intended to re- duce the threat that could be posed to U.S. financial stability by the material financial distress or failure of these organizations and promote their safe and sound operations. Such regulations are de- signed to increase the resilience of systemically important financial institutions and foster such firms’ ability to provide credit and other financial services in times of financial stress. Through speeches and testimony, the Board and its staff also provide infor- mation on how financial institutions, both banks and nonbanks, can reduce the risk they could pose to U.S. financial stability. FSOC designation of nonbanks is not intended to be permanent. The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) provides that the FSOC annually review designa- tions to make sure that they remain appropriate and take into ac- count significant changes at the firms that materially affect the FSOC’s determination. At the time of designation, nonbank finan- cial companies are given a detailed basis for the determination that a nonbank financial company should be subject to supervision by the Board. Factors include the extent of short-term funding activi- ties at those organizations, the firms’ products and associated short-term liabilities, their capital markets activities, securities lending, over-the-counter derivatives, and interconnectedness with the rest of the financial system. Firms can use that information, as well as factors the FSOC is required to consider under the Dodd- Frank Act, to guide their efforts to reduce their systemic footprint. Q.2. Would a clearly marked off-ramp make with specific require- ments for de-risking make it easier for firms to reduce systemic risk? A.2. As stated above, the FSOC designation of nonbanks is not in- tended to be permanent. Because each firm’s systemic footprint is different, the FSOC conducts its analysis on a company-by-com- pany basis in order to take into account the potential risks and mitigating factors that are unique to each company. At the time of designation, nonbank financial companies are given a detailed basis for the determination that a nonbank financial company should be subject to supervision by the Board. Firms can use that VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00087 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 84 information, as well as factors the FSOC is required to consider under the Dodd-Frank Act, to guide their efforts to reduce their systemic footprint. Q.3. The designation of three insurers as systemically important has given the Federal Reserve a large voice in the regulation and supervision of the insurance industry. The Financial Stability Oversight Council has an independent insurance expert and the Federal Reserve has an insurance expert, but beyond that, how often and in what way does the Federal Reserve communicate with State insurance commissioners when making supervisory and regu- latory decisions? A.3. While the Federal Reserve and State insurance regulators, to- gether with the National Association of Insurance Commissioners (NAIC), have distinct statutory authorities and mandates, the Fed- eral Reserve remains committed to working cooperatively with the States on a wide range of insurance supervisory and regulatory issues. The Federal Reserve respects the work of State insurance regulators, collaborating both informally and formally through mechanisms such as supervisory colleges, the evaluation of super- vised insurers’ Own Risk and Solvency Assessments and other su- pervisory matters. Federal Reserve staff continues to meet regu- larly with State insurance departments to discuss supervisory plans and findings for the insurance firms for which the Federal Reserve has consolidated supervisory responsibility. We addition- ally have hosted multiple crisis management groups that included participation from parties including State insurance departments, as well as the Federal Insurance Office and Federal Deposit Insur- ance Corporation. Additionally, the Federal Reserve’s examination teams leverage the important work of State insurance regulators in the evaluation of capital planning and sufficiency. The Federal Re- serve continues to be committed to working with State insurance regulators, the NAIC and other involved regulators in the future. Q.4. Right now, the United States is selling massive amounts of debt to finance U.S. deficits and we strongly rely on foreign Gov- ernments to buy that debt. So far, there has been a strong appetite from foreign Governments for our debt, however, at some point that may change. Is the Federal Reserve concerned about this? A.4. Foreign entities hold close to half of Federal Government debt held by the public, roughly the same share as before the most re- cent recession and subsequent run-up in Federal debt. Foreign offi- cial entities, which include foreign central banks and sovereign wealth funds, hold less than one-third of Federal debt held by the public and make up the bulk of all foreign holdings. In general, for- eign entities often want to hold U.S. Treasury securities because of their liquidity and perceived safety and soundness. Moreover, for- eign holdings of Federal debt imply that there is less reliance on domestic sources of saving in order to finance Government bor- rowing, thereby keeping interest rates on Treasury securities lower than they would be otherwise. At this point, there is no apparent evidence that there has been any material decrease in foreign de- mand for Treasury securities, and interest rates on these securities remain fairly low. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00088 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 85 Q.5. What does the Fed expect will happen to U.S. debt sales when we reach this point? A.5. If, for some reason, foreign and domestic demand for U.S. Treasury securities were to decline significantly, then interest rates would have to rise such that investors would be willing to finance all of the Federal Government’s borrowing needs. The extent to which interest rates have to increase would depend upon the mag- nitude of any decrease in demand. Q.6. Does the Federal Reserve have a model that predicts when the world will be unable or unwilling to absorb additional debt from the U.S.? A.6. The Federal Reserve does not have a model that currently pre- dicts that the world will be unable or unwilling to absorb addi- tional Federal Government debt. Indeed, demand for Treasury se- curities has been quite robust recently, even with the substantial increase in Federal debt over the past decade and projections of further increases in the coming years. Q.7. Rulemakings by the Federal Reserve must follow the require- ments of the Administrative Procedure Act, Regulatory Flexibility Act, and Paperwork Reduction Act. In addition, the Riegle/Neal Community Development and Regulatory Improvement Act require the Federal Reserve to consider the administrative burdens im- posed by new regulations on depository institutions as well as the benefits of such regulations. However, recent rulemaking by the Federal Reserve has failed to release such economic analysis for public comment, which the D.C. Circuit Court of Appeals has held to be necessary to comply with the required economic analysis under these statutes. Why has the Federal Reserve not published the results of its economic analysis for public comment? Will you commit to doing so going forward? A.7. With respect to all rulemakings, the Federal Reserve follows the Administrative Procedures Act and other applicable adminis- trative laws that govern the various aspects of rulemakings, includ- ing the consideration of costs and benefits. The Federal Reserve regularly conducts economic analyses in connection with rulemakings, including considering the potential economic impact of a rule on small depository institutions consistent with the Regu- latory Flexibility Act, and considering the anticipated cost of paper- work consistent with the Economic Growth and Regulatory Paper- work Reduction Act. To the extent possible, the Federal Reserve attempts to minimize regulatory burden in its rulemakings consistent with the effective implementation of our statutory responsibilities. The Federal Re- serve is charged by Congress to promulgate rules largely designed to improve the safe and sound operation of financial organizations and safeguard financial stability. As part of the rulemaking proc- ess, the Federal Reserve specifically seeks comment from the public on the burdens and benefits of our proposed approach as well as on alternative approaches and, in adopting final rules, the Federal Reserve seeks to adopt a regulatory alternative that faithfully im- plements the statutory provisions while minimizing regulatory bur- den. VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00089 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 86 Q.8. The Federal Reserve Bank of Kansas City recently issue a re- port on the agricultural sector of the economy which reported that depressed crop prices, increased inventories, and declining demand for exports caused agricultural lenders and the Fed to have, ‘‘in- creasing concerns about 2016 farm finances.’’ Are you also con- cerned about the future of the farm economy? A.8. Developments in the U.S. farm economy warrant close moni- toring as low agricultural commodity prices have weighed on farm income. To support cash flow, short-term lending from commercial banks to the farm sector has increased. Although the combined bal- ance sheet of the sector remains healthy, primarily due to elevated farm real-estate values, some commercial banks have reported con- cerns about repayment rates on agrelated loans. Looking ahead, continued low commodity prices and a decline in farmland values are key risks to the farm economy. That said, some indicators suggest the sector is demonstrating resilience. In the fourth quarter of 2015, the delinquency rate on agricultural production loans was less than 1 percent, compared with 2.7 percent 5 years ago. Also, agricultural real estate values, which are a significant contributor to the health of balance sheets, have remained relatively stable—though, they have modestly de- clined from recent peaks. To summarize, the downturn in the farm economy has been nota- ble and raises concerns that farm borrowers could face mounting difficulties in the year ahead as the sector continues to adjust to lower commodity prices. The Federal Reserve will continue to close- ly monitor these developments as well as potential of spillover ef- fects to sectors closely connected to the farm sector, banks and the financial system, or to the U.S. economy more generally. Q.9. When you take a look at the health of America’s farmers, what indicators do you look at and who do you listen to? A.9. At the Federal Reserve we follow a wide variety of data on the farm sector, related both to farm finances (for instance, data on farm land prices and farm credit) and farm output (including data on farm product prices, farm income, and farm inventories). More- over, the Federal Reserve Banks provide regular updates on a broad array of farm issues. Staff members reach out regularly to farm contacts in their districts to learn about the health of the sec- tor, and that information is included in our ‘‘Summary of Com- mentary on Current Economic Conditions by Federal Reserve Dis- trict’’ commonly known as the Beige Book, which is published eight times a year. RESPONSES TO WRITTEN QUESTIONS OF SENATOR MORAN FROM JANET L. YELLEN Q.1. During your February 10th testimony in front of the House of Representatives Committee on Financial Services, you were asked by two members of Congress about how Custody banks could be prevented from accepting cash from pension funds and their other customers, especially in a period of financial market stress, because the Supplemental Leverage Ratio (SLR). You replied: ‘‘And the de- cision was made at the time that the leverage ratio is not our main VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00090 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 87 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 in- cluded.’’ Followed by, ‘‘There were considerations on both sides, and a decision was made to include Fed deposits.’’ In the case of the custody banks, it does not appear that the SLR is a ‘‘backstop,’’ but is instead the binding capital constraint, which is impacting these banks ability to accept cash deposits from pen- sion plans and other customers particularly in a period of financial stress or crisis. Can you tell me what your considerations were for including the Fed deposits in the SLR and why, given the nature of a custody banks business model, they were not exempted? Also, if custody banks are unable to accept cash deposits in a time a crisis, what do you believe the pensions and other institu- tional investors will do what that cash? A.1. 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), re- quires internationally active banking organizations to hold at least 3 percent of total leverage exposure in tier 1 capital. The rule cal- culates 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 orga- nization 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 fi- nancial 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 is not a risk-based measure, it is possible that increases in banking orga- nizations’ holdings of low-risk, low-return assets, such as deposits, could cause this ratio to become the binding regulatory capital con- straint. However, when choosing an appropriate asset profile, banking organizations consider many factors in addition to regu- latory 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 re- paid. 1See 79 Fed. Reg. 57725 (September 26, 2014), available at http://www.gpo.gov/fdsys/pkg/ FR-2014-09-26/pdf/2014-22083.pdf. 2The agencies have reserved authority under the capital rule to require a banking organiza- tion to use a different asset amount for an exposure included in the SLR to address extraor- dinary situations. See 12 CFR 3.1(d)(4) (OCC); 12 CFR 217.1(d)(4) (Federal Reserve); 12 CFR 324.1(d)(4) (FDIC). VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00091 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 88 Regulatory requirements established by the Federal Reserve since the financial crisis are meant to address risks to which bank- ing organizations are exposed, including the risks associated with funding in the form of cash deposits. The requirements are de- signed to increase the resiliency of banking organizations, enabling them to continue serving as financial intermediaries for the U.S. fi- nancial system and as sources of credit to households, businesses, State governments, and low-income, minority, or underserved com- munities during times of stress. The SLR requirement and the en- hanced SLR standards do not become effective until January 1, 2018. According to public disclosures of firms subject to these re- quirements, the custody banks and other GSIBs have made signifi- cant progress in complying with the enhanced SLR requirements. Q.2. We continue to see consolidation of the banking industry, par- ticularly at the community bank level. Some of that has to do with market pressures. A lot of that has to do with the avalanche of reg- ulation facing these institutions, and their lack of resources in cop- ing with it. What has the Fed done to tangibly reduce the regulatory burden on such institutions? What impediments stand in front of regulators in aggressively addressing this problem? What areas can the Fed—and other bank regulators—attack to address this problem? A.2. The Federal Reserve has long maintained that our regulatory efforts should be designed to minimize regulatory burden con- sistent with the effective implementation of our statutory respon- sibilities. In addition, the Federal Reserve and the other banking agencies have developed a number of compliance guides that are specifically designed to assist community banks’ understanding of applicable regulatory requirements. Generally, the Federal Reserve strives to balance efforts to en- sure that supervision and regulation are calibrated appropriately for smaller and less risky institutions with our responsibility to en- sure that consumer financial transactions are fair and transparent, regardless of the size and type of supervised institutions involved. The Federal Reserve has worked to minimize regulatory burdens for community banks, by fashioning simpler compliance require- ments and clearly identifying which provisions of new regulations are of relevance to smaller banks. In January 2014, the Federal Reserve Board (Board) imple- mented a new consumer compliance examination framework for community banks. The new program more explicitly bases exam- ination intensity on the individual bank’s risk profile, weighted against the effectiveness of the bank’s compliance controls. The Board also revised its consumer compliance examination frequency policy to lengthen the time between on-site consumer compliance and Community Reinvestment Act examinations for many commu- nity banks with less than $1 billion in total consolidated assets. These changes should increase the efficiency of our exam process and reduce regulatory burden on many community banks. The Board approved a final rule in April 2015 raising the asset threshold of the Board’s Small Bank Holding Company and Sav- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00092 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 89 ings and Loan Holding Company Policy Statement (Policy State- ment) from $500 million to $1 billion and expanding its application to savings and loan holding companies. As a result of this action, 89 percent of all bank holding companies and 81 percent of all sav- ings and loan holding companies are now covered under the scope of the Policy Statement. The Policy Statement reduces regulatory burden by excluding these small organizations from certain consoli- dated capital requirements. In addition to reducing capital burden, the action significantly reduced the reporting burden associated with capital requirements by eliminating the more complex quar- terly consolidated financial reporting requirements and replacing them with semiannual parent-only financial statements for 470 in- stitutions. In addition, raising the asset threshold allowed more bank holding companies to take advantage of expedited applica- tions processing procedures. To deepen its understanding of community banks and the specific challenges facing these institutions, the Board meets twice a year with the Community Depository Institutions Advisory Council (CDIAC) to discuss the economic conditions and issues that are of greatest concern to community institutions. The CDIAC members are selected from representatives of community banks, thrift insti- tutions, and credit unions who serve on local advisory councils at the 12 Federal Reserve Banks. The Board also has launched a number of outreach initiatives, including the establishment of its ‘‘Community Banking Connections’’ program, which is designed to enhance the dialogue between the Board and community banks. In addition, this program highlights key elements of the Board’s su- pervisory process for community banks and provides clarity on su- pervisory expectations. In 2014, under the auspices of the Federal Financial Institution Examination Council (FFIEC), the Federal Reserve, the Comp- troller of the Currency and the Federal Deposit Insurance Corpora- tion (the Agencies) began their decennial review of regulations as required by the Economic Growth and Regulatory Paperwork Re- duction Act of 1996 (EGRPRA) with the release of four Federal Register notices requesting comments on their regulations that are applicable to insured depository institutions and their holding com- panies in 12 substantive categories: Applications and Reporting; Powers and Activities; International Operations; Banking Oper- ations; Capital; the Community Reinvestment Act; Consumer Pro- tection; Directors, Officers and Employees; Money Laundering; Rules of Procedure; Safety and Soundness; and Securities. The final comment period closed on March 22, 2016, and produced over 160 written comment letters. Additionally, the Agencies held six outreach events across the country with over 1,030 participants at- tending in person, by telephone, or via live stream. While the Agencies are in the process of conducting a systematic analysis and consideration of these comments in order to prioritize recommendations and to adopt changes as appropriate, they have already taken action on certain issues. For example, upon author- ization provided in the Fixing America’s Surface Transportation Act, enacted on December 14, 2015, the Agencies moved quickly to raise the asset threshold from $500 million to $1 billion in total as- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00093 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 90 sets for banks and savings associations that are well-capitalized and well-managed to be eligible for an 18-month examination cycle. Additionally, under the auspices of the FFIEC, the Agencies issued a public notice in September 2015 that established a multistep process for streamlining Call Report requirements. The notice included proposals to eliminate or revise several Call Report data items, announced an accelerated start of a statutorily required review of the Call Report, and began an assessment of the feasi- bility of creating a streamlined community bank Call Report. In ad- dition to the formal EGRPRA process, the Agencies are continuing to engage in industry dialogue and outreach, to better understand significant sources of Call Report burden. RESPONSES TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM JANET L. YELLEN Q.1. Last year, the Federal Reserve, in conjunction with the OCC, FDIC, SEC, NCUA, and CFPB issued final standards, as required by the Wall Street Reform Act, to assess the diversity practices of regulated financial institutions. In my view, these standards, which changed little since the draft was released a few years prior, unfor- tunately fall short of what is necessary to achieve real progress. As I noted in my Corporate Diversity Survey last year, it’s no secret that the financial industry has a long way to go to improve the di- versity of its leadership, workforce, and supplier base. And as you know, the Offices of Minority and Women Inclusion were created to help address the lack of diversity within our financial sector, and we need much more than voluntary self-assessments to bring about transparency and meaningful change. This is not some pie-in-the-sky policy—this directly connects to the financial health of our families and our communities. Lack of attention paid to communities of color likely contributed to regu- latory neglect of problems that led to the crisis. Beyond what is contemplated in the OMWI standards issued last year, what other concrete steps does the Federal Reserve plan to take to advance diversity and inclusion both within the Federal Re- serve System and in the banking industry in general? A.1. The Federal Reserve Board (Board) is committed to equal em- ployment in all aspects of employment, and to fostering diversity and inclusion in the workplace. This includes both the letter and spirit of all current law. The Board’s 2016–2019 Strategic Plan in- cludes a strategic objective focusing on the recruitment, develop- ments and retention of a highly skilled workforce that enables the Board to meet its mission and foster and sustain a diverse and in- clusive environment. The Board has collaborated with the Federal Reserve Banks to include in the 2016 Office of Minority and Women Inclusion (OMWI) reports core metrics for measuring key workforce indica- tors and procurement awards. The metrics enable the Board and Reserve Banks to monitor the effectiveness of diversity policies, practices, and programs and adjust activities where needed. Under a Board management mandate adopted in 2015, succes- sion planning, workforce planning, and talent management stra- tegic objectives are being established throughout the Board. In ad- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00094 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 91 dition, the Board implemented a Diversity Scorecard to assist divi- sions in pursuing a comprehensive and strategic focus on diversity and inclusion as a key metric. The scorecard establishes account- ability for setting of diversity objectives and for actions by divisions to achieve those objectives. The scorecard objectives cover four per- formance areas: Leadership Engagement, Talent Acquisition, Tal- ent Management, and Supplier Diversity. We remain committed to evaluating the Board’s personnel prac- tices, policies, and other efforts to ensure that the workplace is free of discrimination and provides equal opportunity and access for mi- norities and women in hiring, promotion, business practices, and retention particularly to senior-management level positions. The Board continues to collaborate with other financial regu- latory agencies in the implementation of the ‘‘Final Interagency Policy Statement Establishing Joint Standards for Assessing the Diversity Policies and Practices of Entities Regulated by the Agen- cies’’ (Policy Statement). On February 29, 2016, the Board, Office of the Comptroller of the Currency, Federal Deposit Insurance Cor- poration, Securities and Exchange Commission, National credit Union Administration, and the Consumer Financial Protection Bu- reau (the Agencies) received approval from the Office of Manage- ment and Budget to collect information pursuant to the policy statement. The information from the self-assessments may be used to monitor diversity and inclusion trends and identify leading poli- cies and practices in the financial services industry. In collabora- tion with the other Agencies, the Board will work with regulated entities and other stakeholders to monitor progress toward meeting the joint standards, and provide technical assistance to the regu- lated entities in addressing diversity. To address diversity in the economics profession the Board has, under the purview of the American Economic Association’s Com- mittee on the Status of Minority Groups in the Economics Profes- sion, continued to organize, oversee, and participate in the three programs intended to foster a long-term strategy in the recruit- ment of minority economists: (1) the Summer Economics Fellow Program; (2) the Summer Training Program; and (3) the Mentoring Program. The Board has also collaborated with Howard University to es- tablish a teaching and mentoring program to build relationships between Board economists and the university’s economics faculty and students. In addition, to encouraging the study of economics as a major, a team of economic research assistants from the Board visited local high schools, focusing on schools with demographically diverse populations. We will continue to explore new and innova- tive ways to increase the availability of minority and female profes- sional economists in the educational and professional pipeline. Q.2. Nonbank lending has grown steadily in recent years, and as you know, nonbank lenders often rely on funding sources that are more vulnerable to runs. The 2015 Shared National Credit Review of bank loans underwriting standards showed that while nonbanks own less than one-quarter of total loans, they own two-thirds of the highest-risk loans. And, with the growth of nonbank lending, inter- mediation chains have also lengthened, to the point where there are frequently banks and other nonbank financial institutions in- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00095 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 92 volved. As you know, the failure of a large, interconnected nonbank financial institution has the potential to wreak havoc on our sys- tem and instigating contagion among other institutions. From my perspective, bringing the largest and most interconnected of these institutions are within the wings of prudential regulation and su- pervision has been and will continue to be critical for our financial stability. What steps is the Fed taking to identify risks to financial sta- bility, and in particular those arising from nonbank institutions not currently subject to prudential supervision? A.2. The Federal Reserve continuously monitors risks to financial stability from all components of the financial system including banks, nonbank financial institutions, financial market utilities, and markets themselves. This monitoring effort includes the activi- ties and risks of various nonbank financial institutions, such as hedge funds, insurance firms, mutual funds, pension funds, con- sumer and business finance companies, as well as more opaque markets, such as repo and over-the-counter derivatives, and inno- vations such as distributed ledger technology. We also supervise the nonbank financial companies that the Financial Stability Over- sight Council (FSOC) has determined should be subject to Federal Reserve supervision and prudential standards—two large insur- ance companies and GE Capital. We are working closely with other FSOC participants on initiatives to evaluate potential systemic risks arising from activities and products in the asset management industry, including liquidity and redemption risk, securities lend- ing risk, operational risk, and resolvability and transition planning. And, we are consulting with the Commodities Futures and Trading Commission (CFTC) to better understand and manage risks around central counterparties. The Federal Reserve also continues its ac- tive participation in the Financial Stability Board, engaging in issues including shadow banking, supervision of global systemically important financial institutions, the development of effective reso- lution regimes for large financial institutions, and evaluation of po- tential systemic risks from marketwide asset management activi- ties. In addition, we have boosted the visibility into the nonbank fi- nancial institution sector by obtaining access to additional data on those firms through coordination with other regulators, purchases from outside vendors, enhanced regulatory reporting to better un- derstand the linkages between banks and nonbank financial insti- tutions, and voluntary collections from industry. For instance, with our colleagues at the Office of Financial Research and the Securi- ties and Exchange Commission, we have launched a pilot project to collect data on bilateral repurchase agreements (see https:// financialresearch.gov/data/repo-data-project/). Q.3. What data gaps have you identified in analyzing risks of nonbank financial institutions? A.3. Regulators and market participants alike understand the role that information gaps played in allowing some of the excesses dur- ing the run-up to the crisis to go undetected and hindering our ef- forts to contain the effects of the crisis. Regulators, including the Federal Reserve, have taken significant steps to improve the VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00096 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 93 breadth and depth of our data collections. Of course, we recognize that data reporting is costly for institutions and we strive to mini- mize the burden consistent with our task of ensuring the safety and soundness of individual regulated institutions as well as the ongoing stability of the entire system. As noted above, one way in which we are filling data gaps is by collaborating with other regu- lators. For instance, with Congress’ repeal of the indemnification clause in section 728 of the Dodd-Frank Wall Street Reform and Consumer Protection Act late last year, we are in the process of ne- gotiating with the CFTC to provide our staff with direct access to interest rate swaps data. The Depository Trust and Clearing Cor- poration provides us with detailed, trade-level data on credit de- fault swap transactions for which at least one counterparty is su- pervised by the Federal Reserve. Despite our efforts to expand the range of data sources with which we can conduct analysis, our abil- ity to collect data from unregulated institutions is still constrained. For instance, we have limited visibility into the leverage of large hedge funds or to the lending practices of certain consumer and business finance companies. Q.4. What has the Federal Reserve Board or Financial Stability Oversight Council done to perform cross-sectoral analyses of bank SIFIs and nonbank companies against each other with regard to systemic risk? A.4. As we learned during the global financial crisis, it is not suffi- cient to focus only on risks that are apparent in the banking sector. Board staff are continuously monitoring risks comprehensively across all financial institutions and markets. As an example, we have in place a systemwide effort to bring together people who are working on understanding the interconnectedness of financial insti- tutions across sectors, and they are monitoring and improving indi- cators of when that vulnerability is higher or lower than normal. One such measure is ‘‘conditional value at risk’’ or CoVaR, which is defined as the increase in the value-at-risk of the financial sys- tem due to an individual firm becoming distressed, and it can be calculated for banks and nonbanks. The detailed methodology for computing the CoVaR is presented in the Federal Reserve Bank of New York Staff Report 348 by Tobias Adrian and Markus Brunnermeier titled ‘‘CoVaR’’ (http://www.ny.frb.org/research/ stafflreports/sr348.html). We communicate our views on key financial vulnerabilities iden- tified in our monitoring efforts in speeches and testimony, as ap- propriate, and provide a concise summary in the Monetary Policy Report to Congress twice a year. In addition, the FSOC’s annual report on financial stability provides a comprehensive assessment of risks throughout the financial system. Q.5. To what extent is the Federal Reserve engaged in coordination and collaboration with State insurance regulators, as well as indus- try, to ensure that the framework is both appropriately tailored to the business of insurance and effectively addresses risks to finan- cial stability? A.5. In its consolidated supervision of insurance firms, the Board remains committed to tailoring its supervisory approach to the business of insurance, reflecting insurers’ different business models VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00097 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 94 and systemic importance compared to other firms supervised by the Board. The Board’s principal supervisory objectives for the insur- ance firms that it oversees include protecting the safety and sound- ness of the consolidated firms, as well as mitigating risks to finan- cial stability. The Board continues to engage extensively with State insurance regulators, the National Association of Insurance Com- missioners, and other interested stakeholders to solicit feedback on insurance prudential standards that would comport with the Board’s statutory authority. We continue to coordinate with State insurance regulators in their protection of policyholders and aim to avoid replicating the supervision that they already perform. We le- verage the work of State insurance regulators where possible and continue to look for opportunities to further coordinate with them. Q.6. In a previous hearing, I asked Federal Reserve Governor Tarullo and others about a practice known as ‘‘regulatory capital relief trades’’, in which regulated financial institutions purchase credit protection (often using credit default swaps) from unregu- lated entities (often formed offshore to avoid regulation) to reduce the amount of capital they need to hold against an investment on their books. In effect, these trades transfer risk from regulated institutions that are subject to capital requirements to unregulated entities that are not. Instead of raising equity to pay for an investment, a bank takes on exposure to an entity that may or may not be able to pay up if the investment goes bad. As I said to Governor Tarullo, if this story sounds familiar, it should—this is strikingly similar to what we saw happen with AIG before the financial crisis. And we know how that worked out. The Treasury’s Office of Financial Research released a report last year on these capital relief trades, which states that ‘‘Regulatory capital relief trades . . . can increase banks’ interconnectedness with nonbanks and . . . reduce transparency for investors and counterparties about a bank’s capital adequacy,’’ and that instead of reducing risk, these transactions merely ‘‘transform credit risk into counterparty risk.’’ The report goes on to say that more transparency and reporting is needed, and that supervisory stress tests do not sufficiently ac- count for possible shocks from the failure of a counterparty to per- form on these transactions. What steps is the Fed taking to account for these transactions and their risks in its capital requirements, stress tests, and other appropriate measures? A.6. Risk mitigation techniques, such as purchasing credit default swap protection, can reduce a firm’s level of risk. In general, the Board views a firm’s engagement in risk-reducing transactions as a sound risk management practice. At the same time, however, there are certain practices for which the risk-based capital frame- work may not fully capture the risks a firm faces in these trans- actions. The Board has issued a supervisory letter (SR letter 13-23, ‘‘Risk Transfer Considerations When Assessing Capital Adequacy— Supplemental Guidance on Consolidated Supervision Framework for Large Financial Institutions (SR letter 12-17/CA letter 12-14)’’) that provides guidance on how these risk-transfer transactions af- VerDate Nov 24 2008 11:48 Aug 09, 2016 Jkt 046629 PO 00000 Frm 00098 Fmt 6602 Sfmt 6602 L:\HEARINGS 2016\02-11 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON 95 fect assessments of capital adequacy. The letter states that ‘‘super- visors will strongly scrutinize risk-transfer transactions that result in substantial reductions in risk-weighted assets, including in su- pervisors’ assessment of a firm’s overall capital adequacy, capital planning and risk management through CCAR.’’ The letter goes on to underscore that firms should bring such transactions to the at- tention of supervisors and that the Board may also decide not to recognize such transactions for risk-based capital purposes. Accord- ingly, the Board has put in place and widely communicated several measures that are intended to ensure that risk-transfer trans- actions which do not result in a significant risk reduction are iden- tified and dealt with accordingly. Q.7. As you know, Congress passed, and the president signed into law, a 5-year transportation bill in December. In an attempt to avoid substantively addressing the insolvency of the Highway Trust Fund, Congress cobbled together a hodge-podge of funding sources—including tapping into the Federal Reserve’s capital sur- plus account—all the while demonstrating an unwillingness to ac- cept the reality that large scale public investments can actually have benefits for our society and economy, and that sometimes hard choices are necessary to make these investments. From an economic perspective, with interest rates still low and slack still remaining in construction employment, and the strong need for new infrastructure investments to prevent even greater costs down the road, isn’t now a particularly good time to fully in- vest in our transportation infrastructure? A.7. As noted by the Congressional Budget Office (CBO), produc- tive infrastructure investment can provide benefits for the economy and society more broadly.1 However, the CBO also projects that Federal budget deficits and Federal Government debt will be in- creasing, relative to the size of the economy, over the next decade and in the longer run, which is an unsustainable fiscal policy.2 To promote economic growth and stability over the long haul, the Fed- eral budget must be put on a sustainable long-run path that ini- tially stabilizes the ratio of Federal debt to nominal GDP, and, given the current elevated level of debt, eventually places that ratio on a downward trajectory. An increase in spending that is financed by an increase in borrowing would not improve the fiscal position of the Federal budget, even if interest rates are low now. When fis- cal policymakers address the crucial issue of long-run fiscal sus- tainability, their choices should certainly consider how to make these necessary policy adjustments in a manner that helps make the economy more productive. But, I believe—as did my prede- cessor—that the specific choices made to achieve a sustainable fis- cal policy are appropriately left to our Nation’s elected officials and the American public. 1See, for example, Congressional Budget Office, ‘‘Public Spending on Transportation and Water Infrastructure’’, March 2015, and ‘‘Approaches To Make Federal Highway Spending More Productive’’, February 2016. 2Congressional Budget Office, ‘‘The Budget and Economic Outlook: 2016 to 2026’’, January 2016, and ‘‘The 2015 Long-Term Budget Outlook’’, June 2015. 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Janet L. Yellen (2016, February 10). Congressional Testimony. Testimony, Federal Reserve. https://whenthefedspeaks.com/doc/testimony_20160211_chair_federal_reserves_first_monetary_policy

@misc{wtfs_testimony_20160211_chair_federal_reserves_first_monetary_policy,
  author = {Janet L. Yellen},
  title = {Congressional Testimony},
  year = {2016},
  month = {Feb},
  howpublished = {Testimony, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/testimony_20160211_chair_federal_reserves_first_monetary_policy},
  note = {Retrieved via When the Fed Speaks corpus}
}