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MONETARY POLICY AND THE 

STATE OF THE ECONOMY 

HEARING 

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED FOURTEENTH CONGRESS 

SECOND SESSION 

FEBRUARY 10, 2016 

Printed for the use of the Committee on Financial Services 

Serial No. 114–71 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

PATRICK T. MCHENRY, North Carolina, 

Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

ROBERT HURT, Virginia 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

MARLIN A. STUTZMAN, Indiana 

MICK MULVANEY, South Carolina 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

KEITH J. ROTHFUS, Pennsylvania 

LUKE MESSER, Indiana 

DAVID SCHWEIKERT, Arizona 

FRANK GUINTA, New Hampshire 

SCOTT TIPTON, Colorado 

ROGER WILLIAMS, Texas 

BRUCE POLIQUIN, Maine 

MIA LOVE, Utah 

FRENCH HILL, Arkansas 

TOM EMMER, Minnesota 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JAMES A. HIMES, Connecticut 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

PATRICK MURPHY, Florida 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

JUAN VARGAS, California 

SHANNON MCGAHN, Staff Director 

JAMES H. CLINGER, Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

February 10, 2016 ............................................................................................ 1 

Appendix: 

February 10, 2016 ............................................................................................ 55 

WITNESSES 

WEDNESDAY, FEBRUARY 10, 2016 

Yellen, Hon. Janet L., Chair, Board of Governors of the Federal Reserve 

System ................................................................................................................... 5 

APPENDIX 

Prepared statements: 

Yellen, Hon. Janet L. ....................................................................................... 56 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Yellen, Hon. Janet L.: 

Monetary Policy Report of the Board of Governors of the Federal Reserve 

System, dated February 10, 2016 ................................................................ 64 

Written responses to questions for the record submitted by Representative Fincher ................................................................................................... 116 

Written responses to questions for the record submitted by Representative Hill .......................................................................................................... 118 

Written responses to questions for the record submitted by Representative Hultgren ................................................................................................. 120 

Written responses to questions for the record submitted by Representative Luetkemeyer .......................................................................................... 124 

Written responses to questions for the record submitted by Representative Lynch ...................................................................................................... 128 

Written responses to questions for the record submitted by Representative Messer .................................................................................................... 130 

Written responses to questions for the record submitted by Representative Mulvaney ................................................................................................ 131 

Written responses to questions for the record submitted by Representative Murphy ................................................................................................... 134 

Written responses to questions for the record submitted by Representative Sherman ................................................................................................. 135 

Written responses to questions for the record submitted by Representative Tipton ..................................................................................................... 137 

Written responses to questions for the record submitted by Representative Waters .................................................................................................... 139 

(1) 

MONETARY POLICY AND THE 

STATE OF THE ECONOMY 

Wednesday, February 10, 2016 

U.S. HOUSE OF REPRESENTATIVES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The committee met, pursuant to notice, at 10:02 a.m., in room 

2128, Rayburn House Office Building, Hon. Jeb Hensarling [chairman of the committee] presiding. 

Members present: Representatives Hensarling, Royce, Lucas, 

Garrett, Neugebauer, McHenry, Pearce, Posey, Fitzpatrick, Luetkemeyer, Duffy, Hurt, Stivers, Stutzman, Mulvaney, Hultgren, Ross, 

Pittenger, Wagner, Barr, Rothfus, Messer, Schweikert, Guinta, Tipton, Williams, Poliquin, Love, Hill, Emmer; Waters, Maloney, 

Velazquez, Sherman, Meeks, Hinojosa, Clay, Lynch, Scott, Green, 

Cleaver, Moore, Ellison, Perlmutter, Himes, Carney, Sewell, Foster, 

Murphy, Delaney, Sinema, Beatty, Heck, and Vargas. 

Chairman HENSARLING. The Financial Services Committee will 

come to order. Without objection, the Chair is authorized to declare 

a recess of the committee at any time. 

This hearing is for the purpose of receiving the semiannual testimony of the Chair of the Board of Governors of the Federal Reserve 

System on the conduct of monetary policy and the state of the economy. I now recognize myself for 3 minutes for an opening statement. 

Last month, we all heard President Obama attempt to take an 

economic victory lap in his State of the Union speech, but the 

American people are having none of it. They are tired of hearing 

from the out-of-touch ruling class in Washington just how good 

things are when their realities are vastly different. 

So, Chair Yellen, notwithstanding the fact that you are a Presidential appointee, I hope you do not follow suit this morning. 

The reality is, since the President was elected and the Fed embarked upon its unprecedented quantitative easing in zero real interest rate policies, working families’ paychecks have declined. 

Their net worth has declined. 

The real unemployment rate continues to hover around 10 percent. Approximately one in six is on food stamps and almost 15 

percent live in poverty. There hasn’t been a single year when economic growth has reached 3 percent. 

As one published report on this failure noted, ‘‘There is no parallel for this since the end of World War II, maybe not since the 

beginning of the Republic.’’ Last year’s less than 1 percent GDP 

growth just punctuates the matter for struggling working families. 

2 

I will not use this hearing to either praise or condemn the Fed’s 

decision to raise by 25 basis points interest rates in December, nor 

do I think it appropriate to advise the FOMC on how to vote during 

its next meeting. But, given that Article I, Section 8 of the Constitution gives Congress the power to coin money and regulate the 

value thereof, I do feel compelled to demand that the Fed adopt a 

monetary policy course that is predictable, transparent, sustainable, and, barring terribly exigent circumstances, to stick with it. 

This is part of the rationale underlying the House-passed Fed 

Oversight Reform and Modernization Act, known as the FORM Act. 

To use Austrian economist Friedrich Hayek’s phrase: ‘‘It is fatal 

conceit to believe that the Fed is capable of micromanaging our 

economy to some state of economic nirvana.’’ We now have at least 

8 years of recent history to prove otherwise. 

Most importantly, no amount of monetary policy can substitute 

for sound fiscal policy. Unless and until the crushing regulatory onslaught of Obamacare, the Dodd-Frank Act, and the EPA is replaced with greater opportunity, competition, and innovation, the 

Fed cannot substantially help our economy; it can only hurt it. 

It can hurt it by continuing to serve as the financier and 

facilitator or our unsustainable Federal debt. Just last month, the 

Congressional Budget Office yet again warned of our unsustainable 

debt in its latest baseline release, which references the debt 199 

times. 

The Fed can hurt our economy by continuing to force investors 

to chase yield, thus inflating dangerous asset bubbles, the deflating 

of which we are likely seeing in our turbulent equity markets 

today. 

The Fed can continue to hurt our economy by failing to unwind 

its unprecedented balance sheet. By growing at almost 500 percent, 

the Fed itself has become one of our largest sources of systemic 

risk. 

Finally, separate and apart from monetary policy, alarmingly, 

the Fed, under Dodd-Frank, can now functionally control virtually 

every major corner of the financial services sector of our economy. 

It does so with almost no accountability or transparency. Not only 

does this harm economic growth, it is an affront to due process, 

checks and balances, and the rule of law. 

The American people should again be duly alarmed that they 

may wake up one day to discover that our central bankers have become our central planners. 

The Chair recognizes the ranking member of the committee, Ms. 

Waters, for 3 minutes for an opening statement. 

Ms. WATERS. Thank you, Mr. Chairman, for this meeting here 

today. 

But I would really like to thank Chair Yellen for being here with 

us today to discuss the state of the economy and your role in ensuring that a full recovery is achieved for all. As a result of your Herculean efforts, the efforts of Democrats in Congress, and the 

Obama Administration, we have truly made tremendous progress 

since the darkest days of the financial crisis. 

Over the past 71 consecutive months, our economy has added 

more than 14 million private sector jobs, and the unemployment 

3 

rate has fallen by more than half. But despite this commendable 

progress, significant work remains. 

Wages have yet to see real gains: 7.8 million workers remain jobless; 6 million workers are involuntarily working part-time jobs; 

and another 2 million Americans indicate they would join the workforce if only the economy was strong enough to support them. 

With inflation consistently running below target, I wonder 

whether the expected path for further raising rates over the course 

of 2016 may overemphasize concerns about inflation and underestimate the weakness in our labor market. 

I look forward to your comments on this issue. 

Absent a full recovery, I fear that further raising rates may be 

a step that takes us further away from what is needed to ensure 

that the needs of vulnerable populations are met. At today’s hearing, I also hope we can explore the ramifications of an exit strategy 

that relies heavily on paying private sector banks not to lend the 

funds they hold in reserve and to discuss reasonable alternatives 

that may exist that do not involve a massive transfer of wealth 

from the Federal Reserve to private sector banks. 

I just wonder if it is possible for these funds to be used for workers who are really worried about whether or not they are going to 

have a pension, or if there can be some social responsibility investment with these funds to help workers in vulnerable populations? 

Finally, many of us have been very patient about the implementation of the living wills. As you know, this is a requirement in the 

Dodd-Frank Act, and it is designed to end too-big-to-fail. 

And I know that you have to give careful consideration to all of 

this, but after not one, not two, but five submissions, the Federal 

Reserve has yet to impose consequences for living wills that are not 

credible. What can we do about this? It is time we understand that 

we have given a lot of opportunities to the banks to get it right and 

they haven’t done that. 

Chair Yellen, I look forward to hearing your views on the economy and I welcome the opportunity to discuss how we can more effectively elevate the needs of the most vulnerable populations and 

promote a safe and sound financial system. And I want you to 

know that our audience today is made up of workers who really 

want to hear you talk about this, so I would welcome opportunities 

to address some of their concerns. 

I yield back the balance of my time. 

Chairman HENSARLING. The Chair now recognizes the gentleman 

from South Carolina, Mr. Mulvaney, the vice chairman of our Monetary Policy and Trade Subcommittee, for 2 minutes. 

Mr. MULVANEY. Chair Yellen, when I sat down last night to get 

ready for this hearing, it occurred to me that I could ask you about 

a bunch of things today. 

I could ask you about your plans on interest rates and how you 

arrived at the decisions that you are going to make, what you used 

to arrive at those decisions. I could ask about your role at the Fed 

in regulating financial institutions. Dodd-Frank, for example, has 

now given you regulatory powers over banks, nonbanks, clearinghouses, and thrift holding companies. 

It also struck me I could even ask you about the role of the Fed, 

and more specifically the New York branch, in the possibly misVerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI
4 

leading statements that I believe Secretary Lew made to two congressional committees regarding the Fed and the Treasury’s role in 

intentionally withholding information from Congress about plans to 

prioritize debt payments during the last government shutdown. 

And then, I realized that is too much. That is too much not just 

to ask you in the few minutes that we are going to have today; it 

is just too much for you to be doing. The Fed has, like so many 

other parts of our government, grown way beyond its original intended scope. 

When Congress chartered the Bank in 1913, we asked it to do 

one thing: keep the financial system, and primarily currency, stable. Today, the Fed is involved in everything from how much purchasing power these people have, to where they can bank, how they 

can invest and save, and, to believe some, whether or not they even 

have a job. 

Maybe you shouldn’t be involved in trying to get us to full employment, something that your own economics orthodoxy teaches us 

you don’t have the ability to do, but only fiscal policy can do. 

Maybe you shouldn’t be involved with regulating mortgages and 

credit cards. And you certainly shouldn’t be involved in political decisions to intentionally keep Congress in the dark about how this 

country is going to pay back its principal and its interest on the 

debt. 

So I hope today we get a chance to talk about a lot of things— 

sound money, the dual mandate, full employment, regulations, the 

debt ceiling, community banks, the impact of zero rates on retirees, 

asset bubbles—in the hopes that at the end we discover that perhaps the time has come to get back to basics, and one and one 

thing only, which is long-term price stability. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentlelady from Wisconsin, Ms. 

Moore, the ranking member of our Monetary Policy and Trade Subcommittee, for 2 minutes. 

Ms. MOORE. Thank you so much, Mr. Chairman, and welcome 

back, Chair Yellen. 

As you can tell from the opening statements, there is plenty to 

discuss since your last appearance before this committee. I supported your rate increase in December. I still do. And I think you 

are providing a lot of credibility to markets with your leadership. 

However, these seem to be economic times that are destined to 

be interesting. Since December we have witnessed a lot of global 

economic turmoil, and now it is turning up in the United States, 

as reflected in our stock market. 

Foreign central banks are moving to ease rates even as we are 

moving to try to tighten them. And I am not saying that we need 

to harmonize our monetary policy, but I am very interested in 

hearing how you and the Fed are working with foreign central 

banks to get in front of these ominous trends. 

As you have stated so many times before, monetary policy is a 

limited tool. But if we are going to grow our economy and keep on 

track, and as I look at the folk in green in the audience, it causes 

me to realize that Members of Congress have to do their part, too, 

and not just throw it in all in the lap of the Fed. We have to embrace proven growth strategies like tackling poverty, especially 

5 

among women, by providing vocational training so that they can 

qualify and compete for sustainable jobs with living wages. 

And with that, I yield back the balance of my time. 

Chairman HENSARLING. The gentlelady yields back. 

Today, we welcome the testimony of the Honorable Janet Yellen, 

Chair of the Federal Reserve. Chair Yellen has previously testified 

before this committee so I believe she needs no further introduction. 

Without objection, Chair Yellen, your written statement will be 

made a part of the record. You are now recognized for 5 minutes 

to give an oral presentation of your testimony. 

Thank you. 

STATEMENT OF THE HONORABLE JANET L. YELLEN, CHAIR, 

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mrs. YELLEN. Thank you. Chairman Hensarling, Ranking Member Waters, and members of the committee, I am pleased to 

present the Federal Reserve’s Semiannual Monetary Policy Report 

to the Congress. 

In my remarks today, I will discuss the current economic situation and outlook before turning to monetary policy. 

Since my appearance before this committee last July, the economy has made further 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 further declines in 

energy prices, the Federal Open Market Committee (FOMC) expects that inflation will rise to its 2 percent objective over the medium term. 

In the labor market, the number of payroll jobs rose 2.7 million 

in 2015, and posted a further gain of 150,000 in January of this 

year. The cumulative increase in employment since its trough in 

early 2010 is now more than 13 million jobs. 

Meanwhile, the unemployment rate fell to 4.9 percent in January, 0.8 of a percentage point below its level a year ago and in line 

with the median of FOMC participants’ most recent estimates of its 

longer-run normal level. 

Other measures of labor market conditions have also shown solid 

improvement, with noticeable declines over the past year in the 

number of individuals who want to work, and are available to 

work, but have not actively searched recently, and in the number 

of people who are working part-time but would rather work fulltime. 

However, these measures remain above the levels seen prior to 

the recession, suggesting that some slack in labor markets remains. Thus, while labor market conditions have improved substantially, there is still room for further sustainable improvement. 

The strong gains in the job market last year were accompanied 

by a continued moderate expansion in economic activity. U.S. real 

gross domestic product is estimated to have increased about 1.75 

percent in 2015. 

Over the course of the year, subdued foreign growth and the appreciation of the dollar restrains net exports. In the fourth quarter 

of last year, growth in the gross domestic product is reported to 

have slowed more sharply, to an annual rate of just 0.75 percent. 

6 

Again, growth was held back by weak net exports as well as by 

a negative contribution from inventory investment. 

Although private domestic final demand appears to have slowed 

somewhat in the fourth quarter, it has continued to advance. 

Household spending has been supported by steady job gains and 

solid growth in real disposable income, aided in part by the 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 home-building activity has continued to 

move up on balance, although the level of new construction remains well below the longer-run levels implied by demographic 

trends. 

Financial conditions in the United States have recently become 

less supportive of growth, with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers, and a further appreciation of the dollar. These developments, if they prove 

persistent, could weigh on the outlook for economic activity in the 

labor market, although declines in longer-term interest rates and 

oil prices provide some offset. 

Still, ongoing employment gains and faster wage growth should 

support the growth of real incomes and, therefore, consumer 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, economic activity will 

expand at a moderate pace in the coming years, and that labor 

market indicators will continue to strengthen. 

As is always the case, the economic outlook is uncertain. Foreign 

economic developments in particular pose risks to U.S. economic 

growth. Most notably, although recent economic indicators do not 

suggest a sharp slowdown in Chinese growth, declines in the foreign exchange value of the renminbi have intensified uncertainty 

about China’s exchange rate policy and the prospects for its economy. 

This uncertainty led to increased volatility in global financial 

markets and, against the backdrop of persistent weakness abroad, 

exacerbated concerns about the outlook for global growth. These 

growth concerns, along with strong supply conditions and high inventories, contributed to the recent fall in the prices of oil and 

other commodities. 

In turn, low commodity prices could trigger financial stresses in 

commodity-exporting 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 tighten further. Of course, economic growth could 

also exceed our projections for a number of reasons, including the 

7 

possibility that low oil prices will boost U.S. economic growth more 

than we expect. 

At present, the Committee is closely monitoring global economic 

and financial developments as well as assessing their implications 

for the labor market and inflation and the balance of risk to the 

outlook. 

As I noted earlier, inflation continues to run below the Committee’s 2-percent objective. Overall, consumer prices, as measured by 

the price index for personal consumption expenditures, increased 

just 0.5 percent over the 12 months of 2015. 

To a large extent, the low average pace of inflation last year can 

be traced to the earlier steep declines in oil prices and the prices 

of other imported goods. And, given the recent further decline from 

the prices of oil and other commodities as well as the further 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 

pressure on domestic inflation from those sources should wane. 

And as the labor market strengthens further, inflation is expected 

to rise gradually to 2 percent over the median term. 

In light of the current shortfall of inflation from 2 percent, the 

Committee is carefully monitoring actual and expected progress 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 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 rages. Overall, however, they 

have been reasonably stable. 

Turning to monetary policy, the FOMC conducts policy to promote maximum employment and price stability, as required by our 

statutory mandate from the Congress. Last March, the Committee 

stated that it would be appropriate to raise the target range for the 

Federal funds rate when it had seen further improvement in the 

labor market and was reasonably confident that inflation would 

move back to its 2 percent objective over the medium term. 

In December, the Committee judged that these two criteria had 

been satisfied and decided to raise the target range for the Federal 

funds rate 0.25 percentage point to between 0.25 and 0.5 percent. 

This increase marked the end of the 7-year period during which the 

Federal funds rate was held near zero. The Committee did not adjust the target range in January. 

The decision in December to raise the Federal funds rate reflected the Committee’s assessment that even after a modest reduction in policy accommodation, economic activity would continue to 

expand at a moderate pace and labor market indicators would continue to strengthen. Although inflation was running below the 

Committee’s longer-run objective, the FOMC judged that much of 

the softness in inflation was attributable to transitory factors that 

8 

are likely to abate over time, and the diminishing slack in labor 

and product markets would help move inflation toward 2 percent. 

In addition, the Committee recognized that it takes time for monetary 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 expectation is consistent with the view that the neutral, 

nominal Federal funds rate, defined as the value of the Federal 

funds rate that would be neither expansionary nor contractionary 

if the economy was operating near potential, is currently low by 

historical standards and is likely to rise only gradually over time. 

The low level of the neutral Federal funds rate may be partly attributable to a range of persistent economic headwinds, such as 

limited access to credit for some borrowers, weak growth abroad, 

and the significant appreciation of the dollar that have weighed on 

aggregate demand. 

Of course, monetary policy is by no means on a preset course. 

The actual path of the Federal funds rate will depend on what incoming data tell us about the economic outlook, and we will regularly reassess what level of the Federal funds rate is consistent 

with achieving and maintaining maximum employment and 2 percent inflation. 

In doing so, we will take into account a wide range of information, including measures of labor market conditions, indicators of 

inflation pressures and inflation expectations, and readings on financial and international developments. In particular, stronger 

growth or a more rapid increase in inflation than the Committee 

currently anticipates would suggest that the neutral Federal funds 

rate was rising more quickly than expected, making it appropriate 

to raise the Federal funds rate more quickly as well. 

Conversely, if the economy were to disappoint, a lower path of 

the Federal funds rate would be appropriate. We are committed to 

our dual objectives and we will adjust policy as appropriate to foster financial conditions consistent with their attainment over time. 

Consistent with its previous communications, the Federal Reserve used interest on excess reserves and overnight reversed repurchase (RRP) operations to move the Federal funds rate into the 

new target range. The adjustment to the interest rate on excess reserves (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 

9 

control the Federal funds rate effectively without having to first 

shrink its balance sheet by selling a large part of its holdings of 

longer-term securities. 

The Committee judged that removing monetary policy accommodation by the traditional approach of raising short-term interest 

rates is preferable to selling longer-term assets because such sales 

could be difficult to calibrate and could generate unexpected 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 securities should 

help maintain accommodative financial conditions and reduce the 

risk that we might need to return the Federal funds rate target to 

the effective lower bound in response to future adverse shocks. 

Thank you. I will be pleased to take your questions. 

[The prepared statement of Chair Yellen can be found on page 

56 of the appendix.] 

Chairman HENSARLING. The Chair now recognizes himself for 5 

minutes for questions. 

Chair Yellen, I know you are familiar with the Fed Oversight Reform and Modernization Act, known as the FORM Act, which was 

passed by the House in November. It is designed to bring about 

greater transparency and accountability at the Fed, to respect the 

Fed’s independence but also ensure that the Fed lets the rest of us 

know the variables that are used in monetary policy and their reaction functions so that working families can plan out their family 

economies. 

I know that you are not a fan of the FORM Act, because I have 

a letter dated November 16th that you sent to the Speaker. In that 

letter, you called the Act ‘‘a grave mistake.’’ I have another letter 

that describes it as an important reform. 

Your letter mentions, or complains that monetary policy would 

be forced to be strictly adhered to by the prescriptions of a simple 

rule. My letter says the legislation does not chain the Fed to any 

rule, and certainly not a mechanical rule. 

Your letter says that the Act would undermine the independence 

of the Fed. My letter says in no way would the legislation compromise the Fed’s independence. On the contrary, publicly reporting a strategy helps prevent policymakers from bending under 

pressure and sacrificing independence. 

Your letter states that the FORM Act would ‘‘severely damage 

the U.S. economy were it to become law.’’ My letter says the new 

legislation would improve economic performance. 

By definition, your letter is signed by you. My letter is signed by 

Dr. Lars Hansen of the University of Chicago, Nobel laureate in economics. 

It is also signed by Robert Lucas, University of Chicago, Nobel 

laureate in economics; Edward Prescott, Arizona State University, 

Nobel laureate in economics; George Shultz, former Secretary of 

the Treasury; Robert Heller, former Federal Reserve Governor; 

Jerry Jordan, former President of the Cleveland Federal Reserve 

10 

Bank; William Poole, former President of the St. Louis Federal Reserve Bank, and former member of the Council of Economic Advisers; Michael Boskin, Stanford University, former Chairman of the 

President’s Council of Economic Advisers; Charles Calomiris, Columbia University, former consultant, Federal Reserve Board of 

Governors; Marvin Goodfriend, Carnegie Mellon, former Research 

Director for the Federal Reserve Board of Richmond; Allan Meltzer, 

Carnegie Mellon; and John Taylor of Stanford University, former 

Under Secretary of the Treasury, member of the Council of Economic Advisers, and author of the Taylor Rule. And there are about 

15 other signatories to the letter. 

So, Chair Yellen, we have three Nobel prizewinners in economics, 

a host of former Federal Reserve officials, and some of the most renowned and respected economists in the country who pretty much 

disagree with everything that you asserted in your three-page missive against the FORM Act. I know you are not a fan, but I would 

just caution you, Chair Yellen, that when you use such apocalyptic 

and hyperbolic language, you might consider whether or not this 

undercuts your credibility as Fed Chair. 

I have one question. In your testimony, Chair Yellen, in characterizing the Fed strategy to increase policy rates, you testified that, 

‘‘removing monetary policy accommodation by the traditional approach is preferable to shrinking the Fed’s balance sheet,’’ which 

now holds almost as much in Treasuries as China and Japan do 

combined. 

I am trying to figure out what precisely is ‘‘traditional’’ about 

this current approach where the Fed—and the ranking member, I 

think, brought this up in her opening statement—subsidizes deposit rates for some of the biggest banks in our country, which can 

distort, as you well know, real asset allocation and constrain economic opportunity. And the last time I checked, as we speak, the 

Fed’s fund rate is just above 30 basis points. You are paying banks 

50 basis points for excess reserves, which would seem to be above 

the market rate. 

You have previously testified that this does not involve a subsidy 

to the banks. It appears to be a subsidy, and it appears to distort 

real asset allocation. So what is traditional about this approach? 

Mrs. YELLEN. The tools that we have used to raise our target for 

short-term interest rates, namely our key tool being interest on excess reserves, is widely used by central banks as a key tool of monetary policy. And it is the critical tool that we need to rely on in 

order to adjust the level of short-term rates to what we regard as 

the appropriate stance to achieve congressionally-mandated goals. 

I would point out that although we are paying interest to banks 

on reserves, those reserves are financing our holdings, a large portfolio of holdings of longer-term Treasury securities and mortgagebacked securities on which we earn substantially greater interest. 

And because of that large balance sheet, this past year the Fed 

transferred back to the Treasury and to the American taxpayers 

$100 billion. 

Chairman HENSARLING. But it is true, Chair Yellen, is it not, 

that you are paying 50 basis points when the Fed funds rate is 30 

basis points? 

11 

Mrs. YELLEN. It is necessary for us to raise benchmark rates in 

order for a whole host of short-term interest rates— 

Chairman HENSARLING. That would seem to imply a subsidy to 

the largest banks. My time has long since expired. 

The Chair now recognizes the ranking member for 5 minutes. 

Ms. WATERS. Thank you, Mr. Chairman. 

Chair Yellen, continuing on the discussion that was just initiated 

by the Chairman, as you continue to embark on the path of raising 

rates I want to explore the alternative approaches that may exist 

for the Federal Reserve to do so in a manner that does not rely so 

heavily on paying massive sums to private sector banks to hold 

onto the reserves they maintain at the Fed. While the Fed paid close to $7 billion on reserves in 2015, as the 

economy strengthens and rates are further increased, the amounts 

paid could increase dramatically into the tens of billions of dollars. 

Can you expand on why you believe that paying interest on excess 

reserves is particularly important for raising rates in the current 

environment and discuss possible alternative approaches that may 

exist? 

And if you talk about what you believe is the mandate of Congress and how you don’t have the authority for alternatives, I want 

to hear more about that and what you do have the authority to do. 

Mrs. YELLEN. Prior to the financial crisis, the Fed adjusted the 

level of short-term interest rates through small variations in the 

supply of reserves to the banking system. Following the financial 

crisis, as our balance sheet expanded, reserves became abundant, 

and the traditional old-fashioned approach was no longer feasible. 

Congress had debated the wisdom of giving us the tool of paying 

interest on reserves for many years and decided to do so in 2006, 

and then speeded up implementation in 2008. The knowledge that 

we had that tool and would be able to use it when we deemed it 

appropriate to begin to raise the short-term level of interest rates, 

as we did in December—the knowledge that that tool was available, as I just mentioned, the tool that is critical to our control of 

short-term rates and widely used globally, that was an important 

fact when we considered all the actions that we took—the unconventional actions that we took—to produce the decline in the unemployment rate and improvement in the labor market that we have 

achieved. 

So if we were denied that tool at the present time, we would not 

be able to easily raise the level of short-term rates. Until we— 

Ms. WATERS. However, if I may interrupt you for a moment, are 

you saying that you are limited only to that action? Or do you have 

the authority to make some other decisions relative to what the interest is that you are paying to big banks? Do you have some flexibility here? 

Mrs. YELLEN. We would likely, to regain effective control of 

short-term interest rates, need to shrink our portfolio from its current large level back to the kinds of levels we had before the crisis. 

And we have set out over several years a plan for how we would 

normalize policy that relies not on selling long-term assets but on 

adjusting short-term interest rates. 

I believe that if we were to follow the plan of selling off long-term 

assets, it could prove very disruptive to the expansion. It is a stratVerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI
12 

egy that I think could harm the economic recovery, and it certainly 

is not what we have set out to the public. We said we would shrink 

our balance sheet in a gradual and predictable way so as to not be 

disruptive. 

Ms. WATERS. So if I may interrupt you again, you are saying it 

was Congress, starting in 2006, who would have to design this approach, and Congress could, if it decided to, take it away as an approach that you would use even though you do not think it would 

be helpful? 

Mrs. YELLEN. I think it would be very disruptive to the economy 

and I really—I want to point out several things about this. First 

of all, although the banks are earning this interest on the excess— 

on the reserves that they hold, as the level of short-term rates 

rises, first of all, on their wholesale funding that many of the 

banks rely on, they are also paying more to gain that funding. 

Eventually this will be the mechanism that would lead, as well, to 

higher deposit rates to reward savers. 

And finally, I really want to emphasize that from the taxpayers’ 

point of view, the Federal Reserve has transferred, since 2008 

through 2015, roughly $600 billion back to Congress, to the taxpayers, to the Treasury, funds that have contributed importantly to 

financing the government, and that has only been possible because 

we have a larger stock of reserves in the banking system and, correspondingly, hold a far larger stock of interest-bearing assets that 

pay in larger amounts. 

Prior to the crisis, a typical level of transfers from the Fed to the 

Treasury was in the order of $20 billion. For the past 2 years, we 

have transferred $100 billion a year. 

Ms. WATERS. Thank you very much. We need to talk about this 

some more. 

I yield back the balance of my time. 

Chairman HENSARLING. The Chair now recognizes the gentleman 

from South Carolina, Mr. Mulvaney, the vice chairman of our Monetary Policy and Trade Subcommittee. 

Mr. MULVANEY. I thank the Chairman. 

A quick follow up, Chair Yellen, on the Chairman’s question: You 

mentioned that using the IOER or the RRP were traditional tools, 

and then you mentioned that other central banks used them before. 

Have you ever used them? 

Mrs. YELLEN. No. 

Mr. MULVANEY. Has the Federal funds rate, which I understand 

now is trading on the market at about 30 basis points, ever been— 

ever—below the IOER, which is now set at 50 basis points? 

Mrs. YELLEN. Has it ever been below? 

Mr. MULVANEY. Yes, ma’am. 

It is since we set the—when we were first given the power to pay 

interest on reserves, we set it at 25 basis points, and the Fed funds 

rate traded below it. And when we raised it to 50, the Fed funds 

rate moved up by 25 basis points, the amount of the increase in 

IOER that continues to trade below it. 

Mr. MULVANEY. All right. So your testimony is that those are traditional tools. So let’s move then to a different discussion with that 

as a background. 

13 

You have in the past been a proponent, though a reserved proponent, of a rules-based system. Back in 2012, you gave a speech 

where you said, ‘‘Why shouldn’t the FOMC adopt such a rule as a 

guidepost?’’ 

The answer is that times are by no means normal now and that 

simple rules that perform well under ordinary circumstances just 

won’t perform well. 

Two years ago, you said something similar to this committee. In 

response to a question about rules you said, ‘‘The conditions facing 

the economy are extremely unusual. I have tried to argue and believe strongly that while a Taylor Rule, or something like it, provides a sensible approach in normal times, like the Great Moderation, under current situations it is not appropriate.’’ 

So, that was your testimony in 2014. You gave a speech in 2012. 

Here we are in 2016. You, by your own testimony, are using traditional tools of monetary policy. Your written testimony begins by 

saying that the economy has made further progress towards the 

Federal Reserve’s objective of maximum employment. You go on to 

say that inflation is low in the near-term but it will rise to its 2 

percent objective over the median term. 

Are we in normal times? 

Mrs. YELLEN. The economy is in many ways close to normal in 

the sense that the unemployment rate has declined to levels that 

most of my colleagues believe are consistent with full employment 

in the longer run. And inflation, while it is below 2 percent, I do 

think there is a good reason to think it will move up over time. And 

in that sense things are normal. 

But what is not normal is that the so-called neutral level of the 

Federal funds rate that I referred to in my testimony and we discuss in the report is by no means normal. In other words, we have 

needed for 7 years to hold the Federal funds rate and—both in 

nominal and inflation in real terms—inflation adjusted or real 

terms—at exceptionally low levels to achieve growth averaging 2 

percent or a little bit above. 

Mr. MULVANEY. I am sorry to interrupt, but I do want to get— 

Mrs. YELLEN. And in that sense, it is not normal. The economy 

is being held back by headwinds. 

I would point out that a tenet of the Taylor Rule is that it 

takes—it assumes and embodies in it an assumption that the equilibrium level of the Fed funds rate with the 2 percent objective is 

4 percent, or that the real equilibrium Fed funds rate is 2 percent. 

And that simply isn’t the case. 

Mr. MULVANEY. Madam Chair, I am not actually, surprisingly, 

not pushing the Taylor Rule. I am simply asking about a general 

rule-based system because you have shown some support for it in 

the past. And I guess my question is this: What does the world 

have to look like? Because I think admittedly, employment is better. Inflation, it seems to be under control. Yes, you say that the 

Fed funds rate is extraordinarily low, which it is, but that is something under your control. 

What does the world have to look like in order for the Federal 

Reserve to start considering transitioning to a rule-based system? 

Mrs. YELLEN. I think the benefit of a rule-based system is it is 

systematic and understandable. And the Federal Reserve has atVerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI
14 

tempted to engage in the systematic policy. It takes a different 

form. 

Mr. MULVANEY. I get that, but what does the world have to look 

like? When you come back next year, what should the world look 

like for you to be saying, you know what, we are considering a 

rules-based system? What has to change? 

Mrs. YELLEN. The Committee looks at guidelines from rules as 

useful benchmarks as it considers the appropriate stance of policy, 

but I believe, and I think most of my colleagues would agree, that 

we shouldn’t mechanically follow that rule or any other rule, but 

that we need to take into account a large set of indicators of how 

the economy is performing. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentlelady from Wisconsin, Ms. 

Moore, ranking member of our Monetary Policy and Trade Subcommittee. 

Ms. MOORE. Thank you so much, Mr. Chairman. 

And again, welcome, Chair Yellen. 

I want to take us in a little different direction. Many of us here 

on both sides of the aisle are really concerned about what is happening with our smaller banks. And we understand that because 

of Basel III and we had a lot of concerns when we debated DoddFrank, including provisions like Volcker and FSOC. 

They were driven by the concerns of the large banks in active 

capital markets. And I know that the Fed is not the only regulator 

overseeing implementation of Dodd-Frank, but I would like your 

thoughts on how the rules may have been tailored, or should have 

been tailored, for small and community banks? 

The stress tests and the capital standards are killing our small 

banks, compliance officers that—where they don’t have the additional staff. Just your thoughts on what should have been done or 

how has it been tailored? 

Mrs. YELLEN. Let me say that I think community banks and 

their vitality is exceptionally important. They provide enormous 

benefits to the country and to the economy. I recognize that the 

regulatory burden on community banks is intense. 

Ms. MOORE. They are shutting down. 

Mrs. YELLEN. For our part, we are focused on doing everything 

that we conceivably can to minimize and reduce the burden on 

these banking organizations. 

We have been conducting an EGRPRA review to identify potential burdens that our regulations impose on these banks, and we 

will do everything that we can to respond to the concerns that are 

identified there to reduce burden. 

We are looking for many ways. First of all, we have tried to tailor our regulations to the size and complexity of institutions. The 

smaller community banks are not subject to stress-testing requirements. Many aspects of Basel III capital requirements and liquidity 

rules do not apply to those banking organizations. We have tried 

to simplify those requirements. 

We are, in addition to that, trying to reduce the duration of the 

time that we spend reviewing banks during exams; we are trying 

to simplify and be more targeted in our requests for documentation. 

15 

We try to identify for community bankers what is relevant to 

them and what they can safely ignore. And we are looking for ways 

to conduct exams that are more focused on the actual risks that are 

relevant to a particular organization. 

So I recognize that the burdens on those banks have been very 

intense and I pledge that we are doing and will continue to do all 

we can to reduce burdens on them. 

Ms. MOORE. Thank you, Madam Chair. 

On this committee, we spend a lot of time talking about moral 

hazard, and so I guess I would like your view on whether or not 

you think there is any moral hazard on not a single person involved in the 2008 crash having gone to jail. They get fines, they 

get sort of compliance letters where they can clean up their act and 

avoid prosecution, and I am wondering if you think that it is important for us to seek—so what? You pay a fine. That doesn’t stop 

anyone from doing the next crime, unlike other of our criminal 

laws. 

Mrs. YELLEN. I agree with you. I do not think that individuals 

who are guilty of wrongdoing should escape paying appropriate 

penalties. 

For our own part, we are not allowed, obviously, to put in place 

criminal penalties. That is a matter for the Department of Justice. 

For our part, we can, when we find individuals to be responsible 

for wrongdoing, make sure that they are not allowed to work at the 

banking organizations where they committed misdeeds. And in 

many cases, we can make sure that they are banned from the business of banking. 

And when we have been able to identify individuals who are responsible, we have put in place those sanctions and will continue 

to do so. And we always cooperate with the Department of Justice 

in their investigations. 

Chairman HENSARLING. The time of the gentlelady has expired. 

The Chair now recognizes the gentleman from North Carolina, 

Mr. McHenry, vice chairman of the committee. 

Mr. MCHENRY. Thank you, Chair Yellen. 

So, does the Federal Reserve have the legal authority to implement negative rates? 

Mrs. YELLEN. I’m sorry, do we have the legal authority to— 

Mr. MCHENRY. Implement negative rates. 

Mrs. YELLEN. This is a matter that the Federal Open Market 

Committee considered around 2010, and we didn’t fully—as we 

were exploring our options to provide accommodation we decided 

not to lower interest rates, either IOER to zero or into negative territory, and we didn’t fully look at the legal issues around that. 

I would say that remains a question that we still would need to 

investigate more thoroughly. 

Mr. MCHENRY. And one of our document requests, that 2010 

memo that I assume is connected to that policy discussion— 

Mrs. YELLEN. That is right. 

Mr. MCHENRY. —raised significant doubts about the Fed’s authority that they currently have to charge—to pay interest on excessive—on excess reserves and whether or not that same authority 

would allow you to demand payment for that. 

16 

Mrs. YELLEN. Congressman, I don’t know of any restriction that 

would prevent us from doing that. That memo indicated—was intended to indicate that the legal issues had not been seriously considered in the time that went to the FOMC. 

Mr. MCHENRY. Have they been seriously considered since 2010? 

Mrs. YELLEN. In the spirit of prudent planning, we always try to 

look at what options we would have available to us, either if we 

need to tighten policy more rapidly than we expect or the opposite, 

to loosen policy. 

Mr. MCHENRY. Do you— 

Mrs. YELLEN. So, we would take a look at it. But the legal issues 

I am not prepared to tell you have been thoroughly examined at 

this point. 

Mr. MCHENRY. So at this point it is unclear whether or not the 

Fed does have the legal authority to implement negative rates? 

Mrs. YELLEN. I am not aware of anything that would prevent us 

from doing it, but I am saying that we have not fully investigated 

the legal issues. That still needs to be done. 

Mr. MCHENRY. So let’s move to regulation. You run the largest 

regulatory organization in the United States of America, perhaps 

on the globe—likely on the globe. 

And as such, I believe in the independence of the Fed to make 

monetary policy, but as a regulator, Congress should have significant oversight of your regulatory action, should they not? 

Mrs. YELLEN. Yes. 

Mr. MCHENRY. Okay. And as such, as a matter of regulation— 

the Chairman raised this question with you the last time you were 

here about Federal Reserve regulators, bank examiners demanding 

to be a part of board of director meetings at member banks. 

And you have exchanged multiple letters on this matter. We still 

hear that this is, in fact, taking place. 

Would you pledge to this committee that you would direct your 

bank examiners and regional bank examiners to stop this practice? 

Mrs. YELLEN. I will look into— 

Mr. MCHENRY. You have already looked into it, and you have exchanged letters and you gave the Chairman the assurance last 

time that you are not aware of it. I assume you are now aware of 

whether or not this is taking place, are you not? 

Mrs. YELLEN. I think there are occasional situations in which 

that occurs. 

Mr. MCHENRY. Do you believe that is appropriate? 

Mrs. YELLEN. I am not certain that it is inappropriate. I want 

to get back to you on that. 

Mr. MCHENRY. This was raised about 6 months ago by the Chairman; you have exchanged multiple letters. I would like to have 

some greater assurance. This is not meant to be a ‘‘gotcha;’’ this is 

a well-worn question. 

And we are hearing—and in fact, there is a press report that the 

Fed directed one of your member banks to incorporate two additional members of the board of directors. And the Fed directing a 

private enterprise to change their board of directors seems somewhat perplexing. 

Do you believe that is appropriate authority for the Fed? 

17 

Mrs. YELLEN. I think it is appropriate as a matter of supervision 

to— 

Mr. MCHENRY. To direct? 

Mrs. YELLEN. —ensure that a board of directors of a financial 

company that we supervise is appropriately constituted in fulfilling 

its corporate governance functions. That is a part of supervision. 

Mr. MCHENRY. My time has expired. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentlelady from New York, Mrs. 

Maloney, ranking member of our Capital Markets Subcommittee. 

Mrs. MALONEY. Chair Yellen, you raised interest rates in December and said that any future interest rate increases, if they happened, would be gradual. I would like to ask you about the recent 

turmoil in global markets. 

As you know, equity markets around the world, led by China, 

have plunged since the beginning of the year as global economic 

growth has weakened. And the United States has not been immune. U.S. stock markets have fallen over 9 percent since the beginning of the year and Treasury yields have plunged 23 percent. 

So my question is, has the turmoil in global markets changed 

your view about the appropriate pace of interest rate increases and 

hikes, or will you wait to see how global market turmoil affects the 

U.S. economy before raising rates again? 

Mrs. YELLEN. We are watching very carefully what is happening 

in global financial markets. It would appear that stresses that we 

have seen since the turn of the year relate to uncertainties regarding Chinese exchange rate policy. There are uncertainties around 

the price of oil. We have not seen shifts in—that seem significant 

enough to have driven the sharp moves we have seen in markets. 

There would seem to be increased fears of recession risk that is 

resulting in rises in risk premium. We have not yet seen a sharp 

drop-off in growth, either globally or in the United States, but we 

certainly recognize that global market developments bear close 

watching. As I mentioned, the financial conditions have become 

less supportive to growth and we recognize that these developments may have implications for the outlook, which we are in the 

process of assessing. 

And I want to make clear that monetary policy is not on a preset 

course and so our evaluation of the likely impact of those developments on the economic outlook and our ability to meet both our 

employment and inflation objectives, those are the factors that will 

govern the future stance of monetary policy. It is not on a preset 

course. 

Mrs. MALONEY. And given the turmoil in global markets and the 

slowing U.S. economy, some analysts are now talking about the 

United States possibly falling into a recession this year. What 

would it take for you to consider cutting interest rates again? A severe downturn in the economy or just stubbornly low inflation? 

Mrs. YELLEN. Our commitment is to achieve our congressionally 

mandated goals of maximum employment and price stability. I do 

not expect that the FOMC is going to be soon in this situation 

where it is necessary to cut rates. Let’s remember that the labor 

market is continuing to perform well, to improve. I continue to 

18 

think that many of the factors holding down inflation are transitory. 

While there is always some risk of recession, and I recognize and 

have just stated that global financial developments could produce 

a slowing in the economy, I think we want to be careful not to 

jump to a premature conclusion about what is in store for the U.S. 

economy. 

So I don’t think it is going to be necessary to cut rates, but that 

said, monetary policy, as I said, is not on a preset course. And if 

it turned out that would be necessary, obviously the FOMC would 

do what is needed to achieve our—the goals that Congress has assigned to us. 

Mrs. MALONEY. You said in December that you were surprised by 

how far oil prices had fallen and that you expected inflation to increase once oil prices stabilized. Since the Fed’s December meeting, 

oil prices have fallen even further. They are down about 25 percent 

since the December meeting and they have fallen 7 percent since 

Friday. 

At the same time, we have also seen inflation expectations fall 

since the December meeting to the lowest levels in quite some time. 

Has this caused you to rethink your inflation projections at all? 

Mrs. YELLEN. We indicated in our statement in January that 

these developments led us to conclude that inflation will stay low 

for a while longer as these developments work through. Clearly, we 

are watching inflation expectations and, as I mentioned, marketbased measures of inflation compensation have moved down now to 

historically low levels. And that is something we are evaluating 

carefully. 

In December when we raised rates, we indicated that with inflation so far below our objective, we would carefully watch incoming 

data and revise our expectations. So I don’t want to jump to a premature conclusion. 

My colleagues and I will issue in March updated projections for 

inflation taking all the evidence we have at hand into account, 

but— 

Chairman HENSARLING. The time of the gentlelady has expired. 

The Chair recognizes the gentleman from New Jersey, Mr. Garrett, chairman of our Capital Markets Subcommittee. 

Mr. GARRETT. I thank the Chair. 

Chair Yellen, thank you for being here. 

I would like to talk a little bit—begin on emergency lending 

under Section 13(3). It was about a year-and-a-half ago that Senator Elizabeth Warren and myself and Mr. Capuano joined together, and Senator Vitter as well, and sent you a letter expressing 

our deep concern with what you were doing with regard to implementing the limiting language in Dodd-Frank at that time. 

And of course, you have come out now with a rule, despite our 

admonition and questions in that letter, a rule that would basically 

allow the Fed to drive a Mack truck through the various loopholes 

in it, and also, once again, as is typical with the Fed, lacking in 

clarity and transparency. 

That being said, the Fed is not always not clear in what they 

want to do, and the regulators are not always clear in what they 

want to do. For example, they came up with the Volcker Rule, and 

19 

in the Volcker Rule the Fed was not shy about elaborating on concepts in that statute. In fact, it went so far as to adopt prohibitions 

in trading assets that were clearly never intended by the statute. 

So the Fed and other regulators came up with this part of the 

Volcker Rule dealing with defining just what the words ‘‘proprietary trading’’ mean. Over 800 pages to make some definitional 

clarity in the area of Volcker and proprietary trading. Compare 

that to what you did with—under the limitations that should be in 

place under Dodd-Frank of 13(3)—47 pages of definition and a lack 

of clarity throughout it. 

So the first question is why in one area can you be exact and precise in precision when you are trying to limit what the private market is doing, but when Congress tells you to put limitations on 

yourself, you lack that clarity and give it a broad brush? 

Mrs. YELLEN. I think we tried in the rule to be as clear as we 

possibly could. We— 

Mr. GARRETT. Let’s take a look at that then. 

Mrs. YELLEN. —took a—we, for example— 

Mr. GARRETT. Now, let me give you an example. 

The Fed claims that it establishes a penalty rate under 13(3), but 

then you failed to provide any specifics whatsoever of what that 

rate would be. 

Compare that to what Congress did. This committee passed a bill 

that would establish a penalty rate that would be commensurate 

with ‘‘a distressed borrower.’’ 

So why wouldn’t the Fed be clear on this? What are the rates 

going to be? 

Mrs. YELLEN. Because what a penalty rate is depends on the specifics of a particular situation. 

Mr. GARRETT. But can’t— 

Mrs. YELLEN. A penalty rate is a rate that when conditions normalize— 

Mr. GARRETT. But we know what a distressed borrower is and 

what the markets are. That is clear. Why didn’t you define it that 

way, compare it to the regular markets so that a distressed borrower in the markets would be charged the same if they are borrowing from the Fed— 

Mrs. YELLEN. Well, in the— 

Mr. GARRETT. —or related to it? 

Mrs. YELLEN. In the type of situation that we found ourselves 

in— 

Mr. GARRETT. Yes. 

Mrs. YELLEN. —during the financial crisis, market rates had shot 

up to extraordinary levels because liquidity had dried up in the financial— 

Mr. GARRETT. I understand what the history of the market was 

at that time, but you could have provided clarity in here. 

So basically what you are telling us is once again, the Fed is 

going to be in the position of picking winners and losers. By your 

prior answer, it seems like you are saying that you could charge 

borrower A one rate and borrower B another rate under similarly 

situated circumstances. Is that not correct? 

20 

Mrs. YELLEN. I think what is an appropriate rate does depend 

on the circumstances. Financial crises, which is when we would be 

using this authority— 

Mr. GARRETT. But that is— 

Mrs. YELLEN. —to set up a broad-based program, are always 

very unique. And— 

Mr. GARRETT. Right. And I think that basically what you are telling us is that nothing really has changed despite the admonition 

and the law in Dodd-Frank to put a limitation. 

And it is not just me saying that, by the way. It is interesting 

that while you are here testifying today, Governor Fisher is also 

making public statements as you speak. 

We just got part of his statement, and he seems to be saying exactly what you are, that you have not limited 13(3). He said, ‘‘But 

in simple language, strengthening fire prevention regulation does 

not imply that the fire brigade should be disbanded.’’ 

He goes on basically to say in his comments today that we are 

not seeing the limitations, that you are going to be able to do similar things to what you did back in, or that—before you were here, 

that the Fed did the last time around. 

Mrs. YELLEN. I want to make clear that I think our 13(3) powers 

and ability to lend to keep credit flowing in the economy during a 

financial crisis is a critical power. It played a critical role during 

the financial crisis. 

Mr. GARRETT. So is he wrong when he says that nothing—my interpretation—has really changed? Your powers are the same as 

they were before? 

Mrs. YELLEN. No, a lot has changed. Congress put in place a series of restrictions that they intended— 

Mr. GARRETT. But your rule does not implement those, does it? 

Mrs. YELLEN. Yes, it does. Our rule does implement those restrictions. 

We cannot lend to an insolvent borrower; we cannot lend to help 

one or more failing firms. We can only put in place broad-based 

programs, and we have defined pretty clearly in that rule what 

constitutes a broad-based program. So Congress clearly changed 

what the Fed can do. 

Mr. GARRETT. But it does not— 

Mrs. YELLEN. It also gave—provided— 

Mr. GARRETT. Governor Fisher is saying we have likely reduced 

the probability that lender of last resort will be needed, but we 

have not reduced that probability to zero. So it appears that, in his 

opinion at least, some of those problems remain. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentlelady from New York, Ms. 

Velazquez. 

Ms. VELAZQUEZ. Thank you, Mr. Chairman. 

Chair Yellen, the unemployment rate is down to under 5 percent 

for the first time in 8 years. However, I remain concerned that unemployment rates remain elevated in the Hispanic and AfricanAmerican communities. 

Does the Fed specifically take unemployment within these 

groups into consideration when making policy decisions surrounding the Fed fund rate? 

21 

Mrs. YELLEN. We track very carefully the unemployment rates 

and experiences of different demographic groups, and we make a 

very careful assessment about whether or not the economy is meeting the objective of maximum sustainable employment, which involves taking account of factors like, are particular groups being 

discouraged from even participating in the labor force because of 

conditions? 

But it is important to recognize that our powers, which involve 

setting interest rates, affecting financial conditions, are not targeted and can’t be targeted at the experience of particular groups. 

I think it always has been true and continues to be true that when 

the labor market improves, the experience of all groups does improve. 

Roughly now, the unemployment rate in the United States is 

close to where it was in the fourth quarter of 2007. Now, AfricanAmericans and Hispanics at that time back in 2007 had higher unemployment rates than the population as a whole. Regrettably, because of the disadvantages that these groups face in the labor market, they have historically tended to have higher unemployment 

rates. 

But as the economy has improved and unemployment has come 

down, the unemployment rates for those groups, for Hispanics and 

African-Americans, has come down. They have fallen to roughly the 

same levels that they were in at the end of 2007 while, again, remaining higher. 

Ms. VELAZQUEZ. So you— 

Mrs. YELLEN. We do look at that, but we don’t have tools to target particular groups— 

Ms. VELAZQUEZ. I understand that. 

Mrs. YELLEN. —rather than others. 

Ms. VELAZQUEZ. Do you consider an 8.8 percent unemployment 

rate among African-Americans today too high? 

Mrs. YELLEN. I do consider it too high, and I think there are any 

number of reasons for that. And I think that the reasons for it are 

ones that Congress should be considering broadly in designing a 

wide range of policies. 

It is something that we want to see a strong labor market, we 

want to see continued progress, and we will put in place policies 

that achieve that. But we cannot target the unemployment rate for 

a particular group. 

Ms. VELAZQUEZ. I heard you. 

As you know, Chair Yellen, U.S. employers have created 14 million jobs during President Obama’s tenure. However, the labor 

force participation rate remains low and discouraged people who 

want to work have stopped looking. How much of the decline in the 

rate can be explained by the trend of flat or declining wages for 

many American workers? 

Mrs. YELLEN. For the country as a whole, an important reason 

that labor force participation has fallen and will continue to fall is 

because of the aging of the population. So that is not going to 

change and the trend is downward. 

But it is also true that for certain subgroups in the population— 

for example, prime age but less educated men—the trend downward has been particularly steep. And there is a lot of economic reVerDate Nov 24 2008 17:34 Jun 29, 2017 Jkt 023566 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 K:\DOCS\23566.TXT TERI
22 

search that tries to understand why men have—their labor force 

participation has declined, and it wouldn’t surprise me if wage 

trends are part of the reason for that. 

Ms. VELAZQUEZ. Right. 

Mrs. YELLEN. So my guess is that they have played a role in discouraging labor force participation. 

Ms. VELAZQUEZ. As wages begin to increase, do you anticipate 

the participation rate to increase as well? 

Mrs. YELLEN. Yes, I anticipate that wage growth will move up 

somewhat. And I do think that labor force participation is somewhat depressed relative to where it will be in a really full employment economy. 

That is why I say I think there does remain some slack in the 

labor market even though the aggregate unemployment rate is at 

4.9 percent. So I do hope that— 

Chairman HENSARLING. The time of the gentlelady has expired. 

The Chair now recognizes the gentleman from Texas, Mr. Neugebauer, chairman of our Financial Institutions Subcommittee. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. 

And thank you, Chair Yellen, for being here as well. Part of your 

remarks were about the state of the economy, and I think you are 

trying to paint a little bit rosier picture, and maybe there is a little 

bit of a rosier picture, but it is not a good picture. 

I am looking at some stats here that we still have 16 million 

American citizens who are unemployed. In fact, the number of 

long-term unemployed Americans is 761,000 higher than it was at 

the start of the recession. 

We have 94 million Americans over the age of 17 who have abandoned the job market. Real disposable income is a paltry annual 

rate at 1.2 percent. 

The real GDP is growing just under 2.2 percent. We have more 

Americans living in poverty than ever before—46.7 million people. 

And we have 45 million people on SNAP. I could read more and 

more. 

I think the issue that I have been thinking about this week is 

that when you look at the original purpose the Fed was formed for, 

and what the Fed looks like today, and I think my good friend Mr. 

Mulvaney pointed this out, is that basically we have a Fed that is 

in charge of monetary policy, some other things have been added 

to that, and then we have a Fed that is the biggest and largest regulator and regulates more assets than any other financial institution in the world. 

And it kind of reminds me that while you all are working on one 

side of the Fed to stabilize employment, keep inflation in check, 

then on the other side of the Fed you have this huge regulatory 

structure that has grown substantially and continues to issue very 

complicated, and some people think that you have become a micromanager of these financial institutions with the regulations. 

So it reminds me of that statement, ‘‘We have met the enemy 

and it is us.’’ Is it counterproductive that you have the—a Fed 

working on one side to create jobs, and you have a Fed on the other 

side of the building that is doing things that a lot of people think 

are killing jobs: micromanaging the financial markets; increasing 

the cost of capital; and reducing the availability of capital, which 

23 

has stymied the ability of this economy to grow? Isn’t that self-defeating? 

Mrs. YELLEN. I think we have to remember that financial crises 

are immensely costly to well-being. And it is important to make 

sure that we do everything—almost everything we can to reduce 

the odds of another devastating financial crisis. 

So we are working hard. We have worked hard in the aftermath 

of the crisis to make sure that we have a financial system that is 

safer, sounder, has more capital, higher quality capital, more liquidity, and is less crisis-prone than the financial system that we 

had that caused this financial crisis. 

Mr. NEUGEBAUER. The time is short. You mentioned the word ‘‘liquidity,’’ and I think a lot of people think some of the things that 

the Fed has done and some of the regulations have actually reduced liquidity in a number of markets. And in fact, you and I have 

had a conversation about the fact that you all have shown some 

concern about liquidity. 

I wanted to see if you knew that the European Commission has 

initiated a review process. They said after 5 years of instituting all 

of these regulations and additional capital requirements, and kind 

of just piling on of regulation and capital, more capital and regulation—and I am not against having adequate capital, but the problem is that we seem to have an add-on game here and the additional capital also comes with additional regulations. 

And so the European Commission has initiated a review process 

that said, ‘‘You know what? Time out here; let’s go back and look. 

We know what we have asked these entities to do; we know what 

we have impounded them with.’’ 

But the question is, how are the markets responding to this and 

how have—basically, it is a cost-benefit analysis of all of the policies that have been in place. 

Has the Fed thought about, hey, maybe we should stop and analyze what we have done here and see if it is positive? 

Mrs. YELLEN. We have a few things we still need to finalize to 

put in place the Dodd-Frank regulations that were called for, and 

we hope to complete that work soon. And it certainly is appropriate 

to evaluate how the system is working. And we do that on an ongoing basis, and I think it is, of course, appropriate to see whether 

or not there are ways in which we can improve or simplify regulations. And we are in the process of doing that in some very important areas. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from California, Mr. 

Sherman. 

Mr. SHERMAN. Mr. Chairman, I feel like I am at a ballroom 

dance on the deck of the Titanic. The faith of the American people 

in our government and institutions is at an all-time low. I have 

been sitting in this room for 20 years and the room has the feel 

that it had 20 years ago, except we don’t have Alan Greenspan in 

front of us. 

Government institutions work better if they listen to the American people, first, because the American people will then accept the 

decisions, and second, because we get better decisions. 

24 

Yesterday, in a small State that is doing better than most of the 

country, two-thirds of the people went out in a very, I think, 

record-setting turnout with inclement weather to say that they are 

mad as hell, particularly at the financial institutions that this committee deals with. And two-thirds of them voted for the most angry 

candidate they could find. 

Too-big-to-fail should be too-big-to-exist. Madam Chair, in response to the gentlelady from Wisconsin, you said it was basically 

the Department of Justice’s failure to have a single criminal prosecution of those who had robbed the banks and, more importantly, 

robbed the American people. And I wonder whether you can really 

just put that at the feet of the Department of Justice? 

Because we have learned institutions can get so big that they are 

too-big-to-fail. Your predecessor was in this room demanding that 

we bail them out. And, God forbid, you will be again if you allow 

these too-big-to-fail institutions to continue to exist. 

They are too-big-to-jail. And as you point out, you may bar somebody from the banking world, but, gee whiz, in a country with more 

people incarcerated than any other country in the world, is it really 

adequate to those who steal hundreds of millions and billions to 

say, ‘‘Well, you can’t go back into the banking world?’’ 

So I will ask you as a member of FSOC, we need moral hazard 

to make sure that major economic decisions made by the giant 

banks are made correctly. They don’t have a moral hazard in the 

sense of not being able to get capital. People are flooding them with 

capital at rates that are said to be up to 80 basis points less than 

they would pay if there wasn’t a belief that we would bail them 

out. So the too-big-to-fail won’t be allowed to fail. As you point out, 

DOJ won’t put anybody in jail. 

The solution is, use your power under FSOC to break them up. 

Are you going to break up the too-big-to-fail institutions? 

I have asked you that before, and I will ask you it again. I think 

I know the answer. 

Mrs. YELLEN. The answer I will give you is that we are using our 

powers to make sure that a systemically important institution 

could fail and it would have systemic consequences for the country. 

We are doing that in a whole variety of ways. First of all, we 

have done many things to diminish the odds that they would fail. 

We are trying to make them, and I think I can enumerate all the 

things we have done— 

Mr. SHERMAN. Are you willing to call the attorney general and 

say, ‘‘We have this thing handled so well that you can start criminal prosecutions because they are not too-big-to-jail anymore?’’ 

Mrs. YELLEN. I said that I am in favor of going after individuals 

who are guilty of wrongdoing. 

Mr. SHERMAN. With such penalties as barring them from the 

banking system. 

Mrs. YELLEN. Well, — 

Mr. SHERMAN. I want to move on— 

Mrs. YELLEN. —what I said is those are the sanctions that the 

Federal Reserve can impose. 

Mr. SHERMAN. I need to move on to another question. 

You are a governmental entity, but it is—in some parts of the entity it is one bank, one vote. It is the only part of our constitutional 

25 

system that puts governmental power in the hands of one bank, 

one vote. 

Are you going to use your considerable power to oppose legislative efforts to try to make the regional bank governors appointed 

exclusively by the President and to try to make the regional banks 

subject to the Freedom of Information Act? 

Mrs. YELLEN. Congressman, I think the current structure of the 

Fed is something that Congress decided after a long debate and 

weighing of a whole variety of considerations. I would say I think 

it has worked pretty well, but it is certainly something— 

Mr. SHERMAN. Wait, excuse me, Madam Chair. Are you saying 

that the Fed, having just lived through 2008, with people not getting raises, that this whole system has worked well? 

Mrs. YELLEN. I’m sorry. I thought you were asking about our 

governance. 

Mr. SHERMAN. Your governance has led to the decisions that 

have nearly brought this country to its knees. 

I yield back. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Missouri, Mr. 

Luetkemeyer, chairman of our Housing and Insurance Subcommittee. 

Mr. LUETKEMEYER. Thank you, Mr. Chairman. 

And welcome, Madam Chair. 

It is kind of interesting, as you discuss all the questions that 

have been asked you here with regards to your ability to micromanage the economy, and as you make the decisions at the Federal 

Reserve to try and do something about unemployment and try and 

do something about the inflation rate, I look at some of these 

things and I am just kind of stunned. 

Let’s start off first with what happens if we have a downturn and 

you already have $4 trillion on your balance sheet? What levers are 

still allowed or are available to you to do something? 

Mrs. YELLEN. The Fed has an array of tools. 

Mr. LUETKEMEYER. Which are? 

Mrs. YELLEN. Most importantly, the path of the short-term interest rates. 

Mr. LUETKEMEYER. Madam Chair, they are already down to almost nothing. How is lowering the rates going to help when they 

are almost nothing right now? 

Mrs. YELLEN. One of the ways in which markets work is that 

they form expectations about what the likely path of the Fed funds 

rate will be over time. Those expectations influence longer-term 

rates in the market. 

And when the economy weakens, market participants naturally 

expect the Fed, in pursuing our mandate, to follow a shallower 

path of interest rate increases, and that shift in expectations moves 

longer-term rates. 

I think you can see that just over the last several weeks, as I 

mentioned, longer-term Treasury yields have come down as market 

participants have become more fearful about a recession. And 

their— 

26 

Mr. LUETKEMEYER. Forgive me for intruding, but I have more 

questions here. So are you saying that this is a good time, then, 

to start to reduce your balance sheet? 

Mrs. YELLEN. We— 

Mr. LUETKEMEYER. Lower interest rates, it would be a nice time 

to short-shift that, wouldn’t it? Are you intending to do that? 

Mrs. YELLEN. We have indicated that we want to make sure that 

normalization is well under way before we begin to shrink our balance sheet. 

And our decision to do that reflects the fact that we feel that 

moving short-term rates is a more reliable and understandable and 

predictable way to manage the economy. 

Mr. LUETKEMEYER. Okay. 

Mrs. YELLEN. And so we are going to wait to shrink our balance 

sheet until a point when short-term interest rates are somewhat 

higher. 

Mr. LUETKEMEYER. So we may never get there, is what you are 

saying? Because there is not much room to go down. So, let’s— 

Mrs. YELLEN. We will have to see. 

Mr. LUETKEMEYER. But let me also go into your decision-making 

process, here. 

We have a labor market that continues to—the labor force participation rate continues to go down, and yet, according to your report here, the hourly rate of employees went up. There should be 

more incentive for people to work, yet they are becoming less. And 

you use the demographics of our country to indicate that. 

So I am concerned that if you look at those numbers, that there 

is minimal ability of your—the way you explained the answer to 

Ms. Velazquez a while ago, of you guys to be able to manipulate 

this. 

The second thing is, I am concerned—what other factors do you 

take into consideration when you look at your rates? For instance, 

do you look at what the Congress is proposing? Do you look at the 

court decisions? 

Because we had—and there has been a big discussion about trying to stop the inversion, the ability of our companies to go overseas and be able to take advantage of those tax rates. So the discussion is to try and cut corporate tax rates to bring those dollars 

home. 

Do you ever think about those sorts of implications about whenever you make decisions on your rates? 

Yesterday, we had a dramatic historic decision by the courts with 

regards to an EPA ruling that would have dramatically changed 

the way that we—the cost of energy in this country. 

Do you take those things into consideration when you make your 

rates? Because those are dramatic—they will have dramatic increases or significant impact on our economy. 

Mrs. YELLEN. We try to take into account in making our decisions any factor that we regard is important in— 

Mr. LUETKEMEYER. But do you have in place right now some 

modeling with regards to the EPA rule? 

Mrs. YELLEN. Not that I know of. 

27 

Mr. LUETKEMEYER. Do you have in place any modeling with regards to potential tax cut for bringing dollars home? Or for corporations? 

Mrs. YELLEN. We routinely look at the stance of fiscal policy— 

Mr. LUETKEMEYER. Do you have a model in place right now, if 

we cut corporate tax rates, that would allow you to make a decision 

on that issue? 

Mrs. YELLEN. If you were to decide that, our staff would attempt 

to evaluate— 

Mr. LUETKEMEYER. But you don’t have one in place right now, 

is what you just said? 

Mrs. YELLEN. Not to the best of my knowledge. 

Mr. LUETKEMEYER. Okay. Thank you very much. 

I yield back. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair recognizes the gentleman from New York, Mr. Meeks. 

Mr. MEEKS. Thank you, Mr. Chairman 

And welcome, Chair Yellen. 

Some of my colleagues may not have been here 9 years ago, 8 

years ago, but I have to tell you, I feel better today than when I 

sat here 8 or 9 years ago. I feel much better today than I did then. 

I can remember some of what was taking place then, and the 

panic that was going on, and the pressure that this government 

was under. And though we have not completely done what we need 

to do, because we do need to let wages grow, we do need to make 

sure we create more jobs, the position that we are in today, would 

you agree, is much stronger than the position we were in 2007 and 

2008? 

Mrs. YELLEN. I believe it is. I believe we have made a lot of 

progress, while recognizing at the same time that there are many 

households that are suffering and that there are a lot of challenges 

that people face and structural— 

Mr. MEEKS. Which, and I think it is important to acknowledge 

that, that—how far we have come. And then, I would hope that we 

would also focus then on what else needs to be done, because we 

do need to make sure that—especially those individuals who were 

victimized by the financial crises. 

For example, if you look at areas in—and I think Ms. Velazquez 

talked about it particularly in African-American and Latino communities, they lost a great amount of wealth. Many of them lost 

their homes; they lost their jobs. And so, they need something so 

that they can get back, and that is why you see this disparity that 

is very high right now. 

My focus then is we had, and I guess because of what took place 

in the past, in 1977 we passed the Community Reinvestment Act 

(CRA). Now, the Fed is in charge of CRA and can enforce it. And 

today, one of the—what we find still is that individuals in communities that were deeply affected, there is no investment going in, 

there is no job creation there, there is no access to credit. They 

don’t have credit because of, primarily, the crisis. 

So I was wondering, since the Fed oversees and can enforce CRA, 

what is the Fed doing in helping to implement CRA, compelling 

some of the large banks to make these investments in these communities as well as into CDFIs, who are focused on trying to make 

28 

sure that the kind of investments are there to create jobs, to grow 

wages in communities that were devastated by the recession? 

Mrs. YELLEN. I think CRA is extremely important in making 

sure that financial institutions, depository institutions serve the 

needs of their communities, and particularly underserved communities. 

We take our enforcement and evaluation of banks’ CRA performance very seriously. We have a whole variety of community development activities and programs that are focused on working, using 

our convening power and their CRA obligations to try to understand and identify what the needs are in particular communities 

and to try to tell banks what works, what kind of programs are 

worth supporting that really seem to make a difference in terms of 

alleviating distress in low- and moderate-income communities. 

Mr. MEEKS. One of the things I think is important, because I 

want to know, and maybe you have the answers, is to show where 

the banks are making these investments in compliance with CRA. 

Because I have found that those numbers have surely sunk, and 

then when I look at access to capital in these communities, you 

have about 70 million people now who are underbanked or 

unbanked in these communities, and so CRA could definitely help 

there. 

I would love to follow up with you to find out exactly where the 

enforcement—who is, in fact, complying and giving and who is not, 

because there has to be some accountability therein. 

Lastly, let me just, in the few seconds I have, because the other 

thing that I think that is important to look at in some of these 

communities, because—and today as well, access to credit is absolutely key and essential. And sometimes, in the way credit is 

looked at, are there alternative systems? 

For example, you find some people who pay their rent every 

month on time, and that is not to be considered when referenced 

to credit scoring models. So are there other models that you are 

looking at with reference to how credit scores are considered that 

the Fed could advocate? 

Mrs. YELLEN. I am not sure about credit scores. We would be 

glad to get back to you on that. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Wisconsin, Mr. 

Duffy, chairman of our Oversight and Investigations Subcommittee. 

Mr. DUFFY. Thank you, Mr. Chairman. 

And welcome, Chair Yellen. 

I want to take a trip down memory lane, because I think there 

is some rewriting of what happened in the crisis. 

There are a lot of people who bought homes, and for lower-income folks, that is their investment. And a lot of them lost their 

investment walking into the crisis, devastating families. 

I know we want to look to Wall Street and there is blame there. 

But I think there is a little bit of revisionist history when we say, 

you know what, Fannie Mae and Freddie Mac didn’t have anything 

to do with the crisis. Fannie and Freddie allowed no-doc loans, no 

income verification, allowing folks to buy homes they couldn’t afford. 

29 

And in Dodd-Frank, that was passed by my friends across the 

aisle, Fannie and Freddie weren’t touched at all. Fannie and 

Freddie were the ones that were allowing folks in this room to get 

homes they couldn’t afford and they were hurt. It didn’t touch 

them. 

The regulators had wild authority and power. They failed. And 

instead of taking a look at the regulation and the regulators, we 

have re-empowered regulators. 

And it’s no wonder that big banks after Dodd-Frank haven’t gotten smaller. Big banks have gotten bigger. And the small community banks that I am sure service a lot of the folks in this room, 

and service folks in my community, are going away. That’s a big 

problem. 

I just had to get it off my chest. 

So there are a lot of exciting things to chat about with you, Chair 

Yellen. But as the chairman of the Oversight Subcommittee, I do 

have some concerns about your willingness to comply with our requests. 

We sent a letter in the Medley investigation in our oversight of 

the Fed asking you for information regarding communication. No 

compliance. Then, we sent you a subpoena in May. You did not 

comply with that. 

We had partial compliance in October. 

We are now a year after my initial letter. I have asked you for 

excerpts of the FOMC transcripts in regard to the discussion—in 

regard to the internal investigation on Medley. You have not provided those to me. 

Is it your intent today to promise that I will have those if not 

this afternoon, then tomorrow? 

Mrs. YELLEN. Congressman, I discussed this matter with Chairman Hensarling and indicated we have some concern about providing these transcripts. 

Mr. DUFFY. Finding the transcripts? 

Mrs. YELLEN. I said with providing transcripts, given their importance in monetary policy. 

Mr. DUFFY. So let me just— 

Mrs. YELLEN. And I received a note back from Chairman Hensarling last night quite late indicating your response to that. And 

we will consider it and get back to you as soon as we can. 

Mr. DUFFY. Oh no, no. I don’t want you to consider it. And I 

think the Chairman would agree with me that this is a conversation not about monetary policy; this is not market-moving stuff. 

This is about the investigation and the conversation of a leak inside of your organization. 

This institution is entitled to those documents. Would you agree? 

Mrs. YELLEN. I will get back to you with the formal answer. 

Mr. DUFFY. No, no, listen. 

Mrs. YELLEN. I believe that we have provided you with all the 

relevant information. 

Mr. DUFFY. That is not my question for you, Chair Yellen. If I 

am not entitled to it, can you give me the privilege that you are 

going to exert that is going to let me know why I am not entitled 

to those documents? 

30 

Mrs. YELLEN. I said we received well after the close of business 

yesterday a letter explaining your reasoning, and I will need some 

time to discuss this matter with my staff— 

Mr. DUFFY. No, I don’t want— 

Mrs. YELLEN. —before I give you a final answer. 

Mr. DUFFY. I don’t want—listen. I sent you a letter a year ago, 

on February 5th. I had to send you a subpoena. 

You knew that I was looking for these documents; you knew I 

was going to ask you about this today. So if you are not going to 

give me the documents, exert your privilege. Tell me your legal authority why you are not going to provide this to us. 

If this is market-moving, I would be sensitive to that. This is not 

monetary policy conversations; this is about the internal workings 

of the Fed. 

And I am not asking for all the transcripts; I am just asking for 

the excerpts specific to our investigation and oversight of the Fed. 

Let me ask you this: You get to oversee banks. If you made a request to a bank for information a year ago and they said, ‘‘Let me 

review with my board. Let me talk about it,’’ but they never comply 

with your request for documents or information, what would the 

Fed do? 

Mrs. YELLEN. I think we have complied very fully with the requests that you have made. 

Mr. DUFFY. I am asking, what would you do if you made that 

kind of a request to a bank that you oversee? What would you do? 

Mrs. YELLEN. We work with banks to make sure we have access 

to the information. 

Mr. DUFFY. If they didn’t, I can’t imagine what the Fed would 

do if someone didn’t comply with your request. And guess what, we 

are entitled to the documents. We expect to get them unless you 

exert a privilege, and there is no privilege that you have. So I expect they will come over. 

I yield back. 

Ms. WATERS. Mr. Chairman? 

Chairman HENSARLING. The time of the gentleman has—for 

what purpose is the ranking member seeking recognition? 

Ms. WATERS. Is it appropriate to ask for unanimous consent for 

clarification on a point of information that was just given by the 

gentleman? 

Chairman HENSARLING. Does the lady have a parliamentary inquiry? 

Ms. WATERS. The inquiry could be considered parliamentary. I 

understand the gentleman to say that they subpoenaed the Fed 

and it was ignored. Is that what he meant? 

Chairman HENSARLING. The gentlelady is not stating a parliamentary inquiry, and as I think the ranking member knows, the 

time of the Chair is limited. If other members wish to pursue that 

in their questioning, they may pursue it in their questioning. 

The Chair now recognizes the gentleman from Texas, Mr. Hinojosa. 

Mr. HINOJOSA. Thank you, Chairman Hensarling and Ranking 

Member Waters, for holding this hearing today. 

31 

Chair Yellen, I thank you for meeting with our committee today 

and for your steadfast leadership at the Federal Reserve. America 

has made great progress since the financial crisis of 2008. 

Our recovery includes 70 consecutive months of job growth, the 

longest streak in our Nation’s history, resulting in an astounding 

14 million private-sector jobs created. And an unemployment rate 

now standing below 5 percent. 

However, we continue to feel the hangover from the financial crisis started during President George W. Bush’s second term. Today, 

the slower-than-average economic growth rate is fueling anxiety 

and weakening confidence in our Nation’s economic growth prospects. 

Additionally, our economy appears to be sailing into strong 

headwinds caused by slowing growth in the developing world, stagnant growth in Europe, the dual effects of plunging oil prices and 

a strong dollar negatively affecting our manufacturing and export 

industries. 

Addressing those challenges also requires us to answer questions 

regarding the sustainability of our national debt and of the ability 

of Congress and the Federal Reserve to act effectively to stimulate 

the economy. 

Despite that market turmoil and economic uncertainty, however, 

I will note that our Nation’s confidence in the safety and soundness 

of our financial system has not been shaken. Indeed, we can attribute a much stronger and more resilient financial system in 

large part to the protections and improvements of the market oversight under the Dodd-Frank Act. 

My first question, Chair Yellen: What else should our Nation be 

doing to help us return to normal growth rates? 

Mrs. YELLEN. One of the distressing aspects of the recovery we 

have seen—I agree with you that we have made progress in the 

labor market, created a lot of jobs and the unemployment rate is 

low. But the growth in the economy that has been consistent with 

that has been quite disappointing. 

So another way of saying what that implies is when output is 

growing at a very weak pace and you have a lot of job growth, that 

means that productivity growth has been very disappointing since 

the financial crisis, and ultimately that determines living standards. 

Mr. HINOJOSA. Chair Yellen, do you think we are dragging down 

the potential growth rate of our economy and doing a disservice to 

our young men and women by saddling them with debt just as they 

are setting out to become full contributing members of our workforce and economic engine? 

Mrs. YELLEN. I think the debt situation that faces this country 

over the longer term is something that Congress certainly needs to 

address. While at this point the debt-to-GDP ratio looks like it 

should be sustainable at present levels for a number of years, as 

the population ages, it will—this is evident from CBO projections— 

be on an unsustainable upward course, and this is something Congress has known about for decades and it is important to address. 

Mr. HINOJOSA. It seems to me that while Congress must do its 

part to raise the minimum wage, expand the Social Security safety 

net, and provide a more progressive tax code, what steps are you 

32 

taking at the Federal Reserve to address the historic level of inequality in the United States? 

Mrs. YELLEN. Congressman, the main contribution that the Fed 

can make to inequality, given that we don’t have policies that target particular groups in the labor force, is to make sure that the 

labor market is performing well, that we attain Congress’ maximum employment objective. 

I am pleased with the progress we have made, but there is further to go, and we are committed to making sure that we stay on 

that course of further improvement in the labor market. 

And it won’t right every disadvantage that workers face, but it 

has resulted and will continue to result in broad-based gains for all 

groups in the workforce. 

Mr. HINOJOSA. My time has run out, and I yield back. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from California, Mr. 

Royce, Chairman of the House Foreign Affairs Committee. 

Mr. ROYCE. Thank you, Mr. Chairman. 

Chair Yellen, it’s good to see you. Thank you for being here. 

The latest stress-test scenario that was published by the Fed includes this scenario where the rate on 3-month U.S. Treasuries 

drops below zero from the second quarter of 2016 through 2019. 

And I recognize that this in no way predicts any future action 

here. As a matter of fact, CCAR announced specifically in the document there that this scenario does not represent a forecast for the 

Federal Reserve. 

Nonetheless, this timing is interesting because it comes at a time 

when the European Central Bank and the Bank of Japan have 

both instituted these negative interest rate policies. 

So the question I was going to ask you—and let me make one 

other point. It may suggest that the Federal Reserve is not opposed 

to reducing its target rate below zero, should economic conditions 

warrant, and may be employing the stress-test process as a tool to 

consider its possible impacts. That strikes me as maybe the reason 

you deployed it in the scenario. 

You told the committee in November that if the economy were 

to deteriorate in a significant way, potentially anything, including 

negative interest rates, would be on the table. 

And I remember those remarks were echoed in January by New 

York Fed President Bill Dudley. 

So assuming for a minute that the Fed figures out this question 

about the legal authority, do you still believe that negative rates 

are a tool in the toolbox? And can we assume that the Federal Reserve would not include this scenario in a stress test if, in fact, it 

were not a potential future action? 

Mrs. YELLEN. Let me say that was not what motivated the inclusion of this scenario in the stress test. We are in an environment 

where, as you pointed out, a number of the ECB, other European 

central banks, and the Bank of Japan, have gone to negative rates. 

Through much of Europe, and in Japan, interest rates are negative way at the yield curve. And we have had periods of market 

stress, where we see a flight into U.S. Treasuries as a safe haven, 

and the scenario that we ask banks to look at is one in which 

Treasury bill yields go negative. 

33 

This is something that could potentially happen without the Fed 

actually setting negative interest rates. It is something that could 

happen, and we have seen it happen for limited periods of time in 

stressful situations. 

Mr. ROYCE. Let me ask a clarifying point— 

Mrs. YELLEN. But— 

Mr. ROYCE. —because it has been kicked around since 2010, the 

possibility of the Fed maybe setting negative interest rates. Right? 

Mrs. YELLEN. Well, yes. 

Mr. ROYCE. Quick question on looking at the Fed authority, you 

haven’t taken a serious look at the Fed authority until now, while 

it was kicked around then and you do the scenario in the interim? 

Mrs. YELLEN. Back in 2010 when we were looking for ways to 

consider—to add accommodation, to have a toolkit available, it is 

something we looked at. We got only to the point of thinking that 

it wasn’t a preferred tool. 

Mr. ROYCE. Right. 

Mrs. YELLEN. We were concerned about the impacts it would 

have on money markets. We were worried that it wouldn’t work in 

our institutional environment. And we thought that zero was really 

the effective or very— 

Mr. ROYCE. I got it. 

Mrs. YELLEN. —just very little was—could be gained. 

Mr. ROYCE. Let me ask you, then, really quickly— 

Mrs. YELLEN. We would—in the spirit of prudent planning— 

Mr. ROYCE. —right. Yes. 

Mrs. YELLEN. —it is something that, in light of European experience, we will look at, we should look at, not because we think there 

is any reason to use it but to know what could potentially be available. 

And it isn’t just a question of legal authority. It is also a question 

of, could the plumbing of the payment system in the United States 

handle it? Is our institutional structure of our money markets compatible with it? We have not determined that. 

Mr. ROYCE. Let me just say that I think that the central banks 

in Japan and Europe are trying to overcompensate for irresponsible 

fiscal policy. I think that is what put them in this position. 

Can we avoid the same mistake here in the United States if we 

get our fiscal house in order? In other words, do you agree that if 

we address the long-term structural problems with soaring mandatory spending, we would decrease the potential need for monetary 

policy actions that reverse course on interest rates? 

Mrs. YELLEN. I think it is certainly desirable and important for 

the long-run stability and growth of this country to take the measures that you have suggested and evaluating the stance of fiscal 

policy. It is something that affects our monetary policy options. 

Mr. ROYCE. Thank you, Chair Yellen. Thank you very much. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Georgia, Mr. 

Scott. 

Mr. SCOTT. Chair Yellen, thank you for being here. Chair Yellen, 

you know I have a lot of respect for you. 

Mrs. YELLEN. Thank you. 

34 

Mr. SCOTT. But I very vehemently disagree with you when you 

say that you can’t target unemployment. 

Let me just say this: It is very important for everyone to know 

that you have an equal mission. Part of that mission, one half of 

it, is to curb inflation. But the other half is unemployment. 

And so just as surely as you go and you target inflation with 

movement of your interest rates, surely you have to understand 

that you have the same authority to deal with the unemployment. 

Now, let me tell you why this is important, Mrs. Yellen: Nobody 

is suffering from unemployment like the African-American community. And they are suffering from that because of the very laissezfaire attitude that the Fed historically has dealt with just employment or unemployment altogether. 

When you look—yes, we can crow about a 4.5 unemployment 

rate. Do you know what the unemployment rate is for AfricanAmerican men between the ages of 18 and 37? It is 36.5 percent 

unemployment. And in some communities like Chicago, Baltimore, 

Atlanta, Houston, any of these big cities, it is hovering at 50 percent. 

When you have this devastating situation, there is nobody else— 

there is no other agency that has the mandate to deal with it as 

the Fed. Now, in order to deal with it, you have to look at the economy like it is a wheel. The economy is a wheel. 

And why is it that we have this high unemployment rate among 

African-American young men? And African-American women in 

that same age group is 26 percent. So why is it that we can’t? And 

a part of that reason is because the Fed has historically 

downplayed unemployment. 

Never in the history of the Fed have you even seen fit to have 

an African-American president of a regional Federal bank for the 

Federal Reserve. That is a part of the reason. We are not even a 

part of the conversation. 

So my whole point is that I want the Fed—nobody is better 

equipped to handle this rigid unemployment facing the AfricanAmerican community in that most pliable age group. That is the 

child-producing age group, 18 to 37. 

Can you imagine if that was the employment rate of 37.6 percent 

of white young men in that age group? All hell would be breaking 

loose right now to do something about it. 

We need that same compassion from you. When you look at the 

sectors of the economy that are growing—transportation, energy, 

agriculture business, health care, construction, rebuilding the infrastructure, manufacturing—we need an advocacy from you to say 

automatically, there must be on-the-job training programs for African-Americans in this hard group to go into these areas and earn 

as they learn. 

In agro-business, we have 1890s colleges, 19 of them, whose authority and mandate through the Farm Bill is to take the money 

that we give them through the Farm Bill and spend in teaching, 

research, and extension. Why not create the other spending category for scholarships and loan forgiveness, students who will go 

in and take advantage of these job openings in agriculture and 

business? 

35 

All I am saying is that, please, we have to get the Fed to get off 

the dime and put the issue of African-American unemployment on 

the front burner. That is the core of all of the domestic issues that 

we are facing. And that is the child-bearing group. What are these 

fathers to do? What is there for them? 

That is why we have so many of the situations in Baltimore, in 

Chicago, and in other places, and it leads to a straight pipeline to 

why we have 1.2 million of them sitting in the prisons. Would you 

help us with that? 

Mrs. YELLEN. Congressman, I— 

Mr. SCOTT. I would love to work with you on it. 

Mrs. YELLEN. —want to assure you that we recognize how serious the problems are that you have discussed, and we take our employment mandate extremely seriously and have been doing everything that we can to promote a stronger labor market that will benefit African-Americans. 

Mr. SCOTT. Would you really consider getting an African-American, for the first time in history, to be a regional president of a 

Federal Reserve bank for the first time in history? 

Mrs. YELLEN. Absolutely. It is our job to make sure that every 

search for those jobs assembles a broad and diverse group of candidates, and I regret that there hasn’t been an appointment of an— 

Mr. SCOTT. Thank you, Mrs. Yellen. 

Chairman HENSARLING. The time of the gentleman has expired. 

Mr. SCOTT. Thank you, Mr. Chairman. 

Chairman HENSARLING. The Chair now recognizes the gentleman 

from Florida, Mr. Posey. 

Mr. POSEY. Thank you, Mr. Chairman. 

Madam Chair, the number one thing I hear from my local community banks and credit unions is the need for regulatory release. 

That is not news to you, obviously, either. And these financial institutions provide critical services to our communities, and they are 

worried that the overregulation is hurting not only their ability to 

provide those services, but eventually is clearly leading to increased industry consolidation. 

What do you consider to be the negative consequences, if any, 

that result from consolidation, and the effects on the local and national economy? 

Mrs. YELLEN. I think community banks play a vital role in supplying credit to groups of borrowers whom larger banks often would 

not be able to serve. And that is a vital role in all communities 

throughout the country, so we want to see those banks thrive, and 

are very focused on ways that we can reduce the burden on those 

banks. 

I mentioned earlier some of the things that we have tried to do 

to reduce the burden, and we will continue looking through the 

EGRPRA process, and by the regular meetings and contact that we 

have with community bankers, to address the burdens that they 

face and look for ways to simplify regulation and reduce burden. 

Mr. POSEY. Madam Chair, do you think that relationship lending 

is important? 

Mrs. YELLEN. It has been very important often for community 

banks in the kind of business that they do, so yes. 

36 

Mr. POSEY. Just a quick follow up: Can you identify some areas 

of priority at the Fed for reducing regulatory burdens on community banks? 

Mrs. YELLEN. Yes. We have been focusing, for example, on the 

duration of our on-site reviews and looking for ways to have our 

examiners spend less time on bank premises. We have been looking 

at ways and have simplified and tried to tailor our pre-examination 

requests for documentation. 

We have been conducting extensive training for examiners to 

make sure that our guidance is properly interpreted and applied in 

ways that are consistent. We have a number of fora in which we 

try to help community bankers understand what new regulations 

or proposals are relevant to them and which ones are not intended 

at all for their organizations. 

As I mentioned, the EGRPRA process is ongoing, and we have 

been holding fora around the country to hear the concerns of banks 

with regulatory burden and will take all of the steps that we possibly can to address the concerns that surface. 

We meet regularly with community bankers through an organization called CDIAC, which is composed of representatives from 

each of the 12 Federal Reserve districts. They come to the Board 

and we meet with them twice a year, the full Board of Governors, 

to discuss their concerns, and we follow up on what we hear. 

Mr. POSEY. Thank you. 

Finally, this week the House is considering legislation that would 

require the Administration to put forth a detailed plan to reduce 

the national debt whenever the debt limit is increased—a commonsense concept, I believe. We also just received the President’s budget request, which would, in the face of a $19 trillion—we just 

passed the $19 trillion mark in the debt clock—increase spending 

by $2.5 trillion. 

When the President took office, the national debt was roughly $10 trillion. When he leaves office, the debt is expected to have 

doubled to about $20 trillion. You have also voiced your concerns 

about the impact of failing to raise the debt limit, failing to pay our 

bills, citing the impact it would have on the economy. 

I don’t disagree, but I am curious, do you have similar concerns 

about the impact on the economy of failing to address our national 

debt? How much debt do you think is too much? 

Mrs. YELLEN. I think if you look at the path that the U.S. Fed 

is on under current policies, it will rise from the present level to 

levels well above 100 percent of GDP and continue rising more or 

less indefinitely. And wherever you draw the line, you have to conclude that is an unsustainable economic situation. So I think it is 

essential that Congress address this longer-run budget deficit 

issue. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Texas, Mr. Green, 

the ranking member of our Oversight and Investigations Subcommittee. 

Mr. GREEN. Thank you, Mr. Chairman. 

I thank Chair Yellen for appearing today, as well. 

Mr. Chairman, Chair Yellen and, of course, Ranking Member 

Waters, I want you to know that there has not been some sort of 

37 

conspiracy among Congressional Black Caucus members to bring 

up this issue of black unemployment, although I think we do talk 

about it among ourselves quite regularly. 

But I do believe that a basic premise that may be of help to us 

is the notion that, ‘‘In the beginning was the Word.’’ And not 

enough talk takes place among those who have the power to influence public policy with reference to African-American unemployment. To this end, I am concerned, and would ask if you have, in 

your statement, given a specific reference to African-American unemployment in the statement that you made today? 

I apologize if I missed it, but was there a specific reference to African-American unemployment? 

Mrs. YELLEN. I referenced in the answer to a previous question 

the very high rates of unemployment of African-Americans that 

persist even with the current aggregate unemployment rate. 

Mr. GREEN. If I may, let me share this thought with you: If it 

is—and I believe you are in agreement that it is a serious problem—not just a problem, a serious problem. 

Mrs. YELLEN. I certainly agree with that. 

Mr. GREEN. If it is a serious problem, I would ask that you make 

it a part of your actual statement that you present, and that you 

publish it, and that you continue to say to those of us who can 

make a difference—and we should be able to make the difference 

here in Congress; we have responsibilities here to focus as well— 

but if you would make it a part of your statement, and if you would 

publish this, I think it can have a meaningful impact on policymakers up and down the line. 

So just a small request, but I think it can make a really big difference, so I am going to ask that you do this. 

Mrs. YELLEN. I am certainly open to doing so. I will certainly— 

Mr. GREEN. Thank you. 

Now, let’s move to the Taylor Rule for just a moment. You have 

indicated that the Taylor Rule would be a grave mistake and that 

it would be detrimental to the economy and the American people. 

Could you, in about 1 minute, give some examples or an example 

of how it would be detrimental to the economy? That is a sort of 

a nebulous term and I think you should provide some clarity. 

Mrs. YELLEN. Sometimes, it provides recommendations for what 

monetary policy should be that clearly overlook important circumstances, and— 

Mr. GREEN. If I may, Madam Chair, would you kindly explain 

the impact that it will have on the economy? What would the impact be if it causes us to do something inappropriate? And I will 

let you decide what is inappropriate. 

Mrs. YELLEN. Either it would have us set a monetary policy that 

would result in much higher unemployment than would be desirable or, alternatively, there could be circumstances in which it 

would recommend an accommodative policy that would result in extremely high inflation. 

Now, I would say right now, as an example, the Taylor Rule 

would recommend an overnight short-term interest rate that would 

be close to 2.5 percent, and I think in light of the slow growth in 

the U.S. economy and the fact that we have needed to hold the 

Federal funds rate for almost 7 years—for 7 years at zero to 

38 

achieve the progress that we have made, that setting it at the level 

that it would now recommend would be highly damaging to the economic situation. 

And we tried to provide some analysis in the monetary policy report we submitted about what—why that is, and in particular this 

idea that the neutral Fed funds rate, because of the damage from 

the financial crisis— 

Mr. GREEN. I regret that I must reclaim my time because I have 

one additional thing that I must say. I appreciate your commentary 

and I think that a good many people have the point. 

But I want to say this: We have some people who are visiting 

today. I don’t want any response from them, but I want to acknowledge their presence because they are concerned about these wages. 

Now, they are concerned about wages across-the-board, especially 

as they impact working people, people who are on salaries, people 

who make minimum wage. 

And it is our desire to see policies that will have greater employment, greater opportunities, but also policies that will target those 

who are hurt the most. 

I thank you, Mr. Chairman. I yield back. 

Mr. MESSER [presiding]. The gentleman’s time has expired. 

The Chair now recognizes the gentleman from Pennsylvania, Mr. 

Rothfus, for 5 minutes. 

Mr. ROTHFUS. Thank you, Mr. Chairman. 

Welcome, Chair Yellen. 

I want to talk briefly about custody banks, which you know follow a different business model from other financial institutions. 

Custodians do not make consumer loans or engage in investment 

banking, and for these reasons pose relatively little credit risk. I 

understand that custody banks, whose customers would include, for 

example, pension funds with millions of beneficiaries, are finding 

it increasingly difficult to provide their core custody services, especially accepting large cash deposits. And this could worsen under 

a period of stress. 

One of the main reasons for this appears to be recent regulatory 

reform, such as the supplementary leverage ratio known as SLR. 

Custody banks typically place cash received on deposit with the 

Federal Reserve. This is cash that comes from pension funds, endowments, municipalities, and other clients. 

However, the Federal Reserve’s supplementary leverage ratio 

does not recognize the essentially riskless nature of Fed deposits or 

the necessity of these placements by custodians. This may cause 

the leading custody banks to reject a customer cash deposit. 

My question is: Is the Federal Reserve aware of the impact that 

this may be having on custody banks? And if so, what do you propose to do about it? 

Mrs. YELLEN. This is something that was considered, what is the 

appropriate treatment of central bank deposits, when the supplementary leverage ratio was adopted. And the decision was made at 

the time that the leverage ratio is not our main capital tool, but 

a backup capital tool that is intended to, in a crude kind of way, 

base capital requirements on the overall size of a firm’s balance 

sheet, and that for that reason it should be included. 

39 

We have more recently put in place capital surcharges that apply 

to the eight largest U.S. banking organizations, including two custody banks. And it is likely that once those are in place, they will 

become the binding capital requirement. But— 

Mr. ROTHFUS. I would encourage you to take a look at it because 

it is an issue for the banks. 

Mrs. YELLEN. We have heard of the problem, and I will address 

it. 

Mr. ROTHFUS. As you know, Chair Yellen, the Bank of Japan recently announced that it would implement a negative interest rate 

policy in an effort to increase spending and investment and spur 

growth. The decision follows close on the heels of the European 

Central Bank’s announcement that it would also launch additional 

monetary stimulus in March, and economists have predicted that 

Sweden, Denmark, Norway, Canada, Australia, and China may follow suit. 

In a recent editorial in The Wall Street Journal, William Poole, 

the former president of the Federal Reserve Bank of St. Louis, argued that these sorts of monetary policy gimmicks will not create 

their intended effects and instead they will only serve to divert attention from the actual structural problems that have plagued 

growth in the United States and around the world over the last 

decades, namely regulatory burdens and tax policies that serve to 

constrain business investment and long-term growth. 

What do you say in response to Mr. Poole? 

Mrs. YELLEN. I agree that there are structural factors that have 

restrained U.S. growth and also been responsible for rising inequality in the labor market. And it is important to take steps to address those problems. They are steps that are in the domain of 

Congress. 

But it is important for the Fed to try to achieve its mandate of 

ensuring a state of the labor market where people who want to 

work are able to find jobs, where there are a sufficient number of 

them. 

And, given the stressed situations that exist in Europe where 

there remains very high unemployment, and in Japan where inflation has for well over a decade undershot their inflation objective, 

it is a tool that has proven useful to them. 

Mr. ROTHFUS. I want to talk a little bit—you testified earlier that 

over the past number of years, the Fed kept the Federal funds rate 

at exceptionally low levels. You testified that even with this ‘‘exceptional’’ strategy, the economy achieved only 2 percent growth. And 

you added that ‘‘The economy is being held back by headwinds.’’ 

I am wondering if any of these headwinds are manmade, or, to 

borrow a phrase, anthropogenic here in the United States? And I 

could identify some: the Affordable Care Act; a Wall Street reform 

bill that missed the mark, frankly; EPA regulations. 

And these headwinds have hit folks in my district, like a mom 

who now has to pay $400 for allergy medicine for her kid when she 

used to pay $10; or the coal miner I talked to last week who is taking care of a 5-year-old, a 3-year-old, and a 1-year-old and won’t be 

able to pay for his mortgage. 

40 

And I just wonder, when the economic history of this decade is 

written, are they going to say that the Fed tried to do with monetary policy what should have been done with fiscal policy? 

I yield back. 

Mrs. YELLEN. I think it is also important for Congress to address 

structural factors that are holding down growth. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Missouri, Mr. 

Cleaver, ranking member of our Housing and Insurance Subcommittee. 

Mr. CLEAVER. Thank you, Mr. Chairman. 

Thank you for being here, Madam Chair. 

Following through on some things that were said earlier, I have 

a bad knee and I have had it operated on 11 times, but the weird 

thing is that whenever I go to the hospital for another surgery, 

they never operate on my shoulder or my fingers. For some strange 

reason, they always operate on the same knee that has been hurt. 

And I know that is weird. 

The issue is we can’t address unemployment in a certain sector 

by saying we are going to operate on the whole body and it gets 

better. That has never been true. 

Now, I differ a little from my colleagues in that I don’t think it 

is your responsibility. I don’t think the Fed has the responsibility 

even with the dual mandate. I think it is to be handled legislatively, and I don’t think we are going to get that done. 

The other thing I have to say is that—and it is been said, and 

every time you come I have to say it because I have to just get it 

off my chest, because I do think that we are declaring minority unemployment to be too-big-to-curtail, and that is somewhat troublesome. 

But Wall Street and the big six banks are too-big-to-jail. If you 

rob a convenience store, you go to jail. If you rob 300 million Americans, you get a cocktail. And I think that is what is creating all 

this anger around the country. 

I know you don’t run the Justice Department, and I know you 

don’t vote on legislation that could address some of these other 

issues. But I think we have to say it as much as we can because 

I don’t think the world is hearing us. 

Now, I would like to yield the remainder of my time to the ranking member of the Financial Services Committee. 

Ms. WATERS. Thank you very much, Mr. Cleaver. 

As you know, originally I was thinking about dealing with the 

question of the subpoena, et cetera. Except if you don’t mind, I am 

so focused on all of this money that goes to these too-big-to-fail 

banks and trying to understand, number one, not only the fact that 

Goldman Sachs got $121 million, JPMorgan $910 million, and that 

with the rise in interest rates from 0.25 percent to 0.5 percent, this 

will double. 

And this money keeps—it is going to the big banks. It is a subsidy to keep them from lending money, and we have this big need 

that has been discussed by my colleagues about this high unemployment rate and the lack of creativity and thinking about how we 

can deal with this. And these banks, too-big-to-fail, who we are 

41 

finding every day because of the predatory lending, et cetera, are 

getting support from the Feds. 

Please, please explain that. 

Mrs. YELLEN. It is an essential tool that we need to adjust the 

level of short-term interest rates. And from the standpoint of the 

taxpayer, our payment of those interest on reserves—we have very 

large reserve balances. We have $2.5 trillion, roughly, of reserves 

in the banking system, as compared with $20 billion or $30 billion 

prior to the crisis. 

The counterpart of that on our balance sheet is that we hold a 

very large stock of assets on which we are earning a substantially 

higher rate of return than we are paying to the banks. And that 

differential between what we earn on our holdings of long-term 

Treasuries and mortgage-backed securities and the 25 or 50 basis 

points we pay to the banks, that differential all shows up in the 

taxpayers’ pocket. It is money that Congress can use to address all 

of the problems that you have discussed. Over the last year, we 

transferred $100 billion because of that. 

Now, if we don’t pay interest on reserves and must use another 

technique to adjust short-term interest rates, likely we will be 

forced to greatly shrink our balance sheet in a rapid fashion, and 

the total amount of money going from the Federal Reserve to Congress will be significantly diminished. In addition to that, it would 

have very adverse effects on the economy. 

Ms. WATERS. I want you to know that not only am I concerned, 

it looks like we are about to have some bipartisan concern on this 

issue. 

Mrs. YELLEN. I hear that. 

Ms. WATERS. And while I understand the argument that you are 

making about the big banks, we cannot feel sorry for them in terms 

of the amount of interest rates that they are getting or not getting, 

et cetera. We really do have to deal with this issue. 

I understand what you are trying to explain by short-term interest rates, but if I may, Madam Chair, let me just say this, that we 

have an opportunity with the discount window to allow for loans 

from some of these small community banks that they are not getting. And if that money went into the small community banks, they 

would be able to do job creation and to support small businesses, 

et cetera. 

And we just don’t get why they are precluded from doing this, 

and increasing the job opportunities in the community, while we 

have given the subsidy to the big banks. We just don’t get it. 

Chairman HENSARLING. Although I agree with much of what the 

ranking member has said, she has long since spent her time. 

The Chair now recognizes the gentlelady from Utah, Mrs. Love. 

Mrs. LOVE. Thank you, Mr. Chairman. 

Thank you, Chair Yellen, for being here today. Chair Yellen, I 

am increasingly concerned about the impact of Dodd-Frank regulations on real economy, economic growth, and especially job creation, which I wouldd like to just ask you a few questions about. 

If you look beyond the headlines, the headline numbers from last 

Friday’s job numbers, and include discouraged workers and the 

underemployment, real unemployment remains high, nearly 10 

percent. In addition, millions of people have stopped looking for 

42 

jobs. They have dropped out of the workforce, and it is a dynamic 

that is driving the Nation’s workforce participation rate to an alltime low at 62.7 percent. 

And I want you to know that I agree with my colleague on the 

other side of the aisle, Representative Scott, when he talks about 

the large number of unemployment with our young Black Americans. Meanwhile, economic growth slowed to just 0.7 percent in the 

fourth quarter. 

I am concerned the Fed and other financial regulators may not 

have a firm grip on the cumulative impact on the real economy of 

thousands of pages of the new Dodd-Frank regulations, especially 

new capital and liquidity rules. I am wondering if you share some 

of those concerns? 

Mrs. YELLEN. I recognize that some of the new concerns are burdensome and do raise banks’ cost of financial intermediation. In designing those regulations, we are always trying to achieve a balance between the benefits of creating a sounder and more resilient 

financial system that is less likely to be subject to the kind of devastating financial crisis that we had. 

We are balancing that against burdens that can raise the cost of 

capital or diminish financial intermediation. And we have tried to 

strike a reasonable balance, remembering that nothing resulted in 

more harm for a longer period of time than the financial crisis that 

we lived through, and I think we now have a much safer and 

sounder financial system. 

Mrs. LOVE. Okay, so another study by the American Action 

Forum found that consumer credit availability deteriorated 12 percent to 14 percent since the passage of Dodd-Frank. I am also concerned about the growing number of borrowers unable to access affordable banking—including a lot of borrowers from low-income 

areas in my district, which is Sigurd, West Valley. These are hardworking Americans who are turning to high cost and unregulated 

online lenders to be able to get the access to the credit that they 

need, whether it is for purchasing a car or even starting a small 

business. They are finding that their ability to access this type of 

credit is unavailable to them. 

And so I am wondering if you also share some of my concerns 

about credit availability and the higher-cost alternatives? 

Mrs. YELLEN. I do share your concerns about credit availability. 

And I think it is clear that credit availability has, in particular segments, been diminished. Home loans, mortgages, for example, for 

individuals without pristine credit ratings is really difficult, remains difficult to obtain. 

In part, we have regulations that are meant to address harms. 

I think lending standards were too easy prior to the financial crisis. 

We don’t want to go back to lending standards that are so loose 

that they lead to the kinds of predatory lending and harms that we 

had that took a toll on the economy and on low-income households 

in communities. We need to achieve a reasonable balance, and we 

are searching for that. 

Mrs. LOVE. Being on the Subcommittee on Monetary Policy, I 

wanted to ask you just a quick question on monetary policy and 

what is happening in Europe and what are the implications. I may 

have stepped out of the room; I don’t know if you have addressed 

43 

this. But very quickly, what are the implications of the Federal Reserve and the ECB pursuing divergent monetary policy? 

Mrs. YELLEN. The ECB has been addressing high unemployment 

and inflation that has slipped very meaningfully below their 2-percent goal by putting in place negative interest rates and large-scale 

asset purchase programs. 

The United States has done better. We are, among advanced 

economies, about the strongest, so we have divergent monetary 

policies. 

It has put upward pressure on the dollar over a long period of 

time, which has harmed manufacturing and net exports. And so, it 

has resulted in negative influences on the part of our economy. 

Chairman HENSARLING. The time of the gentlelady has expired. 

The Chair now recognizes the gentleman from Missouri, Mr. 

Clay, ranking member of our Financial Institutions Subcommittee. 

Mr. CLAY. Thank you, Mr. Chairman. 

And thank you for being here, Chair Yellen. 

The Federal Reserve has a congressional dual mandate to seek 

maximum employment while limiting inflation. To limit inflation, 

the Federal Reserve raises interest rates, which slows the economy 

by discouraging people from borrowing to buy homes and cars, and 

discouraging businesses from investing. 

With this reduced demand, businesses will hire fewer workers. 

And as a result, workers will have less bargaining power, meaning 

they will be less likely to get pay increases. The decision to raise 

interest rates is based on the assessment of the Federal Open Market Committee of the Federal Reserve about whether inflation or 

unemployment poses a greater threat to the American economy. 

Unfortunately, the members of the FOMC largely come from the 

financial industry and, as a result, tend to be more concerned 

about inflation than the population as a whole, and less concerned 

about unemployment. So how do we square that, Madam Chair? 

Mrs. YELLEN. First of all, I want to say that the committee is 

deeply focused on unemployment. We have two objectives, not one: 

maximum employment; and price stability, which we have interpreted as a 2 percent inflation objective. 

And I would really take issue with the idea that we are not focused on achieving our maximum employment objective. We are. 

Monetary policy has been highly accommodative. The Fed funds 

rate was at zero for 7 years. And we also have a large balance 

sheet that has provided a lot of additional accommodation. 

So we are not talking about tightening monetary policy, or a 

tight monetary policy. We have an economy that now has made 

substantial progress, creating 13 million jobs with the unemployment rate down to 4.9 percent. 

We took one small step to raise short-term interest rates but continue to have an accommodative monetary policy, which we see as 

consistent with further progress in the labor market. So it is not 

that we are trying to reverse progress. We continue to see, even 

with modest increases and interest rates, further progress, and we 

want to achieve it precisely because we think that although the unemployment rate is at levels that are probably normal in the longer 

run, there remains slack in the labor market. We want to see more 

progress. 

44 

Mr. CLAY. Although—not to cut you off—we could get to 4 percent unemployment. But, look, while we are pleased to see that 

new jobs are continuing to be created in our economy and to learn 

that the unemployment rate last month fell below 5 percent broadly, these positive signs may lead some to ignore the persistent economic challenges faced by African-Americans in this country. 

The current unemployment rate for African-Americans, for example, remains at nearly 9 percent. It is a commonly accepted view 

that access to gainful employment is one of the most important factors in supporting economic mobility and improving health outcomes. It is also widely known that in areas with higher rates of 

unemployment, there is a lack of consumption, increased crime 

rates, reduced school funding, and reduced political influence. 

Please discuss with us any specific actions that you have personally taken or directed your staff to take to identify solutions to help 

remedy the historical and continued racial disparity between employment opportunity for African-Americans and Whites. 

Mrs. YELLEN. Our staff produces statistics that are among the 

most important in documenting and highlighting disparities in the 

economic situations in terms of assets and income by demographic 

groups. And I have personally given speeches highlighting those 

statistics. So our staff certainly looks at and does work to document 

those disparities. 

And in our community-development programs and work we discussed earlier that relates to the CRA, that is an area in which we 

have the capacity to try to identify particular programs that will 

be helpful in low- and moderate-income communities that suffer 

from special disadvantage in the labor market, and to try to identify programs that work that we encourage to be adopted on a 

broader scale— 

Chairman HENSARLING. The time of the gentleman has expired. 

Mr. CLAY. I would like to work more with you in that area. 

Chairman HENSARLING. The Chair now recognizes the gentleman 

from North Carolina, Mr. Pittenger. 

Mr. PITTENGER. Thank you, Mr. Chairman. 

I would like to just welcome those who have come today with 

your T-shirts on: ‘‘What recovery?’’ ‘‘Let our wages grow.’’ ‘‘Whose 

recovery?’’ These are very pointed and clear statements, and I really commend you for being here and seeing this process. 

Yes, the reality is that this recovery is the most dismal, slow, 

tepid recovery we have ever had from a recession in recorded history. And we look at the realities of this recovery. This last report 

of new jobs was only 150,000 new jobs. We have a 2 percent dismal 

economic growth. 

Frankly, the demographic group that is the lowest recovery is the 

low-income, minority people in this country. That demographic 

group has moved up the ladder less than any other group, albeit 

an intense effort, well-intended, I am sure, by the Obama Administration, by Chair Yellen. 

But through it, what we have seen is very accommodative monetary policy; we have seen a high regulatory environment; we have 

seen Obamacare; we have seen the highest corporate tax rates in 

the industrialized world. All of this has achieved this dismal recovery. 

45 

And I would say to you that the contrast is back in the 1970s, 

we had the same type of dismal economic outlook—high inflation, 

high unemployment. And yet, what happened? We reduced the regulatory environment, we reduced the tax burden, and the economy 

took off. 

We were creating 300,000, 400,000, 500,000 jobs a month. One 

month, a million jobs. We were growing up to 6 percent. 

It seems to me that—logic may come in—perhaps well-intended 

policies have had an adverse outcome of what was ever intended. 

And, Chair Yellen, I commend you for your work and what you 

have sought to do. But it seems to me that these accommodative 

policies have contributed to where we are today. 

I would say, Chair Yellen, I would like to thank you in your remarks that you made reference to the fact that there are those who 

are available to work but not actively searching for work. You have 

also made reference to those who are working part-time and can’t 

get full-time jobs. 

Now, these numbers are not included in the current unemployment rate of 4.9 percent. So in reality, we are really talking around 

10, 11, 12 percent are the stats that I have seen of real unemployment. 

Would that not be correct, Chair Yellen? 

Mrs. YELLEN. Broader measures of unemployment are significantly higher. For example, a definition that the BLS refers to as 

U-6 that includes both of the groups you mentioned—involuntary 

part-time— 

Mr. PITTENGER. The point I want to make is— 

Mrs. YELLEN. —and discouraged— 

Mr. PITTENGER. —the real numbers are much higher than 4.9 

percent. So it is really disingenuous to say to the American people 

that these policies have contributed toward 4.9 percent unemployment. 

In the real world, where people are living—and we have some of 

them here today—it is far less. And I think that should be understood and absorbed by these wonderful people who have come, that 

the types of policies that have been enacted, been enforced this last 

7 years, have worked against your interests. 

What grew the American economy were small businesses who 

could go get loans. That entrepreneur who has been the lifeblood 

of our economy can’t go to a bank today to get that new loan because of compliance requirements. They are the people who create 

those new jobs. 

And on top of that, you have the burden of the obligations of 

Obamacare. In small business, what are they doing? They are cutting jobs so they don’t have to comply. 

What will grow your economy, what will create the jobs that you 

earnestly want, is an open market where companies can grow and 

not have this intense regulatory environment, whether it is 

through monetary accommodative policy or through onerous regulatory environments placed upon them. So I want to encourage you 

with that reality, that we can find that type of opportunity economy. 

I would say to you, Chair Yellen, that the regulatory rulebook— 

it has been in a constant state of revision for the last 6 years. Can 

46 

you see the benefit, then, as a result of what we discussed, in pausing this process in order to assess the cumulative impact that these 

regulations are having on the economy before we proceed further? 

Mrs. YELLEN. We have several regulations that we intend to put 

out during this coming year. And in terms of the list of what was 

mandated by Dodd-Frank, we have made substantial progress. 

Mr. PITTENGER. Consider that outcome. We are saying that we 

think it needs to be done. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair wishes to remind Members that we expect to excuse 

the witness as close to 1:00 p.m. as possible. The Chair anticipates 

getting through perhaps four more Members. 

The Chair now recognizes the gentleman from the Super Bowl 

champion Denver Broncos, Mr. Perlmutter. 

Mr. PERLMUTTER. Thanks, Mr. Chairman. 

And, Chair Yellen, thank you, as always, for being here today. 

I was going to go a little off topic with my first question, to say, 

how about those Broncos, but— 

Mrs. YELLEN. Way to go. 

Mr. PERLMUTTER. —the Chair already beat me to the punch. 

But I do want to talk about the overall conversation today, and 

I want to thank you and I want to thank the Federal Reserve. I 

want to start with the chart that we have on the board, which 

shows what happened at the end of the Bush Administration, when 

we went to 10 percent unemployment, and under Obama, we are 

down to less than half of that. 

Okay? So that is your chart number two in your monetary report. 

And all the Republicans don’t want to let the facts get in the way 

of their rhetoric because then chart number four shows that after 

some time—and that is on page five, Chair—wages are beginning 

to move up after we started getting people back into the job market. 

Chart six, oil prices way down. Chart seven, inflation even. Chart 

13, wealth-to-income—disposable income up ‘‘a robust 3.5 percent.’’ 

Chart 15, household debt service, way down. Chart 20, mortgage 

rates, down. Figure one on page 37, unemployment down looking 

at the long-term, and core price inflation, even. 

Those are your charts. Those are the facts. 

Now, have wages gone up as much as we would like to see? No. 

But we had to get a lot of people back working. Now, we are starting to see them move. 

So the Chair went through a whole list of economists, because 

obviously he didn’t have a lot of questions; he wanted to list a lot 

of names. And there were a couple of guys there with the Hoover 

Institute. 

So Herbert Hoover, grand old Republican President who led us 

into the Great Depression. Not the kind of economy I would like 

to see, all right? 

George Bush, we go from 5 percent unemployment to 10 percent 

unemployment. We lose millions of jobs. 

Under Barack Obama, back down to 4.9 percent. In Colorado, we 

are at 3.5 percent. 

So I just want to thank you, and I want to thank the Administration for getting this economy back on track. 

47 

Now, can we do better? You bet. 

So how would you suggest that we do better? How can this economy get moving so that the folks here can see some real growth 

in wages, which I think are beginning to appear, but what would 

you suggest? 

Mrs. YELLEN. Our objective in terms of what we can do is to try 

to make sure that the picture that you have put up here shows continuing improvement in the labor market. 

I agree with you, I would say the signs of wage growth increasing—they are tentative at this point. There are some hopeful signs, 

but I think if the labor market continues to progress we are very 

hopeful we will see faster progress on wages. 

And we will try to keep that progress going. That is our objective. Inflation is running under our 2-percent objective. I expect 

that will move up over time, as well, with appropriate policy. 

But I appreciate your saying that some of the burden should also 

be on Congress and others, because there are so many problems in 

the labor market and particular groups—we have talked a lot 

about African-Americans and the problems they face. 

The Fed, of course, has a role to play, but job training, educational programs, programs that address other barriers in the 

labor market, I think this is Congress’ job to address. 

Productivity growth is very low. I think Congress has always had 

a role in supporting basic research, making sure that the infrastructure of our country is adequate and putting in place programs 

that make sure that training and education are widely available. 

Mr. PERLMUTTER. All right. Let me move to a soft spot that I 

think exists in the economy, and you and I have talked about it before, and that is on oil and gas and the fact that the Saudi Arabians are pumping like crazy into what appears to be an oversupplied market, causing the price to drop a lot, which in some 

ways is very good for all of us because saves us $10, $15, $20 a 

week or a month in our price at the pump. 

But it also is causing some job losses in the manufacturing sectors, the oil and gas, obviously, transportation. Can you comment 

on what the Fed is doing or reviewing when it comes to oil and gas 

production? 

Mrs. YELLEN. We are taking account, as you said, of the fact that 

the energy sector is very hard-hit. We are losing jobs there. But 

with respect to employment, it is—although there really are very 

severe losses, it is a pretty small sector of the workforce overall. 

We are seeing massive cutbacks in drilling activity, and that is 

rippling through to manufacturing generally, where output is depressed. So, it is having negative consequences. 

On the other hand, if you look at the difference in oil prices now 

relative to 2014, for the average American household, we are looking at a savings of $1,000 a year. 

And that is boosting consumer spending. And we have these two: 

a negative force, positive forces. We are trying to factor all of that 

in as— 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Illinois, Mr. 

Hultgren. 

Mr. HULTGREN. Thank you, Mr. Chairman. 

48 

Thank you, Chair Yellen, so much, for being with us today. 

As you may know, the Financial Crimes Enforcement Network, 

or FinCEN, is in the process of finalizing some new requirements 

to prevent terrorism financing and money laundering under its 

beneficial ownership rules. 

While I fully support efforts to curb terrorism financing, it seems 

the application of FinCEN’s rule to certain non-bank subsidiaries, 

such as premium finance companies, may not be appropriate. 

I understand that my staff is already talking with the Fed about 

this issue, but wondered if I could get a commitment from you 

today about trying to find clarification for if these rules apply to 

premium finance companies that are subsidiaries of banks? 

Mrs. YELLEN. We would be happy to work with you on that. 

Mr. HULTGREN. Thank you so much. 

When you testified before the committee back on November 4th 

of 2015, we discussed the impact of the supplementary leverage 

ratio on custody banks. At that time, you described it as a kind of 

backup ratio that works as a backup to risk-based capital standards. 

When responding to questions from Congressman Rothfus earlier 

today, you stated that, ‘‘When the supplementary leverage ratio becomes effective, that it will likely become the binding capital requirement for some custody banks.’’ 

I understand some of these custody banks already feel they must 

discourage customer cash deposits. As you know, these institutions 

have highly liquid, low-risk balance sheets that support client 

needs. In light of this concern, will the Fed consider adjusting the 

capital requirements for excess cash deposits held with the Federal 

Reserve? 

Mrs. YELLEN. I am not sure if they will become the—if the supplementary leverage ratio will become the binding constraint or 

not. I didn’t intend to say that it is the binding constraint. There 

will also be so-called SIFI capital surcharges that will come into effect that may make those binding constraint. 

This is a matter that I understand what the issue is. We can look 

at it and discuss it. It was debated at the time. There were considerations on both sides and a decision was made to include Fed deposits. 

It is something we can look at, but it was considered. 

Mr. HULTGREN. I hope we are able to discuss that and also look 

and see if it is necessary for us to have congressional intervention, 

as far as legislation, to change the rule. 

Let me move on. I am pleased by the news that the Federal Reserve has been engaged with the insurance industry on capital 

roles appropriate for the business of insurance. 

What are your thoughts on how that process is proceeding, and 

when might we suspect to see proposed rules from the Federal Reserve released for public comment? 

Mrs. YELLEN. We are working very hard on that. I don’t have an 

exact timetable but we are expecting to go out with, for each of the 

firms, a notice of proposed rulemaking, so the public can react to 

these rules. The staff is fairly far along in developing these, so my 

hope is that it won’t be too much longer. 

49 

We have worked hard to have the appropriate interactions with 

the firms and other regulators to do this right. 

Mr. HULTGREN. I appreciate your work on that. From Illinois, insurance is important. We have some wonderful companies there, 

but I know they have questions, and I appreciate the iteration and 

hopefully the resolution relatively quickly. 

One last question: Will the Federal Reserve issue one proposed 

capital rule for all insurers it supervises? And if you could explain 

why or why not? 

Mrs. YELLEN. I am not positive. I think for the particular SIFIs 

that have been designated—Prudential, AIG, and MetLife—they 

are likely to be firm-specific rules, but I am not positive. Let me 

get back to you on that. 

Mr. HULTGREN. That would be great. Thank you. Thanks, Chair 

Yellen. 

Mr. Chairman, I have an additional minute. I would yield that 

back to the Chairman, if the Chairman wants it. Otherwise, I yield 

back. 

Chairman HENSARLING. The gentleman yields back. 

The Chair now recognizes the gentleman from Minnesota, Mr. 

Ellison. 

Mr. ELLISON. Thank you, Mr. Chairman, and Ranking Member 

Waters. 

As we start out, I also want to thank some of the folks who have 

joined us for the hearing today. My good friend, Ron Harris, is here 

from Minneapolis. 

It’s good to see you, Ron. 

And I just want to let you know that this active citizenship of 

coming to these hearings, watching things, is exactly what is needed in order for this government to function properly. In my view, 

this is what democracy looks like. 

Thank you all for being here. 

Chair Yellen, let me point your attention to the words of Mr. 

Narayana Kocherlakota, who was a former Minneapolis Fed chair, 

outgoing President of the Federal Reserve Bank in Minneapolis. On 

Martin Luther King Day, he wrote a blog and here is what he said 

in part: ‘‘There is one key source of economic difference in American life that is likely underemphasized in the FOMC deliberations—race.’’ 

He went on to say that for the year—he went on to say that he 

searched through the transcripts of the FOMC meetings for the 

year 2010, his first year on the committee, and a dire year for African-Americans in our labor market, and in that year our total unemployment rate exceeded 9.25 percent every quarter, but for African-Americans, it exceeded 15.5 percent. 

Today, now, White unemployment in Minnesota is 2.9 percent as 

of December 2015, but Black unemployment is 14.1 percent. And 

in Minneapolis, overall White unemployment is 4 percent, but 

Black unemployment is a shocking 18.9 percent. 

So I say that because this is something that I think needs the 

attention of the Chair. I don’t know what constraints you believe 

are out there, but race matters when it comes to how people experience our economy. 

50 

And if we don’t discuss it, talk about it, then we won’t ever get 

to the heart of the matter as to how to fix it to make equal justice 

for all. 

I will quote one Kocherlakota one more time. He said, ‘‘As we all 

know too well, race matters. The average African-American’s experience with the U.S. economy is different from that of the average 

White person’s.’’ 

So, my question is, what do you make of the commentary from 

the previous Minneapolis Fed president? In your view, is there adequate discussion, attention of the economic situation of AfricanAmerican workers within FOMC deliberations? 

And if there is not—and I suspect you will say there is not— 

what can we do about it? How can we at least focus the committee’s attention on this segment of our fellow Americans? 

Mrs. YELLEN. It is, of course, important that we look at different 

groups, and particularly those who are suffering the most in the 

labor market. And I am surprised that there was no specific mention of race. 

In 2010, the unemployment rate was substantially higher than 

it was. The committee was very focused at the time on what we 

could do to promote a stronger labor market. And I suppose because our tools are not ones that can be targeted at particular 

groups in the labor market, it was clear what we needed to do, and 

that was to support a stronger labor market more generally. 

Mr. ELLISON. But, Chair Yellen, forgive me for the interruption. 

I definitely think that—I get that part. But I would rather talk prospectively, because the past is what happened and there is no 

changing it. 

How can the Fed Chair get the FOMC to say, ‘‘Wait a minute, 

not all Americans, particularly African-Americans, are experiencing 

this upsurge in economic activity?’’ 

For Black Americans, we are still in the midst of a very serious 

depression-recession. What can we do about it, and what—and 

again, I am not here to say—to wag my finger about what happened. We know what happened and it wasn’t right. But in terms 

of what is happening now and what can happen, what can you tell 

me? 

Mrs. YELLEN. I think you are right that we should pay adequate 

attention to how different groups are faring in the labor market. 

We have made clear that we don’t focus on any single statistic, that 

the unemployment rate is only one measure of what is happening 

in the labor market, and it is appropriate for us to really try to do 

a much more detailed assessment of where things stand and what 

we should be aiming for. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair anticipates calling upon two more Members, Mr. Barr 

and Mr. Delaney, and then excusing the witness. 

The Chair now recognizes the gentleman from Kentucky, Mr. 

Barr. 

Mr. BARR. Thank you, Mr. Chairman. 

And, Chair Yellen, thanks for being back before us. 

The last time you were here, we talked about a qualified CLO 

concept, and you were kind enough to respond to that question in 

writing. I want to thank you for that, and I want to particularly 

51 

thank you for recognizing that the qualified CLO concept could be 

considered a positive development in the market. 

And I would like to continue our discussion about the role that 

regulation could very well play in terms of being a source of economic instability, particularly in our capital markets. 

The Basel Committee recently finished a rule in January that increases the capital held against securitization exposures in a bank 

trading book by up to 5 times the amount already required under 

Basel III, as well as the final TLAC rules. 

One industry study suggests that trading in U.S. asset-backed 

securities will become uneconomical if the rule is not tailored to fit 

the U.S. marketplace. 

If it is uneconomical to act as a market-maker for commercial 

mortgage-backed securities or residential mortgage-backed securities, auto loans, credit cards, collateralized loan obligations, then 

banks will pull out of the ABS market, which represents a $1.6 billion source of consumer lending, or 30 percent of all lending to U.S. 

consumers. 

So my question to you, Chair Yellen, is how will the Fed ensure 

that the final rule will be tailored to fit the U.S. market, which is 

the most liquid ABS market in the entire world? 

Mrs. YELLEN. I will have a careful look at that. I am not familiar 

with all of the details of the Basel proposal. 

But anything we implement in the United States—there is nothing automatic that is implemented in the United States, and we 

will have a careful look at what the impact would be. 

Mr. BARR. I appreciate you doing that. And I continue to urge the 

Fed, and you in particular, as a member of FSOC, to look at government regulation as a source of economic instability. 

To that end, we are told by many of the regulated bank holding 

companies that there is no updated organizational chart within the 

Fed. And so my question would be, can you share with us—or can 

your staff share with us—a detailed organizational chart with the 

names and titles of the Bank Supervision and Regulation Division’s 

full professional staff? 

Mrs. YELLEN. I think so. 

Mr. BARR. I am told that whatever organizational chart you have 

is very dated, and so— 

Mrs. YELLEN. Yes— 

Mr. BARR. —we can’t even—many of the folks can’t even ask you 

questions. 

Mrs. YELLEN. —yes. I don’t see any reason we can’t— 

Mr. BARR. I appreciate you doing that. 

Switching gears really quickly to the Consumer Financial Protection Bureau and their funding source, which, as you know, according to the budget overview that the Bureau makes public, transfers 

from the Federal Reserve System are capped at $618 million for 

Fiscal Year 2015, and the transfer cap is estimated to be $631 million for Fiscal Year 2016. 

Given that my time is scarce, if you could just answer the following in yes-or-no responses, that would be greatly appreciated. 

Does the Fed approve the Bureau’s budget? 

Mrs. YELLEN. We fund the Bureau’s budget. 

Mr. BARR. You fund it, but do you approve the budget? 

52 

Mrs. YELLEN. I think the answer is no, but— 

Mr. BARR. Right. Can you veto specific allocations requested? No. 

Mrs. YELLEN. I don’t think so. 

Mr. BARR. Okay. And does the Fed have protocols if the bureau 

seeks to transfer more than the cap on its transfers under the formula? Do you have a protocol in place to prevent that? 

Mrs. YELLEN. We abide by the law. I need to look at the details 

of what our obligations and limits are. I need to look at that more 

fully. 

Mr. BARR. We would like to know if the— 

Mrs. YELLEN. But we certainly have protocols to abide by what 

Congress set out. 

Mr. BARR. This is the problem we have is that we don’t have appropriations control over the Bureau. And so, they get their funding from you. We would hope that they would at least be accountable to you as the funding source. 

Is there any direct oversight of the implementation of the Bureau’s budget by the Fed? 

Mrs. YELLEN. No. Our Inspector General has authority both for 

the Fed and the Bureau, but the Fed does not have authority over 

the budget and spending of the— 

Mr. BARR. Thank you. In my last 10 seconds, you have talked a 

little bit about the need for Congress to address our long-term debt 

and deficit crisis. This seems to me a five-alarm fire. 

Given that mandatory spending is 70 percent of the Federal 

budget, why isn’t the Fed more aggressively warning Congress that 

it must reform mandatory entitlement spending? 

Mrs. YELLEN. Every Fed Chair that I can remember has come 

and told Congress that this is a looming problem with serious economic consequences. I know my predecessor has; I have on many 

occasions; and I certainly remember that Chairman Greenspan discussed with Congress the importance of addressing this. 

Mr. BARR. Thank you. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Maryland, Mr. 

Delaney. 

Mr. DELANEY. Thank you, Mr. Chairman. 

And I want to thank you, Chair Yellen, for not only your leadership in general, but also your participation and patience at this 

hearing. 

I also want to welcome our visitors and guests here today and 

thank you for bringing your important message. 

We do talk about how our unemployment rate has gone down 

substantially, which it has—below 5 percent now. But we all know 

that when you get behind those numbers there are really only two 

types of jobs being created right now in this country: high-skilled, 

high-paid jobs, where you need very, very specific skills and advanced educations to get them; and low-skilled, low-paid jobs. 

And what we are not creating is middle-skilled, middle-class jobs, 

the kind of jobs that have been the backbone of this country for a 

long time and allowed wages to grow and people to raise their families with one job. 

53 

The Chair touched on something very important, which is infrastructure, because there is nothing we can do as a country to help 

address that problem more than rebuilding our country. 

So if I could ever edit your T-shirts I would say, ‘‘Let our wages 

grow, rebuild our country,’’ because I do think it would really make 

a difference in raising wages. 

But my question for the Chair is—and again, thank you for your 

patience—in December, when the decision was made to raise the 

Federal fund rates, in your testimony you said that was in part 

based on a view that economic activity would continue to expand 

at a moderate pace and labor market indicators would continue to 

strengthen. 

And certainly, based on the top-line data from 2015 and 2014, 

where we saw decent GDP growth, improvement in the residential 

market, business investments at a decent level—not where we 

would like them, but at a decent level—increases in R&D investments, et cetera, but even when you take into consideration the 

negatives from the oil and gas sector, the outlook for economic 

growth was reasonably solid, and the labor market data that you 

were looking at, at the time, must have been good because the January numbers were actually encouraging, not only in terms of unemployment but some of the wage data, as you talked about. 

So I guess my question is, a lot has happened since that decision 

in the markets, and that tends to change behavior. When you look 

at the same data you looked at when you made that decision in December, if you look at that data now, does it change your view as 

to your perspective on economic activity, economic growth, and general labor market trends? 

Mrs. YELLEN. I think the answer is ‘‘maybe,’’ but the jury is out. 

We have continued to see progress in the labor market. Over the 

last 3 months, there have been 230,000 jobs per month, averaging 

through. 

GDP growth clearly slowed a lot in the fourth quarter. My expectation is that it will pick up this quarter. 

But on the other hand, financial conditions have tightened considerably, and that can have implications for the outlook. 

And what the Committee said in January—we had previously 

said that we regarded the risks to the outlook for economic activity 

and the labor market as balanced. 

Mr. DELANEY. Right. 

Mrs. YELLEN. What we said in January is that we are evaluating 

and assessing the impact of these developments on the outlook for 

both the labor market and activity for inflation and the balance of 

risks. And that is what we are doing at this point. 

Mr. DELANEY. And when you look, Chair Yellen, at recent data 

that you get better than anyone about credit formation and borrowing activities in the markets, are you concerned that there has 

been a significant contraction in credit availability based on recent 

market activities? And how much does that factor in to your— 

Mrs. YELLEN. That is an important factor. 

Mr. DELANEY. And have you seen it? 

Mrs. YELLEN. Not really at this stage. But what we do see is that 

spreads, especially on lower-graded bonds, have widened considerably. Borrowing rates have widened. 

54 

Mr. DELANEY. What about bank lending? 

Mrs. YELLEN. And it is not just energy. In our most recent survey 

of banks on their lending standards, we have seen a tightening 

that is reported in C&I loans, in CRE loans, and that certainly 

those loans continue to grow but that is something that bears 

watching. It is really those kinds of trends that we need to evaluate— 

Mr. DELANEY. And very quickly, as you weigh your decisions, obviously inflation and labor-market participation are critical, overall, 

the economic activity is critical. This subcomponent, in other 

words, what is happening with credit availability—how important 

is that in your decision-making process? 

Mrs. YELLEN. What we are trying to do is forecast spending in 

the economy. Investment spending and housing are two important 

forms of spending. And credit availability factors into our forecast 

for both of those portions of the economy. They are not the only factors that matter, but they are a factor that is important, and so we 

will be considering those. 

And there are a number of weeks before we meet again in 

March. There is quite a bit of additional data we will want to look 

at. But you have pinpointed exactly the kinds of considerations 

that will bear on our thinking. 

Mr. DELANEY. Thank you again. 

Chairman HENSARLING. The time of the gentleman has expired. 

The ranking member is recognized for a unanimous consent request. 

Ms. WATERS. I ask unanimous consent to insert into the record 

the statement from Financial Innovation Now (FIN) that highlights 

the very important work the Federal Reserve Board is doing 

through the Faster Payments Task Force, of which FIN is a member. 

Chairman HENSARLING. Without objection, it is so ordered. 

Chair Yellen, I thank you for your testimony today. 

The Chair notes that some Members may have additional questions for this witness, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to this witness 

and to place her responses in the record. Also, without objection, 

Members will have 5 legislative days to submit extraneous materials to the Chair for inclusion in the record. 

I ask Chair Yellen to please respond promptly. 

This hearing stands adjourned. 

[Whereupon, at 1:12 p.m., the hearing was adjourned.] 

(55) 

A P P E N D I X 

February 10, 2016 

56 


23566.001

For release at 

8:30 a.m. EST 

February 10,2016 

Statement by 

Janet L. Yellen 

Chair 

Board of Governors of the Federal Reserve System 

before the 

Committee on Financial Services 

U.S. House of Representatives 

February 10,2016 
57 


23566.002

Chairman Hensarling, Ranking Member Waters, and other members of the Committee, I 

am pleased to present the Federal Reserve's semiannual Monetary Policy Report to the Congress. 

In my remarks today, I will discuss the current economic situation and outlook before turning to 

monetary policy. 

Current Economic Situation and Outlook 

Since my appearance before this Committee last July, the economy has made further 

progress toward the Federal Reserve's objective of maximum emplo;ment. And while inflation 

is expected to remain low in the near term, in part because of the further declines in energy 

prices, the Federal Open Market Committee (FOMC) expects that inflation will rise to its 

2 percent objective over the medium term. 

In the labor market, the number of nonfarm payroll jobs rose 2.7 million in2015, and 

posted a further gain of 150,000 in January of this year. The cumulative increase in employment 

since its trough in early 20 I 0, is now more than 13 million jobs. Meanwhile, the unemployment 

mte fell to 4.9 percent in January, 0.8 percentage point below its level a year ago and in line with 

the median ofFOMC participants' most recent estimates of its longer-run normal level. Other 

measures oflabor market conditions have also shown solid improvement, with noticeable 

declines over the past year in the number of individuals who want and are available to work but 

have not actively searched recently, and in the number of people who are working part time but 

would rather work full time. However, these measures remain above the levels seen prior to the 

recession, suggesting that some slack in labor markets remains. Thus, while labor market 

conditions have improved substantially, there is still room for further sustainable improvement. 

The strong gains in the job market last year were accompanied by a continued moderate 

expansion in economic activity. U.S. real gross domestic product is estimated to have increased 
58 


23566.003

- 2 -

about 1-3/4 percent in 2015. Over the course of the year, subdued foreign growth and the 

appreciation of the dollar restrained net exports. In the fourth quarter of last year, growth in the 

gross domestic product is reported to have slowed more sharply, to an annual rate of just 

3/4 percent; again, growth was held back by weak net exports as well as by a negative 

contribution from inventory investment. Although private domestic final demand appears to 

have slowed somewhat in the fourth quarter, it has continued to advance. Household spending 

has been supported by steady job gains and solid growth in real disposable income--aided in part 

by the declines in oil prices. One area of particular strength has been purchases of cars and light 

trucks; sales of these vehicles in 2015, reached their highest level ever. In the drilling and 

mining sector, lower oil prices have caused companies to slash jobs and sharply cut capital 

outlays, but in most other sectors, business investment rose over the second half of last year. 

And homebuilding activity has continued to move up, on balance, although the level of new 

construction remains well below the longer-run levels implied by demographic trends. 

Financial conditions in the United States have recently become less supportive of growth, 

with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers, 

and a further appreciation of the dollar. These developments, if they prove persistent, could 

weigh on the outlook for economic activity and the labor market, although declines in longerterm interest rates and oil prices provide some offset. Still, ongoing employment gains and faster 

wage growth should support the growth of real incomes and therefore consumer spending, and 

global economic grov.1h should pick up over time. supported by highly accommodative 

monetary policies abroad. Against this backdrop, the Committee expects that with gradual 

adjustments in the stance of monetary policy, economic activity will expand at a moderate pace 

in coming years and that labor market indicators will continue to strengthen. 
59 


23566.004

- 3 

As is always the case, the economic outlook is uncertain. Foreign economic 

developments, in particular, pose risks to U.S. economic growth. Most notably, although recent 

economic indicators do not suggest a sharp slowdown in Chinese growth, declines in the foreign 

exchange value of the renminbi have intensified uncertainty about China's exchange rate policy 

and the prospects for its economy. This uncertainty led to increased volatility in global financial 

markets and, against the background of persistent weakness abroad, exacerbated concerns about 

the outlook for global growth. These growth concerns, along with strong supply conditions and 

high inventories, contributed to the recent fall in the prices of oil and other commodities. In turn, 

low commodity prices could trigger financial stresses in commodity-exporting economics, 

particularly in vulnerable emerging market economies, and for commodity-producing firms in 

many countries. Should any of these downside risks materialize, foreign activity and demand for 

U.S. exports could weaken and financial market conditions could tighten further. 

Of course, economic growth could also exceed our projections for a number of reasons, 

including the possibility that low oil prices will boost U.S. economic growth more than we 

expect. At present, the Committee is closely monitoring global economic and financial 

developments, as well as assessing their implications for the labor market and inflation and the 

balance of risks to the outlook. 

As T noted earlier, inflation continues to run below the Committee's 2 percent objective. 

Overall consumer prices, as measured by the price index for personal consumption expenditures, 

increased just 1/2 percent over the 12 months of 2015. To a large extent, the low average pace of 

inflation last year can be traced to the earlier steep declines in oil prices and in the prices of other 

imported goods. And, given the recent further declines in the prices of oil and other 

commodities, as well as the further appreciation of the dollar, the Committee expects inflation to 
60 


23566.005

-4-

remain low in the near tenn. However, once oil and impmi prices stop falling, the downward 

pressure on domestic inflation from those sources should wane, and as the labor market 

strengthens further, inflation is expected to rise gradually to 2 percent over the medium term. In 

light of the current shortfall of inflation from 2 percent, the Committee is carefully monitoring 

actual and expected progress toward its inflation goal. 

Of course, inflation expectations play an important role in the inflation process, and the 

Committee's confidence in the inflation outlook depends importantly on the degree to which 

longer-run inflation expectations remain well anchored. It is worth noting, in this regard, that 

market-based measures of inflation compensation have moved down to historically low levels; 

our analysis suggests that changes in risk and liquidity premiums over the past year and a half 

contributed significantly to these declines. Some survey measures of longer-run inflation 

expectations are also at the low end of their recent ranges; overall, however, they have been 

reasonably stable. 

Monetary Policy 

Turning to monetary policy, the FOMC conducts policy to promote maximum 

employment and price stability, as required by our statutory mandate from the Congress. Last 

March, the Committee stated that it would be appropriate to raise the target range for the federal 

funds rate when it had seen fltrther improvement in the labor market and was reasonably 

confident that inflation would move back to its 2 percent objective over the medium term. In 

December, the Committee judged that these two criteria had been satisfied and decided to raise 

the target range for the federal funds rate 1/4 percentage point, to between 1/4 and 1/2 percent. 

This increase marked the end of a seven-year period during which the federal funds rate was held 

near zero. The Committee did not adjust the target range in January. 
61 


23566.006

- 5 -

The decision in December to raise the federal funds rate reflected the Committee's 

assessment that, even after a modest reduction in policy accommodation, economic activity 

would continue to expand at a moderate pace and labor market indicators would continue to 

strengthen. Although inflation was running below the Committee's longer-run objective, the 

FOMC judged that much of the softness in inflation was attributable to transitory factors that are 

likely to abate over time, and that diminishing slack in labor and product markets would help 

move inflation toward 2 percent. In addition, the Committee recognized that it takes time for 

monetary policy actions to affect economic conditions. If the FOMC delayed the start of policy 

nonnalization for too long, it might have to tighten policy relatively abruptly in the future to 

keep the economy from overheating and inflation from significantly overshooting its objective. 

Such an abrupt tightening could increase the risk of pushing the economy into recession. 

It is important to note that even after this increase, the stance of monetary policy remains 

accommodative. The FOMC anticipates that economic conditions will evolve in a manner that 

will warrant only gradual increases in the federal funds rate. In addition, the Committee expects 

that the federal funds rate is likely to remain, for some time, below the levels that are expected to 

prevail in the longer run. This expectation is consistent with the view that the neutral nominal 

federal funds rate--defined as the value of the federal funds rate that would be neither 

expansionary nor contractionary if the economy was operating near potential--is currently low by 

historical standards and is likely to rise only gradually over time. The low level of the neutral 

federal funds rate may be partially attributable to a range of persistent economic headwinds--

such as limited access to credit for some borrowers, weak growth abroad, and a significant 

appreciation of the dollar--that have weighed on aggregate demand. 
62 


23566.007

-6-

Of course, monetary policy is by no means on a preset course. The actual path of the 

federal funds rate will depend on what incoming data tell us about the economic outlook, and we 

will regularly reassess what level of the federal funds rate is consistent with achieving and 

maintaining maximum employment and 2 percent inflation. In doing so, we will take into 

account a wide range of infonnation, including measures of labor market conditions, indicators 

of inflation pressures and inflation expectations, and readings on financial and international 

developments. In particular, stronger growth or a more rapid increase in inflation than the 

Committee currently anticipates would suggest that the neutral federal funds rate was rising more 

quickly than expected, making it appropriate to raise the federal funds rate more quickly as welL 

Conversely, if the economy were to disappoint, a lower path of the federal funds rate would be 

appropriate. We are committed to our dual objectives, and we will adjust policy as appropriate 

to foster financial conditions consistent with the attainment of our objectives over time. 

Consistent with its previous communications, the Federal Reserve used interest on excess 

reserves (IOER) and overnight reverse repurchase (RRP) operations to move the federal funds 

rate into the new target range. The adjustment to the IOER rate has been particularly important 

in raising the federal funds rate and short-tenn interest rates more generally in an environment of 

abundant bank reserves. Meanwhile, overnight RRP operations complement the IOER rate by 

establishing a soft floor on money market interest rates. The IOER rate and the overnight RRP 

operations allowed the FOMC to control the federal funds rate effectively without having to first 

shrink its balance sheet by selling a large part of its holdings of longer-tenn securities. The 

Committee judged that removing monetary policy accommodation by the traditional approach of 

raising short-tenn interest rates is preferable to selling longer-tenn assets because such sales 

could be difiieult to calibrate and could generate unexpected financial market reactions. 
63 


23566.008

- 7-

The Committee is continuing its policy of reinvesting proceeds from maturing Treasury 

securities and principal payments from agency debt and mortgage-backed securities. As 

highlighted in the December statement, the FOMC anticipates continuing this policy "until 

normalization of the level oftbe federal funds rate is well under way." Maintaining our sizable 

holdings of longer-tenn securities should help maintain accommodative financial conditions and 

reduce the risk that we might need to return the federal funds rate target to the effective lower 

bound in response to future adverse shocks. 

Thank you. I would be pleased to take your questions. 
64 


23566.009

MoNETARY Poucv REPORT 

February 10, 2016 

Board of Governors of the Federal Reserve System 

hlr\Jseat8:30a.m. r-:,1 

february 10, l016 
65 


23566.010

LETTER OF TRANSMITTAL 

BOARD OF GOVERNORS OF THE 

FEDERAL RESERVE SYSTEM 

Washington, D.C., February 10, 2016 

THE PRESIDENT OF THE SENATE 

THE SPEAKER OF THE HOUSE OF REPRESENTATIVES 

The Board of Governors is pleased to submit its Monetary Policy Report pursuant to 

section 2B of the Federal Reserve Act. 

Janet L. Yellen, Chair 
66 


23566.011

STATEMENT ON LoNGER-RuN GoALS AND MoNETARY PoucY STRATEGY 

/\doptf~d effective /dnuary 

The Federal Open Market Committee (FOMC) is firmly committed to fulfilling its statutory 

mandate from the Congress of promoting maximum employment, stable prices, and moderate 

long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public 

as clearly as possible. Such clarity facilitates well-informed decisionmaking by households and 

businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary 

policy, and enhances transparency and accountability, which are essential in a democratic society. 

Inflation, employment, and long-term interest rates fluctuate over time in response to economic and 

financial disturbances. Moreover, monetary policy actions tend to influence economic activity and 

prices with a lag. Therefore, the Committee's policy decisions reflect its longer-run goals, its mediumterm outlook, and its assessments of the balance of risks, including risks to the financial system that 

could impede the attainment of the Committee's goals. 

The inflation rate over the longer run is primarily determined by monetary policy, and hence the 

Committee has the ability to specify a longer-run goal for inflation. The Committee reaffirms its 

judgment that inflation at the rate of 2 percent, as measured by the annual change in the price 

index for personal consumption expenditures, is most consistent over the longer rnn with the 

Federal Reserve's statutory mandate. The Committee would be concerned if inflation were running 

persistently above or below this objective. Communicating this symmetric inflation goal clearly to the 

public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability 

and moderate long-term interest rates and enhancing the Committee's ability to promote maximum 

employment in the face of signilicant economic disturbances. The maximum level of employment 

is largely determined by nonmonetary factors that affect the structure and dynamics of the labor 

market. These factors may change over time and may not be directly measurable. Consequently, 

it would not be appropriate to specify a ftxed goal for employment; rather, the Committee's policy 

decisions must be informed by assessments of the maximum level of employment, recognizing that 

such assessments are necessarily uncertain and subject to revision. The Committee considers a 

wide range of indicators in making these assessments. Information about Committee participants' 

estimates of the longer-run normal rates of outpnt growth and unemployment is published four 

times per year in the FOMC's Summary of Economic Projections. for example, in the most 

recent projections, the median of FOMC participants' estimates of the longer-run normal rate of 

unemployment was 4.9 percent. 

In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its 

longer-run goal and deviations of employment from the Committee's assessments of its maximum 

level. These objectives are generally complementary. However, nnder circumstances in which the 

Committee judges that the objectives are not complementary, it follows a balanced approach in 

promoting them, taking into account the magnitude of the deviations and the potentially ditTerent 

time horizons over which employment and inflation are projected to return to levels jndged 

consistent with its mandate. 

The Committee intends to reaffirm these principles and to make adjustments as appropriate at its 

annual organizational meeting each January. 
67 


23566.012

CONTENTS 

Summary ................................................................ 1 

Part 1 : Recent Economic and Financial Developments ..................... 3 

Domestic Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 

Financial Developments .................................................. 16 

International Developments ............................................... 22 

Part 2: Monetary Policy .................................................. 29 

Part 3: Summary of Economic Projections ................................ 35 

The Outlook for Economic Activity ......................................... 36 

The Outlook for Inflation .................................................. 38 

Appropriate Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 

Uncertainty and Risks . . . . . . . ............................................ 45 

Abbreviations ........................................................... 49 

List of Boxes 

Effects of Movements in Oil Prices and the Dollar on Inflation .................... 8 

Developments Related to Financial Stability .................................. 20 

Monetary Policy Divergence in the Advanced Economies ....................... 24 

The Neutral Federal Funds Rate in the Longer Run ............................. 32 

Monetary Policy Implementation following the December 2015 FOMC Meeting ... 34 

Forecast Uncertainty ..................................................... 47 

NoTE: Unless stated otherwise, the time series in the 

january 20! b; and, for quarterly data, 2015:Q4. In bar 

quarter from the final quarter of the preceding period. 

extend through, for daily data, February 4, 2016; for monthly data, 

exct>t}t dS noted, the ch;mge for a given period is measured to its final 

For figures 32 and 36, note that the Dow Jones Bank Index and the S&P 500 Index ("Indexes") are a Oow jom•s 

!ndic('S I LC and/or its affiliates and have been licensed for use by the Board. Copyright© 2016 S&P Indices lLC, a 

subsidiary o{ the McGraw Hill Financial inc., and/or its affiliates. AI! rights rf'servf'd. Redistribution, reproduction and/or photocopying 

in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow 

Jones Indic-es LLC's indices please visit www.spdji.com. S&P® is a registered trademark of Standard & Poor's Financial Services LLC 

and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow jones Indices LLC, Dow jones 

Tradem<Jrk !- !ofdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to 

the ability of any index to accurately reprPsent the asset class or market sector that it purports to represent and nell her S&P Dow jones 

tndices LLC Dow jones Trademark Holdings LLC, their affiliates nor their third party !icmsors shall have any liability for any errors, 

omissions, or interruptions of any index or the data included therein. 
68 


23566.013

SuMMARY 

Labor market conditions continued to 

improve during the second half of 2015 and 

into early 2016. Payroll employment has 

increased at a solid average pace of 225,000 

per month since June. The unemployment 

rate, which had reached a high of 10 percent 

in late 2009, declined from 5.3 percent last 

June to 4.9 percent in January. Although the 

unemployment rate now equals the median of 

Federal Open Market Committee (FOMC) 

participants' estimates of its longer-run 

normal level, other considerations suggest 

that some further improvement in labor 

market conditions is needed to achieve the 

Committee's maximum employment mandate. 

The labor force participation rate remains 

somewhat below most assessments of its trend, 

and an unusually large number of people 

continue to work part time when they would 

prefer full-time employment. 

Inflation remains below the FOMC's longerrun goal of 2 percent: The price index for 

personal consumption expenditures (PCE) 

rose only 'h percent over the 12 months ending 

in December. The PCE price index excluding 

food and energy items, which often provides 

a better indication of future inflation, also 

remained subdued, rising 1 Y, percent over 

that period. Inflation has been held down 

substantially by the drop in energy prices; 

declines in the prices of non-oil imported 

goods have contributed as well. Meanwhile, 

survey-based measures of longer-run inflation 

expectations have drifted down a little 

since the middle of last year and generally 

stand near the lower ends of their historical 

ranges; market-based measures of inflation 

compensation have fallen and arc at low levels. 

Real gross domestic product (GDP) is 

reported to have increased at an annual rate 

of about l Y. percent over the second half of 

the year, slower than the first-half pace. The 

expansion in economic activity reflected 

continued increases in private domestic final 

demand, supported by ongoing job gains and 

accommodative monetary policy. Government 

purchases rose modestly. By contrast, the rise 

in the foreign exchange value of the dollar over 

the past year and a half and the sluggish pace 

of economic activity abroad have continued 

to weigh on exports. In addition. the pace of 

inventory accumulation slowed markedly from 

its elevated first-half pace, thereby reducing 

overall GDP growth in the second half of 2015. 

Domestic financial conditions have become 

somewhat less supportive of economic growth 

since mid-2015. Recent months have been 

marked by bouts of turbulence in financial 

markets that largely reflected concerns 

about the global economic outlook and 

developments in oil markets. Broad measures 

of U.S. equity prices have declined, on net, 

roughly returning these indexes to levels that 

prevailed during the first half of 2014. And the 

dollar has strengthened further, on balance, 

since the summer of 2015. Corporate risk 

spreads have widened, particularly for lowerrated issuers. Nonetheless, interest rates for 

investment-grade issuers are generally still 

low, reflecting declines in yields on longerterm Treasury securities. Moreover, although 

debt issuance by lower-rated firms bas slowed, 

credit flows to nonfinancial businesses have 

remained solid since the middle of last year, 

supported by continued strong bond issuance 

of higher-rated firms and by bank lending. 

Household access to credit was mixed, with 

mortgages and credit cards still difficult to 

access for some borrowers while student 

and auto loans remained broadly available, 

even to borrowers with lower credit scores. 

Overall, debt growth in the household sector 

has remained modest and continues to be 

concentrated among borrowers with strong 

credit histories. 

The U.S. financial system overall has been 

resilient to the stresses that have emerged 

since mid-2015, and financial vulnerabilities 
69 


23566.014

2 SUMMARY 

remain moderate. Regulatory capital ratios 

and holdings of liquid assets at large banking 

firms arc at historically high levels. Usage 

of short-term wholesale funding in the 

11nancial system is relatively low, and the usc 

of leverage to finance securities purchases has 

declined somewhat. The ratio of aggregate 

private nonfinancial credit to GDP is below 

most estimates of its long-run trend, although 

leverage of speculative-grade nonfinancial 

corporations has risen further since the 

middle of last year and is relatively high. 

Risk premiums for many asset classes have 

increased. For instance, the rise in spreads on 

corporate debt has been larger than would 

be expected given the evolution of expected 

defaults. The direct exposures of the largest 

U.S. banking firms to the oil sector and to 

emerging market economies are limited. If 

conditions in those sectors worsen, however, 

wider stresses could emerge and be transmitted 

to the United States through indirect global 

financial linkages. 

In December, after holding the federal funds 

rate near zero for seven years, the FOMC 

raised the target range for that rate to '/. to 

Y, percent. The decision to increase the 

federal funds rate reflected the Committee's 

assessment that there had been considerable 

improvement in the labor market last year and 

that the Committee was reasonably confident 

that inflation would move back to 2 percent 

over the medium term; thus, the criteria set 

out by the Committee in March 2015 had 

been met. 

The Committee anticipates that economic 

conditions will evolve in a manner that will 

warrant only gradual increases in the federal 

funds rate. This expectation is consistent with 

the view that the neutral nominal federal funds 

rate-defined as the value of the federal funds 

rate that would be neither expansionary nor 

contraetionary if the economy was operating 

at its productive potential-is currently low by 

historical standards and is likely to rise only 

gradually over time, as headwinds to economic 

growth dissipate slowly and as inflation rises 

toward the Committee's goal of 2 percent. 

Consistent with this outlook, in the most 

recent Summary of Economic Projections 

(SEP), which was compiled at the time of the 

December FOMC meeting, FOMC participants projected that the appropriate level 

of the federal funds rate would be below its 

longer-run level through 2018. (The December 

SEP is included as Part3 of this report.) 

With respect to its securities holdings, the 

Committee will continue to reinvest principal 

payments from its securities portfolio, and it 

expects to maintain this reinvestment policy 

until normalization of the level of the federal 

funds rate is well under way. This policy, by 

keeping the Committee's holdings of longerterm securities at sizable levels, should help 

maintain accommodative financial conditions. 

The Committee has emphasized that the actual 

path of monetary policy will depend on how 

incoming data affect the economic outlook. 

In determining the timing and size of future 

adjustments to the target range of the federal 

funds rate, the Committee will assess realized 

and expected economic conditions relative to 

its objectives of maximum employment and 

2 percent inflation. Stronger growth or a more 

rapid increase in inflation than the Committee 

currently anticipates would likely call for faster 

increases in the federal funds rate; conversely, 

if conditions prove weaker, a lower path of the 

federal funds rate would likely be appropriate. 

To move the federal funds rate into the new 

target range announced in December, the 

Federal Reserve raised the rate of interest paid 

on required and excess reserve balances and 

also employed an overnight reverse repurchase 

agreement facility. The effective federal funds 

rate was moved successfnlly into the increased 

target range. The FOMC remains confident 

that it has the tools it needs to adjust shortterm interest rates as appropriate. 
70 


23566.015

3 

PART 1 

RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

The labor market continued to improve during the second half of last year and early this 

year. Payroll employment has increased 225,000 per month, on average, since june. The 

unemployment rate fell from 5.3 percent in june to 4.9 percent in january and thus has reached 

the median estimate among Federal Open Market Committee ( FOMC) participants of the level of 

unemployment that is considered to be normal in the longer run. Even so, the relatively low labor 

force participation rate and the unusually large number of people working part time who would 

prefer full-time employment suggest that some cyclical weakness is still present in the labor market. 

Since mid-2014, a steep drop in crude oil prices has exerted significant downward pressure on 

overall inflation, and declines in the prices of non-oil imported goods have held down inflation 

as well. The price index for personal consumption expenditures (PCE) increased only 'h percent 

during the 12 months ending in December, a rate that is well below the FOMCs longeNun 

objective of 2 percent; the index excluding food and energy prices rose 1 'h percent over the same 

period. Both survey- and market-based measures of inflation expectations have moved down since 

June. Meanwhile, real gross domestic product (COP) increased at an annual rate of 1 '4 percent 

over the second half of 20 15, slower than in the first half. The growth in COP has been supported 

by accommodative monetary policy, favorable consumer confidence, and the boost to household 

purchasing power from lower oil prices. However, lower oil prices have also exerted downward 

pressure on domestic investment in the energy sector. In addition, sluggish growth abroad and the 

higher foreign exchange value of the dollar have weighed on exports, and financial conditions more 

generally have become somewhat less supportive of economic growth. Concerns about economic 

conditions abroad and the energy sector have contributed to lower equity prices and higher 

borrowing rates for some businesses. 

Domestic Developments 

The labor market has continued to 

improve ... 

Labor market conditions strengthened 

further across a variety of dimensions over 

the second half of 2015 and early this year. 

Payroll employment gains remained robust, 

averaging about 235,000 per month over the 

second half of last year, similar to the gains 

over the first half; factoring in the January 

increase of about 150,000, monthly gains since 

June have averaged about 225,000 (figure !). 

The increase in 2015 followed an even faster 

pace of job gains in 2014, and, in total, some 

5'14 million jobs were added over the two years. 

In addition, the unemployment rate-which 

had reached I 0 percent in late 2009----declined 

from 5.3 percent in June 2015 to 4.9 percent in 

January of this year; this level is '14 percentage 

point lower than a year earlier and is equal to 

I. Net change in payroll employment 

3-momhrnovwg<lverages Thousands of Jobs ---------------·-- - -----------

P1ivatc --- 400 

200 

200 

400 

600 

800 

SouRCE Department of Labor, Bureau of Labor Statlsttcs 
71 


23566.016

4 PART 1: RECENT ECONOMIC AND FINANCIAL DEVEl OPMFNTS 

2. Measures oflabor underutilization 

Percem 

16 

!J-4 14 

12 

10 

~__j_ _____ _L _ __j_ __ _l __ ___l __ __j__ _ _L__j_J 

2010 2012 2014 2016 

NoTE U-4 measures total unemployed plus dlSCOuraged workers, as a percent of the labor force plus discouraged workers. Discouraged workers are a subset of 

marginally attached workers who are not currently looking for work b(X:ause they believe no jobs are available for them. U-5 measures total unemployed plus aH 

marginally attached to the labor force, as a percent of the labor force plus persons margmally attached to the labor force. Marginally attached workers are not in 

the labor force, want and are available for work, and have looked for a JOb m the past 12 months. U-6 measures total unemployed plus aH marginally attached 

workers plus total employed part time for <..-conomic rea<;ons, as a percent of the labor force plus all marginally attached workers. The shaded bar md1cates a 

penod of business recession as defined by the National Bureau of Econom1c Research_ 

SouRcE: Department of Labor, Bureau of Labor Statistics. 

3. Labor force participation rate and 

empJoyment~to~population ratio 

Monthly 

EmploymcnHo-popula!!On !Dl!O 

L_LLLLl.J_J __ _j_ L.L_l ___ LLLLLLLJ 2000 2002 2004 2006 2008 2010 2012 2014 ~016 

Both series are a percent of the population aged 16 and over. 

Department of Labor, Bureau of Labor Statistics 

68 

66 

64 

62 

60 

58 

the median of FOMC participants' estimates 

of its longer-run normal level (figure 2). 

Broader measures of labor underutilization, 

such as those including individuals who 

are classified as marginally attached to the 

labor force, declined by similar amounts_ (A 

"marginally attached" individual is defined as 

someone who is not looking for work currently 

and therefore treated as not in the labor force, 

but who wants and is available for work and 

has looked for a job in the past 12 months_) 

... though some labor market slack likely 

remains ... 

While payroll employment and the 

unemployment rate have improved further 

since mid-2015, the labor force participation 

rate fell from an average of 62.7 percent of 

the working-age population during the second 

quarter of 2015 to 62.5 percent in the fourth 

quarter; the participation rate moved back np 

to 62.7 percent in January (figure 3)_ Changing 

demographics-most notably the increasing 
72 


23566.017

share of older people in the population, who 

are less likely to be in the labor force--and 

other longer-run structural changes in the 

labor market have continued to push down 

the participation rate even as cyclical forces 

have been pushing it up. That said, labor 

force participation appears to remain a little 

weaker than can be explained by structural 

factors alone, pointing to the likelihood that 

some slack remains in this dimension of labor 

utilization. In addition, although the share of 

workers who arc employed part time but would 

like to work full time has fallen noticeably 

since June, it is still relatively high, indicating 

some scope for improvement on this dimension 

as well. 

... while labor compensation has shown 

some tentative signs of accelerating ... 

As the labor market has continued to improve, 

the rates of increase in some measures of 

hourly labor compensation have begun to pick 

up while others remain relatively subdued. 

.For example, average hourly earnings for 

all employees increased 2'h percent over 

the 12 months ending in January, above the 

2 percent pace seen throughout most of the 

recovery (tlgurc 4). In addition, compensation 

per hour in the business sector-a volatile 

measure derived from the labor compensation 

data in the national income and product 

accounts, or NJPA-is reported to have 

increased more quickly in 2015 than its 

average pace throughout most of the recovery. 

In contrast, the employment cost index for 

private industry workers, which measures both 

wages and the cost to employers of providing 

benefits, increased about 2 percent over the 

12 months ending in December, similar to the 

pace seen throughout most of the recovery. 

All of these measures of compensation are 

increasing at slower rates than those seen prior 

to the recession. This deceleration probably 

reflects a variety of factors, including the 

slower growth of productivity, the slower pace 

of inflation, and perhaps some remaining slack 

in the labor market. Despite the continued 

relatively small increases in nominal wages, the 

recent very low inflation led to a noticeably 

MONETARY POLICY REPORT: FEBRUARY 2016 5 

4. Measures of change in hourly compensation 

Compensation per hour, 

business sector 

___ P_o_rcentchange from~earearher 

Non: The average hourly eaminp.s data series begins in March 2007 and 

extends through January 2016. The compensatiOn per hour and employment 

cost index data extend through 20t5:Q4. For busmess~sector compensation, 

change 1s over four quarters; for the employmem cost index, change is over 

the 12 months ending m the last month of each quarter; fOr average hourly 

ean1ings, change is !Tom 12 months earlier 

SOURCE, Departrnent ofl.abor, Bureau of Labor Statistics 
73 


23566.018

6 PART 1 o RECENT ECONOMIC AND fiNANCIAL DEVELOPMENTS 

5, Change in business sector output per hour 

---~-----

1948" 1974- 1996-- 2001- 73 95 2000 07 

.Percent_ annual rate 

2008 

15 

-- 4 

Non:: Changes are measured from Q4 of the year immediately preceding 

the period through Q4 of the fmal year of the penod 

SouRCE: Department of Labor, Bureau of Labor Statistics. 

6. Brent spot and futures prices 

Weekl) flo!larspo.'<llmsrel -------~ ·--------

DO 

120 

110 

100 

90 

80 

70 

60 

50 

40 

30 

larger wage gain last year on a purchasingpower-adjusted (or so-called real) basis than 

had been evident earlier in the expansion_ 

... and productivity growth has been 

lackluster 

Over time, increases in productivity are a key 

determinant of the rise in real wages and living 

standards. Labor productivity in the business 

sector increased at an annual rate of just 

'/,percent in 2015 and at an average annual 

rate of just 1 percent since tbe last business 

cycle peak in 2007 (figure 5). The average pace 

since 2007 is a little below the 1974-95 average 

and well below the pace during the period 

from the mid-1990s to 2007_ The reasons 

behind the slower productivity performance in 

recent years arc not well understood, but one 

factor seems to be the slower pace of capital 

accumulation_ 

Falling oil prices continue to hold down 

overall consumer prices ... 

Consumer price increases have remained 

muted and below the FOMC's longer-run 

objective of 2 percent. As discussed in the 

box "Effects of Movements in Oil Prices and 

the Dollar on Inflation," crude oil prices have 

plummeted since June 2014, and the dollar has 

moved appreciably higher; both factors have 

contributed importantly to the low inflation 

readings of the past yearSince July, the price of crude oil has fallen 

appreciably further, on net, with the spot price 

of Brent crude oil dropping below $35 per 

barrel, a level last seen more than a decade ago 

(the blue line in figure 6). Futures prices have 

also dropped significantly and indicate that 

market participants expect only modest price 

increases over the next few years_ Although 

concerns about global growth have contributed 

to the fall in prices, much of the recent decline 

can be attributed to the abundance of global 

supply_ Reductions in US_ production have 

been slower and smaller than expected, and 

OPEC has abandoned its official production 

target in favor of maintaining robust 

production despite declining prices and the 
74 


23566.019

likely increase in Iranian oil exports in the 

coming months. The drop in crude oil prices 

continues to pass through to gasoline prices: 

The national average of retail gasoline prices 

(on a seasonally adjusted basis) moved down 

from more than $2.50 per gallon in June to 

about $2.00 per gallon in January. 

Largely because of the decline in energy 

prices, overall consumer price inflation, as 

measured by the PCE price index, was running 

at just Y. percent for the 12 months ending 

in June 2015; the 12-month change remained 

near that pace until year-end, when it edged up 

to 1;2 percent as some of the sharpest declines 

from a year earlier fell out of the 12-month 

calculation (figure 7). 

Food prices were little changed over the past 

six months after edging down during the first 

half of 2015. Consumer food prices were 

held down in 2015 by falling food commodity 

prices, but futures markets suggest that these 

commodity prices will flatten out, implying 

that this source of downward pressure on 

consumer food price inflation is likely to wane . 

. . . but even outside of the energy and 

food inflalion has remained 

subdued 

As is also discussed in the box "Effects of 

Movements in Oil Prices and the Dollar on 

Inflation," another important factor holding 

down inflation has been the behavior of import 

prices. After declining sharply in the first half 

of 2015, non-oil import prices continued to 

fall in the second half, albeit at a slightly more 

modest pace; the further declines in the second 

half rcllected lower commodity prices as well 

as additional increases in the foreign exchange 

value of the dollar (figure 8). In addition, slack 

in labor and product markets likely placed 

downward pressure on inflation, although this 

factor has probably waned signilicantly. For 

all of these reasons, inflation for items other 

than food and energy (so-called core inflation) 

remained modest. Core PCE prices rose about 

1 'h. percent over the 12 months ending in 

December, similar to the increase in 2014. 

MONETARY POLICY RFPORT: FEBRUARY 2016 7 

7. Change in the price index for personal consumption 

expenditures 

Month I~ !2-momhpercentchange 

-------

8. Non-oil import prices and U.S. dollar exchange rate 

Month!~ 

20 

16 

12 

12 

~oo9 2010 20ll 2012 201~4"'zo::cl5c-'-:-:2o,.,-J6,-L--J Nm&. The data for non-oilnnpon pnces extend 1hrough D<X:ember 2015 

SouRCE. Department of Labor, Bureau of Labor Statistics: Federal Reserve 

Board, Statistical Release H.JO, "Foreign Exchange Rates·· 
75 


23566.020

8 PART 1, RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

Effects of Movements in Oil Prices and the Dollar on Inflation 

Over the past year, inflation has continued to run 

well below the Federal Open Market Committee's 

longer-run objective of 2 percent (text figure 7). 

The 12-month change in the personal consumption 

expenditures (PCE) price index, which was about 

lf2 percent in 2015, was held down most clearly by 

falling prices for oil and farm commodities. Falling 

prices for other commodities and lhe rise in the 

foreign exchange value of the dollar have also 

contributed importantly to continued low rates of 

inflation. Indeed, reflecting these influences, inflation 

for items other than food and energy remained 

relatively low, with core PCE price inflation at slightly 

under 11

11 percent last year. 

Since the middle of 2014, crude oil prices have 

tumbled, with the spot price of the global benchmark 

Brent crude oil falling from over $115 per barrel to 

under $35 per barrel in recent weeks; prices for a 

wide variety of other commodities have also declined 

C(>nsiderably. The pass~through of falling oil prices into 

lower gasoline prices is typically relatively rapid, and 

the drop in consumer energy prices held down overall 

PCE inilation directly by more than 'h percentage 

point in 2015. Falling farm commodity prices also 

reduced consumer food price inflation over the past 

year, although the pass-through oi these commodity 

price changes into overall PCE inflation tends to be 

somewhat smaller and more gradual than with oil 

prices. Additionally, the sustained reduction in both oil 

and non-oil commodity prices has likely lowered core 

inflation somewhat by holding down firms' prorluction 

and distribution costs. rmpirical estimates of the passthrough of energy costs into core inflation are generally 

quite small, with long and variable tags. Nonetheless, 

even with a small degree of pass-through, the very large 

declines in energy prices since the middle of 2014 

have likely been holding down core consumer price 

inflation somewhat. 

The broad dollar has appreciated more than 

20 percent since the middle of 2014, reflecting both 

heightened concerns about the global outlook, which 

have resulted in safe-haven flows toward dollar assets, 

and diverging expectations regarding domestic and 

foreign monetary policy (iigure A). A stronger dollar 

makes foreign goods cheaperfor U.S. consumers. An 

extensive literature, however, has found that the passthrough of exchange rate changes to U.S. import prices 

is incomplete-that is, less than proportionate-as 

foreign exporters prefer to absorb part of the exchange 

rate change by narrowing profit margins. For example, 

a typical estimate is that a 10 percent appreciation 

A. U.S. dollar exchange rate: Broad nominal dollar 

Jrumal) 3.2005 

120 

1!5 

Ito 

105 

JOO 

95 

90 

85 

SOURCE: Federal Reserve Board. Statistical Release H. 10, ''Foreign 

Exchange Rates " 
76 


23566.021

of the dollar causes the prices of non-oil imported 

goods to decline about 3 percent after one year, 1 

Roughly one-third of this effect occurs through the 

effect on imported commodities, as an increase in the 

value of the dollar tends to lower commodity prices 

proportionately. 

Because imported goods and services make up 

only a modest share of lJ .S. consumption, a given 

percentage decline in import prices causes a much 

smaller percentage reduction in core PCE prices. 

Figure B uses a simple econometric model to illustrate 

how a 1 0 percent appreciation of the do! far might affect 

core PCE inflation through this channeL' According to 

this model, core PCE inflation dips in the two quarters 

following the appreciation before gradually returning to 

the baseline, leading to a four-quarter decline in core 

PCE inflation of about 1/4 percentage point relative to 

the baseline in the first year following the shock. Given 

the size of the dollar's appreciation since the middle 

of 2014, this model suggests that falling import prices 

depressed core PCE inflation about 1h percentage point 

last year. Although the exact magnitude of the dollar's 

effect on infbtion depends on the specific model used, 

1. r'<>r more detail, see Joseph Gruber, Andrew McCallum, 

and Robert J. Vigfusson (2016), "The Dollar in the US 

International Transactions (USlT) Model," IFDP Notes 

(Washington; Board of Governors of the Federal Reserve 

System, FebruJry 8), wwwJederalreserve.gov/econresdata/ 

notes/ifdp-notes/2016/the-dollar-in-the-us-internation<~ltransactions-mode!-20 160208. htm!. 

2. This model was discussed in a recent speech by Chair 

Yellen and is described in its appendix. See janet L Yellen 

"lni!arion Dynamics and Monetary Policy," 

the Philip Gamble Memorial lecture, 

Massa<chusetts, Amherst, Mass., September 24, www. 

fcdera!reserve.gov/newseventslspeech/ye!len20150924a.htm. 

MONETARY POLICY REPORT: FEBRUARY 2016 9 

this exercise suggests that the stronger dollar has played 

a material role in holding down PCE inflation. 

Although further declines in energy prices or a 

further rise in the exchange value of the dollar are 

certainly possible, those movements will eventually 

stop. As these prices stabilize, the drag on consumer 

price inflation from oil and import prices will dissipate. 

Moreover, with margins of resource utilization having 

already diminished appreciably and longer-run inflation 

expectations reasonably stable, both core and overall 

inflation are likely to rise gradually toward 2 percent 

over the medium term as these transitory factors fade 

and the labor market improves further. 

B. Effect of 10 percent appreciation on core PCE inflation 

Quarters after shock DemiiJOn from baselme (percentage JXHI'lL~). annual r;~.te 

-·--------~-· _._ .. ~ ~·-----

+ 

------~"··~·-----=:::::::==~- 0.0 

-0.1 

0.2 

0.3 

0.4 

-05 

Nor.E: TI1e x·axis represents the quarters followmg the 10 percent 

appreciation shock 

SouRct: Federal Reserve Board staff calculattons based on an econometric 

model descnbed in the appendix to Janet L Yellen (2015), "InflatiOn 

Dynarmcs and Monetary Policy," speech delivered at the Philip Gamble 

Memorial Lecture, University of Massachusetts. Amherst, Mass., September 

24, www.federalreserve gov/ncwsevcn1slspeedv'ydlcn20 l50924a.h!m. 
77 


23566.022

1 0 PART 1 o RECENT fCONOMIC AND fiNANCIAl DEVELOPMENTS 

9, Median inflation expectations 

-~ 

~ SPF expectatiOns 

for next 10 years 

2002 2004 2006 2008 2010 2012 2014 2016 

NoTE: lbe Mlch1gan survey data are monthly The SPF data for inflation 

expectattons for personal consumpuon expenditures are quarterly and extend 

IJom 2007.Ql through 2015.Q4 

SoURCE: University of Michigan Surveys of Consumers; Federal Reserve 

Bank of Philadelphm, Survey of Professional Forecasters (SPF) 

lO. 5-to-10-year-forward inflation compensation 

Week!;.------- -----

4"0 

3,5 

30 

25 

2.0 

1.5 

Non:· lbe data are weekly averages of daily data and extend tlu·ough 

February 3, 2016, for inflat10n swaps, and February 4, 2016, for TIPS 

breakevens. TIPS is Tre.'lsury inflation-Protected Secunties 

SOURcE: Federal Reserve Bank of New York; Hardays, Fctkral Reserve 

Board staff estimates . 

11. Change in real gross domestic product, gross domestic 

income, and private domestic final purcha,;;es 

_______ l'ercent.aunualmhJ 

• Gross domestJC product 

Ill Gross domestic income 

Private domestic final purchases 

L-l _"""-L"--" _t" 

2009 2010 

* Gross domestic income is not yet avai!ahlc for 20 15·H2 

SouRcE: Depa1tmenl of Commerce. Bureau ofEconom1c Analysis 

Survey- and market-based measures of 

inflation expectations have moved down 

since june 

Wage- and price-setting decisions arc likely 

influenced by expectations for inflation" Survey 

measures of longer-term inflation expectations 

have been quite stable over the past 15 years 

but appear to have moved down some lately, 

including over the past 6 months, to the lower 

end of their historical ranges" This decline has 

occurred both for the measure of inflation 

expectations over the next 5 to I 0 years 

as reported in the University of Michigan 

Surveys of Consumers and for the median 

expectation for the annual rate of increase in 

the PCE price index over the next I 0 years 

from the Survey of Professional Forecasters, 

conducted by the Federal Reserve Bank of 

Philadelphia (figure 9)" Market -based measures 

of medium- (5-year) and longer-term (5-to10-year-ahead) inflation compensation derived 

from the difference between yields on nominal 

Treasury securities and Treasury InflationProtected Securities moved down further, on 

net, over the second half of the year after 

having declined notably between mid-2014 

and mid-2015 (figure 10)" Although changes in 

inflation compensation could reflect changes 

in expected inllation, they also may reflect a 

variety of other considerations, including an 

inflation risk premium, liquidity premiums, 

and other factors"' 

Economic activity expanded at a 

moderate pace in the second half of 2015 

Real GDP is reported to have increased at an 

annual rate of IV. percent in the second half 

of last year, slower than the first-half pace 

(figure II)" As in the first half of the year, 

economic activity during the second half 

was supported by solid gains in private 

I. For further discussion of inferring inflation 

expectations from market-based measures, sec the box 

"Challenges in Interpreting Measures of Longer-Term 

Inflation Expectations." in Board of Governors of the 

Federal Reserve System (2015), Monetary Polhy Report 

(Washington: Board of Governors. February), www. 

fcdcralreservc"gov/monctarypo1icylmpr_20 1 50224 __ part 1 "htm 
78 


23566.023

domestic final purchases-that is, final 

purchases by households and businesses---

and by modest increases in government 

purchases of goods and services. By contrast, 

aggregate demand continued to be held down 

by weak export performance, reflecting the rise 

in the foreign exchange value of the dollar 

and sluggish foreign economic growth. 

In addition, inventory investment slowed 

markedly from its elevated first-half pace, 

thereby reducing overall GDP growth in the 

second half of 2015. 

Gains in income and wealth arc 

supporting consumer spending ... 

Real personal consumption expenditures rose 

at an annual rate of 2'1, percent in the second 

half of 2015, about the same as the first-half 

pace (figure 12). These increases have been 

supported by income gains from the improving 

labor market as well as the fall in gasoline 

and other energy prices, which has bolstered 

consumers' purchasing power. As a result, real 

disposable income-that is, income after taxes 

and adjusted for price changes--rose a robust 

31

/z percent in 2015 after a similar gain in 2014. 

Consumer spending last year was also likely 

supported by further increases in household 

net worth. Although the value of corporate 

equities edged down last year, prices of 

houses---- which are owned much more widely 

than are corporate equities-posted significant 

gains, and the wealth-to-income ratio remained 

elevated relative to its historical average 

(figure 13). In nominal terms, national house 

price indexes are now close to their peaks of 

the mid-2000s, but relative to rents, house price 

valuations are much lower than a decade ago 

(figure 14). 

Coupled with low interest rates, the rise in 

incomes has lowered debt payment burdens for 

many households. The household debt service 

burden-the ratio of required principal and 

interest payments on outstanding household 

debt to disposable income, measured for the 

household sector as a whole-has remained 

at a very low level by historical standards 

MONETARY POLICY REPORT: FEBRUARY 2016 11 

12. Change in real personal consumption expenditures 

and disposable personal income 

11 Personal consumption expenditures 

Disposable persona! income 

Hl H2~ 4 

._L___,-L___,_l I _____ __! __ L_L.J 

2009 2010 2011 2012 2013 2014 2015 

SouRcE· Department of Commerce, Bureau ofEconom1c Analysis 

13. Wealth-to-income ratio 

Q""'_"'-'----

-- 6.5 

6.0 

5.5 

5.0 

LLLLL U_l_LLLLLLLLI 1995 1999 2003 2007 2011 2015 

Norc· The data extend through 2015.Q3. lhc series is the ratiO of 

household net worth to disposable personal income 

For net worth, Federal Reserve Board, Statistical Release Z L 

Accounts of tl1e United States". for mcome, Department of 

Commerce, Bureau of Economic Analysis 

14. Nominal house prices and price-rent ratio 

!'.101lth!y Index 

200 

190 

180 

170 

160 

150 

130 

120 

110 

100 

90 

RO 

70 

Noll'.. lhe data e:-;;tend thmugh December 2015. ll1c Corclogic price 

index is seas.onaHy adjusted by Federal Reserve Board staff. l11e pricc"rent 

ratio is the ratio of nominal house pnccs to the consumer price index of rent 

of primary residence. lhe data are indexed to !00 m January 2000 

SoVRCf.: For prices, C'oreLogic; for rents, Department of labor, Bureau of 

Labor Statistics. 
79 


23566.024

1 2 PART 1: RECENT ECONOMIC AND FINANCIAl DEVElOPMENTS 

15. Household debt service 

_<l<>_:_""_"c..''-----------'-"-""_tofd!sposab!emcome 

14 

13 

12 

ll 

10 

LllLLLLLU_LI II 111111!!! 111!11111! I II!! I 1983 1987 J9t)J 1995 1999 2003 2007 2011 2015 

Norr. 'l"he data extend through 20 l5:Q3. Debt scrv1ce payments consist of 

estimated required payments on outstanding mortgage and consumer debt 

SOURCE: Federal Reserve Board, Statistical Release, "Household Debt 

Service and Financ1al Obligations Ratios." 

16. Changes in household debt 

Bllll<msofdollars . .annualrate 

Mortgages 

B Consumer credit 

-Sum 

L_i_~L~- L _ _j 

2007 2008 2009 2010 2011 2012 20!3 2014 2015 

1,000 

800 

600 

400 

200 

200 

400 

600 

Nor"E. Changes are calculated from year~end to year-end, except 2015 

changes, which are calculated from Q3 to Q3 

SouRCE: Federal Reserve Board, Statisucal Release Z.l, "Financial 

AccOlmt~ of the !Jnited States,. 

17_ Indexes of consmner sentiment and income expectations 

01ffuSn:mmde.' lm!e't 

100 110 

·-- 9() 100 

90 

80 

80 

70 

70 

60 60 

50 50 

N01 E: The data are three-month movmg averages and extend through 

January 2016 Consumer sentiment is indexed to 100 in 1%6. Rea! income 

expectations arc calculated as the net percent of survey respondents ex"{)ectmg 

family inwme to go up more than prices dunng the next year or two 

SOURCE: University of\11chigan Surveys of Consumers 

(figure 15). As interest rates rise, the debt 

burden will move up only gradually, as most 

household debt is in fixed-interest products. 

... as is credit availability 

Consumer credit continued to expand 

moderately through late 2015, as lending 

standards for both auto lending and student 

loans remained accommodative (figure 16). 

In addition, credit card lending has been 

rebounding since early last year. Standards 

and terms on credit cards are still relatively 

tight for riskier borrowers, although there 

has been some modest increase in access for 

borrowers with subprime credit histories. 

Delinquencies on credit card and auto loans 

are still near historical lows, in part due to the 

tight standards. 

Consumer confidence remains high 

Household spending has also been supported 

by favorable consumer sentiment. For the 

past year or so, the overall index of consumer 

sentiment from the University of Michigan 

Surveys of Consumers has registered levels 

comparable to those that prevailed before 

the recession (figure 17). Rising real incomes. 

partly driven by falling energy prices and 

improvements in the labor market, have likely 

driven up consumer confidence. These same 

factors are probably behind the more upbeat 

expectations that households report for real 

income changes over the next year or lwo, 

which are now near pre-recession levels. 

Residential construction has improved 

modestly 

The gradual recovery in residential 

construction activity continued over the second 

half of last year. Both single- and multifamily 

housing starts registered moderate increases 

in 2015 (figure 18). Sales of new and existing 

homes also rose moderately, abstracting from 

the temporary plunge in existing home sales 

in November, which reportedly rcllected 

a lengthening in closing times due to new 

mortgage disclosure rules (figure 19). But 

while multifamily starts have recovered to their 
80 


23566.025

pre-recession level, single-family construction 

continues to be well below its earlier pace. The 

level of housing starts is still being held down 

by a meager pace of household formation, 

tighter-than-average mortgage credit supply, 

and shortages of skilled labor and other inputs 

in the construction sector. 

Although the October 2015 and January 2016 

Senior Loan Officer Opinion Survey on 

Bank Lending Practices (SLOOS) reports 

suggest that a gradual easing of bank lending 

standards has continued over the past six 

months, mortgage credit is still difficult to 

access for borrowers with low credit scores, 

undocumented income, or high debt-toincome ratios2 For borrowers who can obtain 

credit, interest rates on mortgages remain near 

their historical lows, although they inched 

up, on net, over the second half of the year 

(figure 20). In 2015, outstanding mortgage 

debt rose for the first time since the recession 

as mortgage originations for home purchases 

increased and write-downs of mortgage debt 

continued to ebb. 

Overall business investment has slowed 

as a result of a sharp drop in investment 

in the energy sector 

Business investment (private nonresidential 

fixed investment) rose at an annual rate of 

only Yi percent during the second half of 2015 

after increasing at a 3 percent pace during the 

first half of the year (figure 21). Spending on 

equipment rose modestly, and a bit faster than 

during the first half of 2015, but spending on 

intangibles, such as research and development, 

and investment in structures outside of 

drilling and mining flattened out after posting 

strong gains during the first half of the year. 

Investment in structures used in the energy 

sector continued to fall precipitously, as the 

drop in oil prices has scuttled investment in 

higher-cost oil and gas wells. For the year as a 

whole, the pace of overall business investment 

2. The SLOOS is available on the Board's website at 

www.fcderalreserve.gov/boarddocs/snloansurvey. 

MONETARY POLICY REPORT: FEBRUARY 2016 13 

18. Private housing starts and pem1its 

Month!~ M!lhonsoftnuts.armualrate 

18 

14 

1.0 

19. New and existing home sales 

Mdhons.arumalrate M!lhons.annualrate 

I 8 

16 

7.5 

7.0 

6.5 

6.0 

55 

Exi~!ing bnme sales I 4 

5.0 

45 

40 

3.5 

L2 

1.0 

NOTE 'flle data extend through December 2015. "Ex1stmg home sales" 

includes single-family, condo, townhome, and co .. op sales 

SoURCE: For new single-fam1ly home sales, Census Bureau; for existmg 

bome sales, National As.socJation of Realtors 

20. Mortgage rates and housing affordability 

lnde~ 

:\1ortgag_cratcs 205 

185 

165 

145 

125 

105 

85 

2006 2008 2010 2012 2014 2016 

NoTE· The housmg affordab1hty mdex data are monihly lhrough 

November 2015 and t11e mortgage rate data are weekly through Febmary .'L 

2016. At an index value of 100, a median-income family has exactly enough 

income to qualify for a median-priced home mortgage. Housing a!Tordablhty 

is seasonally adjusted by Board staff 

SOURCE For housmg aiTordabihty index, Nat!OIJal AssociatJon of Realtors; 

lOr mortgage rates, Freddie Mac Pnmary Mortgage Market Survey 
81 


23566.026

14 PART 1; RECENT ECONOMIC AND fiNANCIAl DEVElOPMENTS 

21. Change in real private nonresidential fixed investment 

PercenLannualrate 

-----------------

113 Structures 

II Equipment and intangible capital 16 

32 

SouRCE' Department of Commerce, Bureau of Ewnomic Analysis 

22. Selected components of net financing for nonfinancial 

businesses 

Bt!honsofdo!lars,month!)·rate 

Ill Commercial paper 

fiR Bonds 

II Bank loans 

-Sum 

HI 

80 

60 

40 

20 

20 

40 

Norr: The da1a for the components except bonds are seasonally adjusted 

SouRCE Federal Reserve Board, Statistical Release Z.l, ''Financial 

Accow1ts of the United States·· 

23. Corporate bond yields, by securities rating 

Perccntagepomt~ 

[_LLLLLLLLLLLLLLLLLLLLLJ 1998 2001 2004 2007 2010 20l3 2016 

Non:. The y1elds shown are y1elds on 1 0-ycar bonds 

So\JR(E BofA Merrill Lynch Global Research. used w1tb. penmssJOU 

20 

!8 

!6 

!4 

!2 

10 

8 

slowed compared with 2014, mostly as a result 

of the drop in the energy sector. Investment 

has been supported by low interest rates and 

financing conditions that are still generally 

accommodative, though somewhat less so 

than earlier. 

Corporate financing conditions have 

become somewhat less supportive 

Domestic financial conditions for nonfinancial 

firms have become somewhat less supportive 

of growth since last June, particularly for 

non-investment-grade firms. Equity prices have 

declined and bond spreads have widened amid 

concerns about the global economic outlook 

and oil prices. Downgrades of bonds issued by 

nonfinancial companies have increased, and 

the leverage of these companies is near the 

top end of its range over the past few decades. 

Nonetheless, profitability has remained high 

outside the energy sector. Against a backdrop 

of low interest rates, investment-grade 

nonfinancial businesses have continued to raise 

substantial amounts of funds in bond and 

loan markets since last June, in part to finance 

mergers and acquisitions activity (figure 22). 

Speculative-grade bond issuance also was solid 

for much of 2015 but diminished toward the 

end of the year as spreads widened notably, 

particularly for firms in the energy sector 

(figure 23). 

Loan demand remained strong across most 

major categories through the end of 2015. 

Of note, demand for commercial real estate 

(CRE) loans strengthened further and 

issuance of commercial mortgage-backed 

securities (CMBS) remained robust Credit 

conditions tightened for this sector as concerns 

about credit quality led to wider spreads 

on CMBS and, according to the results of 

the October and January SLOOS reports, a 

moderate number of banks had tightened 

lending standards for CRE loans, particularly 

for construction and land development A 

modest fraction of banks also reported having 

tightened lending standards for commercial 

and industrial loans to firms of all sizes since 

the second quarter. 
82 


23566.027

The from federal fiscal policy has 

ended ... 

After being a drag on aggregate demand 

during much of the expansion, federal fiscal 

policy has shifted to a more neutral stance as 

fiscal consolidation efforts have abated. During 

2015, policy actions had little effect on taxes 

and transfers, and real federal purchases of 

goods and services edged up (figure 24). 

The federal budget deficit narrowed further in 

fiscal year 2015 to 2'h percent of GOP, largely 

reflecting the increase in tax receipts owing to 

the ongoing economic expansion as well as the 

modest increase in purchases (figure 25). A 

deficit of this size is small enough to stabilize 

the ratio of the debt held by the public to 

nominal GOP; that said, the current level of 

that ratio is elevated relative to its average 

over the post-World War II period (figure 26). 

The Congressional Budget Office projects the 

deficit to move up to about 3 percent of GOP 

in Jisca12016. 

... and state and local government 

expenditures are rising moderately 

Fiscal conditions of most state and local 

governments continue to improve gradually. 

Tax revenues have been rising moderately, 

supported by the expansion of economic 

activity and increasing house prices. These 

governments boosted spending at a moderate 

rate in 2015. In particular, real state and 

local purchases of goods and services rose 

1 y, percent last year, as employment posted 

another modest gain and real construction 

spending rose markedly for the first time since 

the recession (figure 27). 

In contrast, net exports still held down 

growth in gross domestic product slightly 

Exports held about flat in the second half of 

2015, weighed down by the appreciation of the 

dollar and by soft foreign economic growth 

(figure 28). Although the stronger dollar made 

imports more affordable, import growth was 

also relatively subdued. Imports for inputs 

related to oil exploration and production 

MONETARY POliCY REPORT: FEBRUARY 2016 15 

24. Change in real government expenditures on 

consumption and investment 

Perceot.mmualrale 

Federal 

Ill State and local 

2010 20li 2012 2013 2014 

So\JRCE Department of Commerce, Bureau of EconomiC AnalySIS 

25. Federal receipts and expenditures 

Anmci Percentofnomma!GDP 

Expenditures 26 

24 

22 

Receipts 20 

/\_/ 18 

16 

14 

NoTE. The recc1pts and expenditures data are on a unified~budget baSIS and 

arc for fiscal years (October through September); gross domestic product 

(GOP) data are for the four quarters ending in Q3 

SouRn:: Office of Management and Budget. 

26. Federal government debt held by the public 

Quarterly 

90 

80 

70 

60 

40 

30 

20 

Non, The data extend through 2015:Q3. The data fOr gross domestic 

prodttct (GDP) are at an annual rate Federal debt held by the pubhc equals 

federal debt less Treas<uy secunties held in federal employee defined benefit 

retirement accounts, evaluated at the end of the quaner. 

SouRcE. For GOP, Department of Commerce, Bureau of Econom1c 

Analysts; for federal debt, Federal Reserve Board, Statisllcal Release Z.l, 

"Ftnancial Accounts oftl1e United States" 
83 


23566.028

16 PART 1: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

27. State and local employment and structures investment 

B•llums of chamed (2009) dollars, llruluaJ ra!e Emplov«.>s m m!l!wos 

~-------- --------

320 --·l9.8 

300 -!9.6 

280 

--·19.4 

?60 

-19.2 240 

220 --19.0 

Non;: The employment data are monthly, and the structures <lata are 

q11arter!y 

SoVRCF.: For employment data, Department of Labor, Bureau of Labor 

S!atJstics; for structures data, DepartnH."'tt of Commerce, Bureau of Economic 

Analysis. 

28. Change in real imports and exports of goods 

and services 

Percenl.annualrate 

II Imports 

Exports 

HI 

SouRCE: Department of Commerce, Bureau of Economic Analysis 

29. U.S. trade and current account balances 

!5 

12 

Quancdy Pcrccrl!ofnomma!GOP 

('uJTentaccount 

were particularly weak, consistent with steep 

declines in that industry. In all, real net trade 

continued to be a drag on real GDP growth 

in the second half of 2015. Although the 

real trade balance deteriorated, the nominal 

trade balance was little changed in 2015 in 

part because the value of imports declined, 

largely because of the decline in oil prices. 

Still, the current account deficit widened a bit 

to ncar 3 percent of nominal GDP as U.S. net 

investment income declined (figure 29). 

Financial Developments 

The expected path for the federal funds 

rate over the next several years declined 

Despite further strengthening in labor market 

conditions and a range of other indicators 

that market participants viewed as consistent 

with continued expansion in the U.S. economy, 

market -based measures of the expected path 

of the federal funds rate over the next several 

years have moved down, on balance, since the 

middle of last year. Contributing to this shift 

were concerns abont the foreign economic 

outlook and global disinllationary pressures, 

as well as Federal Reserve communications 

anticipating that economic conditions will 

warrant only gradual increases in the federal 

funds rate. Survey-based measures of the 

expected path of policy also moved down. 

According to the results of the most recent 

Survey of Primary Dealers, conducted by the 

Federal Reserve Bank of New York just prior 

to the January FOMC meeting, respondents' 

expectations for the federal funds rate target 

at the end of this year and next year were 

lower than those reported last June. Marketbased measures of uncertainty about the 

policy rate approximately one to two years 

ahead declined, on balance, from their mid20 15 levels. 

Longer-term Treasury yields decreased 

Yields on longer-term nominal Treasury 

securities have declined since the middle of 

last year on net (figure 30). The decreases in 

nominal yields largely reflected reductions 
84 


23566.029

in inflation compensation; yields on longterm inflation-protected Treasury securities 

were little changed. Participants in the U.S. 

Treasury market reportedly were particularly 

attentive to developments abroad, especially 

turbulence in Chinese financial markets, and 

to fluctuations in oil prices. Consistent with 

the changes in yields on Treasury securities, 

yields on 30-year agency mortgage-backed 

securities (MBS)--an important determinant 

of mortgage interest rates----decreased, on 

balance, over the second half of 2015 and early 

2016 (figure 31). 

Broad equity price indexes decreased ... 

Since the middle of last year, amid 

considerable volatility, broad measures of 

U.S. equity prices have decreased notably, on 

net, as concerns about the foreign economic 

outlook appeared to weigh on risk sentiment 

and the outlook for corporate earnings growth 

(figure 32). Stock prices for companies in the 

energy and basic materials sectors dropped 

sharply, reflecting the continued fall in oil and 

other commodity prices. Implied volatility for 

the overall S&P 500 index, as calculated from 

options prices, increased, on balance, since 

the middle of last year; at times, its movement 

was notable . 

. . . and risk spreads on speculative-grade 

corporate bonds moved up substantially, 

particularly for firms in lne energy sector 

Credit spreads in the corporate sector have 

widened across the credit spectrum. The 

spread of yields on investment-grade corporate 

bonds to yields on Treasury securities of 

comparable maturity rose moderately, and 

credit spreads on speculative-grade bonds 

widened substantially. Spreads for firms in the 

energy sector increased particularly sharply, 

reflecting the further drops in the price of 

oil since late June. Mutual funds investing in 

speculative-grade bonds experienced significant 

outflows over the second half of 2015 and 

early 2016, and, in December, redemptions 

from one such fund were suspended. During 

the second half of last year, the respondents 

MONETARY POliCY REPORT: FEBRUARY 2016 17 

30. Yields on nominal Treasury securities 

NoTE" The Treaswy ceased pubhcation of the 30-year constant maturity 

series on Febmary 18, 2002, and resumed that series on February 9, 2006 

SoURcE: Department of the Treasury. 

31. Yield and spread on agency mortgage~ backed 

securities 

_P_cr_ooo_' ----------·------Bam points 

400 

350 

300 

250 

--- 200 

150 

JOO 

50 

Nou:_ The data are daily. Y1eld shov.n is for the Fannie Mae 30~ycar 

current coupon, the coupon rate at which nevt mortgage-backed secuntws 

would be priced at par, or face, value. Spread shown is to the average of the 

5- and 10-year nominal Treasury yields 

SoURce: Department of the Treasury; Bardays 

32. Equity prices 

December3L2001"" 100 

----------------

160 

140 

120 

100 

so 

60 

40 

20 

NoTE: For Dow Jones Indices licensing informatiOn, sec lhe note on the 

Contents page 

SouRcE The Dow Jones Bank Index and the S&P 500 Index are a product 

of S&P Dow Jones Indices LLC and/or its affiliates 
85 


23566.030

18 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

to the Senior Credit Officer Opinion Survey 

on Dealer Financing Terms reported a 

moderate deterioration in liquidity and market 

functioning in speculative-grade corporate 

bonds and some tightening of the terms under 

which dealers were willing to provide financing 

to clients against such bonds.' In addition, 

some metrics of corporate bond market 

liquidity suggest a slight deterioration over the 

second half of 2015 and early 2016, though 

most indicators remain at levels comparable 

with those seen prior to the crisis. For further 

discussion of corporate bond markets and 

other financial stability issues, see the box 

"Developments Related to Financial Stability." 

Short-term funding markets continued to 

function well 

Short-term dollar funding markets have 

functioned smoothly during the second half 

of 2015 and early 2016. Markets for unsecured 

offshore dollar funding and repurchase 

agreements, or repos, generally did not exhibit 

signs of stress. Year-end funding pressures 

were modest. 

Money market participants continued to focus 

on the Federal Reserve's use of its monetary 

policy tools. These tools proved elfective in 

raising the federal funds rate following the 

FO M C's decision to increase the target range 

in December, while other money market rates 

also moved up broadly in line with the increase 

in the federal funds target range. For a detailed 

discussion, see the box "Monetary Policy 

Implementation following the December 2015 

FOMC Meeting" in Part 2. 

Treasury market functioning and liquidity 

conditions in the mortgage-backed 

securities market were generally stable 

Indicators of Treasury market functioning 

have remained broadly stable over the second 

half of 2015 and early 2016. A variety of 

3. More information on the Senior Credit Officer 

Opinion Survey on Dealer Financing Terms is available 

on the Board's website at www.federalreservc.gov/ 

econresdata/rcleases/scoos.htm. 
86 


23566.031

liquidity metrics-including bid-asked spreads 

and bid sizes-have displayed no notable signs 

of liquidity pressures over the same period. 

In addition, Treasury auctions generally 

continued to be well received by investors. 

Liquidity conditions in the agency MBS 

market were also generally stable. Dollarroll-implied financing rates for production 

coupon MBS-an indicator of the scarcity of 

agency MBS for settlement--suggested limited 

settlement pressures over the second half of 

2015 and early 2016. 

Bank credit has continued to expand and 

ban!< rose further 

Aggregate credit provided by commercial 

banks increased at a solid pace in the second 

half of 2015 (figure 33). The expansion in bank 

credit was mainly driven by strong growth 

in loans coupled with an increase in banks' 

holdings of agency MBS. The growth of loans 

on banks' books was generally consistent with 

the SLOOS reports of increased loan demand 

for many loan categories. 

Measures of bank profitability remained 

below their historical averages but improved 

slightly during the third quarter of 2015 (the 

latest available data), supported by lower 

nonintcrest expenses (figure 34). Net interest 

margins were about unchanged, on average, 

during the third quarter. Delinquency and 

charge-otl rates for most major loan types 

were generally stable, near or at their lowest 

levels since the financial crisis. 

Among large bank holding companies (BHCs), 

despite generally positive third- and fourthquarter earnings reports, equity prices have 

decreased markedly, on balance, since the 

middle of last year. The decline in bank equity 

prices likely reflected concerns about global 

growth, the etlccts of a flatter yield curve 

on the outlook for bank profitability, and 

potential losses due to the decrease in energy 

prices. Credit default swap (CDS) spreads for 

large BHCs increased on net. 

MONETARY POLICY REPORTc FEBRUARY 2016 ] 9 

33. Ratio of total commercial bank credit to nominal gross 

domestic product 

Quarter!~._· ---- Percent 

75 

70 

-~ 65 

60 

55 

I l!!!l!!!l!!II.Utl!!!ll!!l!!!l!I!!Jt!!t!!l!!ll ! 

2005 2007 2009 20ll 2013 2015 

SouRcE: federal Rest'fVe Board, Statistical Release H.R, "Assel~ and 

Liabilines of Commercial Banks in the United States''; DepartmeJJt of 

Commerce, Bureau ofF..(;()nomic Analysis 

34. Profitability of bank holding companies 

P..rcenf.annualrate l'ercent,ann!.lalrate 

Retumonassets L5 -- 20 

TO 

10 

I 0 

20 

Reserve Board, FR Y-9C, Consolidated Financial 

Statements !Or Bank Holding Compames 
87 


23566.032

20 PART 1: RECENT ECONOMIC AND FINANCIAl DEVELOPMENTS 

Developments Related to Financial Stability 

Financial vulnerabilities in the U.S. financial system 

overall have continued to be moderate since mid-2015. 

Regulatory capital and liquidity ratios at large banking 

firms are at historically high levels, and the use of 

short-term wholesale funding remains relatively !ow. 

Debt growth in the household sector continues to be 

modest and concentrated among borrowers with strong 

credit histories. Some areas where valuation pressures 

were a concern have cooled recently; in particular, 

risk premiums for below-investment-grade debt have 

widened. However, high leverage of nonfinancial 

corporations makes some firms highly vulnerable to 

adverse developments, such as lower oil prices or 

slowing global growth, 

Vulnerabilities owing to leverage and maturity 

transformation in the financial sector remain low. 

Regulatory capital ratios at U.S, banking firms 

increased further in the third quarter of 2015, and 

holdings of high-quality liquid assets at banking firms 

also remain at very high levels. In addition, some of the 

largest domestic banks have reduced their reliance on 

potentially less stable types of short-term funding. The 

aggregate delinquency rate on bank loans declined to 

its lowest level since 2006, though delinquency rates 

on loans to the oil and gas industry, which account for 

a small share of most banks' portfolios, have increased. 

Bank underwriting practices in the leveraged loan 

market have improved, on balance, over the past 

year but occasionally still fall short of supervisory 

expectations. Moreover, domestic banking firms have 

only limited exposure to emerging market economies. 

However, developments in foreign economies and 

financial markets, particularly an escalation of recent 

volatility or a worsening of the outlook for China, could 

transmit risks through indirect financial linkages. 

Net secured borrowing by dealers, primarily used 

to finance their own portfolios of securities, continued 

to decrease and is near historical lows, while securities 

financing activities aimed at facilitating clients' 

transactions also remain at low levels. The fatter is 

consistent with reports that dealers have tightened 

price terms for securities financing and derivatives. The 

volume of margin loans outstanding-an important 

component of overall leverage used by hedge fundsappears to have moderated. Short-term funding 

levels remain relatively low, though reforms aimed at 

reducing structural vulnerabilities in those markets are 

still being implemented. 

Overall asset valuation pressures have eased. 

Corporate bond spreads increased notably and are 

now above their historical norms (figure A). Those 

spreads appear to have risen by more than the 

compensation required for higher expected losses, 

suggesting risk premiums have also increased. Issuance 

A. Corporate bond spreads to similar-maturity Treasury 

securities 

Month!\' Percent 

High·yield spread 

!5 

13 

II 

NOTE. The spread is the I O·year yield for corporate bonds less the 1 0-year 

Treasury yield; bond yields are estimated from a smoothed curve fit to OOnd 

yields. and Treasury yield.~ are estimated from a smoothed curve fit to 

off·tlJe-run Treasury securities 

SOURCE: Department of the Treasury; SofA Merrill Lynch Global 

Research, used with perm1ssion. 

of speculative-grade bonds and leveraged loans has 

slowed significantly, which also could reflect, in 

part, an increase in investors' risk aversion. Despite 

the volatility, most indicators of liquidity conditions 

in corporate bond markets, such as trading volumes 

and bid-asked spreads, deteriorated only slightly. 

Nonetheless, the suspension of redemptions in 

December by a high-yield hond mutual fund that 

had a high concentration of very low-rated debt and 

had experienced persistent outflows high lighted a 

vulnerability at open-end mutual funds that offer 

daily redemptions to investors while holding 

Jess-liquid assets. 

Commercia! real estate prices continued to rise, 

supported in part by improved fundamentals, and 

commercial real estate lending by banks accelerated 

in recent quarters. However, spreads on securities 

backed by commercial mortgages widened further 

and bank lending standards reportedly have tightened 

since july, suggesting that financing conditions have 

become- a little less accommodative. In addition, late 

last year, federal banking regulators issued a joint 

statement reinforcing existing guidance for prudent risk 

management in that sector. 1 Residential home prices 

also continued to increase. However, price-to-rent 

ratios do not suggest that valuations are notably above 

1 _ See Board of Governors of the Federal Reserve System, 

Federal Deposit and Office of the 

Comptroller of the Currency 

on Prudent Risk Manae,ement 
88 


23566.033

historical norms, and residential mortgage debt growth 

remains minimal. 

Broad equity indexes have declined significantly 

since July 2015, and forward price-to-earnings ratios 

have fallen to a level closer to their averages of the past 

three decades. Yields on longer-term Treasury securities 

decreased over that period, and estimates of term 

premiums remained low. Because many assets are priced 

based on Treasury yields, their low level continues to 

pose a risk to valuations of assets that have lower-thanaverage earnings yields. However, in December, the 

Federal Reserve's increase in the target range for the 

federal funds rate did not result in significant changes in 

longer-term interest rates or their volatility. 

The ratio of private nonfinancial sector credit to 

gross domestic product remains below estimates of 

its long-term upward trend, reflecting subdued levels 

of household debt. Debt growth in the nonfinancial 

business sector has slowed in recent months, 

particularly among speculative-grade and unrated firms. 

However, leverage of such firms has risen to historical 

highs, especially among those in the oil industry, a 

development that points to somewhat elevated risks of 

distress for some business borrowers. 

As part of its effort to improve the resilience of 

financial institutions and overall financial stability, 

the Federal Reserve Board has taken several further 

regulatory steps. First, the Board finalized a rule that 

increases risk-based capital requirements for U.S. 

global systemically important bank holding companies 

(G-SIBs)-' The applicable surcharges are calibrated 

based on the systemic footprint of each U.S. G-SIB so 

that the amount of additional capita! a firm must hold 

increases with the costs that its failure would impose 

in terms of U.S. financial stability. The G-SIB surcharge 

rule is designed to ensure that U.S. G-SIBs either hold 

substantially more capital, reducing the likelihood 

that they will fail, or choose to shrink their systemic 

footprint, reducing the harm that their failure would do 

to the financial system. 

Second, the Board announced that it is seeking 

public comment on its proposed framework for 

setting the Countercyclical Capital Buffer (CCyB) 

and voted to affirm the CCyB amount at the current 

level of 0 percent--consistent with the continued 

moderate level of financial vu!nerabi!ities. 3 The 

2. See Board of Governors of the Federal Reserve System 

(2015}, "f-ederal Reserve Board Approves Final Rule Requiring 

the largest, Most Systemically Important U.S. Bank Holding 

Companies to Further Strengthen 1heir Capita! Positions;' press 

release, July 20, www.federalreserve.gov/newsevents/press/ 

bcregl20150720a.htm. 

3. See Board of Governors of the Federal Reserve System 

(2015}, "FederJ! Res~rv{> Board SE'€'ks Public Comment on 

MONETARY POLICY REPORT: FEBRUARY 2016 21 

buffer is a macroprudential tool that can be used 

to increase the resilience of the financial system by 

raising capital requirements on internationally active 

banking organizations when there is an elevated risk 

of above-normal losses in the future. The CCyB would 

then be available to help those banking organizations 

absorb shocks associated with worsening credit 

conditions, and it may also help moderate fluctuations 

in the supply of credit. In releasing the framework 

for comment, the Board consulted with the Federal 

Deposit Insurance Corporation and the Office of the 

Comptroller of the Currency. Should the Board decide 

to increase the CCyB amount in the future, banking 

organizations would have 12 months before the change 

became effective, unless the Board established an 

earlier effective date. 

Third, the Board issued for public comment a proposed 

rule that would impose total loss-absorbing capacity and 

long-term debt requirements on U.S. G-S!Bs and on the 

U.S. operations of certain foreign G-SIBs.' The proposal 

would require each covered firm to maintain a minimum 

amount of unsecured long-term debt that could be 

converted into equity in a resolution of the firm, thereby 

recapitalizing the finn without putting public money at 

risk. The proposal would diminish the threat that a G-SIB's 

failure would pose to financial stability and is an important 

step in addressing the perception that certain institutions 

are "too big to fail." 

Finally, the Board, acting in conjunction with 

other federal regulatory agencies, issued a final 

rule imposing minimum margin requirements on 

certain derivatives transactions that are not centrally 

deared.5 The swap margin rule will reduce the risk 

that derivatives transactions would act as a channel for 

fin;mcia! contagion and, by imposing higher margin 

requirements on uncleared swaps than apply to cleared 

swaps, will incentivize market participants to shift 

derivatives activity to central clearinghouses. 

Proposed Polley Statement Detailing the Framework the Board 

Would r-ollow in Setting the Countercyclical Capital Buffer 

(CCyB)," press rdease, December 21, www.federalreserve.gov/ 

newsf.'vents/pressAxreg/201.'> 1221 b.htm. 

4. See Board of Governors of the Federal Reserve System 

(2015), "Federal Reserve Board Proposes New Rule to 

Strengthen the Ability of largest Domestic and Foreign 

Banks Operating in the United States to Be Resolved without 

Extraordinary Government Support or Taxpayer Assistance," 

press release, October 30, www.federalreserve.gov/ 

newsevents/presslbcreg/20151 030a.htm. 

5. See Board of Governors of the Federal Reserve System, 

redera! Deposit Insurance Corporation, Office of the 

Comptroller of th(• Currency, Farm Credit Administr<Jtion, and 

Federal Housing Finance Agency (2015), "Agencies Finalize 

Swap Margin Rule," joint press release, October 30, www. 

federa!reserve.gov/newsevents/press/bcreg/20 151 030b.htm. 
89 


23566.034

22 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

35. U.S. dollar exchange rate indexes 

130 

125 

120 

115 

110 

105 

100 

95 

Nmc: The data, which are m fore1gn currency units per dollar, arc weekly 

averages of datly data and extend through Febmary 4, 2016 

Federal Reserve Board. Statistical Release H.IO, "Foreign 

The M2 measure of the money stock has 

increased at an average annualized rate of 

about 6 percent since last June, about the 

same pace registered in the first half of 

2015 and faster than nominal GDP growth. 

Demand for liquid deposits has continued to 

boost M2 growth. 

Municipal bond markets functioned 

smoothly, but some issuers remained 

strained 

Credit conditions in municipal bond markets 

have generally remained stable since the middle 

of last year. Over that period, the MCDX · an 

index of CDS spreads for a broad portfolio 

of municipal bonds-and ratios of yields on 

20-year general obligation municipal bonds to 

those on longer-term Treasury securities edged 

up on net. 

Nevertheless, significant financial strains 

were still evident for some issuers. In 

particular, Puerto Rico, which continued 

to face challenges from subdued economic 

performance, severe indebtedness, and other 

fiscal pressures, defaulted on some bond 

issues not backed by guarantees from the 

commonwealth and is seeking to restructure 

its debt. 

International Developments 

The dollar continued to strengthen ... 

The foreign exchange value of the dollar 

rose further, on net, since the middle of 

last year, bringing its increase since mid2014, when the most recent run-up began, 

to over 20 percent by the beginning of 2016 

(figure 35). Expectations that the Federal 

Reserve would soon start increasing its policy 

interest rates, even while most foreign central 

banks maintained or expanded monetary 

policy accommodation, boosted the value 

of the dollar. (For more discussion, see the 

box "Monetary Policy Divergence in the 

Advanced Economies.") The dollar has also 

appreciated against the renminbi since last 

summer, when the People's Bank of China 
90 


23566.035

(PBOC) announced it was changing its policy 

to allow market forces to play a greater role 

in determining the renminbi's exchange rate. 

The PBOC allowed the renminbi to depreciate 

3 percent against the dollar in August and 

another 1 y, percent after the turn of the 

year. These developments, which contributed 

to intensified uncertainty about China's 

exchange rate policy and the prospects for its 

economy, fostered episodes of global market 

turbulence that further boosted the dollar. 

Investors became more focused on downside 

risks to prospects for growth in China and, by 

implication, global growth. These concerns 

about growth, along with still-strong oil 

production and high inventories, contributed 

to a sharp drop in commodity prices, which 

in turn weighed on the currencies of several 

commodity-exporting countries. 

... while equity prices and foreign 

sovereign bond yields have declined 

Triggered in part by the unexpected 

devaluation of the renminbi and an ensuing 

increase in concerns about global economic 

growth, equity indexes have dropped, on net, 

in most emerging market economies (EMEs) 

and advanced foreign economies (AFEs) 

since the beginning of the summer (figure 36). 

In particular, Chinese stock prices tumbled 

more than 40 percent despite official 

interventions, including circuit breakers and 

bans on stock sales, that were intended to mute 

some of the downward pressure. The fall in 

Brazilian stock prices was also very sharp, as 

global market turbulence as well as domestic 

developments, including a corruption scandal, 

declining output, and persistent high inflation, 

prompted stock prices to fall nearly 25 percent 

since last summer. 

As in the United States, I 0-year sovereign 

yields declined in most AFEs, likely in part 

because of increasing concerns about potential 

deflationary pressure amid falling commodity 

prices (figure 37). In the euro area, Greek 

sovereign yields, which had risen sharply in 

the first half of the year, declined substantially 

MONETARY POLICY REPORT: FEBRUARY 201 & 23 

36. Equity indexes for selected foreign economies 

Week!~ Januarv4,2{)13~JOO 

240 

220 

200 

ISO 

!60 

140 

I20 

100 

80 

60 

No1E: The data are weekly averages of daily data and extend through 

February 4, 2016. For Dow Jones Indices licensmg informatiOn, see the note 

on the Contents page. 

SO"L"RCE: For Japan, Tokyo Stock Price Index (TOPIX): for the euro area, 

Dow Jones Euro STOA'X Index; for China, Shanghai Composite Index: ti:x 

emerging markets, Morgan Stanley Emergmg Markets MXEF Capital Index: 

all vm Bloomberg 

37. 1 0-year nominal benchmark yields in selected 

advanced economies 

Weekly 

3.0 

2.5 

2.0 

]5 

I 0 
91 


23566.036

2 4 PART 1 o RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

Monetary Policy Divergence in the Advanced Economies 

As recovery has gradually taken hold in the U.S. 

economy over the past few years, both activity and 

inflation in the advanced foreign economies {AFEs) 

have remained persistently weak. This divergence in the 

economic outlooks for the United States and the AFEs 

has led to expectations of divergence in their monetary 

policies. Although the Federal Reserve raised its target 

for the federal funds rate in December, policy rates 

in most AFfs are near zero (and negative for several 

economies) and are expected to remain low for several 

years. Furthermore, the European Central Bank (ECB) 

and Bank of Japan are providing further monetary 

accommodation through sizable asset purchase 

programs, and both of these central banks have 

indicated that asset purchases will continue, given that 

inflation remains well below target. Given this ongoing 

monetary easing, the average policy rate expected 

by market participants over the next 24 months has 

declined in the euro area and Japan since 2014, while 

that of the federal funds rate gradually increased over 

this period as "liftoff" approached (figure A). 

Two effects of these policy divergences that operate 

through financial markets have important consequences 

for the economies invo!ved. 1 First, and most obviously, 

monetary policy divergences have given rise to changes 

in exchange rates: Portfolio rebalancing by international 

investors toward economies and currencies with higher 

interest rates has put downward pressure on AFE 

currencies, and the dollar has appreciated significantly 

against these currencies since mid-2014 (text figure 35). 

This dollar appreciation has contributed to the drag 

that U.S. net exports have exerted on U.S. economic 

growth in recent quarters, but the stronger dollar also 

has contributed to cyclical stabilization abroad as 

expenditures have shifted toward weaker economies. 

This effect on international trade is also a consideration 

for U.S. and foreign monetary policies: All else being 

equal, a smaller contribution to the U.S. economy 

from the external sector likely points to a more gradual 

pace of policy normalization in the United States. By 

the same token, the economic stimulus from moredepreciated currencies abroad may allow AFE central 

banks to provide less monetary accommodation~-or 

to start removing it earlier-than would otherwise be 

the case. 

Second, the effect of monetary policy actions 

on financial conditions may spill over to interest 

rates in other countries. For example, on ECB policy 

announcement days, changes in U.S. and German 

long-term sovereign yields historically have been 

highly correlated (figure B); similarly large correlations 

1. for more detail, see John Ammer, Michiel De Pooter, 

Christopher Erceg, and Steven Kamin (2016), "International 

Spillovers of Monetary Policy," I FOP Notes (Washington: 

Board of Governors of the Federal Reserve System, 

Februmy 8), www.federalreserve.gov/econresdataJnotcsf 

lfdp-notes/2016/inteniationa!-spillovers-of-monetarypolicy-20160208.html. 

A. Two-year overnight index swap rates in selected 

advanced economies 

Percent 

United Kingdom 1.2 

- .8 

.4 

.4 

SoURcE: Bloomberg. 

are observed between U.S. and German yields on 

days when the Federal Reserve has made policy 

announcements. In the context of economic and policy 

divergences, these monetary policy spillovers may 

alter financial conditions in other countries in ways 

that are not necessarily consistent with their cyclical 

stabilization needs. For example, recent monetary 

easing abroad likely has had a tempering effect on 

longer-term U.S. interest rates that partially offsets the 

effect of our own policy normalization. Analogously, 

reduced monetary accommodation in the United States 

likely will partially offset the effect of greater monetary 

accommodation abroad. However, the implications 

of current policy divergences for monetary spillovers 

should not be exaggerated: U.S. policy remains 

accommodative and, on net, likely continues to 

contribute to accommodative conditions abroad. 

B. One-day changes in U.S. and Gennan 10-year yields 

on ECB policy announcement days, 1999·-2015 

.Bas!spoints,l...tayctmnges US JQ.yearymldcbanges 

-- ·-·--·~~-

Correlation '"' 0.58 .. 

NoTE" Each point represents the one-day change in 

to-year yields on the day of an ECB pOii\.-.)' announcement 1 E)<)9 and April 2015. 111e !me indicates the line of best fit 

25 

-20 

L' 

10 

SOURL'E: For U.S. y1elds, Department of the Treasury: for German yields, 

Bf<mmberg; for announcement dates, European Central Bank 
92 


23566.037

as an agreement was reached last summer 

between the European Union and Greece. In 

contrast, bond spreads in a number of EMEs 

rose modestly, on net, in the second half of the 

year before moving up more steeply after the 

start of 2016 amid a widespread increase in 

risk aversion. 

Growth in the emerging market 

economies moved back up from earlier in 

2015 ... 

Following weak growth in the first half 

of 2015, economic activity in the EMEs 

improved in the second half, as the pace of 

growth picked up in Asia and Latin America 

(figure 38). However, growth has been held 

back in part by exports from EMEs, which 

declined appreciably early in 2015 and remain 

subdued on average. 

Economic activity in most of emerging Asia, 

which had been restrained in the first half of 

the year by soft external demand and by the 

outbreak of MERS (Middle East Respiratory 

Syndrome) in South Korea, picked up in the 

second half, as the drag from these pressures 

subsided. In China, GDP growth is reported 

to have held steady around 7 percent in the 

second half of the year, boosted in part by 

relatively strong growth in services. However, 

weak manufacturing, as well as the financial 

market volatility noted previously, Jed to a 

pronounced heightening of concerns about the 

economy during the second half of the year. 

In Latin America, the decline in commodity 

prices, along with other macroeconomic 

challenges, continued to weigh on the 

economic activity of several countries. In 

Mexico, the economy continued to grow at 

a moderate pace in the second half of 2015, 

supported by improving household demand. 

However, low oil prices have pressured 

public finances, and manufacturing exports 

faltered toward the end of the year. In Brazil, 

the economy is undergoing its most severe 

recession in decades. Tight monetary policy 

in response to high inflation, low commodity 

MONFTARY POLICY REPORT: FEBRUARY 2016 2 5 

38. Real gross domestic product growth in selected 

emerging market economies 

Quarterly Percent, annual rate 

II. China 

~Korea 

• Mexico 

Brazil 

• Gross domestic product of Brazil is not yet available for 201 5:Q4 

15 

Non:.: The data for Mexico incorporate the flash: estimate for 20I5·Q4 

·nlC data for China are seasonally adjusted by staff The data for Mexico, 

Bruni, and Korea are seasonally adjusted by their respective government 

agenc1es. 

SOURCE: For Ch:ina, China Natioool Bureau ofStatJstics; for Korea, Bank 

of Korea; for Mexico, Instttuto Nacional de Estadistica Geografia e 

Informatica; for Braz1l, Instituto Brasileiro de Geografia e Estadistica; all via 

Haver Analyncs 
93 


23566.038

2 6 PART 1: RECENT ECONOMIC AND FINANCIAl DEVELOPMENTS 

39. Real gross domestic product gwwth in selected 

advanced t{>reign economies 

Percem,mmualrate 

8 Umted Kingdom 

Will Japan __ , 4 

- ~~::~ ~ II li't , 

::__u_ 

- I 

I ~L -, 

-2 

prices, and the fallout from a high-profile 

corruption scandal eroded business confidence 

and contributed to a collapse in investment. 

Inflation remained subdued in many EMEs, 

as the continuing decline in commodity prices 

contributed to a moderation of headline 

inflation. Consequently, some central banks, 

including those of Korea and India, loosened 

monetary policy to support growth. In China, 

the PBOC also lowered its benchmark rate and 

cut the reserve requirement ratio in August and 

October to address weakness in the economy. 

In contrast, faced with inflationary pressures 

stemming partly from their depreciating 

currencies, Brazil, Chile, and Colombia raised 

their policy rates in the second half of 2015 . 

. . . and in the advanced foreign 

economies, economic activity expanded 

at a moderate pace 

In Canada, where low oil prices induced a 

mild contraction earlier in the year, economic 

activity rebounded in the third quarter 

as exports recovered and business-sector 

investment contracted at a slower pace. 

That said, more recent indicators of growth 

weakened markedly during the fourth quarter. 

In contrast, in the euro area, Japan, and the 

United Kingdom, economic activity grew 

moderately in the third quarter, and recent 

indicators for fourth-quarter growth, such as 

purchasing managers indexes, have largely held 

steady (figure 39). 

As in the United States, inflation remained low 

in most advanced foreign economies. Further 

declines in commodity prices weighed on 

in11ation in the AFEs; in the euro area, Japan, 

and the United Kingdom, consumer prices 

changed little in 2015. Over the same period, 

consumer prices rose about l Y2 percent in 

Canada, reflecting the boost to import prices 

from the sharp depreciation of the Canadian 

dollar over the past year. 
94 


23566.039

With inflation low, AFE central banks 

maintained highly accommodative monetary 

policies, and some signaled their intention 

to maintain large balance sheets well in to 

the future. The European Central Bank, in 

addition to lowering its deposit rate further 

into negative territory, announced an extension 

of the intended duration of its asset purchase 

program through at least March 2017 and that 

it would reinvest principal payments for as long 

MONETARY POLICY REPORT: FEBRUARY 201 n 2 7 

as necessary. The Bank of England announced 

that it will start shrinking its balance sheet 

only after its policy rate rises to about 

2 percent from its current level of 'h percent. 

Meanwhile, in response to weak economic 

performance earlier in 2015, the Bank of 

Canada cut its policy rate further. More 

recently, the Bank of Japan cut the interest 

rate that it pays on a portion of banks' current 

account deposits to negative 0.1 percent. 
95 


23566.040

PART 2 

MoNETARY Poucy 

29 

In December, the f"ederal Open Market Committee (FOMC) raised the target range for the federal 

funds rate by '14 percentage point after seven years in which that rate had been held near zero. 

The FOMCs decision reflected the considerable improvement in the labor market last year and 

the Committee's assessment that, even with the modest reduction in policy accommodation, the 

labor market would continue to strengthen and inflation would return over the medium term to 

the f"OMCs 2 percent objective. Monetary policy remains accommodative, and the Committee 

expects that economic conditions will warrant only gradual increases in the federal funds rate. 

However, the actual path of the federal funds rate will depend on the economic outlook as 

informed by incoming data. 

The FOMC raised the federal funds rate 

target range in December ... 

Since last March, the FOMC had anticipated 

that it would be appropriate to increase the 

federal funds rate when it had seen further 

improvement in the labor market and was 

reasonably confident that inflation would 

move back to 2 percent over the medium term. 

In December, the FOMC,judging that these 

criteria had been met, raised the target range 

for the federal funds rate to '14 to y, percent 

(figure 40)4 

4. See Board of Governors of the Federal Reserve System (2015), "Federal Reserve Issues FOMC Statement," 

press release, December 16, www.federa1reserve.gov/news 

events/press/monctary/20 151216a.htm. 

40. Selected interest rates 

Dmty 

The Committee's decision to raise the federal 

funds rate recognized the time it takes for 

policy actions to affect future economic 

outcomes; if the FOMC delayed the start of 

policy normalization for too long, a relatively 

abrupt tightening of policy might eventually be 

needed to keep the economy from overheating 

and inflation from significantly overshooting 

the Committee's 2 percent objective. Such 

an abrupt tightening cDuld disrupt financial 

markets and perhaps even inadvertently push 

the economy into recession. 

... but monetary policy remains 

accommodative 

Even after the increase in the federal funds 

rate late last year, the stance of monetary 

Percent 

1130 4130 815 !0/~9 !/28 4/29 &ll2 !114 1127 4128 \'.lltl ll/3 !/26 4127 8N 11/2 !125 4115 ~fl !(1114 t!JO Vl 7!}1 1013() 1129 4/30 7130 10/29!/)8 4/2Q 7/2Q J0/28 J/27 

3fll\ 61259!16 121163/18 6124 WlJ121J63!!6 6123 Q/11121!43/15 6!'11 «11112!133.!13 6!20 91!312/12 3120 6/JQ 9/l& 1211:0!!9 6Jl8 9117 !21!73/18 6!!7 9/1712116 

2008 2009 2010 2011 2012 20l3 2014 2015 2016 

NOIE. 'l11e 2~year and I 0-year Treasury rates arc the constant-maturity yJCids based on the most ac!Jve!y traded securities. The dates on the honzontal axis are 

those of regularly scheduled Federal Open Market Committee meetmgs. 

SOURCE: Deparimenl of the T rcasury, Federal Reserve Board 
96 


23566.041

30 PART 2: MONETARY POLICY 

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, 

and 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 ratedefined as the value of the federal funds 

rate that would be neither expansionary nor 

contractionary if the economy was operating 

at its productive potential-is currently low by 

historical standards and is likely to rise only 

gradually over time. One indication that the 

neutral federal funds rate is low is that U.S. 

economic growth has been only moderate in 

recent years despite the very low level of the 

federal funds rate and the Federal Reserve's 

very large holdings of longer-term securities. 

Had the neutral rate been running closer to 

the average level estimated to have prevailed in 

recent decades, these policy actions would have 

been expected to foster a much more rapid 

economic expansion. 

An array of persistent economic headwinds 

have weighed on aggregate demand since the 

financial crisis; these headwinds included, at 

various times, limited access to credit for some 

borrowers, contractionary fiscal policy, and 

weak growth abroad coupled with a significant 

appreciation of the dollar. Although the 

overall restraint imposed by such headwinds 

has declined over the past few years, the effects 

of some headwinds have remained significant. 

As these effects abate further, the neutral 

federal funds rate should gradually move 

higher over time. (for a discussion of how the 

neutral federal funds rate is likely to evolve 

over time, see the box "The Neutral Federal 

Funds Rate in the Longer Run.") 

Another reason that the Committee expects 

only a gradual increase in the federal funds 

rate will be warranted is that, with the federal 

funds rate near zero, the FOMC can respond 

more readily to upside surprises to inflation, 

economic growth, and employment than to 

downside shocks. This asymmetry suggests 

that it is appropriate to be more cautious in 

normalizing the stance of monetary policy 

than would be the case if short-term nominal 

interest rates were appreciably above zero. 

In part reflecting this concern, the FOMC 

continued to reinvest principal payments from 

its securities portfolio, and the Committee 

expects that this reinvestment policy will be 

maintained until normalization of the level 

of the federal funds rate is well under way. 

Maintaining sizable holdings of longer-term 

securities should help support accommodative 

financial conditions and reduce the risk that 

the Committee would not be able to deliver 

sufficient accommodation by lowering the 

federal funds rate in the event of future 

adverse shocks. 

The FOMC expects that, supported by an 

accommodative monetary policy, economic 

activity will continue to expand at a moderate 

pace and the labor market will continue to 

strengthen. Inflation is expected to remain 

low in the near term, in part because of recent 

further declines in energy prices, but to rise 

to 2 percent over the medium term as the 

transitory effects of declines in energy and 

import prices dissipate and the labor market 

strengthens further. ln light of the current 

shortfall of inflation from 2 percent, the 

Committee is carefully monitoring actual and 

expected progress toward its intlation goal. 

The FOMC's policy decisions will 

continue to be data dependent 

Although the Committee expects that 

economic conditions will warrant only 

gradual increases in the federal funds rate, 

the Committee has emphasized that the 

actual path of monetary policy will depend 

on how incoming data affect the economic 

outlook. In determining the timing and 

size of future adjustments to the target 

range, the Committee will assess realized 

and expected economic conditions relative 
97 


23566.042

to its objectives of maximum employment 

and 2 percent inflation. Stronger growth or 

a more rapid increase in inflation than the 

Committee currently anticipates would likely 

call for faster increases in the federal funds 

rate; conversely. if conditions prove weaker, 

a lower path of the federal funds rate would 

likely be appropriate. Similarly, the timing 

of a change in the reinvestment policy will 

depend on economic developments and their 

implications for progress toward the FOMC's 

goals of maximum employment and price 

stability. In assessing realized changes in 

economic conditions and forming its outlook, 

the Committee will take into account a 

wide range of measures, including measures 

of labor market conditions, indicators of 

inflation pressures and inflation expectations, 

and readings on financial and international 

developments. 

The size of the Federal Reserve's balance 

sheet has remained stable 

With the continuation of the Committee's 

reinvestment policy, the Federal Reserve's total 

assets have held steady at around $4.5 trillion 

(figure 41 ). Holdings of U.S. Treasury 

securities in the System Open Market Account 

(SOMA) have remained at $2.5 trillion, 

and holdings of agency debt and agency 

4l Federal Reserve assets and liabilities 

Week!"-'---------

-Assets Other assets 

MONETARY POLICY REPORT: ffBRUARY 2016 31 

mortgage-backed securities at approximately 

$1.8 trillion. Consequently, total liabilities 

on the Federal Reserve's balance sheet were 

largely unchanged. 

Given the Federal Reserve's large securities 

holdings, interest income on the SOMA 

portfolio has continued to support substantial 

remittances to the U.S. Treasury Department. 

Preliminary results indicate that the Reserve 

Banks provided for payments of $97.7 billion 

of their estimated 2015 net income to the 

Treasury. In addition, the Reserve Banks 

transferred to the Treasury $19.3 billion 

from their capital surplus as required by 

an amendment to the Federal Reserve Act 

contained in the Fixing America's Surface 

Transportation Act of 2015. Remittances from 

2008 through 2015 total about $600 billion 

on a cumulative basis-an average of about 

$75 billion a year, compared with about 

$25 billion a year, on average, over the decade 

prior to 2008. 

The Committee continued to focus on the 

implementation of monetary policy 

Consistent with the FOMC's Policy 

Normalization Principles and Plans published 

on September 17, 2014, the Federal Reserve 

used interest paid on reserve balances 

Tn!!u:msofdollars 

-45 

4.0 -3.5 3.0 

2.5 -2.0 

-L5 

I 0 

- - ' 0 

5 ·-· 1.0 -1.5 

-20 

2.5 -3.0 

-3.5 

-- 4 0 

4.5 

Non:. "Credit and hquidity facilities". cons is~ of J?fllUaJY, second~, and seasonal cr~dit, tc_rm auction credit; central bank hq0 d1ty swaps; support for !\1aiden Lane, 

Bear_ Steams. ~nd AlG; and oth?r credit facilttJcs, mc_!uding the Primary Dealer Crcd1t Fac1!ity. the Asset~-!3acked Commcn;Jal_Papcr Money M~rkct Mutual Fund 

Ll(jULdJty Facthty, ~e C'onunercJal Paper ~undin~t Fac1liry, -~d the_ Tcnn Asset-Backed Securitws Loan Fac1hty. "Other assets" mdudes unamortJ;r..ed premitmts and 

discmmts on scct~nttes held outright. "Cap1tal and other habd!tles" mcludes reverse repurchase agreements, the US. Treastuy Genera! Accmmt, and rhe US Treasury 

Supplementary Fmancing AccoWlt. The data extend through February 3. 2016 

Somwr Federal Reserve Board, Statistical Release H.4.l, '·Factors Atfectmg Reserve Balances" 
98 


23566.043

32 PART L MONETARY POLICY 

The Neutral Federal Funds Rate in the longer Run 

As discussed in the main text, t.."Conomic growth 

has been only moderate in recent years despite 

the very low level of the federal funds rate and the 

Federal Reserve's large-scale purchases of longer-term 

securities. This observation suggests that headwinds 

have lowered the "neutral" federal funds rate-<Jefined 

as the value of the federal funds rate that would be 

neither expansionary nor contractionary if the economy 

was operating at its productive potential-to historically 

low levels. 

As economic disturbances dissipate, the neutral 

federal funds rate should rise to its expected longer-run 

level. This longer-run value of the neutral rate plays an 

important role in monetary policy analysis: It is a key 

determinant of the longer-run level of the federal funds 

rate and other nominal interest rates. When expressed 

on a real basis, it also corresponds to the intercept 

of simple policy rules such as those studied in Taylor 

(1993).' Like the current neutral rate, the longerrun value of the neutral rate is not directly observed 

and must be estimated using the available data and 

potentially imperfect models of the economy. 

Since 2012, the median of the projections of 

the longer-run level of the federal funds rate in the 

Federal Open Market Comminee's Summary of 

1. See- john B. Taylor (1993), "Discretion versus Policy Rules 

ln Practice," Carnegie-Rochester Conference Series on Public 

Policy, vol. 39 (December), pp. 195~214. 

and also employed an overnigbt reverse 

repurchase agreement (ON RRP) facility 

to implement its decision in December to 

raise the target range for the federal funds 

rate.' Specifically, the Board of Governors 

raised the interest rate paid on required and 

excess reserve balances to y, percent, while 

the FOMC authorized ON RRP operations 

at an o(fering rate of Y. percent. (For further 

information, sec the box "Monetary Policy 

5. See Board of Governors of the Federal Reserve 

System (2014), "Federal Reserve Issues FOMC 

Statement on Policy Normalization Principles and 

Plans," press release, September 17, www.federalreserve. 

gov/ncwsevents/prcss/monctary/20 l40917c.h tm. 

Economic Projections has fallen from 4.25 percent to 

3.50 percent. 2 In addition, several econometric studies 

have estimated a decline in the longer-run value of the 

neutral rate by statistically modeling the co-movements 

between variables like inflation, interest rates, output, 

and unemployment. 3 Figure A shows estimates from 

2. See the December 2015 Summary of Economic 

Projections, which appeared as an addendum to the minutes 

of the December 1 5·-16, 2015, meeting of the Federal Open 

Market Committee and is included as Part 3 of this report. 

3. See, for example, Benjamin K. Johannsen and Elmar 

Mertens (forthcoming), "The Expected Real Interest Rate in 

the long Run: Time Series Evidence with the Effective lower 

Bound," FEDS Notes {Washington: Board of Governors of 

the federal Reserve System); Michael T. Klley (2015), 'What 

Can the Data Tel! Us about the Equilibrium Real Interest 

Rate?" Finance and Economics Discussion Series 2015-077 

(Washington: Board of Governors of the Federal Reserve 

System, August), www.federalreserve.gov/econresdata/ 

feds/201 S/fi!es/2D15077pap.pdf; Thomas Laubach and John 

Wi!Hams (2015), "Measuring the Natural Rate of Interest 

Redux," Hutchins Center Working Papers 15 (Washington: 

Brookings Institution, November), www.brookings.edu/-/ 

media/Research/Fi!es/Papers/2015/l 0/30-laubach~wil!iams/ 

WP15~lauhach-Wi!liams-natural~interest~rate-redux-2. 

pdf?!a=en; and Thomas A lubik and Christian Matthes {2015), 

"Calculating the Natural Rate of Interest: A Comparison of Two 

Alternative Approaches," Economic Brief 15~ 10 (Richmond: 

Federal Reserve Bank of Richmond, October), https://www. 

r!chmondfed.orgl-/mt"dialrlchmondfedorglpub!ications/ 

rese<uch/economic~brief/2015/pdf/eh_lS-1 O.pdf. In these 

Implementation following the December 2015 

FOMC Meeting.") In addition, the Board 

of Governors approved an increase in the 

discount rate (the primary credit rate) to 

I percent. 

Along with the decision to increase the target 

range for the federal funds rate, the FOMC 

also temporarily suspended the aggregate 

cap on ON RRP transactions, indicating that 

ON RRP operations would be undertaken in 

amounts limited only by the value of Treasury 

securities held outright in the SOMA that 

are available for such operations and by a 

per-counterparty limit of $30 billion per 

day. Nonetheless, total reverse repurchase 
99 


23566.044

two time-series models of the longer-run value of the 

neutral rate, expressed on a real basis. One is from 

Johannsen and Mertens (forthcoming), and the other 

is from Laubach and Williams (2015).' The figure 

includes the uncertainty bands for the Johannsen and 

Mertens estimates, which indicate that the uncertainty 

surrounding the longer-run value of the neutral rate is 

substantial (as it is in other model frameworks). 

Uncertainty about the longer-run value of the 

neutral rate implies uncertainty about the expected 

cumulative rise in policy rates during the policy 

normalization process. The risk that the longer-run 

value of the neutral rate going forward could be 

lower than currently estimated is especially pertinent, 

because such a scenario would likely increase the 

probability that monetary policy will be constrained 

by the effective lower bound on nominal interest 

rates in the future1 with adverse consequences for 

macroeconomic outcomes. 

studies, the longer-run value of the neutral rate is sometimes 

referred to as the longer-run value of the "natural" rate or the 

longer-run "equilibrium" federal funds rate. 

4. The estimates from the Johannsen-Mertens and laubachWil!iams models are not the same because the models use 

different data to infer slack in the economy and because the 

model restrictions and estimation methods are different. 

agreement transactions with the Federal 

Reserve have remained near levels observed 

prior to the increase in the target range for 

the federal funds rate and the suspension of 

the aggregate cap. The Committee intends 

to phase out this facility when it is no longer 

needed to help control the federal funds rate. 

The Federal Reserve also continued to test 

the operational readiness of other policy 

MONETARY POLICY REPORT: FEBRUARY 2016 33 

A Estimates of the neutral real rate in the longer run 

Non::: The data extend through 20l5:Q3. For the Johannsen-Mertens 

model, at each date, the parameters of the model and the longer-nm 

equilibrium real rate are JOintly estimated u..<>ing data up to that date. For the 

Laubach-Williams model, the parameters are estimated on the enttre data 

sample, bllt estimates of the longer-run equilibrium rca! rate use data only up 

to the: date of interest Shaded regions are 50 and 90 percent uncertainty 

bands from the Johannsen-Mcrtens mode!. The shaded bars indicate periods 

of busmess recession as defined by the National Bureau of Economic 

Research. 

SOURCE; Benjamin K. Johannsen and Elmar Mertens (forthcoming), "The 

Expected Real Interest Rate in the Long. Run: Time Series Evidence with the 

EffectJVe Lower Bound," FEDS Notes (Washington: Board of Governors of 

the Federal Reserve System). and Thomas Laubach and Jolm Williams 

(20 15), "Measuring the Natural Rate of Interest R<..-dux," Hutchins Center 

Workmg Papers 15 {Washington: Brookings lmtitution, November). 

www. brookings edu/-/media!Research/Files!Papersno 1511 0/30-JauhachwiHiams!WPJ5-Laubach-Williams-natural-interest-rate-redux-2.pdf?la=en 

tools. Three Term Deposit Facility operations 

were conducted in the second half of 2015. 

The operations offered either 7- or 14-day 

deposits at a floating rate of l basis point over 

the interest rate on excess reserves. In these 

operations, deposit volumes declined slightly 

from previous tests with similar parameters. 
100 


23566.045

34 PART 2: MONETARY POLICY 

Monetary Policy Implementation following the 

December 2015 FOMC Meeting 

At its December 2015 meeting, the Federal Open 

Market Committee (FOMC) increased the target range 

for the federal funds rate from between 0 and 1/4 percent 

to between v.~ and 112 percent, effective December 17.1 

In order to implement the monetary policy stance 

announced in December, the Board of Governors also 

voted to raise the interest rate paid on required and 

excess reserve balances to 0.50 percent Moreover, the 

fOMC authorized an increase in the overnight reverse 

repurchase agreement (ON RRP) facility offering rate to 

0.25 percent and indicated that the aggregate amount 

of the ON RRP operations would be constrained only 

by the value of Treasury securities held outright in 

the System Open Market Account that are available 

for such operations. 2 Each of these monetary policy 

decisions is consistent with the guidance provided in 

the Policy Normalization Principles and Plans outlined 

in the july 2015 Monetary Policy Report.3 

Federal Reserve System 

Reserve Issues FOMC Statement," press 

December 16, www.federa!reserve.gov/newsevents! 

press/monetary/20151216a.htm. 

2. In a related action, the Board of Governors voted to 

approve a lf4 percentage point increase in the discount rate to 

1 percent 

3. See the box "Policy Normalization Principles and Plans: 

Additional Details" in Board of Governors of the Federal 

Reserve System (2015), Monetary Policy Report (Washington: 

Board of Governors, July), p. 35, www.federalreserve.gov/ 

monetarypolicy/iiles/20 150715_mprfu!!report.pdf. 

A Effective federal funds rate 

Daily Bas1spmnts 

Target federal f1mds rate 

- Effective federal funds rate 

75 

The effective federal funds rate rose to 0.37 percent 

at the time of the change to the target range lor the 

federal funds rate amid orderly trading conditions in 

money markets (figure A}. Since the increase in the 

target range, the effective federal funds rate has traded 

in a relatively narrow range of 0.35 to 0.38 percent, 

with !he exception of month-ends, when the rate fell 

temporarily in typical fashion. Increases in interest rates 

in other money markets were similar to the rise in the 

federal funds rate following the December meeting, 

with overnight Eurodollar rates closely tracking the 

effective federal funds rate and the general collateral 

repurchase agreement (or repo) rate maintaining 

spreads to unsecured rates similar to those observed 

before the December meeting. 

Total volume in the ON RRP facility was virtually 

unchanged on the day after the December meeting 

(figure B). In the weeks following the December 

meeting, the total amount of Federal Reserve reverse 

repurchase agreement {RRP) operations reflected 

typical calendar-related effects. On year-end, volume 

in the ON RRP facility was nearly $475 billion, roughly 

in line with aggregate RRP operations seen on recent 

quarter-ends. Following year-end, usage of the ON RRP 

facility rapidly returned to--and has remained at--

levels that prevailed before year-end, consistent with 

recent quarter-end patterns. 

B. Reverse repurchase agreement operations 

120 

110 

!00 

feon RRP 

II ONRRP 

- Participants 

360 

320 

280 

240 

200 

160 

!20 

80 

l\OTE ON RRP IS overnight reverse repm.:hase agreement, 1crm RRP is 

to."lm reverse repurclmse agn.:ement. Dat."' arc daily 

Sm:RcE; Federal Reserve Bank of New York. 
101 


23566.046

35 

PART 3 

SuMMARY oF EcoNOMIC PROJECTIONS 

The following material appeared as an addendum to the minutes of the December 15-16,2015, 

meeting of the Federal Open Market Committee. 

In conjunction with the Federal Open 

Market Committee (FOMC) meeting held on 

December 15-16,2015, meeting participants 

submitted their projections of the most 

likely outcomes lor real output growth, the 

unemployment rate, inflation, and the federal 

funds rate for each year from 2015 to 2018 

and over the longer run6 Each participant's 

projection was based on information available 

at the time of the meeting, together with his 

or her assessment of appropriate monetary 

policy and assumptions about the factors likely 

to affect economic outcomes. The longerrun projections represent each participant's 

assessment of the value to which each variable 

would be expected to converge, over time, 

under appropriate monetary policy and in the 

absence of further shocks to the economy. 

"Appropriate monetary policy" is defined as 

the future path of policy that each participant 

deems most likely to foster outcomes for 

economic activity and inflation that best 

satisfy his or her individual interpretation of 

the Federal Reserve's objectives of maximum 

employment and stable prices. 

FOMC participants generally expected that, 

under appropriate monetary policy, real gross 

domestic product (GOP) growth in 2016 

and 2017 would be at or somewhat above 

their individual estimates of the longer-run 

growth rate and would converge toward 

its longer-run rate in 2018 (table 1 and 

figure !). All participants projected that the 

unemployment rate would decline further 

in 2016. Most participants expected that in 

6. The president of the Federal Reserve Bank of 

Minneapolis did not participate in this FOMC meeting, 

nnd the incoming president is scheduled to assume office 

on January I, 2016. James M. Lyon. First Vice President 

of the Federal Reserve Bank of Minneapolis, submitted 

economic projections. 

2018 the unemployment rate would remain 

somewhat below their individual judgments 

of its longer-run normal rate. Participants 

projected that inflation, as measured by the 

four-quarter change in the price index for 

personal consumption expenditures (PCE), 

would pick up in 2016 and 2017 from the very 

low rate seen in 2015. Almost all participants 

projected inflation in 2018 to be at or very near 

the Committee's 2 percent objective. 

As shown in figure 2, all but two participants 

thought that it would be appropriate to raise 

the target range for the federal funds rate 

before the end of 2015. Most participants 

expected that it would be appropriate to 

raise the target range for the federal funds 

rate gradually over the projection period as 

headwinds to economic growth dissipate 

slowly over time and as inflation rises toward 

the Committee's goal of 2 percent. Consistent 

with this outlook, most participants projected 

that the appropriate level of the federal funds 

rate wonld be below its longer-run level 

through 2018. 

Almost all participants viewed the levels of 

uncertainty associated with their outlooks for 

economic growth and the unemployment rate 

as broadly similar to the norms of the previous 

20 years. Nearly all also viewed the levels of 

uncertainty associated with their inflation 

forecasts as broadly similar to historical 

norms. Most participants saw the risks to 

their outlooks for real GOP growth and the 

unemployment rate as broadly balanced. 

A majority viewed the risks attending their 

projections for both PCE and core PCE 

inflation as broadly balanced, but many 

saw these risks as weighted to the downside. 

Among those who saw the risks to their 

inflation outlook as tilted to the downside, 
102 


23566.047

3 6 PART 3, SUMMARY OF ECONOMIC PROJECTIONS 

Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, under their 

individual assessments of projected appropriate monetary policy, December 2015 Percent 

Median 1 Centra! tendcncy2 Range' 

Variable 

ChangeinrealGDP ... 2.1 

September projection .. . :u 

Unemployment rate .... 

September proj~Xtion .. 

5.0 

5.0 

2.4 2.2 

2.3 2.2 

4.7 4.7 

4.8 4.8 

2.0 

2.0 

4.7 

4.8 

201s 1 2016 1 2011 1 201s Longer 

2.0 2.1 2.3-25 2.0--2.3 LS-2.2: 1.8--2.2 2.0-2.2 2.0-2.7 l.S-2.5 1.7-2.4 1.8-23 

2.0 2.0--23 2.2-2.6 2.0-2.4 L8-2.2l LS-2.2 1.9--2.5 2.1-2.8 1.9-2.6 L6--2.4 1.8-2.7 

4.9 

4.9 

5.0 4.Cr-4.8 4.6-4.8 

5.0--SJ 4.7-4.9 4.7-4.9 

4.6-..5.0 i 4.8-5.0 

4.7-5.0 j 4.9-5.2 

5.0 4.3-4.9 4.5--5.0 4.5-5.3 4.7-5.8 

4.9-5.2 4.5-5.0 4.5-5.0 4.6--5.3 4. 7-5.8 

PC£ inflation ... 0.4 1.6 1.9 2.0 

0.4 L7 1.9 2.0 

2.0 

2.0 

0_4 1.2--1.7 1.8-2.0 1.9-2.0 ; 2.0 0.3·..0.5 1.2-2.1 1.7-2.0 1.7-·2.1 2.0 

September projection .... 0.3-05 LS~I.8 1.8~2.0 2.0 j 2.0 Q.J.J.O l.S-2.4 1.7-2.2 1.8-2.1 2.0 

Core PCE inflation4 •• 

September projection .. 

L3 1.6 1.9 2.0 

1.4 1.7 1.9 2.0 

L3 1.5--1.7 1.7--2.0 1.9-2.0 : 1.2-1.4 1.4-2.1 1.6-2.0 1.7--2.1 

L3- 1.4 1.5~1.8 1.8-2.0 1.9-2.0 l L2-L7 1.5---2.4 1.7-2.2 1.8-2.1 

Memo: Projected 

appropriate policy path 

Federal funds rate .. 0.4 !.4 2.4 3.3 ! 3.5 

0.4 1.4 2.6 3.4 1 3.5 

0.4 0.9~1.4 1.9-3.0 2.9-3.5:3.3-3.5 0.1-0.4 0.9-2.1 1.9-3.4 2.1-3.9 J.G·-4.0 

September projection . 0.1-0.6 l.i-2.1 2.1-·3.4 3.0--3.6; 3.3-·3.8 -0.1-0.9 -0.1-2.9 l.0-3.9 2.9-3.9 3.0-4.0 

r.;oT£. PmJectlons of change m real gross domestiC product (GOP) and projections tor both measures ot mflauon arc percent changes trom the founh quarter ot the pn::vJ<::~us 

y~r to the tOunh quarter <'I the year indicated. PCE inflation and core PC'E inflation are the percentage rates M change in, n:spectively, the price index for personal consumptwn 

expenditures {PCE) and the price index: for PCE ex:dudmg food and energy ProJe<:llons for the unemployment rate are for the avNage civilmn unemployment rate in the JOurth quarter 

of the year indicated. Each participant's projections are based on his or her assessment of appropriate monetary policy. Longer·ruo projecuom. represent each participant's asse;sment 

of the rate to which each vanabk would be expec!ed to converge under 11ppropriate monetary policy and in thl." absence of further shocks to the economy The projections for the 

federal fund'> rate are the value of the midpomt of the projected appropnate target range for the federal fllllds rate or the projected appropriate target level for the federal funds rate 

at !hi." end of the specified calendar year or over the longer run. The September projections were made in conjunction with the meeting of the Federal Open Market Com mince nn 

September 16-17,2015 

I. For each period, the median is the middle projection when the projections are arranged from lowest to highl'St. When the number of projections is even, the median is the average 

ofthctwomJddleproJeclions 

""""" hi,hw'"""'" '"~" 

several highlighted the continued strength 

of the dollar and some recent indications 

that inflation expectations had declined as 

contributing to those risks. 

The Outlook for Economic Activity 

Participants generally projected that, 

conditional on their individual assumptions 

about appropriate monetary policy, real GDP 

would increase in 2016 and 2017 at a pace 

somewhat above their estimates of its longerrun rate. Real GDP growth would then slow 

in 2018 to a rate at or near their individual 

estimates of the longer-run normal rate. 

Participants pointed to a number of factors 

that they expect will contribute to moderate 

output growth over the next few years, 

including labor market conditions that are 

supportive of economic expansion, household 

and business balance sheets that had improved 

significantly since the financial crisis, and a 

stance of monetary policy that was expected to 

remain accommodative. 

Compared with their contributions to the 

Summary of Economic Projections (SEP) 

in September, participants' projections of 

real GDP growth from 2016 to 2018 were 

generally little changed. The median value of 

participants' projections for real GDP growth 

in 2016 was revised up slightly to 2.4 percent; 

some participants cited the Bipartisan Budget 

Act of 2015, which was passed in late October, 

as adding support to economic growth in the 

near term. Very few participants changed their 

for~-casts for real GDP growth in the longer 

run, resulting in an unchanged median. 

All participants projected that the 

unemployment rate would be at or below their 

individual judgments of its longer-run normal 

level from 2016 through 2018. Compared 

with the September SEP, most participants' 

projected paths for the unemployment rate 

were revised down a little over those three 

years, with the median of the projections in 

the fourth quarter of each year at 4.7 percent. 

Many also revised down slightly their 
103 


23566.048

MONETARY POLICY REPORT: FEBRUARY 2016 37 

Figure I. Medians, central tendencies, and ranges of economic projections, 2015 ~18 and over the longer run 

Percent 

Change in real GDP 

-Median of projections - 4 

• Centra! tendency of projections 

I Range 

~ 

of projections 

;;;;;;;;e; ~ 

Actual - 1 

+ 

- 0 

2010 2011 2012 2013 2014 2018 Longer 

run 

Percent 

_ Unemployment rate -10 

- 7 

~ ~ - 5 

- 4 

2010 2011 2012 2013 2014 2015 2016 2017 2018 Longer 

run 

Percent 

PCE inflation 

~ 

- 3 

- l 

20!0 2011 2012 2013 2014 2015 2016 2017 2018 Longer 

run 

Percent 

Core PCE inflation 

- 3 

~ 

20!0 2011 2012 2013 2014 2015 2016 2017 2018 Longer 

run 

NoTE: Definitions of variables are in the general note to table l. The data for the actual values of the variables are annuaL 
104 


23566.049

38 PART 3: SUMMARY OF ECONOMIC PROJECTIONS 

Figure 2. FOMC participants' assessments of appropriate monetary policy: Midpoint of target range or target level for 

the federal funds rate 

Percent 

··-4.5 

···>!~ ·········t· ...................... _ 2.5 

' 

········- 1.5 

' •. ·--" .. ·- ... " J .•• 

···-0.5 

·············· ' 

2015 2016 2017 2018 Longer run 

NorE: Each shaded circle indicates the value (rounded to the nearest 1

h percentage point) of an individual participant's judgment 

of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate at 

the end of the specified calendar year or over the longer run. 

estimates of the longer-run normal rate of 

unemployment, although the median forecast 

of 4.9 percent was unchanged since September. 

Participants generally cited stronger-thanexpected labor market data in recent months 

as a factor explaining the downward revisions 

to their unemployment rate forecasts. 

Figures 3.A and 3.B show the distribution 

of participants' views regarding the likely 

outcomes for real GDP growth and the 

unemployment rate through 2018 and in 

the longer run. The distributions of the 

projections for real GDP growth over the next 

several years and in the longer run narrowed 

some since the September SEP. The diversity 

of views across participants on the outlook 

for GDP growth retlected, in part, differences 

in their individual assessments of the size 

and persistence of the effects of lower energy 

prices and a stronger dollar on real activity; 

the time it would take for the headwinds 

that have been restraining the pace of the 

economic expansion, such as financial and 

economic conditions abroad, to dissipate; 

and the appropriate path of monetary policy. 

With regard to the unemployment rate, the 

distributions of projections over the next three 

years shifted modestly to lower values since 

September. 

The Outlook for Inflation 

Nearly all participants saw PCE price inflation 

picking up in 2016, rising further in 2017, 

and then reaching a rate in 2018 at or very 
105 


23566.050

MONETARY POLICY REPORT: FEBRUARY 2016 3 9 

Figure 3.A. Distribution of participants' projections for the change in real GDP, 2015-18 and over the longer run 

2015 

0 December projections September projt"Ctions 

2016 

1.7 1.9 

2017 

1.7 1.9 

20!8 

1.9 

Longer run 

2.1 

2.1 

21 

2.2"' 

2.3 

Percent range 

2.3 

Percent range 

2.3 

Percent range 

23 

Percent range 

NoTE: Defmitions of variables are in the general note to table l. 

2.5 

2.5 

25 

2.4-

2.5 

Number of participants 

:!.8-

2.9 

-18 

-16 

-14 

-12 

-10 8 

6 

4 

2 

Number of participants 

-18 

-16 

-14 

-12 

-10 8 

6 

4 

~~iil;i=--=~:...:..t..:J 2 

2.7 

2.7 

2.7 

,.. 

2.7 

2.9 

Number of participants 

:t9 

-18 

-16 

-14 

-12 

-10 8 

6 

4 

' 

Number of participants 

2.8-

2.9 

-18 16 

14 -12 

-JO 

8 

6 

4 

2 

Number of participants 

2.8 

2.9 

-18 

-16 

-14 

12 

10 

8 

6 

4 

2 
106 


23566.051

40 PART 3: SUMMARY OF ECONOMIC PROJECTIONS 

Figure 3.B. Distribution of participants' projections for the unemployment rate, 2015-18 and over the longer run 

Number of participants 

2015 -18 0 December projections September projections 16 

14 -12 

-10 

- 8 - 6 

4 

2 

42· 4k 46- 4.8- 5.~ 54 5& 

4.3 4.5 4.7 49 5.3 55 5.7 5.9 

Percent range 

Number of participants 

2016 -18 

-16 14 

12 -10 8 

6 

4 

2 

s.z. 5.4 5.6- 5.& 

4.5 5.3 5.5 5.7 5.9 

Percent range 

Number of participants 

2017 18 -16 

-)4 

-12 10 

8 

6 

L. 4 

2 

4.2- 4.4- 5.~ 5.2- 5.4 5.& 5.& 

43 45 51 53 5.5 5.7 5.9 

Percent range 

Number of participants 

2018 -18 

-16 

-14 

12 

10 

8 

6 

4 

2 

43 4.9 51 53 5.5 57 5.9 

Percent range 

Number of participants 

Longer run -18 16 

14 -12 

-10 8 

6 

4 

2 

4,2- 4.4- 4.& 5.4-- 5.& 5.& 

43 45 4.7 5.5 57 59 

Percent range 

NOTE: Definitions of variables are in the general note to table I. 
107 


23566.052

close to the Committee's 2 percent longer-run 

objective. However, relative to the September 

SEP, almost all participants marked down 

their projections for PCE price inflation in 

2016, observing that recent declines in energy 

prices and the continued strength in the dollar 

could exert additional downward pressure 

on inflation in the near term. Revisions to 

participants' inflation forecasts in 2017 were 

more mixed, while the projections for inflation 

in 2018 were little changed. Most participants 

also marked down their projections for core 

PCE price inflation in 2016, although almost 

all still expected core inflation to rise gradually 

over the projection period and to be at or very 

close to 2 percent by 2018. Factors cited by 

participants as contributing to their outlook 

that inflation will rise over the medium term 

included recent signs of a pickup in wage 

growth, their expectation of tighter resource 

utilization, their expectation that the effects of 

recent appreciation in the dollar and declines 

in oil prices on inflation will fade, their 

anticipation that inflation expectations will 

remain at levels consistent with the FOMC's 

longer-run objective, and still-accommodative 

monetary policy. 

Figures 3.C and 3.D provide information on 

the distribution of participants' views about 

the outlook for inflation. The distribution 

of participants' projections for PCE price 

intlation in 2016 and 2017 shifted to the left 

compared with the September SEP, while 

the distributions of projections for 20 I 8 and 

in the longer run were little changed. The 

distributions of projections for core PCE 

price inflation moved lower for 2016 and 2017 

compared with September but did not change 

for 2018. 

Appropriate Monetary Policy 

Figure 3.E provides the distribution of 

participants' judgments regarding the 

appropriate level of the target federal funds 

rate at the end of each calendar year from 2015 

to 2018 and over the longer run. Relative to 

September, the projections of the appropriate 

MONETARY POLICY REPORT: FEBRUARY 2016 41 

levels of the federal funds rate over the next 

three years generally shifted to lower values. 

The median projection for next year was 

unchanged, but the medians for 2017 and 

2018 declined slightly. The median projection 

now stands at 1.4 percent at the end of 2016, 

2.4 percent at the end of 2017, and 3.3 percent 

at the end of 2018. Given their expectations 

that economic headwinds will persist and 

that inflation will rise gradually to 2 percent 

over the next three years, most participants 

judged that it would be appropriate for 

the federal funds rate to remain below its 

longer-run normal level from 2016 to 2018. 

Participants projected that a gradual rise in the 

federal funds rate over that period would be 

appropriate as some of those headwinds, such 

as sluggish foreign economic growth, diminish 

and the temporary factors holding down 

inflation dissipate. Some participants noted 

that a gradual increase in the federal funds rate 

would be consistent with their expectation that 

the neutral short-term real interest rate will rise 

slowly over the next few years. 

Both the median and the range of participants' 

projections of the federal funds rate in the 

longer run, at 3.5 percent and 3 to 4 percent, 

respectively, were unchanged since September. 

However, several participants revised their 

projections for the longer-run federal funds 

rate slightly lower. All participants judged 

that inflation in the longer run would be equal 

to the Committee's objective of 2 percent, 

implying that their individual judgments 

regarding the appropriate longer-run level of 

the real federal funds rate, in the absence of 

further shocks to the economy, ranged from 

I to 2 percent, the same as in September. 

Participants' views of the appropriate path 

for monetary policy were informed by their 

judgments about the state of the economy 

and the outlook for labor markets and 

inflation. One important consideration for 

many participants was their estimate of 

the extent of slack remaining in the labor 

market, as informed by the incoming data 

on various labor market indicators. Another 
108 


23566.053

42 PART 3: SUMMARY OF ECONOMIC PROJECTIONS 

Figure 3.C. Distribution of participants' projections for PCE inflation, 20 15~ 18 and over the longer run 

2015 

2016 

04 0,6 0,8 1.0 

2017 

04 0,6 LO 

2018 

Longer run 

0,3 0.5 0.9·-

04 06 1.0 

1.1-

1.2 

1.2 

II 

L2 

1.3-

14 

Percent range 

lA 

Percent range 

lA 

Percent range 

Percent range 

1.3-

14 

Percent range 

NOTE: Definitions of variables arc in the general note to table I. 

L5-

1.6 

-

1.6 

1.6 

1.5· 

16 

L7-

1.8 

- - I 

L8 

1.7-

18 

Number of participants 

0 December projections September projections 

-IS 

1.9-

2.0 

2,0 

2.0 

1.9 

20 

-10 

21 2.3· 

22 2.4 

Number of participants 

- lS 

-

- " JQ 

8 

2.2 24 

Number of participants 

- " 

21- 2.3-

2.2 

2.1-

22 

2.4 

Number of participants 

12 

10 

Number of participants 

2.3-

2A 
109 


23566.054

MONETARY POLICY REPORT: FEBRUARY 2016 43 

Figure 3.D. Distribution of participants' projections for core PCE inflation, 2015-18 

2015 

20!6 

20!7 

2018 

11-

12 

1.2 

L!-

L2 

1.3-

13-

14 

1.5 

" 

1.5-

1.6 

1.7-

1.8 

Percent range 

Percent range 

Percent range 

18 

Percent range 

NoTE: Definitions of variables arc in the general note to table L 

,.. -

1.9 

2.0 

1.9·-

2.0 

-

2.0 

--. 

Number of participants 

D December projections September projections 

2.1-

2.2 

2.1 

2.2 

2.1-

n 

2.2 

2.3-

24 

Number of participants 

_, 

-ll 

2.3-

2.4 

Number of participants 

- " - 16 

- ' - 6 

Number of participants 

-ll 
110 


23566.055

44 PART 3: SUMMARY OF ECONOMIC PROJECTIONS 

Figure 3.E. Distribution of participants' judgments of the midpoint of the appropriate target range for the 

federal funds rate or the appropriate target level for the federal funds rate, 2015- 18 and over the longer run 

2015 

Percent range 

2016 

2017 

Percent range 

2018 

Longer run 

-0.37- -012- 013- 0.38- 0.63- 0.88- 1.13- !.38- J.6J- 1.88- 2.13- 2.38- 2-63-

·-0.13 0.12 0.37 0.62 0.87 1.12 1.37 !.62 L87 2.12 237 2.62 2.87 

Percent range 

Number of participants 

a December projections September projections " 16 

14 

12 

10 

8 

6 

4 

2 

Number of participants 

3.13- 3.38- H3· 3.88~ 

3.37 3.62 3.87 4.12 

-IS 

16 

14 

12 

10 

8 

6 

4 

2 

Number of participants 

18 

-16 

-14 

-12 

_JO 

8 

6 

4 

2 

Number of participants 

-IS 16 

14 

12 _]t) 

8 

6 

4 

2 

Number of participants 

" !6 

-14 

-12 

-10 

6 ' 

4 

2 

NoTE: I'hc midpoint<; of the target ranges for the federal funds rate and the target levels for the federal funds rate arc 

measured at the end of the spet.:iiicd calendar year or over the longer run. 
111 


23566.056

was prospects for inflation to return to 

the Committee's objective of 2 percent; 

in making such assessments, participants 

considered a range of factors, including 

measures of inflation compensation and 

longer-run inflation expectations as well as 

the likely persistence and size of the effects 

from low energy prices and the strong dollar. 

Participants also emphasized the potential for 

international developments to continue to have 

important implications for domestic economic 

activity and inflation and thus for appropriate 

monetary policy. Several participants 

discussed potential interactions between policy 

normalization and risks to financial stability. 

In addition, given the continued proximity of 

short-term interest rates to their effective lower 

bound, asymmetric risks around the outlook 

for employment and inflation were noted as 

one reason why a gradual approach to raising 

the federal funds rate may be appropriate. 

Uncertainty and Risks 

As in the September SEP, nearly all 

participants continued to judge the levels of 

uncertainty around their projections for real 

GDP growth and the unemployment rate as 

broadly similar to the average level of the past 

20 years (figure 4) 7 Most participants saw the 

risks to their outlooks for real GDP growth 

and unemployment as broadly balanced, as 

the number of participants who viewed the 

7. Table 2 provides estimates of the forecast 

uncertainty for the change in real GDP~ the 

unemployment rate, and total consumer price inflation 

over the period from 1995 through 2014. At the end 

of this summary, the box "Forecast Uncertainty" 

discusses the sources and interpretation of uncertainty 

in the economic forecasts and explains the approach 

used to assess the uncertainty and risks attending the 

participants' projections. 

MONETARY POLICY REPORT' FEBRUARY 2016 45 

Table 2. Average historical projection error ranges 

Percentage points 

Variable 2015 2018 

Change in real GDP1 ••.• ±0.9 ±1.8 ±2.1 ±2.1 

Unemployment rate1 •••• ±0.1 ±0.8 ±1.4 ±1.8 

TOtal consumer prices2 •• +0.2 +t.O ±LO +J.O 

NO"l~ Error ranges shown are mea.~u:red a.~ plus or minus the root mean squared 

error of projections for !995 through2014 that were released in the winter by 

various pnvate and government forecasten;. A~ described in the bo;~; "Forecast 

IJnccrtaimy,"" und.:r certain assumptions. there is about a 70 pt.'Tttrlt prohabihty 

that actual outcomes for real GDP, unemployment, and consumer pn<:es will be 

in ranges implied by the average size of projectJon errors made in the past. For 

more information, see David Reifschneider and Peter Tulip (2007). '"Gauging the 

Uncertainty of the EconomK Outlook from Historical Forecastmg Errors.'" Finance 

and Economics Discussion Senes 2007-60 (Washington: Board of Governot:S of 

the Federal Reserve System. November), avallable at www.fcdcralreservc.gov/pubsJ 

fedsi2007/200760!200760abs.html; and Board of Governors of the Federal Reserve 

System. Division of ReseaKh and Statistics (2014), "Updated HJstorica\ fOrecast 

Errors." memorandum, April9, www.federalreserve._gov/J(Halti!eJ20140409-historicalforecast-errors.pdf. 

I. Definitionsofvariablesareinthegeneralnotetotabk !. 

2. Measure is the overall consumer price index. the price measure that has been 

moM WJdely used m government and private economic forecasts. Projection is 

pen:;ent change. fourth quarter of the previous year to the fourth quarter of the year 

indicated. 

risks to economic growth as weighted to the 

downside and the risks to the unemployment 

rate as weighted to the upside fell appreciably 

since September. Diminished risks to domestic 

economic activity from developments abroad 

and the strength of recent labor market data 

were among the reasons noted for the more 

upbeat assessment of risks. 

As in the September SEP, participants 

generally agreed that the levels of uncertainty 

associated with their inflation forecasts were 

broadly similar to the average level over the 

past 20 years. The number of participants who 

viewed the risks to their inflation forecasts as 

weighted to the downside declined slightly 

since September, and a majority now viewed 

the risks to both PCE and core PCE inflation 

as broadly balanced. Among those who saw 

risks to inflation as tilted to the downside, 

several highlighted the continued strength 

of the dollar and some recent indications 

that inflation expectations had declined as 

contributing to their perception of those risks. 
112 


23566.057

46 PART 3: SUMMARY OF ECONOMIC PROJECTIONS 

Figure 4. Uncertainty and risks in economic projections 

Uncertainty about GDP growth 

[] December projections 

September projections 

Lower Broadly 

similar 

Number of participants 

Higher 

Number of participants 

Uncertainty about the unemployment rate 

Lower Broadly 

similar 

Uncertainty about PCE inflation 

Lower Broadly 

similar 

Higher 

Number of participants 

-18 

-16 

-14 

-12 

-10 

- 8 

- 6 

4 

Higher 

Number of participants 

Uncertainty about core PCE inllation 

-18 

16 

-14 

-12 

-10 

8 

- 6 

- 4 

L_ ____ ~~~_E~~~2 

Lower Broadly 

similar 

Higher 

Risks to GDP growth 

C December projections 

"' "' September pm_iections 

Weighted to 

downside 

Broadly 

balanced 

Risks to the unemployment rate 

Weighted to 

downside 

Broadly 

balanced 

Risks to PCE inflation 

Weighted to 

downside 

Broadly 

balanced 

Risks to eMe PCE inflation 

Weighted to 

downside 

Broadly 

balanced 

Number of participants 

Weighted to 

upside 

Number of participants 

Weighted to 

upside 

-18 

-16 

-14 

-12 

-10 

- 8 

0 

4 

2 

Number of participants 

Weighted to 

upside 

-IS 

-16 

-14 

-12 

-IO 

- 8 

- 0 

- 4 

2 

Number of participants 

Weighted to 

upside 

-18 

-16 

-14 

Non:; For definitions of uncertainty and risks in economic projections, see the box "Forecast Uncertainty.'' Definitions of 

variables are in the general note to table 1. 
113 


23566.058

Forecast Uncertainty 

The economic projections provided by the members 

of the Board of Governors and the presidents of 

the Federal Reserve Banks inform discussions of 

monetary policy among policymakers and can aid 

public understanding of the basis for policy actions. 

Considerable uncertainty attends these projections, 

however. The economic and statistical models and 

relationships used to help produce economic forecasts 

are necessarily imperfect descriptions of the real world, 

and the future path of the economy can be affected 

by myriad unforeseen developments and events. Thus, 

in setting the stance of monetary policy, participants 

consider not only what appears to be the most likely 

economic outcome as embodied in their projections, 

but also the range of alternative possibilities, the 

likelihood of their occurring, and the potential costs to 

the economy should they occur. 

Table 2 summarizes the average historical accuracy 

of a range of forecasts, including those reported in 

past Monetary Policy Reports and those prepared 

by the Federal Reserve Board's staff in advance of 

meetings of the Federal Open Market Committee. 

The projection error ranges shown in the table 

illustrate the considerable uncertainty associated 

with economic forecasts. for example, suppose a 

participant projects that real gross domestic product 

(GOP) and total consumer prices will rise steadily at 

annual rates of, respectively, 3 percent and 2 percent. 

If the uncertainty attending those projections is similar 

to that experienced in the past and the risks around 

the projections are broadly balanced, the numbers 

reported in table 2 would imply a probability of about 

70 percent that actual COP would expand within a 

range of 2.1 to 3.9 percent in the current year, 1.2 to 

MONETARY POLICY REPORTo FEBRUARY 2016 47 

4.8 percent in the second year, and 0.9 to 5.1 percent 

in the third and fourth years. The corresponding 70 percent confidence intervals for overall inflation would 

be 1.8 to 2.2 percent in the current year, and 1.0 to 

3.0 percent in the second, third, and fourth years. 

Because current conditions may differ from those 

tllat prevailed, on average, over history, participants 

provide judgments as to whether the uncertainty 

attached to their projections of each variable is greater 

than. smaller than, or broadly similar to typical levels 

of forecast uncertainty in the past, as shown in table 2. 

Participants also provide judgments as to whether the 

risks to their projections are weighted to the upside, 

are weighted to the downside, or are broadly balanced. 

That is, participants judge whether each variable is 

more likely to be above or below their projections 

of the most likely outcome. These judgments 

about the uncertainty and tile risks attending each 

participant's projections are distinct from tile diversity 

of participants' views about the most likely outcomes. 

Forecast uncertainty is concerned with the risks 

associated with a particular projection rather than with 

divergences across a number of different projections. 

As with real activity and inflation, the outlook 

for the future path of the federal funds rate is subject 

to considerable uncertainty. This uncertainty arises 

primarily because eacll participant's assessment of 

the appropriate stance of monetary policy depends 

importantly on the evolution of real activity and 

inflation over time. If economic conditions evolve 

in an unexpected manner, then assessments of the 

appropriate setting of the federal funds rate would 

change from that point forward. 
114 


23566.059

ABBREVIATIONS 

AFE 

BHC 

CDS 

CMBS 

CRE 

EME 

FOMC 

GOP 

MBS 

ONRRP 

OPEC 

PBOC 

PCE 

SEP 

SLOOS 

SOMA 

advanced foreign economy 

bank holding company 

credit default swap 

commercial mortgage-backed securities 

commercial real estate 

emerging market economy 

Federal Open Market Committee; also, the Committee 

gross domestic product 

mortgage-backed securities 

overnight reverse repurchase agreement 

Organization of the Petroleum Exporting Countries 

People's Bank of China 

personal consumption expenditures 

Summary of Economic Projections 

Senior Loan Officer Opinion Survey on Bank Lending Practices 

System Open Market Account 

49 
115 


23566.060
116 


23566.061

Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal 

Reserve System from Representative Fincher: 

1. The Basel Committee just finalized new trading book capital rules in January. I 

understand these rules were never intended to increase or decrease capital requirements, 

yet the fmal rule you endorsed last month will result in a 40% increase in capital 

requirements. I understand the Basel Committee conducted a number of impact studies, 

but can you commit that the Fed will conduct its own impact study with cost-benefit 

analysis and share the results with this committee prior to implementing it in the United 

States? Will the Fed consider recalibrating or deviating from this international agreement 

in any way if your own results demonstrate the rule's costs exceeds any incremental benefit 

it provides to financial stability or the safety and soundness of individual institutions? 

Given large trading losses some banks sustained during the fmancial crisis, the Basel Committee 

issued revised standards in 2009 to raise capital requirements for market risks. These revised 

standards, supplemented in 2010, roughly tripled the capital of banks that used internal models 

held against market risk, but did not change the basic framework of the market risk capital rules. 

The Basel Committee on Banking Supervision (BCBS) began the Fundamental Review of the 

Trading Book (FRTB) in 2011 to address some of the shortcomings in the structure of the market 

risk capital rules. Last year the industry commented about the calibration of certain aspects of 

the revised market risk capital rules. The BCBS addressed outstanding issues on calibration 

before publication of the final rule in January. The BCBS will be monitoring any undesired 

increase in capital that could impact market liquidity during the implementation period. 

The 40 percent figure cited is the weighted average increase in total capital across all banks 

under the revised market risk rule. The final decisions on the calibration, however, were not 

based on this figure. Rather they were based on an estimated increase in these capital 

requirements of20 percent for the median large global trading bank. The overall increase in 

capital for U.S. banks was estimated to be considerably less than the weighted average increase. 

Estimating the impact of the new standards entailed an extensive data collection from banks on a 

voluntary basis that tested proposed standards set forth in a consultative document. The data 

quality varied considerably among the banks' submissions and there were clear outliers. For this 

reason, the median was viewed as a more appropriate metric than the weighted average. 

Moreover, given the data quality issues, supervisors felt some increase in capital was appropriate 

to ensure the new standards were calibrated to a prudential level. In addition, the new standards 

for modeled market risk require that a bank's measure of risk exposure against which capital is 

held includes risk factors that a bank does not model well. In most countries, current standards 

do not require such a formal inclusion, but rather a supervisory assessment. The requirement for 

a formal inclusion under the new standard played a significant role in the increase of capital 

requirements for a number of banks. 

It is important to bear in mind that an increase in weighted average capital requirements does not 

translate into an increase for any particular bank. Some banks showed an increase in capital 

requirements, while others showed a decrease. The variability in outcomes underscores the lack 
117 


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-2-

of precision of the capital change estimates collected in Basel quantitative impact studies arising 

in part from differences in the capability of various banks' systems to capture the necessary data. 

Before adopting a standard for revised trading book capital requirements, the Federal Reserve, 

Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation will 

issue a domestic Notice of Proposed Rulemaking for public comment. That notice will describe 

the costs and benefits of the proposed rules and identifY areas where these considerations may 

not be balanced for U.S. banks. 

We recognize that bank holdings of capital market instruments can be very sensitive to 

regulatory capital requirements and that it is important to maintain market liquidity as we 

promote financial stability. We are committed to ensuring that the new framework will not 

unduly disrupt smooth functioning of the capital markets. And we would not adopt any changes 

to the Fed's rules on market risk capital requirements without going through the U.S. comment 

process. 
118 


23566.063

Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal 

Reserve System from Representative Hill: 

1. In your testimony, you referenced "a range of persistent economic headwinds-such as 

limited access to credit for some borrowers, weak growth abroad, and a significant 

appreciation of the dollar." Further, we have had seven years of unprecedented low 

interest rates and exceptional monetary accommodation. The benefits of this "zero interest 

rate" environment have run their course. The long-term negative consequences are clear: 

wealth inequality increasing, asset prices driven up, misallocation of resources, Jack of a 

dependable market risk indicator, punishing of families trying to live on modest savings 

and social security. 

In short, we have sustained poor growth. Recently Dr. William Poole, former President of 

the Federal Reserve Bank of St. Louis, wrote a thoughtful piece in The Wall Street Journal, 

and his premise echoed the questions in this hearing in exploring the topic "persistent 

economic headwinds." In my view, the U.S. economy is facing substantial, non-monetary 

structural impediments to accelerated economic growth. Dr. Poole makes the suggestion 

that these non-monetary policy, structural impediments should be studied by the Federal 

Reserve stafi. 

Has the Federal Reserve formally studied these non-monetary policy structural 

impediments? If not, could you commit to such a study that considers such factors 

including the level of federal debt (to GDP and the current and potential impact of 

"crowding out"), tax policy, the level of federal intervention in the capital markets (impacts 

of Dodd-Frank provisions, Basel Ill regulations, and the Volcker Rule), the level of federal 

intervention in the labor markets (impacts of the Department of Labor rulings on 

compensation, benefits, overtime, etc. and Affordable Care Act mandates)? 

The United States has come much further in recovering from the Great Recession than have 

many other countries, and the evidence overwhelmingly indicates that the Federal Reserve's 

accommodative monetary policy during the past several years has been an essential force 

supporting this recovery. Today, the unemployment rate in the United States, at 4.9 percent, is 

roughly half of what it was during the worst of the Great Recession. For sure, some sectors of 

the economy and regions of the country have yet to fully recuperate, and many families still have 

not felt the benefits of a strong recovery. But the Congress has charged the Federal Reserve with 

promoting the overall macroeconomic health of the U.S. economy, and our monetary policy 

since the fmancial crisis has been effective in promoting a stronger labor market that is 

benefiting all population groups. 

Structural impediments to growth are relevant for the long-term performance of the economy, 

and they may play a role in explaining why the growth of gross domestic product has been as 

sluggish as it has been since the onset of the financial crisis. In addition, we do consider many of 

the factors you listed in judging the longer run sustainable growth rate of the economy through 

their effects on labor market perfom1ance, productivity and business investment. But our 

monetary policy mandate, as given to us by the Congress, is to pursue maximun1 employment 

and price stability. The labor market is much closer now to fulfilling the condition of maximum 

employment than it has been in years. The Federal Open Market Committee (FOMC) has 
119 


23566.064

-2-

interpreted "price stability" as corresponding to 2 percent inflation as measured by the price 

index for personal consumption expenditures. As I mentioned in my testimony, inflation has. 

fallen short of the Federal Reserve's 2 percent objective, on average, in recent years; but the 

FOMC judged, in December 201 S when it frrst raised the federal funds rate above from the range 

that it had occupied for several years, that the Committee was "reasonably confident that 

inflation will rise, over the medium term, to its 2 percent objective." Essentially by definition, 

structural impediments to growth are most relevant to the secular or trend growth of the economy 

over longer periods of time. In conducting monetary policy, the job of the Federal Reserve is to 

focus, frrst and foremost, on the cyclical fluctuations in economic output around its trend, and on 

the fluctuations in inflation around its 2 percent objective. That strategy is proven quite 

successful in helping to promote the economic recovery in a context of price stability. 
120 


23566.065

Questions for The Honorable .Janet L. Yellen, Chair, Board of Governors of the Federal 

Reserve System from Representative Hultgren: 

1. I have expressed concern with the supplementary leverage ratio's treatment of federal 

reserve deposits. You have described it as a "back-up" ratio in your testimony before the 

House Financial Services Committee, but that does not appear to be how the rule functions 

in the real world. 

You committed to both Congressman Rothfus and I that our concerns at minimum deserve 

further consideration by the Federal Reserve. During a February 10,2016, hearing of the 

House Financial Services Committee you stated, "We have heard of the problem and I will 

address it," and "You know, it's something we can look at, but it was considered." 

While you have described the Supplementary Leverage Ratio as the "back-up ratio", this 

and the standardized leverage ratio have or are becoming binding capital constraints for 

custody banks, due to their highly liquid, low risk balance sheets that support client needs. 

In light of your commitment to address these concerns, will the Federal Reserve Board 

consider adjusting the capital requirements for excess cash deposits held with the Federal 

Reserve? What opportunity will there be for input from the public? 

The supplementary leverage ratio rule (SLR rule) adopted by the Federal Reserve, the Offiee of 

the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (the Agencies), 

requires internationally-active banking organizations to hold at least 3 percent of total leverage 

exposure in tier 1 capital. The rule calculates total leverage exposure as the sum of certain offbalance sheet items and all on-balance sheet assets. 1 The on-balance sheet portion does not take 

into account the level of risk of each type of exposure and includes cash. As designed, the SLR 

rule requires a banking organization to hold a minimum amount of capital against on-balance 

sheet assets and off-balance sheet exposures, regardless of the risk associated with the individual 

exposures. This leverage requirement is designed to recognize that the risk a banking 

organization poses to the fmancial system is a factor of its size as well as the composition of its 

assets. Excluding select categories of on-balance sheet assets, such as cash, from totallevcrage 

exposure would generally be inconsistent with this principle. 

The Agencies understand the concern that certain custody banks, which act as intermediaries in 

high-volume, low-risk, low-return financial activities, may experience increases in assets as a 

result of macroeconomic factors and monetary policy decisions, particularly during periods of 

financial market stress2 Because the SLR rule is not a risk-based measure, it is possible banking 

organizations' costs of holding low-risk, low-return assets, such as deposits, could increase if 

such ratio were to become the binding regulatory capital constraint. However, when choosing an 

appropriate asset profile, banking organizations consider many factors in addition to regulatory 

capital requirements, such as yields available relative to the overall cost of funds, the need to 

1 See 79 Fed. Reg. 57725 (September 26, 2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-09-

26/pdfi'2014- 220&3.pdf. 2 The agencies have reserved authority under the capital rule to require a banking organization to use a different 

asset amount for an exposure included in the SLR to address extraordinary situations. See 12 CFR 3.l(d)(4) 

(OCC); 12 CFR 217.l(d)(4) (Federal Reserve); 12 CFR 324.l(d)(4) (FDIC). 
121 


23566.066

-2 

preserve financial flexibility and liquidity, revenue generation, the maintenance of market share 

and business relationships, and the likelihood that principal will be repaid. 

Regulatory requirements established by the Federal Reserve since the financial crisis are meant 

to address risks to which banking organizations are exposed, including the risks associated with 

funding in the form of cash deposits. The requirements are designed to increase the resiliency of 

banking organizations, enabling them to continue serving as fmancial intermediaries for the U.S. 

fmancial system and as sources of credit to household and businesses during times of stress. The 

SLR requirement and the enhanced SLR standards do not become effective until January 1, 

2018. According to public disclosures of firms subject to these requirements, the custody banks 

and other global systemically important banks have made significant progress in complying with 

the enhanced SLR requirements. 

Federal Reserve Board (Board) staff have held meetings with and reviewed materials prepared 

by the custody banks in connection with the implementation of the SLR rule. The Board 

continuously considers potential improvements to its regulations based on feedback from 

affected parties and the general public, but is not actively considering making any modifications 

to the SLR rule at this time. Any future changes to the Board's regulations would take public 

comments into account in a marmer consistent with U.S. law and the administrative rulemaking 

process. 

2. I understand the Federal Reserve already applies existing Customer Identification 

Program (CIP) requirements to all subsidiaries of the banks they supervise, including 

premium finance companies. Would a more nuanced approach for application ofthese 

requirements be appropriate for subsidiaries that pose little risk for money laundering or 

terrorism financing? What risk is posed, if any, by bank-owned premium finance 

companies? 

Will the Federal Reserve confirm that it will not apply further CIP requirements (if such 

rules become final) to the insurance premium finance industry until the Federal Reserve 

and the Financial Crimes Enforcement Network (FinCEN) demonstrate they will prevent 

terrorism financing and money laundering? Absent such confirmation, please explain the 

rational, if any, for application of incremental CIP requirements to bank-owned insurance 

premium finance companies. 

We understand the concerns that have been raised by some in the insurance premium fmance 

industry regarding the requirement to collect customer identification information under the Bank 

Secrecy Act (BSA). In 2003, the Financial Crimes Enforcement Network (FinCEN) and the 

federal banking agencies issued an interagency Customer Identification Program (CIP) rule 

implementing section 326 of the USA PATRIOT Act. The CIP rule requires banks and other 

financial institutions to form a reasonable belief regarding a customer's identity when opening an 

account.3 The CIP rule applies to any "formal banking relationship established to provide or 

engage in services, dealings, or other financial transactions including a deposit account, a 

transaction or asset account, a credit account, or other extension of credit."4 Importantly, the CIP 

3 31 CFR §1020.100(c), (a). 4 31 CFR § 103.12l(a)(i). 
122 


23566.067

-3-

rule does not exempt accounts established for the purpose of insurance premium financing. The 

CIP rule applies equally to banks and their subsidiaries when opening an account within the 

meaning of the rule.5 

The requirements of the CIP rule are typically satisfied by adopting risk -based procedures at 

account opening that enable the bank to verify the customer's identity to the extent reasonable 

and practicable. First, a bank's CIP must obtain a name, date of birth, address, and identification 

number from a customer who is an individual.6 Second, the bank must adopt identity 

verification procedures that describe when and how the bank will verify the customer's identity 

using documentary or non-documentary methods. 7 Finally, the CIP rule has specific account 

recordkeeping and notice requirements.8 The procedures used by the Federal Reserve and other 

banking agencies to examine a bank's compliance with the CIP rule are identified in the 

BSA/Anti-Money Laundering (AML) manual published by the Federal Financial Institutions 

Examination Council (FFIEC) member agencies.9 

In 2014, separate from the CIP rule, FinCEN issued a proposed rule that establishes customer 

due diligence (CDD) requirements for banks and other financial institutions with obligations 

under the BSA. As proposed, the CDD rule requires banks to identify the beneficial owner(s) of 

any legal entity customer who opens an "account" within the meaning of the CIP rule. Although 

the proposed CDD rule exempts certain customers, these exemptions do not extend to customers 

who establish an insurance premium financing relationship with a bank or its subsidiary. The 

Federal Reserve does not have the authority to exempt insurance premium finance companies 

from any increased costs associated with FinCEN's proposed CDD rule. The Federal Reserve's 

responsibility is limited to examining banks under its supervision for compliance with the CDD 

rule once FinCEN reaches its fmal determination. Indeed, only FinCEN retains the authority to 

determine whether the final CDD rule will apply to the insurance premium financing industry. 

3. On November 5, 2015, FDIC Vice Chairman Thomas Hoenig provided remarks to the 

18th Annual International Banking Conference at the Federal Reserve Bank of Chicago. 

During his prepared remarks, entitled "Post-Crisis Risks and Bank Equity Capital," Mr. 

Hoenig stated, regarding the Federal Reserve's proposal to increase minimum debt 

requirements, "A question we must ask, then, is whether the effect of such a requirement 

that is designed to make a firm more resolvable once that firm has failed, could -- prior to 

failure-- increase the firm's leverage and thereby its likelihood to default. Our goal to 

prevent failure should be every bit as important as resolving failed firms." 

Taking into account Mr. Hoenig's statement as well as the long term debt requirements 

under the Federal Reserve's recently proposed Total Loss Absorbing Capacity rules, do 

5 Interagency Interpretive Guidance on Customer Identification Program Requirements under section 326 of the 

USA PATRIOT Act, F AQs Final CIP Rule (April28, 2005). 6 31 CFR § 1020.220(a)(2)(i). 7 31 CFR § 1020.220(a)(2)(ii). 8 31 CFR § 1020.220(a)(3) and (a)(5). 9 See generally, FFIEC, BSA/AML Examination Manual (2014) (available at: 

https://www.ffiec.gov/bsa_ aml_infobase/pages _manual/manual_ online.htm). The FFIEC member agencies 

include the Federal Deposit Insurance Corporation, National Credit Union Administration, Office of the 

Comptroller of the Currency, and the Consumer Financial Protection Bureau, as well as the Federal Reserve 

Board. 
123 


23566.068

4-

you believe that the Fed has overlooked the "prevention of failure" as described by Mr. 

Hoenig and is instead placing unnecessary stress on financial institutions that could in fact 

lead to failure itself? Can you let the committee know what steps the FRB is taking in light 

of Mr. Hoenig's concerns? 

The Federal Reserve is committed to improving the resolvability and resiliency of global 

systemically important banks (GSIBs) and to limiting the systemic damage that would result if a 

large financial institution were to faiL GSIBs are central intermediaries in the U.S. financial 

market, and their failure or distress would thus likely cause the most harm to the financial 

system. The preamble to the Federal Reserve's Total Loss-Absorbing Capacity (TLAC) 

proposal acknowledges the importance of each of these two complementary objectives to the 

Dodd-Frank Wall Street Reform and Consumer Protection Act's broader goal of protecting U.S. 

financial stability and ending "too big to faiL" See 80 FR 74926, 74926-74928. 

The TLAC proposal's long-term debt requirement should not increase the likelihood that a 

banking organization that is subject to the proposed rule would fail. First, the Federal Reserve 

expects that the GSIBs would generally come into compliance with the long-term debt 

requirement without increasing their leverage or the size of their balance sheets, mostly by 

moving long-term debt that is currently outstanding from the GSIBs' bank subsidiaries to their 

holding companies, and by extending the maturity of existing debt. Second, the Federal Reserve 

has in place robust risk-based and leverage capital requirements, including a risk-based capital 

surcharge for the U.S. GSIBs, that are intended to keep the likelihood that a GSIB will fail at a 

very low leveL 10 The TLAC proposal would not weaken or override any of these important 

capital requirement~. 

Indeed, the TLAC proposal's long-term debt requirement should increase the resilience of the 

covered firms and thus decrease the likelihood that one of them would fail. Each covered firm 

would be required to maintain outstanding a substantial amount of eligible long-term debt, and 

the holders of that debt--rather than the short-term unsecured creditors of the covered firm's 

operating subsidiaries--would absorb the banking organization's losses in resolution. This 

requirement would give the entities that invest in a firm's eligible long-term debt strong 

incentives to impose market discipline on the firm, deterring it from taking excessive risks that 

could lead to failure. The requirement would also reduce the risk that the covered firm would 

experience a destabilizing run, because the holders of the long-term debt (which is not runnable) 

would absorb losses ahead of the operating subsidiaries' runnable short-term creditors, meaning 

that those short-term creditors would have diminished incentives to run in the first place. Thus, 

the TLAC proposal advances the goal of improving the resolvability and resiliency of GSIBs as 

well as the goal of reducing the harm that a GSIB failure would do to U.S. financial stability. 

The periodJor public comment on the TLAC proposal has now closed, and the Federal Reserve 

is carefully considering all of the conunents that have been submitted. As the Federal Reserve 

considers these comments and determines how to move forward with the proposal, it will 

continue to place great weight on ensuring the safety and soundness of the U.S. financial system. 

10 See 80 FR49082; Board of Governors of the Federal Reserve System, "Calibrating the GSIB Surcharge" (July 

20, 2015), available at www.federalreserve.gov/aboutthefed/boardmeetingslgsib-methodology-paper20150720.pdf. 
124 


23566.069

Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal 

Reserve System from Representative Luetkemeyer: 

1. The Fed's criteria for applying the Basel Advanced Approaches Capital requirements 

and the Liquidity Coverage Ratio (LCR) is $250 billion or more in assets or $10 billion or 

more in foreign exposures. These criteria were devised as part of Basel II in 2005, more 

than 10 years ago. As a result, the Advanced Approaches and the LCR apply to an entirely 

different group of institutions than the criteria originally captured. Has the Fed 

undertaken any assessment to determine if the $250 billion and $10 billion criteria are 

appropriate for the Advanced Approaches and the LCR, either on an individual firm basis 

or revising the thresholds entirely? 

The Federal Reserve Board (Board) is committed to ensuring that our regulations are 

appropriately tailored to the size and risk profile of regulated institutions. The Board has 

assessed the thresholds used to determine the scope of applicability of its regulations, including 

the advanced approaches capital requirements and the Liquidity Coverage Ratio (LCR) rule, to 

be appropriate for the idiosyncratic and systemic risks those regulations are meant to 

address. The thresholds of $250 billion or more in total consolidated assets or $10 billion or 

more in on-balance sheet foreign exposure capture those banking organizations that are the 

largest and most complex in the U.S. fmancial system and thus, those that pose the most 

systemic risk. The fact that the thresholds capture different firms than in 2005 reflects changes 

in the profiles of those firms. The Board continues to monitor the scope of applicability of the 

advanced approaches capital requirements, LCR rule, and its other regulations. 
125 


23566.070

Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal 

Reserve System from Representative Luetkemeyer: 

2. With respect to the Basel Advanced Approaches Capital requirements, would you 

support the Fed providing exempt relief for companies where their cost of compliance 

greatly exceeds their benefits? If so, how would you make that determination? 

Under the regulatory capital rules, promulgated by the Federal Reserve, the Office of the 

Comptroller of the Currency, and the Federal Deposit Insurance Corporation (the Agencies), 

internationally active banking organizations (specifically, those with total consolidated assets of 

$250 billion or more, or with consolidated total on-balance-sheet foreign exposure of $10 billion 

or more) must calculate risk-based capital using the advanced approaches risk-based capital rules 

(the advanced approaches rule) in addition to the standardized approach. Section IOO(b)(2) of 

the regulatory capital rules provides that a banking organization subject to the advanced 

approaches rule shall remain subject to that rule until the primary federal regulator determines 

that application of the advanced approaches rule is not appropriate in light of the banking 

organization's size, level of complexity, risk profile, or scope of operations. In making such a 

determination, the primary federal regulator must apply notice and response procedures. 1 The 

primary federal regulator may also set conditions on the granting of the waiver as appropriate, 

and any waiver granted must be consistent with safety and soundness. The capital adequacy of a 

banking organization that meets the thresholds described above, but has received a waiver from 

application of the advanced approaches rules would be addressed by standardized risk-based 

capital rules, leverage rules, and capital planning and supervisory stress-testing requirements. 

3. While the Federal Reserve Board has described the Supplementary Leverage Ratio as 

the "back-up ratio", this and the standardized leverage ratio have or are becoming binding 

capital constraints for custody banks, due to their highly liquid, low risk balance sheets 

that support client needs. In light of this concern, will the Federal Reserve Board consider 

adjusting the capital requirements for excess cash deposits held with the Federal Reserve? 

The supplementary leverage ratio rule (SLR rule) adopted by the Agencies, requires 

internationally-active banking organizations to hold at least 3 percent of total leverage exposure 

in tier 1 capital. The rule calculates total leverage exposure as the sum of certain off-balance 

sheet items and all on-balance sheet assets.z The on-balance sheet portion does not take into 

account the level of risk of each type of exposure and includes cash. As designed, the SLR rule 

requires a banking organization to hold a minimum amount of capital against on-balance sheet 

assets and off-balance sheet exposures, regardless of the risk associated with the individual 

exposures. This leverage requirement is designed to recognize that the risk a banking 

organization poses to the financial system is a factor of its size as well as the composition of its 

assets. Excluding select categories of on-balance sheet assets, such as cash, from total leverage 

exposure would generally be inconsistent with this principle. 

1 12 CFR 3.404 (Office of the Comptroller of the Currency), 12 CFR 263.202 (Federal Reserve), and 12 CFR 324.5 

(Federal Deposit Insurance Corporation). 2 See 79 Fed. Reg, 57725 (September26, 2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-09-

26/pd1J2014- 22083.pdf. 
126 


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-2-

The Agencies understand the concern that certain custody banks, which act as intermediaries in 

high-volume, low-risk, low-return financial activities, may experience increases in assets as a 

result of macroeconomic factors and monetary policy decisions, particularly during periods of 

fmancial market stress. 3 Because the SLR rule is not a risk -based measure, it is possible banking 

organizations' costs of holding low-risk, low-return assets, such as deposits, could increase if 

such ratio were to become the binding regulatory capital constraint. However, when choosing an 

appropriate asset profile, banking organizations consider many factors in addition to regulatory 

capital requirements, such as yields available relative to the overall cost of funds, the need to 

preserve financial flexibility and liquidity, revenue generation, the maintenance of market share 

and business relationships, and the likelihood that principal will be repaid. 

Regulatory requirements established by the Federal Reserve since the fmancial crisis are meant 

to address risks to which banking organizations are exposed, including the risks associated with 

funding in the form of cash deposits. The requirements are designed to ·increase the resiliency of 

banking organizations, enabling them to continue serving as financial intermediaries for the U.S. 

financial system and as sources of credit to household and businesses during times of stress. The 

SLR requirement and the enhanced SLR standards do not become effective until 

January 1, 2018. According to public disclosures of firms subject to these requirements, the 

custody banks and other global systemically important banks have made significant progress in 

complying with the enhanced SLR requirements. 

Federal Reserve Board (Board) staff have held meetings with and reviewed materials prepared 

by the custody banks in connection with the implementation of the SLR rule. The Board 

continuously considers potential improvements to its regulations based on feedback from 

affected parties and the general public, but is not actively considering making any modifications 

to the SLR rule at this time. Any future changes to the Board's regulations would take public 

comments into account in a manner consistent with U.S. law and the administrative rulemaking 

process. 

4. In a recent written response to Congress on the insurance capital issue, you wrote that 

the Federal Reserve Board will consider a congressional suggestion regarding a baseline 

approach that would rely in part on the state risk-based capital framework. You also 

wrote that the Board now has the authority to exclude insurance operations from its 

consolidated capital requirements pursuant to the Collins Amendment. Will you please be 

more specific about your plans to rely on the state risk-based capital framework for 

insurance companies? How fully will you rely on the state regime for the insurance 

operations of federally supervised insurers? 

You are correct to note that, in developing our domestic insurance regulatory capital 

requirements, the Board has greater flexibility to tailor these requirements to the business of 

insurance through the Insurance Capital Standards Clarification Act of2014, which gave the 

Board the authority to exclude regulated insurance companies when establishing minimum 

consolidated risk-based capital requirements for supervised insurance savings and loan holding 

companies and nonbank financial companies. 

3 The Agencies have reserved authority under the capital rule to require a banking organization to use a different 

asset amount for an exposure included in the SLR to address extraordinary situations. See 12 CPR 3.1(d)(4) 

(OCC); 12 CFR 217J(d)(4)(Pederal Reserve); 12 CFR 324J(d)(4) (FDIC). 
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We leverage the work of state insurance regulators where possible. The Federal Reserve's 

consolidated supervision supplements existing state based legal-entity supervision, which 

focuses on policyholder protection, with a perspective that considers the risks across the entire 

firm. 

It would be premature for me to comment on how we will treat the unique risks of certain 

insurance lines, mix of business and the like, before the Board has fully considered its potential 

options for consolidated capital frameworks, and we are in the process of doing just that through 

careful deliberations. To that end, in our consolidated supervision of insurance firms, the Board 

remains committed to tailoring our supervisory approach, including a domestic regulatory capital 

framework and other insurance prudential standards, to the business of insurance, reflecting 

insurers' different business models and systemic importance compared to other frrms supervised 

by the Board. Moreover, we are committed to a formal rulemaking process in the development 

of insurance capital requirements. 

5. You have indicated that you were not positive as to whether or not one capital rnle 

would apply to all insurance companies subject to supervision by the Federal Reserve 

Board. You suggested that firm-specific rules might apply to those insurers designated as 

nonbank SIFis. Please clarify the Federal Reserve Board's plan in this regard. What sort 

of firm-specific rules will nonbank SIFI insurers face and how will those rules be applied? 

Without going into specifics as to the Board's plans for each firm, what issues will the rules 

address, e.g., capital and/or stress testing? Will any firm-specific rules be imposed by 

order exposed for public comment rather than traditional rulemaking? 

As I have noted, it would be premature for me to comment on how we will treat insurers' unique 

risks, in the development of consolidated capital requirements for supervised insurance nonbank 

financial companies, before the Board has fully considered its potential options. The Board's 

consolidated supervision supplements existing legal-entity supervision with a perspective that 

considers the risks across the entire firm. The Board's role in monitoring and mitigating risks to 

financial stability seeks to ensure, as appropriate, that supervised insurance firms remain solvent 

as going concerns, maintain their positions as financial intermediaries even in times of stress, and 

are resolvable in a manner that is not destabilizing to the financial system if resolution is 

required. Together with the capital framework that the Board determines for supervised 

insurance nonbank financial companies, the Board intends to conduct stress tests, as prescribed 

under the Dodd-Frank Wall Street·Reforrn and Consumer Protection Act (Dodd-Frank Act), 

which will be appropriately tailored to the business of insurance and the insurance companies' 

solvency under stress conditions. These will be designed in coordination with the Federal 

Insurance Office as specified under the Dodd-Frank Act. As we develop the stress testing 

framework, we will determine the appropriate treatment of circumstances concerning the 

individual company and the financial system. Moreover, with regard to the insurance capital 

rules that the Board develops and applies, we are committed to a formal rulemaking process. 
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23566.073

Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal 

Reserve System from Representative Lynch: 

1. As you know, last year I, along with Congressman Capuano and most of the 

Massachusetts Delegation, wrote to the Fed, the OCC and the FDIC on the regulation that 

requires custody banks to maintain a 6 percent enhanced supplemental leverage ratio to be 

considered well capitalized, even on custody cash funds deposited with the Federal Reserve 

banks. In your response letter dated December 21, 2015, The Fed and the other two 

agencies said: "The agencies understand the concern that certain custody banks, which act 

as intermediaries in certain high-volume, low-risk, low-return financial activities may 

experience increases in assets as a result of macroeconomic factors and monetary policy 

decisions, particularly during times of financial market stress. Because the SLR is not a 

risk-based measure, it is possible that banking organizations' cost of holding low-risk lowreturn assets such as deposits could increase if this ratio were to become the binding 

regulatory capital constraint". The custody banks are telling me the leverage ratio has 

become the binding capital constraint for custody banks, due to their highly liquid, low risk 

balance sheets. Can you assure me the Fed will work with the other regulatory bodies and 

the custody banks to alleviate this concern? I don't think anyone wants to experience a 

crisis scenario where custody banks cannot accept their clients cash deposits, cash that 

would be deposited in the federal reserve system. 

The supplementary leverage ratio rule (SLR rule) adopted by the Federal Reserve, the Office of 

the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (the Agencies), 

requires internationally-active banking organizations to hold at least 3 percent oftotalleverage 

exposure in tier 1 capitaL The rule calculates total leverage exposure as the sum of certain offbalance sheet items and all on-balance sheet assets. 1 The on-balance sheet portion does not take 

into account the level of risk of each type of exposure and includes cash. As designed, the SLR 

rule requires a banking organization to hold a minimum amount of capital against on-balance 

sheet assets and off-balance sheet exposures, regardless of the risk associated with the individual 

exposures. This leverage requirement is designed to recognize that the risk a banking 

organization poses to the financial system is a factor of its size as well as the composition of its 

assets. Excluding select categories of on-balance sheet assets, such as cash, from total leverage 

exposure would generally be inconsistent with this principle. 

The Agencies understand the concern that certain custody banks, which act as intermediaries in 

high-volume, low-risk, low-return financial activities, may experience increases in assets as a 

result of macroeconomic factors and monetary policy decisions, particularly during periods of 

financial market stress.2 Because the SLR rule is not a risk-based measure, it is possible banking 

organizations' costs of holding low-risk, low-retum assets, such as deposits, could increase if 

such ratio were to become the binding regulatory capital constraint. However, when choosing an 

appropriate asset profile, banking organizations consider many factors in addition to regulatory 

capital requirements, such as yields available relative to the overall cost of funds, the need to 

1 See 79 Fed. Reg. 57725 (September 26, 2014), available at http://www.gpo.gov/fdsys/pkg!FR-2014-09-

26/pd£'2014- 22083.pdf. 2 The agencies have reserved authority under the capital rule to require a banking organization to use a different 

asset amount for an exposure included in the SLR to address extraordinary situations. See 12 CFR 3.l(d)(4)(0CC); 

12 CFR 217.l(d)(4) (Federal Reserve); 12 CFR 324.1(d)(4) (FDIC). 
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preserve financial flexibility and liquidity, revenue generation, the maintenance of market share 

and business relationships, and the likelihood that principal will be repaid. 

Regulatory requirements established by the Federal Reserve since the financial crisis are meant 

to address risks to which banking organizations are exposed, including the risks associated with 

funding in the form of cash deposits. The requirements are designed to increase the resiliency of 

banking organizations, enabling them to continue serving as financial intermediaries for the U.S. 

financial system and as sources of credit to household and businesses during times of stress. The 

SLR requirement and the enhanced SLR standards do not become effective until January 1, 

2018. According to public disclosures of firms subject to these requirements, the custody banks 

and other global systemically important banks have made significant progress in complying with 

the enhanced SLR requirements. 

Federal Reserve Board (Board) staff have held meetings with and reviewed materials prepared 

by the custody banks in connection with the implementation of the SLR rule. The Board 

continuously considers potential improvements to its regulations based on feedback from 

affected parties and the general public, but is not actively considering making any modifications 

to the SLR rule at this time. Any future changes to the Board's regulations would take public 

comments into account in a manner consistent with U.S. law and the administrative rulemaking 

process. 
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23566.075

Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal 

Reserve System from Representative Messer: 

1. Chair Yellen, In November, you claimed before this committee that the Fed is studying 

the consequences of all the new regulations on the economy "very closely" including the 

impact on market liquidity. Now European regulators are actually doing a formal review. 

Given that many of our own rules have gone farther than international standards, isn't it 

time for a formal review of the cumulative impact of the new rules here in the United 

States? 

The Federal Reserve conducts a variety of economic analyses and assessments to support the 

rulemaking process. For instance, the Federal Reserve included economic cost and impact 

assessments in its margin trading and Total Loss-Absorbing Capacity proposals. As these 

proposals relate to a specific regulation or requirement, the impact analyses naturally focus on 

the impact of the specific regulation in question, though impact and cost estimates can generally 

be aggregated across different regulatory initiatives. More broadly, the Federal Reserve engages 

in a regular quantitative impact assessment and monitoring program that is coordinated with 

other global regulators through the Basel Committee on Banking Supervision (BCBS) to assess 

the overall impact of prudential capital and liquidity requirements. This impact assessment has 

been conducted and made public regularly since 2012, and it continues to inform the 

Federal Reserve's understanding of the cost and impact of capital and liquidity regulation. 

Additionally, the Federal Reserve participates in a global effort through its participation on the 

Financial Stability Board and the BCBS's Macroeconomic Assessment Group. The 

Macroeconomic Assessment Group published a study in 2010 that assessed the overall 

macroeconomic impact of stronger capital and liquidity requirements. 

The Federal Reserve seriously considers the overall cost and benefit of all of the regulations it 

promulgates. The overarching goal of the Federal Reserve's regulatory program is to enhance 

financial stability while at the same time not creating any undue costs or burdens for the rest of 

the economy. The Federal Reserve is committed to engaging in an ongoing assessment program 

to better understand how post-crisis reform is influencing financial stability as well as the 

potential economic costs of enhanced regulation. 
131 


23566.076

Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal 

Reserve System from Representative Mulvaney: 

1. I would like to follow up on our discussion concerning rules-based monetary policy and 

economic normalization. During the hearing, you testified that "the economy is in many 

ways close to normal," that unemployment rates are at a point "most of my colleagues 

believe are consistent with full employment in the longer rnn," and that you had good 

reason to believe inflation "will move up over time." In fact, you testified, "in a sense, 

things are normal." While you mentioned some concerns with the neutral level of the 

Federal Funds Rate and some other headwinds, you testified that the Taylor Rule wouldn't 

be appropriate due to its underlying assumptions. You testified that the Federal Reserve 

follows systematic policy, but not in the form of a rule. However, at the end of our 

conversation, I was still left wondering what the world would have to look like before the 

Federal Reserve would be willing to employ a rules based system? I recognize that the 

Federal Reserve can still deviate from a rule to consider large sets of indicators about the 

economy's performance, and that employing a rule isn't mechanic, but I do expect to know 

what would be required before the Federal Reserve will consent to using rule based policy. 

It is essential that Congress and the public understand the methods employed by the Fed 

when making monetary policy decisions, and have some ability to predict future economic 

outcomes based on economic conditions (recognizing these change in extraordinary 

circumstances). A rule based policy provides us both the oversight and understanding that 

is essential during normal economic times. 

Chair Yellen, I'd like to provide you another opportunity to answer this question, directly: 

What must the world look like before the Federal Reserve will employ and follow a rules 

based system of monetary policy? 

What must the employment rate be? 

What must the inflation rate be? 

What must the Federal Funds rate be? 

What other factors must change from the state of the economy today before you will follow 

a monetary policy rule- any rule, not just the Taylor rule- of your choosing? 

Please answer each question specifically, including with specific rates and levels. 

My judgment, based on my reading of the research literature on policy rules and my experience 

as a policymaker, is that simple policy rules are a useful input into monetary policy decisions but 

that it is unlikely to ever be appropriate to follow the prescriptions of any simple policy rule. 

The economic research literature on monetary policy rules indicates that it is possible to identify 

optimal policy rules within the context of specific models of the structure and dynamics of an 

economy, but that the optimal rule is not the same in all models. The actual U.S. economy is 

much more complex than any of the extant models of the economy that economists have 

developed, so we cannot say that any particular rule is the right rule. The research literature also 

indicates that the optimal rule changes as the structure or dynamics of the economy changes. We 

know that the structure of the U.S. economy changes over time, but we cannot track those 

changes with any mathematical precision in real time. Moreover, even in the context of a given 

model of the U.S. economy, a rule that produces good outcomes on average does not do so in 
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response to all shocks to the economy. For those reasons, my Federal Reserve colleagues and I 

monitor the prescriptions of a range of policy rules and use them as inputs to our deliberations 

but do not necessarily implement the prescriptions of any rule. 

To the extent that the factors restraining growth in U.S. economic activity (headwinds) are 

stronger now than during the historical period over which any particular policy rule has been 

estimated to work well, the implication is that the federal funds rate needs to be lower, while 

those headwinds persist, than prescribed by the rule. I would note that the economy has 

continued to make gradual progress toward maximum employment over the past couple of years, 

and inflation has been low (even after adjusting for the effects of falling oil prices on reported 

inflation), even as the Federal Open Market Committee (FOMC) kept the federal funds rate near 

zero rather than raising it to the appreciably higher levels suggested by the Taylor rule. Those 

economic outcomes indicate that monetary policy was not too easy even though it was more 

accommodative than the prescriptions of the Taylor rule. Nonetheless, I would not rule out the 

possibility that, as headwinds diminish over time, it could prove appropriate for the FOMC to 

gradually raise the federal funds rate to the level prescribed by the Taylor rule. 

I agree that it is essential that Congress and the public understand the methods employed by the 

Fed when making monetary policy decisions, and that they have some ability to predict future 

monetary policy decisions based on economic conditions. That is what I mean by a "systematic 

policy." A systematic policy is one that responds in a predictable and consistent manner to 

changes in economic conditions and the economic outlook. In practice, market expectations 

about future monetary policy, as indicated by market prices of federal funds futures contracts and 

some other financial instruments, do move in response to economic data that turns out to be 

stronger or weaker than expected; these movements offer evidence that investors understand how 

monetary policy will respond to an accumulation of data that indicates a need for a higher or 

lower path of the federal funds rate to foster maximum employment and price stability. That 

said, market participants, like policymakers, do not always agree about the implications of 

incoming data for the economic outlook, so they do not always agree about the implications of 

incoming data for future monetary policy. That would be true even if policymakers 

mechanically followed a particular rule: to predict future policy actions, investors would need to 

be able to predict the future values of the economic variables that enter the rule. 

2. When making monetary policy decisions, what weight do you place on equity market 

movements in your decision making? 

Of asset prices, stocks are one of the most closely watched and highly sensitive to economic 

conditions. With respect to monetary policy decisions, it should be the case that anticipated 

changes in policy are already discounted by market investors and are unlikely to affect 

equity prices when announced. However, any time a monetary policy decision is not 

aligned with market expectations, it would flow that there would be a greater impact on the 

markets. Have yon found that to be the case as well? Do you find equity market prices to 

transmit the effects of monetary policy, or are monetary policy decisions made in response 

to equity market activities? Are these two factors countercyclical? Do you see a greater 

impact in some types of funds, like exchange traded funds, compared to others, and what 

weight to you give those fluctuations compared to the overall market when making 

monetary policy decisions? 
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Research clearly indicates that widely expected news, whether about monetary policy or fiscal 

policy or economic data releases, has smaller effects on asset prices than does unexpected news. 

The reason, of course, is that a widely anticipated policy decision or data release had its effect on 

asset prices when investors came to anticipate the decision or data. It is worth noting, however, 

that investors are unlikely to all share the same expectation about any policy decision, so it is 

rare for there to be absolutely no market response to the FOMC's decisions. 

The effects of monetary policy actions on equity prices, like the effects of monetary policy 

actions on interest rates and exchange rates, are part of the transmission mechanism through 

which monetary policy affects the economy. For example, when the economy slows and 

unemployment rises, the FOMC typically reduces its target for the federal funds rate. That 

action, plus expectations of further such actions, tends to result in higher equity prices and thus 

higher net worth- and lower interest rates for households and businesses (relative to what they 

would be otherwise). Higher net worth and lower interest rates both tend to foster additional 

consumer spending and business investment spending; that additional spending, in tum, gives 

firms an incentive to increase production and employment. While equity prices and other asset 

prices help transmit the effects of changes in monetary policy to the economy, the 

Federal Reserve does not target any particular level of equity prices or other asset prices. 

Neither does it target a particular level of interest rates other than the federal funds rate. Asset 

prices and interest rates vary in response to many factors other than monetary policy; the 

Federal Reserve does not seek to prevent such variations. However, because asset prices and 

interest rates affect household and business decisions about how much to spend and save, the 

FOMC necessarily takes asset prices and interest rates other than the federal funds rate into 

account when it considers how the economy is likely to evolve and what adjustments in 

monetary policy may be appropriate to foster maximum employment and price stability. 

In a rough sense, broad equity price indexes tend to move with the business cycle, rising during 

economic expansions and declining during economic contractions. But there also appears to be a 

good deal of variation in equity prices- even in broad equity price indexes·- that is not 

associated with the business cycle. Accordingly, the FOMC does not focus on day-to day ups 

and downs in equity prices or other asset prices. I am not aware of evidence that there is a 

systematic difference in the covariation between various types of equity funds and economic 

conditions that would warrant using prices of exchange-traded funds rather than broad equity 

price indexes as an input into an assessment of fmancial conditions and their implications for the 

economic outlook. 
134 


23566.079

Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the 

Federal Reserve System from Representative Murphy: 

1. While we've started to see signs of positive growth recently, do you agree that the 

lack of meaningful and sustained wage growth is an indication that our economy has 

not yet reached an acceptable deimition of full employment? What type of progress 

on rising wages for working families do you see as a pre-requisite of any further rate 

increases? 

We consider a number of indicators when evaluating whether we are on a path to meeting 

our dual mandate such as changes in the labor market, spending growth, and inflation. 

Hence, no single indicator provides a comprehensive view of whether we are on a path to 

meet our dual mandate. That said, wage growth does provide a signal of both the outlook 

for inflation and how much slack there is in the labor market, and so it is an indicator that 

we follow closely. It is our assessment that there remains at least a small amount of slack 

in the economy and that there is scope for wage growth to strengthen consistent with 

achieving our 2 percent inflation objective. 

2. What efforts are you making to weigh the impact of further rate increases on the 

most vnlnerable populations? How in your view will raising interest rates impact 

working families, including in traditionally underserved and minority communities? 

I appreciate that the U.S. economic recovery, which has been substantial overall, has 

been uneven across communities, including some low- and moderate-income (LMI) 

communities, and I am troubled that some LMI communities have experienced long-term 

declines in economic opportunity. The Federal Reserve is limited in the extent to which 

its macroeconomic tools can specifically target those communities where further progress 

is needed. That said, our efforts to promote a strong economy, robust labor market, and 

stable financial institutions particularly benefit LMI communities, who tend to be harder 

hit when the economy falters. 

Given that monetary policy is blunt tool, the best way that we can promote the economic 

health ofLMI communities is to promote a sound economy. Monetary policy is currently 

accommodative, and in my view, assuming that labor markets continue to tighten and we 

are reasonably assured that inflation will return to our target, we will be most able to 

engender a sustainable expansion with a gradual removal of monetary accommodation. 

That said, as our decision not to raise rates in March shows, the path of monetary policy 

is dependent on the evolution of the economy. 
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23566.080

Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal 

Reserve System from Representative Sherman: 

1. What are the Federal Open Market Committee's (FOMC) plans in in the event of 

another economic downturn? Specifically, has the FOMC determined whether it has legal 

authority to implement the following tools: 

Negative interest rates; 

Assistance to states, municipalities, and territories in fiscal distress (e.g., Chicago's Public 

School System, the city of Detroit, and Puerto Rico); 

An emergency lending program using the Federal Reserve Act Section 14 (12 U.S.C. § 355) 

authority to make short-term public investments; 

Under what contingencies would the FQMC consider utilizing the tools listed above? 

Under what circumstances would the FOMC initiate a fourth round of quantitative easing? 

Under what circumstances would the FOMC formulate a target (e.g., 1.0%) for the fiveyear Treasury rate? 

The Federal Reserve's response to economic conditions, including any future financial crisis, 

very much depends on the circumstances. It is important to note that there have been many 

periods of economic downturn coupled with severe strains in fmancial markets that did not 

require the use of emergency lending programs, innovative monetary policy tools, or other 

extraordinary tools. Indeed, prior to the fmancial crisis in 2007-2009, the Federal Reserve had 

not utilized its emergency lending authorities since the Great Depression. 

It simply is not possible to predict the circumstances in which it might be appropriate to 

implement particular policies, such as conducting additional quantitative easing or formulating 

targets for longer-term rates. As the FOMC has noted in recent statements, we expect that the 

economy will continue to strengthen and that inflation will return to our 2 percent goal over time. 

Consistent with that outlook, the FOMC has noted that it believes the economic outlook will 

evolve in way that will warrant a gradual increase in the target federal funds rate. Of course, if 

the economic outlook evolves in an unexpected way, the Federal Reserve will adjust the stance 

ofpoliey- appropriately to foster progress toward-its long-run goals of maximum employment and 

stable prices. 

The policy tools available to the Federal Reserve are provided by statute. The Federal Reserve's 

authority to purchase obligations issued by municipalities is limited to very specific types of 

obligations and may be done only in the open market. The Federal Reserve's authority to 

provide emergency credit to non-depository institutions is limited to programs with broad-based 

eligibility aimed at supporting the flow of credit to households and businesses; under these 

provisions, the Federal Reserve does not have the legal authority to lend to a specific borrower, 

including a municipality, that is failing or seeking to avoid resolution. More generally, providing 

assistance to municipalities inherently involves political judgments. As a result, as the Federal 

Reserve has noted previously, any program designed to provide assistance to municipal 

governments is a matter for tl1e Congress and the Administration to address. 

Negative interest rates are a tool employed by countries in Europe and elsewhere. By some 

accounts, these policies appear to have provided additional policy accommodation. As I have 
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noted previously, we certainly are trying to learn as much as we can from the experience of other 

countries. That said, while I would not completely rule out the use of negative interest rates in 

some future very adverse scenario, policymakers would need to consider a wide range of issues 

before employing this tool in the United States, including the potential for unintended 

consequences. 
137 


23566.082

Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal 

Reserve System from Representative Tipton: 

1. Chair Yellen, I appreciate the recent discussion from regulators acknowledging that 

regulation can be over burdensome. For instance, last month FDIC Vice Chair Thomas 

Hoenig expressed concern that the Fed's TLAC proposal, meant to strengthen supervision 

of systemically important fmancial institutions in the U.S., may not be tailored enough. As 

you are likely aware, the Committee has several pieces of legislation pending, including my 

bill H.R. 2896, that would call ou regulators to be more tailored in their approach to 

prudential regulation. With regard to the TLAC rule, what criteria does the Fed use to 

determine its calibration for applying TLAC? There is a concern that it is not sensitive 

enough to the relative risk posed by individual institutions and I'd like to know what more 

can be done to ensure the level of regulation appropriately matches the risk posed by 

individual firms to the broader US Financial System. 

The Federal Reserve Board (Board) designed its total loss-absorbing capacity (TLAC) proposal 

to be closely tailored to the risks to financial stability posed by each covered entity. This 

tailoring can be seen both in the selection of the firms to which the proposed TLAC and 

long-term debt requirements would apply and in the calibration of those requirements, which 

would vary from finn to firm based on the Board's assessment of each covered firm's systemic 

footprint. 

First, the proposed TLAC and long-term debt requirements would apply only to the eight United 

States bank holding companies that meet the Board's criteria for "global systemically important 

banking organizations" (GSIBs), and to the U.S. intermediate holding companies of foreign 

GSIBs. As the preamble to the TLAC proposal discusses in greater detail, the criteria used to 

identify GSIBs are tailored to select those banking organizations that pose elevated risks to the 

financial system, and the criteria used to determine which foreign banking organizations must 

form U.S. intermediate holding companies are tailored to identifY the foreign banking 

organizations with substantial operations in the U.S. 

Second, the proposed external TLAC requirements include an "external TLAC buffer" whose 

size is scaled based on the systemic footprint of each U.S. GSIB. This scaling results from the 

fact that the external TLAC buffer for each U.S. GSIB includes the surcharge applicable to that 

firm under the first method of the Board's rule imposing risk-based capital surcharges on GSIBs 

(GSIB surcharge rule). See 80 FR, at 74933-74934. The materials issued along with the 

Board's GSIB surcharge rule discuss in detail how the GSIB surcharge applicable to each U.S. 

GSIB was calibrated on the basis of that firm's systemic footprint--that is, the damage that the 

firm's failure would be expected to do to the financial stability of the United States. 

Third, the proposed external long-term debt requirements also incorporate each U.S. GSIB's 

GSIB surcharge, in that the risk-weighted assets component of each U.S. GSIB's external longterm debt requirement would be 6 percent of risk-weighted assets plus the surcharge applicable 

to that firm under the GSIB surcharge rule. Again, the GSIB surcharges are scaled based on the 

systemic footprint of each U.S. GSIB. 
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Finally, under the TLAC proposal, each covered fum's TLAC and long-term debt requirements 

would include a risk-weighted assets component, which sets the dollar amount of the 

requirement on the basis of the level of risk posed by the assets on each individual finn's balance 

sheet. This component tailors the requirements to each firm's probability offailnre, and 

therefore to a key indicator of the risk that the firm poses to the financial stability of the United 

States. Thus, if two firms have balance sheets of the same absolute size but one of them is 

invested more heavily in relatively risky assets, then the firm with the riskier assets would be 

subject to higher requirements under the risk-weighted assets components of the proposed TLAC 

and long-term debt requirements. 
139 


23566.084

Questions for The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal 

Reserve System from Ranking Member Waters: 

1. It's estimated that more than $500 billion in checks are cashed annually, as opposed to 

deposited, and it's largely because of the time it takes for an average check to "clear." 

Would you agree that faster or same-day payments would reduce the need to cash checks? 

2. An FDIC study showed that 60% of people who already have an account with either a 

bank or a credit union want instant access to their money, so much so that they are willing 

to pay exorbitant fees in check-cashing or small dollar loans. What specifically is the 

Federal Reserve doing to address this? 

3. Are you aware that roughly 69% of first-time users of short-term loans said they used 

the loans to cover a recurring expense, such as paying rent or their electric bill? Do you 

agree that same day payments in the U.S. would help meet these daily cash-flow problems 

that so many families and young adults face? 

Response to questions 1 through 3: 

Several of the Federal Reserve's strategies in the payments system realm could help to make 

banking services more responsive to consumers including the unbanked and under banked 

population. The Federal Reserve has undertaken a variety of actions to speed the clearing of 

payments and the availability of funds. These payments system improvements should help lowincome Americans who face challenges managing their daily cash flow. 

With regards to check clearing, the Federal Reserve has led the effort to make the nation's check 

clearing system faster and more efficient, beginning with the initial development of the Check 

Clearing for the 21st Century Act (Check 21), which took effect in 2004, and the provision of 

new services that leverage the Check 21 statutory authorities. Instead of physically moving 

paper checks from one bank to another, Check 21 has enabled banks to collect checks 

electronically. As a result of Check 21 and other check-system improvements, checks are almost 

always delivered to the paying bank within one business day of being deposited in the banking 

system. Also, given the Federal Reserve's restructuring of its check collection service, banks 

generally must make the proceeds of checks available for withdrawal no later than two business 

days following deposit, giving consumers faster guaranteed availability of funds than previously 

was the case. 

The Federal Reserve has offered a voluntary same-day Automated Clearing House (ACH) 

service for several years. This experience has demonstrated that a same-day ACH service can 

only succeed if it is mandatory (that is, require all receiving banks to post same-day ACH 

transactions in a timely manner and make the funds available to the recipient on the day the 

transaction is received). Consistent with actions recently taken by the National Automated 

Clearing House Association or NACHA, the Federal Reserve Banks will introduce an enhanced, 

mandatory same-day ACH service later this year. This service will enable employers to pay their 

hourly workers via direct deposit, rather than by check, which is commonplace today. 

Employers will have more time to accurately determine the amount each hourly employee is due 

and create the ACH file in time to meet the processing deadlines for the current next-day ACH 
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service. The service will also enable banks to provide individuals an easy option to pay bills on 

a same-day basis. The Reserve Banks will encourage the banking industry to use same-day ACH 

for these and other potential use cases. 

Additionally, the Federal Reserve has been leading an effort, together with a broad group of 

interested stakeholders, to evaluate designs for new safe, ubiquitous, faster payment capabilities 

in the United States. With such capabilities, payments could be made in seconds or minutes, 

with the recipient of the payment having prompt access to the funds. This system could help 

consumers manage their money in near real time. We believe that more than a quarter of current 

check payments could migrate to faster payments capabilities. More information on this effort 

can be found at https://fedpaymentsimprovement.org/. Among the criteria that will be used to 

evaluate the various potential faster payments system designs are the speed in which transactions 

would be cleared, how fast funds would be made available to the payee, and importantly, how 

effectively the solution addresses the needs ofthe unbanked or underbanked to affordably send 

or receive payments. 

4. To what extent is lmancial inclusion of nnderserved communities a focus of the Federal 

Reserve's Faster Payments Taskforce? 

The Federal Reserve recognizes that faster payment capabilities have the potential to draw more 

of the unbanked and underbanked population into the financial mainstream. As noted above, one 

of the faster payments effectiveness criteria developed by the Faster Payments Task Force is how 

effectively a faster payments solution addresses the needs of the unbanked or underbanked to 

affordably send or receive payments (for example, by supporting the ability to make payments to 

and/or from a regulated nonbank provider and/or explicitly promoting financial inclusion in the 

payments solution). 

An important aspect of the Faster Payments Task Force's work is bringing together organizations 

with a wide range of views so that these views can be discussed and analyzed. To that end, the 

Federal Reserve has encouraged the Consumer Financial Protection Bureau (CFPB) and other 

consumer organizations to actively participate in the Faster Payments Task Force. Presently, 

representatives from Consumers Union and The Pew Charitable Trusts sit on the Faster 

Payments Task Force Steering Committee as well as a representative from the CFPB. 

Additionally, several other consmner advocacy organizations participate on the Faster Payments 

Task Foree. 

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