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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 THIRTEENTH CONGRESS 

FIRST SESSION 

JULY 17, 2013 

Printed for the use of the Committee on Financial Services 

Serial No. 113–39 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

GARY G. MILLER, California, Vice Chairman 

SPENCER BACHUS, Alabama, Chairman 

Emeritus 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

KEVIN McCARTHY, California 

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 

MICHAEL G. GRIMM, New York 

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 

TOM COTTON, Arkansas 

KEITH J. ROTHFUS, Pennsylvania 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

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 

GARY C. PETERS, Michigan 

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 

SHANNON MCGAHN, Staff Director 

JAMES H. CLINGER, Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

July 17, 2013 ..................................................................................................... 1 

Appendix: 

July 17, 2013 ..................................................................................................... 59 

WITNESSES 

WEDNESDAY, JULY 17, 2013 

Bernanke, Hon. Ben S., Chairman, Board of Governors of the Federal Reserve 

System ................................................................................................................... 7 

APPENDIX 

Prepared statements: 

Watt, Hon. Melvin ............................................................................................ 60 

Bernanke, Hon. Ben S. ..................................................................................... 61 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Bernanke, Hon. Ben S.: 

Monetary Policy Report to the Congress, dated July 17, 2013 ..................... 70 

Written responses to questions submitted by Representative Bachus ........ 126 

Written responses to questions submitted by Representative Kildee .......... 132 

Written responses to questions submitted by Representative Mulvaney .... 133 

Written responses to questions submitted by Representative Pittenger ..... 135 

Written responses to questions submitted by Representative Rothfus ........ 138 

Written responses to questions submitted by Representative Stivers ......... 142 

(1) 

MONETARY POLICY AND THE 

STATE OF THE ECONOMY 

Wednesday, July 17, 2013 

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, Miller, Bachus, 

King, Royce, Lucas, Capito, Garrett, Neugebauer, McHenry, Bachmann, Pearce, Posey, Fitzpatrick, Luetkemeyer, Huizenga, Duffy, 

Hurt, Stivers, Fincher, Stutzman, Mulvaney, Hultgren, Ross, 

Pittenger, Wagner, Barr, Cotton, Rothfus; Waters, Maloney, Velazquez, Watt, Sherman, Meeks, Clay, Lynch, Scott, Green, Cleaver, 

Perlmutter, Himes, Peters, Carney, Sewell, Foster, Kildee, Murphy, 

Delaney, Beatty, and Heck. 

Chairman HENSARLING. The committee will come to order. 

Without objection, the Chair is authorized to declare a recess of 

the committee at any time. 

The Chair now recognizes himself for 5 minutes for an opening 

statement. 

Chairman Bernanke, welcome. We all know your term as Chairman of the Federal Reserve is up at year’s end, and, to paraphrase 

Twain, we do not know if the rumors of your departure are greatly 

exaggerated. I will not ask you to comment, but I at least know 

there is a possibility this could be your last appearance before the 

committee. I certainly hope it is not. We have other matters to discuss with you and the Fed. 

But on the off possibility that it is, I did not want to let the moment pass without stating clearly for the record that, as one who 

has been in public office for 10 years, this chairman considers you 

to be one of the most able public servants that I have ever met. 

I suspect that history will record that at a very perilous point in 

our Nation’s economic history, you acted boldly and decisively and 

creatively, very creatively I might add, and kept your head. And 

under your leadership, the Fed took a number of actions that certainly staved off an even worse economic event, and for that I believe our Nation will always be grateful. 

Now, my words are sincere, but they do not negate my concern 

over the state of the economy today and the role that the Fed is 

playing in it. In today’s semi-annual Humphrey-Hawkins hearing 

on the state of the economy, we once again face the legacy of the 

President’s economic policies, a failed experiment in fiscal policy 

2 

that will forever be remembered for its three central pillars: persistent weak economic growth; higher taxes on working families; 

and unsustainable, record trillion-dollar deficits that one day our 

children must pay off. Witness the debt clock on either side of the 

hearing room. 

The Federal Reserve has, regrettably, in many ways enabled this 

failed economic policy through a program of risky and unprecedented asset purchases that has swollen its balance sheet by more 

than $3 trillion. Our committee has an obligation to carefully scrutinize the Federal Reserve’s decisions and the way it communicates 

those decisions to the American people. 

Chairman Bernanke has correctly observed that credible guidance about the future course of monetary policy is a vital tool that 

the Fed must use to ensure that markets, consumers, and producers can plan their own economic futures. My constituents back 

in Texas are concerned about how much they must save for retirement or for their children’s college tuition. They are left to wonder 

how much longer they will have to endure the paltry, paltry returns on the savings created by the Fed’s current interest rate policy, which favors borrowers over savers. 

And yet, recent panicked responses by financial markets to monetary policy communications and observations from a range of 

economists suggest the Federal Reserve’s forward guidance clearly 

needs some improvement. The market’s recent extreme volatility 

resulting from the offhanded comments of one individual, our witness today, is not healthy for an economy. Again, it indicates a 

monetary policy guidance system that is not working, and it begs 

the question: Are current equity market values based upon the fundamentals or unprecedented quantitative easing? 

Former Fed Chairman William McChesney Martin once observed 

that the Fed ‘‘should always be engaged in a ruthless examination 

of its own record.’’ Today, we will ask Chairman Bernanke to engage in such a ruthless examination of the Fed’s QE exit strategy, 

which is both untested and clearly not well understood by market 

participants. 

Based upon the economy’s performance since the Federal Reserve 

embarked upon its unprecedented campaign of monetary stimulus, 

many economists have observed, and I would tend to agree, that 

it is fair to conclude that rarely has so much been spent in pursuit 

of so little, and rarely has so much been risked in return for so little. The extraordinary measures of 2008 have become the ordinary, 

albeit unsustainable, measures of 2013 and beyond. Again, as recent events demonstrate, it remains very much an open question 

whether the Fed can orchestrate an orderly withdrawal of monetary stimulus. 

Finally, as the Federal Reserve approaches its 100th anniversary 

later this year, it is incumbent upon this committee to engage in 

an honest assessment of the Fed’s performance and consider just 

how we can improve the Federal Reserve over the next century. 

Chairman Bernanke, I appreciate your cooperation with the committee’s work. Thank you for being here today. 

At this time, I will recognize the ranking member for an opening 

statement. 

3 

Ms. WATERS. Thank you very much, Mr. Chairman. I would first 

would like to thank you, Mr. Chairman, for the words in support 

of Chairman Bernanke’s chairmanship. 

And Chairman Bernanke, I would like to thank you for being 

with us today. 

Chairman Bernanke, under your leadership and actions taken by 

the Federal Open Market Committee (FOMC), the recovery continues to strengthen. Treasury yields and mortgage rates have fallen to their lowest levels in decades, and home values have in turn 

risen between 5 and 12 percent over the 12-month period ending 

in April, resulting in a substantial reduction in the number of borrowers with negative equity. Without the dramatic actions you 

have taken to restore economic growth, the economy simply could 

not have recovered to the extent it has today. 

Since your last appearance before this committee to discuss the 

economy and the outlook for monetary policy back in February, 

there has been much debate about when and to what extent the 

FOMC might begin to slow the current pace of asset purchases. As 

the economic outlook improves, I would urge you not to scale back 

your monetary stimulus until it is absolutely clear that the nowfragile recovery will hold and real progress has been made in reducing unemployment. 

Thanks to your efforts, the number of people who are unemployed has steadily fallen since the height of the crisis. However, 

we still have a long way to go before we have achieved any reasonable measure of full employment. More than 11 million Americans 

continue to search for work, and countless others have either given 

up looking altogether or are stuck working fewer hours than they 

need to get by. With inflation in check, well below the 2 percent 

target, I would ask that you and your colleagues on the FOMC continue to give the employment aspect of your dual mandate the critical attention it deserves. 

In addition to the important work you are doing to foster economic growth, the Federal Reserve has also made significant 

progress in implementing key reforms aimed at strengthening our 

financial system. In particular, I was very pleased to see— 

Chairman HENSARLING. Would the gentlelady suspend? 

Mr. Chairman and the audience, forgive us. As my 9-year old 

would say, ‘‘Awkward.’’ But it appears that the problem has been 

fixed. 

If the ranking member wishes to start over, we would— 

Ms. WATERS. Thank you very much, Mr. Chairman. I would like 

to start over. 

Chairman Bernanke, under your leadership and through the actions taken by the FOMC, the recovery continues to strengthen. 

Treasury yields and mortgage rates have fallen to their lowest levels in decades, and home values have in turn risen between 5 and 

12 percent over the 12-month period ending in April, resulting in 

a substantial reduction in the number of borrowers with negative 

equity. Without the dramatic actions you have taken to spur economic growth, the economy simply could not have recovered to the 

extent it has today. 

Since your last appearance before this committee to discuss the 

economy and the outlook for monetary policy back in February, 

4 

there has been much debate about when and to what extent the 

FOMC might be able to slow the current pace of asset purchases. 

As the economic outlook improves, I would urge you not to scale 

back your monetary stimulus until it is absolutely clear that the 

now-fragile recovery will hold and real progress has been made in 

reducing unemployment. 

Thanks to your efforts, the number of people who are unemployed has steadily fallen since the height of the crisis. However, 

we still have a long way to go before we have achieved any reasonable measure of full employment. More than 11 million Americans 

continue to search for work, and countless others have either given 

up looking altogether or are stuck working fewer hours than they 

need to get by. With inflation in check, well below your 2 percent 

target, I would ask that you and your colleagues on the FOMC continue to give the employment aspect of your dual mandate the critical attention it deserves. 

In addition to the important work you are doing to foster economic growth, the Federal Reserve has also made significant 

progress in implementing key reforms aimed at strengthening our 

financial system. In particular, I was very pleased to see the balanced approach taken by the Federal Reserve in issuing the final 

Basel III rule, which appropriately takes into account the unique 

needs of our Nation’s community banks. 

I look forward to your testimony today, and I yield back the balance of my time. 

And thank you, Mr. Chairman. 

Chairman HENSARLING. The chairman now recognizes the vice 

chairman of the Monetary Policy and Trade Subcommittee, Mr. 

Huizenga of Michigan, for 3 minutes. 

Mr. HUIZENGA. Thank you, Chairman Hensarling, and Ranking 

Member Waters. I appreciate you holding this hearing today to discuss the semi-annual report on the state of the economy and our 

fiscal welfare. 

Additionally, Chairman Bernanke, I do want to thank you for 

your distinguished service to our country. Certainly, as the Chairman of the Board of Governors over the last 7 years, no one questions your desire to help our country through some of its most difficult times that we have seen in recent history. 

Today, I am particularly eager to hear your insights on monetary 

policy and the state of the economy. As I hear from small-business 

owners across Michigan, and, frankly, being a small-business 

owner myself in the construction and real estate fields, it is abundantly clear that small businesses are still feeling the negative impacts of the 2008 financial crisis. 

The economy has been painfully slow to recover—in fact, the 

weakest of any of the recent recoveries. And, in turn, job creation 

has lagged. Too many Americans remain out of work, while others 

have simply stopped looking for work altogether. 

These are the forgotten casualties that are oftentimes buried in 

government statistics. I am here to be their voice, and not be a 

voice of Wall Street but to be a voice for Main Street. 

Additionally, Washington’s addiction to spending remains evident. As we can see up here, we are exceeding $17 trillion in debt, 

and our chances for recovery as well as the outlook for our chilVerDate Nov 24 2008 17:17 Apr 11, 2014 Jkt 082861 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 K:\DOCS\82861.TXT TERRI
5 

dren’s prosperity dims. For too long, government has in many 

forms looked upon itself to solve the social and economic ills that 

our country faces. The Federal Reserve hasn’t been any different. 

Some would argue that may be because of the dual mandate and 

other things. 

The Federal Reserve has chosen to implement government-based 

solutions instead of employing a market-based approach, I would 

argue, whether it is artificially lowering and sustaining a near-zero 

interest rate, QE2, Operation Twist, QE3, QE Infinity, as some 

have quipped about, the government-knows-best approach has only 

prolonged high levels of unemployment and perpetuated a lack of 

consumer confidence that has, outside of Wall Street, created an 

economic environment where investment and growth remain stifled. 

With our GDP stagnating and unemployment remaining at 7.5 

percent or more since President Obama has taken office in 2009, 

you don’t see very many economists predicting the economy to take 

off in the near future. The policies implemented and prolonged by 

the Federal Reserve, I believe have worked hand-in-glove with 

that, and have failed. 

So when are these failed policies going to come to an end? We 

know we have had lots of indications. I have already gotten an update from The Wall Street Journal and a number of others who are 

looking at your comments. But the FOMC says they are planning 

on keeping the near-zero rate at least until sometime in 2015, with 

a target of a 6.5 percent unemployment rate. 

Questions that I think a lot of us have are: At what cost? And 

if not at what cost, at what benefit? And there are many who look 

at this analysis and have determined that you are tilting to a 

‘‘dovish monetary easing policy,’’ away from where we have been 

going. As a proponent of the free market and reducing the size of 

government, let me point out that is just one of the many problems 

with the Administration’s policies. 

Chairman Bernanke, I thank you, and I appreciate, again, your 

service and I look forward to today’s hearing. Thank you. 

Chairman HENSARLING. The Chair now recognizes the gentlelady 

from New York, Mrs. Maloney, for 2 minutes. 

Mrs. MALONEY. Thank you. 

I understand this may be Mr. Bernanke’s last testimony on 

Humphrey-Hawkins, as his term expires in January, although I 

hope it is not—I hope you are reappointed—but I did want to join 

my colleagues in thanking you for your extraordinary service during one of the most painful periods in the United States’ economic 

history. 

You have been a creative, innovative leader. The one area where 

you have always been consistent is you have never been boring. As 

a former teacher, I appreciate your ability and willingness to explain the Fed’s extraordinary measures in clear terms that all 

Americans can understand. 

While talk of the Fed’s tapering its asset-buying program has 

dominated the headlines recently, and the United States is still 

suffering from an unemployment crisis, it was reassuring to read 

in your prepared testimony that the Fed will continue its assetbuying program as long as economic conditions warrant. So I am 

6 

glad to see you are shaping Fed policy to help people and not just 

based on rigid ideological dogma. 

I also thank you for listening to the concerns in our letter from 

Chairwoman Capito on the concerns we have for small community 

and regional banks. We asked you to treat them differently from 

large international banks, and that is precisely the approach that 

the Basel III rules took. Community banks did not cause the financial crisis, and I am glad that the Fed came around to seeing our 

view on this issue. 

Thank you for your extraordinary service. 

Chairman HENSARLING. The gentlelady yields back. 

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

Velazquez, for 11⁄2 minutes. 

Ms. VELAZQUEZ. Thank you, Mr. Chairman. 

Welcome, Chairman Bernanke. Thank you for your public service. 

When I am in my district each week, I hear from people who are 

truly struggling in the current labor market. Some are unemployed, others are underemployed, and many have stopped looking 

for work altogether. 

Adding insult to injury, they hear that the stock market has recently achieved new highs and the housing market is recovering. 

But for many, this has not translated into new opportunities. Cuts 

to education and worker retraining programs as well as reduced investment in job-creating infrastructure projects have exacerbated 

what was an already dire situation. The truth is that it is hard for 

many to remember that just 6 years ago, the unemployment rate 

was less than 4.5 percent. 

And while these are anecdotes, the data shows that they are reflective of the Nation as a whole. Unemployment has remained 

above 7 percent since December 2008. Gallup is reporting that 17.2 

percent of the workforce is underemployed, and the labor participation rate is at a historical low. 

While the Federal Reserve has a dual mandate, it is this unemployment backdrop that must be given the greatest weight in its 

deliberations. As the Fed considers when and how to transition 

away from QE3, it must make certain that it does so without making a challenging employment situation worse. 

Thank you, Mr. Chairman. 

Chairman HENSARLING. The Chair now recognizes the gentleman 

from North Carolina, Mr. Watt, for 11⁄2 minutes. 

Mr. WATT. Thank you, Mr. Chairman. And I want to— 

Chairman HENSARLING. If the gentleman would suspend, if staff 

would please shut the door? 

The gentleman is recognized. 

Mr. WATT. I certainly join in the complimentary statements 

about the chairman’s service. And I have a prepared statement 

which I will submit for the record, but I thought it might be helpful 

to just reminisce about some of the changes that this Chairman 

has made. 

I was on this committee for a long, long time and never knew 

where the Federal Reserve was until Chairman Bernanke became 

the Chairman of the Fed. He opened up the process and 

demystified what the Fed does. 

7 

Since that time, we have gone through this whole debate about 

auditing the Federal Reserve, and substantially more of the records 

and proceedings of the Federal Reserve are open to the public. He 

speaks in plain language, as opposed to some of the prior Chairs, 

who tried to make everything seem so complicated and made it impossible for people to understand, either on the committee or certainly in the public. 

So I think he has contributed greatly to the image of the Fed, 

and I just wanted to thank him for his service. 

I will submit my official statement for the record. 

Chairman HENSARLING. Today, we welcome back to the committee, in the words of the gentlelady from New York, the neverboring, Honorable Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System. I believe we all agree he 

needs no further introduction, so he will not receive one. 

I do wish to all Members that the Chairman will be excused 

promptly at 1:00 p.m. And I wish to inform Members on the Majority side that those who were not able to ask questions during the 

Chairman’s last appearance will be given priority today. 

Without objection, Chairman Bernanke, your written statement 

will be made a part of the record. So, you are now recognized for 

your oral presentation. 

STATEMENT OF THE HONORABLE BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE 

SYSTEM 

Mr. BERNANKE. Thank you. Chairman Hensarling, Ranking 

Member Waters, and other members of the committee, I am 

pleased to present the Federal Reserve’s semi-annual ‘‘Monetary 

Policy Report to the Congress.’’ I will discuss current economic conditions and the outlook and then turn to monetary policy, and I 

will finish with a short summary of our ongoing work on regulatory 

reform. 

The economic recovery has continued at a moderate pace in recent quarters, despite strong headwinds created by Federal fiscal 

policy. Housing has contributed significantly to recent gains in economic activity. Home sales, house prices, and residential construction have moved up over the past year, supported by local interest 

rates and improved confidence in both the housing market and the 

economy. Rising housing construction and home sales are adding to 

job growth, and substantial increases in home prices are bolstering 

household finances and consumer spending while reducing the 

number of homeowners with underwater mortgages. 

Housing activity and prices seem likely to continue to recover 

notwithstanding the recent increases in mortgage rates, but it will 

be important to monitor developments in this sector carefully. 

Conditions in the labor market are improving gradually, yet the 

unemployment rate stood at 7.6 percent in June, about a half percentage point lower than in the months before the Federal Open 

Market Committee initiated its current asset purchase program in 

September. Nonfarm payroll employment has increased by an average of about 200,000 jobs per month so far this year. Despite these 

gains, the job situation is far from satisfactory, as the unemployment rate remains well above its longer-run normal level and rates 

8 

of underemployment and long-term unemployment are still much 

too high. 

Meanwhile, consumer price inflation has been running below the 

committee’s longer-run objective of 2 percent. The price index for 

personal consumption expenditures rose only 1 percent over the 

year ending in May. This softness reflects, in part, some factors 

that are likely to be transitory. Moreover, measures of longer-term 

inflation expectations have generally remained stable, which 

should help move inflation back up toward 2 percent. 

However, the committee is certainly aware that very low inflation poses risks to economic performance—for example, by raising 

the real cost of capital investment—and increases the risk of outright deflation. Consequently, we will monitor this situation closely, as well, and we will act as needed to ensure that inflation 

moves back toward our 2 percent objective over time. 

At the June FOMC meeting, my colleagues and I projected that 

economic growth would pick up in the coming quarters, resulting 

in gradual progress toward the level of unemployment and inflation 

consistent with the Federal Reserve’s statutory mandate to foster 

maximum employment and price stability. 

Specifically, most participants saw real GDP growth beginning to 

step up during the second half of this year, eventually reaching a 

pace between 2.9 and 3.6 percent in 2015. They projected the unemployment rate to decline to between 5.8 and 6.2 percent by the 

final quarter of 2015, and they saw inflation gradually increasing 

toward the committee’s 2 percent objective. 

The pickup in economic growth predicted by most committee participants partly reflects their view that Federal fiscal policy will 

exert somewhat less drag over time, as the effects of the tax increases and the spending sequestration diminish. The committee 

also believes that risks to the economy have diminished since the 

fall, reflecting some easing of the financial stresses in Europe; the 

gains in housing and labor markets that I mentioned earlier; the 

better budgetary positions of State and local governments; and 

stronger household and business balance sheets. 

That said, the risks remain that tight Federal fiscal policy will 

restrain economic growth over the next few quarters by more than 

we currently expect or that the debate concerning other fiscal policy issues, such as the status of the debt ceiling, will evolve in a 

way that could hamper the recovery. More generally, with the recovery still proceeding at only a moderate pace, the economy remains vulnerable to unanticipated shocks, including the possibility 

that global economic growth may be slower than currently anticipated. 

With unemployment still high and declining only gradually and 

with inflation running below the committee’s longer-run objective, 

a highly accommodative monetary policy will remain appropriate 

for the foreseeable future. In normal circumstances, the committee’s basic tool to provide monetary accommodation is its target for 

the Federal funds rate. However, the target range for the Federal 

funds rate has been close to zero since late 2008 and cannot be reduced meaningfully further. 

Instead, we are providing additional policy accommodation 

through two distinct yet complementary policy tools. The first tool 

9 

is expanding the Federal Reserve’s portfolio of longer-term Treasury securities and agency mortgage-backed securities. We are currently purchasing $40 billion per month in agency MBS and $45 

billion per month in Treasurys. The second tool is forward guidance 

about the committee’s plans for setting the Federal funds rate target over the medium term. 

Within our overall policy framework, we think of these tools as 

having somewhat different roles. We are using asset purchases and 

the resulting expansion in the Federal Reserves’s balance sheet primarily to increase the near-term momentum of the economy, with 

the specific goal of achieving a substantial improvement in the outlook for the labor market in a context of price stability. 

We have made some progress toward this goal, and, with inflation subdued, we intend to continue our purchases until a substantial improvement in the labor market outlook has been realized. In 

addition, even after purchases end, the Federal Reserve will be 

holding its stock of Treasury and agency securities off the market 

and reinvesting the proceeds from maturing securities, which will 

continue to put downward pressure on longer-term interest rates, 

support mortgage markets, and help to make broader financial conditions more accommodative. 

We are relying on near-zero short-term interest rates, together 

with our forward guidance that rates will continue to be exceptionally low—this is our second tool—to help maintain a high degree 

of monetary accommodation for an extended period after asset purchases end, even as the economic recovery strengthens and unemployment declines toward more normal levels. In appropriate combination, these two tools can provide the high level of policy accommodation needed to promote a stronger economic recovery with 

price stability. 

In the interest of transparency, the committee participants 

agreed in June that it would be helpful to lay out more details 

about our thinking regarding the asset purchase program—specifically, provide additional information on our assessment of progress 

to date as well as the likely trajectory of the program if the economy evolves as projected. 

This agreement to provide additional information did not reflect 

a change in policy. The committee’s decisions regarding the asset 

purchase program and the overall stance of monetary policy depend 

on our assessment of the economic outlook and of the cumulative 

progress toward our objectives. Of course, economic forecasts must 

be revised when new information arrives and are, thus, necessarily 

provisional. 

As I noted, the economic outcomes that the committee participants saw as most likely in their June projections involved continuing gains in labor markets, supported by moderate growth that 

picks up over the next several quarters as the restraint from fiscal 

policy diminishes. The committee participants also saw inflation 

moving back toward our 2 percent objective over time. 

If the incoming data were to be broadly consistent with these 

projections, we anticipated that it would be appropriate to moderate the monthly pace of purchases later this year. And if the subsequent data continued to confirm this pattern of ongoing economic 

improvement and normalizing inflation, we expected to continue to 

10 

reduce the pace of purchases in measured steps through the first 

half of next year, ending then around midyear. 

At that point, if the economy had evolved along the lines we anticipated, the recovery would have gained further momentum, unemployment would be in the vicinity of 7 percent, and inflation 

would be moving toward our 2 percent objective. Such outcomes 

would be fully consistent with the goals of the asset purchase program that we established in September. 

I emphasize that, because our asset purchases depend on economic and financial developments, they are by no means on a preset course. On the one hand, if economic conditions were to improve 

faster than expected and inflation appeared to be rising decisively 

back toward our objective, the pace of asset purchases could be reduced somewhat more quickly. On the other hand, if the outlook 

for employment were to become relatively less favorable, if inflation 

did not appear to be moving back toward 2 percent, or if financial 

conditions, which have tightened recently, were judged to be insufficiently accommodative to allow us to attain our mandated objectives, the current pace of purchases could be maintained for longer. 

Indeed, if needed, the committee would be prepared to employ all 

of its tools, including an increase in the pace of purchases for a 

time, to promote a return to maximum employment in the context 

of price stability. 

As I noted, the second tool the committee is using to support the 

recovery is forward guidance regarding the path of the Federal 

funds rate. The committee has said that it intends to maintain a 

high degree of monetary accommodation for a considerable time 

after the asset purchase program ends and the economic recovery 

strengthens. In particular, the committee anticipates that its current exceptionally low target range for the Federal funds rate will 

be appropriate at least as long as the unemployment rate remains 

above 6.5 percent and inflation expectations remain well-behaved 

in the sense described in the FOMC’s statement. 

As I have observed on several occasions, the phrase, ‘‘at least as 

long as,’’ is a key component of the rate policy guidance. These 

words indicate that the specific numbers for unemployment and inflation in the guidance are thresholds, not triggers. Reaching one 

of the thresholds would not automatically result in an increase in 

the Federal funds rate target. Rather, it would lead the committee 

to consider whether the outlook for the labor market, inflation, and 

the broader economy justifies such an increase. 

For example, if a substantial part of the reductions in measured 

unemployment were judged to reflect cyclical declines in labor force 

participation rather than gains in employment, the committee 

would be unlikely to view a decline of unemployment to 6.5 percent 

as a sufficient reason to raise its target for the Federal funds rate. 

Likewise, the committee would be unlikely to raise the funds rate 

if inflation remained persistently below our longer-run objective. 

Moreover, so long as the economy remains short of maximum employment, inflation remains near our longer-run objective, and inflation expectations remain well-anchored, increases in the target 

for the Federal funds rate, once they begin, are likely to be gradual. 

11 

I will finish by providing you with a brief update on progress on 

reforms to reduce the systemic risk of the largest financial firms. 

As Governor Tarullo discussed in his testimony last week before 

the Senate Banking, Housing and Urban Affairs Committee, the 

Federal Reserve, with the other Federal banking agencies, adopted 

a final rule earlier this month to implement the Basel III capital 

reforms. The final rule increases the quality and quantity of required regulatory capital by establishing a new minimum common 

equity Tier 1 capital ratio and implementing a capital conservation 

buffer. 

The rule also contains a supplementary leverage ratio and a 

countercyclical capital buffer that apply only to large and internationally active banking organizations, consistent with their systemic importance. 

In addition, the Federal Reserve will propose capital surcharges 

on firms that pose the greatest systemic risk and will issue a proposal to implement the Basel III quantitative liquidity requirements as they are phased in over the next few years. 

The Federal Reserve is considering further measures to strengthen the capital positions of large, internationally active banks, including the proposed rule issued last week that would increase the 

required leverage ratios of such firms. 

The Fed also is working to finalize the enhanced prudential 

standards set out in Sections 165 and 166 of the Dodd-Frank Act. 

Among these standards, rules relating to stress-testing and resolution planning already are in place, and we have been actively engaged in stress tests and reviewing the first wave of resolution 

plans. In coordination with other agencies, we have made significant progress on the key substantive issues relating to the Volcker 

Rule and are hoping to complete it by year end. 

Finally, the Federal Reserve is preparing to regulate and supervise systemically important nonbank financial firms. Last week, 

the Financial Stability Oversight Council (FSOC) designated two 

nonbank financial firms. It has proposed the designation of a third 

firm, which has requested a hearing before the Council. 

We are developing a supervisory and regulatory framework that 

can be tailored to each firm’s business mix, risk profile, and systemic footprint, consistent with the Collins amendment and other 

legal requirements under the Dodd-Frank Act. 

Thank you, Mr. Chairman. I would be pleased to take questions. 

[The prepared statement of Chairman Bernanke can be found on 

page 61 of the appendix.] 

Chairman HENSARLING. Thank you, Mr. Chairman. 

The Chair will recognize himself for 5 minutes for questions. 

Mr. Chairman, the first question is probably, in some respects, 

the most obvious question. You are aware better than most that, 

as you testified before the Joint Economic Committee on May 22nd, 

as The Wall Street Journal reports, the stock market ‘‘moved up 

when Mr. Bernanke’s congressional testimony was released in the 

morning, near-triple-digit gains when he began taking questions, 

turned negative when the minutes were released.’’ On June 19th, 

at the mere hint of tapering, the Dow Jones dropped almost 600 

points in 2 days. And then recently, your comments on July 10th 

have seen the S&P hit record highs. 

12 

A couple of questions result from this—a couple of quotes, first. 

Warren Buffett has described our stock market as waiting ‘‘on a 

hair trigger’’ from the Fed. Dallas Fed President Richard Fisher describes stock markets as ‘‘hooked on the drug’’ of easy money. 

You have described your thresholds as providing guidance to the 

market, but you have also qualified that the thresholds provide no 

guidance as to when or how the policy will change once those 

thresholds have been reached. A recent survey of 55 economists by 

The Wall Street Journal gives the Fed a D-minus for its guidance. 

So can you comment on your guidance, and can you comment on 

Mr. Buffett’s and President Fisher’s comments? 

Mr. BERNANKE. Certainly, Mr. Chairman. 

We are in a difficult environment economically, financially, and, 

of course, we are dealing with unprecedented monetary policy developments. I continue to believe that we should do everything we 

can to apprise the markets and the public about our plans and how 

we expect to move forward with monetary policy. I think not speaking about these issues would risk a dislocation, a moving of market 

expectations away from the expectations of the committee. It would 

have risked increased buildup of leverage for excessively risky positions in the market, which I believe the unwinding of that is part 

of the reason for some of the volatility that we have seen. 

And so I think it has been very important that we communicate 

as best we can what our plans and our thinking is. I think the 

markets are beginning to understand our message, and that volatility has obviously moderated. 

Chairman HENSARLING. I hope you are right. 

Let me change subjects. This committee tomorrow will have a 

hearing on a bill designed to reform Fannie and Freddie. The FHA 

put us on a path toward a sustainable housing policy in America. 

The Fed, a number of years ago, released a study that estimated 

that Fannie and Freddie passed on a mere 7 basis points subsidy 

in their interest rates. That was by economists Passmore, 

Sherlund, and Burgess. 

Does the Fed still stand by that study? 

Mr. BERNANKE. It was a good study, yes. 

Chairman HENSARLING. You have been quoted in the past with 

respect to the GSEs, stating, ‘‘Privatization would solve several 

problems associated with the current GSE model. It would eliminate the conflict between private shareholders and public policy 

and likely diminish the systemic risk, as well. Other benefits are 

that private entities presumably would be more innovative and efficient than a government agency, in that they could operate with 

less interference from political interests.’’ 

Do you still stand by that statement? 

Mr. BERNANKE. I stand by the view that the GSEs, as constituted 

before the crisis, had very serious flaws in terms of the implicit 

guarantee from the government that was not compensated, the lack 

of capital, and the fact that they were torn between public and private purposes. So I agree that the GSEs were a significant problem. 

Chairman HENSARLING. Let me ask you about another one of 

your statements. In 2008, you observed, ‘‘GSE-type organizations 

are not essential to successful mortgage financing. Indeed, many 

13 

other industrial countries without GSEs have achieved homeownership rates comparable to that of the United States. One device that 

has been widely used is covered bonds.’’ 

Do you still stand by that statement? 

Mr. BERNANKE. Yes. 

Chairman HENSARLING. Now, as I understand it, you do believe 

that it is advisable to retain some type of government backstop in 

times of great turmoil, as we saw in 2008. The Fed, I believe, has 

put forth its own plan; is that correct? 

Mr. BERNANKE. No, the Fed hasn’t put forth a plan. 

Chairman HENSARLING. Maybe it is Federal Reserve economists 

Hancock and Passmore? 

Mr. BERNANKE. That would be an independent piece of research 

that is not endorsed by the Board of Governors. 

Chairman HENSARLING. Okay. 

Regrettably, I see my time has come to an end. The Chair now 

recognizes the ranking member for 5 minutes. 

Ms. WATERS. Thank you, Mr. Chairman. 

Mr. Chairman, I am interested in the survey that was done by 

the IMF where they reported that the United States could spur 

growth by adopting a more balanced and gradual pace of fiscal consolidation, especially at a time when monetary policy has limited 

room to support the recovery further. 

Specifically, the IMF recommended that Congress repeal the sequester, raise the debt ceiling to avoid any severe shocks, and 

adopt a comprehensive, backloaded set of measures to restore longrun fiscal sustainability. 

Would you agree with the IMF’s conclusion that the austerity 

policies currently in place have significantly depressed growth in 

the United States? And to what extent can monetary policy offset 

the adverse consequences of the current contractual fiscal policy? 

Mr. BERNANKE. As I have said many times, I think that fiscal 

policy is focusing a bit too much on the short run, and not enough 

on the long run. The near-term policies, which include not only the 

sequester but the tax increases and other measures, according to 

the CBO, are cutting about a percentage point and a half, about 

1.5 percentage points from growth in 2013. That would mean, instead of 2 percent growth, we might be enjoying 3.5 percent 

growth. At the same time, Congress has not addressed a lot of longrun issues, where sustainability remains not yet achieved. 

So, yes, my suggestion to Congress is to consider possibilities 

that involve somewhat less restraint in the near term and more action to make sure that we are on a sustainable path in the long 

run. And I think that is broadly consistent with the IMF’s perspective. 

Ms. WATERS. I would like to ask you a question about housing 

finance, since the chairman mentioned that we will be meeting to 

hear about his bill that, among other things, winds down the GSEs 

and effectively ends the government’s guarantee. 

While I support reducing the current government footprint in the 

housing market, I am concerned that such a drastic reduction will 

adversely affect homeowners, depress the broader economy, and 

eliminate the 30-year, fixed-rate mortgage as we know it. 

14 

How might ending the 30-year, fixed-rate mortgage affect access 

to affordable mortgage credit, the housing markets generally, and 

the Fed’s need to continue its extraordinary support of the housing 

market through quantitative easing? 

Mr. BERNANKE. I think it is very important that average people 

in America have access to mortgage credit which allows them to 

buy a home if that is what their financial situation and their needs 

require. As long as the product is consumer-friendly, consumersafe, protected in that respect, and is financially affordable, I don’t 

think it necessarily has to be in a specific form. I think there are 

different ways. Many people use different types of mortgage structures. 

I think the main thing, again, it is not the instrument itself but, 

rather, the access of the average American to homeownership and 

to mortgage credit. 

Ms. WATERS. To what extent is the structure of a country’s housing finance system a prime contributor to macroeconomic volatility? 

Would you agree that housing finance systems with variable-rate 

mortgages are the dominant product and more vulnerable to extreme bubble-bust cycles in the housing market? 

Mr. BERNANKE. That is a good question. I haven’t really seen evidence on that. In the United States, unfortunately, adjustable-rate 

mortgages were often sold to people who weren’t really able to 

manage the higher payments when the payments rose, and they 

weren’t very well disclosed. There are other countries that have adjustable-rate mortgages where they haven’t had quite the same 

problems. 

And I guess one small advantage is that when the central bank 

changes interest rates, it shows up immediately in costs of housing, 

and may be more powerful in that respect. 

But I think the most important issue is disclosure and underwriting, making sure that people can afford the costs of the mortgage even when the payments go up. 

Ms. WATERS. Thank you very much. 

I appreciate your comments about the different types of structures. And I suppose your comments about variable-rate mortgages 

are probably consistent with concerns we have about no-documentation loans and other kinds of things where we know we can’t 

guarantee that those people taking out the mortgages are able to 

repay them. 

Mr. BERNANKE. Was there a question? Sorry. I can’t hear very 

well. 

Chairman HENSARLING. The time of the gentlelady has expired. 

Ms. WATERS. Thank you very much. 

Chairman HENSARLING. The Chair now recognizes the gentleman 

from Michigan, Mr. Huizenga, for 5 minutes. 

Mr. HUIZENGA. Thank you, Mr. Chairman. 

And, Mr. Chairman, I want to quickly cover three areas: one, 

talk a little bit about interest rates; two, talk about too-big-to-fail; 

and three, briefly talk about the Taylor Rule. 

Now, I would be reticent if I didn’t pass along a question one of 

my friends had: Should he refinance right now? I think that is 

probably a question a lot of people have. I know I did, not that long 

ago. You may answer if you would like. 

15 

Mr. BERNANKE. I am not a qualified financial advisor. 

Mr. HUIZENGA. That would be part of the problem with DoddFrank. If you don’t qualify, then nobody qualifies. 

But I think there is that fear out there, with the increase in 

mortgage interest rates. A lot of us, me coming out of a real estate 

background, I think a lot of us finally said, maybe we should be 

watching what your comments were going to be and maybe get 

clued in. 

But what I am really concerned about is that—and this is at 

some risk to myself of maybe not having a very warm welcome next 

time I am up in New York City visiting some of my friends up 

there. But I am concerned that Wall Street is too dependent on the 

Fed and sort of the signals that you are having, while Main Street 

is really getting buffeted about, whether it is interest rates, tax policy, certainly regulatory policy as well. And we need to make sure 

that we are moving beyond that. 

I am sure, who knows, maybe the market just took an uptick 

based on my comments. Or maybe they took a downtick; who 

knows. We know that they are going to be following your comments 

much more closely. But we have to make sure that this is about 

Main Street, not about Wall Street, and how this is going to be affecting people back home. 

On too-big-to-fail, we had a hearing last week regarding too-bigto-fail, and President Lacker from the Federal Reserve in Richmond testified about the new restrictions in Dodd-Frank imposed 

on Section 13.3 of the Federal Reserve Act, an emergency provision 

the Fed used to bail AIG out at the time. 

And he said, ‘‘I think it is an open question as to how constraining it is. It says it has to be a program of market-based access, but it doesn’t say that more than one firm has to show up to 

use it. But it certainly seems conceivable to me that a program 

could be designed that essentially is only availed of by one firm.’’ 

Now, do you agree with President Lacker and the new restrictions added in 13.3 will not be effective in limiting the Fed’s freedom to carry out future bailouts? Or even if it did, would you have 

the authority to enforce those limitations? 

Mr. BERNANKE. So, on your first point, I just want to emphasize 

that we are very focused on Main Street. We are trying to create 

jobs, we are trying to make housing affordable. Our low interest 

rates have created a lot of ability to buy automobiles. 

Mr. HUIZENGA. Is it fair to say, though, that Wall Street has benefited more than Main Street has? 

Mr. BERNANKE. I don’t think so. We are working through the 

mechanisms we have, which, of course, are financial interest rates 

and financial asset prices. But our goals are Main Street, our goals 

are jobs, our goals are low inflation. And I think we have had not 

all the success we would like, but we have had some success. 

I would like to respond to your second one, though, from President Lacker. 

Mr. HUIZENGA. Yes. 

Mr. BERNANKE. I don’t think that 13.3, as significantly modified 

by Dodd-Frank, could be used to bail out an individual firm. According to Dodd-Frank, 13.3 has to be a broadly based program. It 

has to be open to a wide variety of firms within a category. It canVerDate Nov 24 2008 17:17 Apr 11, 2014 Jkt 082861 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 K:\DOCS\82861.TXT TERRI
16 

not be used to lend to an insolvent firm. It requires both the approval of the Board and of the Secretary of the Treasury to be used. 

And it must be immediately communicated to the Congress. 

I do not think that 13.3 could be used in that way. 

Mr. HUIZENGA. Obviously, there may be some disagreement within your organization, but I would love to work with you on trying 

to tighten that up. 

The other item, very quickly, in our last minute here, on the Taylor Rule. A recent survey of 55 economists by The Wall Street Journal gave the Federal Reserve a grade of D-minus for its guidance. 

Now, I would hate to see what it had been previously, 10 years ago, 

let’s say. 

But do you believe that these facts indicate a monetary policy 

guidance function that needs more work? 

Mr. BERNANKE. I don’t know what the grade refers to. It could 

be the fact that there are many different voices at the Fed. There 

are a lot of different views. And I think there is a benefit to having 

a lot of different views. People can hear the debate. On the other 

hand, if people are looking for a single signal, it can be a little confusing. 

I think we are doing a reasonable job of communicating our intentions and our plans in the context of a complex monetary policy 

strategy. 

Mr. HUIZENGA. I’m sorry, I have 10 seconds, and so I will make 

it more of a statement, but I would love to follow up with you in 

writing. I think many of us are concerned that when you rolled the 

threshold guidance out, you described it as Taylor Rule-like, but 

many of us are afraid that it may not have as much similarity to 

a rules-based approach. And I look forward to working with you on 

that. 

Thank you, Mr. Chairman. 

Chairman HENSARLING. The Chair now recognizes the gentleman 

from Missouri, Mr. Clay, the ranking member of the Monetary Policy Subcommittee. 

Mr. CLAY. Thank you, Chairman Hensarling. 

And thank you, Chairman Bernanke, for being here. 

As you know, the unemployment rate is 7.60 percent. The economy added a little over 200,000 jobs per month for the first 6 

months of this year. In 2012, we averaged about 180,000 jobs per 

month. This is a slight increase. And the private sector, I would 

say, added most of the jobs. Under the sequester, State and Federal Governments have lost jobs. Any forecast on, if the sequester 

stays in place, what the condition of the economy will be in the 

next year or so? 

Mr. BERNANKE. The first observation which you made, which is 

quite right, is that in this recovery, even as the private sector has 

been creating jobs, governments at all levels have cut something on 

the order of 600,000 jobs. In previous recoveries, usually the government sector was adding jobs. So that is one reason why the recovery has been slow. 

Again, this year, the best estimate I have is the CBO’s estimate 

at 1.5 percentage points on growth this year. I can’t say we are certain about how long those effects will last, but our anticipation is 

that later this year and into next year, as those effects become less 

17 

restrictive, that the economy will begin to pick up, and we will see 

some benefits from that. But of course that hasn’t happened yet, 

and we have to keep monitoring that. 

Mr. CLAY. Shifting to the housing market, which has been a drag 

on the economy for the last couple of years, it has recently begun 

to show signs of turning around. Do you believe the increase in 

housing prices provide evidence that the Fed’s monetary policy is 

working, and is there a causal or correlative relationship between 

the two? 

Mr. BERNANKE. Yes, I think so. Historically, the two areas of the 

economy which have been most impacted by monetary policy are 

housing and autos, and those are two of the areas right now which 

are leading our recovery. And evidently low mortgage rates have 

contributed, household formation and other factors have also contributed, but the housing sector is certainly an important component of the recovery at this point. And housing prices going up are 

not only beneficial in terms of stimulating more construction, but 

they also improve the balance sheets of households and make them 

more confident, more willing to spend on other goods and services. 

Mr. CLAY. And so you are not concerned that recent increases in 

mortgage rates could jeopardize the fragile housing recovery? 

Mr. BERNANKE. The mortgage rates remain relatively low, but 

they are higher than they were, and we do have to monitor that. 

Mr. CLAY. And they are inching up. 

Mr. BERNANKE. We will see how they evolve, but we do have to 

monitor that, and we will see how housing and house prices go 

from here. 

Mr. CLAY. Do you believe the labor market in which the unemployment rate hovers just below 8 percent reflects a new normal, 

as some have suggested? What is a sustainable rate of unemployment, in your view, over the medium and long term? And what, in 

your view, could be done to strengthen the aspect of the labor force 

beyond the rate of employment, including wages, hours worked, 

and labor force participation? 

Mr. BERNANKE. No. I think we are still far above the longer-run 

normal unemployment rate. To give you one illustration, the projections of the participants of the FOMC suggests that the long-run 

unemployment rate might be closer to 5.2 to 6 percent, but even 

beyond that, that amount of unemployment reflects the fact that 

there are people who don’t have the right skills for the available 

jobs, who are located in the wrong parts of the country. So training, 

education, improving the functioning of the labor market, improving matching, there are things that can be done through labor policy, labor force policy, that could even lower unemployment further 

than the Fed can through just increasing demand. 

Mr. CLAY. So say, for instance, in the African-American community where male unemployment hovers around 13 or 14 percent, do 

you think the Labor Department and community colleges and others need to do a better job of connecting job training to targeted 

growth industries? 

Mr. BERNANKE. I have seen some very good programs where employers, community colleges, and State governments work together 

to try to link up people with jobs, and the community college provides the right training. 

18 

Mr. CLAY. My time is up. I thank you. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Alabama, the 

chairman emeritus of our committee, Mr. Bachus. 

Mr. BACHUS. Thank you, Mr. Chairman. 

Chairman Bernanke, I have not seen a lot of discussion concerning the reduction in Treasury issuance with the deficit coming 

down. It seems like that would give you more latitude to reduce 

your purchases of Treasurys. Would you like to comment on that? 

Mr. BERNANKE. The Fed still owns a relatively small share of all 

the Treasurys outstanding. It is true that as the new issuance 

comes down, our purchases become a larger share of the new flow 

of Treasurys coming into the market. But we have not seen that 

our purchases are disrupting the Treasury market in any way, and 

we believe that they have been effective in keeping interest rates 

low. That being said, as I have described, depending on how the 

economy evolves, we are considering changing the mix of tools that 

we use to maintain the high level of accommodation. 

Mr. BACHUS. Yes, but the fact that they probably will be issuing 

less is, I think, a factor that you would consider. 

Mr. BERNANKE. We would consider that, but our view is that 

what matters is the share of the total that we own, not the share 

of the new issuance. 

Mr. BACHUS. All right. Chairman Bernanke, you mentioned last 

year in Jackson Hole that you viewed unemployment as cyclical. Do 

you still believe that it is cyclical and not structural? 

Mr. BERNANKE. Just like my answer a moment ago, I think that 

probably about 2 percentage points or so, say the difference between 7.6 and 5.6 percent, is cyclical, and the rest of it is what 

economists would call frictional or structural. 

Mr. BACHUS. Have you done any studies—do you think maybe 5 

percent structural and 2 percent cyclical? 

Mr. BERNANKE. Most importantly, so far we don’t see much evidence that the structural component of unemployment has increased very much during this period. It is something we have been 

worried about, because with people unemployed for a year or 2 

years or 3 years, they lose their skills, they lose their attachment 

to the labor market, and the concern is they will become unemployable. So far it still appears to us that we can attain an unemployment rate—we, the country, can attain an unemployment rate 

somewhere in the 5s. 

Mr. BACHUS. Again, the most recent FOMC minutes didn’t specifically address the 7 percent unemployment target, but you mentioned it in your press conference after that. Was that 7 percent 

target discussed and agreed on in the meeting? 

Mr. BERNANKE. Yes, it was. Seven percent is not a target. It was 

intended to be indicative of the amount of improvement we want 

to see in the labor market. So I described a series of conditions that 

would need to be met for us to proceed with our moderation of purchases. We have a go-around where everybody in the committee, 

including those who are not voting, get to express their general 

views, and there was good support for both the broad plan, which 

I described, and for the use of 7 percent as indicative of the kind 

of improvement we are trying to get. 

19 

Mr. BACHUS. Okay. Thank you. 

The FOMC participants have stated, some of them, that their assessment of the longer-run normal level of the Fed funds rate has 

been lowered. Do you agree with that? 

Mr. BERNANKE. A rough rule of thumb is that long-term interest 

rates are roughly equal to the inflation rate plus the growth rate 

of the economy. The inflation rate, we are looking to get to 2 percent. To the extent that in the aftermath of the crisis and from 

other reasons that the economy had a somewhat lower real growth 

rate going forward, that would imply a lower equilibrium interest 

rate as well. 

Mr. BACHUS. Okay. You mentioned—GDP estimates also come in. 

They were too optimistic. 

Mr. BERNANKE. Yes. 

Mr. BACHUS. I think you said earlier you believe one factor is the 

policy decisions made by Congress to a certain extent, the sequester, and failing to address the long-term structural changes in the 

entitlement programs. 

Mr. BERNANKE. That is right, although I should say that we all 

should keep in mind that these are very rough estimates, and they 

get revised. For example, you get somewhat different numbers 

when you look at gross domestic income instead of gross domestic 

product. But, yes, as I have said a couple of times already, I think 

that Congress would be well-advised to focus more on the longer 

term. 

Mr. BACHUS. Thank you. 

Chairman HENSARLING. The time of the gentleman has expired. 

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

Maloney. 

Mrs. MALONEY. It is my understanding that we are going to people who did not have the opportunity to ask questions at the last 

hearing, so the next person would be Mr. Perlmutter. 

Ms. WATERS. Mr. Perlmutter was next on the list, not Mrs. Maloney, so would you please call— 

Chairman HENSARLING. I am happy to do it. It is just the list 

that we received from you, but we are very happy to recognize the 

gentleman from Colorado for 5 minutes. 

Mr. PERLMUTTER. Sure you are. I thank the Chair, and I thank 

the gentlelady from New York. 

Mr. Chairman, it is good to see you. As always, I think—I just 

want to compliment you on being a steady hand through all of this. 

In terms of fiscal policy, we had a very expansionary policy, and 

now we have had a very contractionary policy. And to sort of piggyback a little bit on Mr. Bachus’ question and Mr. Clay’s, and I am 

looking at page 11 of your report where it says, ‘‘The Congressional 

Budget Office estimated that the deficit-reduction policies in current law generating the 21⁄4 percentage point narrowing in the 

structural deficit will also restrain the pace of real GDP growth by 

11⁄2 percentage points this calendar year, relative to what it would 

have been otherwise.’’ 

What does 11⁄2 percent of real GDP mean in terms of jobs and 

wealth? And, 11⁄2 percent is just a number. What is that? 

Mr. BERNANKE. It is very significant. The CBO also estimated 

that 11⁄2 percentage points was something on the order of 750,000 

20 

full-time equivalent jobs. I think with another 11⁄2 percentage point 

of growth, we would see probably unemployment down another 7- 

or 8/10, something like that. So it makes a very big difference. It 

is very substantial. 

Now, again, we are hoping that as the economy moves through 

this period, we will begin to see more rapid growth later this year 

and into next year. 

Mr. PERLMUTTER. Okay. So let us talk about—you have a graph, 

and I don’t know if you have your report in front of you, but the 

graph on the preceding page, 10, graph A, Total and Structural 

Federal Budget Deficit 1980 to 2018. Do you see that? 

Mr. BERNANKE. Yes. 

Mr. PERLMUTTER. Can you explain that graph? It looks to me like 

at some point there isn’t—you project or there is a projection here 

of no structural deficit in about 2017, 2018. What does that mean? 

Mr. BERNANKE. That means taking away the effects of the business cycle. The business cycle causes extra deficit, because with the 

economy weak, you get less tax revenue. You have more spending 

on social programs of various kinds. What that is saying is that if 

we were at full employment, that in 2015, I believe it is, the structural deficit would be close to zero. That is the CBO estimate. 

Mr. PERLMUTTER. Okay. I now kind of want to turn to some 

other questions, if I could. Mr. Huizenga and Mr. Clay were also 

asking you about interest rates, and you said we are at historically 

low interest rates. I would recommend to you, and you probably already know about, an app that you guys have that I can get on my 

iPad. It is called The Economy, and it shows—this one shows how 

we have been doing over the last 40 years. And we are—it was way 

up here in, like, 1980 at about 18 percent, and then way down here 

at about 3.3 percent about 2 months ago. And so we have come way 

down, except that in the last 2 months—see, what is good about 

this app, you can also do it on a 1-year basis. And on a 1-year 

basis, it shows that from April 2013 to the end of June, we went 

about straight up, about 33 percent increase in interest rates, 

which was from 3.3 percent to about 4.5 percent. 

Mr. BERNANKE. You are talking about mortgages now? 

Mr. PERLMUTTER. Mortgage rates, yes, sir. 

So how does that come about? 

Mr. BERNANKE. There will be three reasons for it. The first is 

that the economic news has been a little better. For example, there 

was a pretty strong labor market report that caused yields to go 

up as investors became more optimistic. 

A second factor is probably that some excessively risky or leveraged positions unwound in the last month or two as the Federal 

Reserve communicated about policy plans. The tightening associated with that is unwelcome, but on the other hand, at least there 

is the benefit of maybe perhaps reducing some of those positions 

in the market. 

Mr. PERLMUTTER. The concern I have, and I think it was expressed by both Mr. Huizenga and Mr. Clay, is that one of the 

underpinnings of this recovery, you said, is that now housing is beginning to get much stronger. It was historically so weak, but this 

kind of increase, if it continues, is going to slow that down. 

Wouldn’t you agree? 

21 

Mr. BERNANKE. I agree that we need accommodative monetary 

policy for the foreseeable future, and I have said that. 

Mr. PERLMUTTER. Thank you. 

And I thank the Chair. I yield back. 

Chairman HENSARLING. The Chair now recognizes the gentleman 

from California, Mr. Miller, for 5 minutes. 

Mr. MILLER. Mr. Bernanke, welcome. I want to thank you for listening to us. 

On the recent ruling on Basel III, you acknowledge insurance 

companies are very different from banks, and you postponed any 

negative decision on that. I think that was a very, very wise move. 

You are probably aware that the committee is about to consider 

a housing finance reform bill. I have looked at the GSEs in the 

past, and I have always had a problem with the way they were fundamentally flawed. You had a hybrid situation where the private 

sector made all the profits, and the taxpayers took all the risk, 

which was problematic from the beginning. You can go back to a 

time when you could say they performed their function very well, 

but they created major problems. In recent years, they didn’t adhere to underwriting standards. They were buying predatory loans 

rather than conforming loans. They were chasing the market rather than playing a countercyclical role, and that has been very problematic. 

Now we look at a situation and say, what do we do and where 

do we go? And if the United States were to end the function of the 

GSEs as it applies to conforming loans, would the private market 

be able to provide liquidity to the market? And the second part of 

that is, what about the time of crisis? Would investors be there to 

purchase mortgage-backed securities, and would interest rates tend 

to rise in that type of situation? 

Mr. BERNANKE. Let me first say that I agree with your analysis 

of GSEs. And the Fed for many years was warning about lack of 

capital, the implicit guarantee, the conflict between public and private motives, and so we agree that is something that needs to be 

fixed. 

There are a number of plans out there for reform. I think everyone agrees that one of the key questions is what role, if any, the 

government should play. It seems pretty clear that the private sector should be playing more of a role than it is now. Right now, we 

have basically a government-run mortgage securitization market, 

but in order to protect the taxpayer, to increase efficiency, to allow 

for more product innovation and so on, we would like to have more 

market participation. 

But, again, the question is what role should the government 

play? I don’t know the answer to that, but I would say that, first, 

if the government does play a role, it should be fairly compensated; 

that is, instead of having an implicit guarantee that it ended up 

having to make good on, like the FDIC or some other similar institution, it should receive some kind of insurance premium. 

Mr. MILLER. And I think that is important, because I have argued for a position where if you are going to have a conduit, let 

us say a facility to replace the GSEs, then the profits from the gfees should go into a reserve account to make sure that is solvent. 

And then if you have a reinsurance fee when the mortgage-backed 

22 

security is sold, that should also go in a reserve account. And when 

the account goes up large enough over 7 or 8 years, there is no 

need for a government guarantee, because the reserves will be so 

huge based on the profits that they would turn, based on what they 

historically have done, you wouldn’t put the taxpayer at risk. 

But the problem we have had in the past, and I have always had 

a problem with it, is when you have investors investing in GSEs, 

the GSEs at that point in time chase market share to make investors happy. That is not their role. Their role is to be countercyclical. 

But I am also concerned that if we make a mistake, the government is still going to be there on the hook, because they are not 

going to let the housing market crumble if something goes wrong. 

So if you don’t have some entity that is self-sufficient, has huge 

capital to make sure that it can withstand a downturn, we are 

going to end up in the situation again. Maybe you can respond to 

that? 

Mr. BERNANKE. I think that is right. Either you have to be 100 

percent confident in the private thing you set up, or alternatively, 

if you think there is a scenario in which the government would 

come in ex post, then it might be a good idea to make sure the government gets paid appropriately ex ante, and that the rules of the 

game are laid out in advance. 

Mr. MILLER. But instead of the government, if you can create a 

facility that was independent of government, but established by 

government, let us say, that the profits were held, and they were 

not abused by Congress as a slush fund to be able to take the 

money from, if you just look at the profits that GSEs are making 

today, if there is an entity doing that of an equivalent that was 

backed by some guarantee for ‘‘X’’ amount of years to allow the 

market to recover and stability to occur, and those reserves—and 

the g-fee alone probably in 8 to 10 years would be $800 billion minimum if you charge a reasonable reinsurance fee on the mortgagebacked securities, that is probably $200 billion in 8 to 10 years. 

You have a trillion dollars, which is 6 times the risk the government took in the worst downturn we have ever seen, would that 

not add to market security and stability? 

Mr. BERNANKE. The question there, I think, is whether this new 

entity could charge those g-fees if you had competition, and would 

you be allowing private-sector competition. 

Mr. MILLER. The goal is to allow the private sector in. They are 

not crowding in today, and that is what we want to do. We want 

to get them in, but we still need to provide a surety and liquidity. 

That is my concern. 

Mr. BERNANKE. That is right. 

Mr. MILLER. Thank you. I yield back. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Massachusetts, 

Mr. Lynch. 

Mr. LYNCH. Thank you, Mr. Chairman. 

And welcome, Chairman Bernanke, and thank you for your service and your willingness to come before the committee and help us 

with our work. 

23 

I want to stay right on that line of questioning that Mr. Miller 

actually began. As you may know, both the House and Senate are 

actively considering legislative proposals to reform the GSEs, and 

I think most of us on both sides of the aisle realize some reform 

is necessary. 

Now, I won’t ask you to comment on any particular legislative 

proposal, I am not sure you would anyway, but you are a scholar 

of the Great Depression, and, as you know, Fannie Mae and the 

FHA are sort of creations of the New Deal, and they are—I wanted 

to ask you, historically the 30-year fixed mortgage, which is really 

a major innovation, prior to the government getting in, GSEs getting in and providing that backstop, was that available and— 

Mr. BERNANKE. No. 

Mr. LYNCH. —was the private sector successful in trying to create that? 

Mr. BERNANKE. During the Depression and that period of time, 

people usually took out 5-year balloon mortgages and refinanced 

them sequentially. 

Mr. LYNCH. In terms of the last 80 years of government support, 

and that is really what has created opportunities for middle-income 

homeowners—well, middle-income potential homeowners from getting into the market, and as we are grappling with this GSE reform, I am very concerned about what happens to rates. I can’t— 

I do agree with Mr. Miller, there seems to be some requirement of 

a backstop at some point, and obviously you want the taxpayer to 

be as far back as possible, and that the initial cushion or the initial 

loss, if necessary, would be absorbed by the private sector. And we 

are trying to figure out a way of preserving an affordable 30-year 

fixed mortgage, keep that market going, without having the taxpayer take all that risk up front. That is what we are trying to 

grapple with, and I am wondering if you can help us with that. 

Mr. BERNANKE. Earlier, the chairman asked me about passing on 

subsidies to the consumer. I don’t think that government backstops 

are very effective in lowering rates unless they have a price control 

on the interest rate that the— 

Mr. LYNCH. Isn’t that a function of risk, though? If the private 

sector knows that at a certain point—like with the terrorist risk insurance that we debated here, because the industry knew there 

was a backstop beyond which they would not be responsible, it did, 

in fact, result in a lower rate. 

Mr. BERNANKE. Right, to some extent, but a lot of it doesn’t get 

passed through. 

What I was going to add, though, was that the argument for 

thinking about government participation is exactly the situation 

like we faced the last few years where there is a big housing problem, and private sector mortgage providers or securitizers are, for 

whatever reason, not willing to act countercyclically, then is there 

a role for the government to support this process? And the question 

we were just discussing is if that is going to happen anyway, is 

there a case for setting up the rules in advance in some sense and 

figuring out what the government ought to charge for whatever 

protection it is prepared to provide? 

Mr. LYNCH. Okay. Sir, I want to thank you for your service. I 

have heard stories that this might be your last appearance before 

24 

this committee for this purpose, and I think you have served us 

very well under very, very difficult circumstances— 

Mr. BERNANKE. Thank you. 

Mr. LYNCH. —and I appreciate your service to your country. 

Thank you. 

I yield back. 

Chairman HENSARLING. The gentleman yields back. 

The Chair recognizes the gentleman from California, Mr. Royce. 

Mr. ROYCE. Thank you, Mr. Chairman. 

Chairman Bernanke, I think the risk weighting at the end of the 

day is only as good as the metrics that we develop. I am thinking 

back to Basel I, and now we are looking at the final Basel III. 

The Basel III includes a risk weighting of 20 percent for debt 

issued by Fannie Mae and Freddie Mac, and the rule includes a 

risk weighting of zero for unconditional debt issued by Ireland, by 

Portugal, by Spain, and by other OECD countries with no country 

risk classification. Both of these risk weightings are, in my memory, identical to the risk weightings under the original Basel I. 

So my concern is that we should have learned a few things about 

those metrics, given the consequences of the clear failure, and yet 

here we have the accord of 1988 looking an awful lot like this particular accord. 

Given what we have experienced, the failure of the GSEs, the 

propping up of many European economies, do you think these 

weightings accurately reflect the actual risk posed by these exposures? 

Mr. BERNANKE. Basel III and all Basel agreements are international agreements. And each country can take that floor and do 

whatever it wants above that floor. We would not allow any U.S. 

bank to hold Greek debt at zero weight, I assure you. 

Mr. ROYCE. Yes. 

Mr. BERNANKE. In terms of GSEs, GSE mortgage-backed securities have not created any loss whatsoever. They have to the taxpayer, but not to the holders of those securities. So that, I don’t 

think, has been a problem. 

It is not just the risk weights, though, but Basel III also has significantly increased the amount of high-quality capital the banks 

have to hold for a given set of risky assets. 

Mr. ROYCE. But it still seems to me that at the end of the day, 

in which—with respect to what you are working out as a calculation, you have a situation where high-risk countries like Spain and 

Portugal, should they receive the same risk weight as exposures to 

the United States? And that is the way that would be handled, I 

think, in Europe, but it just seems that should have been addressed in the calculus. 

Mr. BERNANKE. One way to address it is through stress testing, 

where you create a scenario which assumes that certain sovereign 

debt bears losses, and then calculate capital into those scenarios. 

So, that is a bit of a backstop. 

Mr. ROYCE. Let me ask you another question, which goes to this 

issue of the countercyclical role in the housing market that the government should play. And such a role obviously would be far better 

than the role government played during the last crisis, which was 

extraordinarily procyclical, if we look back over the greatly 

25 

ballooned bubble and subsequent bust that was developed as a result of housing policy and a lot of the actions taken. 

Title II of the PATH Act has several provisions meant to allow 

FHA to play that countercyclical role. The goal obviously is to 

greatly expand eligibility, right, during the PATH Act—if the 

PATH Act were enacted, and that would get us to the point of that 

borrower eligibility in such a circumstance. 

Would you agree enabling FHA to play an expanded role in times 

of crisis, as suggested under the Act, will help ensure continued access to the mortgage market for a great majority of borrowers regardless of the market conditions that we might face? 

Mr. BERNANKE. I am not advocating a specific plan. I am just 

pointing out that we need to think about the situation where there 

is a lot of stress in the market, and then we need some kind of 

backstop. I obviously haven’t studied this proposal, but it seems to 

me that FHA could be structured to provide such a backstop. It 

would depend on the details, but that would be one way to have 

the government provide a backstop. 

Mr. ROYCE. I thank you very much, Chairman Bernanke, for attending the hearing here today and for your answers. And we will 

probably be in consultation later with some additional questions. 

Mr. BERNANKE. Certainly. 

Chairman HENSARLING. The gentleman yields back. 

The Chair recognizes the gentleman from Texas, Mr. Green. 

Mr. GREEN. Thank you, Mr. Chairman. 

And thank you, Mr. Bernanke, for appearing again. And I trust 

that this will not be your last visit. I believe that our country has 

benefited greatly from your service, and not just the service itself, 

but the way you have conducted yourself in a time of great turmoil, 

so I am hopeful that you will be back. 

I would like to, for just a moment, ask you to visit with us about 

the issue of certainty and uncertainty, confidence, optimism, because while you may do a lot of things, if consumer confidence or 

producers don’t have confidence, that can have a significant impact 

on long-term growth. Confidence is important to growth. 

I read through your paper, by the way, and I am very, very excited about some of the things that you have said, but I didn’t get 

quite enough on the question of confidence. Would you please 

elaborate a bit? 

Mr. BERNANKE. I think it is quite true that business confidence, 

homebuilder confidence, and consumer confidence are very important, and good policies promote confidence. The Fed policy, congressional policy, we want to try to create a framework where people 

understand what is happening, and they believe they have confidence that the basics of macroeconomic stability will be preserved. 

It is a difficult thing. To some extent, it is a political talent to 

be able to create confidence in your constituents. So nobody has a 

magic formula for that, but clearly the more we can demonstrate 

that we are working together to try to solve these important problems, the more likely we are going to instill confidence in the public, and that in turn will pay off in economic terms. 

Mr. GREEN. I compliment you, and I would like to focus on one 

aspect of what you said about working together. I contend that this 

is an important element in instilling confidence. And I believe that 

26 

the American economy is quite resilient. It is strong, notwithstanding some of the weaknesses that have been exposed. The reason I know it is strong is because it has survived Congress. If the 

economy can survive Congress, I am confident that it will thrive 

eventually. But things that we do, repealing continually, or attempting to repeal some of the significant aspects of bills that have 

passed that will impact the American people, I am not sure how 

much confidence these things engender. More than 30, 40 attempts 

to repeal the Affordable Care Act, an attempt to repeal Dodd-Frank 

without replacement, an attempt to repeal the CFPB without a 

good sense of what the replacement will be. 

It seems to me that at some point we in Congress have to do 

more to engender the confidence that will cause the American people to want to buy, to want to invest, to want to produce. And I 

think that Congress has a significant role it could play, and unfortunately we have not—we have not been able to work together to 

the extent that the American people are confident that we will do 

things to help create jobs, to help build a broader economy. You 

have been very focused on jobs, very focused. We have not been as 

focused on jobs. Legislation that can produce jobs, much of it has 

lingered and has not had an opportunity to move forward. 

I just believe that in the final analysis, your good work, while it 

is going to be lauded and applauded, still needs some help from the 

policymakers in terms of working together to instill confidence. 

Confidence is needed. I think this economy is ready to blossom, but 

when I talk to business people, they say to me, we need confidence, 

we need to know that the rules are going to be static and not dynamic. Consumers say to me, I need confidence. I will buy a house 

when I am confident that the system is going to remain static and 

not dynamic. 

I thank you for your service, and I trust that we will be able to 

help instill the confidence to augment and supplement the good 

work that you have done. 

Mr. BERNANKE. Thank you. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair recognizes the gentleman from Virginia, Mr. Hurt. 

Mr. HURT. Thank you, Mr. Chairman. 

And thank you, Chairman Bernanke, for being here today, and 

we thank you for your hard work. 

I represent a rural district in Virginia, one that has not seen the 

same economic growth that other places in this country have seen. 

We still have places in our district where we have jobless rates at 

double digits. And we certainly look to Washington to adopt policies 

that will make it easier for our businesses to succeed, our families 

to succeed, as opposed to making things more difficult. 

In listening to your remarks, you talk about systemic—adopting 

policies that go to systemic importance. Obviously Basel III, it 

seems to me you discussed Basel III in terms of what is systemically important. You also tip your hat to Main Street, talking 

about how the Fed has adopted policies to support Main Street, 

jobs, consumers, things that we all care about. 

In the aftermath of the rules that were adopted earlier this 

month relating to Basel III, Frank Keating with the American 

Bankers Association said that—asked the question, are we making 

27 

things easier, or are we making things more difficult, and essentially said, if we are making them harder, that is not what we need 

for our economy. That is not what a recovering economy needs. 

So as I think about what we need in my rural southside Virginia 

district, I think about community banks, and I think about what 

an important lifeblood they are to our Main Street economy. And 

I wonder if you could talk a little bit about the reasoning behind 

not just exempting community banks from the application rule that 

you all have adopted, and why you did that. 

Mr. BERNANKE. And I agree with you about the importance of 

community banks, particularly in rural areas which might not be 

served by larger institutions. It is also important, of course, for 

community banks to be well-capitalized so that they can continue 

to lend during difficult periods, they don’t fail, so we want to be 

sure that they are well-capitalized. 

But in terms of the final Basel III rule that we just put out, we 

were very responsive to the concerns raised by community banks. 

They raised a number of specific issues relating, for example, to the 

risk weighting of mortgages, relating to the treatment of other comprehensive income, trust preferreds, a variety of things that they 

were concerned about, which we responded to. And that is part of 

our broader attempt through outreach, through meeting with advisory councils and so on to understand the needs of community 

banks and to make sure that we do everything we can to protect 

them. The— 

Mr. HURT. Have—go ahead. 

Mr. BERNANKE. I was going to say that Basel III is primarily 

aimed at the largest internationally active firms, and most of the 

rule was just not relevant to small firms. 

Mr. HURT. Clearly, you all tried to make some accommodations 

for community banks, and I recognize that. I guess my question is, 

is there a reason that you all—if you could talk a little bit about 

why you all concluded that you could not exempt them entirely. 

And I guess the second question that I have is, do you think— 

based on your studies or anybody else’s studies—that these rules 

will have a disproportionate effect on community banks? Obviously, 

that is the heart of the concern, that the smaller banks have a 

much more difficult time complying with regulations than obviously 

the largest banks. 

Mr. BERNANKE. Again, I don’t think that Basel III is primarily 

aimed at community banks. And the amount of bureaucracy and 

rules is not significantly different from what they are doing now. 

In terms of capital, the community banks already typically held 

more capital as a ratio than larger banks do, and our calculations 

are that community banks are already pretty much compliant with 

the Basel III rules. We don’t expect them to have to raise substantial amounts of new capital. 

Mr. HURT. So you don’t believe there will be a disproportionate 

effect on the smaller banks in complying with these additional regulations? 

Mr. BERNANKE. Smaller banks are disproportionately affected by 

the entire collection of rules that they face, ranging from bank secrecy to a variety of consumer rules, et cetera, et cetera. I think 

that your constituents may not be distinguishing Basel III specifiVerDate Nov 24 2008 17:17 Apr 11, 2014 Jkt 082861 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 K:\DOCS\82861.TXT TERRI
28 

cally from all the other different rules that they face. And, of 

course, the small bank just has fewer resources, fewer people to 

deal with the range of regulatory and statutory requirements that 

the banks have to deal with. 

Mr. HURT. And just finally, in one of your earlier appearances 

here, we talked a little bit about the regulatory structure, what is 

perceived among some as a micromanagement by bank examiners 

and regulators in the function of the Federal Reserve as an examiner. Are you able to give us any indication of what has been done 

in the last 2 years or so to try to improve that? I know that you 

had mentioned that there were some things that the Federal Reserve had in mind and was trying to work with our smaller banks. 

Mr. BERNANKE. Yes. I am not going to have time to go through 

the whole list, but we have a Community Depository Institution 

Advisory Council that meets with the Board, and gives us their 

perspective. We have a special subcommittee. 

Mr. HURT. My time has expired, but do you believe that these 

efforts have been successful? 

Mr. BERNANKE. I think we have made definite progress, yes. 

Mr. HURT. Thank you. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Missouri, Mr. 

Cleaver. 

Mr. CLEAVER. Thank you, Mr. Bernanke, for being here. You 

have had a lot of compliments today. In my business, it is called 

a eulogy, but that is—I am not trying to frighten you. Even the 

Twinkie came back. But I also want to thank you for your service. 

The stimulus, the Fed stimulus, has been roundly criticized by 

many. Can you in a short time express what you believe would be 

the consequences of easing quantitative easing prematurely? 

Mr. BERNANKE. Again, it is important to talk about our overall 

monetary policy stance. Our intention is to keep monetary policy 

highly accommodative for the foreseeable future, and the reason 

that is necessary is because inflation is below our target, and unemployment is still quite high. 

In terms of asset purchases, though, I have been very clear that 

we are going to be responding to the data, and if the data are 

stronger than we expect, we will move more quickly, at the same 

time maintaining the accommodation-to-rate policy. If the data are 

less strong, if they don’t meet the kinds of expectations we have 

about where the economy is going, then we would delay that process or even potentially increase purchases for a time. 

So we intend to be very responsive to incoming data both in 

terms of our asset purchase program, but it is also very important 

to understand that our overall policy, including our rate policy, is 

going to remain highly accommodative. 

Mr. CLEAVER. Thank you. 

One of your former colleagues, Tom Hunting, from my hometown, 

has repeatedly warned in papers that he has written that too-bigto-fail is still a major threat to the U.S. economy. He suggests that 

in many instances, many of the huge financial institutions have 

gotten even larger. Do you think that if we went through again 

what we went through a few years ago, that we would be in a situation where we would almost be required to save the U.S. economy 

29 

and perhaps even the world economy from a depression because 

those—or we would have to step in again to bail out these major 

corporations, AIG and— 

Mr. BERNANKE. I think there is more work to be done before we 

feel completely comfortable about systemic firms. The Dodd-Frank 

Act and Basel III and other international agreements provide a 

framework for working towards the day, which is not here yet, 

where we can declare too-big-to-fail a thing of the past, but we do 

have some tools now that we didn’t have in 2008, 2009. 

Very importantly, we have the Orderly Liquidation Authority of 

the FDIC—the Federal Reserve supports the FDIC in that—which 

would allow us to do a much more orderly resolution of a failing 

firm that would take into account the impact on financial market 

stability, unlike 2008, 2009, when we had no such tools and were 

looking for ad hoc ways to try to prevent these firms from failing. 

In addition, these firms are now much better capitalized than they 

were. And we are making other reforms that will make it much 

less likely that this situation will arise. 

But I wouldn’t be saying the truth if I said the problem is gone. 

It is not gone. We need to keep following through on the various 

programs here, and I think we need to keep doing what is necessary to make sure that this problem is solved for good. 

Mr. CLEAVER. But the question is—and I was here as we went 

through all of this. We didn’t have the time, we were told, and actually I believe, to rationally and thoughtfully consider all the options. And my fear is that if something happened even—I agree 

with you. In Dodd-Frank, we tried to reduce the likelihood that this 

was going to happen, but what assurance do we have that we 

would have time for action by the Fed, by Congress? Thank you. 

Mr. BERNANKE. We have the framework now. We have the Orderly Liquidation Authority. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair recognizes the gentleman from Ohio, Mr. Stivers. 

Mr. STIVERS. Thank you, Mr. Chairman. And Chairman 

Bernanke, thank you for being here today. I really appreciate your 

willingness to come and answer all our questions. I am going to try 

to get through Basel III as well as some QE questions, and we will 

see how my time goes. 

The first thing I want to talk about is following up on the questions Mr. Hurt asked. And you—I will try to quote. You said that 

Basel III was not primarily aimed at community banks, and it is 

clear that it is aimed at the larger financial institutions which 

helped create the financial crisis. And I agree with you that it 

won’t result in most community banks having to raise capital, because their capital is normally higher, but for a few community 

banks that don’t have capital right now, where they have not as 

much access to the capital markets, it actually could harm them. 

And none of these banks are going to be too-big-to-fail; nobody is 

going to come in and bail them out. They also aren’t so interconnected. And I am just curious why, given that Basel III is voluntarily compliant internationally, we didn’t just exempt out the 

community banks? 

Mr. BERNANKE. I think it is important that they be well-capitalized, both to protect the deposit insurance fund, to protect their 

30 

local communities and the borrowers that depend on them. And we 

have seen—in the past we have seen financial crises that were 

small firms, like in the Depression and in the savings and loan crisis, so I think they do need to have capital. 

But on this issue that you mentioned, we are giving really long 

transitions. We aren’t saying, you have to have this level of capital 

tomorrow. And so banks can raise capital through retained earnings and through other mechanisms as well. 

Mr. STIVERS. Right. And I appreciate that. I don’t think it is a 

burden on most community banks, but I do worry about a few of 

them, and I think it could result in consolidation in the industry 

and less community banks that serve some of our rural areas, and 

that troubles me a little bit. 

Mr. BERNANKE. No. I agree with that concern. 

Mr. STIVERS. The second thing I want to recognize in your Basel 

III is that you, I think appropriately, recognize that activity, for example, international activity, increases systemic risk, but I was a 

little troubled that you continue to use artificial asset numbers. 

I am from Ohio. We have a lot of regional banks that serve the 

middle market that are either based in Ohio or have a major presence in Ohio. And, you use the $10 billion number at very bottom 

for the smallest banks; the $50 billion up to $250 billion. And if 

you look at sort of the size of all the 50 largest banks in America, 

there is really—there are kind of some tiers. There are the top 

banks above $2 trillion, and there are 3 of those, I think—I’m 

sorry—2 of those—there are 2 more above $1 trillion, between $1 

trillion and $2 trillion, and then there are 3 more above half a trillion dollars, but then it falls way off to 350. And you set that top 

limit for regional banks at 250. And there are banks that are regional banks that are essentially super community banks that are 

above that 250 to 350. A couple of them have a major presence in 

Ohio and serve our middle market. 

And I guess I would ask where you picked that artificial number 

of 250, because most people would recognize both PNC and U.S. 

Bank as regional banks. 

Mr. BERNANKE. We have met with middle-market banks and 

tried to understand their concerns. The basic philosophy here is 

that both the capital requirements and the supervisory requirements are gradated with size. So, for example, the largest banks 

will have capital surcharges. Where we have failed to gradate appropriately, of course, we can go back and try to figure out how to 

get it right. 

Mr. STIVERS. I appreciate that. And I would really urge you to 

take a look at the major cliffs in our asset sizes, because they really do—that spell themselves out. And I think the big jump between, say—there are no banks between $350 million and $500 

million. There are 2 at just above $350 million, and then there is 

nobody until you get to almost $550 million. So, that is a big jump, 

and I think—I would urge you to take a look at that. 

And the last question I would like to quickly ask is about—you 

talked about stress testing a lot for the banks. And in your QE and 

the way you judge QE portfolio, would you be willing to submit the 

Federal Reserve’s QE to the same kind of stress testing under the 

31 

same kind of provisions you provide for these banks of potential interest rate spikes and inflation? 

Mr. BERNANKE. The stress test has a different purpose for the 

Fed, which is to effect how much remittances we send to the Treasury. And we have done various stress tests in that respect, and 

many of them are publicly available. We have a number of research 

papers. And there are also outside researchers, the IMF and others, who have done these tests. And the bottom line is that for any 

reasonable interest rate path, this is going to end up being a profitable policy for the taxpayer. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair recognizes the gentleman from Michigan, Mr. Peters. 

Mr. PETERS. Thank you, Mr. Chairman. 

And, Chairman Bernanke, thank you for being here today and 

for your service. 

Last week, the Bank of Japan announced that they were going 

to maintain their current monetary policy, which, as you know, includes significant devaluation of the yen for the purposes of improving the competitiveness of Japanese exports. The yen has fallen in value almost 30 percent compared to the dollar since last 

year. And Japan, as you also know, is joining the U.S.-led TransPacific Partnership trade talks. 

I have raised a number of concerns about Japan’s entry into the 

trade talks until they open their markets, particularly to U.S. 

autos. And while they continue to manipulate their currency, this 

increases my concerns, and it could make our trade deficit even 

worse. 

I know in 2011 you expressed concern with China’s devaluation 

of their currency. I am quoting you saying, ‘‘Right now our concern 

is that the Chinese currency policy is blocking what might be a 

more normal recovery process in the global economy, and it is to 

an extent hurting our recovery.’’ 

Could you please discuss your views on Japan’s currency policy, 

its impact on the economy, and do you believe that their currency 

policy is hurting the economic recovery in the globe right now? 

Mr. BERNANKE. Yes. There are some fundamental differences between China’s policy and Japan’s policy. China has managed its exchange rate and kept it for many years below its equilibrium level 

in order to increase its exports. That is what economists call a zero 

sum game: What they gain we lose, basically. 

The Japanese approach is different. They are not manipulating 

their exchange rate. They are not directly trying to set their exchange right at a given level. What they are doing is engaging in 

strong domestic monetary policy measures, trying to break the deflation that they have had for about 15 years, and a side effect of 

that is that the yen has weakened. 

The G20 and the G7 have discussed these matters, and the international consensus is that as long as a country is using domestic 

policy tools for domestic purposes, that would be an acceptable approach. 

Now, I recognize that movements in exchange rates do affect 

competition. You said you are from Michigan, right? Yes. So I can 

see where your concern would come from. I think that it is in our 

interest, though, to see Japan strengthened, to see their economy 

32 

grow faster. It will increase our market there as well as the competitive supply. And over time, if they do, in fact, achieve positive 

inflation, that increase in prices there will partially offset the exchange rate movement. 

So, I recognize the concern. I don’t know how big an effect it has 

had so far. I have actually talked to a couple of people in the auto 

industry at some of the companies to try and get their sense. But, 

again, there is a difference, which is that Japan is trying to expand 

its overall economy, and therefore, there is a benefit as well as a 

cost, and that benefit is a stronger Japanese economy and a stronger Asian market. 

Mr. PETERS. To pick up from that point, so if you could kind of 

give me some sense, as you wind down your quantitative easing activities while Japan maintains this current policy which is driving 

down the yen, do you believe it is going to have an impact on 

American manufacturing and exports as you wind down as they 

continue that policy? 

Mr. BERNANKE. It could. It could to some extent, but, of course, 

as you know, for example, many Japanese producers produce in the 

United States, and there is a sense that for a number of reasons, 

including productivity and others, that U.S. manufacturing is actually generally becoming more competitive globally than it has been 

in some time. So I don’t think that this change in the value of the 

yen would offset that underlying trend. 

Mr. PETERS. If I could just switch briefly, this is another big 

topic, but if you could touch on it. There have been some recent reports, in fact, a recent IMF report came out to talk about monetary 

policy and its impact on inequality in the United States. As you 

know, inequality has expanded dramatically, particularly in the 

last 20, 30 years. And in the report they talk about monetary policies having a much more significant role in driving historical inequality patterns in the United States than has been expected in— 

or that has been anticipated and certainly written about in the economic literature. Would you comment briefly? Do you believe that 

monetary policy has a significant impact on inequality as we are 

seeing it and— 

Mr. BERNANKE. No, I don’t think so. The purpose of monetary 

policy is, first of all, to keep inflation low, and everybody is affected 

by inflation, and to maintain employment at the highest level that 

the economy can sustain. And, of course, jobs are critical to the 

welfare of the broad middle class of Americans. So I really don’t 

understand that. 

It is true that in the short run, some of the tools that we have 

involve changing asset prices, so higher stock prices and things of 

that sort, but we can’t affect those things in the long run. It is only 

a short-run transmission mechanism that is involved there. 

Mr. PETERS. Thank you. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair recognizes the gentleman from Tennessee, Mr. 

Fincher. 

Mr. FINCHER. Thank you, Mr. Chairman. 

And, Chairman Bernanke, thank you for your service and for 

being here today. 

33 

I am going to read a paragraph, for my benefit probably more 

than yours, to get started, and then I have a couple of questions. 

‘‘The Federal Reserve was intended to be a fully independent 

central bank and monetary authority. The authors of the original 

Federal Reserve Act did not want to subject the institution to the 

whims of politicians, but, rather, set clear objectives for the institution in the interests of fostering the macroeconomic stability. That 

independence has eroded significantly since the 2008 financial crisis, when the Federal Reserve and the Treasury Department initially took coordinated steps to stabilize the economy. One persistent concern—that is, if the central bank’s independence is infringed upon by the government, fiscal authorities can compel the 

Fed to monetize sovereign debt.’’ 

A couple of questions. With what has happened with quantitative 

easing, I was looking at the Dow a few minutes ago, 15,400; 

Nasdaq, 3,604; and 1,680 for the S&P. To Chairman Hensarling’s 

comments earlier, I think the private sector is addicted to the government money. And anytime you talk about cutting the money off, 

there is a panic. 

Because we have our own currency and we can manipulate that 

currency, unemployment where it is, inflation where it is, with the 

entitlements in this country where they are—I am saying a lot 

here, but will we ever get to back to that place of unemployment 

at 5 percent? 

I live in a part of the country, in a rural part of the country with 

a lot of farmers, a lot of agricultural real estate. We have seen land 

prices go through the roof, and one reason I think we have is interest rates are so low that people can borrow money. It is just—it is 

there. But that causes problems, also, because if this thing ever 

does turn around, how do you stop it? And interest rates are how 

you stop it. But the country also is in debt up to their eyeballs, 

which creates another problem. High interest rates breaks the back 

of the country. 

So I said a lot, but are you concerned that pumping the money 

into the economy, when we stop that, can the country take it? Can 

the private sector react? And how do we do that? 

Mr. BERNANKE. The reason for the low interest rates is because 

the economy is weak and inflation is low. And even if the Fed 

wasn’t engaging in asset purchases, interest rates would still be 

quite low, as they are in other countries, for example. 

One reason that asset markets react to what the Fed says is that 

they are trying to determine whether the Fed will provide sufficient support for the economy to get back to full employment. That 

is our job, that is our mandate, when the economy is away from 

full employment, to try to provide the financial support that will 

move the economy in that direction. 

Mr. FINCHER. Do you not think the politics over the past 4, 5, 

6 years are playing more of a role than they did 6, 7 years ago? 

Mr. BERNANKE. No, I don’t. Your earlier point about collaborating 

with the Treasury in the financial crisis, that had nothing to do 

with monetary policy. That had to do with the two main financial 

institutions in the government working together to prevent a big 

financial collapse. And I think the collaboration was needed there. 

34 

But at no time during the crisis or at any point did the Administration, the Congress, or the Treasury Department ever tell the 

Fed, we need monetary policy of ‘‘X.’’ We have always maintained 

that independence, and we think it is critically important that we 

maintain it. 

Mr. FINCHER. I just have about a minute left. I fear that the government’s intervention into trying to make sure the private sector 

is running at full capacity creates all sorts of problems. 

Now that I am up here and I see how big this is—I had a constituent the other day who brought this point up, and he said, with 

the regulatory policies that we have, with the choking effect that 

some say, the big government is really good for big business, the 

unintended consequences, because the big businesses can react to 

big government. The smaller businesses have a harder time doing 

that with the resources they have. And I thought about it a 

minute, and it is a great point. 

Again, I am fearful that we are out of control, pumping the 

money in. The private sector is addicted to the pumping of the 

money. And when we ever shut that off, there is going to be a reaction. The reaction now that the stock market is 15,000, if we drop 

back to 12,000, again you are going to see a panic. What do we do 

then? 

So many people, Chairman Bernanke, think now that the government’s role is to step in and save the day. And this is taxpayer 

money. This is very, very dangerous. 

Mr. BERNANKE. There is sort of an idea going around that the 

Fed can step away and not do anything. We have to do something. 

We have to have interest rates somewhere. The Fed does control 

our money supply. So we have to do something, and I think that 

we are better off trying to get the economy moving than not. 

Mr. FINCHER. Thank you. 

Chairman HENSARLING. The time of the gentlemen has expired. 

The Chair recognizes the gentleman from Illinois, Mr. Foster. 

Mr. FOSTER. Thank you. 

Chairman Bernanke, I think when it is time for the T-shirts to 

be passed out at your retirement party, a very good candidate for 

that would be the $34 trillion swing in household net worth. 

When we have seen in the last several years the $16 trillion drop 

in household net worth caused by a complete failure of the Republican fiscal, regulatory, and monetary policy replaced by an $18 

trillion recovery, it is one of the most impressive achievements. 

And there is no doubt that, of the three legs of financial policy— 

monetary, fiscal, and regulatory—monetary policy deserves a lot of 

credit. So I just—you deserve the compliments you have been getting. 

The question I would like to pursue is, it is my understanding 

that the Fed and the CBO maintain roughly comparable macroeconomic models. And in the last few weeks, the CBO has analyzed 

two different macroeconomic scenarios: one in which Congress has 

passed the Senate proposal for comprehensive immigration reform 

and a path to citizenship, which they found resulted in about a 

$1.5 trillion increase in economic activity over the next 10 years 

and about a $200 billion reduction in the Federal debt; and the second scenario, in which the Republicans succeed in blocking comVerDate Nov 24 2008 17:17 Apr 11, 2014 Jkt 082861 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 K:\DOCS\82861.TXT TERRI
35 

prehensive immigration reform, resulting in a $200 billion larger 

level of Federal debt and a $1.5 trillion decrease in economic activity compared to the other scenario. 

And so my question is, do you anticipate, given this policy uncertainty, that you are going to have to separately consider both of 

those scenarios, both the high-debt, low-growth scenario caused by 

Republican obstruction and the high-growth, low-debt scenario that 

would follow congressional passage of the Senate comprehensive 

immigration reform bill? 

Mr. BERNANKE. To begin with, we haven’t done any comparable 

analysis of the economic implications of immigration. I think, in 

general, a growing population, more talented people, all those 

things do help the economy grow. A younger population will also 

help us deal with our aging situation. To use a cliche, we are a Nation of immigrants. 

All that being said, there are a lot of details in setting up a program in terms of how it should be monitored and managed and so 

on that I really think are the province of Congress. And I don’t 

really want to try to set immigration policy. I really think that the 

details there have to be worked out in Congress. 

Mr. FOSTER. I guess my question is, how do you deal with, when 

there are policy choices being made by Congress with fairly large 

macroeconomic effects, this in your forward planning? 

Mr. BERNANKE. Generally, we take those decisions as given, and 

we try to figure out what the best thing we can do is given the economic environment we find ourselves in. So, with respect to fiscal 

policy and the restraint this year from fiscal policy, we sort of take 

that as given, again, and try to figure out how much monetary accommodation is therefore needed. 

And, with respect to immigration, I think these are much longerterm propositions; these are gains and losses over many years. And 

the Fed, because it focuses mostly on short-term cyclical movements in the economy, our focus is typically not 10 or 20 years but, 

rather, the next few years. 

Mr. FOSTER. Okay. 

I would like to follow up on Representative Royce’s questions 

about the countercyclical element in Federal housing policies, 

which are present, as he pointed out, not only in the Republican 

PATH Act proposal but also in the Democratic principles for housing market reform. 

There was also a recent front-page article in The Wall Street 

Journal that was entitled, ‘‘Central Bankers Hone Tools to Pop 

Bubbles.’’ Had you seen that? 

Mr. BERNANKE. ‘‘Central Bankers— 

Mr. FOSTER. ‘‘Hone Tools to Pop Bubbles.’’ It discussed the efforts 

in various countries to implement countercyclical housing policies. 

Mr. BERNANKE. Yes. 

Mr. FOSTER. So you have seen that. The American Enterprise Institute is also hosting a 2-day workshop on this subject at the end 

of this month. 

So my question is, do you believe that regulators have today the 

tools necessary, as well as the collective will, to address the development of potential asset bubbles, such as the housing bubble from 

which we are still recovering? 

36 

Mr. BERNANKE. We have some tools. For example, Basel III included a countercyclical capital requirement. In other words, if we 

see the economy growing too fast with too much credit being extended, we could raise capital requirements. 

I think it makes a big difference that the CFPB and other agencies have done a lot to eliminate the worst kinds of mortgage 

abuses that were very important in the housing boom. The Federal 

Reserve has recently issued some guidance to banks on leveraged 

lending and other kinds of practices that could contribute to asset 

bubbles. 

All that being said, we want to make the financial system as fair 

and transparent as possible, but I don’t think we can guarantee 

that we can prevent any bubble. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair recognizes the gentleman from Indiana, Mr. 

Stutzman. 

Mr. STUTZMAN. Thank you, Mr. Chairman. 

Thank you, Chairman Bernanke, for being here today. 

And I really want to thank you for your comments earlier about 

what Congress should be focused on, and that is the long-term liabilities to our country. I do believe that if we would address those 

issues, the trajectory of our economy would change, instead of 

being focused on such a near-term rhetoric and the effects to the 

economy by short-term policies. So I appreciate what you mentioned earlier. 

I want to talk a little bit about employment. For the entire U.S. 

workforce, employers have added far more part-time employees in 

2013, averaging 93,000 a month, seasonally adjusted, than fulltime workers, which have averaged 22,000. Last year, the reverse 

was true, with employers adding 31,000 part-time workers monthly 

compared with 171,000 full-time ones. 

Earlier in June, I, along with other colleagues from Indiana, 

wrote HHS Secretary Kathleen Sebelius and Treasury Secretary 

Jack Lew to find out whether or not they had forecasted the impact 

of the Affordable Care Act on part-time workers who are currently 

just above the 30-hour threshold. 

Does this shift of a lot of workers, many workers, from the fulltime category to part-time status at all affect your statutory mandate to reach full employment? 

Mr. BERNANKE. I think it does. As I mentioned in my testimony, 

there are a number of problems with the labor market. Unemployment is one problem, but long-term unemployment and underemployment—and by ‘‘underemployment,’’ I mean people who are 

either working fewer hours than they would like or possibly are 

working at jobs well below their skill level—are also indicative of 

a weak labor market. And a stronger economy will help, I think, 

in all those dimensions. 

So, yes, that is part of our concern. And as we look at the unemployment rate and try to determine what it means for the labor 

market, we look at these other indicators as well. 

Mr. STUTZMAN. You mentioned earlier that the taxes at the beginning of the year were affecting the economy. You mentioned 

something else, that I can’t recall. 

37 

Mr. BERNANKE. There were spending cuts from before, and then 

there were tax increases and then sequestration. 

Mr. STUTZMAN. That is right, sequestration and the tax increases. Do you believe that the Affordable Care Act is dragging 

the economy or slowing the economy down at all with the transition that we are currently going through and the effort of implementation? 

Mr. BERNANKE. It is very hard to make any judgment. One thing 

that we hear in the commentary we get at the FOMC is that some 

employers are hiring part-time in order to avoid the mandate there. 

So, we have heard that. 

But, on the other hand, a couple of observations: one, the very 

high level of part-time employment has been around since the beginning of the recovery, and we don’t fully understand it; two, 

those data come from the household survey, and they are a little 

bit inconsistent with some of the data from the firm survey, which 

suggests that work weeks haven’t really declined very much. 

So I would say at this point that we are withholding judgment 

on that question. 

Mr. STUTZMAN. Do you think that a delay in the mandates would 

be appropriate? 

Mr. BERNANKE. That is beyond my pay grade. It would depend 

on questions of how much time is needed to fully implement the 

bill. 

Mr. STUTZMAN. Okay. Thank you. 

With about a minute left, I would like to touch on some of the 

global economic concerns and other countries beginning a trend of 

currency devaluation in fear of currency wars that might follow. 

Could you comment on that at all? 

Mr. BERNANKE. As I mentioned in an earlier answer, the international community makes a distinction between attempts to manipulate an individual exchange rate in order to gain an unfair advantage in export markets versus using monetary or fiscal policy 

to achieve domestic objectives that may have the side effect of 

weakening the currency. 

So this was the example with Japan. Japan has taken policy actions that have weakened the yen, but that wasn’t the focus of 

those actions. Their actions were intended to break the deflation 

which they faced for the last 15 years or so to get their economy 

growing more quickly and to get back to a 2 percent or so inflation 

objective. 

If they are successful, there may be some exchange rate effects, 

as the earlier question raised, but there also will be the benefit 

that a stronger Japanese economy and a stronger Asian economy 

will increase world growth and be a benefit to the United States, 

as well. 

So those are the distinctions between those different types of 

management of the currency. 

Mr. STUTZMAN. Okay. Thank you. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair recognizes the gentleman from Florida, Mr. Murphy. 

Mr. MURPHY. Thank you, Mr. Chairman. 

38 

And thank you, Chairman Bernanke, as well. I want to echo 

what has been said already in thanking you for your service to our 

country. 

Mr. BERNANKE. Thank you. 

Mr. MURPHY. There has been a lot of talk already in the committee about the talk of tapering in the last several weeks. And the 

Board of Governors has come out and tried to clarify some of those 

comments. It has been turmoil somewhat on Wall Street, these ups 

and downs. And this isn’t a knock on Wall Street, but my concern 

is really Main Street. 

What we have seen in the last—I guess since May—is a 40 percent increase in interest rates on mortgage rates. What do you 

think we should be doing? What can you do? And what do you 

think is the effect of this pretty sudden and sharp rise in interest 

rates? 

Mr. BERNANKE. First of all, we are going to continue to communicate our policy intentions and to make clear that, notwithstanding how the mix of policy tools change, we intend to maintain 

a highly accommodative monetary policy for the foreseeable future. 

I think that message is beginning to get through, and I think that 

will be helpful. 

More generally, we will be watching to see if the movement in 

mortgage rates has any material effect on housing. The main thing 

is to see housing continue to grow, more jobs in construction and 

the like. And as we have said, if we think that mortgage rate increases are threatening that progress, then we would have to take 

additional action in the monetary sphere to try to address that. 

Of course, there is always hope for Congress to look at problems 

that remain in the housing market in terms of people underwater, 

in terms of refinancing of underwater mortgages, and other kinds 

of issues that Congress could examine. But we are going to be looking at it from the perspective of whether or not the housing recovery is continuing to a degree sufficient to provide the necessary 

support for the overall economic recovery. 

Mr. MURPHY. Thank you. 

My background is as a CPA. I worked at Deloitte for a while, 

dealing with Sarbanes-Oxley, and as an auditor. So I am not one 

to say we need more or less regulation, necessarily, but that we 

need smarter regulation. 

And, certainly, being here now, trying to understand all the different regulators, and dealing with a lot of the institutions in my 

district, especially the small and medium-sized banks, what are 

you doing to work with all the different regulators to try to streamline and make it easier for these small institutions? 

Mr. BERNANKE. One of the vehicles that we have is an organization called the FFIEC, which is basically the place where the banking regulators gather and talk to each other about policy and regulatory decisions. And the FFIEC has a regular committee which is 

focused on small community banks and trying to find ways to reduce the burden of regulation and to find ways to make it easier 

for them to deal with the regulations that do bear on smaller 

banks. 

As far as the Fed itself is concerned, I mentioned earlier that we 

have an advisory council of community institutions, we have a speVerDate Nov 24 2008 17:17 Apr 11, 2014 Jkt 082861 PO 00000 Frm 00042 Fmt 6633 Sfmt 6633 K:\DOCS\82861.TXT TERRI
39 

cial subcommittee that looks at the effects of our regulations on 

smaller institutions. We have had meetings around the country, 

outreach, special training sessions for examiners and the like. 

So we do take that very seriously, recognizing that there is a 

heavy regulatory burden on community banks, and we want to do 

everything we can to mitigate that. 

And I would just perhaps add that Congress probably has a role 

here, too, since some of the things that community banks have to 

deal with come from the statute and not the regulation. 

Mr. MURPHY. Thank you. I agree with that. 

So this kind of leads to my next question about the systemic importance of banks and determining if the balance sheet is the best 

place we should be drawing this line. And if not, do you have any 

other thoughts on that? And what would the difference be in a 

bank with $55 billion versus say $45 billion, as far as systemic risk 

to our economy? 

Mr. BERNANKE. As I have mentioned, Dodd-Frank tells us to do 

this in a graduated way, to have capital requirements and supervisory requirements become tougher as the size and complexity and 

systemic importance of the bank increases. And so there are obviously going to be certain dividing lines to try to separate banks into 

these different categories. 

But even within the categories, we are trying to distinguish between the smaller banks in that category and the larger banks in 

that category. And as I said earlier to a questioner on the other 

side of the aisle, to the extent that the rules don’t provide sufficient 

smoothness in how they vary by type of bank, we have plenty of 

capacity to go back and look at them. 

But the basic idea is that the very largest internationally active 

banks should bear the hardest burden of regulation. 

Mr. MURPHY. Thank you, Mr. Chairman. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair recognizes the gentleman from South Carolina, Mr. 

Mulvaney. 

Mr. MULVANEY. Thank you. 

Chairman Bernanke, I want to begin by going back to some of 

the questions that Chairman Hensarling began with at the very 

outset of the hearing regarding whether or not the markets were 

addicted to easy money. 

And I have a graph that I think you have in front of you, that 

we would like to put up on the screen. It simply shows the correlation between the size of your balance sheet and the performance 

of the S&P over the course of the last 4 or 5 years. And as you can 

see, there is a strong argument that the two things tend to move 

together. 

So my question to you is fairly simple: What can you say to convince us and to convince the markets that you will be able to return the balance sheet to its normal size, as I think your internal 

study says you want to do by 2018, 2019, Mrs. Yellen says by 2025? 

Will you be able to do that without dragging the markets down at 

the same time, especially in light of what happened last month 

after your comments in the JEC? 

Mr. BERNANKE. The main thing that supports the stock market 

or other markets is the underlying economy. I don’t know what it 

40 

means to say that markets are addicted. I don’t think that is really 

a technical term in finance. But the reason, I think, that markets 

have improved so much since 2009 is because Fed policy and other 

policies have succeeded in providing a stronger economy with low 

inflation. 

Mr. MULVANEY. If the economy is growing at such a strong rate 

as to support some fairly dramatic increases in the stock markets 

that we have seen, then why are you continuing your easy-money 

policies? 

Mr. BERNANKE. Profits are actually ahead of jobs. That is one of 

the problems. So we continue to provide easy money in order to get 

the job situation back to where we need it and also because inflation is below our target. 

I think the kind of scenario you are worried about would be most 

likely to happen if the Fed withdrew easy monetary policies prematurely and the economy relapsed into weakness. Then, I think 

you would see asset prices come down. 

Mr. MULVANEY. Are you satisfied that if you were called upon at 

some point in the future—and I am not trying to rattle any markets—to begin bringing the balance sheet back to normal size, and 

the markets reacted with fairly substantial reductions, you will 

have the staying power to keep that exit strategy despite the fact 

the markets are going down? 

Mr. BERNANKE. I think the key is making sure that the markets, 

first of all, understand our plan, but, secondly, that we have done 

enough that the economy is growing on its own. If the economy is 

growing on its own, it won’t need the Fed’s help and support. And 

then the markets, I think, will be just fine. 

Mr. MULVANEY. Thank you, sir. 

I want to talk about something else that is a little off the beaten 

track. You and I have talked about it before; you mentioned it 

when you were here earlier this year. I am talking about remittances to the Fed. 

Mrs. Yellen mentioned it in a speech she gave at about the same 

time. And I think your written testimony at the time said they 

could be quite low for a time in some scenarios, particularly if interest rates were to rise quickly. Mrs. Yellen was a little stronger 

when she spoke to the NABE and said remittances could cease entirely for some period. 

You have an internal study conducted by Mr. Carpenter and others in January of this year which indicates that having the Fed 

generate combined earnings insufficient to cover its operating costs, 

dividends, and paid-in capital isn’t that much of a problem, as the 

Fed can simply carry it on your balance sheet as a deferred asset. 

But it goes on to say that whenever you have done that in the past, 

when the Fed has done that in the past, it has been for a very 

short period of time and that we have never seen a period where 

the Fed is not able to make these remittances over a fairly long period of time. 

Given the fact that you have an extraordinarily large balance 

sheet, we have gone through this, what I think you called unprecedented expansion of the balance sheet, and given the fact that you 

stand to lose a tremendous amount of money in a higher-interestrate environment—I think we had a witness here testify that a 

41 

100-basis-point interest-rate rise in a short period of time could 

generate losses to the Fed of in excess of hundreds of billions of 

dollars. 

If we end up in an environment where remittances from the Fed 

go on for an extended period of time, how would that impact the 

Fed’s operation and especially its independence? 

Mr. BERNANKE. It won’t affect our ability to do monetary policy. 

Independence is up to Congress. 

In terms of the fiscal impact, we have done many simulations. 

There may be a period of regular remittances, but we have already 

had a period of very high remittances, almost $300 billion in the 

last 4 years. 

Mr. MULVANEY. Which you have already remitted, though. 

Where does the money come from? If your combined earnings don’t 

generate enough to cover your operating expenses, your paid-in 

capital, and whatever else you need to pay for, where does the 

money come from to operate the Federal Reserve? 

Mr. BERNANKE. From the balance sheet. We have all the resources we need to do that. 

Mr. MULVANEY. But if you have tremendous losses on your balance sheet because of higher interest rates, you are paying a lot 

higher interest to the banks that keep their excess reserves and 

you are negative cash, where does the money come from? 

Mr. BERNANKE. It comes from the income from our assets. It is 

just that, from an accounting perspective, we don’t have to recognize those losses unless we sell them. 

Mr. MULVANEY. Is there ever a circumstance where you go to 

your shareholders for a capital call? 

Mr. BERNANKE. No. 

Mr. MULVANEY. And I guess that is the end of my time. Thank 

you, Mr. Chairman. 

Chairman HENSARLING. It is the end of the gentleman’s time, although I wish we could carry it out a little further. 

The gentlemen from Maryland, Mr. Delaney, is now recognized. 

Mr. DELANEY. Thank you, Mr. Chairman. 

And thank you, Chairman Bernanke, for your incomparable service to our country over the last several years of your tenure. 

My first question—I have several questions; I will try to ask 

them quickly, and I think they have relatively short answers—is, 

there has obviously been recent volatility in the bond markets, an 

uptick in rates over the last several months based on a variety of 

factors, and it seems to me that the economy has actually handled 

that pretty well. Would you agree with that assessment? 

Mr. BERNANKE. I think it is a little early to say so far. But as 

I said in my remarks, I think we need to monitor particularly the 

housing market to see if there is any impact from higher mortgage 

rates. 

Mr. DELANEY. You get a lot of very current micro data. Have you 

seen any data to suggest that this uptick in rates has had a negative effect on what appears to be a reasonably good housing recovery? I know, again, I understand, it is very early. 

Mr. BERNANKE. No, I haven’t seen anything that points strongly 

to any particular problem, but again, it is very early. 

42 

Mr. DELANEY. Is there any kind of second-half economic data 

coming out that would lead you to conclude that your original 

views about the economy for the second half of the year, particularly as it relates to your ability to begin to taper, has changed 

your views? 

Mr. BERNANKE. I am sorry, is there any information— 

Mr. DELANEY. Is there any new kind of second-half economic 

data which causes you to think differently about the economy from 

what you did a month ago? 

Mr. BERNANKE. No. Our general, broad outline is that we expect 

the economy to pick up probably later this year. The exact timing 

depends on the impact of the fiscal restraint. We should see continued improvement in the labor market, unemployment continuing to 

fall, and inflation moving back up toward 2 percent. 

That general scenario still seems to be correct. But it has not yet, 

obviously, been confirmed by the data. That is what we need to see. 

Mr. DELANEY. And this notion of a highly accommodative monetary policy, I assume you can taper in the context of that position, 

that doesn’t imply that you can’t begin to taper your purchases. 

Mr. BERNANKE. As I described in my testimony, we think of the 

two tools we have as having different roles. So the purpose of the 

asset purchases was to achieve more near-term momentum, to 

achieve a substantial improvement in the outlook for the labor 

market. We are making progress on that objective. 

But the traditional, most reliable, most powerful tool that the 

Fed has is short-term interest rates. And using low short-term interest rates and guidance about those rates is going to provide us, 

ultimately, with sufficient monetary policy accommodation to 

achieve what we are trying to get to. 

Mr. DELANEY. That sounds like you are maintaining the posture 

you think is important for the economy using short-term interest 

rates. In that context, you should have the flexibility to potentially 

taper consistent with what you had wanted to do. 

Mr. BERNANKE. If the economy does more or less what I described. But as I also emphasized, that is contingent. And if the 

economy is stronger, we can moderate faster. If it is weaker, we 

can moderate more slowly. 

Mr. DELANEY. And you don’t have any data that the economy has 

softened or housing has softened based on this interest-rate volatility that we have seen? 

Mr. BERNANKE. It is just really too early. We have had some 

strong data in some areas. This morning, we had a housing report 

that was a little bit weaker. But again, I think given the amount 

of noise in every piece of data, I don’t think it is appropriate to 

take too strong a signal from that. 

Mr. DELANEY. Switching gears a little bit to banks and their 

portfolios, which is obviously part of the responsibility of the Federal Reserve, how concerned are you about interest-rate risk that 

may be accumulating on the balance sheets of the regulated financial institutions based on the interest-rate environment we have 

been in and some of the asset shortages, if you will, or—it has been 

hard for banks to originate assets. How concerned are you that 

they are building up reasonably significant interest-rate risks in 

their business? 

43 

Mr. BERNANKE. We have been looking at that as regulators, and 

we are reasonably comfortable that banks are managing their interest-rate risk appropriately. 

Note that from the banks’ perspective, even as higher interest 

rates reduce the value of some of their securities that they hold, 

higher interest rates also potentially improve their net interest 

margins and their profitability. So as interest rates have gone up, 

we have actually seen some bank stocks go up, rather than down. 

Mr. DELANEY. Great. 

Thank you again for your service. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Illinois, Mr. 

Hultgren. 

Mr. HULTGREN. Thank you, Chairman Hensarling. 

And thank you, Chairman Bernanke. I very much appreciate 

your time today. 

If I may, I would like to highlight a Crain’s article from earlier 

this year that discussed the rash of bank closings and consolidations in and around Chicago. Certainly, there are many causes, but 

the article uses Hyde Park Bank, which is from President Obama’s 

home neighborhood, to discuss one contributing cause. They talk 

about how the near-zero interest rates, which were set by the Fed, 

make it nearly impossible for banks to invest safely and earn a decent yield. 

I wonder, for communities banks that rely on net interest margin, how do you justify the Fed policy? And is the Fed using the 

tool to help one section of the economy while hurting another? 

Mr. BERNANKE. First, I think that is not accurate. Net interest 

margins have come down a little but not all that much. And profitability in banks in the last few years has been generally quite good. 

Moreover, low interest rates, what is the purpose of low interest 

rates? The purpose is to give us a stronger economy. And a stronger economy means better asset quality, it means more lending opportunities. So what low interest rates take away they give on the 

other hand by giving a better economic environment for banks to 

operate in. 

Mr. HULTGREN. Theoretically, maybe that is true. I just don’t 

hear that from my community banks. They are struggling, partially 

under the regulation I think, the regulatory burden that they are 

feeling, but also feeling because of an interest-rate crunch, is really 

how they are expressing it to me. 

Let me switch gears. Quickly, you have been outspoken on the 

negative effects of Section 716 of Dodd-Frank, the swap push-out/ 

spin-off provision. As some of my colleagues on the committee have 

reversed their position from last year, I wonder if you could quickly 

restate why Section 716 could have a negative effect on end users 

and systemic soundness. 

Mr. BERNANKE. It creates additional costs, essentially, because it 

moves out certain kinds of instruments from the banks, makes it 

more difficult for banks to offer a range of services to their customers, and puts U.S. banks at a potential cost disadvantage to 

international competitors. 

Mr. HULTGREN. So you would still be supportive of changing this 

provision in Section 716? 

44 

Mr. BERNANKE. We have some concerns with that provision. Of 

course, everything depends on what the alternative is and how the 

Congress makes those changes. 

Mr. HULTGREN. Let me switch again to something else. Mr. 

Chairman, as you know, Dodd-Frank requires the Fed to adopt procedures to implement the new limitations on the Section 13.3 authority, its 13.3 authority. It is now 3 years later, and the Fed still 

has not done so. 

How do you justify the Fed’s 3-year delay in implementing these 

basic restrictions on the Fed’s authority to bail out nonbank firms? 

Mr. BERNANKE. First of all, I think that the law is very clear 

about what we can and cannot do. And I don’t think that the absence of a formal rule would allow us to do something which the 

law prohibits. And I mentioned earlier that the law prohibits us 

from bailing out individual firms using 13.3, and there would be no 

way we could do that. 

We have made a lot of progress on that rule, and I anticipate we 

will have that out relatively soon. 

Mr. HULTGREN. You think by the end of the year? 

Mr. BERNANKE. I will check with staff, but I would hope so. 

Mr. HULTGREN. Okay. That would be great. 

Kind of following up on that, as well, I know there were some 

questions asked last time you were here—again, we always appreciate your willingness to come here and spend time with us. But 

I do know, hearing from some colleagues and from myself that 

some questions were submitted and we hadn’t heard back from 

that. I know it has been about 4 months since you were here last 

time. So I am just asking again if maybe you could check on that, 

as well as letting us know from your staff when this final rulemaking would be done. 

Mr. BERNANKE. We will do that. 

Mr. HULTGREN. One last thing that I will touch on—you know 

what? Actually, with 1 minute left, I am going to yield back, if 

Chairman Hensarling has any further questions. 

You are okay? 

Okay. Then, I am going to ask one more question, if I could. And 

getting back to banking rules as applied to insurance companies, 

it seems that the adoption of GAAP accounting for mutual insurance companies remains one of the Federal Reserve’s top priorities. 

However, statutory accounting is considered superior to GAAP for 

purposes of ensuring the sound and prudential regulation of insurance companies. 

Wouldn’t applying SAP be a more prudent approach as the Fed 

develops capital rules for savings and loan holding companies that 

are predominantly in the business of insurance? 

Mr. BERNANKE. We have a lot of issues still. We deferred the 

Basel rule for insurance, for savings and loan holding companies 

that have more than 25 percent insurance activity. So we are looking at a range of issues about how we can adapt the consolidated 

supervisory rules and the capital rules for insurance. And we recognize that there are some differences that we need to look at. 

Chairman HENSARLING. The time of the gentleman has expired. 

Mr. HULTGREN. Thank you, Mr. Chairman. I yield back. 

45 

Chairman HENSARLING. The Chair now recognizes the gentlelady 

from Ohio, Ms. Beatty. 

Mrs. BEATTY. Thank you, Mr. Chairman, and Madam Ranking 

Member. 

Chairman Bernanke, I certainly join my colleagues in thanking 

you for all the work that you have done. We started the questions 

today with a series of quotes or statements from you, so I would 

like to end it with one and thank you for it. And that is, ‘‘Our mission as set forth by the Congress is a critical one: to preserve price 

stability; to foster maximum sustainable growth in output and employment; and to promote a stable and efficient financial system 

that serves all Americans well and fairly.’’ 

My question will be centered around that last part of it, the efficient financial system that will serve ‘‘all Americans.’’ 

I know you have had a lot of questions related to the housing 

market. I want to thank you for opening your testimony and starting with housing, because I am a long-term housing advocate. And 

in reviewing your document this morning, the multiple pages on 

housing put in mind this question for you. 

Will you speak to what impact maintaining an adequate supply 

of affordable housing options for first-time homeowners, as well as 

moderate-income buyers, has? And then, conversely, what will happen to the economy if we only promote a housing finance system 

where only the well-off who have the high credit scores, who have 

the double-digit dollars to put down, 10, 20 percent, what happens 

to our market there? 

Because when you look at what I believe is more than $10 trillion in economic value, the United States housing market certainly 

is inextricably linked to the performance of our Nation’s economy. 

Mr. BERNANKE. In this recovery, one of the credit areas which is 

not normalized is mortgage credit. And we have noted that people 

with lower credit scores and first-time home buyers are not able to 

get mortgage credit in many cases. And, of course, that is a problem for them, it is a problem for their communities, and it is a 

problem for the overall economy since we are looking for a stronger 

housing market as one of the engines to help the economy recover. 

So there are many reasons why mortgage credit is still tight for 

those borrowers, but it is definitely a concern and something we 

are paying close attention to. 

Mrs. BEATTY. And let me take this a step further, because so 

often—and, certainly, that is the answer we get. And I think America expects this Congress to advocate for those folks. Because as 

soon as you say ‘‘low-income’’ and ‘‘moderate-income,’’ then someone 

has to stand up for them. But let’s look at the flip side of this. 

In your opinion, let’s look at what it does to the market for credit 

unions and banks. Because housing is not only being able to purchase the house, but it deals with construction and jobs and employment. So what responsibility do you think those credit unions 

and banks have to play in this environment that we are in now? 

Mr. BERNANKE. We encourage banks to lend to credit-worthy borrowers. We certainly enforce fair-lending laws. It is important that 

first-time home buyers be able to get credit in order to buy a home. 

It is important for our economy. 

46 

There are some issues still out there, as I mentioned, and I think 

regulators have to take responsibility for the fact that not all the 

rules for making mortgage loans are finished and out there. We 

need more clarity on those things. 

There is still a lot of concern among banks about so-called ‘‘putback risk,’’ the notion that the GSEs will put back any mortgage 

that goes bad if there is anything, any technical flaw wrong with 

it. That makes the banks less likely to lend. 

So there are a lot of things to work on to get the mortgage market in better shape. And we are approaching this both from the 

monetary policy point of view, which is trying to keep mortgage 

rates low so that housing is of affordable, but also as regulators 

and working with other regulators to try to solve some of the problems that still exist in extending mortgage credit. 

Mrs. BEATTY. Thank you. 

Chairman HENSARLING. The gentlelady yields back. 

The Chair now recognizes the gentleman from Florida, Mr. Ross. 

Mr. ROSS. Thank you, Chairman Hensarling. 

Chairman Bernanke, I wish to begin by addressing one of your 

earlier comments in your opening statement, when you said that 

the debate concerning other fiscal policy issues, such as the status 

of the debt ceiling, will evolve in a way that could hamper the recovery. 

My concern with that is, I believe that at $17 trillion and counting in debt, as we see on our national debt clock up there, when 

6 percent of our Federal budget is used to pay interest payments 

alone on national debt, I firmly believe that our sovereign debt 

should not go unpaid, but there is a tremendous difference between 

borrowing money to pay for an IRS ‘‘Star Trek’’ video and paying 

our sovereign debt. 

You see, I believe that it is disingenuous to say that the debate 

on the debt ceiling or the debt limit for this country will adversely 

impact us, when, in fact, 2 years ago, the credit-rating agencies 

came to us and said that if we don’t have in place a systemic, longterm path to reduce and address our debt, that we are going to be 

downgraded in our ratings. It wasn’t so much the debate on the 

debt that we had; it was the fact that we failed to take action to 

reduce in a systemic fashion, in a long-term fashion, our debt. 

Out of the debt-ceiling debates that we have had in the past, we 

have come out with things such as Pay-As-You-Go, the GrammRudman Act. There have been good things to help us with that. So 

I think it is important that we acknowledge that having a healthy 

debate on the debt ceiling is prudent and responsible. 

With that, I also want to address the second part of your opening 

statement, when you addressed the important nonbank financial 

institutions, specifically the implementation of the Collins amendment. 

My concern with that—and going back to last week when Fed 

Governor Tarullo testified before the Senate Banking Committee, 

he told Senator Johnson that, in regard to postponing and delaying 

the rules, as you have testified before, on Basel III, on nonbank financial institutions—however, he said, ‘‘That is to say that the Collins amendment does require that generally applicable capital reVerDate Nov 24 2008 17:17 Apr 11, 2014 Jkt 082861 PO 00000 Frm 00050 Fmt 6633 Sfmt 6633 K:\DOCS\82861.TXT TERRI
47 

quirements be applied to all of the holding companies we supervise.’’ 

I look at the Collins amendment, and what concerns me is that 

I am afraid your hands may be tied, in that we have two different 

types of financial institutions here. We have the short-term funding 

and the banks, and we have the long-term—and insurance companies, and yet we are going to give risk-based capital requirements, 

expanded requirements, based on generally accepted accounting 

principles, which don’t apply to insurance companies, we are going 

to increase the cost of insurance. And I come from Florida, a State 

where insurance is very important. And, more importantly, this is 

probably going to result in a conflict between the McCarran-Ferguson Act and the implementation of a Basel III capital requirement for insurance companies. 

How do you feel that we can resolve that? Can we resolve that? 

Mr. BERNANKE. So, quickly, on the debt limit, I wasn’t trying to 

make a policy recommendation other than to say that, the last time 

around, we did get a pretty big shock to consumer sentiment, and 

it was harmful to the economy. So I just hope that whatever is 

done, it is done in a way that is confidence-inspiring. 

On insurance companies, we are going to do our best to tailor our 

consolidated supervision to insurance companies. But I agree with 

you that the Collins amendment does put some tough restrictions 

that— 

Mr. ROSS. Would you agree that we would have to legislate in 

order to give you—in other words— 

Mr. BERNANKE. Yes. 

Mr. ROSS. Thank you. Because I think that where we are at and 

one of the reasons for the delay is that you can’t put the capital 

requirements for banks as the minimum-level capital requirements 

for insurance companies. 

As was pointed out yesterday in a Wall Street Journal opinion 

article, you are going to see that the insurance companies are now 

going to be held to a higher capital standard, do more short-term 

debt. And now, all of a sudden, they may enter the banking business, which is going to be counterproductive to where we want to 

go with the correction that we are trying do. 

So my question to you, I guess, as a result is, if we impose the 

bank-centric capital requirements on insurance companies, would 

that have done anything to have saved AIG from its financial collapse of 5 years ago? 

Mr. BERNANKE. There were a lot of things that AIG was doing 

that it couldn’t do now. Let me just put it that way. 

Mr. ROSS. Right. 

Mr. BERNANKE. On the Collins amendment, it does make it more 

difficult for us, because it imposes, as you say, bank-style capital 

requirements on insurance companies. There are some things we 

can do, but it is providing some— 

Mr. ROSS. Would it be safe to say, in my last 20 seconds, that 

the future is not too bright for the nonbank financial institutions 

in terms of having any reduction in their capital requirements? 

Mr. BERNANKE. There are some assets that insurance companies 

hold that we can differentially weight, for example. There are some 

48 

things we can do. But, again, I think this does pose some difficulty 

for our oversight. 

Mr. ROSS. Thank you. And thank you again for your service. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair recognizes the gentleman from Washington, Mr. Heck. 

Mr. HECK. Thank you, sir. 

Mr. Chairman, given all the eulogies that have been delivered 

here today, at least on the Democratic side, I feel a little bit like 

Bette Midler, the very last guest on the very last episode of ‘‘The 

Tonight Show’’ that Johnny Carson hosted. She famously quipped 

to Mr. Carson, ‘‘You are the wind beneath my wings.’’ There is 

some application to you, sir, as it relates to the economy. And I 

thank you for your service, as well. 

Mr. BERNANKE. Thank you. 

Mr. HECK. I also thank Mr. Ross for brilliantly anticipating 

where it is I wanted to go. I have to admit that, every day that 

goes by, I am increasingly less optimistic that I am a Member of 

an institution that can successfully deal with the debt limit. Sadly, 

I must admit that. 

I am wondering if failure by Congress to deal with it was one of 

the ‘‘unanticipated shocks’’ that you suggested our economy might 

be vulnerable to and, whether it is or not, what you would suggest 

about what the economic consequence would be if Congress does, 

in fact, fail to lift the debt limit later this early fall. 

Mr. BERNANKE. I think it would be quite disruptive. 

It is important to understand that passing the extension of the 

debt limit is not approving new spending. What it is doing is approving payment for spending already incurred. So it would be very 

concerning for financial markets and, I think, for the general public 

if the United States didn’t pay its bills. So I hope very much that 

particular issue can be resolved smoothly. 

I am not claiming in any way that it is not important to discuss 

these critical fiscal issues. It is. But to raise the prospect that the 

government won’t pay its bills, including not just its interest on 

debt but even what it owes to seniors or to veterans or to contractors, is very concerning. And I think it could provide some shock 

to the economy if it got severely out of hand. 

Mr. HECK. Is there a material possibility that the shock would 

be so great as to be recession-inducing? 

Mr. BERNANKE. Depending on how it plays out, I think, in particular, that a default by the U.S. Government would be extremely 

disruptive, yes. 

Mr. HECK. Secondly, and lastly, over the last couple of years the 

Fed has begun targeting interest rates on mortgages, in addition 

to your historic focus on baseline interest rate. Has the Fed considered, is the Fed considering, would the Fed consider implementing 

monetary policy through other credit channels either to minimize 

the possibility of an asset bubble or to target job creation, should 

we not see continued progress toward that lower unemployment 

rate that is desired by so many? 

Mr. BERNANKE. The Federal Reserve actually is quite limited in 

what we can buy. We can basically buy Treasurys and governmentguaranteed agency securities—that is, MBS. We are not allowed to 

49 

buy corporate debt or other kinds of debt. So we don’t really have 

the tools to address other types of credit. 

Mr. HECK. Setting aside for the moment that, if we fast-rewound 

‘‘X’’ number of years, some people would probably have said the 

same thing about the activity you are exactly engaged in today, it 

was you, sir, who 11 years ago in a speech indicated that there 

might be other monetary policy options available to the Fed. 

It just does not seem to me to be much of anything other than 

a fairly easily adapted technical fix to allow you, for example, to 

engage in credit channels that, for example, back infrastructure. 

Infrastructure is something which, of course, is the gift that keeps 

on giving. But I don’t see a legal impediment to you being able to 

venture into that area, as some would conclude you might have 

hinted back in 2002 before you were Chair and some might have 

suggested is a direct parallel to what you are doing today. 

Mr. BERNANKE. I will put you in touch with our General Counsel. 

I don’t think that is within our legal authorities. 

Mr. HECK. You would rule that out altogether? 

Mr. BERNANKE. I don’t see what the legal authority is to do that. 

Mr. HECK. Then I would like to have a conversation with your 

General Counsel. 

Mr. BERNANKE. Okay. We will give you his number. 

Mr. HECK. And in the meantime, in 5 seconds, thank you, sir, 

very much. 

Mr. BERNANKE. Thank you. 

Chairman HENSARLING. The time of the gentleman has now expired. 

The Chair recognizes the gentleman from North Carolina, Mr. 

Pittenger. 

Mr. PITTENGER. Thank you, Mr. Chairman. 

And thank you, Chairman Bernanke. 

In response to an earlier question by Mr. Stivers regarding 

whether the Fed would be willing to conduct the same type of 

stress tests of its quantitative easing exit strategy that it has subjected financial institutions to, you stated that under a reasonable 

interest-rate scenario you would not expect any significant disruptions from the Fed’s withdrawal of monetary stimulus. 

But the whole point of the stress test is to position an extremely 

adverse scenario, akin, say, to the inflation levels last seen in the 

late 1970s and early 1980s, not a reasonable interest-rate environment. 

Mr. Bernanke, has the Fed stress-tested its strategy according to 

that more extreme scenario? 

Mr. BERNANKE. Again, this is not about our strategy; this is 

about our remittances to the Treasury. And when we do very tough 

interest-rate tests—and again, there are a number of them that 

have been published and are publicly available—what we see is, 

first, that even though there may be a period where remittances to 

the Treasury are low or zero, that over the 15-year period from 

2009 to 2023, the total remittances generally are higher than they 

would have been in the case where there were no asset purchases. 

But I think you need to look beyond that, which is that to the extent that our asset purchases are strengthening the overall economy, that is very beneficial to the Treasury because of higher tax 

50 

collections. And so I think most scholars who have looked at this 

conclude that the asset purchases are a winner for the taxpayer 

under almost all scenarios. 

Mr. PITTENGER. Are you concerned by the perception, though, 

that the Fed will stress test the banks and other financial institutions but not review its own policies and strategies by the same 

rules? 

Mr. BERNANKE. It is not comparable. The banks have credit risk. 

We have no credit risk. We buy only Treasurys and governmentguaranteed MBS. So in a recession, we make money, because interest rates go down. 

Mr. PITTENGER. Chairman Hensarling has shown up on the 

board the running debt clocks. Of concern to you, you have already 

expressed earlier, my friend for 20 years, Erskine Bowles, has run 

around the country, he and Alan Simpson were here last week, 

they rang the bell on the concerns relating to the debt. I want to 

get your thoughts on the policies that the Fed could lead to this 

compounding problem when it comes to the interest payments on 

the debt. Do you believe that when interest rates rise over the coming years, and the spending trajectory we are on towards the close 

of the decade, that the interest rates, along with annual deficits, 

could push America’s debt to unsustainable levels, perhaps close to 

what we are seeing across Europe? That is really the thought that 

Erskine left with many of us. He said, ‘‘I used to say this is for my 

grandchildren. Then I would say it is for my kids. Now I would say 

it is for me.’’ And the urgency seems to be gone. President Obama 

has never mentioned it in the State of the Union, in his inauguration. It is the big elephant in the room that for some reason hasn’t 

been there in terms of the focal point, and yet the interest rate, the 

interest requirements are going to be compounded this entire issue. 

How would you like to address that as we look ahead and foresee 

the outcomes that might achieve the same results that they have 

had in Europe? 

Mr. BERNANKE. The CBO and the OMB, when they do the deficit 

projections, they assume that interest rates are going to rise. And 

if the economy recovers, interest rates should rise. That is part of 

a healthy recovery. So that is taken into account in their analysis. 

What their analysis finds is that, for the next 5 years or so, the 

debt-to-GDP ratio is fairly stable. But getting past into the next 

decade, then we start to see big imbalances arising mostly from 

long-term entitlement programs and a variety of other things, including interest payments. 

And so, as I have said on numerous occasions, I am all in favor 

of fiscal responsibility, but I think that in focusing only on the very 

near term and not the long term, you are sort of looking for the 

quarter where the lamppost is rather than looking for it where the 

quarter actually is. So that is my general view, that you should be 

looking at the longer-term fiscal situation. 

Mr. PITTENGER. Straightening pictures while the house is burning down. Thank you, Mr. Chairman. 

Chairman HENSARLING. The time of the gentleman is yielded 

back. 

The Chair now recognizes the gentleman from Michigan, Mr. Kildee. 

51 

Mr. KILDEE. Thank you, Mr. Chairman. 

And thank you, Chairman Bernanke. I will just echo what many 

have said before. We certainly appreciate the great service that you 

have provided to this country. 

When you were here back in February, I was a mere freshman 

with 6 weeks’ experience in Congress, and now I am a seasoned 

Member of Congress with almost 7 months. So I want to follow up 

on a line of questioning that I will take a minute or 2 to pursue. 

And I may not take my full 5 minutes; I may leave some time for 

others. 

But in your prepared remarks, you make some pretty important 

references. I think one of many that got my attention was the reference to improved financial positions of State and local governments. And while I think we all would acknowledge that is generally the case, I want to return to what will likely be my theme 

here for a long time, which is that there is great unevenness or inequity in the condition of municipal governments—State governments for sure, but municipal governments certainly. 

So I ask if you would mind perhaps commenting further. And, actually, in anticipation of not having time, I prepared a letter for 

you that I would like to submit and ask for your response. 

But if you think about it in the context of your dual mandate, 

the potential impact on regional economies and employment as an 

extension of what seems nearly certain to be severe financial stress 

for cities like Detroit—which, in many ways, is sort of a 

placeholder for what is a much bigger problem, and that is the disconnect between the presence of wealth and economic activity in 

America’s legacy cities, older industrial cities, and the obligations 

that those cities have to sustainable regions. 

And so, sort of following on Mr. Heck’s—although maybe not 

quite as far as Mr. Heck’s comment regarding the reach of the Federal Reserve, I would ask if you would think about how you would 

advise Congress or how the Fed itself might pursue policy that 

would have the effect of potentially avoiding but certainly mitigating the economic effect of municipal financial failure. 

The one that always comes to mind first is the potential for municipal bond default, which could affect not only the creditworthiness of the municipality but obviously could have implications for 

State governments, since virtually all municipalities are creatures 

of State government, but, as importantly, the effect on the economic health of particular regions. 

I say this because, as I said back in February, I think this potentially is an institutional failure that is regionalized or localized but, 

for those places, is every bit as much and, I would argue, even 

more a threat than what we have seen with the financial distress 

that we faced back in the last half-decade and in the case of maybe 

the auto industry, what it faced. This is a serious pending crisis. 

I would just ask for your comments. And I will submit my letter 

for further response. 

Thank you. 

Mr. BERNANKE. No. I agree that it is a very serious problem. If 

I am not mistaken, we have a Detroit City Manager on one of our 

local boards, and she has kept us informed about some of the 

projects that are being undertaken razing parts of the City and 

52 

working on economic development and the like. So it is a very serious problem. 

I think as far as the Fed is concerned, there are two kinds of 

things we can do. First, obviously to solve the problem, you have 

to solve the underlying economic problem, and that means jobs, 

and that means economic growth, and our monetary policies are 

aimed at trying to achieve that. I think that is fundamental. 

Beyond that, we do have community development experts at the 

Fed. They work with community development groups, CDFIs and 

others, to try to reestablish an economic base in places that have 

been hollowed out for various reasons. And I recently—a few years 

ago, I guess it was, I went to Detroit and talked to suppliers, auto 

suppliers who provide input to the big companies to try to understand their economy. 

So I think that working through community groups, community 

organizations, CDFIs and the like to try to restore the economic 

base, that is the only long-run solution. You can provide help 

through the government in the short run, but unless the economy 

comes back, you don’t really have a sustainable situation. 

Mr. KILDEE. Thank you. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair recognizes the gentleman from Kentucky, Mr. Barr. 

Mr. BARR. Thank you, Mr. Chairman. 

Chairman Bernanke, thank you for your service and for your testimony here today. 

I have listened to your testimony and I have an observation, then 

a couple of questions. The observation is this: The Fed has held interest rates near zero for 4 years now. The Fed’s balance sheet has 

more than tripled to $3.5 trillion and continues to grow. Today, you 

have testified that a highly accommodative policy will remain appropriate for the foreseeable future, and yet unemployment remains at 7.6 percent; 54 consecutive weeks of unemployment higher than 71⁄2 percent; only 58 percent of the working-age population 

is employed; 5 straight years of declining wages; three-quarters of 

the American people are living paycheck to paycheck; and GDP 

growth remains well below the long-run average of 3 percent. All 

of this has happened coincident to a time when the role of government has grown dramatically as a percentage of our economy, higher taxes, stimulus spending, government bailouts, Obamacare, 

Dodd-Frank, skyrocketing compliance costs on financial institutions 

and crushing overregulation of the energy sector by the EPA. 

Given these realities and the Fed’s extraordinary expansionary 

monetary policy, struggling American families are asking the following very important question: What is the cause of weakness and 

persistent weakness in our labor market? Is it the relative ineffectiveness of the Fed’s monetary policy, or is it the fiscal policies like 

higher taxes, Obamacare, Dodd-Frank and overregulation by the 

EPA? 

My question is related to the exit strategy. During testimony in 

front of Congress last month, you refused to rule out tapering by 

the fall time period. The Federal Open Market Committee then released a statement that the Federal Reserve, ‘‘will continue its purchases of Treasury mortgage-backed securities and employ its other 

53 

policies as appropriate until the outlook for the labor market has 

improved substantially in the context of price stability.’’ 

You have reiterated that today. These are hardly definitive statements about reducing the Fed’s unprecedented and aggressive bond 

purchase program, yet the average 30-year, fixed-rate mortgage, as 

we have discussed earlier today, jumped by 42 basis points, the 

Dow suffered back-to-back declines of more than 200 points, and 

billions of dollars were traded out of credit funds after you said last 

month that the Fed could start winding down bond buying later 

this year. 

Given the sharp reaction of the credit markets to even the possibility of tapering, how will you prevent a catastrophic spike in interest rates when you actually do slow bond purchases? 

Mr. BERNANKE. By communicating, by not surprising people, by 

letting them know what our plan is and how it relates to the economy. You talked about the weakness of the economy. I think that 

is evidence that we need to provide a continued accommodation, 

even if we begin to change over time the mix of tools that we use 

to provide that accommodation. 

You said a lot of correct things about the weakness of our economy. I agree with a lot of what you said. On the other hand, it is 

the case that we have made some progress since 2009, and many 

people think of the United States as one of the bright spots in the 

world. We are doing better than a lot of other industrial countries. 

And while we are certainly not where we want to be, at least we 

are going in the right direction, and we hope to support that. 

Mr. BARR. Given the persistent high unemployment, it seems to 

me that American families who are struggling, many of whom are 

in my district in eastern Kentucky, who continue to remain unemployed, persistently unemployed, and as you testified, the underemployment problem persists in this country, I think they justifiably have to ask themselves, given the expansionary policy that 

you have pursued quite aggressively, and to your credit, there has 

to be a fiscal policy problem here that has created this uncertainty. 

Let me conclude by bringing to your attention a quote that a 

commentator recently had to say about Fed policy, and I would like 

your reaction to it: ‘‘If the economy begins to improve, and the Fed 

does not withdraw the tremendous reserves that it has created 

from the banking system, rampant inflation will follow. If it doesn’t 

withdraw reserves quickly, interest rates will rise rapidly. This situation makes economic calculations extremely difficult and makes 

businesses less willing to invest, especially for the long term. If 

business owners could fully trust the Fed, this would not be an 

issue, but we have all been burned too many times to trust the 

Fed.’’ 

Can you respond to that? 

Mr. BERNANKE. There have been people saying we are going to 

have hyperinflation any day now for quite a while, and inflation is 

1 percent. We know how to exit; we know how to do it without inflation. Of course, there is always a chance of going too early or too 

late and not hitting the sweet spot. That happens all the time 

whenever monetary policy tightens. But we have all the tools we 

need to exit without any concern about inflation. 

Mr. BARR. Thank you. 

54 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chairman has graciously agreed to stay an extra 10 minutes, whether he knows it or not, notwithstanding the fact the 

problem was with our sound system. Without objection, I would 

like to recognize the remaining Members who are in the hearing 

room at this time for 2 minutes apiece. 

The gentleman from Pennsylvania, Mr. Rothfus, is now recognized. 

Mr. ROTHFUS. Thank you. 

Chairman Bernanke, thank you for being here today. A simple 

question that I have is, when I have somebody in my district who 

is going to go out and buy a Treasury bill, that individual is looking to make an investment, they go to their bank, they go to their 

broker, they have $1,000, $5,000, and they get a bill. Where does 

the Fed get its money to buy its Treasury bills? 

Mr. BERNANKE. When we buy securities from a private citizen, 

we create a deposit in the bank, their bank, and that shows up as 

reserves. So if you look at our balance sheet, our balance sheet balances, we have Treasury securities on the assets side. And liabilities side, we have either cash or reserves at banks, and that is 

what has been—on the margin, that is what has been building up 

is the excess reserves and— 

Mr. ROTHFUS. You create the reserves? 

Mr. BERNANKE. Yes. 

Mr. ROTHFUS. And so, is that printing money? 

Mr. BERNANKE. Not literally. 

Mr. ROTHFUS. Not literally. 

Mr. BERNANKE. No. 

Mr. ROTHFUS. It is troubling me, when I look at the balance 

sheet that the Fed has, and I look at 4 years ago, it was $800 billion, and now we are up to $3.5 trillion. And I just—I know you 

say you are confident that you have the tools available to do a 

draw-down when necessary without risking hyperinflation, yet by 

your own admission, what you are doing is unprecedented. What 

assurance can you give to the American people that we are not 

going to have a round of rampant inflation 5 years down the road? 

Mr. BERNANKE. It is not unprecedented, because many other central banks use similar tools to the ones that we plan to use. 

Mr. ROTHFUS. Currently? Or can you look back in history and 

see— 

Mr. BERNANKE. No. 

Mr. ROTHFUS. —somebody that has brought up its balance sheet 

by 311 percent in 4 years without any kind of negative consequence? 

Mr. BERNANKE. Absolutely. Japan, Europe, and the U.K. have all 

done similar kinds of things with very large balance sheets. 

Mr. ROTHFUS. I appreciate your feedback on that, and we may 

reach out to you and get that information. Thank you. 

Mr. BERNANKE. Sure. 

Chairman HENSARLING. The Chair recognizes the gentleman 

from New Jersey, Mr. Garrett. 

Mr. GARRETT. I thank the chairman. 

55 

I thank Chairman Bernanke for our back-and-forth, what we 

have had over the years. So in 2 minutes, let me just run through 

a couple of questions, if I may. 

Right now with the balance sheet, as everyone has pointed out, at $3 trillion, I guess you stand as the world’s largest bond fund 

manager. We have seen recently, since early May, a 1 percentage 

point spike in long-term Treasurys, right? If the Fed were to mark 

to market, can you tell us what the change in value of that fund 

is? 

Mr. BERNANKE. It takes us from an $150 billion unrealized capital gain close to even. 

Mr. GARRETT. One hundred fifty to eight hundred. Can you also 

then give us a rule of thumb going forward, because we have already heard progressions as to increases potentially today, tomorrow, or someday in the future as far as inflation. But if you do see 

further increases in that, maybe as a rule of thumb, illustrate the 

relationship between yields and the 10-year Treasury rates and the 

values of the bond fund. For example, what would the magnitude 

of losses be for every percentage point increase in long-term yields? 

Mr. BERNANKE. I don’t have a rule of thumb. I would refer you 

to the analyses that we published on this. It depends on the mix 

of maturities that we have and also the mix of Treasurys and MBS. 

Mr. GARRETT. And do you compute that regularly to do— 

Mr. BERNANKE. Yes. 

Mr. GARRETT. —to do that? 

Mr. BERNANKE. Yes. And we publish it. 

Mr. GARRETT. And so if we see a 2 or 3 percent, then what would 

that result in? 

Mr. BERNANKE. I don’t have a number for you. 

Mr. GARRETT. All right. And in 20 seconds, right now during the 

week of September 13th, Fannie Mae and Freddie Mac and Ginnie 

Mae have been originating around $12.5 billion in debt. You have 

been purchasing around—or no, they have been generating about 

11.4-. You have been purchasing around 12.5- in agency debt, 

which means a result of about 109 percent ratio there. Is there a 

problem there, and do you look at their originations going forward 

in your bond purchases? 

Mr. BERNANKE. We are not seeing any problems in the MBS 

market, because we are not just buying new stuff, but old stuff as 

well. 

Mr. GARRETT. Right. And I guess that is the point. Do you consider that when you do go forward or— 

Chairman HENSARLING. Time— 

Mr. GARRETT. Okay. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair recognizes the gentlelady from Minnesota, Mrs. Bachmann. 

Mrs. BACHMANN. Thank you, Mr. Chairman. 

And thank you, Chairman Bernanke, for being here today. 

I note that in the daily Treasury statement for July 12th, the 

Fed debt subject to the legal limit was $16,699,000,000,000. It 

stood at exactly $16,699,396,000,000 for 56 straight days, defying 

all forces of nature, when we were accumulating about $4 billion 

a day in additional debt. And I note that just during part of the 

56 

questioning, we have added over $400 million in debt, just in the 

time that you have talked to us today. 

So how could this freak of nature occur that the U.S. Treasury 

would report for 56 straight days that the debt stayed at 

$16,699,000,000,000? Has the Federal Government been cooking 

the books for these 56 days in a row, or what happened? 

Mr. BERNANKE. That is not the Federal Reserve. You would have 

to ask the Secretary of the Treasury. 

Mrs. BACHMANN. Could you comment on that? 

Mr. BERNANKE. I don’t know what the issue is. I would have to 

look at the numbers and what they refer to. 

Mrs. BACHMANN. This was reported at CNS.com, but it is on the 

Treasury statement for July 12th. Were you aware of this— 

Mr. BERNANKE. No. 

Mrs. BACHMANN. —that the debt stayed, by some freak coincidence, at this level? 

Mr. BERNANKE. Maybe it has to do with the use of unusual special measures to deal with the debt limit. There are various things 

they can do, to give some extra space. Maybe that is what is happening, so it is not being counted in the debt. 

Ms. BACHMANN. That is what was reported in the news, that this 

is an extraordinary action, but to the common American citizen 

this clearly looks like the Federal Government is cooking the books. 

Mr. BERNANKE. They are using—as you know, whenever the debt 

limit comes close, Treasury Departments under both parties have 

used a variety of different accounting devices to give some extra 

headroom, some extra space. 

Mrs. BACHMANN. Have we exceeded our debt limit? 

Mr. BERNANKE. I don’t think so. 

Mrs. BACHMANN. Thank you. I yield back. 

Chairman HENSARLING. The time of the gentlelady has expired. 

The last questioner will be the gentleman from New Mexico, Mr. 

Pearce. You are recognized. 

Mr. PEARCE. Thank you, Mr. Chairman. You almost beat the 

clock. I appreciate you staying around. 

As you remember, last time you were here I gave you an invitation to come to New Mexico and explain to seniors about your policy. And we have also talked a couple of times. The group is still 

gathering out there, we are trucking them in for lunches, so if you 

ever decide to come to New Mexico to have that meeting— 

Mr. Perlmutter actually headed down this direction. You continue to take advantage of seniors because they don’t have access 

to sophisticated instruments, so a lot of them have their money in 

cash or near cash equivalents. 

Now, Mr. Perlmutter noted that the home financing has increased by from 3.3 to 4.5. We have a whole sheaf of Wall Street 

profit reports. Those are growing extraordinarily high. Did the seniors even get kind of a mention, an honorable mention, in the question about who is going to pay the bill for this? When are you going 

to start going up on the interest rate just a little bit? Because right 

now you are taking from seniors, and you are giving to Wall Street, 

basically. In my district we are, like, 43rd per capita income, 

$14,000 to $18,000 per year. Seniors live their life right. They paid 

off their bills, and they are being punished for this economy. 

57 

Mr. BERNANKE. Again, I don’t think the Fed can get interest 

rates up very much, because the economy is weak, inflation rates 

are low. If we were to tighten policy, the economy would tank, and 

interest rates would be low. 

Mr. PEARCE. These guys are making record rates. They just went 

up a percent and a half. Their costs are not going up. 

One last question, as we run out of time. I was interested in the 

Republican obstructionism comments earlier. I am wondering why 

the Democrats didn’t do anything from 2009 to 2010 on immigration. Considering the multipliers that came in 1986, they thought 

it was 1 million, they legalized 3.3 million—3.5 million, they 

brought 5- with them. That is 16 million. If we get that multiple, 

150 million people could be here. Is there a number at which the 

economy is adversely affected? 

Mr. BERNANKE. I don’t know. 

Mr. PEARCE. Thank you, sir. I will yield back. 

Chairman HENSARLING. All time has expired. 

I want to thank Chairman Bernanke again for his 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 his 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. 

This hearing is now adjourned. 

[Whereupon, at 1:15 p.m., the hearing was adjourned.] 

(59) 

A P P E N D I X 

July 17, 2013 

60 


82861.001

Statement of Rep_ Melvin Watt 

Full Committee Hearing on "Monetary Policy and the State of the Economy" 

July 17, 2013 

Thank you Chairman Bernanke for appearing before this Committee again and 

for your leadership during tough economic times and I certainly join in the 

complimentary statements of the Chair and other Members. While increasing 

consumer confidence and other economic indicators suggest that we are making 

some progress, I'm pleased to see that the Fed has approached these indicators with 

caution. The unemployment rate in my District, which includes some of the most 

urban areas in the State, has increased to as high as 9.5%, significantly higher than 

the national rate and, unfortunately, I believe the actual unemployment rate is even 

higher because a number of my constituents have been unemployed for so long that 

they are no longer looking for work and because minorities (who predominate in 

my congressional district) are much at risk of being unemployed. 

Mr. Chairman, I hope that you are able to shed some light on these dynamics 

during your remarks today and I look forward to hearing your testimony. 
61 


82861.002

For release at 8:30 a.m. EDT 

July 17,2013 

Statement by 

Ben S. Bemanke 

Chairman 

Board of Governors of the Federal Reserve System 

before the 

Committee on Financial Services 

u.S. House of Representatives 

July 17,2013 
62 


82861.003

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. 

I will discuss current economic conditions and the outlook and then turn to monetary policy. I'll 

finish with a short summary of our ongoing work on regulatory reform. 

The Economic Outlook 

The economic recovery has continued at a moderate pace in recent quarters despite the 

strong headwinds created by federal fiscal policy. 

Housing has contributed significantly to recent gains in economic activity. Home sales, 

house prices, and residential construction have moved up over the past year, supported by low 

mortgage rates and improved confidence in both the housing market and the economy. Rising 

housing construction and home sales are adding to job growth, and substantial increases in home 

prices are bolstering household finances and consumer spending while reducing the number of 

homeowners with underwater mortgages. Housing activity and prices seem likely to continue to 

recover, notwithstanding the recent increases in mortgage rates, but it will be important to 

monitor developments in this sector carefully. 

Conditions in the labor market are improving gradually. The unemployment rate stood at 

7.6 percent in June, about a half percentage point lower than in the months before the Federal 

Open Market Committee (FOMC) initiated its current asset purchase program in September. 

Nonfarm payroll employment has increased by an average of about 200,000 johs per month so 

far this year. Despite these gains, the jobs situation is far from satisfactory, as the unemployment 

rate remains well above its longer-run normal level, and rates of underemployment and longterm unemployment arc still much too high. 
63 


82861.004

2 

Meanwhile, consumer price inflation has been nmning below the Committee's longer-run 

objective of 2 percent. The price index for personal consumption expenditures rose only 

I percent over the year ending in May. This softness reflects in part some factors that are likely 

to be transitory. Moreover, measures of longer-term inflation expectations have generally 

remained stable, which should help move inflation back up toward 2 percent. However, the 

Committee is certainly aware that very low inflation poses risks to economic performance--for 

example, by raising the real cost of capital investmcnt--and increases the risk of outright 

deflation. Consequently, we will monitor this situation closely as well, and we will act as needed 

to ensure that inflation moves back toward our 2 percent objective over time. 

At the June FOMC meeting, my colleagues and I projected that economic growth would 

pick up in coming quarters, resulting in gradual progress toward the levels of unemployment and 

inflation consistent with the Federal Reserve's statutory mandate to foster maximum 

employment and price stability. Specifically, most participants saw real GDP growth beginning 

to step up during the second half of this year, eventually reaching a pace between 2.9 and 3.6 

percent in 2015. They projected the unemployment rate to decline to between 5.8 and 6.2 percent 

by the final quarter of 20 15. And they saw inflation gradually increasing toward the 

Committee's 2 percent objective. 1 

The pickup in economic growth projected by most Committee participants partly reflects 

their view that federal fiscal policy will exert somewhat less drag over time, as the effects of the 

tax increases and the spending sequestration diminish. The Committee also believes that risks to 

the economy have diminished since the fall, reflecting some easing of financial stresses in 

Europe, the gains in housing and labor markets that I mentioned earlier, the better budgetary 

1 These projections reflect FOMe participants' assessments based on their individual judgments regarding 

appropriate monetary policy. 
64 


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- 3 -

positions of state and local governments, and stronger household and business balance sheets. 

That said, the risks remain that tight fedcral fiscal policy will restrain economic growth over the 

next few quarters by more than we currently expect, or that the debate concerning other fiscal 

policy issues, such as the status of the debt ceiling. will evolve in a way that could hamper the 

recovery. More generally, with the recovery still proceeding at only a moderate pace, the 

economy remains vulnerable to unanticipated shocks, including the possibility that global 

economic growth may be slower than currently anticipated. 

Monetary Policy 

With unemployment still high and declining only gradually, and with inflation running 

below the Committee's longer-run objective, a highly accommodative monetary policy will 

remain appropriate for the foreseeable future. 

In normal circumstances, the Committee's basic tool for providing monetary 

accommodation is its target for the federal funds rate. However, the target range for the federal 

funds rate has been close to zero since late 2008 and cannot be reduced meaningfully further. 

Instead, we are providing additional policy accommodation through two distinct yet 

complementary policy tools. The first tool is expanding the Federal Reserve's portfolio of 

longer-term Treasury securities and agency mortgage-backed securities (MBS); we are currently 

purchasing $40 billion per month in agency MBS and $45 billion per month in Treasuries. The 

second tool is "forward guidance" about the Committee's plans for setting the federal funds rate 

target over the medium term. 

Within our overall policy framework, we think of these two tools as having somewhat 

different roles. We are using asset purchases and the resulting expansion of the Federal 

Reserve's balance sheet primarily to increase the near-term momentum of the economy, with the 
65 


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4 

specific goal of achieving a substantial improvement in the outlook for the labor market in a 

context of price stability. We have made some progress toward this goal, and, with inflation 

subdued, we intend to continue our purchases until a substantial improvement in the labor market 

outlook has been realized. In addition, even after purchases end, the Federal Reserve will be 

holding its stock of Treasury and agency securities off the market and reinvesting the proceeds 

from maturing securities, which will continue to put downward pressure on longer-term interest 

rates, support mortgage markets, and help to make broader financial conditions more 

accommodative. 

We are relying on near-zero short-term interest rates, together with our forward guidance 

that rates will continue to be exceptionally low--our second tool--to help maintain a high degree 

of monetary accommodation for an extended period after asset purchases end, even as the 

economic recovery strengthens and unemployment declines toward more-normal1evels. In 

appropriate combination, these two tools can provide the high level of policy accommodation 

needed to promote a stronger economic recovery with price stability. 

In the interest of transparency, Committee participants agreed in June that it would be 

helpful to layout more details about our thinking regarding the asset purchase program--

specifically, to provide additional information on our assessment of progress to date, as well as 

of the likely trajectory of the program if the economy evolves as projected. This agreement to 

provide additional information did not reflect a change in policy. 

The Committee's decisions regarding the asset purchase program (and the overall stance 

of monetary policy) depend on our assessment of the economic outlook and of the cumulative 

progress toward our objectives. Of course, economic forecasts must be revised when new 

information arrives and are thus necessarily provisional. As I noted. the economic outcomes that 
66 


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- 5 -

Committee participants saw as most likely in their June projections involved continuing gains in 

labor markets, supported by moderate growth that picks up over the next several quarters as the 

restraint from fiscal policy diminishes. Committee participants also saw inflation moving back 

toward our 2 percent objective over time. If the incoming data were to be broadly consistent 

with these projections, we anticipated that it would be appropriate to begin to moderate the 

monthly pace of purchases later this year. And if the subsequent data continued to confirm this 

pattern of ongoing economic improvement and normalizing inflation, we expected to continue to 

reduce the pace of purchases in measured steps through the first half of next year, ending them 

around midyear. At that point, if the economy had evolved along the lines we anticipated, the 

recovery would have gained further momentum, unemployment would be in the vicinity of 

7 percent, and inflation would be moving toward our 2 percent objective. Such outcomes would 

be fully consistent with the goals of the asset purchase program that we established in 

September. 

I emphasize that, because our asset purchases depend on economic and financial 

developments, they are by no means on a preset course. On the one hand, if economic conditions 

were to improve faster than expected, and inflation appeared to be rising decisively back toward 

our objective, the pace of asset purchases could be reduced somewhat more quickly. On the 

other hand, if the outlook for employment were to become relatively less favorable, if inflation 

did not appear to be moving back toward 2 percent, or if financial conditions--which have 

tightened recently--were judged to bc insufficiently accommodative to allow us to attain our 

mandated objectives, the current pace of purchases could be maintained for longer. Indeed, if 

needed, the Committee would be prepared to employ all of its tools, including an increase the 
67 


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6 

pace of purchases for a time, to promote a return to maximum employment in a context of price 

stability. 

As I noted, the second tool the Committee is using to support the recovery is forward 

guidance regarding the path of the federal funds rate. The Committee has said it intends to 

maintain a high degree of monetary accommodation for a considerable time after the asset 

purchase program ends and the economic recovery strengthens. In particular, the Committee 

anticipates that its current exceptionally low target range for the federal funds rate will be 

appropriate at least as long as the unemployment rate remains above 6-112 percent and inflation 

and inflation expectations remain well behaved in the sense described in the FOMe's statement. 

As I have observed on several occasions, the phrase "at least as long as" is a key 

component of the policy rate guidance. These words indicate that the specific numbers for 

unemployment and inflation in the guidance are thresholds, not triggers. Reaching one of the 

thresholds would not automatically result in an increase in the federal funds rate target; rather, it 

would lead the Committee to consider whether the outlook for the labor market, inflation, and 

the broader economy justified such an increase. For example, if a substantial part of the 

reductions in measured unemployment were judged to reflect cyclical declines in labor force 

participation rather than gains in employment, the Committee would be unlikely to view a 

decline in unemployment to 6-112 percent as a sufficient reason to raise its target for the federal 

funds rate. Likewise, the Committee would be unlikely to raise the funds rate if inflation 

remained persistently below our longer-run objective. Moreover, so long as the economy 

remains short of maximum employment, inflation remains near our longer-run objective, and 

inflation expectations remain well anchored, increases in the target for the federal funds rate, 

once they begin, are likely to be gradual. 
68 


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- 7-

Regulatory Reform 

I will finish by providing you with a brief update on progress on reforms to reduce the 

systemic risk of the largest financial firms. As Governor Tarullo discussed in his testimony last 

week before the Senate Banking, Housing, and Urban Affairs Committee, the Federal Reserve, 

with the other federal banking agencies, adopted a final rule earlier this month to implement the 

Basel III capital reforms. 2 The final rule increases the quantity and quality of required regulatory 

capital by establishing a new minimum common equity tier I capital ratio and implementing a 

capital conservation buffer. The rule also contains a supplementary leverage ratio and a 

countercyclical capital buffer that apply only to large and internationally active banking 

organizations, consistent with their systemic importance. In addition, the Federal Reserve will 

propose capital surcharges on firms that pose the greatest systemic risk and will issue a proposal 

to implement the Basel III quantitative liquidity requirements as they are phased in over the next 

few years. The Federal Reserve is considering further measures to strengthen the capital 

positions of large, internationally active banks, including the proposed rule issued last week that 

would increase the required leverage ratios for such firms. 3 

The Fed also is working to finalize the enhanced prudential standards set out in sections 

165 and 166 of the Dodd-Frank Act. Among these standards, rules relating to stress testing and 

resolution planning already are in place, and we have been actively engaged in stress tests and 

reviewing the "first-wave" resolution plans. In coordination with other agencies, we have made 

2 See Daniel K. Tarullo (2013), "Dodd-Frank Implementation," statement before the Committee on Banking, 

Housing, and Urban Affairs, U.S. Senate, July II, 

www.federalreserve.gov/newsevents/testimony/taruIl020130711a.htm; and Board of Governors of the Federal 

Reserve System (2013), "Federal Reserve Board Approves Final Rule to Help Ensure Banks Maintain Strong 

Capital Positions," press release, July 2, www.federalreserve.gov/newsevcnts/pressibcreg/20130702a.htm. 

3 See Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, and Office of the 

Comptroiler of the Currency (2013), "Agencies Adopt Supplementary Leverage Ratio Notice of Proposed 

Rulemaking," joint press release, July 9, www.federaJreserve.gov/newseventsipress/bcreg/20130709a.htm. 
69 


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- 8 -

significant progress on the key substantive issues relating to the Volcker rule and are hoping to 

complete it by year-end. 

Finally, the Federal Reserve is preparing to regulate and supervise systemically important 

nonbank financial firms. Last week, the Financial Stability Oversight Council designated two 

nonbank financial firms; it has proposed the designation of a third firm, which has requested a 

hearing before the council.4 We are developing a supervisory and regulatory framework that can 

be tailored to each firm's business mix, risk profile, and systemic footprint, consistent with the 

Collins amendment and other legal requirements under the Dodd-Frank Act. 

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

4 U.S. Department of the Treasury (2013), "Financial Stability Oversight Council Makes First Nonbank Financial 

Company Designations to Address Potential Threats to Financial Stability," press release, July 9, 

www.treasury.gov/press-center/press-releaseslPages/jI2004.aspx. 
70 


82861.011

MONETARY POLICY REPORT 

July 17, 2013 

Board of Governors of the Federal Reserve System 

For use at 8:30 a.m., EDT 

July 17, 2013 
71 


82861.012

LETTER OF TRANSMITTAL 

BOARD OF GOVERNORS OF THE 

FEDERAL RESERVE SYSTEM 

Washington, D.C., July 17,2013 

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. 

Sincerely, 

;£.nC 
72 


82861.013

STATEMENT ON LONGER-RUN GOALS AND MONETARY POLICY STRATEGY 

As amended effective' on j,lIluary 29, 2013 

The Federal Open Market Committee (FOMC) is firmly committed to fulfilling its statutory 

mandate from the Congress of promoting maximum employment, stable prices, and moderate 

long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public 

as clearly as possible. Such clarity facilitates well-informed decisionmaking by households and 

businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary 

policy, and enhances transparency and accountability, which are essential in a democratic society. 

Inflation, employment, and long-term interest rates fluctuate over time in response to economic and 

financial disturbances. Moreover, monetary policy actions tend to influence economic activity and 

prices with a lag. Therefore, the Committee's policy decisions reflect its longer-run goals, its 

medium-term outlook, and its assessments of the balance of risks, including risks to the financial 

system that could impede the attainment of the Committee's goals. 

The inflation rate over the longer run is primarily determined by monetary policy, and hence the 

Committee has the ability to specify a longer-run goal for inflation. The Committee judges 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 run with the Federal Reserve's 

statutory mandate. Communicating this 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 significant 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 fixed 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 output growth and unemployment is published four times per year in the FOMC's Summary of 

Economic Projections. For example, in the most recent projections, FOMC participants' estimates 

of the longer-run normal rate of unemployment had a central tendency of 5.2 percent to 6.0 percent, 

unchanged from one year ago but substantially higher than the corresponding interval several years 

earlier. 

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, under 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 different 

time horizons over which employment and inflation are projected to return to levels judged 

consistent with its mandate. 

The Committee intends to reaffirm these principles and to make adjnstments as appropriate at its 

annual organizational meeting each January. 
73 


82861.014

CONTENTS 

Summary ................................................................. 1 

Part 1 

Recent Economic and financial Developments ............................ 3 

Domestic Developments ............................................... 3 

Financial Developments .............................................. 20 

International Developments ........................................... 28 

Part 2 

Monetary Policy ......................................................... 33 

Part 3 

Summary of Economic Projections ....................................... 39 

The Outlook for Economic Activity ...................................... 42 

The Outlook for Inflation .............................................. 43 

Appropriate Monetary Policy ........................................... 43 

Uncertainty and Risks ................................................ 49 

Abbreviations . ........................................ ................. 53 

List of Boxes 

Economic Effects of Federal Fiscal Policy .................................. 10 

Developments Related to Financial Stability ............................... 26 

The Expansion of Central Bank Balance Sheets ............................. 30 

Forecast Uncertainty ................................................. 52 

NOTE: The figures and tables in this report generally reflect information available as of Friday, July 12, 2013. Unless 

otherwise noted, the time series in the figures extend through, for daily data, July 12, 2013; for monthly data, June 2013; 

and, for quarterly data, 2013:Q1. In bar charts, except as noted, the change for a given period is measured to its final 

quarter from the final quarter of the preceding period. 
74 


82861.015

SUMMARY 

Thus far this year, labor market couditions 

have improved further, while consumer price 

inflation has run below the Federal Open 

Market Committee's (FOMC) longer-run 

objective of 2 percent. Gains in payroll 

employment since the start of the year have 

averaged about 200,000 jobs per month, and 

various measures of underutilization in labor 

markets have continued to trend down. Even 

so, the unemployment rate, at 7'/, percent 

in June, was still well above levels prevailing 

prior to the recent recession and well above 

the levels that FOMC participants think can 

be sustained in the longer term consistent with 

price stability. 

Consumer price inflation has slowed this year. 

Over the first five months of the year, the price 

index for personal consumption expenditures 

increased at an annual rate of only Y, percent, 

while the index excluding food and energy 

prices rose at a rate of 1 percent, both down 

from increases of about I Y, percent over 

2012. This slowing appears to owe partly to 

transitory factors. Survey measures of longerterm inflation expectations have remained in 

the narrow ranges seen over the past several 

years, while market-based measures have 

declined so far this year, reversing their rise 

over the second half of 2012. 

Meanwhile, real gross domestic product 

(GDP) continued to increase at a moderate 

pace in the first quarter of this year. Available 

indicators suggest that the growth of real GDP 

proceeded at a somewhat slower pace in the 

second quarter. Although federal fiscal policy 

is imposing a substantial drag on growth this 

year and export demand is still damped by 

subdued growth in foreign economies, some 

of the other headwinds that have weighed on 

the economic recovery have begun to dissipate. 

Against this backdrop, a sustained housing 

market recovery now appears to be under way, 

and consumption growth is estimated to have 

held up reasonably well despite the increase in 

taxes earlier this year. 

Credit conditions generally have eased 

further, though they remain relatively tight 

for households with lower credit scores--

and especially for such households seeking 

mortgage loans. However, beginning in May, 

longer-term interest rates rose significantly 

and asset price volatility increased as investors 

responded to somewhat better-than-expected 

economic data as well as Federal Reserve 

communications about monetary policy. 

Despite their recent moves, interest rates have 

generally remained low by historical standards, 

importantly due to the Federal Reserve's 

highly accommodative monetary policy stance. 

With unemployment still well above normal 

levels and inflation quite low, and with the 

economic recovery anticipated to pick up only 

gradually, the FOMC has continued its highly 

accommodative monetary policy this year in 

order to support progress toward maximum 

employment and price stability. 

The FOMC kept its target range for the 

federal funds rate at 0 to ~;. percent and 

anticipated that this exceptionally low range 

would be appropriate at least as long as the 

unemployment rate remains above 6Y, percent, 

inflation between one and two years ahead is 

projected to be no more than a half percentage 

point above the Committee's 2 percent 

longer-run goal, and longer-term inflation 

expectations continue to be well anchored. The 

Committee also stated that when it decides 

to begin to remove policy accommodation, it 

would take a balanced approach consistent 

with its longer-run goals of maximum 

employment and inflation of 2 percent. 

The FOMC also has continued its asset 

purchase program, purchasing additional 

agency mortgage-backed securities at a pace 
75 


82861.016

2 SUMMARY 

of $40 billion per month and longer-term 

Treasury securities at a pace of $45 billion per 

month. The Committee has reiterated that 

the purchase program will continue until the 

outlook for the labor market has improved 

substantially in a context of price stability. 

In addition, the FOMC has indicated that 

the size, pacc, and composition of purchases 

will be adjusted in light of the Committee's 

assessment of the likely efficacy and costs 

of such purchases as well as the extent of 

progress toward its economic objectives. The 

Committee has noted that it is prepared to 

increase or reduce the pace of purchases to 

maintain appropriate policy accommodation 

as the outlook for the labor market or inflation 

changcs. 

At the June FOMC meeting, Committee 

participants generally thought it would be 

helpful to provide greater clarity about the 

Committee's approach to decisions about 

its asset purchase program and thereby 

reduce investors' uncertainty about how the 

Committee might react to future economic 

developments. In choosing to provide this 

clarification, the Committee made no changes 

to its approach to monetary policy. Against 

this backdrop, Chairman Bernanke, at his 

postmeeting press conference, described a 

possible path for asset purchases that the 

Committee would anticipate implementing 

if economic conditions evolved in a manner 

broadly consistent with the outcomes the 

Committee saw as most likely. The Chairman 

noted that such economic outcomes involved 

continued gains in labor markets, supported 

by moderate growth that picks up over the 

next several quarters, and inflation moving 

back toward its 2 percent objective over time. 

If the economy were to evolve broadly in line 

with the Committee's expectations, the FOMC 

would moderate the pace of purchases later 

this year and continue to reduce the pace of 

purchases in measured steps until purchases 

ended around the middle of next year, at 

which time the unemployment rate would 

likely be in the vicinity of 7 percent, with 

solid economic growth supporting further 

job gains and inflation moving back toward 

the FOMe's 2 percent target. In emphasizing 

that the Committee's policy was in no way 

predetermined, the Chairman noted that 

the pace of asset purchases could increase 

or decrease depending on the evolution of 

the outlook and its implications for further 

progress in the labor market. The Chairman 

also drew a strong distinction between the 

asset purchase program and the forward 

guidance regarding the target for the federal 

funds rate, noting that the Committee 

anticipates that there will be a considerable 

period between the end of asset purchases 

and the time when it becomes appropriate to 

increase the target for the federal funds rate. 

In conjunction with the most recent FOMC 

meeting in June, Committee participants 

submitted individual economic projections 

under each participant's judgment of 

appropriate monetary policy. According to 

the Summary of Economic Projections (SEP), 

Committee participants saw the downside 

risks to the outlook for the economy and 

the labor market as having diminished since 

the fall. (The June SEP is included as Part 3 

of this report.) Committee participants also 

projected that, with appropriate monetary 

policy accommodation, economic growth 

would pick up, the unemployment rate would 

gradually decline, and inflation would move 

up over the medium term from recent very low 

readings and subsequently move back toward 

the FOMes 2 percent longer-run objective. 

Committee participants saw increases in the 

target for the federal funds rate as being quite 

far in the future, with most expecting the first 

increase to occur in 2015 or 2016. 
76 


82861.017

3 

PART 1 

RECENT ECONOMIC AND FiNANCIAL DEVElOPMENTS 

Real economic activity continued to increase at a moderate pace in the first quarter of 20 13, though 

available indicators suggest that the pace of economic growth was somewhat slower in the second 

quarter. Federal fiscal policy is imposing a substantial drag on economic growth this year, and 

subdued growth in foreign economies continues to weigh on export demand. However, some other 

headwinds have diminished. and interest rates, despite recent increases, have generally remained low 

by historical standards, importantly due to the ongoing monetary accommodation provided by the 

Federal Open Market Committee (FOMC). A sustained housing market recovery appears to be under 

way, and, despite the increase in taxes earlier this year, consumption growth is estimated to have held 

up reasonably well, supported by higher equity and home prices, more-upbeat consumer sentiment, 

and the improving jobs situation. Payroll employment has continued to rise at a moderate pace, and 

various measures of underutilization in labor markets have improved further. But, at 7 \'2 percent 

in June, the unemployment rate was still well above levels prevailing prior to the recent recession. 

Meanwhile, consumer price inflation has slowed further this year, in part because of falling energy 

and import prices and other factors that are expected to prove transitory, and it remains below the 

FOMes longer-run objective of 2 percenl. Survey measures of longer-term inflation expectations have 

remained in the fairly narrow ranges seen over the past several years. 

Domestic Developments 

Economic growth continued at a moderate 

pace early this year 

Output appears to have risen further in the first 

half of 2013 despite the substantial drag on 

economic growth from federal fiscal policy this 

year and the restraint on export demand from 

subdued foreign growth. Real gross domestic 

product (GDP) increased at an estimated 

al1nnal rate of I:y. percent in the first quarter 

of the year (figure 1), the same as the average 

pace in 2012, though available indicators point 

at present to a somewhat smaller gain in the 

second quarter. Economic activity so far this 

year has been supported by the continued 

expansion in demand by u.s. households 

and businesses, including what appears to be 

a sustained recovery in the housing market. 

Private demand has been bolstered by the 

historically low interest rates and rising 

prices of houses and other assets, partly 

associated with the FaMe's continued policy 

accommodation. 

In addition, some of the other headwinds that 

have held back the economy in recent years have 

dissipated further. Risks of heightened financial 

stresses in Europe appear to have diminished 

1. Change in real gross domestic product, 2007-13 

Percent,annua!rate 

II j Ii' -- 2 

SOURCE" Department of Commerce, Bureau of EconomiC AnalYSIS. 
77 


82861.018

4 PART 1, RECENT ECONOMIC AND FINANCiAL DEVELOPMENTS 

2. Net change in payroll employment, 2007-13 

3-mtlnlhmuvlogavernges Thousands of Jobs 

400 

200 

200 

600 

800 

SOURCE: Department of Labor, Bureau of Labor Statistics. 

3. Change in output per hour, 1948-2013 

Percent.annualralC 

=1.u.L .. ,_' 

somewhat, consumer confidence has improved 

noticeably, and credit conditions in the United 

States generally have eased. Nonetheless, tight 

credit conditions for some households are still 

likely restraining residential investment and 

consumer spending, and uncertainty about 

the foreign outlook continues to represent a 

downside risk for U.S. financial markets and for 

sales abroad. 

Conditions in the labor market have 

continued to improve ... 

The labor market has continued to improve 

gradually. Gains in payroll employment 

averaged about 200,000 jobs per month over 

the first half of 2013, slightly above the average 

increase in each of the previous two years 

(figure 2). The combination of this year's 

output and employment increases imply that 

gains in labor productivity have remained slow. 

According to the latest published data, output 

per hour in the nonfarm business sector rose 

at an annual rate of only \I, percent in the first 

quarter of 2013, similar to its average pace in 

both 2011 and 2012 (figure 3). 

Meanwhile, the unemployment rate declined 

to 7\1, percent in the second quarter of this 

year from around gy. percent a year earlier. 

A variety of alternative, broader measures of 

labor force underutilization have also improved 

over the past year, roughly in line with the 

official unemployment rate (figure 4). 

While the unemployment rate and total payroll 

employment have improved further, the labor 

force participation rate has continued to decline, 

on balance. As a result, the employmentpopulation ratio, a measure that combines 

the unemployment rate and labor force 

participation rate, has changed little so far this 

year. To an important extent, the decline in 

the participation rate likely reflects changing 

demographics-most notably the increasing 

share in the population of older persons, 

who have lower-than-average participation 

rates--that would have occurred regardless 

of the strength of the labor market. However, 
78 


82861.019

it is also likely that some of the decline in the 

participation rate reflects an increase in the 

number of workers who have stopped looking 

for work because of poor job prospectsl 

... but considerable slack in labor 

markets remains ... 

Although labor market conditions have 

improved moderately so far this year, the 

job market remains weak overall. The 

unemployment rate and other measures of 

1. As was discussed in the box "Assessing Conditions 

in the Labor Market" in the February 2013 ,Wonetary 

Policy Report, the unemployment rate typically provides 

a very good summary of labor market conditions; 

however, other indicators also provide important 

perspectives on the health of the labor market, with the 

most accurate assessment of labor market conditions 

obtained by combining the signals from many such 

indicators. For the box, see Board of Governors of the 

Federal Reserve System (2013), Monetary Policy Report 

(Washington: Board of Governors, February), 

www,federalreserve.gov/monetarypolicy/ 

mpr_20130226_partl,htm, 

4. Measures of labor underutilization, 2001-13 

2003 2005 2007 

MONETARY POLICY REPORT: JlILY 2013 5 

labor underutilization are still well above their 

pre-recession levels, despite payroll employment 

having now expanded by nearly 7 million jobs 

since its recent trough and the unemployment 

rate having fallen 2';' percentage points since 

its peak, Moreover, unemployment has been 

unusually concentrated among the long-term 

unemployed; in June, the fraction of the 

unemployed who had been out of work for 

more than six months remained greater than 

one-third, although this share has continued to 

edge down (figure 5), In addition, last month, 

8 million people, or 5 percent of the workforce, 

were working part time because they were 

unable to find full-time work due to economic 

conditions, 

... and gains in compensation have been 

slow 

Increases in hourly compensation continue 

to be restrained by the weak condition of the 

labor market. The I2-month change in the 

employment cost index for private industry 

Percent 

-------------------------

16 

14 

12 

t~ 10 

-- 8 

Unemployment rate 

2009 2013 

NOTE: U-4 measures total unemployed plus discouraged workers, as a percent of the labor force plus discouraged workers. Discouraged workers arc not 

currently looking for work because they beheve no Jobs are available for them. U~5 measures total unemployed plus all marginally attached to the labor force, as 

a percent of the labor force plus persons marginally attached to the labor force. Marginally attached workers are not in tbe Jabor force, want and are available for 

work, and have looked for a job in the past 12 months. IJ-6 measures 10tal unemployed plus all margmally attached workers plus total employed part time for 

economic reasons, as a percent of the labor force plus all marginally attached workers. 

SOURCF: Department of Lubor, Bureau of Labor Statistics. 
79 


82861.020

6 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

5. Long-tenn unemployed, 1979-2013 

Monthly Percent 

50 

40 

30 

20 

10 

1981 1989 2013 

NOTE: The series shown is the percent of tOlal unemployed persons who 

have been unemployed for 27 w~ks or more, 

SOl.i'RC'E: Department of Labor, Bureau of Labor Statistics. 

6. Measures of change in hourly compensation, 

2003-13 

Quafledy hrcelll 

NOTE: For nonfann business compensation, change is over four quarters; 

for the employment cost index, change is over the 12 months ending in tbe 

last month of each quarter. 

SOlJRCE: Department of Labor, Bureau of Labor StatlstlCS. 

workers, which measures both wages and the 

cost to employers of providing benefits, has 

remained close to 2 percent throughout most 

of the recovery (figure 6). Compensation 

per hour in the nonfarm business sector~·a 

measure derived from the labor compensation 

data in the national income and product 

accounts-rose 2 percent over the year ending 

in the first quarter of 2013. Similarly, average 

hourly earnings for all employees---the 

timeliest measure of wage developmentsincreased 2:4 percent in nominal terms over the 

12 months ending in June. Even with relatively 

slow productivity gains, the change in unit labor 

costs faced by firms-an estimate of the extent 

to which nominal hourly compensation rises 

in excess of labor productivity-has remained 

subdued. 

Consumer price inflation has he en 

especially low ... 

The price index for personal consumption 

expenditures (PCE) increased at an annual 

rate of just '/, percent over the first five months 

of the year, down from a rise of 1'/2 percent 

over 2012 and below the FOMe's long-run 

objective of 2 percent (figure 7). The very low 

rate of inflation so far this year partly reflects 

declines in consumer energy prices, but price 

inflation for other consumer goods and services 

has also been subdued. Consumer food prices 

have remained largely unchanged so far this 

year, and consumer prices excluding food and 

energy increased at an annual rate of 1 percent 

in the first five months of this year after rising 

I y, percent over 2012. With wages growing 

slowly and materials prices flat or moving 

downward, firms have generally not faced cost 

pressures that they might otherwise try to pass 

on . 

. . . as some transitory factors weighed on 

prices ... 

In addition to the decline in energy prices, this 

year's especially low inflation reflects, in part, 

other special factors that are expected to be 

transitory. Notably, increases in both medical 

services prices and the nonmarket component 
80 


82861.021

of PCE prices have been unusually low. While 

the average rate of medical-price inflation 

as measured by the PCE index has been 

considerably lower during the past few years 

than it was earlier, the increase over the first 

five months of 2013~at below V2 percent~has 

been extraordinarily muted, largely reflecting 

the effects on medical services prices of cuts 

in Medicare reimbursements associated with 

federal budget sequestration. (In contrast, 

medical services prices in the consumer price 

index (CPI), which exclude most Medicare 

payments, have risen at an annual rate of nearly 

2 percent so far this year.) Because medical 

services have a relatively large weight in PCE 

expenditures (as the PCE price index reflects 

payments by all payers, not just out-of-pocket 

expenses as in the CPI), price changes in this 

component of spending can have a sizable effect 

on top-line PCE inflation. 

The nonmarket PCE price index covers 

spending components for which market prices 

are not observed, such as financial services 

rendered without explicit charge; as a result, the 

Bureau of Economic Analysis imputes prices 

for those items. Overall, this nonmarket index 

declined early this year before moving up again 

in recent months; however, these prices tend to 

be volatile and appear to contain little signal for 

future inflation. 

... and as oil and other commodity prices 

declined ... 

Global oil prices have come down, on net, from 

their February peak of nearly $120 per barrel, 

though in recent weeks they have increased 

somewhat from their spring lows to almost 

$110 per barrel (figure 8). Tensions in the 

Middle East have likely continued to put 

upward pressures on crude oil prices, but those 

pressures have been mitigated by concerns 

about the strength of oil demand in China 

and the rest of emerging Asia and by rising 

oil production in North America. Nonfuel 

commodity prices have eased since the 

beginning of the year, also reflecting slowing 

economic growth in emerging Asia. Notably, the 

MONETARY POLICY REPORT, JULY 2013 7 

7. Change in the chain-type price index for personal 

consumption expenditures, 2007-13 

Monthly P~.rcent 

LL_~.l_~_~__ _ _______ 1. ___ L ___ ~ j 

2007 2008 2009 2010 2011 2012 2013 

l\OTE: The data extend through May 2013; changes arc from one year 

earlier 

SOCRCf.: DepartmentofCommeree, Bureau of Economic Analysis 

8. Prices of oil and nonfuel commodities, 2008-13 

hnuary::' . .!O!)~- IOf) DoJlarspcrbarrel ---~--------~--.------- ---,-_ .. _--------

140 

120 120 

110 

100 

100 

80 90 

8O (Jl: 60 

JO 40 

Non:. The data are weekly through July ! 2, 2013. The price of oil is the spof 

price of Brent crude oil, and the pnce of non fuel commodities is an mdex of 23 

primary-<:ommodJty pnccs. 

SOURCE: Commodity Research Bureau, 
81 


82861.022

8 PART I, RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

9. Median inflation expectations, 2001-13 

.... ~ 

~ 

SPF expectations for next }Oyears 

Percent 

2011 2013 

Non,; TIle Michigan survey data are monthly and extend through a 

preliminary estimate for July 2013. The SPF data fQr inflation cxpectatwns 

for personal consumption expenditures are quarterly and extend from 

2007:Ql through 2013:Q2. 

SOURCE: Thomson ReutersiUniversity of Michigan Surveys of Consumers; 

Survey of Professional Forecasters (SPF). 

10. Inflation compensation, 2001-13 

- I 

NOTE: Inflation compensation is the difference between yields on nominal 

Treasury securities and Treasury inflation-protected securihes (T1PS) of 

comparable maturities, based on YIeld curves fitted to off-the-run nominal 

Treasury securities and on- and off-the~ruZl TIPS. The 5-yeur measure is 

adjusted for the effect of indexation lags. 

SOURCE: Federal Reserve Bank of New York; Barclays; Federal Reserve 

Board staff estimates. 

price of iron ore, widely viewed as an indicator 

of Chinese demand for commodities, has fallen 

roughly 20 percent since early January. Along 

with falling commodity prices, prices of nonoil imported goods declined in the first half of 

2013, also likely holding down domestic price 

increases this year . 

. . . but longer-term inflation expectations 

remained in their historical range 

The Federal Reserve monitors the public's 

expectations of inflation, in part because these 

expectations may influence wage- and pricesetting behavior and thus actual inflation. 

Survey-based measures of longer-term inflation 

expectations have changed little, on net, so far 

this year. Median expected inflation over the 

next 5 to 10 years, as reported in the Thomson 

Reuters/University of Michigan Surveys of 

Consumers (Michigan survey), was 2.9 percent 

in early July, within the narrow range of 

the past decade (figure 9).2 In the Survey of 

Professional Forecasters, conducted by the 

Federal Reserve Bank of Philadelphia, the 

median expectation for the increase in the PCE 

price index over the next IO years was 2 percent 

in the second quarter of this year, similar to its 

level in recent years. 

Measures of medium- and longer-term inflation 

compensation derived from the differences 

between yields on nominal and inflationprotected Treasury securities have declined 

between V. and 12 percentage point so far this 

year (figure 10). Nonetheless, these measures 

of inflation compensation also remain within 

their respective ranges observed over the past 

several years, as the recent declines reversed 

the rise over the second half of last year. In 

general, movements in inflation compensation 

can reflect not only market participants' 

expectations of future inflation but also changes 

in investor risk aversion and fluctuations in the 

relative liquidity of nominal versus inflationprotected securities; the recent declines in 

inflation compensation may have been amplified 

2. The question in the Michigan survey asks about 

inflation generally but does not refer to any specific price 

index. 
82 


82861.023

by a reduction in demand for Treasury inflationprotected securities amid increased volatility in 

fixed-income markets. 

Fiscal consolidation has quickened, 

leading to stronger headwinds but smaller 

deficits 

Fiscal policy at the federal level has tightened 

significantly this year. As discussed in the box 

"Economic Effects of Federal Fiscal Policy," 

fiscal policy changes-including the expiration 

of the payroll tax cut, the enactment of other 

tax increases, the effects of the budget caps 

on discretionary spending, the onset of the 

sequestration, and the declines in defense 

spending for overseas military operationsare estimated, collectively, to be exerting a 

substantial drag on economic activity this year. 

Even prior to the bulk of the spending cuts 

associated with the sequestration that started in 

March, total real federal purchases contracted 

at an annual rate of nearly 9 percent in the 

first quarter, reflecting primarily a significant 

decline in defense spending (figure II). The 

sequestration will induce further reductions 

in real federal expenditures over the next few 

quarters. For example, many federal agencies 

have announced plans to furlough workers, 

especially in the third quarter. However, 

considerable uncertainty continues to surround 

the timing of these effects. 

These fiscal policy changes-along with the 

ongoing economic recovery and positive net 

payments to the Treasury by Fannie Mae and 

Freddie Mac-have resulted in a narrower 

federal deficit this year. Nominal outlays have 

declined substantially as a share of GDP since 

their peak during the previous recession, and 

tax receipts have moved up to about 17 percent 

of GDP, their highest level since the recession 

(figure 12). As a result, the deficit in the federal 

unified budget fell to about $500 billion over 

the first nine months of the current fiscal 

year, ahnost $400 billion less than over the 

same period a year earlier. Accordingly, the 

Congressional Budget Office projects that the 

budget deficit for fiscal year 2013 as a whole will 

be 4 percent of GDP, markedly narrower than 

MONfTARY POLICY REPORT: JULY 2013 9 

1 J. Change in real government expenditures 

on consumption and investment, 2007-l3 

Pc{ccnLannuulrnte 

n Federal 

.. Statcand local 12 

QI 

[. i. L~' _~ 

2007 2008 2010 2011 2012 

SOURCE: Department ofCommcfce, Bureau of Economic Analysis. 

12. Federal receipts and expenditures, 1995-2013 

_____ ~ ______ P'_~_'"_'o_fllommal GDP 

14 

t I I I I I I LI I I I ! I I I f I I ! ! I 

1997 200 I 2005 2009 20! 3 

::-.sorE: Through 2012, receipts and expenditures are for fiscal yean 

(October-September); GDP is for the four quarters ending in Q3. For 2013, 

receipts and expenditures are for the 12 months ending in June, and GDP is 

the average of 2012:Q4 and 2013:QL Receipts and expenditures are on a 

unified-budget basis. 

SOURCl:: Office of Management and Budget. 
83 


82861.024

10 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

Economic Effects of Federal Fiscal Policy 

Federal fiscal policy has had important effects on 

the pace of economic growth in recent years. One 

useful indicator of the stance of fiscal policy is the 

structural component of the federal budget deficit 

The structural deficit excludes the cyclical part of 

the deficit-that is, changes in government revenues 

and expenditures that occur automatically over the 

business cycle. (it also excludes the budgetary effects 

of financial stabilization programs. t) Changes in 

1. Financial stabilization programs include the Troubled 

Asset Relief Program (TARP), the conservatorship of 

Fannie Mae and Freddie Mac, and deposit insurance. 

lhcsc programs are excluded from the structural deficit 

because, although the programs helped stabilize financial 

market<; and alleviate the crisis, neither their budgetary 

nor their economic effects are well captured in the deficit 

figures, owing in part to the accounting procedures used 

A Total and structural federal budget deficit, 1980-2018 

the structural deficit mainly result from fiscal policy 

actions: Expansionary fiscal policies that can boost 

near-term economic growth generate increases in the 

structural deficit, whereas contractionary policies that 

can temporarily restrain growth generate reductions 

in the structural deficit 

The evolution of one measure of the structural 

deficit is shown by the blue line in figure A.' During 

to score these programs in the budget. For example, in 

the case of the TARP, the budget scores the estimated net 

subsidy cost of the program tadjusted for market risk) as an 

outlay. Reassessments of the subsidy cost have led to large 

fluctuations in TARP-rclatcd outlays from year to year that 

do not reflect changes in policy. 

2. The structural deficit used here is constructed based on 

estimates by the Congressional Budgf't Office. For estimates 

of the cydica! component of the deficit, see Congressional 

Percent of nomma! 001' 

10 

- 7 

~ 6 

L_L j ! I ! ! i I j ! I I _L_L1.._1 j ! I I I I I I I _L.I I I I ! I I _ I ! I I ! I ... J 1983 1988 J993 1998 2003 2008 2013 2018 

NOTE: The data are on a unified~hudget ha~is and are for fiscal years (Oelober-September); GDP is for the four quarters ending III Q3. Deficits appear as 

posltive numbers. The structural deficit excludes the cyclical part of the deficit as wcll as the budgetary effects of financial stabihz.ation programs, which include 

the Troubled Asset Relief Program. the conservatorship of Fannie Mae and freddie Mac, and deposit insurance. 

Sm!RcE: Federal Reserve Board calculations based on Congressional Budget Office data and projections. 
84 


82861.025

the recession and early in the recovery, federal 

fiscal policy was quite expansionary, as indicated 

by the widening of the structural deficit from 

1 '/4 percent of gross domestic product (GOP) in 

fiscal year 2007 to 7 percent in fiscal 2010. The 

tax cuts and federal spending increases put in 

place by the Economic Stimulus Act of 2008; the 

American Recovery and Reinvestment Act of 2009; 

and the Tax Relief, Unemployment Insurance 

Reauthorization, and Job Creation Act of 201 0 

were the primary policy changes contributing to the 

increase in the structural deficit over this period.3 In 

addition, the so-called automatic stabilizers caused 

the total deficit to be wider than the structural 

deficit. Starting in 2011, however, fiscal policy 

transitioned from expansionary to contractionary 

as the structural deficit began to narrow. The 

narrowing intensified somewhat last year as the 

structural deficit decreased from 6% percent of 

GOP in 2011 to 4';' percent of GOP in 2012; As 

some temporary stimulus-related policies expired; 

federal policymakers shifted to deficit-reduction 

efforts with the enactment of the Budget Control 

Act of 2011, and spending on overseas military 

operations continued to decrease. 

Budget Office {2013), The Effects of Automatic Stabilizers 

on the Federal Budget JS of 20 13 (Wa<;hington: (BO, 

March), available at www.cbo.gov/pubHcation/43977. 

For projections of the total deficit, and of transactions 

rdated to financial stabiliLation programs, for fiscal 

years 2013-18, see Congressional Budget Office (20B), 

Updated Budget Projections: Fiscal Years 2013 to 2023 

(Washington: CBO, May), available at www.cbo.gov/ 

publication/44172. 

3. Several supplemental appropriations bills enacted 

during this period also contributed to the increase in the 

structural deficit. 

MONETARY POliCY REPORT; JULY 2013 11 

This year, the structural deficit is expected 

to decline a further 2'/4 percent of GOP. This 

large decrease reflects the expiration of the 

temporary payroll tax cut and the enactment of 

some income tax increases, as weI! as significant 

restraint on government expenditures from the 

budget caps on discretionary spending specified 

in the Budget Control Act, the onset of the 

spending sequestration, and further declines in 

defense spending for overseas operations, The 

Congressional Budget Office estimated that the 

deficjt~reduction policies in current law generating 

the 21/4 percentage point narrowing in the structural 

deficit will also restrain the pace of real GDP 

growth by 1 'h percentage points this calendar year, 

relative to what it would have been otherwise.4 

Under current law, fiscal policy is slated during 

the next couple of years to continue restraining 

economic growth, albeit to a diminishing extent 

compared with the current year, as the structural 

deficit shrinks further but at a slowing pace. 

Despite the substantial near-term narrowing 

of the structural deficit, the federal government 

continues to face significant longer-term fiscal 

pressures. Indeed; under current policies, the 

structural deficit is projected to begin rising again 

later in this decade, in large part reflecting the 

budgetary effects of population aging and rising 

health-care costs, along with mounting debt service 

payments. 

4. See Congressional Budget Office (2013)' The Budget 

and Economic Outlook: Fiscal Years 2013 to 2023 

(Washington: CSO, February), available at www.cbo.gov/ 

pub!ication/43907. 
85 


82861.026

1 2 PART 1: RECENT ECONOM1C AND F1NANClAL DEVElOPMENTS 

13. Federal government debt held by the public, 1963-2013 

Pcrcenlofl1OmmaJGDP 

80 

70 

60 

50 

40 

30 

20 

Non,: The data for debt through 2012 are as of year-end, and the 

corresponding values for GDP are for Q4 at an annual rate. The observation 

for 2{)13:Q2 is based on an estimate for debt in Q2 and GDP in Qt. Excludes 

securities held as investments of federal government accounts 

SOlJRCE: Depar1ment of Commerce, Bureau of Economic Analysis; 

Department of the Treasury, Financial Management Service 

14. Private housing starts, J999-2013 

MOrHhly MIHionsofu!1!ts,annuaira1e 

1.8 

1.4 

1.0 

.6 

.2 

NOTE: The data extend through May 2013. 

SOIIRCE: Department of Commerce , Bureau of the Census 

the deficit of 7 percent of GDP in fiscal 2012. In 

addition, as shown in box figure A, the deficit is 

projected to narrow further over the next couple 

of years in light of ongoing policy actions 

and continued improvement in the economy_ 

Despite the substantial decline in the deficit, 

federal debt held by the public has continued to 

rise and stood at 75 percent of nominal GDP in 

the first quarter of 2013 (figure 13). 

At the state and locallevcl as well, the 

strengthening economy has helped foster a 

gradual improvement in the budget situations 

of most jurisdictions. In the first quarter of 

2013, state tax receipts came in 9 percent 

higher than a year earlier. (Some of the recent 

strength in receipts, though, likely reflects tax 

payments on income that was shifted into 

201 2 in anticipation of higher federal tax rates 

this year.) Consistent with improving sector 

finances, states and municipalities are no longer 

reducing their workforces; employment in 

the nonfederal government sector edged up 

over the first half of the year after contracting 

only slightly in 2012. However, construction 

expenditures by these governments have 

declined significantly further this year. In all, 

real government purchases at the state and local 

level decreased in the first quarter and have 

imposed a drag on the pace of economic growth 

so far this year. 

The housing market recovery continued to 

gain traction ... 

Activity in the housing market has continued to 

strengthen, supported by low mortgage rates, 

sustained job gains, and improved sentiment on 

the part of potential buyers. In the Michigan 

survey, many households report that low 

interest rates and house prices make it a good 

time to buy a home; a gro\\wg percentage of 

respondents also expect that house price gains 

will continue. Reflecting the improving demand 

conditions, sales of both new and existing 

homes have continued to move up, on net, this 

year. Construction of new housing units has 

also trended up over the past year (figure 14), 

contribnting to solid rates of increase in real 

residential investment in the first half of 2013. 
86 


82861.027

Even so, the level of construction activity 

remains low by historical standards. The steep 

rise in mortgage interest rates since May could 

temper the pace of home sales and construction 

going forward, though the pace of purchase 

mortgage applications so far has shown no 

material signs of slowing, even as the pace of 

refinancing applications has tailed off sharply. 

The strengthening in housing demand has 

occurred despite the fact that mortgage credit 

remains limited for borrowers without excellent 

credit scores or the ability to make sizable down 

payments. Responses to special questions in 

the Federal Reserve's April Senior Loan Officer 

Opinion Survey on Bank Lending Practices 

(SLOOS) suggested that some banks had 

actually tightened standards over the past year 

on some loans that are eligible for purchase 

by the government-sponsored enterprises and 

loans guaranteed by the Federal Housing 

Administration, specifically those to borrowers 

with credit scores below 620 and with low down 

payments. Indeed, only about 10 percent of new 

prime mortgage originations made this spring 

were reported to be associated with FICO 

scores below 690, compared with a quarter of 

originations in 2005 (figure 15). 

... as house prices rose further 

House prices, as measured by several national 

indexes, have increased significantly further 

since the end of last year (figure 16). In 

particular, the Core Logic repeat -sales index 

rose about 7 percent (not at an annual rate) 

over the first five months of 2013 to reach 

its highest level since the third quarter of 

2008. Some of the largest recent gains have 

occurred where the housing market has been 

most severely depressed. Recent increases 

notwithstanding, house prices remain far below 

the peaks reached before the recession, and 

the national price-to-rent ratio continues to be 

near its long-run average. Still, the increase in 

house prices has helped to materially reduce the 

number of "underwater" mortgages and made 

households somewhat less likely to default on 

their mortgages. 

MONfTARY POUCV REPORT: JULY 2013 13 

15. Credit scores on new prime mortgages, 2003-13 

_M_o"_'h1'-y _______________ Fl_COsc,w~ 

820 

780 

740 

700 

660 

620 

Non:: Includes purchase mortgages only. The data extend through May 

2013 

SOl!RCE: McDash Ana!ytics. LLC. a wholly owned subsidiary of Lender 

Processing Services. Jne 

16. Prices of existing single-family houses, 2002-13 

M[Jnthly 

S&P,{·:l~c-Shilkr 

2fJ-nty llldc"'{ 

Peak,IOO 

100 

90 

80 

70 

60 

50 

NOTIo Tbe S&PfCasc-Shil!er and FHFA data extend through April 2013 

The CoreLogic data extend through May 2013. 

SOIJRCE: CoreLogic: Federal Housing Finance Agency; S&P. 
87 


82861.028

14 PART 1; RECENT ECONOMIC AND FINANCiAL DEVELOPMENTS 

17. Mortgage interest rate and mortgage refinance 

index, 1990-2013 

h'Tcent MarchI6.1990~100 

11 

10 

I I I I I I I ! ! I L! I I I I ! ! ! I j I I L.LJ 1992 1995 1998 2001 2004 2007 2010 2013 

10,000 

8,000 

6,000 

4,000 

2,000 

The mterest rate data are weekly through Hl, 2013. The 

data are a seasonally adjusted 4-wcck average through 

For interest rate, Federal Home Loan Mortgage Corporation; for 

refinance index, Mortgage Bankers Association 

18. Change in real personal consumption expenditures, 

2007-13 

PI.'n:-cnt,annualrall.' 

H1 HI 

1111= -- 1 

U ____ L I I 

2007 2008 2009 2Q1O 201! 2012 2013 

NOTE: The reading for 2013:Hl IS the annualized May/Q4 change. 

SOURCE: Departmem of Commerce, Bureau of Economic Analysis 

19. Wealth-to-income ratio, 1993·-2013 

Quarterly RallO -----

! i I ! I I I I I I I I I I ! I ! ! j ! ! I ! I 

!993 1997 2001 2005 2009 20}3 

NOl E: The ratio is household net worth to disposable persona! income 

SOURCE: For net worth, Federal Reserve Board, flow of funds data; for 

Income. Department of Commerce, Bureau of Economic Analysis. 

Mortgage interest rates increased but 

remained low by historical standards 

Mortgage interest rates have increased 

significantly in the past conple of months 

from record lows reached earlier this year 

(figure 17). However, rates are still low by 

historical standards, reflecting in part the 

Federal Reserve's ongoing purchases of 

mortgage-backed securities (MBS) and highly 

accommodative overall stance of monetary 

policy The spread between rates on conforming 

mortgages and yields on agency-guaranteed 

MBS has decreased slightly since the end of 

2012. 

Low mortgage rates, along with rising house 

prices, continued to facilitate a significant pace 

of refinancing for most of the first half of 2013, 

which has helped households reduce monthly 

debt service payments. However, refinancing 

remained difficult for households without solid 

credit ratings and those with limited home 

equity. Moreover, as mortgage rates moved 

higher, refinancing activity began to decrease 

sharply in May. 

Consumer spending has held up despite 

the drag from tax increases early this year 

Real consumption expenditures rose at an 

annual rate of about 2 percent over the first five 

months of this year, about the same as in the 

previous two years (figure 18), These increases 

have occurred despite higher taxes and have 

been supported by several factors. The gains 

this year in house prices and equity values have 

helped households recover some of the wealth 

lost during the recession; indeed, the ratio of 

honsehold net wealth to income is estimated 

to have moved up sharply in the first quarter 

(figure 19). In recent months, indicators of 

consumer sentiment have become more upbeat 

as well (figure 20), Furthermore, in contrast 

to mortgage rates, interest rates on auto loans 

and credit cards have changed little, on balance, 

since the end of 2012. With interest rates low, 

the household debt service ratio--the ratio 

of required principal and intcrest payments 
88 


82861.029

on outstanding household debt to disposable 

personal income--remained near historical 

lows (figure 21). 

In addition, real disposable personal income 

has increased slightly, on balance, over the past 

year, as moderate gains in employment and 

wages have more than offset the implications 

for income of changes in tax policy.' And 

household purchasing power has been 

supported so far this year by low consumer 

price inflation. On balance, moderate increases 

in spending have outpaced disposable income 

growth, pushing the personal saving rate down 

to around 3 percent in recent months, close 

to the level that prevailed before the recession 

(figure 22). 

The financial conditions of households 

continued to improve slowly 

Although mortgage debt continued to 

contract amid still-tight credit conditions for 

some borrowers, consumer credit expanded 

at an annual rate of about 6 pereent in the 

first quarter of 2013. Student loans, the vast 

majority of which are guaranteed or originated 

by the federal govemment and subject to 

minimal underwriting criteria, are estimated 

to have increased rapidly and now total nearly 

S I trillion, making them the largest category of 

consumer indebtedness outside of mortgages. 

Auto loans are also estimated to have increased 

at a robust pace. Stable collateral values and 

favorable conditions in the asset-backed 

securities market may have contributed to 

easier standards for such loans. In contrast, 

revolving consumer credit (primarily credit 

card lending) was little changed in the first 

3. The income data have been quite volatile in recent 

months, reflecting both direct and indirect effects of 

the changes in tax policy this year. Personal income is 

reported to have surged late last year and then fallen 

back sharply early this year, as many firms apparently 

shifted dividend and employee bonus payments into 2012 

in anticipation of higher marginal tax rates for highincome households this year. In addition, the rise in the 

payroll tax rate and a surge in personal income taxes 

at the beginning of the year pushed down disposable 

personal income in the first quarter. 

MONETARY POLICY REPORT, JULY 2013 1.5 

20. Consumer sentiment indexes, 2000-13 

.\10nlhly 

140 

--- 120 

100 

80 

60 

40 

20 

NOTE: The Conference Board series equals 100 in 1985. The Midllgan 

survey series equals 100 in 1966 and is a preliminary estimate for July 2013. 

SOURCE: The Conference Board; Thomson ReuterslUniversity of Michigan 

Surveys of Consumers 

21. Household debt service, 1980-2013 

Quart ... ,,-ly f'c'rcentofd"posabl,,;ncome 

14 

13 

12 

11 

10 

Non;: Debt service payments consist of estimated required !X1yments ()Jl 

outstanding mortgage and cunsumer debt 

SOURCE: Federal Reserve Board, statistical release, "Household Debt 

Service and Financial ObhgatlOns RatIos" 

22. Personal saving rate, 1993-2013 

Percent 

-- 4 

-2 

2009 

NOTE: The data arc through 20 13:Q2. which is the April-May average 

SOURCE: Department of Commerce, Bureau of Economic AnalYSIS. 
89 


82861.030

16 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

23. Credit card balances, 2000--13 

Quarterly BiHionsofdollars 

2001 2003 2005 2007 2009 2011 

550 

500 

450 

400 

350 

300 

--- 250 

200 

150 

100 

50 

o 

NOTE: Subpnmc refers to borrowers with Equifax Risk Scores lower than 

660; prime, between 660 and 779: and superprime, greater than 779. 

SOeR('!:: Federal Reserve Bank of NY Consumer Credit Panel; Equifax. 

24. Financial ratios for nonfinancial corporations, 

1990-2013 

RatIO Ra!i(l .--------------------------

.34 

32 

.28 

26 

.24 -.04 

200 I 2004 2007 20 J 0 2013 

NOTE.: The data are annual through 1998 and quarterly thereafter. 

SOURCE: Compustat, © 2013 Standard & Poor's FinanCIal Services LLC 

("S&P"), All rights reserved. No further distribution or reproduction 

permitted 

quarter, and standards and terms on credit 

card loans appeared to remain tight, especially 

for consumers with less-than-pristine credit 

histories. For instance, spreads of interest rates 

on credit card loans over reference interest 

rates remained historically wide. Consequently, 

credit card debt extended to consumers with 

prime credit scores remained well below its precrisis levels, while debt extended to those with 

subprime credit scores-that is, Equifax Risk 

Scores below 66O----continued to trend down 

(figure 23). 

According to the most recent available data, 

indicators of distress for most types of 

household debt have declined since the end 

of 2012. ror home mortgages, for example, 

the fraction of current mortgages becoming 

30 or more days delinquent has now reached 

relatively low levels as a result of strict 

underwriting conditions for new mortgages as 

well as improved conditions in housing and 

labor markets. Measures of late-stage mortgage 

delinquency, such as the inventory of properties 

in foreclosure, also improved but remained 

elevated. Delinquency rates on student loans 

also remained high, likely reflecting in part the 

lack of underwriting on the federally backed 

loans that make up the bulk of the student 

loans outstanding. 

The financial conditions of nonfinancial 

firms continued to be strong ... 

In the first quarter, the aggregate ratio of liquid 

to total assets for nonfinancial firms ticked up 

and remained near its highest level in 20 years, 

while the aggregate ratio of debt to assets 

was still well below its average over the same 

period (figure 24). Strong balance sheets, in 

tum, have contributed to solid credit quality: 

Bond default rates, as of June, stayed low by 

historical standards, and the delinquency rate 

on commercial and industrial (C&I) loans 

continued to fall in the first quarter from 

already low levels. However, over the first 

half of the year, the volume of nonfinancial 

corporate bonds that were upgraded by 

Moody's Investors Service was less than the 

volume downgraded. 
90 


82861.031

... and corporate bond and loan issuance 

remained robust 

With corporate credit quality strong and 

interest rates near historically low levels 

through much of the first half of 2013 

(figure 25), nonfinanciallirms continued to 

raise funds, especially using longer-duration 

instruments. The pace of bond issuance 

by both investment- and speculative-grade 

nonfinancial firms remained extraordinarily 

brisk until interest rates rose signilicantly in 

May, while nonfinancial commercial paper (CP) 

outstanding was little changed (figure 26). C&I 

loans outstanding at commercial banks in the 

United States continued to expand dnring the 

lirst half of 2013 but at a slower pace than in 

the second half of 2012, when finns reportedly 

ramped up their C&I borrowing in part to make 

larger-than-usual dividend and bonus payments 

in advance of anticipated year-end tax hikes. A 

relatively large fraction of respondents [0 the 

April SLOOS indicated that, over the preceding 

three months, they had eased standards 

and pricing terms for C&I loans to firms of 

all sizes. Meanwhile, issuance of leveraged 

loans extended by nonbank institntions in 

the syndicated loan market was very elevated 

(fignre 27), boosted by strong investor demand 

for these floating-rate instruments manifested 

through inflows to loan mutual funds and 

rapid growth of newly established collateralized 

loan obligations. More than two-thirds of the 

proceeds from such syndicated loan issuance, 

however, were reportedly used to repay existing 

debt. 

Borrowing conditions for small businesses 

improved, though demand for credit 

remained subdued 

Some indicators of borrowing conditions for 

small businesses have improved since the end 

of 2012. According to the surveys conducted 

by the National Federation of Independent 

Business (NFIB) dnriug the first half of 

2013, the fraction of small businesses that 

found credit more difficult to obtain than 

three months prior declined on net. Recent 

MONETARY POLICY REPORT, JULY 2013 17 

25. Corporate bond yields by securities rating, 1997~2013 

Daily Pcrcenlagepoims 

:::: )~ 

-~~'BB H1hhq,ld -

~ ~ 

\\ ~ ~ 

1997 

Non;: The yields shown are yields on IO-year bonds. 

20 

l' 

16 

14 

12 

10 

SOURCE: Derived from smoothed corporate yield curves using MerrH! 

Lynch bond data 

26. Selected components of net financing for nonfinancial 

businesses, 2006-13 

______ B;... lH_""_"_fdo!]an, monthly rate 

:--J Commercial paper 

II Bonds 

• Bank loans 

-Sum 

'0 

60 

40 

20 

20 

--~ 40 

i_J __ ~ I . .L_L.....J.......lLL...J 2{J06 2007 2008 2009 2010 2011 2012 2013 

The data for the components except bonds are seasonally adjusted 

Federal Reserve Board, flow of funds dllta 

27. Leveraged loans extended by nonbank 

institutions, 2006--13 

_____ ..:",,'"::.c'""::.':.:.ofdolJars, rnonlhly rate 

II Other 

• Retlnancing QI2 70 

60 

50 

4() 

~ ~ 

,

=1l H2 

= ~...l.OlHIJ.BCLIlIIIL..J :: 

2006 2007 2008 2009 2010 2011 2012 2013 

NOTE: Refinancing repres.ents. the portion of syndicated loan issuance 

reportedly being used to repay existing dent 

SOURCE: Thomson Reulers LPC's LoanConncctor. 
91 


82861.032

18 PART 1, RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

28. Change in real business fixed investment, 2006-13 

Pcrn:l1t,annllalrale 

[J Structures 

• Equipment and software -- 30 

10 

10 

10 

20 

30 

l-L_~~ _____ l __ ----L~ __ --L--LJ 

2006 2007 2008 2009 2010 20ll 1012 2013 

SOURCE: Department of Commerce, Bureau of Economic Analysis 

readings from the Federal Reserve's Survey of 

Terms of Business Lending indicate that the 

spreads charged by commercial banks on newly 

originated C&I loans with original amounts less 

than $1 million-a large share of which likely 

consist of loans to small businesses-continued 

to edge down, though they remained elevated.' 

However, demand for credit from small firms 

apparently remained subdued compared with 

demand from large and middle-market firms. 

Relatively large fractions of respondents in 

recent NFlB surveys indicated that they did 

not have any borrowing needs, and the total 

dollar volume of business loans with original 

amounts of $1 million or less outstanding at 

U.S. commercial banks was little changed in the 

first quarter. 

However, business spending on capital 

investment has been rising at only a 

modest pace 

Despite the large amount of business 

borrowing, businesses' capital investment has 

been rising only modestly. Real spending on 

equipment and software (E&S) increased at an 

annual rate of 4 percent in the first quarter after 

having risen at a similar, below-average pace 

in 2012 (figure 28); these increases likely reflect 

the tepid growth in business output over the 

past year. Shipments and orders of nondefense 

capital goods and other forward-looking 

indicators of business spending are consistent 

with further moderate gains in E&S spending in 

the spring and summer of this year. 

Business investment in structures has also been 

relatively low so far this year, even apart from a sharp 

drop-off in expenditures on wind-power facilities 

following a tax-related burst of construction late last 

year. 'The level of investment in drilling and mining 

structures has stayed elevated, supported by high oil 

prices and the continued exploitation of new drilling 

technologies. However, investment in nonresidential 

buildings continues to be restrained by high vacancy 

4. Data releases for the Survey of Terms of Business 

Lending are available on the Federal Reserve Board's 

website at www.fcdcralreserve.gov/rcIcases/e2! 

default.htm. 
92 


82861.033

rates for existing properties, low commerdal real 

estate (CRE) prices, and tight financing conditions 

for new construction. Indeed, banks' holdings of 

construction and land development loans have 

contracted every quarter since the first half of 2008. 

Despite weak fundamentals, conditions in 

markets for CRE financing appeared to loosen 

somewhat. A moderate fraction of banks in 

the April SLOOS again reported having eased 

their lending standards on CRE loans, while a 

somewhat larger fraction continued to report 

some increase in demand for these loans. In 

addition, the pace of issuance of commercial 

mortgage-backed securities has stepped up, on 

balance, this year, but it remained well below its 

peak reached in 2007 (figure 29). 

Foreign trade has been relatively weak 

Export demand, which provided substantial 

support to domestic activity earlier in the 

recovery, has weakened since the middle 

of 2012, partly reflecting subdued foreign 

economic activity. Real exports of goods and 

services declined at an annual rate of I percent 

in the first quarter of 2013 (figure 30), though 

data for the first two months of the second 

quarter suggest that they rebounded. Exports to 

Japan have been particularly weak, but those to 

Canada continue to risco 

Real imports of goods and services edged down 

in the first quarter after falling substantially 

in the fourth quarter of 2012. Data for April 

and May suggest that imports recovered at a 

moderate pace in the second quarter. Although 

imports of non-oil goods and services rose, 

imports of oil declined further as US. oil 

production continued its climb of recent years. 

Altogether, net exports were a neutral influence 

on the growth of real GDP in the first quarter 

of 2013, and partial data suggest that the same 

was the case in the second quarter. 

The current account deficit remained at about 

2'12 percent of GDP in the first quarter of 2013 

(figure 31), a level little changed since 2009. 

MONETARY POLICY REPORT: JULY?013 19 

29. Commercial mortgage-backed securities 

issuance, 2006--13 

BI1!lOn$(lrdollars,monlhlyr~te 

SOURCE: Hamson Scott Puhlications Commercial Mortgage Alert 

30. Change in real imports and exports of goods 

and services, 2007-13 

20 

18 

16 

14 

12 

10 

f'ercellt.anl1ualrate 

[] Imports 

• Exports 

III 

12 

~~iL~~~1 -4 

SOURCE: Department of Commerce, Bureau of Economic Analysts 

31. U.S. trade and current account balances, 2004-13 

Quarterly Pe;centofl1omma!GDP 

_ .. 6 

SOliRe!:: Department of Commerce, Bureau of Economic Analysis. 
93 


82861.034

20 PART 10 RECENT ECONOMIC AND FINANCIAL DEVElOPMENTS 

32. U.S. net financial inflows, 2008-13 

B,!hQnsofdo!br~, annua!ralC 

• u.s. private (including bankmg) 

• Foreign pnvate (mcluding bankmg) 

a U.S. official 

::::J Fureign official 

HI ~ j' ~ ~ ~ -u--

u__ _ ___ ~_~ __ ~' ___ ---1_~_j _______ LJ 

2008 2009 2010 2011 2012 2013 

2,400 

2,000 

1.600 

i,200 

800 

400 

400 

800 

NOTE: Negative numbers indICate a balance of payments outflow, 

generated when U.S. residents, on net, purchase foreign a'i.sets or when 

foreign residents, on net, selJ U.s. assets. A negative number for "u.s. private" or "D.S. official" indicates an increase in foreign positions. U.S. 

official flows include the foreign currency acquired when foreign central 

banks draw on their swap lines with the Federal Reserve. 

SOl'RCE: Department of Commerce, BUfC<lU of Economi.c Analysis. 

33_ Net saving, 1993-2013 

Quarlerly Pen:cnt of nominal GDr 

Nonfederal saving 

!993 2005 2009 

NOlE: ?\Ionfederal saving is the sum of persona! and net business saving 

and the net saving of state and local governments. 

SOURCE: Department of Commerce, Bureau of Economic Analysis. 

The current account deficit had narrowed 

substantially in late 2008 and early 2009 when 

US. imports dropped sharply, in part reflecting 

the steep decline in oil prices_ 

In the first quarter of 2013, the current account 

deficit continued to be financed by strong 

financial inflows, mostly from purchases of 

Treasury securities by both foreign official 

and foreign private investors (figure 32). 

Consistent with continued improvement in 

market sentiment, US investors made further 

strong purchases of foreign securities, especially 

equities. 

National saving is very low 

Net national saving-that is, the saving of US_ 

households, bnsinesses, and governments, net 

of depreciation charges-remains extremely 

low by historical standards (figure 33)_ In the 

first quarter of 2013, net national saving was 

I percent of nominal GDP, up Ii-om figures 

that averaged around zero over the past few 

years. As discussed earlier, the near-term federal 

deficit has narrowed because of fiscal policy 

changes and the economic recovery, and further 

declines in the federal budget deficit over the 

next few years should boost national saving 

somewhat. With the economy still weak and 

demand for investable funds limited, the low 

level of national saving is not constraining 

growth or leading to higher interest rates_ 

However, if low levels of national saving 

persist over the longer run, they will likely 

be associated with both low rates of capital 

formation and heavy borrowing from abroad, 

limiting the rise in the standard of living for 

US residents over time. 

Financial Developments 

The expected path for the federal funds 

rate in 2014 and 2015 steepened ... 

Market-based measures of the expected 

future path of the federal funds rate moved 

higher over the first half of the year, as 

investors responded to somewhat better-than-
94 


82861.035

expected incoming economic data and to 

communications from Federal Reserve officials 

that were seen as suggesting a tighter stance 

of monetary policy than had been anticipated. 

The modal path of the federal funds rate-that 

is, the values for future federal funds rates 

that market participants see as most likelyderived from interest rate options shifted up 

considerably, especially around the June FOMC 

meeting, suggesting that investors may now 

expect the target funds rate to lift off from its 

current range significantly earlier than they 

expected at the end of 2012. However, a part of 

this increase may have reflected a rise in term 

premiums associated with increased uncertainty 

about the monetary policy outlook. According 

to a survey of primary dealers conducted 

shortly after the June FOMC meeting by the 

Open Market Desk at the Federal Reserve Bank 

of New York, dealers' expectations of the date 

of liftoff have moved up one quarter since the 

end of last year, to the second quarter of 20155 

... while yields on longer-term securities 

increased significantly but remained low 

by historical standards 

Reflecting the same factors, yields on longerterm Treasury securities and agency MBS are 

also substantially higher now than they were 

at the end of last year (figures 34 and 35). The 

rise in longer-term yields appears to have been 

amplified by a pullback from duration risk 

as well as technical factors, including rapid 

changes in trading strategies and positions that 

had been predicated on the continuation of very 

low rates and volatility. On balance, yields on 

5-, 10-, and 30-year nominal Treasury securities 

have increased between 65 and 85 basis 

points, on net, to 1 Y, percent, 2'12 percent, and 

3% percent, respectively, since the end of last 

year. 

Yields on 30-year agency MBS increased more 

than those on Treasury securities, rising about 

5. The results of the survey of primary dealers are 

available on the Federal Reserve Bank of New York's 

website at www,newyorkfed.orglmarkets/ 

primarydealer _survey _questions.html. 

MONETARY POLICY REPORT: JULY 2013 21 

34. Yields on nominal Treasury securities. 2000-13 

Percell! 

Non:: The Treasury ceased publication of the 30-year constant maturity 

senes on February 18, 2002, and resumed that series on February 9, 2006. 

SOURCE: Department of the Treasury. 

35. Yield and spread on agency mortgage-backed 

securities. 2000-13 

_________________ ".::"'.::'spomts 

Ll I I I ! I ! I I I I I ! I I ! 

200 I 2003 2005 2007 2009 20! 1 20 J 3 

40{) 

350 

300 

250 

20il 

150 

lOil 

50 

NOT": The data are dady. Yield shown is for the Fanme Mae 30-year 

current coupon, the coupon rate at which new mortgage-backed securities 

would be priced at par, or face, value. Spread shov.n is 10 the average oftlle 

5- and JO-year nominal Treasury yields. 

SOlJRCE: Department of the Treasury; Barc1ays. 
95 


82861.036

22 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

36. Dollar-roll-implied financing rates (front month), 

Fannie Mae 30-year, 2011-13 

2011 2012 

NOTE: The 3.0 percent coupon data series hegtns on June 1, 2012 

Sm.'RcE: J.P. Morgan 

Pt'rcent 

1.0 

1.5 

2.0 

I'/. percentage points, on net, since the end of 

2012, to about 3\1, percent. Agency MBS yields 

also rose significantly more than the yields on 

comparable nominal Treasury securities after 

adjusting for the effects of higher interest rates 

on the likelihood that borrowers will prepay their 

mortgages (the option-adjusted spread), likely 

reflecting investors' reassessment of the outlook 

for the Federal Reserve's MBS purchases as well 

as subsequent market dynamics. 

Nonetheless, yields on longer-term securities 

continue to be low by historical standards. 

Those low levels reflect several factors, 

including subdued inflation expectations as well 

as still-modest economic growth prospects in 

the United States and other major developed 

economies. In addition, despite their recent 

rise, term premiums~-the extra return investors 

expect to obtain from holding longer-term 

securities as opposed to holding and rolling 

over a sequence of short -term securities for the 

same period-remain small, reflecting both the 

FOMC's ongoing large-scale asset purchase 

program and strong demand for longer-term 

securities from global investors. 

Indicators of market functioning in both 

the Treasury and agency MBS markets were 

generally solid over the first half of the year. 

In particular, the Desk's outright purchases 

of Treasury securities and agency MBS did 

not appear to have a material adverse effect 

on liquidity in those markets. For example, 

available data suggest bid-asked spreads in 

Treasury and agency MBS markets continued 

to be in line with recent averages, though some 

widening has been observed of late amid 

increased market volatility. In the Treasury 

market, auctions generally continued to be 

well received by investors. In the agency MBS 

market, settlement fails remained low, and 

implied financing rates in the "dollar roll" 

market··-·an indicator of the scarcity of agency 

MBS for settlement-have drifted up over the 

past six months, indicating reduced settlement 

pressures (figure 36).' 

6. Dollar roll transactions consist of a purchase or sale 

of agency MBS with the simultaneous agreement to sell 
96 


82861.037

Short-tcrm funding markets continucd to 

function well 

Conditions in short-term funding markets 

remained good, with many money market rates 

having edged down from already low levels 

since the end of 2012 to near the bottom of the 

ranges they have occupied since the zero-Iowerbound period began (figure 37). In the market 

for repurchase agreements, bid-asked spreads 

and haircuts for most collateral types were 

reportedly little changed, while rates moved 

down slightly, on net, for general collateral 

finance repurchase agreements. Despite the high 

level of reserve balances and the substantially 

reduced volume of trading in the federal funds 

market since 2008, the effective federal funds 

rate has continued to be strongly correlated 

with tl1ese money market rates. Rates on 

asset-backed commercial paper (ABCP) also 

fell, and spreads on ABCP with European 

bank sponsors have generally converged back 

to those on ABCP with U.S. bank sponsors. 

Rates on unsecured financial CP for both U.S. 

and European issuers have remained low, even 

during the temporary flare-up of concerns 

about European financial stability surrounding 

the banking problems in Cyprus, while forward 

measures of funding spreads have continued to 

be narrow by historical standards. 

Broad equity price indexes increased 

further ... 

Broad equity price indexes notched substantial 

gains and reached record levels in nominal 

terms, boosted by improved market sentiment 

regarding the economic outlook, the FOMC's 

sustained highly accommodative monetary 

policy, and stable expectations about mediumterm earnings growth (figure 38). Despite the 

increased volatility around the time of the 

June FOMC meeting, as of mid-July, broad 

measures of equity prices were 18 percent 

higher, on net, than their levels at the end of 

2012. Nonetheless, the spread between the 

or purchase substantially similar securities on a specified 

future date. The Committee directs the Desk to engage in 

these transactions as necessary to facilitate settlement of 

the Federal Reserve's agency MBS purchases. 

MONETARY POLICY REPORT: JULY 2013 23 

37. Ovemight money market rates, 2009-13 

4-weekmovrngaw,mgesofdailydata Percent ~ --------.. ---~~~----

30 

.25 

20 

.15 

10 

05 

Non,: GCF is general collateral finance; repo is repurchase agreement 

SOURCE: Federal Reserve Bank of New York; Depository Trust & Clearing 

Corporation. 

38. Equity prices. 1996-20]3 

Dally De<!(:rnb~r31, 1.007""100 

140 

120 

100 

80 

60 

40 

20 

2007 2009 201! 20J3 

SOIIRC": Dow Jones; Standard & Poor's. 
97 


82861.038

24 PART 1: RECENT ECONOMIC AND FINANCIAL DEVElOPMENTS 

39, Market~implied equity premium, 1995-2013 

Monthly 

10 

expectations. 

SOURCE: Standard & Poor's; Thomson Reuters Financial: Federal Reserve 

Board; Federal Reserve Bank ofPhiladeJphia 

12-month expected forward earnings-price ratio 

for the S&P 500 and a long-run real Treasury 

yield-a rough gauge of the equity risk 

premium~stayed very elevated by historical 

standards, suggesting that investors remain 

somewhat cautious in their attitudes toward 

equities (Jigure 39). Outside of the period 

surrounding the June FOMe meeting, implied 

volatility for the S&P 500 index, as calculated 

from option prices, generally remained near the 

bottom end of the range it has occupied since 

the onset of the financial crisis . 

. . and market sentiment toward financial 

institutions continued to strengthen as 

credit quality improved 

On average, the equity prices of domestic 

financial institutions have outperformed 

broader equity indexes since the end of last 

year. Improved investor sentiment toward 

the financial sector reportedly was driven by 

perceptions of reduced downside risk in the 

housing market as well as expectations of 

continued improvements in credit quality and 

of increased net interest margins as the yield 

curve steepened over the past few months. 

However, prices of real estate investment trust 

(REIT) shares underperfonned, especially 

after interest rates started rising in May, 

partially reflecting a broader shift on the part 

of investors from income-oriented shares 

toward more cyclically sensitive issues. Shares 

of mortgage R EITs were particularly affected 

by the sharp rise in Treasury and agency MBS 

yields. 

Equity prices for large domestic banks have 

increased 24 percent since the end of 2012 

(figure 38). However, they have yet to fully 

recover from the very depressed levels reached 

during the financial crisis. Standard measures 

of the profitability of bank holding companies 

(BHes) edged down in the first quarter but 

remained in the upper end of their subdued 

post-crisis range. BHe profits were held down 

by modest noninterest income and a further 

narrowing of net interest margins. By contrast, 

profits were supported by additional reductions 
98 


82861.039

in noninterest expenses and decreases in 

provisioning for loan losses, as indicators of 

credit quality improved further in every major 

asset class. Banks' allowances for loan and lease 

losses continued to trend down as charge-offs 

of bad loans once again exceeded provisions in 

the first quarter (figure 40). 

Risk -based capital ratios (based on current 

Basel I definitions) of the 25 largest BHCs 

decreased in the first quarter because of the 

adoption of the new market risk capital rule, 

while risk-based capital ratios at smaller 

BHCs edged up.' Nonetheless, BHCs of all 

sizes remained well capitalized by historical 

standards as they prepare for the transition 

to stricter Basel III requirements (see the box 

"Developments Related to Financial Stability"). 

Aggregate credit provided by commercial banks 

continued to increase in the first half of 2013 

(figure 41). 

M2 rose at a more moderate rate, but 

balances remain elevated 

M2 has increased at an annual rate of about 

4% percent since the end of 2012, notably 

slower than the pace registered last year. 

However, holdings of M2 assets-including 

their largest component, liquid depositsremained elevated relative to what would have 

been expected based on historical relationships 

with nominal income and interest rates, likely 

due to investors' continued preference to 

hold safe and liquid assets. The monetary 

base-··which is equal to the sum of currency 

and reserve balances-·-increased briskly over 

the first half of the year, driven mainly by the 

significant rise in reserve balances due to the 

Federal Reserve's asset purchases. 

7. The new market risk capital rule requires banking 

organizations with significant trading activities to adjust 

their capital requirements to better account for the 

market risks of those activities. For more information 

on this change, see Board of Governors of the Federal 

Reserve System (2012), "Federal Reserve Board 

Approves Final Rule to Implement Changes to Market 

Risk Capital Rule," press release, June 7, 

www.federalreserve.gov/newsevents/press/bcregl 

20120607b.htm. 

MONETARY POLICY REPORT: JULY 2013 25 

40. Provisions and charge-ofTs, 2005-13 

Quarterly BHhonsofdQllars 

300 -- .. Provlsions for loan and lease losses (right scale) 

.. Net charge¥otf~ (right scale) 240 - ALLL (left scale} 

180 --

80 

60 

~ G 

60 ~ 20 

-HflHHHfH1HtHHt tIfHtt 20 

40 

60 

NOT!:: ALLL is the allowance for loan and lease losses. 

SOURCE: Federal Reserve Board, Reporting Fonn FR Y~9C, "Consolidated 

Financial Statements for Bank Holding Companies." 

41. Change in total bank credit, 1990-2013 

Quancrly Perccnt.annuairale 

2001 2004 2007 2010 2013 

20 

t5 

10 

10 

15 

NOTE: The data extend through 2013:Q2. The data are seasonally adjusted 

Sor-RrE: Federal Reserve Board, Statistical Release B.S, "Assets and 

Liabilitic .. of Commercia! Bank.<; in the United States." 
99 


82861.040

26 PART 1; RECENT ECONOMIC AND FINANCiAL DEVELOPMENTS 

Developments Related to Financial Stability 

As highlighted in previous Monetary Policy 

Reports; the Federal Reserve has devoted increased 

resources to mon itoring potentia! risks to financial 

stability. In addition to new regulations to strengthen 

the financial system, comprehensive monitoring 

is necessary because the system will evolve in 

response to new regulations, and because market 

participants' risk tolerance and perceptions tend to 

vary with economic and financial conditions. The 

Federal Reserve's increased monitoring efforts focus 

on identifying financial vulnerabilities-features of 

the financial system that can transmit and amplify the 

effects of unforeseen adverse events. For example, 

vulnerabilities can arise through excess leverage, 

through excess maturity transformation~that is, 

financing long-term assets with short-term debtsand through the complexity and interconnectedness 

of financial institutions. In recent years, a stronger 

regulatory framework and an enhanced focus by the 

private sector on potential risks have contributed to 

significant re-ductions in vulnerabilities and a more 

resilient U.S. financial system. However, important 

challenges remain, and the Federal Reserve wilt 

monitor developments regarding ongoing and 

emerging financial vulnerabilities. 

The financial strength of the banking sector 

continued to improve last year. Sank holding 

companies (SHes) increased the proportion of 

common equity in their funding base, continuing a 

trend of recent years. For example, the ratio of tier 1 

common equity to risk-weighted assets among the 

firms participating in the recent Comprehensive 

Capital Analysis and Review and the stress tests 

mandated by the Dodd-Frank Wall Street Reform and 

Consumer Protection Act of 2010 (Dodd-Frank Act) 

has more than doubled since the first similar stress test 

in 2009 and totaled 11.3 percent at the beginning of 

this year. 1 These stress tests are regulatory tools that 

the Federa! Reserve uses to help ensure that financial 

institutions have robust capital-planning processes 

and are able to maintain adequate capital even 

following an extended period of adverse economic 

conditions. Indeed, capital ratios maintained under 

the hypothetical "severely adverse" macroeconomic 

scenario specified in the most recent stress tests 

suggest that SHCs have become more resilient to 

possible adverse macroeconomic shocks. 

The banking system has also improved its liquidity 

position relative to pre-crisis levels, For example, 

1. Information on these stress tests and the Comprehensive 

Capital Analysis and Review is available on the Federal 

Reserve Board's website at www.federalreserve.gov/ 

bankinforeglstress-tests-capita!-p!anning.htm. 

large SHCs' holdings of cash and high-quality liquid 

securities have risen from less than 16 percent of 

total assets in 2007 to 24 percent in the first quarter 

of 2013. Further, firms have sharply reduced their 

dependence on wholesale short-term funding, which 

proved highly unreliable during the crisis. 

In addition, the credit risk of banks' assets has 

generally declined as banks have tightened lending 

standards and as some borrowers--both households 

and nonfinancial firms-have strengthened their 

financial positions by refinanCing their debt at lower 

interest rates. This improvement has also been aided 

by the rise in house prices and equity values amid the 

recovery in economic activity. Consistent with all of 

these improvements, premiums on SHe credit default 

swaps (CDS) have fallen by nearly one-half from their 

2009 levels, Similarly, systemic risk measures for these 

firms-which assess the amount of financial stress that 

would be realized in the event of a sizable financial 

shock based on COS premiums, stock prices, and 

correlations-have declined substantially. 

The significant amount of funding channeled 

through the "shadow banking" sector contributed to 

the financial system's fragility before the financial crisis, 

largely because of that sector's reliance on wholesale 

short-term funds to finance longer-term assets. Activity 

in this sector contracted significantly in the wake of 

the crisis and has expanded only moderately since the 

post-crisis trough. The risks inherent in some forms of 

shadow banking have been addressed through tighter 

banking regulations that require more recognition 

of exposures to off-balance-sheet vehicles, such as 

asset-backed commercial paper conduits. Nonetheless, 

signjficant vulnerabilities associated with wholesale 

short-term funding remain. 

While the extended period of low interest rates has 

contributed to improved economic conditions and 

increased resiliency in the financial sector, it could also 

lead investors to "reach for yield" through excessive 

leverage, duration risk, credit risk, or other forms 

of risk-taking. There are signs that the low level of 

interest rates, as well as improved investor sentiment, 

has contributed to a modest pickup in leverage and 

maturity transformation in some markets. However, the 

recent rise in interest rates and volatility may have led 

some investors to reevaluate their risk-taking behavior. 

Securitization markets grew rapidly over the past 

year and a half, as investors reportedly increased 

their exposure to structured finance products in order 

to boost returns. New U.5, securitization issuance 

excluding agency residential mortgage-backed 

securities (MBS) was roughly $500 billion (at an 

annual rate) in the first quarter, up sharply from the 

level a year ago but still well below the peak of over 
100 


82861.041

$2 trillion reached before the crisis. Collateralized 

loan obligations and commercial mortgage-backed 

securities (CMBS) accounted for a substantial part 

of the increase. Dealer responses in the June Senior 

Credit Officer Opinion Survey on Dealer Financing 

Terms indicate that demand for funding of securitized 

products, such as non-agency residential MBS and 

CMBS, had increased, suggesting some investments 

were being funded with short-term debt. 2 

In addition, low Treasury yields likely boosted 

the pace of investment in corporate bond and loan 

funds and contributed to sizable issuance of highyield bonds and syndicated leveraged loans this year. 

However, spreads of yields on corporate bonds relative 

to those on comparable-maturity Treasury securities 

were not unusually narrow by historical standards, 

and purchases generally do not appear to have been 

financed with leverage or short-term funding, which 

should limit the risk of a disorderly unwind. As 

Treasury yields have risen since the beginning of May, 

corporate bond funds have experienced substantial 

outflows and bond yields have risen, although spreads 

over Treasury securities have posted small mixed 

changes. For syndicated leveraged loans, underwriting 

standards, such as the number of covenants and 

required debt-to-earnings multiples, have been easing, 

and continued flows to loan funds suggest pressures in 

underwriting may continue. Banking supervisors are 

currently working on implementing new supervisory 

guidance on leveraged lending practices, which 

should help mitigate the potential for a buildup of 

vulnerabilities.3 

Agency mortgage real estate investment trusts 

(agency RE1Ts) are another area where investors have 

displayed a willingness to take on risk to achieve 

higher returns. Agency RFITs purchase agency MBS, 

funded largely by relatively short-term repurchase 

agreements, and thus combine high leverage with 

extensive maturity transformation, creating the 

potential to disrupt MBS markets if, for instance, 

rates were to rise sharply. Amid the recent increase 

in interest rates and widening of MBS spreads, stock 

prices of agency REITs have fallen about 20 percent, 

and some of these firms have reportedly sold assets to 

offset the resulting increase in their leverage. To 

2. The survey is available on the Federa! Reserve Board's 

website at wVl/w.federa!reserve.gov/econresdatalre!easesl 

seoas.htm. 

3. See Board of Governors of the Federal Reserve System, 

Division of Banking Supervision and Regulation (2013), 

"Interagency Guidance on leveraged lending," Supervision 

and Regulation letter SR 13-3 (March 21), 

www.federalreserve.govlbankinforeglsdetters/sr1303.htm. 

MONETARY POLICY REPORT: JULY 2013 27 

date, sales by these agency REITs and other funds with 

similar positions reportedly have amplified the initial 

rise in rates and spreads, but market functioning has 

not been impaired. 

At commercial banking firms, the low interest 

rate environment in recent years has been pressuring 

net interest margins, and some firrns appear to have 

extended the duration of their securities holdings 

to boost profits. Supervisors have been working with 

banks on interest rate risk-management practices 

to ensure that the banks' practices comply with 

the interagency adviSOry that was issued in 2010.4 

Improved practices should make the banks more 

resilient to unexpected interest rate shocks. The low 

interest rates also appear to be pressuring profits 

among life insurance companies, and some insurers 

have added marginally more credit and liquidity risk 

to their asset portfolios. 

The Federa! Reserve has continued to make 

progress on financial reform. The Federal Reserve 

recently finalized its proposal to implement the 

Basel III capital requirements. The final rule promotes 

a stronger banking system by increasing the quantity 

and quality of required regulatory capital, which 

is accomplished by setting a new tier 1 common 

equity capital ratio of 4.5 percent of risk-weighted 

assets (RWA), a capital conservation buffer of 

2.5 percent of RWA, and strict eligibility criteria 

for regulatory capital instruments. In addition, the 

rule contains a supplementary minimum leverage 

ratio and a countercyclical capital buffer for large 

and internationally active banking organizations. 

Furthermore, the Federal Reserve is working this year 

toward finalization of additional rules that would 

implement sections 165 and 166 of the Dodd-Frank 

Act, a broad set of enhanced prudential standards 

for BHes with total assets of $50 billion or more and 

systemically important nonbank financial companies 

designated by the Financial Stability Oversight 

Council (FSOC). The rules relating to resolution 

planning and stress testing are already completed, 

and the Federa! Reserve is working to finalize rules 

for capital requirements, liquidity requirements, 

single-counterparty credit limits, an early remediation 

regime, and risk-management requirements. The FSOC 

recently designated two nonbank financial firms, and 

it has proposed the designation of a third firm, which 

has requested a hearing before the council. 

4. See Board of Governors of the Federal Reserve System, 

Division of Banking Supervision and Regulation (2010), 

"Interagency AdviSOry on Interest Rate Risk," Supervision and 

Regulation letter SR 10-1 Uanuary 11), www.federalreserve. 

gov/boarddocs/srietters/201 0/sr1 001.htm. 
101 


82861.042

28 PART 1: RECENT ECONOMIC AND FlNANClAl DEVELOPMENTS 

42. 10·year nominal benchmark yields, 2012-13 

43. Equity indexes for selected foreign economies, 

2012-13 

-4 

-2 

Dmly Jan\lary~.2012-100 

J70 

160 

150 

140 

130 

120 

llO 

100 

90 

80 

SOtIRCf.: For emerging markets. Morgan Stanley Emerging Markets MXEF 

Capital Index; for the euro area, Dow Jones Euro STOXX Index; for Japan, 

Tokyo Stock Exchange (TOP!X): illl Via Bloomberg 

International Developments 

Foreign bond yields have risen and asset 

prices have declined, on net, especially in 

emerging market economies 

Foreign benchmark sovereign yields have 

moved somewhat higher, on net, since the 

beginning of the year (figure 42). Rates moved 

lower in March and April, in part reflecting 

weak incoming data on activity; anticipation 

of the Bank of Japan's (BOJ) asset purchase 

program may have also contributed to declining 

Japanese government bond (JGB) yields early 

in the year. Since early May, however, as with 

US. Treasury securities, sovereign yields have 

risen worldwide, as investors responded to 

better-than-expected US. economic data and 

to Federal Reserve communications about 

monetary policy. Sovereign yields are up, on 

net, in Europe, Japan, and Canada and have 

increased substantially in Korea, Mexico, and 

Dther emerging market economies (EMEs). 

Equity indexes in the major advanced foreign 

economies CAFEs) rose earlier in the year 

(figure 43), especially in Japan, where stock 

prices continued to soar as Prime Minister 

Abe's ambitious stimulus program began to 

take shape. However, since mid-May, equity 

prices have declined on net. Corporate bond 

issuance eased somewhat in June as rates 

climbed higher, but year-to-date issuance totals 

are still strong relative to recent years. Since 

the start of the year, sovereign and corporate 

credit spreads have narrowed slightly. Financial 

stresses in Europe have remained well below 

their highs last year despite banking problems 

in Cyprus and political tensions in several other 

European countries. 

The significantly higher interest rates in EMEs 

have been accompanied by sharp moves in 

other EME financial markets. Since mid-May, 

stock prices have declined and credit spreads 

have widened markedly. EME bond and equity 

funds have also experienced sizable outflows, 

as investors reassessed the economic outlook in 
102 


82861.043

these economies as well as the returns on EME 

assets relative to those in advanced economies. 

The improved sentiment toward the U.S. 

economic outlook and anticipation of lessaccommodative monetary policy have pushed 

the U.S. dollar higher against a broad set of 

currencies since the end of 2012 (figure 44). In 

particular, the dollar has appreciated sharply 

against the Japanese yen, on net, as the BOJ 

adopted a more accommodative monetary 

policy stance. 

Activity in the advanced foreign 

economies remained subdued 

despite a pickup ... 

Activity in the AFEs improved to a stillmuted pace in the first half of 2013 (figure 45), 

supported in part by stronger exports and 

the easing in financial stresses in Europe. The 

euro-area economy shrank further in the first 

quarter, but the pace of contraction moderated 

as consumption stabilized. In the United 

Kingdom, real GDP resumed growing, at a 

I';' percent pace, in the first quarter; retail sales 

and the purchasing managers index (PM!) 

suggest that growth firmed in the second 

quarter. First-quarter activity accelerated in 

Japan, reflecting a strong rebound of exports 

and a pickup in consumption. Canadian 

growth also firmed in the first quarter, and the 

labor market notched solid employment gains 

through the second quarter. 

With activity weak and inflationary pressures 

low, several foreign central banks took 

additional steps to support their economies. 

(See the box "The Expansion of Central Bank 

Balance Sheets" for a broader overview of 

central bank actions.) The European Central 

Bank (ECB) and the Reserve Bank of Australia 

lowered their main policy rates, and the ECB 

stated after its July meeting that it will keep 

key policy rates low "for an extended period." 

The Bank of England extended its Funding 

for Lending Scheme until January 2015 and 

increased banks' incentives to lend to small and 

MONETARY POLICY REPORT, JULY 2013 29 

44. U.S. dollar exchange rate against broad index 

and selected major currencies, 2012-13 

Jalluary4,2012 

Nor£: The data are if! foreign clUTcncy units per dollar 

140 

135 

130 

125 

120 

115 

110 

lOS 

100 

-- 95 

90 

SmJRCF; Federal Reserve Board, Statistical Release H_10, "Foreign 

Exchange Rates." 

45, Real gross domestic product growth in selected 

advanced foreign economies, 2010-13 

Quarterly Percent, annual rate 

2010 

SOl)RCE: For Canada, Stattstics Canada; for the eum area, Eurostat; for 

Japan, Cabinet Office of Japan; for the United Kingdom. Office for National 

StatIstics. 
103 


82861.044

30 PART 1, RECENTECONOMIC AND HNANCIAL DEVELOPMENTS 

The Expansion of Central Bank Balance Sheets 

The severity of the recession associated with the 

global financial crisis led central banks in some of 

the advanced economies to take policy measures that 

drove short-term market interest rates nearly to zero. 

As the recession dragged on, however, several major 

central banks~~-including the Federal Reserve, the 

Bank of England (BOE), the Bank of Japan (BO)), and 

the European Central Bank (ECB)-sought to provide 

further economic stimulus through the adoption of 

unconventional policies that aimed to reduce longerterm interest rates and ease financial conditions more 

generally. These policies, which included purchases 

of longer-term assets and repurchase operations with 

extended terms to maturity, left the central banks with 

balance sheets of unprecedented size. Total assets of 

the Federal Reserve rose from about 6 percent of gross 

domestic product (GOP) (around $870 billion) in the 

summer of 2007 to 22 percent of GOP ($3.5 trillion) 

as of June 2013. As shown in figure A, the assets of the 

80E, BO), and ECB also increased markedly relative 

to the sizes of their economies. This box offers some 

detail on the circumstances and policies that led to the 

balance sheet expansions for these central banks. 

like the Federal Reserve, the BOE began its asset 

purchases relatively soon after the advent of the global 

financial crisis. Also like the Federal Reserve, the goals 

of the BOE's purchases were to help lower longerterm interest rates and to ease financial conditions 

more broadly, thereby providing further support for 

economic growth. During its initial program, between 

March 2009 and January 2010, the BOE bought 

£200 billion (14 percent of GOP) of longer-term assets, 

mostly U.K. government bonds, with commercial 

paper and corporate bonds making up the residual. 

The BOE resumed purchases in October 2011 as the 

economy continued to struggle amid spillovers from 

the euro-area financial crisis. Total securities holdings 

are currently near £375 billion, or almost 25 percent 

of GOP, and account for nearly all of the BOE's 

balance sheet. 

A. Central bank assets in selected advanced 

economies, 2006-13 

Quarterly Percent of oomma! GDP 

40 

35 

30 

25 

20 

15 

10 

NOTE: For the United Kingdom, the series stans to 2oo6'Q2, For the cum 

area, 2013:Q2 assets are as of the end of May. For each economy, 2013:Q2 

assets are divided by 2013:QI GOP. 

SOURCE: For the euro area, European Central Bank and Eurostat; for Japan, 

Bank of Japan and Cabinet Office of Japan; for the United Kingdom. Bank of 

England and Office for National Statistics; for the United States, Federal 

Reserve Board and Bureau of EconomIc Analysis. 
104 


82861.045

Compared with the Federal Reserve or the BOE, initially 

the SOl did not expand its balance sheet as much during 

the crisis, but more recently it has laid out plans for 

substantial asset purchases. By late 201 0, with entrenched 

deflation and GDP still well below its pre-crisis peak, 

the BOI announced its Asset Purchase Program of about 

¥35 trillion (about 7 percent of GDP) and later expanded 

the size of the program to ¥1 01 trillion by the end of 2012. 

But in lanuary of this year, the SOj announced plans to 

begin a series of open-ended asset purchases in pursuit of 

its now-higher 2 percent inflation target. And, finally, in 

April the BOI announced that it would enter a new phase 

of monetary easing, accelerating asset purchases to double 

the monetary base within two years in pursuit of Its inflation 

target. The SO) also substantially extended the maturity 

of its japanese government bond OGS) purchases. All 

maturities, including 40-year bonds, are eligible, and the 

average maturity of )GB purchases has risen from slightly 

less than 3 years to about 7 years. To date, asset purchases 

have increased the size of the BOYs balance sheet to almost 

40 percent of GDP. The SO) expects its balance sheet to 

reach approximately 60 percent of 2012 GDP by the end 

of2014. 

In contrast to the other central banks, the ECB has 

taken a different approach to balance sheet expansion but, 

nonetheless, one that has offered support to economic 

activity. The ECB has conducted very few outright purchase 

operations. The main exception was the Securities Markets 

Programme, terminated in late 2012, under which the 

ECB holdings reached almost €220 billion in peripheral 

sovereign debt in january 2012 (abollt 2.5 percent of euroarea GDP). Instead, its substantial balance sheet expansion 

has been driven primarily by loans to banks and, in 

MONETARY POLICY REPORT; JUtY 2013 31 

particular, longer-term refinancing operations (LTROs), 

which have maturities of one month or longer. In 

the fall of 2008, departing from its past practice of 

offering banks a fixed amount of loans at interest 

rates determined by auction, the ECB announced it 

would provide unlimited collateralized loans to banks 

at a fixed rate. The size of the ECS's balance sheet 

increased about €O.5 trillion (almost 6 percent of the 

GDP of the euro area) to about €2 trillion (around 

22 percent of euro-area GDP) in 2008 and remained 

near that level until mid-2011. Severely deteriorating 

financial conditions in Europe led the ECB in 

December 2011 to announce LTROs with maturities 

of three years. Banks drew a bit more than €1 trillion 

under these LTROs, pushing the ECB's balance sheet to 

over 30 percent of GDP. The stated aim of the lTROs 

was to provide liqUidity to the financial system rather 

than to ease monetary policy. However, insofar as the 

LTROs helped pushed down bank funding costs and 

sovereign yields in vulnerable European countries 

and alleviated financial stresses more generally, they 

likely provided some support to economic activity 

as well. By the same token, the ECB's latest program, 

Outright Monetary Transactions (OMT), is focused 

on reducing the currency risk premium embedded in 

European sovereign bonds, which has the benefit of 

easing financial conditions generally but especially in 

countries with high sovereign spreads. To this point, no 

purchases have been made under the OMT program. 

Even so, its availability as a backstop appears to have 

helped ease financial stresses in Europe, which, in 

turn, has likely reduced the downward pressure on the 

economy. 
105 


82861.046

32 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

medium-sized businesses. In April, the BOJ 

announced a sharp rise in its purchases of JGBs 

and other assets, as well as an extension of the 

maturity of the JGBs that it purchases. 

Authorities in some AFEs also eased fiscal 

policy in response to still-subdued activity. 

The Japanese parliament approved a fiscal 

stimulus package worth about 2 percent of 

GDP, with the bulk of the spending directed to 

infrastructure projects. European authorities 

postponed deadlines for several euro-area 

countries, including France and Spain, to 

reduce fiscal deficits below 3 percent of GDP. 

. . . while growth slowed in the emerging 

market economies 

Aggregate real GDP growth in the EMEs 

picked up in the fourth quarter of 2012 despite 

the weakness in Europe and the United States, 

led by a strong performance of the Chinese 

economy. However, EME growth slowed 

considerably in the first quarter, in part as 

a step-down in Chinese growth weighed on 

activity in the rest of emerging Asia and on 

the commodity-dependent economies of 

South America. Recent indicators of exports, 

industrial production, and PM Is suggest that 

EME activity remained subdued in the second 

quarter. Amid concerns about economic growth 

and lack of inflationary pressures, the central 

banks of several countries in Asia and Latin 

America f urlher eased monetary policy over the 

first half of the year. However, more recently, 

concerns about reversal of capital inflows and 

currency depreciation pressures are giving EME 

central banks pause about further rate cuts, and 

a few have begun to raise rates. 

In China, macroeconomic data for the second 

quarter indicate that growth continued to 

be modest by the standards of recent years. 

Although retail sales rose slightly faster in April 

and May than in the subdued first quarter, fixed 

investment increased at roughly its first-quarter 

pace . 

Activity also cooled across Latin America. 

In Mexico, growth had already slowed in the 

second half of last year, weighed down by 

weaker U.S. manufacturing activity. Growth 

slowed further in the first quarter, as exports 

declined and domestic demand weakened. In 

response, the Bank of Mexico reduced its policy 

rate for the first time since mid-2009. Mexican 

activity appears to have remained subdued 

in the second quarter. Brazilian real GDP 

growth stepped down a little in the first quarter, 

extending the lackluster performance of the 

past two years. Indicators of economic activity 

for the second quarter, including industrial 

production and exports, have been mixed. 

Unlike many of its EME counterparts, Brazil's 

central bank raised its policy rate to combat 

rising inflation. 
106 


82861.047

PART 2 

MONETARY POLICY 

33 

With unemployment still well above normal levels and inflation below its longer-run objective, the 

Federal Open Market Committee (FOMC) has continued its highly accommodative monetary policy 

this year by maintaining its forward guidance with regard to the target for the federal funds rate and 

continuing its program of large-scale asset purchases. 

To foster the attainment of maximum 

employment and price stability, the FOMe 

kept in place its forward guidance on the 

path of the federal funds rate ... 

With unemployment still elevated and declining 

only gradually, and inflation having moved 

further below the Committee's 2 percent longerrun objective, the FOMC has maintained its 

highly accommodative monetary policy stance 

this year. Because the target range for the 

federal funds rate remains at its effective lower 

bound, the Committee has been relying mainly 

on its forward guidance about the future path 

of the federal funds rate and on its program of 

large-scale asset purchases to make progress 

toward its mandated objectives. 

With regard to the federal funds rate, the 

Committee has continued to indicate its 

expectation that the current exceptionally 

46. Selected interest rates, 2008-13 

Dally ----_._--------_._-_. 

low target range of 0 to Y. percent will 

be appropriate at least as long as the 

unemployment rate remains above 6'h percent, 

inflation between one and two years ahead is 

projected to be no more than a half percentage 

point above the Committee's 2 percent longerrun goal, and longer-term inflation expectations 

continue to be well anchored (figure 46). In 

determining how long to maintain its target 

range for the federal funds rate, the Committee 

has stated that it would also consider other 

information, including additional measures of 

labor market conditions, indicators of inflation 

pressures and inflation expectations, and 

readings on financial developments. The FOMC 

also has reiterated that a highly accommodative 

stance of monetary policy would remain 

appropriate for a considerable time after the 

asset purchase program ends and the economic 

recovery strengthens. Moreover, the Committee 

has indicated that when it decides to begin 

Percent 

! ! ! , ! ! ! ! ! ! ' t ! I ! ! t ! ! f ! ! ! ! ! ! ! ! ! ! ! ! ! .-J 1130 4/30 815 10'29 1128 429 8/12 !!,'4 !Q7 428 lidO j) '

3 1126 4,27 819 11'2 1125 425 all 1024 1130 5,] 3/!8 6125 91!6 12,16 311& 6tH 9/231216 3tl6 6123 9/111214 31!5 6m <lI21 12!3 3!l3 6/209111 !1!2 3120 6/19 

2008 2009 2010 201! 2012 2013 

NOTE: The 2-year and iO-year Treasury rates arc the constant-maturity yields based on the most activc\y traded securities. The dates on the horizontal a1(is are 

those of regularly scheduled Federal Open Market Committee meetings. 

SOL'RCr: Department of the Treasury; Federal Reserve Board 
107 


82861.048

34 PART 2: MONETARY POLICY 

to remove policy accommodation, it would 

take a balanced approach consistent with its 

longer-run goals of maximum employment and 

inflation of 2 percent. 

... and maintained its policy of largescale asset purchases ... 

To sustain downward pressure on longer-term 

interest rates, support mortgage markets, and 

help make broader financial conditions more 

accommodative, the FOMC has continued 

its large-scale asset purchases; the Committee 

also has maintained its practices of reinvesting 

principal payments it receives on agency debt 

and agency-guaranteed mortgage-backed 

securities (MBS) in new agency MBS and 

of rolling over maturing Treasury securities 

at auction. Over the first half of this year, 

purchases of longer-term securities totaled 

$510 billion, with the Committee purchasing 

additional agency MBS at a pace of $40 billion 

per month and longer-term Treasury securities 

at a pace of $45 billion per month. The 

Committee reconfirmed at each meeting during 

the first half of 2013 that it would continue 

purchasing Treasury and agency MBS until 

the outlook for the labor market has improved 

substantially in a context of price stability. 

In determining the size, pace, and composition 

of its asset purchases, the Committee has taken 

account of the likely efficacy and costs of 

such purchases. As noted in the minutes of the 

March FOMC meeting, most participants saw 

asset purchases as having a meaningful effect 

in easing financial conditions-for example, 

keeping longer-term interest rates, including 

mortgage rates, lower than they would be 

otherwise--and so supporting economic 

growth.' FOMC participants generally judged 

that these benefits outweighed the likely costs 

and risks of additional purchases. However, 

the Committee has continued to monitor those 

8. See Board of Governors of the Federal Reserve 

System (2013). "Minutes of the Federal Open Market 

Committee, March 19-20,2013," press release, 

April 10, www.federalreserve.gov/ncwsevents/press/ 

monetary/20 13041 Oa.htm. 

costs and risks, including possible effects on 

financial stability, security market functioning, 

the smooth withdrawal of monetary 

accommodation when it eventually becomes 

appropriate, and the Federal Reserve's net 

income.9 

. .. while providing additional information 

about potential adjustments to its asset 

purchases 

During the first half of 2013, the FOMC 

took various steps to provide greater clarity 

regarding its thinking about possible 

adjustments in the pace of asset purchases 

and the eventual cessation of those purchases. 

In its statement after the March meeting, the 

Committee added that the size, pace, and 

composition of its asset purchases would reflect 

the extent of progress toward its economic 

objectives, in addition to the likely efficacy 

and costs of such purchases. 10 And in May, to 

highlight its willingness to adjust the flow of 

purchases in light of incoming information, 

the Committee noted that it was prepared to 

increase or reduce the pace of its purchases to 

maintain appropriate policy accommodation 

as the outlook for the labor market or inflation 

changedIl 

At the June FOMC meeting, Committee 

participants generally thought it would be 

helpful to provide greater clarity about the 

Committee's approach to decisions about its 

asset purchase program and thereby reduce 

investors' uncertainty about how it might 

9. For further discussion of these issues, see the box 

"Efficacy and Costs of Large-Scale Asset Purchases" 

in Board of Governors of the Federal Reserve System 

(2013), Monetary Policy Report (Washington: Board 

of Governors, February), www.federalreserve.gov/ 

monetarypolicy/mp,-20 130226_part2.htm. 

10. See Board of Governors of the Federal Reserve 

System (2013), "Federal Reserve Issues FOMe 

Statement," press release, March 20, www.federaJrcserve. 

gov/newsevents/press/monetary/20130320a.htm. 

11. See Board of Governors of the Federal Reserve 

System (2013), "Federal Reserve Issues FOMC 

Statement," press release, May 1. www.fedcralreserve.gov/ 

newsevents/presslmonetary/20 13050 1 a.htm. 
108 


82861.049

react to future economic developments. In 

choosing to provide this clarification, the 

Committee made no changes to its approach 

to monetary policy. Against this backdrop, 

Chairman Bemanke, at his postmeeting press 

conference, described a possible path for asset 

purchases that the Committee would anticipate 

implementing if economic conditions evolved in 

a manner broadly consistent with the outcomes 

the Committee saw as most likely." The 

Chairman noted that such economic outcomes 

involved continued gains in labor markets, 

supported by moderate growth that picks up 

over the next several quarters, and inflation 

moving back toward its 2 percent objective over 

time. If the economy were to evolve broadly 

in line with the Committee's expectations, the 

FOMC would moderate the pace of purchases 

later this year and continue to reduce the pace 

of purchases in measured steps until purchases 

ended around the middle of next year, at which 

time the unemployment rate would likely be in 

the vicinity of 7 percent, with solid economic 

growth supporting further job gains and 

inflation moving back toward the FOMe's 

2 percent target. 

In emphasizing that the Committee's policy was 

in no way predetermined, the Chairman noted 

that if economic conditions improved faster 

than expected, the pace of asset purchases 

could be reduced somewhat more quickly. 

Conversely, if the outlook for the economy or 

the Jabor market became Jess favorable, inflation 

did not move over time toward the Committee's 

2 percent longer-term objective, or financial 

conditions were judged to be inconsistent with 

further progress in the labor markets, reductions 

in the pace of purchases could be delayed or 

the pace increased for a time. The Chairman 

also drew a strong distinction between the asset 

purchase program and the forward guidance 

regarding the target for the federal funds rate, 

noting that the Committee anticipates that there 

12. See Ben S. Bernanke (2013), "Transcript 

of Chairman Bemanke's Press Conference," 

June 19, www.fedcralrescrve.gov/mediacentcr/filesl 

FOMCpresconf20130619.pdt: 

MONETARY POLICY REPORT, JULY 20B 35 

will be a considerable period between the end of 

asset purchases and the time when it becomes 

appropriate to increase the target for the federal 

funds rate. 

The Committee's large-scale asset 

purchases led to a significant increase in 

the size of the Federal Reserve's balance 

sheet 

As a result of the Committee's large-scale asset 

purchase program, Federal Reserve assets have 

increased significantly since the end of last year 

(figure 47). The par value of the System Open 

Market Account's (SOMA) holdings of U.S. 

Treasury securities increased about $300 billion 

to $2 trillion, and the par value of its holdings 

of agency debt and MBS increased about 

$270 billion, on net, to $1.3 trillionY These 

asset purchases accounted for nearly all of the 

increase in total assets of the Federal Reserve 

and were accompanied by a significant rise in 

reserve balances over the period. As of July 10, 

the SOMA's holdings of Treasury and agency 

securities constituted 56 percent and 36 percent, 

respectively, of the $3.5 trillion in total Federal 

Reserve assets. By contrast, balances of 

facilities established during the financial crisis 

declined further from already low levels. '4 

13. The difference between changes in the par value 

of SOMA holdings and the amount of purchases of 

securities since the end of 20 J 2 reflects, in part, lags in 

settlements. 

14. The outstanding amount of dollars provided 

through the temporary U.S, dollar liquidity swap 

arrangements with foreign central banks decreased 

$7 billion to about $1 billion because of the improvement 

in offshore US. dollar funding markets. During the 

financial crisis, the Federal Reserve created several 

special lending facilities to support financial institutions 

and markets and strengthen economic activity. These 

facilities were closed by 2010; however, some loans made 

under the Term Asset-Backed Securities Loan Facility, 

which is closed to new lending, remain outstanding and 

will mature over the next two years. Other programs 

supported certain specific institutions in order to avert 

disorderly failures that could have resulted in severe 

dislocations and strains for the financial system as a 

whole and harmed the U.S. economy. While the loans 

made by the Federal Reserve under these programs 

have been repaid, the Federal Reserve will continue to 

receive cash flows generated from assets remaining in the 
109 


82861.050

36 PART 2: MONETARY POliCY 

47. Federal Reserve assets and liabilities. 2008~13 

_W_"-'kly'-_____________ ... ~,._ .. ~. __ . __ ~" _________ _ TriHi()!lsofdoHars 

-Assets 

- Liabilities and capital 

Other assets 

- 4.0 

3.5 

3.0 

- 25 

2.0 

-15 

-_. 1,0 

- .5 

- 0 

- .5 

-1.0 

-1.5 

- 20 

2.5 

3.0 

-3.5 

~_~~~~~.-L-L-'-,_,~,__'_,_,L_1..., ~,-L-L~~~~__'_-L~LJ__'__L_L. " II , " " , " '.L1....-'-' -L-'-L-L_~O li3n 4130 85 IOJl9 1128 4/29 8ill 114 lill 4128 8!O 1;/3 1/26 4127 IV? 1112 li25 4,"25 8:1 10124 lI30 511 

3/;8 6/25 916 !2!l6 3118 6124 9/~3 Wl6 3i!6 6123 9/21 !21l4 3115 6122 9/21 l?113 3fH (:,/20 <)!3 12112 3,~O 6/19 

200S 2009 2DlO 2011 2012 2013 

NOTE: The data extend through July 10,2013. Credit and liquidity facihties consists ofpnmary, secondary, and seasonal credit; tenn auctlOlI crcdl\: centra! bank 

liquidity swaps; support for Maiden Lane, Bear Steams, and AIG; and other credit facilities, including the Primary Dealer Credit Facility, the Asset-Backed 

Commercial Paper Money Market Mutual Fund Liquidity facility, the Commercial Paper Funding Facility, and the Ternl Asset-Backed Securities Loan Facility. 

Other assets includes unamortized premiums and discounts on securities held outright. Other liabilities includes reverse repurchase agreements, the U.S. Treasury 

General AccOIlllr, and the U.S. Treasury Supplementary Financing Account. The dates on the horizontal axis are those of regularly scheduled Federal Open Market 

Committee meetmgs. 

SOURCE; Federal Reserve Board, Statistical Release H 4.1, "Factot"$ Affccting Rcserve Balancc~," www.fcderalreserve.gov/releases/h411. 

Interest income on the SOMA portfolio 

continued to support a substantia! sum of 

remittances to the Treasury Department. In 

the first quarter, the Federal Reserve provided 

more than $15 billion of such distributions 

to the Treasury.15 The Federal Reserve has 

also released detailed transactions data on 

open market operations and discount window 

operations with a two-year lag in compliance 

with the Dodd-Frank Wall Street Reform and 

Consumer Protection Act of 2010. 

The Committee also reviewed the 

principles for policy normalization 

During its May and June meetings, the FOMC 

reviewed the Federal Reserve's principles for 

the eventual normalization of the stance of 

monetary policy, which initially were published 

in the minutes of the Committee's June 2011 

portfolios established in connection with such support, 

principally the portfolio of Maiden Lane LLC. 

15. The Quarterly Report on Federal Reserve Balance 

Sheet Dei'elopments for the first quarter is available 

on the Federal Reserve Board's website at www, 

fcderalreserve.gov/monetarypolicy/quarterlY M balanceshcet-developments-report.htm. 

meeting. 16 The Committee's discussion included 

various aspects of those principles-the size 

and composition of the SOMA portfolio in 

the longer run, the use of a range of reservedraining tools, the approach to sales of 

securities, the eventual framework for policy 

implementation, and the relationship between 

the principles and the economic thresholds 

in the Committee's forward guidance on the 

federal funds rate. Meeting participants, in 

general, continued to view the broad principles 

set out in 2011 as still applicable. Nonetheless, 

they agreed that many of the details of the 

eventual normalization process would likely 

differ from those specified two years ago, that 

the appropriate details would depend in part on 

economic and financial developments between 

now and the time when it becomes appropriate 

to begin normalizing monetary policy, and 

that the Committee would need to provide 

additional information about its intentions as 

that time approaches. Participants continued 

16. Sec Board of Governors of the Federal Reserve 

System (2011), "Minutes of the Federal Opcn 

Market Committee, lUlle 21-22, 2011," press release, 

July 12, www.federalreserve.gov/newsevents/press/ 

monetary/20lI0712a.htm. 
110 


82861.051

to think that the Federal Reserve should, in 

the long run, hold predominantly Treasury 

securities. Most, however, now anticipated that 

the Committee would not sell agency MBS as 

part of the normalization process, although 

some indicated that limited sales might be 

warranted in the longer run to reduce or 

eliminate residual holdings. 

The Federal Reserve continued to test 

tools that could potentially be used to 

manage reserves 

As part of the Federal Reserve's ongoing 

program to ensure the readiness of tools to 

manage reserves, the Federal Reserve conducted 

a series of small-scale transactions with 

eligible counterparties. During the first half 

of 2013, the Federal Reserve conducted four 

repurchase agreement (repo) operations and 

three reverse repurchase agreement (reverse 

repo) operations. Operation sizes ranged 

between $0.2 and $2.8 billion using all eligible 

collateral types. While the repo transactions 

MONETARY POLICY REPORT: JULY 2013 37 

were conducted only with primary dealers, 

two of the reverse repo operations were opeu 

to the expanded set of eligible counterparties, 

which include not only primary dealers, but also 

banks, government-sponsored enterprises, and 

money market funds.17 In addition, the Federal 

Reserve Board conducted three operations for 

28-day term deposits under the Term Deposit 

Facility (TDF). These operations included two 

competitive single-price TDF auctions totaling 

$3 billion in deposits and an offering with a 

fixed-rate, full-allotment format, which totaled 

$10 billion in deposits. 

17, To prepare for the potential need to conduct 

large-scale reverse repo transactions, the Federal Reserve 

Bank of New York is developing arrangements with an 

expanded set of counterparties with which it can conduct 

these transactions. These cQunterparties are in addition 

to the existing set of primary dealer countcrparties with 

which the Federal Reserve can already conduct reverse 

repos. The list of the expanded set of counterparties is 

available on the Federal Reserve Bank of New York's 

website at www.ncwyorkfed.orglmarkets/ 

expanded~counterparties.htrnl. 
111 


82861.052

39 

PART 3 

SUMMARY OF ECONOMIC PROJECTIONS 

The following material appeared as an addendum to the minutes of the June 78-79, 2013, meeting of 

the Federal Open Market Committee. 

In conjunction with the June 18-19,2013, 

Federal Open Market Committee (FOMC) 

meeting, meeting participants-the 

7 members of the Board of Governors and the 

12 presidents of the Federal Reserve Banks, 

all of whom participate in the deliberations of 

the FOMC--submitted their assessments of 

real output growth, the unemployment rate, 

inflation, and the target federal funds rate for 

each year from 2013 through 2015 and over 

the longer run." Each participant's assessment 

was based on information available at the time 

of the meeting plus his or her judgment of 

appropriate monetary policy and assumptions 

about the factors likely to affect economic 

outcomes. The longer-run projections 

represent each participant's judgment of the 

value to which each variable would be expected 

to converge, over time, under appropriate 

monetary policy and in the absence of 

18. Although President Pianalto was unable to attend 

the June 18-19,2013, FOMC meeting, she submitted 

economic projections. 

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. 

Overall, FOMC participants projected that, 

under appropriate monetary policy, the pace 

of economic recovery would gradually pick up 

over the 2013-15 period, and inflation would 

move up from recent very low readings but 

remain subdued (table I and figure 1). Almost 

all of the participants projected that inflation, 

as measured by the annual change in the price 

index for personal consumption expenditures 

(PCE), would be running at or a little below 

the Committee's 2 percent objective in 2015. 

As shown in figure 2, most participants judged 

that highly accommodative monetary policy 

was likely to be warranted over the next few 

Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, June 2013 

Percent 

Variilhle 

2013 2015 Longer run 2013 2015 Longer run 

Change in real GDP .... 2.3 t02.6 3.0to 3.5 2.9 to 3.6 2.3 to 2.5 2.0 to 2.6 2.2 to 3.0 2.3103.8 2.0103.0 

March projection .. 2.3 ta2.8 2.9 to 3.4 2})to 3.7 2.3 t02.5 2.0 to 3.0 2.6to 3.8 2.5103,8 2.0103.0 

Unemployment rate" . 7.2 to 73 6.5to 6.8 5.8to 6.2 5.2 to 6.0 6.9 to 7.5 6.2 to 6.9 5.7 to 6.4 5.0106.0 

Man:h projection 0- 7.3 to 7.5 6.7 to 7.0 6.0 to 6.5 5.2 to 6.0 6.9 to 7.6 6.! to 7.1 5.7 t06,5 5.0t06.0 

peE mfiauon .. 0.8 to 1.2 lAta 2.0 2.0 0.8 to 1.5 lA to 2.0 1.6 to 2.3 2.0 

March projection .... 1.3 to J.7 1.5 t02.0 2.0 Dtal.O 1.4102.1 1.6 to 2.6 2.0 
112 


82861.053

40 PART 3: SUMMARY OF ECONOMIC PROJECTIONS 

Figure 1. Central tendencies and ranges of economic projections, 2013-15 and over the longer run 

_ Change in real GDP 

• Centra! tendency of projections 

I Range of projections 

Actual 

2008 2009 2010 

Unemployment rate 

PCE inflation 

2008 2009 2010 

Core peE inflation 

2008 2009 2010 

2011 2012 2013 2014 2015 

2014 2015 

20ll 2012 2013 2014 2015 

2011 2012 2013 2014 2015 

Longer 

run 

Longer 

run 

Longer 

run 

Longer 

run 

Note: Definitions of variables arc in the general note to table I. The data for the actual values of the variables are annual. 

Percent 

- 4 

- 3 

- 1 

Percent 

-10 

- 8 

Pcrt.'t!nt 

- 3 

- 1 

Percent 

- 3 

- 2 

- 1 
113 


82861.054

MONETARY POLICY REPORT JULY 2013 41 

Figure 2. Overview of FOMe participants' assessments of appropriate monetary policy 

:-Jumb(':;ofpartlClpants 

Appropriate timing of policy tinning 14 -14 

-13 

-l2 

-11 

-10 

- 9 

- 8 

- 7 

- 6 

-5 

- J 

- 2 

-I 

2013 2014 2015 2016 

Appropriate pace of policy finning Percent 

Target federal funds rate at year-end , ····················T ...........•• .- 6 

....... ···················&H 

., .• , .•••••• ~$~, 

2013 2014 2015 

, 

, ··········r·· 

, 

"r 

, ..... ( 

................... ····-5 

···.~~~@M··· ,.- 4 

* 

.. ········-3 

······················-1 

Longer run 

Note; In the upper panel, the height of each bar denotes the number of FOMe participants who judge that, under appropriate 

monetary policy, the first increase in the target federal nmds rate from its current range of 0 to Y4 percent will occur in the specified 

calendar year. In March 2013, the numbers of FOMe participants who judged that the first increase in the target federal funds rate 

would occur in 2013, 2014, 2015, and 2016 were, respectively. 1,4,13, and 1. In the lower panel, each shaded circle indicates the 

value (rounded to the nearest t;.; percentage point) of an individual participant's judgement of the appropriate level of the target 

federal funds rate at the end of the specified calendar year or over the longer nll1. 
114 


82861.055

42 PART 3, SUMMARY or ECONOMIC PROJECTIONS 

years to support continued progress toward 

maximum employment and a gradual return 

toward 2 percent inflation. Moreover, all 

participants but one judged that it would 

be appropriate to continue purchasing both 

agency mortgage-backed securities (MBS) and 

longer-term Treasury securities at least until 

later this year. 

A majority of participants saw the uncertainty 

associated with their outlook for economic 

growth and the unemployment rate as similar 

to that of the past 20 years. An equal number 

of participants also indicated that the risks to 

the outlook for real gross domestic product 

(GDP) growth and the unemployment rate 

were broadly balanced. Some participants, 

however, continued to see downside risks to 

growth and upside risks to unemployment. 

A majority of participants indicated that the 

uncertainty surrounding their projections for 

PCE inflation was similar to historical norms, 

and nearly all considered the risks to inflation 

to be either broadly balanced or weighted to 

the downside. 

The Outlook for Economic Activity 

Participants projected that, conditional 

on their individual assumptions about 

appropriate monetary policy, the economy 

would grow at a faster pace in 2013 than it 

had in 2012. They also generally judged that 

growth would strengthen further in 2014 

and 2015, in most cases to a rate above their 

estimates of the longer-run rate of output 

growth. Most participants noted that the high 

degree of monetary policy accommodation 

assumed in their projections, continued 

improvement in the housing sector and the 

accompanying rise in household net worth, 

and the absence of further fiscal tightening 

should result in a pickUp in growth; however, 

they pointed to the foreign economic outlook 

as an ongoing downside risk. 

The central tendency of participants' 

projections for real GDP growth was 2.3 to 

2.6 percent for 2013, 3.0 to 3.5 percent for 

2014, and 2.9 to 3.6 percent for 2015. Most 

participants noted that their projections were 

little changed since March, with the downward 

revisions to growth in 2013 reflecting the 

somewhat slower-than-anticipated growth 

in the first halL The central tendency for the 

longer-run rate of growth of real GDP was 2.3 

to 2.5 percent, unchanged from March. 

Participants anticipated a gradual decline 

in the unemployment rate over the forecast 

period; a large majority projected that the 

unemployment rate would not reach their 

estimates of its longer-run level before 2016. 

The central tendencies of participants' 

forecasts for the unemployment rate were 

7.2 to 7.3 percent at the end of 2013, 6.5 to 

6.8 percent at the end of 2014, and 5.8 

to 6.2 percent at the end of 2015. These 

projections were slightly lower than in 

March, with participants reacting to recent 

data indicating that the unemployment rate 

had declined by a little more than they had 

previously expected. The central tendency 

of participants' estimates of the longer-run 

normal rate of nnemployment that would 

prevail under appropriate monetary policy 

and in the absence of further shocks to the 

economy was 5.2 to 6.0 percent, the same as in 

March. Most participants projected that the 

unemployment rate would converge to their 

estimates of its longer-run normal rate in five 

or six years, while some judged that less time 

would be needed. 

As shown in figures 3.A and 3.B, the 

distributions of participants' views regarding 

the likely outcomes for real GDP growth and 

the unemployment rate were relatively narrow 

for 2013. Their projections for economic 

activity were more diverse for 2014 and 2015, 

reflecting their individual assessments of 

appropriate monetary policy and its economic 

effects, the likely rate of improvement in 

the housing sector and households' balance 

sheets, the domestic implications of foreign 

economic developments, the prospective path 

for U.S. fiscal policy, the extent of structural 

dislocations to the labor market, and a 
115 


82861.056

number of other factors. The dispersion of 

participants' projections for 2015 and for 

the longer run was little changed relative to 

March; there was some reduction in the upper 

ends of the distributions in 2013 and 2014 for 

both real GDP growth and the unemployment 

rate. 

The Outlook for Inflation 

All participants marked down their projections 

for both PCE and core PCE inflation in 2013, 

reflecting the low readings on inflation so far 

this year. Participants generally judged that 

the recent slowing in inflation partly reflected 

transitory factors, and their projections for 

inflation under appropriate monetary policy 

over the period 2014-·15 were only a little 

lower than in March. Participants projected 

that both headline and core inflation would 

move up but remain subdued, with nearly all 

projecting that inflation would be equal to, 

or somewhat below, the FOMe's longer-run 

objective of 2 percent in each year. Specifically, 

the central tendency of participants' 

projections for overall inflation, as measured 

by the growth in the PCE price index, moved 

down to 0.8 to 1.2 percent in 2013 and was 1.4 

to 2.0 percent in 2014 and 1.6 to 2.0 percent 

in 2015. The central tendency of the forecasts 

for core inflation shifted down slightly in 2013 

and 2014, to 1.2 to 13 percent and 1.5 to 

1.8 percent, respectively; the central tendency 

in 2015 was little changed and broadly similar 

to that of headline inflation. In discussing 

factors likely to return inflation to near the 

Committee's inflation objective of 2 percent, 

several participants noted that the reversal 

of transitory factors currently holding down 

inflation would cause inflation to move up 

a little in the near term. In addition, many 

participants viewed the combination of 

stable inflation expectations and diminishing 

resource slack as likely to lead to a gradual 

pickup in inflation toward the Committee's 

longer-run objective. 

Figures 3.C and 3.D provide information 

on the diversity of participants' views about 

MONETARY POLICY REPOH JULY 2013 43 

the outlook for inflation. The range of 

participants' projections for overall and core 

inflation in 2013 shifted down, while those 

ranges narrowed in 2014-15. The distributions 

for core and overall inflation in 2015 remained 

concentrated near the Committee's longer-run 

objective, and all participants continued to 

project that overall inflation would converge 

to the FOMe's 2 percent goal over the longer 

run. 

Appropriate Monetary Policy 

As indicated in figure 2, most participants 

judged that exceptionally low levels of the 

federal funds rate would remain appropriate 

for a couple of years. In particular, 

14 participants thought that the first increase 

in the target federal funds rate would not be 

warranted until sometime in 2015, and one 

judged that policy Jirming would likely not 

be appropriate until 2016. Four participants 

judged that an increase in the federal funds 

rate in 2013 or 2014 would be appropriate. 

All of the participants who judged that raising 

the federal funds rate target would become 

appropriate in 2015 also projected that the 

nnemployment rate would decline below 

6Y2 percent during that year and that inflation 

would remain near or below 2 percent. In 

addition, most of those participants also 

projected that a sizable gap between the 

unemployment rate and the longer-run 

normal level of the unemployment rate would 

persist nntil2015 or later. Three of the four 

participants who judged that policy firming 

should begin in 2013 or 2014 indicated that, 

in their judgment, the Committee would need 

to act relatively soon in order to keep inflation 

near the FOMe's longer-run objective of 

2 percent and to keep longer-run inflation 

expectations well anchored. 

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 

2013 to 2015 and over the longer run. As 
116 


82861.057

44 PART 3: SUMMARY OF ECONOMIC PROJECTIONS 

Figure 3.A. Distribution of participants' projections for the change in real GDP, 2013-15 and over the longer run 

Number of partlclpllnl~ 

2013 -20 

-2014 

-2015 

2.H21 

21 

- Longer run 

2.3 

2.2-

13 

22-

2.3 

24-

2.5 

24-

2.5 

2.6-

27 

27 

28-

29 

3.0-

" Percent range 

2.8-

2.9 

Percent range 

Percent range 

Percent range 

Note: Definitions of variables are in the general note to table 1. 

3.2-

:U 

3.2-

3.3 

l3 JuncprojcctlOns 18 

- .. March projections 16 

34-

3.5 

34-

3.5 

36-

37 

36-

3.7 

H39 

-14 

-12 

-10 

8 

- 4 

Number of participants 

38-

39 

-20 

18 

-16 

-14 

-12 

-10 

8 

- 4 

- 2 

Nlimberofparticlpant~ 

-20 

-18 

-16 

-14 

12 

-10 

Numberofpartlcipants 

38-

39 

-20 

18 

-16 

-14 

12 

-10 

8 

- 6 
117 


82861.058

MONETARY POLICY REPORT: JULY 2013 45 

Figure 3.B. Distribution of participants' projections for the unemployment rate, 2013-15 and over the longer run 

NUmb(.'"fofpartlClpants 

-2013 -20 

- EI June projections 18 

.- March projections -16 

-14 

-12 

10 

L. -- 2 

5.2- 54- 5.6- 5.8- 60- 6.2- 64- 0.6- ,,- 70- 7.{,-

51 53 55 5.7 " 61 63 65 67 69 71 7.7 

Percent range 

Number of participants 

-2014 -20 

-18 

-16 

-14 

-12 

-10 

- 4 

50- 5.2- 5A- %- 58- 60- 7.0- 7.2- 7.4- 76-

5.1 53 5.5 5.7 59 6.1 6.7 71 73 75 77 

Percent range 

Number of participants 

-2015 -20 

-18 

-16 

14 

-12 

-1O 

- 4 

5.0- 5.2- 5.4- 6.4- ,,- 68- 7.0- 7.2- 7A" ,,- 51 5.3 55 65 67 69 71 73 75 7.7 

Percent range 

Number of participant~ 

Longer run -20 

-18 

16 

-14 

-12 

10 

- 4 

6.2- 64- 66- 68- 70- 4- 7,6-

63 6.5 6.7 69 7.1 73 7.5 77 

Percent range 

Note: Definitions of variables are in the general note to table 1. 
118 


82861.059

46 PART 3: SUMMARY OF ECONOMIC PROJECTIONS 

Fi~urc 3.e. Distribution ofparticieants' projections for peE inflation, 2013-15 and over the longer run 

Number of participants 

-2013 -20 

I!I June projections 18 

-. March projections -16 

14 

-12 

10 

8 

- 6 

.r - - , - 4 

L - 2 

07- 0'- 11- 13- !.s- 17- 1.9- 21- 23° 25-

0.8 10 12 " L6 LS 20 22 24 26 

Percent range 

Number of participants 

-2014 -20 

-18 

-16 

-14 

11 

10 

8 

- 6 

- 4 

- 2 

07- D"- 11-

08 LO 12 2.2 2.4 2.6 

Percent range 

Numberofparticip.ants 

-2015 -20 

18 

-16 

-14, 

, -12 

-10 

L - 4 

07- 0.9- !.i" I.}- l5- 17- 19- 21- B· 25-

08 LO 12 14 16 " 2.0 22 2.4 26 

Percent range 

Numberofpllrticipants 

- Longer run -20 

-18 

-16 

-14 

-12 

-10 

- 4 

- 2 

09- 11- 13- is- 1.7- 1.9- 2.1- 23-

0.8 10 1.2 14 16 18 20 22 2.4 2.6 

Percent range 

Note: Definitions of v811ablcs arc in the general note to table I. 
119 


82861.060

MONETARY POLICY REPORT: JULY 2013 47 

Figure 3.D. Distribution of participants' projections for core peE inflation, 2013--15 

2013 

liiJ June projections 

- .... March projections 

2014 

2015 

uLl 

Il~ 

Ll 

1.3-

14 

J5-

1.6 

17-

L' 

L 

Percent range 

Percent range 

Percent range 

Note: Definitions of variables are in the general note to table 1. 

!9~ 

2.0 

23-

24 

Number of particIpants 

15~ 

2.6 

-20 

-18 

-16 

-14 

12 

-10 

- 6 

Numbefofparticipants 

2.5-

2.6 

-20 

18 

-16 

14 

12 

-10 

-8 

- 6 

-4 

- 2 

Number of participants 

-20 

18 

16 

-14 

-12 

-10 

-8 

- 6 

-2 
120 


82861.061

48 PART 3: SUMMARY OF ECONOMIC PROJECTIONS 

Figure 3.E. Distribution of participants' projeclions for the target federal funds rate, 2013--15 and over the longer run 

2013 

000- 0.38- {)03- O.SR- 1.13-

037 062 087 III 137 

2014 

J.]3- 1.38-

062 1.37 1.62 

2015 

--I 1_'-- _ I 1 .--1 

__ 111ilI11I1II 0.00- 038· 06}- O.8R- \.13- UR037 062 087 Ll2 137 1.62 

Longer run 

000- 038- 063-

037 062 OR7 

!63- !gg. 213- 1.J8-

1'(.7 2.12 237 2,62 

Percent range 

163- 188- 213- 2.3R- 2.63- 2.88- 3.13· 

187 2.12 237 262 2.87 3.12 337 

Percent range 

IBi!!!lI!!IilI .l1li. 163- 188- 2.13- 2.38- 263- 2.88- 313-

187 2.12 2.37 262 287 3.12 3.37 

Percent range 

213- 238- 263- 2&8- 313-

2.37 262 2.87 3.12 337 

Percent range 

NumiJerofpartlclpan15 

m June projections 

... March projections 

3.38-

362 

3.3R3.62 

-'0 . 363- 3.83- 413- 4.38-

387 4.12 437 462 

Numberofp~rtjcipanlS 

363· ~t88- 413- 438-

"7 412 437 462 

Nl,Imberofparticipants 

- 20 

- " 

- JO 

, 

r: -I ... -I "I 3.63- 388- 4,13- 4.38" 

3.87 412 437 462 

Number ofpartlcipanL~ 

Note: The target federal funds rate is measured as the level of the target rate at the end of the calendar year or 

in the longer run, 
121 


82861.062

previously noted, most participants judged 

that economic conditions would warrant 

maintaining the current low level of the federal 

funds rate at least until 2015. Among the four 

participants who saw the federal funds rate 

leaving the effective lower bound earlier, their 

projections for the federal funds rate at the end 

of 2014 ranged from I to 1\12 percent; however, 

the median for all participants remained 

at the effective lower bound. Views on the 

appropriate level of the federal funds rate 

at the end of 2015 varied, with the range of 

participants' projections a bit narrower than in 

the March Summary of Economic Projections 

and the median value unchanged at I percent. 

All participants saw the appropriate target for 

tbe federal funds rate at the end of 2015 as still 

well below their assessments of its expected 

longer-run value. Estimates of the longerrun target federal funds rate ranged from 3V. 

to 4\12 percent, reflecting the Committee's 

inflation objective of 2 percent and 

participants' individual jUdgments about the 

appropriate longer-run level of the real federal 

funds rate in the absence of further shocks to 

the economy. 

Participants also described their views 

regarding the appropriate path of the Federal 

Reserve's balance sheet. Given their respective 

economic outlooks, all participants but 

one judged that it would be appropriate to 

continue purchasing both agency MBS and 

longer-term Treasury securities. About half of 

these participants indicated that it likely would 

be appropriate to end asset purchases late 

this year. Many other participants anticipated 

that it likely would be appropriate to continue 

purchases into 2014. Several participants 

emphasized that the asset purchase program 

was effective in supporting the economic 

expansion, that the benefits continued to 

exceed the costs, or that continuing purchases 

would be necessary to achieve a substantial 

improvement in the outlook for the labor 

market. A few participants, however, indicated 

that the Committee could best foster its dual 

objectives and limit the potential costs of the 

MONETARY POLICY REPORT: JULY 2013 49 

program by slowing, or stopping, its purchases 

at the June meeting. 

Key factors informing participants' views 

of the appropriate path for monetary policy 

included their judgments regarding the values 

of the unemployment rate and other labor 

market indicators that wonld be consistent 

with maximum employment; the extent to 

which the economy fell short of maximum 

employment and the extent to which 

inflation was running below the Committee's 

longer-term objective of 2 percent; and the 

implications of alternative policy paths for 

the likely extent of progress, over the medium 

term, in returning employment and inflation 

to mandate-consistent levels. A couple of 

participants noted that persistent beadwinds 

and somewhat slower productivity growth 

since the end of the recession made their 

assessments of the longer-run normal level 

of the federal funds rate, and thus of the 

appropriate path for the federal funds rate, 

lower than would otherwise be the case. 

Uncertainty and Risks 

A majority of participants reported that 

they saw the levels of uncertainty abont 

their projections for real GDP growth and 

unemployment as broadly similar to the 

norm during the previous 20 years, with the 

remainder generally indicating that they saw 

higher uncertainty about these economic 

outcomes (figure 4).19 In March, a similar 

number of participants had seen the level 

of uncertainty about real GDP growth and 

the unemployment rate as above average. A 

majority of participants continued to judge 

that the risks to their forecasts of real GDP 

19, 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 1993 through 2012. At the end 

of this summary, the box "torecast 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. 
122 


82861.063

50 PART 3, SUMMARY OF ECONOMIC PROJECTIONS 

Figure 4. Uncertainty and risks in economic projections 

- Uncertainty about GDP growth 

- m June projections 

- _.. March projections 

Lower Broadly 

similar 

- Uncertainty about the unemployment rate 

lower Broadly 

similar 

- Uncertainty about PCE inflation 

Lower Broadly 

similar 

- Uncertainty about core peE inflation 

Lower Broadly 

similar 

Numocrofpart!Clpants 

Higher 

-20 

18 

- 16 

NumberofpartidpantS-

-20 

- 18 

- 16 

Higher 

Numberofparlicipants 

Higher 

-20 

18 

- 16 

14 

12 

Number of participants 

-20 

-18 

- 16 

Higher 

- Risks to GDP grO\vth 

- ED June projections 

- ..... March projections 

Weighted to 

downside 

Broadly 

balanced 

- Risks to the unemployment rate 

Weighted to 

downside 

- Risks to PCE inflation 

Weighted to 

downside 

Broadly 

balanced 

Broadly 

balanced 

- Risks to core PCE inflation 

Weighted to 

downside 

Broadly 

balanced 

Numberofpartidpanb 

Weighted to 

upside 

- 20 

- 18 

- 16 

14 

Number of participants 

Weighted to 

upside 

- 20 

-18 

- 16 

- 14 

Numbi:rofpartlopanls 

Weighted to 

upside 

-20 

-18 

- 16 

Numbcrofparticipanl~ 

Weighted to 

upside 

-20 

-18 

- 16 

Note: For definitions of uncertainty and risks in economic projections, see the box "Forecast Uncertainty." Defmitions 

of variables are in the general note to table I. 
123 


82861.064

growth and unemployment were broadly 

balanced, with the remainder generally 

indicating that they saw the risks to their 

forecasts for real GDP growth as weighted 

to the downside and for unemployment as 

weighted to the upside. The main factors cited 

as contributing to the uncertainty and balance 

of risks about economic outcomes were the 

limits on the ability of monetary policy to 

offset the effects of adverse shocks when shortterm interest rates are ncar their effective lower 

bound, as well as challenges with forecasting 

the path of fiscal policy and economic and 

financial developments abroad. 

Participants reported little change in their 

assessments of the level of uncertainty and 

the balance of risks around their forecasts 

for overall PCE inflation and core inflation. 

Fourteen participants judged the levels of 

uncertainty associated with their forecasts 

for those inflation measures to be broadly 

similar to, or lower than, historical norms; 

the same nnmber saw the risks to those 

projections as broadly balanced. A few 

participants highlighted the likely role 

played by the Committee's adoption of a 

2 percent inflation goal or its commitment 

to maintaining accommodative monetary 

policy as contributing to the recent stability of 

longer-term inflation expectations and, hence, 

MONETARY POLICY REPORT: JULY 2013 51 

Table 2. Average historical projection error ranges 

Percentage points 

VariabJe 2013 2015 

Change in real GDP), < ±I.O ±1.6 ±1.8 

Unemployment rate! ±OA ±t2 ±tS 

Total consumer prices2• to.8 tlO 4::1.0 

NOTE: Error ranges shown are meaSllred as plus or minus the root 

mean squared error of projections for !993 through 2012 that were 

released in the summer by various private and govemm1':n1 fOft'Casters. As 

dcS{:ribed in the box "Forecast Uncertainty," under certain assumptions, 

there is about a 70 percent probability that actual outcomes for real GDP. 

unemployment. and consumer prices will be in ranges implied by the 

average siz.e of projection errors made in the past. Further mformallon is 

in David Reifschneider and Peter Tulip (2007), "Gaugmg the Uncertainty 

of the Economic Outlook from Historical Forecasting Errors:' Finance 

and Economics Discussion Series 2007+60 (Washington: Board of 

Governors of the Federal Reserve System, :"\ovember), 

J. Definitions of variables are lU the general note to table I. 

2. Measure is the overall consumer price index, the price measure that 

has been most Widely used in government and private economic foreca~ts 

Projection is percent change, lourth quarter of lhe previous year to the 

fourth quarter of the year indicated. 

the relatively low level of uncertainty. Four 

participants saw the risks to their inflation 

forecasts as tilted to the downside, reflecting, 

for example, risks of disinflation that could 

arise from adverse shocks to the economy 

that policy would have limited scope to offset 

in the current environment. Conversely, 

one participant saw the risks to inflation as 

weighted to the upside, citing the present 

highly accommodative stance of monetary 

policy and concerns about the Committee's 

ability to shift to a less accommodative policy 

stance when it becomes appropriate to do so. 
124 


82861.065

52 PART 3: SUMMARY OF ECONOMIC PROJECTIONS 

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 po!icymakers 

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 oy 

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 (GDP) and total consumer prices 

will rise steadily at annual rates of, respectively, 

3 percent and 2 percent. If the uncertainty attending 

those projedions 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 GDP would expand within a range of 2.0 to 

4.0 percent in the current year, 1.4 to 4.6 percent 

in the second year, Jnd 1.2 to 4.8 percent in the 

third year. The corresponding 70 percent confidence 

intervals for overall inflation would be 1.2 to 

2.8 percent in the current year and 1.0 to 3.0 percent 

in the second and third years. 

Because current conditions may differ from 

those that 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 the risks attending each participant's 

projections are distinct from the 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 each 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. 
125 


82861.066

ABBREVIATIONS 

ABCP 

AFE 

BHC 

BOJ 

C&I 

CP 

CPI 

CRE 

Desk 

ECB 

EME 

E&S 

FOMC 

GDP 

JGB 

MBS 

Michigan survey 

NFIB 

PCE 

PMI 

RElT 

repo 

reverse repo 

SEP 

SLOOS 

SOMA 

S&P 

TDF 

asset-backed commercial paper 

advanced foreign economy 

bank holding company 

Bank of Japan 

commercial and industrial 

commercial paper 

consumer price index 

commercial real estate 

Open Market Desk 

European Central Bank 

emerging market economy 

equipment and software 

Federal Open Market Committee; also, the Committee 

gross domestic product 

Japanese government bond 

mortgage-backed securities 

Thomson Reuters/University of Michigan Surveys of Consumers 

National Federation of Independent Business 

personal consumption expenditures 

purchasing managers index 

real estate investment trust 

repurchase agreement 

reverse repurchase agreement 

Summary of Economic Projections 

Senior Loan Officer Opinion Survey on Bank Lending Practices 

Systcm Opcn Market Account 

Standard & Poor's 

Term Deposit Facility 

53 
126 


82861.067

Questions for The Honorable Ben Bernanke, Chairman, Board of Governors of the Federal 

Reserve System, from Representative Bachus: 

Chairman Bernanke, you have stated that in the future, depending on the strength of the 

economy, you will begin to exit from your quantitative easing programs. Qnce assets cease 

being purchased, the Fed is left with a massively expanded balance sheet. The Fed's prefinancial crisis balance sheet was $800 billion, and by the time you end your asset 

purchases it will be over $3 trillion. This brings with it several questions. 

• Can these securities be returned to the private market without damaging the economy? 

The Federal Reserve conducts monetary policy at all times to foster its longer-term objectives of 

maximum employment and stable prices, and this principle will guide the process of normalizing 

the size and composition of the Federal Reserve's balance sheet. The Federal Reserve expects 

that the process of normalization will be gradual and conducted in a manner that is open and 

transparent to all market participants. However, if there are signs that this process is proving 

disruptive to financial markets or having adverse effects on the economy, the Federal Reserve 

can make adjustments as appropriate. It is important to recognize that the Federal Reserve need 

not sell large volumes of longer-term securities to normalize the size of its balance sheet. 

Instead, much of the adjustment can occur slowly as existing securities mature over time. 

Indeed, as I noted in a press conference following the June 2013 FOMC meeting, a strong 

mlljority of FOMC participants now expect that the FOMC will not sell agency mortgage-backed 

securities during the process of normalizing policy. 

• Can the securities be sold without incurring substantial losses? 

As noted above, the adjustment in the size of the Federal Reserve's balance sheet can be 

accomplished without sales oflonger-term securities. As a result, the Federal Reserve can 

normalize the size of the balance sheet without sustaining substantial capital losses. Even if the 

Federal Reserve were to sell some portion of its longer-term securities holdings gradually over 

time, capital losses on the sales of these securities would likely be modest and more than offset 

by positive eamings on its remaining securities holdings. For example, the Congressional 

Budget Office (CBO) recently projected that remittances from the Federal Reserve to the 

Treasury will amount to about $510 billion from 2013 until the end of their projection period in 

2023, even with an assumption of sales oflonger-term securities and associated realized capital 

losses. I Such remittances would greatly exceed the average annual amount seen prior to the 

crisis. 

I See "Updated Budget Projections; Fiscal Years 2013 to 2023" released by the CBO in May 2013. Also, see 

Carpenter et al. (2013), "The Federal Reserve's Balance Sheet and Earnings; A Primer and Projections," Finance and 

Economics Discussion Papers 2013-0 I, Board of Governors of the Federal Reserve System (U.S.), for additional 

infonnation on the effects of different interest rate assumptions and exit strategies on Federal Reserve income. 
127 


82861.068

- 2-

• What will be the inflation effects of rcturning these securities to the private market? 

Various estimates suggest that the Federal Reserve's expanded holdings oflonger-tenn securities 

have put significant downward pressure on longer-tenn interest rates. The nonnalization of the 

Federal Reserve's balance sheet would thus be expected to remove some ofthls downward 

pressure on longer-tenn interest rates. As I noted in a speech earlier this year, as the economy 

improves and the Federal Reserve begins to gradually nonnalize the size of the balance sheet, 

longer-tenn interest rates can be expected to increase over time. Indeed, the current tenn 

structure of interest rates suggests that investors currently anticipate that longer-tenn interest 

rates will increase graduaJly in coming years to more nonnal levels. All else equal, higher 

interest rates will tend to put some downward pressure on inflation. Of course, when the 

economy has recovered more fully, a somewhat higher level oflonger-tenn interest rates will be 

consistent with maintaining maximum employment and keeping inflation close to the FOMC's 

long-run target of 2 percent with stable long-run inflation expectations. 

• What effects will the sale of these securities have on the market's ability to absorb other 

private sales of securities? 

As noted above, the nonnalization of the Federal Reserve's balance sheet can be accomplished 

without asset sales. That said, once the size of the Federal Reserve's balance sheet has returned 

to nonnal, the private sector will hold a larger volume of longer-tenn Treasury and agency 

mortgage-backed securities than would otherwise be the case. The Federal Reserve's securities 

holdings consist entirely of Treasury and agency securities; these securities are highly liquid and 

actively traded in global fixed-income markets. As a re,;ult, it seems likely that markets will be 

able to absorb this additional supply of longer-tenn Treasury and agency mortgage-backed 

securities without adversely affecting the capacity of the market to absorb new private-sector 

issues. Moreover, it's important to recognize that the nonnalization of the Federal Reserve's 

balance sheet will involve both a reduction in its holdings of longer-term securities and a 

corresponding reduction in its liabilities (principally reserves). Thus, the nonnalization of the 

size of the Federal Reserve's balance sheet will not increase the size of the balance sheet of the 

private sector overall: On net, the private sector will hold more longer-tenn securities but will 

hold lower amounts of reserves and other Federal Reserve liabilities. As a result, the 

nonnalization of the Federal Reserve's balance sheet will not increase the total magnitude of 

financial assets financed by the private sector, so market participants should be able to continue 

to absorb new issues of private securities. Of course, the Federal Reserve will be monitoring 

financial markets and the economy carefully during the nonnalization process and can make 

adjustments as appropriate. 
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Questions for The Honorable Ben Bernanke, Chairman, Board of Governors of the Federal 

Reserve System, from Representative Bachus: 

1. The Federal Reserve has used a 6.5% unemployment rate as a threshold for an exit 

from simulative monetary policy. Can you provide more detail on the timing of this exit? 

You have mentioned in the past your concern over the labor force participation rate. How 

much weight in your calculation do you give this figure, and do you have a particular 

number in mind with respect to labor force participation? 

First, the timing of our exit from an accommodative stance of monetary policy will be 

determined by the evolution of the state of the economy. As the Committee indicated in the 

statement released on September 18, 2013, with respect to its asset-purchase program: 

The Committee will closely monitor incoming information on economic and 

financial developments in coming months and will continue its purchases of 

Treasury and agency mortgage-backed securities, and employ its other policy 

tools as appropriate, until the outlook for the labor market has improved 

substantially in a context of price stability. In judging when to moderate the pace 

of asset purchases, the Committee will, at its coming meetings, assess whether 

incoming information continues to support the Committee's expectation of 

ongoing improvement in labor market conditions and inflation moving back 

toward its longer-run objective. Asset purchases are not on a preset course, and 

the Committee's decisions about their pace will remain contingent on the 

Committee's economic outlook as well as its assessment of the likely efficacy and 

costs of such purchases. 

Similarly, with respect to the future path of the federal funds rate, the Committee indicated in the 

same statement: 

[T]he Committee decided to keep the target range for the federal funds rate at 0 to 

114 percent and currently anticipates that this exceptionally low range for the 

federal funds rate will be appropriate at least as long as the unemployment rate 

remains above 6-112 percent, inflation between one and two years ahead is 

projected to be no more than a half percentage point above the Committee's 

2 percent longer-run goal, and longer-term inflation expectations continue to be 

well anchored. In determining how long to maintain a highly accommodative 

stance of monetary policy, the Committee will also consider other information, 

including additional measures of labor market conditions, indicators of inflation 

pressures and inflation expectations, and readings on financial developments. 

When the Committee decides to begin to remove policy accommodation, it will 

take a balanced approach consistent with its longer-run goals of maximum 

employment and inflation of2 percent. 

As you noted, and as the Committee indicated in its statement, the 6-112 percent level of the 

unemployment rate is a threshold, not a trigger; accordingly, when that level of the 
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unemployment is reached, it will become appropriate for the Committee to consider the full 

range of evidence regarding the optimal time to begin raising the funds rate. 

With regard to your second question, as I have indicated on many occasions, including at my 

press conference on September 18, the Committee will examine a broad range of indicators, 

including those pertaining specifically to the labor market. With regard to the labor market, we 

are looking for a broad pattern of improvement. The labor-force participation rate is one 

indicator of developments in that market, but far from the only one we will inspect. 

2. The unemployment rate is steadily dropping, but GDP is still below the Fed's forecasts. 

Are you concerned about slowing GDP, even though it is not part of the dual mandate? 

Does the FOMe anticipate further stimulus ifit sees a continued slowing in GDP growth? 

Maximum employment is part of the Federal Reserve's dual mandate, and the FOMC's 

communications have emphasized the importance of labor market conditions for our decisions 

about both the future path of the federal funds rate and our large-scale asset purchases. But 

improvements in the labor market that are not supported by overall economic growth might not 

be sustainable. Thus, the prospects for GDP growth certainly do factor into our deliberations 

about the outlook for the labor market. Indeed, in my June press conference in which I provided 

greater clarity about the FOMC's approach to decisions about our asset purchase program, I cited 

solid economic growth supporting further job gains as being among the conditions I would 

expect to see when we cease our asset purchases. 

3. In the past, when other central banks have purchased assets through quantitative 

easing, they have eventually sold those assets back to the market. Originally, this was the 

Federal Reserve Board's plan as well. How will asset sales, if any, be a part of a more 

immediate exit from quantitative easing? What impact will delayed asset sales have on 

future interest rates? 

The FOMC continues to anticipate that it will not permanently hold the securities that it has 

acquired through its large-scale asset purchases. As indicated in the minutes of the FOMC's 

meeting on June 18 and 19,2013, Committee participants generally continued to view the broad 

exit strategy principles set out in the minutes of the Committee's June 2011 meeting as still 

applicable. In particular, participants continued to think that the Federal Reserve should, in the 

long run, hold predominantly Treasury securities. As of this June, however, most participants 

anticipated that the FOMC would not sell agency mortgage-backed securities (MBS) as part of 

the policy normalization process; instead, the Committee's holdings ofMBS would decline over 

time after the Committee ends its policy of reinvesting principal payments from its holdings of 

agency debt and agency mortgage-backed securities (MBS) in new MBS. Some participants 

indicated that limited sales might be warranted in the longer run to reduce or eliminate residual 

holdings. Avoiding or postponing sales ofMBS likely would mean that the Federal Reserve's 

holdings ofMBS would decline less rapidly than would otherwise be the case; the less rapid 

decline should, all else constant, help maintain downward pressure on longer-term interest rates, 

including mortgage rates, somewhat longer than otherwise. 
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4. There have been concerns that the Federal Reserve's balance sheet has grown too large. 

Has an upper limit been established regarding a percentage of GDP to the FRB's balance 

sheet or will quantitative easing be applied when deemed necessary regardless ofthe size of 

the balance sheet? 

The Committee has not set an upper limit for the Federal Reserve's balance sheet as a percentage 

of GDP. The Committee has indicated that it will continue its purchases of Treasury and agency 

mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook 

for the labor market has improved substantially in a context of price stability. The Conunittee 

also has indicated that it is prepared to increase or reduce the pace of its purchases to maiutain 

appropriate policy accommodation as the outlook for the labor market or inflation changes, and 

that in determining the size, pace, and composition of its asset purchases, it will continue to take 

appropriate account of the likely efficacy and costs of such purchases as well as the extent of 

progress toward its economic objectives. 

5. How has forward guidance issued from other central banks, such as the European 

Central Bank or the Bank of England, altered your current course of action? Will 

continued easing or tightening from foreigu central banks impact your decisions? 

On July 4, the Governing Council of the European Central Bank (ECB) issued forward guidance 

stating that it "expects the key ECB interest rates to remain at present or lower levels for an 

extended period of time." The FOMC issued similar forward guidance (using "extended 

period") from March 2009 through June 2011. On August 7 the Monetary Policy Committee 

(MPC) of the Bank of England (BOE) announced that it intends to keep its policy rate at the 

current level of 0.5 percent at least until the unemployment rate has fallen to a threshold of 

7 percent, subject to three "knockout" conditions under which that guidance would cease to hold. 

The knockout conditions are: (1) in the MPC's view, it is more likely than not, that CPI inflation 

18 to 24 months ahead will be 0.5 percentage points or more above the 2 percent target; (2) 

medium-term inflation expectations no longer remain sufficiently well anchored; and (3) the 

BOE's Financial Policy Committee judges that the stance of monetary policy poses a significant 

threat to financial stability that cannot be contained by the substantial range of mitigating policy 

actions available. (The MPC also stated that it will not reduce-but may increase-the stock of 

assets purchased and held by the BOE at least until the unemployment rate has fallen to 

7 percent, subject to the same three "knockout conditions.") The MPC's forward guidance about 

interest rates is similar to the rate guidance that the FOMC began releasing in December 2012. 

The FOMC's rate guidance says that the Committee anticipates that its current 0 t01l4 percent 

target range for the federal funds rate "will be appropriate at least as long as the unemployment 

rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be 

no more than a half percentage point above the Committee's 2 percent longer-run goal, and 

longer-term inflation expectations continue to be well anchored." 

The FOMC's dual mandate is to promote maximum employment and price stability in the 

United States. To the extent that economic and financial developments abroad affect-or seem 

likely to affect-the U.S. economy, the FOMC would take them into account in making decisions 
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about the appropriate settings of monetary policy in the United States. To date, however, the 

forward guidance issued by the ECB and the BOE has not had an appreciable effect on the U.s. 

economic outlook. 

6. What foreign triggers (e.g. slowing Chinese growth, European sovereign debt issues, or 

conflict in the Middle East) would cause a delay in the tapering off of asset purchases or 

cause interest rates to be raised more quickly? 

U.S. exports have increased considerably over the course of the economic recovery and we 

certainly hope to see further gains. Slower growth abroad would have negative consequences for 

U.S. economic growth. There are some downside risks from abroad. A number of important 

emerging market economies have experienced [mancial turbulence as improving economic 

growth in advanced economies has sparked an increase in interest rates and some reversal of 

capital flows, which could lead to more adverse outcomes than are currently anticipated. 

Chinese growth slowed earlier this year and the Chinese authorities appear to have accepted that 

the economy is undergoing needed structural change and transitioning to a somewhat lower, 

although still very strong rate of growth. There is some risk that the Chinese economy could 

slow more sharply, which would have repercussions for many other emerging market economies. 

The economic situation in Europe has been improving and euro-area authorities continue to 

move slowly toward implementation of banking union. However, as the recent Cyprus crisis 

earlier this year illustrates, financial factors could still disrupt the economic recovery in Europe. 

Borrowing costs remain high in peripheral countries. There is also a risk that the implementation 

of banking union may run into more delays. In addition, the unrest in Egypt and Syria poses a 

risk for oil prices, as these are major transit routes for oil. 

The FOMC's dual mandate is to promote maximum employment and price stability in the 

United States. To the extent that economic and financial developments abroad affect-or seem 

likely to affect-the U.S. economy, the FOMC would take them into account in making decisions 

about the appropriate settings of monetary policy in the United States. If, for example, a 

pronounced economic downturn abroad were to result in declining U.S. exports, a slowdown 

growth of output and employment in the U.S., and downward pressure on prices, highly 

accommodative monetary policy would remain appropriate longer than would otherwise be the 

case. In contrast, if foreign developments were to strengthen the U.S. economic recovery and 

put upward pressure on U.S. inflation, a somewhat earlier or more rapid reduction in policy 

accommodation could be appropriate. In either case, a foreign shock that seemed likely to have 

only transitory effects on the U.S. economy would be unlikely to result in an appreciable change 

in U.S. monetary policy. 
132 


82861.073

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

WASHINGTON, D. C. 20551 

The Honorable Daniel T. Kildee 

House of Representatives 

Washington, D.C. 20515 

Dear Congressman: 

September 9, 2013 

BEN S. BERNANKE 

CHAIR~IAN 

Thank you for your letter dated July 17, 2013, concerning the fiscal challenges 

facing some municipalities today. 

The Federal Reserve regularly monitors the fiscal situations oflocal and state 

governments, along with conditions in municipal bond markets. We recognize the 

difficulties confronting many local and state governments in putting together their budgets, 

staffmg their workforces, funding their pensions, and providing resources for 

infrastructure. Moreover, constraints on state and local spending have added to the 

headwinds restraining the pace of the economic recovery since the last recession. 

Consistent with the mandate that the Congress has given the Federal Reserve, we 

have put in place a highly accornmodative monetary policy in order to help promote a 

stronger recovery in the overall U.S. economy with price stability. Importantly, a stronger 

overall economy should help improve the fiscal situations of municipalities as rising 

incomes and decreasing unemployment boost the revenues of state and local governments 

and reduce the demands on their social benefit programs. 

In the Federal Reserve Act, the Congress severely limited the authority of the 

Federal Reserve to lend directly to, or provide other forms of aid for, specific municipal or 

state governments. This limitation was established to support the fundamental principle of 

the independence of the central bank. We believe that is an important principle and would 

not seek a new role in this regard. Indeed, our misgiving about assuming such a role is that 

these are essentially political decisions reserved for fiscal policymakers in the Congress 

and the Administration to address. 

The Federal Reserve is cornmitted to its statutory mandate of promoting maximum 

employment in the context of price stability and financial stability. A return to a stronger 

economy should help to substantially lessen the fiscal strains affecting many municipal 

governments. 

Sincerely, 
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82861.074

Questions for The Honorable Ben Bernanke, Chairman, Board of Governors of the Federal 

Reserve System, from Representative Mulvaney: 

1. Mr. Chairman, when you appeared before the Committee, we discussed the possibility 

of an environment where remittances from the Federal Reserve cease for an extended 

period of time. You stated that such an euvironment "won't affect our ability to do 

monetary policy." However, I also asked how such a circumstance would affect day-to-day 

operations. Specifically, I asked about where the money would come from to run the 

Federal Reserve if the combined earnings were negative for an extended period of time. In 

response to my question, you stated that it comes "from the balance sheet." 

If the Federal Reserve's balance sheet is not providing enough combined earnings to cover 

all its expenses, including any amount needed to equate surplus to capital paid-in, how does 

the Federal Reserve pay its bills? I understand the accounting principles behind the use of 

deferred assets, but in a net negative cash flow position, where does the money actually 

come from to pay the Federal Reserve's obligations? 

From an accounting perspective, the Federal Reserve pays its obligations by crediting the 

accounts that depository institutions hold at the Reserve Banks. The Federal Reserve would 

continue to meet its obligations in this manner, even in a scenario in which a Reserve Banks' 

earnings were insufficient to provide for the costs of operations, payments of dividends, and 

reservation of an amount necessary to equate surplus with capital paid-in. In such a case, 

remittances to the Treasury would be suspended and a deferred asset would be recorded that 

represented the amount of net earnings the Reserve Bank would need to realize before 

remittances to the Treasury resumed. The deferred asset would be reduced in periods when 

Federal Reserve earnings exceeded expenses. It is important to note that an outcome in which 

the Federal Reserve would need to book a deferred asset as a result of negative net earnings is 

highly unlikely. Prior to the crisis, the Federal Reserve regularly generated net eamings of about 

$25 billion per year. With the expansion of the Federal Reserve's balance sheet over recent 

years, Federal Reserve remittances to the U.S. Treasury have increased sharply. Last year alone, 

the Federal Reserve remitted $82 billion to the U.S. Treasury. Moreover, the CBO projects that 

cumulative Federal Reserve remittances over the period 2013-2023 will amount to about 

$510 billion, an average annual pace well above pre-crisis norms, and also that projected Federal 

eamings will substantially exceed projected expenses in each year. I 

2. What are the eomponents (sources of cash) of the combined earnings of the Federal 

Reserve? What are the components of its expenses and other obligations (uses of cash)? 

The components of the Federal Reserve's combined earnings and expenses are presented in the 

annual audited financial statements, which are available at 

http://www.federalreserve.gov/monetarvpolicyibstfedfinancials.htm. Information regarding 

sources and uses for cash are provided in, or may be derived from, the audited combined 

statements of condition, income, changes in capital, and accompanying notes to the financial 

statements. 

I See "Updated Budget Projections: Fiscal Years 2013 to 2023" released by the CBO in May 2013. 
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Most of the combined earnings of the Federal Reserve come from interest earnings on securities 

held in the System Open Market Account (SOMA). As the Federal Reserve's balance sheet has 

expanded in recent years, the income derived from the balance sheet has also grown, with the 

interest earnings on SOMA holdings remaining the primary source of combined earnings, 

accounting for more than 90 percent of total net income. During the period from 2008-2012, the 

Reserve Banks remitted approximately 95 percent of their net income to the U.S. Treasury. 

The Federal Reserve's expenses and cash outflows are small relative to total earnings. The 

primary components of Federal Reserve expenses are interest expense paid on the account 

balances that depository institutions hold at Reserve Banks and operating expenses incurred to 

fulfill the Federal Reserve's mission. Interest on depository institutions' account balances has 

been paid since October 2008, but this expense category has remained at relatively low levels 

because the interest rate paid on these balances has been at 114 percentage points since 

December 2008. Interest expense paid on depository institutions' account balances and Reserve 

Bank operating expenses have amounted to about 10 percent of Reserve Banks' net earnings for 

the year ended December 31, 2012. The interest expense category will increase at some point 

when the Federal Reserve begins to normalize the stance of monetary policy. However, the 

CBO projects that Federal Reserve expenses will remain modest relative to its earnings over the 

coming years. 
135 


82861.076

Questions for The Honorable Ben Bernanke, Chairman, Board of Governors of the Federal 

Reserve System, from Representative Pittenger; 

1. When was the last time the Fed used Reg[ulation] D for monetary policy? 

2. How many times has the Fed used Reg[ulation] D for monetary policy? 

3. Can you provide a justification for retaining Reg[ulationJ D? 

4. What methods of managing monetary policy does the Fed have, other than 

Reg[ulationJ D? 

5. If Congress were to eliminate the six limit transfer under Reg[ulation] D, what concerns 

would the Fed raise? 

Response to questions 1-5 

The Federal Reserve Act (FRA) directs the Federal Reserve to conduct monetary policy to foster 

a dual mandate of maximum employment and price stability and provides the Federal Reserve 

with the authority to utilize a range of tools to achieve that mandate. One important tool 

provided for in the FRA is reserve requirements. 

Reserve requirements provide a stable and predictable demand for reserve balances. In 

implementing monetary policy, the Federal Reserve then adjusts the supply of reserve balances 

so as to maintain the level of the federal funds rate close to the target level set by the Federal 

Open Market Committee (FOMC). The Federal Reserve operated in this way over the last 

several decades before the financial crisis, and the stable demand for reserves created by reserve 

requirements was central to the daily implementation of monetary policy over this entire period. 

Over recent years, the Federal Reserve has found it necessary to utilize nontraditional monetary 

policy tools to foster its macro objectives. In current circumstances, reserve balances far exceed 

the level of reserve requirements and the level of reserve requirements thus plays only a minor 

role in the daily implementation of monetary policy. However, as discussed in the minutes of the 

June 2011 FOMC meeting, the FOMC will eventually take steps to normalize the size and 

composition of the Federal Reserve's balance sheet and return to the usual mechanisms for 

targeting the federal funds rate. 

The FRA specifies that reserve requirements can be applied only to narrow classes of liabilities 

of depository institutions-principally transaction accounts and nonpersonal time deposits. In 

order to abide by this statutory requirement, the Federal Reserve has developed precise 

regulatory definitions of transaction deposits and nonpersonal time deposits. 

These definitions are laid out in Regulation D and include the distinctions between transaction 

accounts (which are subject to reserve requirements) and savings deposits (which are not subject 

to reserve requirements). An important element of the regulatory definition of a "savings 

deposit" is the six-withdrawal limit. While this limit is sometimes criticized as unnecessarily 
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restrictive and burdensome, the Federal Reserve must have a way of defining transaction 

deposits and savings deposits in order to impose reserve requirements in the manner envisioned 

in the FRA. Absent a binding limitation on withdrawals from savings deposits, banks could 

provide checking and other transaction services through savings deposits rather than transaction 

accounts and completely avoid reserve requirements. The resulting decline in required reserveS 

could have adverse implications for monetary policy implementation. 

In 2008, the Congress granted the Federal Reserve the authority to pay interest on required and 

excess reserve balances held by depository institutions. As discussed in previous testimony by 

Federal Reserve officials and in the minutes of the April 2008 FOMC meeting, this authority 

could allow the Federal Reserve to conduct monetary policy without reserve requirements. The 

Federal Reserve will consider a range of possible operating regimes once the size and 

composition of the Federal Reserve's balance sheet has been normalized. While policymakers 

might ultimately conclude that it is desirable to reduce reserve requirements to zero, it would be 

premature at this stage to implement changes in statute or regulation that would limit the 

effectiveness of reserve requirements. 

6. The Fed has made a number of regulatory changes that have facilitated transfers in 

some instances. Hasn't this already weakened the rule for purposes of monetary policy? 

The Federal Reserve made one regulatory change in 2009 that eliminated the distinction 

previously drawn in Regulation D between transfers made by check or debit card, and other 

convenient transfers like preauthorized or automatic transfers. Prior to 2009, Regulation D 

limited the number of "convenient" transfers and withdrawals that could be made from savings 

deposits to not more than six per month. Within that limit of six per month, not more than three 

of the transfers or withdrawals could be made by check, debit card, or other similar order made 

by the depositor and payable to third parties. In 2009, the Federal Reserve eliminated the 

sublimit on check and debit card transfers so that all convenient transfers from savings deposits 

would be subject to the same numeric limit. The Federal Reserve did not, however, raise the 

overall limit of six per month on convenient transfers from savings deposits. The elimination of 

the sublimit did not weaken the Federal Reserve's capacity to distinguish between transaction 

accounts and saving deposit accounts for the assessment of reserve requirements because the six 

per-month limitation on convenient transfers or withdrawals from saving deposit accounts 

provides the needed distinction. 

7. How do central banks in other countries conduct monetary policy without a 

Re[gulationj D type of requirement? 

Some central banks have been able to implement monetary policy without reserve requirements. 

In these countries, banks' demand for reserves often stems from the need to maintain working 

balances at the central bank to facilitate payments. While the Federal Reserve could consider 

moving to such a system at some point in the future, the unique features of the U.S. banking 

system raise some important questions about how such a system would operate in the 

United States. For example, with thousands of depository institutions managing their balances a1 
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the Federal Reserve each day to facilitate daily payments flows, the aggregate demand for 

reserves could be quite volatile and that, in turn, could complicate the implementation of 

monetary policy. 

Some central banks that rely on reserve requirements to implement monetary policy may be able 

to avoid a limitation on savings accounts withdrawals similar to that in Regulation D if the 

statutory authority for reserve requirements in those countries extends to a relatively broad set of 

depository institution liabilities. For example, reserve requirements are an important part of the 

framework for monetary policy implementation for the European Central Bank (ECB). In 

contrast to the statutory authority for reserve requirements in the United States, the ECB is able 

to impose reserve requirements on very broad array of depository institution liabilities induding 

essentially all bank deposits and debt securities. As a result, depositories are not able to avoid 

reserve requirements simply by shifting balances from transaction accounts to savings accounts. 

In the Euro area, the statutory authority for the ECB to apply reserve requirements against a very 

broad set of depository institution liabilities thus has the benefit of allowing for a much simpler 

regulatory framework for deposit reporting than in the United States. 
138 


82861.079

Questions for The Honorable Ben Bernanke, Chairman, Board of Governors of the .Federal 

Reserve System, from Representative Rothfus: 

1. Mr. Chairman, just last week, you highlighted the persistent anemic nature of the 

current economic recovery noting that the June unemployment rate of 7.6% "probably 

understates the weakness of the labor market." You previously indicated that the 

Federal Reserve would keep interest rates effectively at zero until unemployment falls to 

6.5%. How does your new perspective that the unemploymcnt rate understates the 

weaknesses of the labor market change this policy and the timeline for how the Fed's 

quantitative-easing program will be tapered and then halted? 

Promoting maximum employment is part of the Fed's dual mandate, and the FOMC's 

communications have emphasized that improvements in labor market conditions and in the 

outlook for the labor market are important for the Committee's decisions about both our largescale asset purchases and the future path of the federal funds rate. With respect to its asset 

purchase program, the Committee has indicated that it will continue its purchases of Treasury 

and agency mortgage-backed securities until the outlook for the labor market has improved 

substantially in a context of price stability. If the Committee were to conclude that the labor 

market conditions associated with a given level of unemployment were weaker than it had 

previously thought, then, holding other things equal, a lower level of unemployment would be 

necessary to satisfY the FOMC's criteria for ending asset purchases. That said, the 

unemployment rate is only one of many indicators of labor market conditions that the FOMC 

considers, and the FOMC has not established a specific unemployment rate that it would require 

before ceasing to purchase assets. 

With respect to its target for the federal funds rate, the FOMC has indicated in its post-meeting 

statements that its current 0 to 114 percent target range for the federal funds rate "will be 

appropriate at least as long as the unemployment rate remains above 6 112 percent, inflation 

between one and two years ahead is projected to be no more than a half percentage point above 

the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be 

well anchored." Importantly, the guidance is couched in terms of thresholds, not triggers. While 

the FOMC does not anticipate increasing its target for the federal funds rate before one of the 

thresholds is crossed, it may leave its target unchanged after one or both is crossed. 

Consequently, if the FOMC concluded that the labor market situation was weak despite an 

unemployment rate that had fallen below 6 112 percent, and inflation remained low, it might 

leave its target range for the federal funds rate at its current low level. 

2. Mr. Chairman, the last time you testified before this Committee, you discussed the 

impact of the low interest rate environment on seniors who are living on IlXed incomes. 

While you admitted that low interest rates were stressful for those living on IlXed incomes, 

you were quick to pivot and widen the discussion to include all savers, including those still 

working or those hoping for home price appreciation. 

Today, I want to ask you solely about those retirees who are living on fIXed incomes, whose 

limited investments are predominantly in bonds, CDs, and savings accounts, and who are 

not as concerned about home price appreciation as they are about their diminished income. 
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According to research published by a former colleague of yours at the Council of Economic 

Advisers, if interest rates were at their normal level of 4%, the average senior would see 

$9,500 more in the pocket every year. And if rates were 6 percent, the average senior 

would earn $15,800 more per year. Can you acknowledge that for this group of seniors, the 

Fed's loose monetary policy has been particularly harmful? And, do you believe this harm 

to seniors is merely a necessary byproduct of your loose monetary policy? 

Congress established for the FOMC the goals of maximum employment and price stability. In 

response to the most severe recession since the Great Depression, the Committee has pursued a 

very accommodative monetary policy to stimulate the economy and put citizens back to work. 

The severe recession, sluggish recovery, low inflation, and accommodative monetary policy have 

all contributed to the low level of interest rates. The low level of interest rates has reduced the 

incomes of individuals whose income depends heavily on interest earnings. Ifthe Committee 

were to tighten monetary policy before it was appropriate to do so, interest rates and interest 

incomes would rise, but as a result, the economic recovery would slow or reverse, and the 

unemployment rate would rise further above levels consistent with maximum employment. 

3. Mr. Chairman, during the financial crisis, the Federal Reserve provided liquidity to 

virtually every corner of the financial markets. Much of that was done ad hoc. And the 

inconsistency of the government's response - rescuing Bear Stearns, letting Lehman fail, 

and then rescuing AIG - added uncertainty and panic in the markets. 

Dodd-Frank is supposed to end "Too Big to Fail" and prohibit bailouts. Based on hearings 

that our Committee has conducted, I think that is debatable. But Dodd-Frank also 

directed the Federal Reserve to undertake a rulemaking, in consultation with the Treasury, 

to establish policies and procedures for emergency liquidity, if necessary, to be provided to 

the financial system on a broad base, and not for a bailout. Section 1101 of Dodd-Frank 

specifically requires an open and public rulemaking, so that the policies and procedures for 

how the Federal Reserve provides liquidity in a future emergency will be transparent and 

well understood. 

Now, three years later, the Fed has still not done this. So, do you think it is important for 

the Federal Reserve to be subject to open and transparent rules for providing emergency 

liquidity, so we can avoid uncertainty and panic in the event of a future freezing up ofthe 

credit markets? If so, how do you justify the Fed's three-year delay in writing these basic 

rules and restrictions? 

The Dodd Frank Act imposed numerous requirements upon the Board for rulemakings, both on 

its own as well as in consultation with other agencies, as well as requirements for process 

changes and development, studies, consultations, and reports. The Board has taken its 

obligations under the Dodd Frank Act very seriously. As of last month, the Board had completed 

27 final rulemakings, 12 proposed rulemakings, and 12 studies and reports (on its own or jointly 

with other agencies). The Board has undertaken substantial work both internally and with other 

agencies where required on other Dodd Frank Act requirements, including on the policies and 
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procedures intended to implement the Dodd Frank Act amendments to section 13(3). The Board 

expects to issue a proposal for public comment on the section 13(3) policies and procedures 

shortly. 

4. Mr. Chairman, during your recent appearance before our Committee, you stated that 

the sort of extraordinary measures that the Federal Reserve has implemented in response 

to the imancial crisis are "not unprecedented" and that "many central banks" have in fact 

used "similar tools" to address their own economic problems. You then cited both Japan 

and the United Kingdom as examples of countries that have dramatically expanded the size 

of their balance sheets - specifically, in excess of 300 percent within a four-year time period 

- withont suffering "any kind of negative consequences." 

Can you please expound on this answer? In particular, can you spccify what actions these 

countries took that led to such an increase and during what time period? What have been 

the consequences of those actions, both positive and negative? 

The Bank of Japan (BOJ) was the fIrst major central bank to adopt policies leading to substantial 

expansion of its balance sheet. In March 200 I, facing an economy in recession and entrenched 

deflation, the BOJ announced it would expand the level of banks' reserves and increase its 

purchases oflong-term Japanese government bonds. The implementation of this quantitative 

easing policy (QEP), which was maintained until March 2006, was followed by a decline in 

interest rates, arguably helping to ease deflationary pressures. There has been some debate over 

whether QEP also entailed some costs. With the BO] acting as the market maker by providing 

ample liquidity to banks, interbank money markets were replaced by central bank lending, 

raising some concern regarding the flow of credit by financial institutions to the non-fInancial 

sector. However, there is no evidence that this restricted the ability of banks to make loans, and 

money markets recovered smoothly after QEP ended. 

In response to the global financial crisis, several m,yor foreign central banks used tools which 

also resulted in dramatic expansion of their balance sheets. Most notably, the Bank of England 

(BOE) initiated an Asset Purchase Facility (APF) in January 2009. Through the APF, the BOE 

has purchased £375 billion (equivalent to 24 percent of2012 U.K. ODP) of high-quality assetsmostly longer-term U.K. government bonds-by the creation of central bank reserves. Largely as 

a result of this program, the BOE's balance sheet rose nearly 3 112 times over four years starting 

in September 2008. Although the APF is ongoing and thus it is too early to express a final 

judgment, there is ample empirical evidence that the BOE has been fairly successful in lowering 

interest rates while keeping inflation expectations well-anchored. As noted in the Monetary 

Policy Report (see fIgure 47), the BOJ and the European Central Bank have also signifIcantly 

expanded their balance sheets in recent years, albeit though different means. In addition, several 

major foreign central banks, starting with the Bank of Canada, have introduced forward guidance 

on the future path of policy rates, which can put downward pressure on long-term interest rates 

and thus provide additional monetary stimulus. 
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More recently, the BOJ initiated a policy of "quantitative and qualitative easing" that is aimed at 

achieving a target of2 percent consumer price inflation at the earliest possible time, with a time 

horizon of about two years. The BOJ plans to double the monetary base over that period. 

Although it is still early, the new policy does appear to have boosted the economy and helped to 

combat deflationary expectations. 
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Questions for The Honorable Ben Bernanke, Chairman, Board of Governors of the Federal 

Reserve System, from Representative Stivers: 

1. Financial Stability Qversight Council Section 11 01 

The Dodd-Frank Act prohibited bailouts. It also directed the Federal Reserve to undertake 

a rulemaking, in consultation with the Treasury, to establish policies and procedures for 

emergency liquidity, if necessary, to be provided on a broad base to financial markets, but 

not for a bailout. Section 1101 of Dodd-Frank specifically requires an open and public 

rulemaking, so that the policies and procedures for how the Federal Reserve provides 

liquidity in a future emergency will be transparent and well understood. That section 

required that the rules be established, "as soon as practicable" after the date of enactment 

of Dodd-Frank, which was July 21, 2010. Has the Federal Reserve adopted, or even 

proposed, the rules required under Section 1101? 

The Dodd Frank Act imposed numerous requirements upon the Board for rulemakings, both on 

its own as well as in consultation with other agencies, as well as requirements for process 

changes and development, studies, consultations, and reports. The Board has taken its 

obligations under the Dodd Frank Act very seriously. As oflast month, the Board had completed 

27 final ruIemakings, 12 proposed rulemakings, and 12 studies and reports (on its own or jointly 

with other agencies). The Board has undertaken substantial work both internally and with other 

agencies where required on other Dodd Frank Act requirements, including on the policies and 

procedures intended to implement the Dodd Frank Act amendments to section 13(3). The Board 

expects to issue a proposal for public comment on the section 13(3) policies and procedures 

shortly. 

2. Role of Financial Stability Oversight Council 

a. In various public statements, FRB Board of Governors members have worried about the 

potential for money market funds to destabilize "wholesale funding" of large banks (e.g., 

Governor Tarullo in his statement before the Senate Banking Committee on July 11,2013). 

If this is the case, why doesn't the FRB directly regulate bank holding company reliance on 

short term financing instead of insisting that the Securities and Exchange Commission 

make fundamental changes to money market fnnds? 

The Federal Reserve is working on multiple fronts to regulate bank holding company reliance on 

short-term financing. The proposed Enhanced Prudential Standards implementing section 165 of 

the Dodd-Frank Act and the proposed Liquidity Coverage Ratio are two specific proposals that 

would require firms to hold highly liquid assets to mitigate risks associated with a reliance on 

short-term wholesale funding. Additionally, the Federal Reserve, along with the OCC and 

FDIC, is working with our international colleagues to further develop the Net Stable Funding 

Ratio, which would provide further incentives for firms to utilize more stable funding sources. 

These actions should mitigate or reduce banks' reliance on short-term financing. 

The risks that MMFs present to the overall economy would remain, however, as most of the 

funding provided by MMFs to private firms and institutions goes to foreign entities over which 
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U.S. banking regulators have limited or no jurisdiction. For example, in August 2013, about 80 

percent of all private financing provided by MMFs--that is, financing excluding lending to the 

U.S. Department of the Treasury, U.S. government agencies, U.S. government-sponsored 

enterprises, and state and local governments--went to foreign entities. Because losses on dollardenominated instruments issued by foreign firms could quickly trigger runs on the MMFs that 

hold them, such losses could have serious spillover effects in the U.S. short-term funding 

markets. For that reason, the Federal Reserve engaged through the FSOC, working with the SEC 

and other agencies, on measures that would enhance the resiliency ofMMFs and mitigate their 

continued vulnerability to destabilizing runs. 

b. Are there any ways that money market funds reduce systemic risk, such as by 

diversifying the financial system, reducing maturity transformation, and reducing 

dependence on the "Too Big to Fail" banks? 

The mutual fund model does offer some potential to reduce systemic risk, insofar as a mutual 

fund's portfolio risks are dispersed over a broad group of investors who hold equity shares, 

rather than being concentrated on the balance sheet of a large fmandal institution that finances 

itself with debt or deposits. But money market funds as currently structured do not fulfill that 

potential, because MMF risks historically have not been borne by their shareholders. 

Prospectuses warn investors that "it is possible to lose money" by investing in MMF shares, but 

instead sponsors have absorbed losses in almost every case in which MMFs have lost money. 

This practice fosters complacency among investors during normal times and probably attracts 

highly risk-averse investors to MMFs who do not believe that they bear risks. The 2013 AFP 

Liquidity Survey of institutional investors, for example, found that 37 percent of respondents 

expected support to be forthcoming from an MMF sponsor if a fund suffers losses, 14 percent of 

respondents expected the U.S. government to provide "adequate capital" for MMFs in a crisis, 

and just 34 percent expected that they themselves might lose some principal. 

Hence, MMF risks in practice have not been dispersed over a large group of investors, but 

instead have been concentrated on a relatively small group of firms that sponsor the funds, which 

include large bank holding companies. Importantly, however, sponsor support is voluntary and 

not contractually guaranteed, so uncertainty about sponsor support during periods of market 

stress can drive rational investors to redeem their shares immediately when they suspect that 

sponsors no longer have the capacity or desire to provide such support. 

Thus, an important goal for any such structural reform of MMFs--and a prerequisite for 

mitigating their vulnerability to runs--is to clarifY who really bears the risks present in MMF 

portfolios. 

MMFs do not reduce maturity transformation; instead, these funds perform maturity 

transformation by offering shares that investors may redeem on demand while also investing in 

relatively longer-term instruments, such as term CP and term repo. In the event of shareholder 

redemptions in excess of an MMF's available liquidity, a fund may be forced to sell less-liquid 

assets to meet redemptions. In times of stress, such sales may cause funds to suffer losses that 
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must be absorbed by the fund's remaining investors, reinforcing incentives to run from troubled 

MMFs. 

3. Floating NA V pushing assets to "Too Big to Fail" banks 

If, as a result of regulatory restrictions, money market funds do not exist going fonvard, or 

their assets under management are sUbstantially reduced, where will those assets move, 

and will there be a consequent reduction or increase in systemic risk in the financial 

markets? 

Cash-management alternatives to MMFs and potential shifts towards these alternatives are 

discussed in the "Report of the President's Working Group on Financial Markets: Money 

Market Fund Reform Options" (October 2010), the FSOC's "Proposed Recommendations 

Regarding Money Market Mutual Fund Reform" (November 2012), and the SEC's release 

regarding its proposed rule for money market fund reform (available at 

www.sec.gov/rules/proposedl2013/33-9408.pdf;see, in particular, pp. 283-301). 

4. Gating 

a. The FSOC, in a Dodd-Frank Section 120 proceeding initiated last year, circulated a 

proposal to recommend to the Securities Exchange Commission (SEC) that money market 

funds be required to convert to a floating NA V. The SEC recently proposed a floating 

NA V, although it is narrower than the FSOC request. Can you provide any data or 

evidence supporting the proposition that requiring money market mutual funds to convert 

to a floating NA V would prevent a flight to safety by investors iu the money markets, as we 

saw during the 2008 fmancial crisis? 

Analysis and discussion of the advantages of a floating NA V are available in a variety of places, 

including for example, the "Report of the President's Working Group on Financial Markets: 

Money Market Fund Reform Options" (October 2010), the FSOC's "Proposed 

Recommendations regarding Money Market Mutual Fund Reform" (November 2012), and the 

SEC's release regarding its proposed rule for money market fund reform (available at 

www.sec.gov/rules/proposedl2013/33-9408.pdf; see, in particular, pp. 47-61). 

b. The other option in the SEC's recent Release is that Boards of Directors of money 

market mutual funds be given authority to impose "gates" - that is, temporary restrictions 

on redemptions from money market mutual funds, in circumstances where there may be a 

danger that shareholders could be treated unequally because some investors redeem before 

others. Are you aware that a Putuam institutional prime fund successfully imposed gates 

in 2008 at the same time that The Reserve Fund "broke the buck"? In your assessment, 

would "gates" be more effective in stopping a "run" than a floating NA V? 

We are aware that the Putnam Prime Money Market Fund closed and halted redemptions amid 

the widespread run on MMFs in September 2008. However, Putnam's experience provides little 
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insight into how proposals for standby liquidity fees and gates would affect markets during 

periods of stress. Putnam's investors in 2008 would not have anticipated the fund's decision to 

halt redemptions, since that generally was not permitted at the time, and therefore investors 

would not have been motivated to redeem shares before redemptions were halted. In contrast, 

rules that cause MMFs to impose fees or gates in a crisis could prompt rapid withdrawals during 

periods of stress as investors try to redeem shares while they still can. Indeed, these incentives 

could generate runs that otherwise would not have occurred. 

In addition, the broader effects of the Putnam fund's closure, which occurred on September 17, 

2008, were mitigated by the armouncements two days later of the Treasury's Temporary 

Guarantee Program for Money Market Funds and the Federal Reserve's Asset-Backed 

Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), which stabilized the 

MMF industry, as well as the merger of the Putnam fund into a Federated prime MMF on 

September 24, which gave Putnam investors access to their cash. 

o