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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 TWELFTH CONGRESS 

SECOND SESSION 

FEBRUARY 29, 2012 

Printed for the use of the Committee on Financial Services 

Serial No. 112–103 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

SPENCER BACHUS, Alabama, Chairman 

JEB HENSARLING, Texas, Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

THADDEUS G. McCOTTER, Michigan 

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 

NAN A. S. HAYWORTH, New York 

JAMES B. RENACCI, Ohio 

ROBERT HURT, Virginia 

ROBERT J. DOLD, Illinois 

DAVID SCHWEIKERT, Arizona 

MICHAEL G. GRIMM, New York 

FRANCISCO ‘‘QUICO’’ CANSECO, Texas 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

BARNEY FRANK, Massachusetts, Ranking 

Member 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

JAMES H. CLINGER, Staff Director and Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

February 29, 2012 ............................................................................................ 1 

Appendix: 

February 29, 2012 ............................................................................................ 53 

WITNESSES 

WEDNESDAY, FEBRUARY 29, 2012 

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

System ................................................................................................................... 6 

APPENDIX 

Prepared statements: 

Paul, Hon. Ron .................................................................................................. 54 

Bernanke, Hon. Ben S. ..................................................................................... 56 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Bernanke, Hon. Ben S.: 

Monetary Policy Report to the Congress, dated February 29, 2012 ............. 65 

Written responses to questions submitted by Chairman Bachus ................. 129 

Written responses to questions submitted by Representative Fitzpatrick .. 131 

Written responses to questions submitted by Representative 

Luetkemeyer .................................................................................................. 134 

Written responses to questions submitted by Representative Schweikert .. 136 

(1) 

MONETARY POLICY AND THE 

STATE OF THE ECONOMY 

Wednesday, February 29, 2012 

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The committee met, pursuant to notice, at 10 a.m., in room 2128, 

Rayburn House Office Building, Hon. Spencer Bachus [chairman of 

the committee] presiding. 

Members present: Representatives Bachus, Hensarling, Royce, 

Paul, Biggert, Capito, Garrett, Neugebauer, McHenry, McCotter, 

Pearce, Posey, Fitzpatrick, Luetkemeyer, Huizenga, Duffy, 

Hayworth, Renacci, Hurt, Dold, Schweikert, Grimm, Canseco, Stivers, Fincher; Frank, Waters, Maloney, Velazquez, Watt, Ackerman, 

Sherman, Meeks, Capuano, Hinojosa, Clay, McCarthy of New York, 

Baca, Lynch, Miller of North Carolina, Scott, Green, Cleaver, 

Ellison, Perlmutter, Donnelly, Carson, Himes, Peters, and Carney. 

Chairman BACHUS. This hearing will come to order. We meet 

today to receive the semiannual report to Congress by the Chairman of the Board of Governors of the Federal Reserve System (the 

Fed) on the conduct of monetary policy and the state of the economy. Pursuant to committee rule 3(f)(2), opening statements are 

limited to the chair and ranking minority member of the full committee and the chair and ranking minority member of the Subcommittee on Domestic Monetary Policy and Technology for a period of 8 minutes on each side. 

Without objection, all Members’ written statements will be made 

a part of the record. I recognize myself for 5 minutes for an opening 

statement. 

In my opening statement today, I am going to avoid making any 

predictions about future events since I do not have a crystal ball. 

Nor do you, Mr. Chairman. Instead, I am going to address two subjects: the need for long-term entitlement reform; and the Federal 

Reserve’s dual mandate. 

For the last 3 years, we have operated in a low interest rate environment, which has artificially lowered the cost of our debt servicing. This temporary respite will not last forever. 

Chairman Bernanke, in each of your past appearances before 

this committee, you and I have discussed the dangers posed to the 

U.S. economy by record levels of debt and deficits and the critical 

need for entitlement reform. 

Let’s have order in the committee, and respect from all of the 

Members, and that will go for the staff, as well. 

2 

We have discussed how long-term restructuring of our entitlement programs will have clear benefits for our economy today and 

will give our country a greater chance of success in the long term. 

Fortunately, and sadly, too few in Washington appear to be listening to this discussion. Your appearance here today is yet another 

opportunity for us to have this important dialogue, and it is my 

hope that Congress and the White House will join together and address entitlement reform. And as we have discussed, this is not 

something the Federal Reserve can do. You have kept interest 

rates low. It has given us an opportunity, but it is not an opportunity that will last forever. 

Your appearance is also an opportunity for us to have another 

important dialogue, this one on the Federal Reserve’s dual mandate. You discuss this in your opening statement. The Federal Reserve’s conduct of monetary policy through the manipulation of interest rates and its control of the money supply implies a certain 

level of government management of the economy. While this makes 

some Americans uncomfortable, and makes me uncomfortable at 

times, there is a general recognition of the need for an independent 

central bank to set monetary policy. Yet, if one closely examines 

the Federal Reserve’s dual mandate—price stability; and maximum 

employment—it quickly becomes apparent that while the first part 

of that mandate involves monetary policy, the second is largely a 

function of economic policy. You acknowledge this, Chairman 

Bernanke, in your testimony for today’s hearing when you state 

that ‘‘while maximum employment stands on an equal footing with 

price stability as an objective of monetary policy, the maximum 

level of employment in an economy is largely determined by nonmonetary factors that affect the structure and dynamics of the 

labor market. 

‘‘By giving the Federal Reserve a mandate that includes maximum employment, it is fair to ask whether we have surrendered 

too much control over the economy to a government agency and 

whether a mandate that is more centrally focused on monetary policy would be a better approach.’’ 

In other words, the Federal Reserve would continue to deal with 

monetary policy, but would not have responsibility or the burden, 

and really you don’t have the power, to control economic events. Indeed, for the first 65 years of its existence, the Federal Reserve did 

not operate under a dual mandate. It was only in 1977 that Congress passed a law requiring the Federal Reserve to promote both 

maximum employment and price stability. It may therefore be appropriate for Congress to revisit the dual mandate with an eye towards refocusing the Fed on its core mission of long-term price stability and other matters that constitute monetary policy. The Congress, on the other hand, could focus on employment, because it is 

and continues to be our responsibility to focus on jobs. 

Chairman Bernanke, I know all of us look forward to your testimony. I now recognize the ranking member, Mr. Frank. 

Mr. FRANK. Thank you, Mr. Chairman. I will accept your invitation for a civil debate on these subjects. Let me begin with the deficit reduction, which I agree is a great requirement, but I disagree 

with this focus which you reflect on entitlement reform. Before I 

reduce Social Security payments to elderly people—particularly, for 

3 

example, those who want to reduce the cost-of-living increase so 

that 82-year old women living on a fairly modest income would get 

less of a compensation for inflation, particularly since healthcare 

costs are a major cost for them and go up more than regular inflation—I think we should withdraw from Afghanistan. 

I support the President’s decision to withdraw troops from Iraq, 

and I know that many on the Republican side have been critical 

of that. We do have to reduce spending. But we spend far more as 

a favor to much of the rest of the world on the military than we 

need to. And before I will impose costs on elderly Americans, I 

should add, I regard the enactment of Social Security and Medicare 

as two of the great accomplishments of this country in the 20th 

Century. They were opposed on partisan grounds, both of them, 

when they came. Yes, there are some areas where there can be 

greater efficiencies, but the notion that that is the major place you 

get savings, when we continue to spend 5.4 percent or more or less, 

but around 5 percent of our gross domestic product on the military 

while our NATO allies spend 1.7 percent and get the benefit of an 

enormous subsidy from us, makes no sense. When people are critical of the President’s proposal to begin to withdraw from Afghanistan, I think it ought to be done more quickly, and then tell me 

that they want to cut the deficit and don’t want to raise taxes, I 

fear for Social Security and Medicare because to do that would require cuts in those programs that go far beyond efficiency or reference to sort of reduce what goes to people in the upper-income 

brackets. 

I particularly welcome this debate on the dual mandate because 

I think there is an illogic in the way it was just stated. It is true 

that the Federal Reserve has more direct impact control of the 

monetary policy than it does over employment, but the point is that 

monetary policy, the level of interest rates, has an effect on employment. The notion that they are unconnected, obviously, isn’t 

the case. The chairman didn’t say that, but I think that is the implication of saying that the Federal Reserve shouldn’t be dealing 

with employment. 

In fact, let me give an example. We have had a debate about 

what should have been done because of mortgages being given that 

shouldn’t have been given. One argument has been that the Federal Reserve should have shut down the whole economy to some extent by raising interest rates, that it should have deflated the bubble by raising interest rates, with a consequent negative effect on 

employment as well as other things. Many of us believe instead 

that the Federal Reserve under Mr. Bernanke’s predecessor—not 

him—should have used the authority this Congress gave him in 

1994 to prevent the bad mortgages; that is, that there should have 

been more targeted efforts to deal with this rather than deflate the 

economy as a whole as a way of dealing with that problem. 

We do have a serious employment problem. It is to Mr. 

Bernanke’s credit that he has taken seriously this dual mandate, 

and this shouldn’t be a partisan issue. I think people may sometimes forget that Mr. Bernanke, whose work in this job I greatly 

admire, was one of the highest ranking appointees on economic 

matters by President George W. Bush. He was Chair, I believe, of 

the Council of Economic Advisors. It was President Bush who apVerDate Nov 24 2008 18:30 Nov 19, 2012 Jkt 075075 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\75075.TXT TERRI
4 

pointed him to the Federal Reserve. He is an example of bipartisanship, and what I find is that while a lot of my colleagues like 

bipartisanship in principle, they just have never found an example 

of it that they want to tolerate. Mr. Bernanke’s concern for inflation and employment is a very good one, and the notion that we 

should say okay to the Federal Reserve, you don’t pay attention to 

employment, we will handle that, and you should simply try to prevent inflation invites them to impose an interest rates regime 

which would be unfortunate. And by the way, I would contrast the 

Federal Reserve under our dual mandate with the European Central Bank until recently with their unitary mandate of just inflation. I think, frankly, that the Federal Reserve’s record in trying 

to deal with the balanced economy has been a better one, and to 

some extent the European Central Bank has improved partly because they have almost explicitly been following the model of the 

U.S. Federal Reserve, which has cooperated with them. 

So yes, I think we should reduce the deficit, but to talk about 

doing that by cutting Social Security, and Medicare to the exclusion, in fact, many of my colleagues want to spend even more on 

the military as this great gift to the rest of the world so they don’t 

have to spend on their own, and the notion that the Federal Reserve, a very powerful economic entity, should set interest rates 

with no regard for their impact on employment both seem to be 

wrong, and I think the country would benefit from that kind of debate. 

Chairman BACHUS. I thank the gentleman. And let me simply 

say that I think we could address both of them. I don’t think that 

they are mutually exclusive, and as you know, I have a son who 

served in the Marines, and— 

Mr. FRANK. Mr. Chairman, if we are getting in extra things, I 

would simply respond to what you said, and you are a representative of a large group that talks about entitlements and the military 

only comes up as an afterthought. 

Chairman BACHUS. I think it needs to be a grand bargain. We 

discussed that, and I think we need to agree on that. Everything 

ought to be on the table but without entitlement reforms we won’t 

get— 

Mr. FRANK. Mr. Chairman, are we going to continue this debate 

after our 5 minutes? 

Chairman BACHUS. All right, at this time Mr. Paul, your thorn 

in the flesh, is recognized for 3 minutes. 

Dr. PAUL. Thank you, Mr. Chairman, and welcome, Chairman 

Bernanke. I guess over the last 30 or 40 years I have criticized the 

Fed on occasion, but the Congress deserves some criticism, too. The 

Federal Reserve is a creature of the Congress, and if we don’t know 

what the Fed is doing, we have the authority and we certainly have 

the authority to pursue a lot more oversight, which I would like to 

see. 

So although the Fed is on the receiving end, and I think rightfully so when you look at the record, the Fed has been around for 

99 years, a few years before you took it over, and 99 percent, 98 

percent of the dollar value is gone from the 1913 dollar. So that 

is not really a very good record. And I think what we are witnessing today is the end stages of a grand experiment, a philoVerDate Nov 24 2008 18:30 Nov 19, 2012 Jkt 075075 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 K:\DOCS\75075.TXT TERRI
5 

sophical experiment on total fiat money. Yes, they have been debasing currencies for hundreds, if not thousands of years, and it always ends badly. They always return to market-based money, 

which is commodity money, gold and silver. But this experiment is 

something different than we have ever had before, and it started 

in 1971, where we were actually given an opportunity in many 

ways to be the issuer of the fiat currency, and we had way too 

many benefits from that than people realized. 

But it has gone on for 40 years and people keep arguing from the 

other side of this argument that it is working, it is doing well, and 

yet, from my viewpoint and the viewpoint of the free-market economists, all it is doing is building a bigger and bigger bubble. And 

the free-market economists were the ones who predicted the 

NASDAQ bubble, the housing bubbles, but we never hear from the 

Keynesian liberal economists and the central bankers saying watch 

out, there is a bubble out there. There is too much credit, too many 

problems there. There is a housing bubble. We have to deal with 

it. Usually, we get reassurance from the Fed on that. 

But I believe that there is a logical reason for this, because the 

Federal Reserve is given a responsibility to protect the value of the 

dollar. That is what stable prices are all about. We don’t even have 

a definition of a dollar. We ask about the definition of a dollar; oh, 

it is whatever it buys. Every single day it buys less than the next 

day. To me, it is sort of like building an economy and having economic planning, like a builder had a yardstick that changed its 

value every single day. Just think of the kind of building you would 

have. This is why we have this imbalance in our economic system. 

But it was a system designed to pyramid debt. We have a debtbased system. The more debt we have and the more debt that the 

Federal Reserve buys, the more currency they can print, and they 

monetize this debt. And no wonder we are in a debt crisis. It is 

worldwide. I think it is something we have never experienced before. And I think the conclusion would be a vindication either for 

sound money, or if you win the argument and say yes, we are great 

managers, we know how to do it, we want the credit for the good 

times, and we want the credit for getting us out of those good 

times, I think within a few years, we are going to know. Of course, 

I am betting that the market is smarter, commodity money is 

smarter, nobody is smart enough to have central economic planning. So I am anxiously waiting for this day, for the conclusion, because reforms have to come. They are already talking about—when 

you see Robert Zoellick talking about monetary reforms, and talking about gold, the time has come for serious discussion on monetary reform. 

Thank you, Mr. Chairman. 

Chairman BACHUS. Thank you, Dr. Paul, for that statement. And 

at this time, the gentleman from North Carolina, Mr. Watt, is recognized for 3 minutes. 

Mr. WATT. Thank you, Mr. Chairman, and I appreciate the opportunity to substitute for my friend, William Lacy Clay, the ranking member of the subcommittee, because he is unable to be here 

due to a conflict. 

And I am glad to see my friend President Paul back from the 

campaign trail. This seems to me like deja vu all over again since 

6 

I was the chairman of the Monetary Policy Subcommittee and he 

was the ranking member, and I got to go back to back with him 

quite often. 

Since I am substituting, I think I can do something kind of out 

of the ordinary today, and that is praise the work of my good 

friend, Chairman Bernanke, for doing his job and really not bowing 

to the political pressure of either the right or left, or political pressure of Republicans and Democrats, since the Federal Reserve is 

supposed to be free of all of those influences. I just think he has 

done a magnificent job, and the Fed has done a magnificent job of 

navigating us through some very, very difficult times, even as we 

will, I am sure, experience in today’s sharing in the midst of criticisms about the dual mandate, which the chairman has already 

raised, which I am sure the Federal Reserve certainly can’t do anything about. We gave them that mandate. They can’t refuse to do 

it. Criticisms about inflation-fighting policy, steps required for recovery of the economy, interest rate policies, quantitative easing, 

transparency, involvement with the European Union and the rest 

of the world, involvement with the IMF, there is going to be plenty 

of criticism to go around today, and so I am pleased to have this 

opportunity to say thank you on behalf of myself, and hopefully 

some other members of the committee, and certainly members of 

private enterprise who believe that the Fed has stayed steady, and 

followed a course of action that has really saved our economy rather than leading us into the kind of defaults and problems that we 

could have experienced in these turbulent economic times. 

So I say that, and I yield back, Mr. Chairman. 

Chairman BACHUS. Thank you, Mr. Watt. I think you gave a 

very thoughtful statement, and I think Mr. Clay would approve of 

your statement. 

I will pick up on what Mr. Watt said, and thank you for being 

here, Chairman Bernanke. You do have a difficult job. You have 

tremendous challenges that face the country. 

Chairman Bernanke has informed us that he will need to leave 

at 1 p.m., and it is a gracious accommodation to be here for that 

length of time, so the Chair will strictly enforce the 5-minute rule. 

Without objection, Chairman Bernanke, your written statement 

will be made a part of the record, and you will now be recognized 

for a summary of your testimony. 

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

SYSTEM 

Mr. BERNANKE. Thank you. Chairman Bachus, Ranking Member 

Frank, and other members of the committee, I am pleased to 

present the Federal Reserve’s semiannual Monetary Policy Report 

to the Congress. Let me begin with the discussion of current economic conditions and the outlook, and then I will turn to monetary 

policy. 

The recovery of the U.S. economy continues, but the pace of expansion has been uneven and modest by historical standards. After 

minimal gains in the first half of last year, real GDP increased that 

a 21⁄4 percent annual rate in the second half. The limited information available for 2012 is consistent with growth proceeding, in 

7 

coming quarters, at a pace close to or somewhat above the pace 

that was registered during the second half of last year. 

We have seen some positive developments in the labor market. 

Private payroll employment has increased by 165,000 jobs per 

month on average since the middle of last year and nearly 260,000 

new private sector jobs were added in January. The job gains in 

recent months have been relatively widespread across industries. 

In the public sector, by contrast, layoffs by State and local governments have continued. The unemployment rate hovered around 9 

percent for much of last year, but has moved down appreciably 

since September, reaching 8.3 percent in January. New claims for 

unemployment insurance benefits have also moderated. 

The decline in the unemployment rate over the past year has 

been somewhat more rapid than might have been expected given 

that the economy appears to have been growing during that timeframe at or below its longer-term trend; continued improvement in 

the job market is likely to require stronger growth in final demand 

and production. And notwithstanding the better recent data, the 

job market does remain far from normal. The unemployment rate 

remains elevated, long-term unemployment is still near record levels, and the number of persons working part time for economic reasons is very high. 

Household spending advanced moderately in the second half of 

last year, boosted by a fourth quarter surge in motor vehicle purchases that was facilitated by an easing of constraints on supply 

related to the earthquake in Japan. However, the fundamentals 

that support spending continue to be weak. Real household income 

and wealth were flat in 2011, and access to credit remains restricted for many potential borrowers. Consumer sentiment, which 

dropped sharply last summer, has since rebounded but remains relatively low. 

In the housing sector, affordability has increased dramatically as 

a result of decline in house prices and historically low interest 

rates on conventional mortgages. Unfortunately, many potential 

buyers lack the downpayment and credit history required to qualify 

for loans. Others are reluctant to buy a house now because of concerns about their income, employment prospects, and the future 

path of house prices. On the supply side of the market, about 30 

percent of recent home sales have consisted of foreclosed or distressed properties, and home vacancy rates remain high, putting 

downward pressure on house prices. More positive signs include a 

pickup in construction in the multifamily sector and recent increases in home builder sentiment. 

Manufacturing production has increased 15 percent since the 

trough of the recession and has posted solid gains since the middle 

of last year, supported by the recovery in motor vehicle supply 

chains and ongoing increases in business investment and exports. 

Real business spending for investment of equipment and software 

rose at an annual rate of about 12 percent over the second half of 

2011, a bit faster than the first half of the year. But real export 

growth, while remaining solid, slowed somewhat over the same period as foreign economic activity decelerated, particularly in Europe. The Members of the Board and the Presidents of the Federal 

Reserve Banks recently projected that economic activity in 2012 

8 

will expand at or somewhat above the pace registered in the second 

half of last year. Specifically, their projections for growth in real 

GDP this year, provided in conjunction with the January meeting 

of the FOMC, have a central tendency of 2.2 to 2.7 percent. These 

forecasts were considerably lower than the projections they made 

last June. 

A number of factors have played a role in this reassessment. 

First, the annual revisions to the national income and product accounts released last summer indicated the recovery had been somewhat slower than previously estimated. In addition, fiscal and financial strains in Europe have weighed on financial conditions and 

global economic growth, and problems in U.S. housing and mortgage markets have continued to hold down not only construction 

and related industries, but also household wealth and confidence. 

Looking beyond 2012, FOMC participants expect that economic activity will pick up gradually as these headwinds fade, supported by 

a continuation of the highly accommodative stance for monetary 

policy. 

With output growth in 2012 projected to remain close to its 

longer run trend, participants did not anticipate further substantial declines in the unemployment rate over the course of the year. 

Looking beyond this year, FOMC participants expect the unemployment rate to continue to edge down only slowly towards levels consistent with the committee’s statutory mandate. In light of the 

somewhat different signals received recently from the labor market 

than from indicators of final demand and production, however, it 

will be especially important to evaluate incoming information to assess the underlying pace of the economic recovery. 

At our January meeting, participants agreed that strains in global financial markets posed significant downside risk to the economic outlook. Investors’ concerns about fiscal deficit and the level 

of government debt in a number of European countries have led to 

substantial increases in sovereign borrowing costs, stresses in the 

European banking system, and associated reductions in the availability of credit, and economic activity in the euro area. 

To help prevent strains in Europe from spilling over to the U.S. 

economy, the Federal Reserve in November agreed to extend and 

to modify the terms of its swap lines with other major central 

banks, and it continues to monitor the European exposures of U.S. 

financial institutions. A number of constructive policy actions have 

been taken of late in Europe, including the European Central 

Bank’s program to extend 3-year collateralized loans to European 

financial institutions. Most recently, European policymakers agreed 

on a new package of measures for Greece, which combines additional official sector loans with a sizeable reduction of Greek debt 

held by the private sector. However, critical fiscal and financial 

challenges remain for the euro zone, the resolution of which will require concerted action on the part of European authorities. Further 

steps will also be required to boost growth and competitiveness in 

a number of countries. We are in frequent contact with our counterparts in Europe and will continue to follow the situation closely. 

As I discussed in my July testimony, inflation picked up during 

the early part of 2011. A surge in the price of oil and other commodities along with supply disruptions associated with the disaster 

9 

in Japan that put upward pressure on motor vehicle prices pushed 

overall inflation to an annual rate of more than 3 percent over the 

first half of last year. As we had expected, however, these factors 

proved transitory and inflation moderated to an annual rate of 11⁄2

percent during the second half of the year, close to its average pace 

in the preceding 2 years. In the projections made in January, the 

Committee anticipated that over coming quarters, inflation will run 

at or below the 2 percent level we judge most consistent with our 

statutory mandate. Specifically, the central tendency of participants’ forecast for inflation in 2012 ranged from 1.4 to 1.8 percent, 

about unchanged from the projections made last June. Looking further ahead, participants expected the subdued level of inflation to 

persist beyond this year. Since these projections were made, gasoline prices have moved up, primarily reflecting higher global oil 

prices, a development that is likely to push up inflation temporarily 

while reducing consumers’ purchasing power. We will continue to 

monitor energy markets carefully. Longer-term inflation expectations as measured by surveys and financial market indicators appear consistent with the view that inflation will remain subdued. 

Against this backdrop of restrained growth, persistent downside 

risk to the outlook for real activity, and moderating inflation, the 

Committee took several steps to provide additional monetary accommodation during the second half of 2011 and in early 2012. 

These steps included changes to the forward rate guidance included 

in the Committee’s post-meeting statements and adjustments to 

the Federal Reserve’s holdings of Treasury and agency securities. 

The target range for the Federal funds rate remains at 0 to 1⁄4 percent, and the forward guidance language in the FOMC policy statement provides an indication of how long the Committee expects 

that target range to be appropriate. 

In August, the Committee clarified the forward guidance language, noting that economic conditions, including low rates of resource utilization and the subdued outlook for inflation over the 

medium run, were likely to warrant exceptionally low levels for 

Federal funds rate at least through the middle of 2013. By providing a longer time horizon than had been previously expected by 

the public, the statement tended to put downward pressure on 

longer-term interest rates. 

At the January 2012 FOMC meeting, the Committee amended 

the forward guidance, further extending the horizon over which it 

expects economic conditions to warrant exceptionally low levels of 

the Federal funds rate to at least through late 2014. 

In addition to the adjustments made to the forward guidance, the 

Committee modified its policies regarding the Federal Reserve’s 

holding of securities. In September, the Committee put in place a 

maturity extension program that combines purchases of longerterm Treasury securities with sales of shorter-term Treasury securities. The objective of this program is to lengthen the average maturity of our securities holdings without generating a significant 

change in the size of our balance sheet. Removing longer-term securities from the market should put downward pressure on longerterm interest rates and help make financial conditions more supportive of economic growth than they otherwise would have been. 

To help support conditions in the mortgage markets, the ComVerDate Nov 24 2008 18:30 Nov 19, 2012 Jkt 075075 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 K:\DOCS\75075.TXT TERRI
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mittee also decided at a September meeting to reinvest principal 

received from its holdings of agency debt and agency MBS in agency MBS, rather than continuing to reinvest those proceeds in 

longer-term Treasury securities as had been the practice since August 2010. The Committee reviews the size and composition of its 

security holdings regularly and is prepared to adjust those holdings 

as appropriate to promote a stronger economic recovery in the context of price stability. 

Before concluding, I would like to say a few words about the 

statement of longer-run goals and policy strategy that the FOMC 

issued at the conclusion of its January meeting. The statement reaffirms our commitment to our statutory objectives given to us by 

the Congress of price stability and maximum employment. Its purpose is to provide additional transparency and increase the effectiveness on monetary policy. The statement does not imply a 

change in how the Committee conducts policy. 

Transparency is enhanced by providing greater specificity about 

our objectives. Because the inflation rate over the longer run is determined primarily by monetary policy, it is feasible and appropriate for the Committee to set a numerical goal for that key variable. The FOMC judges that an inflation 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 

its statutory mandate. While maximum employment stands on an 

equal footing with price stability as an objective of monetary policy, 

the maximum level of employment in an economy is largely determined by non-monetary factors that affect the structure and dynamics of the labor market. It is therefore not feasible for any central bank to specify a fixed goal for the longer-run level of employment. However, the Committee can estimate the level of maximum 

employment and use that estimate to inform its policy decisions. In 

our most recent projections, in January for example, FOMC participants’ estimates of the longer-run normal rate of unemployment 

had a central tendency of 5.2 to 6.0 percent. As I noted a moment 

ago, the level of maximum employment in an economy is subject 

to change. For instance, it can be affected by shifts in the structure 

of the economy and by a range of economic policies. If at some 

stage the Committee estimated that the maximum level of employment had increased, for example, we would adjust monetary policy 

accordingly. 

The dual objectives of price stability and maximum employment 

are generally complementary. Indeed, at present, with the unemployment rate elevated and the inflation outlook subdued, the Committee judges that sustaining a highly accommodative stance for 

monetary policy is consistent with promoting both objectives. However, in cases where these objectives are not complementary, the 

Committee follows a balanced approach in promoting them, taking 

into account the magnitude of the deviations of inflation in employment from levels judged to be consistent with the dual mandate, 

as well as potentially different time horizons over which employment and inflation are projected to return to such levels. 

Thank you, and I would be pleased to take your questions. 

[The prepared statement of Chairman Bernanke can be found on 

page 56 of the appendix.] 

11 

Chairman BACHUS. Thank you, Chairman Bernanke. Chairman 

Bernanke, the biggest driver of the ever-increasing deficits this Nation faces is the runaway growth in all of our major entitlement 

programs: Medicare; Medicaid; and Social Security. You have repeatedly stressed that the United States needs to return the Federal Government to a sound fiscal footing over the long term. Yet, 

the Administration’s 2013 fiscal budget does nothing to reform 

these programs or rein in their costs. 

Now, we did address military spending with cuts in the budget 

and with sequestration, but if we fail to reform our major entitlement programs, what will be some of the consequences? And if we 

do make major long-term structural changes on entitlement programs, do you see immediate or short-term benefits? 

Mr. BERNANKE. Yes, Mr. Chairman, thank you. I have often, as 

you noted, talked about the importance of establishing long-run fiscal sustainability in the United States. If you take a look at the 

Congressional Budget Office’s report that recently came out, what 

you see is that under current law, which is the basis of the projections they have to make, over the next 10 to 15 years you begin 

to see an increasing acceleration in the size of the debts and deficits. It reaches a point where obviously it is just not going to be 

sustainable. Once the markets lose confidence in the ability of the 

government to maintain fiscal sustainability, then there are numerous risks. The most extreme case would be a financial crisis or 

a sharp increase in interest rates, analogous to what we have seen 

in some European countries. Even absent that extreme result, 

large deficits and debt over a longer period of time raise interest 

rates above levels where they normally would be and crowd out private investment and are bad for growth and productivity. They also 

involve borrowing from foreign lenders, which also is a drain on 

current U.S. income. 

So it is important to address this issue. I guess one point I would 

make is that there may be some problems with the focus on the 

10-year window that is part of the effective analysis of the Congress since many of the problems are really just becoming more severe after 10 years. So I would ask Congress to consider not just 

the 10-year window, but the longer horizon implications of their 

policy decisions. 

Would they have benefits for today? I think that a credible plan 

put in place that would strengthen the view that the United States 

would be fiscally sustainable in the longer term, it would have current benefits in terms of lower expected tax rates, greater confidence, and perhaps lower interest rates. 

Chairman BACHUS. Thank you, Chairman Bernanke. Chairman 

Bernanke, you are a member of the Financial Stability Oversight 

Council (FSOC), which is charged with responding to threats to financial stability and mitigating the problem of too-big-to-fail. The 

Economist recently published a piece on the Dodd-Frank Act entitled, ‘‘Too Big Not To Fail,’’ which noted that there is never more 

apparent risk that the harm done by the massive cost and complexity of its regulations and the effects of its internal inconsistencies will outweigh what good may come of it. 

Will the Financial Stability Oversight Council consider the threat 

to financial stability that the cost and complexity of Dodd-Frank 

12 

poses to the financial system and offer advice on how to minimize 

that cost and complexity, and how do you view the Fed’s role in 

that process? 

Mr. BERNANKE. Yes, Mr. Chairman. I have actually been quite 

pleased with the functioning of the FSOC. We have met regularly. 

The meetings involve essentially every principal, who come to every 

meeting. We have good discussions, and between the formal meetings, we have extensive discussion among the senior staff of the 

various agencies. So, there has been a lot of interaction. 

I think there are a lot of benefits to coordination. We have talked 

to each other about making sure our policies are as consistent as 

possible, that they provide a level playing field and obviously, 

where we can avoid redundancy and successive complication, we 

want to do that. 

At the Federal Reserve’s level, we support the basic goals of 

Dodd-Frank, which are to create a more macro-prudential approach 

to supervision to make sure that we are looking for systemic risks 

as well as risks to individual institutions, to make sure that our 

large institutions have more capital, more liquidity, and are better 

supervised. All those are the key goals. We understand that the 

specifics of the regulations make a big difference. It is very important to make sure that we get the best result for the least burden. 

And we have a process of both comments, consultations, and of 

course cost-benefit analyses to try to make sure that we are putting 

out rules that are, on the one hand, effective at reducing the risk 

of financial crisis, but that minimize the regulatory cost; particularly, I would add, for the smallest banks, which are least able to 

deal with those costs. 

Chairman BACHUS. Thank you very much. 

Ranking Member Frank? 

Mr. FRANK. Mr. Chairman, thank you for that implicit refutation 

of the notion that the financial reform bill is causing people all of 

these terrible problems. I should point out, by the way, that its bipartisan nature has not been fully understood. In addition to yourself, one of the major contributors to that bill was another appointee of President Bush whom I greatly admired, Sheila Bair, 

who was head of the FDIC. I was at the Treasury Department and 

noted the portrait of Hank Paulson that has gone up in which a 

write-up that obviously was with his approval at least, noted his 

having initiated many of the reforms that wound up in the financial reform bill. So Mr. Paulson, who was also there. 

I do want to go back again to the deficit, because the chairman 

said to me, yes, he agrees it should be the military, but again he 

only talks about the entitlements. And when you talk about the 

level of reduction we need, if you are going to get that all out of 

Social Security and Medicare and not go elsewhere, you are going 

to be doing damage. And I believe you start with overseas military 

expenditures that are quite excessive. Let me just ask you from an 

economic standpoint, given the importance of a longer-term policy 

to produce a deficit, from a purely economic standpoint, there are 

policy preferences that I know you don’t want to get into, but from 

the purely macroeconomic standpoint, would it be greatly different 

if those came from, say, reducing the cost of living increases, Social 

Security or restricting Medicare, or from some change in the Tax 

13 

Code at the upper levels of income? Would there be any macroeconomic difference? 

Mr. BERNANKE. From a macroeconomic perspective, the main 

thing is to achieve sustainability, which means that deficits come 

under control, and debt to GDP ratio— 

Mr. FRANK. So it didn’t make that much difference which way 

you did it from the macroeconomic standpoint? 

Mr. BERNANKE. Of course, it is important to make good decisions 

about how you spend your money. 

Mr. FRANK. I appreciate that, but I just want to go back to this 

question of the dual mandate and the notion that somehow you 

really can’t do much about employment. You repudiate that, and I 

think you have not just done this rhetorically; you have done it in 

practice. About a year ago, two very distinguished economists, Alan 

Blinder and Mark Zandi, did a paper about how the Great Recession was brought to an end. Now, Mr. Blinder was a Democrat. He 

was the Vice Chair with you at the Fed, but Mr. Zandi has been 

bipartisan, and let me quote from them. They talk about aggressive 

fiscal and monetary policies that not only averted a Great Depression but are resulting now in the beginnings of a recovery. When 

we divide these into two components, one attributed to the fiscal 

stimulus and other to financial market policies, including the Fed’s 

quantitative easement, we estimate that the latter was substantially more powerful than the former. In other words, this assessment of how we did better says that monetary policy and things 

within the jurisdiction of the Fed were even more important than 

the stimulus, although they thought the stimulus was important. 

So this effort to denigrate the role you can play in that seems to 

be greatly mistaken. 

I also have handed out a chart to the press, and I would ask people who have a copy to look to page 17 of your report. And there 

is a chart on the bottom, ‘‘Net change in private payroll employment, 2005 to 2012.’’ It measures monthly job loss. The nadir of 

this, the lowest point, the worst monthly job loss comes in early 

2009, in other words, just after the change in Administrations. And 

you then are beginning, and I would say this looks like February 

or March of 2009, you get one of the steepest rises I have ever 

seen. You get a very substantial, an almost vertical increase in employment that takes place. You have a drop of the numbers losing, 

and then it hits, in early 2010 it goes into a positive thing. It levels 

off. I think that Europe was part of the problem, and then it starts 

to rise again. And I would note not only does this show a very significantly—it shows the worst employment position was right 

around the time of the changes in Administrations, but very substantial increases beginning with early 2009, and a point now 

where the monthly increases in 2012 are equal to what they were 

in 2005. We have come back now. The total losses were so great 

during that period below the line that we haven’t yet undercut it. 

I would also note that you correctly point out that while we have 

done very substantial improvements in the private sector, not yet 

what we want, that has been diminished somewhat by reductions 

in State and local government. And the fact is if State and local 

government had been even, no gains, but hadn’t lost over half a 

million, then unemployment would now be under 7 percent. 

14 

Now, let me ask you because we are moving along. As I see it, 

one of the major problems we have—and I guess I won’t even ask 

you to comment. I will say this. I think I am reflecting what you 

said, that one of the major obstacles or the major problems that 

might keep us from a continued upward trend, which is a good 

trend, although slower than we would like, would be troubles in 

Europe. I should just note, I think the role that you and your agency have played in helping to get Europe to avoid greater troubles 

has been very helpful. And I think it is striking that you were getting criticism, particularly on the Republican side, but some from 

people on the left for a series of very constructive actions. 

So I just wanted to express my support for what you have been 

doing with the swap agreement, and in other ways, because the 

greatest threat to the American economy at this point is in Europe. 

I should note, by the way, thanks in part to what we have been 

doing here where there are problems, the American economy, I 

think, is the best performing economy of the developed world right 

now of any size, and you have been helping that. And the attacks 

on what the Fed has been doing to try and keep you from continuing to encourage the right kinds of things in Europe are about 

as disastrous a prescription for American policy, and I hope you 

will continue to ignore them. 

Chairman BACHUS. Dr. Paul? 

Dr. PAUL. Thank you, Mr. Chairman. Mr. Bernanke, if you don’t 

mind, would you tell me whether or not you do your own shopping 

at the grocery store? 

Mr. BERNANKE. Yes, I do, sir. 

Dr. PAUL. Okay, so you are aware of the prices. This argument 

that the prices are going up about 2 percent, nobody believes it. In 

the old CPI, it says prices are going up about 9 percent so they believe this. People on fixed incomes are really hurting. The middle 

class are really hurting because their inflation rate is very much 

higher than the government tries to tell them, and that is why they 

lose trust in government. But this whole idea about prices and 

debasement of currency, if you loaned me $100, and 2 years from 

now I gave you $90 back, you would be pretty upset. But we pay 

that money back and it is worth 10 or 15 or 20 percent less, and 

nobody seems to be able to do anything about it. It is very upsetting. But it is theft if I don’t give you your full $100 back and you 

loan me $100. I am stealing $10 from you. So somebody is stealing 

wealth and this is very upsetting. But in January, at one of your 

press conferences, you said that—you sort of poked a little bit of 

fun at people to downplay the 2 percent inflation rate, but if you 

say it is 2 and I say it is 9, let’s compromise for the sake of argument; it is 5 percent. You said that it doesn’t hurt you unless you 

are one of those people who stick the money in the mattress. But 

where are you going to put it? Are you going to put it in a CD and 

not make any money at all? So this doesn’t make any sense. It 

doesn’t encourage savings. And it just discourages people. 

But I do want to make a point about prices, because prices go 

up. That, to me, is not the inflation. It is one of the bad consequences of the inflation which comes from the increase in the 

money supply. And that is one of the bad effects. But you took over 

the Fed in 2006. I have a silver ounce here, and this ounce of silver 

15 

back in 2006 would buy over 4 gallons of gasoline. Today, it will 

buy almost 11 gallons of gasoline. That is preservation of value. 

And that is what the market has always said should be money. 

Money comes into effect in a natural way, not in edict, not by fiat 

by governments declaring it is money. 

But why is it that we can’t consider, the two of us, an option? 

You love paper money. I think money should be honest, constitutional, it is still on the books, gold and silver legal tender. Why 

don’t we use it? Why don’t we allow currencies to run parallel? 

They do around the world. One of my options, as much as I would 

like to do something with the Fed, I say the Fed is going to selfdestruct eventually anyway when the money is gone. But why 

wouldn’t we legalize competing currencies? Why couldn’t people 

save, put this in a mattress, and get 4 or 5 times as much of the 

value in a few years. So the record of what you have done in the 

last 6 years is to destroy the value of real money, of paper money, 

at the same time real money is preserved. 

But a competing currency—we already have a silver eagle. It is 

legal tender for a dollar, and some people say well, it is legal tender. It is a dollar. It is on the books and they use it and they get 

into big trouble. The government comes and closes them down. You 

can get arrested for that. But what would be wrong with talking 

about parallel currency, competing currencies? This is something 

that Hayek talked about, something that I think would be a compromise and that we could work along those views. 

Mr. BERNANKE. First of all, it is good to see you again, Congressman Paul. Just one word on inflation. Of course, those numbers are 

constructed by the Bureau of Labor Statistics, not by the Fed. They 

are independently constructed, and I think they are done in a very 

serious and thoughtful way. 

On alternative currencies, nobody prevents you from holding silver or gold if you want to. It is perfectly legal to do that, and it 

is also perfectly fine to hold other currencies, euros or yen or whatever else. So in that respect, you can do that and I would be happy 

to talk to you about— 

Dr. PAUL. But Mr. Chairman, that is not money. When you pay 

taxes to buy a coin or you have capital gains tax, when it is not— 

if you have to settle a lawsuit, it is always settled in depreciating 

Federal Reserve notes. It is never settled in the real contract. So 

that is nothing near money when it is illegal to use it. But to do 

it, you would have to repeal the legal tender laws. You would have 

to legalize this. You would have to get rid of the sales taxes, you 

would have to get rid of the capital gains taxes. People even in 

Mexico, they are talking about this. They are trying to have competing currencies. They have been wiped out too many times with 

inflation, and wiped out the middle class. They are allowing people 

to start to save in a silver currency. 

So I hope we move along in that direction because there 

shouldn’t be any overwhelming changes all of a sudden that there 

could be a transition so people could vote on it. Maybe they will 

give up on the Federal Reserve note and vote for real money. 

Mr. BERNANKE. I would be very happy to talk to you about it. 

Dr. PAUL. Thank you very much. 

Chairman BACHUS. Thank you. 

16 

Ms. Waters? 

Mr. FRANK. Mr. Chairman, can I just make an announcement for 

the Democratic Members? We are going to follow the policy on our 

side. Obviously, we won’t be able to get to everybody here. The 

committee is too big. I wish it wasn’t. But our policy will be when 

Mr. Bernanke comes back for his second appearance this year, we 

will begin where we left off. So Members who do not get to ask a 

question today, we will start from there, and they will get to ask 

questions the second time. Thank you. 

Chairman BACHUS. Thank you. We also have some procedures. 

Dr. Paul and Chairman Bernanke are getting along so marvelously, 

Ms. Waters, and we hope you will continue this cordiality. 

Ms. WATERS. Thank you very much. I am interested in housing. 

Everyone agrees that this economy is not going to rebound until 

the housing market is vigorously operating. So I want to find out 

a little bit about what is happening with the servicers and maybe 

something about principal reduction. 

On February 9th, the Federal Reserve assessed monetary penalties totaling $776 million on the 5 largest market servicers pursuant to the consumer orders you issued in April of 2010. These 

five servicers also happen to be part of the settlement between the 

State Attorneys General and the Federal Government announced 

on the same day. As I understand it, the penalties paid by the 

servicers, under the consent orders issued by the Fed, can be satisfied by loan modifications that they make under the State AG settlement. In other words, unless the servicers fail to comply with 

the settlement with AGs, there will be no monetary penalties for 

servicing violations identified by the consent orders, though we 

don’t know all of the details yet, because the State AG settlement 

terms have not been released. I understand that servicers can satisfy at least some of the requirements of the $26 billion AG settlement by writing down loans, including investor loans, owned loans 

that they service. 

My question is, will servicers be able to use the writedown of 

loans held by investors to satisfy the penalties levied by the Fed 

in response to their unsafe and unsound practices? That is the first 

part of my question. 

Mr. BERNANKE. No, we are part of the overall agreement and by 

participating we helped make it happen. By the way, we just released our engagement letters and action plans for those companies 

that we oversee. The banks will have to verify that they have reduced their own holdings, their own assets by the amount that they 

are taking credit for in the overall holding, and if they don’t meet 

those full amounts, then they will have to pay the rest in cash. 

Ms. WATERS. On the issue of whether to pursue principal reduction modifications on residential mortgages, your report, your Federal Reserve White Paper report acknowledges some of the problems with negative equity, but the report never endorses principal 

reduction as a stabilization strategy. So with that said, I wanted 

to ask you what you thought of the speech by New York Fed President Dudley shortly after your paper came out. In his remarks, Mr. 

Dudley suggested that principal reduction for GSE loans could minimize loss of value on the delinquent loans they guarantee, and 

that a shared appreciation approach could help policymakers withVerDate Nov 24 2008 18:30 Nov 19, 2012 Jkt 075075 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 K:\DOCS\75075.TXT TERRI
17 

out giving certain homeowners a windfall. He also suggests a reduction to people who are current on their payment. 

What do you think of the ideas proposed by Mr. Dudley in his 

speech? Does this approach abort some of the problems with principal reduction you identified in your report? Couldn’t this shared 

appreciation approach discourage homeowners from defaulting 

when they could otherwise pay their mortgage? 

Mr. BERNANKE. First, the Fed has no official position on principal 

reduction, and we were careful not to make explicit recommendations precisely because we thought that was the congressional prerogative to make those determinations. We tried to provide a balanced analysis of principal reduction. 

I think it is a complex subject. It is not that we disagree on the 

goals. We want to reduce foreclosures and delinquencies. We want 

to help people who want to move to be able to do that, but there 

are often a number of alternatives in different situations. For example, if the idea is just to be able to move, then a short sale or 

deed in lieu might be the most effective way to do it. If the goal 

is to reduce payments, then refinancing at a lower interest rate or 

modification might be the most effective way to do it in terms of 

the dollars spent. 

So I think there are some interesting questions from the perspective of public policy about what the best way to proceed is, whether 

that is the most cost-effective approach or not. 

Ms. WATERS. We are really interested, many of us, in principal 

reduction. In your report to Congress you note that facilitating 

principal modifications for all underwater borrowers would be too 

costly, but that identifying targeted segments of borrowers who 

would go to foreclosure without principal reduction is too difficult. 

And I won’t go on to talk about what Mr. Dudley said. 

So if you are not supporting principal reduction, and you are not 

talking about how homeowners can get out from under this foreclosure problem, what are you suggesting we do to improve this 

housing market? 

Mr. BERNANKE. We discuss a whole variety of things in our 

White Paper, though again with the proviso that our goal was to 

provide background analysis that would help the Congress make 

good decisions. For example, we have a big overhang of homes in 

the market. One of the ideas that we have discussed is moving 

REO, that is real estate owned, to rental. That is something that 

the FHFA has begun a pilot program on that is interesting. We 

talked about trying to identify some of the barriers to doing that 

on a large scale. That is one potential direction. 

There are a lot of issues right now with the tightness of mortgage standards where people are not able to get mortgage credit, 

even when they meet the GSE standards. So we have talked about 

clarifying the representations and warranties that are part of the 

mortgage contract. FHFA and the GSEs have in fact looked at that 

as well, and I think that could be a constructive step. 

Servicing is an important issue. You referred to, in the beginning, the servicing agreement. Since early last year, we have put 

consent orders on all of the major servicers requiring them to improve their practices to have principal points of contact for individual borrowers, to provide more counseling, better controls, and 

18 

so on. There are a variety of things that can be done. Not all of 

them are congressional. Some of them are our own responsibilities 

as regulators, but some of them would require some congressional 

input. 

Chairman BACHUS. Thank you. Thank you, Chairman Bernanke. 

The vice chairman of the full committee, Mr. Hensarling, is now 

recognized for 5 minutes. 

Mr. HENSARLING. Thank you, Mr. Chairman. Chairman 

Bernanke, in your testimony you describe the recovery as modest 

relative to historic terms. I would note for the record that in this 

Administration, when you add in those who are underemployed, 

those who have left the labor force due to giving up, the true unemployment rate is 15.4 percent. 

Half of all Americans are now classified by the Census Bureau 

as either low income or in poverty, and one in seven now have to 

rely on food stamps. So from the perspective of my constituents, 

the use of the term ‘‘modest’’ is indeed modest. 

I would like to first return to the subject of our structural debt. 

One of the major players in our economy has said, ‘‘The major driver of our long-term liabilities—everybody here knows it—is Medicare and Medicaid. In our health care spending, nothing comes 

close.’’ That, of course, was President Barack Obama. 

So I would suggest to the ranking member that when convenient, 

he first debate the President on this subject before he debates us. 

And I would ask this simply, Mr. Chairman. Even if we cut the 

Pentagon by 25 percent, make it 50 percent, have we solved the 

long-term structural debt crisis in our Nation? 

Mr. BERNANKE. You refer specifically to health care. And this is 

an area where costs have been going up much faster than GDP. 

The output of the health care industry is not markedly better than 

other countries. So, clearly, not only for fiscal issues, but also for 

private sector productivity, it is an important issue to address. And 

as a matter of arithmetic, it is true that over time, an increasing 

share of the total outlays to the Federal Government will be going 

to Medicare, Medicaid, and other health-related programs. So it is 

very important to address that. 

Mr. HENSARLING. Thank you. 

On page 7 of your testimony, in dealing with your dual mandate, 

you said the maximum level of employment in an economy is largely determined by nonmonetary factors. In my remaining time, I 

really want to pursue this theme. I certainly agree with the assessment, but I question—after 3 years of the most highly accommodative monetary policy, I believe, in the history of our Nation—the recent announcement that we will continue this policy for 2 more 

years. 

I note according to your own statistics that public companies are 

now sitting on $2.1 trillion in excess liquidity. Banks have $1.5 trillion of excess liquidity, which seems to suggest that perhaps monetary policy is not the challenge that we have today. 

Recently, the Dallas Fed President, Richard Fisher, made me 

aware of a Harvard business study showing the greatest impediments to job creation to be taxation, red tape, and uncertainty. A 

recent Gallup Poll of small businesses, of which you may be aware, 

19 

shows that roughly half believe that health care and government 

regulations are what is causing them not to hire more workers. 

You have job creator after job creator, like Bernie Marcus in 

Home Depot, saying, ‘‘I can tell you today that the impediments 

that the government imposes are impossible to deal with; Home 

Depot would have never succeeded if we tried to start today.’’ 

I would add the voices of just about every small business person 

I have talked to in the Fifth Congressional District of Texas, which 

I represent. 

And so, again, it begs two questions: Number one, the limits of 

the efficacy of monetary policy, and frankly, the risk as well. It was 

brought up earlier that we have retirees who are being squeezed, 

pension funds, savers. You certainly know that community banks 

are feeling squeezed. Many of them are lending out on the risk 

curve. 

And I am very grateful that you have shown your concern and 

anxiety over the structural debt, but to some extent, you are one 

of the major players by creating these artificial rates that I would 

argue mask the true cost of our fiscal folly. And to some extent, by 

keeping rates artificially this low, aren’t you simply postponing and 

exacerbating the problem, particularly the unintended consequences of another asset bubble? Do you share these concerns, 

and how do you balance them? 

Mr. BERNANKE. You raise a lot of good points. First, I do think 

the monetary policy has been constructive in bringing employment 

back toward the maximum employment level. Ranking Member 

Frank pointed out the sharp movement in March of 2009. That was 

exactly the date when we began QE1. Since QE2 in November 

2010, there have been 2.5 million new jobs created. Now, I don’t 

claim credit for all of those jobs; of course, many other factors are 

at work. But I think it has been constructive. 

But you are also absolutely right, that in terms of what longterm employment productivity gains can be sustained by this economy, monetary policy is not the answer to that; the answer is certainly the private sector but in a partnership with good other economic policies, ranging from trade to regulation to education to infrastructure to tax code and so on. And all those things are in the 

province of Congress. 

Of course, I certainly agree with you that monetary policy is not 

a panacea, that it could help offset cyclical fluctuations in financial 

crises like we have had, but the long-term health of the economy 

depends mostly on decisions taken by Congress and the Administration. 

Chairman BACHUS. Thank you very much. 

Mrs. Maloney? 

Mrs. MALONEY. Thank you. Welcome, Chairman Bernanke, and 

thank you very much for your public service. 

In your testimony today, you had some encouraging points, specifically that in January, the private sector gained over 260,000 private sector jobs and that we have seen over the past 23 months a 

steady gain in private sector employment, over 3.7 million new jobs 

gained. I believe your chart that the ranking member pointed out 

is very graphic. We were losing 700,000 jobs a month when President Obama took office, and we have been moving forward with 

20 

economic recovery. And I thank you for your leadership, really your 

brave and innovative leadership during this time. 

But we are still facing many, many challenges, including the 

challenge of the long-term unemployed, that seems so persistent 

and deep and strong. Over 40 percent of those who are unemployed 

have been so over 6 months. I would like to know whether you feel 

this is structural, or is this something we can address with improved conditions in our overall economy? 

And I am deeply concerned about the fact that we are facing the 

largest income disparity in the history of our country and that the 

gap seems to be getting larger and larger, and the challenges for 

the middle-, moderate-, and low-income people become stronger for 

them to make progress. The Administration has announced that 

their number one priority is creating jobs, growing our economy. 

What are the things that we could accomplish in order to stabilize 

our economy and create the conditions that would improve the opportunity for more job growth? I, obviously, believe in the dual 

mandate. 

Specifically, do you think that at this point in the cycle, we need 

the kind of budgetary tightness or shrinking of the government 

that my friends on the other side of the aisle are advocating for? 

Doesn’t it make more sense in terms of our fragile economy to have 

more fiscal stimulus, to pass the transportation bill, to help create 

jobs and improvements in our economy? 

And again, thank you for your service. 

Mr. BERNANKE. Thank you. 

It is a very worrisome problem, the very high level of long-term 

unemployment. As you say, 40-plus percent of the unemployed 

have been unemployed for 6 months or more, which is the highest 

by far in the post-war period. I think that happened because the 

decline in the economy was so sharp and so severe in 2008 and 

2009 that firms in a panic-stricken mode just cut many, many 

workers, and many of those people have not found work. 

This has a lot of potentially serious long-run consequences. We 

know that if you lose a job, and you are out of job for a long time 

and you find a new job, it will typically be a much lower paying 

job, for example, or a much less secure job. The concern in particular is that people who are out of work for 6 months or more will 

be starting to lose skills. They will be losing attachment to the 

labor force. They won’t know what is happening in their field or 

their industry. And that is really one reason for urgency, to try to 

get jobs created and try to bring the economy back to a more normal labor market. So that is certainly something to which we are 

paying a lot of attention. 

There is obviously no easy solution here. You asked about fiscal 

policy, and I have tried to make three points about fiscal policy. 

One, as we have already talked about—that achieving long-run 

sustainability and providing comfort to the public and the markets 

that deficits will come under control over a period of time—is very 

important for confidence and for creating more support for the recovery. 

But at the same time, I think you also have to protect the recovery in the near term. Under current law, on January 1, 2013, there 

is going to be a massive fiscal cliff of large spending cuts and tax 

21 

increases. I hope that Congress will look at that and figure out 

ways to achieve the same long-run fiscal improvement without having it all happen one day. So attention should be paid to the— 

Mrs. MALONEY. Mr. Chairman, my time is running out. In some 

ways, monetary policy has replaced fiscal stimulus. And wouldn’t 

the recovery happen faster if we had a better balance between the 

two? Could you comment on the need for more fiscal stimulus— 

Mr. BERNANKE. I think if you do that, it needs to be part of a 

two-handed plan, so to speak. The actions that you take in the 

short run, whether they be infrastructure or education or tax reform or whatever they may be, I hope that they are considered and 

wisely chosen. But it is also important that we keep in mind the 

long-term necessity of making fiscal policy sustainable. So you need 

to think about those two things together. 

Mrs. MALONEY. Thank you very much. 

Chairman BACHUS. Thank you. 

The Chair at this time recognizes the Chair of the Subcommittee 

on Financial Institutions, Mrs. Biggert, who has actually done 

some very good work on housing issues, on housing actually. 

Mrs. BIGGERT. Thank you, Mr. Chairman. And I would like to return to housing for a moment. Today, through FHA and RHS and 

Fannie Mae and Freddie Mac, the Federal Government and taxpayers back nearly 100 percent—it is in the 90 percent range right 

now—of residential mortgages. Is this healthy for the economy, and 

what are the barriers to private capital reentering the mortgage 

lending and the secondary market for home loans? 

Mr. BERNANKE. You are correct that government-supported agencies are now pretty much the entire securitization market. They 

don’t make all the mortgage loans, but they do securitize and buy 

most of the mortgages in the economy. That obviously is not 

healthy. We would like to have a more diversified system with 

greater private-sector participation. We are not seeing that. 

The reasons are not certain. I think, in part, the private label 

(so-called) mortgage markets are still recovering from the shocks of 

the financial crisis. There is still a lot of uncertainty about where 

the housing market is going, and therefore, the uninsured securities that are put together by non-GSE securitizers are not yet as 

appealing as they were before. There is still uncertainty about the 

regulatory and legal framework for securitization in the future. So 

there are a lot of reasons, and we need a more diversified system. 

Mrs. BIGGERT. Does Dodd-Frank help or hurt the reentry of the 

private capital into the market? 

Mr. BERNANKE. I think it is important to create more certainty, 

and we are not there yet. There is still a lot of discussion. 

For example, the Federal Reserve and the other agencies are still 

thinking about risk-retention requirements for example, and those 

have not been specified. So it would be helpful to get greater clarity. 

It would also be helpful to get greater clarity about what the 

long-run housing market or mortgage market structure will be. 

There has been plenty of discussion in this committee about GSE 

reform, about covered bonds and other types of structures, but 

there is still a lot of uncertainty about which way that is going to 

go. 

22 

Mrs. BIGGERT. Thank you. 

And then I go on to another question. The Dodd-Frank effective 

date for the Volcker Rule is July 21st. And we have heard that regulators think it is a daunting task to complete that by then. Do you 

have any plans to phase in implementation of the Volcker Rule? 

Mr. BERNANKE. Yes. The statute allows for a 2-year transition 

period. And so, we will certainly be giving institutions adequate 

time to adjust and adapt to whatever rule is put out. 

Mrs. BIGGERT. Thank you. I have heard from some of my constituent insurance companies that Fed staff has been deployed to 

insurance companies. What is the purpose of their presence, given 

that the insurance companies are regulated by the States? Is the 

Fed simply increasing its insurance expertise, or does Dodd-Frank 

give the Fed the authority to regulate insurers? 

Mr. BERNANKE. No, we don’t have any authority to regulate insurers, unless in the future, a systemically critical insurance company is so designated by the FSOC. That has not happened yet. I 

am not quite sure what you are alluding to. It could be that there 

have been some discussions to give us a better insight into the industry. 

Mrs. BIGGERT. What I am alluding to is that there have been insurance companies where 10 of your staff members have kind of 

moved in and taken up residency, and they don’t exactly know why 

they are there. 

Mr. BERNANKE. I will find out, and I will communicate with you. 

Mrs. BIGGERT. I appreciate that. 

And what kind of discussions are you or your staff having with 

the new Federal Insurance Office (FIO), which was designated to 

be a Federal insurance expert on national and international issues? 

Mr. BERNANKE. We have been interacting with them on the 

FSOC, the Financial Stability Oversight Council, and our staff has 

been interacting in that respect. On your previous question, it 

could be that the insurance companies in question are thrift holding companies because they hold thrifts, in which case we would 

have actually some oversight. 

Mrs. BIGGERT. All right. Thank you. 

I yield back, Mr. Chairman. 

Chairman BACHUS. Thank you. 

Ms. Velazquez? 

Ms. VELAZQUEZ. Thank you, Mr. Chairman. 

Chairman Bernanke, while credit conditions for small businesses 

have improved over the past year, the number of small dollar 

loans, loans of $250,000 or less, remains below pre-recession levels. 

And as you know, these are the type of loans that are important 

to early stage and start-ups. Do you think credit availability for 

these loans will ever fully rebound to the high water mark set in 

2007? 

Mr. BERNANKE. I think there are a number of reasons why the 

number of loans being made is lower. First, given that the economy 

isn’t that strong, the demand for loans is not quite what it was. 

Second, of course, lending standards have tightened since before 

the crisis, and some of that is appropriate, because as you know, 

credit standards were on the whole too easy before the crisis. So 

there are some reasons why lending has fallen, which no doubt will 

23 

improve over time. But I think it is still the case that the pendulum has swung a little bit too far, and we are certainly working 

with banks, particularly small banks. And I will reiterate this point 

that it is incredibly important for banks to take a balanced approach and for examiners to take a balanced approach so that, on 

the one hand, they make safe and sound loans, but that they also 

make loans to credit-worthy borrowers because they are so important for our communities and our economy to recover. 

Ms. VELAZQUEZ. If you look at the type of loans that banks are 

making, they are the big loans, because they are the profitable 

ones. So, in that regard, this is why we passed the small business 

lending bill where the Feds were lending community banks money 

that they used to pay TARP money back, but they didn’t make the 

loans that we were expecting them to make. So given that scenario, 

do you think that it is still an important and meaningful role for 

the Federal Government to play in providing lending programs that 

will fill that gap that exist for the private sector? 

Mr. BERNANKE. The Fed has had a good relationship with the 

SBA, the Small Business Administration, and there were some additional provisions during the crisis that gave them more flexibility 

and more funding. That might be an area worth looking at. 

Ms. VELAZQUEZ. Under your leadership, the Fed has significantly 

increased its commitment to transparency, holding more press conferences and releasing interest rate forecasts for the first time in 

its history. While these policy tools are good for the financial markets and most big firms, they are of limited use to the general public. Would you consider releasing guidance for households and 

small businesses after FOMC meetings on what changes to monetary policy means to them? 

Mr. BERNANKE. That is an interesting idea. We have of course 

many speeches, and I am here giving a report to Congress about 

monetary policy. 

I would like to think about what that would look like. But obviously, we are trying to communicate to the general public. I have 

been on some TV programs and the like. And in fact, later this 

spring, I will be giving lectures at George Washington University, 

which will be available to anybody online, about the Fed and the 

financial crisis. So we are working to improve our communications, 

and your suggestions are more than welcome. 

Ms. VELAZQUEZ. Thank you. 

Thank you, Mr. Chairman. 

Chairman BACHUS. Thank you. 

Mr. McCotter? 

Mr. MCCOTTER. Thank you, Mr. Chairman. 

First, just a quick note, we heard much talk about the Wall 

Street reform bill and we will continue to, and it was said that the 

bill was bipartisan and that the nature of that should not be overlooked. I would just like to point out for the record that the bill is 

so bipartisan it is called Dodd-Frank. 

Mr. Bernanke, thank you for being here today. In your testimony, in your written remarks, there are some things coming from 

Michigan, a very hard-hit State that is struggling to come back in 

this stagnant economy, there are some things that bear repeating 

on page, I believe, 2: ‘‘The economy appears to have been growing 

24 

during that timeframe at or below its long-term trend. Continued 

improvement in the job market is likely to require stronger growth 

and final demand in production. Notwithstanding the better recent 

data, the job market remains far from normal. The unemployment 

rate remains elevated. Long-term unemployment is still near 

record levels, and the number of persons working part time for economic reasons is very high. 

‘‘Fundamentals that support spending continue to be weak. Real 

household income and wealth were flat in 2011. And access to credit remained restricted for many potential borrowers. Consumer sentiment, which dropped sharply last summer, has since rebounded 

but remains relatively low.’’ 

Now, two questions, and then I will be quiet and listen. The first 

is in terms of the credit still not getting to potential borrowers, 

what specifically do you think the reason for that is, and what do 

you think would be specifically done about it if not by you? I can 

understand why you can’t discourse on that. 

And finally, my concern is that—just a question about how this 

operates. It says here on page 6 that the target range for the Federal funds rate remains at zero to a quarter percent. Now, when 

that type of rate remains in effect, does that have an effect on the 

personal savings interest rates that individuals who bank get? And 

if that is the case, somehow that stops them from getting a higher 

rate of return, would that not constitute them essentially subsidizing the operations to try to get money to, say, the banks or to 

other people, who are still not getting the credit, which then leads 

to the horrible things that I started off my remarks with? 

Mr. BERNANKE. On the latter point, we are certainly paying attention to the effects of low interest rates, not only on savers but 

on other financial institutions and the like. The banks complain 

about the low interest rates. They say that reduces their net interest margin, so it is not a profitable thing from their perspective. 

I would say from the point of view of savers, though, for most 

savers, I think, on average, something less than 10 percent of all 

savings by retirees is in the form of fixed-interest instruments like 

CDs. Remember, people also own equities. They own money market 

funds. They own mutual funds. They have 401(k)s and a variety of 

things. And those assets are assets whose returns depend very 

much on how strong the economy is. And so, in trying to strengthen the economy, we are actually helping savers by making the returns higher, as we can see has happened in the stock market for 

example. 

Mr. MCCOTTER. That is a very important point. 

I personally don’t subscribe to the fact that just because it is 10 

percent, that would mean it was okay to have their rate of return 

artificially lowered. And I think that what you are saying then is 

that, yes, they are subsidizing this, but in the long run, it is better 

for them because you believe this will lead to economic growth. Although, again, and we will get to the second part of my question, 

that very much remains in doubt; doesn’t it? 

Mr. BERNANKE. The economy has been recovering, and I believe 

monetary policy is set appropriately to help the economy recover. 

Again, you can’t get good returns in the economy unless you have 

growth. The other thing, as you know, is we have set an inflation 

25 

target, and we are committed to keeping inflation low and stable. 

And that, also, of course, is good for savers because it is the inflation adjusted return that matters in the end. 

Mr. MCCOTTER. If I can, and we can skip the first part of the 

question because they are interrelated. So, in short, it is almost as 

if you decided that you are going to invest what their potential interest rates return would have been into your recovery for the economy. And again, it may be recovering, but by your own admission, 

it is either at or below long-term trends. We still have trouble getting money down into the hands for people for credit, into the 

hands of people who can grow this economy and get jobs back. And 

the long-term prognosis is not particularly good for unemployment 

rates dropping in a precipitous fashion any time soon. That doesn’t 

necessarily sound like a very good investment if I am saving and 

you are spending my money on recovery. 

Mr. BERNANKE. We are not spending anybody’s money. It is arguable that interest rates are too high, that they are being constrained by the fact that interest rates can’t go below zero. We 

have an economy where demand falls far short of the capacity of 

the economy to produce. We have an economy where the amount 

of investment and durable goods spending is far less than the capacity of the economy to produce. That suggests that interest rates 

in some sense should be lower rather than higher. We can’t make 

interest rates lower, of course; they can only go down to zero. And 

again, I would argue that a healthy economy with good returns is 

the best way to get returns to savers. 

On providing credit, I would just make one observation, which 

was the news this morning that bank lending increased last quarter at the fastest rate since the recession. 

Chairman BACHUS. Thank you. 

Also, the housing market declined in I think 19 or 22 major markets. We are seeing some signs of deflation. 

Mr. Watt? 

Mr. WATT. Thank you, Mr. Chairman. 

I just wanted to let my friend know that the protocol has been 

to name bills after the people who head the committees of jurisdiction, which is why the bill was called Dodd-Frank. We had the majority in the House and the Senate. When it was split, it was Sarbanes-Oxley, which he doesn’t like anymore, I guess. Oxley was a 

Republican because we were in the majority; the Republicans were 

in the majority in the House. So we are following the same protocol. 

Mr. MCCOTTER. If the gentleman will yield? 

Chairman BACHUS. Of course, you know we didn’t vote for it either. 

Mr. WATT. But the name of the bill is voted for as part of the 

bill, and you lost that vote, and nobody has reversed it yet. So anyway— 

Mr. MCCOTTER. If the gentleman will yield? 

Mr. WATT. Let me get on to what we are here for. 

Chairman Bernanke, one of the problems with setting these horizons out so far is that when you set an accommodative policy horizon out through late 2014, the private sector starts to expect that. 

And if circumstances change, crawling back off that limb could be 

26 

very difficult from a private sector perspective. What if things do 

change substantially in a different direction? I assume the Fed has 

given itself enough leeway here to say we can go back to a more 

aggressive, less accommodative policy, is that correct? 

Mr. BERNANKE. Yes, sir. The policy is a conditional policy. It 

says, based on what we know now, this is where we think we are 

going to be. But of course, if there is a substantial change in the 

outlook, we would have to adjust accordingly. 

Mr. WATT. Good luck if it does. I know how the private sector 

relies on accommodative policy, but I won’t—we don’t need to go 

any further on that. I just wanted to make sure that everybody 

knows that you can go in the opposite direction; the Fed has the 

authority to go in the opposite direction. 

On page 5 of your statement, you talk about continuing to monitor energy markets carefully. And one of the real uncertainties out 

there is gas prices and the extent to which we rely on gas prices 

as an indicator of how the economy is going and what we can do 

in our own individual lives. Are there really any things that we can 

do as Congress? I know you can’t do anything as the Fed, but are 

there things that we can do? Is there a menu of possibilities that 

we might consider on the energy side? 

Mr. BERNANKE. There are many things that you can debate 

about long-term development of natural resources—hydrocarbons 

and so on. But in the short run, I think the main problems are 

coming from some supply disruptions or some fear to supply disruptions, particularly Iran. So I think the best thing we could do 

would be to resolve that situation. But obviously, that is well beyond my capacity or probably anyone’s capacity. So I am not sure 

what can be done to provide substantial relief in the very short 

term. 

Mr. WATT. I guess President Gingrich is getting ready to tell us 

at some point how to solve this problem, although he didn’t solve 

it when he was the Speaker. Maybe he thinks he can solve it that 

way. 

Let me ask one other question. Europe, obviously, is the major, 

even more major than oil prices is what happens in Europe. Are 

you satisfied that they are taking steps in the right direction to try 

to satisfy their problems, and have we done as much as we can reasonably do to help with that? 

Mr. BERNANKE. They have taken some positive steps recently, as 

I mentioned in my testimony. The ECB had its second long-term 

refinancing operation today, 3-year lending to the banks. They are 

still working on getting the Greek deal done. A number of the 

countries in fiscal trouble had been taking strong steps to try to 

improve their budget balances. There has been some progress on 

a fiscal compact, whereby there will be more coordination among 

countries. But there is still a lot to be done. 

In the short term, there still needs to be more effort on providing 

so-called firewalls that will be financial backstops in case there is 

a default or potential contagion. And in the long run, the real problem—or a very serious problem that has not been solved—is that 

many of these countries are not only fiscally challenged, but they 

are not competitive. They have large current account deficits, and 

27 

their costs are too high, and so that is a process that can take a 

long time to fix. 

Mr. WATT. Thank you, Mr. Chairman. I yield back. 

Chairman BACHUS. Thank you. Let me point out one thing about 

energy that we all need to look at, and that is natural gas. I think 

it was in 1985 that we estimated we had 200 TCFs of reserves; it 

is now 2,500. So we ought to take advantage of that price differential, and I know we do that with natural gas vehicles, but it will 

be a game changer. 

Ms. Hayworth? 

Dr. HAYWORTH. Thank you, Mr. Chairman. 

And welcome, Chairman Bernanke. It is always a pleasure to 

hear from you because you are eminently sane about all these 

issues. 

I have heard from our life insurers and grantors or providers of 

annuities that they are very concerned, as you can imagine, about 

an interest rate squeeze that may occur in the future, that almost 

feels predictable in certain respects. How do you recommend that 

they proceed, that they anticipate the challenges we are facing because of the way in which we have to have an accommodative monetary policy? 

Mr. BERNANKE. We have had numerous discussions with insurance companies and pension funds and others, and there certainly 

is a problem in the sense that under our current accounting rules, 

their obligations to put money into the fund can be greater with 

low interest rates. And I agree that is a problem and one that we 

have discussed with them. 

Again, going back to my conversation with Mr. McCotter, on the 

other side, we are trying to strengthen an economy that will give 

them higher returns on their portfolios, so it cuts both ways. As I 

have said, I have talked to insurance companies. They recognize 

that low interest rates are not a permanent condition, that at some 

point, the economy will get back to the situation where interest 

rates can be more normal, that we are trying to help the economy, 

that we recognize that there are some side effects of low interest 

rates and that we are attentive to that. But again, our first responsibility is to meet our dual mandate and try to support the economy and keep inflation near its target. 

Dr. HAYWORTH. A similar question, obviously, could be asked on 

behalf of our community banks who are concerned about their longterm loans that are being obviously offered at very low interest 

rates, the same sort of approach, I assume? 

Mr. BERNANKE. Yes. I actually discussed this point in a speech 

I gave a couple of weeks ago at the FDIC. And I made essentially 

the same point, which is that the net interest margin has two 

parts: the difference between deposit rates and safe rates; and the 

difference between safe rates and loan rates. The ability to make 

profitable loans depends on having a healthy economy. And so the 

short-run cost of low rates should be worth it if we can get the 

economy moving again. 

Dr. HAYWORTH. Chairman, if I may, a bit broader question or 

perhaps more of a 30,000-foot question. You have many, many 

times, including here today, pointed out how important it is to have 

Federal policy that reflects the impending crisis that we face in 

28 

terms of managing the debt and how that weighs on economic 

growth. Do you ever feel as though you are talking past your Administration and Congress, that we are talking past each other, 

and somehow you know how can we make your message resonate? 

People like me are very sympathetic to it, obviously. 

Mr. BERNANKE. These criticisms are easy for me to make. I don’t 

have to deal with the politics. And I know they are very, very difficult. It is always hard to explain to people why you have to tighten your belt one way or another. 

I think, on the one hand, that educating the voters is an important thing and making sure people understand what the tradeoffs 

are. I think if they understand it, they will be more sympathetic 

to the tough choices that we face as a country. But I also think that 

there is some scope for bargaining within the Congress. We have 

had some very close calls recently in terms of making progress. 

And we have, as I mentioned before, this fiscal cliff on January 1st. 

That might prove an opportunity to negotiate a better longer-term 

outcome. We will see. 

But I think those are the two directions: one is trying to create 

a framework in Congress for debates, maybe a set of goals, for example; and the other is to get the voters on our side by education. 

Dr. HAYWORTH. I sympathize very much, sir, with that point of 

view and have said so myself as well, that it is about education and 

awareness. The fiscal cliff to which you refer would be the enormous tax increase that we face— 

Mr. BERNANKE. We have a number of measures, including both 

tax increases, the expiration of the payroll tax cut, the sequestration that comes out of the supercommittee negotiations. All those 

things are hitting on the same day basically, and it is quite a big 

impact. 

Dr. HAYWORTH. Thank you for emphasizing how important that 

is, sir, and thank you for your great work. 

I yield back, Mr. Chairman. 

Chairman BACHUS. Very good points, Chairman Bernanke and 

Ms. Hayworth. 

Mr. Meeks, I appreciate your thoughtful questions on every occasion. 

Mr. MEEKS. Thank you, Mr. Chairman. 

Mr. Chairman, I want to pick up where Congressman Watt left 

off. I am on this committee, of course. I am also the lead Democrat 

on the Europe-Eurasia Subcommittee, so Europe is very much on 

my mind. And we just recently came back from a trip over in Europe where their economy, of course, was much discussed. 

So I would like to ask two questions, because I know I have limited time, and see if I have any time left after your answer. First, 

given the close linkage between our economies, it seems access to 

the Fed’s swap lines is crucial in times of market tension. And so, 

can you discuss how American companies benefit from the availability of the Fed swap lines with foreign central banks and the difficulties U.S. companies and workers would face, if any, if those 

swap lines did not exist? 

Second, could you also tell us, what is the exposure of U.S. financial institutions to European sovereign debt? And can you catVerDate Nov 24 2008 18:30 Nov 19, 2012 Jkt 075075 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 K:\DOCS\75075.TXT TERRI
29 

egorize our financial system’s exposure—or would you categorize it, 

the exposure, as significant? 

Mr. BERNANKE. Very good questions. On the swap lines, European banks do significant business in dollars, so they need dollars 

to conduct that business. They were having a great deal of difficulty accessing those dollars. About half of those dollars are used 

for making loans in the United States, so they directly affect credit 

availability in the United States and therefore affect households 

and businesses in this country. The rest mostly goes for trade finance, which helps facilitate international trade and also adds to 

prosperity. So we have a direct interest in having international dollar funding markets work well. And indeed, it creates confidence in 

the dollar that those markets are working properly. The swap lines 

seem to have been very successful. They have reduced the stress 

in dollar funding markets. And it looks at this point that the demand for those swaps is starting to go down as stress has been reduced. 

In terms of U.S. financial institutions, we are monitoring that 

very carefully. We have continuously looked at banks’ exposures. 

We are making them do stress tests of their European exposures. 

Our basic conclusion is that the direct exposure, say, of U.S. banks 

to European sovereign debt is quite limited, particularly on the periphery. Exposure to Italy and Spain is somewhat greater, obviously, than to the smaller three countries. We think the banks generally have done a pretty good job of hedging the exposures they 

have to sovereign debt and, to some extent, to European banks. 

They will be reporting this information. The SEC has provided 

some guidance on how to report both their exposures and their 

hedges to the market to the public. So a lot of progress is being 

made there. Having said that, I think if there was a major financial accident in Europe, the main effects on our banks would not 

be so much through direct exposures as through general contagion, 

flight from risk-taking, loss of faith in the financial system, economic stress and so on. 

So I think there is a significant risk, even though we have done 

what we can to make sure banks are managing their direct exposures to banks and sovereigns in Europe. 

Mr. MEEKS. I think that answers my question, but just so it is 

clear, how closely linked would you say that the U.S. and European 

economies are with respect to the U.S. export market and U.S. corporate profits? 

Mr. BERNANKE. We are obviously very integrated. About 2 percent of our GDP is in the form of exports to Europe. So if Europe 

has a significant slowdown, we will feel that. Our companies are 

highly integrated. You think of companies like Ford and GM, which 

produce in Europe as well as the United States. 

However, we do think that if Europe has a mild downturn, which 

is what they are currently forecasting, and if the financial situation 

remains under control, that the effect on the United States might 

not be terribly serious—at least it would probably not threaten the 

recovery—but nevertheless, it would certainly have an effect. 

Mr. MEEKS. One of the things that was also discussed when we 

were over in Europe was the fact that they said that Greece 

equalled about 2 percent of the economy, and they were going to 

30 

try to keep them so that they wouldn’t have to move the euro. But 

they said if they did and Greece defaulted, that there would not be 

contagion, that they thought it would be pretty much contained, 

and they would move on; they liked what was happening in Italy. 

So I would just like to get from your viewpoint, if Greece was to 

default, do you see the possibility of contagion to Italy, Portugal 

and Spain, or are they such a small part of this that it doesn’t matter? 

Mr. HENSARLING [presiding]. The time of the gentleman has expired. So, Mr. Chairman, if you could give a very brief answer. 

Mr. BERNANKE. I would just say that leaving the euro would be 

very difficult, and an uncontrolled disorderly default would create 

a lot of problems. 

Mr. HENSARLING. The gentleman from Illinois, Mr. Grimm, is 

recognized for 5 minutes. 

Mr. GRIMM. Thank you, Mr. Chairman. 

And thank you, Chairman Bernanke, for being with us today. If 

I could switch gears a little bit and ask, obviously, the Volcker Rule 

is a topic of discussion in the financial services industry. And Section 619 becomes effective this July. But just last month, the Federal Reserve governance rule mentioned that it probably wouldn’t 

be implemented, completed until January of 2013. When do you expect the Volcker Rule to be finalized, and do you expect that there 

will be a re-proposal for public comment? 

Mr. BERNANKE. I don’t think it will be ready for July. Just a few 

weeks ago, we closed the comment period. We have about 17,000 

comments. We have a lot of very difficult issues to go through. So 

I don’t know the exact date, but we will obviously be working on 

it as fast as we can. 

As I understand it, the Volcker Rule includes a 2-year transition 

period starting in July. And as we did, for example, with the interchange fee, where we were also late relative to the statute, we will 

make sure that firms have an adequate period of time to adjust 

their systems and comply with the rule. 

Mr. GRIMM. So I am assuming then, that obviously, you are not 

going to be strictly enforcing a rule that is not in place yet? 

Mr. BERNANKE. Obviously. 

Mr. GRIMM. So that does leave some ambiguity and uncertainty 

as to how we are going to treat market-making and underwriting. 

And that I think is the concern for industry, that we are laden with 

so much uncertainty. And I would just emphasize that bringing 

some certainty to the markets obviously should be part of the goal. 

Mr. BERNANKE. It is. Thank you. 

Mr. GRIMM. A question that I have had for awhile, Mr. Volcker 

was unable to really give a clear definition; basically, I will know 

it when I see it. That is as uncertain I think as you can get. Do 

you have a definition of what proprietary trading is? 

Mr. BERNANKE. Proprietary trading is short-term trading in financial assets for the purposes of the profits of the bank itself as 

opposed to its customers. That is my best definition. But obviously, 

it is hard to know in every case whether it fits that definition or 

not. 

31 

Mr. GRIMM. But you believe that is what the regulators will use 

in promulgating the rule and enforcing the rule, something similar 

to that? 

Mr. BERNANKE. The most difficult distinction is between proprietary trading and market making. Because in market making, 

firms often have to buy assets, which they hold for a short period, 

and then they sell to a customer. So the question is, did they buy 

that asset for a proprietary purpose, or did they buy it for a market-making purpose? We will need to develop metrics and other criteria to distinguish those two types of activities. 

Mr. GRIMM. Switching gears again. I am concerned that the 

President’s proposed budget for 2013 could lead to massive increases in capital gains as much as—I think as much as triple, 

from 15 percent to almost 45 percent. I believe a dramatic rate increase like that will discourage investment and entrepreneurship. 

And I would like—over the long term, I think it would be detrimental—your views on increasing capital gains that significantly. 

Do you think it could have a negative effect? 

Mr. BERNANKE. It will be a tax on investment, that is for sure. 

I think I have been advocating at least consideration of doing a still 

more comprehensive type of reform. We have a lot of inconsistencies say between the way corporations are taxed and the way private individuals are taxed. So, for example, if you eliminate the deductibility for interest at the corporate level and then you still have 

private individuals paying taxes on interest, you are double taxing 

interest as much as you are double taxing dividends. So these are 

ultimately congressional decisions. But I think it would be useful 

to put this all in a broader framework and try to find a reform, 

both to corporate and to individual tax codes, that fits together and 

makes sense from the perspective of achieving both the equity and 

the efficiency goals. 

Mr. GRIMM. From a purely economic point of view, from an economist point of view, we are seeing that in the U.K., they raised 

their top rate to 50 percent, and in their first month, they actually 

took in less revenue than they did before the increase. Is it logical 

to say that is a possibility and a strong possibility if we were to 

raise our rates substantially that way and see that deduction? 

Mr. BERNANKE. Yes, in the short run, because capital gains people can choose when to realize capital gains, and they may decide 

to delay that realization and that could affect that in the short run. 

In the longer run, it might be less elastic. 

Mr. GRIMM. I see my time has expired. I will yield back. Thank 

you very much, Mr. Chairman. 

Mr. HENSARLING. The gentleman from Texas, Mr. Hinojosa is 

now recognized for 5 minutes. 

Mr. HINOJOSA. Thank you, Mr. Chairman. 

Chairman Bernanke, I want to thank you for coming to visit our 

committee and giving us your thoughts. 

I would like to thank you and your staff at the Federal Reserve 

for offering your insights on the drag of the housing market on our 

economy in that recent White Paper. That paper explains that foreclosures are considered dead weight loss to the economies we have 

heard from, meaning that they cost everyone. They cost the banks, 

they cost the government, they cost families, and they cost society. 

32 

I think there is no better word for the glut of vacant properties in 

my district in deep south Texas. I think that they are being 

dragged by this dead weight of foreclosed homes and by the 

headwinds of negative equity. 

Project Rebuild would put Americans to work refurbishing and 

repurposing current foreclosed properties to help ease the shortage 

of affordable housing options. So my question is, if programs such 

as the Real Estate Own-to-Rent (REO) Program, the Housing Trust 

Fund, and Project Rebuild were to be enacted and funded, what do 

you predict would be the effect of not only the housing market but 

the rental market? 

Mr. BERNANKE. First, Congressman, I agree that foreclosures impose a lot of costs, not only on the family, the borrowers and the 

lending institution, but also on the neighborhood, the community, 

and the national housing market, so it is very costly. 

I am not all that familiar with the specific programs you are referring to, but we have discussed in the White Paper the idea of 

REO-to-rental. It would seem to make sense to remove any artificial barriers to letting the market do what the market seems to 

want to do—which, given higher rents and low house prices, it 

seems like it would make sense to take some of those empty houses 

and put them up into rental. 

As you know, the GSEs are doing a pilot program to see if that 

will work. The issues have to do with whether there are enough 

foreclosed homes within a local area; is there financing available 

for mass purchases of homes? Are there supervisory restrictions on 

banks that would prevent them from doing so? I think there are 

some barriers that we can remove that might make this economic— 

we might see even the private sector undertaking this, and part of 

that would be refurnishing—refurbishing and repairing dilapidated 

homes. 

Mr. HINOJOSA. The biggest barrier that I see has been the lack 

of community banks giving loans to those who want to carry out 

those programs. 

But let me move to another question that is of great interest to 

me. I serve as ranking member of the Higher Education Subcommittee, and I am deeply concerned about the cost of higher education and the ever-increasing amount of debt that our students 

are being burdened with. Last year, students received more than 

$100 billion in college loans for the first time ever, and the total 

outstanding college loans are projected to surpass $1 trillion. Student debt now exceeds credit card debt for the first time, and recently, default rates from college loans have jumped up. I would 

like to hear your insights on the possible effects of such unprecedented student college loan debt on our economy and the possibility 

of a student loan bubble crisis here in our country. 

Mr. BERNANKE. Student loans are becoming a very large category 

of loans. My son in medical school recently informed me that he expects to have $400,000 in debt when he graduates from school. I 

don’t know about a bubble, per se, because going forward, most of 

the new lending is being done by the Federal Government. 

Now, there could be, of course, losses that might affect the taxpayers if that program is not adequately managed, so I think it 

does require some careful oversight. On the one hand, it is good 

33 

that people who don’t have the means can obtain the means to go 

to school; that is important. And student loans play an important 

role in that respect. 

But one might consider whether there are ways of tying repayment to financial conditions, for example, as a share of income 

earned or with discounts for certain types of service. There are various ways to look at how to repay student loans that might better 

adjust the cost of the loans to the capacity of the student. But student loans are a good thing in principle, but obviously, the program 

has to be well-managed, and it has become increasingly a Federal 

responsibility to do that. 

Mr. HENSARLING. The time of the gentleman has expired. 

The gentleman from Texas, Mr. Canseco, is now recognized for 

5 minutes. 

Mr. CANSECO. Thank you, Mr. Chairman. 

And Chairman Bernanke, thank you very much for being here 

with us today. Our Nation’s fiscal health is in very bad shape and 

only getting worse as Medicare and Social Security begin to absorb 

all of the Baby Boomers who are entering into the system. And 

former White House Budget Director Alice Rivlin and Senate Budget Chairman Pete Domenici recently said that while the President’s 

budget stabilizes debt over the next decade, the real problems arise 

thereafter, as entitlement costs spiral out of control and revenues 

are inadequate to deal with a wave of retiring Baby Boomers. You 

said before that Congress needs to act now to put our fiscal house 

in order. So would you agree that in order to do that, Congress 

must address the unsustainability and pending insolvency of Medicare and Social Security? 

Mr. BERNANKE. I noted earlier that the current budgeting procedures focus on the next 10 years, but many of the most serious 

problems occur after 10 years, and they do include entitlements as 

one major category of spending. So I urge Congress in thinking 

about this not to be artificially constrained by the 10-year budgeting window, but to be thinking even longer term, because the 

longer in advance you can make changes, the more time there will 

be for people to adjust to them and the easier it will be politically. 

Mr. CANSECO. Excuse me, I don’t mean to be putting words in 

your mouth, but your answer is, yes, we need to address that? 

Mr. BERNANKE. Particularly on the health care side, I think costs 

are very high. 

Mr. CANSECO. And in your opinion, was the budget passed by the 

House of Representatives last year a serious effort to address our 

Nation’s long-term fiscal health? 

Mr. BERNANKE. I hope you will forgive me if I don’t get into a 

political debate like that. Those are Congress’ decisions. My role 

here I think is to try to encourage you to address the long-run sustainability issue. 

Mr. CANSECO. And I hope I am not putting you in a political yeaor-nay type of situation, but I highlight the words ‘‘serious effort.’’ 

It has to be addressed. 

Would you say that any legislative effort to deal with our Nation’s long-term fiscal health that doesn’t address Medicare and Social Security is not a serious proposal? 

34 

Mr. BERNANKE. It is a fact that health care costs, Medicare and 

Medicaid in particular, are going to become an increasingly large 

part of the Federal budget, and that unless you are willing to have 

the government be a much bigger share of the economy than it is 

now, ultimately those programs would basically squeeze out the 

other components of Federal spending. 

Mr. CANSECO. And we will ultimately see a situation where our 

entitlement programs are 90 or 80 percent of the budget, and the 

rest we will have to fight over. To your knowledge, has the Administration put forward a plan to address the impending bankruptcy 

of Medicare and Social Security? 

Mr. BERNANKE. Again, I think the focus has been on the next 10 

years. The Administration has addressed the long-run issues to 

some extent through some of the aspects of the Affordable Care Act 

that have oversight boards and other kinds of things that would try 

to reduce costs. But obviously, it is still a major challenge for Congress to address health care costs. 

Mr. CANSECO. In your opinion, would you say that the Administration’s budget would not seriously address our long-term deficits 

because it does not address our entitlements? 

Mr. BERNANKE. I would just reiterate that the budget they put 

out was for the next 10 years. By definition, if you are only looking 

at the next 10 years, you are not addressing the very long-run implications. 

Mr. CANSECO. Thank you very much. Let me go now to regulations. I don’t know if you read this cover of last week’s Economist 

entitled, ‘‘Overregulated America.’’ It presents a pretty dark portrait of our financial system in the wake of ‘‘Dodd-Frankenstein,’’ 

as the article puts it. I think the last sentence of the article just 

about sums it up in ambition is often welcome, but in this case, it 

is leaving the roots of the financial crisis under-addressed and 

more or less everything else in finance overwhelmed. 

Now, Mr. Chairman, Dodd-Frank required that regulators write 

over 400 rules for the financial system, yet over 300 of these remain unwritten. Would you agree that this lack of clarity is a hindrance on the financial sector? 

Mr. BERNANKE. I think so. We are working as quickly as we can. 

We want to create as much clarity as we can. As you note, some 

of these rules are complex, and it is important to get comment and 

input and to do a good job. 

Mr. CANSECO. So as a follow-up— 

Mr. HENSARLING. The time of the gentleman has expired. 

Mr. CANSECO. Thank you, Mr. Chairman. 

Mr. HENSARLING. The gentleman from Missouri, Mr. Clay, is now 

recognized for 5 minutes. 

Mr. CLAY. Thank you, Chairman Hensarling. 

And thank you, Chairman Bernanke, for your return to the committee. 

Unemployment is declining and is now at 8.3 percent, the lowest 

in 3 years, and we can get pretty technical in these hearings. But 

my constituents in St. Louis would like to know what we in Congress and you at the Federal Reserve can do to put Americans back 

to work in ways that perhaps we can all understand. What do you 

suggest? 

35 

Mr. BERNANKE. From the Federal Reserve’s point of view, as you 

know, we have been keeping interest rates low and trying to create 

financial conditions that will foster investment in entrepreneurship 

and demand on the part of consumers, and that should help bring 

the economy back toward a more normal level of functioning. But 

as I said earlier, again, the Fed cannot affect the long-run health, 

prosperity, and productivity of the economy. That is really up to 

Congress. And there is a whole range of policies there, starting 

with fiscal I would say, having a fiscal program that on the one 

hand, achieves fiscal sustainability in the long run, and on the 

other hand, is protective of the recovery, which is still not complete. 

We need to talk about skills. We need to talk about the Tax 

Code, infrastructure, etc., that allows our economy to function at 

its best level. So there is a lot to be done, but I guess I would put 

the fiscal issue first, from Congress’ point of view, and from the 

Fed’s point of view, we are going to pursue our dual mandate. 

Mr. CLAY. Speaking of interest rates, it has been suggested by 

the House Budget Chair that if interest rates remain low until 

2014, this will hurt the dollar. Do you think that is accurate, and 

would it risk fueling asset bubbles? 

Mr. BERNANKE. I would like to make a distinction that is not 

often made. When people say, ‘‘hurt the dollar,’’ there are two definitions of the dollar. One is the buying power that is the inflation 

rate in the United States. Does the dollar buy more today than it 

did yesterday? The other definition is the dollar versus other currencies, the foreign exchange value of the dollar. Those are two 

separate concepts. Now, in fact, our policies have been accommodative since 2008, and on both counts, I think we are doing okay. Inflation over my tenure as Chairman has been about 2 percent, 

which is lower than previous Chairmen. At the same time, over the 

last 3 years, the dollar in its foreign exchange sense has been up 

and down, but it is roughly where it was 3 years ago. So I don’t 

think that is really a problem, although I think it is important to 

distinguish those two components. 

You asked about interest rates on the second part of your question? 

Mr. CLAY. Yes, on refueling the asset bubble. 

Mr. BERNANKE. The bubble. Obviously, that is something that we 

have to pay close attention to. We have greatly expanded our ability at the Fed to monitor the financial system broadly to take a socalled macroprudential approach. And right now, we don’t see any 

obvious bubbles in the economy, but certainly that is something 

that we are going to need to look at and continue to monitor. 

Mr. CLAY. Thank you for your response. And Mr. Chairman, 

many citizens in the Nation are concerned about the rise in gasoline prices at the pump, especially the working class. What measures can the Federal Reserve take to stabilize the recent rise in gas 

prices? 

Mr. BERNANKE. We are concerned about it as well. It has a direct 

effect on inflation, and it is also bad for growth because it takes 

away buying power from households. So it is a real concern for us. 

On the other hand, overall inflation is low and stable, so it is really 

a question of this particular product becoming more expensive relVerDate Nov 24 2008 18:30 Nov 19, 2012 Jkt 075075 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 K:\DOCS\75075.TXT TERRI
36 

ative to other products. And again, as I mentioned earlier, the 

main reason for it is the higher price of crude, which in turn relates to a number of factors, but among them is uncertainty about 

supply in Iran and in the Strait of Hormuz and in Africa. So I don’t 

think the Fed can do much about the price of gas. It is more important that we try to establish security of supply and also take measures to continue to reduce demand, and it is important to note that 

the United States has been reducing its dependence because we are 

producing more energy and we are importing less. 

Mr. CLAY. Would you suggest tapping into the reserves? 

Mr. BERNANKE. That is really for the Administration to decide. 

The reserves are typically used for disruptive situations where 

there has been some breakdown in supply chains, like during Hurricane Katrina, for example. It would be of less assistance during 

a situation where there is a long-term supply/demand problem, but 

again that is an Administration decision. 

Mr. CLAY. Thank you. My time is up. 

Mr. HENSARLING. The gentleman from Ohio, Mr. Stivers, is now 

recognized for 5 minutes. 

Mr. STIVERS. Thank you, Mr. Chairman. And thank you to the 

Chairman for coming to testify before us. I appreciate the job you 

do and you have a hard job. I want to ask you about one big-picture 

question, and then talk about some things that are important in 

my district. The big-picture question is, I have been here for 13 

months and I have pretty quickly realized that the only things that 

happen in this town are the things that have to happen. And you 

have heard some really robust debate in this committee about how 

we might solve our fiscal crisis. You have admitted that it is the 

thing that we should stay focused on and I believe the best way 

to fix it is to require it to happen through a balanced budget 

amendment. That doesn’t say how we will balance the budget, but 

it just requires it to happen, and I do believe we can do that in a 

thoughtful way with some relief valves for natural disaster, time 

of war, for only that spending related to those activities. Usually, 

you punt these questions, but I am going to ask you anyway. What 

do you think about a balanced budget amendment as a technique 

for solving our fiscal crisis long term and forcing it to become one 

of the things that has to happen in this town? 

Mr. BERNANKE. In general, I think there is some evidence that 

rules or structures are helpful in getting better fiscal outcomes— 

for example, offsets and things of that sort. I think 1 year might 

be too short a time to demand balance. But over a longer period 

of time with appropriate provisions, some kind of rule—I don’t 

know whether you want to go the amendment route—for the Congress to provide a guidepost both to its own deliberations and for 

the public’s awareness could be a helpful structure to make things 

happen. 

Mr. STIVERS. Thanks for that thoughtful answer. I do want to follow up on a question Mr. Clay just asked, and I asked you this last 

year, but—and I know that the Bureau of Labor Statistics does 

both of your measures that you measure yourself against, unemployment and inflation, and I just want to ask you to continue to 

pay attention to the way they measure things because the unemployment number does not count the people who have dropped out 

37 

and are no longer looking for work. It also does not account for underemployed folks and as we go through structural changes in our 

economy, I am not asking you to comment because I know you 

don’t do these, but I am worried about the way that they count. 

I am also worried about the way they count inflation because 

when they put together the consumer basket for inflation the reduction in the price of housing masking the massive increases in 

commodity prices, including oil and gas, including foodstuffs that 

people buy at the grocery story. And if you think about how the 

people in my district and in the rest of this country manage their 

finances, they lock in long-term rates on their housing through a 

mortgage or a long-term lease and they have a known amount that 

they are going to pay, which changes only a minor amount. The 

thing that changes their real inflation they see is commodity prices, 

the price of gas at the pump, the price of foodstuffs at the grocery 

store. So I know the Bureau of Labor Statistics does that work for 

you, but I learned a long time ago in the military that what you 

measure is what counts and how you measure it counts. So I would 

remind you again to always review the way those things are measured, and I am not asking you to comment because I know it is not 

yours, but I would like you to pay attention. 

Mr. BERNANKE. Thank you. I would comment that the BLS does 

provide alternative unemployment measures U5 and U6, which do 

take into account discouraged workers and so on. 

Mr. STIVERS. Yes, sir. And so, I would ask you to keep looking 

at those. 

The last thing I want to talk about is community banks. You 

mentioned it in your testimony when you talked about your work 

in the FSOC, and I think we all recognize that community banks 

weren’t the interconnected cause of the crisis in 2008, and that 

they also bear a disparate impact of many of these regulations because of their size and the fact that they don’t have big compliance 

departments. I will tell you a story, and then remind you to talk 

to your friends at the FDIC and the OCC because I will tell you, 

I have not heard a bad story about Fed regulators from community 

banks, but I have heard several horror stories about the FDIC and 

I will tell you a new one that I heard since the last time we talked. 

There is a community bank that recognized a borrower was in a 

deteriorating position. They asked him to put money in an account, 

sign an agreement with them, a forbearance agreement, but they 

got a year of principal and interest in a restricted account the consumer can’t touch so they know that loan is good for a year. And 

the FDIC came in and asked them to put all of that money towards 

principal and write the loan down and violate the forbearance 

agreement with the customer, and then basically downgraded the 

loan. They know that loan is going to be good for a year, and the 

gentleman’s financial condition may change in that year. They have 

taken responsible action, and the FDIC has forced them to do 

things that I think are irresponsible. 

My time has expired, but I would ask you to go back to the regulators at the FDIC and the OCC and ask them to please not encourage our community banks to do things that actually hurt borrowing and hurt our economy. Thank you. 

38 

Mr. HENSARLING. The gentleman from California, Mr. Sherman, 

is now recognized for 5 minutes. 

Mr. SHERMAN. Thank you. Chairman Bernanke, I want to commend you on everything you have done to keep short and long interest rates as low as possible. We face a difficult circumstance and 

the Fed is doing more than any other agency of government to try 

to get us out of it. 

I will have a question for the record for you on the Volcker Rule 

and applying it to international situations, and my first question 

is about the Society for Worldwide Interbank Financial Telecommunications, SWIFT. I am the lead Democrat here in the 

House on a bill designed to, in effect, expel Iran from SWIFT. Do 

you agree that allowing Iranian access to SWIFT undermines U.S. 

national security objectives and our objectives in preventing money 

laundering in the financing of terrorism and proliferation, and do 

you think that we can successfully exclude all Iranian banks from 

SWIFT rather than just those Iranian banks that are under EU 

sanction? 

Mr. BERNANKE. I shouldn’t make national security judgments, 

and I won’t. But on SWIFT, I will say that the Fed is one of the 

supervisors of SWIFT. We work with the Bank of Belgium and 

other international supervisors, and my understanding is that it 

would be feasible and it is a very important system because it is 

part of almost every international money transfer that occurs. So 

it could be a real problem for Iranian financial markets or financial 

institutions if they were banned from using it, yes. 

Mr. SHERMAN. Let me assure you that every institution of the 

Federal Government that is typically involved in national security 

policy would like to see Iran as financially isolated as possible, and 

so while you don’t have a national security staff, whether it is the 

Foreign Affairs Committee, the House, the full House, the Senate, 

the State Department, I think you should use your position at 

SWIFT to achieve what is already the national security policy. 

Mr. BERNANKE. We will do whatever Congress instructs us to do. 

Mr. SHERMAN. Turning to another issue, I want to commend you 

for your White Paper on the U.S. housing market. And I think it 

is appropriate for the Fed to comment on the housing sector. There 

is this program of going REO-to-rental, and I think it is important 

that we not sell these homes in such large packages that only huge 

Wall Street firms are likely to bid. I think it is important that you 

sell packages of homes in the same area so that the same management company could administer 20, 50, 100 homes, and I think it 

is important that you deal with local investors who have a real 

stake in the local community. I don’t know if you have any comment about all of that? 

Mr. BERNANKE. Only that the FHFA is running a pilot program. 

The tradeoff is you need to have enough homes so that it is economical for the management company to maintain them. But otherwise, I think it makes sense not to over-concentrate the ownership. 

Mr. SHERMAN. And I think whatever package you have ought to 

be in the same area. 

Mr. BERNANKE. Certainly. 

39 

Mr. SHERMAN. Now, we have seen adjustments to the LLPA from 

Fannie Mae and Freddie Mac, the GSEs, and Congress needed to 

fund a couple of months of the lower Social Security tax, so we hit 

another 10 basis points for the next 10 years. Do you see us hurting the housing market if we go back to that well again and increase the LLPA or increase the guarantee fee that is put on top 

of what home buyers, and home refinancers have to pay when they 

get a home mortgage? 

Mr. BERNANKE. Here is the tradeoff. The benefits of a higher fee 

are, first, the fiscal benefits: reducing increasing profits of the 

GSEs and reducing their call on the Treasury. Another benefit is 

that by raising those fees gradually, you may eventually begin to 

bring private competitors into the market. That is part of the strategy. On the other side, as you point out, if you make it more costly 

to get a mortgage, in the short term that will hurt the demand for 

housing, which is already pretty weak. 

Mr. SHERMAN. Yes, and I would think another decline in housing 

prices, or a failure to stabilize them and get them inching upward 

would be very bad for the economy, at least for the people I represent. I yield back. 

Mr. HENSARLING. The gentleman from California, Mr. Royce, is 

now recognized for 5 minutes. 

Mr. ROYCE. Thank you, Mr. Chairman. I would like to go back 

to that chart, ‘‘Government Spending as a Share of the Economy,’’ 

and have that posted. The Congressional Budget Office puts this 

together every year, and they project, Mr. Chairman, the point at 

which the general fund transfers to entitlements equal the total tax 

revenue for the Federal Government. And I would just ask you, is 

this projection sustainable? Is this situation sustainable? 

Mr. BERNANKE. No, I don’t think it is. 

Mr. ROYCE. And what impact might continuing on this trajectory 

have in terms of interest rates? Say, for a minute, that the bond 

vigilantes start to turn on us the way they did on Europe based 

upon the projections. What potential impact could that have on cost 

of borrowing? 

Mr. BERNANKE. If market participants are not persuaded that 

the United States is on a sustainable fiscal course, then eventually 

something will give, and that could be a financial crisis. It could 

be something else. 

Mr. ROYCE. And since this is a projected budget, what do we do, 

and what responsibility do we have in order to elevate this issue, 

and get Americans, and get the Congress to realize the necessity 

of dealing with reform on this front? 

Mr. BERNANKE. It is one of the most fundamental responsibilities 

of the Congress and the Administration to manage our finances. 

But as I indicated in an earlier question, it is obviously politically 

very difficult, and that is what you have to confront. Part of the 

problem, I think, is that the public may not fully understand all 

of the issues and they need to be further educated. 

Mr. ROYCE. And that is why I think part of the responsibility lies 

with Congress, part lies with the central bank, and part lies with 

the Federal Reserve in terms of demonstrably explaining to the 

public the consequences of this. And your colleague, Mr. Draghi, 

the head of the ECB, made headlines just last week. He had some 

40 

very harsh words for member countries of the ECB. He said, 

‘‘There is no feasible tradeoff between economic overhauls and fiscal belt tightening.’’ And he had some very damning words also for 

the future of the European welfare state. 

I would like to get your thoughts about Mr. Draghi’s comments, 

and also in light of the 2012 projected deficit for the United States, 

which is 8.5 percent of GDP. I am looking at these numbers for the 

PIIGS nations; it is comparable or maybe a little worse in some 

cases. So looking at what you describe as the sizeable structural 

budget gap under current policy, and looking and beginning to compare that, I would ask structurally, is there any material difference 

between us and these nations, or is it simply that the market has 

turned on Europe, but they haven’t yet turned on us? 

Let me get your thoughts on that front. 

Mr. BERNANKE. There is an important structural difference in 

Europe, in that they have a common monetary policy but they don’t 

have a common fiscal policy. In the United States, if a single State 

is in fiscal distress, Social Security and Medicare payments still get 

made because they are done by the Federal Government. There is 

no equivalent of a Federal Government in Europe, and so part of 

their reform process is seeing to what extent there should be greater fiscal union. Overall, it is true that Europe doesn’t have a bigger 

deficit than we do. So that is certainly true. 

All I can say is that Mr. Draghi certainly is right, at least for 

the peripheral countries like Greece, Portugal, and Ireland, which 

really have no alternative but to tighten the belt immediately. 

There may be more flexibility in other countries. 

Mr. ROYCE. Okay, I understand that, but with our debt to GDP 

now over 100 percent, with these comparable short-term annual 

deficits when we look at Europe, with comparable structural deficits, at what point do our general calls for debt reduction become 

more in line with the comments that your counterpart is making? 

At what point do we ring that bell and say the long-term structural 

adjustments have to be made? 

Mr. BERNANKE. You mentioned 8.5 percent. Part of that is cyclical and part of that can be addressed by having the economy recover. Part of it is structural. In other words, it is not going to be 

better once the economy gets back to full employment. So I think 

you have to pay attention to the recovery in the very short run. 

You can’t ignore that. But it is important to create a credible plan 

for long-run sustainability as soon as possible, and that would remove a risk to our economy. 

Mr. ROYCE. I agree, but to the extent that you explain this to the 

public, and explain it loudly, more demonstrably, I think that they 

could then understand the need for the structural reforms. At this 

point, I don’t think it is understood. 

Mr. HENSARLING. The time of the gentlemen has expired. The 

Chair now recognizes the gentleman from Massachusetts, Mr. 

Lynch, for 5 minutes. 

Mr. LYNCH. Thank you, Mr. Chairman. And thank you, Chairman Bernanke, for your willingness to help this committee with its 

work. In your remarks, I think on page 4, you cited the concern regarding the downside risk of the economic outlook that is due to 

stresses in the European banking system and the euro zone in genVerDate Nov 24 2008 18:30 Nov 19, 2012 Jkt 075075 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 K:\DOCS\75075.TXT TERRI
41 

eral. And I note that recently there was an agreement between the 

Greek Government and private bondholders where the Greek Government will impose a haircut of about a little over 50 percent on 

those bondholders. But I am trying to understand the agreement 

itself. It looks like there is a collective action clause that says once 

a certain amount of the old bonds are redeemed, then the government will impose a collective haircut across all of those bondholders, and there is a question here—I guess you could say that 

charitably at least, there is a default here. And I guess there is a 

controlled default, and what remains unclear is whether these bond 

swaps will constitute a credit event for some of our default protection derivatives and whether it will trigger a payout on a credit default swap on Greek debt. 

And I guess what I am concerned about, even though the amount 

is fairly small, 3 plus billion is still a small number, relatively 

speaking, is what that means to U.S. banks’ exposure to Greek 

debt, and whether or not credit default swaps are still a mechanism for protecting against that event. Does this make you concerned about what those balance sheets look like if there is a rather loose definition now of what a default really is and whether or 

not that protection is actually there? 

Mr. BERNANKE. There is a private sector body that determines 

whether a credit event has happened. And I don’t know what they 

will determine. My guess would be if they invoke the CACs, the 

collective action clauses, and enforce the write-down on all private 

lenders, I think it would be a pretty high probability that body 

would invoke the CDS contracts. So that would be my guess. And 

in terms of U.S. banks, their exposure either hedged or unhedged 

to Greek debt is very small, so I don’t expect any direct impact. But 

it is important to maintain market confidence more broadly both in 

the CDS contract, but also in the idea that whatever happens in 

Greece, so to speak, stays in Greece, and doesn’t spread to other 

countries, and that is why I talked before about the need for financial firewalls or other protections that will prevent contagion from 

Greece to other vulnerable countries. 

Mr. LYNCH. Okay, so, I guess—what if a decision goes the other 

way? What if they say a default has not occurred and there is no 

payout? I know that is hypothetical. I know that the derivatives association probably won’t come out that way, but what if we ended 

up with that scenario? Would that undermine the whole idea of 

this protection? 

Mr. BERNANKE. In some people’s minds, I am sure it would, yes. 

But again, it is up to this group, which obviously is interested in 

maintaining confidence in those contracts to make that determination. 

Mr. LYNCH. All right, thank you. I yield back. 

Mr. HENSARLING. The Chair now recognizes the chairman of the 

Capital Markets Subcommittee, Mr. Garrett of New Jersey, for 5 

minutes. 

Mr. GARRETT. Thank you, and I thank Chairman Bernanke, and 

I am perhaps your last questioner. I appreciate your stamina for 

being here at this time. What I would like to talk to you about is 

what is necessary in some economists’ view as to get jobs going, the 

economy broadening and what have you, and that is dealing with 

42 

the money multiplier effect, and for the need for that to expand. 

At least some economists I read say that the decline in the multiplier effect is directly related to or has some correlation to the fact 

that the Fed pays interest on reserves, and you are nodding, so you 

know where I am heading on this. 

So the purpose of doing that, to pay interest on the reserves, is 

to do what, create a floor, if you will, right? You have already sort 

of created that floor by what interest rates are now set in the zerobound range. So can you elaborate as to why the Fed continues to 

see the need under the power that it has to pay IOR? 

Mr. BERNANKE. Yes. We have looked at the possibility of not paying that 25 basis points, 1/4 of 1 percent that we currently pay. In 

the perspective of, would it be beneficial to the economy, the Federal funds rate is currently around 10 or 12 basis points, or something like that. So limiting that might lower it further, but obviously not below zero. 

Mr. GARRETT. Right. 

Mr. BERNANKE. So the stimulative effect, the effect on interest 

rates generally in eliminating that or the effect on credit extension 

would be quite small. On the other side, we have some concerns 

about the effects of the almost zero rates on various financial institutions like money market mutual funds, and also on the functioning of the Federal funds market itself. We have a weaker guidance from the market in terms of what the funds rate actually is 

because there are fewer participants than there used to be because 

the rates are so low that it doesn’t cover the cost of making the 

market. So we think there are some financial side effects that 

would be negative, that the benefits for the economy would be very 

small, and for that reason, we haven’t reduced the— 

Mr. GARRETT. Am I correct to understand that what you are actually doing by this is sort of incentivizing the banks, I guess, for 

the reasons that you just said, incentivizing the banks to keep their 

excess reserves at the Fed? 

Mr. BERNANKE. Right. 

Mr. GARRETT. And that would, in my way of thinking about it, 

sort of contract their ability, and outset the multiplier effect on 

their ability then, or their incentive to lend. Isn’t that sort of 

counter to what your policy should be? If you did away with it, I 

understand some of the other ramifications that you just talked 

about, but if you did away with it, there would be less incentive 

for me as a bank to leave my reserves with you and hopefully then 

to lend to a business? 

Mr. BERNANKE. No, analytically you are correct, but quantitatively, it is trivial, because against the 25 basis points, the 

banks also have to pay an FDIC assessment. So they are basically 

getting maybe 1/10 of 1 percent return to hold that money with us. 

That is certainly not going to prevent them from making good 

loans. 

Mr. GARRETT. Is that a better—if I am a bank right now say that 

is still a better bet than what I am getting elsewhere, and if you 

did away with that entirely, then would I have an incentive to try 

and find that—I don’t want to use the word ‘‘better’’—investment 

elsewhere? 

43 

Mr. BERNANKE. It would be a 10-basis point incentive and that 

is pretty small. That is only an overnight rate. It is probably less 

of an effect on the monetary rates. 

Mr. GARRETT. Okay, so if that is the case then it seems that 

would—watching my time here—run counter to what your opening 

statement is as far as the incentive and the effect on the money 

market funds and the rest, since it is only a de minimis amount? 

Mr. BERNANKE. No, because, remember, bank loans are typically 

a year or more, whereas money market funds are mostly under 30- 

day investments. And the Federal funds market of course is an 

overnight market. 

Mr. GARRETT. Another question—I only have a minute here. A 

couple of questions. One, you talked about the situation in Greece 

and what stays there should stay there. One of the concerns about 

it not staying there is the fact that you have an open swap line, 

not just with—not necessarily with Greece, but with Europe. Can 

you just comment briefly as to why we should not be concerned as 

far as the potential for the contagion if things do not stay in Greece 

and things do not stay in Europe, that this swap line may be negatively impacted as the asset values drop over there? 

Mr. BERNANKE. First of all, the swap line has some very distinct 

benefits that I discussed before. 

Mr. GARRETT. I understand those. 

Mr. BERNANKE. And on the cost side, it is a very safe proposition. 

First, our counterparty is the ECB. It is not banks, it is not Greece. 

It is the European Central Bank itself, which in turn is well-capitalized and it has behind it the national central banks of 17 countries. The swaps are also collateralized by euros, and in addition, 

the contracts are such that they pay us back in dollars in interest 

rates determined in advance. So we have no interest rate risk, we 

have no exchange rate risk and we believe that we have no credit 

risk. 

Mr. HENSARLING. The time of the gentlemen has expired. The 

Chair now recognizes the gentlemen from Georgia, Mr. Scott, for 5 

minutes. 

Mr. SCOTT. Thank you very much, Mr. Chairman. Welcome, 

Chairman Bernanke, it is very good to have you here. Let me commend you and the Fed. I think it is very important for us to recognize the achievement and the progress we are making with the economic recovery, and I think it is in no small measure due to your 

monetary policy of accommodation and creating credit facilities and 

certainly ensuring liquidity for borrowers. I think that is the real 

core. And unemployment now is going down. We are at 8.3 percent. 

We have come up. We are averaging about 200,000 new jobs each 

month now. We are not bleeding jobs. We are adding them. The 

Dow Jones is still cracking around 13,000. We have come a long 

way, but we are not out of the woods. But I do—it is important for 

us to recognize your contribution in helping us to wade through 

some very troubled waters. 

Let me just ask you about the stringent prudential standards 

under Dodd-Frank, and under Section 165 of Dodd-Frank. You 

were given the opportunity to differentiate among companies on an 

individual basis, or by category, taking into consideration their capital structure, riskiness and complexity, and of course Congress put 

44 

this provision in because we expected that you will differentiate between the largest and most complex bank holding companies and 

those with more traditional activities who also exceed the $50 billion level in assets. 

Can you tell us, have you yet established, at least conceptually, 

the different categories or tiers of risk subcategories and associated 

enhanced safeguards, including specifically with regard to capital 

that will exist for the bank holding companies that have assets 

larger than $50 billion? 

Mr. BERNANKE. As you know, that is Section 165, 166 of DoddFrank. We put that out for comment. We are still receiving comment on that, and we have also made public our discussions on the 

Basel capital rules, Basel III. And both of those call for gradated 

application to banks, with the highest application to the largest, 

most complex banks and then obviously less going down. So that 

would be true both in terms of supervisory effort, but specifically 

in terms of capital. As you know, the Basel III involves a capital 

surcharge, and that will be determined by a formula which I believe we have provided, or at least some variant of it. That will put 

the highest surcharge only at the very top most complex banks and 

then will be gradated down essentially to zero, once you get to 

large but less complex banks. So the capital surcharge and the extended supervisory oversight will be gradated according to size and 

complexity. 

Mr. SCOTT. Right. Let me just turn for a moment to the Volcker 

Rule as well, and its implication regarding what is happening 

around the world. And let me just add, too, I think your policy of 

the firewall to kind of keep what is going on in Greece in Greece, 

but let me just ask you, how is Spain doing? Is this firewall—I 

think Spain’s situation is probably the next most egregious. Is its 

firewall doing a good job from getting to spread there? 

Mr. BERNANKE. Generally, the firewalls, which are European 

funding to stand as a backstop in case there is contagion, we think 

more needs to be done there and the Europeans I am sure will be 

looking at that and trying to strengthen those firewalls. So I think 

there is more to be done there. But Spain, on the one hand, I think 

is doing better. They have made progress in terms of their fiscal 

consolidation. They are taking actions to strengthen their banking 

system, and their cost of credit has gone down probably in part because of fundamentals, but also in part because of the ECB’s longterm refinancing operations. 

Mr. SCOTT. Now, let me ask you very quickly about the Volcker 

Rule. I am curious as to why you believe it is appropriate to extend 

the jurisdiction of the United States throughout the world in this 

regard. It seems to me that we should at a minimum wait to see 

what other countries are doing in this regard so that we do not put 

the United States capital markets or U.S. investors at risk. Are 

other countries, to your knowledge, planning to adopt an approach 

such as the Volcker Rule? 

Mr. BERNANKE. Not to my knowledge, no. But we are not extending jurisdiction outside the country, except insofar as that American-based banks will have to follow the rule in their worldwide operations. But we are obviously not going to require European banks 

operating in Europe to obey the rule. 

45 

Mr. SCOTT. But our banks who are operating will? 

Mr. BERNANKE. Yes. 

Mr. HENSARLING. The time of the gentleman has expired. The 

Chair now recognizes the chairman of the Oversight and Investigations Subcommittee, the gentleman from Texas, Mr. Neugebauer, 

for 5 minutes. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. Chairman 

Bernanke, it is good to have you back again. I have two or three 

questions here. One of the things, the G8 central banks have expanded their balance sheets. If you convert all of their currencies 

to dollars to about $15 trillion over the last 2 years, what do you 

see looking forward? How much more expansion in these balance 

sheets in these central banks do you see, and what could be some 

of the consequences of that? 

Mr. BERNANKE. I don’t know what the expansion may or may not 

be. The Japanese, for example, have, again, begun some asset purchases. The ECB has put out again this morning about a half a 

trillion euros of bank lending, but it doesn’t all reflect a larger balance sheet. Some of it, I think, is sterilized. Each of these central 

banks is dealing in a similar way. In this respect, the Federal Reserve is not unusual. It is trying to find ways to provide more accommodation in a situation where interest rates are close to zero, 

and so cutting the basis of the Federal funds rate by 25 basis 

points doesn’t work. All of the central banks in question have similar tools to the ones we have, including the ability to pay interest 

on reserves, the ability to sell assets, and the ability to sterilize 

their balance sheets so that I think we all have adequate tools to 

withdraw that accommodation and to shrink those balance sheets 

at the appropriate time. I think this is currently where the best approach, the best available approach is to provide additional financial accommodation in a world where rates are close to zero, and 

we can’t obviously go below zero. 

Mr. NEUGEBAUER. So keep printing, basically? 

Mr. BERNANKE. I know there has been some debate about the use 

of the word ‘‘printing.’’ It is in fact the case that the amount of currency in circulation has not been affected by any of these policies. 

What has happened is that the amount of electronic reserves held 

by the banks at the Federal Reserve has gone up by a great deal, 

but they are sitting there. They are not doing much. Mr. Garrett 

raised the question of whether they should be doing more in some 

sense, but so far we have not seen any indication that they have 

proved inflationary. 

Mr. NEUGEBAUER. Another question, does the Federal Reserve 

own gold? 

Mr. BERNANKE. No. 

Mr. NEUGEBAUER. So you don’t hold any gold? 

Mr. BERNANKE. I don’t think so. Maybe a little bit. 

Do we hold gold? Looking to my colleagues there, I don’t think 

so, no. 

Mr. NEUGEBAUER. Somebody asked me to ask you that question, 

so I am— 

Mr. BERNANKE. I am told we have gold certificates. 

Mr. NEUGEBAUER. Gold certificates, okay, and what do we do 

with those? 

46 

Mr. BERNANKE. They are part of our reserves. 

Mr. NEUGEBAUER. And can you furnish me with how much that 

is? 

Mr. BERNANKE. We will, but what I do know is that the great 

bulk of U.S. gold is held by the Treasury, and not by the Fed. 

Mr. NEUGEBAUER. Okay, thank you. We have been trying to 

track the cumulative effect of the Dodd-Frank Act and, as you 

know, it has about 400 rulemaking requirements in it. Some of 

them you are required to comply with. And recently, we have 

reached a milestone. I think of the 400, we have put out about 140 

of the rules, and so we still are about a third of the way through 

there. It was alarming to find that basically the regulators themselves published that it would take about 22 million manhours per 

year to comply with the first 140 regulations. That means we are 

two-thirds of the way through, and so we are obviously headed to 

a lot of compliance hours. It was interesting also to note that it 

only took 20 million manhours to build the Panama Canal. I think 

that most everybody would agree that 20 million manhours spent 

building the Panama Canal created more economic opportunity 

than the 22 million manhours complying with regulations. 

Are you concerned that this level of regulation and this kind of 

burden that we are putting on the markets and the market participants, is that healthy? 

Mr. BERNANKE. Congressman, I do think it is important to point 

out what we are trying to prevent. We had a terrific financial crisis 

that has cost this country enormous amounts of money and created 

enormous amounts of hardship, and it is certainly worth some cost 

to try to make sure that it doesn’t happen again. Yes, those regulations are costly, but speaking for the Fed, we have taken a lot of 

steps to try to minimize those costs, including bunching, grouping 

rules together in packages so that we can look at the interactions 

among them; doing a lot of cost-benefit analysis; having long transition periods and so on. So we need to do what needs to be done 

to prevent another crisis, certainly, and of course people can differ 

on how much needs to be done. But we are trying as best we can 

to carry out the statutory obligations that Congress gave us at the 

lowest cost to the industry. 

Mr. HENSARLING. The time of the gentleman has expired. The 

Chair now recognizes another gentlemen from Texas, Mr. Green, 

for 5 minutes. 

Mr. GREEN. Thank you, Mr. Chairman. And I thank you, Chairman Bernanke, for being here today. We greatly appreciate your 

attendance, and you always share great information with us. 

Mr. Chairman, FSOC, the Financial Stability Oversight Council, 

has that been beneficial? Do you find it beneficial to meet with the 

other prudential regulators? Could you just elaborate for a moment 

on this, please? 

Mr. BERNANKE. Yes, it has been beneficial. I believe there are 10 

voting members, and we have been meeting on a reasonably frequent basis. And as I mentioned earlier, virtually every principal 

is there at every meeting so the leadership is really there to talk. 

And it has had two other benefits. One is that we have extensive 

staff interactions so there is staff interaction going on between 

meetings which has been very useful. And in addition, while there 

47 

has always been a certain amount of interagency cooperation, coordination, and joint rules and so on, I think that has really picked 

up and been improved and been helped by the fact that we are 

working together in this FSOC context. So I think it has been helpful. 

Mr. GREEN. Is it fair to say that you did not have a similar circumstance prior to Dodd-Frank, a similar meeting arrangement 

comparable to what FSOC provides? 

Mr. BERNANKE. Not exactly. We did have the President’s working 

group which involved some of the agencies and we did have a lot 

of bilateral and trilateral discussions over various rules. But we did 

not have a single place where all the major regulators got together 

to discuss possible threats to the economy. 

Mr. GREEN. Are these meetings well-coordinated and do they 

take place at the specific times such that this has become a part 

of your agenda? 

Mr. BERNANKE. The meetings are, although on specific dates, 

they are set up by the Treasury. Sometimes it is hard to schedule 

because we want all of these folks to be there, but we have been 

meeting more frequently than quarterly, and again the meetings 

are quite substantive. They usually have both a private session 

where we discuss matters among ourselves and then there is a 

public session as well. 

Mr. GREEN. One additional question on this. With FSOC, are you 

better positioned to deal with systemic risk than you were prior to 

FSOC? 

Mr. BERNANKE. I believe so, because it allows us to take a broader perspective. Each individual agency, for example, if it has an 

issue it is working on, can make a presentation to everybody, and 

we will all be informed about what, say, the SEC is doing on money 

market mutual funds or the insurance people are doing on insurance issues. 

Mr. GREEN. Let’s talk for just a moment about cutting our way 

to prosperity. Is there a downside to cutting our way to prosperity, 

and I am referencing to some extent, cutting to the extent that we 

start to decrease the number of jobs, we are cutting jobs. We talk 

quite often about systemic risk, well, actually stimulus, providing 

a stimulus for the economy, and not wanting to provide too much 

stimulus. But can we also move to a point where we are cutting 

such that we are hurting the economy? 

Mr. BERNANKE. I have expressed concern about what happens on 

January 1st, which would be a major fiscal contraction. I think it 

would pose a risk to the recovery. But what I have advocated is 

sort of a two-point, two-part process, one of which is critically making sure that we have a fiscally sustainable path going forward in 

the medium to long term, but that at the same time we pay attention to the recovery and make sure we don’t snuff it out unintentionally. 

Mr. GREEN. Ranking Member Frank presented a chart from your 

Monetary Policy Report, and this is number 30, and this chart really speaks volumes about what has happened and what is happening. If you consider zero terra firma or above water, obviously, 

we were going down fast, sinking. We were falling off a cliff, and 

now we are coming up. In fact, we are back above water, on terra 

48 

firma. Not where we would like to be, but we are clearly moving 

in the right direction. If down is bad, then up is good. It is kind 

of simple to see where we are here. If down is wrong, up is right; 

if down is worse, up is better. I hate to use this highly technical 

terminology. Some people may not quite comprehend all of what I 

am saying, but I thank you for the chart. 

Mr. HENSARLING. The time of the gentlemen has expired. The 

Chair now recognizes the gentleman from New Mexico, Mr. Pearce, 

for 5 minutes. 

Mr. PEARCE. Thank you, Mr. Chairman. And thank you, Chairman Bernanke, for being here today. Mr. Garrett was asking a little bit about the European exposure, and you stated that the European banks are pretty sound. Did I hear you correctly that you 

were saying that they have pretty stable— 

Mr. BERNANKE. I was talking about the European Central Bank, 

the central bank. The European banking system is currently being 

asked by the European banking authority to raise a good bit more 

capital, and of course, their liquidity situation is being satisfied almost entirely by, or very substantially by the European Central 

Bank rather than by private markets. 

Mr. PEARCE. So that would explain, because I was a little confused. On page 4, you were talking about your continuing to monitor the European exposure of U.S. financial— 

Mr. BERNANKE. Yes. 

Mr. PEARCE. So that would be that. How long have you been 

watching the exposure of U.S. firms to financial—to the European 

financial— 

Mr. BERNANKE. The European situation became prominent about 

2 years ago, so pretty much throughout that period. 

Mr. PEARCE. I guess my question then is about the New York 

Fed that gave primary dealer status to MF Global, and so 2 years 

ago would be somewhere in the timeframe that they were making 

application, in February of 2011 is when they got the application 

done. That is when it was given. And so this watching of exposure, 

MF Global had gone up by $4 billion during that very time period. 

Why didn’t the New York Fed catch this exposure if that was something you all were concerned about? 

Mr. BERNANKE. Because we are regulating banks and we are 

looking at the banks’ exposure. MF Global wasn’t a bank and we 

weren’t their regulator. 

Mr. PEARCE. But they were taking a look at them. They had to 

take a look at them to give dealer— 

Mr. BERNANKE. But only as a counterparty. They met the criteria 

for size and capital and experience. 

Mr. PEARCE. They had been turned down several times before. 

Mr. BERNANKE. I don’t know. 

Mr. PEARCE. I will tell you, they were turned down several times 

before. 

Mr. BERNANKE. They met the criteria when the New York Fed 

gave the primary dealer status. It has been our goal not to restrict 

the primary dealer status to just a few of the larger institutions. 

We want to have a number of institutions there, and they met the 

standards to be a counterparty to the New York Fed. But again, 

it is not the New York Fed’s responsibility to supervise them. 

49 

Mr. PEARCE. Okay. You used some fairly significant words regarding what is downstream from us if we continue this spending 

by the Federal Government. Didn’t you earlier, in answer to a 

question; in other words, if we keep going, it is going to get fairly 

significant. You used terms that were almost catastrophic. 

Mr. BERNANKE. There is a significant risk that if fiscal sustainability is not achieved within a reasonable period, markets might 

decide it is never going to be achieved, and then we would face a 

crisis of confidence. That is always a possibility. 

Mr. PEARCE. So this spending that we are doing is deficit spending. You would say it is borrowed money, except that no single 

country has the ability to loan a trillion dollars when we are running $200 billion, $300 billion deficits. China could lend us the 

money, but with a $6 trillion economy, China doesn’t appear to be 

able to lend $1 trillion, which would be 1/6, every year. So the Federal Reserve by owning $1.2 trillion in U.S. treasuries is really facilitating this spending, and it seems like you all have the capability to give some discipline into the institutions here in Washington that don’t have the discipline internally. Even if it was only 

a 10 percent reduction, say, we are not going to buy that many 

Treasuries, not going to do that much quantitative easing, or whatever method you are using. Why don’t you all say no? 

Mr. BERNANKE. Because our mandate given to us by Congress is 

to try to achieve maximum employment and price stability, and 

that is what determines our interest rate. 

Mr. PEARCE. Maximum employment and price stability, you already said that we are facing very serious things if we keep spending what we are spending. 

Mr. BERNANKE. That is correct, so that is why I am here advocating to Congress that Congress take responsible action. 

Mr. PEARCE. You are independent, and you are not indicating 

any discipline, in disciplining us. Thank you, Mr. Chairman. I yield 

back. 

Mr. HENSARLING. The time of the gentleman has expired. The 

Chair now recognizes the gentleman from Colorado, Mr. 

Perlmutter. 

Mr. PERLMUTTER. Thank you. And thank you, Chairman 

Bernanke, for being here, and for staying all this time. I usually 

get to ask questions right at the end. And I appreciate your stamina, really, through this hearing, and through a storm that none 

of us quite understood what was coming. You can always look back 

and say—and I look at Casey Stengel or Yogi Berra who said, 

‘‘Look it up.’’ We can look it up in this monetary report, and we 

can see the storm. You can see where the cliffs were. You can see 

the drop in the employment. You can see the drop in the GDP, and 

I think as we went through this storm, and there are still some 

showers to come, there is no question about that, but we came 

through this storm, and I just want to compliment you for being 

a pretty good captain, one of many, but a pretty good captain in 

all of this. 

But I do have a few questions, and Mr. Pearce just brought up 

something for me. I would like to discuss charts 23 and 24; Chart 

23 is Federal receipts and expenditures, 1991 through 2011; and 

Chart 24 is change in real government expenditures on consumpVerDate Nov 24 2008 18:30 Nov 19, 2012 Jkt 075075 PO 00000 Frm 00053 Fmt 6633 Sfmt 6633 K:\DOCS\75075.TXT TERRI
50 

tion investment, 2005 through 2011. So when I look at Chart 23, 

I see a continued reduction in revenue to the Federal Government, 

and I see in part of those spikes, a huge spike in the fall of 2008 

and 2009, as demand for Federal services or services went up, GAP 

being debt accumulated. Would that be a fair statement? 

Mr. BERNANKE. Yes. 

Mr. PERLMUTTER. Okay, and then in 24, as opposed to saying, 

there hasn’t been any effort to rein in experiences, if I read chart 

24 correctly, there has been a reduction, at least based on this 

chart in Federal expenditures. Is that correct? Am I reading it 

right or wrong? 

Mr. BERNANKE. Yes, you are reading it correctly. That is really 

the phasing out of the stimulus in 2009, and then of course, States 

and localities also have been laying off workers and cutting back 

spending. 

Mr. PERLMUTTER. Okay, so let’s talk about what is happening at 

the end of this year. Now, if our goal is to pay down the country’s 

debt, there are two ways to do it. You have more revenue and you 

have less expense, as opposed to what we saw in chart 23, where 

we had less revenue and more expense. So if I am not mistaken, 

you called it a fiscal cliff. I am not sure I would say that. It is the 

Bush tax cuts expire, so revenue increases, and the sequestration 

or the budget cuts kick in, we can start paying down the debt. 

Now, you said that may cause a major contraction. Can you explain 

that? 

Mr. BERNANKE. I don’t think I used those words exactly, but— 

Mr. PERLMUTTER. Okay, so use your own words. I don’t mean to 

put words in your mouth. 

Mr. BERNANKE. I would just cite as my authority the CBO, the 

Congressional Budget Office, has to make projections based on current law. So they assumed in their projections that the current law, 

the current expiration of the tax cuts and of the payroll tax relief 

and the sequestration all came into play in 2013, and their economic projection based on that was for 1 percent growth and for 

unemployment to begin to rise again. And it is just the usual logic 

that if you cut spending sharply and raise taxes, you are going to 

pull demand out of the economy, and it is going to hurt the recovery. 

Again, it is very important to address these issues in the medium 

to long term, but if it all hits the economy at one time, it would 

be very hard to adjust to that. 

Mr. PERLMUTTER. So I guess what you are saying is that we have 

these two things out there, and if we have the opportunity, both 

sides of the aisle, we ought to be a little more refined or targeted 

as we try to approach paying down the debt. At least that is how 

I am understanding your— 

Mr. BERNANKE. You can get the same pay-down, the same longterm benefits, but just a little more gradually, I think. 

Mr. PERLMUTTER. I have a question on page 2 of the report. It 

says, ‘‘Additionally the ECB made a significant injection of euro liquidity via its first 3-year refinancing operation and central banks 

agreed to reduce the price of U.S. dollar liquidity based on swap 

lines with the Federal Reserve.’’ What does that mean? 

51 

Mr. BERNANKE. So, European banks are having trouble raising 

funds. 

Mr. PERLMUTTER. Right. 

Mr. BERNANKE. Most of their funding is in euros. Some of it is 

in dollars. On the euro side, the European Central Bank, which 

controls the supply of euros, has lent a trillion euros for 3 years 

to European banks on a collateralized basis and that has greatly 

reduced the problems that European banks have in raising euro 

funding. The European Central Bank doesn’t control dollars. The 

Federal Reserve controls dollars. In order to get dollars to the European banks who use it, in turn to make loans to U.S. citizens, 

among other things, the Federal Reserve has swapped dollars for 

euros. We give the European Central Bank dollars, and they give 

us euros. On their recognizance they take the dollars and lend 

them for shorter periods, not 3 years, less than 3 months, to European banks thereby relieving them of their dollar funding problems. They pay us back with interest, so we don’t lose anything, 

but it helps relieve the funding tensions for European banks. 

Mr. PERLMUTTER. All right, thank you. Thank you, Mr. Chairman. 

Mr. HENSARLING. The time of the gentlemen has expired. The 

gentleman from Minnesota, Mr. Ellison, is recognized for the remaining time. 

Mr. ELLISON. Thank you, Mr. Chairman. Chairman Bernanke, 

thank you for coming. I just want to know your views on what 

more you think could be done to try to help the housing market get 

back on track? Let me just observe that about 60 percent of all the 

mortgages are either owned or backed by the GSEs, and perhaps 

some people have proposed that we write those down, the ones we 

can write down. And yet, they haven’t been, and there is some resistance to that. 

Is that a feasible solution? And if not, what other ideas do you 

have regarding the housing market, because it seems like that is 

the one persistent thing that is dragging the economy down. It is 

not just construction jobs. It is just the loss of equity. People did 

not—it is the general prevailing sort of diminishment of demand, 

as I see it. So let me hand it over to you. That is actually going 

to be my only question. 

Mr. BERNANKE. As you may know, Congressman, the Federal Reserve put out a White Paper recently that had an analytical discussion of a variety of different options without making recommendations. 

There are a whole range of issues. GSEs have actually addressed 

some of them to some extent. One problem is getting the excess 

supply of housing off the market, so to speak. And one way to do 

that is to convert housing, REO housing, into rental housing. GSEs 

have a pilot program to do that, and we discussed some of the 

issues related to that in our White Paper. 

There is also for us to get rid of dilapidated or uninhabitable 

houses, land banks and similar institutions are a useful tool potentially. We also consider—we have not taken a position, and there 

certainly is no official Fed position on principal reduction, but we 

have looked at various alternatives to foreclosure, including, for exVerDate Nov 24 2008 18:30 Nov 19, 2012 Jkt 075075 PO 00000 Frm 00055 Fmt 6633 Sfmt 6633 K:\DOCS\75075.TXT TERRI
52 

ample, deed in lieu or short sales, which allow people to get out of 

the house and for the bank to avoid the foreclosure process. 

I guess a final area where we have a good bit of discussion is 

about availability or access to mortgage credit which is now very, 

very tight. And one of our recommendations was that the GSEs 

look at their policies regarding representations and warranties to 

provide greater assurance to originators that their loans would not 

be returned to them. GSEs are looking at that. That is a positive 

development. 

Another way to improve originations is to reduce uncertainty 

about servicing obligations. And between the various agreements 

that have occurred recently in the Fed’s cease-and-desist orders, 

current discussions about national servicing standards and the 

like, I think some of that uncertainty is being removed. So there 

is a whole variety of things that can be done. None of them is a 

silver bullet, but many of them could be helpful. 

Mr. ELLISON. Thank you. 

Thank you, Mr. Chairman. 

Mr. HENSARLING. The time of the gentleman has expired. 

Chairman Bernanke, we thank you for your testimony today. 

The Chair notes that some Members may have additional questions for Chairman Bernanke, which they may wish to submit in 

writing. Without objection, the hearing record will remain open for 

30 days for Members to submit written questions to Chairman 

Bernanke and to place his responses in the record. This hearing is 

now adjourned. 

[Whereupon, at 1:02 p.m., the hearing was adjourned.] 

(53) 

A P P E N D I X 

February 29, 2012 

54 


75075.001

United States House of Representatives 

Committee on Financial Services 

Hearing on "Monetary Policy and the State of the Economy" 

2/29/2012 

Congressman Ron Paul 

Statement for the Record 

Mr. Chairman, thank you for holding this hearing on monetary policy and the state of the economy. 

believe that now, more than ever, the American people want to hold the Federal Reserve accountable 

for its loose monetary'policy and want full transparency of the Fed's actions. 

While the Fed has certainly released an unprecedented amount of information on its activities, there is 

still much that remains unknown. And every move towards transparency has been fought against tooth 

and nail by the Fed. It took disclosure requirements enacted within the Dodd-Frank Act to get the Fed 

to provide data on the its emergency Icnding facilities. It took lawsuits filed by Bloomberg and Fox 

News to provide data on discount window lending during the worst parts of the financial crisis. And it 

will take further concerted action on the part of Congress, the media, and the public to keep up pressure 

on the Fed to remain transparent. 

Transparency is not a panacea, however, as a fully transparent organization is still capable of engaging 

in all sorts of mischief, as the Federal Reserve does on a regular basis. Ironically, one of the Fed's more 

egregious recent actions, adopting an explicit inflation target, was hailed by many as another wonderful 

example oftransparency. Yet if you think about what this supposed 2% inflation target actually is, you 

realize that it is an explicit policy to devalue the dollar and reduce its purchasing power. Two percent 

annual price inflation means that prices rise 22% within a decade, and nearly 50% within two decades. 

Indeed, if you look at the performance ofthe consumer price index (CPI) under Chairman Bernanke's 

tenure, prices have risen at a rate of2.25% per year. Many, perhaps even most, economists would 

consider this a modest rise, an example of sober, cautious monetary policy. Some economists of Paul 

Krugman's persuasion might even argue that this is too tight a monetary policy. However, 2.25% is not 

too far off from the Fed's new 2% target. 

Now look at the performance of the US economy since February I, 2006, the date Chairman Bernanke 

took the mantle from Alan Greenspan. Trillions of dollars have been wasted on bailouts, stimulus 

packages, and other feckless spending. Millions of Americans have lost their jobs and have lost hope 

of ever regaining employment. The national debt has risen to more than 100% of GDP, as the federal 

government continues to rack up trillion-dollar deficits, aided and abetted by the Fed's policies of 

quantitative easing and zero percent interest rates. And we are supposed to believe that a 2% inflation 

rate, similar to what has prevailed during the worst economic crisis since the Great Depression, is the 

cure lor what ails this economy. 

This explicit 2% target also fails to take into account that whatever measure is used to determine price 

inflation, be it CPI, core CPI, PCE, etc., will always be chosen with an eye towards underreporting the 

true rate of inflation and price rises. Pressure will be exerted on those calculating the price indices, so 

as not to alarm the public when prices begin to accelerate. One need only look at what is taking place 

in Argentina today, where the government publishes an ofiicial CPI figure that is often less than half 

that reported by private sources. 
55 


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A similar situation exists in this country, where economists calculating cpr according to the original 

basket of goods have determined that price inflation has increased 9.5% per year since 2006, rather 

than the 2.25% reported by the government. Even the government's own data reports price rises of 

nearly 7% per year since 2006 on such consumer goods as gasoline and eggs. Bread, rice, and ground 

beef have increased by nearly 6% per year, while bacon and potatoes have increased nearly 5% per 

year. This means that in a little over half a decade, prices on staple consumer goods have increased 30-

50%, all while wages have stagnated and millions of Americans find themselves out of work and 

without a paycheck. Of course, government officials claim that price increases do not affect the average 

American because they can always buy hamburger instead of steak, or have cereal instead of bacon. 

But the American people can see how they are suffering because of the Fedcral Reserve. The 

government's claims that the official statistics show no reason to be concerned about inflation is 

Marxist-as in Groucho, who famously said: "Who are you going to believe, me or your own eyes?" 

The Federal Reserve continues to keep interest rates low in the hopes of boosting lending and 

consumption. But keeping interest rates at zero discourages saving, particularly as the rate of price 

inflation continues to rise. Why stick money in a savings account earning 0.05% if it is guaranteed to 

lose at least 2% of its value every year? And this is a guarantee, as the Fed has promised a 2% rate of 

increase in price inflation, while also guaranteeing a zero percent federal funds rate through 2014. 

Retirees living on fixed incomes, dependent on savings, or on interest income from investments will 

see their savings drawn down as they are forced to consume principal. Young people, hard hit by the 

recession and struggling to find jobs, will fail to see the virtue of thrift. Saving or investing is an 

exercise in futility, as parking money in the bank or in CDs will guarantee a loss, while investing in 

stocks, bonds, or mutual funds will net at best paltry gains, and at worst massive losses in this 

continuing weak economy. 

The longer the Federal Reserve keeps interest rates low and discourages savings and investment, the 

more societal attitudes will change from being future oriented to present oriented. The Federal Reserve 

and its policies already served to stimulate and prioritize consumption over saving, creating the largest 

debt bubble the world has ever known. The extended zero interest rate policy only serves to promote 

more consumption and debt now, eviscerating thrift and savings-the true building blocks of 

prosperity. This present-oriented mindset has become pervasive especially among politicians, putting 

the government in dismal financial shape as Congressmen and Presidents over the years have taken to 

heart Louis XV's famous saying: "Apres moi, Ie deluge." rfthe American people follow the same path 

in their own lives, this country will be ruined. Capital will be depleted, infrastructure will fall into 

disrepair, and the United States will be a mere shadow of its former self. It is well past time to end the 

failed monetary policy that encourages this mistaken preference for cheap money now. 
56 


75075.003

For release on delivery 

10:00 a.m. EST 

February 29,2012 

Statement by 

Ben S. Bernanke 

Chairman 

Board of Governors of the Federal Reserve System 

before the 

Committee on Financial Services 

U.S. House of Representatives 

February 29,2012 
57 


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Chairman Bachus, Ranking Member Frank, and other members of the Committee, I am 

pleased to present the Federal Reserve's semiannual Monetary Policy Report to the Congress. 

~ill begin with a discussion of current economic conditions and the outlook and then turn to 

monetary policy. 

The Economic Outlook 

The recovery of the U.S. economy continues, but the pace of expansion has been uneven 

and modest by historical standards. After minimal gains in the first half of last year, real gross 

domestic product (GDP) increased at a 2-1/4 percent annual rate in the second half.l The limited 

information available for 2012 is consistent with growth proceeding, in coming quarters, at a 

pace close to or somewhat above the pace that was registered during the second half of last year. 

We have seen some positive developments in the labor market. Private payroll 

employment has increased by 165,000 jobs per month on average since the middle of last year, 

and nearly 260,000 new private-sector jobs were added in January. The job gains in recent 

months have been relatively widespread across industries. In the public sector, by contrast, 

layoffs by state and local goverrunents have continued. The unemployment rate hovered around 

9 percent for much of last year but has moved down appreciably since September, reaching 8.3 

percent in January. New claims for unemployment insurance benefits have also moderated. 

The decline in the unemployment rate over the past year has been somewhat more rapid 

than might have been expected, given that the economy appears to have been growing during 

that time frame at or below its longer-term trend; continued improvement in the job market is 

likely to require stronger growth in final demand and production. Notwithstanding the better 

recent data, the job market remains far from normal: The unemployment rate remains elevated, 

I Data for the fourth quarter of 20 11 from the national income and product accounts reflect the advance estimate 

released on January 27, 2012. 
58 


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- 2-

long-term unemployment is still near record levels, and the number of persons working part time 

for economic reasons is very high. 2 

Household spending advanced moderately in the second half of last year, boosted by a 

fourth-quarter surge in motor vehicle purchases that was facilitated by an easing of constraints on 

supply related to the earthquake in Japan. However, the fundamentals that support spending 

continue to be weak: Real household income and wealth were flat in 2011, and access to credit 

remained restricted for many potential borrowers. Consumer sentiment, which dropped sharply 

last summer, has since rebounded but remains relatively low. 

In the housing sector, atTordability has increased dramatically as a result of the decline in 

house prices and historically low interest rates on conventional mortgages. Unfortunately, many 

potential buyers lack the down payment and credit history required to qualifY for loans; others 

are reluctant to buy a house now because of concerns about their income, employment prospects, 

and the future path of home prices. On the supply side of the market, about 30 percent of recent 

home sales have consisted of foreclosed or distressed properties, and home vacancy rates remain 

high, putting downward pressure on house prices. More-positive signs include a pickup in 

construction in the multifamily sector and recent increases in homebuilder sentiment. 

Manufacturing production has increased 15 percent since the trough of the recession and 

has posted solid gains since the middle oflast year, supported by the recovery in motor vehicle 

supply chains and ongoing increases in business investment and exports. Real business spending 

for equipment and software rose at an annual rate of about 12 percent over the second half of 

2011, a bit faster than in the first half of the year. But real export growth, while remaining solid, 

2 In January, 5-l/2 million persons among those counted as unemployed--about 43 percent of the total--had been out 

of work for more than six months, and 8-1/4 million persons were working part time for economic reasons. 
59 


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- 3 -

slowed somewhat over the same period as foreign economic activity decelerated, particularly in 

Europe. 

The members of the Board and the presidents of the Federal Reserve Banks recently 

projected that economic activity in 2012 will expand at or somewhat above the pace registered in 

the second half of last year. Specifically, their projections for growth in real GDP this year, 

provided in conjunction with the January meeting of the Federal Open Market Committee 

(FOMC), have a central tendency of2.2 to 2.7 percent. 3 These forecasts were considerably 

lower than the projections they made last June.4 A number of factors have played a role in this 

reassessment. First, the annual revisions to the national income and product accounts released 

last summer indicated that the recovery had been somewhat slower than previously estimated. In 

addition, fiscal and financial strains in Europe have weighed on financial conditions and global 

economic growth, and problems in U.S. housing and mortgage markets have continued to hold 

down not only construction and related industries, but also household wealth and confidence. 

Looking beyond 2012, FOMC participants expect that economic activity will pick up gradually 

as these headwinds fade, supported by a continuation of the highly accommodative stance for 

monetary policy. 

With output growth in 2012 projected to remain close to its longer-run trend, participants 

did not anticipate further substantial declines in the unemployment rate over the course of this 

year. Looking beyond this year, FOMC participants expect the unemployment rate to continue 

3 See table I, "Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents, 

January 2012," of the Summary of Economic Projections available at Board of Governors of the Federal Reserve 

System (2012), "Federal Reserve Board and Federal Open Market Committee Release Economic Projections fTOm 

the January 24-25 FOMC Meeting," press release, January 25, 

www.federalreserve.gov/newsevents/press/monctaryI20120125b.htm; also available in Part 4 of the February 2012 

Monetary Policy Report to the Congress. 

4 Ben S. Bernanke (2011), "Semiannual Monetary Policy Report to the Congress," statement before the Committee 

on Financial Services, U.S. House of Representatives, July 13, 

www.federalreserve.gov/newsevents/testimonylbemanke20110713a.htm. 
60 


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-4-

to edge down only slowly toward levels consistent with the Committee's statutory mandate. In 

light of the somewhat different signals received recently from the labor market than from 

indicators of final demand and production, however, it will be especially important to evaluate 

incoming information to assess the underlying pace of economic recovery. 

At our January meeting, participants agreed that strains in global financial markets posed 

significant downside risks to the economic outlook. Investors' concerns about fiscal deficits and 

the levels of government debt in a number of European countries have led to substantial 

increases in sovereign borrowing costs, stresses in the European banking system, and associated 

reductions in the availability of credit and economic activity in the euro area. To help prevent 

strains in Europe from spilling over to the U.S. economy, the Federal Reserve in November 

agreed to extend and to modify the terms of its swap lines with other major central banks, and it 

continues to monitor the European exposures of U.S. financial institutions. 

A number of constructive policy actions have been taken of late in Europe, including the 

European Central Bank's program to extend three-year collateralized loans to European financial 

institutions. Most recently, European policymakers agreed on a new package of measures for 

Greece, which combines additional official-sector loans with a sizable reduction of Greek debt 

held by the private sector. However, critical fiscal and financial challenges remain for the euro 

zone, the resolution of which will require concerted action on the part of European authorities. 

Further steps will also be required to boost growth and competitivencss in a number of countries. 

We are in frequent contact with our counterparts in Europe and will continue to follow the 

situation closely. 
61 


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- 5-

As I discussed in my July testimony, inflation picked up during the early part of20]1 5 

A surge in the prices of oil and other commodities, along with supply disruptions associated with 

the disaster in Japan that put upward pressure on motor vehicle prices, pushed overall inflation to 

an annual rate of more than 3 percent over the first half of last year.6 As we had expected, 

however, these factors proved transitory, and inflation moderated to an annual rate of 

1-1/2 percent during the second half of the year--c1ose to its average pace in the preceding two 

years. In the projections made in January, the Committee anticipated that, over coming quarters, 

inflation will run at or below the 2 percent level we judge most consistent with our statutory 

mandate. Specifically, the central tendency of participants' forecasts for inflation in 2012 ranged 

from 1.4 to 1.8 percent, about unchanged from the projections made last June.7 Looking farther 

ahead, participants expected the subdued level of inflation to persist beyond this year. Since 

these projections were made, gasoline prices have moved up, primarily reflecting higher global 

oil prices--a development that is likely to push up inflation temporarily while reducing 

consumers' purchasing power. We will continue to monitor energy markets carefully. Longerterm inflation expectations, as measured by surveys and financial market indicators, appear 

consistent with the view that inflation will remain subdued. 

Monetary Policy 

Against this backdrop of restrained growth, persistent downside risks to the outlook for 

real activity, and moderating inflation, the Committee took several steps to provide additional 

monetary accommodation during the second half of2011 and early 2012. These steps included 

'Bernanke, "Semiannual Monetary Policy Report to the Congress" (see note 4). 

6 Inflation is measured using the price index for personal consumption expenditures. 

7 See table I available at Board of Governors, "Federal Reserve Board and Federal Open Market Committee Release 

Economic Projections" (see note 3), 
62 


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-6-

changes to the forward rate guidance included in the Committee's post-meeting statements and 

adjustments to the Federal Reserve's holdings of Treasury and agency securities. 

The target range for the federal funds rate remains at 0 to 114 percent, and the forward 

guidance language in the FOMC policy statement provides an indication of how long the 

Committee expects that target range to be appropriate. In August, the Committee clarified the 

forward guidance language, noting that economic conditions--including low rates of resource 

utilization and a subdued outlook for inflation over the medium run--were likely to warrant 

exceptionally low levels for the federal funds rate at least through the middle of2013. By 

providing a longer time horizon than had previously been expected by the public, the statement 

tended to put downward pressure on longer-term interest rates. At the January 2012 FOMC 

meeting, the Committee amended the forward guidance further, extending the horizon over 

which it expects economic conditions to warrant exceptionally low levels of the federal funds 

rate to at least through late 2014. 

In addition to the adjustments made to the forward guidance, the Committee modified its 

policies regarding the Federal Reserve's holdings of securities. In September, the Committee put 

in place a maturity extension program that combines purchases of longer-term Treasury 

securities with sales of shorter-term Treasury securities. The objective of this program is to 

lengthen the average maturity of our securities holdings without generating a significant change 

in the size of our balance sheet. Removing longer-term securities from the market should put 

downward pressure on longer-term interest rates and help make financial market conditions more 

supportive of economic growth than they otherwise would have been. To help support 

conditions in mortgage markets, the Committee also decided at its September meeting to reinvest 

principal received from its holdings of agency debt and agency mortgage-backed securities 
63 


75075.010

7 

(MBS) in agency MBS, rather than continuing to reinvest those proceeds in longer-tenn Treasury 

securities as had been the practice since August 2010. The Committee reviews the size and 

composition of its securities holdings regularly and is prepared to adjust those holdings as 

appropriate to promote a stronger economic recovery in the context of price stability. 

Before concluding, I would like to say a few words about the statement oflongcr-run 

goals and policy strategy that the FOMC issued at the conclusion of its January meeting. The 

statement reaffinns our commitment to our statutory objectives, given to us by the Congress, of 

price stability and maximum employment. Its purpose is to provide additional transparency and 

increase the effectiveness of monetary policy. The statement does not imply a change in how the 

Committee conducts policy. 

Transparency is enhanced by providing greater specificity about our objectives. Because 

the inflation rate over the longer run is detennined primarily by monetary policy, it is feasible 

and appropriate for the Committee to set a numerical goal for that key variable. The FOMC 

judges that an inflation 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 its statutory 

mandate. While maximum employment stands on an equal footing with price stability as an 

objective of monetary policy, the maximum level of employment in an economy is largely 

detennined by nonmonetary factors that affect the structure and dynamics of the labor market; it 

is therefore not feasible for any central bank to specify a fixed goal for the longer-run level of 

employment. However, the Committee can estimate the level of maximum employment and use 

that estimate to infonn policy decisions. In our most recent projections in January, for example, 

FOMC participants' estimates of the longer-run, nonnal rate of unemployment had a central 
64 


75075.011

- 8 -

tendency of 5.2 to 6.0 percent. 8 As r noted a moment ago, the level of maximum employment in 

an economy is subject to change; for instance, it can be affected by shifts in the structure of the 

economy and by a range of economic policies. If at some stage the Committee estimated that the 

maximum level of employment had increased, for example, we would adjust monetary policy 

accordingly. 

The dual objectives of price stability and maximum employment are generally 

complementary. Indeed, at present, with the unemployment rate elevated and the inflation 

outlook subdued, the Committee judges that sustaining a highly accommodative stance for 

monetary policy is consistent with promoting both objectives. However, in cases where these 

objectives are not complementary, the Committee follows a balanced approach in promoting 

them, taking into account the magnitudes of the deviations of inflation and employment from 

levels judged to be consistent with the dual mandate, as well as the potentially different time 

horizons over which employment and inflation are projected to return to such levels. 

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

8 See table 1 available at Board of Governors, "Federal Reserve Board and Federal Open Market Committee Release 

Economic Projections" (see note 3). 
65 


75075.012
66 


75075.013

February 29, 2012 

Board of Governors of the Federal Reserve .... ,d·"'rn 
67 


75075.014

BOARD OF GOVERNORS OF TIlE 

FEDERAL RESERVE SYSTEM 

Washington, D.C., February 29, 2012 

THE PRESIDENT OF THE SENATE 

THE SPEAKER OF THE HOUSE OF REPRESENTAflVES 

The Board of Governors is pleased to submit its Iv[onetary Policy Report to the Congress 

pursuant to section 2B of the Federal Reserve Act. 

Ben Bernanke, Chairman 
68 


75075.015

1 Part 1: Overview 

5 Part 2: Recent Economic and Financial Developments 

6 Domestic Developments 

6 The Household Sector 

6 Consumer Spending and Household Finance 

8 Housing ACTivity and Finance 

10 The Business Sector 

10 Fixed Investment 

II Inventory Investment 

II Corporate Profits and Business f<inance 

13 The Government Sector 

13 Federal Government 

15 State and Local Government 

15 The External Sector 

17 National Saving 

17 The Labor Market 

17 Employment and Unemploymel1l 

18 Productivity and Labor Compensation 

18 Prices 
69 


75075.016

ji 

20 Financial Developments 

2() Monetary Policy Expectations and Treasury Rates 

21 Short-Term Emding Markets 

22 Financial Institutions 

26 Corporate Debt and Equity Markets 

28 Monetary Aggregates and the Federal Reserve's Balance Shed 

30 International Developmenls 

30 International Financial Markets 

33 The Financial Account 

35 Advanced Foreign Economies 

36 Emerging Market Economies 

39 Part 3: Monetary 

39 Monetary Policy over the Second Half of 20ll and Early 2012 

43 FOMC Communications 

47 Part 4: Summary of Economic Projections 

49 The Outlook li)r Economic Activity 

51 The Outlook lor I nflalion 

54 Appropriate Monetary Policy 

58 Uncertainly and Risks 

61 

List of Boxes 

24 Financial 

32 An 

36 U.S. Funding Pressures and Dollar 

45 FOMC Statement Regarding Longer-Run Goals Strategy 

60 Forecast Uncertainty 
70 


75075.017

Economic activity in the United States expanded at a 

moderate rate in the second half of 2011 following an 

anemic gain in the first halt: and the moderate pace of 

expansion appears to have continued into the opening 

months of 2012. Activity was held down in the first 

half of 2011 by temporary factors, particularly supply 

chain disruptions stemming from the earthquake in 

Japan and the damping efIcct of higher energy prices 

on consumer spending. As the effects of these factors 

waned over the second half of the year, economic 

activity picked up. Conditions in the labor market have 

improved since last summer, with an increase in the 

pace of job gains and a noticeable reduction in the 

unemployment rate. Meanwhile, consumer price inilation has stepped down from the temporarily high levels 

observed over the fIrst half of 2011, as commodity and 

import prices retreated and as longer-term inflation 

expectations remained stable. Looking ahead, gro-wth 

is likely to be modest during the coming year, as several 

factors appear likely to continue to restrain activity, 

including restricted access to credit for many households and small businesses, the still-depressed housing 

market, tight liscal policy at alllevcls of government, 

and some slowing in global economic growth. 

In light of these conditions, the Federal Open Market Committee (FOMe) took a number of steps during the second half of 2011 and early 2012 to provide 

additional monetary policy accommodation and 

thereby support a stronger economic recovery in the 

context of price stability. These steps included modifying the forward rate guidance included in postmeeting 

statements, increasing the average maturity of the Federal Reserve's securities holdings, and shifting the reinveslment of principal payments on agency securities 

from Treasury securities to agency-guaranteed 

mortgage-backed securities (MIlS). 

Throughout the second half of 2011 and early 2012, 

participants in financial markets focused on the fiscal 

and banking crisis in Europe. Concerns regarding the 

potential [or spillovers to the U.S. economy and fmancial markets weighed on investor sentiment, contributing to significant volatility in a wide range of asset 

prices and at times prompting sharp pullbacks from 

risk-taking. Strains cased somewhat in a number of 

financial markets in late 2011 and early this year as 

investors seemed to hecome more confident that European policymakers would take the steps necessary to 

address the crisis. The more positive market sentiment 

was bolstered by recent U.S. data releases, which 

pointed 10 greater strength, on balance, than investors 

had expected. Nonetheless, market participants reportedly remain cautious about risks in the fInancial 

system, and credit default swap spreads for lJ.S. financial institutions have widened, on net, since early last 

summer. 

After rising at an annual rate of just 'l4 percent in the 

tlrst half of 2011, real gross domestic product (GDP) is 

estimated to have increased at a 2 Y4 percent rate in the 

second halP The growth rate of real consumer spending also tirmed a bit in the second half of the year, 

although the fundamental determinants of household 

spending improved little: Real household income and 

wealth stagnated, and access to credit remained tight 

for many potential horrowers. Consumer sentiment has 

rebounded from the summer's depressed levels but 

remains low hy historical standards. Meanwhile, real 

investment in equipment and software and exports 

posted solid gains over the second half of the year. In 

contrast, the housing market remains depressed, 

weighed down by the large inventory of vacant houses 

fi.)r sale, the substantial volume of distressed sales, and 

homebuyers' concerns about the strength of the recovery and the potential for further declines in house 

prices. In the government sector, real purchases of 

goods and services continued to decline over the second half of the year. 

Labor market conditions have improved. The unemployment rate moved down from around 9 percent 

over the first eight months of 2011 to SOl, percent in 

January l012. However, even with this improvement, 

the jobless rate remains quite elevated. Furthermore, 

the share of the unemployed who have been jobless for 

more than six months, although down slightly from its 

peak, was still above 40 percent in January--roughly 

double the fraction that prevailed during the economic 

expansion of the previous decade. Meanwhile, private 
71 


75075.018

Mondary Policy Report to the Congress [J February 2012 

payroll employment gains averaged 1(')5,000 jobs 

month in the second half of 2011, it bit slower than the 

pace in the flrsl half of the yC<:l1~ but gains in December 

and January wen: more robust, almost 

24(),OOO per month. 

Consumer price inflation stepped down in the second half of 2011. After at an annual rate of 

perccnt in the first half of the year, prices for personal consumptiun expenditures (per:) rose just 

11/2 percent in the s10cond half per prices excluding 

food and energy also decelerated, rising at an annual 

ruLe of roughly 111:2 percent in the second half of 201 I, 

compared with about 2 percent in the 11rs1 halC The 

decline in inHation was largely response [0 decreases 

in global commodity prices ri)llo\\!ing their early 

in 2011, as Vi!~ll as restoratiun of supply chains fC)f 

motor vehicle produclioll that had been disrupted after 

the earthquake in Japan and some deceleration in the 

prices of impl..-wted goods other than raw commodities. 

The European fiscal and banking intensified in 

1 he second haIr of the year. During t ht.': summer, the 

governments of 11aly and Spain came under 

i1nanc1r.ll pressufe and borrowing cnsts increased for 

many curo-area and banks. in early 

August, the European Central Bank (FeB) responded 

by purchases of market able debt sccuril ics. 

Although yields on the government lkb! Df Haly and 

Spain temporarily moved 1\)\\ler, markcl conditions 

deteriorated in the Call and funding pressures !<"lr some 

governml.mls and hanks increased further. Over the 

second hall' of the year, Europ.;an kUi.krs \vorkt:d 

toward bolstering th..: financial backstop rt)f curn-area 

gt}\l\'rnments, reinforcing the l1scal discipline or those 

govt::rnnWnl8, and strengthening the capital .. lOll liquidpositions or banks. /\ddi!ional1y, the FeB made a 

significant injection of euro liquidity via its first threeyear refInancing operation. and central banks agreed to 

rt:duce the price of U.S. dollar liquidity based on S\vap 

lines with the Federal Reserve. Since December, following these actions, yields on the deb! of vulnerable 

European governments declined to some extent and 

funding pressures on European banks c<:L'icd. 

A numher of sources of inveSTor including 

the European crisis, concerns about Lhc suslainahili1y 

of u.s. fiscal policy, and a slowdo\vn in global 

gro¥lLh--weighcd on U.S. iinancial markets early in the 

second half of 20 ll. More n:ccntly, these concerns 

cased somewhat, rel1ccting actions taken by gll)bal central hanks well as U.S. data releases that pointed to 

greater strength, Gn balance, than markeL participants 

had anticipated. Broad ..:;quity prices feU notably in 

August but suhs-.;qu<.:ntly retraced, and they arc now 

little -changed, on net, since early July. Corporate bond 

spreads rcrnain eievnted. Partly a result of the l()r-

\vard guidanct: and ongoing maturity extension program provided by the Federal Reserve, market participants expect the target federal rate to remain low 

for a longer period than the) thl'lIght early last July, 

and Treasury yields have moved dO\vn significantly. 

Meam;vhik, measures of inflation compensation over 

the next nve years derived f'rom yields on nominal and 

int1ation-indcxed Treasury ~ecuritks are little changed, 

on balanct:, Lhough the ron-yard measure 5-tu- 1() years 

ahead remains bdo\,,' its level in the middle of last year. 

Among nonfmancial cDrporations, iargcr and 

highcr-credir-quality llrms v,,:ith access t.o capital markets took advantage of generally atfn.lctivc [inancing 

conditions to raise funds in the second half or 2011. 

On th(; other hand, for smaller urms without access to 

crcdilmarkcts and those \vith less-solid financial situations, borrowing conditions remained more challenging. Renecling these deVelopments, investment-gradt: 

nontlnancial corporations continueclto issue debt at a 

robust pace \vhile speculative-grade issuance declined, 

investors' appetite for riskier assets diminished. 

Similar issuance patterns evident in the market 

syndicated loans, where investment-grade issuance 

cnntinued 10 be strong \vhile that or higher-yielding 

leveraged 10uns fell hack. In uddiLion, commercial and 

indusLrial (C&1) loans i)ll banks' books expanded 

strongly, particularly kw larger dom..:stic banks that arc 

most iikcly to lend to big firms. According to the January Senior Loan OHker Opinion Survey on Bank 

Lending Practices (SLOOS), domestic banks cased 

terms on C&I loans dnd cxpcriem:ed increased loan 

demand during the fourth quarter of the year, the latter deVelopment in p3rt renccting a shirt in some borrowing away from European banks.~ By contrast 

although credit supply conditions for smaller tirms 

arpear to have eased some\vhat in the last several 

months, they remained tighter relative to historical 

nnrms than fell' larger firms, Commercial 

debt continued !o decline through the third quarter of 

201 albeit moderate pace than in 20W. 

Household debt appears to have dcdint.:d at 

slightly slower pace in the second hall' or 2011 than in 

lhc llrs.l halL with the cominm'd contraction in mortgage debt partially offset by growth in consumer creJi1. 

Lven though mortgage rates cont inued tu lx: near historically low levels, the volume of nc\v mortg"lgc It'ans 

remained muted. The smaller quantity of new mortgage origination renee!.!) potential buyers' lack of dther 

the dmvn payment or credit hislory required to ljualify 

2. Th~ Sf/)t)S is available- on the F<;)(l~ra! R-:serv..: Uoard's \\'eh~ik 

at w\\w.J~d:;;ntlreserve.g()\!bc)(.\f{JJo<.:s/Sn J .oanSul'Vey 
72 


75075.019

loans, and many appear reluctant to buy a 

house now hecause or concerns about their income 

prospects and employment statns, well as the- risk of 

further declines hous::: prices. Delinquency rah;s on 

of residential edged lower 

but stayed ncar recent highs, and the of properties in the foreclosure process remained elevated. 

Issuance of consumer asse1-backed securil1es in the 

second half of 20 i 1 ran at about the same rate as it 

had o\'Cr the previous 18 months. A modest net 

tion of SLOOS respondents 10 both the October and 

January surveys indicated that the)' had cased their 

standards on al! categories of consumer loans. 

Measures nf lht: prolltahl1ily of the U.S. banking 

indu~try have edged up, on net, since mid-2011, as 

indicators of' (:fcdiL quality continued to show signs of 

improvcmt2nt and hanks trimmed non interest expenses. 

Meanwhile, banks' regulatory capital rntios remained 

at historic,ally high levels, as authorities continued to 

take steps to enhance their regulation of 11nancia1 instItutions. Nondheless, condirions in unsecured inkrbank funding deteriorated. Strains were particulaxly evidcnL f()r European tlnandnl institutions, 

with funding costs increasing and maturities shortening, on balan()\.:, <;1S investors focused on counlcrpariy 

credit risk a.mid about 1 be ongoing 

crisis in Europe. Given solid deposit growth and lnl,dcst expansion in bank credit aews::; the industry, most 

domestic hanks reportedly had limited need for unsecured funding. 

Concerns ahoul the condltion of financial lnslitulions gave rise to hdghtencd inveslor anxiety regarding 

counterparty exposures during lhe second half of 

2011. Responses to the December Senior Credit OlTtccr 

Opinion Survey on Dealer Financing Terms, or 

SCOOS, indicat~d that dc,,-ucrs dc-voted increased time 

and attention to the management of concentrated 

credit exposures to other financial intermediaries over 

the previous three months, and 80 percent of dealers 

reported reducing credi! limits ft,r some specific counterparties . .1 Respondents also reported broad but 

moderate tightening of credit terms applicable to 

importnn1 classes of counkrpartics preV1011S 

lhrcc months, importantly reJ1ccting a worsening in 

market liquidity and functioning as wdl a 

reduced \villingness to take on risk. 

nrcicr to support a stronger economic recovery 

and help ensure that inHation, over lime, is alkyds 

consislent wlth its dual mandate. the FOMe provided 

additional monetary policy accommodation eluring tbe 

3. '1 he: SCOOS is availabh: on tJH~ Fcdcral R'::;';CfV':: Board's ,;n::hsik 

at ,y\;vw.fcdcralrcscrvc.goy/ccQnrcsdataJrckascs/scoos.htm. 

Hoard (~f Gvvernors (~( the Federal Reserve S):stem J 

second hall' of 20 It and 2012. In August, the 

Commit1ee mndiHed it~ f()rward rate guidance, noling 

thai economic conditions were likely to warrant exccption.-:t.lly low levels for the federal funds rak at least 

through mid-20 1 3. The FOMC decided September meeting!o extend the maturity of its 

Treasury holdings, and to reinvest principal payments 

from its holl.Hngs of agency debt and agency MBS in 

agency fVfBS rather than in Treasury securities. 4 

Finally, at the Committee's January 2012 meeting, the 

rOMC modified its forward guidance to indicate 1hat 

it expected economic conditions to warrant cxc!.!ptionally low level::;; for the federal fund::;; rate at least through 

lale 2014. The Committec noted lhat 1t would regu!arly 

revlcw the size and composition of its securities holdings and is prepared to adjust lh~)se holdings as apprnprlate to promotc a stronger economie recovery in the 

context of price sl ability. 

In addition to these policy actionsJ the Federal 

Reserve took further steps to improve communications 

regarding its mondary p()licy decisions and deliberations:. At lhe Committee's January meding, th(> 

FOl\1C released a statement of its longer-run goals 

and policy slrategy in an dIurt to enhance transparency, acc(Hllltaoility. and of monetary 

policy and to faclli1ale \vell-informed decisionmaking 

by housebolds and hllsjncss~s. The statement emphasizes the Federal Reserve's iirm commitment to pursue 

its congressional mandate l(, promoLt; maximum 

employment, stahle prices, and mudcrak lung-tenn 

in lefest rates. To ctarify how il s<.::cks to achkve these 

objectives, the F'OMC staled that inllation at the rate 

of 2 percent, as measured by tht2 annual chflngc in the 

peE price index, is most (;onsislcnt over the longer run 

with the Federal Reserve's slalulory mandate. \Vhik 

noting 1hat the Committee's assessments of the maximum level of employment necessarily uncertain 

and subject to revision, the statement indicated that 

the ecntr<ll tendency of FOMC participants' current 

t~stimaks of the longer-run normal rate of unemployment between 5.2 and 6.0 percent. It stressed thaI the 

Federal Reserve's statutory objectives are generally 

complementary, but when lhey not, the Committee 

wi1l1/)llow a balanced approach in its efTor1s to return 

both inl1ation and empioyment to 1c-vc1s consistent 

\\i1 h its mandate. 

Tn addition, the January Summary of Economic 

Projections (SFP) provided inti.1 rmation Ii.)r the Hrst 

time about j;OMC participants' individual assessments 
73 


75075.020

4 lVIonetary Policy Report tu the C\mgrcss 0 February 2012 

(11' the appropriate timing of the first increase in the 

target federal funds rate given their view of the economic situation and outlook, as well as participants' 

assessments of the appropriate level of the target federal funds rate in the fourth quarter of each year 

through 2014 and over the longer run, The SEP also 

included quaWative inf()rmation regarding individual 

participants' ~xp(:ctations for the Fe<.1eral Reserv<.;'s 

balance sheet under appropriate monetary policy. 

The economic projections in the January SLP (pn:-

sented in Parl 4 or this report) indicated that rOMe 

participants (1he mcmhcrs of the Board ()f Governors 

and the presidents ~)f the 12 f'cdcral Reserve Banks) 

generally anticipated aggregate output to increase at. a 

som~\vhat faster pace in 2012 t.han in 20] L Although 

t.he participants marked dO\vn t.heir GDP grmvth projcclions slighlly compared with those prepared in 

November, they stated that the economic ini{xmation 

received since that time showed con1inued gradual 

improvement in the pace of economic activity during 

the second half of 2011, as the iannenee of Ihe le111po1'ar1' factors that darnpcd activity in the first hall' of the 

year subsided. Hmvcver, a number of additionall:1.ctors, including ongoing weakness in the housing sector, 

modest grmvth in re,11 disposab!c income, and the 

restraining cficcts of fiscal consolidation, suggested 

that the pace of Lhe recovery Wl1tIld he modes! in coming quarters. Participants also read the information on 

economic activity abroad, particularly in Europe, as 

pointing to vv\;akcr demand for US. cxport~. As these 

Cactors wanc, rOMe parlicipnnts anticipated tbat the 

pace of the economic expansion will graduaHy 

strengthen over the 2013-~14 period, pushing the rate of 

increase in real GDP abnvc their estimates of the 

longer-run rat..: of output growlh. \Vilh real (iDP 

expcc:ted to increase at a modest rate in 2012, the 

unemployment rate \vas projected to decline only a 

little this year. Participanrs expected further gradual 

improvement in labor marke1 conditions over 2013 and 

2014 as the pace of output growth picks up. They also 

noted that inflation expectations had remained stable 

over lht: past year d0spitc fluctuations headline 

inflation. Most participants anticipated 1hat both 

headline and core intlalion would remain suhdued over 

the 2012 14 period at ratcs at or below the FOMC's 

longer-run objective of 2 percent. 

With the unemployment rate projected to remain 

deyated over the projection period and inflation 

expected to be subdued. most participants expected 

that the federal funds rak would remain ~xjraordinarily for som0 time. Six participants anticipated 

thaI, under appropriate 11101H.:lnry policy, the firsj 

increase in the larget federal funds rale \vould Dccur 

an(~r 2014, and five cxpr.:cted policy firming to commence during 2014, The remaining six participants 

judged that raising the federal funds rale sonner would 

he re4uircd to forestall inl1ationary pressures or avoid 

distortions in the I1nancial system. i\!t of the individual 

assessments of the appropriate target federal funds rate 

over the next few years \-vcre bdo\v the participants' 

estimates 0[' the longer-run level or the j(:d~ral funds 

rate. Eleven of the 17 participants placed the target 

federal funds rate at 1 percent or lower at t he end of 

2014, while 5 sa\-v tht:: appropriale rate as:2 percenl or 

higher. 

A sizable majurity of participants continued 10 

judge the level of uncertainty associated with their projections for real activity and the unemployment rate as 

exceeding 1h(': average of the past 20 years. Many also 

at tnched greatcr-l han-normal1cvc1 ~)f unccrtainty to 

their forecasls f()r inl1ation. As in Novcmhcr, many 

par1icipants sa\\< downside risks attending their f()fecasts of real GDP growth and upside risks to their 

t(JfCcasts of the uncmploymen1 rate; most participants 

vicw!2d the rlsks In thelr inlbtion projections as 

broadly balanced. Participants also reported their 

assessmcnts of the values to which key mncroccol1omk 

variahlcs would he expccted to converge over the 

longer term under appropriak monc1ary policy and in 

the absence of further shocks to the economy. The centrill tendencies of these longer-run projections were 

2.3 to 2.0 percent for real O-DP gro\v1h and 5.2 to 

6.0 percent t()f the unemployment rate. In light of the 

2 percent. inflation that is the objective included in the 

stat.ement of longer-run goals and policy s1rategy 

adop1ed at the January meeting, the range and central 

tendency of participants' projeclions of longer-run 

in!1alion were aU equal to pcrccnt. 
74 


75075.021

Real gross domestic product (GDP) increased at an 

annual rate of 2:,~ percent in the second half of 2011, 

according to the advance estimate prepared by the 

Bureau of Economic Analysis, fonowing gro-wth of less 

than I percent in the J1rst half (figure I). Activity was 

held down in the first half of the year by temporary 

factors, particularly supply chain disruptions stemming 

from the earthquake in Japan and the damping dlect 

of higher energy prices on consumer spending. As the 

effects of these factors waned over the second half of 

the year, the pace of economic activity picked up. But 

growth remained quite modest compared with previous economic expansions, and a number of factors 

appear likely to continue to restrain the pace of activity into 2012; these factors include restricted access to 

credit for many households and small businesses, the 

depressed housing market, tight fiscal policy, and the 

spillover eflects of the fiscal and financial difficulties in 

Europe. 

Conditions in the labor market have improved since 

last summer. The pace of private job gains has 

increased, and the unemployment rate has moved 

lower. Nonetheless, at g~ percent, the jobless rate is 

still quite elevated. Meanwhile, consumer price inl1ation stepped down from the higher levels observed over 

the first half of last year, as commodity and import 

prices retreated while longer-term int1ation expectations remained stable (figure 2). 

1. Change in real gross domestic product, 2005-11 

2007 2008 2009 20W 2011 

Here and in subsequent figures, except as noted, change for a given 

period is measl.lNd to il<; final quarter from the final quarter of the preceding 

period. 

SOURCE: Depaltment of Commerce, Bureau of Economic Analysis. 

The fiscal and banking crisis in Europe was a primary focus of financial markets over the course of the 

second hall' of 2011 and early 2012. Growing concerns 

regarding the potential for spillovers to the U.S. 

economy and financial markets weighed on investor 

sentiment, contributing to significant volatility in a 

wide range of asset prices. Nonetheless, development.s 

in financial markets have been mixed, on balance, since 

July. Unsecured dollar funding markets became signitlcantly strained, particularly for European institutions, 

though U.S. institutions generally did not appear to 

face substanti;:.u funding ditliculties. Risk spreads on 

corporat.e debt. stayed elevat.ed, on net, but yields on 

corporate bonds generally moved lower. Broad equity 

prices, which declined significantly in July and August, 

subsequently returned to levels near those seen in early 

July. Credit conditions for most large nontlnancial 

firms were accommodative and corporate profIt growth 

remained strong. 

In response to a pace of economic growth that was 

somewhat slower than expected, the Federal Reserve 

provided additional monet.ary policy accommodation 

during the second hall' or 2011 and early 2012. Partly 

as a result, Treasury yields moved down signitlcantly, 

and market participants pushed nut the date al which 

they expect the federal funds rate to move above its 

current. t.arget. range of 0 to %. percent and built in 

2. Change in the chain-type price index for personal 

consumption expenditures, 2005-11 
75 


75075.022

6 Monetary Policy Report to the Congress [J February 2012 

expectations of a more gradual pace of increase in the 

federal funds rate after liftoff. 

Domestic 

The Household Sector 

COlIsllmeJ" Spelldillg lImlHollse/wid Fil1ilnce 

Real personal consumption expenditures (PC E) rose at 

an annual rate of about 2 percent in the second half of 

2011, following a rise of just 1 ;/; percent in the tlrst half 

of the year (figure 3). Part of the spending gain was 

at tributable to a fourth-quarter surge in purchases of 

motor vehicles following very weak spending last 

spring and summer stemming from the damping effects 

of the eart hquake in Japan on motor vehicle supply. 

Even with the step-up, however, PCE growth was modest compared with previous business cycle recoveries. 

This subpar performance retlects !he continued weakness in the underlying determinants of consumption, 

including sluggish income growth, sentiment that 

remains relatively low despite recent improvements, the 

lingering elTects of the earlier declines in household 

wealth, and tight access to credit lor many potential 

horrowers. With consumer spending subdued, the saving rate, although down from its recent high point, 

remained above levels that prevailed prior to the recession (figure 4), 

Real income growth is currently estimated to have 

been very weak in 2011. After rising 2 percent in 20 I 0, 

aggregate real disposable personal income (DPI)~,­

personal income less personal taxes, adjusted for price 

changes- was essentially flat in 2011 (figure 5). The 

wage and salary component of real DPI, which reflects 

3, Change in real personal consumption expenditures, 

2005-11 

Pcrcentannnalrak 

HI H2 

I _. 2 

4. Personal saving rate, 1988-2011 

hoth the number of hours worked and average hourly 

wages adiusted for inflation, rose at an annual rate of 

1 p~rcent in 2011. The increase in real wage and salary 

income reflected the continued, though tepid, recoveries in both employment and hours worked; in contrast, 

hourly pay was little changed in real terms. 

The ratio of household net worth to DPI dropped 

back a little in the secoml half of 2011, reflecting further declines in house prices and equity values 

(figure 6). The wealth-to-income ratio has hovered 

close to 5 in recent years, roughly the level that prevailed prior to the late 1 990s, hut well below the highs 

recorded during the boom in house prices in the mid2000s. Consumer sentiment, which dropped sharply 

last summer. has rebounded since then; nevertheless, 

5. Change in real disposable personal income and in real 

\,,:age and salary disbursements, 2005-11 

--~- ~--'~' -~! - ~! -~~ 

2005 2006 2007 200S 2009 2010 2011 
76 


75075.023

6. Wealth-lo-incomeratio,1988-2011 

RatJU 

these gains only moved sentiment back to ncar the top 

of the range that has prevailed since late 2009 

(figure 7). 

Household debt-the sum of both mortgage and 

consumer debt---continued to move lower in the second half of 20 II. Since peaking in 2008, household 

debt has fallen a total of 5 percent. The drop in debt in 

the second half of 2011 reflected a continued contraction in mortgage debt that was only partially offset by 

a mouest expansion in consumer credit. Largely due to 

the reduction in overall household debt levels in 2011, 

the debt service ratio···lhe aggregate required principal 

7. COUStmlCr sentiment indexes_ 1998-2012 

140 

120 

IOO 

80 

60 

40 

20 

Board of Governors (~f the Federal Reserve S~vstem 7 

and interest payment on existing mortgages and consumer deht relative to incomc······also decreased further 

and now is at a level last seen in 1994 and 1995 

(llgure 8). 

The moderate expansion in consumer credit in the 

second half of 2011, at an annual rate of about 

4;,s percent, has been driven primarily by an increase in 

nonrevolving credit, which accounts for about twothirds of total consumer credi1 and is composed 

mainly of auto and student loans. Revolving consumer 

credit (primarily credit card lending), while continuing 

to lag, appeared to pick up somewhat toward the endof the year. The increase in consumer credit is consistent with reccnt responses to the Senior Loan Officcr 

Opinion Survey on Bank Lending Practices (SLOOS). 

Indeed, modest net fractions of banks in both the 

October and January surveys reported that they had 

eased standards on all major categories of consumer 

loans, and that demand had strengthened for auto and 

credit cards loans on balance. However, data on credit 

card solicitations suggest that lenders in that area are 

primarily interested in pursuing higher-quality 

borrowers. 

Indicators of consumer credit quality generally 

improved. Delinquency rates on credit card loans 

moved down in the second half of 2011 to the low end 

of the range ohserved in recenl decades. Delinquencies 

and charge-offs on nonrcvolving consumer loans also 

generally improved. Moreover, a majority of respondents to the January SLOOS reported that they expect 

further improvement in the quality of credit card and 

other consumer loans this year. 

8. Household debt servicc. 1984-20 I j 

Per~~nt (\fdlspo;.abl~ meowe 

13 

12 

11 
77 


75075.024

g Monetary Policy Report to the Congress [] February 2012 

Interest rates on consumer loans held fairly steady, 

on net, in the second half of 2011 and into 2012. Interest rates on new-auto loans continued to be quite low, 

while rates on credit card loans remained stubhornly 

high. Indeed, spreads of credit card interest rates to the 

two-year Treasury yield arc very elevated. 

Consumer asset-backed securities (ABS) issuance in 

the second half of 2011 was in line with that of the 

previous 18 months. Securities backed by auto loans 

continued to dominate the market, while issuance of 

credit card ABS remained weak, as growth of credit 

card loans has rcmalllcd suhdued and most major 

banks have chosen to fund such loans on their balance 

sheets. Yields on ABS and their spreads over 

comparable-maturity swap rates were little changed, on 

net, over the second half of 2011 and early 2012 and 

remained in the low range that has prevailed since 

early 20]() (figure 9). 

Housing A ctil'ity allii Financc 

Activity in the housing sector remains depressed hy 

historical standards (ligure 10). Although aftordability 

has been hoosted by declines in house prices and historically low interest rates for conventional mortgages, 

many potential buyers either lack the dO\vTI payment 

and credit history to qualify for loans or are discouraged by ongoing concerns about future income, 

employment, and the potential for further declines in 

house prices. Yet other potential buyers----even those 

with sufficiently good credit records to qualify for a 

9. Spread::; of asset-backed securities yields over rates on 

comparahle-maturity interest rate S\\,[lPS, 2007-12 

500 

Auto 

400 

300 

SOlJRCE: JPlI,'1organ Chase & Co. 

10. Private housing starts, 1998-2012 

Mllhons.ofumts.>ml]l1Jlntte 

1.0 

.6 

.2 

1998 200n 2002 200..j. 2006 2008 2010 2012 

11w data are monthly and extend through January 2012. 

SOURCE: Departm.::nt of Commerce, Bureau of the Census. 

mortgage insured by one of the housing governrnentsponsoreu enterprises (GSEs)-continue to face difficulty in ohtaining mortgage fInancing. Moreover, 

much of the demand that does exist has been channeled to the abundant stock of relatively inexpensive, 

vacant single-family houses, thereby limiting the need 

for new construction activity. Given the magnitude of 

the pipeline of delinquent and foreclosed homes, this 

factor seems likely to continue to weigh on activity for 

some time. 

Nonetheless, recent indicators of housing construction activity have been slightly more encouraging. In 

particular, from July 2011 to January 2012, new singlefamily homes were started at an average annual rate of 

ahaut 455,000 units, up a bit from the pace in the first 

half of 20ll. In the multifamily market, demand l(Jr 

apartments appears to be increasing and vacancy rates 

have fallen, as families who are unable or unwilling to 

purchase homes are renting properties instead. As a 

result, starts in the multifamily sect or averaged about 

201l,OOO units at an annual rate in the second half of 

2011, still below the 300,OOO-unit rate that had prevailed for much of the previous decade but well above 

the lows recorded in 2009 and early 2010. 

I-louse prices, as measured by several national 

indexes, fell further over the second half of 2011 

(ligure 11). One such mea",re with wide geographic 

coverage~ the CoreLogic repeat-sales index ~fel1 at. an 

annual rate of aboul6 percent in the second half of the 

year. House prices are being held down by the same 

factors that are restraining housing construction: the 

high number of distressed sales, the large inventory of 

unsold homes, tight mortgage credit conditlons, and 

lackluster demand. The inventory of unsold homes 

likely will remain high for some time, given the large 
78 


75075.025

11. Prices of exh.iing single-family houses, 2001-11 

!lIdexwll.l.i! 

JOO 

90 

80 

70 

50 

number of homes that arc already in the foreclosure 

pipeline or could he entering the pipeline in the coming 

months. As a resull of the cumulative decline in house 

prices over the past several years, roughly one in five 

mortgage holders owe more on their mortgages than 

their homes are worth. 

Indicators of credit quality in the residential mortgage sector continued to reflect strains on homeowners 

confronting depressed home values and hi9.:h unemployment. In December, serious de1inquen~y rates on 

prime and near-prime loans stood at 5 percent and 

13 percent for fixed- and variable-rate loans, respectively (figure 12). While delinquencies on variable-rate 

m()rtgages tar hoth prime and suhprime borrowers 

have moved down over the past two years, delinquencies on fixed-rate mortgages have held steady at levels 

near their peaks in early 20105 Meanwhile, delinquency and charge-ofT rates on second-lien mortgages 

held by banks also arc at elevated levels, and they have 

declined only slightly Irom their peaks. 

The numher of properties at some stage of the f'oreclosure process remained elevated in 201 L This high 

level partly reflected the difliculties that mortgage serVleers continued to have with resolving det1ciencies in 

t heir foreclosure procedures. Resolution of these issues 

could eventually be associated with a sustained 

increase in the pace of completed foreclosures as servicers work through the backlog of severely delinquent 

loans. 

5. A mortgage is defined as seriously delinquent if the borrower is 

90 days or more behind in payments or the property is in foreclosure. 

Board (~f Governors (~f the Federal Reserve S-'ystem 9 

lL Mortgage delinquency rates., 2000-11 

~_ Prime and nc:ar prime 18 

15 

-- 12 

._---'- ~ 

2001 2003 2005 2007 2009 2011 Perc.~:nl 

Suhprimc: 50 

--.'-._ 40 

30 

Interest rates on fixed-rate mortgages fell steadily 

during the second half of 2011 and in early 2012 

(ijgure 13), though not as much as Treasury yields, 

leaving spreads to Treasury securities of comparable 

maturilies wider. The ability of potential horrowers to 

obtain mortgage credit for purchase transactions or 

refinancing continued to be limited. In part, the low 

level of mortgage borrowing reflected characteristics of 

the would-be borrowers, most prominently the widespread incidence of negative equity and u~employment. In addition, credit supply conditions remained 

tight. Indeed, it appeared that some lenders were reluctant to extend mortgages to horrowers with less-thanpristine credit even when the resulting loans would be 

eligible for purchase or guarantee by GSEs. (, One 

manifestation of this constriction was the fact that the 

distribution of credit scores among borrowers who 

succeed in obtaining mortgages had shifted up signif1-

cantly (figure 14). As a result of these inlluenccs, the 

pace of mortgage applications far home purchase 

declined, on net, over the second half of 2011 and 

remains very sluggish. The same factors also appear to 

have limited refinancing activity, which remains subdued compared with the large number of households 
79 


75075.026

10 Monetary Policy Report to the Congress rJ February 2012 

13. Mortgage interest rates, 1995-2012 

PClcent 

that would potentially benefit from the low rates available to high-quality borrowers. 

The outstanding stock of mortgage-backed securities (MBS) guaranteed by the GSEs was little changed, 

on net, over the second half of 2011. The securitization 

market for mortgage loans not guaranteed by a 

housing-related GSE or the Federal Housing Administration continued to be essentially closed. 

Tile Business Sector 

Fixed bll'!!stmellt 

Real spending by busjncsses for equipment and software (E&S) rose at an annual rate of about II percent 

over the second half of 20 II, a paec that was a bit 

14. Credit scores on new prime mortgages, 2003-11 

90th percentile 

800 

780 

760 

740 

720 

700 

faster than in the first half (figure 15). Much of this 

strength was recorded in the third quarter. Spending 

growth dropped back in the fourth quarter, to 5 percent, likely reflccting----arnong other influencesheightened uncertainty of business owners about 

global economic and financial conditions. Although 

spending hy businesses for high-tech equipment has 

held up reasonably well, outlays for a broad range of 

other E&S slowed appreciably. More recently, however, 

indicators of business sentiment and capital spending 

plans generally have improved, suggesting that firms 

may be in the process of becoming more willing to 

undertake new investments. 

Alter tumbling throughout most of 2009 and 2010, 

real investment in nonresidential structures other than 

drilling and mining turned up last spring, rising at a 

surprisingly hrisk pace in the second and third quarters 

of 20 II. However, investment dropped back in the 

fourth quarter. Conditions in the sector remain difficult: Vacancy rates are still high, prices of existing 

structures are low, and financing conditions for builders are still tight. Spending on drilling and mining 

structures also dropped back in the fourth quartel~ but 

15. Change in real business fixed investment, 2005-11 

Percent, annnal rute 

Structures 

Equipment and software 30 

20 

10 

10 

20 

30 

40 

20 

20 

40 

SUCRCE: Derailment of Commerce, Bureau of Lconomic Analysis. 
80 


75075.027

outlays in this category should continue to be supported by elevated oil prices and advances in technology ie)r horizontal drilling and hydraulic fracturing. 

111l'entm:1' Inl'estment 

Real inventory investment stepped down a bit in the 

second half of 2011 (figure 16). Stockbuilding outside 

of motor vehicles increased at a modest pace, and surveys suggest that firms are generally comfortahle with 

their own, and their customers', current inventory 

positions. In the motor vehicle sectOl~ inventories were 

drawn down in the second halt~ as the rise in sales outpaced the rebound in production following the supply 

disruptions associated with the earthquake in Japan 

last spring. 

Corporate ami Bllsilll!ss Fillallce 

Operating earnings per share for S&P 500 firms continued to rise in the third quarter of 2011, increasing at a 

quarterly rate of nearly 10 percent. Fourth-quarter 

earnings reports by 1lrms in the S&l' 500 puhlished 

through late February indicate that this measure has 

remained at or ncar ils pre-crisis peaks throughout the 

second half of 2011. 

In the corporate sector as a whole, economic profits, 

which had heen rising rapidly since 2008, increased 

further in the second half of 2011. This rdatively 

strong profit growth contributed to the continued 

robust credit quality of nonfinancial firms in the second half of 2011. Although the ratio of liquid assets to 

total assets on the halance sheets of nonfinancial corporations edged down in the third quarter, it remained 

16. Change in real business inventories, 2005-11 

Rillton" deh,uned C005) dollars. ilmma! rat<.' 

toO 

50 

50 

]00 

150 

2005 2006 2007 2008 2009 2010 2011 

SOl'RCE: Department of Commerce. Bureau ofEeonomic Analysh. 

Board qf Governors (~f the Federal Reserve S)stem 11 

at a vcry high level, and the aggregate ratio of debt to 

assets ····a measure of corporate leverage··· ·staycd low. 

With corporate balance sheets in generally healthy 

shape, credit rating upgrades once again outpaced 

downgrades, and the bond default rate illr nonfinancial 

firms remained low. In addition, the delinquency rate 

on commercial and industrial (C&I) loans at commercial banks continued to decline and stood at around 

112 percent at year-end, a level ncar the low end of its 

historical rangc. Most banks responding to the January 

SLOOS reported that they expected further improvements in the credit quality of C&! loans in 2012. 

Borrowing by nonfinancial corporations continued 

at a reasonably robust pace through the second half of 

20 II, particularly for larger, higher-credit -quality firms 

(figure 17). Issuance of investment-grade bonds progressed at a strong pace, similar to that observed in the 

first half of the year, buoyed by good corporate credit 

quality, attractive financing conditions, and an improving economic outlook. In contrast to higher-grade 

bonds, issuance of speculative-grade bonds dropped in 

the second half of the year as investors' appetite for 

riskier assets waned. In the market for syndicated 

loans, investment-grade issuance moved up in the sec~ 

and half of 20 II from its already strong 1lrst-half pace, 

while issuance of higher-yielding syndicated leveraged 

loans weakened (figure 18). 

C&! loans on banks' books grew steadily over the 

second half of 2011. Banks reportedly competed 

aggressively for higher-raled credits in the syndica1ed 

leveraged loan market, and some nonfinancialllrms 

reportedly substituted away from bond financing 

because of volatility in bond spreads. In addition, 

according to the SLOOS, some domestic hanks gained 

17. Selected components of net financing for nonfinancial 

businesses, 2005-1 I 

Conunercial paper 

Bonds 

Bank loans 

Bilhonsofdollufs.lll<..'llthlyratl: 

80 

60 

40 

20 

20 

40 
81 


75075.028

12 Monetary Policy Report to the Congress fJ February 2012 

18. Syndicated loan issuance, by credit quality, 2005-11 

Lcveraged 

Investment grade 900 

750 

600 

450 

300 

150 

business from customers that shifted away from European banks. Although domestic banks reported little 

change, on net, in leTIl.1ing standards for C&I loans 

(figure 19), they reduced the spreads on these loans as 

well as the costs of credit lines. Banks that reported 

having eased their credit standards or terms for C&I 

loans over the second half of 2011 unanimously cited 

increased competition from other banks or nonbank 

sources of funds as a factor. 

19. Change in standards and demand for commercial and 

industrial loans. 1991-2012 

Borrowing conditions for smaller businesses continued to be tighter than those for larger firms, and their 

demand f~)r credit remained relatively weak. However, 

some signs of casing began to emerge. Surveys conducted by the National Federation of Independent 

Business showed that the net fraction of small businesses reporting that credit had become more difficult 

to obtain relative to the previous three months 

declined, on halance, during the second half of 20 II 

(figure 20). Moreover, the January 2012 SLOOS found 

that terms for smaller borrowers had continued to ease, 

and about 15 percent of banks, on net, reported that 

demand for C&1 loans from smaller firms had 

increased, the highest reading since 2005. Indeed, C&1 

loans held by regional and community banks--those 

not in the 25 largest banks and likely to lend mostly to 

middle-market and small firms---advanced at about a 

6 percent annual rate in the second half of 2011, up 

from a 21h percent pace in the first half 

Commercial mortgage debt has continued to decline, 

albeit at a more moderate pace than during 2010. 

Commercial real estate (CRE) loans held on banks' 

books contracted further in the second half of 2011 

and early 2012, though the runofl appeared to ebb 

somewhat in 201 L That slowing is more or kss consistent with recent SLOOS responses, in which moderate 

net fractions of domestic banks reported that demand 

for such loans had strengthened. In the January survey, 

banks also reported that, for the !lrst time since 20t)7, 

they had raised the maximum loan size and trimmed 

20. Net percentage of small businesses that reported more 

dit1iculty in obtaining credit, 1990-2012 

P~f~ent 

15 

\2 

Sm'RrE: National Federation ofIndependcnt Busin.:ss. 
82 


75075.029

spreads of rates on CRE loans over their east or funds 

during the past 12 months, By contrast, life insurance 

companies reportedly increased their holdings of CRE 

loans, especially of loans issued to higher-quality borrowers. Although delinquency rates on CRE loans at 

commercial banks edged dmvn further in the fourth 

quarter, they remained at high levels, especially on 

loans for construction and land development; delinquencies on loans held hy life insurance companies 

remained extraordinarily low, as they have done for 

more than a decade (figure 21). Vacancy rates for most 

types of commercial properties are still elevated, exerting downward pressure on property prices and impairing the performance of CRE loans, 

Conditions in the market for commercial mortgagebacked securities (CMBS) worsened somewhat in the 

second half of the year. Risk spreads on highly rated 

tranches of CMBS moved up, on balance, and about 

half of the respondents to the December Senior Credit 

Officer Opinion Survey on Dealer Financing Terms 

(SCOOS) indicated that liquidity conditions in the 

markets for such securities had deteriorated somewhat 

Issuance of CMBS slowed further, but did not halt 

21. Delinquency rates on commerclal real estate loans, 

1991-2012 

Commercial banks Percent 

20 

15 

10 

J991 1994 1997 2000 2003 2006 2009 2012 Pelcem 

10 

Board (~r Governors (~f the Federal Reserve J.)~vsteJ11 l3 

completely. Delinquency rates on CRE loans in CMBS 

pools held steady just below 10 percent. 

In the corporate equity market, gross issuance 

dropped significantly in the third quarter amid substantial equity market volatility, but it retraced a part 

of that decline in the fourth quarter as some previously 

withdrawn issues were brought hack to the market. 

Net equity issuance continued to decline in the third 

quarter, retlecting the continued strength of cashtinanced mergers and share repurchases (figure 22), 

Tile Govemmellt Sector 

GOl'emment 

The deficit in the federal unified budget remains very 

wide. The budget deficit for fiscal year 2011 was 

S1.3 trillion, or gYo percent of nominal GDP--·-a level 

comparable with deficits recorded in 2009 and 2010 

but sharply higher than the deficits recorded prior to 

the onset of the financial crisis and recession, The budget deJicit continued to be boosted by spending that 

was committed by the American Recovery and Reinvestment Act of 2009 (ARRA) and other stimulus 

policy actions as well as by the weakness of the 

economy, which has reduced tax revenues and 

increased payments for income support. 

Tax receipts rose 61h percent in 118ca1201 L However, 

the level of receipts remained very low; indeed, at 

around 1512 percent of GDp, the ratio of receipts to 

national income is only slightly above the 60-year lows 

21, Components of net equity iSSUlllCC, 200S-I1 

Hllbons of dollars. monthly rate 

30 

30 

60 

90 
83 


75075.030

14 Monetary Policy Report to the Congress [] February 2012 

recorded in 2009 and 2010 (tlgure 23). The rise in revenues in tlscal 2011 was the resull or a robust increase 

of more than 20 percent in individual income tax payments that reflected strong final payments on 2010 

income. Social insurance tax receipts fell about 5 percent in fiscal 2011, held down by the temporary 2 percentage point reduction in payroll taxes enacted in 

2010. Corporate taxes also fell around 5 percent in 

2011, wilh the decline largely the result of legislation 

providing more-favorable tax treatment for some business investment. In the first four months of fiscal 2012, 

total tax receipts increased 4 percent relative to the 

comparable year-earlier period. 

Total federal outlays rose 4 percent in fiscal 2011. 

Much of the increase relative to last year is attributable 

to the earlier unwinding of the effects of financial 

transactions, such as the repayments to the Treasury of 

ohligations for the Troubled Asset Relief Program, 

which temporarily lowered measured outlays in fiscal 

2010. Excluding these transactions, outlays were up 

about 2 percent in 2011. This small increase reflects 

reductions in hath ARRA spending and unemployment insurance payments as well as a subdued pace of 

defense and Medicaid spending. By contrast, net interest payments rose sharply, reflecting t he increase in 

federal debt. Spending has remained restrained in the 

current fiscal year, with outlays (adjusted to exclude 

financial transactions) down about 5 percent in the first 

fenlr months of fisca120 12 relative to the comparable 

year-earlier period. 

As measured in the national income and product 

accounts (NIPA), real federal expenditures on consumption and gross investment· ··the part of federal 

23. Federal receipts and expenditures, 1991-2011 

PcrCentofnoIDmalGDP 

26 

24 

22 

20 

18 

16 

14 

spending that is a direct component of GDP·decreased at an annual rate of about 3 percent in the second half of 2011, a little less rapidly than in the tirst 

half of the year (figure 24). Defense spending fell at an 

annual rate of about 4 percent in the second half of the 

year, a somewhat sharper pace of decline than in the 

iJrst halt~ while nondefense purchases were unchanged 

over this period. 

Federal debt surged in the second half of 2011, aner 

the debt ceiling was raised in early August by the Budget Control Act of 2011 7 Standard and Poor's (S&P), 

which had put the U.S. long-term sovereign credit rating on credit watch negative in June, downgraded that 

rating from AAA to AA+ following the passage of the 

act, citing the risks of a continued rise in federal government debt ratios over the medium term and declining confidence that timely fiscal measures necessary to 

place U.S. public finances on a sustainable path would 

be forthcoming. Other credit rating agencies subsequently posted a negative outlook on their rating of 

US. sovereign debt, on similar grounds, but did not 

change their credit ratings. These actions do not 

appear to have affected participation in Treasury auctions, which continued to be well subscribed. Demand 

('or Treasury securities was supported by market participants' preference for the relative safety and liquidity 

Savings Plan. 

24. Change in real government expenditures 

on consumption and investment, 2005-11 

Federal 

State and local 

2009 2010 2011 

SOURCE: Department of Commerce. Bureau of Economic Analy~is. 
84 


75075.031

of such securities. Bid-to-cover ratios were within historical rangcs, and indicalors of foreign participation 

remained near their recent levels. Federal debt held by 

the public, as a percentage of GDp, continued to rise 

in the third quarter, reaching about 6R percent 

(figure 25). 

State alltl Local GOl'cmmclIt 

State and local governments remain under significant 

fiscal strain. Since July, employment in the sector has 

declined by an average of 15,000 jobs pcr month, just 

slightly under the pace of job losses recorded f()r the 

flrst half of 2011. Meanwhile, reductions in real construction expenditures ahated after a precipitous drop 

iu the first half of 2011. As measured in the NIPA, real 

state and local expenditures on consumption and gross 

investment decreased at an annual rate of about 2 percent in the second half of 2011, a somewhat slower 

pace of decline than in the first half of the year 

(figure 24). 

State and local government revenues appear to have 

incrcased modestly in 2011. Notably, at the statc level, 

third-quarter tax revenues rose 5Yz percent over the 

year-earlier period, with the majority of the states 

experiencing gains. However, this increase in tax revenues was partly ofrset by a reduction in federal stimulus grants. Tax collections have been less rohust at the 

local leveL Property tax receipts have been roughly fiat, 

on net, since the start of 2010 (based on data through 

the third quarter of 2011), reflecting the downturn in 

home prices. Furthermore, many localities have experi25. Federal govel1111lent debt held by the public, 1960-2011 

P"rcentofnOlllmaiGDP 

70 

60 

50 

40 

30 

20 

govemmcnt accounts. 

Sm;RcE: Federal Reserve Board, flow of fuml'> data. 

Board of Governors (~f the Federal Resel'Ve S~vstem 15 

enced a decrease in grants-in-aid from their state 

government. 

Issuance of long-term securities by state and local 

governments moved up in the second half of 2011 to a 

pace similar to that seen in 2009 and 20 10. Issuance 

had been subdued during the first half of the year, in 

part because the expiration of the Build America 

Bonds program led to some shifting of financing from 

2011 into late 2010. 

Yields on statc and local government securities 

declined in the second half of 2011 and into 2012, 

reaching levels ncar the lower end of their range over 

the past decade, but they fell to a lesser degree than 

yields on comparable-maturity Treasury securities. The 

increase in the ratio of municipal bond yields to Treasury yields likely reflected, in part, continued concern 

regarding the financial health of state and local governments. Indeed, credit default swap (CDS) indexes for 

municipal honds rosc, on balance, over the second half 

of 2011 but have narrowed somewhat in early 2012. 

Credit rating downgrades outpaced upgrades in the 

second half of 2011, particularly in December, following the downgrade of a municipal bond guarantor. 8 

The Extemal Sector 

Real exports of goods and services rose at an annual 

rate of 4% percent in the second half of 2011, boosted 

by continued growth in overall foreign economic activity and the lagged effect of declines in the foreign 

exchange value of the dollar earlier in the year 

(figure 26). Exports of aircraft and consumer goods 

registered some of the largest gains. The increase in 

export demand was concentrated in the emerging market economies (EMEs), while exports to the euro area 

declined toward the end of the year. 

With growth of economic activity in the United 

States moderate during the second half of 2011, real 

imports of goods and services rose at only about a 

3 percent annual rate, down from about 5 percent in 

the first half. Import growth was weak across most 

trading partners in the second half of last yeal~ with 

the notabk exception of imports from Japan, which 

grew significantly after dropping sharply in the wake of 

the March earthquake. 

Altogether, net exports contributed about ~.:;, percentage point to real GDP growth in the second half of 
85 


75075.032

16 Monetary Policy Report to the Congress [J February 2012 

26. Change in real imports and exports of goods 

and services_ 2007-11 

~lc<.'nt,a!UlUalmte 

ImpOits 

EXP0l1S 

2007 2008 2009 2010 2011 

SOLRCE: J)"partml<nl of Conun.::rcc, Bureau of Economic Analysis. 

15 

10 

2011, as export growth outpaced import growth. At an 

annual rate, the current account ddicit in the third 

quarter of 2011 (the latest available data) was $441 billion, or about 3 percent of nominal GDP, a touch narrower than the $470 billion deficit recorded in 2010 

(figure 27). 

Oil prices moved down, on net, over the second half 

of last year. The spot price of West Texas Intermediate 

(ViTI) crude oil, which jumped to SIlO per barrel last 

April after a near-complete shutdown of Libyan oil 

production, subsequently reversed course and declined 

sharply to an average of just under $86 per barrel in 

September. The prices of other major benchmark 

crude oils also fell over lhis period, although by less 

than the spot price of WTI (figure 28). The drop in oil 

prices through September likely was prompted by the 

winding down of the conflict in Libya as well as growing concern about the strength of global growth as the 

European sovereign debt crisis intensified, particularly 

toward the end of summer. From September to January of this year, the price of oil from the North Sea 

(the Brent benchmark) was essentially !lat as the potential implications of increased geopolitical tensions·"" 

most notahly with Iran-,~ hav\,:': ofTset ongoing concern 

over the strength of global demand and a faster-thanexpected rebound in Libyan oil production. In February; the price of Brent moved higher, both with 

increasing optimism regarding the outlook for global 

growth as well as a further heightening of tensions 

with Iran. The spot price of WTI crude oil also 

27. U.S. trade and current account balances, 2003-11 

Perccnt()fnommllilJDP 

increased in February, though by less than Brent, 1()1-

lowing a rdatively rapid rise over the fmal three 

months of last year. 9 

After peaking early in 2011, prices of many non-oil 

commodities also moved lower during the remainder 

of 2011. Despite moving up recently, copper prices 

remain well below their early 2011 level. In agricultural 

markets. corn and wheat prices ended 2011 down 

about 20 percent from their relatively high levels at the 

end of August as global production reached record 

lcvds. In early 2012, however, corn prices edged up on 

worries ahout dry growing conditions in South 

America. 

After increasing at an annual rate of 6YS percent in 

the first half of 2011, prices or non-oil imported goods 

were flat in the second half Fluctuations in prices of 

imported finished goods (such as consumer goods and 

capit al goods) were moderate. 
86 


75075.033

28. Prices of oil and nonfucl commodities, 2007-12 

160 

120 140 

100 

120 

&0 

100 60 

'0 40 

L,_' __ ~.~~~~L: 

2007 2008 2009 2010 2011 2012 

nonfuel 

National Saving 

Total US net national saving-that is, the saving of 

U.S. households, businesses, and government.s, net. of 

depreciation charges-remains extremely low by historical standards (figure 29), After having reached 

4 percent of nominal GDP in 2006, net national saving 

dropped over the subsequent three years, reaching a 

low of negative 2 Y:; percent in 2009. Since then, the 

national saving rate has increased on balance: In the 

third quarter of 2011 (the latest quarter for which data 

are available), net. national saving was negative :.:1 percent of nominal GDP The recent contour of the saving rate import.antly reflects the pattern of federal budget deficits, which widened sharply in 2008 and 2009, 

but. have edged down as a share of GDP since then. 

National saving will likely remain relatively low this 

year in light of the continuing large federal budget 

delicit. 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 of 

U.S. residents over time. 

The Labor Market 

Employment all/i Ull'ClIi![J/,'I}'I,rlel'lt 

Conditions in the labor market have improved some of 

latc. Private payroll employment gains averag~d 

Board (~f Governors (?f the Federal Reserve ~)~vslem 17 

29, Net saving, J991-2011 

165,000 jobs per month in the second half of 201 La 

bit slower than the pace in the first half of the year, but 

gains in December and January were morc robust, 

averaging almosl240,000 per month (figure 30), The 

unemployment rate, which hovered around 9 percent 

ftlf much of last year, is estimated to have moved dO\vll 

noticeably since SepLemht.':r, reaching 8~4 percent in 

January, the lowest reading in almost three years 

(figure 31), 

Although the recent decline in the jobless rate is 

encouraging, the level of unemployment. remains very 

elevated. In addition, long-duration joblessness continues to account for an especially large share of the t.otal. 

Indeed, in January, 5:;2 million persons among those 

counted as unemployed-about 43 percent of the 

total~-had been out of work [or morc than six months, 

30. Net change in private payroll employment, 2005-12 

2005 2006 2007 2008 2009 2010 2011 2012 

Nt/flo:: 'TIK data ar.: monthly and extend du'ough January 2012. 

SOl;RCE: Department of Labor. Bureau of Labo!" Statistics. 

400 

200 

200 

400 

600 

800 
87 


75075.034

18 Monetary Policy Report to the Congress rJ February 2012 

3 L Civilia11lUlemployment rate, 1978-2012 

P"1cent 

12 

10 

l1gurcs that were only a little below record levels 

(figure 32). Moreover, the number of individuals who 

arc working part time for economic reasons-~~,another 

indicator of the undcrutilization of labor, ,remained 

roughly twice its pre-recession value. 

Pl'lulllctil'ity ll1ul Labo!' Compellsatiol/ 

Labor productivity growth slowed last year. Productivity had risen rapidly in 2009 and 20 I 0 as firms strove to 

cut costs in an environment of severe economic stress. 

In 2011, however, with operations leaner and workforces stretched thin, firms needed to add labor inputs 

to achieve the desired output gain~ and output per 

32. Long-term unemployed, 1978-2012 

Percent 

50 

40 

30 

20 

10 

hour in the nonfarm business sector rose only ~-2 percent (figure :13). 

Increases in hourly compensation remained suhdued 

in 2011, restrained by the wide margin of labor market 

slack (figure 34). The employment cost index, which 

measures both wages and the cost to employers of providing benefits, fl1r private industry rose just 2~ percent in nominal terms in 2011. Nominal compensation 

per hour in the nonfarm business sector .. ·-derived from 

the labor compensation data in the NIP!\---is estimated to have increased only 1% percent in 2011, well 

below the average gain of about 4 percent in the years 

before the recession. Adjusted for the rise in consumer 

prices, hourly compensation was roughly unchanged in 

2011. Unit labor costs rose 1 ~ percent in 2011, as the 

rise in nominal hourly compensation outpaced that of 

labor productivity in the nonfarm business sector. In 

2010, unit lahor costs fell almost 1 percent. 

Prices 

Con:mmer price inflation stepped down in t he second 

half of 201 L After rising at an annual rate of 3," percent in the first half of the year, the overall peE chaintype price index increased just 1 :12 percent in the second half ([igure 35). PCE prices excluding food and 

energy also decelerated in the second half of 2011, rising at an annual rate of about 11;2 percent, compared 

with roughly 2 percent in the first half The recent contour of consumer price intlation has reflected movements in global commodity prices, which rose sharply 

33. Change in output per hour, 1948-2011 

Percent. mmulli rdte 

--- 6 

Nonfatm business sector. Change for each multiyear period is 

measured to the founh quarter of th" final year of the period from the fourth 

qU31ter of the year immediately preceding the period. 

SOlTRCE: Department of Labor, Bureau of Labor Statistics. 
88 


75075.035

34. Measures of change in hourly compensation, 

2001-11 

index 

quarter. 

institutions, and hou<;eholds. 'Ill.~ seclor coverd by 

nonfann business sector plus nonprofit institutions. 

SOt'Rt'E: Department of Labor, Bureau ofLahor Statistics. 

Pe,cent 

early in 2011 but have moved lower during the second 

half of the year. Information from the consumer price 

index and other sources suggests that inflation 

remained suhdued through January 2012, although 

energy prices have turned up more recently. 

The index of consumer energy prices, which surged 

in the !lrst half of 2011, fell back in the second half of 

the year. The contour mainly rel1ected the rise and subsequent reversal in the price of crude oil; however, 

gasoline prices started to rise again in February following a recent upturn in crude oil prices. Consumer natural gas prices also feU at the end of 2011, as unseaSOll35. Change in the chain-type price index for personal 

consumption expenditures, 2005-11 

P~rC~!lt.arumalrate 

Total 

Excluding food and energy 

HI 

SOCRCE: Department of Commerce. Bureim of Economic AIlaly~is. 

Board (~r Governors (~r the Federal Reserve S~vstem 19 

ahly mild temperatures and increases in supply from 

new domestic wens helped boost inventories above 

typicallcvels, All told, the overall index of consumer 

energy prices edged lower during the second half of 

2011, compared with an increase of almost 30 percent 

in the first half of the year. 

Consumer prices for food and beverages exhibited a 

similar pattern as that of energy prices. Prices for farm 

commodities rose briskly early last year, reflecting the 

combination of poor harvests in several countries that 

are major producers along with the emerging recovery 

in the global economy. These commodity price 

increases fed through to higher consumer prices for 

meats and a wide range of other more-processed foods. 

With the downturn in farm commodity prices late in 

the summer, the index of consumer food prices rose at 

an annual rate of just 3% percent in the second half of 

2011 after increasing 6:;' percent in the first half 

Prices- for consumer goods and services other than 

energy and food have also slowed, on net, in recent 

months. Core PCE prices had been boosted in the 

spring and summer of 2011 by a number of transitory 

factors, including the pass-through of the first-half 

surge in prices of raw commodities and other imported 

goods and a boost to motor vehicle prices that 

stemmed from supply shortages following the earthquake in Japan. As the impulse from these factors 

faded, core PCE price inflation stepped down so that, 

for 2011 as a whole, core PCE price inflation was just 

1% percent. 

Survey-based measures of near-term inflation expectations are down since the middle of 2011. Median 

year-ahead inflation expectations as reported in the 

Thomson Reuters/University of Michigan Surveys of 

Consumers (Michigan survey), which had risen sharply 

earlier in the year reflecting the run-up in energy and 

leJOd prices, subsequently fell back as those prices 

decelerated (figure 36). Longer-term expectations have 

remained generally stable. In the Michigan survey, the 

intlation rate expected over the next 5 to 10 years was 

2.9 perc~nt in Fehruary~ within the range that has prevailed over the past 10 years; in the Survey of Prolessional Forecasters, conducted hy the Federal Reserve 

Bank of Philadelphia, expectations for the increase in 

the price index for PCE over the next 10 years 

remained at 2~!i percent, in the middle of its recent 

range. 

Measures of inl1ation compensation derived from 

yields on nominal and inflation-indexed Treasury securities declined early in the second half of 2011 at both 

medium-term and longer-term horizons, likely refl~cting a worsening in the economic outlook and the 
89 


75075.036

20 Monetary Policy Report to the Congress I-J February 2012 

36. Median inilatioll expectations, 2001-12 

}.<cxt 12 month'l 

intensification of the European fiscal crisis. More 

recently, inflation compensation estimates over the next 

five years have edged back up, apparently reflecting 

investors' more optimistic econornic outlook, and is 

about unchanged, on net, for the period. However, the 

forward measure of five-year inflation compensation 

five years ahead remains about 55 basis points below 

its level in the middle of last year (ligure 37). 

Financial UevelOplrnents 

In light of the disappointing pace of progress toward 

meeting its statutory mandate to promote maximum 

employment and price stability, the Federal Open Market Committee (FOMe) took a number of steps to 

provide additional monetary policy accommodation 

during the second half of 2011 and early 2012. These 

steps included increasing the average maturity of the 

Federal Reserve'5 securities holdings, shifting the 

reinvestment of principal payments on agency securities from Treasury securities to agency-guaranteed 

MBS, and strengthening the forward rate guidance 

included in postmecting statements. 

Financial markets were butTeted over the second half 

of 2011 and in early 2012 by changes in investors' 

assessments of the ongoing European crisis as well as 

in their evaluat.ion of the U.S. economic outlook. As a 

result, developments in financial market conditions 

have been mixed since July. Unsecurcd dollar funding 

markets, particularly f()[ European institutions, 

became significantly strained, though domestic financial finns generally maintained ready access to shortterm unsecured funding. Corporate bond spreads 

remained elevated, on net, while broad equity prices 

37. Inflation compensation, 2006--] 2 

P~IC~HI 

5 to 10 years ahead 

2007 200S 2009 2010 2011 2012 

The dala are daily ami extend tlu'ough Febmary 24. 2012. Inflation 

compensation is: the diH;;rencc bel\veen yic1d~ on nominal Treasury securities 

and Treasury inflation~protcetcd securities (TIPS) of eomparabk maturitks. 

based on yield cmves fitted by Federal Reserve staff to off-the-run nominal 

off-the-nm TIPS. The 5~ycar measure is 

York: Barclays: Federal Resolve 

werc little changed, although they exhihited unusually 

high volatility. Partially rellecting additional monetary 

policy accommodation, Treasury yields moved down 

significantly. Similarly, investors pushed out the date at 

which they expect the federal funds rate to rise ahove 

its current target range, and they are currently anticipating a mor~ gradual pace of increase in the funds 

rate following liftoffthan they did last July. 

In response to the steps taken by the FOMC to 

strengthen its forward guidance and provide additional 

support to the economic recovery, market participants 

pushed out further the date when they expect the federal funds rate to first rise above its current target 

range of 0 to y, percent and scaled back their expectations of the pace at which monetary policy accommodation will be removed. On balance, quotes on overnight index swap (OlS) contracts, as of late February, 

imply that investors anticipatc the federal funds rate 

will rise ahove its current target range in the fourth 

quarter of 2013, about four quarters later than the 

date implied in July. Investors expect, on average, that 

the effective federal funds rate will be about 70 basis 
90 


75075.037

points by late 2014, roughly 165 basis points lower 

than anticipated in mid-201].1O 

Yields on nominal Treasury securities declined significantly over the second half of 2011 (l1gure }8). The 

bulk of this decline oceurred in late July and August, 

in part reflecting weaker-than-anticipated U.S. economic data and increased investor demand for the relative safety and liquidity of Treasury securities amid an 

intensiflcation of concerns about the situation in 

Europe. Following (he FOMC announcement of the 

maturity extension program (MEP) at its September 

meeting, yields on longer-dated Treasury securities 

declined further, while yields on shorter-dated securities helJ steady at very low levels. 1l On net, yields on 

2-, 5-, and 10-year Treasury notes have declined 

roughly 10, 65, and 110 basis points from their levels in 

mid-20l1, respectively. The yield on the 30-year bond 

has dropped about 120 basis points. Though liquidity 

and functioning in money markets deteriorated notahly for several days at the height of the debt ceiling 

debate last summer, neither the downgrade of the US. 

long-term sovereign credit rating by S&P in August 

10. Wh~n interest rates are dose to ZCl'f), determining the p',int at 

which financial market quotcs indicate that the federal funds ratc will 

movc ahove its current range C<'1n be complic..'1kd. The path dcscribed 

in thc text is t11C mean of a distribution c..'llculated frnm OIS rates. 

Altcrnatively. one C~ln usc similar derivatives to calculate tht;) most 

end of 2015. 

11. As of Pebruary 24. the Open Market Desk had sold 

$223 billi(lIl in shorter-term Treasury securities and purchased 

$211 billion in longer-term Trcasury securities. 

38. Interest rates on Treasurv secmities at selected 

maturities,21l04-12 . 

----------------------------

:.J"OTE: 

Percent 

Board of Governors of the Federal Reserve S~VS{e111 21 

nor the failure of the Joint Select Committee on De1icit 

Reduct.ion to reach an agreement in November 

appeared to leave a permanent imprint on the Treasury 

market. Uncertainty about longer-term interest rates, 

as measured by the implied volatility on Ill-year Treasury securities, moved sideways through most of the 

second half of 20 II and then declined late in the year 

and into 2012, reflecting improved sentiment in financial markets following a number of policy actions hy 

central banks and some signs of slrengthening in the 

pace of economic recovery. 

Measures of market functioning suggest that the 

Treasury market has continued to operate smoothly 

since mid-20l1 despite the S&P downgrade in August. 

Bid~asked spreads for most Treasury securities were 

roughly unchanged, though they have widened a bit, 

on net, for the 30-year bond since August. Dealer 

transaction volumes have remained within historically 

normal ranges. 

Short-Term FUllding Markets 

Conditions in unsecured short-term dollar funding 

markets deteriorated, on net, over the second half of 

2011 and in early 2012 amid elevated anxiety about the 

crisis in Europe and its implications [or European 

firms and their counterparties. Funding costs increased 

and tenors shortened dramatically for European institutions throughout the third and into the fourth quart.er. Funding pressures eased somewhat late in the year 

following the European Central Bank's (ECB) first 

injection of cum liquidity via a three-year refinancing 

operation and the reduction of the price of U.S. dollar 

liquidity of Ie red by the ECB and other central hanks; 

they subsequently eased further j()llowing the passage 

of year-end. On halance, spreads of London interbank 

offered rates (LIBOR) over comparable-maturity OIS 

rates,,· ·a measure of stress in short-term hank funding 

markets~- have widened considerably since July, particularly for tenors beyond one month, though they 

have moved down since late last year. Indeed, throughout much of the third and fourth quarters, many European institutions were reportedly unable to obtain 

unsecured dollar funding at tenors heyond one week. 

Additionally, more-forward-Iooking measures of interbank funding costs---such as the spread between a 

three-month forward rate agreement and the rate on an 

OIS contract three to six months ahead-moved up 

considerably in the second half of 2011 and have only 

partially retraced in 2012 (Jigure 39). Despite the pressures faced by European financial institutions, U.S. 

llrms generally maintained ready access to short-term 
91 


75075.038

22 Monelary Policy Report 10 the Congress I-J February 2012 

unsecured funding markets. Against a backdrop of 

solid deposit growth and modest expansion in bank 

credit across the industry, most domestic banks reportedly had limited need for unsecured funding. 

Pressures were also evident in the commercial paper 

(CP) market. Issuance in the United States of unsecured financial CP and negotiable certificates of 

deposit by entities with European parents declined signiJicantly in the second half of 2011. By contrast, the 

pace of issuance by U.S. firms edged down only 

slightly, on net, over the period. On balance, spreads of 

rates on unsecured A2/P2 commercial paper over 

equivalent maturity AA-ratcd nonfinancial CP rose a 

bit for both overnight and 30-day tenors. AA-rated 

asset-hacked CP spreads increased more notably over 

thc second half of 2011 but largely retraced following 

year-end (figure 40). 

In contrast 10 unsecured dollar funding markets, 

signs of stress were largely absent in secured shortterm dollar funding markets. For example, in the market for repurchase agreements (repos), bid-asked 

spreads for most collateral types were little changed. In 

addition, despite a seasonal dip around year-end, volumes in the triparty repo market were largely stable on 

balance. That said, the composition of collateral 

pledged in the repo market moved further away from 

equities and fixed-income collateral that is not eligible 

for open market operations, shifting even more heavily 

toward Treasury and agency securities as counterparty 

39. LIBOR minus ovemight index swap rate, 2007-12 

- 350 

300 

250 

200 

150 

100 

50 

40. Commercial papcr spreads, 2007-12 

,\2,'P2-rated 

nonfinancial 450 

400 

350 

300 

250 

200 

150 

100 

and are 

concerns became more evident. Respondents to the 

SCOOS in both S"ptember and December noted a 

continued increase in demand for funding across collaleral types but reported a general tightening in credit 

terms under which several securities types are financed. 

Tn addition. market participants reportedly became 

wmewhat less willing to fund riskier collateral types at 

longer tenors as year-end approached. However, yearend pressures remained muted overall, with few signs 

of dislocations in either secured or unsecured shortterm markets, and conditions in term funding markets 

have improved in early 2012. 

Money market funds, a major provider of funds 10 

short-term funding markets such as those for CP and 

fL)f repo, experienced signifIcant outflows across fund 

categories in July, as investors' focus turned to the 

deteriorating situation in Europ~ and to th~ debt ceiling debate in 1he United S1a1e& Those outtlows largely 

shifted to hank deposits, resulting in significant pressure on the regulatory leverage ratios of a few large 

banks. However, investments in money market funds 

rose, on net, over the remainder of 201 I, \\-ith the composition of those increases reflecting the general tone 

of increased risk aversion, as government-only funds 

faced notable inflows while prime funds experienced 

steady outflows. 

Finallcial IIlStitUtiOlls 

Market sentiment toward the banking industry 

declined rapidly early in the second half of 2011 as 
92 


75075.039

investors turned their focus on exposures to European 

sovereigns and financial institutions and on the possible spillover ctTects of the European crisis. Some 

large U.S. institutions also remained significantly 

exposed to legal risks stemming from their mortgage 

banking operations and foreclosure practices. 12 More 

recently, however, investor sentiment has improved 

somewhat following the actions of central banks and 

incoming data suggesting a somewhat hetler economic 

outlook in the United States. On balance, equity prices 

j()f banking organizations (figure 41) have completely 

retraced their declines from last summer, while CDS 

spreads (figure 42)--which reflect investors' assessments of and willingness to bear the risk that these 

institutions will default on their deht ohligations··~·have 

declined from their peaks reached in the fall, but not all 

the way back to mid-20 II levels. 

Measures of bank profitability edged up, on net, in 

recent quarters but remained well below the levels that 

prevailed before the financial crisis began (figure 43). 

Although proflts at the largest institutions were supported over that period by reductions in noninteres1 

expenses, net interest margins remained very low, capital markets revenues were subdued, loan loss provisions are still somewhat elevated relative to pre-crisis 

12. {)n FebnJary 9, it was announced that the federal govemmcnt 

lawsuits. 

41. Equity price index for banks, 2009-12 

______________ Jrmllilly 2,200()=IOO 

120 

110 

IOn 

90 

80 

70 

- 60 

50 

40 

30 

Board (~r Governors (~f the Federal Reserve /))Istem 23 

42. Spreads on credit default swaps for selected 

U.S. banking organizations, 2007-12 

400 

350 

norms, and a few banks booked large reserves for litigation risks associated with their mortgage portfolios. 

Indicators of credit quality at commercial hanks 

continued to show signs of improvement. Aggregate 

delinquency and charge-otr rates moved down, though 

they remained quite elevated on residential mortgages 

and both residential and commercial construction 

loans. Loss provisioning has leveled out in recent quarters near the upper end of its pre-crisis range. Nonetheless, in the January SLOOS, a large fraction of the 

respondents indicated that they expect credit quality to 

improve over the next 12 months f()r most major loan 

43. Profitability of bunk holding companies, 1998-2011 

Percentanml"lrate P~rcent.mmuallate 

25 1.5 20 

1.0 IS 

10 .5 

.5 10 

1.0 IS 

20 1.5 25 

Statements for Bank Holding Companies. 
93 


75075.040

24 Monetary Policy Report to the Congress I~ February 2012 

Financial aHhe federal Reserve 

resent. crisis, 

financial stability policy tended to b~' overshadowed by monetary policy, which had corne 10 be 

viewed as the principal function of central banks. 

HOWCVN, in the aftermath ufthe financial crisis, 

financial stability policy has taken on prentern,·onl;-

ncnce and an equally 

critical banks. As such, the 

ff'd0ra! Reselve has mad", significant organiLational 

changes and tah~n oth,,'r actions to improve its 

ability to understand and address systemic risk. In 

addition, its statutOlY role in maintaining financial 

stability has been expafl(if~d by the Dodd-Frank 

Wall Street Refonn and Consumer Protection Act of 

2010 (Dodd Frank Act). 

Onp of the Dodd -Frank Act is its 

macrc'Dn)(le nllal orientation, ilS reflected in many 

of the provisions to be the Fedpral 

Reserve and macroprudential approach to and supervision 

still pays clost" attention to the safety and soundness of individual financial institutions, but it also 

takes into account the linkages among those entitips and tlw condition of the financial sys{prn as a 

whole. 1'0 implement the macroprudenLial 

Dodd-Frank Act established tht" 

nlll,It;"P"'WV financial Stability Ovprsight Council 

is tasked vvith promoting a more 

m,,,,,,,,h,,",,;,,>, monitoring and l11itlFederal ResPlve is one of 

rsoc 

categories if economic activity progresses in line with 

consensus forecasts. 

Credit provided by domeslic banks-the sum of 

loans and securities-increased moderately in the second half of 2011, its first such rise since the first half of 

2008. Bank credit grew as holdings of agency MilS 

expanded steadily and most major loan categories 

exhibited improvement in the second half of the year. 

The expansion was consistent with recent SLOOS 

responses indicating that lending standards and loan 

terms eased somewhat and that demand for loans from 

businesses and households increased, on net, in the 

second half of 2011. In particular, C&l loans showed 

persistent and considerable strength over the second 

half of 2011 and into early 2012. Loans to nonbank 

financial institutions, a category that tends to be vola-

;\ significant aspf'ct of the macroprudential 

is the heightened focus on entities 

or finanda! distress could result in 

outsized destabilizing effects on the fest of thf' 

Underthe Dodd-hank Act, the Federal 

is responsible forthe supclvision of all systemically important financial institutions (Sins), 

which includp both bank holding companies 

designated by the' 

impo!1ant. Even beforf> the 

the ~pderal Reserve 

LIp to help in 

the ovprsight of systpmica!1y impO!1ant financial 

market utili! ies. 

The Federal ReSPTVe has also established the 

omce of financial Stability Policy and Research 

(OFS) to hplp the Federal Reserve rnore pffectively 

rnonitor the financial and develop policies 

HIP OfS's function is to 

a 

context. In addition, the' Federal Reserve works wilh 

other u.s. agpncies and international bodies on a 

range of issues to strengthen the financial system. 

tile, also grew rapidly over that period as did holdings 

of agency MBS. Consumer loans held by banks edged 

up in the third and fourth quarters. Those increases 

ofrset ongoing declines in commercial real estate and 

home equity loans, both of which remained very weak. 

Regulators continued to take steps to strengthen 

their oversight of the financial industry. In particular, a 

variety of measures mandated hy the Dodd·-Frank 

Wall Street Reform and Consumer Protection Act of 

20lO arc being, or are soon to be, implemented, including enhanced capital and liquidity requirements [or 

large banking organizations, annual stress testing, 

additional risk-management requirements, and the 

development of early remediation plans (sec the box 

"Financial Stability at the Federal Reserw"). As part 

of those efrorts, the Federal Reserve began annual 
94 


75075.041

SystfOrnic financia! risks can take severa! forms. 

Some risks can be described as structural in nature 

lwcause they are associated with structural features 

of financial markets and thus are largely 

dent of economic conditions; thE-se indudf', 

example, the by a sin whose failun~ can 

haw' outsiLecl thf' financial orthe 

degree to which 

susceptibk,to 

bf' elescribf'd 

example, asset valuiltions and 

cr('elit growth that arise in buoyant economic times 

but can unwind in destabilizing ways should condiboth types of risk is 

critical in monitoring of systemic risk and thp 

forrnulation of appropriate macroprudcntial policy 

reviews of the capital plans for u.s. hank holding companies with total consolidated assets of S50 billion or 

more under its Comprehensive Capital Analysis and 

Review program. Going into those reviews, reported 

regulatory capital ratios of u.s. banking institutions 

generally remained at historically high levels over the 

second half of 20 II. 

Concerns ahout the condition of European tInancial 

institutions, coupled with periods of heightened attention paid to U.S. securities dealers, raised investor anxiety regarding counterparty exposure to dealers during 

the second half of 2011. Indeed, responses to the 

December SCOOS suggested that dealers devoted 

increased time and attention to the management of 

concentrated credit exposures to dealers and other 

financial intermediaries over the previous three months 

Board (~f Governors (~r the Federal Reserve S)!stem 25 

Resetve 

dimension of financial r('gu!ation. It is also working 

with its regulatory counterparts to improve the 

quality and timdiness of financial data. 

The Federal R('serve is likewise 

to address cyclical systemic risks. 

it routinely monitors a number of iterns-inand 

the balance sheets of the finns and provide a COnlof how the finns' 

likely evolw over a 

under advPrse economic and 

Meanwhile, etforts are under 

way to (-"valuate and develop new macroprudential 

tools that could help limit future buildups of cyclical systemic risk, 

In the Federa! Reselve has taken a 

risk. 

(figure 44).13 In addition, survey respondents reported 

that they had reduced aggregate credit limits for certain specillc institutions, Investors appeared to he particularly concerned ahout the stability of fimding in 

the event of financial market stress hecause most dealer 

firms are highly reliant on short-term secured funding. 

Respondents to the December SCOOS reported a 

broad but moderate tightening of credit terms applicable to important classes of counterparties over the 

previous three months. This tightening was especially 

evident for hedge fund clients and trading real estate 
95 


75075.042

26 Monetary Policy Report to the Congress fl February 2012 

44. Net percentage of dealers reporting increased attention 

to exposmc to other uealers, 2010-11 

P"1cent 

80 

60 

investment trusts (figure 45).14 The iustitutions that 

reported having tightened credit terms pointed to a 

worsening in general market liquidity and functioning 

and a reduced willingness to take on risk as the most 

important reasons for doing so. Indeed, for each type 

of collateral covered in the survey, notable net fractions of respondents reported that liquidity and functioning in the underlying asset market had deteriorated 

over the previous three months. Dealers reported that 

the demand for funding most types of securities continued to increase over the previous three months, particularly the demand ror term runding with a maturity 

greater than 30 days, which increased tl1r all security 

types. 

Net investment flows to hedge funds in the third and 

fourth quarters ,vere reportedly significantly smaller 

than in the first hall' of the year as hedge funds markedly underperformed the broader market in 2011. 

Information from a variety of sources suggests that the 

use of dealer-intermediated leverage has declined, on 

balance, since mid-20ll. Indeed, while the use of 

dea1cr-intcrmeuiated leverage was roughly unchanged 

for most types of counterparties according to Septemher and Decemher SCOOS respondents, about hall' of 

those surveyed indicated that hedge funds use of 

flnancialleverage, considering the entire range of 

assets backed by 

45. Net percentage of dealers reporting a tightening 

of price tenus, by countelvarties, 2010-11 

transactions with such clients, had decreased 

somewhat. 

Corporate Debt and Equity Markets 

30 

20 

10 

10 

20 

30 

On net since July of last year, yields on investmentgrade corporate bonds have declined notably, while 

those on speculative-grade corporate debt posted 

mixed changes. However, reflecting a decline in investor risk-taking amid concerns about the European situation and heightened volatility in flnancial markets, 

spreads of these yields to those on comparablematurity Treasury securities widened notably in the 

third quarter and have only partly retraced since that 

time (figure 46). In the secondary market for leveraged 

loans, the average bid price dropped in line with the 

prices of other risk assets in August but has recovered 

since then, as institutional invcstors--which include 

collateralized loan obligations, p~nsion funds, insurance companies and other funds investing in fixedincome instruments· .. --have reportedly continued to 

exhibit strong appetites for higher-yielding leveraged 

loans against a backdrop of little new supply of such 

loans (figure 47). Liquidity in that market has recovered recently after a sharp deterioration during the 

summeL 

Broad equity prices arc about unchanged, on balance, since mid-20 11 but exhibited an unusually high 

level of volatility (figure 48). Equity markets fell 
96 


75075.043

46. Spreads of corporate bond yield:;;: ov~r.comp~able 

off:'thc-nm Treasury yields, hy secuntlcs ratmg, 

1997-2012 

_______________ P~rc~ntilgepOlnts 

18 

16 

'" .- 12 

10 

from smoothed corporatt: yield curves using Menill 

sharply in late July and early August in response to 

concerns about the European crisis, the U.S. debt ceiling debate, and a possible slowdown in global growth. 

Equity prices roughly retraced these losses during the 

fourth quarter of 2011 and early 2012, reflecting somewhat better-than-expected economic data in the United 

States as well as actions taken by major central banks 

to mitigate the financial strains in Europe. Nonetheless, 

equity ~xices have remained highly sensitive to news 

regarding developments in Europe. Implied volatility 

fcw the S&P 500 index, calculated from option prices, 

47. Secondary-market bid prices for syndicated loans, 2007-12 . 

Percentofpal\'alue 

NOTE: The data are dailY and extend through Fcbtuary 24-, 2012. 

SOURCE: LST A/TI10ms~n Reuters ?vlark-to-:~\ilarkel Pricing. 

100 

90 

80 

70 

60 

50 

Board (~r Governors (~f the Federal Reserve S):stem 27 

48. Stock price index, 1995-2012 

JiUluiiry:l.2OD$ 100 

140 

120 

100 

80 

60 

40 

ramped up in the third quarter of 2011 but has since 

reversed much of that rise (1]gure 49). 

Amid heightened stock market volatility over the 

course of the second half of 2011, equity mutual funds 

experienced sizable outflows. Loan funds, which invest 

primarily in LIBOR -based syndicated leveraged loans, 

also experienced outflows as retail investors responded 

to loan price changes following indications that the 

Federal Reserve would keep interest rates lower for 

longer than previously anticipated. With declining 

yields on fixed-income securities boosting the performance of bond mutual funds, these funds, including 

speculative-grade and municipal bond funds, attracted 

net inflows (figure 50). 

49. Implied S&P 500 volatility, 1995-2012 

Pelc~nt 

80 

70 

60 

50 

40 

30 

20 

10 
97 


75075.044

28 Monetary Policy Report to the Congress [J February 2012 

50. Net nows into mutual flUlds. 2006-11 

L' _ '---_'--cc~ '----: 2006 2007 2008 2009 2010 20ll 

120 

90 

60 

30 

30 

60 

90 

The d.1-ta exclude reinvested dividends and are not seasonally 

Investment Company Institute. 

The M2 monetary aggregate expanded at an annual 

rate of ahout 12 percent over the second half of 2011 

(figure 51)15 The rapid growth in M2 appears to bethe 

result of increased demand for safe and liquid assets 

due to concerns about the European situation, comhined with a very low level of interest rates on alternative short-term investments. In addition, a number of 

regulatory changcs have likely boosted M2 of late. In 

particular, unlimited insurance by the Federal Deposit 

Insurance Corporation (FDIC) of onshore noninterest-bearing deposits has made these deposits 

increasingly attractive at tlmcs of heightened volatility 

and uncertainty in ilnancial markets. In addition, the 

change in the FDIC assessment hase in April 201 I 

added deposits in domestic banks' otIshore olIices, 

eliminating some of the benefits to banks of booking 

deposits ahroad and apparently leading, in some cases, 

to a decision to rchook some of these deposits 

51. M2 growth rate, 2005-11 

NUT1I: i'm'oonru",,,, 0> 

SOl'RCE: 

l\Jeasures." 

III 

H2 

--- 14 

12 

10 

onshore. Indeed, liquid deposits, the single largest 

component of M2, grew at an annual rate of 20 percent in the second half of 2011.16 The currency component of the money stock grew at an annual rate of 

7 percent over the second half of 2011, a bit faster 

than the historical average but a slower pace than in 

the lirst half of the year. The monetary base--which is 

equal to the sum of currency in circulation and the 

reserve balances of depository institutions held at the 

Federal Reserve--expanded at an annual rate of 

3% percent in the second half of the year, as the rise in 

currency more than offset a slight decrease in reserve 

halances. 17 

The size of the Federal Reserve's balance sheet 

remained at a historically high level throughout the 

second half of 2011 and into early 2012, and stood at 

about $2.9 trillion as of February 22. The small rise of 

about $61 billion since July largely reflected increases 

in temporary U.S. dollar liquidity swap balances with 

the ECB, which were partially offset hy a decline in 

securities holdings (table 1). Holdings of US, Treasury 

securities grew $32 billion over the second half of 

2011, as the proceeds from paydo\vns of agency dt:bt 

and agency MRS were reinves1ed in longer-term Treasury sccuritit:s until the FOMC decision in September 

tn switch the reinvestment of those proceeds to agency 

MBS; total holdings of MBS declined into the fall. The 

subsequent small increase in MBS holdings reflects the 
98 


75075.045

Board 0/ Go·vernors (~r the Federal Reserve ,--\vslem 29 

1. Selected components of the f'ederal Reserve balance sh~et, 201 0-l2 

M11lionsofdc·llars 

reinvestment of maturing agency debt into MBS. 

Agency debt declined about $14 billion over the entire 

period. The composition of Treasury holdings also 

changed over this period as a result of the implementation of the MIlE As of February 24, 2012, the Open 

Market Desk at the Federal Reserve Bank of New 

York (FRBNY) had purchased $211 billion in Treasury securities with remaining maturities of 6 to 

30 years and sold $223 billion in Treasury securities 

with maturities of 3 years or less. 

In the second half of 2011 and early 2012, the Federal Reserve reduced some of its exposure to lending 

facilities estahlished during the financial crisis to support specific institutions. The portfolio holdings of 

Maiden Lane LLC, Maiden Lane II LLC, and Maiden 

Lane III LLC-entities that were created during the 

crisis to acquire certain assets from the Bear Stearns 

Companies, Inc., and American International Group, 

Inc., or AIG, to avoid the disorderly failures of those 

institutions-declined, on net, primarily as a result of 

asset sales and principal payments. Of note, the 

FRBNY sold assets with a face amount of S13 billion 

from the Maiden Lane II porttolio in early 2012 

through two competitive processes conducted by the 

FRBNY's investment manager.lll 

Use of regular discount \vindow lending t'.:'1cilitles, 

such as the primary credit facility, continued to be 

minimaL Loans outstanding under the Term AssetBacked Securities Loan Facility declined and stood 

just below $8 billion in late February. 

On November 30, 20 II, in order to ease strains in 

global Jinaneial markets and thereby mitigate the 

efleets of such strains on the supply of credit to U.S. 

households and businesses, the Federal Reserve 

announced coordinated actions with other central 

banks to enhance their capacity to provide liquidity 

18. On January 19. 2012. the f'RBNY announced the s.'11e ()f assets 

with a face amount of $7.0 billion from the Maiden Lane II LLC 

2012, the 
99 


75075.046

30 Monetary Policy Report to the Congress rJ February 2012 

support to the global financial system19 The FOMC 

authorized an extension of the existing temporary 

U.S. dollar liquidity swap arrangements through February 1, 2013, and the rate on these swap arrangements 

was reduced from the U.S. dollar OIS rate plus 

100 basis points to the OIS rate plus 50 basis points. 

The lower cost spurred increased usc of those swap 

lines; the outstanding amount of dollars provided 

through the ~'wap lines rose from zero in July to 

roughly $1O~ billion in late February. 

On the liability side of the Federal Reserve's balance 

sheet, reserve balances held by depository institutions 

declined roughly S4() billion in the second half of 2011 

and early 2012 while Federal Reserve noies in circulation increased roughly S57 billion. The Federal Reserve 

conducted a series of small-scale reverse repurchase 

transactions involving all eligible collateral types and 

its expanded list of counterparties. The Federal 

Reserve also continued to offer small-value term deposits through the Term Deposit Facility. In July of last 

year, the Treasury reduced the balance of its Supplementary [<'inancing Account at the Federal Reserve 

from $5 billion to zero. 

International Ucvelop:rnents 

Tn the second half of the year, financial market devcIopments abroad were heavily influenced by concerns 

ahout the heightened fiscal stresses in Europe and the 

resultant risks to the global economic outlook. Foreign 

real GDP growth stepped up in the third quarter, as 

Japan rebounded from the elTects of its March earthquake and tsunami, leading to an easing of supply 

chain disruptions. In contrast, recent data indicate that 

foreign economic grmvth slowed in the fourth quarter, 

as activity in the euro area appears to have contracted 

and as flooding in Thailand weighed on growth in several economics in Asia. 

International Finallcial Markets 

The foreign exchange value of the dollar has risen 

since July about 31

/: percent on a trade-weighted basis 

against a broad set of currencies (figure 52). Most of 

the appreciation occurred in September as market par52, V,S, dollar nominal exchange rate, broad index, 

2007-12 

f)~cemb"'r'1,2007-100 

120 

115 

110 

105 

100 

95 

Exchange Rates." 

ticipants became increasingly pessimistic about the 

situation in Europe. Safe-haven nows buoyed the yen 

and the Swiss franc, and in response, the Bank of 

Japan and the Swiss National Bank separately intervened to counter further appreciation of their currencies (figure 53), 

On net in the second half of the year, government 

bond yields for Canada, Germany, and the United 

Kingdom fell over 100 basis points to record lows, 

53. U.S. doUar exchange rate against selected major 

currencies, 20l0~12 

31.Z0{)"-lOO 
100 


75075.047

54. Yields on bcnchmark govemment bonds in selected 

advanced forcign cwy{"omies, 2009-12 

Jan. Apr. July Oct. Jan 

2011 2012 

honds, are daily. The last 

SOCRCE: Bloomhcrg. 

driven by safe-haven flows as well as a deteriorating 

global outlook (figure 54). By contrast, sovereign bond 

spreads for Greece rose st.eeply, and Spanish and Italian sovereign spreads over German bunds also 

increased (figure 55). Prices of other risky assets were 

very volatile over the period as market part.icipants 

reacted to news about the crisis. (See the box "'An 

Update on t.he European Fiscal Crisis. ") 

As sovereign funding pressures spread t.o I taly and 

Spain in July and August and as concerns also 

mounted regarding U.S. fiscal policy and the durability 

of the global recovery, equity prices in the advanced 

foreign economies (AFEs) generally plunged 

55. Govemmcnt debt spreads for peripheral 

European economics, 2009-12 

Pe)cenl 

- 32 

Gre-oce 28 

Board qf Governors of the Federal Reserve /)~vstem 31 

56. Equity indexes in sclected advanced foreign economies, 

2009-12 

______________ ---"'Jw":,,":3"':,'D.2009·-100 

150 

(figure 5()). Those equity markets remained quite volatile but largely depressed through early December, 

when market sentiment seemed t.o take a more concerted turn lor the better. Although most AFE equity 

indexes remain below their mid-summer levels, they 

have risen markedly in the past two months. Emerging 

markets equity prices followed a path similar to those 

in the AFEs (ligure 57). Emerging markets bond and 

equity funds experienced large out11ows during periods 

57. Aggregate equity indexes for emerging market 

economies, 2009-12 

160 

145 

130 

115 

]00 

85 
101 


75075.048

32 Monetary Policy Report to the Congress rJ February 2012 

An on the European fiscal Crisis 

The European fiscal crisis intensifif>d in the spcond 

half of 2011, as concerns overfisca! 

spread to additional 

region's financial backstop, 

and address liquidity sholtages for banks. On balmark(~t conditions have somewhat 

but a possible 

the adequacy of dw financial 

backstop for othervulrl(>rabh~ f'co!10mips have 

kept yif'lds on debt elevated and funding 

for Europpan limited. 

1 he crisis began in smaller euro-area countries 

with high fiscal deficits or debt and vulnerable 

banking systems. In 2010 and the first half of 2011, 

eo\'err.m,,,,ts in Greece, Ireland, and Portugal sufreduced access to market funding and 

required financial assistance from tlw European 

Union ([U) and the International Monetary fund 

Olvlr). 

nomic growth rl'<.mn.n',,'orl 

political commitment to fiscal consolidation, and 

caUs for the debt 

rattled investor confidence. of 

financial conditions led to twightened political tel1-

siclfls in vulnprable economies, contributing to 

in Greece, haly, and Spain later 

Financial stresses spread quickly to European 

banks with exposures to Italy, Spain, and the 

othen/ulr'er<".ble economies, and access to funding 

became limited for all but the shortest maturities 

and strongest institutions. In turn, concerns over 

the potential fiscal burdens for govNnnwnt5, 

should they need to recapitali7e financial instituof heightened concern::; about the European crisis, but 

inflows have resumed more recently. 

Euro-area bank stock prices underperformed the 

broader market, as concerns about the health of European banks intensified over the second half of 2011. 

The CDS premiums on the debt of many large hanks 

in Europe rose substantially, reflecting market views of 

increased risk of default (figure 58). Quarterly earnings 

for many banks were reduced hy wrile-downs on 

Greek debt. Although only eight banks failed the 

European Banking Authority (EBA) European 

Union -·wide stress test in July, concerns about the capiBelgium/ and rrance. 

Europc>an ieadprs rc>sponded to these devplopments with a number of policy measures. In 

amid 1he growing realization that 

n0,pd funher financial assistanCf~, [LJ and IMr- offidais announced plans for a second rescue packag(~, induding a call for limited reduction in the 

value of the df'1l1 held In Febits creditors are nnw working to put in place the 

and the new officialdebt amottital adequacy of large European banks persisted. Partly 

in response to these concerns, the EBA announced in 

October that banks would be required to put in place a 

temporary extraordinary capital bumor by June 2012. 

boosting their core Tier 1 risk -hased capital ratio to 

9 percent. As market sentiment about European banks 

deteriorated over the period, their access to unsecured 

dollar funding diminished, particularly at tenors 

heyond one week. (Sec the box "U.S. Dollar Funding 

Pressures and Dollar Liquidity Swap Arrangements .. ,) 

European hanks <-.uso faced pressure in curo funding 

markets. As banks' willingness to lend excess liquidity 
102 


75075.049

ing facility, to July 2012, about a ypar f'arlierthan 

originally planned. 1 his euro-arE'a leaders 

wi!! consider lifting the -E-:SOO 

comhirwd lending of thf> ErSF and tlw 

addition, European officials ca!!E'd for an expansion 

of the IMf·'s lending capacity and pledged a joint 

contribution of elSO billion toward that goal. 

!-inally, to improVf~ the 

debt 

resumed 

in August, rcportedly including tlw debt of Italy 

and Spain. 

PoHcyrnakers also took steps to SUppOit financial 

markets and institutions atfec.ted by the soven~ign 

crisis. To irnprovl' transparency and bolstpr the ability of turopcan banks to withsland losses on sovereign holdings, the European BankingAuthority 

(EBA) conductpd a second stress test of largf-' EU 

tlnancial institutions, the results of which wen> 

releast:>d in rnid-July, along with detailed information about banb' f'xposures to borrowers in EU 

counlri('s. Market conCE'nlS ahout bank capital per~ 

sistC'd, and in Oct()bel~ the- EBA 

announced that banks would be required to 

build up "exceptional and temporary" capital buffers to mer·t a o)rc Tier1 capita! ratio of9 pE'rcent 

and cover t!1f> cost of rnarking sovereign exposures 

to market by the end ofJu!lc 2012. In Decelllbe,~ 

the tBA disdospd that til(' aggregate rNjuired capital buffer for large banks would be cfJ15 billion if 

risk-weighted asset<; were to remain al the levels 

tht'y had readlE'd at thf-~ end ofSepternber 2011. 

The banks subrnittpd their capita! plans to theif 

national supervisors for approval, and the LBA has 

BOW summarized these plans. Excluding the Crf'ek 

banks and three other institutions that will be 

recarJlrall"eo separately by national authorities, the 

banks intend tn create capital buffers 

billion, about 25 percent larger 

buffers, use 

measures (such as 

to one another decreased, the cost of obtaining funding in t he market rose, and banks relied more heavily 

on the ECB for funding, The first three-year ref mancing operation, held by the ECB on December 21, led to 

a significant injection of new liquidity, and funding 

conditions in Europe seemed to improve gradually in 

the weeks that followed, Short-term euro interbank 

rates declined, euro-area shorter~duration sovereign 

bond yields feU sharply, and both governments and 

banks were able to raise funds more easily. 

Board (~f Governors (~f the Federal Reserve j.)~vstern 33 

kets from stresses in Eurolw, in late 

federal Reserve! the EeB, and four other major 

c('ntral to reduce the fee on draws on 

billion a1 the new facility in f)ecelllbel~ raisingthe total arnount of outstanding ECB refinanc~ 

ing operations by roughly -€-:200 billion. A second 

thn>e-year liquidity operation is schpduled for the 

end of February. 

rhe improved availability of do!!arand euro 

funds late in the year, against the background of 

th(~ other policies be-ing e-lTIployed to addre-ss tlw 

haY(' pmt!y allayed market COllbanks as well vulmont hs, turopean banks have seen ;n"',""VN'"'''''' in their access to funding, and in 

mips, credit sprpads on the banks and 

government bonds 

tlwless, significant risks remain as 

struggle to implement the new Greek program and 

debt exchange, bank 

capital, and 

The Finallcial Accollnt 

Financial flows in the second half of 2011 rellected 

heightened concerns about risk and the pressures in 

currency markets resulting from the European crisis. 

Based on data for the third quarter and monthly indicators for the fourth quarter (not shown), foreign private inves10rs Hocked to U.S. Treasury securities as a 

safe-haven investment while selling U.S. corporate 

securities, especially in months when appetite for risk 
103 


75075.050

:14 Monetary Policy Report to the Congress [-] February 2012 

58. Credit default swap premiums for banks in 

selected European cotUltrics. 2011-12 

700 

600 

500 

400 

300 

200 

100 

was particularly weak (figure 59). US. investors also 

pulled back from investments in Europe, significantly 

reducing deposits with European banks and selling 

securities from curo-area countries. Overall, U.S. purchases of foreign securities edged down in the third 

quarter (figure 60). 

The large purchases of Treasury securities dominated total private financial flows in the third quarter, a 

pattcrn thaI likely continued in the fourth quarter. Net 

!lows by hanks located in the United States were small, 

hut these flows masked large offsetting movements by 

foreign- and US.-owned banks. US. hranches of 

European hanks brought in substantial funds from 

59. Net foreign purchases of U.S. securities, 2007-11 

nl1h0n~0fd011ar$ 

-----------

Onidal purchases ofU,S, Treasury securities 

Private purchases ofC.S< TreasUlY securities 

Purchases of other u.s. secUlltks 

600 

500 

400 

300 

200 

100 

toO 

200 

Other FS. &eeurities include corporate equities and bond~, agency 

and municipal bonds. 

SOClteE: Department ofCommcrce. Bureau of Economic Analysis. 

GO, Net US. purchases of foreign securities, 2007~11 

100 

so 

50 

100 

ISO 

affiliates abroad over the course of 2011, building 

reserve balances in the first half of the year and covering persistt.mt declines in U.S. funding sources. In contrast U.S. hanks. subject to less-severe market stress, 

sent funds abroad to meet strong dollar demand. 

Inflows from foreign official institutions slowed 

notahly in the second half of 201 1 (figure 61). A number of advanced countries acquired some U. S. assets, 

seeking to counteract upward pressure on their currencies by purchasing U.S. dollars in foreign exchange 

markets. However, inflows from official institutions in 

the EMEs trended down significantly in 20 11, especially in the third and fourth quarters when the 

61. u.s. net financial intlows. 2007-11 

600 

400 

200 

200 

when 
104 


75075.051

strength of the dollar Jed to reductions in their intervention activity. 

AdYanced Foreign Economies 

The intensification of the curo-area sovereign debt crisis was accompanied by a widespread slowing of economic activity in the AFEs. In the euro area, financial 

tensions increased despite the various measures 

announced by European leaders to combat the crisis. 

Real GDP contracted in the euro area at the end of 

last year according to preliminary estimates, and spillovers from the euro area likely contributed to the 

fourth-quarter GDP decline in the United Kingdom. 

In Japan, economic activity rebounded rapidly from 

the disruptions of the March earthquake and tsunami 

but dipped again in the last quarter of 2011 as exports 

slumped. In Canada, elevated commodity prices and a 

resilient labor market have supported economic activity, but the export sector is sho~ing signs of 

weakening. 

Survey indicators suggest that conditions improved 

somewhat around the turn of the year, with widespread upticks in dillcrent countries' purchasing managers indexes. However, uncertainty about the resolution of the euro-area crisis continues to affect 

investors' sentiment, while trade and financial spillovers weigh on activity f(.1f all of the AFEs. 

Twdve-month headline inflation remained elevated 

in most of the AFEs through the end of 2011, largely 

62. Change in conSlm1er prices tor major foreign 

economies, 2007-12 

Board {~r Governors of the Federal Reserve ,»)stem 35 

reHeeting the run-up in commodity prices earlier last 

year and, in some countries, currency depreciation and 

increases in taxes (figure 62). However, underlying 

inflation pressures remained contained and, in recent 

months, intlation rates have begun to turn down, 

reflecting weaker economic activity and, as in the 

United States, declines in commodity prices since last 

spring. As with output, inflation performance differs 

significantly across countries. Twelve-month headline 

inflation currently ranges from 3.6 percent in the 

United Kingdom, partly due to hikes in utility prices, 

to slightly negative in Japan, where deflation resumed 

toward the end of 2011 as energy price inflation moderated. 

Several foreign central banks in the AFEs eased 

monetary policy in the second half of las1 year 

(figure 63). The ECB cut its policy rate SO basis points 

in the fourth quarter, bringing the main refinancing 

rate back to 1 percent, where it was at the beginning of 

the year. At its December meeting, the FeB also 

expanded its provision of liquidity to the banking sector by introducing two three-year longer-term refinancing operations, reducing its reserve ratio requirement from 2 percent to 1 percent, and easing its 

collateral requirements. The Bank of England has held 

the Bank Rate at 0.5 percent but announced a.£75 billion expansion of its asset purchase facility in October 

and a further £SO billion increase in Fehruary that will 

bring total asset holdings to £325 billion upon its 

completion in May 2012. The Bank of Japan also 

expanded its asset purchase program, raising it from 

63. OiTicial or targeteu interest rates in selected 

auvanced roreign economies, 2008-12 

P~rccnt 

- . 
105 


75075.052

36 Monetary Policy Report to the Congress IJ February 2012 

U.S. Dollar Pressures and Dollar 

sentim(>flt deteriorated, European 

l11f>diurn- and long-term dollar funding markf!ts 

diminished markedly, with many unable to obtain 

unsecurerl dollar funding at maturities pxcpeding 

one week. Th,,' pullback of U.S. mOll('Y market 

funds (MMFs) from liabilities of f'uro-area b<lnks 

beginning in mid-2011 (figure A) was an important 

p~lIt of the run-oJf of shorH,~rrn dollar funds, 

although MMI-s were not the only investors to 

reduce ttwir('xposllres tu European banks. !\s a 

many European banks faced h;ohN onll,,· 

banks to do!!arfunding 

through the foreign exchange (FX) swap markf>t 

rose as financial pressures increase-d. rhe cost of 

do!!arfunding through this markf't (the black line in 

B), as banks borrow ("uros at the ("uro l.oninterbank offered rate (UBOR) and 

dollars in thf> fX swap rnarb,t, 

last s",,,mwrlO about 20D basis points 

late November. 

Although tlw efff'cts of thf'se dollar funding 

strains arc difficult to gauge, they pose substantial 

risks forthe u.s. economy. Large European banks 

borrow heavily in dollars partly because they are 

active in U.s. markefs, purchasinggovernmenland 

corporate securities as W('I! as making loans to u.s. households and businesses. A possible 

alollg with capibe for European banks to 

¥15 trillion to ¥20 trillion in October and then to 

130 trillion in February. 

Emerging Marl,et Economies 

Many EMEs experienced a slowdo\vn in economic 

growth in the third quarter of last year relative to the 

pace seen in the first half. Both earlier policy tightening, undertaken amid concerns about overheating, and 

weakening external demand weighed on growth. However, third-quarter growth in China and Mexico 

remained strong, supported by robust domestic 

demand. Recent data indicate that the slowdown continued and broadened in the fourth quarter, as the 

financial crisis in Europe softened external demand 

A. U.S. money market fund holdings, 2011 

Rt1h(ln~()fdolllll$ 

700 

600 

500 

400 

300 

sell their dollar assets or r('(rain from fUlther dollar 

lending, which could ill turn result in a reduction of 

the uf'dit they supply to u.s. firms and households 

while also r('dueing credit to European and othf'r 

fon~ign firms involved in tradp with the United 

fur! her stresses on 

overto the United 

and the floods in Thailand impeded supply chains In 

the second half of last year, concerns about the gloh"u 

economy prompted EME authorities either to put 

monetary policy tightening on hold or, in several 

cases-such as Brazil, China, Indonesia, and Thailand -to loosen monetary policy, 

In China, real GDP growth stepped down to an 

annual rate of about 8 percent in the fourth quarter. 

Retail sales and fixed-asset investment slowed a touch 

but continued to grow hriskly, reflecting solid domestic 

demand. But net exports exerted a small drag on 

growth, as weak external demand damped exports. 

Twelve-month headline inflation moderated to about 

4;;2 percent in January, as food prices retreated from 

earlier sharp rises. With growth slowing and inflation 

on the decline, Chinese authorities reversed the course 
106 


75075.053

J3. Costs of three-month dollar funding through 

the foreign exchange swap market, the central 

bank swap line, and dollar LIBOR, 2011-12 

Basispmnts ----------------

200 

--- 160 

120 

80 

Board (~r Governors of the Federal Reserve c)~vstem 37 

a rate 

index swap rate, a rpduction of 50 

the ratp at which the forpign cpntra! 

been providing dollar loans since May 2010. 

Thp reduction in do!1arfunding costs due to 1h(> 

revised pricing of the central bank swap lirws 

hC'lped strengtlJ(>n tlw liquidity positions of Euroand otherforeigrl banks, therpby be-twfiting 

Unite-d Slates by supfJOIting Ihe continued supply of credit to LJ.S. households and busirlPss{'s 

while mitigating other channels of risk. Draws on 

lin('s, especially from the lCH, have [wen 

December 7, at the first three-month 

4() doillar!er,der ulld"" tile !levY the 

LeB allocated about $51 billion, 

land, and the United Kingdom announced an 

of monetary policy toward easing by lowering the 

reserve requirement for large banks toO hasis points, to 

20.5 percent. In 2011, the Chinese renminbi appreciated 4:;' percent against the dollar and about 6 percent 

on a real trade-weighted basis; the latter measure 

gauges the renminbi's value against the currencies of 

China's major trading partners and adjusts 1t)r diflerences in inflation rates. 

In Mexico, economic activity accelerated in the second and third quarkrs as domestic demand expanded 

robustly. However, incoming indicator~ such as tepid 

growth of exports to the United States, point to a 

increase over prpvious operations. As of Fdmrary 

24, thp feB, the Bank of Japan, and the Swiss 

National Bank had aboLlt S89 billion, SlB billion, 

and SO.S billion outstanding, reSDe':1IVeIV. 

their dollar swap lint:' allotments, 

aboLlt SlOB billion. In an indication that the swap 

lines have been dollar 

funding pressure, the cost 

thp rx swap market has dropped slrbstantially since 

Novpmber 30. Dollar UBOR, which measures dollar funding costs in the intf'rhank market for U.s. 

and foreign institutions, has also declined ovprthe 

past tvvn mont hs. 

slowdown in the ft)urth quaricr. Mexican consumer 

price inflation rose sharply in the second half of the 

year, driven largely by rising food prices and the 

removal of electrical energy subsidies. In Brazil, in contrast to most EMEs, GDP contracted slightly in the 

third quarter, hut incoming indicators point to a return 

to growth in the fourth quartel; partly as a result of 

several rounds of' monetary policy easing that began in 

August. As the direction of capital flows turned to a 

net outflow, Brazilian authorities loosened capital controls that had been introduced earlier in the [ace of 

massive inflows and associated fears of overheating. 
107 


75075.054

Monetarv 

of 2011 ~nd 

over the Second Half 

2012 

To promote the I'ederal Open Market Committee's 

(FOMC) objectives of maximum employment and 

price stability, the Committee maintained a target 

range for the federal funJs rate of 0 to 1.4 percent 

throughout the second half of 2011 and into 2012 

(figure 64). With the incoming data suggesting a somewhat slower pace of economic recovery than the Committee had anticipated, and with inliation seen as settling at levels at or below those consistent with its 

statutory mandate, the Committee took steps during 

the second half of 2011 and in early 20 12 to provide 

additional monetary accommodation in order to support a stronger economic recovery and to help ensure 

that inflation, over time, runs at levels consistent with 

its mandate. These steps included strengthening its 

fonvard rate guidance regarding the Committee's 

expectations for the period over which economic conditions will warrant exceptionally low levels for the 

federal funds rate, increasing the average maturity of 

the Federal Reserve's securities holdings through a 

program of purchases and sales, and reinvesting principal payments on agency securities in agency64. Selected init..'TCst rates, 2008-12 

guaranteed mortgage-backed securities (MBS) rather 

than Treasury securities. 

39 

On August 1, the Committee met by videoconference to discuss issues associated with contingencies in 

the event that the Treasury was temporarily ~nable to 

meet its obligations because the statutory federal debt 

limit was not raised or in the event of a downgrade of 

the u.s. sovereign credit rating. Participants g~nerally 

anticipated that there would be no need to make 

changes to existing bank regulations, the operation of 

the discount window, or the conduct of open market 

operations. 20 With respect to potential policy actions, 

participants agreed 1hat the appropriate response 

would depend importantly on the actual conditions in 

markets and should generally consist of standard 

operations. 

The information reviewed at the regularly scheduled 

rOMe meeting on August 9 indicated that the pace of 

20. Me/Jlbn~ of the FOMe' consist of the members of the Board 

of Govemors of the F0d0ral ReS0rve System plus the presid.mt of 

the Federal Reserve Bank of ;\CW York and 4 of the remaining 

11 Reserve 

12 R:,:scrvc Bank presidents. 
108 


75075.055

40 Monetary Policy Report to the Congress [] Fehruary 2012 

t he economic recovcry had slow in recent 

months and thallahor market conditions continued to 

be weak. In addition, revised data for 2008 through 

2010 from the Bureau of E-eonomic Anal~/sis indicated 

thnl the 1'ccen1 had been deeper than previously thought and that the level or real gross domestic 

product (GDP) had net yet regained its pre-recession 

peak by the second quarter of 2011. Moreover, downward revisions 10 t1rst-quarter GDP groVyth and the 

slow growth rcporkd for the second quar1cr indicated 

that the recovery had been quit.e sluggish in the ilrst 

half of 2011. Privati:: nonfarm payroll employment rose 

at a considerahly slower pace in June and July than 

carlier in the y~ar, und parLicipants noted a dekrioration in lahor market conditions, 810\vcf household 

spending, a drop in consumer and hUS111CSS cont1dcncc, 

and continued weakness in the hOllsing sector. TnHation, which had picked up earlier in the year as a result 

\.)1' higher prices for some commodilies Hnd imported 

goods as well as supply chain disrupt ions resulting 

from the nat ural disaster in Japan, moderated more 

recently as prices of energy and commodities fell 

back from their earlier peaks. Longer-term inl1ulion 

expectations remained stable. U.S. financial markets 

were s1rongly influenced by development::; regarding 

the tiscal situations in the United States and in Europe 

and by gt,;nerally \\'cakcr-than-cxpccted n:adings on 

cconGmic activity, as t~)rcign economic growth 

appeared ~o have s]owcll signllkantly. Yields on nominal Treasury s~(:uri1ies fe11 notably, on nct, \vhilc 

on both invcstment- and speculatiyc-gradc corporate 

bonds fell little less than those on comparabkmaturity Treasury securities, leaving risk spreads wider. 

Broad U.S. stock price indexes declined significantly. 

Most members agreed that thc ec{)nomic ()ullook 

had deteriorated by enough to \varrant a Committee 

response at the August meeting. Those vie\\<1ng shift 

toward more accommodative policy as appropriate 

generally agreed that a strengthening of the Comm11-

tec"s fonvard guidance regarding the federal funds 

by being more explicit about the period over 'which the 

C('mmiHee expected the federal funds rak to remain 

exccptional1y low, would be a response the 

dt.:krioration in the outlook over the intermecting 

period. The Committee agrced to kcep the target range 

i{)f the federal funds rate at () to perc(:nt and to 51 ate 

that economic conditions-including low rates of 

resource utilizalion and a suhdued outlook for inflation over the medium run---nn: likely to \varrant exceptionally 10\\: levels for the federal funds rall.: at leasl 

through mid-2013. That anticipated path tzw the fedcrul funds rate \vas viewed as uppropriate in light of 

most members' outlook f~)r the economy. 

The in hand at the September 20 21 FOMC 

meeting indicated that economic acliviiy continued to 

expand a1 a sIo\-v pace and that labor market conditions remained weak. Consumer pricc intlation 

appeanxl t.o have moderated in the year as 

prices energy and some commodities (kc1incd from 

their peaks, hut it had not yet come down much as 

participants had expected at previous meetings. Industrial production expanded in July and August, real 

business spending on equipment and soibvan: 

appeared 10 expand furthcr. and rcal consumer spending posted a selEd gain in July: IIov,:cver, private nonfarm employmenL rose onlY sJighlly in Augusl, and the 

unemploymcl1l rute rr:maincJ high. Consumer scntiment deteriorated signiIlcant!y further in August and 

siayed dO\vnbcal in carly September. Activity in the 

housing sector continued to be depressed hy weak 

demand, uncertainty about future home prices, tight 

credit conditions for mortgages and construction 

loans, and a suhstantial inventory of foreclosed and 

distressed properties. Financial mnrkets wt.'re volatile 

the intermeeting period as investors respondea1o 

somewha! disappoin ting ne\vs, 011 balance, regarding 

economic activity in the United States and abroad. 

Weak eCOntm11c data contrihuted h_' rising expectations 

among market participants of additional monetary 

accommodation; those expcctaLi,m5 and increasing 

conccrns about the nnandal situation in Furopc kd to 

an appreciable decline intcrmc(liate- and longerterm nominal Trea~mr:y yields. l-'l11ctllaLions in investors' level or concern about European fIscal and llnancial prospects aIs(l contributed to market volatility, 

particularly in equit:v markets, and spreads of yields c'n 

invcstment- and speculative-grade c!.)rporatc honds 

.over those on comparable-maturity Treasury securities 

rose significantly oyer the intermeeting period, reaching levels last registered in late 2009. 

In the discussion of monetary policy, most members 

agreed that the outlook had deteriorated some'Vvhat, 

and that there were signiilcant do\vnside risks to the 

economic outlook, including strains in global 11nancial 

markets. As a result, the Commith;e decided that proadditional monetary accommodation would be 

appropriate to slIpporl a stronger recovery and to hdp 

ensure that inHanon, over time. was at a level consisl(:nl with the Committee's dual mandate. Those Vie'l}ling greater policy accommodation as appropriatr: at 

this meeting generally supported a malurily (:xtenslon 

program thut would c(lmbine asset purchases and sales 

to extend the average ma1Urity \.,r securities held in the 

System Open Market Account without generat.ing a 

substantial expansi()l1 of the E:deral Ri:SCrve'3 balance 

sheet or reserve balances. Specifically_ those members 
109 


75075.056

supporlell a und~r \vhich the Comrnitte~ 

would announce its intention to purchas.t:.\ by the end 

of 2012, $400 billion of Treasury securities with 

remaining maJurities or 6 to 30 and to seU 

an ey.unl arn()unt of Treasury remaining 

maturities or 3 years or kSB. They expected this program to put dO\:vnward pressure on longer-term interest rates and to help make broader financial conditions 

more a~commodativc. fn addition, to hdp support 

con<-Etions in mtlrtgagc markets, the Committee 

decided 10 reinv('st principal received from its holdings 

of agency debt and agency ']\riBS in agency MBS rather 

than continuing to reinvest those funds in longer-term 

Treasury securities as had heen the Committee's practice since the August 20W rOMe meeting. At the 

same time, the Commitlcc decided to maintain its 

existing policy of rolling over mat.uring Treasury seCllrities at auction. In its statement, 1he Committee noled 

that it would. continue!o regularly review the size and 

composition of its securities holdings and that it was 

prepared to adjust those holdings as appropriate. The 

Committee also decided to keep tht:: target range for 

the fedcf;;u funds rate a! 0 to percent and to reaflirm 

its anticipal ion that economic conditions I,vcre likely to 

warrant exceptionally low kvds for the federal funds 

rate least through mid-20B. 

The information reviewed at Ih('; Novcmbt:r 1-2 

meeting indicated that the pace of economic activity 

sirenglhcncd somcl,.vhat in the 1 hird quartef. rd1ccting 

in part a reversal of the tcmportJry factors that 

"·veigh~d on ~conornic growth in th!.; ilrsl half of the 

year. Global supply chain disrupti(>Ds associated with 

the natural disaster in Japan had diminished, and the 

prices of energy and some commodities had come 

down Crom their recent peaks, casing strains on household budgets ancllikely contrihuting to a som0what 

stronger pace of consumer spending in recent months. 

Real equipment and software investrnent expanded 

appreciably, and real personal consumption expendiiUTes (peE) rose moderately in 1he third quarttT. However, real disposable income declined in the third (.jl.wrter and consumer sentlmBnt continued to be downbeat 

in October. In addition, labor market conditions 

remained weak as thl;~ pace of private-sector job gains 

in the third quarter as a whole was less than it was in 

the ill'S! half of the year. Overall consumer price inflation was more moderate than earlier in t.he year, a:-; 

prices or energy and some commodities declined from 

their recent peaks, and measures of longer-run inl1ation expectations remained stable. Financiai markds 

were quite v01ati1<.: and investor sentiment was stnJDg!y 

influenced by prospects r;,x Europe, as market participants remained highly atlUned t.o developments 

Board of Governors of the Federal Reserve 5)'sl('m 4] 

possible steps to contain the flscal and banking probkm.-{ thBre. Longer-term Treasury yields 

declined appreciably, on net, over the period, and 

yields on invcstmenl- and sp!..~culative-gradc corporate 

bonds moved leaving (heir spreads 10 Treasury 

securities slightly narro\vcr. Although equity markeis 

volatile, broad U.S. equity price indexes ended the 

interrneeting period little changed. 

Most FOfvIC members anticipated that the pace of 

ec,,)O(.1mic growth would remain moderate over coming 

quarters, with unemployment declining only gradually 

and 1n11ation se! lling: at or hdow levels consistent with 

the dual mandate. Moreover, lhe recovery \..vas still seen 

as subject to signiflcant dt1wnside risks, including 

strains in global llnancial markets. Accordingly) in t.he 

discussion of mondary policy, all Committee mcmber~ 

agreed to continue the program of extending the average maturity of the Federal Reserve's holdings of securities as announced in September. Thl) Commit tee 

decided to maintain its existing policy of reinvesting 

principal payments from its holdings of agency deb1 

agency MBS in MBS and of rolling 

maturing Treasury sl2curities aL auction. In addition, 

the Committee agreed to keep the target range for the 

federal funds rat('; at 0 to percent and to reiterate its 

expectation tha1 economic conditions vverc likely 10 

warrant ~xccptionally low levels [or the federal funds 

rate at least through mid-201 3. 

Over subsequent \veeks, tln<:lncial markets appeared 

to hecome incn.~asingly concerned that a timely reso!ution of the European sovereign deht situation might 

not occur despite the measures that authorities there 

announced Octoher; pressures on European sovereign dcht markets increased, and cunditions in Furopenn funding markets deteriorated appreciably. The 

greater financial stress. appeared likely to damp economic activity in the curo area and potentially to pose 

a risk to the ~conomic recovery in the United States. 

On November 2~, the Committee met by videoconft~rence to di~cuss a proposal to amend and augment 

the Federal Reserve's temporary liquidity swap 

arrangements with fi)rcign central banks in light of the 

strains in global financial The proposal included a six-month extension or the sunsd 

date and a 50 basis point reduction in the pricing on 

the existing dollar liquidity swap arrangements with 

the Bank of Canada, the Bank of England, the Bank 

of Japan, the FUfopcan Central B<J.nk (Fen), and the 

Swiss National Bank. In addition, the proposal 

included th~ establishment, as a contingency measure, 

of sv:.'ap arrangements that. would allow the Federal 

Reserve to provide liquidity to U.S. institutions in foreign currencies should the need arise. The proposal was 
110 


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42 :tv1ondary Policy Report to the Congress rJ February 2012 

aimed at helping to ease s1rains in llnancial markets: 

and 1 hereby to mitigate the dlccts of such strains on 

the supply of credit to U.S. households and businesses. 

thus supporling the economic recovery. :tYlost participants agreed that the proposed changes 10 the swap 

arrangements \vould represent an important demonstration of the commitment of the Federal Reserve and 

the other central banks to work togeth~r to the 

gJohal tinancial sy:-;1cm. At the conclusion of discussion, almost all members agreed to support the 

changes t.o the existing SVi"ap line arrangements and the 

establishment of' the new fordgn currcnc:y swap 

agreements. 

A~~ of the December 13 FOl\1C meeting, the data 

indicated thaL U.S. economic activity had expanded 

moderatdy despite some apparent slowing in the 

growth of foreign economics and strains in global 

tlnancial markds. Conditions in the labor market 

seemed to have improved some\vha1, as the unemployment rate dropped in November and private nonfarm 

employment continued lc· increase modera1ely. In 

October, industrial production rose, and overall real 

PCE gr.;w modestly [ollU\:ving signincant gains in the 

previous month, HowevCf, revised estimates indicated 

that households' real disposable income dedined in the 

second and third quarters, the net \'vcalth of households decreased, and consumer scnLimcnt was still at a 

suhdued level in early December. Activity in the housing markcl remained depressed hy the suhstantial 

invcntl1ry of forednsed and distressed propcrtil':s and 

hy \vcak demand 1hat rclkcled lighl cn .. 'dit conditions 

for mort.gage loans and uncertainty ahout future home 

prices. Overall consumer price inflation continued 10 he 

more modest t.han earlier in lhe year, and measures of 

in11a1 inn cxpectaUons had bccn stahle. The 

associated \vith the {-13ca] and financial ditliculties 

in Europe remained the fC!eus of attention in fmancial 

markds over the intermeeting period and contributed 

to heightened volatility in a \vide range of asset markets. However, stock prices and longer-term interest 

rates had changed little, on balance, since the November meeting. 

:rvlembers viewed the information on U.S, economic 

activity receivBd over the intenneeting period as suggesting that the economy \:>,Eould continue to expand 

moderalely. Strains in global flnanciai nnrkets continued to pose signitkanL (ltmrnsidc risks to economic 

activity. 1V1cmbers alsn anticip<'ltcd that inllation would 

sdtk, over coming quarkrs, aL levels or below those 

consistent \vlt.h Lhe Committee's dual mandate. In the 

discussion of mondary policy !'l)f the perind immediately ahead, Committee mcmhers generally agreed tha~ 

their ovcraJI assessmenls of the economic oullook had 

not changed greaHy since their previous meeting. As 

result, the Committee decided to COl'll tnnc the program 

of extending the average maturity of the Federal 

Reserve's holdings of securities as announced in September. to retain the existing policies regarding the 

reinvestment of principal paynlents from Federal 

Reserve holdings of securities, and to keep the target 

range f~)r the federal funds rate at 0 to percent. 

While several memhers noted tha11he reference to mid2013 in the f()[ward rate guidan.:c might need to be 

adjusted hefore long. and a numher of them looked 

fonvanl to considering possihlc enhancements to the 

Committee's communications, the Committee agre(;d 

to reiterate iis anticipation that economic conditions 

were to warrant exceptionally low kvcls for the 

fcderul funds rate at least through mid-20l3. 

The information reviewed at the January 24 25 

meeting indicated Ihat U.S. economic acth'ity continued to expand moderately, while global gn1"\cvth 

appeared to be slowing. Labor market indicators 

poinkd to some further improvement labor mark.:1 

conditions. but progress \vns gradual and lhe llnemploym;;::nt rate remain(:d devatt:d. Household spending 

had continued to advance at a moderate pace despite 

diminished growth in real disposable income, but 

grt,wth in nusinl2ss fixl2d itrvesLmcnL had slowl2d. The 

housing sect.or remained depressed. Inflalion bad been 

suhdued in recent months, lhere was little evidcn-.:e or wage or cost pressures, and longer-term int1ation 

expectations had remained stahle. Ml':ding participants 

observed that Hnancial conditions had improved and 

ilnancial market stresses had eased somewhat during 

the intcrmeeting period: Equity prices were higher, 

volatility had ckclincd, and hank lending conditions 

appeared 10 be improving. Participants noted that the 

ECWs three-year retinancing operation had apparently 

resulted in improved conditions in European sovereign 

debt markets. Nonethdess, participants expected that 

global l1nancial markets would remain focused on the 

evolving situation in Europe and they anticipated that 

further policy drorts \vould be required to fully 

address the tlscal and financial problems there. 

With the economy facing continuing heucl\:V'lnds and 

growth slowing in a numher of U.S. export markets, 

members generally expected a modest pacc of economic gro\'lth over coming quar1ers, with thc unemployment rate declining onty gradually. At the samc 

time. members thought that 1n11a110n would run at levels at or below those consistent with the Committee's 

dual mandate. Against this backdrop, members agreed 

that it would he appropriate to maintain the existing 

highly accommndativt.~ stance of mnnc1ary policy. 

They agreed to keep the targe1 range for the federal 
111 


75075.058

funds rate at 0 to Y, percent, to continue the program 

of extending the average maturity of the Federal 

Reserve's holdings of securities as announced in September, and to retain the existing policies regarding the 

reinvestment of principal payments from Federal 

Reserve holdings of securities. ln light of the economic 

outlook, most memhers. also agreed to indicate that the 

Committee expects to maintain a highly accommodative stance for monetary policy and anticipates that 

economic conditions are likely to warrant exceptionally 

low levels for the federal funds rate at least through late 

2014, longer than had been indicated in recent FOMC 

statements. The Committee also statcd that it is prepared to adjust the size and composition of its securities holdings as appropriate to promote a stronger economic recovery in a context of price stability. 

FOMC Commullications 

Transparency is an essential principle of modern central banking because it appropriately contributes to the 

accountability of central hanks to the government and 

to the public and because it can enhance the efTectiveness of central banks in achieving their macroeconomic objectives. To this end, the Federal Reserve provides to the public a considerable amount of 

information concerning the conduct of monetary 

policy. Immediately following each meeting of the 

FOMC, the Committee releases a statement that lays 

out the rationale ror its policy decision, and detailed 

minutes of each FOMC meeting are made public three 

weeks fc,llowing the meeting. Lightly edited transcripts 

of FOMC meetings arc released to the public with a 

five-year lag. 2l Moreover, since last April, the Chairman has held press conferences aftcr regularly scheduled two-day FOMC meetings. At the press conferences, the Chairman presents the current economic 

projections of FOMC participants and provides additional context for its policy decisions. 

The Committee continued to consider additional 

improvements in its communications approach in the 

second half of 2011 and the lirst part of 2012. In a 

discussion on external communications at the September 20·-21 POMC meeting, most participants indicated 

that they favored taking steps to increase further the 

transparency of monetary policy, including providing 

more information about the Committee's longer-run 

policy objectives and the factors that inf1uence the 

Board qf Governors (~f the federal Reserve !.)~vslem 43 

Committee'5 policy decisions. Participants generally 

agreed that a clear statement of the Committee's 

longer-run policy objectives could be helplul; some 

noted that it would also be useful to clarify the linkage 

between these longer-run objectives and the Committee's approach to setting the stance of monetary policy 

in the short and medium runs. Participants generally 

saw the Committee's postmecting statements as not 

well suited to communicate fully the Committee's 

thinking about its objectives and its policy framework, 

and they agreed that the Committee would need to use 

other means to communicate that int~)rmation or to 

supplement information in the statement. A number of 

participants suggested that the Committee's periodic 

Summary of Economic Projections (SEP) could be 

used to provide more information about their views on 

the longer-run objectives and the likely evolution of 

monetary policy. 

At the November 12 FOMC meeting, participants 

discussed alternative monetary policy strategies and 

potential approaches for enhancing the clarity of their 

public communications, though no decision was made 

at that meeting to change the Committee's policy strategy or communications. It was noted that many central 

hanks around the world pursue an explicit inflation 

ohjective, maintain the flexibility to stabilize economic 

activity, and seek to communicate their i()fecasts and 

policy plans as clearly as possib!e. Many participant.s 

pointed to the merits of specifying an explicit longerrun inflation goal, hut it was noted that. such a step 

could be misperceived as placing greater weight on 

price stability than on maximum employment; consequently, some suggested that a numerical inflation goal 

would need to be set forth within a context that clearly 

underscored the Committee's commitment to fostering 

both parts of its dual mandate. Most of participants 

agreed that it could be beneficial to formulate and publish a stat.ement that would elucidate the Committee's 

policy approach, and participants generally expressed 

interest in providing additional information to the public about the likely future path of the target federal 

funds rate. The Chairman asked the subcommittee on 

communications, headed by Governor Yellen, to give 

consideration to a possible statement of the Commit~ 

tee's longer-run goals and policy strategy, and he also 

encouraged the subcommittee to explore potential 

approaches for incorporating information about participants' assessments of appropriate monetary policy 

into the SEp'22 

22. The suiXDmmittee on communications is chuired hy Governor 

Yellen and includes Governor Raskin, and Presidents Eyans and 

Plosscr. 
112 


75075.059

44 Ivlonetary Policy· Report 10 the Congress [] Fehruary 2012 

At the Decemher 13 FOMC meeting. participants 

further considered in which Lhe Committee might 

enhance the clarity .and transparency of its public communications. The subcommittee on communications 

recomrn.:nded an approach for incorporaling information about participants' projections of appropriate 

future monetary policy into the SEP, which the FOMC 

rdeas.:s four times each year. In the SEP, participants' 

f~,r economic gn:n.\ih; unempJoyment, and 

are condWoncd on their individual assessments of the path of monclary policy that is most 

likely to he consistent with the Federat Reserve's statu·· 

tory mandate 10 promote maximum employmL:nt and 

price stahility, hut information abl.mt those assessments 

has not heen included in the SFP. Most par!icipants 

agreed that adding 1 heir projectk1ns of the target federal funds nIk to 1he economic projections already 

provided in the SEP would hdp the public hel kr 

understand the Committee's monetary policy decisions 

and the wa'y'S in which those dc:cisions depend on members' assessments of economic and financial conditions. At the conclusion of the discussion, participants 

decided to incorporate int()fmation ahout their projections of appropriate monetary policy into the SEP 

beginning in January. 

Following up on the Commitke's discussion of 

policy frame'vvorks at its Novemb~r meeting, the subcommittee on communications prcsentcd draft statement of the Committec's lonp.:r-run goals and policy 

strategy. Part icipanls generally agreed thal issuing such 

a stakrnt:nt c~)llld he helpful in enhancing the transparency and accounlahllity 0[' monetary policy and in 

facilitating wcll-inftlrmcd dccisionmaking by households and husincss(;s_ and lhus in enhancing the Committee's ability to promok the goals spccil1ed 

sLatut\)ry mandate in the face of signifkant cconomk 

disturbances. However, a couple of participants 

expressed the concern that a statement that \vas sufflcienny nuanced 10 cnptuf(: the diversity of views on the 

Committee rnight not. in fact., enhance public understanding of the Commi!tce's actions Hnd inl~n!ions. 

Pariicilxmts commented on the draft statement, and 

the Chairman encouraged the subcommittee to make 

adjustments to the draft and to present a revised version for the Commiltec's further consideration in 

January. 

At the January 24 25 meeting, the suhcommittce on 

communications presented a revised draft of a statement of prindplcs regarding the FOMC's longer-run 

goals and monetary policy strategy. Almost all participants "upportcd adop1ing and releasing the revised 

s1alCmcnl (sec the hox '·fOl\1C Statement Regarding 

L()figcr-Run Cioa]s and !vronetary Policy Stratcg::y"). It 

was noled that the prOfl(\sed statement did not represent a change in the CommiUec'5 policy approach. 

Tnsicad, thc statement "vas in1cnded 10 help enhance 

the transparency, accountability, and dkclivencss or 

monetary policy. 

In addition, in light of the decision made at the 

December meeting, the Committee provided in the 

January SEP inf<'lrmation about each participanfs 

assessments of appropriate monetary policy. Specifically, the SliP included inforrnation about participants' 

estimates of the appropriate level of the target federal 

funds rate in tht: fourth quarter of the current year and 

the next few calendar years, and over the longer run; 

the SEP also reporh~d participants' cnrrent projt~ctions 

u1' the likely j iming of the appropriate fIrst increase in 

the target rak givcn their projections of future economic conditions. The a('{;ompany-ing narrative 

described the key i~lctors underlying those assessments 

and provided St)mc qualitath'e inf()rmation regarding 

participants' expeclations t(1[ thl..': Federal Reserve's 

balance sheet. A number or participants :\uggested further possihlc enhancements 10 the SFP, the Chairman 

asked the subcommittee to explore such enhancements 

over coming months. 
113 


75075.060

FOMC Statement 

deliberations at its recpnt rneel~ 

ings, the Opf'n Market Committee (FaMe) 

has reached broad the following 

busint-~sses, 

and monintends to 

tainty, increases the effectiveness of monetalY 

policy, and f'nhances transparency and accountability, which arf' ess0.ntial in 

Inflatiot1, employment, and long-term 

rates fluctuate over time in 

and financial disturbances. 

'I he intlation rate overthe longer run I:; primarily 

det(~rmit1ed by monetaty policy, and hence the 

Committee has the ability 

goal for intlation. 

tion at the ratp of 2 

Board 0/ Governors (~r [he Federal Reserve ,))stem 45 

Goals and Monetary 

must informed maximum 

level of employmf'nt, !'f'cognizing that such asspssments are necessarily lHlcPttain and subject to revision. The Committee consid(-"rs a wide of 

indicators in ",alkln,,,hp," """",,,en" 

lion aboul 

trw longer-run normal 

unemploynwnt is puhlisfwd 

the rOMe's SummJlY of Economic 

example, in the most recent projections, FOMC 

palticipants' estimates of the longer-run normal 

ratf~ of unemployment had a central tendency of 

5.L percent to 6.0 pprcent, roughly unchanged 

from last January but substantially higher1han the 

corresponding interval several t~arlif'r. 

!n setting monetafY policy, Committee seeks 

to mitigate deviations of inflation from its 

run goal and 

COfl1mittcp's assessments of its maximum level. 

These objectives art.' generally comp!f'mcntaty 

under circumstances in which th(~ Comthat the objectives are not complementalY, approach in promoting them, taking into account the magnitude of the 

d(-'viations and the potentially different tinll:' horizons over which employnwnt and inflation an~ 

jected to r('lurn to levels judged 

mandatf'. 
114 


75075.061

Thefol1olving material appeared as an addendum to the 

minutes (~f the January 24-25,2012, meeting 0/ the 

Federal Open Market Committee. 

In conjunction with the January 24"25, 2012, Federal 

Open Market Committee (FOMC) meeting, the members of the Board of Governors and the presidents of 

the Federal Reserve Banks, all of whom participate in 

the deliberations of the FOMC, submitted projections 

for growth of real output, the unemployment rate, and 

int1ation lor the years 2012 to 2014 and over the longer 

run. The economic projections were hased on information available at the time of the meeting and participants' individual assumptions about factors likely to 

aired economic outcomes, including their assessments 

of appropriate monetary policy Starting with the 

January meeting, participants also submitted their 

assessments of the path for the target federal funds rate 

that they viewed as appropriate and compatible with 

their individual economic projections. Longer-run projections represent each participant's assessment of the 

rate to which each variable would be expected to converge over time under appropriate mondary pollcy 

and in the absence of further shocks" "Appropriate 

monetary policy" is defined as the future path of 

policy that participants deem most likely to loster outcomes for economic activity and intlation that best 

satisfy their individual interpretation of the Federal 

Reserve's objectives of maximum employment and 

stable prices" 

As depicted in figure I, FOMC participants projected continued economic expansion over the 2012-14 

period, with real gross domestic product (GDP) rising 

at a modest rate this year and then strengthening f urther through 2014. Participants generally anticipated 

only a small decline in the unemployment rate this 

yeae In 2013 and 21ll4, the pace of the expansion was 

projected to exceed participants' estimates of the 

longer-run sustainable rate of increase in real GDP hy 

enough to result in a gradual further decline in the 

unemployment rate. However, at the end of 2014, participants generally expected that the unemployment 

rate would still be well above their estimates of the 

longer-run normal unemployment rate that they currently view as consistent with the FOMC's statutory 

mandate for promoting maximum employment and 

price stability. Participants viewed the upward prcs47 

sures on inflation in 2011 from factors such as supply 

chain disruptions and rising commodity prices as having waned, and they anticipated that intlation would 

fall back in 2012" Over the projection period, most participants expected infiation, as measured hy the annual 

change in the price index for personal consumption 

expenditures (PCE), to be at or helow (he FOMC's 

objective of 2 percent that was expressed in the Committee's statement of longer-run goals and policy strategy. Core inflation was projected to run at about the 

same rate as overall inflation. 

As indicated in table 1, relative to their previous projections in November 2011, participants made small 

downward revisions to their expectations for the rate 

of increase in real GDP in 2012 and 2013, but they did 

not materially alter their projections for a noticeably 

stronger pace of expansion by 2014. With the unemployment rate having declined in recent months by 

more than participants had anticipated in the previous 

Summary of Economic Projections (SEP), they generally lowered their forecasts for the level of the unem~ 

ployment rate over the next two years. Participants' 

expectations for both the longer-run rate of increase in 

real GDP and the longer-run unemployment. rate were 

little changed from November They did not significantly alter their forecasts for the rate of inflation over 

the next (hree years" lIowever, in light of the 2 percent 

inflation that is the objective included in the statement 

of longer-run goals and policy strategy adopted at the 

January meeting, the range and central tendency of 

their projections of longer-run intlation were all equal 

to 2 percent. 

As shown in f1gure 2, most participants judged that 

highly accommodative mondary policy was likely to 

be warranted over coming years to promote a stronger 

economic expansion in the context of price stahility. In 

partieulat; with the unemployment rate projected (0 

remain elevated over the projection period and inflation expected to he suhdued, six participants anticipated that, under appropriate monetary policy, the first 

increase in the target federal funds rate would occur 

after 2014, and five expected policy firming to commence during 2014 (the upper panel). The remaining 

six participants judged that rai,ing the federal funds 

rate sooner would be required to forestall int1ationary 

pressures or avoid distortions in the financial system. 

As indicated in the lower panel, all of the individual 
115 


75075.062

48 Monetary Policy Report to the Congress fJ February 2012 

Figure L Central icnJ(:''llcies and ranges or economic projections, 2012-14 and over the longer run 

l illGl11ployment rat..:: 

2007 2008 2009 2010 2011 2012 2013 2014 

Cor,;; peE inflation 

LongGf 

run 

Percent 

-- 1 

L! 

Pacent 

Pert~nt 

Percent 
116 


75075.063

Board (~f Governors of the Federal Reserve S:vstem 49 

Table 1. Economic projc'Ctions of Federal Reserve Board members and Federal Reserve Bank presidents, January 2012 

Percent 

Variar.le 

Change In rea! GDP 

Novemher projection. 

peE inflati,m . 

assessments of the appropriate target federal funds rate 

over the next several years were below the longer-run 

level of the federal funds rate, and 11 participants 

placed the target federal funds rate at 1 percent or 

lower at the end of 2014. Most participants indicated 

that the)' expected that the normalization of the Federal Reserve'5 balance sheet should occur in a way consistent with the principles agreed on at the June 20 it 

meeting of the FOMC, with the timing of adjustments 

dependent on the expected date of the first policy 

tightening. A few participants judged that, given their 

current assessments of the economic outlook, appropriate policy would include additional asset purchases 

in 2012, and one assumed an early ending of the maturity extension program. 

A sizable majority of participants continued to 

judge the level of uncertainty associated with their projections for real activity and the unemployment rate as 

unusually high relative to historical norms. Many also 

attached a greater-than-normallevel of uncertainty to 

their forecasts for inflation, but, compared \vith the 

November SEP, two additional participants viewed 

unt--ertainty as broadly similar to longer-run norms. As 

in Novemher, many participants saw downside risks 

attending their forecasts of real GDP growth and 

upside risks to their forecasts of the unemployment 

rate; most participants viewed the risks 1.0 their inflation projections as broadly balanced. 

The Outlook for Economic Activity 

The central tendency of participants' forecasts for the 

change in real GDPin 2012 was 2.2 to 2.7 percent. 

This le)fecast for 2012, while slightly lower than the 

projection prepared in November, would represent a 

pickup in output growth from 2011 to a rate close to 

its longer-run trend. Participants stated that the economic information received since November showed 

continued gradual improvement in the pace of economic activity during the second half of 2011, as the 

influence of the temporary factors that damped activity in the 11rst half of the year subsided. Consumer 

spending increased at a moderate rate, exports 

expanded solidly, and business investment rose further. 

Recently, consumers and businesses appeared to 

become somewhat more optimistic ahout the outlook. 

Financial conditions for domestic nonfinancial businesses were generally favorable, and conditions in consumer credit markets showed signs of improvement. 

However, a number of factors suggested that the 

pace of the expansion would continue to be restrained. 

Although some indicators of activity in the housing 

sector improved slightly at the end of 2011, new homebuilding and sales remained at depressed levels, house 

prices were still falling, and mortgage credit remained 

tight. Households' real disposable income rose only 

modestly through late 2011. In addition, federal spend-
117 


75075.064

50 Monetary Policy Report to the Congress [l February 2012 

Figure 2. Overview of FOMe participants' assessments of appropriate monetary policy 

Appropriate Timing of Policy Firming Number of Participants 

,----------------------------------------------------------------,10 

2012 2013 2014 2015 2016 

Appropriate Pace of Policy Firming Percent 

,-------------------------------------------,--------------,6 

Target Federal Funds Rate at Year·End 

1-···-···········-··--·····--·-····-·-·····-···-··-·········--····· __ ·-·_··-······-········_·-·_-·····_ .. 1 .... ·····"·-~'~~~~~.-····-·~4 

2013 Longer run 

NO'!E: In the upper paneL the height of each bar denotes the number of FOMe participants who judge that, under appropriate monetary policy and in 

the absence of further shocks to the economy, the first increase in the target federal funds rate from its current range of 0 to !j4 percent will occur in 

the specified calendar year. In the lower panel, each shaded circle indicates the value (rounded to the nearest % percent) of an individual participant's 

judgment of the appropriate level of the target fedetal funds tate at the end of the specified calendar yeat or over the longer run. 
118 


75075.065

ing contracted toward year-end, and the restraining 

elIccts of Jlscal consolidation appeared likely to be 

greater this year than anticipated at the time of the 

November projections, Participants also read the inf{)fmation on economic activity abroad, particularly in 

Europe, as pointing to weaker demand for u.s, exports 

in coming quarters than had seemed likely when they 

prepared their forecasts in Novemher. 

Participants anticipated that the pace of the economic expansion would strengthen over the 2013~14 

period, reaching rates of increase in real GDP above 

their estimates of the longer-run rates of output 

growth. The central tendencies of participants' forecasts for the change in real GDP were 2.8 to 3.2 percent in 2013 and},} to 4.0 percent in 2014. Among the 

considerations supporting their forecasts, participants 

cited their expectation that the expansion would be 

supported by monetary policy accommodation, ongoing improvements in credit conditions, rising household and business cDnfidence, and strengthening 

household balance sheets. Many participants judged 

that u.s. Jlscal policy would still be a drag on economic activity in 2013, hut many anticipated that progress would be made in resolving the fIscal situation in 

Europe and that the foreign economic outlook would 

be more positive. Over time and in the absence of 

shocks, participants expected that the rate of increase 

of real GDP would converge to their estimates of its 

longer-run rate, with a central tendency of 2,3 to 

2.0 percent, little changed from their estimates in 

November. 

The unemployment rate improved more in late 2011 

than most participants had anticipated when they prepared their November projections, falling from 9.1 to 

8.7 percent between the thin1 and fourth quarters. As a 

result, most participants adjusted down their projections for the unemployment rate this year. Nonetheless, 

with real GDP expected to increase at a modest rate in 

2012, the unemployment rate was projected to decline 

only a little this year, with the central tendency of participants' forecasts at 8.2 to 8.5 percent at year~end. 

Thereafter, participants expected that the pickup in the 

pace of the expansion in 2013 and 2014 would be 

accompanied by a further gradual improvement in 

labor market conditions. The central tendency of participants' forecasts for the unemployment rate at the 

end of 2013 was 7.4 to 8.1 percent, and it was 6.7 to 

7.6 percent at the end of 2014. The central tendency of 

participants' estimates of the longer-run normal rate of 

unemployment that would prevail in the absence of 

further shocks was 5.2 to 6.0 percent. Most participants indicated that they anticipated that five or six 

years would be required to close the gap hetween the 

Board of Governors (~f the F'ederal Reserve S~vstem 51 

current unemployment rate and their estimates of the 

longer-run rate, although some noted that more time 

would likely he needed. 

Figures 3.A and 3.B provide details on the diversity 

of participants' views regarding the likely outcomes for 

real GDP growth and the unemployment rate over the 

next three years and over the longer run. The dispersion in these projections reflected diffcrem::cs in participants' assessments of many factors, including appropriate monetary policy and its effects on economic 

activity, the underlying momentum in economic activity, the cfTects of the European situation, the prospective path lor U.S. fiscal policy, the likely evolution of 

credit and financial market conditions, and the extent 

of structural dislocations in the lahor market. Compared with their November projections, the range of 

particip,U1ts~ forecasts for the change in real GDP in 

2012 narrowed somewhat and shifted slightly lower, as 

some participants reassessed the outlook for global 

economic growth and for u.s. fiscal policy. Many, however, made no material change to their forecasts for 

growth of real GDP this year. The dispersion of participants' forecasts for output growth in 2013 and 2014 

remained relatively wide. Having incorporated the data 

showing a lower rate of unemployment at the end of 

2011 than previously expected, the distribution of participants' projections for the end of 2012 shilled 

noticeably down relative to the November forecasts. 

The ranges {()I' the unemployment rate in 2013 and 

2014 showed less pronounced shifts toward lower rates 

and, as was the case with the ranges f()f output growth, 

remained wide. Participants made only modest adjust~ 

mcnts to their projections of the rates of output 

growth and unemployment over the longer run, and, 

on net, the dispersions of their projections lor hoth 

were little changed from those reported in November. 

The dispersion of estimates for the longer-run rate of 

output growth is narrow, with only one participant's 

estimate outside of a range of 2.2 to 2.7 percent. By 

comparison, participants' views about the level to 

which the unemployment rate would converge in the 

long run are more diverse, reflecting, among other 

things, different views on the outlook for labor supply 

and on the extent of structural impediments in the 

labor market. 

The Olltlook for Inflation 

Participants generally viewed the outlook for inflation 

as very similar to that in November. Most indicated 

that, as they expected, the dfeets of the run-up in 

prices of energy and other commodities and the supply 
119 


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52 Monetary Policy Report to the Congress [] February 2012 

Figure 3.A. Distribution of participants' projections for the change in real GDP, 2012-14 and over the longernm 

Percent range 

?\fmuberofpmtlcipants 

~18 

-16 

14 

-- 12 

10 

__________________ ~ _______________ Nu!llberofparucipant~ 

2013 

_ 2014 

Percent rang.; 

Percent range 

-18 

16 

-14 

12 

~!O 

- 8 

--18 

16 

14 

-]2 

- !O 

_________________________________ Nl_"_!herofpart\cipams 

Longer run 

Percent range 

NOTE: Definitions of variables are in the general note to table 1. 

18 

-16 

14 

~12 

--- 10 

8 
120 


75075.067

Board (~f (iovel'nnrs of the Federal Reserve S)stem 53 

Figure 3.B. Di~iribution of participants' projections for the unemployment rate, 2012-14 and over the longer nm 

_________________________________ Nnruberofparudpunts 

Pereentrange 

__________________________________ N1_unberofparticipunts 

2013 

_ 2014 

Percent range 

Percent range 

--18 

16 

--14 

12 

-to 

8 

Nllmberofparticipanh 

-18 

16 

t.I 

-12 

to 

_________________________________ Nlullberofprnticipants 

Longer run 

Perecntrange 

Definitions ofvarlables are in the general note to table 1. 

18 

-16 

14 

-12 

--- 10 

8 
121 


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54 Monetary Policy Report to the Congress [] February 2012 

disruptions that occurred in the first half of 2011 had 

largely waned, and that inflation had been subdued in 

recent months. Participants also noted that in11ation 

expectations had remained stahle over the past year 

despite the fluctuations in headline inflation. Assuming 

no further supply shocks, most participants anticipated 

that bot h headline and core inflation would remain 

subdued over the 2012~ 14 period at rates at or below 

the FOMCs longer-run objective of 2 percent. Specifically, the central tendency of participants' projections 

for the increase in inflation, as measured hy the peE 

price index, in 2012 was 1.4 to 1.8 percent, and it edged 

up to a central tendency of 1.6 to 2.0 percent in 2014; 

the central kndencies of the forecasts for core peE 

inflation were largely the same as those for the total 

measure. 

Figures 3.C and 3.1) provide inl()rmation about the 

diversity of parlicipants' views about the outlook for 

int1ation. Compared with their November projections, 

expectations fC)f int1ation in 2012 shifted down a bit, 

with some parlicipants noting that the slowing in inl1ation at. the end of 2011 had been greater t.han they 

anticipated. Nonetheless., the range of participants' 

forecasts for inflation in 2012 remained wide, and the 

dispersion was only slightly narrower in 20B. By 2014, 

the range of inflation forecasts narrowed more noticeably, as participants expected that, under appropriate 

monetary policy, inflation would begin to converge to 

the Committee's longer-run objective. In general, the 

dispersion of views on the outlook ft)r inflation over 

the projection period represented differences in judgments regarding the degree of slack in resource utilization and the extenl to which slack influences inflation 

and inflation expectations. In addition, parlicipants 

differed in their estimates of how the stance of monetary policy would influence inflation expectations. 

Appropriate MOlletary Policy 

Most participants judged that the current outlookfor a moderate pace of economic recovery with the 

unemployment rate declining only gradually and int1ation subdued-warranted exceptionally low levels of 

the federal funds rate at least until late 2014. In particular, five participants viewed appropriate policy 

fIrming as commencing during 2014, while six others 

judged that the l1rst increase in the federal funds rate 

would not be warranted until 2015 or 2016. As a result, 

those 11 participants anticipated that the appropriate 

federal funds rate at the end of 2014 would be I percent or lower. Those who saw the llrst increase occurring in 2015 reported that they anticipated that the 

federal funds rate would be 10 percent at the end of 

that year. For the two participants who put the first 

increase in 2016, the appropriate target federal funds 

rate at the end of that year was 1:.:1 and 1 % percent In 

contrast. six participants expected that an increase in 

the target l~deral funds rate would be appropriate 

within the next two years, and t hose participants 

anticipated that the target rate would need to be 

increased to around 1 ~h to 2% percent at the end of 

2014. 

Participants' assessments of the appropriate path for 

the federal funds rate reljected their judgments of the 

policy that would best support progress in achieving 

the Federal Reserve's mandale for promoting maximum employment and stable prices. Among the key 

factors informing participants' expectations about the 

appropriate setting for monetary policy were their 

assessments of the maximum level of employment, the 

Committee's longer-run inflation goal, the extent to 

which current conditions deviate rrom these mandakconsistent levels, and their projections of the likely 

time horizons required to return employment and 

inflation to such levels. Several participants commented that their assessments took into account the 

risks to the outlook for economic activity and inflation, and a few pointed specifically to the relevance of 

financial stability in their policy judgments. Participants also noted that because the appropriate stance of 

monctary policy depends importantly on the evolution 

of real activity and intlation over time, their assessments of t he appropriate future pat h of the federal 

funds rale could change if economic conditions were 

10 evolve in an unexpected manner. 

All participants reported levels f(x the appropriate 

target federal funds rate at the end of 2014 that were 

well below their estimates of lhe level expected to prevail in the longer run. The longer-run nominal1evels 

were in a range from 3% to 4:12 percent, rcl1ecting participants' judgments about the longer-run equilibrium 

level of the real federal funds rate and the Committee's 

inflation objective of 2 percent. 

Participants also provided qualitative information 

on their views regarding lhe appropriate path of the 

Federal Reserve's balance sheet. A few participants 

assessments of appropriate monetary policy incorporatcd additional purchases of longer-term securities in 

2012, and a number of participants indicated that they 

remained open to a consideration of additional asset 

purchases if the economic outlook det.eriorated. All 

but one of the participants continued 10 expect that 

the Committee would carry out the normalization of 

the balance sheet according to the principles approved 

at the June 2011 FOMC meeting. That is, prior to the 
122 


75075.069

Board of Governors oj the Federal Reserve ,'))stem 55 

Figure 3,C. Distribution of participants' projections fc)f peE inflation, 2012-14 and over the longer run 

Percent range 

_________________________________ Nl_nnbe,ofparticipant5 

2013 

Percent range 

__ 2014 

Percent range 

-18 

--·16 

- 14 

12 

-10 

-- 8 

-18 

16 

14 

--12 

10 

_________________________________ Nlnnherofparticip~nts 

Longer run 18 

Percent range 

Definitions ofvariablcs are in the general note to table 1. 
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56 Monetary Policy Report to the Congress rJ February 2012 

Figure 3.D. Distribution of participants' projections for core peE inflation, 2012-14 

Percent range 

2013 

Percent range 

2014 

Definitions ofvaliablcs are in the general note to table L 

first increase in the federal funds rate, the Committee 

would likely cease reinvesting some or all payments on 

the securities holdings in the System Open Market 

Account (SOMA), and it would likely begin sales of 

agency securities from the SOMA sometime after the 

first rate increase, aiming to eliminate the SOMA's 

holdings of agency securities over a period of three to 

five years. Indced~ most participants saw sales of 

agency securities starting no earlier than 2015. IIowever. those participants anticipating an earlier increase 

in the federal funds rate also called for carlier adjustments to the balance sheet, and one participant 

)iumkrofparticipants 

-18 

--16 

1-1 

-12 

10 

8 

r;Hlnkr()fpmti~'11Xlnt;; 

18 

-16 

I. -12 

10 

-- 6 

18 

-16 

-\4 

-12 

assumed an early end of the maturity extension 

program. 

]0 

Figure 3,E details the distrihution of participants' 

judgments regarding the appropriate level of the target 

federal funds rate at the end of each calendar year 

from 2012 to 2014 and over the longer run. Most participants anticipated that economic conditions would 

warrant maintaining the current low level of 1he federal funds rate over the next two years. However, views 

on the appropriate level of the federal funds rate at the 

end of 2014 were more widely dispersed, with twothirds of participants seeing the appropriate level of 
124 


75075.071

Board (~r Governors of the Federal Reserve $vstem 57 

Figure 3,E. Distribution of participants' projections tor the target federal flUlds rate, 2012-l4 and over the longer nUl 

January projections 

_ 2013 

2014 

Longcrnm 

Percent range 

Percent range 

Percent range 

3.38-

302 

NOTE: The target funds rate is measured as the kvel of the target r'lte at the end of the calendar year or in the longer run. 

-;\fUHlWfOflMlticipal1\S 

-18 

--- 16 

10 

8 

-18 

--16 

-14 

-12 

Numbcrofp3rticJpants 

-18 

16 

-14 

12 

-to 

8 

-6 

- 2 

18 

-16 

-- 14 

12 

10 

~- 8 
125 


75075.072

58 Monetary Policy Report to the Congress [] February 2012 

the federal funds rate as I percent or below and five 

seeing t.he appropriate rate as 2 percent or higher. 

Those participants who judged that a longer period of 

exceptionally low levels of the federal funds rate would 

be appropriate generally also ant.icipated that the pace 

of the economic expansion would he moderate and 

that the unemployment rate would decline only gradually, remaining well above its longer-run rate at the end 

of 2014. Almost all of these participants expected that 

inflation would be relatively stable at or below the 

FOMC's longer-run objective of 2 percent until the 

time of the tirsi increase in the federal funds rate. A 

number of them also mentioned their assessment that 

a longer period of low federal funds rates js appropriate when the federal funds rate is constrained by its 

eflective lower hound. In contrast, the six participants 

who judged that policy firming should begin in 2012 or 

2013 indicated that the Committee would need to act 

decisively to keep intiati()fl at mandatc-c()nsistent levels 

and to limit the risk of undermining Federal Reserve 

credihility and causing a risc in inflation expectations. 

Several were projecting a faster pickup in economic 

activity, and a few stressed the risk of distortions in the 

fInancial system from an extended period of exceptionally low interest rates. 

Uncertainty and Risks 

Figure 4 shows that most participants continued to 

share the view that their projections for real GDP 

growth and the unemployment rate were subject to a 

higher level of uncertainty than was the norm during 

the previous 20 years.:':3 Many also judged the level of 

uncertainty associated \vith their inflation forecasts to 

he higher than the longer-run norm, hut that assessment was somewhat less prevalent among participants 

than was the case for uncertainty ahout real activity. 

Participants identified a number of factors that contrihuted to the elevated level of uncertainty about the 

outlook. In particular, many participants continued to 

cite risks related to ongoing developments in Europe. 

More broadly, they again noted difliculties in forecasting the path of economic recovery from a deep recession that was the result of a severe financial crisis and 

thus dificred importantly from the experience with 

summary. the box "Forec'lst Cnc-ertainty" discusses the sources and 

Table 2. Average histoJic.:'tl projection error ranges 

recoveries over the past 60 years. In that regard, participants continued to be uncertain about the pace at 

which credit conditions would ease and about prospects for a recovery in the housing sector. In addition, 

participants generally saw the outlook for fiscal and 

regulatory policies as still highly uncertain. Regarding 

the unemployment rate, several expressed uncertainty 

about how labor demand and supply would evolve 

over the forecast period. Among the sources of uncertainty about the outlook for inflation were the difficulties in assessing the current and prospective margins of 

slack in resource markets and the effect of such slack 

on prices. 

A majority of participants continued to report that 

they saw the risks to their forecasts of real GDP 

growth as weighted to the downside and, accordingly, 

the risks to their projections for the unemployment 

rate as skewed to the upside. All but one of the remaining participants viewed the risks to both projections as 

broadly balanced, while one noted a risk that the 

unemployment rate might continue to decline more 

rapidly than expected. The most frequently cited 

downside risks to the projected pace of the economic 

expansion were the possihility of financial market and 

economic spillovers from the flscal and flnancial issues 

in the euro area and the chance that some of the factors that have restrained the recovery in recent years 

could persist and weigh on economic activity to a 

greater extent than assumed in participants' baseline 

f()fccasts. In particular, some partjcipan1s mentioned 

the downside risks to consumer spending from stillweak household balance sheets and only modest gains 

in real income, along with the possible effects of stillhigh levels of uncertainty regarding fiscal and regulalory policies that might damp businesses' Willingness 
126 


75075.073

Figure 4, Uncertainty and risks in economic projections 

~umber,-'fp3rtJ('lpanIS 

____ tlnccltainty about the unemployment rate -18 

--16 

"Uncertainty about PCE inflation --1R 

--111 

14 

Uncertainty about core PCE inflation -18 

-16 

14 

Board qf Governors (~r the Federa! Reserve ,)~vstem 59 

~\lmbcr<}fpmHdpal).t'l 

---------

-- 18 

---16 

-- 10 

~- 4 

Nilll\bcrl'fpmti~lpants 

---------- --

_ Risks to the unemployment rate 

Risks to IJC'E in.11ation 

Risk<; to core PCE inflation 

-18 

-10 

-18 

-16 

14 

-1::: 

-18 

-16 

14 

-. 12 
127 


75075.074

60 Monetary Policy Report to the Congress [J February 2012 

forecast 

The (~conornic projections provided by the members of the Board of Coy{'rnors and the pn"sirients 

of the Federal RE-'serve 8anks inform discussions of 

hOWt~ver. fhe economic and statistical 

relationsh ips used to help produce 

economic forE'casts are necessarily imperff~ct 

descriptions of the rea! world, and the futmc path 

of the economy can be affected myriad unfon"-

seen developments and events. 

stance of rnolldalY policy, 

not only what appears to be the 

nomic outcome as embodied in 

but also the range of altf'rnative 

likf>lihood of th(>ir occurring, potentia! 

costs to the economy should they occur. 

Table 2 summariz(>s the averagf-' historical accuracy of a range of fore-cast.">, indudingthosE' 

reported in past MOlletary Polky Repo/1s and those 

by the Federal Resetve Board's stafTin 

of nlP.f>tings of the FedNal Opf>n Market 

Comrnittec. The projcLlion error ranges shown in 

the table illustrate the considerab!f> uflcf>rtainty 

associated wit h pconotnic forecasts. For example, 

suppose a participant projects that real gross 

domestic product (CDP) and total 

will rise steadily at annua! rates of, "'>U'''''V''''V, :3 peru·nt and 2 If the 

ingthosc 

in the P8.st the risks around the 

broadly balanced, the 

would imply a probability of about 70 percent that 

actual GDP would expand within 

4.3 pen'{'nt in the current yeat~ 1.3 

to invest and hire. A number of participants noted the 

risk of another disruption in global oil markets that 

could not only boost inflation hut also reducc real 

income and spending. The participants who judged the 

risks to be hroadly halanced also recognized a number 

of these dmvnside risks to the outlook but saw them as 

counterbalanced by the possibility that the resilience of 

economic act ivity in late 20 II and the recent drop in 

the unemployment ratc might signal greater underlying 

momentum in economic activity. 

In contrast to their outlook for economic activity~ 

most participants judged the risks to their projections 

of inflation as broadly h11anced. Participants generally 

viewed the recent decline in int1ation as having been in 

line with their earlier forecasts, and they noted that 

inflation expectations remain stable. \Vhile many of 

the second year, and 1.2 to 4.8 in the third year. ThE' 

corresponding 70 percpnt confidf'nce intetvals for 

overall inflation would be 1.1 to 2.9 percent in the 

CUtT0ntyear and 1.0 to 3.0 percent in the second 

and third years. 

Because Cllrrent conditions may differ from 

thos(' that prevailed, on average, over history, participants provide judgnlf>nts as to whether tIl(> 

uflcprtainty attached to their proj0ctions of each 

variable is gr('ater than, smaller than, or broadly 

similar to typicallpvels of forecast unccttainty in 

the as shown ill table 2. prothese participants saw the persistence of substantial 

slack in resource utilization as likely to keep intlation 

subdued over the projection period, a few others notcd 

the risk that elevated resource slack might put more 

downward pressure on int1ation than expected. In contrast, some participants noted the upside risks to inflation from developments in glo bal oil and commodity 

markets, and several indicated that the current highly 

accommodative stance of monetary policy and the 

substantial liquidity currently in the financial system 

risked a pickup in inflation to a level above th~ Committee's objective. A few also pointed to the risk that 

uncertainty about the Committee's ability to effectively 

remove policy accommodation \vhen appropriate could 

lead to a risc in inflation expectations. 
128 


75075.075

ABS 

AFE 

ATG 

ARRA 

CDS 

C&I 

CMBS 

CP 

CRE 

DPI 

EBA 

FCB 

EMF 

E&S 

FDIC 

rOMe 

FRBNY 

GDP 

GSE 

LIBOR 

MEl' 

MBS 

NIPA 

OIS 

PCE 

rcpo 

SCOOS 

SEP 

SLOOS 

S&P 

SOMA 

WTI 

asset-backed securities 

advanced foreign economy 

American International Group, Inc. 

American Recovery and Reinvestment Act 

credit default swap 

commercial and industrial 

commercial mortgage-backed securities 

commercial paper 

commercial real estate 

disposable personal income 

European Banking Authority 

European Central Bank 

emerging market economy 

equipment and software 

Federal Deposit Insurance Corporation 

Federal Open Market Committee; also, the Committee 

Federal Reserve Bank of New York 

gross domestic product 

government-sponsored enterprise 

London interbank offered rate 

maturity extension program 

mortgage-backed securities 

national income and product accounts 

overnight index swap 

personal consumption expenditures 

repurchase agreement 

Senior Credit Officer Opinion Survey on Dealer Financing Terms 

Summary of Economic Projections 

Senior Loan Officer Opinion Survey on Bank Lending Practices 

Standard and Poor's 

System Open Market Account 

West Texas Intermediate 

61 
129 


75075.076

Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the 

Federal Reserve System, from Chairman Bachus: 

• Section 165 of the Dodd-Frank Act requires that the Federal Reserve establish 

prudential standards for the largest banking institutions that are more stringent than 

those that apply to smaller banks. In doing so, the Board may differentiate among 

companies on an individual basis or by category, taking into consideration their capital 

structure, riskiness, complexity, financial activities, size, and any other risk-related 

factors that the Board deems appropriate. Congress included this provision to give you 

the flexibility to differentiate between the largest and most complex bank holding 

companies, and those with more traditional activities that nevertheless exceed $50 

billion in assets. 

o Has the Board established a way to tailor its application of enhanced 

prudential standards based on the riskiness or complexity of a company's 

activities? Will the Board establish a tiered approach to enhanced 

standards, with increasingly stringent standards or capital surcharges being 

applied to the most complex institutions? 

On December 20,2011, the Board of Governors of the Federal Reserve System ("Board") 

invited public comment on a package of proposed rules to implement sections 165 and 166 of the 

Dodd-Frank Wall Street Reform and Consumer Protection Act of2010 ("Dodd-Frank Act") for 

nonbank financial companies that the Financial Stability Oversight Council has designated for 

supervision by the Board and bank holding companies with consolidated assets of$50 billion or 

more (collectively "covered companies"). See Enhanced Prudential Standards and Early 

Remediation Requirements for Covered Companies; Proposed Rule, 77 Fed. Reg. 593 (Jan. 5, 

2012). The package includes proposals for risk-based capital and leverage requirements, 

liquidity requirements, single-counterparty credit limits, stress testing, risk-management 

requirements, and an early remediation regime. The Board's proposal generally includes 

standards that are calibrated to take account of a covered company's capital structure, risk 

profile, complexity, activities, size, and any other appropriate risk-related factors. 

The public comment period on the proposed rules closed on April 30, 2012, and the Board 

received nearly 100 comment letters from individuals, trade and financial industry groups, 

community groups, and financial institutions. Many commenters provided views on how the 

Board could further tailor application of the proposed standards to covered companies based on 

their systemic footprint and risk characteristics. The Board is currently reviewing comments 

received on the proposal carefully, and will take the views expressed by commenters into 

consideration as it works to develop [mal rules to implement sections 165 and 166 of the DoddFrank Act. 

o Has the FSQC recommended that the Board use a tiered approach in 

applying enhanced standards? 

Section 115 of the Dodd-Frank Act provides that the Financial Stability Oversight Council 

("Council") may make recommendations to the Board concerning the establishment and 
130 


75075.077

- 2-

refinement of prudential standards and reporting and disclosure requirements applicable to 

covered companies. 12 U.S.C. 5325(a)(I). The Board consulted with the Council, including by 

providing periodic updates to members of the Council and their staff on the development of the 

proposal the Board issued in December 2011. The proposal reflects comments provided to the 

Board as a part of this consultation process. 
131 


75075.078

Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the 

Federal Reserve System, from Representative Fitzpatrick: 

1. Larry Summers has said "New regulations that burden investment should be avoided 

unless there is an urgent and compelling rationale." He also pointed out that "[mJost 

policy failures in the US ... take steps that would have been productive pre-crisis but are 

counterproductive now with the economy constrained by lack of confidence and demand." 

In particular, he mentioned financial regulation, pointing out that "even as the gap 

between the economy's production and its capacity increases," financial regulation makes 

our economic problems worse because right now, "financial regulation focuses on 

discouraging risk-taking." 

a) Given the Federal Reserve's unique perspective as both a financial regulator and the 

caretaker of the economy, can you give me your view of the Dodd-Frank Act and its 

implementation? 

The Federal Reserve Board and its staff are keenly aware of the need to be on guard against the 

human tendency, highlighted by Dr. Summers' admonition, to "refight the last battle" by 

gravitating toward measures that address circumstances which no longer exist rather than being 

more appropriately focused on current and future conditions. But acceptance of that proposition 

I view as wholly consistent with my continued support for the key provisions of Dodd-Frank, 

which I believe will, once implemented, give us a set of useful tools and authorities that were 

conspicuously lacking in the past. As a result of their absence, problems at individual financial 

firms that became evident during the 2007-2008 crisis ultimately had more profound and 

damaging consequences for the financial system as a whole as well as for the broader economy. 

To my mind, Dr. Summers' standard of "urgent and compelling rationale" is satisfied by the 

provisions of Dodd-Frank providing for the formation of the multi-agency Financial Stability 

Oversight Council ("FSOC") with the authority to designate systemically important nonbank 

financial firms; the Federal Deposit Insurance Corporation's (FDIC's) orderly liquidation 

authority; stricter prudential standards for large financial firms; and better transparency and 

regulation of over-the-counter derivatives. 

The Federal Reserve considers the costs and benefits of every rule that we write, including 

regulations implementing Dodd-Frank and regulations implementing international agreements on 

bank prudential requirements. We seek to balance carefully the need to promote financial 

stability--recognizing the very sizable and long-lasting negative macroeconomic effects of 

financial crises--while minimizing effects on economic growth and credit availability, which of 

course are the desirable consequences of risk-taking by private sector market participants. We 

strive to present our regulatory proposals as a package of integrated changes wherever possible 

to ensure that banking institutions and other private sector market participants have the 

opportunity to evaluate and express their views regarding the impact of these changes 

collectively, and encourage other regulatory agencies to take a similar approach. We recognize 

that a series of measures which, individually, might have only modest costs can nonetheless 

interact in a manner that has more serious implications for risk -taking and capital formation than 

does any component in isolation. I believe that our approaches to enhanced prudential standards 
132 


75075.079

- 2-

for systemically important financial institutions (SIFIs), development of Basel III capital 

adequacy regime, and other key regulatory reform provisions clearly reflects this sensitivity. 

In working with other agencies to implement these provisions, we are also highly focused on 

questions of competitive equity along two critical dimensions: First, we recognize the important 

role that smaller banks play in the financial system, and are attune to the risk that regulatory 

refoun could have unintended consequences that would weaken their competitive position in 

certain markets with respect to larger institutions. We are committed to mitigating possible 

differential impacts on small banks, including by providing adequate transition periods. Second, 

we are very aware that the financial system, in many important respects, has become a global 

one. U.S. institutions must compete, within the U.S. and overseas, against institutions 

headquartered in many other jurisdictions. We do not want to strengthen the oversight of and 

standards for U.S. markets and institutions in a manner that will merely shift activity elsewhere. 

That outcome would both undermine the long-term viability of the U.S. financial services 

industry and at the same time fail to protect the U.S. economy from the risks associated with 

financial crises. With this concern in mind, the Federal Reserve is pursuing the most important 

and wide-reaching regulatory reform initiatives, including all of those I cited above, in close 

coordination with central banks and supervisors in other jurisdictions, in many cases through 

multilateral groups including the Basel Committee on Banking Supervision, the Committee on 

the Global Financial System, and the Financial Stability Board. 

b) Did Congress go too far in discouraging risk-taking when we need it the most? 

I believe that Dodd-Frank can be implemented in a manner that allows a reasonable balancing of 

the need to preserve risk -taking by private sector market participants, and the consequent 

positive implications for capital formation and credit availability, with the need to impose 

reasonable limitations on aggregate risk in the financial system. The basic approaches that I 

described above are, in my mind, key to achieving that reasonable balancing, and I believe that 

these approaches are eminently workable. In the event that I become concerned that there is not 

sufficient flexibility in the statute, that the interaction between different provisions creates 

unintended adverse consequences, that the implementation of regulatory reform threatens in 

practice to materially harm the competitive positions of U.S. financial firms relative to their 

peers abroad, or small firms relative to their larger brethren, I will bring that conclusion to the 

attention of yourself and your colleagues. 

I would also note, however, that the 2007-2008 fmancial crisis, which had a devastating effect on 

the U.S. financial system and economy, was caused in material part by excessive and imprudent 

risk taking on the part of private firms. While I recognize the important role of risk-taking by 

private sector market participants in the economy and the imperative to not unduly discourage 

such behavior, it would be unacceptable in my view if steps--including robust implementation of 

the four key provisions of Dodd-Frank that I highlighted above--were not taken to materially 

diminish the likelihood of such shifting financial crisis occurring again in the future. 
133 


75075.080

- 3 -

2. Can you discuss the effect that our nation's low interest rates have had on the amonnt of 

savings that the average family has and the level of participation in this eountry? Are more 

Americans saving or less? Specifically what has been the effect on retirees who may be 

living off of savings? 

In the aggregate, the personal saving rate - that is, the proportion of disposable personal income 

that households saved each month - was 4.7 percent in 2011, as compared with 2.4 percent in 

2007. The increase in the saving rate over this period reflects a number of influences, including 

concerns about job loss in a weak economy and the need for many households to rebuild their 

balance sheets following the losses to their net worth from the declines in house prices and the 

stock market, that seem to have more than offset the negative influence of low interest rates on 

saving. That said, the Federal Reserve is quite aware that monetary policy decisions have 

implications for savers, including retirees who may be living off of their savings. In particular, 

we recognize that the accommodative monetary policy we have put in place to support the 

economic recovery means that savers may receive less income from their interest-bearing assets 

for a time. However, it is important to recognize that savers invest in a variety of assets--

including stocks, corporate bonds, and other securities--and that a weak economy adversely 

affects the returns on these assets. In this regard, a goal of monetary policy is to promote the 

return of the economy to its potential, so that it is sustaining increases in jobs, income, and 

opportunities for investment that wi111ead to higher returns across a wide range of assets for 

savers and investors. In addition, the Federal Reserve aims to keep inflation low and stable over 

time, which limits the risk to investors, that high inflation will undermine the value of their 

savings. 

3. In your testimony you described the inflation outlook as "subdued" at least in the nearterm. Looking out, as best you can, beyond 2 or 3 years, what are your projections for 

inflation? 

At the time of the January meeting, the members of the Board of Governors and the Reserve 

Bank presidents provided projections for inflation, as measured by the annual change in the price 

index for personal consumption expenditures, for the next several years and in the longer-run. 

The central tendency of these projections pointed to subdued inflation rates of between 1.4 and 

2.0 percent through the end of2014 (on a fourth quarter to fourth quarter basis) and a longer-run 

rate of 2.0 percent. Since January, energy prices have increased, contributing to a rise in 

consumer price inflation. However, longer-term inflation expectations have remained stable and 

the Committee anticipates that the increase in inflation is only temporary; the Committee expects 

that inflation will subsequently run at or below 2 percent, which is the rate that the Committee 

judges to be most consistent with its dual mandate (as stated in the Committee's statement on its 

Longer-Run Goals and Policy Strategy: 

http://www.(ederalreserve.gov/newsevents/press/monetary/20120125c.htm!. 
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Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the 

Federal Reserve System, from Representative Luetkemeyer: 

1. The Dodd-Frank Act sets $50 billion as an arbitrary cut-off for insured depositories that 

will be subject to more stringent prudential standards under section 165 of the Act. 

However, for purposes ofimplemeuting those more rigorous prudential standards, the 

language also grants the Board of Governors and the FSQC the discretion to differentiate 

among the so-called systemically important banks according to a range of risk-related 

factors. Size, complexity, financial activities and riskiness might be among those factors the 

Board of Governors conld choose to look at when drafting the implementing regulations. 

Congress recognized that institutions below the $50 billion threshold do not present the 

same risks to the overall economy. A one-size-fits-all approach would appear to be 

unnecessary and inappropriate given the broad discretion Congress granted to your 

organization, particularly in the area of additional capital requirements. Does the Board of 

Governors plan to tier treatmeut among those institutions subject section 165 and, if so, 

how? 

On December 20,2011, the Board of Govemors of the Federal Reserve System ("Board") 

invited public comment on a package of proposed rules to implement sections 165 and 166 of the 

Dodd-Frank Wall Street Reform and Consumer Protection Act of2010 ("Dodd-Frank Act") for 

nonbank financial companies that the Financial Stability Oversight Council has designated for 

supervision by the Board and bank holding companies with consolidated assets of $50 billion or 

more (collectively "covered companies"). See Enhanced Prudential Standards and Early 

Remediation Requirements for Covered Companies; Proposed Rule, 77 Fed. Reg. 593 (Jan. 5, 

2012). The package includes proposals for risk-based capital and leverage requirements, 

liquidity requirements, single-counterparty credit limits, stress testing, risk-management 

requirements, and an early remediation regime. The Board's proposal generally includes 

standards that are calibrated to take account of a covered company's capital structure, risk 

profile, complexity, activities, size, and any other appropriate risk-related factors. 

The public comment period on the proposed rules closed on April 30, 2012, and the Board 

received nearly 100 comment letters from individuals, trade and financial industry groups, 

community groups, and financial institutions. Many commenters provided views on how the 

Board could further tailor application of the proposed standards to covered companies based on 

their systemic footprint and risk characteristics. The Board is currently reviewing comments 

received on the proposal carefully, and will take the views expressed by commenters into 

consideration as it works to develop final rules to implement sections 165 and 166 ofthe DoddFrank Act. 

2. Regardless of how you score seigniorage, and which agency- the Treasury Department 

or the Federal Reserve- collects those profits, don't you agree that a dollar coin, which lasts 

over 30 years, will be cheaper for the US to maintain than a dollar bill, which last 2-3 

years? Why should the Federal Reserve be able to count the seigniorage of paper currency, 

while the Treasury only gets to count the seigniorage of coins? Shouldn't the Treasury 

Department be able to count the seigniorage for both paper currency and coin? 
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The most recent GAO study, completed in February 2012, states that the cost of producing 

sufficient coins to replace all one dollar notes is never fully recovered during the 3D-year 

analysis and that all savings are attributable to increased seigniorage income. One dollar coins 

last about six times longer than one dollar notes, and they cost approximately six times more to 

produce. One dollar notes have an estimated life of 56 months while one dollar coins have an 

estimated life of 30 years. One dollar notes cost approximately five cents to produce while one 

dollar coins cost about 30 cents to produce. Overall, since more than lone dollar coin is 

required to replace lone dollar note, the production costs of the one dollar coins needed to 

replace the one dollar notes would exceed the production costs of continuing to supply the 

economy with one dollar notes. In addition, the GAO's study did not address the broader 

societal costs to consumers, retailers and other businesses, and state and local governments of a 

transition to one dollar coins. Nor did the analysis address the counterfeiting risks associated 

with a large-scale replacement of the one dollar note with a one dollar coin. These additional 

costs and risks should be considered before making any policy recommendations to eliminate the 

one dollar note. 

We believe it is important to recognize that the seigniorage earnings from currency and coin are 

essentially a transfer from the holders of these forms of money to the government. Both the 

U.S. Mint and the Federal Reserve transfer their seigniorage earnings in excess of the operating 

costs of their organizations to the Treasury's general fund. 
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Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the 

Federal Reserve System, from Representative Schweikert: 

1. Mr. Bernanke, you have urged Congress to reduce spending and narrow our 

incomprehensible budget deficits. I can agree with you more. Yet, I have noticed the 

Federal Reserve has stepped up its criticism of an effort that will save the government 

billions of dollars without cutting one program or raising one tax-replacing the dollar bill 

with the dollar coin. As you may know, I have introduced legislation to phase out the 

dollar bill, which lasts only a couple of years, has to be disposed of in landfills, and is more 

expensive to maintain. Can you explain to this committee why, when every other 

industrialized nation has moved to a single denomination coin, and the polls have shown 

that the US public will support it then told of the money it saves, the Federal Reserve 

continues to be the primary opponent to this common sense move? 

The most recent GAO study, completed in February 2012, states that the cost of producing 

sufficient coins to replace all one dollar notes is never fully recovered during the 30-year 

analysis and that all savings are attributable to increased seigniorage income. The GAO's 

analysis did not address the broader societal costs to consumers, retailers and other businesses, 

and state and local goveruments of a transition to one dollar coins. The analysis also does not 

address the counterfeiting risks associated with replacing the one dollar note with a one dollar 

coin. These additional costs and risks should be considered before making any policy 

recommendations to eliminate the one dollar note. 

A number of other economies in recent decades have replaced one dollar notes with one dollar 

coins. In general, the low-denomination note that was replaced in those economies had a far 

shorter useful life (typically three to six months) than is the case with the one dollar note, which 

currently has a useful life of about 56 months. In the United States, one dollar coins last about 

six times longer than one dollar notes, but they also cost six times more to produce. Since more 

than one dollar coin is required to replace one dollar note, the production costs of one dollar 

coins would exceed the production costs of one dollar notes. Therefore, unlike in countries with 

shorter note lives, there is no readily apparent cost-based justification to replace the one dollar 

note with the one dollar coin in the United States. 

2. Currently, the Federal Reserve buys dollar bills from Treasury at cost (6 cents) and sells 

them at face ($1). The Fed buys approximately 3 billion $1 bills annually, meaning on the 

dollar bills alone, the Fed makes a profit of $2.82 billion. Yet, the Fed must buy coins from 

the Treasury and the US Mint at face, and sell them at face. Isn't that the REAL reason 

the Federal Reserve opposes the dollar coin program? You don't make any money off the 

coins, so regardless of the fact that the GAO has consistently encouraged the US 

Government to move to the dollar coin, it simple isn't in the Fed's best interest. 

We believe it is important to recognize that the seigniorage earnings from currency and coin are 

essentially a transfer from the holders of these forms of money to the goverument. Both the U.S. 

Mint and the Federal Reserve transfer their seigniorage earnings in excess of the operating costs 

of their organizations to the Treasury's general fund. The seigniorage earnings on one dollar 

notes, however, represent only a small fraction of the seigniorage earnings on Federal Reserve 
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notes. In particular, while one dollar notes represent 31.6 percent of the number of notes in 

circulation, they represent less than one percent of the value of currency in circulation and the 

associated seigniorage earnings on Federal Reserve notes.