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FEDERAL RESERVE’S FIRST MONETARY POLICY 

REPORT FOR 2012 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

ON 

OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSUANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978 

MARCH 1, 2012 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.fdsys.gov/ 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

KAY HAGAN, North Carolina 

RICHARD C. SHELBY, Alabama 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

ROGER F. WICKER, Mississippi 

DWIGHT FETTIG, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director 

CHARLES YI, Chief Counsel 

LAURA SWANSON, Policy Director 

GLEN SEARS, Senior Policy Advisor 

JANA STEENHOLDT, Legislative Assistant 

ANDREW J. OLMEM, Republican Chief Counsel 

MICHAEL PIWOWAR, Republican Chief Economist 

DAWN RATLIFF, Chief Clerk 

RYKER VERMILYE, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)

C O N T E N T S 

THURSDAY, MARCH 1, 2012 

Page 

Opening statement of Chairman Johnson ............................................................. 1 

Prepared statement .......................................................................................... 31 

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 2 

WITNESS 

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

System ................................................................................................................... 4 

Prepared statement .......................................................................................... 31 

Responses to written questions of: 

Chairman Johnson .................................................................................... 35 

Senator Menendez ..................................................................................... 38 

Senator Hagan ........................................................................................... 44 

Senator Crapo ............................................................................................ 46 

Senator Toomey ......................................................................................... 47 

Senator Wicker .......................................................................................... 50 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Monetary Policy Report to the Congress dated February 29, 2012 ..................... 52 

(III)

(1) 

FEDERAL RESERVE’S FIRST MONETARY 

POLICY REPORT FOR 2012 

THURSDAY, MARCH 1, 2012 

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Committee met at 10:04 a.m., in room SD–538, Dirksen Senate Office Building, Hon. Tim Johnson, Chairman of the Committee, presiding. 

OPENING STATEMENT OF CHAIRMAN TIM JOHNSON 

Chairman JOHNSON. I call this hearing to order. 

Today I welcome Chairman Bernanke back to this Committee to 

deliver the Federal Reserve’s semiannual Monetary Report to Congress. 

There are reasons to be optimistic about our Nation’s economic 

recovery. The U.S. economy has expanded for 10 straight quarters, 

and private sector employment has increased for 23 straight 

months. Private employers added 2.1 million jobs last year, the 

most since 2005. 

But there are also reasons to be concerned, such as the European 

debt crisis and the continuing drag of the housing market on the 

broader economy. This Committee has paid close attention to these 

two issues and held numerous hearings. While I remain hopeful 

that we are moving in the right direction, we must continue to 

monitor the situation in Europe closely. On housing, there is a variety of policy proposals—some that do not require an act of Congress—that should be considered to improve the housing market. I 

want to thank Governor Duke for her thoughtful testimony on 

Tuesday before this Committee on the Federal Reserve’s white 

paper on options to improve the housing market. 

An additional challenge, the sharp increase in oil prices, has the 

potential to impede the economic recovery. Americans continue to 

grapple with higher fuel costs when they fill up their cars or heat 

their homes. It is important that oil markets are closely monitored 

for signs of manipulation or supply disruption, and I look forward 

to hearing the Fed’s views on how rising oil prices may affect consumer spending and economic growth. 

I appreciate all the Fed has done to ensure continued economic 

recovery. Chairman Bernanke, I look forward to hearing more from 

you on the Fed’s recent actions and possible future actions to protect our economy. 

Congress also has an important role in making sure the economy 

continues to grow and more Americans continue to find the jobs 

2 

they need. This week, the full Senate continues to consider the 

transportation bill. This bill includes the bipartisan effort of this 

Committee to update our Nation’s public transit infrastructure and 

create jobs. I am also hopeful that the Senate can find consensus 

on capital formation initiatives, the topic of another hearing next 

week before this Committee, to promote job creation while protecting investors. 

With so many Americans in search of work, it is not too late for 

bipartisan action to create jobs and promote sustainable growth. I 

look forward to your views, Chairman Bernanke, on these and 

other steps Congress can take to improve our Nation’s economy. 

To preserve time for questions, opening statements will be limited to the Chair and Ranking Member. However, I would like to 

remind my colleagues that the record will be open for the next 7 

days for additional statements and other materials. 

I will now turn to Ranking Member Shelby. 

STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you, Mr. Chairman. Welcome again, Mr. 

Chairman. 

Since the Federal Reserve took unprecedented actions in response to the financial crisis, there has been a growing recognition 

that the Fed needs to become more transparent. There was a time 

when central bankers met behind closed doors and stubbornly refused to inform the public of their decisions. Those days are clearly 

over. 

The public now rightly demands that policy makers not only explain their decisions but also be accountable for their actions. This 

is especially true of the Federal Reserve, which, thanks to DoddFrank, now exercises even greater authority over the American 

economy and the lives of every American. 

To his credit, Chairman Bernanke has long recognized the need 

to modernize the Fed. In his first confirmation hearing before this 

Committee, he stated that he believed making the Fed more transparent would, and I will quote his words, ‘‘increase democratic accountability, promote constructive dialog between policy makers 

and informed outsiders, and reduce uncertainty in financial markets and help anchor the public’s expectations of long-run inflation.’’ 

During Chairman Bernanke’s last Humphrey-Hawkins appearance, I noted that he has taken some important steps to improve 

the transparency of the FOMC, including holding press conferences 

to discuss monetary policy. Since then, the FOMC has taken another step to improve transparency by adopting an explicit inflation 

goal of 2 percent. This is a significant event in the history of the 

Federal Reserve. 

As Chairman Bernanke himself has stated, an explicit inflation 

target could reduce the public’s uncertainty about monetary policy 

and more effectively anchor inflation expectations. Yet it remains 

uncertain if the Fed’s recently announced inflation goal will achieve 

these objectives. 

While the Fed was establishing its inflation goal, it was at the 

same time communicating contradictory signals about his commitment to that inflation target. The FOMC minutes reveal that 

3 

Chairman Bernanke indicated that he believed the inflation goal 

would not represent a change in the FOMC’s policy. In addition, 

the FOMC has stated that it believes economic conditions are ‘‘likely to warrant exceptionally low levels for the Federal funds rate at 

least through late 2014.’’ In other words, the Fed is signaling to 

market participants that it expects to continue its near zero interest rate policy for at least 3 more years. 

I believe that begs the question: Is the FOMC focused on targeting low interest rates or its new inflation goal? If the inflation 

goal conflicts with keeping interest rates near zero, which target 

will prevail? In other words, why should market participants have 

confidence that the Fed is actually committed to achieving its inflation goal? And if the Fed is not serious about achieving its inflation 

goal, how will the Fed’s credibility suffer when inflation rises above 

2 percent? 

Accordingly, today I hope that Chairman Bernanke can give the 

Committee more insight into how the FOMC’s inflation goal will 

work in practice. I would also like to hear whether he believes Congress should hold the FOMC accountable for meeting its inflation 

goal. And while the Chairman has taken steps to improve the 

transparency of the FOMC, the transparency of the Board of Governors appears to be getting worse. 

A recent Wall Street Journal article noted that the Board has 

held 47—yes, 47—separate votes on financial regulations since 

Dodd-Frank became law, yet they have held only two public meetings, Mr. Chairman. The article noted that there has been a steady 

reduction in the number of open meetings by the Board since the 

early 1980s when the Board had more than 30 open meetings. As 

a result, the Fed is making sweeping financial regulatory policy decisions behind closed doors. This is inconsistent with, Mr. Chairman, your professed goal of making the Fed more transparent. 

In another troubling new development, the Fed recently decided 

to enter into the debate on housing policy. On January 4th, the Fed 

issued a white paper entitled ‘‘The U.S. Housing Market: Current 

Conditions and Policy Considerations.’’ The stated goal of the paper 

was not to provide a blueprint but, rather, to outline issues and 

tradeoffs that policy makers might consider. However, subsequent 

actions by Fed officials suggest that the Fed has views about the 

policies Congress should enact. 

Just 2 days after the white paper was released, Fed Governor 

Elizabeth Duke gave a speech in which she advocated for specific 

housing policies and effectively asked the GSE conservator to ignore his statutory mandate to conserve and preserve assets of the 

GSEs. That same day, Mr. Chairman, New York Fed President 

William Dudley gave a speech in which he argued that it would, 

in his words, ‘‘make sense’’ for Fannie and Freddie to ‘‘routinely reduce principal on delinquent mortgages using taxpayer dollars.’’ 

These statements suggest to many that the Fed does, in fact, 

have a blueprint there for housing market policy. That blueprint 

appears to involve using the taxpayer-supported GSEs as a piggy 

bank. 

In weighing in on housing policy, certain Fed Governors have 

begun to take sides in what should be a congressional policy debate, I believe. The Fed’s independence for monetary policy has alVerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON
4 

ways been premised on its remaining nonpartisan and not advocating for specific legislative measures. The Fed has been and 

should, I believe, continue to be a useful resource for information 

and analysis on the housing market. I believe it should not become 

an active participant in the legislative debate over the future of 

housing finance. I hope that the Fed’s recent foray into housing 

policy will not become common practice. 

Mr. Chairman, I believe when you say that you believe the Fed 

is most effective when it is nonpartisan, transparent, and accountable, I believe that is right. I am interested in hearing from you 

today, Mr. Chairman, on how you intend to continue to improve the 

Fed’s performance on all three objectives. 

Thank you. 

Chairman JOHNSON. Thank you, Senator Shelby. Welcome, 

Chairman Bernanke. 

Dr. Ben Bernanke is currently serving his second term as Chairman of the Board of Governors of the Federal Reserve System. His 

first term began under President Bush in 2006. Dr. Bernanke was 

Chairman of the Council of Economic Advisers during the Bush administration from June 2005 to January 2006. Prior to that, Dr. 

Bernanke served as a member of the Board of Governors of the 

Federal Reserve System from 2002 to 2005. 

Chairman Bernanke, please begin your testimony. 

STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF 

GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

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

Shelby, and other Members of the Committee, I am pleased to 

present the Federal Reserve’s Semiannual Monetary Policy Report 

to the Congress. I will begin with a discussion of current economic 

conditions and the outlook and then turn to monetary policy. 

The recovery of the U.S. economy continues, but the pace of the 

expansion has been uneven and modest by historical standards. 

After minimal gains in the first half of last year, real GDP increased at a 21⁄4-percent annual rate in the second half. 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 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. Notwithstanding the better recent data, the job 

5 

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. 

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, affordability 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 

of last 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, 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 

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 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. 

6 

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 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 the 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 3-year collateralized loans to European financial institutions. 

Most recently, European policy makers 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 the 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 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. 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’ forecasts for inflation in 2012 ranged from 1.4 

to 1.8 percent, about unchanged from the projections made last 

June. 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. Longer-term 

7 

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 

risks 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 early 2012. These 

steps included changes to the forward rate guidance included in the 

Committee’s postmeeting 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 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 of 2013. 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 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 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 back into 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 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 just 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 of monetary policy. The statement does not imply a change 

in how the Committee conducts policy. 

8 

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 the economy is largely determined 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 inform 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 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. And, of course, I am pleased to take your questions. 

Chairman JOHNSON. Thank you for your testimony. 

We will now begin the questioning of our witness. Will the clerk 

please put 5 minutes on the clock for each Member for their questions? 

Dr. Bernanke, what are the reasons for the modest pace of the 

current expansion? Is the economy recovering as you would expect 

following a major financial crisis? Or has the Great Recession led 

to any permanent adjustments in either output or unemployment 

levels? 

Mr. BERNANKE. Mr. Chairman, normally when an economy suffers a severe recession, the recovery is comparatively stronger. So 

a sharp decline tends to have a stronger expansion subsequently. 

However, our economy has been hit by two unusual shocks. One is 

the housing boom and bust, and we know from history—and recent 

Fed research supports this—that housing busts tend to take some 

time to be offset, in particular since housing is an important part 

of the recovery process in most expansions. 

9 

Additionally, we have had a severe financial crisis which has left 

still many stresses in the banking system and on the financial system, and, again, research, notably by Ken Rogoff and Carmen 

Reinhart, has pointed out that historically recoveries following financial crises also tend to be somewhat slower than they otherwise 

would be. So having been hit by both of these factors and with 

housing problems still being important, as you noted, and as financial conditions, including some of the stresses coming from Europe, 

still being a drag to some extent on economic activity, we have had 

a slower recovery than we otherwise would have anticipated. 

Nevertheless, of course, we have now had growth since mid-2009 

and unemployment has come down, but, of course, the growth is 

not as strong and the improvement in the unemployment rate is 

not as quick as obviously we would like. 

Chairman JOHNSON. U.S. consumers are deleveraging to reduce 

high debt levels, credit is still tight for U.S. companies and households, and fiscal policy has begun to tighten. As we consider economic growth in the near and long term, should Congress enact 

drastic spending cuts and balance the budget this year? Or would 

a plan to curb deficits and address structural issues over a longer 

time horizon make more sense economically? Also, what sectors of 

our economy could provide sustainable growth over the long term? 

Mr. BERNANKE. Well, Mr. Chairman, first of all, as Senator Shelby correctly pointed out, the Federal Reserve does not make recommendations on specific fiscal policy decisions. But in the broad 

context, let me make two points. 

The first is that, as I have said on a number of occasions, including in front of this Committee, the United States is on an 

unsustainable fiscal path looking out over the next couple of decades. If we continue along that path, eventually we will face a fiscal and financial crisis that would be very bad for growth and for 

stability. So, therefore, whatever we do, it is very important that 

we be planning now for a long-term improvement in our situation 

in terms of long-term fiscal sustainability. 

At the same time, I think it is important that we keep in mind 

that the recovery is not yet complete. Unemployment remains high. 

The rate of growth is modest. And under current law, as you know, 

on January 1st of 2013, there will be a major shift in the fiscal position of the United States, including the expiration of a number 

of tax cuts and other tax provisions, together with the sequestration and other provisions that would together create a very sharp 

shift in the fiscal stance of the Federal Government. 

I think that we could achieve the very desirable long-run fiscal 

consolidation that we definitely need and we need to do soon, but 

we can do that in a way that does not provide such a major shock 

to the recovery in the near term. And so I am sure that Congress 

will be debating the details of this over the next year and trying 

to take into account both the need for protecting the recovery, at 

the same ensuring that we do achieve fiscal sustainability in the 

long term. 

On the second part of your question, Mr. Chairman, we are seeing that manufacturing and industrial production in general have 

been leading the recovery. Housing, which normally does lead the 

recovery, of course is lagging. But, generally, it is—and autoVerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON
10 

mobiles, of course, being one part of manufacturing. But, generally, 

it is hard to predict, of course, what sectors—will have the greatest 

growth in the longer term. 

You asked me earlier in the first question about potential 

growth. We do not see at this point that the very severe recession 

has permanently affected the growth potential of the U.S. economy, 

although, of course, we continue to monitor productivity gains and 

the like. But one concern we do have, of course, is the fact that 

more than 40 percent of the unemployed have been unemployed for 

6 months or more. Those folks are either leaving the labor force or 

having their skills eroded, and although we have not seen much 

sign of it yet, if that situation persists for much longer, then that 

will reduce the human capital that is part of our growth process 

going forward. 

Chairman JOHNSON. I have been working with my colleagues in 

the Senate to move forward a set of proposals to update securities 

laws and make it easier for startups and small businesses to raise 

capital while maintaining critical investor protections. Do you generally agree that these types of proposals will help create jobs and 

strengthen our economic recovery? 

Mr. BERNANKE. Well, Mr. Chairman, I do not know the specific 

proposals, but it is certainly true that startup companies, companies under 5 years old, create a very substantial part of the jobs 

that are added in our economy. And, of course, if there is anything 

that can be done to encourage startups and entrepreneurship, 

whether it is reducing burdensome regulation or providing other 

kinds of assistance—of course, Congress makes all the decisions 

about the specifics, but, again, promoting startups is, I think, an 

important direction for job creation. And, in particular, the fact 

that startups and business creation has been quite weak during the 

expansion is one of the reasons that job creation has lagged behind 

the usual recovery pattern. 

Chairman JOHNSON. Senator Shelby. 

Senator SHELBY. Thank you. 

Chairman Bernanke, at our last hearing right here in the Committee on the European debt crisis, I asked the Federal Reserve 

witness about the exposure of our largest banks to the European 

financial system. The Fed has yet to respond to my request for this 

information. Will you provide the Committee with this information 

regarding the individual exposures of our largest banks to Europe? 

Mr. BERNANKE. Of course, supervisory information has legal protections, but we would be happy to work with the Committee to 

provide you with the information—— 

Senator SHELBY. Well, we need to know what is going on as far 

as our exposure of our banks to Europe. 

Mr. BERNANKE. Yes. We want to make sure you understand the 

situation and have all the information you need to make good decisions. I just wanted to add that the SEC, working with other agencies, has provided now some guidance and templates to banks to 

provide public information on a quarterly basis about their exposures and their hedges. But, yes, we certainly can work with you 

to help you understand everything you need to know to make good 

decisions. 

11 

Senator SHELBY. Are you concerned with some exposure of our 

largest banks to Europe? 

Mr. BERNANKE. Well, we are concerned in the sense that we are 

paying a lot of attention to it. Our sense is, having done a lot of 

work on this, including asking banks to stress their European positions in their current capital stress tests that they are doing now, 

our sense is that the direct exposures of U.S. bank to sovereign 

debt in Europe, particularly that of the weaker countries, is quite 

limited and is well hedged, and that those hedges in turn are pretty good hedges, that is, the counterparties are diversified and financially strong. 

So if you look more broadly, of course, our banks are exposed to 

European companies and banks, inevitably their major trading 

partners and major financial partners. Again, they have been working hard to provide adequate hedges, but let me just say I think 

it is very important to note that if there is a major financial problem in Europe, there will be so many different channels that would 

affect the stability of our financial system that I would not want 

to take too much comfort from that. 

Senator SHELBY. Could you explain to the Committee, to this 

Member, too, the situation as far as credit default swaps and why 

they are not deemed to—certain Nations have defaulted—to trigger 

the action on that? What is going on here? Is this a Government 

intervention in the market? Or what is it? 

Mr. BERNANKE. No, sir. There is a private body, the ISDA, which 

makes determinations as to whether a credit event has occurred—— 

Senator SHELBY. When a default happens? 

Mr. BERNANKE. When default occurred, that is right. And in the 

case of Greece, which is the relevant issue, thus far there has been 

a so-called private sector involvement, purportedly voluntary agreement with the private sector bond holders. And there has also been 

an exchange of bonds by ECB and other Government agencies with 

Greece that essentially give some protection to the ECB for its 

Greek debt holdings. 

The news this morning, I believe, was that the ISDA had determined that those two events did not constitute a credit event for 

the purpose of a CDS activation. However—— 

Senator SHELBY. And why did it not create the dynamic there? 

Why did it not cause voluntary—— 

Mr. BERNANKE. Well, I guess their view is that so far the negotiations have been voluntary. Now, the possibility exists—the 

Greek Government has retroactively created so-called collective action clauses which it could use in the future to force other private 

sector investors to take losses even if they have not agreed to this 

voluntary deal. And in that case, the ISDA would look at it again. 

and perhaps in that case it would declare a default had occurred. 

But that has not occurred yet. 

Senator SHELBY. I want to go into one other thing. The DoddFrank Act created a new position of Vice Chairman for Supervision 

at the Fed, which is subject to Senate confirmation. It is almost 2 

years later. That was 2 years ago. The President has still not nominated anyone for this position. 

12 

Who is currently fulfilling those duties as Vice Chairman of Supervision would have at the Fed, if they are being done? 

Mr. BERNANKE. They are, of course, being done, and the duties 

are distributed across the Governors and the staff. But I would say 

that the point person, as you know, is Governor Tarullo, who is the 

head of the Bank Supervision Committee and has on many occasions testified before this 

Committee on regulatory matters. 

Senator SHELBY. Do you believe that that position should be 

filled, nominated and filled? 

Mr. BERNANKE. Well, Congress created that position, and, yes, I 

would like to see it filled, and I would also like to see the Board 

filled as well. 

Senator SHELBY. And my last question has to do with the balance sheet of the Fed, which is approximately, to my understanding, about $2.9 trillion. How are you going to shrink that? I 

know you are not going to shrink it now, but do you have a plan? 

I am sure you have talked about it. We have talked about it a little 

bit at times, but that is a huge balance sheet to start shrinking, 

and it probably is not the time to shrink it now. I do not have any 

information on that, but how are you going to do that? 

Mr. BERNANKE. Senator, we have provided on numerous occasions an exit plan. For example, in the minutes, I think sometime 

ago, we provided an agreement of the Committee about how we 

would proceed. In the very short term, we can both, of course, allow 

securities to run off, which we have not been—we have been reinvesting them at this point. And we can reduce the impact of those 

securities on the economy, both through various sterilization measures and by raising the interest rate we pay on reserves to keep 

those reserves locked up at the Fed. 

Over a longer period of time, of course, we are going to have to 

sell some of the securities and, of course, we will. Our goal is to 

get back to—eventually, at the appropriate time, our goal is to get 

back to a more normal size balance sheet consisting only of Treasury securities. 

Senator SHELBY. Thank you. 

Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Reed. 

Senator REED. Well, thank you very much, Mr. Chairman, and 

thank you, Chairman Bernanke. And let me just say I thought that 

the Federal Reserve’s white paper on housing was very thoughtful, 

very analytical, and nonprescriptive, which is appropriate. I think 

also, thinking back, such an analytical paper might have been extremely useful to us in 2005 or 2006 or 2007 to alert policy makers 

to develop it into a housing market that proved to be catastrophic. 

And the final point, I think, is that it is fully consistent with the 

enhanced responsibilities under the FSOC that the Federal Reserve 

must display. So on all those points, I think it was appropriate. 

One of the issues that was raised in the paper, which you might 

elaborate on, is that there are short-term programs that might in 

the long term produce more returns, enhanced value to the Government and taxpayers. But if they are not pursued, even if there is 

an up-front cost, ironically we could have even a further deterioraVerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON
13 

tion in the profit, the profitability, assets of these GSEs. Can you 

elaborate on that, Mr. Chairman? 

Mr. BERNANKE. Certainly, and I would like just quickly to mention to Senator Shelby, who asked about this, that the speeches 

given by Governors Duke and President Dudley are their own recognizance. They do not represent official Fed positions, and, of 

course, as you know, Fed members often give their views, their own 

individual views. 

Sorry, Senator Reed. One point that we make is that in a typical 

negotiation between a borrower and a lender, a modification or 

some other arrangement like a short sale or a deed in lieu, for example, or other activities like REO-to-rental are typically taken on 

a narrow economic basis, the benefits of the lender and the borrower, which makes sense in a free market economy. But in the 

current situation, I think it is important at least to recognize that 

the problems in the housing sector, including massive numbers of 

foreclosures, uncertainty about the number of houses coming on the 

market, whole neighborhoods with many empty houses, all of those 

things have implications not only for the borrower and the lender 

but also for the neighborhood, for the community, and, of course, 

for the national economy because the weaknesses in the housing 

market, again, as I mentioned earlier, are slowing the pace of the 

recovery, and from the Federal Reserve’s point of view are probably 

muting, to some extent, the impact of our low interest rate policy 

because low mortgage rates do not help if people cannot get mortgage credit. 

So some of the benefits of actions to improve conditions in the 

housing market go beyond just those of the lender and the borrower and accrue to the broader society as well. 

Senator REED. And one other point you might comment upon is 

that we have several challenges facing us economically, as you 

have illustrated. One is the housing market. The other is potential 

energy spikes. Relatively speaking, it seems to me that we have 

much more ability to influence effectively and correctly housing policy here than international energy prices, and as a result, it would 

be, I think, a good investment of our time and effort to do so. Is 

that a fair comment? 

Mr. BERNANKE. Well, I think if there was a goal of the white 

paper, it was simply to encourage Congress to look at these issues, 

which represent, I think, one of the directions whereby we could be 

doing something on a policy basis that might help the recovery be 

stronger. 

Senator REED. Let me turn to the issue of the Volcker Rule, 

which is pending. The European Governments are urging that their 

sovereign equities be sort of treated preferentially in the rule, even 

though, as I understand it—and you might correct me—that under 

the Basel rules there is a zero risk weighting to sovereign debt. Is 

that correct? 

Mr. BERNANKE. There is a zero risk weighting yes. 

Senator REED. So the Greek debt has no risk? 

Mr. BERNANKE. Well, the way that it has been handled by the 

European banking authorities at the moment is to force the banks 

to write down their sovereign debt, and that in turn affects the 

amount of capital that they can claim. 

14 

Senator REED. And in addition, too, the level of capital and resulting liquidity for European banks is rather substantial relative 

to ours in terms of the kind of liquidity ratios they can bear under 

Basel. Is that also accurate? 

Mr. BERNANKE. That it is lower? 

Senator REED. No, that they can have much higher liquidity than 

we can or a much higher ratio of debt to equity. 

Mr. BERNANKE. Oh, I see. At the moment there are several 

issues. In principle, we are all agreeing to the same set of rules, 

the Basel III rules. But there are at least two questions. One has 

to do with the fact that the ratio of risk-weighted assets to total 

assets is lower in Europe than the United States, and the question, 

therefore, is: Are European supervisors in some way allowing lower 

risk weights being put on comparable assets? The Basel Committee 

takes this very seriously and has a process underway to try to 

verify that the two continents are operating comparably. 

The other issue is that the Basel rules have not yet been implemented in Europe or, of course, in the United States either. There 

is a European Union directive in process which we are looking at 

carefully. It does not in our view completely—it is not completely 

consistent with the Basel III agreements, but it is not a final document. But we want to be sure that the capital rules in Europe do, 

in fact, adhere to the agreement that we all signed on to. 

Senator REED. Just a final, quick point, Mr. Chairman. In the 

context of the Volcker Rule, you are still looking very, very closely 

at these differentials between European treatment of their sovereign debt and ultimately the way the Volcker Rule will treat it. 

Mr. BERNANKE. Well, the issue that the Europeans and the Canadians and the Japanese and others have raised is that because 

there is an exemption for U.S. Treasurys but not for foreign 

sovereigns in the Volcker Rule, they believe they are being discriminated against and that the Volcker Rule might affect the liquidity and effectiveness of their sovereign debt markets. We take 

this very seriously. We are in close discussions with those counterparts, and, of course, we will be looking carefully to see if changes 

are needed, and we will do what is necessary. 

Senator REED. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Crapo. 

Senator CRAPO. Thank you, Mr. Chairman. And, Chairman 

Bernanke, I want to follow up on the Volcker Rule. I read with interest your comments yesterday, and, frankly, candid comments, 

that the regulators will not be ready to issue the rule by the deadline of July, which I think is becoming more and more self-evident. 

I assume the reason for that is that because you have 17,000 comments, you have the issues that were just raised by Senator Reed 

with regard to the reaction of other markets in the world to what 

we may do with that rule, and the need to conduct a cost/benefit 

analysis, which is likely not to happen by the time we hit the statutory deadline in July. Is that correct? 

Mr. BERNANKE. Yes, and in addition, it is a multiagency rule, 

and that requires coordination. But I do want to say that, of course, 

we will be working as quickly and as effectively as we can to get 

it done. 

15 

Senator CRAPO. Well, I appreciate that. The question I have is: 

As I read the statute, there is a deadline in July for the agencies 

to act, but if the agencies do not act, the rule, whatever it is, goes 

into effect. And the market participants are, understandably, I believe, concerned about what they should do on July 21st if the 

agencies have not been able to coordinate effectively and promulgate a rule. 

The question I have to you is: Wouldn’t it be helpful if Congress 

were to correct that aspect of the statute and make it clear that 

on July 21st we are not going to have a Volcker Rule go into effect 

that does not have the clarification and cost/benefit analysis and 

fine-tuning that the agencies are now trying to give it? 

Mr. BERNANKE. Well, Senator, we certainly do not expect people 

to obey a rule that does not exist. There is a 2-year conformance 

period built into the statute that allows 2 years from July of this 

year before they have to conform to the rule, and we will certainly 

make sure that firms have all the time they need to respond. And 

I think 2 years will probably be adequate in that respect. 

Senator CRAPO. Well, thank you. I would like to shift during the 

remainder of my questions to the topic of a question that the 

Chairman asked you about whether it is time for us to begin more 

aggressively controlling the spend-out rate in Congress’ spending 

habits or whether we need to continue to hold off because of the 

impact on the economy. And I believe, as I understood your response, you indicated that in January we are going to see tax cuts 

expire, and we are going to see the sequestration impact and a 

number of other things will happen. I believe your answer was that 

soon we need to take some action, and I want to pursue that with 

you a little more in this context. 

We have been having this debate in Congress now for a number 

of years, but I want to go back to the Bowles-Simpson Commission, 

which issued its report 2-plus years ago now. In that report it was 

recognized that there needed to be an easing into the aggressive 

control of spending in Washington, and immediately following that, 

we had the debate over the $800 billion stimulus bill where the argument was made, you know, it is not time to control Federal 

spending yet, we need another year or two before we start getting 

into the serious control of spending. And between then and now, 

we have basically put about another $5 trillion on the national 

debt, not to count the trillions of dollars that have been used to 

help sustain economic activity, whether we agree with them or not 

from the Fed’s actions. And we still see the argument being made 

that it is not time yet for us to become aggressively engaged in controlling the spending excesses in Washington, even though we have 

over 40 cents of every dollar borrowed today, and the budgets that 

are being proposed continue that trend for the next decade. 

I know you do not get heavily engaged in fiscal policy, but you 

have already tiptoed a little bit into those waters, and I would like 

to ask you: When will it be time? I believe it is past time. But when 

will it be time if it is not time now for us to start aggressively dealing with the fiscal structure of our country on the spending side of 

the equation? 

16 

Mr. BERNANKE. Just a word on the Fed. The Fed’s purchase of 

securities actually reduced the deficit because of the interest that 

comes back to the Treasury. 

The two things are not incompatible. You know, you can moderate the very near term impact at the same time that you make 

strong and decisive actions to put us on a path—I mean, you have 

not done—you have not taken any actions, you have not passed the 

laws that will bring us on a glidepath into sustainability over the 

next decade or so. And I would add that I think one concern there, 

as I mentioned yesterday, is that the 10-year budget window may 

artificially constrain some of the things that Congress should be 

thinking about because many of the issues that we face in terms 

of not only entitlements but other issues as well are multidecade 

issues. And I think you could take strong actions that would be 

taking place over time. I think about the early 1980s Social Security reform that phased in a whole bunch of things, including the 

later retirement age, which is still happening today 30 years later. 

So you could take those actions, lock them in, you could get the 

benefit of the confidence there, but it would not have necessarily 

quite as big an impact as the very big shock that would otherwise 

occur next January 1st. 

I am not saying that you cannot do it and take serious action. 

I just think you should balance those objectives. 

Senator CRAPO. Well, thank you. I take it that you are saying 

that we need to adopt a long-term plan to deal with this crisis. 

Mr. BERNANKE. Absolutely. 

Senator CRAPO. And I would just observe that at this point the 

budgets that are being proposed simply go the other direction. 

Other than some others, like the Bowles-Simpson Commission and 

others, we still have not got proposals on the table here in Congress to deal with that long-term plan, and I personally think it is 

time we get at it. 

Chairman JOHNSON. Senator Menendez. 

Senator MENENDEZ. Well, thank you, Mr. Chairman. Thank you, 

Chairman Bernanke, for your service. 

I read your statement, and, you know, obviously creating jobs is 

the single most important issue in our country for families, for our 

collective economy. When such a large part of our GDP is consumer 

demand, obviously, without income, there is not the opportunity to 

make that demand. 

How would you describe—how are the latest programs of quantitative easing and Operation Twist helping us get to a more robust 

growth and creating those opportunities? 

Mr. BERNANKE. Well, of course, it is very difficult to figure out 

exactly how to attribute the progress that we have made to monetary policy, to fiscal policy, to other sources of growth. But if you 

look at the record, for example, if you look back at the Quantitative 

Easing 2, so-called, in November 2010, the concerns at the time 

were that it would be highly inflationary, it would hurt the dollar, 

that it would not have much effect on growth, et cetera. But since 

November 2010, where we have had since then the QE2 and the 

so-called Operation Twist, we have had about 2.5 million jobs created. We have seen big gains in stock prices, improvements in credit markets. The dollar is about flat. Commodity prices ex oil are not 

17 

much changed. Inflation is doing well in the sense that we are 

looking at about a 2-percent inflation rate for this year. 

So I think that one other point is that in November 2010 we had 

some concerns about deflation, and I think we have sort of gotten 

rid of those and brought ourselves back to a more stable inflation 

environment as well. 

So I think that the record is positive, again, acknowledging you 

cannot necessarily disentangle all the different factors. But it is a 

constructive tool, but obviously monetary policy cannot do it all. We 

need to have good policies across the board, including housing, including fiscal policy and so on. But looking back, I think that those 

actions played a constructive role. 

Senator MENENDEZ. Well, let me go to that point you just made 

on other elements, housing as one of them. Mr. Dudley, who is the 

president of the Federal Reserve Bank of New York, in a recent 

speech in my home State of New Jersey talked about those borrowers who are underwater, and he said, in part, without a significant turnaround in home prices and employment, a substantial 

portion of those loans that are deeply underwater will ultimately 

default absent an earned principal reduction program. Do you 

agree with his analysis? 

Mr. BERNANKE. No, I want to be clear, the Federal Reserve does 

not have an official position on principal reduction, and I think it 

is a complicated issue. It depends on what your objectives are. In 

terms of avoiding delinquency, there is, I think, a reasonable debate in the literature about whether reducing principal or reducing 

payments is more important. So that is one issue. 

In terms of issues like mobility for example, ability to sell your 

home and move elsewhere, there are also alternatives to principal 

reduction, including things like deed in lieu and short sales. 

So I think it is a complicated issue. There are certainly circumstances where principal reduction would be constructive and 

would be cost-effective in terms of reducing default risk and improving the economy, but I do not think there is a blanket statement that you can make on that. 

Senator MENENDEZ. Well, let me ask you a broader question. 

Right now, Fannie Mae and Freddie Mac currently own or guarantee 60 percent of the mortgage market in the country. Do you 

think that their regulator at the FHFA has been aggressive enough 

in using their market power to stabilize the housing market? 

Mr. BERNANKE. Well, he has to make judgments about the effect 

of those policies on the balance sheet of the GSEs and whether or 

not they meet the conservatorship requirements, and he has made 

judgments about that. I guess what I would just suggest is that a 

variety of different tools can be tried, that you can make a mix of 

different things, and that you can be experimental. And the GSEs 

look to be doing that to some extent. We are seeing the experimental REO-to-rental program, for example. They have done HARP 

II. So they have been taking steps in that direction, and I think 

there is a big element here of trying to figure out what works best 

per dollar of cost. And FHFA and the GSEs, we may not all agree 

exactly on their particular actions, but I think they are trying some 

things, and we will see what benefits accrue from. 

18 

Senator MENENDEZ. Well, let me just make a final note that 

there are two ways of preserving, you know, the corpus of your interest. One is through foreclosure; the other one is through looking 

at the whole process of refinancing and, where appropriate, the private sector has taken about 20 percent of its portfolio in the banks 

and said it makes sense to do, you know, reductions in principal. 

So I just worry that our whole focus seems to be in those entities, 

preserving the corpus through foreclosure, which at the end of the 

day has a whole other destabilizing element in the marketplace. 

Mr. BERNANKE. Senator, I would just like to agree with you on 

that. Foreclosure is very costly not only for the borrower and the 

lender but for the community and for the country. And what I was 

discussing was not whether foreclosure is a good thing. I was talking about what are the best ways to address the foreclosure issue. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Corker. 

Senator CORKER. Thank you, Mr. Chairman. And thank you, Mr. 

Chairman, for being here. I know we alternate between the House 

and Senate going first. This is sort of a postgame interview, but we 

thank you for being here today. 

I want to home in a little bit on the Volcker Rule since there has 

been a lot of testimony about the economy and quantitative easing 

and all those things related to how that affects prices and savers 

and all of that over the last day and a half. 

Let me just ask you, with the Volcker Rule—and I think most 

of us are in a place where we are just trying to make it work now. 

We understand that it is passed. Why were Treasurys and mortgage-backed securities excluded from the Volcker Rule in the first 

place? It is quite odd that those would be the only two instruments 

that it did not apply to? 

Mr. BERNANKE. Well, of course, Congress made that decision, and 

I assume it had to do with a desire to maintain the depth and liquidity of the Treasury market. 

Senator CORKER. And so by that statement you just made, we 

have taken away the depth of liquidity in all other instruments, 

and thus we have had an outcry from foreign Governments and 

just middle American companies that realize they are not going to 

have the depth of liquidity. And I know you focus on economic 

issues. You are a renowned economist. Is that something that is 

good for our country to lose liquidity with those other instruments? 

Or would we be better off putting Treasurys and mortgage-backed 

securities on the same basis and maybe moving them into the 

Volcker arrangement? 

Mr. BERNANKE. Well, there is certainly a tradeoff. There is going 

to be at least some marginal effect from Volcker on markets. In 

principle, there is a market-making exemption, as you know, and 

we are going to try and do our best to clarify the distinction between proprietary trading and market making. 

Senator CORKER. And you think market making is a good thing 

for our country and by these regulated entities, by virtue of that 

statement. Is that correct? 

Mr. BERNANKE. I do, and it is exempted from the Volcker Rule, 

but, of course, we have got to draw that line in a way that does 

not inhibit good market making. 

19 

Senator CORKER. Yes. You know, I have talked with some of the 

folks who are advocates for the Volcker Rule, and we have tried to 

come up with a one-sentence solution to allow appropriate market 

making to take place by the regulated entities. And some of the 

people, at least the people we have talked to, actually want to see 

the Volcker Rule used as a way to get to Glass-Steagall through 

the back door. 

By virtue of what you have just said, I think you would believe 

that to be not a good thing for our country. Is that correct, or at 

least as it relates to market making? 

Mr. BERNANKE. Well, I have not been an advocate of GlassSteagall because I think if you look back at the crisis, the separation of commercial and investment banking was not particularly 

helpful. Investment banks obviously were a big source of the problem by themselves, separately. 

Senator CORKER. Right. 

Mr. BERNANKE. But, again, you know, as I was saying before, 

there are tradeoffs. The goal of the Volcker Rule is to reduce risk 

taking by institutions, and we are trying to do that in a way that 

will permit hedging and market making. 

Senator CORKER. Well, when you have a rule that, you know, 

people describe like in many ways pornography—in other words, 

you know it when you see it. It is hard, I know, to make a rule. 

And would it be helpful if Congress clarified the fact that market 

making is not intended to be overturned by virtue of the Volcker 

Rule, that market making is a very valid and appropriate process 

for these regulated entities to be involved in? And do you think 

that might help—you know, you have had all these comments, you 

have got all these regulators that are trying to come to a conclusion, each with—being pushed, by the way, by various constituencies in Congress and outside. Would it be helpful to you if we 

clarified that we as a Congress do believe that market making 

should not be negatively impacted by the Volcker Rule. 

Mr. BERNANKE. Well, Senator, of course, the Federal Reserve 

pushed for these exemptions, and I think the statute is clear that 

market making is exempt, and we want to do our best to make that 

operational. 

I understand your intent, I hear your intent, that market making 

and hedging should be excluded from proprietary trading—or distinguished from proprietary trading. 

Senator CORKER. So I think we are, generally speaking, on the 

same page as it relates to the Volcker Rule, and we do not want 

it to do damage to the depth of liquidity unnecessarily for lending 

activities in this country. Is that correct? 

Mr. BERNANKE. That is correct. 

Senator CORKER. And I think we are on the same page that it 

is probably a legitimate concern for other sovereign Governments, 

like Canada, like Japan, like other ones, to say, look, this is incredibly unfair for the largest economy in the world to place a tremendous bias on liquidity of Treasurys and mortgage-backed securities, 

unbelievably, but not our own sovereign debt. Would you agree that 

that is a little bit of a problem? 

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20 

ference, which is that the primary markets for, say, Japanese debt 

are in Japan and, of course, therefore are not broadly affected by 

the Volcker Rule, except to the extent that U.S. banks are doing 

it. 

Senator CORKER. Right. 

Mr. BERNANKE. But, yes, I agree that we want to make sure that 

we are not doing unnecessary damage to those markets. 

Senator CORKER. OK. Do you agree that the zero weighting that 

we place on sovereign debt, especially in this world and especially 

in light of the fact that we are our own worst enemy in this country 

and we still have not been able to, as Senator Crapo was alluding 

to, deal with our longer-term issues with the Basel rules that are 

in place? Should there be a zero risk weighting for Treasurys or 

any other kind of sovereign debt? We have seen some big risk out 

there. 

Mr. BERNANKE. Well, none of those securities is completely riskless. That is true. We have in the case of non-U.S.—we have approached this in various ways. In the case of non-U.S. sovereign 

debt, as I mentioned before, the Europeans have asked the banks 

to write down the value of that debt so in some sense it is subtracted from capital one for one. And in the United States, we have 

been making banks—we are not just relying on the capital ratio. 

We are making banks do stress tests and look at their European 

holdings and their hedges and so on to make sure that they are 

safe and sound. So we are not ignoring that by any means. 

In the case of U.S. Treasurys, our assumption is that the biggest 

source of risk is interest rate risk as opposed to default risk. Under 

a default, I think the whole Fiscal Commission would be in enormous trouble. 

Senator CORKER. Right. 

Mr. BERNANKE. But we do ask banks to stress test their interest 

rate risk, including their risk of holdings of Treasurys and municipalities and so on. 

Senator CORKER. Mr. Chairman, I thank you, and I know you 

have received some criticism over the housing white paper, and I 

know we had a brief conversation about it, and I know you shared 

that those were not your ideas necessarily. I do hope that in your 

core area, since the Fed has been pretty active in giving advice in 

outside their core areas, I would love to see a white paper on the 

effect of the financial regulation that we just passed on our country. I do not know if that would be forthcoming, but I would just 

suggest, especially since it is in your core area, it would be very 

useful to us as we try to work through these details. 

Thank you for your testimony, and thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Akaka. 

Senator AKAKA. Thank you, Mr. Chairman. 

Chairman Bernanke, this is a question which is a follow-up on 

your discussion with Chairman Johnson and Senator Crapo. In 

your testimony you note there has been some modestly encouraging 

data recently, including slightly better performance in the labor 

market, improved consumer sentiment, and some increases in manufacturing. But these signs of economic recovery are not necessarily 

reflected yet in the experiences of our workers and their families 

in the communities. 

21 

Putting aside a crash in the euro zone, what possible setbacks 

concern you the most with respect to risks and our economic recovery? For instance, could action to cut critical investments too quickly send the economy back into a slowdown? 

Mr. BERNANKE. Well, let me just say first that one of the points 

that I talked about in my remarks was that there still is a little 

bit of a contradiction between the improvement in the labor market 

and the speed of the overall recovery in terms of growth. In particular, I mentioned that income had been flat for consumers in 

2011. The revised data from yesterday actually says it was a little 

bit better than flat but still less than 1 percent, so you have still 

got consumption spending growing relatively weakly. You have got 

the fiscal issues that are hanging over our heads. So in order to 

make this a really sustainable, strong recovery, we need to have 

both declines in unemployment and strong growth in demand in 

production, and I think that is something we have to watch very 

carefully. 

In terms of the risks to that, I do have to mention Europe because I think that is important. Another is the oil prices. We have 

seen a number of movements up and down in energy prices. To 

some extent, a little bit of the movement in commodity prices is essentially inevitable because if the economy is growing and the 

world economy is growing, the demand for commodities goes up, 

and that is going to create some tendency toward higher commodity 

prices. But when you have shocks to commodity prices arising from 

geopolitical events and the like, those are unambiguously negative 

and are bad for both households and for the broader economy. 

Housing I think remains a very difficult area. We are hoping for 

price stabilization. We think once people have gotten a sense that 

the housing markets have stabilized, they will be much more willing to buy and that banks will be more willing to lend. But right 

now there is still uncertainty about where the housing market is 

going, which I think is troubling. And finally, I would mention fiscal policy, which both in the short term, in terms of the uncertainty 

about where fiscal policy is going to go over the next year, and in 

the long term, in terms of whether or not Congress and the administration will work together to have a sustainable fiscal path, I 

think both of those things are creating some uncertainty and concern that do pose some risks to the economy. 

So there are a number of different things, but overall, of course, 

there has been some good news, and, of course, that is welcome. 

Senator AKAKA. Thank you for that response. 

Chairman Bernanke, as you know, I am most concerned with the 

well-being of consumers. In the current economic climate, consumers are confronted with difficult financial decisions, and this is 

the case in Hawaii where many homeowners face possible foreclosure, and the average credit card debt of a resident is the second 

highest in the country. 

We know that by saving, individuals can help protect themselves 

during economic downturns and unforeseen life events. We also 

know that our slow economic recovery is partially due to low consumption or consumer spending. 

My question to you relates to the intersection of these two factors. How can we continue our efforts to promote economic recovery 

22 

and at the same time encourage responsible consumer behavior 

and financial decision making? 

Mr. BERNANKE. Well, that is a very good question. Part of the 

problem now is that the demand, the total demand in the economy 

is not adequate to fully utilize the resources of the economy, and 

that is why we talk about the need for greater consumer spending 

and greater investment and so on. 

Of course, we want consumers to be responsible as well, and they 

have, in fact, raised their savings rates and have reduced their leverage, and all that is positive. 

I think there are two answers to your question. One is that demand comes from places other than consumer spending. It can 

come from capital investment, for example; it can come from net 

exports. Those are some areas where unambiguously higher investment creates more capital and more potential growth in the future. 

Greater exports reduces our trade deficit, increases our foreign 

earnings, makes us more competitive internationally. So those are 

alternatives to consumer spending to provide growth. 

But then there is also the bit of a paradox that consumer spending collectively, if it generates more activity, more hiring, more 

wage income, actually can in the end lead to sounder consumer finances than the alternative because if the economy is growing 

strongly and jobs are being created, income is being created, then 

consumers will actually be better off. 

So confidence is really important. If people are confident about 

their job prospects and about their income prospects, it can be a 

self-fulfilling prophecy as they go out and they become more confident in their purchasing habits. 

Of course, this all relates, as you have often mentioned, to financial literacy and the ability to make good decisions. We obviously 

want people to make decisions that are appropriate for their own 

needs, for their stage in the life cycle, for their family responsibilities, for their retirement, and all those things. And that remains 

an important goal even, you know, as we worry about trying to get 

the economy back to full employment. 

Chairman JOHNSON. Senator DeMint. 

Senator AKAKA. Thank you very much, Mr. Chairman. 

Senator DEMINT. Thank you, Mr. Chairman. 

Mr. Chairman, thank you for being here. You have mentioned 

several times the need for us to have a plan for a sustainable fiscal 

policy. Would a plan that balanced our Federal budget within a 10- 

year window be what you consider a reasonable transition toward 

good fiscal policy? 

Mr. BERNANKE. I would go for—at a minimum I would aim for— 

in the next 10 to 15 years, I would aim for eliminating the so-called 

primary deficit, that is, everything except interest payments, because once you eliminate the primary deficit so that current spending and current revenues are equal, that means that the ratio of 

your debt to your GDP will stabilize. And then as you go beyond 

that, you start to bring the debt-to-GDP ratio down. 

You mentioned 10 years. The other thing I would say, as I mentioned earlier, is, of course, that many of the things that are going 

to be problems are kicking in after 10 years, and so I hope ConVerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON
23 

gress will take, at least for planning purposes, a longer-term horizon than that. 

Senator DEMINT. In my conversations with some of your Governors and some of the central bankers around the world, there 

seems to be a broad consensus that there is not the political will 

here, Europe, and many other places to actually get control of fiscal 

policy, and that much of our monetary policy here and around the 

world is really driven by trying to clean up the mess that policy 

makers make. And you may not want to comment on that, but 

quantitative easing, for instance, is dealing with the tremendous 

we have created as policy makers, and what we see in Europe happening today, again, dealing with debt but from a monetary policy 

rather than fiscal policy. 

My concern now—and I know you meet with central bankers all 

over the world regularly, and as I see what appears to be a coordinated increase in money supplies here, Europe, and other places, 

it may not be formal coordination, I do not know. But there appears to be an effort to keep relative values of currencies the same 

as we increase our monetary supply, others are doing it. And I 

would just love to have some insight beyond just the individual 

policies here as to what degree you feel like you can be honest with 

us as the ones who primarily create the problems. Is it at least 

within the—is it true that a lot of monetary policy is now driven 

by irresponsible fiscal policy from policy makers? And is there an 

effort for central banks around the world to work together to deal 

with that? 

Mr. BERNANKE. I would say no to both questions. Our monetary 

policy is aimed at our dual mandate, which is maximum employment and price stability. We are trying to set monetary policy at 

a setting that will help the economy recover in the context of price 

stability. I think it is interesting that other countries are following 

our basic approach. It is not because we have coordinated in any 

way. It is because they face similar situations—weak recoveries, 

low inflation, and the fact that interest rates are close to zero, and 

so some of these quantitative easing type policies are the main alternative once you have got interest rates close to zero. 

So, no, this is not an attempt to cover up or clean up fiscal policy. 

On the other hand, I think the concerns that people express both 

about the United States and other countries about the political will 

and the ability of the political system to deliver better fiscal results 

over the long term, I think that is an issue that a lot of people are 

concerned about. I have noted on previous occasions that the reason S&P downgraded U.S. Treasurys last August was not because 

of the size of the debt but because they took the view that our political system was not adequately progressing on making long-term 

sustainable fiscal plans. 

I hope we can prove them wrong. I think that this January 1st 

event where so many things, if left unchanged, will be happening 

that would be I think on net contractionary, I hope that will be sort 

of a trigger point to sort of force Congress to say, well, how are we 

going to solve this problem? And so, of course, I realize how difficult it is politically, but I encourage you to make every effort to 

help restore fiscal sustainability in the United States. 

24 

Senator DEMINT. Well, my concern is that I really do believe ob- viously we would not have $16 trillion in debt going on 25 or whatever the projections are if we had not been irresponsible as policy 

makers over many years. I am not blaming that on any President 

or party, but it is clearly a problem. 

But as has been pointed out by the Wall Street Journal today 

and in other articles in financial magazines, the loose monetary 

policy is compounding the potential problems in the future. And I 

think as Senator Shelby talked about, the need for transparency, 

the need to understand where we are headed with this is pretty 

important to us as policy makers, first for you to be brutally honest, and maybe even more than you have been today, that we are 

on an unsustainable path. It hurts me to hear you say in 10 or 20 

years we need to bring it under control when the analysis I have 

seen of worldwide available credit suggests that a 5-year window 

may be tough for us on our current pace as far as borrowing the 

money. 

But we seem to have a compounding and growing problem and 

not a sense of urgency that one would expect given where we are 

from a political side and now a monetary system around the world 

that seems to be potentially making that much worse. I will just 

let you comment, and then I will yield back. 

Mr. BERNANKE. Well, I would only say that I do not mean that 

no actions should be taken until 10 or 20 years. I mean that the 

plan needs to be a long-run plan because our problems are longrun problems, and that looking only at 2013 is not going to be helpful. We need to look at the whole horizon. 

Chairman JOHNSON. Senator Bennet. 

Senator BENNET. Thank you, Mr. Chairman. And thank you, Mr. 

Chairman, for being here today. 

I wanted to focus my questions on the economy with you since 

you actually know what you are talking about. But before I do that, 

I wanted to go back to an answer that you made earlier on interest 

rates. You had said that you thought the risk of default was not 

a serious one— obviously, it would be catastrophic if it happened— 

but that the risk that you are worrying about is interest rate risk 

for our financial institutions and economy. Could you talk a little 

bit more about that, what would cause that interest rate risk and 

what the effects would be of a more normalized interest rate than 

the one we have today? 

Mr. BERNANKE. Well—— 

Senator BENNET. Which is at a historic low, isn’t it? 

Mr. BERNANKE. Right. So both short-term and long-term interest 

rates are quite low. You know, our current expectation, as we have 

said in our statement, is that the short-run rate will stay low for 

a good bit more time. But eventually at some point, the economy 

will strengthen, inflation may begin to rise, and the Fed will have 

to begin to raise short-term interest rates. At the same time, 

stronger economic conditions here and globally will cause longerterm rates to begin to rise, and that is a good thing. That is a normal, healthy thing as the economy returns to normal. But, of 

course, depending on how your portfolio is structured, you could 

have the risk of losing money on holdings of bonds. And we just 

want to make sure that banks understand their risks and that they 

25 

are well protected and hedged against whatever course interest 

rates might take in the future. I mean, eventually they will begin 

to rise. We just do not know when. 

Senator BENNET. Senator Akaka made the point earlier that we 

have seen some economic growth, but it has not yet hit home in 

many ways. I have a chart that is not useful for this because it is 

so small, but I will carve it in the air for you. The top line is GDP 

growth, and what we see is that our GDP is actually higher than 

it was before we went into this recession, which surprises a lot of 

people when they hear that our economic output is higher today 

than it was when the recession started. It has gone up since the 

early 1990s. Productivity has risen mightily over that same period 

of time because—think of our response to competition from abroad 

and the use of technology and then the recession itself, which drove 

the productivity index straight up because firms were trying to figure out how to get through with fewer people. 

As you observed, median family income has actually fallen over 

the decade, and we are producing that economic output with 23 or 

24 million people that are either unemployed or underemployed in 

this economy. So we are in a sense stuck with a gap of economic 

output and productivity here and wages and jobs here. 

As a learned economist, can you help me think about the kinds 

of things that would begin to lift that median income curve in the 

right direction, that job curve in the right direction? And I would 

encourage you to think broadly about that so education and immigration and whatever it is you think will—— 

Mr. BERNANKE. Well, sure—— 

Senator BENNET. ——because that, unlike the political stuff we 

are all talking about in Washington that actually does not make 

any sense to people at home, that is the issue that they are confronting, is what I just described. 

Mr. BERNANKE. Of course. Well, let us not belittle the impact of 

getting back to full employment. That would obviously be very 

helpful, and that is what the Fed is trying to do with our monetary 

policy. 

But more generally, there are a couple of interesting things. One 

is that the profit share of GDP is unusually high, the share of income going to wage earners is lower than normal, and that is a bit 

of a puzzle. It may have to do with globalization, it may have to 

do with the fact that a lot of profits are earned overseas rather 

than domestically and so on. So that is one question. 

But I think more generally, there is a whole raft of issues associated with globalization, including trade competition, including the 

fact that low-skilled workers are now effectively competing with 

low-skilled workers around the world, advent of new technologies 

provides a lot of benefits to people with greater education and 

greater training and creates discrepancies between them and people with less training and education. 

So from that there are not a lot of good answers, but certainly 

the most basic thing is training and skills because those are highly 

rewarded in our society still, but the low-skilled workers are effectively competing with low-skilled workers globally, and it is very 

difficult for them to earn a high income. 

26 

Senator BENNET. I am out of time, Mr. Chairman. I realize that. 

I just would say that the worst the unemployment rate got for people in this recession with a college degree was 4.5 percent, and 

there is a lot, I think, that we can learn from that. 

I will submit my other questions for the record. Thank you for 

being here today. 

Mr. BERNANKE. Thank you. 

Chairman JOHNSON. Senator Vitter. 

Senator VITTER. Thank you, Mr. Chairman. And thank you, Mr. 

Chairman, for being here. 

I am concerned about some of the negatives, which could clearly 

grow over time, about the zero interest rate policy. What would you 

consider the list of present or potential negatives? And how do you 

go about sort of monitoring those to always determine whether this 

continues to make sense in your mind? 

Mr. BERNANKE. Well, a number of issues have been raised. One 

that is often raised is the return to savers—with low interest rates, 

that we not penalize savers. We are aware of that. We take that 

into account in our discussions. But as I mentioned yesterday, of 

total household wealth, something only less than 10 percent, according to the Survey of Consumer Finances, is in fixed income instruments like CDs or bonds and so on. Most household wealth is 

in other forms—equity, small business ownership, real estate, et 

cetera. And our efforts to strengthen the economy will increase the 

returns and value of those assets, and so on net our activities are 

raising household wealth overall even if they are reducing the interest rate you can receive on fixed income assets. And, of course, 

keeping inflation low also helps in that respect. 

The second issue that we hear a lot about is pension and insurance that low interest rates increase the contributions that those 

companies have to make. Again, we have had many conversations 

with those folks about these issues. I would say that it is a serious 

issue and one that we look at. There, again, are countervailing factors. If you look, for example, at compensation to workers, which 

includes pension contributions, it remains quite low, like 2 percent 

a year growing. So these pension contributions are significant but 

not massive. And on the other side of the balance sheet, of course, 

pension funds and insurance companies have to invest in the economy. And, once again, a stronger economy produces higher returns 

in equity markets, real estate markets, and the like. 

The third issue, which is very tricky, has to do with possibly creating financial bubbles of various kinds. People have different 

views about that. Our view is basically that the first line of defense 

against bubbles should be what is called macroprudential supervision. There should be supervisory approaches looking at what is 

happening in the system and making sure that financial institutions are as strong as possible through capital, for example, and we 

have greatly upgraded our ability to monitor the financial system 

since the crisis, and we are both trying to identify potential problems but also making sure the institutions are sufficiently strong 

that if there is a problem, they will be able to withstand it. 

If those things do not seem to be working, then we are prepared, 

I think, to take that into account in monetary policy. But those are 

some issues, and we are aware of them. 

27 

Senator VITTER. One thing that might have been first on my list 

is commodity prices, a weak dollar pushing investment toward 

commodities, pushing up commodity prices. And, of course, now the 

most obvious example of that is gasoline prices. 

Briefly, how would you analyze that? And when does that start 

becoming such a negative that you rethink this? 

Mr. BERNANKE. So I think there are two ways in which low interest rate policies realistically would affect commodity prices. First 

would be through weakening the dollar, but the dollar has been 

pretty stable. It really has not moved much since, for example, November 2010 when we introduced QE2. The second is by creating 

growth both here and perhaps to some extent internationally. 

Higher growth increases demand for commodities. That raises 

prices. That is kind of inevitable. If you want to have a growing 

economy, that is going to put more pressure on oil prices and so 

on. 

So those two things I think have not been a big problem. I think 

particularly if you look at commodities, the one commodity that has 

been particularly troublesome has been oil, and currently, I mean, 

it is quite obvious that there are a number of factors affecting the 

supply of oil, including concerns about Iran and supply issues in 

Africa and so on that are contributing to that increase. 

Senator VITTER. Most of the quantitative easing announcements 

have more or less coincided with increases in oil prices. Are you 

saying that is largely a coincidence or not? 

Mr. BERNANKE. No, it is not entirely a coincidence. First of all, 

if you look over longer periods, it is not quite as close a correlation 

as you might think. But I think part of the reason, again, that 

there is a coincidence is because to the extent that monetary policy 

is structured in a way to increase growth expectations, that feeds 

into commodity prices through the demand channel. So that is one 

link that I do agree exists. 

Senator VITTER. And if I can just wrap up, Mr. Chairman, at 

what point, particularly with regard to oil, at what point would 

that factor driving up prices be a sufficient negative in terms of 

economic growth that you would pause in terms of this 2014 zero 

interest rate policy? 

Mr. BERNANKE. Well, we will always keep looking at it, but our 

analysis suggests that the other benefits of low interest rates 

through a whole range of asset prices, through increased consumption and investment spending and so on, outweighs reasonable estimates of the effects of that on commodity prices in terms of growth. 

And, again, I think the reason we have seen these sharp movements has more to do with the international situation than with 

U.S. monetary policy. But, obviously, it is a negative and something we want to keep monitoring. 

Senator VITTER. Thank you, Mr. Chairman. 

Chairman JOHNSON. Chairman Bernanke, I would like to thank 

you for your testimony today. There is a vote going on which requires my attention, and I will turn over the gavel to Senator 

Schumer for a few last questions. 

Senator SCHUMER [presiding]. Well, I would like to recognize 

Senator Schumer to ask 5 minutes of questions. Thank you, Mr. 

Chairman. 

28 

The first question is about the highway bill, the surface transportation bill that is on the floor. It will, according to its sponsors, create or save 2 million jobs, has broad bipartisan support. APTA, the 

Public Transportation Association, estimates that every $1 billion 

of Federal investments in highways creates 36,000 jobs. 

What impact would passing long-term transportation reauthorization legislation have on the pace of economic growth? 

Mr. BERNANKE. I do not know enough about the details of that 

bill to give you any kind of estimate. I just would like to make one 

observation, which is the jobs part is important. That is part of 

helping the recovery. But I think when you think about long-term 

infrastructure investments, you also want to think about whether 

these are good investments in terms of the returns. 

President Eisenhower’s investment, as you know, in the interstate system produced tremendous dividends in terms of reduced 

transportation costs and integration of our economy. So I would 

urge you—and I know you are doing this—as you approve projects 

that you take very seriously that you want to do the ones that are 

going to be more productive. 

Senator SCHUMER. That goes to the quality of the project, but at 

this point in time, that kind of stimulus in a sense would serve the 

economy well and would be needed. 

Mr. BERNANKE. Well, there are different ways to provide stimulus—— 

Senator SCHUMER. Assume it would be spent decently well. 

Mr. BERNANKE. Well, Senator, you know, there are different 

ways to provide stimulus. Infrastructure, if it is well designed and 

has a good return, I think is often a good approach. But you understand that I do not want to—— 

Senator SCHUMER. Endorse a specific bill. 

Mr. BERNANKE. ——endorse a specific bill. 

Senator SCHUMER. No, I did not ask you that because you made 

the caveat it may not have good projects. But I am just making the 

point that at this time when you have said the economy is moving 

forward but at a slow pace, taking away infrastructure money 

might hurt the economy, adding infrastructure money would certainly help the economy. And, of course, you want to do it as well 

as possible so there are other long-term benefits. Is that a fair recapitulation? 

Mr. BERNANKE. Yes, although, again—— 

Senator SCHUMER. Say no more. 

Mr. BERNANKE. ——there are various alternatives. 

Senator SCHUMER. OK. Yes, but those alternatives are not—this 

is a yes-or-no situation for us now. Money market funds. We all remember the dark days of the fall of 2008, the panic that ensued 

when a large money market fund broke the buck and there was a 

run on the funds. The SEC instituted some reforms, as you know, 

in 2010 to address the problems that led to the run in 2008. 

However, Chairman Schapiro and FSOC, you remember, have 

made it clear they believe more should be done, so in their recent 

reports they have discussed a few options—this was in the newspaper—including a requirement that would lock up a portion of investors’ money and a proposal to require funds to abandon the stable $1-a-share net asset value. The proposals have the potential to 

29 

fundamentally change the nature of the product. Some would say 

it would drive it out of existence. We would not have money market 

funds. Obviously, they play an important role in short-term financing of many different types of businesses. 

What are the risks to the economy and financial system if we 

were to fundamentally alter the nature of the money market funds? 

What do you think of the two different proposals made to strengthen them? I am particularly interested—I have heard that if investors have to keep 3 percent or a certain percentage aside, you 

know, and cannot pull it out right away, it is not worth an investment to them anymore—it is not worth investing in a money market fund to them anymore. 

Mr. BERNANKE. Well, first, as you pointed out, the SEC has already done some constructive things in terms of, for example, improving liquidity requirements. I think, though, the Federal Reserve in general and I personally would have to agree that there 

are still some risks in the money market mutual funds. In particular, they still could be subject to runs, and one of the implications of Dodd-Frank is that some of the tools that we used in 2008 

to arrest the run on the funds are no longer available. As you 

know, the Treasury can no longer provide the ad hoc insurance it 

provided. The Fed’s ability to lend to money market mutual funds 

is greatly restricted because of the fact that we would have to take 

a hair cut on their assets, and that is not going to work with their 

economics. 

So we support the SEC’s attempts to look at alternatives, and 

you mentioned some different things, but I believe their idea is to 

put out a number of alternative strategies. One would be to go 

away from the fixed net asset value approach. I think that the industry will reject that pretty categorically, and so then the question 

is what else could be done. 

One approach would be essentially to create some more capital. 

They have very limited capital at this point, and there might be 

ways maybe over time to build up the capital base. So that is one 

possible approach. And then either complementing that or as a separate approach would be something that involved not allowing the 

investors to draw out 100 percent immediately. 

Senator SCHUMER. Right. 

Mr. BERNANKE. If you think about that, what that really does is 

that it makes it unattractive to be the first person to be to withdraw your money and, therefore, it reduces the risk of runs considerably. It also has an investor protection benefit, which is that if 

you are ‘‘a slow investor’’ and you are not monitoring the situation 

moment by moment and so you are the last guy to take your money 

out, you are still protected because there is this 3 percent, or whatever—— 

Senator SCHUMER. But I have heard from some investors and 

from some funds that, given the low margin that money market 

funds pay, it would just end the business more or less. Or certainly 

I have heard from investors that they would not put money in if 

they knew they had to keep 2 or 3 percent in there. Does that 

worry you? 

Mr. BERNANKE. Well, it is certainly a difficult time because interest rates are very low and, therefore, their attractiveness is less. 

30 

I do not know. I think you would have to have some kind of discussion here because part of the reason that investors invest in money 

market mutual funds is because they think they are absolutely 100 

percent safe and there is no way to lose money. And that is not 

true. 

Senator SCHUMER. We learned that the hard way. 

Mr. BERNANKE. If that is not true, then we have to make sure 

that investors are aware and that we take whatever actions are 

necessary to protect their investment. 

Senator SCHUMER. Do you think money market funds play a useful role, though, in the economy and we should try to keep them 

going? 

Mr. BERNANKE. Well, generally speaking, they do, and they are 

a useful source of short-run money. And, again, please do not 

overread this, but Europe does not have any, and they have a financial system—there are different ways of structuring—— 

Senator SCHUMER. And they are in great shape. 

Mr. BERNANKE. They are in great shape, yes. There are many 

ways to structure your financial system, but, again, I envision that 

money market mutual funds will be part of the future of the U.S. 

financial system. 

Senator SCHUMER. Thank you, Mr. Chairman. I appreciate it. 

Senator REED [presiding]. There are no more questions. Thank 

you, Mr. Chairman. On behalf of the Chairman, unless I am instructed otherwise, I will adjourn the hearing. 

Mr. BERNANKE. Thank you. 

[Whereupon, at 11:45 a.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 

31 

1Data for the fourth quarter of 2011 from the national income and product accounts reflect 

the advance estimate released on January 27, 2012. 

PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON 

Today I welcome Chairman Bernanke back to this Committee to deliver the Federal Reserve’s Semiannual Monetary Report to Congress. 

There are reasons to be optimistic about our Nation’s economic recovery. The U.S. 

economy has expanded for 10 straight quarters, and private sector employment has 

increased for 23 straight months. Private employers added 2.1 million jobs last year, 

the most since 2005. 

But there are also reasons to be concerned, such as the European debt crisis and 

the continuing drag of the housing market on the broader economy. This Committee 

has paid close attention to these two issues and held numerous hearings. While I 

remain hopeful that we are moving in the right direction, we must continue to monitor the situation in Europe closely. On housing, there is a variety of policy proposals—some that do not require an act of Congress—that should be considered to 

improve the housing market. I want to thank Governor Duke for her thoughtful testimony on Tuesday before this Committee on the Federal Reserve’s white paper on 

options to improve the housing market. 

An additional challenge, the sharp increase in oil prices, has the potential to impede the economic recovery. Americans continue to grapple with higher fuel costs 

when they fill up their cars or heat their homes. It is important that oil markets 

are closely monitored for signs of manipulation or supply disruption, and I look forward to hearing the Fed’s views on how rising oil prices may affect consumer spending and economic growth. 

I appreciate all the Fed has done to ensure continued economic recovery. Chairman Bernanke, I look forward to hearing more from you on the Fed’s recent actions 

and possible future actions to protect our economy. 

Congress also has an important role in making sure the economy continues to 

grow, and more Americans continue to find the jobs they need. This week, the full 

Senate continues to consider the Transportation bill. This bill includes the bipartisan effort of this Committee to update our Nation’s public transit infrastructure 

and create jobs. I am also hopeful that the Senate can find consensus on capital formation initiatives, the topic of another hearing next week before this Committee, 

to promote job creation while protecting investors. 

With so many Americans in search of work, it is not too late for bipartisan action 

to create jobs and promote sustainable growth. I look forward to your views, Chairman Bernanke, on these and other steps Congress can take to improve our Nation’s 

economy. 

PREPARED STATEMENT OF BEN S. BERNANKE 

CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

MARCH 1, 2012 

Chairman Johnson, Ranking Member Shelby, and other Members of the Committee, I am pleased to present the Federal Reserve’s semiannual Monetary Policy 

Report to the Congress. I will 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 21⁄4 percent annual rate 

in the second half. 1 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 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. 

32 

2 In January, 51⁄2 million persons among those counted as unemployed—about 43 percent of 

the total—had been out of work for more than 6 months, and 81⁄4 million persons were working 

part time for economic reasons. 3See, table 1, ‘‘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 From the January 24–25 FOMC Meeting’’, 

press release, January 25, www.federalreserve.gov/newsevents/press/monetary/20120125b.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/testimony/bernanke20110713a.htm. 

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, 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, affordability 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 of last 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, 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 of 2.2 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 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. 

33 

5 Bernanke, ‘‘Semiannual Monetary Policy Report to the Congress’’ (see, n. 4). 6 Inflation is measured using the price index for personal consumption expenditures. 

7See, table 1 available at Board of Governors, ‘‘Federal Reserve Board and Federal Open Market Committee Release Economic Projections’’ (see, n. 3). 

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 3-year collateralized loans to 

European financial institutions. Most recently, European policy makers 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 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. 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 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’ 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. Longer-term 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 of 2011 and 

early 2012. These steps included changes to the forward rate guidance included in 

the Committee’s postmeeting 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 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 of 2013. 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 

34 

8See, table 1 available at Board of Governors, ‘‘Federal Reserve Board and Federal Open Market Committee Release Economic Projections’’ (see, n. 3). 

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 (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 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 of longerrun 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 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 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 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 longerrun level of employment. However, the Committee can estimate the level of maximum employment and use that estimate to inform 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. 8 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 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. 

35 

RESPONSES TO WRITTEN QUESTIONS OF 

CHAIRMAN JOHNSON FROM BEN S. BERNANKE 

Q.1. Before the House Financial Services Committee on February 

29th, in a response to Representative Velazquez, you said that 

‘‘There are some reasons why lending has fallen, which no doubt 

will improve over time. But I think it’s still the case that we’re a 

little bit too far on this side of the—the pendulum has swung a little bit too far.’’ To strengthen the economic recovery, I think it is 

important to find the right balance between safe and sound lending 

and making loans to credit worthy borrowers. What steps has the 

Fed taken to ensure the pendulum is swinging in the right direction? Is there anything else the Fed can do? 

A.1. A critically important step taken by the Federal Reserve to 

support the economic recovery and improve the pace of lending has 

been to ease the stance of monetary policy. The easing has taken 

three main forms: First, we aggressively reduced the interest rate 

that we traditionally have relied on as our main policy tool. Since 

late 2008, that rate—known as the Federal funds rate—has been 

essentially at its zero lower bound. Second, we have provided participants in financial markets much greater clarity about where we 

see the Federal funds going in the future. In the statement released after its September meeting, the Federal Open Market Committee stated that ‘‘exceptionally low levels for the Federal funds 

rate are likely to be warranted at least through mid-2015.’’ Third, 

we have purchased longer-term Treasury and agency securities, 

with the goal of bringing down longer-term interest rates and improving conditions in markets in which many households and businesses borrow, including mortgage markets. In our judgment, these 

steps have caused financial and economic conditions to be much 

better than they otherwise would have been. 

The Federal Reserve has also taken several actions using its supervisory authority to promote lending to creditworthy households 

and businesses: 

• In conjunction with other Federal banking regulators, we 

issued interagency policy statements to reinforce our position 

that, while maintaining appropriately prudent standards, lenders should do all they can to meet the legitimate needs of creditworthy borrowers (Interagency Statement on Meeting the 

Needs of Creditworthy Borrowers, November 12, 2008; Interagency Statement on Meeting the Credit Needs of Creditworthy Small Business Borrowers, February 5, 2010). We also 

issued guidance that encourages banks to work constructively 

with borrowers experiencing financial distress and provides 

specific examples of ways in which banks can prudently restructure commercial real estate transactions to the benefit of 

both banks and their borrowers (Supervision and Regulation 

Letter 09-4, ‘‘Prudent Commercial Real Estate Loan Workouts,’’ October 30, 2009). 

• To support these statements, we have held training sessions 

for lenders in order to promote awareness about both the credit 

environment and available lending guidance and resources 

(Addressing the Financing Needs of Small Businesses, July 12, 

2010). And we have continued to train bank examiners to use 

36 

a balanced approach to reviewing banks’ credit policies and 

practices with respect to lending. 

• Along with the other Federal banking agencies, the Federal 

Reserve assisted the Treasury Department in implementing its 

Small Business Lending Fund program (SBLF), which was established by the Small Business Jobs Act of 2010. The SBLF 

is intended to facilitate new lending to creditworthy small 

business borrowers by providing affordable capital support to 

community banks. 

• We have also looked into specific concerns raised about the examination process and its effect on banks’ willingness to lend. 

For example, during 2011, we reviewed commercial real estate 

loan classification practices to assess whether examiners were 

properly implementing the interagency policy statement on 

workouts of commercial real estate loans. We analyzed documentation for more than 300 loans with identified weaknesses 

in six Federal Reserve Districts. We found that Federal Reserve examiners were appropriately implementing the guidance and were consistently taking a balanced approach in determining loan classifications. Moreover, the documentation we 

reviewed indicated that examiners were carefully considering 

the full range of information provided by bankers, including 

relevant mitigating factors, in determining the regulatory 

treatment for the loans. More recently, we investigated reports 

from some banks that examiners were inappropriately criticizing performing commercial loans. We found no evidence that 

Federal Reserve examiners were deviating from well-established supervisory practices and rules for classifying commercial loans. 

• During 2012, we issued guidance to examiners stressing the 

importance of promptly upgrading a bank’s supervisory rating 

when warranted by a sustainable improvement in its condition 

and risk management (Supervision and Regulation Letter 12- 

4, ‘‘Upgrades of Supervisory Ratings for Banking Organizations 

with $10 Billion or Less in Total Assets,’’ March 1, 2012); Some 

analysis has indicated that, all else being equal, banks with 

lower supervisory ratings tend to lend less; prompt upgrades 

by supervisors when such upgrades are appropriate may thus 

ease an unnecessary constraint on lending. 

The Federal Reserve continues to evaluate options to improve 

credit conditions and is committed to taking additional steps as 

needed to facilitate a balanced lending climate that ensures access 

to loans for credit worthy borrowers. 

Q.2. I have heard some concerns about the liquidity coverage ratios 

promulgated under the Basel III Committee and specifically the exclusion of agency debt from Level 1 assets. Some suggest that this 

might encourage U.S. financial institutions to bulk-up on Treasuries and cash. Also, there are concerns that small financial institutions will have to hold and buy Treasuries at much higher levels 

than they currently do, further impacting their ability to lend. 

What do you think about these concerns? And would this exclusion 

put U.S. institutions at a disadvantage to their European counterparts? 

37 

A.2. The Board, in conjunction with the other U.S. Federal banking 

agencies, anticipates undertaking a domestic rulemaking in the 

United States based on the international liquidity standards established by the Basel Committee on Banking Supervision (BCBS) in 

2010 (Basel III liquidity framework). The Basel III liquidity framework, like BCBS capital standards, applies to ‘‘internationally active’’ institutions. In the U.S., these are banking organizations with 

$250 billion or more in consolidated assets or $10 billion or more 

in foreign exposure. The Board has not determined that it is appropriate to apply the Basel III liquidity framework to community 

banking organizations. 

The Board, along with the other U.S. Federal banking agencies, 

carefully considers the appropriate scope of application when implementing any Basel standard or other prudential standard in the 

United States, including the impact of such standard on institutions of various sizes and complexity. In addition, the particular 

characteristics of U.S. markets and the U.S. banking system and 

the impact of new prudential standards on relevant markets, including competitive factors, are important concerns the Board takes 

into account when developing a rulemaking. In this respect, the 

Board would carefully consider the appropriate categorization of assets when implementing the Basel III liquidity framework. 

Any proposal the Board puts forth to implement the Basel III liquidity standards would be subject to a notice and comment process. We will carefully consider your comments and any others we 

receive regarding these proposals. 

Q.3. As regulators implement the Wall Street Reform Act—which 

I believe is critical to returning our economy to sustainable 

growth—I’ve heard a wide range of concerns about the proposed 

Volcker Rule. Specifically, once the rule is finalized, which agency 

will take the lead to interpret, supervise, and ultimately enforce 

the final rule? 

A.3. Section 619(b)(2) of the Dodd-Frank Act itself divides authority for developing and adopting regulations to implement its prohibitions and restrictions between the Federal Reserve, the OCC, 

FDIC, SEC, and CFTC based on the type of entities for which each 

agency is explicitly charged or is the primary financial regulatory 

agency. The statute also requires these agencies, in developing and 

issuing implementing rules, to consult and coordinate with each 

other for the purposes of assuring that such rules are comparable 

and to provide for consistent application and implementation. 

Under the statutory framework, the CFTC is the primary Federal 

regulatory agency with respect to a swap dealer and the SEC is the 

primary financial regulatory agency with respect to a securitybased swap dealer; the Federal Reserve is explicitly charged with 

issuing regulations with respect to companies that control an insured depository institution, including bank holding companies. 

The OCC, Federal Reserve, and FDIC must jointly issue rules to 

implement section 619 with respect to insured depository institutions. 

To enhance uniformity in both rules that implement section 619 

and administration of the requirements of section 619, the Federal 

Reserve, OCC, FDIC, SEC, and CFTC have been regularly conVerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00041 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON
38 

sulting with each other in the development of rules and policies 

that implement section 619. The rule proposed by the agencies to 

implement section 619 contemplates that firms will develop and 

adopt a single, enterprise-wide compliance program and that the 

agencies would strive for uniform enforcement of section 619. 

RESPONSES TO WRITTEN QUESTIONS OF 

SENATOR MENENDEZ FROM BEN S. BERNANKE 

Q.1. There has been some speculation in the press about the Federal Reserve and OCC’s thoughts on whether borrowers should be 

required to waive their legal rights as a condition of compensation 

under the foreclosure review being conducted under the consent orders. 

Does the Federal Reserve agree that homeowners should not be 

required to waive their legal rights in order to receive relief under 

the consent order process? Does the OCC agree with you on this 

issue? 

A.1. The Board and OCC publicly stated their position on waivers 

in guidance issued by the agencies on June 21, 2012. In that guidance, the agencies stated that servicers may not ask borrowers to 

release any claims in order to receive remediation payments under 

the consent orders issued by the agencies. The guidance can be 

found on the Board’s Web site at http://www.federalreserve.gov/ 

newsevents/press/bcreg/bcreg20 120621b1.pdf, item 34. 

Q.2. During the past year or so, while the private sector has added 

about 2 million jobs, state and local governments continue to shed 

jobs. One estimate says that there have been 500,000 public sector 

job losses since the start of the recession. 

First, Chairman Bernanke, are you concerned about the level of 

public sector job losses, and can you comment on their effect on our 

economic recovery? Do you see a continued loss of public sector jobs 

to be a downside risk in our economic recovery? 

From the Federal fiscal policy perspective, is there anything Congress can be doing to mitigate against these public sector job 

losses? 

A.2. The recent recession and the relatively sluggish pace of the 

subsequent recovery have placed significant fiscal strains on state 

and local governments. State and local tax revenues declined in the 

wake of the recession, and revenue gains since then have been relatively moderate, reflecting the slow recovery. As a result, state 

and local government spending has been under intense pressure. In 

particular, State and local governments have reduced the number 

of their employees by about 500,000 since the beginning of the recession, which represents 21⁄2 percent of their workforce. (By comparison, private-sector employment remains around 4 million- or 

33⁄4 percent-below its level at the start of the recession, even 

though there have been private job gains since early 2010.) The decline in state and local employment has contributed importantly to 

the overall contraction in purchases of goods and services by these 

governments over the past 21⁄2 years, which has been a notable 

headwind for the economy as a whole. For example, the decline in 

inflation-adjusted state and local purchases subtracted 1⁄4 percentVerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00042 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON
39 

age point, on average, from the rate of real GDP growth over the 

past four quarters. As the pace of the economic recovery picks up 

and state and local finances continue to improve, net hiring by 

these governments is anticipated to eventually turn positive. 

The most helpful thing that the Congress could do to improve the 

fiscal conditions of State and local governments would be to help 

ensure that the economic recovery becomes stronger. As I have 

stated on many occasions, the primary task for Federal fiscal policymakers should be to put in place a credible medium-term budget 

plan that would put fiscal policy on a sustainable trajectory while 

also avoiding undue risk to the pace of the recovery in the near 

term. Doing so earlier rather than later would assist the current 

recovery by reducing uncertainty, holding down long-term interest 

rates, and maintaining the U.S. government’s credibility in financial markets. 

Q.3. Since your last testimony on the economy, oil prices have 

spiked, rising about 15 percent. 

I’m curious to probe what you think the causes are of this increase in oil prices. To what extent are the price increases due to 

tensions with Iran or instability in Europe? And to what extent are 

prices rising simply because people hope that the economy is recovering, and therefore oil demand might increase? Finally, to what 

extent do speculators continue to drive up the price of oil? 

Does the increase in oil prices at all change the Fed’s view that 

inflation will remain at or below your 2 percent goal over the medium term? 

A.3. Oil prices have been volatile since the beginning of the year 

with the spot price of Brent crude oil, a widely regarded benchmark for global oil prices, exhibiting a long swing up over the first 

3 months of the year only to fall back sharply moving into the early 

summer. In recent weeks, oil prices have turned up once again and 

have recently returned to a level close to that which prevailed late 

last year. Along with other developments, we think that both geopolitical risk and uncertainty regarding the prospects for global 

growth—owing, in part, to developments in Europe—likely played 

a significant role in shaping oil price dynamics over this period. 

The Brent spot price averaged just under $110 per barrel in December of last year, supported by the loss of a significant amount 

of production due to the civil war in Libya. Rising geopolitical tensions stemming from the announcement of a new round of sanctions on Iran pushed oil prices steadily higher over the first three 

months of this year, with the spot price of Brent rising to an average of just under $125 per barrel in March. However, beginning in 

late March the intensification of the European debt crisis as well 

as data pointing to a slowdown in growth in both China and the 

United States began to raise concerns regarding the strength of 

global growth. Moreover, geopolitical tensions eased owing to increased diplomacy with Iran, while near-record high production 

from Saudi Arabia helped to assuage concerns regarding the ability 

of producers to offset any Iranian production lost as a result of the 

sanctions. Spot Brent prices subsequently declined over the next 3 

months to touch just over $95 per barrel in June. Tensions with 

Iran have ratcheted up in recent weeks, and the geopolitical risk 

40 

premium appears to have pushed spot Brent prices back up to the 

$110 per barrel range that prevailed late last year. 

There is little compelling evidence to support the claim that speculators were a significant factor in driving up the oil price early 

this year. If speculation drove oil prices well above levels consistent 

with physical supply and demand, then we would have expected inventories to rise as high prices both encouraged additional production and, at the same time, discouraged consumption. In fact, available measures of crude oil inventories were low relative to historic 

norms earlier this year and remained at relatively low levels until 

only recently. This was particularly true in both Europe and Asia, 

where crude oil inventories only slowly recovered from the loss of 

Libyan oil production last summer. In contrast, crude oil inventories have been elevated in the United States, particularly in 

Cushing Oklahoma, the delivery point for the benchmark West 

Texas Intermediate (WTI) contract. However, rather than speculation the buildup of inventories at Cushing likely reflects a rapid increase in crude oil supply in the Midwest, particularly from North 

Dakota, and the lack of sufficient infrastructure to integrate the region with the GUlf Coast and global markets. A consequence of the 

increase in inventories in the Midwest has been the emergence of 

a large price discount for WTI relative to similar grades of crude 

oil. 

The recent run up in oil prices is likely to be largely temporary. 

This view is supported by the oil futures curves, which are currently downward sloping, suggesting that financial market participants expect oil prices to decline. To the degree that an increase 

in oil prices is temporary in nature, it has a muted impact on underlying core inflation. As such, despite the run up in oil prices, our 

view that inflation will remain at or below 2 percent over the medium term is not materially altered. That said, going forward we 

will continue to closely monitor developments in commodity markets and the Fed stands ready to act if broader inflationary pressures materialize. 

Q.4. Last September you called the unemployment situation a ‘‘national crisis,’’ noting in particular the plight of the long-term unemployed. You said ‘‘This has never happened in the post-war period 

in the United States. They [the long-term unemployed] are losing 

the skills they had, they are losing their connections, their attachment to the labor force.’’ 

In light of recent studies that show America falling behind in our 

commitment to providing workers the opportunities to train for 

skills needed in the 21st century economy, can you comment on 

your view of the magnitude of this challenge for the long-term unemployed? 

Do you believe that business focused training, that is partnerships between businesses and colleges where unemployed and underemployed are provided the opportunity to train in the skills 

needed by employers in the region, can be an effective way to meet 

this challenge both for our current recovery and America’s longterm competitiveness? 

A.4. Long-term unemployment presents a serious challenge. Unemployment creates enormous financial hardship for families, and 

41 

workers who lose their jobs and remain unemployed for some time 

often experience sharp declines in earnings that may last for many 

years, even after they find new work. There is evidence that unemployment takes a toll on people’s health as well. And unemployment strains public finances because of both lost tax revenue and 

the payment of unemployment benefits and other types of income 

support. The high rates of unemployment and long-term unemployment, and the prospect that these could remain elevated for some 

time, are important reasons why the Federal Reserve has pursued 

a highly accommodative monetary policy over the past several 

years. 

People unemployed for a long time have historically found jobs 

less easily than those experiencing shorter spells of unemployment, 

perhaps because their skills erode, they lose relationships within 

the workforce, or they acquire a stigma that deters firms from hiring them. I have frequently spoken about the importance of lifelong learning, including continuing education for adults, and welldesigned programs to assist the unemployed can play a valuable 

role in that regard. In particular, many in the business and academic communities believe that business-focused training, of the 

sort you describe, has been effective in many cases where it has 

been tried. Such approaches may be a fruitful avenue to explore, 

in concert with general improvements in our educational system 

and broader actions to address our current macroeconomic situation. 

Q.5. Safeguarding the U.S. financial systems from proliferation financing, terror financing, money laundering and other criminal 

acts is crucial to the long term health of the U.S. economy and the 

security of our Nation. I believe the Federal Reserve has a central 

role in ensuring all U.S. based financial institutions maintain robust risk management and compliance programs to address these 

threats. 

Can you describe the efforts of the Federal Reserve to ensure the 

U.S. financial system is not abused to aid the financing of terrorism and weapons proliferation, and money laundering, particularly when it comes to Iran? 

A.5. The Federal Reserve, in coordination with the Department of 

the Treasury and the other U.S. Federal financial regulatory agencies, seeks to ensure that financial institutions maintain appropriate risk management and compliance programs related to money 

laundering, financing of terrorism, and sanctions administered by 

the Office of Foreign Assets Control (OFAC), including the extensive sanctions against Iran. 

While the Department of the Treasury maintains primary responsibility for issuing and enforcing regulations to implement the 

Bank Secrecy Act (BSA), the comprehensive Federal antimoney 

laundering (AML) and counter-terrorism financing (CFT) statute, it 

has delegated to the Federal banking agencies responsibility for 

monitoring banks’ compliance with the BSA. During bank examinations, Federal Reserve examiners review and assess an institution’s 

compliance with relevant BSA and OFAC sanctions requirements, 

following a risk-based approach. 

42 

The Federal Reserve has coordinated extensively with OFAC on 

its efforts under the Comprehensive Iran Sanctions, Accountability, 

and Divestment Act of 2010 (CISADA). This law builds upon the 

U.S. Government’s role in protecting its domestic financial system 

from exposure to Iran’s illicit and deceptive financial practices by 

strengthening existing U.S. sanctions. The Federal Reserve regularly shares examination findings and enforcement proceedings 

with OFAC under the 2006 interagency memorandum of understanding. 

The Federal Reserve actively participates in a number of coordination initiatives related to money laundering, terrorism financing, 

and sanctions. These include the Treasury-led BSA Advisory 

Group, which includes representatives of regulatory agencies, law 

enforcement, and the financial services industry and the FFIEC 

BSA/ AML working group, a monthly forum for the discussion of 

pending BSA policy and regulatory matters. In addition to the Federal banking agencies, the BSA/AML working group includes 

FinCEN and, on a quarterly basis, the Securities and Exchange 

Commission, the Commodity Futures Trading Commission, the Internal Revenue Service, and OFAC in order to share and discuss 

information on policy issues and general trends more broadly. 

In the international context, the Federal Reserve is a member of 

the U.S. delegation to the intergovernmental Financial Action Task 

Force (FATF) and its working groups, contributing a banking supervisory perspective to the formulation of international standards 

on these matters. Recently, the Federal Reserve provided input and 

review of ongoing work to revise the FATF Recommendations in 

order to ensure that they continue to provide a comprehensive and 

current framework for combating money laundering and terrorist 

financing. The Federal Reserve also participates in ongoing work of 

the Basel Committee that focuses on AML/counterterrorism financing issues. 

Q.6. A few months ago, I met with many of the OMWI directors 

at the Federal Reserve about the steps you are taking on diversity, 

particularly in the procurement area. I was not particularly happy 

with the meeting, as I did not feel that sufficient progress was 

being made when it comes to contracting with Hispanic-owned 

businesses. One of the responses we heard echoed by the Directors 

was that Hispanic diversity has been an ongoing challenge, although I was not able to get specifics. 

Therefore, I am asking now what barriers you have identified for 

women- and minority-owned firms to compete. What barriers are 

unique to Hispanic-owned firms? What are you doing to overcome 

those barriers? 

A.6. What barriers have been identified for women- and minorityowned firms to compete? 

The following challenges have been identified: 

• Lack of knowledge by businesses on how to do business with 

the Federal Reserve Board 

• Lack of knowledge by businesses on the goods and services procured by the Board 

43 

• Ability to identify and track women- and minority-owned businesses and the products and services they offer in order to 

match to the products and services contracted by the Board 

• Lack of networking opportunities between prime contractors 

and women- and minority-owned firms interested in subcontracting opportunities 

What barriers are unique to Hispanic-owned firms? 

There are no unique barriers and/or challenges for Hispanicowned firms to compete in relation to those identified for womenand minority-owned firms. 

What is being done to overcome barriers? 

The Board has hired a Supplier Diversity Specialist to focus on 

the inclusion of minority- and women-owned businesses in the business practices of the Board. A public Web site is also being developed that will enable companies to register, identify their business 

classification, and include information regarding their products and 

services. The Web site will also enable the Board to search for companies that provide goods or services called for in specific solicitations. The Web site is in final testing and is projected to be available the fourth quarter of 2012. 

The Board has instituted a number of initiatives to communicate 

how to do business with the Board. For example, the Board continues to host an annual business fair to attract diverse pools of 

vendors. These annual fairs provide an opportunity for businesses 

that provide the products and services the Board procures to discuss their companies with specific Board purchasing departments. 

Participants also attend a workshop on how to compete for business contracts at the Board. The most recent business fair, held in 

May 2012, included information about the projected Board’s 2012– 

2013 acquisition forecast. In April 2012, the Board hosted a business forum for minority- and women-owned firms which provided 

information on building business capacity to compete for Federal 

contracts. This forum is projected to be yearly. The Supplier Diversity Specialist also meets with prospective suppliers to prequalify 

and offer technical assistance to minority- and women-owned businesses that are interested in and/or responding to open solicitations. The Board continues to operate under its Small Disadvantaged Business Acquisition policy, consistent with applicable law, 

to ensure small and socially and economically disadvantaged businesses have an equitable opportunity to compete in the Board’s 

procurement activities. The Boards general contract provisions include standard language that requires contractors to confirm their 

commitment to ensuring fair inclusion of women and minorities in 

employment and contracting. During the contract solicitation 

phase, prospective vendors can submit a subcontracting plan with 

their proposal that supports this requirement. 

The Board’s external strategies focus on developing partnerships 

with minority- and women-owned business advocacy, community 

and industry groups to further cultivate relationships. We are applying for membership in local and national associations focusing 

on minority- and women-owned business such as Women Business 

Enterprise National Council (WBENC), National Minority Supplier 

Development Council (NMSDC), and the Greater Washington HisVerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00047 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON
44 

panic Chamber of Commerce (GWHCC). The Board has significantly strengthened its relationship with Hispanic advocacy 

groups, by forging relationships through collaboration. The Board 

regularly submits pertinent information regarding upcoming solicitations to the GWHCC for their members to participate in the 

Board’s acquisition process. We also participated in the GWHCC 

Business Expo to meet with Hispanic firms to discuss future opportunities as well. Through our partnership with the GWHCC, we 

have identified over 20 Hispanic firms to participate in our 2012– 

2013 acquisition process. The Board also exhibits at various conferences to promote our contracting opportunities. We continue to 

participate at the national business conferences such as National 

8 (a) Association Conference, WBENC, NMSDC, and continue to 

work with chambers of commerce including the U.S. Hispanic 

Chamber of Commerce. The Board’s Procurement staff met with 

Hispanic firms during the U.S. Hispanic Chamber of Commerce 

Legislative Summit to discuss their capabilities both for current 

and future acquisitions. 

The OMWI Director also has participated on panels at conferences discussing minority-and women-owned firms doing business with the Federal government which included the 2011 Minority Economic Conference hosted by the Florida Minority Community Reinvestment Coalition. 

The Board has had a continued commitment to the inclusion of 

minority- and women-owned businesses in its procurement practices. The OMWI and Procurement offices, which have the primary 

responsibility for ensuring current and proposed policies and practices affecting inclusion of minority- and women-owned businesses, 

will meet on a regular basis to assess results of supplier diversity 

objectives and activities and to determine whether additional efforts would be helpful in assisting minority- and women-owned 

firms to compete successfully in the Board’s acquisition process. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR HAGAN 

FROM BEN S. BERNANKE 

Q.1. Section 1: Chairman Bernanke, in your testimony you noted 

that in September of last year the Federal Open Market Committee 

determined that it would reinvest principal received from holdings 

of agency MBS and agency debt in agency MBS. 

What is the impact of a dollar of principal that is reinvested in 

a Treasury security relative to a dollar of principal invested in 

agency MBS? 

A.1. The Federal Reserve’s purchases of longer-term assets are intended to put downward pressure on longer-term interest rates and 

ease financial conditions more generally. The effect of a dollar invested in a Treasury security relative to a dollar invested in an 

agency MBS depends on many factors, including the remaining maturity of the securities. In general, longer-term securities would be 

thought to have a somewhat more powerful effect. Both Treasury 

securities and agency MBS purchases have the effect of easing 

broad financial conditions and putting downward pressure on 

longer-term interest rates. In principle, MBS purchases should also 

improve conditions in mortgage markets and so help support the 

45 

housing sector and thereby contribute to a stronger economic recovery. 

Q.2. Is reinvested principal going into new or seasoned or new 

issues of Agency MBS? 

A.2. The Open Market Desk (the Desk) at the Federal Reserve 

Bank of New York purchases agency MBS that are concentrated in 

newly-issued agency MBS in the To-Be-Announced market, although the Desk may purchase other fixed-rate agency MBS securities guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae if 

market conditions warrant. The eligible assets include, but are not 

limited to, 30-year and 15-year securities of these issuers. A summary of agency MBS purchases is reported on the Federal Reserve 

Bank of New York’s (http://www.newyorkfed.org/markets/ambs). 

Additional information on the Desk’s agency MBS purchases can 

be found at the following link: http://www.newyorkfed.org/markets/ambs/ambslfaq.html. 

Q.3. As borrowers take advantage of historically low rates to refinance, is the Fed seeing an acceleration in principal payments? 

A.3. Principal payments of agency mortgage-backed securities 

(MBS) tend to increase when mortgage rates decline. Since the 

summer of 2011, mortgage rates have fallen to very low levels and 

principal payments have increased. The Federal Reserve has seen 

an acceleration in principal payments on its agency MBS holdings, 

with principal payments averaging about $25 billion per month 

since October 2011, roughly double the level seen during the summer of 2011. A number of other factors also influence the speed of 

principal payments. Currently, tight underwriting standards and 

low levels of housing equity are likely damping mortgage refinancing activity and, hence, holding down prepayments. 

Q.4. Section 2: Section 619 of the Dodd-Frank Wall Street Reform 

and Consumer Protection Act (Dodd-Frank) seeks to prohibit federally insured depository institutions and their affiliates from engaging in short-term proprietary trading and to limit certain relationships with hedge funds and private equity funds. 

Specifically, Section 619 added a new Section 13 to the Bank 

Holding Company Act of 1956 (BHC Act), that prohibits a ‘‘banking 

entity’’ from acquiring or retaining an ownership interest in or 

sponsoring a ‘‘hedge fund’’ or ‘‘private equity fund,’’ subject to certain exceptions. 

I want to applaud the Federal Reserve, with its expertise as the 

primary regulator of bank holding companies, for acknowledging 

the importance of traditional asset management services and for 

attempting to propose a rule that does not unduly constrain the 

ability of U.S. banking entities to provide those services. 

It is clear from the statute and the congressional record that 

Congress intended to cover only those funds that ‘‘engage in activities or have characteristics of a traditional private equity fund or 

hedge fund.’’ 

Generally speaking, does the Federal Reserve see non-U.S. funds 

that are publicly offered by U.S. banking entities as posing the 

same risks as traditional hedge funds and private equity funds? 

46 

A.4. The joint proposal issued by the Federal Reserve, OCC, FDIC, 

and SEC requested comment on a wide variety of issues, including 

regarding how section 619 applies to non-U.S. funds, as well as the 

scope of the statutory exemption for certain hedge fund and private 

equity fund activity and investment that occurs ‘‘solely outside of 

the United States.’’ See 12 U.S.C. 1851(d)(l)(l). The agencies’ proposal invited comment on whether non-U.S. funds posed the same 

risks to U.S. banking entities as U.S. funds. The agencies received 

a significant amount of comment on the joint proposal and the Federal Reserve is carefully reviewing and considering these comments 

as we work to finalize implementing rules. 

Q.5. Would the Federal Reserve be willing to work to craft a ‘‘covered fund’’ definition that would treat analogous U.S. and non-U.S. 

funds similarly, as was the intent of the statute? 

A.5. The joint proposal issued by the Federal Reserve, OCC, FDIC, 

and SEC applies to activities by U.S. banking entities involving 

non-U.S. funds in the same way it applies to activities by those entities in U.S. funds to the extent that the non-U.S. fund would be 

covered by the statute were it a U.S. fund. The joint agency proposal also invited public comment on whether the proposed rule effectively and correctly implemented the statutory definition of 

hedge fund and private equity fund and treatment of non-U.S. 

funds for purposes of section 619. The agencies received a significant amount of comment on the joint proposal and the Federal Reserve is carefully reviewing and considering these comments as we 

work to finalize implementing rules. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO 

FROM BEN S. BERNANKE 

Q.1. Following up on your Volcker comments, I agree with you that 

‘‘we certainly don’t expect people to obey a rule that doesn’t exist’’ 

and welcome your comment that the Agencies ‘‘will certainly make 

sure that firms have all the time they need to respond.’’ And yet, 

while Dodd-Frank provides a two-year conformance period, the preamble to the proposed rule states that the Agencies expect full 

compliance ‘‘as soon as practicable’’ after the effective date (July 21, 

2012). In addition, commenters are concerned that the proposed 

rule would effectively require firms to have sophisticated reporting 

and recordkeeping systems and procedures in place on the effective 

date, notwithstanding the 2-year conformance period. This is because, as drafted, the proposed rule conditions the availability of 

key statutory exemptions (e.g., market making and hedging) on the 

existence of these systems and procedures. How do you intend to 

resolve this discrepancy? 

A.1. Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank Act) required the Federal Reserve to adopt rules governing the conformance periods for activities and investments restricted by section 619, which the Federal 

Reserve did on February 9, 2011 (Conformance Rule). In its Conformance Rule, the Federal Reserve explained that it would revisit 

the conformance period rule, as necessary, in light of the requirements of the final rule implementing the substantive provisions of 

47 

the Volcker Rule. Subsequently, the Federal Reserve received a 

number of requests for clarification of the manner in which this 

conformance period would apply and how the prohibitions would be 

enforced. On April 19, 2012, the Federal Reserve issued a statement clarifying that an entity covered by section 619 has the full 

2-year period provided by statute to fully conform its activities and 

investments to the requirements of section 619 and any implementing rules adopted in final under that section, unless the Board 

extends that conformance period. The other agencies charged with 

enforcing section 619 simultaneously announced that they would 

enforce section 619 in accordance with the Federal Reserve’s statements regarding the conformance period. 

Additionally, the Federal Reserve, the OCC, the FDIC, SEC, and 

CFTC have proposed rules to implement section 619; as part of 

those proposals, the agencies met with many interested representatives of the public, including banking firms, trade associations and 

consumer advocates, and provided an extended period of time for 

the public to submit comments to the agencies. The agencies have 

received over 19,000 comments addressing a wide variety of aspects 

of the proposal, including the exemptions for market making-related activities, risk-mitigating hedging activities, the use of 

metrics, and the reporting proposals. The agencies are carefully reviewing those comments and considering the suggestions and 

issues they raise in light of the statutory restrictions and provisions. We will carefully consider the issues you note as we continue 

to review all comments submitted in crafting a final rule to implement section 619. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY 

FROM BEN S. BERNANKE 

Q.1. Chairman Bernanke, I would like to ask you about the Federal Reserve’s supervisory authority over thrift holding companies, 

which is new authority granted to the Federal Reserve as part of 

the Dodd-Frank Act. Some of these thrift holding companies are, or 

own, life insurers. It is my understanding that the Federal Reserve, 

in exercising this new authority, has placed supervisors on site at 

some of these thrift holding companies. 

Can you discuss the Fed’s efforts to supervise thrift holding companies as well as what the Fed is doing to increase its expertise 

and knowledge base with regard to insurers? 

A.1. As of December 31, 2011, there were 417 top tier Savings and 

Loan Holding Companies (SLHCs) with estimated total consolidated assets of $3 trillion. These SLHCs include approximately 48 

companies engaged primarily in nonbanking activities, such as insurance underwriting (approximately 26 SLHCs), commercial activities (approximately 11 SLHCs), and securities brokerage (11 

SLHCs). Since the transfer of SLHC supervision to the Federal Reserve on July 21, 2011, 114 SLHCs have been issued indicative ratVerDate Nov 24 2008 13:55 Jan 15, 2013 Jkt 048080 PO 00000 Frm 00051 Fmt 6602 Sfmt 6602 L:\HEARINGS 2012\03-01 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON
48 

1 An ‘‘indicative rating’’ indicates to the SLHC how it would be rated if the RFI rating system 

was formally applied. 2 A discovery review is an inspection activity designed to improve the Federal Reserve’s understanding of a particular business activity or control process. 3SR letter 11-11, ‘‘Supervision of Savings and Loan Holding Companies’’ (July 21, 2011), describes the supervisory approach to be used for the first cycle of supervision of SLHCs 

(www.federalreserve.gov/bankinforeg/srletters/sr1111.htm). 4 NAIC is an organization formed by State insurance regulators and has no regulatory authority. 

ings, 1 50 discovery reviews 2 have been completed, and an additional 34 discovery reviews, 27 inspections and 21 offsite reviews 

have been initiated. 

A dedicated SLHC section in the Board’s Division of Banking Supervision and Regulation has been staffed and is working to continue the supervisory and policy oversight of the SLHCs. Regarding 

the 26 SLHCs that are primarily engaged in insurance activities, 

the Federal Reserve is using the first cycle of SLHC inspections to 

learn more about the particular operations of each insurance SLHC 

(ISLHC), as explained in SR letter 11-11 (July 21, 2011) 3 Supervisory assessments are currently being conducted at each ISLHC 

and its subsidiaries to more fully understand the activity make up 

of each ISLHC and to determine if any activities pose safety and 

soundness concerns. The Board’s consolidated supervisory program 

is applied to ISLHCs in a risk-focused manner and supervisory activities (such as, continuous monitoring, discovery reviews, and 

testing) vary across the portfolios of institutions based on size, complexity, and risk. Board and Reserve Bank staffs are working to 

create supervisory plans that address the risks associated with the 

activities of ISLHCs. For example, pilot ISLHC inspection procedures have been developed and are currently being used by examiners in the inspection of ISLHCs. Staff will revise and finalize 

these procedures based on feedback received from examiners. 

To foster consistency and assist examiners in developing their 

knowledge of the unique aspects of ISLHCs, the following activities 

also have been instituted: 

• Four conferences for Board and Reserve Bank staff supervising 

ISLHCs have been held since the transfer of SLHC supervision 

to the Federal Reserve. (August 2012, D.C.; June .2012, D.C.; 

November 2011, D.C.; and August 2011, Chicago). 

• Ongoing System-wide calls are held and have included training 

sessions conducted by outside vendors on insurance related 

issues and discussions on ISLHC supervision. Participants include Reserve Bank and Board staff. Internal insurance training courses also are under development. 

• Regular communication with the National Association of Insurance Commissioners (NAIC) 4 along with Reserve Bank and 

Board attendance at NAIC conferences. 

• Regular communication with the Federal Insurance Office and 

the Financial Stability Oversight Council. 

Q.2. Previously, when asked, Mr. Volcker was unable to give a 

clear definition of ‘‘proprietary trading’’ but essentially said that he 

knew it when he saw it. 

As the regulators draft the Volcker Rule, which is focused on proprietary trading, what is your definition of the term? 

49 

Is this the exact definition used in the proposed rule? 

If not, how does the definition in the proposed rule differ? 

A.2. Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) generally prohibits banking 

entities from engaging in proprietary trading. Section 619(h)(4) of 

that Act defines ‘‘proprietary trading’’ to mean ‘‘engaging as principal for the trading account in any transaction to purchase or sell, 

or otherwise acquire or dispose of specified financial instruments. 

See 12 U.S.C. 1851(h)(4). Another part of section 619 defines ‘‘trading account’’ as any account used to engage in proprietary trading 

for the purposes of profiting from short-term price movements. See 

12 U.S.C. 1851(h)(6). The statute also provides a number of exemptions from the prohibition on proprietary trading, such as exemptions for market making-related activity or risk-mitigating hedging 

activity. See U.S.C. 1851(d)(l)(B) and (C). The proposal to implement section 619 of the Dodd-Frank Act by the Federal Reserve, 

OCC, FDIC, SEC, and CFTC (the ‘‘Agencies’’) requested public comment on a definition of ‘‘proprietary trading’’ that restates the statutory definition. 

The Agencies received over 19,000 comments regarding the proposed implementing rules, including comments that specifically addressed the issues of proprietary trading and related definitions. 

The Agencies are currently considering these comments as we work 

to finalize implementing rules. 

Q.3. Apparently, the definition of state and municipal securities in 

the Dodd-Frank Act does not conform with the earlier Securities 

Exchange Act definitions, subjecting these securities to the Volcker 

Rule. 

What will the additional costs be to State and local governments 

in issuing bonds? 

A.3. Section 619(d)(l)(A) of the Dodd-Frank Act provides an exemption for proprietary trading in obligations of the United States or 

any agency thereof, obligations, participations, or other instruments of or issued by certain Government sponsored entities, and 

obligations of any State or of any political subdivision thereof. See 

12 U.S.C. 1851(d)(l)(A). A number of Securities Exchange Act provisions apply to obligations and instruments of any agency of a State 

or political subdivision thereof, as well as to obligations of the State 

of a political subdivision itself. The Dodd-Frank Act, however, did 

not by its terms extend its exemption to proprietary trading in obligations of an agency of any State or political subdivision thereof. 

The Agencies proposed an exemption for municipal securities that 

mirrored the words of the Dodd-Frank Act. The Agencies also requested public comment on whether the exemption should be extended to include the broader definition of ‘‘municipal security’’ 

used in the Securities Exchange Act. 

The Agencies received over 19,000 comments regarding the proposed implementing rules, including comments that specifically addressed the exemption for government obligations and the definition of municipal security. The Agencies are currently considering 

these comments as we work to finalize implementing rules. 

50 

Q.4. Do you believe that, as proposed, the Volcker Rule has the potential to raise the cost of capital for nonfinancial small and midsize businesses? 

Has any analysis been performed on this issue in relation to the 

proposed Volcker Rule? 

Has any analysis been performed on the potential impact on access to capital for nonfinancial small- and mid-sized businesses 

that may be created by the confluence of the Volcker Rule, the implementation of Basel III, and the SEC’s impending money market 

regulations? 

Will you please provide my office with copies of any such analysis 

or assessments? 

A.4. As part of the proposed rules to implement section 619 of the 

Dodd-Frank Act, the Agencies proposed a multifaceted regulatory 

framework to implement the statute in accordance with its terms. 

In the proposal, the Agencies recognized that there are economic 

impacts that may arise from the proposed rule, and invited comments on potential economic impacts. The Agencies also encouraged commenters to provide quantitative information about the impact of the proposal not only on entities subject to section 619, but 

also their clients, customers, and counterparties, specific markets 

or asset classes, and any other entities potentially affected by the 

proposed rule, including nonfinancial small and mid-size businesses. The Agencies received over 19,000 comments regarding the 

proposed implementing rules, including comments regarding potential costs and benefits. The Agencies are currently considering 

these comments as we work to finalize implementing rules and will 

take account of the potential costs and benefits of any implementing rules as the agencies develop a final rule consistent with 

the requirements of the statute. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR WICKER 

FROM BEN S. BERNANKE 

Q.1. The unemployment rate’s drop in recent months to 8.3 percent 

may have overshadowed a troublesome trend, which is the fact 

fewer Americans are looking for work. For example, the latest jobs 

report showed that the share of working-age people in the labor 

force had declined to the lowest level in 29 years. Furthermore, 

while unemployment has fallen 1.4 percentage points over the past 

24 months, the participation rate has dropped 1.1 percentage 

points. The share of Americans with jobs, known as the employment-to-population ratio, hasn’t budged—posting the same number 

last month (58.5) as in January 2010. This information combined 

with the fact we have seen record numbers of long-term unemployed is very concerning. Chairman Bernanke, is the recent trend 

of lower labor force participation a significant indicator of the 

strength of the U.S. economic recovery? Should U.S. policy makers 

be concerned about this trend? 

A.1. Several factors account for the decline in labor force participation that we have seen. Part of the decline reflects longer-term demographics that are largely distinct from the weak economic situation. In particular, as the baby boom cohort ages, larger numbers 

of individuals have been reaching ages at which, typically, labor 

51 

force participation is lower. But demographics probably cannot 

fully explain the relatively low participation rate that we have 

seen. The fact that the labor market remains weak, with relatively 

few jobs available, has likely led many individuals to remain out 

of the labor force. On the other hand, the loss of housing and stockmarket wealth associated with the housing collapse and the recession no doubt induced many others to stay in the labor force for 

longer than they otherwise might have. Quantifying these various 

forces is difficult, but to the extent that the slowing in participation 

does reflect cyclical factors, then as the economy strengthens, participation may be expected to increase, or at least to decline by less 

than the underlying demographic trend would suggest. 

A downward trend in labor force participation that represents 

natural demographics may not be a cause for concern. However, 

there are some potentially concerning aspects to the decline. The 

effect of a declining workforce on public finances is one potential 

issue. Another concern stems from the large rise in disability rolls, 

and the possibility that part of that rise represents individuals who 

could and would work if more jobs were available. Moreover, participation rates for teens and young adults have declined. To some 

extent, this decline for young people reflects increased schooling, 

which is likely for the good; but if the lower participation implies 

that young people are not gaining valuable work experience, it 

would be a cause for concern. 

Q.2. Chairman Bernanke, you noted in your testimony that the job 

market has seen some improvement but that ‘‘continued improvement in the job market is likely to require stronger growth in final 

demand and production . . . 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.’’ What type of ‘‘stronger growth’’ is necessary to tackle the 

problem of anemic job creation? 

A.2. In the latter part of 2011 and early this year, job growth 

picked up and the unemployment rate declined even though GDP 

was rising at only a modest rate. Normally, when GDP rises at its 

longer run ‘‘potential’’ rate associated with normal growth of the 

labor force and productivity, the unemployment rate will remain 

stable; a declining unemployment rate generally requires GDP to 

rise at a rate faster than potential. A number of factors might help 

account for the decline in the unemployment rate despite only modest GDP growth, but part of the story could be that last year’s decline in unemployment represented a ‘‘catch up’’ from the deepest 

part of the recession, when employers were cutting payrolls even 

more sharply than would have been predicted given the declines in 

demand that they were facing, perhaps because they feared that an 

even sharper contraction might be in the offing. Such a period of 

catch up eventually will come to an end, and indeed, since early 

this year the unemployment rate has been about flat at 81⁄4 percent, while GDP growth has slowed only a little. Thus, to achieve 

further declines in unemployment, we will likely need to see GDP 

growth rising more rapidly than we have seen over the past year. 

52 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

53 


Monetary Policy Report 

to the Congress 

Submitted pursuant to section 2B 

of the Federal Reserve Act 

February 29, 2012 

Board of Governors of the Federal Reserve System 
54 


Letter of Transmittal 

BOARD OF GOVERNORS OF THE 

FEDERAL RESERVE SYSTEM 

Washington, D.C., February 29, 2012 

THE PRESIDENT OF THE SENATE 

THE SPEAKER OF THE HOUSE OF REPRESENTATIVES 

The Board of Governors is pleased to submit its Monetary Policy Report to the Congress 

pursuant to section 2B of the Federal Reserve Act. 

Sincerely, r 

~ke' Chainnan 
55 


Contents 

I Part 1: Overview 

; Part 2: Recent Economie and FUlancial Developments 

6 Domestic Developments 

6 The Household Sector 

6 Consi/mer Spending and Household Finan ce 

8 /lousing ActiJJity and Finance 

10 The Business Sector 

10 Fixed /l1\'eSlmelll 

11 Jm"emory /l1\'eSlmenl 

11 Corporate Profits and Business Finllll ce 

13 The Go\'ernmenl Sector 

13 Federal Goremmen/ 

[5 Stale and Local GOl"ernmelll 

[5 The External Sector 

17 National Sa'"ing 

17 11le Labor Markel 

17 Emp/O}lnelll and Unemp!oymeIU 

18 Productivity and Labo, Compensation 

18 Prices 
56 


20 Financial Developments 

20 Monetary Policy Expectations and Treasury Rates 

21 Short· Term Funding Markets 

22 Financial Institutions 

26 Corporate Debt and Equity Markets 

28 Monetary Aggregates and the Federal Reserve's Balance Sheet 

30 International Developments 

30 internatiotk'l.l Financial Markets 

33 The Financial Aocount 

3S Advanced Foreign Economies 

36 Emerging Market Economies 

39 Part 3: Monetary Policy 

39 Monetary Policy over the Second Half of 201 I and Early 2012 

43 FOMCCommunications 

47 Part 4: Sununal1' of Economic Projections 

49 The Outlook for Economic Acti\~ty 

SI The Outlook for InHation 

54 Appropriate Monetary Policy 

S8 Uncertainty and Risks 

61 Abbreviations 

List of Boxes 

24 Financial Stability at the Federal Reserve 

32 An Update on the European Fiscal Crisis 

36 U.S. Dollar Funding Pressures and Dollar Liquidity Swap Arrangements 

4S FOMC Statement Regarding Longer·Run Goals and Monetary Policy Strategy 

60 FOlrolst Uncertainty 
57 


Part 1 

Overview: 

Monetary Policy and the Economic Outlook 

Economic aCli,ity in the Uniled States expanded at a 

tmderate rate in the second half of 2011 followiogan 

anemic gain in the first half, and the tmderate pace or 

expansion appears to have continued inlo the opening 

lmnthsof 2012. Actr<'ityWls held down in the first 

half of WI I by lempmry factors., particularly supply 

chain disruptiom stemming from the earthquake in 

hpan and Ihedampiog effect of bigherenergy prices 

on consumer spending. As the effects of these factors 

wilned over the second half of the year, economic 

actr.'ity picked up. Conditions in the boor nurket han 

impro,"ed since last summer, with an increase in the 

p:ux of job gains and a noticeable reduction in the 

unemployment rale. Meanwhile, consumer price infla· 

tion has stepped down from the temporarily higb lewis 

obselwd over the first balf of 2011. asconumdity and 

imJXlfl prices remaled and as longcHerrn inflation 

expectations remained stable" Looking ahead. growth 

is !ike~ to be lOOdest during the coming year. as several 

factors appear lik 'to continue to restrain activity. 

including restricted access to credit for many bouseboldsand sm.ill businesses, the still-depressed bousing 

market. tight fiscal policy at aU levels of g<ll"ernment, 

and some >lowing in global economic growtb. 

In light of tbese conditions, the Federal Open Market Commil1ee FO~ q took a number of steps during the strond balf of 2011 and early 2012 to provide 

additional moneury policy accornm;x\ation and 

thereby support a stronger economic ltCOver)' in the 

contexl of price stability. These steps included modifying the IOrw:ud rate guidance included in postmeeting 

sutements, increasing tbe x,-erage nulUrity of tbe Federal Reserve's5eCurities holdings. and shifting tbe reinvesDnent of prindpll PJymentson agency securities 

from Treasury securities to agency-guaranteed 

mortgage-OOcked securities(MBS). 

Throughout the second half of 2011 and ear~' 2012, 

participants in financial markets focused on the fiscal 

and OOnking crisis in Europe. Concerns regarding tbe 

potential ror spillovers to the US. economy and finan -

cial markets weighed on inl"estor sentiment. contributing to significant lulatility in a wide range of asset 

prices and at times prompting sharp puUbacks from 

risk-taking. Strains eased somewb.n in 1 number of 

financial markets in late 2011 and early this year as 

investors seemed to become more confident that European poliC)1lUkerswould take tlie steps necessary to 

address tbe crisis. Tbe more posith-e market sentiment 

was bolstered by recent Us. data releases, which 

pointed 10 greater strength, on OOlance, than inl'estors 

bad expected. Nonetbeless, market p,lrticip,lnts reportedly renuin cautious about risks in the financial 

system, and credit default SI\'ap spreads for Us. financial institutions have lIidened, on net. sinct early last 

summer. 

After rising at an annual rate of just V. percent in tbe 

first balf of WI!. real gross domestic product(GDP) is 

estimated 10 haw increased at a 2Y. percent rate in the 

second bal[1 The growth rate of rei! consumer spending also firmed a bil in the second balf of the year. 

although tbe fundamenul determinan\Sof household 

spending improl'ed little: Rell household inoome and 

wealth s!agnated, and access to credit remained tight 

for nuny potential borrowers. Consumer sentiment has 

rebounded from the summer'sdepressed ItI'els but 

remains low by historical sundard& Meanwhile. reJl 

investment in equipment and software and exports 

posted solid gainso\"er the second half of the year. In 

contrast. the housing nurket remains depressed. 

weighed down by tbe large inventory of vacant houses 

for sale. tbe substantial lulume of distressed sales, and 

bomebuyers' COnctrnli about the strength of tbe ltCOI'-

ery and tbe potential lOr further declines in bouse 

prices. In the government sector. reJl purchases of 

goods and services continued to decline over the second balf of the year. 

Labor market conditions 001'( improved. The unemployment rate ITIOled down from around 9 percent 

om the first eight months of 2011 to 8Y. percent in 

JanUlry 2012. HO\\"eleT. eYen with this irnprovemen~ 

the jobless rate remainsquiteelevlted. Furthermore, 

the share of the unemployed who have been jobless for 

more than six months. although down slightly from its 

pelk, was still abol"e40 percent in Janual)'--roughly 

double the fraction tblt prtl'liled during the economic 

exfUnsion of the prtl'KlU5 decade. Meanwhile, private 

t. The aumkn; io this t<pC'It IR' basN 011 tl1< Bur.au or EcOl1OlDic AnoIysis'.(BEA) aa.oa1lCe ISIiroatl:of fourtb"lUirttt 

GDp, ~'bich ~~I rdtas<d 00 AtIIIOl)' 2J, 20\2. Tho BE.-\. ~; tl ,",iSI' 

• ",iscd<Stimatl: 011 February 29. 2011 
58 


MoneUI)' ltllicy Report to the Congress O February 2012 

payroU employment gains averaged 165,1XXl jobs per 

month in the ~nd hJlf of 20\ I, a bit slower tbn the 

pace in the first half of the year, but gains in December 

and hnu31)' were more robust, a\'eraging almost 

240,000 per mon th, 

Consumer price inflation stepped down in the se<"-

ond balf of 2011. Afier rising at an annual rate of 

3\4 pelttllt in the first half of tbe ~'ear, prices for per· 

sonal consumption expenditures (PCE) rose just 

lYi pelttllt in the second half. PCE prices excluding 

!Ood and energy also decelerated, rising at an annual 

rateof roughly 1 Y, perctnt in the second half of 2011. 

compared with about 2 perctnt in tbe first hJlf. The 

decline in inflation W3S largely in response to decreases 

in global conumdity prices following their surge early 

in 2011, as well as a restoration of supply chJins for 

motor I'ehicle production that had been disrupted after 

the earthquake in Jap,ln and some deceleration in the 

prices of imported goods other thJn raw conumdities. 

The European fiscal and banting crisis intensified in 

the second balf of theyear. During the summer. tbe 

gOI'ernmenl> of haly and Spain came under significant 

financial pressure and borrowing com increased for 

many euro-area governments and banks In ear~' 

August. the European CenlIll Bank (EeB) re§pCInded 

by resuming purcbases of marketable debt securities. 

Although yields on the government debt of haly and 

Spain temporarily moved lower, market conditions 

deteriorated in the fall and funding pressures for some 

gol'ernmentsand banks increased furtber, Om the 

seo:md half of the year, European leaders worked 

toward bolsming tbe financial backstop foreuro-area 

gonrnments, reinforcing the fiscal discipline of tbose 

gOI'ernments, aDd strengthening the capital and liquidity positions of banh Additionally. the ECB made a 

significant injection of euro liquidity via its fim threeyear refinancing operation, and central banks agreed to 

reduce the priceof U.S. doUar Uquidity based on swap 

Unes with the Federal Reser\"¢. Since December. hUowing these actions, yields on tbe debt of vulnerable 

European governments declined to some extent and 

funding pressures on European bankseased. 

A number of so\IJCes of investor anxiety-including 

the European crisis, concerns about the ;ustainabi1ity 

of US. fiscal policy. and a slowdown in global 

growth- weighed on U.s. financial market. early in the 

second half of 2011. More recent~', tbeseconcerns 

eased somewbat. reHecting actions taken by global central banks as well as US. dJta releases tbat pointed to 

greater strengtb. on balance, than market participants 

bad anticipated. Broad equity prices fell notab~' in 

August but subsequently retraced, and they are now 

lilt Ie changed, on net, since early Ju~ . Corporate bond 

spreads remain ele-.'ated. Panly as a result of the hrward guidance and ongoing maturity extension program prol;ded~' the Federal Resent, market p,lrtici. 

p,ln1S expect the target federal funds rate to remain loll' 

for a longer period than they thought early 11st July, 

and Trelsury yields hal'e Ir£ll"ed dOllll gnificant~', 

Meanwbile. measuresof inHation compensation ol'er 

the next he years deril'ed from jields on nominal and 

inHation-indexed Treasury securities are little cbanged. 

on balance. though the fOf\\'lrd melsure 5-to-1O years 

ahud rema ins below its level in tbe middle of !lst year. 

Among nonfinancial corporations, larger and 

bigher -credit-quality finns with access to capital market5took advantage of generally attractive financing 

conditions to ra ise funds in the second half of 2011. 

On tbe other band, for smaller finns without access to 

credit markets and those with less-solid financial situations, boITOlliog conditions remained more challeng· 

ing. Reflecting these developments, inl'e5tment-grade 

nonfinancial corporations oontinued to issue debt at a 

robust p,lct while spe\:ulative-grade issuance declined, 

as investors' appetite for riskier assets diminisbed. 

Similar issuance patterns were evident in the market 

for syndicated loans, where invesUllent-grade is>"1laDct 

continued to be strong wbile tbat of bigber.}ieJding 

leveraged loans feU back. In addition, commercial and 

industrial(C&I) loans on banks' books expanded 

strongly, particular~' for 11rgerdomestic banks tbatare 

mo5l 1ikely to lend to big firms. Accenting \0 the hnuary Senior Loan Officer Opinion Sur,ey on Ban k 

Lending Practices (SLOOS), domestic banks eased 

term. on C&I loons and experienced increased loan 

demand during tbe fourth quarter of tbe year. tbe lat· 

terdeveJopment in part reflecting a shift in some borrowing away from European ban ~l Byoontrast. 

although credit supply conditions for smaller firms 

appear to baveeased somewhat in tbe last 5e\'eral 

months, they remained tighter relative to bistorical 

nonns than for larger firms. Conunerdal mortgage 

deht continued to decline tbrough tbe third quarter of 

2011 , albeit at a Ir£lre Ir£ldmte pace than in 2010. 

Household debt appears to have declined at a 

slightly slower pace in the second balf of 2011 than in 

the first half, lIith tbe continued contraction in mort· 

gage debt partiaUy offset by growtb in consumer credit. 

Enn though Ir£lrtgage rales continued to be near his· 

toric.ally low lel'els, tbe I"Olume of nell' mortgage loans 

remained muted. The smallerquantit), of new IDJrtgage origination reHects potential buyers' lack of either 

the down payment or credit history required to qualify 

2. The SLOOS ~ ;>lilablt OIl the FNeraI ReseM Iloard'i ~m;te 

ol " ...... l"tJmt .. !tI'~V"lOOardJo<:&lS"LoonSU"'t;t 
59 


tor these loans. and many appear reluctant to buy a 

house now because of concerosabout their income 

prospect. and emplo}1Tlent statu;, as well as the risk of 

further declines in house price~ Delinquency rates on 

most categories of residential mortgage; edged lower 

but stayed nelf recent highs. and the number of properties in the foreclosure process remained de\"ated. 

Issuance of consumer asset-b.tcked securities in the 

serond half of 201 1 ran at aoout tbe same rate as it 

bad over the previous 18 month A modest net fraction of SLOOS respondents to both the Cktober and 

hnuary sU!1·eys indicated that they had eased tbeir 

sundardson all c':llegories of consumer loan~ 

'\Ieasuresof the profitabmty of the u.s. banking 

industry hal·e edged up, on net. since mid-lO ll, as 

indiCltorsof credit quality continued to show sigm of 

improl·enlent and banks trimmed noninterest expense~ 

Meanwbile, banks' regulatory capital ratios remained 

at historically high levels, as authorities ron tinued to 

take step; to enhance their regulation of financial institution~ Nonetheless, conditions in unsecured interbank funding markets deteriorated. Strains were particular~' evident for European financial institutions, 

with funding rosts increasing and maturities sbortening, on balance, as investors focused on counterparty 

credit risk amid growing anxiety abouttheongoing 

crisis in Europe. Gil·en solid deposit growtb and JOOd . 

est expansion in bank credit across the industry, most 

domestic banks reportedly had limited need for unsecu red funding. 

Concerns about the condition of 1'm.1ncial institutions gal·e rise to heightened inmtor anxiety regarding 

countelJlarty exposures during tbe second half of 

201 I. Responses to tbe December Senior Credit Officer 

Opinion SU!1·ey on Dealer Financing Te rms. or 

SCOOS. indicated thatdellersdevoted increased time 

and attention to the management of concentrated 

credit exposures to other financial intermediaries over 

the prel'ious three lmnths, and 80 percent of dealers 

reported re<!ucing credit ~mit; for some specificcoun. 

terpart e~l Respondentsalso reported a broad but 

rooderate tigh tening of credit terms applicable to 

important classes of counterparties Ol·er the pm-ious 

three months, importantly refte<"ting a worsening in 

general markc:t ~quidity and functioning as weU asa 

reduced \liUingness to take on risk. 

In order to support a stronger economic recove£)' 

and belp ensure that inflation. over time, is at Ie\·el, 

consistent with itsdua! mandate. the FOMC pf()\'ided 

additional lmneta£)' policy acoomroodation during the 

1 TI» SOXlS ~ .... ibbleon lbo Folenl R<smoe IIo,ard·, ubsitt 

'l"""'.f.t.:r.l,.,.,.,.,.~",·!cconr<sdI.lalrdeasesl~tm. 

BoanIojwlV'/!ol'l'ojlhe Federal ResmeSystem J 

second balf of 201 I and ear~' 2012. In Augus~ the 

Corruninee JOOdifie<! its forward rate guidance, noting 

that eoonomicconditions were likely to warrant exceptional~' low Imls forthe fe<leral funds rate at least 

through mid-20ll The FOMe decided at its September meetiIlg to ex tend the 31-erage maturity of its 

Treasury boldings, and to reinvest principal payments 

from its holding;; of agency debt and agency MSS in 

agency MBS rather tban in Treasury securities. ~ 

Finally, at tbe Committee's January 2012 meeting, the 

Fa MC JOOdified its fOfll'lrd guidance to indicate that 

it expected eoonomicconditions to warrant exceptiona1~' low le\·els for the federal funds rate at leaS! through 

late 2014. The Comminee note<! that it would regullrly 

review the size and composition of its securities bold· 

ings and is prepared to adjust those holdings as appropriate to promote a stJOngereconomic recol"ery in the 

context of price .tability. 

[n .1ddition to these policy action;, the Federal 

Rese!1"e took further step. to improl·ecommunkations 

regarding its lmnetary po!icydecisionsand deliberations. At the Comminee's January 2012 meeting, the 

FaMC released a statement of its longer-run goal;; 

and policy strategy in an effort to enhance the transpartncy. acoounubility, and elfectil"enessof monetary 

policy and to facilitate well·informed decisionmaking 

by bousebolds and businesses. The statement empbasizes the Fe<!eral Reser\"e'sfirm commitment to pursue 

its congressional tn.1odate to promote maximum 

employment .• table prices, and rooderate Iong·term 

interest rates. To cl.1rify how it see!:s to achiel·e the;.;: 

objectil·es,tbe Fa MC SUted that inHation at the rate 

of 2 percent. as measured by the annual cbange in tbe 

PCE price index, is I\l)st consistento\·er the longer fUn 

\lith tbe Federal Rese!1·e's statutory mandate. While 

noting tbattheCommittee's assessments of the maxi· 

mum lenl of employment are neceSS:lri~' unceruin 

and subject to revision. the 5Utement indicated that 

the central tendency of FO.\fC participants" current 

estimates of the longer·run nonna! rate of unemploy· 

ment is between 5.2 and 6.0 percent It stressed that the 

Federal Rescm's sUtutory objecti\'esare generally 

complementary, but when they lit not, the Committee 

\lill follow a balanced approach in its efforts to return 

botb inflation and empJo:1Tlent to Ie\·e!sconsistent 

\lith its mandate. 

In addition.tbe January Summary of Economic 

Projections(SEP) PlQlided information for the first 

time about FO.\IC participants' indilidua! assessments 

4. !let,...cu lbo AugUSl2010acd Sq>ttnlbr, 20t t FOMC 1DI!diugs.. 

prilripat M ·",...l. from l<:Curil;" beLl on II» F<Jmt Rt:;:t"" 

N/ance , bed b.d \'CCI! mn_ed ill longc-r·term Trtuu'l' """",1", 
60 


4 Moneury ltllicy Report to the Congress O February 2012 

of the appropriate timing of the first increase in the 

target federal funds rate gn'en their view of the economic situation and outlook, as well as participants' 

asses;mentsof the appropriate lel'el of the target federal fund; rate in the fourth quarter of each yelr 

through 2014 and over the longer run, The SEP also 

included quaUtative information regarding individual 

participants' eXpe<:tations for the Federal Reserve's 

b:ilance sheet under appropriate JOOnetary poUcy, 

The economic projections in tbe hnuary SEP(preseoted in Part 4 of tbis report) iDdicated that FO~1C 

participants(the membersof tbe Board of Governors 

and the presidents of the 12 Federal Reserve Banks) 

general~' anticipated aggregate output to incmse at a 

somewbat faster pace in 2012 tban in 2011, Altbough 

the participant> marked down their GDP gro\llh projections slightly compartd \lith those prepared in 

Norember, they stated that the economic information 

rt(eived since that time showed continued gradual 

impromnent in the pace of economic activity during 

the second balf of 2011, as the inOuence of the temporary factors tbat damped actil'ity in the first half of tbe 

year subsided, Howtl-er, a number of additional factors, including ongoing weakness in tbe housing sector, 

roode,t growth in real dispoSlble income, and the 

restraining effect~ of fiscal consolidation, suggested 

that the pace of the recoI'ery would be modest in corning quarter~ Participants also read the information 00 

economic activity abroad, particularly in Europe, as 

pointing to weaker demand for U.S, exports. As these 

factors wane, FOMC participants anticipated that the 

pace of th e ecooomicexpansion wiU gradual~' 

strengtben over the 2013-14 period, pushing the rate of 

increase in real GDP above their estimates of tbe 

longer-run rate of output growtb, Witb ~I GOP 

expected to increase at a me,t rate in 2012, tbe 

unemployment rate was projected to decline only a 

Ullie tbis year, Participantsexpe<:ted further gradual 

improl'elOOlt in labor J11.'Irket conditionsol'er 2013 and 

2014 a~ the pace of output grolllh picks up. They also 

noted that inHation expectations had remained stable 

over tbe past year despite Ouctuations in headline 

inHation, Most participant; anticipated that both 

beadline and core inRation 1I0uid remain subdued oyer 

the 2012-14 period at rates at or below tbe FOMC's 

longer-run objectire of 2 percent. 

With Ihe unemployment rate projected to remain 

elevated over the projection period and inHation 

expected 10 be subdued, most participantsexpe<:ted 

that the froeral funds rate would remain extraordinari~' loll' lOr some time. Six participants anticipated 

that. under appropriate monetary policy, the 6rst 

increase in the target federal funds rate would occur 

after 2014, and fr.-e eXpe<:ted (XlUcy firming to cornmence during 2014, The remaining six participants 

judged that raising the federal funds rate sooner would 

be required to forestall inl\ationary pre>suresor avoid 

dinortions in the financial system AU of the individual 

asseS>tnents of the appropriate target federal funds rate 

Ol'er the next few years were below the p3rticipanB' 

estinutesof the longer-run lel'el of the federal funds 

rate. EltI'en of the 17 participants placed the tlrget 

federal funds rate at 1 percent or lower althe end of 

2014, while 5 >.1\1' the appropriate Tate as 2 percent or 

bigher, 

A sizable majority of participants continued to 

judge the leYe! of uncertainty a:.sociated witb tbeir projections for real activity and the unemployment rate as 

exceeding tbe al'erage of the pan 20 years. Many also 

attached a greater-than-nomulltl'el of uncertainty 10 

their forecasts for inflation, As in November, many 

participants 5.111' downside risks anending their forecasts of T¢al GOP growth and upside risk; to their 

fort<'astsof the unemployment Tate; most participants 

viewed the risks to their inHation projections as 

broadly b.1lanced, Participants also reported tbeir 

asses;;ment, of the values to wbich key macroeconomic 

variables would be expected to convergeovcr the 

longer term under appropriate monetary poUcy and in 

the absence of further shocks to tbe economy, The centraltendencies of tbese longer-run projections were 

2.3 to 2,6 percent lOr real GOP growtb and 5.2 10 

6,0 percent for the unemployment rate, In lightof the 

2 percent inHation tiut is the objective included in the 

statement of longer-run goals and policy strategy 

adopted at the bnuary meeting, the range and central 

tendenc:-' of participants' projections of longer-run 

inflation were aU equal to 2 percent. 
61 


Part 2 

Recent Economic and Financial Developments 

Real grossdomeSlic product (GDP) increased at an 

annual raleor 2\1. percent in the second half of 2011, 

according to the ad\'loce eslinule prepared by the 

Bureau of EoonomicAollysis, following growth of Jess 

than 1 percent in the first half (figure I). Actil'it)' WlS 

held down in the 6rsl b31f of the year by temporary 

factors, particularly supply chain disruptions stenuning 

from the earthquake in bpan and tbe damping effect 

of higher energy priet; on consumer spending. As the 

effec!! of these factors wanedo\'er tl!{ second half of 

the year, the pace of eoooomic activity picked up. But 

growth remained quilt lOOdestcompared lIith previous eronomicexpansions. and a Dumberof factors 

appear likely lD continue to restrain the pace of activity into 2012; these factors include restricted access to 

credit for nuny bouseboldsand snuI[ businesses. the 

depres5e\l housing nurkel tight fiscsl policy. and the 

spiUovereffeclsof the fiscal and financial difficulties in 

Europe. 

Conditions in the labor nurket ha-.'e improved since 

la,t summer. The PJce of pril'lte job gains has 

increased, and the unemployment rate has JOOred 

lower. Nonetheless, at 811. perctnt, the jobless rate is 

still quite elevated, Meanwhile, consumer price infla, 

tion stepped down from the higher lerelsobser.edorer 

the first half of last year, as conumdity and import 

prices retreated wbile Ionger,term infiltion expectations remained subJe (figure 2), 

l. OIange inrtal gross OOmestic proouC!, XIOS-ll 

It t I :D.lS m 'YfI m 10CJIl altO altt 

Non: 1'-..t n """""""r(II ... <=Jt .. Id!<l~ b 'V'''' pttJCd . .. asondlnf' fNl.".,n&o.1ho rNl~<l.lhoft~ 

""" SoolCl: ~Qie:.lDtfct,8In",Qi"""-"AfI3ty'k 

The fiscal and banting crisis in Europewasa primary focusof financial marketso\,er tbe course of tbe 

second balf of 2011 and ear~' 2012, Grolling concerns 

regarding the potential for spillovers to the u.s. economy and financial markets weighed on inl'estor 

sentiment, contributing to significant I'olatility in a 

lIide range of asset prices. Nonetheless. de',elopments 

in financial markets ha,'e been mixed, on bJlance, since 

July. Unsecured dollar funding markets became significantly strained, particularly for European institutions, 

though U.S, institutions generaUy did not appear to 

face substaDlial funding difficulties. Risk spread! on 

corporate debt stayed elel'ated, on nel, but )ields on 

corporate bonds geoeraUy IOOwd lower, Broad equity 

prices, which declined significantly in July and Augusl, 

subsequently returned to levels near those seen in early 

July, Credit conditions for trostlarge nonfinancial 

firms were accommodative and corporate profit growth 

relTllined strong. 

In response to a paaof oconornicgrowth tbat was 

somewhat slower than expected, the r-ederal Reserve 

prolided additionallOOnetary policy acronunodation 

during the second half of 2011 and early 20 12, Pa rt~' 

as a result, Treasul)' yields mnl'ed down signifieantly, 

and market participants pushed out the date at wbicb 

they expect the federal funds rate to more abo"e its 

current target range of 0 to II, percent and built in 

2, (baoge in \hecwill-t)"pe price iD;Jo; f(I personal 

coosuu:¢oo expenditures, XIOS-ll 

- , 

-, 

- , 

-, 

- , 

- , I I! t ! t 1 

:D.lS m 'YfI)Xl! m altO alIt 

Non: ')h, dill. "" ..nhIy ..t"m;J ~ D<ctmb<r 201 t; cl\q« 

a-.i.,.,..,Y""'''';'' 

Sow;,;; n.p.._<l.O:a .... ct,II_IIU<I.~Ana!) .;._ 
62 


6 Monetary ItIli<:y Report to the Congress O February 2012 

expectations of a 100ft gradual pactof increase in the 

federal funds rate after liftoff. 

Domestic Del·elopments 

The Household Sector 

Consumer Spending and Household Finance 

Real personal consumption expenditures (PCE) rose at 

an annual rate of about 2 percent in the second half of 

2011. follollinga rise of just lYi percent in the first half 

of the year (figure 3). Part of the spending gain was 

attributable to a fourth"'luarter surge in purchases of 

IOOtor vehicles fol\oll;ng I·ery weak spending last 

spring and summer stemming from the damping effects 

of the earthquake in bpan on IOOtor vehicle supply. 

Even lIith the srep--up. however, PCE growth was modest compared with prel'ious busincsscyde recoveries. 

This subpar performance rellects the continued weakness in the underlying determinants of consumption, 

including sluggish income growth, sentiment that 

remains relatil'e~'lowdespite recent improvements, the 

lingering elfectsof the earlier declines in household 

wealth, and tight access to credit for many potential 

borrower~ With consumer spending subdued. the saving rate, although down from its rerent high poin~ 

remained above levels tbat prevailed prior to the recessiOD (figure 4). 

Real income grolllh iscurrent~' estimated to hal'e 

been I-ery weak in 201 1. After rising 2 percent in 2010, 

aggregate real disposable personal income (DPI}-

personal income less personaltues, adjusted for price 

changes-was e5St'lltial~'fiat in 2011 (figure 5). The 

wage and salary romponent of real DP!, which reHetts 

3. (bange in ml pmooal oonsumpuoo e:qltnditwcs, 

200$--1] 

-"'-"" -, 

=11 I ni'i= ~ I - , 

-, 

- , 

- , I] ] 

:ro; m 'K1fl m m IlIO !lIt 

Non: n..dII .... .,.....,1j- nl"'_tlrnJth<l:lll:Q-l Soooct:: ~<l.eo._.Bo. ... d."""-,,AnaIy1,~ 

4. Pe!SODll sal·ingrate, \988-20\1 

-

-. 

-. 

- , 

t ]!!!II II ]]]]]]]II I II I II]] 

1991 tm 1999 m 'XIJI 3Jll 

NO'll: n..u. .. ~nl<1t<n:1tm.gh::nll:Q1 

Sow;,.; n.p.._olOJm""'ce.Il"'lIDof~AruIy';"" 

both the number of hours lI'orked and lverage hourly 

wages adjusted for infiation, rose at an annual rate of 

J peltent in 201). The increase in realwlge and salary 

income reflected the continued. thougb tepid. re\Xl1-er· 

ies in both employment and hours worked; in contrast, 

hourly pay w3slinie changed in re.1lterms. 

The ratio of household net lIurth to DP! dropped 

back a lillIe in the second half of 2011, reOecting 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 le\,elthat preI'ailed prior to the late 19901, but well below the highs 

recorded during the boom in house prices in the mid2Q((1s. Consumer sentiment, which dropped sharply 

last sununer, has reboullded since then; ne\"ertheless. 

s. a.:mge in real dispc&bJe pt'rsoJl:ll ilK'Ol!le and inrt;ll 

\\'age and salary disoorsements, 2OOS-11 

-

-. 

-, 

- , 

-, 

- , 

-. !] I ! ] ! 

:ro; :ro; m )Xl! m lOtO )'lIt 

Nan: Cbqt ,,&...Doo:t .... "'~. Th! , .. 1 ... .-.:1 w., dilluoo_ om.. i1 ,..,mI _ .00 • .....,. diItu,,_ddlMod by 

""p<r«DOI~t~dto.c.. 

Sow.-?: n.p..._dCom_ce,I\_lIDof~AruIy';" 
63 


6_ We3lth-lo-iocOO1e rltio, 1988-20[ I 

_____ --"0. 

-1 

- II. /I -. ~ ~ l 

[""" ' " ' "'""' "" ' " I 19'11 1995 1m :m3 1«J/ Xlll 

Non: Tho <10:. "" """"ly..t nt<n:l ~ )Jll:Ql Tho ... olth· 

"'~,...,islhern,d_ ... wtttlrt()~~p"o<:tl.ol 

.... ScoRe!: Fa "" ....... r.dtrol R.ooorn Boood.lIowoflirldsd .. ; for 

_.~oCCom..,.".s.. ... d e.",.,.i<Ar..tyri< 

the.>e gains only IOOvcd sentiment back 10 near the top 

of the range tbat bas prevailed since late 2009 

(figure 7). 

Housebold debt-tbe sumof both IOOrtgage and 

consumerdebt----mntinued to IOOI"e lower in the second half of 2011. Since peaking in 2008, household 

debt has fallen a tOLl) of 5 per«nl. Thedrop in debt in 

the second balf of 201 I reflected a continued contraction in mortgage debt that lI'asonly partiallY offset by 

a m:xiest expansion in consumer credit. L1rge!y due to 

the reduction in OI-era1l household debt levels in 2011 , 

the debt ser.'ice ratio-the aggregate required prinCipal 

7. Coosumer sentiment iIJde.\es, [998-2012 

- '00 

I ' I ' I I ' , I ' I ' I I ' I ' I ))XI m m m Xl12 

Non: Thoc.rn..r.:.BOOIddlu"" .:rc hly..tnterd~l.....,. 

XlI2; .... min is mud "' «p>al 100 in 1981_ Tho n.:.....r R.tM..u .... .my d ~!idut;'"' <10: ••• -..hlj- ..t nterd ~ 

~)J12;"" ........ m...d1O"JI'II100", 1966. 

Sooi:C!: Tho c.:m..r-.. ... 8ooo;J ..t n.:.....r ..u""ml}" of 

M"-1Ij~:n S .... ~'d C;o.um..~ 

&wd of a>\~or$ of/he Federal ~r\'e Syslem 7 

and interest payment on existing IOOrtgagesand consumerdebt relative to income- also decreased further 

and now isat a lel·ella;t seen in 1994 and 1995 

(figure 8). 

The IOOderateexpansion in con;umer credit in the 

secoDd balf of 2011, at an annual rale of about 

4Yi percent, has been dri'.-en prinurily by an increase in 

nonrevo\ving credit, which acrounts for about two· 

thirds of total consumer credit and is composed 

nuinly of auto and student loans, Re\1)ll'ing consumer 

credit (prinurily credit card lending). while conlinuing 

10 Jag, appeared to pick up somewbatlOwlrd the end 

of tbe year. The increase in consumer credit is consistent with recent re;ponses 10 the Senior Loan Officer 

Opinion Surwy on Bank Lending Practices(SLOOS). 

Indeed. trodest net fractions of bank; in both the 

Cktober and January sur.·e}'S reported that they had 

eased standards on aU major C3.legoriesof consumer 

loans, and that demand had strengthened fOf auto and 

credit cards loan. on bllance. HcwC\·er, data on credit 

card solicitations suggesllhatlenders in tbat area are 

prinurily interested in pursuing bigher-quality 

borrowers. 

Indic3.tors of consumer credit quality generaUy 

improl~. Delinquency rates on credit card loans 

IOOVoo down in the second half of 2011 to the low end 

of tbe range ob>en-OO in recent decades. Delinquencies 

and chlrge-offson nonrevol\'ing consumer loans also 

generally imprc\~. MOr(:()\'er, a majority of respondents to the hnuary SLOOS reported that tbe)' expect 

further impl"()\'ement in the quality of credit card and 

other consumer loans this year. 

8. HousdloIddebl senice, 1984-2011 

! [ ! [I[[[[I[ ! [ ! [ ! [[[[I[ ! [ ! [ ! [[[ ! 

1m 1991 1m 1m »)l xm XIII 

Non: Tho diu "" ~..t -m hnrsh Xlll:Q3. n.bt om' .... 

PI)"_ <UIri~ d ", .. 3ft<d ""'PII«I [lOl'_ a> ouudq.atl4< ..,~ ... SoIE!!. r.dtrlll R...rv. bd. "1Iruo./dd Dtbt ""if< a-d Fiwriol 

ObqIfi<n<Rm.-.--.I,."' .... 
64 


8 MonetaI)' ItIli<:y Report to the Congress O February 2012 

Interest rates 00 consumer Joans held fairly steady, 

on net, in the second half of 2011 and into 2012. Interest rates on new-auto Joanscontinued to be quite low, 

while rates on credit md loons reffi1ined stubbornly 

high. Indeed, spreads of credit md interest rates to the 

two-)'eJrTre3iury yield are I"er)' elel'ated. 

Consumer asset-backed smlritieS (ABS) issuance in 

the second half of 2011 was in Un e with that of the 

prel'ioui 18 IOOnths. Securities backed by auto loans 

continued to dominate the market, while issuance of 

credit card ABS rema ined weak. as growth of credit 

card Joans has reffilined subdued and IOOst ffi1jor 

banks have chosen to fUDd such JoaDson their balaDce 

sheets. Yields on ABS and their spreads over 

comparable. maturity swap rates were little chaDged. on 

net, om the second half of 2011 and C.1.rly 2012 and 

reffi1 ined in the low range that has preva iled since 

C.1.r~' 2010 (figure 9). 

Housing Acth'ity and Finance 

Actil'ity in the housing sector remains depressed by 

historical standards(figure 10). Although affordabilit)' 

hH beeD boosted by declines in bouse prices and historically low interest rates for conl'entionallOOrtgages, 

many potential buyers either lack the down payment 

and credit history to qualify for Jo:lDsor are discouraged byongoing ooncern, about future income, 

empJo)1l1eJlt. and the potential for further declines in 

house prices. Yet other potential buyers-(I'en those 

lI;th sufficient~' good aedit records to qualify lO r a 

9. Spre3ds of assel-backed securities }iekk 0I'e( rates 011 

oompanble-maturity interest rate SWl(lS, 2007-12 

-------------------------."'.~ 

-" 

Non:; Tho <hi, 10' -u,. nl .. tml ~ F.«u.y 23, ))11 Tho 

opt .... ....,." 10' tho )'ltil;"" l_ lU r1.Ud-,. """.bo.:bd ..,.., ... 

leulil, .. ""tw-j'<iI _Iill< .. ,,,,," 

5cm:C!: /P!olcqan 0.... &: Co. 

10. PriI"lubousiogstlrtS,I'I98-20l2 

-u 

I I I 

~ I I I I I I I I I I I I I I 

1m 2(0) 3Xl2 IDI m m ))10 ))12 

Nom: Thod:r.a ... ..-hIynltlt<fldlk;qh ~))ll 

500= I:<po.!_ofeo."""",B ...... oflhtc...u. 

" 

IOOrtgage insured by one of the housing gol'ernmentsponsored enterprises (GSEs)-rontinue to fatt difficulty in obtaining mortgage financing. Mor(:(lI'er, 

much of thedeffi1nd that does exist has been channeled to the abundant stock of relatil'e!y inexpensil'e, 

vacant single-family house~ thereby limiting the need 

for ntw construction aail;ty. Gil'en the ffilgnilUde of 

the pipeline of delinquent and foreclosed homes, this 

factor seems likely 10 continue 10 weigh on activity for 

someume. 

Nonetheless, ftctllt indiCllDrsof housing construction actil'ity Jure been slightly ITKlre enoouraging. In 

particula~ from July 2011 to ln~a y 2012, new singlefami~' homes were SlJrted at an average annUlI rate of 

about 455,000 units, up a bit from the pace in the first 

half of 2011. In the multifamily mlrket, deffi1nd lOr 

apartments appears to be increlSing and I'aeaney rates 

have falkn, as families who are unable or unwilling to 

purchase homes are renting properties instead. Asa 

result, starts in the multifamily sector aI'eraged about 

200,000 units at an annUlI rate in the second JuIf of 

2011, still below the 3OO,000-unit rate thai had prevailed for much of the previous decade bu t well alx)I'e 

the !oil'S recorded in 2009 and e:lfly 2010. 

Uouse prices, as measured by several national 

inde:xe~ fell furtherorer the second half of 2011 

(figuft 11). One such measure with wide geographic 

coverage-the CoreLogic rtpelt-sales index- fell at an 

annual rate of about 6 percent in the socond half of the 

year. House priCes are being held down by the same 

factors that are re.training bousing construction: the 

high Dumberof distressed sale~ the la~e inl'enlOl)' of 

unsold homes., tight IOOrtgage credit conditions, and 

lackluster deJl1.'lnd. The inl'eJ)tof)' of un>old homes 

likely will remain high for some time. gil'en the large 
65 


II. PrictS of existing single-flDlily booses. 2001 - 11 

-------------------------',. ... 

I I I I 

"" I I I I I '" '" I I I .n 

• 

Nom: u"cbb_ ..;dJIyoltlOtlld no))II:Q.!.W riln .... twn 

""".>r<t ", 1IuI iI, p'. is 100. iWltlle Ctul.osi<I'''' irrleJI nl be 

AlFA ru... (hanl)' <OINI.a!<d b)' be 0fI' ... <i. Fodnal HOUIl! 

EMIt.. Oom.g,.) "",UIO !'1m. If1In:tionI 0fIIy. u" 

S&PK:_ Shillt<m'''lle<t< ..... ,· ~ .... ''''''''-w..in,. .... "1«I 

1II<IIq<Il;~ " .... 

Swtc!; Rw Catlos". CatLop:; fa AlFA. Fodnal ~ "'""" 

~;b s.t I'!l: ... -ShlItt.Ston:brd&Poor· •. 

number of homes that are already in the foftClmure 

pipeline or could be entering the pipeline in the coming 

month~ Al a mul! of the cumulatil'e dedint in bouse 

pricesowr the put several years. roughly one in fixe 

mortgage holders owe more on their mortgages than 

thdr home;; are worth. 

Indicatorsof credit quaUt)' in the residential mortgage sector continued to rellect strains on homeowners 

confronting depressed home values and high unem. 

ploymenl. In December, serious delinquency rates on 

prime and near-prime loam stood at 5 percent and 

13 perct'nt for fixed · and variable-rate loans, respectively (figure 12). While delinquencies on variable·rate 

mortgages for both prime and subprime borroll'ers 

have mol'ed down OYer the past two years, delinquencieSOD fixed·rate mortgages hal'e held ;teady at lel'els 

near their peak! in early 2010.1 Meanwhile, delin· 

quency and cbarge-olf rates on second-lien mortgages 

held by ronks also are at elel'ated lel·e[s. and they have 

declined only slightly from tbeir peaks. 

The numberof properties at some stage of the foreclosure process remained elel'ated in 201 1. This high 

ltl~l partly rellected the difficulties that ITVrtgage ser· 

'lcers continued to ha\~ with reroll'ing deficiencies in 

their foreclosure procedure~ Rerolution of these issues 

could el'entually be associated with a sustained 

increase in the p:1ce of completed foreclosures as seTI;cers work through the backlog of St\'erely delinquent 

loans. 

AmM~agt ""iiDol>l!eriOU$/yddj"lu"l! flbe~jl 

90 day.; or """" behind in pi)1llClll< or {be prorerty iI in k...::100= 

&wd of a>\~or$ of/he Federal ~r\'e Syslem 9 

12. Mortgage delinquency rates. 2(0)..11 

------'- _ Pnroe and rear prime 

I I I { I I I 

:DJt lID 100S 

Sut>prime !iJ 

= ('-=: IO I I I I I I I I I I I I I I I 

XOI XO} 100S m1 )))9 ))ll 

Non: Th:dlull. IICfIh!y ..-d ,,".ndl~llo<t .. ba ))1I krl'_ 

nt .. " P"'" nt~Noo<""" ))11 b,.qn" Do~ .. ;'h p!'K<lt<i.m...90dope< _ """lbe<in n...:""" 

~ """I'''' iind .. " p" .... J1ISAwlitdAnol)-to::s; b oUlp' .... 

Catlosic. 

Intere!t rates on fixed·rate mortgage! fell steadily 

during the sroJnd half of 2011 and in elrly 2012 

(figure 13), though not as much as Treasul)' yields. 

leal'ing spreads to Treasury securities of comparable 

maturities wider. The ability of potential borroll~rs to 

obtain mortgage credit for purchase transactions or 

refinancing continued to be limited. In part, the low 

level of mortglge boIT(llling reflected characteristics of 

the would-he borrowers, most prominent~ the widespread incidence of negatil'e equity and unemployment. In addition, credit supply conditions remained 

tight. Indeed, it appeared that some lenders were reluctant 10 extend mortgages to borrowers with leSHlian· 

pristine credit even when the resulting loans would be 

eligible for purchase or guarantee by GSh' One 

nunifestation of tbis constriction was the facttbat the 

distribution of credit ;;cores among borrowers who 

succeed in obtaining mortgages had shifted up signifi. 

cantly (figure 14). As a result of these inOuences, the 

pace of mortgage appUC.1tions for home purchase 

dec~ned, on net. over the sroJnd half of 2011 and 

remains very sluggish. The Slme factors also appear to 

bare limited refinancing actil;ty. whicli remain! subdued compared with the large number of households 

6. M e:wupIc, <>DIy aboullatf of leaden .. pemJ to Lo:nSifler 

dati 1lt'I'i:u lhat ~ muid o/ft1 a oom'ttIUooal fully doctuueclo.:! 

mMpg< .. i1b.90" •• ttll!\oa"l"'''''hr ftliofor~ .. 'i!h 

CO of 620. 
66 


10 Monetary ftlhcy Report to the Congrtss O February 2012 

[3. MOI1gageinle!eslrlles, [99S-2012 

... 

-, 

-, 

-, [ I II I " " I I I " " I I " I 19972O:))nnmm:rll2 

Non: Thtdn, """,,,:I"< wt<kI)' RI",,1tIId h"'IdIf.tbru.y12. ~Il. 

... ",""",,,,, ... <tl:JO.)'<,,""".!~ 

SooOCL Fodn~ I"-l<>IIII~htt. Capc:ulm. 

that would potentially benefit from the low ratesalllilable to high.quality borrowers. 

The outstanding stock of nxmgage-backed securities(MBS) guaranteed by the GSEs was little changed, 

on net, om the second half of 201 l. The securitization 

J1l.1.rket for IOOrtgage loans not guaranteed by a 

housing-related GSE or the FederalllousingAdminis-

[ration continued to be e~ntiallycloscd, 

The Business Sedor 

Fixed lm'estnrent 

Real spending by businesses for equipment and software (E&S) rose at an annual rate of about II perctnt 

over the second half of 201 1, a pace tht wasa bit 

14. Cr.:dil sroreSOODeW prime mortgages, 2((13-1 1 

------------------~=-

-~-" 

-'> -'" - - 100 

- -1.rJ 

Mfdillll - 1lJ 

-

:: 1,.,,,,,_,10 -::: WJ 

- -"" I I [ [[ 1 I I I nnmmml.ll1 

NO'!!: Thtdn, _i1."'W<!U<haoo __ l~<rly>.,._hlyRi 

",1tIIdtt..;qh~l.l11 

Soom: IPSAp;IIiodAnolytri 

faster than in the fif'lt half (figure [5). Much of tbis 

strength was recorded in the third quarter. Spending 

growth dropped back in the fourth quarter, to 5 percenl, likely reOetting-among other inHuencesheightened uncerta inty of business owners about 

global economic and financial condition~ Allhougb 

spending by busine.se;; for high-tech equipment has 

held up reasonably weU, outlays for a broad range of 

other E&S slowed appreciab~ . More m:ently, boWell:r, 

indicators of business sentiment and capital spending 

plans generaJ~' hal'e improved, suggesting that firms 

J1l.1.)' be in the process of becoming more willing to 

undertake new in\'estment~ 

After tumbling throughout J1X)st of 2009 and 2010, 

real inl·estment in nonresidential structures other than 

drilling and mining turned up last spring, rising at a 

surprisingly brisk PJce in the second and third quarter> 

of 2011, Howem, inyeslment dropped back in Ihe 

fourth quarter. Conditions in tbe ~tor remain difficult: Vacancy rate. are sliU high, pri«.of existing 

structures are low, and financing conditions lOr build· 

er> are still tight Spending on driUing and mining 

structures also dropped back in the fourth quarter, but 

15. Change in real business fIXed iIlvesbDeot, 2005-11 

-" 

-" 

t [ [! [[ [ , I 

mmmmml.llOl.lll -.. ,""""- o s..rt. .. ndudqIlDltDl~i11iot 

• ~lnrI!DI~,n", - 00 

-< 
67 


outlay~ in thi~C3.tegOly should continue to be ~up' 

ported by elevated oil prices and advances in technol, 

ogy for horizontal drilling and hydraulic fracturing, 

In~'t ntory Investnrent 

Real inventory investment stepped down a bit in tbe 

second half of 2011 (figure 16), Stoc1building outside 

of Imtor I'ebicles increased at a mode;! pace, and ~url'eyS sugge;t that firms are generally comfortlble \I;th 

theiro\lll, and their customers', current inventory 

position~ In tbe Imtorvebicle sector, inventories were 

drawn down in the second half, as the rise in sales outpaced tbe rebound in production foUowing tbe supp~' 

disruptions associated witb the earthquake in Japan 

Ia;t spring, 

Corporate Profits and Business FiNlnce 

Operating earnings per share for S&P 500 firms continued to rise in the third quarter of 2011, increasing at a 

quarterly nne of nearly 10 percent. Fourth.quarter 

earnings reports by firms in the S&P 500 published 

through late February indicate tbat this measure bas 

remained at or near its pre<risis peaks throughout the 

second half of 2011, 

In the corporate lector as a whole, economic profits. 

which had been rising rapidly since 2008, increased 

further in the second half of 2011. This rel3tiwl), 

strong profit gr<l\l1h contributed to the continued 

robust credit quality of nonfinancial firms in the sev 

ond balf of 2011. Although the ratio of liquid assets to 

total asselson tbe balance sheetsof nonfinancial corporations edged dO\\'ll in tbe tbird quarter, it remained 

16 OJangein lealllIsilWss illl'('fItories, 2005--11 

_ '00 

I ! ! t 

))l\ m VJ1 m m ;010 ))Il 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 11 

at a I'ery high level. and the aggregate ratio of debt to 

assets-a measure of corporate lel'erage-stayed low. 

With corporate bJ.1ance sheets iu generally healthy 

shape, credit rating upgrades once again outpaced 

downgrades, and the bond default rate for nonfinancial 

firms remained low, In addition, the delinquency rate 

on commercial and industrial (C&I) loans at commercial banks rontinued 10 dcdine and stood at around 

l'h percent at yeaHnd, a level near tbe low end of its 

bj",orica1 range. Most banks responding to the January 

SLOOS rqx>rted thai they expected further improvements in the credit quality of C&I loans in 2012. 

Borrowing by nonfinanciil corporations continued 

at a reasonably robust p3ce through the second half of 

2011, particularly for larger, higher-credit-quality firms 

(figure 17), Issuance of inl'eStment-gflde bonds progtt;.sed at a strong p3te, similar to that observed in the 

first balf of the year, buoyed by good corporate credit 

quality, allracti\'e financing conditions. and an improving eronomicoutlooi:.. In contrast to higher-grade 

bonds. issuance of s~ulatil'C-grade bonds dropped in 

the second half of tbe year as investors' appetite lOr 

riskier assets waned, In the market for syndicated 

loans. investmeDl-grade issuance JOOved up in tbe second bilf of 2011 from its ilready strong first,bilf pace. 

wbile issuance of bigher,yielding syndicated leveraged 

loans weakened (figure 18), 

C& l loanson banks' books gr(N,' steadily o\·er the 

second half of 2011 , Banks reporledlycompeted 

aggressil'ely for higher-rated credits in the syndicated 

leveraged loan market, and some nonfinancial firms 

reportedly substituted away from bond financing 

OO:auseof volatility in bond sPreJd~ In addition, 

according to the Sl(X)S, some domestic banks gained 

17. Selecto:l oom!XJlleDlS of 00 financing for nooflDlIlCial 

businesses, 2005-1 I 

-" 

-< 

I I I I I t II I I 

Dl'i3ll6mmm3:l1O))1l 

Non: fu<b!'k<~--,<=p_",........tIj' Idj.-L 

Sow::>;; Fo.kalJ<e.o.o..Bo.d.tIo.<l.ltn!t:dat~ 
68 


12 Monetary ftlhcy Report to the Congrtss O February 2012 

18. Syndicated ioonissulDCt, by credit quality, 2005-[ I 

"' 

HI HI 

[ I 

"' - ,., 

- <00 

I I 

Nom: L<-m~Io;n- .. <Io;n-,*"lIBt,. _.,.1H*<IIo;n- . liII 

.-.. _1IuI",,· ••• opIrH'I'.ildlolht l.<nbJ iootrhft:dftttd 

..... ,. IlBCil.11>o b'ot of ... '1' ... :1 rtq.Jnd let. loon lObo labtlo:l. 

1rnrO«d1oon v ..... aoo::<dOJglo_oordiIio:m..Jircmtlllly 

U'lb!<Kpo!If<. 

s.o<mz: Tho.smRMt.,~ 

business fromcu~tomer; that sbifted away from European banh Altbough domestic banks reported ~ule 

change, on net, in lending slJndards forC&l loans 

(fig ure 19). they reduced the spreads on these l03nS3; 

well as the coS!! of credit lines. Banks that reported 

ba\ing eased tbeir credit standards or terms for C&! 

loans onr tbe second balf of 2011 unanirmuslycited 

increased competition from other banks or nonbank 

SOUKtS of funds as a factor. 

19. Gange install(brds and ~llllIld fa: OOIlIIllercial and induslrialloons, 1991- 2012 

------------.------."'--~'.' 

-J5 ,,,,,", 

- .1$ 

NO!!: 11>0<111> ",,<i ~n fro •• ...., g'IItDllyronh:!<d ....... P'" 

)'<'0<; Iht It!I """""''''''' It fro. "" J ... .y 3:lt2 .... t)', .·htoh ,,",'m 

;Q1l:Q4.Eod>..n.. It. "'.poI,," DIn ht,,,,,tonlI.lht ... ptK<fII,!<of 

"'1I"",cioimlini.o"'ioI""",,,,domtsIitft~·bolm;<""foI 

.ru:hbart.rtpO<Itd~~OWl:IudoOl~IwId:."n:lO"<Irft: 

P'" h", -m.. 'II'fh ~.bo><d",C.rIR<portdm- 11>0 <h>do:Ibon 

nli<lI<ptnod>olba ..... """""" .. d:lln.dbylht N.1iomI Bm. .. of E>xm.,,~ 

Sow:!:: I ~. Bod s.n.x to.n Off_ Oponm s...y on 

Bri.~~ordC.IIRt9om. 

Borrowing condition, for muller businesses continued 10 be tighter tban thOl:e for larger 6rms, and their 

dern.'wd for credit rermined reLltively weak. \Iowe\'er, 

some signs of easing began to emerge. Surveys conducted by the National Federation of Independent 

Business showed tbat the net fraction of snull businesses reponing that credit bad become rrvre difficult 

to obtain relative to tbe previous tbree montbs 

decUned, on baJaoce. during the second balf of 2011 

(figure 20). \loreo\'e~ tbe January 2012 SLOOS found 

that terms for smaUer borrowers bad continued to ease. 

and about 15 percent of banks. on net. reponed that 

demand farC&l loans from smaUer firms had 

incre3sed, the highest reading ~ince 200S.lndeed, C&I 

loans held by regional and cotrulUlnity banks-those 

not in tbe 25 Largest banks and likely to lend mostly to 

middle-market and small firms-adl'anced at about a 

6 perttnt annual rate in the serond balf of 2011, up 

from a 2~ percent pace in the 6rst hair. 

Commercial mortgage debt hascoDtinued to decline, 

albeit at a!mre mxlerate pace tban during 2010. 

Commercial real estate (eRE) iOlDsheJd on banks' 

bookscontracled funher in the second balf of 2011 

and ear~' 2012, though the runoff appeared to ebb 

somewhat in 2011. That slowing is!mre or less consistent lIith recent SLOOS responses, in which JOOderate 

net fractioDsof domestic banks reported thatdemaDd 

far such loans had strengthened. In the January survey. 

bank; also reported that, for the first time since 2007, 

Ihey had raised Ihe nuximurn loan size and trimmed 

20 Net percentage of smaU busiresses IlIat reported lIKKe 

difficulty in obtainingcr~di{, 1990-2012 

--------------------------~.~ 

I I I I ! I I ! I I ! I I ! I I ! I I ! I I " I I Iml996m:n»m8))1? 

N= Tho dolo 10' th.n i<a • .... '.y <mirt«I ~ -.I .. 

.. >SalOl)' odilSIt<I; rft: Ia\( """"'1lb<CI i. & .. tho JDlK)' 3:112 U"'Y, 

~hio."'''''''''O'':' ... 3:II1,Thod3<.rtp<stnlIht~ofb«roo. .... 

.mtwgloa«ti .. thop"' ...... ..m.-tho:,~'"""<i/foruky .. 

'*"UlIn!:n.dirlmtho~thoIr<pOIIfd- .... .. ~ 

""" Soula: NaIIOrI>lFodtfall<llofl~B""""" 
69 


spreads of rates on CRE loam overtheir cost of funds 

during the past 12 I1'I)nths. By contrast. life insurance 

companies reportedly increased their holdings of CRE 

loam, e>pe<:bJly of loam issued to bigher-qullity borrower~ Althougb delinquency rates on CRE loans at 

commmill blnks edged down further in the lOurth 

quarter, they remained at high levels. especiaUyon 

loans hrconstruction and land dC\'elopmen~ delillquencics on loans held by life insurance companies 

remained extraordinarily low, as they have done hr 

I1'I)I'l: than a decade (figure 21), Vacancy rates for !TKlst 

types of commercial propenies are still elevlted, exertiIlg downward pressure on property prices and impairing the performance of CRE loans. 

Conditions ill the market for commercial trortgagebacked securities (O-IBS) worsened somewhat in the 

second half of the year, Risk spreads on highly rated 

tranchesof CJ\tBS 11'1)\'00 up, on balance, and about 

half of the rtSjXIndents to the December Senior Credit 

Officer Opinion Surrey on Dealer Financing Terms 

(SCOOS) indicated that liquidity coDditions in the 

markets for sucb securities had deteriorated somewhat. 

Issuance of CMBS slowed further, but did not halt 

21. DelinCfleocy rales OIl COOlIIlerci31 rell estale loans, 

1991 - 2012 

__ c_ .... ___• __ .. _" ________________ --C ... 

IIIII! I III ! I I! II I I! I II I! I 

1991 t9'/.l t997 3D) 200J :m6 VII :.!O12_. 

~-;:: ( = 'j- ; 

, I I! III I ! III I ! II! I II I ! II! I 19'11 19'/.1 1997 3D) 200J :m6 VII :.!OIl 

Non: Th:dJuf«~a1l>dfonJliCtlll\l"...,«JIIIPD'$ .. 

""""'" onJ.-.I Ibuogh :.!011,Q4 n! llll:QJ. """",ivo!y. Th: <b:> 

h- ~i.Il ""t>g<·brltd.....nn (ams)..,.nIJIy onJ tUffid 

Ih-<qh J....,. 2011 Th: n.lnvn<J' , ... b .,.,._<1IIl brio onJ 

OIBS ..... perMr!<iIonJOdo)-~<t ""'poII cb", rw:j """""' 

m...o;.Th:n.~ r .. f<tlilt ...... ,..,.~~t"'perMr!oI 

bm;60doj-,<t_poIIh<t rnl"""""l_ oo.~ R:. .,.,.gmlll bH:l, ~.. F""'ial 1no6u"", 

Ell......,., U:tn",l Caoolrlll:od Rlpct1I <i Carlr"" m rr.:-. (CoIl 

Rop:xt); f«if<'n'.n-.' .. ~.~Comcil<il4.r ..... ~b 

alBS,Cil~ 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 13 

completely. Delinquency rates on eRE loans in CMBS 

pools held steady just below 10 percent. 

[n the corporate equity market gross issuance 

dropped significantly in the third quarter amid subSlantial eqUity market I'olatiliry, bur it retraced a part 

of thm dedille in the fourth quarter as some previously 

withdrawn issues were brought back: to rhe market. 

Net equity issuance continued to dec~ne in the Ihird 

quarter, reOeclillg the contillued strength of cash· 

financed mergers and share repurchases (figure 22). 

The Gowrnn.:ot Sedor 

Federal Government 

The deficit in the federal unified budget remains I'ery 

wide. The budget deficit for fiscal year 2011 was 

$IJlrillion, or 8~ pelttnt of nominal GOP-a leI'eI 

comparable \\;th deficits recorded in 2009 and 2010 

but sharply higher than the deficits recorded prior to 

theonstt of the financial crisis aDd recession, The bud· 

get deficit continued to be boosted by spendillg that 

wascommil1ed by the American Rccol'ery and Reinvestment Act of 2009 (ARRA) and other stimulus 

policy actions as well as by thewe:lk:ness of rhe 

economy, whicb has reduced tax revenues and 

iIlcreased payment:; for income support. 

Tax receipts rose 6\1 percent in fi;ca[ 2011. Howel'er, 

the lel'el of receipts remained very low: indeed, at 

around 15\1 percent of GOP, the ratio of receipts to 

national income is only slightly abol'e the 6O-year lows 

22. COIIlpQllf'ntsQf net tqnity issuance, 200s-11 

-. PIt.li<......,. • 1m ... ,,,,,,,,,,, 

- . Rt!u<holn 

M"-F"m~ 

- _ T",. 

I I I I [ I! ! I 

:.ro5 :m6 WJ m m 2OtO 2011 

• 

• 

Non; Nt!..,......,. .the di/for.,.,.bd-..f<JIIO)";"",.j b)' 

~"""P""" ... pojIl"", P"" _btl m..:pty,<1t <d1buogh 

dur<~~<..t>-f"",-"Od_",f<njpl,,,,,,,,,01 

U.s. f .. ~ ~ imurroe n or. Iini: rivtsI<d by pi .... ...., 

~"",,,onJ>t:lo:lr"''':''P~ 

S<:M.ta: n.-mFiomoial,!nI""'_~Rtpc:t1;M"" I'T"" 

Rop::rtbyPr""~ NObOrral\' ...... Co{ootalA""".oon. mV<rn<&m:-.", 
70 


14 Monetary ftlhcy Report to the Congrtss O February 2012 

recorded in 2009 and 2010 (figure 23). The rise in re\'o 

enue~ in fiscal2011 wa~ the reiult of a robust increase 

of more than 20 perrent in individual inrome tax payments that reOected strong final payments on 2010 

inrome. Social insurance tax receipts fell about 5 percenl in fiscal 2011, held down by the temporar), 2 percentage point reduction in payroll tamenactw in 

201 0. Corporate taxes also fell around 5 percenl in 

2011, with the decline largely the result of legislation 

providing more-favorable tax treaDnent for some business inl·e.tment In the first four months of fiscal 2012. 

total tax receipts increased 4 perrent relatil·e to the 

comparable Ye3.r-earlier period. 

Total federal oUIl.1.)"S rose 4 percent in fiscal 2011 . 

Much of the increase relatiw to bst yell" is attributable 

to theeulier unwinding of the effects of finlDcial 

transactions, such as the repayments to the Treasury of 

obligations lOr the Troubled Asset Relief Program, 

\\·hich temporarily lowered measuredoutl.1.ys in fiscal 

201 0. Excluding these transactions. oullays were up 

about 2 perrent in 2011 . This small increase reHects 

reductions in both ARRA spending and unemployment insurance payments as well as a subdued pace of 

defense and Medicaid spending. By contrast. net interest payments rose sharply, reHecting the increase in 

federal debt. Spending has remained restrained in tbe 

current fiscal year, with outlays(adjusted to exclude 

financial transactions) down about 5 perrent in tbe fifSl 

four months of fiscal 2012 relatr.·c to the comparable 

year-tarlier period. 

As measured in the national income and product 

acrounl!(NIPA), real federal e.>:pendiIUfe! on consumption and gross investment- the part of federal 

23. FeO.>raJ receipts andeJ:peOOitur~, 1991-201 1 

/¥<>IIct".,,,.IOOI' 

- . ..." 

- D 

1 " " 1 ! " " " " " ! " " ! 1 19'Il 1m 1999 m m7 lilt 

Na,,;; n.."",,,,n:I~.w..IR .... IriI",..j~n.;.uI 

_ fur fll<">l )"ta. «(),;@n lIrwgh s.p.""",~ t"'" dow\l" "m.:. (GDP) " fur tie klz o:pWl • ..-df\tonQ3. $oolCl: OIf""' d. ~ianal<_ul~. 

spending that is a direct comp:ment of GDP.....{jecreased at an annual rate of about 3 percent in the socond half of 2011 , a little less rapidly than in the first 

half of the year (figure 24). Defense spending fell at an 

annual rate of about 4 percent in the 5C«1nd half of the 

year. a somewbat sharper pace of decline than in the 

first half. wbile nondefense purchases were unchanged 

ol·er this period. 

Federal debt surged in the second half of 2011, after 

the debt ceiling was raised in early August by the Budget Control Act of 2011. 1 Standard and fuor·s (S&Pj, 

which had put the U.S. long.termsovereigo credit rating on credit watch negative in June, downgraded that 

wing from AAA to AA + following the passage of the 

act. citing the risks of a continued rise in federal gOI'-

eroment deht ratios oyer the me<lium term and dedining conftdence that timely fiscal measure! nectSS.1.!)' to 

place U.s' pub~c finances on a sustainable path v,ould 

be forthroming. Other credit rating ageocie; subsequently posted a negative outlook 00 their rating of 

U.S. sovereign debt. on similar grounds, butdid not 

change their credit ratings. These actions do not 

appear to hll·e affected participation in Treasury auctions. which continued to be well subscribed. Demand 

for Treasury securities was supported by market par· 

ticipants' preference for tbe relative safety and liquidity 

1. On by 16, tilt frknl o'dlI ",,,,btd tl<: $14194 1riI~"" I;mi~ 

.00 lbe Secretary <>f lbe Tr=ury dcclarc.l a -<kbt ;"""'''''' <IIipCIl 

o:ioo period" h !be 0.;1 Smicc R.tittment ,nd Disability Fun;\. 

pnmjnio;g!be TIWWy to !<dma , l'C'tioa of ni;mg T",OSU/)' 

!l<"IlI"i!ies bdd by Ih>I fwd *1 invellnlttlli and 10 snspn>d ;"""'''''' rJ ".... TrtaSllr)'OO:wilico; to Ibal fund a, invei!IMIlS. The T",as"'Y 

.""bel!i'nsu;pcndill800med.· daily~lofT"",sury 

se<:IIriri<s bdd .. ~ by !be G<lImIlImI Securitioo l,.....· 

ID<I!t Fund d t~ Fcdml Emplo)..s' R<timnent S)st<ID Thrift 

Saviogsi'bn 

2-:1 Cb:IDgI! in lell gOl·emroeut expenditures 

OIl consnmption illld inl"estmml, 2005-11 

-. 

-. 
71 


of such securities. Bid,to-cQI'er ratios were within historical ranges. and indicato~ of foreign participation 

rert\1 ined near their recentleveJs. Federal debt held by 

the public, as a percentage of GDP. oontinued to rise 

in the third quarter, reaching about 68 percent 

(fig ure 25), 

State and Local Gomnmtnt 

State and local governments rert\1in under significant 

fi;cal strain, Since July, employment in the s(:(tor has 

declined by an average of 15,0CKl jobs per IOOnth,just 

slightly un<!er the pace of job lossesreroroed for the 

first half of 2011, Meanwhile, reduction! in real con· 

struction expendilUtesabated after a precipitous drop 

in the first half of lOll , As measured in tbe NIPA, real 

state and local expenditures on consumption and gross 

inl'estment decreased at an annual rate of about 2 percent in the second half of lOll. a somewbat slower 

pace of decline than in the first half of the year 

(figure 24). 

State and local government rel'enuesappear to haw 

increased modestly in 201 1, Notably, althe stale level. 

third-<juarter tax re\'enues rose 5~ percentO\'er the 

year-(Jrl~r period, \lith the rt\1jorit}' of the stales 

experiencing gains. o\\-e\"e~ tbis inntasc in tax rev· 

enueswas pan~' offset by a reduction in federal stimulu! grants. Tax ooll(:(tionshave!>ten Its. robust at tbe 

1oc.tI1eI'CL Propeny tax receipts bave been roughly Oat, 

on net, since the .tan of 2010 (based on data through 

the third quarter of 2011), reflecting the downturn in 

bome prices. Funherroore, many localities have experi25, Federal gol'emment dcl>t held by the public, 1960-2011 

- 0 

I """""""""'""""""""""'"""'""" I t96t 1911 t98t 1991 :rot 201! 

N(I!'I!: Thou.fadtl:< ..... ofY".«rl;""""'""':rirnh3:111;,., 

....... _n..OC1I~ ....... htr"'"~'f"I'h'1(mP) •• fa 

QI 01 .,...w , ... E.<.:hdoo """".a.. h":1 _ "'_ of I!dot>l 

,.-~ 

$ OOlCl: F..:mI!l.=wBoa-d,l\:;lwoffinkdato. 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 15 

cneed a decrease in grants-in-aid from tbeir state 

gOl'ernment 

Issuance of Iong·term sccurities by state and loci! 

gOl'ernmenlS IOOVe<! up in the second half of 20 11 to a 

p.1ce similar 10 tMt seen in 2009 and 20W. lssuance 

bad betn subdued during tbe first half of tbe year, in 

pan bcalusc the expiration of the Build America 

Bonds program led to some shifting of financing from 

2011 into late20lO, 

Yields on state and local gOl-emmeDl securities 

decUned in tbe strond half of 2011 and into 2012, 

reacbing 1¢I'els ne-ar tbe lower end of their range over 

the past decade, buttbey fell to a lesser degree than 

}ield~ on comparable-l1llturit Trea~ury securi ie~ The 

increase in the ratio of municipal boDd yields 10 Treasury yields likely reOecte<!, in part, continued concern 

regarding the financial he:dth of state and local gOI'em· 

ments. Indeed, credit default swap(CDS) indexes for 

municipal bonds rose, on balance, om the strond half 

of 2011 but haw narrowed som:lI'hat in early 2012, 

Credit rating downgrade;; outpaced upgrades in the 

secoDd bIlf of 2011. panicular~' in December, iollowing tbe downgrade of a municipal bond guarantor,3 

The External Sector 

Real exporlSof goods and servKesro;;e at an annual 

rate of 4'1. percent in the strond balf of 2011, booste<! 

by continued gJ\)\\1h in ol'erall foreign ecooomic actil'-

ity and the lagged effect of declines in the foreign 

excbange value of the dollar earUer in the year 

(figure 26), Exportsof aircraft and ooosumergoods 

registered some of tbe largest gains. The increase in 

export demand was concentrated in the emerging I1llr· 

ket economies (HIEs), while exports 10 the euro area 

declined toward the en<! of the ~'ear, 

With growtb of eronorrOC activity in tbe United 

States IOOderateduriog the second half of 2011, real 

imports of goodsand services rose at only about a 

3 percent annual rate, down from about 5 percent in 

the fim half. Import groll1h was weak across most 

trading partoe~ in the second balf of last year, lIith 

the notable exception of imports from hpan, which 

grew significantly after dropping sharply in the wake of 

the Marcb earthquake. 

Altogether, net exports contribute<! about \I. per· 

centage point to real GOP growth in the second balf of 

8. !k>v.llgl'ldc& 10 bood gua, .. 'orsaD .,,1>0 l1uogoof all 

IlIUIIicipal il."PriIies gIl>l'lCl<td by tbOit finn, as ikl1tiDg or I 

lttIIrilyis ikhigh<rofeitber'btpublisbtdWl<krl)-ing9tClll'i!}' 

I1tiDg Of ik tltiogof ike,ui!}, PfO''iJing ,begumntoo 
72 


16 Monetary ftllicy Report to the Congrtss O February 2012 

26. Change in real inlpa"ts and exports of goods 

and sm1Ces, 2007- 11 

I I 

O I,,1UI< 

.-

mmnYll:l102011 

- <0 

I I 

2011. as export growth outpaced import growth. Atan 

annual rate. the cum:nt aerount deficit in the third 

quarter of 2011 (the latc>tal-ailabledata) II-aS $441 billion, or about 3 percent of nominal GDP, a touch narrower than the $470 biUion deficit recorded in 2010 

(figure 27). 

Oil prices moved down, on net, om the second lialf 

of last year. The spot price of West Texas Intermediate 

(WTI) crude oil, wh ich jumped to $110 per barreilasl 

April after a near-rornplete shutdown of Libyan oil 

production. subsequently rtl·ersed course and dec~ned 

sharJl~' to an average of just undtr 586 per burtl in 

September. The price! of olher rn.1JOr benchnurk 

crude oils aoo feU over this period, although by Ie>! 

than the spot price of \Vf1 (figure 28). The drop in oil 

prices through September likely was prompted by the 

winding down of the conHict in Libya as weU as growing concern about the ;trength of global grolllh as the 

European sol·ereign debt criiis in tensified, particullr~' 

toward the end of summer. From September to hnu· 

ary of this year, the price of oil from the North Sea 

(the Brent benclimark) w:lsesstntiaUy Hat as tlie potential implications of increased geopolitical tensions--

most notably lIith Iran- have offset ongoing concern 

over the strengtb of global denund and a raster-thanexpected reoound in Lib)'an oil production. In February, the price of Brent tml"ed higher. both with 

increasing optimism regarding the outlook for global 

growth as well asa further heightening of tensions 

with Iran. The spot price of \Vn crude oil also 

27. U.S.lJadt lOd C\lITC\lt aCCQ\lIIt baJaoces, 2003- 1 I 

- , 

-, 

- ) 

,,," 

-, 

- , 

- ) 

I I I I I I I I I I I I 

nnm1f1!lnYl2011 

NOT!: Th<<b" .. ~. f<:rthon!d< _ "" <in""t<n:I 

<Inug/l2011:Q!;hthe<UR<ll"""""'.theJ".xt<n:I<Inug/l201LQJ.Cll£' 

"p:ao-.~~. 

Sooi:ce: Dtport_ d.C-'O'.B ..... d. Ii«n>D: AnI/y<is. 

increased in February, tbough by less tban Brent. following a relatr,ely rapid rist ol·er tbe finaltbret 

months of last j'ear.9 

After pelDng early in 2011, prices of nuny non-oil 

co!l1lOOdities also tml·ed lower during the remainder 

of 20 1!. Despite lJlO\'ing up recent~ , copper prices 

remain well below their ea rly 2011 1e-.·eJ. In agricullural 

rn.1rket,;, coru and wheat prict'l ended WI 1 down 

about 20 percent from their relatil·ely high levels at the 

endof August as global production reached record 

levels. In early 2012, howe-.·er. corn prices edged up on 

worries aoom dry growing conditions in SOUlh 

America. 

After increasing at an annual rate of ~ percent in 

the first half of WI I, prices of non-oil imported goods 

Wert Hal in the second balf. Fluctuations in prict'lof 

imported finished goods (such as consumer goods and 

capital goods) were JOOdernte. 

9. The 1Il0lt llrid fiIloofWTI lhao od>t1 grades of cru.:lt oil allix 

Old of 201 1 rdl<c1S !be narmwmg of . di;:counl {bal bad optOt>l up 

bet_n WIlandOlbergrades .. rliet iIIlbe)"". "lbrougboolmool. 

of 2011, conlinuo.l incm. ... in !be "'!'Ply of oil primarily from 

Canada .nd Norlh Da~<u, .,~ 'j ahle 10 floy,. into CllibiD& OUa· 

boma (Ibe dd~· poinl f<>r!be \\'I1 <m oiI ~ and lbe lock of 

tflDSJ'OrtatiOll iofflAAICl\lJI~ 10 pls; !be "'Wlies 011 to global 

m"tru, dopR:SS<d !be price of WII !dali", 10 ad .... grad<; of crudt 

oiL tnmiJ.NOYeJnbcr. ~pbn,,,,,,",a"t>OIlDOOd o,,,,,,,,,'be 

b·d. teypipcl.,.,hat=tIy tIlIrnporucrudt oil from tbe 

Gulf 0-into o..sbiug. BJ· flismg {be poiQ"bitity d al!o-iahlql lbe 

SUpply glul of crude oit iu lbe Midll1eSl, !be O~I of!hi! 

bft\aoathas Ie.lIjlO! WI! prices{ori""O ' k<.d lhal is"""" ill 

line " i!h lbe price of otller gra<b of crudt oiL 
73 


28. Prices of "I and ooofuel cOOllllOOities. 2007- 12 

0.:._2000.100 DoIn prt _1 

,oo- - ,. - ,. ,. - _ '00 

'" - • 

'00 - • 00 - • I I I I I 

:rm m :oJIl 3)10 3)11 3)11 

NOTIi' n..d ..... ~_ n..oiI prioeis .... """ prioe <:JBr<ltcml< 

oil mJ .... I .. ~ .. "" is !be .. -..~ b ""', 

lUll)' l-ZI,3)I2. Thep:""<J"'""'I~,.,,,,,,.m<J4S 

p:, ... )'."..IOOdio:yp:.,..mJ"I!fds~'.......,.3)(l 

Soom: IU oil. "., eo.~ R ... "clI B ... ao; f« r>;JO/u<l oom...-:db<-s.n.....autMooflIll)'Fmi 

National Sa\'ing 

Total US. nel nalional sal'iog- lhat is, lhe saving of 

Us. households, husinesses, and g<lI'ernmeDls, nel of 

depreciation charges-relTllin~ extremely loll' by his, 

torical standards(figure 29). Aller having reached 

4 perctllt of nominal GDP in 2006. net natiooal saving 

dropped over the subsequent Ihrtt years. reaching a 

low of negatil'e 2\4 percent in 2009. Since then. the 

national Sowing rale ha~ increased on halloce: In the 

third quarttrof 2011 (the latest quarter for \\hich data 

are al'ailable), net national saving was negath'e \4 per· 

centof nominal GDP. The recent contour of the 5.11', 

ing rate importln~y reflects the pattern of federal bud· 

get deficits, which widened sharply in 2008 and 2009, 

but have edged down as a share of GDP since then. 

National saving will likely renuin relatively loll' this 

year in light of the continuing large federal budgel 

deficit. If loll' leI'elsof national 5a1'ing persist over the 

longer run, theywillli e~' be associated wilb both low 

rates of mpital fonrution and heal'Y borrowing from 

abroad, limiting tbe rise in tbe rundard of Ih'ingof 

Us. residents Ol'er time. 

The Labor Market 

Employment and Unemployment 

Conditions in the labor market hal'e improved someof 

late. Pril"Jte payroll employmeot pins al'eraged 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 17 

29. Nel sal'ing, 1991-2011 

-~:: -, '''' . 

~ - - , 

- ~ -. _ 9 

ttl I tt t i t tt l t tt l t ttl t t t t 19'11 1m 1m 200J :rm 3:l11 

NOTIi: n., <In ". """"'" mJ two:! Ibwgh 3:l1l:Ql ~III ....-q:i,Ib._<l.ptI...w..-.:!ntlbus ..... , .. ·ir>&..-.:!lb.ntI....-"'!<I. 

'''I'mJ''''''"~.GCf',,'' ... '*-''"'pro:b:I. 

So~: Dot-I_<l.Com_oo,B ... "'<l.r.:.:....i<AnaI)' ... 

165,000 jobs per roonth in the second half of 2011, a 

bit slower than the pace in the first half of Ihe year. but 

pins in December and h nuary were!IDre robust. 

a..-eraging al!IDst 240,CKXl per !IDnth (figure 30). The 

unemployment rate. which hOI'ered around 9 percent 

for much of last year. is estimated to have nwed do\\n 

noticeably nce September, re3ching gy. perrent in 

January. the lowest reading in almosl tbrtt years 

(figure 31). 

Although the rectnt decline in the jobless rate is 

encouraging, the iel"tl of unemployment remains I-ery 

elevated. In addition, Iong-duration joblessness continues to account for an espelially large share of the total. 

Indeed. in January, 5\1, million persons among those 

counted as unemployed-about 43 perrent of the 

totaJ-had been OUI of work for!IDre than six fIIlnlhs, 

30. Netcbangein pri\'3Ie pa)loU employment. 200>'12 

-'" 

- m 

-<00 

- '" 

I I I tit I I )))5 m :rm m :oJIl 3)10 3)11 3)11 

N".., The dolo:n...wy mJtlItId Ik<qh JnJ.y »11 

s.oo..a: n.p... ..... <l.LM.s ...... <l.LM"" .. ", 
74 


18 Monetary ftlhcy Report to the Congrtss O February 2012 

31. Civilian unemploymeO! nle, 1978-2012 

----------------------~ ... 

- , 

11 11111111 11 111111 111111 11 111111 11111 I 1900 1988 199Ii mI ))12 

N;m: n.. dr':R lIOIrh/ynl<ll<n:lh«>ghI~ ))ll 

~ n.r--<l.Ux..Bo:<IOI<1.Ii>crSU ~ri. 

6gures that were only a Unle below rerord Jel"els 

(6gure 32). Moreover, the numherof individual! who 

art working part time for economic reasons-another 

indicator of the underutiliz3tion of laoor-remained 

roughly twice its pre-recession value. 

Producti~'ity and Labor Compensation 

1..1oor productivity groll1h slowed last year. Produni\'· 

ity had risen rapidly in 2000 and 2010 as !irlm strove to 

cut OOStS in an environment of ~'ere e<:onomil: stress. 

In 2011, hOIl"ever, with operations leaner and won:-

IOrces stretched tbin, !irlm needed to add boor inputs 

to achiel'e the desired output gains, and output per 

32. Loog-Imn ufi'mployed, 1978-2012 

--------------------~ ... 

- " 

-~ 

-~ 

-~ 

11 111'1111 11 1'11 111' 1111 11 1'1111 1111' ! 

"" , .. ,,. '" Sa,,;; Thr. do. :R IIOIrh/y nl"tm:l1lIwth J.-, ))\1 Thr. ... io< 

""""I'IiI!IJ!~<I.~ .. ..... lIpIoy<dptt""' M"" Mn 

..... "'YI ....... <A.:n. 

SOOlCl: ~<l.Ux..Bo:<IOI<1.Ii>crS"",ri. 

hour in the nonfarm husiness sector rose only Yo: percent (figure 33). 

Increases in hourly compen5.ltion rtnuined subdued 

in 2011, restrained by the lIide nutzin of llbor market 

slack (figure 34). The employment C05t index, which 

meJsures both wages an<! the cost to employers of providing benefits, for pril'atc industry rose just 2\t, per· 

cent in nominal terms in 2011. Nominal compensation 

per hour in the nonfarm business sector-derived from 

the laoorcompensation data in the NIPA- ise,ti· 

mated to have increased only 1';' percent in 2011. well 

below the average gain of about4 percent in the yms 

before the recession. Adjusted for the rise in conSllmer 

prices, hourly compensation WlS roughly unclunged in 

2011. Unit labor cost> rose I \I. percent in 2011, as the 

rise in nominal hourly compensation outpaced tlut of 

labor productivity in the nonfarm business sector. In 

2010, unit1abor COStS fellalroostl percent. 

Prices 

Consumer pri« inflation stepped down in the second 

half of 2011. After rising at an annual rate of 3\1 per· 

cent in the first half of the year, theol'erall PCE chaintype price index inmased justl Y> percent in the secDod half (6gure 35). PCE prices excluding food and 

energy also dt("tlenlled in the second half of 2011, rising atan annual rate of aooutl \1 percent. compared 

with rough~' 2 percent in the first half. The recent contourof consumer price inHation has reOected rrmements in global col1llOOdity prices, which rose sharp~' 

33. Cbaogein output perhour, 1948-201 1 

-. 

- , 

-, 

- , 

-, t I I I I I I I I I I I I t'/.13- ]974- tm- "lOOt-lXIS WI m ))11 13 9S :roJ ()I 

Ncm: Nrnf .. boo ..... _ ~ f<A ,*", ...tot:.- P"»;] ;, 

.. ......:I",,,,, bdI ~<I. !IJ! r....J <l. .... pttJO:t,.,. .... kuth 

'f.'WI<I. .... yt ... JO<di ... !y~!IJ!1"'f'O'i 

: 0tp0r! _ <l.1i>cr. a..."'d.Ux.s.. .. '" 
75 


34. MeaSllJes of chlnge in boutly oompet6luoo. 

2001 - 11 

•.. 

-. 

- , 

-. 

-, 

- , 

- , 

- , 

- , 

I I I I I I I I I I I I I I 

lXlI m m mI 3XJIl !lll 

Non: Tho cbu .. <p.-dy nl .,1ml hwth !lll:Q\. fir ..n". """""",.m."""'to io,,, .. ku <J.lllWt kt""''''''''''''_ nJa{Ea dwgo 5"'''''''' 12 111Cfths ~1I""1Io! IIIOIIIII ci .a:b 

""""

... --...n..",," . nlOC""OOU'. ~"'"1<W=W«"' fu """" """'""by '''e.. 

~_

Eel_,",. ~ i.e.. 

Mnf • • boonm _ plw",......'inotitt".,.. 

SOO.a:~olLtlxt IIIr • .,olLoba:SlIII<5tiot. 

ear~' in 2011 but h.r.-e rrvved lower during the second 

half of the year. Information from the consumer price 

index and other sources suggests that inllation 

remained subdued through h nuary 2012, although 

energy prices have turned up ITIJre recent~. 

The index of comumer energy prices. which surged 

in the first half of 2011 , feU back in tbe second half of 

the year. TheconlOur mainly reflected tbe rise and sulr 

sequent rel'etsal in the price of crudeoi~ howC\'cr, 

gasoline pricesSiarted to rise again in FebrUlry follow· 

ing a T«ent upturn in crude oil prices. Consumer natural gas prices also fell at tbe end of 2011. as unseason35. Olangein!be cb:1iJl.type price index forpenooal 

coosllmplioo e>ipeIlditul\'S, 2005-11 

-... --

1/1 _ 4 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 19 

ably mild temperatures and increases in supply from 

Dell' domestic wells helped boost inventories abol'e 

typical lel'els. All told. the ol'erall index of consumer 

energy prices edged lower during the second half of 

2011 , compared with an incrtJseof allTlJst JO percent 

in tbe first half of tbe year, 

Consumer prices for lOod and beI'erage; exhibited a 

similar pattern as Ihal of energy prices. Prices for farm 

comroodities rose briliklyearly laslyear, reOecting the 

combinalion of poor harvests in several countries that 

are major producers along with tbe emerging recovery 

in the global economy, Tht'Se comroodity price 

inCteases fed through to higber conswner prices hr 

meats and a wide range of other lOOre-proce;sed food~ 

With the downturn in farm coll1lOOdity prices late in 

the summer. tbe index of consumer food prices rose at 

an annual rate of just Jy. percent in the second half of 

2011 after in('teasing 6Y.. peKent in the first half. 

Prices for consumer goods and sen'ices other than 

energy and food ba,'e also slowed, on net in rectm 

IOOnlru. Core PCE prices had been boosted in tbe 

spring and summer of 2011 by a numberof transitory 

factors, including Ihe pasHhrough of Ihe first-balf 

surge in prices of raw comrooditiesand other imported 

goods and a boost to IOOlOr I'ehicle prices tbat 

stemmed from supply shortages follolling the earthquake in h pan, 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 

p;. pereent 

Surl'e}'-b.1sed measures of near-term inflation expev 

talions are down sioce Ibe middle of 2011. Median 

year-ahead ioOation expectations as reported in the 

Thomson ReuterslUnil'ersity of Mi('higan Sumys of 

Consumers (Micbigan suney), which had risen sharply 

earlier in the year reOecting the run-up in energy and 

food prices. subsequently feU back u tbose prices 

de\Xlerated (figure 36), Longtr-term expectations have 

remained generally stable, In tbe Michigan survey. the 

inflation rate expected over the next 5to \0 yem was 

2,9 percent in FebrUll)', within the range that has prevailed orer the past \0 a~ in the Sun'ey of Professional Foreca5 er~ conducted by the Federal Resem 

Bank of Philadelphia. expectation; for the increase in 

the price index for PCE over tbe next 10 years 

remained at 2V. pef<'en(, in the middle of its recent 

range, 

Measuresof inDation compensation derived from 

}ields on nominal and inflation-indexed Treasury securities declined early in the second balf of 20 11 at both 

medium-term and longer-term horizons. likely reOeeting a '1'orsening in the economic outlook and the 
76 


20 Monetary ftlhcy Report to the Congrtss O February 2012 

36. Median ioflltiOO e.qlOCla~ODS, 2001- 12 

. .. Nat I,..,.. - , 

-, 

-, 

- , 

- , 

-, 

I I I I I I I I I I I I I I 

m:! ::IDI :o:l6 m ))10 ))12 

Non: Tho"" ... ~zd""""'fnqh J...,."llil 

Soot",; n.:.""'~' ....... ,rydMichq:IOls.n.y,da:...-.. 

intensification of the European fiscal crisis. More 

reantly, inflation compensation e.timatesover the nm 

fin years haw edged rock up, apparently refieeting 

investors· more optimistic economic outlook. and is 

about unchanged. on net. for the period. However. the 

IOrward measure of he-year inflation compensation 

6n yearsahud remains about 55 basis points below 

its hel in the middle of last year (6gure 37). 

Financial De,·e1opmenls 

In lightof the disappointing pace of progres,toward 

meeting its statutory mandate to promote maximum 

employment and price stability, the Federal Open Mar· 

ket Committee (Fm.IC) took a number of step. to 

pMide additional monetary po~cy aCIXIll1lOOdation 

during the second half of 2011 and early 2012. These 

steps inclnded increasing the a.,.trage maturity of the 

Federal Reserve's serurities holdings, shifting the 

reinl"e.,tment of principal JllymenlS on agency securities from Treasury securities to agency-guaranteed 

MBS, and strengthening the forward rate guidance 

included in postmeeting statement~ 

Financial markets were buffeted Ol·er the second half 

of 20\1 and in early 2012 by changes in investors' 

assessments of theongoing European crisis as well as 

in their eI'3.luation of the u.s. economic outlook. As a 

result. de.,.elopments in financial market conditions 

have been mixed since Ju~. Unserured dollar funding 

markets, particular~' for European in5titution~ 

became significantly strained. though domestic financial firms generaUy maintained ready access to shortterm unsecured funding. Corporate bond spre:tds 

remained elel-ated, on net, while broad equity priets 

37. IO/h~ODrompeIlsa~on.2006-12 

- hdO,.. .. nad -, 

l""'V" "" -, 

= r-/''''¥ - , 1 

V~"'''~''''~J -, 

1111l11l1111l ! 1I 1111111 1 ;m] m m ))10 ))I! ))12 

NO'll: ]h,dr.>_<bily zd..-.;!h"oughF.bru..yZ4.llI1lnflili<:o 

~""i'h~btn""'"jitldorn""""""TI<",,,,!"""'''' 

zdTm.IIi}'","""",p;~"""""""(IIPS)d""",,,,.~ t .... 

b....Jrnyitld~fll<dbyF«lnol~ou/flOoff. nJI,.".m1 

TI<"OIII:)" ...,....itit< zd ",. ni off.u...nJI nps. Tho Sol'''' ........ ;, aljI-'la tt., ,ffedd ;,m.It", I,!~ 

Sow::!; Ftdo<oI &.om .. Rri dN.., Yak; belay<; I'td."i Room .. 

BOIIdsufl<ll, ...... 

were lillie changed, although they exhibited unusually 

high l'Olatility. Partial~' reflecting additional monetary 

policy accommodation. Treasury j;elds mo\·ed down 

significantly. Similarly, illl·estors pushed out the date at 

which they expect the federal fundi rate to rise abow 

its current target range, and they are currently anticipating a tmre gradual pace of increase in the funds 

rate following liftoff than they did last Ju~. 

Monetary Policy Expectations and 

Treasury Rates 

In response to the ~teps taken by the FOMe to 

strengthen its for\\'3.rd guidance and pro\ide 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 Yo percent and scaled back theirexpecta. 

tionsof the pact at which monetary policy accoll1!OOdation wiU be remo\·ed. On balance. quotes on overnight index .wap(OIS) contracts, as of late February, 

imply that investors anticipate the federal funds rate 

wiU rise abcl\"l: its current taQlet range in the lOunh 

quanerof 2013, about fourquaners bterthan the 

date implied in July. Investors expect. on average, that 

the effective federal funds rale wiU be aoout 70 basis 
77 


JXlint~ by late 2014, roughly 165 b3si~ )XIints lower 

than anticipated in mid_201I ,w 

Yield; on nominal Treuury securities declined signilklntlyoyer the second half of 2011 (figure 38), The 

bulk of this decline occurred in late July and August, 

in pJrI reflecting weaker-than-anti<'ipJted US. economic data and increased inl"tStor demand for the relative safety and liquidity ofTre,lSury securities amid an 

intensification of roncerns about the situation in 

Europe, Following the FOMC announcement of the 

maturityextcnsion program(MEP) at its September 

meeting, yields on Ionger-dated Treasury securities 

declined further, while yields on shorter-dated securilies held steady at wry lowleyel~l1 On net, };elds on 

2-,5-, and lCl-year Treasury notes have declined 

roughly 10, 65, and 110 basi, )XIints from their lewl, in 

mid-2011, respectil'ely, The yield on the 3Cl-year bond 

has dropped about 120 basis )XIintl. Though liquidity 

and functioning in money markets deteriorated notably for 5eI'eral day! at the height of the debt ctiling 

debate last SU/lUllef, neither the downgrade of the US, 

long-term sovereign credit rating by S&P in August 

10_ II ...... iOl<ml"'lrS.~d(litl(>W\\drl<nni ni ngllltpoill.t 

"bich financial motte! qu«cs indicale lhot tllt f<Jen.1 fund> ",Ie "ill 

"""'" .b.:lo'. iu=t "'ll!!" ca. lit complic.ted Tho p"lh dcscrtM:d 

iltllt le>:t is tbt mon d. diSlrilo.lIioo <akul.l<\I ["'Ill OIS "le& 

AltmI,til"d)', _ cn Ui<'Rroit.! &erivam't:S t(>cak;tJ'1e t~ IDOiII 

ild)', or"modaI: tb of tho fMml l'IIods "'to, • naornt thaI 

ICII,}; 10 lit more wblo. Thi. oItemotM tnea>IR b.., >I", ~ 

00.,11, <>Dnet,sin<e tbtmi..-lJk of1011, but it RJFUI fblle'r"'~

all 111Ftor)' IQr tilt largl:t f<Jen.1 funds "to; """,,".ling to ~bi:h tho 

tff«til't raledoo aot rise .oc.-e iuclOml! tofid TOnge through lilt 

rodd!(l15. 

II. "" of Ftbruory 24, tbe Optu M.tte! Dcl had ",Id 

S;l2J bia;on ill .l»ner·lC1lll r,.asury sccurit .... M purtb""'d 

$;11 t bia;on ill longer-term Tru>UrJ' occurities. 

38. 1ll1eresl mes OIl TrelSul)' se.:urities at selected 

malwities, 200+-12 

... 

-, 

-. 

- , 

-, 

I I ! ! I I ! I I I 

"" "" em 3:l1O 3:lt2 

Non: Thodr.l<edoily n:lnlmltlwtqhl'tbru.yu' 3:lt2 

Soo.C[;~ofIheT",...., 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 21 

ner the failure 'Of the Joint Select Commillee 'On Deficit 

Reduction to reach an agreement in Nel·ember 

appeared to !eal'e a permanent imprint on the Treasury 

market. Unceruinty aboutlenger.term interest rales, 

as mea;ured by the implied volatility on 100year Treasury securities, moyed sidl:ll'ays through most of the 

second half of lOll and then declined late in the year 

and into 2012, reflecting imprDl"ed sentiment in financial markets follo\\iog a numbcrof policy actions by 

centnl banks and some signs of strengthening in the 

pJct of economic rerol-eT)'. 

Measuresof market functiening suggest that the 

Treasury market has continued to 'Operate stmOtbly 

since mid·2011 despite the S&Pdowngrade in August. 

Bid-asked spreads fer most Treasury securitie~ were 

roughly unchanged, thougb they hare widened a bit, 

on net, for the 3O-}'elr bond sinct August. Dealer 

transaction 1'Olume. h3l-e remained within historically 

nermal ranges. 

Sbort-Term Funding Markets 

Conditions in unserured short-termdellar funding 

markets deteriorated, on net, over the second half 'Of 

2011 and in ear~' 2012 amid elevated anxiety about the 

crisis in Europe and its implicatiens for European 

firms and heircounterpartie~ Funding costs increased 

and teners shortened dramatical~' fer European insti· 

tutions throughout the third and into the fourth qua rter. Funding pressures eased somewhat late in the year 

fellowing tbe European Central B.:mk·s (ECB) first 

injection of euro liquidity via a three.year refinancing 

operation and the reduction of the price of U.S, dollar 

liquidity offered by the ECB and other central banks; 

they subsequently eased further following the passage 

of year-end. On balance, spreads 'Of London interbank 

'Offered rates(UBOR) 'Over comparable-maturity OlS 

rates-----a measure of stress in short·term bank funding 

markets-have widened coDS derab~' since July, par· 

ticularly ferteners bey'Ond 'One month, though they 

h3\'e lOO\·ed down since late last year. Indeed, throughout much 'Of the third and fourth quarters, many European institutiens were reportedly unable to ebuin 

unsecured dollar funding at tenors beyond one week. 

Additionally, JOOre--folll'ard-looking measures of interbank funding roS15- such as the spread between a 

three-month forward rate agreemc:nt and the rate on an 

OIS contraci three 10 six monthsahcad- m'O.,-ed up 

considerably in the second half 'Of lOll and have 'Only 

partially retraced in 2012 (figure 39). Despite the pres· 

sures faced by European financial institutions, US. 

firms generally mainuined ready access t'O shert-term 
78 


22 Monetary ftlhcy Report to the Congrtss O February 2012 

unsecured fund ing markets. Against a backdrop of 

solid deposit growth and modest expansion in bank 

credit across the indUstry, most domestic banks reportedly Iud limited need lOr unsecured funding . 

Pressures were also evident in the oommercial paper 

(CP) market. issuanCt in the United States of un;;tcured financial CP and negotiable cenifiCltesof 

deposit by entities with European parentsdedined signikmtly in the second half of 2011. By oontrast, the 

pace of issuance by us. firms edged down only 

s1ight~·. on net. orer the period. On balance. spreads of 

rates on unsecured A2IP2 commercial paper orer 

equivalent maturity A.-\·rated nonfinancial CP ro;;t a 

bit for both orernight and 30-day tenori AA-rated 

asset-backed CP spreads increased more notably orer 

the second balf of 2011 bUllargely retraced following 

year-end (figure 40). 

In oomrast to unsecured dollar funding markets, 

signs of stress were large~' absent in secured short· 

term doliar fuDding maTlets. For example. in the market for repurchase agreements (repos). bid-asked 

spreads for most oollateral types were ~ttle clunged. In 

addition, despite a seasonal dip around year-end, volumes in the triparty repo maTlet were largely stable on 

lulane¢. That Slid, the oomposition of oollateral 

pledged in the repo market mored funher away from 

equities and fixed-income oollateral that isnot eligible 

lOr open market operations, shifting eren more hmily 

toward Treasury and agency securities as rounterpany 

39. UBOR minn~ QI'ffiliglu iodeJ; swap rate, 2007-12 

-", 

I ! , ! 

I .... lilly I .... lilly Jan. July I .... July J .... July , .... 

m :leO> m l.l1O l.llt l.l12 

Nan: The dau,.. d.dy ord at<fId tItc:qh FcUu.r 2-1. l.lll An 

QI'...,;v. ..... "''P(OlS);,II"I ........... ,.,.,.·lIl1'" fboi",!"",btd »"'m'<idaily~,....n ... ''"''''t/.,tff'''''''JtQ" .. _ 

_ . AI -...y ..... t.., pn.. !O t/., ''''P """_ nttmv . .., the 

w..'clt/.,op«lnotlOll:ll_thediff .. """b«-..m.tIla.>."tUOd 

.dw:rLUd"".ruOlt~.,.....Jb)'" ... ottiI!:dw:~<A"""".fIIlO 

n., U.s. dol'" (USl)).,.. ... ~coIcuI"'" ...,..l.on:lon """"*-""" ... _(UBOl1.)h-.l,.",..-(FltA)tu.»m"",,",theru.u 

ord ... illlploo:tk ... ..:tas""'bthe ..... J"<tOO' 

SOJ : Biood>n,. 

40. COllDl1ercialpaperspreads.2007-l2 

- ", 

- ,", 

- '" - '00 

" . o ! ~ 0 

Ion. July 'on. Ioly , .... kiy , .... lilly Jon. IiZI Ion. 

m )Xl! m l.l1O llll l.l12 

N","" The dau .. ....l1y ord tUm! ... ruth I'tIoru.y 21 l.ltl 

C-,ai PIP" )'"Id 'P ....... h .. " .....,p: IIlHI}' ord •• 

ox~ .. b!"~!O ... AAnonfnar."~ , .... 

~T .... ordCIo.i>tC<:quoo:il;n 

concerns became more e\-ident. Res)Xlndents to the 

SCOOS in both September and December noted a 

oontinued increase in demand for funding across 001-

lateral types but reponed a genen.! tigh tening in credit 

terms under which several securities types are financed. 

In addition, maTtet panicipants reponed~' became 

S<lmewhatle;s lIilling to fund riski<r rollateraltypes at 

longer tenors as ~'ear-<:Dd approached. Howeyer, yeJ.rend pressures remained muted o\'era ~ with few sign! 

of dislocations in either sec:ured or unSCI:ured shortterm markets. and oonditions in term funding markets 

hare improred in early 2012. 

Mone), market funds. a major provider of funds to 

shon·term funding markets such as those for CP and 

for repo, experienced significant outllows across fund 

Cltegories in July, as inwstor;' focus turned to the 

deteriorating situation in Eurnpe and to the debt ceil· 

ing debate in the United States. Those outllows large~' 

shifted to bank deposits, resulting in significant pressureon the regulatory lererage ratios of a few large 

banks. Howe'Ier, inl"estmenls in money market funds 

rose, on net, orer the remainder of 2011, lIith the oomposition of those increases reflecting the general tone 

of increased risk al'mion, as gorernment-only funds 

faced notable inflows while prime funds experienced 

steadyoutOows. 

Financial Institutions 

Market sentiment toll'lrd the banking industry 

dec~ned rapidly early in the second half of 2011 as 
79 


investors turned their heus OD exposures to European 

sovereigns and financial institutions and on the possible spillowr effects of the European crisis. Some 

large Us. institutions also retJ\3 ined iignificantly 

expo;e<lto legal risks stemming from their mortgage 

banking operations and for«Josure practices. ll More 

recently, bO\\l!l"tr. investor sentiment has iroprolW 

somewbat follo\\;ng the actions of central bank. and 

inroming dall suggesting a somewhat bener eronomic 

outlook in tbe United States. On bllaoce. equity prices 

lOr banting organizations (figure 41) bave rompletdy 

retraced their declines from last summer, wbile CDS 

spreads(6gure 42}-whkh rellee! in"estors' assessmentsof and \\;Uingness to belI the risk that these 

institutions will default on their debt obligations-bave 

declined from their peaks re3ched in the fall. hut not all 

the way rock to mid·201 J Imls. 

Measures of bank profitability edged up, on net. in 

rectnt quarters but remained lI'en below the \evels that 

prevailed before the financial crisis began (figure 43). 

Altbough profits at tbe largest institutions '.I'm supp;lned ol'er that period by reductions in noninterest 

expenses. net interest margins remained I'ery loll'. capi. 

tal markets rel'enues were subdued, loan loss provi. 

sionsare stiD somewhat tlCl'ated relath~ 10 pre-crisis 

U. 0. FebruarJ 9, it ~-.s iIltI<'IIIICCI.:I th.tl"" feJetat g<I'O<1IlD<I)l 

..,d49i .. ltl(IO~'igroml4l ttaelll>.l. S2Sbi oo~.1 

"ilht"" n'lion',fi .. l>fllCilmortgagelf1\'i<er$load<lrts:<!lIOf1g'l!l' 

loon "",icing ,nd [,""burt .. """, lbt>gr<e1lltllt doco lIOl 

r<"""nl Wlte..,d fo.:lenJ authorities from pursuing crimilli]..,foo;e. 

lDI:tIl ",,"0111 mated (0 this or olbn' c""doct by (be "",ir:tn or from 

p.t1Iishing "wngfuill>'Urititalioll CQlldoo:~ iI also dOlS 00( pfN'"Ot 

211J'''''[ioo by"Jiyidll3l~"'b.lwi<b lobringlboi,CIO'U 

1I.,,>OJit. 

-II. Equilypriceindc.\forbW,2009-12 

NO'!'!: n.,cbuncbily ... ,,~dnughFtllruoryU,Xlll 

Soom: Stnhd&lI::tt'. 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 23 

42. Spreads OIl credit (\efault swaps for sel~ted 

U,S. banl:iog organizations, 2007-12 

...... 

--

In July In July In July In July In July In 

'MJ/ 1WJ 'MIl ))10 ))11 Dt:l 

N"", n., dol • •• doil'l ..... l....t .. ~ FtbruIry 'l4, Xlll ~I!di., 

'P.ad<icf<ixbri~~",,,,,,,oktNrh 

SMa: ~uru 

DOrms, and a fev.' banks booked llrge reserves for ~ti · 

gation risks associated lIith their lmngage portfolios. 

Indic3.torsof credit quality at commercial ronks 

continued to show signs of improvement. Aggregate 

delinquency and charge-offratts mol'ed down, though 

they remained quite ele1'ated on residential mortgage. 

aDd both residentill aDd oommertill construction 

loans. loss provisioning has Inded out in ret'entquar· 

tel'S near the upper end of its pre-crisis range. NODe· 

thele.lS, in the January SLOOS. a large fraction of th e 

respondent! indicated that they expect credit qUality to 

imp!(l\~ over the next 12 months for mostll'lljor loan 

41 Profilability of banlookling cOOlpmes, 1998-2011 

a.,.,. . .....-l "" 

1.5 - ...... - 1.0 -

, - ...... .,., 

s1,0 _ 

J.!i-

_._, .. 

-

- " 

- " 

- " w 

i 

• 

-w 

_ u 

-" -" LI "'""""l99'/ "I--'-1 "'~;"o!-' "'--'-, ;"~I--'-I "'-o.c"UI 

N"", n"doI:''''oJIn'I'l)- ... .,._h<uth:ml:Q! ScM",: FodItai Rtoer> .. &.rd. I'll: Y-9C. C"",,,hd.r<d Finlaoal 51 ... _ fa Sri Hollins CooDpw:o. 
80 


24 Monetary ftlhcy Report to the Congrtss O February 2012 

Financial Stability at the Federal Reserve 

Tne Federal Reserve's responsib;lity fa. promo/ing 

financial >tab;lity >terns from its role in SUI>e,vising 

arK! regulat'"& ballks, operating tile mtton's payments s)'SIeJT\ arK! se"'lng as the !errde!' oflast 

reso.1.ln the decMl':S prior tothe financial cri;i" 

financial stab;llty poIicyteOOed to be overshadowed by monetary polK.)', which had come to be ___ 'ed as the I"incrpal fund>on of ~ntral baris. 

Howe'l'ef, .., the aftermath of the manOal aisis, 

financial stabrlity polK.)' has tal:en on greater I"omr· 

nenre and is row generally coosidered an equal ly 

(frtical respon-;ib~ityof centla! banks. /'oj such, the 

Federal Reserve has made significant organizational 

changes aoo taken other nions to imprOl"e lIS 

abriityto uooerstand and address sy>temic nd:.ln 

additiol\ Its statutory role In malntainmg financial 

stability has been expaoded by the Dodd-Frallk 

lVal15l:reet Reform and Consumer ProtectlOfl Ad of 

2010 (Dodd-FranlAct). 

One ley featureof lhe Dodd-Frallk Act is its 

maaoprudential orientatIOn, as ref\ected in many 

of the prOl1siol'tsto be ,mplemented by the federal 

Reser\"e arK! othe, manOal regularors. Tile macroprudential approach to regulatlOfl and sUpeI\ision 

slill pa)Hiose altentoon to the xtfety aoo wurid· 

ness of ind i\'iodual manoal 'f"6t'tulrons, but ,t alw 

takes Intoaccount the linl.:age> among tho5eenti· 

t,es and the cond~ on of lhe financial S)~\em as a 

whole. To implement the macroprudenl'al 

apl"oactr. the Dodd-Franl Act ~blished the 

multiagen<:y financial Stability o..'ersight Council 

(FSOC), whorn is tasled with promoting a more 

romprehef"6l\"e approach to monitonng arid mitlga~ng S)~temic risl The Federal Resffi-e is one of 

1O.uling members oflhe FSOC. 

categorie, if eronomic activi ty progre»e, in line with 

com;ensu~ IOrecasts. 

Credit pfO\ided by domestic banks-the sum of 

loans and securities-increased tmderately in the sec.. 

ond half of 2011. its first suck rise since tbe first half of 

2008. RJ n~ credit grew as holdings of agency MBS 

expanded steadily and most major loon categories 

exhibited improl'ement in the SI!COnd half of the )"elr. 

The expansion was consistent \\;Ih reant SLOOS 

resJXlnses indicaling that lending standards and loan 

terms eased somewhal and that denund for loons from 

businesses and households increased. on net. in the 

serond half of 201 I. In pankular, C&l loans showed 

persisteD! and considerable strength ol'er the second 

half of 201 1 aDd into el ~' 2012. loaDS to nonbaDk 

financi:ll institutions, a category that tends to be \u]a· 

A srgn;licant aspect of the maaoprudent'al 

approach is tne Ileighlened focus on entities 

who:sefaiureor finaocialdistresscould resuk in 

outsized desOOlllllng effects OIl the rest of the 

S)'stem. Under the Dodd-frank Act the Federal 

Resffi"e is responsible for thesupe!\ision of all S)stemically importanl financrallnstrtutions (51Fls1 

which ,ndude both large bank hold'ng comparues 

and nonbart finarrcial fi rfll!j dl':S,~ed t.,·the 

fSOC as S)'S1emically i~nI. h-en beforelhe 

Dodd-FrankActwasenacted, the Federal Resm"e 

was making organtzatlOflai ch.Yrges to facilitale the 

iocorporatioo of S)~temic rislconsiderations into 

the SUpe!\lSO!)' pr~. Notably, rt created the 

large If"6tltUtIOflSYpe!\1S1Ofl Coordinating Commltee (lISCQ to bnng an Interdisciplinary and 

(foss·film perspedr.-elo the superr.,ron oflarge, 

compIexm;nial 'nst,tutions; the usce act> 10 

ensurethat tile financiall'Osrtions of these large 

if"61itutions arestrong eroogh 10 w,thstand am'er>e 

!hods. A $imilat body has been set up to help in 

the oversight of S)'SIemically important IinanciaI 

ma,ke\utilities. 

The Federal Reser.-e has ako established the 

Office ofFinaooal Stability PolK.)' and Research 

(OFS) to help the federal Reserve more elfed"eiy 

mon~or the finaocial S)'SIem and devek:.p polroes 

fQrm gal"'gS)stemicr~ks. The OISsfundion illo 

coordinate iltId an<V)"l:e informaroon bearing on finaocialstabilityfromawide rangeofperspect~,es 

and to place the supervi$ion ofif,dividual instrtu· 

lIOns w~h n a broader maaoerooomic and finaocial 

ronteXlln addrtron, the Federal Reserve works with 

other US. agencies and internatronal bodies on a 

raoge of ISSues tostrengthen the financial S)~tem. 

tile. also grtI\' rapidly over that period as did holdings 

of agency MRS. Consumer loonsheJd by banks edged 

up in the third and lOunh quarter~ Those increases 

offset ongoing declines in commercill rell esL:lte and 

bomeequity loans, both of wbich rema ined rery welk. 

Regulatorsoontinued to take steps to strengthen 

their orersight of the fiDancial industry. In plnkular, a 

variety of measures I11lndated by the Dodd ran~ 

Wall Street Reformand Comurrrer Protection Actof 

2010 are being, or are soon 10 be. implemented. indud· 

ing enhanced c.:rpital and liquidity requirements lOr 

large banking org:lnizations, annual stress te5ling, 

addilioDli rnk-nunagement requirements, and the 

development of early remedi:ltion plans (see the box 

"Financial Stability at the Federnl Reserve'). As pan 

of those efJoru, the Federal Reserve began annual 
81 


Systemic financial risks can take seo,'e.al b'ms, 

Some risks can be desaibed as structural in natu re 

bec311se tlley are associated with structural ~.lIure5 

of financial marlets and !hIlS oxe 1.Yge~ independent of ewnomiccondihons; these mclu<x>, b' 

example, the risk posed by aSIF I whosefallure can 

hil'-e oul5rzed e!fects on the finilllOal S}~tem or the 

degreeto which monq' market mutual fur.&; oxe 

su:;ceptible to liquod ' pressures. Other risks can 

be de5Cfibed as cyclical in natureand irr:lude, fOr 

example, elevated asset valuations and exre\S;"e 

aedlt growth that allse in buoyal1. economic limes 

but can unwind in destab~iling wa)~ should conditions mange. Allenul-e1leSS to tJoIh ~'pes of IIsk is 

artical,n the mOllltorlllg of S}~mic risk and the 

fonnulationof ap!>,opriate macroprudemral polK)' 

responses. 

The FWera Re!e"-e has taken step> to odentrfy 

structural vu oerab~ities in thefinancia system and 

to devise policies 10 mitigate the associated risks. 

Fo< exa~le, in Clecembef 201~ the Board released 

a proposa to strengthen the regulatlOll and supermir:m oflarge b.YIk holding cornpar»e! and S}~­

temical~ Important oonbanl:. financial firms. The 

proposa comprISeS a wide range of measures, 

Including nsk·based capital and Ie ... erage requ"ements, liquodlty requlrernenl5, stress tests, ~ngIe' 

counterp.:fiyaedit limol5, and eox~ remedlat>on 

requ iremr:r-ts.lnaddition, inWobe<2011, the 

Board apprO\ed a final rule 10 implemenl the reso' 

lution plan (1;"'ing will) requ irement of the DoddFrankAct,. which is intended to reducethe ~eI;­

hood that thefailure of a SlFl--should «ocrurrtviewsof the capital plans for u.s. bank holding companies with total consolidated assets of $50 billion or 

IOOre under its Comprehensi\"e Capital Analysis and 

Re\iew program Going into those reviews. reponed 

regulatorYClpital ratios of US. banking institutions 

generally remained at historiCllly high le\'els orer the 

secondhalfof2011. 

Concerns aboUlt~ condition of European financial 

institutions. coupled with periods of heightened allention paid to US. securities dealers. raised im'estoranxiety regarding counterpart), exposure to dealers during 

the second balf of 2011, Indeed, responses to the 

December scaos suggested that dealers de\"Oled 

increased time and altention to tbe management of 

concentrated credit exposures to dealers and otber 

financial intermediaries over the pm'ious three Imntbs 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 25 

would causeserK>usdamage to the financial 

system. In all ofits rulemal:ing respon>ibdities. the 

Federa Reser.-e is attentive to the inlernational 

dimension of financial regulation. It IS also wor\.;rng 

with Its regulatory counterp;jffi 10 ImprO\e the 

qualityand bmeimessoffinancra data. 

The Federal Resen-e is likewise 11)()\'lng forwoxd 

to add ress cyclical S}~\emIc risks. To identify such 

risks, it rOlJtlne1y rnorotOfS a number of items- including. b'e>3ITlple, measures ofb'erageand 

maturity mi,m.llC"h .lI1inarriai intelrnediilf>es-and 

oo~ for sig.nsof a aedn-induced bu ildup of S}~­

ternie risk. In addition,. ~ conducts regular stress 

tests of the nation's largest bar*ng firms; these 

tests oxe based on detailed confidential data about 

the balance sheets oflhe firms and !>'ol"KIe a corn-

!>'ehens;"-e, r%orous a>sessmenl of r.ow the fi rrns' 

financial condrtions wOIJId likely e-.'01I.e over a 

rrulli)-ear period under ad\"ersee<:enomic and 

financials~narios Me""while, efforts ilIe under 

way to eva u.lle and develop new rm::ro!>,udentlal 

tools that could help limn IUture bu ildup> of cyclical s~emic nsk. 

In summai)', the Federal Reser\-e h.ts tal..en a 

senesof actrons 10 Im plemenlthe reiel-anl prOll' 

SIOIlS of the Oodd-FrankAct and to meet rts 

broader ooanaal stabihty respoo>ibrlitres In a 

time!)' w~. The Federal Reser.-e h.ts made importanl dur.ges to its orgam:atlOflal structure to sup' 

""" a rnacroprudentia ap!>,oach tosupet\i!ion 

and regulation, and ithas instituted processesfo< 

odeml~ing and re5JX111d ing tosources of S)stemic 

risk. 

(figure 44).11 [n addition, survey respondents reponed 

that they had reduced aggregate credit limits for certain specific institutions. Investors appeared to be pl!"-

ticularly concerned about tbe stability of funding in 

thee\'ent of financial market stress b«ause most dealer 

Hrms are highly reli."lnt 00 short-term secured funding. 

Re spondents to tbe December SCOOS reported a 

broad but m::xlerate tigh teoingof crtl.lit terms applicable to important classes of oounterp.1rtieso\'er the 

prt'.ious three months. This tightening was especially 

evident for he<lge fund clients and trading real estate 

11 FolIMg lbo faiNt. of. prima!), deale<; lbo IUnl Rtscn~ 

link of Nt-o. Yort inlpimltukJ. ri;I:'ID'D~1 program th'l rtquRd prim.!)' dealer; to p:l$I m>rgin 00 r"",,, J'''''th ~ agency 

MBSInnsa<tioa~ 
82 


26 Monetary ftlhcy Report to the Congress O February 2012 

44. Net percemage of dealm reporting increased attention 

10 e~posure 10 odJer dealers, 201 0-11 

--------------------------~ ... 

I ' 

Nun; Thtd, .... d . ... ",- ..... ...,«:rdl.-udn.t ... P"""; .., IaIt d:><m">tUl " f"", the o..:...bof lOll ..... ..., •• t..:lI «W<"l' 1011:Q.I. Nt! ""_~~tho~",,d""''''''"ht"'!'''1«l 

..... 1Iinl _Kn t"m<_ ~"'Iy" <J[ "n:.._ .-_tun _ tho ""C<t'la!td_ .... <h;t1tf01'<l"""""Il&_m idMt_«1IISdn~· '" "'*<tt_..--'*1. SOOla: Ftdo<aIR..,...Boad,SeniorCr<ditorr.:..~s..v.y<J[l 

D.mF""""",!:T",-. 

inreSlmenttrnS1S(fignre 45).1' The institutions that 

reported having tightene<l credit tenm pointed to a 

worsening in general market liquidity and functioning 

and a redUC(d willingness to 13ke on risk as the most 

important reasons fordoing so. Indeed. for eacb type 

of collateral cowred in the survey, notable net fraetionsof respondeDls reported that liquidity and functioning in tbe underlying asset market bad deteriorate<l 

ol"er tbe pm'ious thftt month~ Dealers reported tbat 

the demand for funding most types of securities con· 

tinued to increase OI'er the previous three months. particularly the demand for tennfunding with a maturity 

greater than 30 days. which increa;e<i fOr all security 

W' 

Net in\'estment Ilows to bedge funds in the tbird and 

fOurth quarters were reportedly significantly smaller 

than in tbe first balf of the yeJT as bedge fund. markedly underperformed the broader market in 2011. 

Information from a \'al"kty of sources suggts15that tbe 

use of dealer-intennedilted lel"erage has dedine<l. on 

balance, since mid-2011. lndetd, while tbe use of 

dealer-intermediated leverage was roughly unchlnged 

for most types of counterparties according to September and December SCOOS respondeDls. about half of 

those sur,eyed indklted tbat hedge funds' use of 

financiille\·erage. considering theentire range of 

14. T,..diIlg,..1 <St>.tt im<Stmellt tlllSU j","tiI. in lSittI NeW by 

lnI ..... t.,..oo thaD dim:tl} io rtolewtt. 

45. Net perceotage of dealers rep.xtiug a tigil teuiDg 

of price terrm, by COI1Ilto.'l"))3rties, 2Q1O-II 

--------------------------~.~ 

-" 

-w !'tll .... pool. ., ... - " - < 

I , 1 I 

Q' ll~ ~ QI Ql llll Ql ~ 

N<m: Tho dab •• d ... " r.:.. ....... f)' <:<nb:ud fro: " .... P" 1<~ 

tho I ....... ""'" " no. he n..:..,b« lilt UVf)' •• 1Ii:h 1X1'<r' llll~. Pluto'" ~"'llll """ ..... fInk .. h odll!; .... _ ........... !JU<I,(RET.)....,~t~.nh,,;.. .. «plIIJ' 

f~ •• ulotJen "l"-. pool.d<>ptal.. Nto P"C<t'la!t.."..a the 

rv>r«l"lt". d Rbu"'" oIIaI ttp<>t<d t'¢lt""" t" .. ('"t;y.t<rN 

"""dn1bly-" ~'!I>Itn<d .-w·) ..... he l'ff«I"It~d 0"101"'"", 

Ilutr<porUd<",",&"" .. ,<_"",id ... bly·,,"<_..-.t..") 

; ~al~1Io.d S«nc..ditOff""OpnionSIDf)'OII 

D.oInF ...... """'&T ...... 

transactions \I;th such client;, had decrea;e<i 

somewhal. 

Corponte Debt and Equity i\'larkets 

On net since July of Ian year, yield~on investmentgrade corporate bonds haw declined notably, while 

those on specu13tive-grade corporate debt posted 

mixed changes. I~ O\\"e\'er, reflecting a decline in inwstor risk-taking amid concerns about the European situation and heigbtened I"OlatiUty in financial market& 

spreads of these );elds to those on comparablematurity Treasury securities widened notably in tbe 

third quarter and bave only pmly 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 institutiollli im'estors-which include 

COllateralized loan Obligations, pension funds. insur· 

ance companies and other funds inl'ening in fixed· 

income instruments-h.1I·e reportedly continued 10 

exhibit strong appetites for higher·yielding leveraged 

loans against a backdrop of linle new supply of sucb 

10m (figure 41). Liquidity in that market has reco\'-

ertd rocently after a sbarpdeterioration during tbe 

summer. 

Broad equity prices are about uncbanged, on balance, since mid·20\ I but exhibited an unusually high 

lel"el of lulatiUty (figure 48). Equity markets feU 
83 


46. Sprm of corp:lI'alt hood yields ol'er canparable 

off·lIle-l1ln Treasul)' yields. by securities rating, 

1997-2012 

11 ! 111!!!!I! !!! I ! !' 

1998 :lOll 2f11I WI m 2008 ))10 2012 

N"", Tho dn .. cbiIy :nl ""kn:I Ihoogh r.m..y U. 201 .. Tho 

",.od..t.m. .. "'" )i<!dr rn Io.y.. bmillm "'" Io.y.. TI<"""Y 'i~1i 

SOOla: 1mI'<d ""'" ,~""""" ... yitlJ .,..... _ ~\:n~1 

LJ ...... t.:nJdft 

sharply in late July and early Augusl in response to 

concerns about the European crisis. the U.S, debt ctiling debate, and a possible slowdown in globll groll1h. 

Equity prim roughly retraced these Ios;esduring the 

lOurth quamrof 201 1 and ear~' 2012. rtllecting somewhat bener-than-<xpected economic data in the United 

States as weU as actions taken by nujorctntrll banks 

10 mitigate the financialruains in Europe. Nonetheless. 

equity prices hal'e renuined highly sensitive to news 

regarding dmlopments in Europe. Implied rolatmty 

lOr the S&P 500 index, calculated from option prices. 

47. Seroooary·lIIllrl:eI I1d prices fir s)lIrncaled Imns, 

2007- 12 

- >00 

N""" Thocb .. ncbily:nl,,~IInu;ghFtl!ruoryU,)lll 

Soom: ISTAJ'Tl.-:rIRru: ... M .. t.t<>.\llOt.oPti<in&-

• 

• 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 27 

48. Stoctpriceindex,I995-20[2 

..,~l(l(lloIOO 

[ , , , , ! ! , " " , , , , , ! , , [ 

19% 1m m 2f11I))}I m m 2010 2012 

N""" Thod:r.a ... cbily:nl","", ... «Jth~U,J)I" 

Soo.&c!: Dowlooeohl .... 

ramped up in the third quarter of 201 1 but has since 

reversed I\JJch of that rise (figure 49), 

Amid heightened stock nurket rolalilityowr the 

course of the second half of 2011. equity mutual funds 

experienctd siubleoutHows. Loan funds. which im'est 

prinuri[y in UBOR-based syndicated lewraged loans, 

also experienced ou!Hows as retail in\'es!ors responded 

to loan priCt changes following indications tbattht 

Federal Resen-e would keep interest rates lower for 

longer than prel'ious~' anticipated, With declining 

}ields on fixed-income securities boosting the perfornunce of bond mutual funds, these funds, including 

speculath'e-grade and municipal bond funds, al1racted 

ne! inOoll's(figure 50). 

49. Implied S&P 5OOvolltility, [995-2012 

------------------------~.~ 

I, , ! , ! , , , , , , , , , , ! , ! , I 

t9%l998lOll2f11l2OOlm2008:l!!02012 

Non: Tho dol. •• -kIJt :n:t ",,",,, hwsh tht .....r. tndq 

r.m..y U 2012. Tho ""'" """'_ VIX-is ibe ..pied JO.dry ""OIibty<l. .... S&PSOO..,.'t"".m'.~rro. .... 1fh«I 1\ .... <1.0\1""'" ..... 

, ~J!o,.dl#i<m~. 
84 


28 Monetary ftlhcy Report to the Congress O February 2012 

SO. Nell1owsiDtODl\llualfunds,~ll 

o Ma., ... kdfll'do 

-

. 

• Ekrdlnllribrodfll'do 

..., .... 

I I I ! I I I " I I 

Monetary Aggregates and the Federal 

Resem's Balance Sheet 

• 

• 

• 

The Mll1lJnetary aggregate expanded at an annual 

rattof about 12 peKenl over the socood half of lOll 

(figure SI),IITbe rapid growth in 1\1 2 appears to be the 

result of increased demand for safe and liquid asset, 

duc to concerns aboU1the European situation, combifl(d with a ICI)' low lel'cl of intere,t rates on a1tCroluIe short-term invesUt1eDts. In addition, a number of 

regulltol}' changes h:m likely boosted M2 of late. [n 

particular, unlimited insurance by the Federal Deposit 

Insurance Corporation (FDIC) of onshore noninterest- belring deposits bas made these deposits 

increasingly auractive al limes of heightened volatilit)' 

and uncer1.1inty in financial mar~ets. [n addition, the 

change in the FDIC assessmenl base in April2011 

added depo,it, in dome5lic banks' offshore offices., 

e~minating someof the bencfits 10 banhof booking 

deposits abroad and apparently leading. in some cases, 

to a ded,ion to reboo k some of these deposits 

t5. M2 ooDsisu<>l' (l)t""""')' oullide It.. u.s. T..asuTY, FeJmI 

~ BaDn.. .OJ It.. '''''''10<>1' dqlo;ilO!), io stil'!(iou~ (2) 1W'ritr'1 

dl<chof nonboDk i;$!>:<s; (1) dem.",d dtp<Jij1S.1 eomm:!ci.J banh 

(CI<luding t"""" ..,ou,lI. """ by deposiloryinslilUl>om, tbe us. 

V'crtlIIXtI~ ,tid ~ bank, aDd official iosritutioa,) Iosicaih 

"IllS io tbe procc;$ of oolk>:~ atld Fedenl ksm.: BOII~ (4) other 

,,,,,,bble depoGilS ("'lloriable adtr of ~;Ibdra~"'. <Jf NOW, 

""'''''01> aDd aUlomatic InlIIfer om'icc ac.rouDI< at deposiI"'l' insri· 

IIlrion~ rrtdil uoioo $ha .. draft "",runts;.tId dem, nd depoI:ilO>I 

l!!rift ioSlitu ioo,~ (5) .... i~depoI:il«i""luding..,...,. markt 

deposit ,=unl<~ (6) ... all-drnomioatioo lime depoiil«timo<JeroouisRoeJiniID""'IS<>fIcsiIh", $IOO.OOiJ) bJilldr.iduai rtlirtm:ol 

""''''''I (IRA) and Keogh boan:es at depoiitOl)· i(Jl;lil:ntions; and 

(7) l:»lan:e< in rtIa~ monrymartet fund! less IRA and Keogh 

biJ'IK:es,'mooeymorb:tt'tmd:< 

51. ,1.12 growth tlle, 2005-1 I 

Non: Md<fDliondMl ___ 1S 

"' 

-" 

" - 12 

Sow;,.; ~ol IQ".,.. bd. St.ri>t~ .. 11. ..... IU, "Mon.y St<d 

M ...... • 

onshore. Indeed. ~quid deposits, the single largest 

component of M2, grew at an annual rate of 20 percent in the socond half of 201 po Tbe currency component of the I1lJney stock grew at an annual rate of 

7 percent om the second half of 2011, a bit faster 

than the biltorical al·erage bUI a slower pace tban in 

the first half of the year. The l1lJoeury base- which is 

eqU.1.110 the sum of currency in circulation and the 

rescl"I'e balances of depositol)' institutions held lithe 

Federal Rescn-e-expanded at an annual rate of 

3% perrent in the seeond half of the Ye.1r, as the rise in 

currency JOOre lhan offset a slight decrease in resene 

balances.l1 

Tbe size of the Federal Reserve's balance slieet 

remained ata hi,torically high lel'Cl throughoUl the 

second half of 2011 and into e.1r~' 2012. and,tood at 

about S2.9trillioo as of FebrU.1.1)' 22. Tbe small rise of 

about S61 billion since July largely reflected increases 

in temporary Us. dollar liquidity swap balances with 

the ECB, which were pal1ial~' offset by a decline in 

securities holdings(table I). Holdingsof U.S. Treasul}' 

securities grew S32 billion om the socond half of 

lOll, as the proceeds from paydowns of agency debl 

and agency MBS were reinl'C,led in longer-lerm Treasury securities until the FOMe decision in September 

to ,witch the reinl-estmcnl of those proceeds to agency 

MSS: total boldingsof MBS declined into the fall. Tbe 

subsequent ,mall increase in MBS holding, reflects the 

16. RegulatiOll Q, ~'brh had pmhibitnllh< l")"""[ <>f iD~ on 

dematlddepooils. ~~'''f''akdbylbeBoardOll July14. Th~ repeal 

m'l' ""'" ali.:>cOIItnbuled, in, imiIl ~~ to !he growth in M2. 

11. Tho MEPtbat"~I'DlIOIIII<:eJ.at IboSorlemkf FmtCm«\-

ing ~udes~1X>i 1~i1XrtaSe!he ~ malurilY of Ibe Fe<haI 

Rr;tr:e •• ""uriit; hoIJiDg ... 'bilo Ieal';"g !hequantil}' '" """'"'" 

boa""," roughly wrha. 
85 


Board of w,'erno/'l' of lhe Federal &serre SysleJII 29 

l. Sclw:ed coo:p.mtllli ofllx Federal Reserve balano: 1bte1, 2{l1O-12 

MiIioo,ofdoD .. , 

ToI,I_ . -_. Orail '"'rto:ltd /a iqalizotJ "",,, .. ,,., ..Jilt"", P .... 'Y creJit 

Ct.~,j W lirsiJill ""I". 

Orail '"'rto:ltJ/aO!!tr ~l:ttF"""ip4ur 

T" ....... l-Bad:t.l s.n ...... Loa. Fdity (TALI') 

Nt< pon"lio loI.limpofTALF LLC .. 

0..:, 29, 

MO 

l,lll,m 

" " 24,M ., 

Feb.1l. 

.n 

l.87.\.&19 l.9.lS,J.19 

, 101,91~ 

,,,. 1 .. 29 m '" ~';::.i~1.~:":ft .. oiJoO w. u.c. MoiJn J..o n LLC. oo.l MoiJoo La .. TIl UC' 66.312 19,637 ;1),822 

~~:.:=~~ .. ~~~~~i&~~ij;.;pLi.C··· SOYWJOtIJ ... ,iF.' Us.TItaSO'Y ...... "' ... .. 

=::=~~i;,;;,;ri·.;.:;(iXIi)i·:·· 

T ... Il>1i1U<! .. 

S<kcIoJIiabiliIir< 

Fe.ioI>lR<s.r>'tOOlelilomlllioo .. ~",,,po"'''''1I9_0U 

~'o.\jb)dtro<it"'J'io<I~-.uc... 

or.-hid.,T,,.d<posiu 

~~ i=~:~~=-~ F;;;'-;.d.; i·~;~i " 

T ... I<>';I>I 

No!!. LLCinbm,,«IliIbiilJ'<OlOpaoy 

"" :Ji,l}51 

1,01',11ll 

1(1,400 

m ,HI 

1.w;,8..~ 

943,149 

\9,24.1 1.025,8)9 I,m 

"'" '"'" 

56~1 

1.1il4.1Il 1."",lS1 1Il.010 IOOM1 ""., ~),Ml 

lJl:!.ll:! tiIM_'56 

990,861 1.00,(1).1 

'1.m ~,Sl4 

1.66J.ll21 1,622,000 

• • 61,110 ;6,on , ... • 51 ,661 "'"' 1 Th, I'.~ R=w!w Clloldtol aodll ",><>er1II LLCs ",onl"""'" 'II"1th d!oru ~"'PPOO ",U<o] imt .. """" M""",, Lao. LLC ... furntod "''''I''"''''''''' 

=~S: .. =::-~~";:~~I:(~r:"L:.mtuli:.:~:=":tb<Ji.~;":=~= -.ttl<ltthtF~PtOO_,"",pO/AlG1w-.n","<r«IL1c1e1ultrwap<Olltra<l1 

llD<lcd .... ~MSSpo_tbot""oIlea1yKttl«l ""-

SoiRa: P.~ Ratn-o B<aN. StutI:oI RdtoI'e H . 1. "Fi<IOt1A11"«It", Ram B>Jao""o/ Dtpooto<yl,Itt\lltrlllllDl Coo<t:ooo Sti.1<I:t<"Olo/ F«I"~ Rn<no ~n· 

reinl'e5[men[ of tn1[uring agency debt into MBS. 

Agency debt declined about $14 billion om the entire 

period. TheromJXIsition of Treasury holdings also 

cbanged over this period as 1 result of the implemen[a-

[ion of the MEP: I\ S of Febrl11 ry 24, 2012, the Open 

Marke[ Desk ltthe Federal Re5CI1'e Bank of Nell' 

York (FRBNY) had purchased $211 billion in Treasury securities with remaining tn1turities of 610 

30 years and sold $223 billion in Treasury securities 

with tn1turi[iesof 3 yelrs or less. 

In the second balf of 2011 and elT~' 2012, [he Fed· 

ernl Reserve reduced some of it; exposure 10 lending 

facilities established during the financial crisis to support speci6c institutions. The portfolio holdings of 

Maiden Lane LLC, Maiden Lane II LLC, and Maiden 

Llne III LLC---tn[ities tbat lI"ere mated during the 

crisis to acquire certain assets from the Bear Steams 

Companies. nc"~ and American Internationa[ Group, 

Inc., or A[G, to x.-oid the disorderly failures of those 

ins[i1ution5-----declined, on net, primarily asa result of 

asset sa1esand principal pa)'men[~ Of note. the 

FRBNY sold assets witb a face aroount of 513 billion 

from the Maiden Lane 11 JXlrtfo[io in early 2012 

through tll"O competitive processes conducted by the 

FRS}''Y's inm[ment tn1l!3ger.

1l 

Use of regular disrountwindow lending facilities, 

such as the pritn1ry credit facility, continued to be 

minitn11l.oans outstanding under the Term AS5e[-

Backed S~ritie; Loan FaciUty dedined and stood 

just below $8 billion in la[e February. 

On No\'Cmber 30, 2011, in order [0 ease strains in 

globll financial market;; and tbereby mitigate the 

effects of such strains on the supply of credit [0 U.S. 

households and businesses, the Federll Reserve 

announced coordinated actions lIitb other central 

banh to enhance their capacity 10 provide liquidi[), 

[8. 0. .b.1lIIiI'Y 19, 2012, tho FRBNY . DDouo;;a:] tho",leof .sst .. .. ilh . ~ iIIDOtIIll of S1.0 biDi .. from tho MaiJeu La .. II LlC 

ponfoio lhrough 0 <ompe1jli»o process. 0. Fdllll>l)' &, 2012, 1110 

FRBNY .DDoo1n>.llbe We of oddiU ... [ ........ ilb. flU "Doo1l1 

of $6.2 billioo ff\)l1l tbe ~bi&e., LaDO 11 lLCponfolio. abo lhrough 

o o<>mpdiri",)Y(ItltS5.l'rocttJs from lbest ttl" In",,,,ti01li .. iD 

m1b1etho"l")metlloftho<nIin:n:mainingOO1.ltilndingbal. 1ICCof 

lbe...nor loa" from tho FRSNY 10 M.iko La .. [[ nc. 
86 


30 Monetary ftlhcy Report to the Congrtss O February 2012 

support to the global financial system. 19 The FOMC 

authorized an extension of the existing temporary 

Us. dolbr liquidity !",.ap arrangement! through February I, 2013. and the rate on these !i\\'ap arrangements 

was reduced from the US dolbr DIS rate plu! 

100 basis points to the DIS rate plusSO blSis points 

The lower cost spurred increased use of those swap 

Unes; the outstandingamounl of doUm prol'ided 

through the swap lines rose from zero in July to 

rough~' S108 billion in bte February. 

On the Uability side of the Federal Resef'-e's balance 

sheet, reserve balances held by depository institutions 

declined roughly S40 billion in the second half of 2011 

and early 2012 while Federal Reserve notes in circubtion increased roughly S57 billion. The Federal Reserve 

conducted a series of SlJl3!I-scale reverse repurchase 

trJnS.1ctions in\"olling all eligible collateral types and 

its expanded list of counterparties. The Federal 

Resent also continued to offer lrtl.1.11·value termdeposits through the Term Deposit Facility. In July of laSt 

YeJr, the Treasury reduced the balance of its SuppJe. 

menlary Financing Account at the Federal Resm'e 

from $5 billion to zero. 

International Del"clopments 

In the second half of theyen, financial market developmen15 abroad wert he.ll'i~' inftuenced by concerns 

about the heightened fiscal Slre>se, in Europe and the 

resullant risks to the global economic outlook. Foreign 

real GDP growth stepped up in the third quarter, as 

hpan reoounded from theelfectsof its March earthquake and tsunami, 1e3d.ing to an easing of supply 

chain disruptions. In contrast, recent data indiC3te that 

foreign economicgroWlh slowed in the klurth quarter, 

as activity in the euro area appears to ba\"econtracted 

and as Hooding in Thailand weighed on growth in SCI'-

eral ecooomie! in Asia. 

International Financial Markets 

The tOreign exchange value of thedoUar has risen 

since July aoout Wl percent on a trade-weighted basis 

against a broad set of curreucies(figure 52). Mostor 

the appreciation occurred in September as market part9. The B""k of c'nw, the Bank of Engl>nd, the BanI: of 

Japan. the Elropem c.nt .. 1 Bank, the Fe.Jent ~~ ""d the 

SwiA National B,n' coonIin,led tbis action. In l<Uiti"" IS I 

C01Iti~y JrQSUI't, the FO~1CWttd to esatlisb liroillllall]» 

"I}' "'~p :tm.ngntl'w ~; tb tbtse fu"tCftlltli. b.anh I~ p-<M .... 

iquiJityil.nyoflbeircum:!l<iesif ....... sary 

52. U,S,doUlroominal e.~chaoge tale, tlood inde.~. 

2007- 12 

o. ... :b" ll. lOOI_1OO 

-m 

- )]0 

- '00 

" I t t I 

'IfJJI m m ))10 W1I ))12 

N<m: Thedaa. ~·hId. .... kw.'PlaDIrr)'miI'p"Itibr, .. daiIy 

Tho ~"""'""",b n. ...... iolflr...,-2I. WI:!. The broo:I...tn. io. 

~I$hod " ... oltho "'''PI txdmtt ...... ol t.e U.s. dollar ,!mIl 

1ht ..... ....,i«ol . br!<P<'4'oll:h<_o.p;.. ... U.s.w~l'fl>". 

11., om, ... 1gIo~ m.."h dlq< "'" ,...,. lit. dtri'«l fro. U.s. <EpJI1 

"-' lit>:! fro. U.s. nib."" iOilpIl "-'. 

Sowa: Ndnal Rts<r.'. 8oIItd. SUhll>:al R<~ ... 1l10; ~ 

~h.

ticipants became increaSingly pessimisticaoout the 

situatioo in Europe. Safe-hal'en Hows buoyed the yen 

and the 511"i:.> franc, and in rtsponse. the Bank of 

Japan and the SlIiss National Bank separate~' intervened to counter fnrther appreciation of theircuITen· 

cies (figure 53). 

On net in the second half of the yea~ government 

oood }ields klr Canada, Germany, and the United 

Kingdom feU ol'er 100 basis points to record lows, 

53. U,S, dolllre:o:roaoge flle 3gilinslseledoo Illljor 

currencies,20W-12 

I t 

• 

" " 

N<m: Thedaa.~ .... kw.IPI~_,pttdolbr, .. daiIy 

ThoI_ctotr.-llion"'.dl ....... ;,~2I.))12 

Soota: Ndnal Rts<r.'. 8oIItd. SUIlII>:al R<~ ... 1l10; '1'<mtn ~h ... -
87 


54. Yields on reoctmarl:. government bonds in selected 

advanced foreign ecooomies. 2009- 12 

I, I I I I I I 

~Q,t.I ... Ap.IulyQ,t. I ... Ap,IoIyQ,t I ... 

m '.!Ow Ill! '.!OI' 

Non: n.. dab. otrl at f<t to-yt. bmdo ••• d.dy. n.. lOll 

~M"'" f<t .... t. ....... §FcbruKy21,'.!011 Soolc!: Ilb>mbe<t. 

drnu by safe-haven lIows as well as a deteriorating 

global OUlloo1:. (6gure 54). By oontl'3St, sovereign bond 

spreads for Greece rose steeply, and Spanish and hal· 

ian sovereign spreads over German bund; also 

increased (figure 55). Pricesof other rist:)' asset; were 

very 1'O)atik om Ihe period as market participanl. 

reacted 10 newsaboUl tbe crisi& (See lhe box "An 

Update on the EUrope.1D Fiscil Crisi&") 

As sovereign funding pressures spread \0 Italyand 

Spain in July and August and as concerns also 

truunted regarding US. fiscal policy and tbe durability 

of the global recovery, equity prices in tbe adl'anced 

tOrdgn eoonomies(AFEs) generally plunged 

55. GIl\'enment debt sprelds for peripheral 

EUf()jlean econanies, 2009-12 

--------------------~-.. 

I I I I I I I I I 

m IlIO '.!Oil '.!O12 

N"",; Tho <1M. ,,< -tty. Tho I» ~MIrn b ,rl ... '" "' 

Ftbruay 2.1, Illl n.. 'P'd """" atlbo j .. 1:h '" IO-yt. bmdo!...- dltIO-yt.a.. .... bcrd)';,1d 

Soom: llIoomIJtt-t. 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 31 

)6. Equityindexes in selectcl i\(iI'lOCtd foreign ecooom:~s. 

2009-12 

I I I I Iu!y Q,t I ... A,". ~ Oct. I ... Ap. llI)" Q,t In 

m '.!OIO Ill! '.!O12 

• 

N<JrL n.. dMt ... d.d". n.. I .... a....,'MIrn fa ...-h ... iH it 

Fmu.yU,'.!Oll 

Sown:f«c:.n.Jo. T"""",,Slock~Xl)~ .. Ml;b 

<1m .... no... Jor... FaoSTOXX Irdn; h-'-Tckr<>Sicrl ~ 

(TOOX~ ui b dIt !bled ~ l<nlon Slrl ~ (FISE 

;oo~"I" .. B"""""",. 

(figure 56). Thoseequity markets remained quite volatile but Ilrgely depressed through early December, 

when market senlimenl seemed to take a more concerted turn for the bener. Although tmst AFE equity 

indexes reTI1lin below their mid-sununer levels, they 

hare risen markedly in the past two tmnlh& Emerging 

markelS equity pri~e> followed a path similar 10 tbose: 

in the AFEs(6gure 57). Emerging markets bond and 

equity funds experienced largeouillowsduring periods 

57. Aggregale equity ilXlms fIX eme!gingrmrktt 

eoornxnies,2009-12 

Nom: n.. dMt lit dail)". n.. I .... obc<rnI"", b: ... -11 ... "" i. 

F.brwry U, "Xlll n., r.. .. A.tri< .. ~ z< Azf«O .... 1Ir.,;t, OW, 0::00.bu. M",ioo, nl P..u; Ibo ..... ,"'1: A';" oca.::.iH .. 

Chilo. In:b~ In:lonol.~ M"'I'''~ !'&i ..... Ibo I'III~ Sc:tm Kru~ 

T.won.nlThaiInl. 

Sown: B~ 
88 


32 Monetary ftlhcy Report to the Congrtss O February 2012 

An Update on the European Fiscal Crisis 

Tne turopean fiscal crisis Inter'tlified In the second 

haif of20n, il$~nsO\'effiscll ,ustainability 

spread to additional euro-area economil's amid 

weakening erooomic growth prospects.nl missed 

fiscal t<vgets. European fin.nciallr'tIlitutlOO> also 

fm sharply reduced access to funds, gr,'en their 

large exposures to lulnerab!eso>",reogn5.ln 

respon>e, poIicpnakers tool ~evs to imprO\", fiscal 

balarJCe>, boI~e< the ref,Km's ~nanoal bacl5top, 

and iddress liquidit)" s~ k>< banl.:s. On bai· 

ance, rffiIkeI conditions Ime imprO\w !lO<1leWhat 

sioce Decembef, oot concerns about apossible 

Creek defauh and the adequacyof the financial 

bacl5top for other lulnerable eronomies h<J,,,, 

kept )1eld5 on SOIerelgn debt eleo.-ated and funding 

for Eu rorem ~nancial InstnutKlr'tl hmlted. 

The OISl5 began In >mailer euro-<veacountries 

with hlgt. fi5C.l1 defiot> or debt and I"ulnerable 

banking systems. In 2010 am tne fir~ half of2011, 

gO\",rll/Tll'f1ll; in Cr~, Ireland, and Portugal suf· 

fered reduced access to marl;et fund ing.nl 

requ ired fmncial assistance &om the European 

Union (W) and the Inle<nalional Mooelaf)' Fund 

(I,~ If). Last .kJ ~, SO\·eretgn spreads O\er German 

bunds rose marked~ for Italy and Spain,. as eronomicp1h d~polllted, doubts increased 0\"" 

poitK:ai commitment to fiscal cor'tlohdallon,. and 

calls k>< the r~ru cturing of Creek SOI",retgn debt 

rallied ifll-estor conIideoce. The dete<iorationof 

finarcial conditions led to heoghtened "aIrtical ten· 

,ions in \1.lnerable t)COf"()mies, rontllbuting to 

leadefship changes in Cr~, lta~, and Spain late< 

tnthefall. 

Financial stresses spread quidly to Eu ropean 

banks with large exposures to Italy, Spaln, .nl the 

other 1'Ulnerab!e economies, and access to funding 

became limrted for all oot the short~ matuntres 

and ongest n~.tutlOll5.ln turn,. ~1"6 0\"" the potential fisOlI burdens for gO\'I!.rYnents, 

shookl they need to recaprtalire linancial.nstir: uof heightened concerns about the European crisi~ but 

inflows have resumed m::lre recently. 

Euro-area hank stock prices underperformed the 

broader nurket. asconcernsa'oout the health of European bank. intensified over Ihe second half of 2011. 

The CDS premiums on the debt of many luge banks 

in Europe rose substantially, reRecting nurket views of 

increased risk of default (figure 58). Quanerly earnings 

lOr nuny banks were reduced bywrite-downs on 

Greek debt. Although only eight banks failed the 

European Banking Authority (EBA) European 

Union-wide stress lest in u~ . coocerns about lhe capi. 

tions, caused sO\·ereign)'ieIds 10 rise sha'ply in the 

fall for otheo euro·area countries, irdudingAll5tll(l,. 

Beigrum, am france. 

European leaders responded to these deo.'elopments w.th a number of poItcy measures. In Ju~, 

amid the grOWing realizailOfI that Creecewoold 

need fuJlhe!firraJJCiai ass.stance, EUand LWoffi· 

cials annoo~ plans for a se::ond .escue pack. 

3f,e, inc1udingacal forl imrted reduction inthe 

value of the debt held by p"vate creditors. In Feb· 

ruary 2012, in .espon;e to Creece·, falte"ng IiscaJ 

j)elformance and plungi~ ootpo~ the Creel: goy- emmentand its creditors ayeed on an enhanced 

rescue package, looudlnga large! reduction in pri· 

l"atecreditors' dalms. The Creekgo',ernment and 

its creditors are now worl:Jng to pot In place the 

prll-ate-;ector debt exchange and the new offiaal· 

;ector support program before a la.ge debt amorti· 

urian P"rment <:orneS due in mid·Ma.ch. 

In recenl months. [u.opean illIthor.tre5 hal", also 

made progress on plans to impfOl'l! fiscal gOVel· 

nance with in troe region. EU members (exduding 

the UMed Kingdom am Czech Republic) ha-.e 

agreed on the t""'t of a new iiscaJ compact treaty 

de>igned to strengthen fiscal rules, surI .... lllance, 

and enforcement. Among othe! mea5u res, thrs 

treaty \\ill require coontJles to 1egr,Iale naltonal 

fisca rules, which shoukl genera ~ lill1lt structural 

fisca deIiots to ~ pelCeJlt of gross domesticprod· 

uct. The Ifeaty is e<pede<J to be ,igned .n "''Ia.ch, 

after which naiionaJ parliaments mUSl.ai.fy it am implement the requrred iegistation. 

Leaders also tool:a number of stevs to irrcrease 

the SIZe of thefmncial badstop for theeuro area. 

The flexlbihty. scope, and effectil'l! 1eodlng capac· 

ityof the €440 b.llion Eu.opean Fin.n.ial Stab~rty 

faality (HSf), deslgrred to >upport \"u JJefablegO\~ 

e!nmenll;, were illl1eitied. Autr.or.tresa1", m:;>o,'ed 

up the introduction of the [u.opean Stabilrty 

MecIlar-.sm(£5.\Il, a j)ermallenl €SOO billron lend· 

tal adequacy of large European banb persisted. Partly 

in respon;e to the;e concern~ the EBA announced in 

October that banb would be required to PUI in place a 

temporary extraordinary capital buffer by June 2012. 

boosting their core Tier I risk·based capital ratio to 

9 percent. As market sentiment about European blots 

deteriorated over the period, their aC(:ess to unsecured 

doUar funding diminished. particularly altenors 

beyond one week. (See the box ··U.S. DoUar Funding 

Pressures and DoUar Liquidity SwapArrangemenlS. ") 

European blOks also faced pressure in euro funding 

nurkets As banks' willingness to lend excess liquidity 
89 


ingfacility, to Ju~2012, about ayear etrliefthan 

original~ planned, This Marm, euro-area leaders 

will consider lifting the €SOO billion reiling on the 

rombn1W ~dlllgoftheHs/" and the[SM,ln 

additKlfl, [uropt'Ml offiaak called k>r an expansIOn 

of the 1,\lF's lending ca~ty and iJledged a JOInt 

contriblJllOn of €ISO billion towNd that goal. 

Final~, to Imp<O\'l thefundiOfllflg of SO\erelgn 

debt marlet5. the European Central Bank (EeB) 

resumed purchases of eunrarea marketable debt 

in August, repo<ted~ including the debt of Italy 

arK! Spain, 

PoIic)makers also lockstep:! 10 support financial 

m~eIS and InstitutIOnS affected by the SO'o'eleign 

aislS, To imprO\'e transparenq' Mld boIslerthe a~l· 

Ity of[ulopean ronks 10 hstand losses OfISO\'{'felgn holdings, the EuropeiO"l BanIJ~Authorlty 

(EBA) conducted a =end ~ress test oflarge EU 

finarriallrt>fitutions, the resull$ of whim were 

released in mid Ju~, a~ with detailed infO/mationabout tIanls- e..posuresto oo.rowers inW 

roonllies. I<la!h.1 concerns about bankcapital pelsisted, howe..er, and in October, the £BA 

anoounced thatlargebankswOIJId be required to 

bUild up 'excepliOflai and temporary" capital buf· 

fers to meet a core Tie< I cap<tal ratIO of 9 percent 

arK! COI'er the cost of mMj~so\'{'felgn exposures 

to mallet l:>fthe end of June 2012.ln December, 

the EBA dO$dosed that the aggregate requ irw <apital bufferk>r large banLs woold be €lIS billion if 

risk-we.ghted assets we.e to remam at the b-els 

theyha::l reached at. theend of September 20n. 

The ronks subm.tted tr.e.r capital plans to their 

natioml supeJ\1SOfsfor appJOl'a~ and the [BA has 

now summarized these plans. £xcIud ~ the Creek 

banks and three other 1ns1ltutl()flS thai Wil l be 

recapitalized §epNateiy by natioml authorities, the 

rerrtaHl"'g 62 banks HlterK! to aeate capital buffer> 

equi"alent 10 -£98 billion, about 25 percenliarr,er 

than thel! requrred buffers, and they plan to use 

di'ect Qlpital measures burn a\ retaining 

to one another decreased, the co;t of obtaining funding in the m.utet roSt', ami banks relied more heal'ily 

on tbe ECB for funding. The first three·year refinancing operation, held by the EeB on Dccrmber 21, led 10 

a significant injoction of nC\'.' liquidity, and funding 

condilion;; in Europe seemed to improve gradually in 

the week> that followed. Sbort-term earo interbank 

rate, declined, euro-area sborter-\luration sovereign 

rond yields fell sharp~ , and botb governments and 

bank> were able to raise funds trore easily. 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 33 

eamlllgs, issurng new shares, and coo"elli~ h)ilrid 

instruments to common equ,ty)to achie\.e €iS billion of their buffer. The remainder of the buffer will 

be genetated by measures that reduct! riskweighted a56e15-p<lmanly §ellingassel$ and 

~~chrng from the standNdiled to the ad\!iO"ICed 

approach to me<l>ure Jlsk welght~. These measures 

wil l be subject 10 supervisory aweement 

To address spilloo.er> to Us. doilN fundl;g mar· 

kets from ,tresses In [urope. in late NO\ember the 

federal Reserve. the £CB, and fOur othei milJOl' 

cmtral banks agreed to reduce thefee on draws on 

their dollar liquidity ~ap Ii.-.es and e>;tend the 

durationof ~UCIl facihties.ln early December, the 

[CB announced a reduction In 11$ poii<)' Interest 

raleand I\Sre§el';erequirement,an ea.s ~of rules 

on collateral for ECB refir.ancr~ operall()flS, and 

theprO"o"iSlOllofthr_yeN refrnancingtobanksto 

imprO\'e their fuooi~ ,ituation. Banks oo.rowed 

£489 billion at tfle new facility in ~mbi:<, ral$-

~ the to!al afT'lOlJnt of outstand ~ £CB refir.aoc-

~ operatlOll5 by rOlJgh~ £100 ~lIion. A serond 

tlv_)'ea, liqUidity operation is scheduled for the 

end of February. 

The Imp!"O\ed availabtlityof dollar and euro 

funds late in tfle )'ear, agaifl>lthe bad;uound of 

the other ~Kles bemg emplo)ed 10 address the 

alSOS, appears to ha'>e part~ allayed marlet c0ncerns about banLs as wdlas gO\"ernrnertts In ",I· 

r.erableeuro-area roontries. Over the pM! two 

rroolh$, European banks ha,-eseen imprO\ements 

in their oc:ress to fundillg. and in '1Jinerable erooom.es, aed~ sp<eads OIl the banks and spreads on 

gDI'ernment bondslm-e general~ declined. Nevertheless. significanl nsks remain <I> Europeans 

struggle to Implement the fleW Greek p<0lf'I" and 

debt exchange, meet targets fOr budgel$ and bank 

capital, arid expand the finanoal ba::btop. CNerthe 

'enger term, the region must meet the difficuk challenges of oc'"e~ ngsustalOed fiscaJ consolidation, 

stimulatingwowth, and improving competitiveness. 

The Finaocial Accounl 

Financial Hows in the S(:cond half of 201 1 reOeCled 

beightened concerns about risk and tbe pressures in 

currency markets resulting from the European crisi~ 

Based on data for the third quarter and tronthly indicators for the founh quarter(not shown), foreign private investors Hocked 10 U.S. Treasury securities as a 

safe-baven iltye;tment while selling U.S. corporate 

S(:curities., especiaUy in trontbs wben appetite for risk 
90 


)4 Monetary ftlhcy Report to the Congrtss O February 2012 

58. Credildefaull SWlP premiums fOf haol:s in 

selected Europe:m rouoUies, 2011-12 

----------------------~"=-.. 

-M 

' ... - .. - '" 

<oo 

- Spa, - 300 

- •. . U_I:. - 3),J 

- - 100 

N"",Thodal>vo.ily. TholaltoWo·""", b .>do",,;" iI 

~ 24.2012. CudoI o.fUl'~V"" bri _dobIonJ .. ,g.,d by bri 1<UI ....... 

SooiC!: M..tf;IIloo.t...-&;~ .. R..or.veBo;ro.uif<>lrnl.rm. 

was puticularlyweak (figure 59). Us. investors also 

pulled oock from investments in Europe, siguifiC30!ly 

reducing deposits with European banks lnd seUing 

securities from euro-area couDlries. OveraO, U.S. purchases of foreign securities edged down in the tbird 

quarter (figure 60). 

The large purc-hasesof Treasury securities domi· 

nated t01l1 privlte financial HOII'5 in the third quarter, a 

paltern that likely continued in the fourth quarter. Net 

Oows by bank510cated in the United States were small, 

but these ftOIl'! masked large offsetting mol"ements by 

IOreign- and US.-owDed banks. US. branches of 

European banks brought in substantial funds from 

59. Net f(l"eigu JXlrctwes of U.S, securities, 2007-1 I 

II 

• OO'~loI~ofU.s. TI<OIII)',.".... ... 

Ptiva<~orU.s.T,.....,..."..rie< 

o Flrduorrof"""U.s_OKUlt", 

WI m )XJ'! 2010 201t 

- .. - " -<00 

- '" -" 

-<00 

- '00 

-" 

t I 

N",,; ot...U.s.......,;.,iDoW."""".f<pII ... onJl<nl<.~ 

l<nl<.m~l<nl<. 

SOIII:C!: ~ofeo..,.,.,..BInouorli«n>m~Wyci;. 

60. Net U.S, purcblStSofforeigo seo:urities, 2007-11 

- '00 

- '00 

II I I 

N= Nq:,""" IUIIbor< -... Nbrn of 1'")_ ",flow 

ilhf"'.""'U.s_~ofkuip'''''';';'' 

Sow:.; o.,..t_clc-....Bo: .... of~AnaIy<,~ 

affiliates abroad overthe course of 2011, bu ilding 

rese[\'e b.l!ances in the first half of the year and co\'ering pcrsislent declines in U.S. funding sources. In con· 

trast, U.s. banks. subjocttO less-severe market sire5.$., 

sent funds abroad to lll«t strong dollar demand. 

InOows from foreign official institutions slowed 

notabl)' in the second balf of 20ll (figure 61). A DUm-

!lerof advanced countries acquired some U.S. assets. 

seeking to counteract upward pressureoD tbeircurrencie, by plJIClilsing u.s. doOm in foreign exchange 

markets. Howerer, inllow, from official institutions in 

the EMEs trended dO\\ll signifiC3Dtly in 2011, especially in the tbiro and fourtb quarters when tbe 

61. U.S.netfinancialinflows.2007-1 1 

o P" •• (n:hdiog briq) 

. U.s.offo:ial 

~l7'oIf~--w 

WI m )XJ'! 2OtO 2011 

- "" 

-'" 

-'" 

Non: u.s. off.rut n.:,.., irrW, .... k .. '!" all'''')" ~ ....... 

k:ttlgI ....... oI bril.tow """". ,..'IIp ...... 'm .... Hdttollwnw. : Dop:01_oic-.:..Bo:, ... dIi<<n>Di<AnaIy<I ~ 
91 


strength of the dollar Jed to rt'\Iuctions in their interI'ention actility, 

Am'anced Foreign Econonies 

The intensification of the euro-area sovereign deht crisis was accompanied by a lIidespread s10lling of ec0-

nomic activity in the AFEs.. ln the euro area, financial 

tensions increased despite the various measures 

announced by European leaders to combat the crisis. 

Real GDP contracted in theeuro area at the end of 

Ian year according to preliminary estUrutes. and spill, 

overs from the euro area likely contributed to the 

tOurth-quarter GDPdecline in the United Kingdom 

In Japan, economic activit}' rebounded rapid~' from 

the disruptions of the March earthquake and tsunami 

but dipped again in the last quamr of 2011 as exports 

slumped, In Canada, elevated conunodity price; and a 

resilient labor nurket hal'e supported economic actil" 

ity, but the export sector is sholling sign, of 

weakening. 

SUI'-ey indicators suggest that conditions improved 

somewhat around the tum of the year, with widespread upticks in different countries' purchasing nunagers indexes. However, uncertainty about the resolu· 

tion of tbe euro-area crisis continues to affect 

inreSlors' sentiment, while trade and fiD3.ncialspill. 

overs weigh on actility for all of the AFEs. 

Tllcll'¢·month headline inHation renuined elevated 

in mon of the AFEs through the end of 2011, largely 

62 0I31lg~ in consmne! prices for m::Ijcr [creign 

ecooomies,2007-12 

! ! 

'!WI m m JJ10 :lit! :lit, 

_. 

- • - , 

- • - , 

- , 

- , 

· " - ,

- , 

- , , I 

NOlI: Thedol ... ...:ttliy ... huOfd*oqhl_y:llt2f<tc...do. 

t..e\W .... arddwoUnll<dK~ardt~Do<t.bor:lltt '" bpar!;1Il<""_<hq:<i<Irooo"""J'<" , .... 

Sooocz; Rw 1Il< e\W .... the Et.q>e .. ~~ B.:t; b 1Il< tnoed 

Kqoo.. Iht UK 00" .. f<t NOImoi StM .. h,.; b I""", to. I..,., StM'"~' &.<111;..-.J. fa C"""" $urom::. c...da; oItvi. Hmr AnaI),~ .. 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 35 

rellecting the run·up in conunodity prices earlier last 

year and, in some countries. currency depreciation and 

increases in taxes(figure 62). However. underl}ing 

inllation pressures renuined conuined and, in recent 

monlh~ inllation r:ues hal'e begun to turn down, 

rellecting weJ.ter economic activity and, as in the 

United Sutes., declines in comroodity prices since Ian 

spring. As with output, inllation performlnce differs 

significantly aCrDS,countries. Tweh-e-roonth headline 

inllation current~· ranges from 3.6 percent in the 

United Kingdom partly due to hikes in utility prices, 

to slightly negath-e in Japan, wheredellation resumed 

toward the eod of 2011 aseuergy price inllation trod· 

erated. 

Several foreign central banb in the AFEs eased 

moneury policy in the second balf of ]a,t year 

(figure 63), The ECB cut its policy rale 50 basis points 

in the fourth quarter, bringing the nuin refinancing 

rate back to 1 percent. where it was at the beginning of 

the year. At its De«mber metting,the ECB also 

expanded its pfO\"ision of liquidity to the banking sector by introducing two three.year longer ·term refinancing operations. rt'\Iucing its resme ratio requirement from2 perceDi to I percent, and easing its 

collateral requirements The Bank of England has held 

the Bank Rate at 0.5 percent but announced a£7; bil· 

lion expansion of its asset purchase facility in October 

and a further £50 billion increase in Fehruary that wiu 

bring toul a;set holdings to £325 billion upon its 

completion in Iay 2012. The funk of Japan also 

expanded its asset purchase program raising it from 

63 Official or tMg!"ledimerest rates in seltcted 

3dvm.:e<l fCleigIl e.:ooomies, 2008-12 

-. 

-, 

-, 

NOlI: Tho dO!o .. daily ard",l«ddw,\dl """"'" U. Wl1. Thodll. """"_.be"""" "'u'g<lfa ", ,,,-..nip_;fa oho..., .... Iht 

• .-..bKl , .. "" • .." <f....,"'!:.,,..-"otm;fal"""'the'a-v!f"lht 

oaIt, .. ; ..... bthoUniledKirJtdooa.dwoofli<ooII1ri.RoIt. :Tho«ffiolWo/ .. :b" .. "..........ay.ro..n. 
92 


36 Monetary ftlhcy Report to the Congrtss O February 2012 

u.s. DollarFunding Pressures and Dollarliquidity Swap Anangements 

As the euro-area crisis ,ntens,lied, Eu ropean b.Yl1s 

faced yeater dollat hllld'rlf,pressures. Mar'l'f European banls were especially lulnerable to chMges 

rn illo"e5tor sentiment th rough the" relialce on 

sOOr\-term doIlar-denornmated fund ing_ A5 mallet 

sentrment deteriorated, Eu ropean b.Yiks' acce\S to 

mediurr.. and long-term dollar funding market> 

dunrIMshed markedly, with maII)' unallie to obtajn 

Ull5l'C\lred dollar funding at maturrtres exceeding 

onewm. ThepulibadofUS. moneymarket 

funds{I\t\,fs) from liabilities of euro-area t:.anks 

beginning in mid-2011 {figu re AI was an rmportant 

part of the ruo-off of short-term dollar funds, 

although ~ l\\Fs were not the only im'eS'ors to 

redu~!herr apo5ures to Eu ropean banls. As a 

resuk, many European banls faced hrgher dollar 

fund ing cost>. for eo;ample, the cost for euro-oYea 

banks to obtain thr~month dollar funding 

trvough theforeign ",change (fXI swap market 

rClSeru;finar>::ial pr~ures increased. The cost of 

dollar fUMing through this market {the bIacI: line in 

figure Bl, as banks borrow euros atheeuro LOIldoornterbankoffered rate(LlBORjMdswap into 

dollars InthefX !iWapmarket, rose from 40 basis 

POints early last >ummer to about 200 Msrs pomt> 

rn late N()\-ember. 

Akhough the efffrts of these dollar funding 

straHl! are difficult to g<luge, they pose substantoal 

risls for the US. ocommy. Larlt European banb 

borrow he""ily in doIl<fi "artly be<:oose they ¥e 

act~'e rn US. markets, purchasrng gOl'ernment and 

corporate secunties as well as making loans to US. 

households and busillel.\es. A possible res~ to 

dollar funding marns, along with ooghtened capital requ irements, might be for European banks to 

\'15trillion 10 no aillion in October and then 10 

\'30 trillion in February. 

Emerging Markel Economies 

Many EM& experienced a slowdown in economic 

growth in the third quarter of L15t year relatiw to the 

pace seen in the first hal[ Both earlier policy tigh tening, undertaken amid concerns about o\'crheating, and 

weakening external demand weighed on groll1h. However, third-quarter gro\\1h in China and Mexico 

remained strong, supported by robust domestic 

demand. Ret'entdata indicale thlttbe ,k1\\do\\'l1 con" 

tinued and broadened in Ihe fourth quarter, as the 

finandll crisis in Europe softened externll demand 

A U,S. money m:u\.::('\ fuod iloldings, WI I 

I I 

N= The ..... -.onIhIyald .. ..mIlw"'!hS<:wt..,.,))IL 

OIhe!E...,.,.= .. d.Dmllld.~Ncr,, 'I',S.tdm. 

Sn.m.rdaldhUnf<d~ 

s.o..c.: s..-.. .... Rl &..~ Commim:n 0 .. N,\!FP. 

M<nhly &tweBdt d.I\nfot.,HokIq< d.~1oo;y Mn.. IUdo 

sell thelr dollar a>sets or refra'" from further doItar 

lending. which could In turn re;uk In a reductlOll of 

the credit thepupply to U.s. frrlll!i and household! 

while also redUCIng creditlo European am other 

foreign firlll!i in'."olved in trade with the United 

Stales. Theodore, Iirrtherstresse$OO European 

banl.:scould spill OI-er to the United States by 

weigh ing on OOSIIlesS and CORiumer actr-;ity, 

restrarlllngour exports. and adding to pressures on 

US. fiww-Klal rnar'.;ets and loslltullons. 

and tbe IIoods in Thailand impeded supply chain~ In 

the second half of last year, concerns about the global 

eronomy prompted EME authorities either 10 put 

tmnetary policy tightening on hold or. in several 

cases.-such as Brazil, China, Indonesil, and Thailand-to loosen tmnetary 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 inl"eStmem slowed a touch 

but continued to grow briskly, reflecting solid domestic 

demand. But net export> exerted a smlll dragon 

groWlh. as weak external demand clamped exports. 

Twelve-tmnth headline inllation tmderated to arout 

4'h percent in January, as food priCtS retreated from 

earlier sharp rises. With gtOlllh slowing and inllation 

on the decline, Chinese authorities rt\"ersed the course 
93 


B. COSIS oftlree-mooth dollar fundiog lll'oogb 

tbt> for<'ign exclmlge swap martel,!be central 00.01: swap line, aM dollar UBOR, 2011-12 

-])J 

N"", The dolo .. doiI), The 1asI<:bo'lIimf" .rlIsorie<" 

1'<kuy24, :lIl1. n... ...... 00II. fIrIdi1tdl"""dIt k«o:gn 

rn/lq< (FX) "'II' ...uo: .......... m. bart< ft~ 110)' tWO 

LlBOl1;(Lcni;:"idtrbftoll't.<d_)toobuan...,fIming. 

--

To acidness >trains in dollar fuooirlf, m",kels, the 

Federal Reserve, the [ulOpean Central Bank (£CBt 

aM the central tlanks of Canada. Japan, Swiller· 

1.100, and the UllIted Kingdom arll)()(Jnced an 

of trunetal)' policy toward a~ing by lowering the 

reserve requirement for large banb 100 bnis point~ to 

20.5 percent. In 2011, the Chinese renminbi appreciated 4\', percent against the doUar and aoout6 percent 

on a T¢31 trade-weighted basis; the latter measure 

gauges the renminbi's value against tbe currtlK"ies of 

Cbina's major trading panners and adjusts for differ· 

ences in inflation rate~ 

In Mexico, «XJnomicactil"ity arxelerated in the second and third quarters as domestic demand expanded 

robustly. owe\'e~ incoming indicators, such as tepid 

growth of exports to the United States., point to a 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 37 

agreement on N()\\'~mber 30 to rel'ise, extend, and 

exp<Vld the U.s.doIlarswiljJ lines, Tnere>'iled· 

agreement klwere:l the IHire of dollar fuoo irlf, prolided through the swaps (the red line 10 figure B) to 

a rate of50 basls pOUlt> 0I'l'f the dollar O\ernrght 

iooex swap rate, a reductKlllofSO basls POHlts In 

the rate at which the fOJelgn central bart> had 

l>een pr()',iding doll", loans Slr.;dla)' 2010. 

The reduction In dollar fuMing costs dueto the 

revised proong of the centlai bani; swap lines 

nelped strengthen the liquidity positions of [urorean and other foreign banks, thereby benefrtlng 

the Un~ed States bysuppo<t,rlf, the continued supplyof oedit to US households .100 businesses 

whde mitigating other charrrrels of nsk Draws on 

the swap lioes, e:Sj>eCially nom the ECB, ha'.e l>een 

s.gnlilavlt. On December 7, at thefir>t three-month 

dollar tender uooerthenew prOcingrnme, the 

ECB allocated about ~51 billion, as ub$tanlial 

increase ()\e< pre .... ious operations. As ofFebrll3l)' 

24, the ECB, the Bankof Ja~ and the SwiS$ 

National Bankhad mut$89 bd liol\ SIS billion, 

aM 105 billion outsIMCimg, respectively, from 

their dollar swap hne allotments, for a total of 

about SlOB billKlll.ln an ,ndocatoon that the swap 

lines ha'e l>een effect;"e at reduong O\"eJal l dollar 

funding pressure, the cost of obIamUlgdoilars OIl 

the FX swap marlet has dropped sub>tant,allys,nce 

Novtmbeo" 30. Doll", lIBOR, which measure> dol· 

lar fuMing cost:; mthe interbank market for US 

aM foreign inst,tutions, has 31$0 declined ()',er the 

pasttl'Klmonths. 

slowdown in the fourtb quarter. Mexican consumer 

price inflation rose sharply in the second balf of the 

year, driven I.1rgely by rising food prices and the 

rem:)\'alof electrical eoefJiY subsidie~ In Brazil, in 000· 

ttast to trust H,IEs, GDP contracted slightly in the 

third quarter, but inooming indicators point to a return 

to groWlh in the founh quamr, panly as a result of 

se,'eral rounds of m:lDetary policy eaSing that began in 

August. As the direction of capital flows turned to a 

netoutilow, Brazilian authorities loosened ClpitalcontroIs tbat had been introduced elr~er in the face of 

massive inflows and associated fears of ovemcating. 
94 


J9 

Part 3 

Monetary Policy: Recent Developments 

and Outlook 

MOnelar)' PoUcy O\'er the Second Half 

of 201 t and Early 2012 

To promote the Federal Open Markel Committee's 

(FOMC)objeetil'es of rmxiroom employment and 

pritt stabi~ty, the Commiuee rn1intained a target 

range lOr the federal funds r.lle of 0 to Yo percent 

tbroughoul1he second balf of 2011 and into 2012 

(figure 64). With the incoming data suggesting a some· 

what slower paCtOr economic recovery than the Commil!ee bad anticipated, and with inflation seen as settling al levels 11 or below those coosi;tent with ils 

statutory tnlndale, the Connninee look slepsduring 

the second half of 2011 and in early 2012 to prol'ide 

additional monetary accommodation in order to support a stronger economic reool"ery and to help ensure 

that inflation, Ol'er lime, runs at \evelsoonsistenl \Iith 

ils mandate. These steps included strengthening ils 

IOrward rale guidance regarding the Committee's 

expect31ioDSfoT the periodorer which eronorrOCoon· 

ditions wiU warrant exceptionally low hds for the 

federal funds nile, increasing Ihe average maturity of 

the Federal Reserve's securities holdings through a 

program of purcbasesand sales, and reinve,ting principal paymeDlson agency securities in agency6t Seloct«l inleJ\'St rales, 2008-12 

guarantee{[ tmrtgage-backed securities(MBS) rather 

than Trea~ury securitie~ 

On August!, the Commillee met by lideoconferenee 10 discuss issues associated with ooDtingenciesin 

thee\'entthatthe Treasury was temporarily UMble 10 

meet ils obligations becluse the statutory federal dtbt 

limit was not raised or in the ewnt of a downgrade of 

the U.S, sovereign credit rating, Participants generally 

anticipated that there would be DO nee{[ to make 

change, to exi>ling bank regUlations, the operation of 

thedis:count window, or the conduct of open market 

operation~2°With respect to potential policy actions, 

participaDls agreed that the appropriate response 

would depend important~' on the actualoonditiom in 

markets lnd ,hould generally oonsi>l of standard 

operation~ 

The information rel'iewed at the regularly scheduled 

FOMe meeting on Augu.t 9 indicated that the pace of 

20. Mtmhm<Jl tbe FO~tC COtI$i;I of {bell><1llbm<Jl tbe BoaN 

<Jl o-m.:.n<Jl {be Fe.krallbc=Sy.tem plus {be ~.rn{ c( 

tbe Federal R.seroo Banl:ofN .... Yort:.nd4c({be .... ainin8 

II Rc!e"" Baok p,..;dtuu. ~..., '""" OIlO')',ar {<mil"" • rolaUIl8 

basis. fprid;l.l~rs It FO~!c ~iug>oo.gll <Jl {hi: nxrob<n c( 

tbe BoaN <Jl Go\~ of the Fe.Ienl ~ Syu<m Ind.D 

12~Bankp"';dtutG. 

... 

- , 

- , 

- , 

{ { { { { { { { ~------- { { { { { { { " 

No:"' n., ,L .... doily ..... l<D:Ihnlgh FtI:m:.y U, KIll lb.11).)'<III T",aDJ' _ i<t..""", ... ___ ., yi<lll>....t "''''' ..... ,;.,.lytrUd 

...".t,.,_lb._",""IoIZ<Ill .. atir .. ~<i.rttuI<l:lykherulrdr.dml~M_Ct.. ...... ...mv S""m : o.pw..nt<i. .... T ... ~ ... thorodt .. lksffI' •• 
95 


40 Monetary fulicy Report to the Congrtss O Fcbruary 2012 

the economic recovcry hd fttnlined slow in recent 

months and tht labor tnlrket conditions oontinued to 

be weak. In addition, m'ised data for 2008 through 

201 0 from the Bureau of Eoonomic Analysis indicated 

that the ment recession Md been deeper than pre-lioU51y tbought and that the lnel of real gross domestic 

product (GOP) had not yet regained its pre-rece>Sion 

peak by the second quarter of 2011. MortOwr, downward revisions to fir51-qumer GOP growtb and tbe 

0011' groll1h reported for the second quarter indicated 

that the recovery bad betn quite sluggisb in the first 

half of 2011. Private nonfarm pa}TOU employment rose 

at a oonsiderably slower pace in June and July tMn 

earlier in tbe year, and participants noted a deterioration in labor market oonditions. slower household 

spending, a drop in oon;umer and husiness oonfidence, 

and continued wcakne;s in the housing sector, Inflation. which had pided up earlier in tbe ~'ear asa result 

of higher prices for some oortlJll;Xlities and imported 

goods as well as supply chain dilruptions resulting 

from tbe natural di>aster in Japan. rooderated more 

recently as prices of energy and some oortlJll;Xlities fell 

IxIck from their earUer peaks. Longer-term inOation 

expectationsretnlined stable. u.s. financial markets 

were strong~' influenced by del'elopments regarding 

the fiscal situations in the United States and in Europe 

and by generallyweaker-thao-expected readings on 

economic activity. as foreign oconomicgroll'th 

appeared to have slowed significant~ . Yields on nominal Treasury S¢("urities feU notably, on net, while yields 

on both inmtment- and speruJatil'e-gradecorporate 

bonds feU a little le:;s than thoseon comparabletnlturityTreasury securities. iel"ing risk spreads wider. 

Broad u.s. stock price indexes declined significantly. 

Most members agreed that tbe economic outlook 

had deteriorated by enough to warrant a Comminee 

response at the August meeting. Those I'iewing a shift 

toward more accortlJll;Xlati\'e policy as appropriate 

general~' agreed that a strengthening of the Committee'~ forward guidlnre regarding the federal funds rate, 

by being more explicit about the period o\'erwhich the 

Comminee expected the federal fund:; rate to remain 

exceptionally low, would be a measured response to the 

deterioration in the outlook oyer the intermeeting 

period. TheCommilte<: agreed to keep the target range 

fOr the federal funds rate at 0 to \I, pef("ent and to state 

that roJnomic conditions-induding loll' rates of 

resource utilization and a subdued outlook for inflation over the medium run-are likely to warmnt exceptionally low leyels for the federal funds rate at least 

through mid-20ll That anticipated path for the federal funds rate was viewed as appropriate in ligbt of 

most members' outlook for the eronOlll)'. 

The data in hand at the Seplember 20-21 FOMe 

meeting indicated that economic acti\ity continued to 

expand at a slow pace and that labor market conditions remained weak. Consumer price inHation 

appeared 10 hal'e rooderated sinC(' C.1rher in the yC.1r as 

prices of energy and some oortlJll;Xlities declined from 

their peaks. but it had not yet come down as mucb as 

partidplDlS had expected at previous meetings. Industrial production expanded in July and August. real 

business spending on equipment and software 

appeared to expaoo further. and real consumer spending posted a solid gain in Ju~. However. private nonfarm employment rose only slight~' in August, and the 

unemployment rate renuined high. Consumer sentiment deteriorated significantly further in August and 

stayed downbeat in early September. Acti\'ity in the 

housing sector oontinued to bedepressed by weak 

denund, uncertainty about future home prices, tight 

credit oonditions for mortgages and oonstruction 

loans. and a substantial iOl'enlOry of foreclosed and 

db,ressed properties. Financial tnlrkets were volatile 

ol'er the intermeeting period as investors responded to 

somewhat disappointing nN's. on IxIlance, regarding 

economicaClivity in the United States and abroad, 

Weak economic data oontributed to rising expeC'l3tions 

among tnlrket participants of additional monetary 

accortlJll;Xlation: tbose expeC'l3tionsand increasing 

concern;; about the financial situation in Europe led to 

an appreciable decline in intermediate- and longerterm nominal Treasury )ields. Fluctuations in inmtors' level of coneun about European fiscal and financial prospects also contributed to nurket lulatility, 

particularly in equity nurkets. and spread, of yields on 

investment- and speculati\-c-grade oorporate bonds 

over those on comparable-tnlturity Treasury securities 

rose significantly oyer the intermeeting period, reaching lel'els last registered in late 2009. 

In the discussion of monetary policy, most members 

agreed that the outlook had deteriorated somewhat, 

and that there were ~ignificant downside risks to the 

ecooomic outlook, including strains in global financial 

tnlrket~ As a result. the Comminee decided that pro-

~iding additional monetary lcronunodation would be 

appropriate to support a stronger rtOOl'ery and to help 

ensure tbat inllation, ol-er time, was at a leYel oonsistent lIith the Comminee'sdual tnlndate. Those viewing greater poUcy acrolIUllodation as appropriate at 

this meeting generally supported a tnlturity extension 

program that would combine asset purchases and sales 

to extend tbe l"erage maturity of securities held in tbe 

System Open ~bIket Acoount without generating a 

substantial expansion of the Federal Reserl-e's IxIllnce 

sheet or resme lxllanccs. Specifically, those members 
96 


supported a program under which the Committee 

would announce its intention 10 purchase. by the end 

of June 2012, $400 billion ofTreJsury securit~s lIith 

remaining maturities of 6 yell'S to 30 years and 10 sell 

an equal amount of Treasury securities \\ith remaining 

maturities of 3 years or leso. They expected this program 10 put downward pressure on longer-term inter, 

eSI rates and to beip make broader financial oonditions 

more acronuoodative. In addition. to help support 

oonditions in mortgage markets, tbe Committee 

decided to reinw;;1 principal received from its holdings 

of agency debt and agency MBS in agency MBS rather 

than continuing to reinl'est those funds in Ionger,term 

Treasury ;ocurit~; as had been the Comminee's practice since tbe August 2010 FOMC meeting, At the 

same time, the Committee decided 10 maintain its 

existing poliC)' of rolling over maturingTreasury securitiesat auction, In its statement, the Committee DOted 

that it liQuid continue to regularly rel'iell' the size and 

composition of its securities boldingsand tbat it was 

prepared to adjust those holdings as appropriate, The 

Comminee aoo decided to keep tbe target range for 

the federal funds rate at 0 to Yo percent and to reaffirm 

its anticipation that economic conditions were likely 10 

warrant exceptional ' loll' lel'els for the federal funds 

rate at least through mid·20l l 

The information re\iewed at tbe NOI'ember 1-2 

l1'Jetting indicated that the pace of economic activity 

strengthened ;ome'what in the third quarter, reflecting 

in part a reversal of the temporary factors that 

weighed on economic growth in the 6rst half of tlie 

year. Global supply chain disruptions associated lI;th 

the natural disaster in hpan bad diminished, and the 

prices of energy and;ome ootniOOdities had oome 

down from their fteeDt peaks. easing strains on household budgets and likely contributing to a ;omewhat 

,tronger pace of consumer spending in recent Jmnths. 

Real equipment and software inl'estment expanded 

appreciahly, and real per;ollli oonsumption expenditures(pcE) rose moderately in the third qUlrter, How· 

ever, ftal disjXI53hle income declined in the third qU3r· 

ter and oonsumer sentiment continued to be downbe:11 

in October, In addition, labor tn.'lrket conditions 

remained weak as the pace of private-sector job gains 

in the third quarter asa whole was less than it was in 

the fir.t half of the year, Oreral! consumer price infla· 

tion was IOOre moderale than earlier in the year, as 

prices of energy and;ome cotniOOditiesdedined from 

their recent peaks. and mea,ufts of longer.run infla· 

tion expectation, remained stahle. Financial market, 

were quite volatile and inl'eslOr sentiment was strong~' 

influenced by prospects for Europe, a~ market participants ftmained highly alluned to developments 

&ard of Gtn'erno/'l' of lhe Fedaa! &serre SysteJII 41 

regarding possible Slep~ to contain the fiSC3.l and banking problems there, Longer-term Treasury yields 

dedined appreciably, on ner, orer the period, and 

yield, on investment- and speculath'e-grade oorporate 

bonds mol'cd lower, lea~;ng their spread; to Treasury 

securities sUghtly narroller, Although equit)' martets 

were I'olatik, broad u.s. equity price indexes ended the 

interm«tiog period Utile changed. 

Most FO;"IC members anticipated that the pace of 

economic growth would remain moderate ol'er ooming 

quarters. with unemploymentdedining only gradually 

and inflation settling ator below levels consistent with 

the dual mandate, Moreover, the recovery was stiU seen 

as subject to significant downside risks, including 

strains in global financial markets. Accordingly, in the 

discussion of IOOnetary jXllicy, all Commiuee members 

agreed to coptiMe tlie program of extending tlie 3Vtrage maturity of the Fe<leral Reserl'e's holdings of securities as announced in September, The Comminee 

de<ide<l to maintain its existiog policy of ftinmting 

principal payment> from its holdings of agency debt 

and agency MRS in agency MBS and of rolling ol'er 

maturing TrelSU!)' securities at auction. In addition. 

the Committee agreed to keep the target range for the 

federal funds rate at 0 10 Y. percent and to reiterate its 

expectation that economic conditions were likely 10 

warrant exceptional~' low le\'el, for the federal fuod, 

rate at least through mid-201l 

Om subsequent wee~s. financial market; appeared 

to be<:ome increaSingly oonOO'ned that a timely re;olution of tlie European ;ol'ereign debt situation might 

not ocrur despite the melsures that authorities there 

announced in October; pftssuftson European sol'ereign deht markets increased, and condition, in European funding markets deteriorated apprecilb~'. The 

greater financial ,tress appeared likely to damp economicactivity in theeum area and potentially to pose 

a risk 10 the economic recoW1Y in the United State~ 

On NOI'ember 28, the Commiuee met by videoconference to discus; a proposilto amend and augment 

tlie Federal Reserve's temjXIrary liquidity swap 

arrangements with foreign central ronks in light of the 

increased strains in global financial markets. The proposil included a six-month extension of the sunset 

date and a 50 basi;; point reduclion in the pricing on 

the existing dollar liquidity swap arrangement; lI;th 

the Bunk of Canada, the Bunk of England, the Bank 

of Japan, the European Central Bank (ECB), and the 

Swiss National Bunk, In addition, the proposal 

included the establishment, as a contingency measure, 

of swap amngements that would allow the Federal 

Reserl'e to prol'ide liquidity 10 U.S, institutions in foreign currencies should the nee<! arise, The propo$.11 was 
97 


42 Monetary fuhcy Report to the Congress O February 2012 

aimed at helping to ease strains in financial markets 

and thereby 10 mitigate the effects of such strains on 

the supply of credit 10 US, households and businesses. 

thus supporting the economic recovery, Most partici, 

pants agreed that the proposed changes 10 the SI\'ap 

arrangements would repm.ent an important delOOnstration of theconunitmenlof the Federal Resen-e and 

tlie other central I>3nb 10 work together 10 support tbe 

global financial system Atthecondusion of the dis, 

cussion, ahrust all members agreed to support the 

changes to the existing swap ~ne arrangement, and the 

establishment of tbe new foreign currency swap 

agrttments. 

Asof the December 13 FOMC meeting, the dau 

indiclIed tlut u.s. economic actil·ity had expanded 

rmderately despite some apparent slowing in the 

growth of toreign economies and strains in gl01>31 

finan,iil markets. Conditions in tbe labor market 

seemed to have improved SOmell'hat, as the unemployment rate dropped in NOI'ember and private nonfarm 

employment continued to increase rmderately, In 

October, industrial production rose, and overall real 

PCE grew l1l"Jdestly following significlntgains in the 

previous IOOnth, However, revised estimates indicated 

that bousebolds' real disposable income declined in the 

second and third quarters, the net wealth of house-

'ooIds decreased, and consumer sentiment was stiU at a 

suMued lel'el in early December. Actn'ity in the bousing ourret renuined depre;sed by the substantial 

inl'entory of toredosed and distressed properties and 

by weak demand that reflected tight credit conditions 

tor IOOrtgage loans and uncertainty about future home 

prices. O .. erallconsumer price inHation continued 10 be 

more rmde>t than earlier in tbe year, and measures of 

long-run inflation expecutions had been >table. The 

risks associated witb tbe fiscal and financial difficulties 

in Europe remained the focus of allention in financial 

marketsol'er the intermeeting period and coDlributed 

to beightened volatility in a wide rangeof asset markets. HOIm'cr, ;tock prices and Ionger,term intere;t 

!"ltcs had cbanged little. on balance, since the NOI'ember meeting, 

Members viewed the infornution on U.S, ~onomic 

Jctn'it)' receil'ed ol'er the intermeeting period as .uggesting tlut the economy \\uuld oontinue to expand 

rmderately, Strains in globJ.l finan,iil nurkm continued to pose significant downside risks 10 t\."Onomic 

J("(n'ity, Members alw anticipated that inflation \\uuld 

sellJe, over comingquarlers, at levels at or below those 

consistent with tbe Conunittee's dual nuO(late. In the 

discussion of IOOneury policy lOr the period innnediately ahead, Conunillee members generally agreed that 

theirorerall asscssments of the economic outlook had 

not cbanged greatly since their pm'ious meeting. A, a 

reSUlt, the Conunillee decided to continue the program 

of extending the amage outurity of the Federal 

Resen'e's holdings of securities as announced in September, 10 reuin the existing policies TegaJding the 

reinvestment of principal payments from Federal 

Resen'e holdings of securities, and to keep the target 

range for th e federal fund, rate at 0 to Y. percent 

While several members noted that tbe reference to mid2013 in the forward rate guidance might need to be 

adjusted before long, and a number of tbem looked 

fOrw:lrd to oonsidering possible enhancements to the 

Conunillee's communications. the Conuninee agreed 

to reiterate its anticipation that economic condilions 

were likely to warrant exceptionally low levels for the 

federal funds rate at least through mid-lOll 

The inforoution Tel'iewed at the January 24- 25 

meeting indicated that u.s. economic activity continued to expand rmderately, while global gro\\lh 

appeared 10 be slowing, Labor market indicators 

pointed 10 some furtber improvement in labor market 

conditions, but progress WlS gradual and the unemployment rate remained elented, Housebold spending 

bad oontinued to adl'ance at a IOOderate pace despite 

diminished growth in real disposable income, but 

gro\\1h in business fixed inl'estment had slowed, The 

bousing sector remained depressed, InDation Iud been 

subdued in recent IOOnths, there was linle e\'idence of 

wage or cost pressures, and Ionger,term inflation 

expectations bad renuined stable. Meeting participant. 

observed that financial condition; had improved and 

financial nurket stresses had eased somewhat during 

the interrneeting period: Equity prices Wert bigher, 

volatility had d~lined, and bank lending conditions 

appeared 10 be iroproving, Participants noted that tbe 

ECB's three,year refinancing operation bad apparently 

resulted in iropl\J\'ed conditions in European so\'ereign 

debt nurkets. Nonetheless. participants expected that 

global financial nurket> would remain focused on the 

erolving situation in Europe and they anticipated thlt 

further policy efforts \\uuld be required to fully 

address tbe 6scal and financial problems there. 

With the economy facing continuing head\\inds and 

gro\\lh slowing in a number of u.s. export ourket~ 

members generally expected a rmdest pace of economiegro\\th over coming quarters, with the unemployment rate d~lining only gradU11~ , At the same 

time, members tbought tlut inOation would fUn at levelsat or below those consistent with the Conuninee'1i 

dual nundate. Against tbis backdrop, members agreed 

that it \\uuJd be appropriate to mainuin the existing 

bighly accommodatr.'e >tance of moneury poUcy, 

They agreed to keep the target range tor the federal 
98 


funds rate at 0 10 ~~ percent, to continue the program 

of extending the awrage maturity of tbe Federal 

Re>erl'e's boldingsof 5t(urities as announced in September, and to retain the existing policies reglrding the 

reinl'e5tment of principal p1yments from Federal 

Resene boldingsof senJrities. In ~ght of theeeDnomic 

outlook, /IlJst members also agrttd to indicate tbat tbe 

CommiUee expects to maintain a highly accomrooda· 

tive stance for monetary policy and anticipates that 

economicconditioDsare likely 10 warrant exceptionally 

low lel1:1s for tbe federal funds rate at least through late 

2014, longer than bad beeD indicated in recent FO~ C 

stalement~ The Comminee al>o stated that it is prep1red to adjust the size and composition of ils 5t(uri, 

ties holdings as appropriate 10 pro/llJle a stronger economic recol'ery in a contexl of price stability, 

FOMC Communications 

Transplreucy is an essential principle of rmdem cen, 

tral banking because it appropriately contribules to Ihe 

accountability of central banks to the gOl"emment and 

to the public and because it can enhance the effective. 

nmof central banks in achiel'ing their macroeconomic objectives. To this end, the Federal Reserl'e provides to the public a considerable alJKlunt of 

inlOrnution concerning the conduct of IJKlnetary 

policy, Immediately IOUowiDg eacb meeting of the 

FOMC, Ihe Commil1ee releases a statement thtlays 

out the rationale for its policy decision, and detailed 

minutes of each FOMC meeting are made public three 

weeks foUo\ling tbe meeting. lightly edited transcripts 

of FOMC meetings are released to the public \lith a 

fil'e-},car lag.11 Moreom, since last April, the Chair' 

man has held press conferences after regularly scheduled two-day FOMC meeting;. At the press confereDCts, tbe Chairman prc!CntS the cumnt economic 

projections of FOMC participlntsand pro\'idesadditional context lOr its po~cy decision~ 

The Commillee continued 10 consider additional 

improl"ements in its communications approacb in the 

second half of 2011 and the first pan of 2012, In a 

discussion on external rommunicationsat the September 20--21 FOMCmeeting, rmst participants indicated 

that they fal'ored taking steps 10 incre:J.se further the 

transparency of /IlJnetary policy, including providing 

rmre information abouttheCommillee's longer,rnn 

policy objectil'es and the factors that inHuence the 

21. FOMCSlaItTDtOIS. roiuules. and unS<Tipts. as .. -dI asQIbtt m.1<d intorm.rioa, ~,,~ table 00 tho I'tdrnI R<smoo e,."d', 

...m1e'l .. "",f~g"'im"""tarypo"",,Ibn:,blDL 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 43 

Commillee's policy decision~ Participantsgeneral~' 

agreed that a dt.1 r statement of the Commil1ee's 

Ionger,run policy objective; could be helpful: some 

noted that it would also be uscfullO clarify the ~nkage 

between these longer-run objectil'es and the Committee'sapproach to selling the stanet of rmottary po~c:' 

in tbe sbort and medium run~ Participants generally 

saw tbe Commillee', poslmteting statements as not 

weU suited 10 communicate fuUy tlx Commillee's 

thinkiDgabout its objectives and its policy framework, 

aDd they agreed that tbe Comminee would need 10 usc 

other means 10 rommunicate that information or 10 

supplement inform:ltion in the SUlemenl. A number of 

participants suggested that the Committee's periodic 

Summary of Economic Projt'ctions (SEP) could be 

used to prol'ide more information about their I'iell'soo 

the longer-run objectives and the likely evolution of 

monetal)' policy, 

At the NOl'ember 1-2 FOMC meeting, participants 

discuS5ed alternatil'e /IlJnetar)' po~C}' strategies and 

potential approaches for enhancing the clarity of their 

public communications. tbough DO decision was made 

at that meeting to change tbe Comminee's plUcy strategy or communications. It was noted that many central 

banks around tbe lI\Jfld pursue an explicit infiation 

objectil'¢, mainl3in tbe Hexibmty to stabilizeeconomic 

actilit)', and seek \0 communicate their kJrecasts and 

policy plans a:; clearly as possible. Many participants 

pointed 10 the merits of specifying an explicit longerrun inllation goal. but itwls nOled that such a step 

rould be misperceil'ed a, placing greater weight on 

price stability tban on maximum employment: consequently, some suggested tbal a numerical inOation goal 

would need 10 be set forth within a coDtext tbat clear~' 

uDdmcored tbe Commil1ee', commitment to fostering 

both pam of its dual mandate. Mostof participants 

agreed that it could be beneficial to formubte and pubUsb a statement tbat1l'0uld elucidate the Commillee's 

policy approach, and participants generally expressed 

interest in prol'idingadditional inlOrmation 10 the public about the likely future path of the target federal 

funds rate. The Chairm:ln asked tlx subcommillee on 

rommunications, Ixaded by GOI'emor Yellen, to gil'e 

romideration to a possible statement of tbe Commit· 

tee'slonger-ruD goals and policy slIategy, and he also 

encouraged the subcommittee to explore potential 

approaches for incorp::>rating information about plrticipants' assessmeDts of appropriate IJKlneury plUcy 

into the SEP.22 

n. The ..... 'oo:>l\lJ1liUte 011 COJ1)mwnlious is cb.;,w b~ G<l\>troor 

YeIIn! l.d io<lIlJ •• o",",""" RastiD, "".I PrtsidtIllS E"..us .. d 

"-
99 


44 Monetary fuhcy Report to the Congrtss O February 2012 

At the December 13 Fm.IC meeting, participants 

further considered ways in which the Comminee might 

enhance the clarity and tramp,Utney of its public communic;lIion~ The 'iubcomminee 00 communications 

rerommended an approach for incorporating inforlTll' 

tion about participants' projection> of appropriate 

future IlXlnetary poUcy into tbe SEP, wbicb the FOMC 

releases four timeseaeh year, In th e SEP, participants' 

proje<:tions lOr economic growth, unemployment, and 

inllation are conditioned on tbeirindi\idual assessmentsof the patb of IlXlnetary poJicy that is roost 

likely to be consistent witb tbe Federal Reserve's SUtu· 

tory mandate to promote maximum employment and 

price Slahmty, but inforl1l3tion about those assessments 

bas DOt been included io the SEP: Most participant> 

agree<ilhat adding their proje<:tionsof the urget fed· 

eral fund, rale to the eronomie projections alreJdy 

provided in the SEPwould belp the public beuer 

undersl.1nd the Conuninee's monetary policy decisions 

and the ways in which tbose deci,ions depend on members' asse.,ments of eronomicand financial condi· 

tion~ !\ ttbe conclusion of thediscus.ion, panicipaDls 

decided to incorporate information abouttbeir projec. 

tionsof appropriate monetary poUcy into the SEP 

beginning in hnua£)~ 

Following up 00 tbe Conuninee', discussion of 

policy frameworks at its November meeting, the subcommineeon conununiC3.1ions preseoted a draft state· 

ment of theComminee's longer.run goals and policy 

strategy. Pa rticipants generally agreed that issuing such 

a statement could be helpful in enhancing the tran'p:n· 

cncy and acroumability of monetary policy and in 

facilitating weD·informed decisionJ11.1l;:ing by bouse· 

boldsand businesses. and thus in enhancing tbe Committee's ability to prollXlte the goals specified in its 

statutory mandate in tbe face of significant economic 

;turblDCe~ Howe\'er, a coDpleof participants 

expressed the concern tbat a sutemeDlthat was suffi· 

ciently nuanced to capture the di\'ersityofviewson tbe 

Conuninee might Dot, in fact , enbance public under· 

standing of the Conuninee's actions and intention~ 

Participant! commented on the draft sta!ement, and 

the Chairman encouraged the subconunillee to nuke 

adjustments to the draft and 10 present a revised \'cr· 

sion for tbe Conuninee's further consideration in 

hnua£)~ 

At tbe hnna£)' 24-25 meeting, the subconuninee on 

communications presented a rtlised draft of a state· 

ment of principles regarding the FOMC's longer.run 

goals and monetary policy strategy, Almost all partici. 

pants suPPJrted adopting and releasing the revised 

sutement (see the box FO~IC Slltement Regarding 

Longer.Run Goalsand Monetary Policy Strategy'l lt 

was noted thattbe proposed slltement did not repre· 

sent a change in the Conuninee's policy approacb. 

Instead, the statement wa, intended 10 help enhance 

the transparency, accountability, and effectiveness of 

monel.1ry policy. 

In addition, in light of the decision I1l3de at tbe 

December meeting, the Conuninee provided in tbe 

January SEP inlOrmation about each participant's 

me.,menl> of appropriate monetary policy, Specifi. 

c:illy, tbe SEP included information about participants' 

estimates of the appropriate le\·el of the target federal 

funds rate in the fourth quarter of the current year and 

the next few calendar years. and over the longer run: 

the SEP also reported participants' current projections 

of the likely timing of the appropriate first increase in 

the target rate given their projectiom of future eco· 

nomiecondition;. The accompanying narrative 

described the key factors underlying those asse.,menl! 

and provided some qualitative information regarding 

participlnts' expectations for the Federal Reser,e's 

balance sheet. A number of participants suggested fur· 

ther possible enhancements to the SEP: the Cbairman 

asked the subcomminee to explore such enbancements 

ol-er coming months. 
100 


Board of w,'erno/'l' of lhe Federal &serre SysleJII 45 

FOMe Statement Regarding Longer-Run Goals and Monetary Policy Strategy 

Following careli.d deliber.JIions 31 its ~nt meeIirw, the Fede.al Open Market Committee (FO.\lq 

has reached mood Weement 00 thefollowlng 

prinaples regarrhng Its longer-run goals and monetary polK:'( 51",tegy. The (omllllttee intend> to 

reaffirm these pnocipies and to make adjustments 

;c; appropriate at Its aooual orglllllZatlooal meetIng 

each January. 

The rO~1C is f.mlycorrmitted to fulfilling Its 

,taMory mandatefrOffl the Congress of ",omoting 

maximum emplojment, stable prices, and moderate lang-term Interest. ",tes. The Commmeeseels 

to e.:pIain its monet;uy poIicydeciOOns to the public as dearly as possIble. Sum dan!)' facilitates 

well·rnformed demlooomang by households and 

businesses, reduceseconomic and financial UI"lC'eftamty, Increases the e/fectl\"l'Ol'SS of mooetary 

poky, and enflance; transparency and account· 

amli!)" which :.ee5selllial in a demooatic $OcieIy. 

InIlalion,employment,and Iong·term interest 

rates fluctuate over time in re$pon5e to economic 

and fmncial disturbance;. MOfOOl"er, monetary 

poky actions tend to Influe~ economIC actJ\i!)' 

and price:switha lag. Therefore,theCommmee's 

poky demlOflS rdlect Its langel·run goals, Its 

medlU ..... term outlook, and (s assessmentsof the 

balaroce of nsb, lrocludllg flsls to the financial 

sptemthat could HllpeOe thealtalnment of the 

Comminee'$ goals. 

The inflation rate o"er the longer run is primaflly 

determined by!l'lOflelar)' fIOIOcy,and heocethe 

Comm,nee hasthe abili!), to specify a langer-run 

goal for inflatlOfl. The Commmee Judges thai "'flation at the rate of2 percent, as measured by the 

aooual mange in the price In<ie; for personal coosumption expend, ures, IS most con\~ ent 0I'et the 

longer runwlth the fede",1 ReseJ\e's statutory 

mand<lle. Commumcabng thIS ini1ation goal deaJfy 

to the public helps keep Iooge<.term inflatl:rn 

expedations firmly anchored, thereby fostenng 

price stabilr!)' and moderate long-term Interest 

rate! and eriurocing the (omrlllttee's ability to promote maxImum emploj'me.~ in the fare of significant economic di>lurb.n:es. 

The maxImum bel of emplo)lnent is largely 

detelJfMroed by nonmooetary factors that affect the 

strudureanddynarnic!ofthe labor mar\et. Theie 

factorsma'ichangeOl'ett,mea<Jd mayJlOl be 

directlymeasu ab~. Consequently, ,twould JIOI 

be appropnate to specify a Ii<ed goal k>r employment; rather, the Corrwrunee's policy decisions 

must be informed by assessmenlS of the maXImum 

level of emplo)men~ recogniz ing that sum assessments are nocessarl~ Uncertain and subject to re.i1IOfI. The Comrl1lttee constders a wide range of 

iooicators in makmg theseassessmerts. InformatlOfl about CommIttee iJ<IflIcipanll' es~mates of 

the Ionger.run normal rates of output growth and 

unemplojment ~ pu~ished four times per lear in 

the FO,\ICs SumlTl3l)' of Economic PrOJections_ for 

example, inthemost recent prOJfdions, FO,"tC 

participants' es~mates of the langel-run oormal 

raleof unemplo)'JJ\eIlI had a centraJ tendencyof 

51 petrefllto 6.0 percent, roughly unchanged 

from last January but substanhally hIgher than the 

co<res.,ond ing IIItervai se.eral Yell! e.vlrer. 

Insettlngmonetary polK.)', theCommitteeseffi 

to mlbgate de\latlOflS of InilatlOfl from rts longer· 

ru ngoal and de-.-.alionsofempIo)1TIe<lt from the 

Committee'sassessmertsofits """"mum bel. 

TheseobJect;..·es are generally complementary. 

Howe."er, undel circumstance; in which the Comrrnttee JUdges that theobjectl\"t5 are JIOI complementary, it follows a balanced approach In promolIngthefl\ takinglntoarx:ountthe m<rgnltudeofthe 

de\1at1OflS and the potentlalo/ diffelent bme hori· 

ZOfI) o,er whICh emploj'ment and IIlllabon <we ",0-

jeded to retumto bets Judged consIstent Wlth its 

mardate. 
101 


47 

Part 4 

Summary of Economic Projections 

The/allowing material appeared as an addemium /0 the 

minules {)j IheJl1Iluary 14--15,1012, meeling oj the 

Fedulli Opt/! Marktt ummlil/u. 

In conjunction \lith the hOlJ3ry 24-25, 2012, Federal 

Open Market Commiuee O~ q rowing, the membersof the Board of Go\'ernors lDd the presidents of 

the Federal Reserve Banks, all of whom paniciPlte in 

the deUberalioDsof the FOMe, submilled projectioD' 

lOr growth of real output, the unemployment rale, and 

inllation for the years 2012 \0 2014aod over the longer 

run. Theeconomic projections were based on infOfll1l· 

liOD available lithe time of the metting and partici. 

paDtS' individual assumptions aoou1 factors like~' to 

affect eoonomicoutoolDts, including their lS>e'S5men\S 

of appropriate JOOoetary policy. Starting with the 

January roo:ling. participants aJ;;o submitted their 

as.sessmeDlsof the path lOr the target federal funds rale 

that they \1ewed as appropriate and compatible with 

their individual eronomic projections.. Longer-run projections represent each puticipani's assessment of the 

rale to wbicb each I'ariabk would beexp«ted to conI"age over time under appropriate rmnetar)' policy 

and in the absence of further sboch "Appropriate 

rmnetary po~cy" is defined as Ihe fUlure palh of 

policy that participant! deem rmst likely to fosteroulcomes for eronomicactil'ity and iollation that best 

satisfy their indi,;dual interpretation of tbe Federal 

Resene's objectil-es of maximum employment and 

stable prices.. 

Asdepicted in figure I, FOMC participants projected continued economic expansion over tbe 2012-14 

period, with real gross domestic product (GDP) rising 

at a IOOdest rate tbisyear and then strengthening further througb 2014, Participants geneflUy anticipated 

only a mull decline in tlie unempkl ment rate tliis 

year. In 2013 and 2014, the pace of the expansion was 

projected to exceed participants' estirnates of the 

longer-run sustainable rate of incre.1se in real GOP by 

enough to result in a gradual further decline in the 

unemployment rale. Hown'er, at tbe end of 201 4, participants generally exp«ted Ihat the unemployment 

fltewould still be well abol"t their estimates of tbe 

longer-run nornul unemployment flte thai they current~' view as consistent witb tbe FOMC's statutory 

rnandate for prormting maximum employment and 

price stabmty. Participants I'iewed the upward pressures on inllation in lOll from faclors such as supply 

chain disruptions and rising comroodity prices as baving waned, aDd they anticipated Ihal inftation would 

faU back in 2012, Ol'er the projection period, rmst participantsexp«led inllation, as measured by the annual 

change in the price index for personal consumption 

expenditures (PC£), 10 be at or below the FO;\lC's 

objectr.-e of 2 percent that was expressed in the Commillet's statement of longer-run goals aDd policy strategy, Core inllation was projected to run at about the 

same: flte as overall iollation. 

As indicated in table I, reLnil-e to their prel'ious projections in November 2011, participants rnade smali 

downward revisions 10 their exp«tatioo> for the rate 

of increase in real GDP in 2012 and 2013, but tbey did 

not rnlterially alter tbeir proje<"tionsfor a noticeably 

stronger pace of expansion by 2014. With the unemployment rate having declined in rtttnt rmnths by 

rmre than participants bad anticipated in the previous 

Surnnury of Economic Pro,J(C1ioo> (SEP), Ihey general~ low red their IOrecasts for the !eyel of the unemployment rateorer the next t\\O years. Participants' 

exp«tations for both tbe longer-run flte of increase in 

real GDP and the longer-run unemployment rate were 

~tt!e cbanged from November. They did not significantly alter their folt("asls for Ihe rale of inllation over 

the next thrtt years. HowCl-er, in light of the 2 percent 

inflation that is the objectil'e included in the statement 

of longer-run goals and policy strategy adopted at the 

h nuary meeting, the range and central tendene~' of 

their projections of longer-run infialion were all equal 

to 2 pem-nt. 

As shown in figure 2, JOOst paIticipaDls judged tbat 

bigh~' accommodatil'e rmnetary policy was ~keJy 10 

be warranted over coming years to proJOOte a stronger 

eronomicexplnsion in the context of price stability. In 

particu\a~ with the unemployment rate proje<"ted to 

rernain eJel'ated ol'er tbe projection period and inllation expected to be subdued, six participants anticipated that, under appropriate rmnetary policy, the fim 

increase in the target federal funds flle would occur 

after 2014, and five e.>:pected policy firming to commence during 2014 (tbe upper panel). The remaining 

six participants judged that flising the federal fuDds 

flte sooner would be required to furestall infiationary 

pressures or avoid distortions in the financial system. 

As indicated in tbe lower panel. aD of the inwI'idu.:d 
102 


48 Monetary ftlhcy Report to the CongrtssO February 2012 

Figuu L Centtal lenoi'ocies and ranges of e«lOcmic ~ojt"CtiOflS, 2012-1~ aodOl·('[" tile Iongerrun 

-

-, 

iii .. - , -, 

- 1 -0 

- , 

- , - , , I 

~" ~I! WI1 WI> 1014 Coo., .0 

Unemp.o)"llIem 11l~ 

-

- , 

-, 

-, ~ ~ , 

III -, 

- , I I I I ,., '" ,.. ~'" WI! 2011 2013 2014 Coo,. 

.. !U:inflation -

-, 

• i iii -, 

- , 

,., ,.. ,.. WIO Wit 1012 WI> 1014 '-' .0 

Con PCE inlbtion -

- , 

~ ~ II III!II 

-, 

- , 

I I I I ,., '" ,., WIO WI! 2012 Wil 2014 

Ncm: Dtlino"",d •• _ .. in ......... tot~ I. ~d:r.ah h lk"IIIlII ....... dtbe ... _ .. ....w. llrduh .... dill!vin .... 

rnP. PCE inI\oI:""," aid .... PCE inI\oI:m ..... ktW11 ...-.xp:<'" h odI· ........ "'dGDPf<t .... bIIh"""" dWI I. """'" iIIo &rtto 

dr..:m-: ANI) .• , .. It"":!at JIIlW)' "II. :lm. n... m ill'!!"" . ... ..x .... ail3I>1t to FQ\]C IIIt<IItl! porI>:I(IIU'a! .... I_ d ..... _lilt-
103 


Board of w,'erno/'l' of lhe Federal &serre SysleJII 49 

Table 1. Econooic projediom of Fedtrlll Resm't &lllrd m::mbo:!I aDd Fedtral Resm't Bank prtOOmu, January 2012 

..... , 

C<o(fah • .o.O<!" .. ", \'ariablo 

l!jll I I lOll I I "" NI4 w.II""" "" ." '--, 

a ug< iu" GOP .. 1.11011 !S1.n )JIOU lJ!Ol.6 !Ho3.0 H!OJ.S l.8!OU 11103.0 

s .... b.,projrctioo 2.51019 >'OloB 1.0loH Hto!7 23toB 11104.0 l1.,H 2.2to1.0 

Uot.,pioy .... t,1II< ... 8.1t08.5 Ht08.1 PooH U!OU 1.3toH 1.01081 6J.,1.1 .\.OtoU 

N ....... 'pfOje«ioo. &.Sloll J.8lo8.1 6.8IOJ.1 51106.0 tl!OS.9 1.5 IOU 6.5lOs.o S,O!OU 

PCEiotwioo . iAlo1.8 I.HolO 1.61010 " 1.3102.5 U!OlJ 1.51Ol.1 

N .... bM-projt<-!ioo IAto1.O 1.5to1.0 ]j!OlO Utol.O Hto1.8 14",lS U",l.4 ]jtol.O " Cot<PCEiolbtioo' . UtolJ 1.5to1.0 1.6 10 10 I.3tol.O I.~"'",O 1.4"'".0 

N ....... '1".jrctioo . UI.10 1.41.1.9 1.51010 1.310l.1 1.41021 1.~!Ol1 

N:ra Proj_oI~LOraI"",ckm""cpro1oct(GOPJud~iJ<I:ct.bIll"""",oI"kIoo ... h"",tb<btrth~IW"'oI<h'pr<YIOOIyear"'th< 

bor!itqOWldlborou_ ~E~blmud_l'CE"tioo"'!h<_tit'''!ao/olIao!''''.~Ibo~'''lDltlktpemoalo:cstllllp!i<1l 

~""(I'a!J .. dth.po",~"'I'a!<lOIl>l",rM .. d",,,,,,p""""CC1b-th<'''''''~l''''.,.ktth<_cma.o ..... ~ ...... ,,th. m<!hqOWldlboroui_ Eaeb;atti<ipao('"""""""""'_OdbllOfllo:......., .. td 'll"OJ>'IlI<"""""'7poUql..oo$e<'''''""""",",,,,,,,,,"' 

;:t'=~=~\c!:::...~~-:;:=:"!~=:::-~::ro;.~=='h=.'~,,~~oIr'"lI<rlbo<b''' I 1b.'«rIttoI!<O<I"",_tb<w..¥"udw.._~1:><<aobI'illOlJ<"oa<iI)'!at 

1 Th<"""rOl • .., .... II."'"")'W=_~PllII<OpI!It(prqt<tiom.r"'"'_"'III(l>M.b-tllat_iotbllyear 

J. L<qor~" I'f\li""">ni br "'" l'C£"ht>oa ... "",<Ul<aod. 

assessmeDlsof lhe appropriate urget federal funds rate 

over Ihe nexl ;e\'eral years were below Ihe longer-run 

leI'el of Ihe federal funds rale, and II parlicip.1nls 

plated the Urget federal funds rate at I pereent or 

lower al the end of 2014. Most p.1rticipants indicaled 

that the), expected that the DOrmalization of tbe Federal Reserve's halance sbett sbould OCCIlr in a way oonsistent with the principles agreed on ltthe June 2011 

meeting of the FQ,\IC, with the timing of adjustments 

dependent on the expected dale of the first poUcy 

tightening. A few participants judged that. gn'en their 

current assessments of the economicoul oo~. appropriate lXllicy would include additional asset purchases 

in 2012, and one assumed an e:Hly ending of Ihe maJUrIt)' exlenSlon program. 

A sizable majority of p.1rticipJnts continued to 

judge Ihe Iml of unceruinl)' associated lI;th lheir pro· 

jections for !'tal actn;t)' and the unemployment rate as 

unusually high relative 10 historical norms. Many also 

attached a greater-lhan.normallel~1 of uncertainty to 

their forecasts for inflation, bUI. comparro witb the 

NOI'ember SEP, IWO additional participants viewed 

uncertainty as broadly similar to longer-run norms. As 

in November. many pJrticipanls S3W downside risks 

auending their forecasts of real GDPgrollth and 

upside risb to their forecasts of lhe unemployment 

rale; !l'I.)st pJrticipanls vicl';ed the risks 10 their inf\.1-

lion projections as broadly balanced. 

The Outlook for Econonic Ac!i"ity 

The central lendency of participJnl;" forecasts for the 

change in !'tal GDP in 2012 was2.2 to 2.7 percent. 

This forecasl for 2012. while slightly lower than the 

projection prepared in November. would represent a 

pickup in OUtpUI grolltb from 201110 a rate close to 

its longer-run trend, Participanls stated tbat the eco· 

nomic information recen'ed since NOlmlber showed 

continued gradual improvement in the pace of economicacth'ity during the second half of 2011, as the 

inflnenceof the lemporary factors tMI damped activo 

ity in tbe first Mlf of the year subsided. Consumer 

spending incTe3sed ala mxierale rale, exports 

expJnded solidly, and business im'cstmenl rose further. 

Rettntly, oonsumers and businesses appeared to 

become semewMI roore optimisikaboul the outlook. 

Financial condition! for dcmestic nonfinancial businesses were gcneral~' falurable, and ooDditioDsin CODsumercredil markets showed signs of improl~ment. 

Howcyer. a number of factors suggested tbllthe 

pace of tbe expansion would continue to be restrained. 

Although some indicalOrsof acth·it)' in the bousing 

seclor impro\'ed slighll)' lilhe end of 2011, new homebu ilding and sales remained at depressed levels, hou;e 

price; were stilI falling, and roortgage credit remained 

tight. Households' real di;posable income rose only 

roodesl~ through llie 2011 . In addilion, federal spend-
104 


50 Monetary ftlhcy Report to the CongrtssO February 2012 

I 

, 

• 

1 

6 

5 5 

• , , , 3 

2 2 

I 

0 >112 >113 >11, >115 >116 

6 

Tqet Feu Pnnoh R-= • Y~-&Id 

5 

...... ... 

I 

• • 

3 

• 

... 2 

• 

• I .. • 

I • • .. ....... H ..... ........... . ..... 0 >112 :.n >II, 

No;nE:"'~"""pood.~ho/cbI<Ltadlbotac-.1bc"'""'*ofl'OYC~ ... 1hor, ..... ~-rpolir;J_io 

~ obocnctofm.tbcrolloc:b ...... """"""'J.1IIom.ilc:rtut io 1llo.1i:dt!a1 fudo 1ft r...n .. _,..01010 ~ pao:otd ....... i11 

_opcQ6cdco,lQ:dqo,...1A1bcJo.u!*'d."""lhtdedcildc ___ .(I!IIIIOkdI01bc_~~oE.iDdioidDd~ 

jodgII>o:IIIoE_"fIf""P'ioItltw:lal_.&:dasIfuodolft ...... cadal_optci&dcobdu,..."' ...... ~Jarrca ..... 
105 


ing oontracted towlId year-eod, and tbe re,training 

effects of fiscal consolidation appeared ~ke!y to be 

greater this year than anticipated at the time of the 

November projection~ Participants also read the information on economic actil;ty abroad. particularly in 

Europe. as pointing to weaker demand for US. exports 

in comingquartm than had seemed likely when the)' 

prepared their forecasts in November. 

Participants anticipated that the pact of the economic expan,ion would strengthen ol'er the 2013--14 

period, reaching rates of increase in real GOP aool'e 

their estimates of the longer-run rates of output 

growth. The central tendencies of participlnts' foreelsts for the change in real GDP were 2.8 to 12 perctnt in WI3 and 3.3 to 4.0 percent in 2014. AlTIJng tbe 

comiderations supporting their forocJ.st>, participlnts 

cited their expectation that the expan;ion liQuId be 

supported by lTIJnelary policy acconunodalion, ongoing improvements in cre<lit condition;. rising house· 

bold and business confidence. and strengthening 

bousehold balance ,heet~ Many partidpantsjudged 

that US. fiscal policy would ,till be a drag on economic actil'ity in 2013. but man)' anticipated that prog. 

re;;s would be made in resolling the fi,;ca\ situation in 

Europe and that tbe foreign economic outlook would 

be lTIJre positil'e, Orer time and in the absence of 

,;hocks, participants expected that the rate of increase 

of real GOP would converge to their estimates of its 

longer-run rate, with a central tendency of 2J to 

2,6 percent, little changed from their estimltes in 

NOI'ember. 

The unemployment rate improved more in late lOll 

than lTIJst participants had anticipated wben they prepared their Nowmber projection;, falling from 9.1 to 

8.7 percent between the third and fourth quarters. Asa 

result. lTIJst participants adjusted down their projections for the unemployment rate this year. Nonetheless, 

with real GDP expected to increase at a JOOde,t rate in 

2012, the unemployment rate wa~ projected to decline 

only a lillIe this year, lIitb the central tendency of particip:mt;' foreca515 at 8.210 8.5 percent at year-end. 

Thereafter, participaDls expected that the pickup in tbe 

pace of the expansion in 2013 and 2014 would be 

acrompanied by a further gradual improl'ement in 

labor market oonditions. Thecentral tendency of par· 

ticipant,' forecast. 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 cenlfaltendency of 

plrticipanl:i' estimates of the longer-run normal rate of 

unemployment tbal would prtl'ail in the absence of 

further shocks wa~ 5.2 to 6.0 percent. Most participants indicated that they anticipated that fil'c or six 

years would be required to dose the gap betnen the 

Board of w,'erno/'l' of lhe Federal &serre SysleJII 51 

CUrrtllt unemployment rate and their estimates of the 

Ionger·run rate, althougb some noted thatlTlJre time 

would likely be needed. 

Figures 3.A and 1 B providedetai1s on the dim'sity 

of partiCipants' viC'll'S regarding the likely outcomes for 

real GDP growth and the unemployment rateol'¢r tbe 

next three years and OHr tbe longer run. The disper. 

sion in tbese projections reOected differenm in participants' asse55mentsof many fal'lors, including appropriate lTIJnetal)' policy and its effects on economic 

actil'ity. tbe underlying lTIJmentum in economicactil'-

ity, the effects of tbe European situation, the prospertil'e path for Us. fiscal policy, the likelye\'Olution of 

credit and financial market condition;, and tbe extent 

of ,tructural disJocatiom in the laoor market. Compared with their NOI'ember projections, the range of 

participants' forecasts for the change in real GOP in 

2012 narrowed somewbat and shifted slightly lower. as 

some participants reassessed the outlook for global 

economic growlh and for US. 6scal poUcy. Many, how· 

e\'er. made no material cbange 10 tbeir forecasts for 

growth of real GOP this year. The dispersion of participlDts' forecasts for output growtb in 2013 and 2014 

remained relatil'¢ly wide. Having incorporated the data 

shOllinga lower rate of unemployment attbe end of 

2011 tban previou;Jyexpected, the distribution of participants' projections for the end of 2012 shifted 

noticeab~' down relative to the NO\'ember forecast;. 

The ranges for the unemployment rate in 2013 and 

2014 sbowed less pronounced shifl! toward lower rates 

and, as was the case lIith the ranges for output grDIIlh, 

remained wide. Participants made only modest adjust· 

ments to their projections of the rates of output 

growth and unemployment over the longer run, and, 

on net. the dispersions of tbeir projections for both 

were lillIe cbanged from those reponed in November. 

The di~persion of estimates for the Ionger.run rate of 

output growth is narrow. with only one participant's 

estimlte outside of a range of 2.2 to 2.7 percent. By 

complrison, participants' viC'll'S about the Ie\'el to 

which the unemplo}ment rate would conl'erge in the 

long run are more diverse, reflecting, alTlJng otber 

things. different Viell'S on the outlook for labor supply 

and on the extent of structural impediments in the 

labor market. 

The Oullook for Inflation 

Participants generaUy viewed the outlook for inOation 

as very similar to that in NOI'¢mber. Most indicated 

that, as tbey expected, the effects of the run-up in 

price; of energy and other colllIOOdities and the supply 
106 


52 Monetary ftlhcy Report to the CongrtssO February 2012 

Figuu 3.A. Distribulioo ofpanicipants' j:fQ)ectioos fQfthe ch:mge in r~3 1 GOP, 2012-14 30001'("., ~ Iooger run 

_ 2012 

- _ I--r~ N<7'<IIIborpuj<cti<m 

.-- ~ 

- .' .. "'" r------~ 

~ ft ~ ~ I tt R tt ~ H ~ 

..... - _ 2013 

it 

_ 2014 

-Oi 

-" 

- " 

- " - 00 

-. -. - , 

- , 

- Oi 

-" 

- " -" 

-00 

-. -. ____ __ 1---1 - '

1 1 10' . '--- -, 1 1 

__ ---,-, 2 

~ R ~ ~ fr tt R li ~ ~ a a tt 

_ lollge, .. n - Oi 

- " 

- " 

- " - 00 

-. - , 

-. 

-, 
107 


Board of w,'erno/'l' of lhe Federal &serre SysleJII 53 

Figuu 3.B Dislribution Orpaititipanrs' projectioos ref lh~un('fllploymmt r:lI~, 2012-14 and OWl' !he Iong\'f roo 

_ 2012 

- _ I--r~ N<7'<IIIborpuj<cti<m 

_ 2013 

_ 2014 

~ ~ ~ u u ~ ~ ~ u ~ u ~ u u u ~ u u u u u v 

""'''''''''''!' 

tt H li ~ R U R tt ~ H n H li li B K H H tt 

""'''''''''''!' 

_ lollgernm 

tt a li ~ R U fr tt ~ H ~ H n ~ a W li 

""'''''''''''!' 

-" -" 

- " 

- " -m 

- • - • - , 

, 

I ~ 

" 

- " -" 

- " -" 

-m 

-. -. 

-, 

-, 

I 

" " 
108 


54 Monetary ftlhcy Report to the Congress O February 2012 

diIDJptions that occurred in the fim balf of 2011 had 

largely waned, and tbat inflation had been subdued in 

re«nt months. PartiCipant; also noted that inflation 

e:<pectatiooshad reJ11.'lined suble om the past year 

despite the fluctuations in headline inftation. Assuming 

DO furtber supply shocks, most participants anticipated 

that both headline and core inflation would reJ11.'lin 

subdued ol'er the 2012- 14 period at rates at or below 

the FO;\IC's longer-run objeaive of 2 percent. Specifi. 

cally, theceDiral tendency of participants' projections 

lOr the increase in inflation, as measumi by the PCE 

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 tendencies of the forecasts for core peE 

inflation were large~' the sam: as those for the total 

melsure. 

Figures 3.C and 3.D prol'ide inforrmtion about the 

dil'crsity of participants' I;ews about the outlook. for 

infution. Compared with their November proje(tions, 

expect3tionsfor inflation in 2012 shifted down a bit, 

with some participants noting that the slowing in inflation at the end of 2011 had been greater than they 

anticipated. Nonetheless, the range of participants' 

IOrecasts for ioDation in 2012 remained wide, and the 

dispersion was only slight~' narrower in 2013. By 20 14, 

the range of inflation forecasts narrowed IOOre noticeably, as participants expected tbat, under appropriate 

IOOneury po~cy, inflation would begin to converge to 

the Corruninee'S longer.run objeail'c. In general. the 

dispersion of I'iellson the ontlook for inflation om 

the projeaion period represented differences in judgments regarding the degree of slack in resource utilization and the extent to which slack influences ioDation 

and inllation expecution~ In addition. pmicipants 

differed in their estimates of bow the sunct of monetary policy would influence inflation expecution~ 

Appropriate Monetary Policy 

Most participants judged that the current outlook.-

lOr a tmderate pluof economic recovery with the 

unemployment rate declining only gradually and inflation subdued-warranted exceptionally low levels of 

the federal funds rate at least until late 2014. In particular, 111'e participants viewed approprilte policy 

firming as commencing during 201 4. wh ile six others 

judged that the 6rst increase in the federal funds rate 

would not be warranted until2015 or 2016. As a result, 

those II participants anticipated tbat the appropriate 

federal funds rate at the end of 2014 would be I percent or lower. Those who saw the first increaseoccurring in 2015 reported that they anticipated that the 

federal funds rate would be )h percent at the end of 

that rear. For the two participants who put the first 

increase in 2016, the appropriate target federal funds 

rate at the end of tbat rear was 1)h and 11;' percent. In 

contrast, six participants expected that an increase in 

the target federal funds rate would be appropriate 

within the next two years, and those participants 

anticipated that the target rate would need to be 

increased to around l)h to 2't. percent at the end of 

2014. 

Participants' a»essments of the appropriate path for 

the federal funds rate rellected their judgments of the 

policy that would best support progress in achieving 

the Federal Reserve's mandate for prolOOting J11.'lximum employment and stable price~ AlOOng the key 

factors informing participants' expecutiom abou t the 

appropriate setting for monetary policy were their 

assessment! of the rmximum lel'eI of employment, the 

Corrunittee'S longer-run inllation goal, the extent to 

which current conditions deviate from these mandateconsistent kl"el~ and their projections of the like~' 

time horizons required to relUro employment and 

inllation to such Ie\"el~ SeYeral partidpants COJ1l.. 

mented that their assessments took into aemunt the 

risks to the outlook. foreconomicactility and inflation, and a few pointed specifically to the relevance of 

financial stahility in their po~cy judgments, Partici· 

pants also noted that becuse the appropri:tte sunce of 

IOOneul)' polity depends importantly on the evolution 

of Ttl! actil'ity and inflation over time, their assessmentsof the appropriate future patb of the federal 

funds rate could change if economic conditions were 

to e\"oll'e in an unexpected maDner. 

All participants reponed INls for the appropriate 

target federal funds rate at the end of 201 4 that were 

well below their estimates of the level expected to prevail in the longer run. The lODger-run nomiDallevels 

were in a range from 3'/. to 4\1, percent, relJecting par· 

ticipants' judgments about the longer.run equilibrium 

level of the real federal funds rate and the Corrunittee's 

inflation objectil'e of 2 percent. 

Participants also provided qualiutil'e information 

on their ~;ews regarding the appropriate path of the 

Federal Resel'l't', balance sheet. A kll' participants' 

messmenl5 of appropriate InJDetary policy incorporated additional purchases of longer-term 5e(:urities in 

2012, and a number of participants indkated that they 

reJ11.'lined open to a consideration of additional asset 

purchases if the economic outlook deteriorated. All 

but one of the plflicipants continued to expm that 

theCommiuee would carry out the normalization of 

the halance sheet according to the principles approved 

at the June 2011 FOMe meeting. That is. prior to the 
109 


Board of w,'erno/'l' of lhe Federal &serre SysleJII 55 

Figuu 3.c. Dislribution of paititipanrs' projectioos f(l" PCE inf\atioo, 2012-14 and o."er tilt" loIlger /uP 

_ 2012 

- _ I--r~ N<7'<IIIborpuj<cti<m 

_ 2013 
110 


56 Monetary ftllicy Report to the Congrtss O February 2012 

Figuu 3.D. Distribulioo ofpanicipants' j:fQ)ectioos forcore PCE inf\atioo, 2012-\4 

_ 2012 

- _ I--r~ N<7'<IIIborpuj<cti<m 

_ 2013 

, --------,-

--< 

first increase in the federal funds rate, the Committee 

would likelyceasc reim'esting some or all p.1}mentson 

the securitie'llioJdings in the System Open ~lJrl::et 

Account (SOMA). and it would 1i~ely begin sales or 

agency seeurities from the SOMA sometime after the 

first rate inma5e, aiming to eliminate the SO'\'1A', 

holdings of agency stcuritie'l over a period of three 10 

6n years. Indeed. most partkiplnts saw sale,of 

agency seeurities starting no ear~er than 20 15. However. tbose p.1niciplntsanticiplting an earlier increase 

in the federal funds rate also called for earlier adjust. 

ments to tbe blllnct sbeet. and one paIticiplnt 

assumed aD early end of the m.:Iturity extension 

program 

Figure lE details the distribution of particip:!n15' 

judgments regarding the appropriate 1m! of the target 

federal funds rate at the end of each calendJr year 

from 2012 to 2014 and ol-er tbe longer run. "'lost participants anticipated thaI economic conditions would 

warrant maintaining tbe current low k.,e\of the fed , 

eral funds rateo.,er tbe next two yeJrs, Hov,c ... cr, ... iews 

on the appropriate leI'el of tbe federal funds rate at the 

end of 2014 were moft widely dispersed, with twothirds of participants seeing tbe appropriate leI'dof 
111 


Board of w,'erno/'l' of lhe Federal &serre SysleJII 

figure lE. Distributioo ofparticip.lDlS' projections for !he targel feder31 funds rlle, 20[2-[4 andO\'er the longer run 

_ 2012 

Inw}'~ 

01. ,~ = = -., '" .• ,~ .. 1.11 ~ = w ~ on "' '" " '" '" on '" '" •• w " w Pcc_,_ 

_ 2013 

,~ I __ - . ~ = = = , .• .. --

,~ , •. I,ll· .. = "' ,. '" M on " '" ," on '" '" .. on " w Pcc_,_ 

_ 2014 

,=1 __ - ,~ '" = ., , .• 

-.. = -.. w .-~ = "' , . '"' M on I,ll '" '" on '" Pcc_, , .. on 

_ on l.ll W 

_ longer"," 

~oo. OJ.'- ow. (lis. 1,1.). lJa. 1.oJ. I.!I· I,ll· l.l~ lOJ. liS. ),1.). 

~ ~ rn LIl W W W au u W W ill ill 

-~ 

_ .. pri;p ... 

- " 

- " -" 

- " -" -. 

- , -, 

-, , .. " ,. '.11 .. .• 

"' on '" .. , •• W 

-"pri>p1u 

-" -" 

- " 

- " 

- " -. 

- , - , - , , •• " ,. ,. ',11· u· .~ 

W ' .11 '" '" on 

-"poniopuU 

- " -" 

- " -" -" -. 

- , -, 

- , , .. ,~ ,. '.11 .• .~ 

"' on ". '." .. on 

- " 

- " 

- " 

- " 

- " -. - , -, 

-, , ~Ja. MJ. l.!l· ' ,Il· ,.)I. ',OJ. 

l~ In ' .11 01 0,&2 on 

57 
112 


58 Monetary ftlhcy Report to the Congrtss O February 2012 

the federal funds rate as 1 percent or below and five 

seeing the appropriate rate as 2 percent or higher. 

Those particip:mt; who judged that a longer period of 

exceptionally low levels of the federal funds rate would 

be appropriate generally also anticipated that the pace 

of the economic expansion would be moderate and 

that the unemployment rate would decline on~' gradually, remaining weU above ils IongeHun rate at the end 

of 2014, Ahoost all of these panicipantsexpected that 

inllation would be relatively suble at or below the 

Fm.-ICs longer-run objective of 2 percent until tbe 

time of the first increase in the federal funds rate. A 

number of them also mentioned their assessment that 

a longer period of low federal funds rates isappropriate when the federal funds rate is constrained by in 

effectire lower bound. In contrast, the six participant; 

who judged that policy firming should begin in 2012 or 

2013 mdi(:;lted that the Committee would need to act 

decisirely to keep inftation at mandate-consistent le\'els 

and to limit the risk of undennining Federal Reser-I'e 

credibility and causing a rise in inDation expecutiono. 

Several were projecting a faster pickup in economic 

activit)'. and a f¢ll' stressed the risk of distortions in the 

financial system from an extended period of exception. 

ally low interest rate~ 

Uncertainly and Risks 

Figure 4 shows that tmst participants continued to 

shm the I'iew that their projections for real GDP 

growth and the unemployment rate were subject to a 

higher le'lel of uncertainty than W3S the norm during 

the previous 20 years.ll Many also judged the le',el of 

uncertainty associated lIith their inRation forecasts to 

be higher than the longer-run norm, bUlthat assessment was somewhat less prevalentamoog participants 

than was the case for uncertainty about real activity. 

Participants identified a number of factors that contributed \0 the elel'lted leI'el of u!!Certainty about the 

outlook. In particular, many plrticipanlscontinued to 

cite risks related to ongoing del'elopments in Europe. 

More broldly, they again noted difficulties in fortClsting the path of economic recovery from a deep recession that was the result of a seI'ere financial crisis and 

Ihusdiffered important~' from tbe experience with 

23. Tal* I p""'&<$im.1!<$<>ftbtf<mnS{IIl>IlM.intyfortbt 

chango;. ... t GDP, tbt u ..... ploy"'.'u nte, .Dd totat OODiumer 

;ticeinllation""", tbt period from t99t lo2010.AI Ihc..,d<>flbis 

AIm .... !)', lbtbox "ro..c. .. UlICC(uinlJ~ ~ Ibt~ .. d 

iJlQ"prftllioo of IlIn1UnUy in tbtecooomio fonruu and expl. in. 

II» oW"""b IRd to 11$_ !be w.:.ru.itll)' ond lis'" ou..,ding tbt 

",nicip"'''pro:i<cIion, 

Table 2. A'mlg<: historical projection error rangel 

Po""''"9'poiol! 

roliablt 1II! !\Ill 

a...uio...JGDP' .. !U ±17 

u .... f'Io) .... t .. '•• ±0.7 ±H 

To ... ""' ............. !O.9 no 

!\II( 

lU 

±U 

lUI 

Non: """'''"¥''Ibon&r<_o:I .. pJ .... ''''''''tbt'''''' ..... .. _"' .. of~_famllhiooCltl!JIOI2IaI_,._ .. tbt_ t<rb-j"""",,,,_ODd_O<"<Iltror-,, .. Jdd=ribo:llltbtU·"",,,. 

.... u_,~·"<Io:<ftI1Il, .... ,,.pI>OOI, .... <r<~D:lot.J!l""'''''pOOobIInJIlIal_ootoO<Dafo<'eaiGDP.""",pIoJm<ll~ODd~""'PI""wilI 

bo"~""pbo:lb)"b""'lg<"lIZ<ofPl"""""mon",,",,, ..... port. FtI. tbu",Ior_~"DftlRelfICb_IWd"" .. Tl:4Jp(lOOJ),~"tbt 

U_.tyofth.EOOOQIOICQall:;Jol: r"""H~calF""""".,E,,,,,,,· 

F""""udEooa"" .. DI>:cmoos..",lOOJ.IIJ(Wu'"'lfL'II Board 01 a.-. .... 01 tbt FedmI R...... s,..ID, Nootmb<l~ 

lR>r~,"OOI,r<fu"reo«aI_lllOj)~l 

1 M"",.utbe_~I""""""'PI"IIcla.tbtpnc<"""",tlw ... boeo 

"""'"fMIIJO>Ol;.*""" ...... lOdp....,...,.,...;c"'''''''''~~p<t. 

""'<Ill{)"'mrtb~1W'" of !It< PI"""""'" 10th. """" ~","'of tho Y'"' "d"",0:1 

recoveries over the past 60 }'ears. In that regard, participantscontinued to be unCtrtain about the pace at 

which credit condition; would ease and about prospects for a JtCO\'ery in the housing sector. In addition. 

participants generally saw the outlook for fiscal and 

regulatory p:lUciesas still highly uncertain. Regarding 

the unemployment rate. several expressed uncertainty 

about how labor demand and supply liQuId evoh'e 

Ol'er the IOrecast period. Am:mg the sources of UnCtf· 

tainty about the outlook for inOation were the dil!kulties in assessing the current and prospectil"e margins of 

slack in resource markets and the effect of such slack 

00 pnCtt 

A majority of participants continued to report that 

they saw the risk; to Iheir IOrecastsof real GDP 

groll1h as weighted to the downside and. accordingly. 

the risks to their projections for tbe unemployment 

rate as skewed to the upside. AU but one of the rmuming participants ~i¢ll'ed the risks to both projections as 

broad~' balanced, while one noted a risk thai the 

unemployment rate might continue to decUne tm/t 

rapidly than expected. The Imst frequently cited 

downside risks to the projected pace of the economic 

expansion were the p:lssibility of financial market and 

economic spillo\"ers from the fiscal and financial issue; 

mthe earo area and the chance that some of the facIOrs that hal'C restrained the JtCO\'ery in recent years 

oould persist and weigh on economic activity to a 

greater extt"Dt than assumed in participants' blseline 

forecast~ In particular, some participants mentioned 

the downside risks to oonsumer spending from stillweak: household balance sheets and only tmdest gams 

m real income, along with tbe p:lssible effects of stillhigh leI'cl.! of uncertainty regarding fiscal and regulatory p:llicies that might damp businesses' lIiUingness 
113 


Fi&ure4" UnctrUinty and liw in OCOIlCIllk pro;e.:tioos 

_ U"-" 

~ 

Ib<U (l)P It""'" 

.. 

-,,--

-" 

-" -" , ______ ,_ 11 

. 

, '- , 

. 

L . , 

r ' 

-,,--

-" 

-, 

-" 

-" 

Board of w,"ernQ/1 of lhe Federal &serre SysleJII 59 

~ 

, 

, 

~ 

-' , 

• 

- -----, , 

• 

R,ib toea. PCE D1alOO 

- " 

-, 

-" 

- " - , 

-. 

-. 

-. - , 

" 

-" 

-, 

- " 

-" 

-" 

-, 

-" 

- " 

-, 

-. 

-. 

- " - , 

-" 

-" 

- , 

-. -. 

-. 

NOIIt F<r"'m-<i..........,.lI<Iri;b • ..,..,.;.,~""""ta:"_c""""""'.·Dt_<i..oriobb ..... IIo<_ .. -.,-, 
114 


60 Monetary ftlhcy Report to the Congrtss O February 2012 

Forecast Uncertainty 

The economic projections prOlided by the membefs of the Board of Go\-erllOfS m the presidenlS 

of the Federal Re:\e,,'e Banks inform discussions of 

monetary policy ~ poIiqmakers and can ilId 

pu~ic uoderst3llding of the basis for polItY acbons. Coosidera~e uncertainty attends these 

prqectioos. howe--ef. The ~ arid >t<tI~fC3.1 

models and 'elatoonsh'pl' used to help produce 

~/Orecasts are necessarily imperiect 

desoiptions of the real wo<ld, and the futme path 

of the economy eM t:.e affected by ffi)"fiad Urforeseen de.elopments and events. Th.ts, in setting the 

stance of monetaJy policy, partICipants Cort!idef 

not only what appears to bethe most hlely emnomicoutcome as embodied in the,r prOfOOK>n>, 

but also the ra'lge of aiternat"·e po5Sibilitie>, the 

li keliflOOd of their ooo.rrnng. arid the potential 

CO>Il; tothee<:orlOlf1)·,hould they occur 

TaWe 2 SUITlr'l'W~es the a>-erage t.$Iorir:aJ a<:t:\lracy of a ~e of fore:.:asts, including trose 

reported in pastMootlary Pdjcy II.q>Orls arid trose 

prepared bytheFedelal Reser\'e Bm-d's staffrn 

advanceof meetings of the Federal Open ~ \ar\.:et 

Committee. The prOfOOKln errOf ranges shown in 

the ta~e rllustrate tile considerable uncertarnty 

~ted with economrcfore::<OO. For aample. 

suppose a participant projectS that real gross 

domestic produd (COP)and total con,Urnef prire> 

will rise steadily at aooual rares o~ respect,,-e\y, 

3 pe!cent and 2 j}eJcent.lf the uncertajnty attending those proyrtions i$ >imjlar to that exjlenenced 

In the past and the risks around the projections are 

broadly balanced, the numbers reported In ta~e 2 

would imply a probabrlityof about 70 percerrt that 

actual COP would eo.pand wdlln a rangeof1.7 to 

43 pe;cent on the ament lear, 13 to 4.i pe;cent In 

to inH'st and hire. A number of plrticipanl5 noted the 

risk of another disruption in global oil markets that 

could not on~' OOoS! inlhtion but also reduce real 

income and spending. The panicipan!s who judged the 

risks to be broadly balanced also recognized a number 

of these downside risks to the outlook but saw them as 

counterbllanced by the possibmty that the resilienceof 

cconomicacti~; y in late 2011 and the recent drop in 

the unemployment rate might signal greater underlying 

momentum in economic activity. 

In contrast to Iheir OUllook for economic activity, 

most participants judged the risks 10 Iheir projections 

of inflation as broadly balanced. Participants Tal~' 

I;ewed Ihe recenl doxline in inHalion as having been in 

line with their earlier wrecas!s, and they nOled that 

inllation expectations remain stable. While many of 

tile second year, and 11 to 4.8 in tile third lear. The 

correspooding 70 percent confidence IrrtE'IVaiS for 

OIerall inflation woold be \.I to 2.9 percent in the 

rurrerrt lear m 1.0 to 3.0 percent In the second 

aridtt.rd)'eilr>. 

Becauserurrent condrtions maydtlJer !Tom 

those that prevailed, 0fI a~ratr, OI-er t.,tory, participants pr0\1Oe Judgments a> to whether the 

UncertaInty attached to their projectlOlls of eocll 

~ariable i$ greater than. smaller than, or broadly 

similar to typical bels of forecast uncertainty in 

the pas~ a> shown in taMe 2. Participanl! also prolide Judgments as to whetne. the risksto their pro--

jections are we.glned to the upside, are wetghted 

to the OOwro>ide, or are broadly balanced. That IS, 

participa'll5 Judge whether each vd lable i, more 

likely to be.iJO\e or bdowtherr prOJection> of the 

most lilelyoutcome. These judgments alx>ut the 

UncertaInty ard the risks atterding eocll partKi· 

pant·s projection> are di)\lnc\ from the d~=,tyof 

participants' \"M :!bout the IJ'IOn likely outcomes. 

forecast uncertaUlty i$ coocemed wIth the risks 

associated with a partlClJlar prOJeclion rathe! than 

with dr.-ergeoces across a number of different 

I"ojections. 

A>w,threal actll1tym ,ni1axion, theoutlookfor 

thefuturepathofthel'edeJlllfund, rate lS>ubJecl 

to con>idelabie UJl(%J\alnty. ThIS UJl(%rtajnty arise 

primarily because each participant·$ assessment of 

the appropriate stance of moneta')' [dicy 

deperds importanllyontheevolutionof realadivity and inilationO'."eI time. If economic conditKlns 

e\ooe III an unapected manner, then ilSse>sments 

of the appropriate setting of thefederal fund> rate 

woold cMlgefromthat ~ntforward. 

these panicipanls sa\\" the persistence of sub>1anlial 

slack in resource utilization as likely to keep inDalion 

subdued Ol'er the projection period, a few others DOled 

the risk that elevated resource slack might put more 

downward pressure on inlhtion than expected. In con· 

trast, some participants noted the upside risl;:s to inDa· 

tion from developments in global oil and cotnmJdity 

ITl.1.rtets, and meral indicated that the current highly 

accommodatire stance of troneta£), policy and the 

suhstantial liquidity currently in the 6nancial system 

risked a pick up in inHation 10 a level above the Commiuee'sobjeclil"e. A fnl· also pointed to Ihe risk that 

uncertainty about the Commitlee·, ability 10 effectil·ely 

retrol"e po~cy acconunodalion when approprim could 

lead 10 a rise in inilation expectalions. 
115 


Abbreviations 

A' S 

AFE 

AIG 

ARRA 

CDS 

C&l 

o ms 

CP 

CRE 

DPl 

EBA 

ECR 

E:\!E 

E&S 

FDIC 

FOMe 

FRBNY 

GOP 

GSE 

UBOR 

MEP 

MBS 

NIP. .... 

OIS 

FCE 

.po 

SCOOS 

SEP 

SLOOS 

s&P 

Sm.!A 

'Vfl 

asset·bJcked securities 

advanced foreign economy 

Armrican International Group, Inc. 

ArmrieaD Reconry and Reinvestment Act 

credit default swap 

oommercill and indumill 

commercial mortgage-backed securities 

commercial paper 

commercial real estlte 

disposable periOoal inoome 

European Banking Authority 

European Central Bank 

emerging nurkel economy 

equipment and software 

Federal Deposit Insurance Corporation 

Federal Open ar~el Comminee: also, the Corruninee 

Federal Resel"l"¢ funk of Nt'll' York 

gro;sdome>tic product 

govemment-spomored enterprise 

Lo ndon interbank offered rate 

nuturityextenSlOn program 

mortgage-bJded securities 

national income and producI1OCOUnlS 

overnight index swap 

personal consumption expenditures 

repurcblse agreement 

Senior Credit Officer Opinion Survey on Dealer Financing Terms 

Summary of EcoDOmic Projections 

Senior Loan Officer Opinion Survey on funk Lending Practices 

Sundard and funr'! 

System Open Market Account 

We;t Texas Intermediate 

61