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S. HRG. 113–6 

FEDERAL RESERVE’S FIRST MONETARY POLICY 

REPORT FOR 2013 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED THIRTEENTH CONGRESS 

FIRST SESSION 

ON 

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

FEBRUARY 26, 2013 

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 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

KAY HAGAN, North Carolina 

JOE MANCHIN III, West Virginia 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

MIKE CRAPO, Idaho 

RICHARD C. SHELBY, Alabama 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

TOM COBURN, Oklahoma 

DEAN HELLER, Nevada 

CHARLES YI, Staff Director 

GREGG RICHARD, Republican Staff Director 

LAURA SWANSON, Deputy Staff Director 

COLIN MCGINNIS, Policy Director 

GLEN SEARS, Deputy Policy Director 

GREG DEAN, Republican Chief Counsel 

MIKE PIWOWAR, Republican Senior Economist 

DAWN RATLIFF, Chief Clerk 

RIKER VERMILYE, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

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C O N T E N T S 

THURSDAY, FEBRUARY 26, 2013 

Page 

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

Prepared statement .......................................................................................... 37 

Opening statements, comments, or prepared statements of: 

Senator Crapo ................................................................................................... 2 

WITNESS 

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

System ................................................................................................................... 3 

Prepared statement .......................................................................................... 37 

Responses to written questions of: 

Senator Warren ......................................................................................... 41 

Senator Corker .......................................................................................... 44 

Senator Johanns ........................................................................................ 45 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Monetary Policy Report to the Congress dated February 26, 2013 ..................... 47 

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(1) 

FEDERAL RESERVE’S FIRST MONETARY 

POLICY REPORT FOR 2013 

TUESDAY, FEBRUARY 26, 2013 

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

The Committee met at 10:15 a.m., in room SD–106, Dirksen Senate Office Building, Hon. Tim Johnson, Chairman of the Committee, presiding. 

OPENING STATEMENT OF CHAIRMAN TIM JOHNSON 

Chairman JOHNSON. Today’s hearing is with Chairman Bernanke 

on the Federal Reserve’s Monetary Policy Report to Congress. 

While progress toward maximum employment has been slow, it 

has been positive and steady, thanks in part to the Fed’s thoughtful and well-measured monetary actions. Our economy has added 

private sector jobs for 35 straight months. During that time, over 

six million new jobs have been created, but we should not sacrifice 

those gains by slamming on the brakes now. 

Without a fix, automatic spending cuts will take effect in just a 

few days and could send our economy into reverse at a time when 

we should continue moving forward on creating jobs. Projections 

suggest that the sequester will cost us 750,000 jobs this year. In 

addition to layoffs for cops, fire fighters, and teachers that could 

devastate our communities, these cuts will impact many of our Nation’s most vulnerable citizens, including kids, seniors, and the disabled. At a time when the U.S. faces an array of national security 

threats, the sequester will affect our military readiness. 

It is unacceptable that we are lurching from one manufactured 

crisis to the next, and Americans have had enough. These fights 

are bad for the economy and are making it harder for families to 

make ends meet. 

The steep drops in consumer confidence during the fights over 

the debt limit and the fiscal cliff rival the fallout after Lehman 

Brothers’ failure and 9/11. This has consequences. If consumers do 

not spend, businesses will not prosper and hire more workers. If 

businesses are not hiring, our economy will not grow. It is that 

simple. 

We must do all we can to restore confidence in not only our financial system, but also in our ability as a country to tackle longterm challenges in a responsible, bipartisan manner. In addition to 

Congress acting on a deficit reduction plan that is balanced and 

promotes job creation, there are things this Committee can do to 

help achieve these goals. From rigorous oversight, to confirming 

2 

well-qualified nominees, to reauthorizing expiring laws, to reaching 

consensus on the future of housing finance, there are steps this 

Committee can take to promote consumer confidence, provide businesses clarity to move forward with long-term plans, and strengthen our economic recovery. 

Chairman Bernanke, I look forward to hearing your views as 

both the Fed and the Congress pursue policies supporting our Nation’s economic recovery. 

I now turn to Ranking Member Crapo. 

STATEMENT OF SENATOR MIKE CRAPO 

Senator CRAPO. Thank you, Mr. Chairman. 

Today, we will hear from our Federal Reserve Chairman Ben 

Bernanke, who will testify on the Fed’s monetary policy and the 

state of the economy. Mr. Bernanke, I want to thank you at the 

outset for your ongoing initiatives to improve the transparency of 

the Federal Open Market Committee. Because so much is at stake 

for the U.S. economy, the Fed has the responsibility to make as 

much information available to the American people as possible on 

its actions. 

I also thank Chairman Bernanke for his steadfast reminder to us 

that one of the most important risks to our economy is our fiscal 

situation. I completely agree with him. That is why I have consistently said that the fiscal reform and economic growth should top 

the list of our priorities in Congress. We need to address the Federal spending problem, reform our badly broken tax system, and 

promote a sustainable economic recovery that will result in increased jobs. 

Unfortunately, with the fiscal cliff deal completed, some officials 

are looking for an easy way out by claiming that our fiscal problems are nearly solved. Nothing could be further from the truth. 

Our economy contracted in the last quarter. Our unemployment 

rate remains far too high. Medicare will be insolvent in just over 

10 years, and Social Security will be insolvent after that. Until we 

take specific steps to reform our entitlements and to make them 

solvent for generations to come and reform our tax code to produce 

significant, sustained economic growth, our fiscal problems are far 

from solved. 

In addition to our own fiscal situation, the ongoing fiscal and 

banking crisis in Europe also presents substantial risks to our 

economy. In response to unsustainable fiscal policies here and 

abroad, central bankers throughout the world have turned to unconventional monetary policies over the past few years. Near-zero 

interest rates, large-scale asset purchases, and record-size central 

bank balance sheets have become the norm. 

However, some authorities have become increasingly concerned 

that the costs of prolonged easy money policy outweigh the benefits. In its annual report released last June, the Bank of International Settlements laid out the risks entailed with the worldwide 

expansion of central bank balance sheets and their extended low 

interest rate policies. Not only did the report conclude that such actions may delay the return to a self-sustaining recovery, but they 

create longer-term risks to central banks’ credibility and operational independence. 

3 

More recently, the minutes of the Federal Open Market Committee’s January meeting show that several FOMC members expressed concern that the Fed’s prolonged easy money policies could 

result in excessive risk taking and threaten the financial stability 

of the United States. These concerns warrant serious consideration, 

given the scale, scope, and duration of the Fed’s unconventional 

monetary policies. 

The Fed has kept the target range for the Federal Funds Rate 

at zero to one-quarter percent for more than 4 years. The Fed has 

engaged in multiple rounds of asset purchases, commonly referred 

to as quantitative easing. The Fed is currently buying $40 billion 

of agency mortgage-backed securities per month and $45 billion of 

longer-term Treasury securities per month, for a total monthly pace 

of $85 billion, or an annualized pace of more than $1 trillion. And 

primarily as a result of its large-scale asset purchases, the Fed has 

ballooned its balance sheet to more than $3 trillion and growing. 

I look forward to hearing from Chairman Bernanke about the 

concerns raised about the risks of the Fed’s prolonged easy money 

policies and why they cannot overcome our bad fiscal policy. 

I also look forward to hearing from Chairman Bernanke about 

how the uncertainty surrounding the Dodd-Frank implementation 

is hampering our recovery. In particular, what specific legislative 

fixes can be achieved to remove this uncertainty? 

At our last Humphrey-Hawkins hearing, Chairman Bernanke 

confirmed that regardless of Congressional intent, the banking regulators view the plain language of the statute as requiring them 

to impose some kind of margin requirement on nonfinancial end 

users of derivatives unless Congress changes the statute. Chairman 

Bernanke also confirmed that the Fed is comfortable with an explicit statutory exemption. I look forward to hearing Chairman 

Bernanke’s suggestions for other legislative fixes to Dodd-Frank 

that could garner bipartisan support. These and many other issues 

are critical to us and I appreciate again, Chairman Bernanke, your 

attendance at this hearing. 

Chairman JOHNSON. Thank you, Senator Crapo. 

This morning, opening statements will be limited to the Chairman and Ranking Member to allow more time for questions from 

the Committee Members. I want to remind my colleagues that the 

record will be open for the next 7 days for opening statements, 

questions for the record, and any other materials you would like to 

submit. 

Now, I would like to introduce our witness. Ben Bernanke is 

Chairman of the Board of Governors of the Federal Reserve System, a position he has held since February 2006. I thank you for 

being here today to testify on the Monetary Policy Report to the 

Congress. Your written statement will be included in the hearing 

record. Chairman Bernanke, you may begin your testimony. 

STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF 

GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

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

Members, I am pleased to present the Federal Reserve’s Semiannual Monetary Policy Report. I am going to begin with a short 

4 

summary of current economic conditions and then discuss aspects 

of monetary and fiscal policy. 

Since I last reported to this Committee in mid-2012, economic activity in the United States has continued to expand at a moderate 

if somewhat uneven pace. In particular, real GDP is estimated to 

have risen at an annual rate of about 3 percent in the third quarter, but to have been essentially flat in the fourth quarter. The 

pause in real GDP growth last quarter does not appear to reflect 

a stalling out of the recovery. Rather, economic activity was temporarily restrained by weather-related disruptions and by transitory 

declines in a few volatile categories of spending, even as demand 

by U.S. households and businesses continued to expand. 

Available information suggests that economic growth has picked 

up again this year. Consistent with the moderate pace of economic 

growth, conditions in the labor market have been improving gradually. Since July, nonfarm payroll employment has increased by 

175,000 jobs per month, on average, and the unemployment rate 

declined three-tenths of a percentage point, to 7.9 percent, over the 

same period. Cumulatively, private sector payrolls have now grown 

by about 6.1 million jobs since their low point in early 2010, and 

the unemployment rate has fallen a bit more than 2 percentage 

points since the cyclical peak in late 2009. 

Despite these gains, however, the job market remains generally 

weak, with the unemployment rate well above its longer-run normal level. About 4.7 million of the unemployed have been without 

a job for 6 months or more, and millions more would like full-time 

employment but are able to find only part-time work. 

High unemployment has substantial costs, including not only the 

hardship faced by the unemployed and their families, but also the 

harm done to the vitality and productive potential of our economy 

as a whole. Lengthy periods of unemployment and underemployment can erode workers’ skills and attachment to the labor force 

or prevent young people from gaining skills and experience in the 

first place, developments that could significantly reduce their productivity and earnings in the longer term. The loss of output and 

earnings associated with high unemployment also reduces Government revenues and increases spending, thereby leading to larger 

deficits and higher levels of debt. 

The recent increase in gasoline prices, which reflects both higher 

crude oil prices and wider refining margins, is hitting family budgets. However, overall inflation remains low. Over the second half 

of 2012, the price index for personal consumption expenditures rose 

at an annual rate of 1.5 percent, similar to the rate of increase in 

the first half of the year. Measures of longer-term inflation expectations have remained in the narrow ranges seen over the past several years. Against this backdrop, the Federal Open Market Committee, the FOMC, anticipates that inflation over the medium term 

will likely run at or below its 2 percent objective. 

With unemployment well above normal levels and inflation subdued, progress toward the Federal Reserve’s mandated objectives of 

maximum employment and price stability has required a highly accommodative monetary policy. Under normal circumstances, policy 

accommodation would be provided through reductions in the 

FOMC’s target for the Federal Funds Rate, the interest rate on 

5 

overnight loans between banks. However, as this rate has been 

close to zero since December 2008, the Federal Reserve has had to 

use alternative policy tools. 

These alternative tools have fallen into two categories. The first 

is forward guidance regarding the FOMC’s anticipated path for the 

Federal Funds Rate. Since longer-term interest rates reflect market 

expectations for shorter-term rates over time, our guidance influences longer-term rates and thus supports a stronger recovery. 

The formulation of this guidance has evolved over time. Between 

August 2011 and December 2012, the Committee used calendar 

dates to indicate how long it expected economic conditions to warrant exceptionally low levels for the Federal Funds Rate. At its December 2012 meeting, the FOMC agreed to shift to providing more 

explicit guidance on how it expects the policy rate to respond to 

economic developments. Specifically, the December post-meeting 

statement indicated that the current exceptionally low range for 

the Federal Funds Rate will, quote, ‘‘be appropriate at least as long 

as the unemployment rates above 6.5 percent, inflation between 1 

and 2 years ahead is projected to be no more than half-a-percentage point above the Committee’s 2 percent longer-run goal, and 

longer-term inflation expectations continue to be well anchored,’’ 

close quote. 

An advantage of the new formulation relative to the previous 

date-based guidance is that it allows market participants and the 

public to update their monetary policy expectations more accurately in response to new information about the economic outlook. 

The new guidance also serves to underscore the Committee’s intention to maintain accommodation as long as needed to promote a 

stronger economic recovery with stable prices. 

The second type of nontraditional policy tool employed by the 

FOMC is large-scale purchases of longer-term securities, which, 

like our forward guidance, are intended to support economic growth 

by putting downward pressure on longer-term interest rates. The 

Federal Reserve has engaged in several rounds of such purchases 

since 2008. Last September, the FOMC announced it would purchase agency mortgage-backed securities at a pace of $40 billion 

per month, as Senator Crapo noted, and in December, the Committee stated that, in addition, beginning in January, it would purchase Treasury securities at an initial pace of $45 billion per 

month. 

These additional purchases of longer-term Treasury securities replace the purchases we were conducting under our now completed 

Maturity Extension Program, which lengthened the maturity of our 

securities portfolio without increasing its size. The FOMC has indicated that it will continue purchases until it observes a substantial 

improvement in the outlook for the labor market in a context of 

price stability. 

The Committee also stated that in determining the size, pace, 

and composition of its asset purchases, it will take appropriate account of their likely efficacy and costs. In other words, with all of 

its policy decisions, the Committee continues to assess its program 

of asset purchases within a cost-benefit framework. 

In the current economic environment, the benefits of asset purchases and of policy accommodation more generally are clear. MonVerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON
6 

etary policy is providing important support to the recovery while 

keeping inflation close to the FOMC’s 2 percent objective. Notably, 

keeping longer-term interest rates low has helped spark recovery 

in the housing market and led to increased sales and production 

of automobiles and other durable goods. By raising employment 

and household wealth, for example, through higher home prices, 

these developments have, in turn, supported consumer sentiment 

and spending. 

Highly accommodative monetary policy also has several potential 

costs and risks, which the Committee is monitoring closely. For example, if further expansion of the Federal Reserve’s balance sheet 

were to undermine public confidence in our ability to exit smoothly 

from our accommodative policies at the appropriate time, inflation 

expectations could rise, putting the FOMC’s price stability objective 

at risk. However, the Committee remains confident that it has the 

tools necessary to tighten monetary policy when the time comes to 

do so. As I noted, inflation is currently subdued and inflation expectations appear well anchored. Neither the FOMC nor private 

forecasters are projecting the development of significant inflation 

pressures. 

Another potential cost that the Committee takes very seriously 

is the possibility that very low interest rates, if maintained for a 

considerable time, could impair financial stability. For example, 

portfolio managers dissatisfied with low returns might reach for 

yield by taking on more credit risk, duration risk, or leverage. On 

the other hand, some risk taking, such as when an entrepreneur 

takes out a loan to start a new business, or an existing firm expands capacity, is a necessary element of a healthy economic recovery. Moreover, although accommodative monetary policies may increase certain types of risk taking, in the present circumstances, 

they also serve in some ways to reduce the risk in the system, most 

importantly by strengthening the overall economy, but also by encouraging firms to rely more on longer-term funding and by reducing debt service costs for households and businesses. 

In any case, the Federal Reserve is responding actively to financial stability concerns through substantially expanded monitoring 

of emerging risks in the financial system, an approach to the supervision of financial firms that takes a more systemic perspective, 

and the ongoing implementation of reforms to make the financial 

system more transparent and resilient. Although a long period of 

low rates could encourage excessive risk taking and continued close 

attention to such developments is certainly warranted, to this 

point, we do not see potential costs of the increased risk taking in 

some financial markets as outweighing the benefits of promoting a 

stronger economic recovery and more rapid job creation. 

Another aspect of the Federal Reserve’s policies that has been 

discussed is their implications for the Federal budget. The Federal 

Reserve earns substantial interest on the assets it holds in its portfolio, and other than the amount needed to fund our cost of operations, all net income is remitted back to the Treasury. With the 

expansion of the Federal Reserve’s balance sheet, yearly remittances have roughly tripled in recent years, with payments to the 

Treasury totaling approximately $290 billion between 2009 and 

2012. 

7 

However, if the economy continues to strengthen, as we anticipate, and policy accommodation is accordingly reduced, these remittances would likely decline in coming years. Federal Reserve 

analysis shows that remittances to the Treasury could be quite low 

for a time in some scenarios, particularly if interest rates were to 

rise quickly. 

However, even in such scenarios, it is highly likely that average 

annual remittances over the period affected by the Federal Reserve’s purchases will remain higher than the precrisis norm, perhaps substantially so. Moreover, to the extent that monetary policy 

promotes growth and job creation, the resulting reduction in the 

Federal deficit would dwarf any variation in the Federal Reserve’s 

remittances to the Treasury. 

Although monetary policy is working to promote a more robust 

recovery, it cannot carry the entire burden of ensuring a speedier 

return to economic health. The economy’s performance, both over 

the near term and in the longer run, will depend importantly on 

the course of fiscal policy. The challenge for the Congress and the 

Administration is to put the Federal budget on a sustainable longrun path that promotes economic growth and stability without unnecessarily impeding the current recovery. 

Significant progress has been made recently toward reducing the 

Federal budget deficit over the next few years. The projections released earlier this month by the CBO indicate that under current 

law, the Federal deficit will narrow from 7 percent of GDP last 

year to 21⁄2 percent in fiscal year 2015. As a result, the Federal 

debt held by the public, including that held by the Federal Reserve, 

is projected to remain roughly 75 percent of GDP through much of 

the current decade. 

However, a substantial portion of the recent progress in lowering 

the deficit has been concentrated in near-term budget changes, 

which, taken together, could create a significant headwind for the 

economic recovery. The CBO estimates the deficit reduction policies 

in current law will slow the pace of real GDP growth by about 11⁄2

percentage points this year relative to what it would have been 

otherwise. A significant portion of this effect is related to the automatic spending sequestration that is scheduled to begin on March 

1, which, according to the CBO’s estimates, will contribute about 

six-tenths of a percentage point to the fiscal drag on economic 

growth this year. 

Given the still moderate underlying pace of economic growth, 

this additional near-term burden on the recovery is significant. 

Moreover, besides having adverse effects on jobs and incomes, a 

slower recovery would lead to less actual deficit reduction in the 

short run for any given set of fiscal actions. 

At the same time, and despite progress in reducing near-term 

budget deficits, the difficult progress of addressing longer-term fiscal imbalances has only begun. Indeed, the CBO projects that the 

Federal deficit and debt as a percentage of GDP will begin rising 

again in the latter part of this decade, reflecting in large part the 

aging of the population and fast rising health care costs. 

To promote economic growth in the longer term and to preserve 

economic and financial stability, fiscal policy makers will have to 

put the Federal budget on a sustainable long-run path that first 

8 

stabilizes the ratio of Federal debt to GDP, and given the current 

elevated level of debt, eventually places that ratio on a downward 

trajectory. Between 1960 and the onset of the financial crisis, Federal debt averaged less than 40 percent of GDP. This relatively low 

level of debt provided the Nation much needed flexibility to meet 

the economic challenges of the past few years. Replenishing this 

fiscal capacity will give future Congresses and Administrations 

greater scope to deal with unforseen events. 

To address both the near and longer-term issues, the Congress 

and the Administration should consider replacing the sharp frontloaded spending cuts required by the sequestration with policies 

that reduce the Federal deficit more gradually in the near term but 

more substantially in the longer run. Such an approach could lessen the near-term fiscal headwinds facing the recovery while more 

effectively addressing the longer-term imbalances in the Federal 

budget. 

Finally, the size of deficits and debt matter, of course, but not all 

tax and spending programs are created equal with respect to their 

effects on the economy. To the greatest extent possible, in their efforts to achieve sound public finances, fiscal policy makers should 

not lose sight of the need for Federal tax and spending policies that 

increase incentives to work and save, encourage investments in 

workforce skills, advance private capital formation, promote research and development, and provide necessary and productive 

public infrastructure. Although economic growth alone cannot 

eliminate Federal budget imbalances in either the short run or the 

longer term, a more rapidly expanding economic pie will ease the 

difficult choices that we face. 

Thank you, Mr. Chairman. 

Chairman JOHNSON. Thank you for your testimony. 

As we begin questions, I will ask the Clerk to put 5 minutes on 

the clock for each Member. 

Chairman Bernanke, what is your assessment—please elaborate—of the sequester’s impact on our economy in the short term 

if Congress did nothing, and what would be the impact if Congress 

manufactures another crisis with a fight over the CR? 

Mr. BERNANKE. Well, Mr. Chairman, as I mentioned in my remarks, with respect to the sequester, the CBO estimates that it 

would cost about six-tenths a percent of growth in this year and 

the equivalent of about 750,000 jobs, and so it would be a drag on 

near-term economic recovery. More broadly, all of the actions taken 

this year, according to the CBO, would be a drag of about 11⁄2 percentage points, which is quite significant. 

So in that respect, I think an appropriate balance would be to 

introduce these cuts more gradually and to compensate with larger 

and more sustained cuts in the longer run to address our long-run 

fiscal issues. 

As you note, there are a couple of other issues this year, including the continuing resolution and the debt ceiling. Again, I hope 

that Congress can work together effectively to address these issues 

with a minimum of uncertainty, because the uncertainty itself, of 

course, is also costly in terms of the ability of the private sector to 

plan, to take risks, and to help grow the economy. 

9 

Chairman JOHNSON. Housing is important to our economic 

growth and the Fed is working on mortgage rules in Basel that will 

have a major impact on housing. Chairman Bernanke, do you agree 

with Governor Tarullo that nothing prevents QRM from being the 

same as QM, and what will you do to ensure new Basel rules do 

not hinder mortgage lending? 

Mr. BERNANKE. Mr. Chairman, as you know, the QRM is required to be no more broad than the QM, so we have had to wait 

for the QM to be done before we could attack the QRM process, although we have put out previous proposed rulemakings. 

The QM, of course, is intended to help consumers. The QRM is 

meant to try to strengthen the securitization market. They are 

somewhat different purposes. But I would say, responding to your 

question, that the six agencies which are currently discussing the 

QRM consider the idea of making the QRM essentially identical to 

the QM is a realistic option and is one that we are considering. 

Chairman JOHNSON. Thank you for your answer. 

Also regarding Basel, Ranking Member Crapo and I sent you a 

letter on the potential impact of Basel rules on insurance companies and community banks. I look forward to your response. 

Chairman Bernanke, there is an increased focus on cybersecurity 

and the United States, including within our financial system. 

FSOC has noted the issue in its annual reports. What is the Fed 

doing, both with the banks you supervise and your own networks, 

to strengthen financial data protection and enhance the 

cybersecurity of the financial sector? 

Mr. BERNANKE. Well, Mr. Chairman, as you know, your point is 

absolutely right, that cybersecurity concerns in the financial system have become more acute lately. Since last fall, there have been 

a number of so-called denial of service attacks on banks, which essentially flood the public-facing Web sites and prevent the public 

from accessing their accounts, for example. These are obviously 

quite disruptive and problematic. 

The leadership on cybersecurity for the financial system is being 

taken, on the one hand, by the Treasury, and on the other hand 

by the various intelligence and securities agencies. The Federal Reserve is very much engaged in cooperating with these agencies, 

sharing information, and working with our banks to make sure 

that they have appropriate procedures and oversight in place to 

deal with such problems. But, I have to say, we do not have to 

press them very hard because they recognize it is very much in 

their own interest to do whatever they can to prevent these attacks 

from being effective. 

Chairman JOHNSON. While some urge the Fed to focus solely on 

inflation, which has been a bigger threat to our economic prosperity 

since 2007, Chairman Bernanke, unemployment or inflation, what 

is the most important step the Fed has taken to promote maximum 

employment? 

Mr. BERNANKE. Well, Senator, as you know, we have a dual mandate given to us by Congress. That is entirely appropriate. Congress should set our objectives and then the Federal Reserve 

should figure out how to meet them. So we are interested both in 

achieving higher levels of employment and in maintaining low inflation and price stability. 

10 

Our monetary policy, as I mentioned in my remarks, has been 

quite accommodative in that respect. It is very much like that essentially in all other advanced economies. In doing so, we have, obviously, in the first instance, provided support for the real economy 

and for job growth through strengthening housing, for example, 

through strengthening the demand for automobiles and other durables, through wealth effects and the like. 

But I would note that with inflation at or below our 2 percent 

target, our policies have also had the effect of greatly reducing any 

risk of deflation, which at the moment does not seem like much of 

a concern, but at certain times, as inflation gets close to the zero 

critical level, that risk increases. And keeping inflation from going 

too low—I realize sometimes it is hard to explain to people why inflation that is too low is a problem—but if it is too low, you run 

the risk of a Japanese-style situation, where prolonged deflation is 

a barrier to economic growth and stability. 

So our accommodative monetary policy has not really traded off 

one of these against the other. It has supported both real growth 

in employment and kept inflation close to our target. We have 

many other things that we do on the regulatory side and so on, but 

the monetary policy, of course, is the tool that the Fed has to try 

to address that mandate. 

Chairman JOHNSON. Senator Crapo. 

Senator CRAPO. Thank you, Mr. Chairman. 

Chairman Bernanke, as you mentioned in your testimony, the 

Fed is currently monitoring whether its prolonged near-zero interest rate policy could result in excessive risk taking and threaten 

the financial stability of the United States. I am interested in what 

specific metrics you used to evaluate whether these risks are increasing. 

Mr. BERNANKE. Well, first, Senator, we have greatly expanded 

our resources that we use in the monitoring process. We have created a new Office for Financial Stability. We are working very intensively with the Financial Stability Oversight Council. So the 

amount of effort we put into this has greatly increased. Our internal monitors, in turn, report regularly to the Board and they report 

to the Federal Open Market Committee. So our discussions of monetary policy include extensive discussions of financial stability 

issues. 

The kind of metrics that are used include things like leverage, 

are people who are investing taking on too much leverage? Are 

asset valuations out of line according to standard metrics? Is interest rate risk or other kinds of risk too concentrated? As you know, 

of course, the Fed is also a bank supervisor, so we spend a lot of 

effort looking at banks and other financial institutions, trying to 

ensure that they have appropriate capital, appropriate liquidity, 

and are appropriately managing their risk. And so there’s a wide 

range of ways in which we look at this. 

Again, as I indicated, we are watching this very carefully. To this 

point, and I think this is a view shared by others on the Committee, while there are things that we really have to pay attention 

to, at this point, they are not of sufficient concern that they outweigh the important benefits of trying to support a continued recovery. 

11 

Senator CRAPO. Well, thank you. I probably would disagree with 

those conclusions. I know a number of my colleagues are going to 

get into this issue a little further, so I am going to go on because 

of the shortness of time. 

I want to talk with you briefly about Dodd-Frank reform. If we 

are able to achieve some bipartisan consensus on steps to improve 

Dodd-Frank, what are some of the provisions that you think need 

clarification or improvement for reconsideration? 

Mr. BERNANKE. Well, first, as a general matter, Senator, DoddFrank is a very big, complicated piece of legislation. It addresses 

many different issues and I am sure there are many aspects of it 

that could be improved in one way or another. I recall, in fact, that 

you yourself had a bill 5 or 6 years ago on regulatory reform and 

simplification—— 

Senator CRAPO. That is right. 

Mr. BERNANKE. ——which was a bipartisan effort to find ways to 

reduce costs without losing the purposes of the regulation, and I 

think something along those lines would be very doable in this context. The Federal Reserve would certainly be willing to work with 

you closely. 

In terms of specifics, we would want to do the work, of course, 

but you mentioned in your opening remarks the end user issue, 

clarity on what Congress would like us to do about end users, for 

example. Another area which is proving difficult is the push-out 

provision for derivatives. And I think, more generally, I think we 

all agree that the burden of regulation falls particularly heavily on 

small community banks, which do not have the resources to manage those regulations very effectively. So I would say as a general 

proposition that we ought to work together to try to find ways to 

lower that regulatory burden on those smaller institutions. 

Senator CRAPO. Well, thank you, Mr. Chairman, and I appreciate 

your advice and your expression of willingness to work with us on 

these and others as we move forward to try to improve our regulatory climate. 

The last issue, at least that I will have time for in this round, 

is I want to talk about the crisis in Europe. Last week, the European Union released its 2013 forecast for the eurozone economy 

and the E.U. economists predict that the eurozone economy will 

shrink for the second year in a row and the third in the last five. 

What specific risks does a prolonged recession in Europe present to 

the outlook for the U.S. economy? 

Mr. BERNANKE. Well, the risks that we have been facing for the 

last couple of years have been primarily financial, given uncertainties about the stability of certain countries’ sovereign debt, given 

the risk on, risk off behavior we have been seeing in financial markets as news comes in about financial developments. 

The European Central Bank has taken a number of important 

steps, including most recently the outright monetary transactions, 

which have helped to bring down the sovereign debt yields for the 

more fiscally challenged countries. That has been helpful. There 

have been a number of other positive steps which have generally 

reduced the financial stresses in Europe, notwithstanding the 

issues raised by the Italian election yesterday and today. And so 

12 

while that remains a concern, I think the financial stresses are certainly less today than they were over the last 2 years. 

At the same time, as you mentioned, even as the financial 

stresses have moderated to some extent, the European economy 

and the eurozone is in recession. Unemployment is rising, not falling. And that affects us in a number of ways, partly through the 

financial sector, but also simply through trade. Our economy prospers when we can export and the European market is an important 

market for us and we have noticed a decline in our ability to export 

to Europe. So that is a risk, as well. 

Senator CRAPO. Thank you. 

Chairman JOHNSON. Senator Reed. 

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

Thank you, Mr. Chairman, for your testimony. Over the last several years, the Federal Reserve has been providing stimulus to the 

economy through QE3, through other programs, and particularly as 

we are on the verge of the sequestration, it seems that our fiscal 

policy is not complementary to your policy. In fact, contradictory. 

And as you suggest in your testimony, if we could in the short run 

have a complementary policy, that would also add jobs rather than 

subtract them in the short run, add growth that would actually do 

better in closing the deficit and, in fact, provide an opportunity in 

the long run to solve some of the challenging problems. 

In addition, and I would like your comments, if we continue to 

sort of use austerity as our major approach, that, I presume, would 

complicate your ability, as you suggest you can do, to, in a measured way, move away from quantitative easing at the right time. 

Could you comment on those points? 

Mr. BERNANKE. Well, as I have noted, and I noted again today, 

monetary policy is no panacea, is no cure all, and we do not have 

the ability—we can all disagree on how powerful these measures 

are, and I do think they are effective, but I do not think that they 

can offset the 11⁄2 percentage points of fiscal restraint we are seeing this year, for example. So in terms of the near-term recovery, 

I think there is a sense in which monetary and fiscal policy are 

working at cross purposes. 

Having said that, I want to just be clear that I am not in any 

way denying the importance of long-run fiscal stability. I just think 

that, to some extent, the fiscal policy decisions being made are mismatched with the timing of the problem. The problem is a longerterm problem and should be addressed over a longer timeframe 

and in a way that, to the extent possible, and perhaps it is not entirely possible, but to the extent possible, does no harm with respect to the ongoing recovery. And that is the kind of balance I 

hope that the Congress will consider. 

Senator REED. So do I. I may be repeating myself, is that if our 

policies in the short run were complementary, that would probably 

bring down the deficit faster than the current sort of cross purposes. Is that your sense, too? 

Mr. BERNANKE. Well, certainly the—I do not know if it would be 

literally faster in the short run, because on the one hand, you 

would have fewer cuts and tax increases. On the other hand, you 

have greater growth. So those two factors might be going in the 

other direction. 

13 

But it is true that you get less bang for the buck, so to speak, 

for a given cut or a given tax increase because of the effect on 

short-term growth. So you would get a longer and larger long-run 

deficit impact and do less damage to the growth process by looking 

at this over a longer timeframe. 

Senator REED. Thank you very much. 

Let me quickly turn to another issue, and that is the Basel Committee announced significantly weaker liquidity coverage ratio 

rules, allowing sort of the use of mortgage-backed securities as liquid assets, et cetera. Do you intend to follow that approach with 

respect to the Fed, particularly the cautionary words you gave us 

today about risk taking and adding leverage to the financial markets? 

Mr. BERNANKE. Well, I think that will be our starting point. We 

need to start with the international agreement and ask ourselves, 

to what extent do we need to strengthen it? To what extent do we 

need to customize it for the U.S. context? You have to remember 

that, unlike capital, liquidity requirements are a new thing, and 

there was a significant amount of discussion about what was reasonable, what might be the side effects of liquidity requirements in 

other markets, and the like. And so there was a bit of iteration in 

terms of what the international agreement was. But we will certainly, of course, meet the international agreement, and then we 

will be looking to see whether additional steps or U.S. 

customization is necessary. 

Senator REED. Finally, and very quickly, Senator Crapo touched 

on the European situation. From afar, it looks like their policies of 

austerity have not helped them grow at all, in fact, have complicated their economic situation. Is that a fair judgment? 

Mr. BERNANKE. Well, austerity is not the only problem. They 

have, obviously, high interest rates and a variety of other factors 

that are affecting their economies. But, again, I would say that it 

is possible to achieve both objectives, short-term growth and 

longer-term financial sustainability, with a more judicious combination of short-term and long-term fiscal adjustments. 

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

Mr. Bernanke. 

Chairman JOHNSON. Senator Shelby. 

Senator SHELBY. Thank you. 

Mr. Chairman, welcome again to the Committee. The portfolio or 

the balance sheet of the Fed, you said is $3 trillion, more or less, 

is that right? 

Mr. BERNANKE. I did not say, but yes, that is about right. 

Senator SHELBY. Is that about right? 

Mr. BERNANKE. Yes, sir. 

Senator SHELBY. But you said it then, did you not? It is about 

$3 trillion. 

Mr. BERNANKE. Yes, sir. 

Senator SHELBY. You studied the Fed a long time before you ever 

came to the Fed. Has there ever been that type of balance sheet, 

close to that? 

Mr. BERNANKE. I do not think so. 

14 

Senator SHELBY. No. OK. Does it concern you, not how you add 

to the balance sheet, but how you might have to deleverage the balance sheet, and will that be a challenge for the Fed, or could it be? 

Mr. BERNANKE. Well, Senator, I should comment that although 

the Fed has not had a balance sheet this size, other central banks, 

like the Japanese, for example, have—— 

Senator SHELBY. And they have paid for it, too, have they not? 

Mr. BERNANKE. Well, it depends on your point of view. The current Prime Minister thinks they have not done enough. 

Senator SHELBY. What do you think? 

Mr. BERNANKE. I think that they should try to get rid of deflation. I support their attempts to get rid of deflation. 

In terms of exiting from our balance sheet, we have put out—a 

couple years ago, we put out a plan. We have a set of tools. I think 

we have belts, suspenders, two pairs of suspenders. We have different ways that we can do it. So I am not—I think we have the 

technical means to unwind it at the appropriate time. Of course, 

picking the exact moment to do it, of course, is always difficult. You 

know, you want to withdraw the support at the right time, not too 

early, not too late. That is always a judgment call. 

But in terms of the ability to get out and to normalize our balance sheet, we have, again, a set of tools, which I would be happy 

to go into, if you like, but which will allow us to normalize policy 

either by selling assets or by retaining assets and doing other 

things, like raising the interest rate we pay on reserves. 

Senator SHELBY. Do you think you will grow to a $4 trillion balance sheet? 

Mr. BERNANKE. Well, we do not have—we did not announce any 

number. What we are doing is we are looking—we are tying our 

asset purchases to the state of the economy. We want to continue 

purchases until we see a substantial improvement in the outlook 

for the labor market, conditional on inflation remaining stable. We 

are also, as I mentioned in my remarks, we are looking at the costs 

and benefits, including the financial stability issues that Senator 

Crapo alluded to. So we do not have—we have not given a specific 

number, but we are certainly paying close attention to all of these 

issues. 

Senator Crapo mentioned the transparency of the Fed. We are 

having this debate in public. You may have noticed that many 

Members of the Committee talk in public. We want everyone to understand that we are looking at all these issues. We are taking 

them all into account. And we are trying to do the right balancing 

of our objectives. 

Senator SHELBY. Is your portfolio public? 

Mr. BERNANKE. Yes, sir. 

Senator SHELBY. It is public. In other words, the $3 trillion value 

of your portfolio, it is public as to what securities you have and 

how they are doing, performing and nonperforming, is that—— 

Mr. BERNANKE. They are all performing, every single one. I 

mean, they are all Treasuries and Treasury-guaranteed agency securities. 

Senator SHELBY. Just about all of them are Treasury and Treasury-related securities? 

15 

Mr. BERNANKE. By law, we can only buy Treasuries and agencies. 

Senator SHELBY. And they are all performing right now? 

Mr. BERNANKE. A hundred percent. 

Senator SHELBY. OK. I want to discuss Basel III—I just have a 

minute. Where is Basel III as far as implementation in Europe and 

the U.S.? Bring us up to date. 

Mr. BERNANKE. Yes, sir—— 

Senator SHELBY. Because I think this is a very important regulatory challenge for everybody. 

Mr. BERNANKE. Right. Well, as you know, we put out a proposed 

rule on Basel III. We received lots of comments. We work to those 

comments. We have continued to talk to our international partners 

and we are planning to have a final rule out on Basel III—I cannot 

give you an exact date, but somewhere in the middle of this year, 

and with the aim of getting the implementation of Basel III during 

2013. 

I would point out, also, that as far as we can tell through our 

stress tests and other measures, virtually all of our banks are already well on track to meet the Basel III requirements. So it is not 

a question of the banks not being adequately capitalized. They are 

already either at or about to reach the Basel III capital levels. 

Senator SHELBY. What about Europe and their banks? 

Mr. BERNANKE. Europe is also in the process of implementing 

Basel III. Their banking system is weaker, I think. It has strengthened some in recent quarters. We are discussing with them some 

of the details of their plans, some of which differ from the international agreement, in our view. But they are also in the process 

of implementing this agreement. 

Senator SHELBY. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Schumer. 

Senator SCHUMER. Thank you, Mr. Chairman. 

First, I want to welcome Senator Crapo as our new Ranking 

Member and look forward to working with you on the Committee. 

And to the other new Members of the Committee, welcome. It is 

a great Committee with a great group, and I hope we will have a 

good, productive time under the Chairman’s leadership. 

OK. My first few questions are about sequestration, and then I 

want to talk a little about Italy. 

Estimates suggest that letting sequester take effect could reduce 

the GDP by as much as half a point over the remainder of the year. 

I first want to know if it is—I am going to ask you a series and 

you can answer them. Is that a fair estimate? 

Instead of stopping sequestration, some have suggested letting 

the full amount of cuts take effect, but rearranging the cuts rather 

than imposing them across the board. In your opinion, would this 

reshuffling mitigate the negative effect of GDP growth in any 

meaningful way this year or next, or would the net effect on shortterm GDP be more or less the same since the total amounts of cuts 

would be the same? 

And my second question on sequestration is this. It goes into effect Friday. There is some debate about how quickly the cuts will 

take place and how quickly the impact on jobs and the economy 

will be felt. CBO says sequestration will cost 750,000 jobs. When 

16 

do you think we will start seeing the impact in the job market? In 

the March job numbers? In April? When? Those are my questions 

on sequestration. 

Mr. BERNANKE. Sure. The six-tenths on GDP growth in 2013 is 

a CBO number, and we get very similar results to that. I think 

that is a reasonable estimate. 

In terms of whether or not rearranging the cuts would be beneficial, it could be beneficial from the point of view of more efficient 

allocation of the cuts or cuts that are more consistent with the preferences of Congress, but that, of course, is a Congressional decision. I have no input there other than to say that I think the nearterm effect on growth would probably not be substantially different 

if you did it that way. 

In terms of the effects on jobs and employment, the spending implications of the sequester take place over a period of time, so I—— 

Senator SCHUMER. Mr. Chairman, you did not answer the second 

one. I asked you, would it—regardless of the political preferences 

that the Congress might have—would the rearrangement, if there 

is flexibility, affect economic growth in any real way—— 

Mr. BERNANKE. Oh, sorry—— 

Senator SCHUMER. ——if the cut level is the same? 

Mr. BERNANKE. Not significantly. It would be about the same, I 

think. 

Senator SCHUMER. Got you. Good. 

Mr. BERNANKE. In terms of the impact, the sequestration takes 

place over time. Furloughs take place over time. Spending cuts 

take place over time. So I would not expect to see a big impact immediately. I think it would probably build over a period of months. 

Senator SCHUMER. Right. One of my colleagues—I do not want 

to steal his thunder, he is not here—but at a meeting earlier described it like the metaphor of the frog who jumps into a pot and 

the water just starts boiling, and you do not feel it at first, but if 

you stay in that pot, you are going to be singed pretty badly. Is 

that a fair analogy? 

Mr. BERNANKE. Well, again, I think that it would take effect over 

a period of time, and remember, it is also in conjunction with the 

other measures that have been taken this year, as well. 

Senator SCHUMER. Yes. Thank you. 

The next question is on Italy. So the markets reacted quite nervously, shall we say, to the elections in Italy and the idea that they 

might not be able to form a Government, or might form a Government that would be less willing to go along with the present economic policies. My question is, A, what do you think of that, but 

B, more importantly, what is the exposure of our American financial institutions to Italy’s debt? How dangerous—let us say—let us 

take the worst case scenario and let us say they cannot form a Government and they go through a little bit of what Greece or Spain 

has. How big an effect would that have on the stability—not on the 

world economy, not on our selling to Italy, but on the stability of 

our American financial institutions? 

Mr. BERNANKE. Well, the market is reacting, first and foremost, 

to uncertainty. It does not know which way the Italian Government 

is going to go and how those policies will be affected. 

17 

I am not an expert in Italian politics, but I do not think that any 

of the candidates have outright rejected either staying in the Euro 

or maintaining the policies that are being required of Italy in order 

to continue to receive—you know, in order to continue to be in the 

eurozone. But, again, there is a lot of uncertainty there to see what 

happens. 

Italy is unusual in that its current deficits are not very large, but 

it has a very large outstanding debt, and so there is a lot of Italian 

debt held around the world. Our assessments, going back, is that 

our banking exposure to Italian and Spanish debt is moderate, that 

it would be meaningful, but—again, I am not forecasting in any 

way—would not inflict serious damage on our financial institutions. 

There are, of course, also money market funds that lend a lot of 

funds to European banks, including Italian banks, and those are 

connected. The fate of those institutions is connected to the fate of 

the fiscal situation. 

But, again, I think that the main effects would be more indirect. 

I think—and again, I want to emphasize, this is totally hypothetical—that serious concerns about, say, the ability of Italy to remain in the Euro would probably have much broader effects on 

other asset classes—stock market, bond yields around the world, 

bank stocks, et cetera—and those effects would be more unpredictable and more concerning probably than direct losses and exposures in terms of Italian debt holdings. 

Senator SCHUMER. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Corker. 

Senator CORKER. Thank you, Mr. Chairman. 

When the Fed decided that it was going to stimulate a global 

currency war as it did, did you embark on that thinking, well, our 

country is in trouble and let us sort of the heck with everybody 

else, or did you think it would leverage the wealth effect, if you 

will, if everybody had a race to the bottom? I know the Fed has 

been really purposeful in trying to create this sort of faux wealth 

effect. Did you think it would multiply your efforts? 

And speaking to that, so overall wealth effect, I know you all do 

calculations all the time, but could you tell us exactly what sort of 

the wealth effect is, the part of it that is not real, that if you were 

to stop doing what you are doing as it relates to monetary supply 

today, how much of a diminishment in national wealth would take 

place? 

Mr. BERNANKE. On the first question, we are not engaged in a 

currency war. We are not targeting our currency. The G7 put out 

a statement which was very clear that it is entirely appropriate for 

countries to use monetary policy to address their domestic objectives, in our case, employment and price stability. Our position is 

that our expansionary monetary policies, which are being replicated, of course, in other industrial countries, are increasing demand globally and helping not only our businesses but also the 

businesses in other countries that export to us. And so this is not 

a ‘‘beggar thy neighbor’’ policy. It is one that benefits our trading 

partners. 

Senator CORKER. But the wealth effect is something you have 

tried to stimulate here, and I wonder if you could tell me—— 

Mr. BERNANKE. Yes, that—— 

18 

Senator CORKER. ——how much wealth diminishment would 

take place if you were to, if you will, move away from the punch 

bowl. 

Mr. BERNANKE. Well, there would be some, but I would point out 

that if you look at the stock market, for example, that the so-called 

equity premium, the risk premium associated with stock prices, is 

actually quite wide. In other words, stock prices by that metric do 

not appear over-valued, given earnings and given interest rates. 

Now, if interest rates went up some, that would have some effect 

on stock prices. 

But the point here is not to create what you call a faux wealth 

effect. The point here is to stimulate the economy, create some forward momentum in growth and employment, and that, in turn, 

shows up in earnings and that creates a genuine increase in 

wealth, the same with house prices. 

Senator CORKER. So I think that, you know, I do not think there 

is any question that you would be the biggest dove, if you will, 

since World War II. I think that is something you are rather proud 

of. And we have a Federal Government that is spending more relative to GDP than at any time since World War II. Those are working well together in that the Fed is actually purchasing a large portion of the new debt issuances as we live beyond our means, and 

so it is working very well together in that regard. 

I am just wondering if you all talk at all in your meetings about 

the degrading effect that is having on our society and how it is basically punishing people who have done the right things and throwing seniors under the bus and others that have saved money. Do 

you all ever talk about the longer-term degrading effect of these 

policies as we try to live for today? 

Mr. BERNANKE. I think one concern we have is about the effect 

of long-term unemployment and people who do not have jobs for 

years. That means they are never going to acquire skills. They are 

never going to be a productive part of our workforce. So the jobs 

part is very important. 

You called me a dove. Well, maybe in some respects, I am, but 

on the other hand, my inflation record is the best of any Federal 

Reserve Chairman in the postwar period, or at least one of the 

best, about 2 percent average inflation. So we have worked on both 

sides of the mandate and we are trying to achieve a stronger economy for everybody. I do not think there is any degrading going on. 

You mentioned, in particular, the issue of savers, and I think 

that is an important issue. I would just point out that if we tried 

to raise interest rates from, say, the current 10-year yield is 2 percent—if we tried to raise it to three or four or 5 percent while the 

economy was still weak, it could not be sustained. Our economy is 

not weak enough to sustain high real returns to savers. If we tried 

to do that, we would throw our economy back into recession and 

we would have low interest rates like the Japanese do. The only 

way to get interest rates up for savers is to get a strong recovery, 

and the only way to get a strong recovery is to provide adequate 

support to the recovery. So I do not agree with that premise. 

Senator CORKER. Do you concern yourself at all with just the 

whole notion of being perceived—you know, we watch regulatory 

capture take place here, where basically the regulators end up 

19 

working for the people that they regulate. You know, we have 

TARP, which most people who voted felt like that was a needed 

thing during a crisis, and then we have had this easy money policy 

which really allowed the big institutions, especially on Wall Street, 

to really reap tremendous benefits in the early stages without 

doing anything. And then you are getting ready, I guess, in a few 

years, as you alluded to, when interest rates rise, to basically have 

to print money to sell securities at losses and then pay interest on 

reserves, which people have pointed out, and I think all have 

talked about, is going to be billions and billions of dollars going to 

these institutions that, again, you regulate. Do you concern yourself at all with the Fed being viewed as not as independent as it 

used to be and working so closely with many of these institutions 

that you regulate? 

Mr. BERNANKE. Well, we are concerned about perceptions, that is 

true, but none of the things you said are accurate. For example—— 

Senator CORKER. Well, yes, they are. 

Mr. BERNANKE. Well, so to take the case of paying interest on reserves in the exit, for example, that is, number one, that is beneficial for the taxpayer because on the left hand side of the balance 

sheet is reserves, but on the right hand side is the securities that 

we hold, which pay a higher interest rate than the reserves. So by 

doing that, we actually make a profit which we remit to the Treasury. 

Senator CORKER. Well, it is really good for the institutions. 

Mr. BERNANKE. We are not helping the banks. We are not helping the banks because—— 

Senator CORKER. No, when you exit. When you begin to draw the 

money supply in, it is going to be very, very beneficial to these institutions. 

Mr. BERNANKE. Why? 

Senator CORKER. Oh, they are going to be yielding huge returns 

on their reserves as you pay the—— 

Mr. BERNANKE. We will be paying market rates. We will be paying exactly what they can be getting in the repo market, in the 

commercial paper market, anywhere else. There is no subsidy involved. 

Senator CORKER. OK. 

Chairman JOHNSON. Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Chairman Bernanke, thanks for your testimony. You mentioned 

the housing market and that being important. It has always been 

one of the drivers of our economic recovery. And in that respect, 

Senator Boxer and I have reintroduced the Responsible Homeowner 

Refinancing Act, which would remove barriers to refinancing for 

borrowers with GSE mortgages and have a history of paying their 

mortgage on time. In the State of the Union, President Obama said 

too many families who have never missed a payment and want to 

refinance are being told no and urged the Congress to act. 

In that respect, could you discuss the benefit to both individuals 

and the national economy of enabling more families to refinance 

mortgages at today’s historically low interest rates? 

Mr. BERNANKE. Well, on the side of the borrowers, if they are 

able to refinance, then they will have, obviously, lower payments, 

20 

lower debt burdens, and to some extent, more income and ability 

to spend. I guess the question on the other side is whether there 

are needed subsides or other costs and how large those would be. 

That would be the tradeoff I would look at. 

But it is true from the borrower’s point of view, being able to refinance at a lower rate is going to increase the chance that you can 

stay in your house and increase your income. 

Senator MENENDEZ. Would we not be, in essence, solidifying an 

entire universe of responsible, so far responsible, borrowers to be 

able to ensure that they can continue to be a responsible borrower, 

be able to avert any movement toward foreclosure and create an 

economic stimulus, because if I have been patching the roof on my 

house because I do not have the money to fully repair it and now 

I am paying $300 or $400 less a month, I am going to have the 

wherewithal to spend that money in an economy that would ultimately have a ripple effect? Would that not be a fair statement? 

Mr. BERNANKE. Well, Senator, as you know, I do not like to endorse specific legislative proposals. In this case—— 

Senator MENENDEZ. Well, forget about the proposal. Just the 

question in general of the possibility of refinancing at historically 

lower rates. 

Mr. BERNANKE. Again, from the borrower’s point of view, that is 

clearly better. They will have lower payments. They will have more 

income, discretionary income, a better chance of staying in their 

house. And I guess the question is, what implications would it have 

on the lenders’ side or on the fiscal side. Would there be some 

money coming in from the Government to offset it on the other 

side, would be the question I think you would have to look at. But 

your basic point, would it help borrowers, obviously, it would. 

Senator MENENDEZ. Let me ask you this. With reference—you 

said in your testimony—I do not know if you verbalized this, but 

I read it—it says, the sizes of deficits and debt matter, of course, 

but not all tax and spending programs are created equal with respect to their effects on the economy. To the greatest extent possible, in their efforts to achieve sound public finances, fiscal policy 

makers should not lose sight of the need for Federal tax and spending policies that increase incentives to work and save, encourage 

investments in workforce skills, advance private capital formation, 

promote research and development, and provide necessary and productive public infrastructure. 

With that view being your statement, is not sequester—which is 

something I did not vote for because I saw exactly where we were 

going to be headed—is not the way sequester takes place totally in 

contrary to that view? 

Mr. BERNANKE. I think there is a tendency, Senator, when you 

are thinking about the budget and the deficit, to just talk about 

total spending, total taxes, and I am saying, and I think it is consistent with your point, that it is also very important whether the 

tax policy is a good tax policy, whether the spending is productive 

spending that increases the productive capacity of our economy or 

achieves desirable social goals. So I hope it is not too controversial 

to say that I think the Congress ought to think carefully about how 

it taxes and spends and try and achieve the best outcomes it can. 

21 

Senator MENENDEZ. Well, in sequester, you have across-theboard cuts. 

Mr. BERNANKE. That is right. 

Senator MENENDEZ. Now, if you are in the private sector and you 

lost revenue, either you try to make up that revenue or, if you had 

to make cuts in your business, you would make it in accordance 

with what would pose you for growth again. So it might be in the 

context of one company human capital. In another company, it 

might be technology, whatever. 

Mr. BERNANKE. Mm-hmm. 

Senator MENENDEZ. Across-the-board cuts are indiscriminate 

and, therefore, do not have the balance that you suggest is necessary. Would that be a fair statement? 

Mr. BERNANKE. That is fair, but the question is, will the Senate 

and the Congress be able to agree on how to replace the sequester 

with a different set of programs? If they can, obviously, if they can 

find a better combination, obviously, that would be better for our 

economy. 

Senator MENENDEZ. Well, it would certainly be more desirable, 

assuming that that agreement could be achieved, than a meat axe 

approach, across the board, regardless of understanding the very 

issues that you raise. How do you create policies that create incentives to work and save, encourage workforce skills, capital formation, and what not. 

Mr. BERNANKE. I agree. 

Senator MENENDEZ. Thank you. 

Chairman JOHNSON. Senator Toomey. 

Senator TOOMEY. Thank you, Mr. Chairman, and thank you, 

Chairman Bernanke, for joining us. 

I would just like to follow up for a moment on the point that the 

Senator from New Jersey was making, because I think, if I understood the gist of what he was saying, we might have a lot of agreement on this, and that is whether we like it or not, it is certainly 

possible and actually looks quite likely that the sequester will at 

least begin. And as it is currently codified, it is without regard to 

any sense of what are higher and lower priorities in the different 

agencies that would be affected. 

It is hard to imagine that that is the optimal way to go about 

cutting spending. It is impossible for me to believe that all spending is equally meritorious and that every category of spending 

within every agency has equal merit and equal priority. And so it 

seems to me that the most sensible way to go about this would be 

to give some flexibility to the people who are closest to these spending decisions—the agency heads, the Administration, the OMB—so 

that they can at least make the cuts that are least disruptive. 

Some cuts are more disruptive than others, and it just seems that 

it could be less disruptive to our economy if they had a chance to 

do this through a thoughtful process than if it has to be done uniformly across the board. Does that make some sense? 

Mr. BERNANKE. Yes, sir. 

Senator TOOMEY. Thank you. Another point about the sequester 

I just have to make—I was not going to get into this, but I just 

have to strongly disagree with the notion that we have some kind 

of severe austerity program that is about to kick in. We have a 

22 

Federal Government that has doubled in size in the last 10 years, 

100 percent growth in total spending. The sequestration contemplates 2.5 percent budget authority reduction, which, as you 

know, about half of that would be actually spent in this fiscal year. 

So we are talking less than 1.3 percent of Federal spending and 

outlays that would be curbed. 

The fact is, if the sequestration fully goes into effect, in fiscal 

year 2013, the Federal Government will spend more money than it 

did in 2012. It is hard for me to understand that as draconian 

spending cuts and austerity. And, by the way, by my math, the actual outlay is a reduction that is equal to about one-quarter of 1 

percent of GDP. How that has a disastrous impact on GDP growth 

escapes me. 

And, frankly, the idea that we would somehow postpone it and 

promise that we will make cuts in the future, I think the credibility 

of those promises would be worth zero and our economy would respond in a very adverse way, because it would see that we have 

absolutely no willingness, no political ability, to begin even the 

slightest imposition of fiscal discipline. And so I think that has 

very negative implications. 

My specific question is for you on monetary policy, Mr. Chairman. You talked about the fact that inflation has not manifested 

itself as a problem by conventional measures at this point. I take 

your point. To what extent are you concerned about asset bubbles? 

There are people who think we have bubbles in the works right 

now in Treasury securities and agricultural real estate, some even 

in the equity markets. How do you know when there is a bubble, 

and how concerned are you that this absolutely unprecedented 

monetary policy could manifest itself in inappropriate asset appreciation? 

Mr. BERNANKE. It is a concern, as I said in my remarks. We are 

approaching it two ways. First, we are putting a lot of effort into 

measuring, monitoring, assessing asset prices and financial activities. Second, we are trying to make sure that, to the extent that 

there may be some frothiness in a particular asset class, that the 

holders of those assets are prepared to deal with the losses. So, for 

example, banks have twice as much capital today than they did a 

few years ago and we stress them according to different possible 

scenarios where asset prices move sharply and ask, would they still 

be able to lend and be stable. 

Senator TOOMEY. And I have got very little time, so I acknowledge that, but I think you perhaps would agree that it can be very 

difficult to know when a bubble is really forming and it is getting 

frothy as opposed to being driven by fundamentals. 

And the other concern that I have, as you mentioned earlier, I 

think, in conversation with Senator Shelby and perhaps Senator 

Corker, that you are confident that you have the ability to unwind 

the very large balance sheet that you have got. There is no question, you have the ability to unwind. What worries me is the impossibility of knowing the impact of the unwind. 

For instance, just the suggestion of maybe a little bit more dissent within the FOMC than people previously thought existed precipitated a significant sell-off in equities a week or two ago. What 

23 

would the impact be of actually having to liquidate a big portion 

of your holdings on the bond market, on the equity markets? 

Mr. BERNANKE. We do not anticipate having to do that. We think 

that we can—— 

Senator TOOMEY. Not ever? 

Mr. BERNANKE. We could exit without ever selling by letting it 

run off, and we could tighten policy by raising interest rates that 

we pay on reserves. That would be one strategy, for example. 

In any case, we have said that we will sell slowly, with lots of 

notice, and we will, of course, also be offering our forward guidance 

about rates so that there will not be a shift in rates, expectations 

on the part of the market. So we are giving a lot of thought to 

these issues. 

Senator, if I could just make one very quick point, there is no 

risk-free approach to this situation. I mean, the risk of not doing 

anything is severe, as well. So we are trying to balance these 

things as best we can. 

Senator TOOMEY. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Warner. 

Senator WARNER. Thank you, Mr. Chairman, and Chairman 

Bernanke, thank you for your work and your efforts to, as I think 

we all have some concerns, take extraordinary actions, oftentimes 

because, at least to date, it seems like we have failed to keep up 

our end of the bargain to put in place the kind of balanced, comprehensive, phased in deficit reduction plan that you have called 

for and many of us have worked on for years. 

I would add, as well, that every one of those plans from SimpsonBowles on had a revenue component that was substantially higher 

than the revenue secured on the New Year’s Eve deal. I would also 

acknowledge all of those had an entitlement reform component that 

also has not been part of the agreements to date. 

I do want to come back at one level on the sequestration, because 

I heard some of my colleagues say the hit to the economy of sequestrations, which was set up to be the stupidest option possible, such 

an outrageous option that rational people would never allow it to 

come to pass, we look at that kind of top-line number and its effect 

it would have on the economy, and one of the things—I know you 

have got great folks who do analysis—whether you have been able 

to kind of dig in at a kind of level below—beyond just the kind of 

top-line cut, the failure to have it phased in, the failure, for example, to have a balance with some revenue additions, but to actually 

get to the level of granularity where, in many cases, because of this 

across-the-board approach without any prioritization, 975 separate 

line items in the Navy not of equal value to the taxpayer or to our 

defense, where in many cases we will actually be costing the taxpayer more money by these cuts, where we will be either in one 

case breaking volume contract purchases on—not just on the DOD 

side, but on other sides, or the cases where—I had a university 

president here today with me where NIH grants that may have 

had three or 4 years’ worth of research where the last year of research now cannot be let and consequently all of the previous work 

kind of goes down the drain. Or, while we talk about the economic 

costs of furloughing individuals, whether you have been able to do 

the analysis and say what that downstream might mean when it 

24 

is meat inspectors or poultry inspectors which then might have a 

subsequent driving up of prices to consumers because not as much 

food gets into the grocery store. 

Has your analysis taken on the kind of, not just top line, but the 

kind of the extra added stupidity value that was not built into this 

legislation? 

Mr. BERNANKE. Well, I agree with a couple of previous speakers 

on both sides that a thoughtful approach that looked at all these 

issues would be better if it could be agreed upon than a just acrossthe-board approach. But we do not get into line items and specific 

programs. 

Senator WARNER. And I agree. Top line, the number is going to 

have an enormously detrimental effect, and again, why I think we 

need balance. But I would argue that there is a perhaps stupid and 

slightly less stupid way and I am, I think, only digging into some 

of the—literally some of the absurdities that will take place. And, 

actually, some of the costs that the taxpayers will incur under the 

guise of, quote-unquote, ‘‘cutting’’ is pretty remarkable. 

I want to come back to—I have a host of questions, and my time 

is quickly going away, as well—two other items. One, a lot of conversation for those of us who have been wrestling with the fiscal 

issues on any kind of historic basis. Clearly, we are at historic 

spending levels, historically high spending levels. We are also at 

historically low, the last 50 years, at least, revenue levels. 

One of the things that sometimes is cited is, well, our goal ought 

to be a 50-year running average of what our revenue should be as 

a percent of GDP. I guess I just really wonder, with the demographic bulge that we have, with the aging of our population, that 

even those of us who have been very strong proponents of major 

entitlement reform, do you really think that kind of a backwardslooking 50-year historic revenue target is appropriate as an economist when you look at both our aging population and the kind of 

demographic bulge of the baby boom coming in, even with meaningful entitlement reform? 

Mr. BERNANKE. Well, the way I think about it is in terms of debtto-GDP ratio. As I mentioned in my remarks, we had a national 

asset of a 40 percent debt-to-GDP ratio before the crisis and we 

have lost a lot of that asset. And given what is happening, you 

know, 10, 20, 30 years out, we should be trying to buildup over the 

next decade some fiscal capacity to deal with it. 

Senator WARNER. My time is up, but just would you say what 

that debt-to-GDP goal should be going forward? You have made 

that comment at various times—— 

Mr. BERNANKE. I do not think there is a magic number, but historically, we have not been at 75 percent at any time since just 

after World War II. So if we can bring it down from here some, it 

would be helpful, I think. 

Senator WARNER. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Coburn. 

Senator COBURN. Thank you, Mr. Chairman, for being here. I appreciate your work. 

Just a comment on Senator Warner. The revenue that was 

passed was certainly less than what Simpson-Bowles had agreed 

to, but I would remind my colleague, Simpson-Bowles revenue was 

25 

used to lower tax rates to stimulate the economy, not to raise taxes 

and not stimulate the economy. And what is outrageous is that we 

have not done anything to address our long-term problems. And I 

know my colleague from Virginia has been very effective in working across the aisle to try to accomplish that. 

My questions really have to do with QE. Do you think—is there 

a diminishing return on your efforts at quantitative easing, in 

terms of its effect? 

Mr. BERNANKE. That is a good question when we have debated. 

On the one hand, the first round in 2009 had some very substantial 

benefits in terms of market functioning. Markets were in turmoil. 

Our purchases helped calm markets and set the stage for recovery 

in financial markets. Of course, we do not have quite that situation 

today. 

On the other hand, there are some things working in the other 

direction. For example, credit markets are more open today. Banks 

are lending more today. And so in some sense, the low interest 

rates can pass through more easily today than they could have a 

couple years ago. 

So that is a good question. We do not know exactly which way 

it goes, but I think, as I said in my remarks, I think there is pretty 

good evidence that 3.5 percent mortgage rates are one of the reasons why housing looks like it is turning around, low auto rates 

one of the reasons why car sales are up. So whether it is bigger 

or less, I am not sure, but it does seem to be having some positive 

benefits in terms of growth. 

Senator COBURN. Now that we have Japan actually pretty well 

duplicating some of our efforts in terms of QE to fight deflation, 

which I agree is a proper goal for them—they have struggled with 

that for 20 years—do you worry at all, now that the European 

countries have done a quantitative easing, in effect, Japan has 

done it, the Bank of China has done it, we have done it, that the 

competitive ratio or the net competitive differences might divert 

away and we see this in terms of trade protectionism in terms of 

the international markets? 

Mr. BERNANKE. Well, first, Senator, you make a good point that 

the Fed is not at all extraordinary. In terms of balance sheets, in 

terms of long-term interest rates, we are very similar to a lot of 

other countries. 

As I was saying before, we do not view monetary policy aimed 

at domestic goals as being a currency war. It is not like putting 

tariffs on your imports so that you can ‘‘beggar thy neighbor’’ to the 

benefit of your domestic industries. That is not what we are doing. 

If all the major economies that need support provide stimulus and 

extra aggregate demand, that is mutually beneficial because, for 

example, China depends on the strength of Europe and the U.S. as 

their export market, and we, too, depend on other countries, as 

well, as a market for our goods. So this is, I think, a positive sum 

game, not a zero sum game, that we have here. 

Senator COBURN. But there was some concern in the last G20 

meeting in terms of this target of the end being at 110 instead of 

90—instead of 78, like it was 90 days ago, or maybe longer. But 

there is some concern that currencies can get out of balance and 

26 

that will have a significant impact on trade. Would you agree with 

that? 

Mr. BERNANKE. Well—— 

Senator COBURN. There was certainly discussion in the press. 

Mr. BERNANKE. There was certainly discussion of the issue. The 

emerging market economies, which are at full employment in many 

cases, are unhappy because low interest rates in the advanced 

economies give them a choice they do not like. Either they have to 

accept low interest rates, which they feel causes inflation or problems in their own economy, or, alternatively, they have to raise— 

let their exchange rate appreciate, which hurts their export market. So they have had some concerns with accommodative monetary policy in advanced economies, in general, but I do not think 

Japan really raises a special case, notwithstanding the rhetoric. Of 

course, we have not seen what they are going to do yet. I mean, 

they have not even officially appointed the new Governor. But, presumably, what they are going to do is monetary policy aimed at domestic objectives and not specifically at the exchange rate. 

Senator COBURN. One final, and you do not have to answer this, 

but if you would give me your thoughts. A recent paper, ‘‘Crunch 

Time: Fiscal Crises and the Role of Monetary Policy,’’ would you 

mind at some point in time giving me your thoughts on that? I 

think you have seen that. 

Mr. BERNANKE. I will, but I think the main thing I would say is 

that—and I want to be very clear—the CBO agrees that the Federal Reserve’s balance sheet policies are with very high probability 

going to be a very significant boom to the taxpayer in terms of returns to the Treasury. 

Chairman JOHNSON. Senator Merkley. 

Senator MERKLEY. Thank you, Mr. Chair, and thank you for your 

testimony. 

I wanted to start with too big to jail. We had the situation with 

Hong Kong-Shanghai Bank Corporation, HSBC, where the United 

States decided not only not to investigate any individual, but not 

to investigate the bank as a whole, related to money laundering or 

related to terrorist organizations and drug organizations. It is no 

small thing, no small thing. Drug organizations in Northern Mexico 

are responsible for 40,000 deaths. Terrorist organizations, obviously, are a threat to the United States. And the too big to jail 

echoes the fact that we still have banks that are so large that we 

are concerned about creating any ripples. In this case, it sends a 

message, as well, about future behavior. If current behavior, be it 

manipulation of the LIBOR rate, which have had fines associated 

with it but not criminal prosecutions, I do not believe, or too big 

to jail for money laundering, does this not kind of undermine in a 

way our international regulatory structure for financial institutions? 

Mr. BERNANKE. Well, I agree that no individual and no institution should be exempt from paying for crimes that they commit. On 

this particular case, we worked very closely with the Department 

of Justice. We cooperated in every possible way to give them information. In the end, the company paid a $2 billion fine. If it relates 

to the bigger issue you are thinking of, of too big to fail, we also 

agree that that is something that really needs to be addressed and 

27 

that many of the parts of Dodd-Frank are intended to address that 

and we are pushing those as hard as we can. 

Senator MERKLEY. Thank you. And I think it does certainly say 

to us we are a long ways from getting there if we are that concerned about any form of shakiness in these large banks. 

But there is another aspect of this, too, and that it continues to 

tell folks that it is safer to invest, if you will, in large banks than, 

say, community banks. A community bank would have been shut 

down or at least investigated thoroughly. And in what I see in the 

economy in Oregon is often it is the community banks that are willing to lend into the local economies because they understand it better. They are more comfortable with it. They understand they may 

have relationships to know the competency of any individual companies and so forth. And is this sort of bias kind of counterproductive to our overall health of our economy? 

Mr. BERNANKE. Absolutely. It means the playing field is not 

level. It means that there is not market discipline, so there is too 

much risk taking. So getting rid of too big to fail is, I think, an incredibly important objective and we are working in that direction. 

Senator MERKLEY. Thank you. I want to turn now to the fiscal 

cliff. We had a drop in GDP in the fourth quarter of last year. Do 

you share the view somehow that that was, in part, attributable to 

the December 31 fiscal cliff? 

Mr. BERNANKE. Only incidentally. One of the factors that happened to contribute to the fourth quarter was a 22 percent annual 

rate drop in defense spending, and it is possible that in anticipation of the sequester, for example, there may have been some 

changes in spending patterns. But, as I said in my remarks, I think 

the fourth quarter was really a combination of transitory factors. 

I do not think it really signaled any real change in the pace of 

growth of the economy. On the other hand, the pace of growth of 

the economy remains around 2 percent, which is positive, but it is 

not as strong as we would like. 

Senator MERKLEY. So now we are looking at the different items 

that you mentioned, the debt ceiling, continuing resolution, the sequester, which does convey a feeling of lurching from crisis to crisis. We have heard many companies have put substantial money 

aside, that they have not reinvested. They have had some very 

profitable years. Is this style that we seem to have adopted, of 

being unable to get our act together and plan a year at a time, if 

you will, in the traditional sense, really kind of shooting ourselves 

in the foot? 

Mr. BERNANKE. I think so, Senator. We have not been able to 

identify with accuracy the quantitative impact of uncertainty about 

policy, but we certainly, around the FOMC table, hear many anecdotes from businesses about their reluctance to expand or hire, 

given that they are not sure what the fiscal situation is going to 

be. 

Senator MERKLEY. Switching gears, the Volcker Rule, or Volcker 

firewall between hedge fund -style activities and banks that take 

deposits and make loans, still has not—the rulemaking has not 

been completed. We are well past the 2-year mark headed toward 

3 years. Does this need to get done so that institutions know what 

the appropriate boundaries are and also so that here, we can demVerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON
28 

onstrate that we actually have the ability to pass laws and the 

rules that go with them and operate as a competent society? 

Mr. BERNANKE. We would like to get it done and we have made 

a lot of progress on it. The issue at this point is that there really— 

the Volcker Rule is really three or four different rules. The CFTC, 

the SEC, and the banking agencies each has a Volcker Rule which 

applies to the institutions that they supervise and there is a strong 

sense that we have that we would be much better served if those 

rules were closely coordinated and as close to being identical as 

possible. So I think the issues at this point are not the work that 

we have done at the Federal Reserve, for example, the issues are 

finding agreement and closure among the different agencies who 

are working on the rule. 

Senator MERKLEY. Thank you. 

Chairman JOHNSON. Senator Heller. 

Senator HELLER. Thank you, Mr. Chairman, and Mr. Chairman, 

thank you for being here today. I have not had a chance to raise 

some questions since 2008 on the Financial Services Committee on 

the other side, so it is good to have you in front of me and thanks 

for taking time. 

Mr. BERNANKE. Sure. 

Senator HELLER. You know, we ask a lot of questions a lot of different ways, and I am probably not going to be any different, but 

let us give it a shot. 

You know, we have not passed a budget around here in 4 years. 

Are you optimistic that sometime in your lifetime we may pass another budget around here in Washington, DC? For that matter, let 

me ask you another question, and you can answer them together. 

Do you think we will ever balance a budget, have a balanced budget in your lifetime? 

Mr. BERNANKE. Well, I would settle for stabilization of the ratio 

of debt-to-GDP, which is a slightly less tough level. 

Senator HELLER. It sounds like a ‘‘no.’’ 

Mr. BERNANKE. I have—you know, it is easy to criticize, but the 

politics is very difficult. I understand that there are a lot of very 

different views and strongly held views and it is not easy to come 

to an agreement. So I do not think Congress is not trying. I know 

you are trying, and I hope that you can find the agreement to see 

these important objectives. 

Senator HELLER. Well, the reason I raise the question, I think 

the sequestration issue that we have in front of us on Friday is a 

result of our lack of budgeting and effort to budget. I am from Nevada, so if I am putting money down, I am putting $100 down that 

sequestration comes and goes on Friday. Then as soon as that occurs, we get into our Budget Committee markups that are supposed to happen on March 11 through the 15th. I am putting another $100 down that that does not happen. 

Then we are supposed to bring those bills down to the floor sometime on March 18, and then March 27, Government funding expires because we do not budget, and I am arguing that that day 

comes and goes and we have a big argument. All I am talking 

about is the instability that we have and how difficult does that 

make your job? 

29 

Mr. BERNANKE. Well, it makes my job difficult, but it also makes 

the economy’s job difficult. Again, as Senator Merkley mentioned, 

the uncertainty associated with not knowing how policy is going to 

be developed and what tax rates will be and what spending will be 

and what programs will be and which contractors will be receiving 

funding, et cetera, those are important concerns. 

Senator HELLER. And I know your policies are based on monetary policy and also unemployment and employment, and I have to 

believe that our indecisiveness and inability to get things done is 

causing a lot of consternation. 

You made a comment, and you have actually repeated this in 

this hearing, that you will continue—I want to go to quantitative 

easing, that is your purchasing of these assets—will continue until 

substantial improvements in the outlook of the labor market in the 

context of price stability. Will you explain to me a little bit more 

in depth what that means? 

Mr. BERNANKE. Well, sure. We are going to be looking at a variety of variables. We will be looking at payroll employment, is it 

strengthening, is it sustainably strengthening? Is the unemployment rate coming down? So those are indications—— 

Senator HELLER. Do you have a target? 

Mr. BERNANKE. We do not have a specific target. We have given 

thresholds for our rate policy. We have not extended those to our 

asset purchases, and there are a couple of reasons. One is, as you 

mentioned, there are a lot of other things happening in our economy, like the fiscal issues that you referred to. But in addition, we 

are paying very close attention, as a number of you have mentioned, to the efficacy and cost of these policies and that makes it 

very difficult to say this is the number we are going to achieve. 

So we are doing our best to communicate the criteria for action, 

but we have not been able to come to a specific number which encapsulates both the change in outlook for the labor market and the 

assessment of costs and efficacy, which is another part of the decision process. 

Senator HELLER. Do you believe that your asset purchases are 

causing any kind of an equity bubble? 

Mr. BERNANKE. I do not see much evidence of an equity bubble. 

Earnings are very high. As I said, the equity risk premium is above 

normal. That is, in other words, equity holders are still being somewhat risk averse in their behavior. 

But again, we have a two-part plan. First is to monitor these different asset markets. The second is to try to understand what 

would be the implications if we are wrong. What would happen? 

Who would be hurt? What would happen to financial institutions? 

Would there be broad knock-on effects if, in fact, some particular 

asset turned out to be in a bubble? So we are trying to do both of 

those things and we do not rule out that if these problems become 

sufficiently worrisome, that they would be taken into account in 

our monetary policy. 

Senator HELLER. Mr. Chairman, thank you. 

Mr. Chairman, thank you. 

Chairman JOHNSON. Senator Warren. 

Senator WARREN. Thank you, Mr. Chairman, and I also want to 

say thank you, Mr. Chairman. This has been my first chance to say 

30 

in public how grateful I am for your help in setting up the consumer agency and how helpful all the people were at the Fed during the time of transition of the consumer function, so thank you 

very much. 

I would like to go to the question about too big to fail, that we 

have not gotten rid of it yet, and so now we have a double problem 

and that is that the big banks, big at the time that they were 

bailed out the first time, have gotten bigger, and at the same time 

that investors believe with too big to fail out there that it is safer 

to put your money into the big banks and not the little banks, in 

effect creating an insurance policy for the big banks, that the Government is creating this insurance policy not there for the small 

banks. 

And now some economists, including an economist at the IMF, 

have started to document exactly how much that subsidy is worth. 

Last week, Bloomberg did the math on it and came up with the 

number $83 billion that the big banks get in what is essentially a 

free insurance policy. They borrow cheaper than the small banks 

do. 

So I understand that we are all trying to get to the end of too 

big to fail, but my question, Mr. Chairman, is, until we do, should 

those biggest financial institutions be repaying the American taxpayer that $83 billion subsidy that they are getting? 

Mr. BERNANKE. Well, the subsidy is coming because of market 

expectations that the Government would bail out these firms if 

they failed. Those expectations are incorrect. We have an orderly 

liquidation authority. And even in the crisis, in the cases of AIG, 

for example, we wiped out the shareholders—— 

Senator WARREN. Excuse me, Mr. Chairman. You did not wipe 

out the shareholders of the largest financial institutions, did you, 

the big banks? 

Mr. BERNANKE. Because we did not have the tools. Now, we 

could. 

Senator WARREN. Well, but the—— 

Mr. BERNANKE. Now we have the tools. 

Senator WARNER. Eighty-three billion dollars says that whatever 

you are saying, Mr. Chairman, $83 billion says that there really 

will be a bailout for the largest financial institutions if they fail. 

Mr. BERNANKE. No, that is the expectation of markets, but that 

does not mean that we have to do it. I think what we have to do 

is solve the problem, Senator. I think we are really in agreement 

on this. Too big to fail is not absolute. There are spreads. The credit default swaps say there is some probability of failure. Moody’s 

and others have downgraded these firms. They have taken down 

some of their Government support ratings, as you know. But we 

have a lot more to do, I agree, and I think that is a good debate 

to have, but we are in complete agreement that we need to stop 

too big to fail. 

Senator WARREN. But I do not understand. It is working like an 

insurance policy. Ordinary folks pay for homeowners’ insurance. 

Ordinary folks pay for car insurance. And these big financial institutions are getting cheaper borrowing to the tune of $83 billion in 

a single year simply because people believe that the Government 

31 

would step in and bail them out. And I am just saying, if they are 

getting it, why should they not pay for it? 

Mr. BERNANKE. I think we should get rid of it. 

Senator WARREN. Well, all right, then I will ask the other question. You were here in July and you said that you were—you commended Dodd-Frank for providing a blueprint to get rid of too big 

to fail. We have now understood this problem for nearly 5 years. 

So when are we going to get rid of too big to fail? 

Mr. BERNANKE. Well, as we have been discussing, some of these 

rules take time to develop. The orderly liquidation authority, I 

think we made a lot of progress on that. We have got the living 

wills. I think we are moving in the right direction. If additional 

steps are needed, then Congress obviously can discuss those. But 

we do have a plan and I think it is moving in the right direction. 

Senator WARREN. Any idea about when we are going to arrive in 

the right direction? 

Mr. BERNANKE. It is not a zero, one kind of thing. It is over time 

you will see increasing market expectations that these institutions 

can fail. And I would make another prediction, and predictions are 

always dangerous, that the benefits of being large are going to decline over time, which means that some banks are going to voluntarily begin to reduce their size because they are not getting the 

benefit that they used to get. 

Senator WARREN. I read you on this. I read your predictions on 

this in your earlier testimony. But so far, it looks like they are getting $83 billion for staying big. 

Mr. BERNANKE. Well, that is one study, Senator. You do not 

know whether that is an accurate number or—— 

Senator WARREN. Well, OK. We will go back and look at it again 

if you think there is a problem with it. But does it worry you? 

Mr. BERNANKE. Of course. I think this is very important, and we 

are putting a lot of effort into this. It is a problem that we have 

had for a very long time and I do not think we can solve it immediately, but I assure that, as somebody who has spent a lot of late 

nights trying to deal with these problems and the crisis, I would 

very much like to have the confidence that we could close down a 

large institution without causing damage to the rest of the economy. 

Senator WARREN. Fair enough. I know we are both trying to go 

in the same direction. I am just pointing out that in all that space 

in between, what is happening is the big banks are getting a terrific break and the little banks are just getting smashed on this. 

They are not getting that kind of break, and that has long-term impact for all of the financial system. 

Mr. BERNANKE. I agree with you 100 percent. 

Senator WARREN. Thank you. 

Chairman JOHNSON. Senator Vitter. 

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

Chairman, for being here. 

My top concern is actually exactly the same as Ms. Warren’s, and 

I think that is a statement in and of itself that there is growing 

bipartisan concern across the whole political spectrum about the 

fact—I believe it is a fact—that too big to fail is alive and well. 

32 

First of all, in terms of the study, Ms. Warren cited the 

Bloomberg calculations, but that is clearly not the only thing out 

there. There is an FDIC study released in September that concludes that, quote, ‘‘The largest banks do, in fact, pay less for comparable deposits. Furthermore, we show that some of the difference 

in the cost of funding cannot be attributed to either differences in 

balance sheet risk or any non- risk-related factors. The remaining 

unexplained risk premium gap is on the order of 45 basis points. 

Such a gap is consistent with an economically significant too big to 

fail subsidy paid to the largest banks,’’ close quote. 

In addition, an IMF working paper has attempted to quantify 

this subsidy and it said the subsidy, quote, ‘‘was already sizable, 

60 basis points, as of the end of 2007, before the crisis. It increased 

to 80 basis points by the end of 2009,’’ close quote. 

Then we have the Bloomberg quantification which was working 

off that IMF work that was mentioned, and also a Board member, 

Daniel Tarullo, who says, quote, ‘‘To the extent that a growing systemic footprint increases perceptions of at least some residual too 

big to fail quality in such a firm, notwithstanding the panoply of 

measures in Dodd-Frank and our regulations, there may be funding advantages for the firm which reinforces the impulse to grow,’’ 

close quote. 

So my first point is it is not just one outlier study. Given all of 

that, what specifically is in process in terms of regulations or 

should be put in process to counteract that, because my concern is 

even if this problem is solved 2 years from now, the entire landscape of American banking will be different by then, including a lot 

of solid smaller firms gone, and I think that is a real loss to our 

financial system. 

Mr. BERNANKE. There is a three-part plan under Dodd-Frank. 

Part number one is to impose costs on large institutions that offset 

the benefits they get in the funding markets, for example, capital 

surcharges, activity restrictions, liquidity requirements, living 

wills, a whole bunch of other things that impose greater cost and 

force the largest firms to take into account their systemic footprint. 

That is number one. 

Number two is the orderly liquidation authority, which we are 

working closely with the FDIC and with our foreign counterparts 

to figure out how we would take down a large institution without 

bringing down the system. 

And part three is a whole raft of measures to try to strengthen 

the overall financial system so that it would be more credible that 

we could take down a large institution without bringing down the 

system. 

That is sort of the three-part plan. It is working to some extent. 

For example, even though U.S. banks are stronger financially than 

European banks. Frequently, U.S. banks have wider credit default 

swap spreads, indicating a higher probability of actual failure, because the differences between U.S. and Europe in terms of Government—perceived Government support. So that is the process. That 

is the plan. 

There have been additional ideas, such as, essentially reinstating 

Glass-Steagall, separating the commercial banking and investment 

banking activities. We are doing that to some extent, for example, 

33 

with the Volcker Rule, but I do not think that Glass-Steagall by 

itself really would be all that helpful because, after all, in the crisis, some of the firms that failed were straight investment banks 

and some of the firms that were in trouble were straight commercial banks. 

So I am open to discussing additional measures, but the plan is 

to impose costs on the largest banks to make them internalize their 

systemic imprint, to develop a liquidation authority, and to 

strengthen the overall system. And over time, that ought to improve the situation, but if it does not, I think we ought to consider 

alternative and additional steps. 

Senator VITTER. Well, in closing, I would really continue to encourage you all doing that now. And again, I think this is a bipartisan concern. I have expressed this concern and several ideas, for 

instance, with Senator Brown on the Committee. 

The three components you described are understood by the market. In my opinion, they have been digested and valued by the market and the market still says there is too big to fail. In particular, 

I would continue to urge you to revisit higher capital requirements 

beyond the marginally higher requirements that you have instituted so far for megabanks and I would continue to urge you all 

to think of alternatives to Basel III, as well, in the same spirit. 

Thank you. 

Mr. BERNANKE. Thank you, Senator. 

Chairman JOHNSON. Senator Manchin. 

Senator MANCHIN. Mr. Chairman, thank you. 

Chairman Bernanke, thank you for being here. 

First of all, when I first came to the Senate 21⁄2 years ago, I was 

in the Armed Services Committee and Admiral Mullins at that 

time was asked, what is the greatest threat the United States 

faces, and I thought I would hear some military challenge. And he 

did not even hesitate by saying that the debt of this Nation is our 

greatest threat, and I did not know if you shared that same 

thought. 

Mr. BERNANKE. It is certainly an important economic risk and I 

think it is very important that, over the longer term, that we develop a sustainable fiscal plan, no question about it. 

Senator MANCHIN. I mean, his assessment was it was the greatest threat we faced. 

Mr. BERNANKE. I do not know. There are many possible candidates for that. 

Senator MANCHIN. Also, I know they talked a lot about sequestering today, and we were talking back and forth the consequences 

if we do and if we do not. The bottom line, sequestering came into 

being because in 2011, the summer of 2011, we thought we put a 

supercommittee together that had a goal of $1.5 trillion. If they did 

not reach that goal, they had a minimum penalty of $1.2 trillion 

across the board in defense and nondefense. We voted on that as 

a body. Now, we are looking for every way to get out of that, saying 

it was too draconian. We should never have done it. 

But we did it. And what we were saying is if we do not do it at 

all and negate that responsibility and promise of a vote that we 

made for the public, what effect would that have on the market? 

I know I have heard everything about the effects that it would 

34 

have if we do it. What effects would it have on the market if we 

do not do it? 

Mr. BERNANKE. Well, my recommendation, and, of course, I can 

only recommend to you—— 

Senator MANCHIN. Sure. I agree. 

Mr. BERNANKE. ——it is obviously Congress’s decision how to 

proceed—is a two-part recommendation. Look at both the short run 

and the long run. I think it is true that just canceling the sequester 

would not solve the overall problem—— 

Senator MANCHIN. No—— 

Mr. BERNANKE. ——which is the long-term fiscal issue. So if you 

cut the sequester or delay it, however you modify it—— 

Senator MANCHIN. Right. 

Mr. BERNANKE. ——you ought to compensate for that with, in my 

recommendation, by looking at measures that address the longerterm fiscal concerns, which is what the CBO shows to be the point 

where the debt really begins to explode. And that is the trade-off 

I would suggest. 

Senator MANCHIN. It would be irresponsible for us not to do 

something. We have two alternatives, two paths to take here. Either fix the financial problems in a longer-term, bigger fix, or do 

something with sequestering that we punished ourself basically because we have been unable as a body to come together. So I think 

that was also said. If we are going to do a sequestering, should it 

not be done in a more or smarter way to where there is more flexibility? 

Mr. BERNANKE. Well, as you point out, it was done to be sort of 

like Dr. Strangelove—— 

Senator MANCHIN. Right. Right. 

Mr. BERNANKE. ——you know, the bomb that goes off. So obviously, if you can find a way to, in a bipartisan way, to make it 

more effective and better prioritized, that would be a good thing. 

Senator MANCHIN. OK. 

Mr. BERNANKE. And people disagree on the second point, but 

again, what I suggested today is trying to make some tradeoff between the effects on the near-term recovery and aligning the policy 

with the timing. The timing says that you have made progress in 

the very near term as far as the budget is concerned. Where the 

problem still remains unaddressed is in the longer term. And so it 

does not quite match to be doing tough policies today when the real 

problem is a somewhat longer-term problem. 

Senator MANCHIN. Sure. 

Mr. BERNANKE. That is what I am trying to suggest. 

Senator MANCHIN. Well, I am just saying that there are a lot of 

us concerned about we keep kicking the can down the road, but 

that is a whole another conversation. 

My final question would be, sir, how big is our national debt? 

Mr. BERNANKE. Well, there are a lot of different measures of it. 

The—— 

Senator MANCHIN. What would be your explanation of it? 

Mr. BERNANKE. Well, the basic measure, which is the debt held 

by the public, which includes the debt held by the Fed, it is about 

$11 trillion—— 

Senator MANCHIN. Right. 

35 

Mr. BERNANKE. ——about 75 or 73 percent of GDP. 

Senator MANCHIN. Correct. 

Mr. BERNANKE. That does not include, though, for example, socalled unfunded liabilities, such as the promises that have been 

made to future Medicare recipients, for example—— 

Senator MANCHIN. Well, the average person would understand 

that they have a responsibility and their ability to pay back in good 

faith. So how much of what is our total national debt that is responsible by the good faith of this country and the people in this 

country? 

Mr. BERNANKE. It is currently about $11 trillion. 

Senator MANCHIN. OK, but if you had everything when you—our 

gross Federal debt? 

Mr. BERNANKE. Gross Federal debt includes debt owed by parts 

of the Government to other parts of the Government, like the Social Security Trust Fund, for example—— 

Senator MANCHIN. Responsibilities of Fannie and Freddie? 

Mr. BERNANKE. So that is another element. That is guarantees. 

That is not direct debt. That is a potential liability. So it is complicated. 

Senator MANCHIN. Yes. 

Mr. BERNANKE. As I said at the beginning, it is hard to—— 

Senator MANCHIN. If you looked at all of the—— 

Mr. BERNANKE. ——get a single number. 

Senator MANCHIN. ——the worst case scenario, the faith and full 

credit of this country, what would you say it would be? 

Mr. BERNANKE. Well, I saw the article I think you are referring 

to and it included the possibility that—— 

Senator MANCHIN. Is it accurate? 

Mr. BERNANKE. It included the possibility that the Government 

would have to pay off every deposit in the United States through 

the FDIC—— 

Senator MANCHIN. Yes. 

Mr. BERNANKE. ——which is not a realistic possibility. There are 

some alternative measures which are certainly bigger than $11 trillion—— 

Senator MANCHIN. I think they were saying—— 

Mr. BERNANKE. ——but I do not have those numbers—— 

Senator MANCHIN. They said as much as $30 trillion it could be, 

total exposure. 

Mr. BERNANKE. If you include all of the Medicare and—— 

Senator MANCHIN. But it is definitely higher than $16 trillion. 

Mr. BERNANKE. Yes, I would say that is fair. 

Senator MANCHIN. Thank you. 

Chairman JOHNSON. There is a vote pending, but does the Senator from Tennessee care to make a brief—— 

Senator CORKER. Just one very quick question, and I was interested—I went back to the office and did not expect to come back, 

but listening to the exchange with Senator Warren and Senator 

Vitter, it reminded me of—the questioning was Tarullo, who was 

in last, who you served with on the Fed Board, and just—he had 

mentioned—I asked him about systemic risk, and I know that the 

Fed is obviously a member of the FSOC and your goal is to identify 

systemic risk and deal with that. And that was much like the anVerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON
36 

swer that you gave to Senator Warren a minute ago. It is kind of, 

we are on this journey. 

But I would ask the question. Is there any entity in our country 

that if it failed would create systemic risk, and if so, why is that 

still the case after the creation of Dodd-Frank? I mean, why have 

we not moved more quickly? Why are we taking so long on this 

journey? And is there an institution that if it failed would pose systemic risk to our country? And if so, would you identify it? 

Mr. BERNANKE. The only answer I can give you is that DoddFrank is a complicated bill. Many of the rules are not—— 

Senator CORKER. But that piece of it is not very complicated. It 

is only about eight words, and so that is not complicated. It is a 

directive to you, and you are a big part of this and you came out 

a big winner in Dodd-Frank. And I guess I would just ask the question, why would you not go ahead and identify that, and if there 

is an entity that is in our Nation, if it failed, something that poses 

systemic risk, you would know that. Why do we not go ahead and 

move to deal with that? 

Mr. BERNANKE. Well, the FSOC actually has the authority to 

designate nonbank firms that it views as systemic and they come 

under the oversight of the Fed. 

Senator CORKER. Well, let me ask you, if we have firms, though, 

are we going to—is it your thought that under this power that you 

have been given, is it your thought that we could continue to have 

firms operating in our country that if they failed, they would pose 

systemic risk, or are we going to try to mitigate that in some other 

way? I would just be curious. 

Mr. BERNANKE. The goal of the powers that you gave to the Fed 

and other agencies is to, as much as possible, eliminate that problem over time. Additional steps, I think, would require Congressional action beyond what we have implemented. 

Senator CORKER. I do not think so. I am going to follow up with 

a letter. I thank you for your testimony—— 

Mr. BERNANKE. Sure. 

Senator CORKER. And I do not think that is the case. 

Chairman JOHNSON. Thank you again, Chairman Bernanke, for 

your testimony and for being here with us today. 

This hearing is adjourned. 

[Whereupon, at 12:10 p.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 

37 

1Data for the fourth quarter of 2012 from the national income and product accounts reflect 

the advance estimate released on January 30, 2013. 

PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON 

The Committee will come to order. 

Today’s hearing is with Chairman Bernanke on the Federal Reserve’s Monetary 

Policy Report to Congress. While progress toward maximum employment has been 

slow, it has been positive and steady thanks in part to the Fed’s thoughtful and 

well-measured monetary actions. Our economy has added private sector jobs for 35 

straight months. During that time, over 6 million new jobs have been created, but 

we should not sacrifice those gains by slamming on the brakes now. 

Without a fix, automatic spending cuts will take effect in just a few days, and 

could send our economy into reverse at a time we should continue moving forward 

on creating jobs. Projections suggest the sequester will cost us 750,000 jobs this 

year. In addition to layoffs for cops, fire fighters, and teachers that could devastate 

our communities, these cuts will impact many of our Nation’s most vulnerable citizens including children, seniors, and the disabled. At a time when the U.S. faces 

an array of national security threats, the sequester will affect our military readiness. It is unacceptable that we are lurching from one manufactured crisis to the next, 

and Americans have had enough. These fights are bad for the economy and are 

making it harder for families to make ends meet. 

The steep drops in consumer confidence during the fights over the debt limit and 

the fiscal cliff rival the fallout after Lehman Brothers’ failure and 9/11. This has 

consequences. If consumers do not spend, businesses will not prosper and hire more 

workers. If businesses are not hiring, our economy will not grow. It is that simple. 

We must do all we can to restore confidence in not only our financial system, but 

also in our ability as a country to tackle long-term challenges in a responsible, bipartisan manner. In addition to Congress acting on a deficit reduction plan that is 

balanced and promotes job creation, there are things this Committee can do to help 

achieve these goals. From rigorous oversight, to confirming well-qualified nominees, 

to reauthorizing expiring laws, to reaching consensus on the future of housing finance, there are steps this Committee can take to promote consumer confidence, 

provide businesses clarity to move forward with long-term plans, and strengthen our 

economic recovery. 

Chairman Bernanke, I look forward to hearing your views as both the Fed and 

the Congress pursue policies supporting our Nation’s economic recovery. 

PREPARED STATEMENT OF BEN S. BERNANKE 

CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

FEBRUARY 26, 2013 

Chairman Johnson, Ranking Member Crapo, and other Members of the Committee, I am pleased to present the Federal Reserve’s Semiannual Monetary Policy 

Report. I will begin with a short summary of current economic conditions and then 

discuss aspects of monetary and fiscal policy. 

Current Economic Conditions 

Since I last reported to this Committee in mid-2012, economic activity in the 

United States has continued to expand at a moderate if somewhat uneven pace. In 

particular, real gross domestic product (GDP) is estimated to have risen at an annual rate of about 3 percent in the third quarter but to have been essentially flat 

in the fourth quarter. 1 The pause in real GDP growth last quarter does not appear 

to reflect a stalling-out of the recovery. Rather, economic activity was temporarily 

restrained by weather-related disruptions and by transitory declines in a few volatile categories of spending, even as demand by U.S. households and businesses continued to expand. Available information suggests that economic growth has picked 

up again this year. 

Consistent with the moderate pace of economic growth, conditions in the labor 

market have been improving gradually. Since July, nonfarm payroll employment 

has increased by 175,000 jobs per month on average, and the unemployment rate 

declined 0.3 percentage point to 7.9 percent over the same period. Cumulatively, private-sector payrolls have now grown by about 6.1 million jobs since their low point 

in early 2010, and the unemployment rate has fallen a bit more than 2 percentage 

points since its cyclical peak in late 2009. Despite these gains, however, the job market remains generally weak, with the unemployment rate well above its longer-run 

38 

2See, Board of Governors of the Federal Reserve System (2012), ‘‘Federal Reserve Issues 

FOMC Statement’’, press release, December 12, www.federalreserve.gov/newsevents/press/monetary/20121212a.htm. 3The numerical values for unemployment and inflation included in the guidance are thresholds, not triggers; that is, depending on economic circumstances at the time, the Committee may 

judge that it is not appropriate to begin raising its target for the Federal funds rate as soon 

as one or both of the thresholds is reached. The 61⁄2 percent threshold for the unemployment 

rate should not be interpreted as the Committee’s longer-term objective for unemployment; because monetary policy affects the economy with a lag, the first increase in the target for the 

funds rate will likely have to occur when the unemployment rate is still above its longer-run 

normal level. Likewise, the Committee has not altered its longer-run goal for inflation of 2 percent, and it neither seeks nor expects a persistent increase in inflation above that target. 

normal level. About 4.7 million of the unemployed have been without a job for 6 

months or more, and millions more would like full-time employment but are able 

to find only part-time work. High unemployment has substantial costs, including not 

only the hardship faced by the unemployed and their families, but also the harm 

done to the vitality and productive potential of our economy as a whole. Lengthy 

periods of unemployment and underemployment can erode workers’ skills and attachment to the labor force or prevent young people from gaining skills and experience in the first place—developments that could significantly reduce their productivity and earnings in the longer term. The loss of output and earnings associated 

with high unemployment also reduces Government revenues and increases spending, thereby leading to larger deficits and higher levels of debt. 

The recent increase in gasoline prices, which reflects both higher crude oil prices 

and wider refining margins, is hitting family budgets. However, overall inflation remains low. Over the second half of 2012, the price index for personal consumption 

expenditures rose at an annual rate of 11⁄2 percent, similar to the rate of increase 

in the first half of the year. Measures of longer-term inflation expectations have remained in the narrow ranges seen over the past several years. Against this backdrop, the Federal Open Market Committee (FOMC) anticipates that inflation over 

the medium term likely will run at or below its 2 percent objective. 

Monetary Policy 

With unemployment well above normal levels and inflation subdued, progress toward the Federal Reserve’s mandated objectives of maximum employment and price 

stability has required a highly accommodative monetary policy. Under normal circumstances, policy accommodation would be provided through reductions in the 

FOMC’s target for the Federal funds rate—the interest rate on overnight loans between banks. However, as this rate has been close to zero since December 2008, the 

Federal Reserve has had to use alternative policy tools. 

These alternative tools have fallen into two categories. The first is ‘‘forward guidance’’ regarding the FOMC’s anticipated path for the Federal funds rate. Since 

longer-term interest rates reflect market expectations for shorter-term rates over 

time, our guidance influences longer-term rates and thus supports a stronger recovery. The formulation of this guidance has evolved over time. Between August 2011 

and December 2012, the Committee used calendar dates to indicate how long it expected economic conditions to warrant exceptionally low levels for the Federal funds 

rate. At its December 2012 meeting, the FOMC agreed to shift to providing more 

explicit guidance on how it expects the policy rate to respond to economic developments. Specifically, the December postmeeting statement indicated that the current 

exceptionally low range for the Federal funds rate ‘‘will be appropriate at least as 

long as the unemployment rate remains above 61⁄2 percent, inflation between 1 and 

2 years ahead is projected to be no more than a half percentage point above the 

Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.’’ 2 An advantage of the new formulation, relative to the 

previous date-based guidance, is that it allows market participants and the public 

to update their monetary policy expectations more accurately in response to new information about the economic outlook. The new guidance also serves to underscore 

the Committee’s intention to maintain accommodation as long as needed to promote 

a stronger economic recovery with stable prices. 3

The second type of nontraditional policy tool employed by the FOMC is large-scale 

purchases of longer-term securities, which, like our forward guidance, are intended 

to support economic growth by putting downward pressure on longer-term interest 

rates. The Federal Reserve has engaged in several rounds of such purchases since 

late 2008. Last September the FOMC announced that it would purchase agency 

mortgage-backed securities at a pace of $40 billion per month, and in December the 

Committee stated that, in addition, beginning in January it would purchase longerVerDate Nov 24 2008 14:21 Aug 30, 2013 Jkt 048080 PO 00000 Frm 00042 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\02-26 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON
39 

4See, Board of Governors of the Federal Reserve System (2012), ‘‘Federal Reserve Issues 

FOMC Statement’’, press release, September 13, www.federalreserve.gov/newsevents/press/monetary/20120913a.htm; and Board of Governors, ‘‘FOMC Statement’’, December 12, in n. 2. 5The Federal Reserve is also monitoring financial markets to ensure that asset purchases do 

not impair their functioning. 6See, Board of Governors of the Federal Reserve System (2013), ‘‘Reserve Bank Income and 

Expense Data and Transfers to the Treasury for 2012’’, press release, January 10, 

www.federalreserve.gov/newsevents/press/other/20130110a.htm. 

term Treasury securities at an initial pace of $45 billion per month. 4 These additional purchases of longer-term Treasury securities replace the purchases we were 

conducting under our now-completed maturity extension program, which lengthened 

the maturity of our securities portfolio without increasing its size. The FOMC has 

indicated that it will continue purchases until it observes a substantial improvement in the outlook for the labor market in a context of price stability. 

The Committee also stated that in determining the size, pace, and composition of 

its asset purchases, it will take appropriate account of their likely efficacy and costs. 

In other words, as with all of its policy decisions, the Committee continues to assess 

its program of asset purchases within a cost-benefit framework. In the current economic environment, the benefits of asset purchases, and of policy accommodation 

more generally, are clear: Monetary policy is providing important support to the recovery while keeping inflation close to the FOMC’s 2 percent objective. Notably, 

keeping longer-term interest rates low has helped spark recovery in the housing 

market and led to increased sales and production of automobiles and other durable 

goods. By raising employment and household wealth—for example, through higher 

home prices—these developments have in turn supported consumer sentiment and 

spending. 

Highly accommodative monetary policy also has several potential costs and risks, 

which the Committee is monitoring closely. For example, if further expansion of the 

Federal Reserve’s balance sheet were to undermine public confidence in our ability 

to exit smoothly from our accommodative policies at the appropriate time, inflation 

expectations could rise, putting the FOMC’s price-stability objective at risk. However, the Committee remains confident that it has the tools necessary to tighten 

monetary policy when the time comes to do so. As I noted, inflation is currently subdued, and inflation expectations appear well anchored; neither the FOMC nor private forecasters are projecting the development of significant inflation pressures. 

Another potential cost that the Committee takes very seriously is the possibility 

that very low interest rates, if maintained for a considerable time, could impair financial stability. For example, portfolio managers dissatisfied with low returns may 

‘‘reach for yield’’ by taking on more credit risk, duration risk, or leverage. On the 

other hand, some risk-taking—such as when an entrepreneur takes out a loan to 

start a new business or an existing firm expands capacity—is a necessary element 

of a healthy economic recovery. Moreover, although accommodative monetary policies may increase certain types of risk-taking, in the present circumstances they 

also serve in some ways to reduce risk in the system, most importantly by strengthening the overall economy, but also by encouraging firms to rely more on longerterm funding, and by reducing debt service costs for households and businesses. In 

any case, the Federal Reserve is responding actively to financial stability concerns 

through substantially expanded monitoring of emerging risks in the financial system, an approach to the supervision of financial firms that takes a more systemic 

perspective, and the ongoing implementation of reforms to make the financial system more transparent and resilient. Although a long period of low rates could encourage excessive risk-taking, and continued close attention to such developments 

is certainly warranted, to this point we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more-rapid job creation. 5

Another aspect of the Federal Reserve’s policies that has been discussed is their 

implications for the Federal budget. The Federal Reserve earns substantial interest 

on the assets it holds in its portfolio, and, other than the amount needed to fund 

our cost of operations, all net income is remitted to the Treasury. With the expansion of the Federal Reserve’s balance sheet, yearly remittances have roughly tripled 

in recent years, with payments to the Treasury totaling approximately $290 billion 

between 2009 and 2012. 6 However, if the economy continues to strengthen, as we 

anticipate, and policy accommodation is accordingly reduced, these remittances 

would likely decline in coming years. Federal Reserve analysis shows that remittances to the Treasury could be quite low for a time in some scenarios, particularly 

40 

7See, Carpenter, Seth B., Jane E. Ihrig, Elizabeth C. Klee, Daniel W. Quinn, and Alexander 

H. Boote (2013), ‘‘The Federal Reserve’s Balance Sheet and Earnings: A Primer and Projections’’, 

Finance and Economics Discussion Series 2013-01 (Washington: Federal Reserve Board, January), available at http://www.federalreserve.gov/pubs/feds/2013/201301/201301pap.pdf. 8See, Congressional Budget Office (2013), ‘‘The Budget and Economic Outlook: Fiscal Years 

2013 to 2023’’ (Washington: CBO, February), available at www.cbo.gov/publication/43907. 

if interest rates were to rise quickly. 7 However, even in such scenarios, it is highly 

likely that average annual remittances over the period affected by the Federal Reserve’s purchases will remain higher than the precrisis norm, perhaps substantially 

so. Moreover, to the extent that monetary policy promotes growth and job creation, 

the resulting reduction in the Federal deficit would dwarf any variation in the Federal Reserve’s remittances to the Treasury. 

Thoughts on Fiscal Policy 

Although monetary policy is working to promote a more robust recovery, it cannot 

carry the entire burden of ensuring a speedier return to economic health. The economy’s performance both over the near term and in the longer run will depend importantly on the course of fiscal policy. The challenge for the Congress and the Administration is to put the Federal budget on a sustainable long-run path that promotes 

economic growth and stability without unnecessarily impeding the current recovery. 

Significant progress has been made recently toward reducing the Federal budget 

deficit over the next few years. The projections released earlier this month by the 

Congressional Budget Office (CBO) indicate that, under current law, the Federal 

deficit will narrow from 7 percent of GDP last year to 21⁄2 percent in fiscal year 

2015. 8 As a result, the Federal debt held by the public (including that held by the 

Federal Reserve) is projected to remain roughly 75 percent of GDP through much 

of the current decade. 

However, a substantial portion of the recent progress in lowering the deficit has 

been concentrated in near-term budget changes, which, taken together, could create 

a significant headwind for the economic recovery. The CBO estimates that deficitreduction policies in current law will slow the pace of real GDP growth by about 

11⁄2 percentage points this year, relative to what it would have been otherwise. A 

significant portion of this effect is related to the automatic spending sequestration 

that is scheduled to begin on March 1, which, according to the CBO’s estimates, will 

contribute about 0.6 percentage point to the fiscal drag on economic growth this 

year. Given the still-moderate underlying pace of economic growth, this additional 

near-term burden on the recovery is significant. Moreover, besides having adverse 

effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run for any given set of fiscal actions. 

At the same time, and despite progress in reducing near-term budget deficits, the 

difficult process of addressing longer-term fiscal imbalances has only begun. Indeed, 

the CBO projects that the Federal deficit and debt as a percentage of GDP will 

begin rising again in the latter part of this decade, reflecting in large part the aging 

of the population and fast-rising health care costs. To promote economic growth in 

the longer term, and to preserve economic and financial stability, fiscal policy makers will have to put the Federal budget on a sustainable long-run path that first 

stabilizes the ratio of Federal debt to GDP and, given the current elevated level of 

debt, eventually places that ratio on a downward trajectory. Between 1960 and the 

onset of the financial crisis, Federal debt averaged less than 40 percent of GDP. 

This relatively low level of debt provided the Nation much-needed flexibility to meet 

the economic challenges of the past few years. Replenishing this fiscal capacity will 

give future Congresses and Administrations greater scope to deal with unforeseen 

events. 

To address both the near- and longer-term issues, the Congress and the Administration should consider replacing the sharp, frontloaded spending cuts required by 

the sequestration with policies that reduce the Federal deficit more gradually in the 

near term but more substantially in the longer run. Such an approach could lessen 

the near-term fiscal headwinds facing the recovery while more effectively addressing 

the longer-term imbalances in the Federal budget. 

The sizes of deficits and debt matter, of course, but not all tax and spending programs are created equal with respect to their effects on the economy. To the greatest extent possible, in their efforts to achieve sound public finances, fiscal policy 

makers should not lose sight of the need for Federal tax and spending policies that 

increase incentives to work and save, encourage investments in workforce skills, advance private capital formation, promote research and development, and provide 

necessary and productive public infrastructure. Although economic growth alone 

cannot eliminate Federal budget imbalances, in either the short or longer term, a 

more rapidly expanding economic pie will ease the difficult choices we face. 

41 

1Kirilenko, Andrei A., Kyle, Albert S., Samadi, Mehrdad, and Tuzun, Tugkan, ‘‘The Flash 

Crash’’, The Impact of High Frequency Trading on an Electronic Market (May 26, 2011). Available at SSNR: http://ssrn.com/abstract=1686004 or http://dx.doi.org/10.2139/ssrn.1686004. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN 

FROM BEN S. BERNANKE 

Q.1. The United Kingdom has had a Financial Transactions Tax 

(FTT), in the form of stamp duty on stock purchases, for more than 

300 years. It does not seem to have hindered London’s financial development. And now 11 European countries are about to impose a 

new FTT of 10 basis points on trading. They say it will discourage 

certain kinds of quick in-and-out transactions that benefit traders 

but not investors—and pull in about $41B in revenue. Today, there 

is widespread belief in this country that a lot of trading activity is 

unproductive, and we also have a serious deficit problem. My colleague Senator Tom Harkin has a bill for a FTT that would be 3 

basis points and that the Joint Tax Committee has scored at $350 

billion in revenue. 

Do you think that this tax would succeed at raising revenue 

while making our stock markets less about flash trading and more 

about real value investing? 

A.1. Existing studies present mixed evidence on the net effect of 

FTTs on revenues. A 2011 European Commission working paper 

presents evidence that, despite a relatively low tax rate, the U.K. 

stamp duty has generated substantial revenue over the last decade. 

However, a different academic study found that when Sweden implemented an FTT in the 1980s, the country experienced a net loss 

in revenue as investors, in an effort to avoid the tax, moved trades 

offshore. 

While an FTT likely would discourage high frequency trading in 

financial markets that are subject to the tax, studies of the effect 

of FTTs on asset market price volatility show mixed results. One 

study by staff at the International Monetary Fund found that FTTs 

are associated with an increase in volatility, possibly resulting from 

lower trading volume and reduced liquidity caused by FTTs. Another study of the U.K. stamp tax found no significant effect of the 

tax on the volatility of U.K. equity prices, though intermediaries 

like broker-dealers are exempt from the U.K. stamp duty (but 

would not be under the European FTT). A study by Federal Reserve staff of the 2010 U.S. ‘‘flash crash,’’ a day in which U.S. equity markets exhibited extremely high volatility, found that although high frequency trading did not cause or prevent the ‘‘flash 

crash,’’ it did exacerbate volatility on that day. 1

Further considerations of the FTT may include its impact on 

market efficiency, security valuation, and the cost of capital for corporations. Some academic studies have suggested that if FTTs result in reduced trading volume and diminished market liquidity, 

then they may hamper the price discovery process in financial markets, so that asset prices are less able to quickly reflect changes in 

economic and financial market conditions. Other studies have 

found that the implementation of FTTs is associated with lower equity prices, and thus higher costs of capital for domestic firms, 

which may discourage investment. 

42 

Q.2. What do you think the impact will be on the markets of the 

FTT taking affect across Europe? 

A.2. The impact is very difficult to assess at this stage. The FTT 

proposal is still at a relatively early stage, with many important 

details yet to be determined, and the details matter to its impact. 

Moreover, as noted previously, existing evidence about the impact 

of FTTs is inconclusive. 

As with any tax, market participants will try to avoid it, and in 

the case of trading may try to do so by locating their trading activity elsewhere in the world. Their ability and willingness to do so 

is likely to depend greatly on the details of the tax and on the details of transaction taxes in other jurisdictions. At the margin, 

trading activity is likely to migrate to jurisdictions without such 

taxes, especially in the case of over-the-counter trading that does 

not require an exchange. 

Q.3. It has been exactly a century since Congress designed the Fed 

structure that is still to a large extent in place today, and a lot of 

people might be surprised to know that bankers get to select the 

Class A and Class B boards of directors of the regional Federal Reserve banks. That means, of course, that oftentimes they select 

themselves. So, for example, when the New York Federal Reserve 

Bank played a central role in the 2008 bank bailouts, it had big 

bank CEOs on its boards at that time. There are real advantages 

of Federal Reserve officials consulting with banks to understand 

what is going on, but, at the same time, a lot of people worry about 

the influence the biggest banks have on our Government. 

Do you think it still makes sense for bank executives to be able 

to select Class A and Class B directors at the regional Feds? 

A.3. Congress designed the structure of the Federal Reserve System to give it a broad perspective on the economy and on economic 

activity in all parts of the Nation and to provide the Reserve 

Banks, as the operational arms of the central bank, with banking 

experience on their boards of directors. The public–private structure of a Government agency composed of presidentially appointed 

and Senate-confirmed members that oversee 12 banks with stock 

ownership and some directors chosen by member banks also allowed Congress to fund the Federal Reserve System with capital 

paid-in by member banks rather than the taxpayer. Congress chose 

also to include a two-thirds majority of representatives of other 

parts of the economy, including representatives from agriculture, 

commerce, industry, services, labor, and consumers, including three 

nonbankers chosen by the Board of Governors. 

The Federal Reserve recognizes the potential conflicts of interest 

that could arise from the statutory requirement that the boards of 

directors of Reserve Banks be comprised of the presence of bankers 

and other private citizens. As a result, the Federal Reserve has 

long had policies in place that prevent members of the Reserve 

Bank boards of directors (from any class of directors) from participating in any lending decisions involving the discount window or 

an emergency credit facility, having access to confidential supervisory information, or participating in setting regulatory or supervisory policies. 

43 

The GAO, in its Report No. 12-18 regarding Federal Reserve 

Bank governance, confirmed that the Federal Reserve has policies 

in place that are effective in addressing these conflicts of interest. 

The GAO also noted in that report that, in choosing Class C directors, the Federal Reserve Board makes it a priority to encourage 

selection of directors that represent broad and diverse perspectives. 

Q.4. What would be the advantages and disadvantages of Congress 

taking action to make the regional Fed boards more independent 

of the bankers they regulate? 

A.4. As explained above, the Federal Reserve has taken important 

steps to ensure that the boards of directors of Reserve Banks are 

not involved in supervision or regulation of banking entities. Moreover, Congress in the Dodd-Frank Act reinforced these policies by 

eliminating the role of Class A directors in the selection of the Reserve Bank presidents. The GAO recognized that the Federal Reserve Board and Reserve Banks have been sensitive to avoid both 

potential and perceived conflicts of interest associated with a statutorily mandated governance structure that includes bankers on the 

boards of Reserve Banks. For example, the report confirmed that 

Reserve Bank directors are not involved in supervision and regulation activities, such as examinations and enforcement actions. The 

GAO also confirmed that Reserve Bank directors took no part in 

approving loans extended to banks through the discount window or 

other emergency liquidity facilities, and that institutions with representatives on Reserve Bank boards were not given special treatment at the discount window or at emergency liquidity facilities. 

The Federal Reserve Board believes that representation on Reserve Bank boards of directors by local bankers, as well as participants in other aspects of the real economy helps provide a broad 

perspective on the economy in various Reserve Bank districts. Reducing this avenue of information would weaken that insight without providing any significant advantage to Federal Reserve supervision or regulation of banks. 

Q.5. In the wake of Canning v. NLRB, some commentators have 

questioned whether CFPB Director Rich Cordray’s recess appointment in 2011 was a valid use of the President’s executive powers. 

While there is abundant evidence that Director Cordray’s appointment was valid and that assertions to the contrary are based on 

flawed legal reasoning, the ongoing assault on the President’s attempts to nominate a Director to the CFPB has nonetheless created 

additional anxiety in the marketplace. In particular, some commentators have argued that, if the Director’s recess appointment 

was invalid, then the CFPB’s recently issued mortgage rules are 

also invalid, and thus various Dodd-Frank default mortgage requirements in Title IV were instead operative as of January 21, 

2013. While I disagree strongly with that view, some have expressed concern that many financial institutions would be out of 

compliance with the law if the Dodd-Frank rules are in fact in effect. 

Can you reassure investors or others who are concerned about 

mortgage issuers’ potential legal exposure from noncompliance with 

the Dodd-Frank automatic rules that the risks are not sufficient to 

44 

pose a safety and soundness threat to individual banks or systemic 

threat to the economy? 

A.5. We expect banking organizations and other entities that are 

subject to oversight by the prudential regulators to assess the legal 

and other applicable risks in connection with their mortgage lending activities and to properly manage these risks, which includes 

using prudent underwriting standards. It is not clear how courts 

might eventually rule in determining whether the Dodd-Frank 

Act’s default effective date applies, or the potential liabilities that 

might stem from any court decision. 

Q.6. What do you believe is the cost to the ongoing uncertainty 

about CFPB’s future? 

A.6. The Federal Reserve has not conducted any qualitative or 

quantitative analysis regarding the cost of any uncertainty about 

the CFPB’s future and thus has no estimates as to any such cost. 

Q.7. Has the Federal Reserve conducted any analysis regarding the 

ongoing cost of uncertainty about CFPB’s future? If so, can you 

share it with the Committee? 

A.7. Please see response for [Question 6]. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORKER 

FROM BEN S. BERNANKE 

Q.1. Are there any individual financial institutions whose failure 

would pose a systemic risk to the United States? Are there currently any financial institutions so large or so complex that their 

failure would threaten the financial stability of the United States? 

If so, how do you plan to resolve this issue? 

A.1. The Dodd-Frank Act contemplates three types of financial institution whose failure could potentially pose a systemic risk to the 

United States. These include bank holding companies with greater 

than $50 billion in assets, nonbank financial companies designated 

by the Financial Stability Oversight Council (‘‘FSOC’’ or ‘‘Council’’), 

and financial market utilities (FMUs) designated by the Council. In 

accordance with the Dodd-Frank Act, the Federal Reserve has developed enhanced prudential standards under Section 165 and 166 

to reduce the risk posed by the first two of these categories of institutions, including regular stress tests, capital requirements, 

counterparty credit limits, and more. Bank holding companies with 

$50 billion or greater in assets have been identified and are subject 

to these standards. In addition, the Council has issued a final rule 

and interpretive guidance pursuant to which the Council is considering nonbank financial companies for designation. The Council 

also designated eight FMUs under its Dodd-Frank authority, and 

those firms are now subject to the enhanced standards issued by 

the relevant supervisory agencies, including the Federal Reserve. 

As a supervisory agency, the Federal Reserve has also instituted 

a merger screen that considers the financial stability implications 

of mergers or acquisitions proposed by its largest firms, and, as a 

member of the Basel Committee on Banking Supervision and the 

Financial Stability Board, has supported additional capital requirements for firms that are found to be systemically important internationally. While these measures have not eliminated the risk 

45 

posed by these firms, measures such as the capital requirements 

and surcharges on the largest financial institutions will help to 

equalize their cost of funding with other banks and make them 

safer so that the risk of their failure is more limited. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR JOHANNS 

FROM BEN S. BERNANKE 

Q.1. Mr. Chairman, as you know, numerous Senators have weighed 

in with the Board of Governors that, in enacting Dodd-Frank, Congress intended to utilize State-risk based capital rules governing 

capital for insurance-based SLHCs. As you have heard in your recent appearances before the House Financial Services and Senate 

Banking Committees, many of us remain deeply troubled by the 

Federal Reserve’s insistence in applying bank-centric standards to 

such companies. In particular, Senator Collins has written to you 

pointing out that ‘‘it was not Congress’ intent that Federal regulators supplant prudential State-based insurance regulation with a 

bank-centric capital regime.’’ In your recent appearance before the 

House Financial Services Committee, however, you indicated the 

Board of Governors was constrained by the Collins Amendment in 

addressing the insurance-banking distinction. 

Given that the statute does not preclude utilizing insurance capital standards to satisfy minimum capital requirements that are 

equivalent to Basel standards, and that congressional intent is now 

clear on permitting the use of such insurance standards, will the 

Board continue to insist that the Collins Amendment mandates the 

use of bank-centric standards for insurance-based SLHCs and 

grants the Board no flexibility or discretion in this area? If so, 

could you provide the legal rationale as to why the Board of Governors believes it has no such flexibility and discretion? 

A.1. Section 171 of the Dodd-Frank Act, by its terms, requires the 

appropriate Federal banking agencies to establish minimum capital 

requirements for bank holding companies (BHCs) and savings and 

loan holding companies (SLHCs) that ‘‘shall not be less than’’ ‘‘nor 

quantitatively lower than’’ the generally applicable capital requirements for insured depository institutions. Section 171 does not contain an exception from these requirements for an insurance company that is a BHC or an SLHC, or for a BHC or an SLHC that 

controls an insurance company. 

To allow the Board an additional opportunity to consider prudent 

approaches to establish capital requirements for SLHCs that engage substantially in insurance activities within the requirements 

of the terms of section 171, the Board, on July 2, 2013, determined 

to defer application of the new Basel III capital framework to 

SLHCs with significant insurance activities (i.e., those with more 

than 25 percent of their assets derived from insurance underwriting activities other than credit insurance) and to SLHCs that 

are themselves state regulated insurance companies. After considering the concerns raised by commenters regarding the proposed 

application of the proposed regulatory capital rules to SLHCs with 

significant insurance activities, the Board concluded that it would 

be appropriate to take additional time to evaluate the appropriate 

capital requirements for these companies in light of their business 

46 

models and risks. Among other issues, commenters argued that the 

final capital rules should take into account insurance company liabilities and asset-liability matching practices, the risks associated 

with separate accounts, the interaction of consolidated capital requirements with the capital requirements of State insurance regulators, and differences in accounting practices for banks and insurance companies. The Board is carefully considering these issues in 

determining how to move forward in developing a capital framework for these SLHCs, consistent with section 171 of the DoddFrank Act. 

47 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD


LETTER OF TRANSMITTAL 

BOARD OF GOVERNORS OF THE 

F EDERAL R ESERVE SYSTEM 

Washington, D.c., February 26, 2013 

THE PRESIDENT OF THE SENATE 

THE SPEAKER OF THE HOUSE OF REPRESENTATIVES 

The Board of Governors is pleased to submit its Monelary Policy Report pursuant to 

section 2B of the Federal Reserve Act. 

Sincerely, 

~f!:::-
48 


CONTENTS 

Summary ........... ................................................. ... . 

Part 1 

Recent Economic and Financial Developments . 5 

Domestic Developments. 5 

Financial Developments .................................................. 22 

International Developments ............................................... 29 

Part 2 

Monetary Policy ..... ........ . .. .. .. . . . . . . . . . .. .. .. .. .. ........... 37 

Part 3 

Summary of Economic Projections . . .... 43 

The Outlook for Economic Activity ......................................... 45 

The Outlook for Inflation. . ... 47 

Appropriate Monetary Policy .............................................. 52 

Uncertainty and Risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. .. .. .. ........... 53 

Abbreviations .............. ... .. .. .. . . .......... 59 

List of Boxes 

Statement on Longer-Run Goals and Monetary Policy Strategy ........ . 3 

8 

. .... JO 

. J2 

Assessing Conditions in the Labor Market . 

The Federa l Reserve's Acti ons to Foster Financial Stability ......... . 

An Update on the European Fiscal and Banking Crisis .. 

Efficacy and Costs of Large-Sca le Asset Purchases . . .. . . ...... .• 

Forecast U ncerta inty .. . .. . .................. . .. . ...... . •. 

. .. . . 39 

. .... 57 
49 


SUMMARY 

The u.s. economy continued to expand at a 

moderate rate, on average, over the second half 

of 2012. The housing recovery appeared 10 

gain additional traction, consumer spending 

rose moderately, and business investment 

advanced further. Financial conditions eased 

over the period but credit remained tight for 

many households and businesses, and concerns 

about the course of federal fiscal policy 

and the ongoing European situation likely 

restrained private-sector demand. In addition, 

total government purchases continued to 

move lower in an environment of budget 

restraint, while export growth was held back 

by slow foreign economic growth. All told, real 

gross domestic product (GDP) is estimated 

to have increased at an average annual rale 

of 1 Y2 percent in the second half of the year, 

similar to the pace in the first half. 

Conditions in the labor market gradually 

improved. Employment increased at an 

average monthly pace of 175,00J in the 

second half of the year, about the same as in 

the first half. The unemployment rate moved 

down from 8~ percent last summer to a 

linle below 8 percent in January. Even so, 

the unemployment rate .... -as still well above 

levels observed prior to the recent recession. 

Moreover, it remained the case that a large 

share of the unemployed had been out of 

work for more than six months, and that a 

significant ponion of the employed had pantime jobs because they were unable to find fulltime employment. Meanwhile, consumer price 

inflation remained subdued amid stable longterm inflation expectations and persistent slack 

in labor markets. Over the second half of the 

year, the price index for personal consumption 

expenditures increased at an annual rate of 

I \Ii percent. 

During the summer and fall, the Federal Open 

Market Comminee (FOMC) judged that the 

economic recovery would strengthen only 

gradually over time, as some of the factors 

restraining activity- including restrictive credit 

for some borrowers, continuing concerns about 

the domestic and international economic 

environments, and the ongoing shift to .... -ard 

tighter federal fiscal policy-were thought 

likely to recede only slowly. Moreover, the 

Commil1ee judged that the possibility of an 

escalation of the financial crisis in Europe and 

uncenainty about the course of fiscal policy in 

the United States posed significant downside 

risks to the outlook for economic activity. 

However, the Committee expected that, 

with appropriate monetary accommodation, 

economic growth would proceed at a moderate 

pace, with the unemployment rate gradually 

declining to .... -ard levels consistent with 

the FOMes dual mandate of maximum 

employment and price stability. Against 

this backdrop, and with long-run inflation 

expectations well anchored, the FOMC 

projected that inflation would remain at or 

below the rate consistent with the Committee's 

dual mandate. 

Accordingly, to promote its objectives, 

the FOMC provided additional monetary 

accommodation during the second half 

of 2012 by both Strengthening its for .... -ard 

guidance regarding the federal funds rate 

and initiating additional asset purchases. In 

September, the Comminee announced that 

it would continue its program to extend the 

average maturity of its Treasury holdings and 

would begin purchasing additional agencyguaranteed mortgage-backed securities (MBS) 

at a pace of $40 billion per month. The 

Commil1ee also stated its intention to continue 

its purchases of agency MBS, undertake 

additional asset purchases, and employ 

its other policy tools as appropriate until 

the outlook for the labor market improves 

substantially in a context of price stability. The 

Commil1ee agreed that in determining tbe size, 

pace, and composition of its asset purchases, 
50 


2 SUMW\RY 

it would, as always, take account of the likely 

efficacy and costs of such purchases. The 

Committee also modified its forward guidance 

regarding the federal funds rate at the 

September meeting, noting that exceptionally 

low levels for the federal funds rate were 

likely to be warranted at least through mid2015, longer than had been indicated in 

previous FOMC statements. Moreover, the 

Committee stated its expectation that a highly 

accommodative stance of monetary policy 

would remain appropriate for a considerable 

time aft er the economic recovery strengthens. 

In December, the Committee announced 

that in addition to continuing its purchases 

of agency MBS, it would purchase longerterm Treasury securities, initially at a pace 

of $45 billion per month, starting after the 

completion at the end of the year of its 

program to extend the maturity of its Treasury 

holdings. It also further modified its forward 

rate guidance, replacing the earlier date-based 

guidance with numerical thresholds for the 

unemployment rate and projected inflation. 

In particular, the Committee indicated that it 

expected the exceptionally low range for the 

federal funds rate would remain appropriate 

at least as long as the unemployment rate 

remains above 6Y2 percent, inflation between 

one and two years ahead is projected 10 be 

no more than Y2 percentage point above the 

Committee's 2 percent longer -run goal, and 

longer-term inflation expectations continue to 

be ".ell anchored. 

Partly in response to this additional monetary 

accommodation, as .... ell as to improved 

sentiment regarding the situation in Europe, 

broad financial conditions eased over the 

second half of 2012. Although yields on 

nominal Treasury securities rose, on net, yields 

on inflation-protected Treasury securities 

declined, and longer-term interest rates 

paid by households and firms generally fell. 

Yields on agency MBS and investment- and 

speculative-grade corporate bonds touched 

record lows, and broad equity price indexes 

rose. Conditions in short-term dollar funding 

markets eased over the summer and remained 

stable thereafter, and market sentiment tovo>ard 

the banking industry improved. Nonetheless, 

credit remained tight for borrowers with lower 

credit scores, and borrowing conditions for 

small businesses continued to improve more 

gradually than for large firms. 

At the time of the most recent FOMC 

meeting in January, Committee panicipants 

S3\\' the economic outlook as little changed 

or modestly improved from the time of their 

December meeting, when the most recent 

Summary of Economic Projections (SEP) was 

compiled. (The December SEP is included as 

Part 3 of this reporL) Participants generally 

judged that strains in global financial markets 

had eased somewhat, and that the downside 

risks to the economic outlook had lessened. 

Under the assumption of appropriate 

monetary policy- that is, policy consistem 

with the Comminee's Statemem on LongerRun Goals and Monetary Policy Strategy 

(see box)- FOMC participants expected the 

economy to expand at a moderate pace, with 

the unemployment rate gradually declining 

and inflation remaining at or below the 

Committee's 2 percem longer-run goal. 
51 


MONETARY POLICY R[PORT: FEBRUARY 2013 3 

Statement on Longer-Run Goals and Monetary Policy Strategy 

As amended effective on January 29, 2013 

The Federal Open Market Committee (FOMC) 

is firmly committed to fulfilling its statutory 

mandate from the Congress of promoting maximum 

employment, stable prices, and moderate long-term 

intere5t rate;. The Comnittee seeks to explain its 

monetary policy decisions to the public as clearly 

as possible. Such clarity faci litates well-informed 

decisionmaking by households and busine;ses, 

reduces €O:ononic and financial uncertainty, increases 

the effectiveness 01 monetary policy, and enhance; 

transparency and accountability, which are essential in 

a democratic society. 

Inflation, employment, and long-term interest 

rates fluctuate over time in response to economic and 

financial disturbances. Moroover, monetary policy 

actions tend to influence economic activity and prices 

with a lag. Therefore, the ComniUee's p:lIicy decisions 

reflect its longer-run goals, its medium-term outlook, 

and its assessments of the ba lance of risks, including 

risks to the financial system that could impede the 

attainment of the Committee's goals. 

The inflation rate over the longer run is primarily 

deternined by monetary policy, and hence the 

Committee has the ability to specify a longer-run 

goal for inflation. The Committee judges that inflation 

at the rate of 2 percent, as measured by the annual 

change in the price index for personal consurrption 

expenditures, is most consistent over the longer 

run with the Federal Reserve's statutory mandate. 

Communicating this inflation goal clearly to the 

public helps keep longer-term inflation expectations 

firmy anchored, thereby fostering price stability 

and moderate long-term interest rates and enhancing 

the Committee's ability to promote maximum 

employment in the face of significant economic 

disturbances. 

The maximum level of errployment is largely 

deternined by nonmonetary factors that affect the 

structure and dynamics of the laoor market. These 

factors may cha nge over time and may not be 

directly measurable. Consequentl y, it would not be 

appropriate to specify a fixed goal for errployment; 

rather, the Corrmittee's policy decisions rTI.Ist be 

informed by assessments of the maximum level of 

employment, recognizing that such assessments are 

necessarily uncertain and subject to revision. The 

Committee considers a wide range of indicators 

in making these assessments. Information about 

Committee participants' estimates of the longer-run 

normal rates of output )y'(1.vth and unemployment is 

published four times per year in the FOMC's Summary 

of Economic Projections. For example, in the most 

recent projections, fOMC participants' e;timates of the 

longer-run normal rate of unemployment had a central 

tendency 01 5.2 percent to 6.0 percent, unchanged 

from one yea r ago but substantia lly higher than the 

corresponding inter.'al sel'eral years earlier. 

In setting monetary policy, the Committee seeks 

to mitigate deviatiorJS of inflation from its longerrun goal and deviations of empjoyment from the 

Committee's assessments of its maximum level. These 

objectives are generally complementary. However, 

under circumstances in which the Committee judges 

that the obj€O:til'eS are not complementa ry, it fol lows 

a balanced approach in promoting them, taking 

into account the magnitude c4 the deviations and 

the potentially different tim: horizons over which 

employment and inflation are projected to return to 

levels judged consistent with its mandate. 

The Conrnittee intends to reaffirm these principles 

and to make adjustments as appropriate at its annual 

organizational meeting each January. 
52 


PART 1 

RECENT ECONOMIC AND FINANCIAL DEVElOPMENTS 

Real gross domestic product (COP) increased at a moderate annual rate of I V2 percent, on average, 

in the second half of 20 12 -similar to the rale of increase in the first half-as various headwinds 

continued 10 restrain grolVth. Financial conditions eased over the second half in response to the 

additional monetary accommodation provided by the Federal Open Markel Committee (FOMe) 

and to improved sentiment regarding the crisis in Europe. However, credit availability remained light 

for many households and businesses. In addition, declines in real government purchases continued 

/0 weigh on economic activity, as did household and business concerns aboullhe economic 

outlook, while \veak foreign demand restrained exports. In/his environment, conditions in the labor 

market continued 10 improve gradually but remained \veak. At a little under 8 percent in January, 

the unemployment rale was still lvell above levels prevailing prior to the recent recession. Inflation 

remained subdued at the end of last year, Ivith consumer prices rising at about a 1 V2 percent annual 

rate in the second half, and measures of longer-run inflation expectations remained in the narrow 

ranges seen over the past several years 

Domestic Developments 

GOP increased moderately but continued 

to be restrained by various headwinds 

Real GOP is estimated to have increased 

OIange in rcal gross dOOlestic product, 2006-12 

"' 

5 

at an annual rate of 3 percent in the third 

quarter but to have been essentially flat in the 

fourth, as economic activity was temporarily 

restrained by weather-related disruptions and 

declines in some erratic categories of spending, 

including inventory investmem and federal 

defense spending.l On average, real GOP 

expanded at an annual rate of 1 Y2 percent in 

the second half of 2012, similar to the pace of 

increase in the first half of the year (figure 1). 

The housing recovery gained additional 

traction, consumer spending continued to 

increase moderately, and business iIwestment 

rose further. Hov."f\"er, a severe drought 

-II 

I 

I ilir; 

in much of the country held down farm 

production, and disruptions from Hurricane 

Sandy also likely held back economic activity 

somewhat in the fourth quarter. More 

fundamentally, some of the same factors 

that restrained grov.'1h in the first half of last 

year likely continued to weigh on activity. 

Although financial conditions continued to 

I. Data for the fourth quarter of 2012 from the 

national income and product acoowlts reflect the ad\'ance 

estimate released on January 30, 20 13. 

- , 

11 11 

200Ii 1001 200& 2009 2010 2011 21112 

NOll: Hm on<l in subseque::l flglJmo, =<pt . no:ed, chc:g, for . g;'e:: 

""':00 i,,,,,,..,,,..,;! to ... f,::oI gUM« Ihn th, ft:al <rartor ofth'JI",,,,rli:lc 

.... SoolcE DopIrtmec.lofCcm......c' ,BurnuofEc.,.""" Acaly>i~ 
53 


6 PART 1: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

2. Net change in pa}roll employment, 2006-13 

~ 

- ,., 

- ,., 

- "" - oro 

- .., 1 I I I I I I I I I I lOO6 W07 :!llO> ltlO9 2010 ))11 2012 2013 

NO'll: 111< data .... thffl,·"""lth movi::g t m1ll\" t:JI ,rt<:>i tlwugh 

)0'"1>1),2013 

Soula: Deparunetil. ofLcb<r, Bure", ofLebor SlItisti". 

1 Civilian l.lI1employment rate, 1979-2013 

--------------------------~~~ 

-n 

11 11 1111" 11"111" 1111 11 111 11" 11111 I 1~1 1989 1997 ;!OOS 2013 

NO'll; 11I<dalaottm<r:lhIy .. dall!ndthroughJan""Y2013 

Soula: Depan:ncl ofLtbor, Bureau ofLcb<r Stati01ic •. 

4. Loog·tenn Ullemployed, 1979-21)13 

____________________________ -".d 

~ 

- w 

1 "1]1"11 " 11"1 11111]1 " 11"1]1 " " 1 19&1 19&9 t997 200S 201l 

NO'll: 111< data ott lDOllthly m! e=d1lJrou&!l )""UL"y 20tl. 11I<..no. 

sl:0WlI i. th. ~. of total ~Ioyed pe:'SOllO who have b=. 

~loyoclf<r27w .. ""'''''' SoottE Dqlartmtn1 ofLebor, Bureou O(LIbor Sail1;"" 

improve overall, the financial system has not 

fully recovered from the financial crisis, and 

banks remained cautious in their lending to 

many housebolds and businesses. In particular, 

restricted financing for home mongages 

and new-home construction projects, along 

with the depressing effects on bousing 

demand of an uncenain outlook for bouse 

prices and jobs, kept the level of activity in 

the housing sector well below longer-run 

norms. Budgetary pressures at all levels of 

government also continued to .. veigh on GDP 

growth. Moreover, businesses and households 

remained C{)ncerned about many aspects of 

the economic environment, including the 

uncertain course of u.s. fiscal policy al the 

turn of the year as well as the still-worrisome 

European situation and the slow recovery 

more generally. 

The labor market improved somewhat, 

but the unemployment rate remained 

high 

In this economic environment, firms increased 

their workforces moderately. Over the second 

half of last year, nonfarm payroll employment 

rose an average of about 175 ,0IXl per month, 

similar to the average increase in the first 

half (figure 2). These job gains helped lo .... -er 

the unemployment rate from 8.2 percent in 

the second quaner of last year to 7.9 percent 

in January (figure 3). Nen:rtheless, the 

unemployment rate remained much higher 

than it was prior to the recent recession, 

and long-term unemployment continued to 

be widespread. In the fourth quarter, about 

40 percent of the unemployed had been out 

of work for more than six months (figure 4). 

Moreover, the proportion of workers 

employed part time because they were unable 

to find full-time work remained elevated. Some 

of the increase in the unemploymem rate since 

the beginning of the recem recession could 

reflect structural changes in the labor marketsuch as a greater mismatch bet .... -een the types 

of jobs that are open and the skills of workers 

available to fill them- that would reduce the 

maximum sustainable level of employment. 

Ho .... -e'·er, most of the economic analysis 
54 


on this subject suggests that the bulk of the 

increase in unemployment probably reflects a 

deficiency in labor demand.l As a result, the 

unemployment rate likely remains well above 

levels consistent ..... ith maximum sustainable 

employment. 

As described in the box "Assessing Conditions 

in the Labor Market," the unemployment 

rate appears to be a very good indicator of 

labor market conditions. That said, other 

indicators also provide important perspectives 

on the healt h of the labor market, and the 

most accurate assessment of labor market 

conditions can be obtained by combining the 

signals from many such indicators. Aside from 

the decline in the unemployment rate, probably 

the most important other pieces of evidence 

corroborating the gradual improvement in 

labor market conditions over the second half 

of last year were the gains in nonfarm payrolls 

noted earlier and the slight net reduction in 

initial claims for unemployment insurance. 

Restrained by the ongoing v.eak conditions 

in the labor market, labor compensation 

has increased slowly. The employment COSt 

index for private industry workers, which 

encompasses both wages and the cost 10 

employers of providing benefits, increased 

only 2 percent over the 12 months of 20 12, 

similar to the rate of gain since 2010 (figure 5). 

Similarly, nominal compensation per hour 

in the nonfarm business sector~a measure 

deri\'ed from the labor compensation data in 

the national income and product accounts 

(N IPA)~increased 2Y:z percent over the four 

quarters of 2012, well below average increases 

2. See, for example, Mary C. Daly, Bart Hobijn, 

Ay~giil $ahin, and Robert G. Valletta (2012), "A 

Search and Matching Approach to Labor Market;;: 

Did the Natural Rate of Unemployment Rise?» ]Oiuna! 

of Economic PerspeCfi~es, \"01. 26 (Swllmer), pp. 3- 26; 

Michael W. L. E1;by, Bart Hobijn, A}"~giil $allin, and 

Robert G. Valletta (2011), "The Laoor Market in the 

Great Recession-An Update to September 2011," 

Brookings Papers on Economic AClirilY, Fall, pp. 353-71; 

alld Jesse Rothstein (2012), "The Labor Market Four 

Yearn into the Crisis: Assessing Structural Explanatioos,» 

lLRReriew, \"01. 65 (July), pp. 467-500. 

MONfTARY POLICY REPORT: FEBRUARY 2(lt3 7 

5. Mmures of change ill hourly compensation, 

2002- 12 

-, 

- , 

II I I 1 1 I I I I 1 2002 2001 2006 21m 2010 2012 

NOli: The ,",to..,.. quomty o:xI o;tc<I<llhrou¢ 2012:~. r", """""," 

IrJ.in ... ~clw>t.i.OVf!tfourqotttm;f",!he"",O>ymem«>JI. 

index (ECI), ".,.. i. w ... !he 12 months <n<!q ill the IasI mooth o{ .... h 

,.:.o:ter. n, n-xfarn. ~ ~"",Ia! .. tom.., 11lV'm.....m, """""f~ 

imtil:llions, wi """,,,hol.U. The ot.cto< ~ by 11:. EO u...:! W II th, 

II<InWm Ir.am... O«torplus :lO::.p:of~ i::aitulions. 

Some<: o.p..-tment o{lJOOr, B1lUII.u o{lJOOr stotistil"S 
55 


8 PART 1: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

Assessing Conditions in the Labor Market 

No single statistic can prol'ide a complete picture 

of a labor market as large and diverse as that in 

the United States. The evidence suggests that the 

unemployment rate is probably the most useful 

single summary indicator of labor market conditions. 

However, other indicators, prominently including but 

not limited to nonfarm payroll employment, provide 

imjXIrtant additional infOfmation. 

The unemployment rate is intended to measure 

the extent of the most obvious, and arguably the 

most important, problem in a slack labor market: the 

inability of some people who are looking for work to 

find acceptable jobs. The unemployment rate is also 

well correlated with, and representative of, a broad set 

of labor market indicators that portray many aspects 

of the job market. This relationship is demonstrated 

in iigure A, which plots the detrended unemployment 

rate along with the first principal component from 

a lactor rrodel of labor market indicators described 

in a paper by Barnes and others.' In addition, other 

research suggests that the unemployment rate is 

1. The first prirocipal COfIlIO!leru is a sUlllllilry ~tistic 

that captures thecommon llDI'emellt among a IIlrie!y of indicators. See Michelle Sa,r.es, Ryan Chahrour, GiOI\lnni 

Olivei, and Gaoyan Tang(2007), "A Priocipal ConpHlents 

Aw'OiIrn w Estimating Lalxx Market Pressure and Its Illl'lications 100Inllation," Public Policy Briefs 07-2 (Boston: 

fedf'lal Res<>I\'E' Bank of Boston, Decerrber), www.bostooled. 

orglecorromiclprbnOO7Ippb071.pdf 

generally a reliable indicator of the overall state 01 the 

businesscycle.2 

Of course, the unefllJloyment rate does not, by 

itself, provide a cOfllJlete and full y accurate portrait 

of labor market conditions. As with most iro:!icators, 

the unemployrrent rate is subject to sampling and 

other measurement errors, so month-to-month 

movements should be interpreted with some caution. 

Even over longer periods, the unefllJloyment rate 

may not always characterize the situation in the labor 

market altogether accurately. for example, if many 

unemplo)'ed indil'iduals cease looking for work (aro:! 

so are no longer counted as unemployed) because 

they have become discouraged about their job 

prospects, the measured unemployment rate could 

decline even if the del1l3nd for labor has not improved. 

Also, the unemployment rate may not always move 

in step with other types of underemployment, such as 

2. fOf two ex3lll'les, seeCharlesA. fleischrn.lo aod 

John M. Roberts (2011), "From Many Series, One Cycle: 

Illl'rOYE'd E,timatl>S 01 the Business Cycle lrom a Muttivariate 

Uocbserved COI"JllOnent5 Model: fil\.loceand Ecooomics 

Discussion Series 2011-46 (Washi ng\l)n: Boord of 

Governors 01 the federal ReserVE' S)'51enl, October), WWW. 

ledf'lalreserve.govlpoos/ledsI20 l1f2011461201146pap, 

jldf; and Jf'lenl)' J. Nalewaik (2011 ), "Fore.-;asting Recessioos Using Stall Speeds: Finanre and Economics Diso,J!O,ioo Series 2011-24 (Washingwn: Boord of Govf'lrlOlS oftne fedf'lal Res<>I\'E'Systt>m. April), www.federalres<>l\'E'.govl\JlbsI 

fooj/2011 n OI1241201124pap.pd!. 

A. Detrended unemploymwl rate and principal component, 1%7-2012 

,., 'm "" "" '"' "" ,., ,00> 

N<m: The ~d tar. i::dra porio<l:l- ofbulil:rll- ="-I»n .. "'fi...,d b)' 0):, Notional BuJ"u of&<l:tllO".io R"",,,,cll 

Sooo.a; : r,dmt~,Bcl.{_'T1ff 

- 1 

- , 

- , 

-1 

2012 
56 


persons working part time because they cannot find 

full-time jobs. For this reason, broader measures of 

labor underulilization, such as the Bureau of labor 

Statistics' (BlS) U-4, U-S, and U-6 rates, can be useful 

supplements to the standard unemployment rate. These 

measures include the number of discouraged workers 

and part· time workers who are unable to find a fu ll· 

time job, and they are derived from the same survey 

of households as is the offICial unel"lllloyment rate 

(figure B). 

Other than the unemployment rate, payroll 

employment as measured in the BlS survey of 

establishments may be the most uselullabor market 

indicator. A decline in the unemployment rate that 

is accompanied by a roughly prOfXlrtionate increase 

in payroll employment is rll:)re likely to truly rellect 

improvement in the labor market. Of course, payroll 

employment is also an impenect measure, and on 

some occasions the initial estimates of payrolls have 

been revised to show a substantial ly different picture 

than they originally did. Therefore, it can be useful to 

also look at a I\.uiety 01 other labor market indicators. 

These indicators may be less brood·based than either 

the unemployment rate or payroll employment, 

but--<;olloctil'ely-they may reduce the uncertainty 

surrounding the message from the primary measures 

B, Measures of labor underutilization, 2001-13 

MONfTARY POliCY REPORT: FEBRUARY Xlt3 9 

and provide information about some specifiC aspects 

01 the labor ma rket. 

One set of useful supplementary indicators consists 

01 measures of job losses and hiring. These measures 

describe the large gross flows of workers in and out of 

employment that underlie the net changes reflected 

in the unemployment rate and payroll employment. 

For exal"lllle, the improvements in the employment 

situation thus far during the current recovery have 

been driven fOOre by reductions in job losses than 

by increases in hiring. A second set d indicators, the 

rate of job vacancies and measures 01 firms' hiring 

plans, may be informatil'e about the susta inability 

01 any increase in hiring. Quit rates, a third set, are 

useful because workers hal'e, historically, been much 

more likely to quit their jobs when they perceive or 

anticipate a strong labor market. In addition, surveys of 

consumers and businesses provide informa tion about 

the perceptions d a large number of individuals about 

labor market conditions. As with the unemployment 

rate and payroll employment, these other indicators 

have, lor the most part, improved considerably during 

the economic recovery but remain substantially 

weaker than would normal ly be associated with a 

healthy labor market. 

-p~----------~--,---------~

Uoli _ 16 

- " 

- 10 

,., 

,-tl l I I 

'"" '"" ;00; "'" W" 2011 

Non: n., <1m"" """'f:Jy lD:!.,,,,,,:d t!noot:I>lamary 201; . U-4 """'C:."LOt2lIl."""'ipioytd P~_>l:M _Urt, "'JI'fC"'l oflh, I...,.. forr ~ 

dl<coor>f:'d "",!k<o: ~ IliscooIagtd wo!kat ~""I rurrtlIll)' Iootiog for work btOSlllt th'Y btIi ... no jobs .:. avail"''' f,.. thm:. u·s mu"" .. l<UJ 

1llltlIIpI000M pm.u margin>tl)' .ttclod \0 W t...,.. f,..ct ... 'J'fIol1ll ofcbt Iabo, fot<t pm pm<Il' m.a:gina1ly wobtd ", tho labor (orr .. ~.atl)' .ttclM 

work ... ", •• 01 " the labor forte. w."tlD:! or, ..... ibbIo {or"",!k. lD:! ha .... ~ fo:.job m m. p."IOf 12 mo:nIII. Uoli o:e>sWe' \ollt unempIoytdpb aU 

marg .... Uy OIlIclxd w",km p~ 1O:a1 ... ,p!oyM pa:1 ti". .. fo: <C«I"",k , .. oorl~ " . J'fI=t of lobo: 10"" ph,. all ..... "'P»Uy Ol""btd wO!\;m. n., L':ad<d In:< 

icdi<n perio<lI 01"""''',<$$ =miOll .. dmO<'d bylhe N";OIlat aw.,., ofEwnotnr Rts..,ch 

~ ~,ofl.aM:.BIttl'.,ofL>borSta:ii!iot. 
57 


10 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

Change in the chain-type: price index for pc:rsonal 

cons\DllptiOil expenditures, 2006- 12 

________________________ cc'-' 

-1 

-1 

- , 

- , I I I I 

200Ii 2001 1008 2009 1010 1011 lj)11 

NOli: The elm.,.. """,thtymi exIeod th:"uahDmmber lOt!; cha:ig .. 

.,.. fro"""' YW""~'" Soo1c!:: Dtportmtnl ofCOJll:Ilmt, SurtauofEcona:n", Analysi~ 

7. a.ang inQ\l1pl~perho\lr,'9_l.8__2012 

- . 

- 1 

- 1 

- , 

- , I I I I I I I I I 

t94S- 1974_ 19096- 200t _ 2008 2010 2012 73 95 2000 07 

Ncm N<mfama bu>io ..... _. Chor.g. for each multiyear pniod i. 

"...,.=1 to the fou:lh qua:tcT ofth. fmat )_ o,the pciod from the ,o::nh 

qUtrttr ofth, yw i:n.... dia .. 1y """ediq t/:.pniod. 

SoolC]t o.par.- «Labor, Burt"" ofLabot swistil'S 

of close 10 4 percent in the years prior to the 

recent recession. As a result of these modest 

gains, nominal compensation has increased 

only about as fast as consumer prices over the 

recovery. 

Inflation remained low . .. 

Consumer price inflation was low over the 

second half of 2012. With considerable slack 

in labor markets and limited increases in labor 

coSts, relatively stable prices for commodities 

and impons, and well-anchored longer-term 

inflation expectations, prices for personal 

consumption expenditures (peE) increased 

at an annual rate of 1 Y:z percent in the second 

half of the year, similar to the rate of increase 

in the first half (figure 6). Excluding food and 

energy prices, consumer prices increased only 

I percent in the second half of the year, down 

from 2 percent in the first half. A deceleration 

in prices of imported goods likely contributed 

to the low rate of inflation seen in the second 

half, though price increases for non-energy 

services were also low. 

As noted, gains in labor compensation have 

been subdued given the weak conditions in 

labor markets, and unit labor costs-which 

measure the extent to which compensation 

rises in excess of productivity- have increased 

very little over the recovery. That said, 

compensation per hour rose more rapidly 

last year, and productivity gro\\'th, which 

has averaged I Yl percent per year over the 

recovery, was relatively low (figure 7). As a 

result, unit labor costs rose 2 percent in 2012, 

v.-ell above average increases earlier in the 

recovery. 

Global oil prices rose in early 2012 but 

subsequently gave up those gains and remained 

about fiat through the laler pan of the year 

(figure 8). Developments related to Iran, 

including a tightening embargo on Iranian oil 

exports, likely put upward pressure on prices, 

but these pressures were apparently offset 

by continued concerns about weak global 

demand. However, in recent v.-eeks, global oil 
58 


prices have increased in restxlnse to generally 

positive demand indicators from China and 

some reductions in Saudi production. Partly 

in response to this rise, retail gasoline prices, 

which changed lillie, on net, over 2012, have 

moved up appreciably. 

Nonfuel commodity prices have remained 

relatively flat over the past year despite 

significant movements in the prices of a few 

specific commodities. Of particular interest, 

prices for com and soybeans eased some over 

the fall after having risen sharply during the 

summer as the scale of the drought at1"ecting 

much of the United States became apparent. 

Given this easing and the small share of grain 

costs in the retail price of food, the effect of 

the drought on U.S. consumer food prices is 

likely to be modest: Consumer food prices 

rose at an annual rate of 2 percent in the 

fourth quarter following increases of less than 

1 percent in the middle of last year. 

In line with these flat overall commodity 

prices, as well as earlier dollar appreciation, 

prices for imported goods excluding oil were 

about unchanged on average over the last fi\"e 

months of 2012 and the early part of 2013 . 

. , . and longer-term inflation 

expectations stayed in their historical 

range 

Survey measures of longer-term inflation 

expectations have changed lillIe, on net, since 

last summer. Median expected inflation over 

the next 5 to 10 years, as reported in the 

Thomson ReuterslUniversity of Michigan 

Surveys of Consumers, was 3 percent in 

early February, within the narrow range of 

the past 10 years (figure 9). In the Survey of 

Professional Forecasters, conducted by the 

Federal Reserve Bank of Philadelphia, the 

median expectation for the increase in the 

price index for PeE over the next 10 years 

was 2 percent in the first quarter of this 

year, similar to its level in recent years. A 

measure of 5-year inflation compensation 

derh"ed from nominal and inflation-protected 

MONETARY POl ICY REPORT: FEBRUARY 2013 11 

S. Prices of oil and oonfuel cO!IUIIodities, 2003-13 

D<_~ OO [101 ... ",,_ 

,. - -140 

- 120 140 -

- '00 

120 _ 

.. ' 00 _ 

• 00 -

'" ! I I I 

200& 2009 U)]O 20ll 2012 WI) 

Ncm: Tho d.ota.,. maolhly. Tho oil price is Ihe 1pOt price ol Bt""! crud. 

oi~ ""'!he lastobserVltiol! islheaverogo forFtbnwy 1-2I,2Illl. Th. pri« 

or ..",mol """""""r.ios is !Ill i:da ol 4S primary·cun:nodi!y pri«s ~ 

<'Xttndothrrugh.la::t!ary201J 

Sruus:: For oil, Ihe CIIIII:lIOdiIy RtSN<"h BlIrtal!; r", nontu..1 

~ilios, l:!omoIional Monetoryfund. 

9. Median innation expectations, 2001-13 

M;"hipnlUM")"eq>t&tiom 

rOf=:lS to 10 

~ 

"'" 

~ f"" ,w IO)"..,. 

- , 

- , 

-, 

- , 

I! [ [ [ [ [ [ [ [ ! I 1 I 1 

2001 2003 2005 2001 2009 20 11 20ll 

Ncm: Tho Mid:igon '""0)" ""ta .... monthly and .xtend from January 

2001 w.".:gh . prdimi::ary .. ~mate fOf Fdm!a:)" lOll. 11>: SPF data .... 

quaJ'''''iyar.i ... .tndfIO.:Il 2007:Q1 throughlO13:QI 

Sroru:J: T1xIm<oo R"'t=lUni .... :"ily .fM;"hipn S\ll"W")'"SofC""'''''' .... 

and SurYe}' .fProc ... ional F.,... .. 1c"o (SP!'). 
59 


12 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

10. rnflatiOll compensation, 2004---[3 

-----------------------=~ 

- , 

- , 

- , 

- , 

- , 

- , I I .I. 1 .. 01 .I. 1 ... 1 .I. 111 01 01 I 

20() ~ 2007 2009 2011 2013 

Ncm; : Tho data ate we<l:Iy 1Vm&" of d&iIy dall ond OXleruilMough 

febt=y t5. !Oll. ["notioo CUIlp""...:iou io!be <lifl'=« botwtetl yields 

on nominal rr.&S"'Y I«1lriti .. oruI Trtasury d1ation-p:ol"'W """"ti .. 

(TIPS) ~"able maturiti.~ base<! on yield cunrn fitted to olf-lhe--nm 

nom;;>! Treasury .... -.mti .. lId on· lId o/r·the-run TIPS. 11::. j .Y'" 

"' .... ", .. io O<!j\l<led fer lb. <'if"" of iodao,onlags 

Soowi: F..r..I Roserve &:ik .fN"", YOlk; Bacclays; F,clmI R.SCTV< 

Boord .... ff.OIiroate1. 

11 Change in real pmonal CO!lSIDDptiOll expenditures and 

disposable personal incoox:, 2006- 12 

I I 

• Chan&< inreal PCB 

o Clan&< in re>l DP] 

IJ 

2006 2007 !008 2009 20]0 2011 201 2 

-. 

N01t: Th!dall .. quarttrlyondexle!<!Ihrout!t 2012:QoI 

Scmci: DepanmetiI ofC=~ .. Bu .... u ofEe"""",,, ArooIysiL 

Treasury securities has increased 55 basis 

points since the end of June, while a similar 

measure of inflation compensation for the 

period 5 to 10 years ahead has increased about 

30 basis points; both measures are within their 

respective ranges observed in the several years 

before the recent financial crisis (figure 10). 

While the increases in these measures could 

reflect changes in market participants' 

expectations of future inflation, they may 

also ha\'e been affected by improved investor 

risk sentiment and an associated reduction in 

demand for the relatively greater liquidity of 

nominal Treasury securities 

Consumer spending continued to 

increase mod erately 

Turning to some important components 

of final demand, real PCE increased at a 

moderate annual rate of 2 percent over the 

second half of 2012, similar to the rate of 

increase in the first half (figure 11). Household 

v ..ealth- buoyed by increases in house prices 

and equity values-moved up over the second 

half of the year and provided some support 

for consumer spending (figu re 12). In addition, 

for those households with access to credit, 

low interest rates spurred spending on motor 

vehicles and other consumer durables, which 

increased at an annual rate of 11 percent over 

the second half of last year. But increases in 

real wages and salaries were modest over the 

second half of the year, and overall grol,l:th in 

consumer spending continued to be held back 

by concerns about the economic outlook and 

limited access to credit for some households. 

After rising earlier in the year, consumer 

sentiment- which reflects household views 

on their own financial situations as well as 

broader economic conditions-fell back at the 

end of the year and stood well below Iongerrun norms (figure 13). 

Real disposable personal income (DPI) rose at 

an annual rate of 3Y2 percent over the second 

half of 2012. HOI,I,'Cvcf, much of this increase 

was a result of unusually large increases in 

dividends and employee bonuses, as many 

firms apparently shifted income disbursements 
60 


into 2012 in anticipation of an increase in 

marginal ta.x rates for high-income households 

at the beginning of this year. Excluding these 

special payments, real DP! is estimated to 

have increased at a modest annual rate of 

1 Y. percent over the second half of the year, 

similar to the average pace of increase over 

the recovery. The surge in dividend and bonus 

payments also led the personal saving rate to 

jump from 3.8 percent in the second quarter 

to 4.7 percent in the fourth quarter (figure 14). 

In their absence, the saving rate would have 

likely been [il1[e changed over the second half 

of the year. 

Households contin ue to pay down debt 

and gain access to credit 

Household debt- the sum of mortgage 

and consumer debt-edged down further 

in the third quarter of 2012 as a continued 

contraction in mortgage debt more than offset 

a solid expansion in consumer credit. With 

the reduction in household debt, [ow levels 

of most interest rates, and modest income 

growth, the household debt service ratiothe ratio of required principal and interest 

pa}wents on outstanding household debt to 

DPI-decreased further and, at the end of the 

third quarter, stood at a level last seen in 1983 

(figc.re 15). 

Consumer credit expanded at an annual 

rate of about 5Y. percent in the second half 

of 2012. Nonrevolvingcredit (mostly auto 

loans and student loans), which accounts for 

about two-thirds of total consumer credit 

outstanding, drove the increase. Revolving 

consumer credit (primarily credit card 

lending) was about flat on net. Overall, the 

increase in nonrevolving consumer credit is 

consistent with banks' recent responses to the 

Senior Loan Officer Opinion Sun'eY on Bank 

Lending Practices (SLOOS), which indicated 

that demand had strengthened and standards 

eased, on net, for auto loans (figure \6).l 

3. The S100S is 2I'ailable on the Federal Reser..-e 

Board's website at www.federaJresen·e.glJlilboarddocsl 

SnLoanSuney. 

MONETARY POlICY REPORT: FEBRUARY 2013 13 

12. Weahh-to-income mlio, 1989-2012 

______________________ -C~o 

-, 

-, 

1 I I I I I I I I , I I I I , I I I I I I I I I " I 

1992 1996 2000 2000: ~ 2012 

NOl"I: The c!ala.,. qUIMIy and =d Ihrough 2012:QJ. Th • .....,.;, 

lh'rlIi>ofh~lJnot" .. :tb!ll~.pmon1l""""'" 

Soomi: For not "mIh, FodmJ P.o.""" Boarrl, no... of f.J>ld1 <!ota; for 

inro:l>o, Dc-partm",\ <Ie.""",.,..,., B::r<"" ofEoo::o:n;; Alla~~;, 

13. Consumer sentiment indexes, 1999- 2013 

'00 

I I I I I I I I I I I I I I I I I I 2001 2001 2001 2010 2~lJ 

Non:: Tho: C,,:If<,..,.;. B .... -d d.Ia, illllo;.d!ll 100 i:a t985, II"< mOtithly and ,>.:tl>d Ihrough JI!I. 2011. Tho M;;h. survey dola, indt",d ,,, 100 "' 1966, 1I"<!IlOtIIhIy and.lI<IId tIIrouzh . !"<I..,i:wy Feb. 1013 ati.'DI!e. 

Soot.a;; The Co:lfm:>ee &ard and Tho:n'''" R!IlI<rSIUni,·.,.ily "f 

Mi.;:hip:l Surv<),ofCo=m. 

14. Personals3vingmle, 1989-2012 

-. 

I1 1 11 1 1 1 11 1 1 1 11 1 1111 1 1 1 111 1992 1996 2000 2000 200> 2012 

NOli: Thed>ru .. eqU1rt<r1y and<':ln!\luDugh2Q12:Ql 

Saru::r; : Dc-partmon,ofC""""",,,,,. Bumn "fEcOtl""'" A<.o~'is 
61 


14 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

15 HQllSehold debt service, 1980 21)12 

-B 

-B 

-H 

' 11 I1111 11 I1111 11 I1111 11I1111 1111 11 I 19&0 1984 ~&8 1992 19% 2000 2004 2008 2012 

Ncm: 1M <!ata .:. quonaty and <Xttnd!hrrugh 2011:03. Debt 'eM"" poy:n<w """,iot or nWio:oi .. ",~oi pa)n><:rts QtI outN:l!iug~. 

ando"",u:nerdebt. 

Soo.acI: F.~aol R ........ Boord, '1Imaehold D<bl Servk< m! FiI=oial 

Qblig,ti""" Rati .. ; .~ti$ti"" .. I<>$<. 

16 Change in standards and demand for alrto loons., 

21)11 12 

)1,,1"""" 

- w 

I I 

Ql Q2 OJ Q4 01 Q2 QJ 0' 

2011 2012 

NCf1I: lkdatamfro:n''''"''"Y!'''''''Iy<:<ltl<!::,ted4Unospo!"yeor; 

tho Iut obsorudion j. fro::n d:. Jan. 2011 "'"""Y, wl'.icll '"""" 2012:Q4 

&:h ..nos rqnoens the DOt perunt of ourveyed ba:ks that reported ~ 

tigl::.oiug or .~I.> "" "'''''Il'''' o<:nWl f", O11to I""", over tba ,...t ;.""'" 

Soo1a: Fedaal R ....... Board, S<nior Loon Oill ... O(Rtlion Surv<y" 

BODklr..JlitlgPtu!m 

Changes in interest rates on consumer loans 

v,ere mixed over the second half of 2012. 

Interest rates on auto loans declined a bit, as 

did most measures of the spreads of rates on 

these loans over yields on Treasury securities 

of comparable maturity. Interest rates on 

credit card debt quoted by banks generally 

declined slightly, while rates observed in credit 

card offer mailings continued 10 increase. 

The housing market recovery gained 

traction ... 

The housing market has continued to recover. 

Housing starts, sales of new and existing 

homes, and builder and realtor sentiment all 

increased over the second half of last year, 

and residential investment rose at an annual 

rate of nearly 15 percent. Combined, single· 

family and multifamily housing starts rose 

from an average annual rate of 740,CKXl in the 

second quaner of last year to 9C(),OOO in the 

fourth quarter (figure 17). Activity increased 

most noticeably in the smaller multifamily 

sector -where starts have nearly reached pre· 

recession lewis- as demand for new housing 

has apparently shifted toward smaller rental 

units and away from larger, typically owner· 

occupied single·family units. 

... as mortgage interest rates reached 

record lows and house prices rose ... 

Mortgage interest rates declined to 

historically low levels toward the end of 

20l2- importantly reflecting Federal Reserve 

policy actions-making housing quite 

affordable for households v,~th good credit 

ratings (figure 18). However, the spread 

between mortgage rates and yields on agency· 

guaranteed mortgage·backed securities (M13S) 

remained elevated by historical standards. 

This unusually wide spread probably reflects 

still-elevated risk aversion and some capacity 

constraints among mortgage originators. 

Overall, refinance activity increased briskly 

om the second half of 20l2- though it was 

still less than might have been expected, given 

the level of interest rates- while the pace of 

mortgage applications for home purchases 
62 


remained sluggish (figure 19). Recent responses 

to the SLOOS indicate that banks' lending 

standards for residential mortgage loans were 

litt le changed over the second half of 2012. 

House prices., as measured by several national 

indexes, continued to increase in the second 

half of 2012. For example, the Core Logic 

repeal-sales index rose 3~ percent (nol an 

annual rate) over the lasl six months of 

the year 10 reach ils highest le\'el since late 

2008 (figure 20). This recent improvement 

notwithstanding, this measure of house prices 

remained 27 percent below its peak in early 

2006. 

... but the level of new construction 

remained low, and mortgage 

delinquencies remained elevated 

Despite the improvements seen over the second 

half of 2012, housing starts remained well 

below the 1960-2000 average of 1.5 million 

per year, as concerns about the job market 

and tight mortgage credit for less-creditworthy households continued to restrain 

demand for housing. In addition, although the 

number of vacant homes for sale has declined 

significantly, the stock of vacant homes held 

otT the market remained quite elevated. Once 

put on the market, this "shadow" inventory, 

which likely includes many bank-owned 

properties., may redirect some demand a\vay 

from new homes and toward attractively priced 

existing homes. With home values depressed 

and unemployment still high, measures of 

late-stage mortgage delinquency, such as 

the im·entory of properties in foreclosure, 

remained elevated, keeping high the risk of 

homes transitioning to vacant bank-owned 

properties (figure 21). 

Growth of business investment has 

slowed since earlier in the recovery 

After increasing at double-digit rates in 2010 

and 20 II, business expenditures on equipment 

and software (E&S) decelerated in 2012 

(figure 22). Pent-up demand for capital goods, 

an important contribulor to earlier increases 

MONETARY POlICY REPORT: FEBRUARY 2013 15 

17 Private housing starts, 1999-2013 

- 1.8 

- l.4 

- l.0 

- , I! , ! ! I ! I ' , , ! , t ! , 

1m 2001 ))(IJ 2005 2007 2009 2011 20ll 

NOll: Th. data .,. <I>lIlthly anda:el:d Ihrou&b )."ua:y2013. 

Soo.acI: [)eponrnontmC"""""",., Bum.u<ith< C=u 

18. Mortgage intmst rates., 1995-2013 

I I I I I I ! I I I I I I I I I I I 1!I'll 1998 ))(11 201.).: 2007 2010 

-, 

Ncm: lbt data, "'hio!! L .... ~.tdy and rom! thmJgb. FeImwy lG, lOt;, 

... "",,1rI;;t!l1<'OIIJO-)'tIl"IlIO:I8I1&<' . 

$(mo. r.&r.lHo:uo[.oo.nMOItglgtCo.:p"":I.ion 

19. Mortgage Bankers Association purchase and refinance 

indexes, 19%-2013 

M.-:I>'~'91".1 'OO _'~'990 QO 

;00 - -

.., -

'00 -

'00 -

'00 -

1111!!!! !!I IIIIIII !!I!!!1 I 1992 1995 1m 2001 201.).: lim 2010 201l 

10,00:1 

,,00 

,oro 

' ,oro 

,,,, 

Ncm: Th: data, w~"h II< .. l><Ially O<!r~w, .", I f"""· ...... k movin, avmte and rom! ~ Fdnwy 15, 2013. 

SOOlCl!. M<r.glll.&tik<:-sAssoci.tiOll-
63 


16 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

20 Prices of existing single-family houses, 2002- 12 

----------------------~ .. ~. 

I I I I 

'00' I I ,.,. 

S&P,C ... ·Sh'" .. 2O.",ty i:>!ox 

I I 

,., I I I 

2012 

NOTi: ThedallmlJlO::'.hlyand=c!in101011:Qo:. Eachindoxhasb«n 

""""oliud .. tbt it. "'" is 100. Both u.. C_L>gi< ~ io<kx and the FHF A ""'" inobl. puro .... tt=aclioru only_ The S&PiCu.·ShiU", iode:< 

r<I-...ruollum'.-Ie::&th .. le>tmIJaCti"""iIIsdettc<llllOlrOpOiitao L ..... 

SoI.ru:E: F .. Co:-d.ogi<, C_Logic; (" f1IFA, F.dmI Housillj; FWce 

A~"''Y; for S&PiCaOI!.shilkr, Sa!>lanI & Poo!'~ 

21. Current prinx: mortgages becoming delinquent 

and foreclosure inventory, 2000- 12 

r..-,l· __ _ 

15 _ 

1.4 _ 

IJ -

12-

l.l1.0 -

.. -

.-,-

-15 

-1.0 

- , 

2(1(10 2002 !(!O.! 2006 lllOO 2010 2011 

NO'!!! Thedmf"lli:nelD<l:lg.,..l>e«tDi:l,:do6"""""tmlllO:ltl:!yand 

"",-"", thrO'.:gh n",.".,.,. 2012 The data rqmstnl tho pettentage <i: 

mo:\iIi" thIl trIImitiw !Mn bei:lc CIIITe::l to beiog .1 1 ... 1 30 da)--. 

&'Iioq\l<ll\ ",hmon\h. n. dlTl for fw"lw..,. ",V<llto:y ... qusrtmy and 

"",-"", tbrou!h 2011:QJ. The shadtd bon clii:Ole ,....;cw or busi:l<oi 

rtC<S.ion .. defm<d by the Nati..,.1 B ..... u ofB:<wo:ni, R ...... h. 

s.oo.c.; For ptirD!- OI<rtgag1S, LPS App6"" k.!Iyti .. ; for f"""I0._ inVttlcry, F!:danl R...,.. Boord IW1 ,olculatiol:s lw!:d on <Iota !Mn 

MOIIpg' &Ilk.,. A.ooeiolion. 

in E&S spending, has likely diminished as 

the recovery has aged. In addition, concerns 

about possible threats to economic growth 

and stability from U.S. fiscal policy and the 

situation in Europe may have contributed 

to soft investment spending in the middle 

of last year. As a result, despite a pickup 

in the pace of gains toward the end of the 

year, E&S investment increased at an annual 

rate of 5 percem in the second half of the 

year, similar to the first-half pace. As for 

business investment in structures, a sustained 

recovery has yet to take hold, as high vacancy 

rates, tight credit for new construction, 

and low prices for commercial real estate 

(eRE) are still hampering investment in new 

buildings. However, in the drilling and mining 

sector, elevated oil prices and new drilling 

technologies have kept investment in structures 

at a relat ively high leveL 

Inventory investment remained at a moderate 

le\'el in the second half of last year, as limited 

gro\,\'1h in final sales and the uncertain 

economic environment continued to limit 

firms' incentives to accumulate inventories. 

Census Bureau measures of book-value 

inventorY-lo-sales ratios, as well as SUf\'eys 

of private inventory satisfaction and plans, 

generally suggest that stocks were fairly well 

aligned with sales at the end of 2012. 

Corporate earnings growth slowed, but 

firms' balance sheets remained strong 

After having risen 6 percent over the firSI half 

of 2012, aggregate operating earnings per 

share for S&P 500 firms were about Bat on a 

seasonally adjusted basis in the second half 

of 2012, held down, in part, by weak demand 

from Europe and some emerging market 

economies (EMEs). However, Ihe ratio of 

corporate profits to gross national product in 

the second half of 2012 hovered around its 

historical high, and cash Bow remained solid. 

In addition, the ratio of liquid assets to total 

assets for nonfinancial corporations was close 

to its highest level in more than 20 years, and 

the aggregate debt-to-asset ratio remained low 

by historical standards (figure 23). 
64 


With corporate credit quality remaining robust 

and interest rates at historically low levels, 

nonfinancial firms continued to raise funds at 

a strong pace in the second half of 2012, Bond 

issuance by both investment- and speculativegrade nonfinancial firms was extraordinarily 

strong, although much of the proceeds from 

bond issuance appeared to be earmarked for 

the refinancing of existing debt (figure 24). 

Meanwhile, nonfinancial commercial paper 

(CP) outstanding .... 'aS about unchanged. 

Issuance in the institutional segment of 

the syndicated le\"eraged loan market 

accelerated in the second half of the year, 

boosted by rapid growth of newly established 

collateralized loan obligations. Commercial 

and industrial (C&l) loans outstanding at 

commercial banking organizations in the 

United States continued to expand at a brisk 

pace in the second half of 2012, Moreover, 

according to the SLOOS, modest net fractions 

of banks continued to report having eased 

their lending standards on C&I loans over the 

second half of the year, and large net fractions 

of banks indicated having reduced the spread 

of rates on C&I loans over their cost of funds, 

largely in response to increased competition 

from other banks or nonbank lenders 

(figurd5). 

Gross public equity issuance by nonfinancial 

firms slowed a bit in the second half of 2012, 

held down by a moderate pace of initial 

public offerings. Meanwhile, data for the 

third quarter of 2012 indicate that net equity 

issuance remained deeply negative, as share 

repurchases and cash-financed mergers by 

nonfinancial firms remained robust (figure 26). 

Borrowing conditions for small 

businesses continued to improve, albeit 

more gradually than for large firms 

Borrowing conditions for small businesses 

continued to improve over the second half of 

2012, but as has been the case in recent years, 

the improvement was mOfe gradual than 

for larger firms. Moreover, the demand for 

credit from small firms apparently remained 

subdued. C&I loans with original amounts 

MONETARY POlICY REPORT: FEBRUARY 2013 17 

22 Change in real business fixed investment, 2006--[2 

-w 

IcI IH2-1O c 

~ - w 

-w 

- w 

1 I [ 1 

2006 2007 2001 2009 ~IO ~ll 1012 

23. Financial ratios for nonfinancial cocporations. 

1990-2012 

.. C-______________________ ~ .. 

L'quidWOlSov<:< 

;; - .. - -.ll 

W - -. " - - .m 

" - D.t.t.,.." - .0 " - tow ....... 

1""""""""""",,1 1992 1996 2000 XII)4 2008 2012 

No,.., n. dall are..""".] thm:gh 1995, quuterly th"",.n.:, and",ttlOl! 

thrvuch2!l11:QJ. 

SooJcE: C."..,. ... tat. 

24. Selected cOOlpooents of net fmancing foc noofmancial 

businesses, 2005- 12 

I I 

D C=:rt.lI'Oi!lp&p<r 

.""" . &nkll)&;1$ 

- s"", 

.- W 

-w 

- w 

- w 

-~ 

I , I I 

2005 2(106 2001 lOOS ,009 2010 lOll :on 

Non: Th! d..to for Ih< '''''p<lrI<Il~ .;tc<:ptbonds m "!I$():>llty tdj .. to:d ScmcJ; From! R<S<JV<Boa:d,!low offunds clall. 
65 


18 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

25 Change in standards and spreads nf1nan rates nvcr 

banks' cns! nf fimds fm cntruneTCial and industrial 

lOOIls, 1991-2012 

.... 19'92 1996 2000 2004 2000 2012 

N<YIII: Thod.m"",cI:a""'fm:n."",~yttnmllyoondt!cttdf<llrtimes ptr 

ym; the last ~ i. from tho JIID.ua:y 20ll '\ItVt')', whi:h rovm 

2012;Qo1, E",b ..n.. f<PI""':I/. the 00\ P<=I of.~ bcl. tbot 

ttpIImd. tighttnint or.taJ>latds '" inm .. ioj: <pruds of,.,.. ra! .. 11m the 

ba::k's C<IOlor I'und1 rMcllllllllm'iai ond industrial I""" over the past1hm 

mo::~ Tho Ih>dNI bars ioili,.,t< l""iodI. oi h.uiool.l "",,"ion '" d<of",,,,,- by 

theNO!i.o::l.aIllIlfflw.oi~'R" .. "",!t. 

SooJi:'J;;: F"rloral R,Il't'.', Boord, Sf:lio:r u.n orii"", OpiniM SuMy OJ> 

&Ilk Lendq rr..:u: ... 

26. Cnmponents of net equity issuance, 2006-12 

- I Public issumc< 

I PriYatoil$"""'o 

- I Rqrnro!w/S 

o Mergers and acquisitions - _ Total 

I I I I I I I 2006 2007 2008 2009 2010 201l 20\2 

30 

,,. 

NOT>; Net eqJ.ity ;"",noo is the diITmnco b<two." <qcity i'o.Jod by 

domesli<: eo"",ani .. ill public II" pri .... :. mllk<'.s and equity mimi tbrougb 

share "V.crcr...... dom ... .i. <:I.1b·Iinanc.d mergm, II" fmtign:aktovtrs of 

U.s. rl:!DS. Eq-.:ity iSiS'"""'" i:>::b ... ftwdo ilI",s:od by prival' <qt:ily 

partI><:1hil"and ,took "I".ion p:=t<h 

SOOAC!:: n.o:."", Rtulers Fm:.:iol, llIvestrn<Il1 8t!>:.h:Ilck RtpOIl; 

I'ricewtt~~ and NotioOll V<Iltc.'< C~ital Al$OOiOlion. 

M""oyTrt.R<pon. 

of $1 million or less-a large share of which 

likely consist of loans to small businessesfose slightly in the second half of 2012, at 

about the same rate that prevailed in the 

first half. Recent readings from the Survey 

of Terms of Business Lending indicate that 

the spreads charged by commercial banks 

on newly originated C&I loans v.;th original 

amounts less than $1 million, while still quite 

elevated, continued to decline.4 

According to surveys conducted by the 

National Federation of Independent Business 

during the second half of 2012, the fraction of 

small businesses with borrowing needs stayed 

low. The net percentage of respondents that 

found credit more difficult to obtain than three 

months prior edged up, on balance, over this 

period, as did the net percentage that expected 

tighter credit conditions over the next three 

months; both measures remained at relatively 

high levels in the January survey. 

Financial conditions in the commercial 

real estate sector eased but remained 

relative ly tight 

Financial conditions in the e RE sector 

continued to ease but remained relatively 

tight amid weak fundamentals. According to 

the SLOOS, a modest net fraction of banks 

reported having eased standards on e RE 

loans oyer the second half of last year, and 

a significant net fraction of banks reported 

increased demand for such loans. Consistent 

with these readings, the multiyear contraction 

in banks' holdings of CRE loans continued 

to slow and, indeed, came roughly to a halt 

as banks' holdings of CRE loans were about 

flat over the last quarter of 2012. Issuance 

of commercial mortgage-backed securities 

(CMBS) continued to increase over the second 

half of 2012 from the low levels observed in 

2011 . Nonetheless., the delinquency rate on 

loans in CMBS pools remained extremely 

4. Data releases for the Survey ofTenns of Business 

Lendingare available on the Federal Re:;en'e Board's 

website at wwwJedera1reserve.gov/releasesle2ldefault. 

him. 
66 


high, as some borrowers with five-year loans 

issued in 2007 were unable to refinance upon 

the maturity of those loans because of high 

loan-to-value ratios. While delinquency 

rates for e RE loans at commercial banks 

continued to decline, they remained somewhat 

elevated, especially for construction and land 

development loans. 

Budget strains for state and local 

governments eased, bul federal purchases 

continued 10 decline 

Strains on state and local government 

budgets appear to have lessened some since 

earlier in the recovery. Although fede ral 

grants provided to state governments in the 

American Recovery and Reinvestment Act 

have essentially pbased out, state and local 

tax receipts, which have been increasing since 

2010, rose moderately further o\'er the second 

half of last year. Accordingly, after declining 

at an annual rate of I Viz percent in the first 

half of last year, real government purchases 

at the state and local level changed little in tbe 

second half (figure 27). Similarly, employment 

levels at states and municipalities, which had 

been declining since 2009, changed little, on 

balance, over the second half of last year. 

Federal purchases continued to decline over 

the second half of 2012, reflecting ongoing 

efforts to reduce the budget deficit and tbe 

scaling back of overseas military activities. 

As measured in the NIPA, real federal 

expenditures on consumption and gross 

investment- the part of federal spending 

included in the calculation of GDP- fell at 

an annual rate of 3Viz percent over the second 

half of 2012. Real defense spending fell at an 

annual rate of a little over 6 percent, while 

nondefense purchases increased al an annual 

rate of 2 percent. 

The deficit in the federal unified budget 

remains high. The budget deficit for fiscal 

year 2012 was SI.1 trillion, or 7 percent of 

nominal GDP, down from the deficit recorded 

in 2011 but still sharply higher than tbe 

MONETARY POlICY REPORT: FEBRUARY 201 3 19 

27 Change in real gOI'erJUIItllt e,;:pendirures 

011 consumption and investment, 2006-12 

o f edm.1 

• Stot.l!:ld 

"" 

• 

I I 2006 2007 2008 2IXl9 2010 21111 201 1 

- , 

- , 

- , 

I I 

Soo.ruJj: D!partmtnt ofCom:n"" ., Bum.u ofEo"",:"i< Analysi~ 
67 


20 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

28 Federnl receipts IlIXI aperxlitures, 1992 2012 

Rectipts - n 

I " 111 "' 11 ' '' '' 111''111 I 1992 19915 nJO 200l 2OOl! 101. 

NDTI: n.-rec.ipts .. d....,.....ditu... data aro.., . ""if .. d.budgellwi.oru! 

an! for f=l )'tat:I (Octobtr throu&h Sq:r."",ber~ 1:"'" d<rn .. tio ~ 

(OOP) is for tl:. four ",=oro endm; io QJ. 

s.c..tacJ;: Ofil,.ofM.nag,""""tandBudt<!t. 

29 Federal govcnunent debt heM by the public, 196IJ-2012 

I 1II II IIt' lllI ltllt ltll l!tll ltll ll 'lIt lllt l'l ll lt!t lllt I ,., 1m ,m 1992 2002 2012 

N<"I11 : no da!a for dtbt tI:too&h 1011 art 11 of ym.end, and tho 

C<msp<l:ilin3 vW. f ... "",. WmtsIr product (GDp) art for Q4 JI II:! 

a

_. ll:,,!.''':'' ~"~"""",,!JO.MI~ .. ~:.<>ffedml~ 

Soom::I!: Bur= of Eronom>:- AllaIY"~ D<partmrllI of tho Treasury. 

F= .. IM""",,,..otS<,,,,,,.. 

30 Change in real imports and exports of goods 

and services, 2007- 12 

I I 

~ 

. -

J 

1JJfJ7 200lI ))1)9 2010 lOll 2012 

- w 

I I 

Soola: Depa!1ml<llofC"""" ..... Bure", .fEronornioAWysiL 

deficits recorded prior to the onset of the last 

recession. The narrowing of the budget deficit 

relative to fiscal 20 II reflected an increase in 

ta,\ revenues that largely stemmed from the 

gradual increase in economic activity as well 

as a decline in spending. Despite the rise in 

tax revenues, the ratio of federal receipts to 

national income, at 16 percent in fiscal 2012, 

remained near the low end of the range for 

this ratio over the past 60 years (figure 28). 

The ratio of federal outlays to GOP declined 

but was still high by historical standards, at 

23 percent. With deficits still large, federal 

debt held by the public rose to 73 percent of 

nominal GDP in the fourth quarter of 2012, 

5 percentage points higher than at the end of 

2011 (5gur<29). 

Net exports added modestly to real GOP 

growth 

Real imports of goods and services contracted 

at an annual rate of nearly 2 percent over the 

second half of 2012, held back by the sluggish 

pace of U.S. demand (figure 30). The decline 

in imports was fairly broad based across major 

trading partners and categories of trade. 

Real exports of goods and services also fell at 

an annual rate of about 2 percent in the second 

half despite continued expansion in demand 

from EM&. Exports v.'Cfe dragged down by 

a steep falloff in demand from the euro area 

and declining export sales to Japan, consistent 

with weak economic conditions in those areas. 

In contrast, exports to Canada remained 

essentially flal. Across the major categories 

of exports, industrial supplies, automoti\'e 

products, and agricultural goodscomributed 

to the overall decrease . 

Overall, real net exports added an estimated 

0.1 percentage point to real GOP growth in 

the second half of 2012, according to the 

advance estimate of GOP from the Bureau 

of Economic Analysis, but data received 

since then suggest a somewhat larger positive 

contribution. 
68 


The nominal trade deficit shrank, on net, 

o\'er the second half of 2012, contributing to 

the narrowing of the current account deficit 

to 2* percent of GOP in the third quarter 

(figure 3\). The trade deficit as a share of GOP 

narrowed substantially in late 2008 and early 

2009 when U.S. imports dropped sharply, in 

part reflecting the steep decline in oil prices. 

Since then, the lrade deficit as a share of GOP 

has remained close to its 20091e\'el: Although 

imports recovered from their earlier drop, 

exports strengthened as well. 

The current account deficit in the third 

quarter was financed by strong inflo\\'$ from 

foreign official institutions and by foreign 

private purchases of Treasury securities 

and equities (figure 32). More-recent data 

suggest continued strong foreign purchases of 

Treasury securities and equities in the fourth 

quaner of 2012. Consistent with improved 

market sentiment over the third quaner, U.S. 

investors also increased lheir holdings of 

foreign assets, as shown in figure 32. 

National saving is very low 

Total U.S. net national saving-that is, the 

saving of U.S. households, businesses, and 

governments, net of depreciation chargesremains extremely low by historical standards 

(figure 33). In the third quarter of last year, net 

national saving as a percent of nominal GDP 

was close to zero. The relative flatness of the 

national saving rate over the past few years 

reflects the ofTsening efTects of a narrowing 

in the federal budget deficit as a share of 

nominal GOP and a downward movement 

in the private saving rate. National saving 

will likely remain low this year, in light of the 

still-large federal budget deficit. A ponion 

of the decline in federal savings relative to 

pre-recession levels is cyclical and would be 

expected to reverse as the economy recovers. 

If low levels of national sa'~ng persist over the 

longer run, they \\~ll ikely be associated \\~th 

both low rates of capital formation and heavy 

borrowing from abroad, limiting the rise in the 

standard of living for U.S. residents over time. 

MONETARY POlICY REPORT: FEBRUARY 2013 21 

3t US track and currml 3c\:Oll!lt balances, 2004-12 

I! ! 

'''' ",. I I I I 

200s 1010 

, 

WI> 

- , 

- , 

- , 

- • 

- , 

- • - , , I 

Non: Th< <!ala.,.. quanerly o:d ex!<":Id !hrou&h2012:QJ for!ht CUIml! 

aro>UIl! ond 2012:Q4 for!Ilde. GD? i. groo. Wmc-oti, pro<!::OI. 

Soot",: o,.p..-w.n! "'C~B"" .. ."of&o""",;" A:>aly>i~ 

32. US net financial inflows, 200S-l2 

o U.S.p:;\*(iodudi:gbcl.irI&) 

• FmiY'P:;\':!!. (indlldintN.ol:t:.g) 

• U.SolT.d.1 

• FmiY'0ff" ial 

I I I I 

'" 2009 1010 "" 2012 

"., 

... 

... 

'00 

'00 

'00 

' 00 

NOli: Th< dJIa art C[IWI<rIy a::d .... ",nd !hrou&h 2012:Q3. Negative 

numbon indica'" • babnce of p.)metlts OUIO"... ~ whOII u.s. midMns, on n.t, ~ romgn .. "" orwh", forIoigt ~ onn<l, 0<11 u.s . ... !IS. ThmiOrt,' "'got;.. .• number r,.. ·U.s. privot." or ·U.S . 

• ff"ior i::.~",.toJ "" i:t=ue;, r....:", jrniuoao. u.s .• ff,,;.] a",,~ itd. 

!ht f ... ign =""1' ."quirN ... !.-n f<I-,;Y' "':~ t.cl1 drow on I!><ir...-.p 

lioIs"·i\hlheF<dmIR ....... . 

Sooru:1: ~"'C"""".r ... B""'.uofEoono:ni"~I)'>i~ 
69 


22 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

33. Net saving, 1992- 2(112 

l'tt:<o, oI_rnp 

I I I I I I I I I I I I I I I I I I I I ' II I t!l9! 1996 !ooo ! 004 !008 !On 

NOlI n. dst.a.,.. """,my o::d ",to<,d ~ 2Il12 :Ql N,,::f<:drn.1 

,.,..;"gi, Ih. """, ~m:lnO! bu$ io"'I&>ing""" tMIl<'t .. vi:og of 

state and 10<01 l<N<mmelltJ. GDP io VO"1lomt"", product. 

SooJa: Depon:n",' "f COOlIllOTC<, Bum.u "fEcotJ>mi, Anal},>". 

34. Interest rates on Treasury securities at selected 

ma.turities, 2004- 13 

{).~"'''''''''!II I 

~I- v,,,, ~ \, ""w' 

V" 

I I )~ 

'''' '''' '''' "" ." 

,-

- , 

-. 

- , 

- , 

- , 

-, 

I I 

Nom: n. dati. n daityand exte:od throoch Febnwy 21,2011. Trwwy 

u:/bti(l:.prolfl"ttd l'Iln~ " (TIPS) ., . ...... '" yield <1m'" frtW. II)' 

f.r.ml R."", •• tl.fft<>on· and oCf·fht.run nps 

SoulcE Dtpart::IeIl! ~ lb. TmsuI)': BL."Ia)'l; F.r.ml R,,,,,,. Bolrd 

,uff .. !CWe<. 

Financial Developments 

Expectations rega rding the future 

stance of mon etary policy refl ected the 

additional accommodation provid ed by 

th e Federal Open Market Committee ... 

In response to the steps taken by the FOMe 

to provide additional monetary policy 

accommodation over the second half of 

2012, market participants pushed out the 

date when they expect the federal funds rate 

to first rise atxwe its current target range of 

o to ~ percent. In particular, interest rates on 

overnight index ~aps indicate that investors 

currently ant icipate that the effective federal 

funds rate will rise above its curremtarget 

range around the fourth quarter of 2014, 

roughly four quarters later than they expected 

at the end of June 2012. Meanwhile, the modal 

target rate path-the most likely values for 

future federal funds rates derived from interest 

rate options-suggests that invest ors think 

the rate is most likely to remain in its current 

range through the first quarter of 2016. In 

addition, recent readings from the Survey 

of Primary Dealers conducted by the Open 

Market Desk at the Federal Reserve Bank of 

New York suggest that market participams 

expect the Federal Reserve to hold about 

$3.75 trillion of Treasury and agency securities 

at the end of 2014 , roughly $1 trillion more 

than was expected in the middle of 2012.1 

... and held yields on longe r-term 

Treasury securities and agency mortgagebacked securities nea r histori c lows 

Yields on nominal and inflation-protected 

Treasury securities remained near historic 

10 .... 'S over the second half of 2012 and 

into 2013. Yields on longer-term nominal 

Treasury securities rose, on balance, over this 

period, while yields on inflation-protected 

securities fell (figure 34). These changes likely 

5. The Sur;·ey of Primary Dealers is available on 

the Federal Reser;·e Balik of New York's website at 

www.newyorkfed.org/marketslprimarydealeuumy_ 

questiolls.html. 
70 


reftect the effects of additional monetary 

accommodation, a substantial improvement 

in sentiment regarding the crisis in Europe 

that reduced demand for the relative safety 

and liquidity of nominal Treasury securities., 

and increases in the prices of key commodities 

since the end of June 2012. On balance, 

yields on 5-, 10-, and 3D-year nominal 

Treasury securities increased roughly 15 basis 

points, 30 basis points, and 40 basis points, 

respectively, from their levels at the end of 

June 2012, while yields on 5- and IO-year 

inflation-protected securities decreased 

roughly 55 basis points and 15 basis points, 

respectively. Treasury auctions generally 

continued to be ""'ell received by im'estors, and 

the Desk's outright purchases and sales of 

Treasury securities did not appear to have a 

material adverse effect on liquidity or market 

functioning. 

Yields on agency MBS were lin Ie changed, 

on net, o\·er the second half of 2012 and 

into 2013. They fell sharply following the 

FOMe's announcement of additional agency 

MBS purcbases in September but retraced 

o\"er subsequent months. Spreads of yields 

on agency MBS over yields on nominal 

Treasury securities narrowed, largely reflecting 

the effects of tbe additional monetary 

accommodation (figure 35). The Desk's 

outright purcbases of agency MBS did nOI 

appear to have a material adverse effect on 

liquidity or market functioning, although 

implied financing rates for some securities in 

the MBS dollar roll market declined in the 

second half of 2012, and tbe Desk responded 

by postponing senlement of some purchases 

using dollar rolliransaciions. 6 

6. Dollar roO transactioos consist of a purchase or sale 

of agency MRS with the simultaneous agreement to sell 

or purchase substantially similar securities on a specified 

future date. The Conuuittee dim:ts the Desk to engage in 

these transactions as necessary to facilitate settlement of 

the federa l Reserve's agency MRS purchases. 

MONETARY POl ICY REPORT: FEBRUARY 1Q13 23 

35. Current-coupon yield and spread fOf agencyguaranteed mortgage-backed securities, 2009-13 

'-:,-------------=-

m 

- ,. 

- m 

I I I " I " I Jon July JOil. My Jan. July Jan. kly JOil. 

2009 ~10 2011 2012 lOll 

N<m The do!>. 1ft d>ily and <'Xtrnd throu#t Fobrtwy 21, ~IJ Yiot.! 

shown is Cor Iho fotci. M1t 3O_yur =111 OO"flOO, tho «q>OlI ralt at 

which • .,. !IIOt\p!.-bock<d so:uriti .. WlrJd bo pi.:odat par, or r",., vaIu<. 

Spreod shown is to tho 0"""3' of tho wllQ.y""~T'"""wyyield& 

~ !)qwtmom oltho TrtlIS1l/Y; 1latt1a)'S. 
71 


24 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

36 Spreads ofcOJporate bond yields over comparable 

ofI·tbe·nDJ Treasury yields, by securities rating, 

1997 2013 

ti t I I I I I I I ! I I ! I I I tit 

1997 1999 1001 2003 ZOOS 1007 2009 20ll 2013 

NOTt: 1M dIIIa m daily and .xtend through F!bruary 11, 1013. Th. 

!p!uds sh""",m th< yiolds on to-ytar bonds 10 .. tit. to-yea< T'"""'Y 

)'io!d. 

&.ru:i:: D!:tived fm:n s:nooth.d oO!pO!ll. yidd = <:sing, Me:riIt 

LytclIboc:dda:a. 

37. S&P500index,199'>-2013 

jlvY 

-/ 

- ,~ 

I I I I " " 1 I I II 1 I I I " " I t995 1998 200t 2004 2007 2010 1013 

NOTli: Thtdall "" daily ooda:e::dlhnrJgb February 21,201J. 

Sovm:: StaI&rd & l'ooI'l 

Yields on corporate bonds reached record 

lows, and equity prices increased 

Yields on in\'estmem- and speculative-grade 

bonds reached record 10v.'S in the second 

half of 2012 and early 2013, respectively, 

partly reflecting the effects of the FOMe's 

additional monetary policy accommodation 

and increased il1\'estor appetite for bearing 

risk. Spreads to comparable-maturity Treasury 

securities also narrowed substamially but 

remained above the narrowest levels that they 

reached prior to the financial crisis (figure 36). 

Prices in the secondary market for syndicated 

leveraged loans have increased, on balance, 

since the middle of 2012. 

Broad equity price indexes have increased 

about 10 percent since the end of June 2012, 

boosted by the same factors that comributed 

10 the narrowing in bond spreads (figure 37). 

Nevertheless, the spread between the 12-month 

forward earnings-price ratio fo r the S&P 500 

and a long-run real Treasury yield- a rough 

gauge of the equity risk premium-remained 

at the high end of its historical range 

(figure 38). Implied volatility for the S&P 500 

index, as calculated from option prices, spiked 

at times but is currently neaf the bottom end 

of the range it has occupied since the onset of 

the financial crisis (figure 39). 

Conditions in short-term dollar funding 

markets improved some in the third 

quarter and remained stable thereafter 

Measures of stress in unsecured dollar funding 

markets eased somewhat in the third quarter 

of 2012 and remained stable at relatively low 

le\'els thereafter, reflecting impro\'ed semimem 

regarding the crisis in Europe. For example, 

the average maturity of unsecured financial CP 

issued by institutions with European parents 

increased, on nel, to around the same length 

as such CP issued by institutions with U.S. 

parents. 

Signs of stre~ were largely absent in secured 

short-term dollar funding markets. In the 

market for repurchase agreements (repos), 
72 


bid-asked spreads and haircuts for most 

collateral types have changed little since the 

middle of 2012. Howen:r, repo rates continued 

to edge up over the second half of 2012, likely 

reflecting in part the financing of the increase 

in dealers' inventories of shorter-term Treasury 

securities that resulted from the maturity 

extension program (MEP). Following yearend, repo rates fell back as the MEP came 

to an end and the level of reserve balances 

began to increase. In asset-backed commercial 

paper (ABCP) markets, volumes outstanding 

declined a bit for programs with European and 

U.S. sponsors, while spreads on ABCPwith 

European bank sponsors remained slightly 

above those on ABCP with U.S. bank sponsors. 

Year-end pressures in short-term funding 

markets were generally modest and roughly 

in line with the experiences during other years 

since the financial crisis. 

Market sentiment toward th e banking 

industry improved as the profitability of 

banks increased 

Market sentiment toward the banking 

industry improved in the second half of 2012, 

reportedly driven in large part by perceptions 

of reduced downside risks stemming from the 

European crisis. Equity prices for bank holding 

companies (BHCs) increased, outpacing 

the increases in broad equity price indexes, 

and BHC credit default swap (CDS) spreads 

declined (figure 40). 

The profitability of BHCs increased in the 

second half of 2012 but continued to run 

well below the levels that prevailed before 

the financial crisis (figure 41). Measures of 

asset quality generally improved further, as 

delinquency and charge-otT rates decreased for 

almost all major loan categories, although the 

recent improvement in delinquency rates for 

consumer credit in part reflects a compositional 

shift of credit supply toward higber-creditquality borrowers. Loan loss provisions were 

flat at around the slightly elevated levels seen 

prior to the crisis., though they continued 

\0 be outpaced by charge-otTs. Regulatory 

MONETARY POl ICY REPORT: FEBRUARY 2013 25 

38 Real lOf1g·nuJ Treasury yiekl and 12·month forward 

earnings-price ratio for the S&P 500, 1995-2013 

------------------------~,--

-w 

1 I I I 11 1 I I I I 1 I I 1 I I 1 I 111 

19'1:S 1m 2001 2(1(14 2007 2010 lOll 

N01I!: Th. data .... IIIOllthly cd .. tend lhrou&!> .ianill:)' 2011. lb< 

"'I"""I<dral y;.ld on 10.1""' fItMIll)' ~ Mfrntd .. tht o(f·tht·"", 10"1""' 

Trtuury y;.1d Ie" tbt F<dml R.oerve Bank of Philadtlrtia', IO·ynr 

~il:fIolion. 

SWm: S~ &: P(Wli~ Th>:n$<ll) R<U!rn Fin.a:rio1;F<dm.1 ~ 

B=d; FtdmI R".,... Bank ofPhilodtljrnL 

39 Implied S&P 500 volatiliry, 1995 2013 

- w 

- ," 

~ 

- ,. 

-~ 

-,. 

-w 

-w 

, I I 1 11 I 1 1 I 1 1 1 I 1 1 I 1 1 I 1 I 

1m 1998 2001 200< 2007 2010 lOll 

N01I!: The dato "" weekly aM <'XtrruI througb tht w..o: rn.!i", 

F<'bruary 15, 2Il13. Th. w:rits sl»wn--tht VLX_ is tbt imp~td )O.doy 

wlQilily of tbt S&P 500 0I<>d: I'ri<,< io<!O< .. ,o1cu1l1e1l from , " .. iglmd 

'¥mg' rI. opions Iri:<~ 

Sool£i: Chi:a&" BoudOp;imIs Exohar!&" 
73 


26 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

4<l. Spreads 011 credit default swaps for selected 

U.S. bankingorganizatioM, 2007- 13 

B_,_ 

- '00 

- '" - ' 00 

I ho\ruojJ""""o" ~~ ... - '" 

,\ ~ - ' 00 

'" ".L v ~ '00 

" 2001 200& 1009 2010 20 11 lOtl 2013 

NO'JII : n.. dA:a 1ft daily ood a ttnd Ihrou&h FdIruary 21, 2013. M«!ia:I 

'f't<Ids fOlIi>; Iq< bonk holdiq , ornpW<> oed oW< oll:<r bcls. Soolc>;, Ma:kit 

41. Profitability of bank holding companies, 1997 2012 

l.l -

1.0 -

1.0 -

l.l -

I ! I I I I ! I II I I I I I I II I t!)97 100) »)3 1006 1009 1012 

NOT!' Th. dat>., whiob .,.. " """,Dy uljusttd, L ... qUOrlrny and <l1<::o 

tbrou# 1012Q4. 

Scoc:i: FodmI R • ..,.... &ord, FR Y-9C, COIISOUo.t<d Fin.o:!oiaJ 

S:o.t""",(sfor&:il<Hoidi", C"",,,,,,,i ... 

capital ratios remained at high levels based 

on current standards., but the implementation 

of generally more stringent Basel III capital 

requirements will likely lead to some decline in 

reported regulatory capital ratios at the largest 

banks. Overall, banks remain well funded 

with deposits., and their reliance on short-term 

wholesale funding stayed near its low levels 

seen in re<:em quarters. The expiration of 

the Federal Deposit Insurance Corporation'S 

Transaction Account Guarantee program 

on December 31, 2012, does not appear to 

have caused any significant change in the 

availability of deposit funding for banks. 

Credit provided by commercial banking 

organizations in the United Slates increased 

in the second half of 2012 at about the same 

moderate pace as in the first half of the year. 

Core loans- the sum of C&I loans, real 

estate loans, and consumer loans-expanded 

modestly, with strong growth in C&I loans 

offsetting l,I:eakness in real estate and credit 

card loans (figure 42). Banks' holdings of 

securities continued to rise moderately overall, 

as strong growth in holdings of Treasury and 

municipal securities more than offset modest 

declines in holdings of agency MBS. 

Despite continued improvements in 

market conditions, risks to the stability of 

financial markets remain 

While conditions in short-term dollar funding 

markets have improved, these markets remain 

vulnerable to potential stresses. Money market 

funds (MMFs) han! sharply reduced their 

overall exposures to Europe since the middle 

of 2011 , but prime fund exposures to Europe 

continue to be substantial. MMFs also remain 

susceptible to the risk of investor runs due 

to structural vulnerabilities posed by the 

rounding of net asset values and the absence 

of loss-absorbing capital.) 

7. In November 2012, the Financial Stability O..-eroigbt 

CoWlcil proposed reconunendations for structural 

refonns of U.S. MM Fs to reduce their vulnerability to 

runs and mitigate as:!OCiated risks to the financial system. 
74 


Dealer firms have reduced their wholesale 

short -term funding ratios and have increased 

their liquidity butTers in recent years, but 

they still heavily rely on wholesale short -term 

funding. As a result, they remain susceptible 

to swings in market confidence and a possible 

resurgence of anxiety regarding counterparty 

credit risk. Respondents to the Senior Credit 

Officer Opinion Survey on Dealer Financing 

Terms indicated that credit terms applicable to 

important classes of counterparties were lillie 

changed over the second half of 20 12.8 Dealers 

reported increased demand for funding of 

securitized products and indicated that the use 

of financial leverage among trading real estate 

investment trusts, or REITs, had increased 

somewhat. Hov.'ever, respondents continued 

to note an increase in the amount of resources 

and allention devoted to the management 

of concentrated exposures 10 Central 

counterparties and other financial utilities as 

well as, to a smaller extent, dealers and other 

financial intermediaries. 

With prospective returns on safe assets 

remaining low, some financial market 

participants appeared willing to take on more 

duration and credit risk to boost returns. The 

pace of speculative-grade corporate bond 

issuance has been rapid in recent months, and 

while most of this issuance appears to have 

been earmarked for the refinancing of existing 

debt, there has also been an increase in debt 

to facilitate transactions involving significant 

risks. In particular, in bonds issued to finance 

private equity transactions, there has been a 

reemergence of payment-in-kind options that 

permit the issuer to increase the face value of 

debt in lieu of a cash interest payment, and 

anecdotal reports indicate that bond covenants 

are becoming less restricti\'e. Similarly, 

issuance of bank loans \0 finance dividend 

recapitalization deals as \\'ell as covenant -lite 

loans was robust over the second half of the 

8. The Senior Credit Officer Opinion Sumy on Dealer 

Financing Term;; is available en the Federal Rese!'\'e 

Board's website at wwwJederairesen·e.gOllleconresdatal 

releaseslscoos.htm. 

MONETARY POl ICY REPORT: FEBRUARY 1Q13 27 

42 Change in commercial811d industrial loans and core 

loans, 1990-2012 

w 

-w 

- '" I I I I I I I I I I II I I I I I I I I I I I I I I 

t991 1'194 1!m 2000 1003 2006 100\1 1012 

NOlI: The cla,., which.", ,etI<IlII.lly adj".:st«I, .... quorteIly and ",n~ 

!hn>ugb :!012:Q4.COf< ""'" =si_Qf'O:o:q,ml lo::d iwiustrioll_ .. ,I 

.. tate k>o::s, o.nd 0""'''''''''' k>a:u. Data hove """" adjUJll:d for bo:W" 

inl>l<memation Qfe<r!lin ",,=tiog 11lI. dlongt< (i:1'~.Idio& tho Finan..-iol 

A"' .. .:::!i:1,S~Il<>&nf tat""'<C.ti QfFi=io l~ su:.lOO 

Noo. 160 aru:l167jandf<Itho.ffe<Uo>flq.nort.clir.stitntion!«>nmliog 

toro:n:n~iol DaW O:!IIOT!in3 .. ;thl""""",~iol h:lk. 

Soolt::i; F<dmI Rfiervo JkIo.--d, SlItist.,.1 R ...... H.S, "AWtl aru:l 

Liahi~ti .. o>fC"""",mol Bcl:s "' tho U-.... .ed Swos: 
75 


28 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

Table I. Selected components of the Federal Resen'e balance sheet, 2012- 13 

;\li!li"",ofdolJars 

T ... I .... t<" .. 

Selo:ltJ u .. tI 

Crodi! e:<~ lori.:ponMl 'Im·r.JJWnJ rM dealen Primlryortdit... 

Crodi! tx~IOC'!JD".".Wparri~" 

Term AoseI·BaobJ Securities Loilo Facilily (TAL!'). .. . 

N<I portfolio boidioy ofTALF LLC 

S~pon b/ ctiN,,1 itI,i/w'"" 

~b.22, 

"" 

.9~.1 49 

107,959 

7,679 

'" 

""" WB 

1.S6S,ms J.Il9Ii.801 

" 27,059 5.192 

,m 

'OS '" ~, 

N<t portfolio boldi""of Maiden La .. LLC, Maiden La ... II LLC, and Maiden La .. III LLC' .. >0,822 15, 03 1 1,4S1 

SmI~""IoddOUlrit;Jt' 

U.s,Tr",u'Y9l!Cllrilieo .. . 

AlJOIICYdobt...:urit;.., .. . 

Ayo<y""'rt~"""Bl9l!Clllilieo MBSJ .... 

T ... n ,WiriH 

Selo:"" liabilities 

IW:ral RneM AQ(t< ill cimJlatioo ... 

Re. ..... rep"rcb""'~.u .. o.po.it< bol.l bot do"""it"')' i .. tiulli"", .. 

or .. 'bib:Ttrmdoposiu 

.s T"~''"'Y I:''""raIO<X:<)"nl 

U.s, T,u,u'll S"~pltrutolil'Y Finfin<illt A""'""l .... 

TOIll copill1 

N""" LlC. , 'i""d I"bilily """'1"l' 

1,656,581 

100,817 

353,M5 

'"'"'' 

1.{I48,00I 

S9,S~ 

1,622,800 

• >6,033 

• 

"'" 

1,666,530 1,136,456 

91,41 ;4,613 854,9j9 1,031,112 

2.8 11.019 J.{).I1.8W 

1,061,91 1 1,12l,l2J 

Sl,nJ !n,ll) 

1,491,988 1,668,381 

m.m • • 40)03 

• • 

"'" 5-4.982 

1 n. Fedml Ro""" buut .. ded mdil to,"",,,1 u.c." ""jUlleoo, witll ,rr .. "., "'I'P"" .,."~'" ;,,"rooo,. Maid" lAo. UC .... f<rOled '0 "'l";" """~ ... ,~ of 

n, it" S~."'. eoOlp>.>itl 1>0. M..,,, Wo' n LLC .... f<rmol '" ptltOlut "oiJ,,';"llI>Ortg'tl!'·b«h4 '""""~. I"" ,he US. """',., k'di'l "'~mtot'" ponfoJiool 

JuWid,uiuor AIIl",~ ... I>~",""'''' Orou~ "'~ (Ala), Maid" La, m LlC .... formed to pur<l> ..... oIti_r ",It.<mliz<d d.bt oliiptiou oo. ...,io\. Ib, Fi .. oci~ I'rod""b 

,,,,,!,ol AIO •• d ..ntt" -=I. d,bul, '"'I'eoOl,,",," 

~ "'~d" "'I)' MRS purlOb .... "''' ."" "''''''Y ,mb:! Scola; Fed.,,1 R<""", lloanl,S,,"=!C>I R, • ..., H~ I, "F"" .. A!I;,,"'i R,,,,,,, lIo.1u<to of Dtp«;,'1)' 1 .... ",_ .. d eo.d.". St~''''''' of Fe4",1 R,,,,,,, 11>,1:0.' 

year. (For a discussion of regulatory steps 

taken related to financial stability, see the 

box "The Federal Reserve's Actions to Foster 

Financial Stability.") 

Federal Reserve assets increased, and the 

average matu rity of its Treasury holdings 

lengthened, . , 

Total assets of the Federal Reserve increased 

to $3,097 billion as of February 20, 2013, 

$231 billion more than attbe end of 

June 2012 (table 1). The increase primarily 

reflects growth in Federal Reserve holdings 

of Treasury securities and agency MBS as a 

result of the purchase programs initiated at the 

September 2012 and December 2012 FOMC 

meetings. As of February 20, 2013, the par 

value of Treasury securities and agency M BS 

held by the Federal Reserve had increased 

$70 billion and $178 billion, respectively, 

since the end of June 2012. The composition 

of Treasury securities holdings also changed 

over the second half of 2012 as a result 

of the continuation of the MEP, which was 

announced at the June 2012 FOMC meeting. 

Under this program, betv.een July and 

December, the Desk purchased $267 billion in 

Treasury securities \\'ith remaining maturities 

of 6 to 30 years and sold or redeemed an 

equal par value of Treasury securities with 

maturities of 3 years or less. As a result, the 

average maturity of the Federal Reserve's 

Treasury holdings increased 1.7 years over the 

second half of 2012 and into 2013 and, as of 

February 2013, stood at 10.5 years. 
76 


· .. while exposure to facilities 

established during the crisis continued to 

wind down 

In the second half of 2012, the Federal 

Reserve continued to reduce its exposure to 

facilities established during the financial crisis 

to support specific institutions. The portfolio 

holdings of Maiden Lane LLC and Maiden 

Lane III LLC-entities that were created 

during the crisis to acquire certain assets 

from The Bear Steams Companies, Inc., and 

American International Group, Inc., to avoid 

the disorderly failures of those institutionsdeclined $14 billion to approximately 

$1 billion, primarily reflecting the sale of the 

remaining securities in Maiden Lane III LLC 

that was announced in August 2012. These 

sales resulted in a net gain of $6.6 billion for 

the benefit of the U.S. public. The Federal 

Reserve's loans to Maiden Lane LLC 

and Maiden Lane III LLC had been fully 

repaid, with interest, as of June 2012. Loans 

outstanding under the Term Asset-Backed 

Securities Loan Facility (TALF) decreased 

$4 billion to under 51 billion because of 

prepayments and maturities of TALF loans. 

With accumulated fees collected through 

TALF exceeding the amount of TALF 

loans outstanding, the Federal Reserve and 

the Treasury agreed in January to end the 

backstop for TALF provided by the Troubled 

Asset Relief Program. 

The improvement in ofTshore U.S. dollar 

funding markets over the second half of 2012 

led to a decline in the outstanding amount 

of dollars provided through the temporary 

U.S. dollar liquidity swap arrangements 

with other central banks. As of February 20, 

2013, drav.--s on the liquidity swap lines "'ere 

$5 billion, down from $27 billion at the end of 

June 2012. On December 13, 2012, the Federal 

Resef\'e announced the extension of these 

arrangements through February 1, 2014. 

On tbe liability side of the Federal Resen'e's 

balance sheet, deposits held by depository 

institutions increased $176 billion since 

MONETARY POl ICY REPORT: FEBRUARY 2Ot3 29 

June 2012, while Federal Reserve notes in 

circulation rose $60 billion, reflecting solid 

demand botb at home and abroad. M2 

bas increased at an annual rate of about 

8 percent since June 2012. Holdings of M2 

assets, including its largest component, liquid 

deposits, remain elevated relative to what 

would have been expected based on historical 

relationships with nominal income and 

interest rates, likely due to investors' continued 

preference to hold safe and liquid assets. 

As pan of its ongoing program to ellsure the 

readiness of tools to manage resen'es, the 

Federal Reserve conducted a series of smallvalue re\·erse repurchase transactions using 

all eligible collateral types with its expanded 

list of counter parties, as \\'ell as a few smallvalue repurchase agreements with primary 

dealers. In the same vein, the Federal Reserve 

continued to otTer small-value term deposits 

through the Term Deposit Facility to provide 

eligible institutions with an opportunity 

to become familiar with term deposit 

operations. 

International Developments 

Foreign financial market stresses 

abated ... 

Since mid-July, global financial market 

conditions ha\·e improved, on balance, in 

part reflecting reduced fears of a significant 

worsening of the European fiscal and financial 

crisis. Market sentiment was bolstered 

by a new European Central Bank (ECB) 

framework for purchases of sovereign debt 

known as Outright Monetary Transactions 

(OMT), agreements on continued officialsector support for Greece, progress by Spain 

in recapitalizing its troubled banks, and some 

steps toward fiscal and financial integration 

in Europe. Nevertheless, financial market 

stresses in Europe remained elevated, and 

policymakers still face significant challenges 

(see the bo:< "An Update on the European 

Fiscal and Banking Crisis"). 
77 


30 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

The Federal Reserve's Actions to Foster Financial Stability 

The Federal Reserve continued to take actions 

in Ihe second half of 2012 and ea~y 2013 to me€t 

its financial stability responsibil ities. Although 

much remains 10 be done, the Federal Reserve 

has implemented regulatory reforms to streogthen 

the U.S. financial system, and it has taken further 

steps to gather in/ormation from the supervisioo of 

large banks, market reports, and other aonomic 

and financial sources to assess threats to financia l 

stability. The Federa l Reserve also has continued 

to work closely with its domestic regulatory 

counterparts and has taken actions to increase the 

resilience of the international financial regulatory 

architature. 

Regulation 

A core element of the globa l regulatory 

comrrunity's efforts to improve banking regulation 

has been the d€\felopment 0/ the Basel III capita l 

reforms. In June lOll, the Federal ReselVe Board and 

the other u.s. banking agencies issued a proposal 

to amend the u.s. bank capital rules to implement 

these reforms. The Basel III reforms will raise the 

quantity of capital that must be held by u.s. banking 

firms, improve the quality of regulatory capital 01 

those firms, and strengthen the risk.weight framework 

of u.s. bank capital rules. 

Consistent with the requirements of the DoddFrank Wall Street Re/orm and Consumer Protection 

Act r:i 2010 (Dodd-Frank Act), the Board has 

also proposed rules to strengthen the oversight 01 

the U.S. operations 01 foreign banks. Under the 

Board's Decerrber 2012 proposal, foreign banking 

organizations (FBOs) with a large U.S. presence 

would be required to create an intermediate holding 

company (IHC) over their U.S. subsidiaries, which 

would help/acilitate cOllSistent and enhanced 

supetvision and regulation of the U.S. operations of 

these/oreign banks. An IHC 01 a foreign bank would 

be required to meet the same U.S. risk·based capital 

and leverage ru les as a U.S. bank holding company 

(BHC).ln addition, IHCs and the U.S. branches and 

agencies of foreign banks lvith a large U.S. presence 

would need to meet liquidity requirements simlaI' to 

those imposed on U.S. BHCs. 

Progress in regulato!), reform outside 01 the 

traditional banking sector has been notable as well. 

For example, as mandated by the Dodd-frank Act, 

the n€lv supervisory framework for systemically 

important financial market utilities IFMUs}-that 

is, lhose entities that provide the infrastructure 

to make payments and clear and settle financial 

lransactions-has continued to take shape. In 

July 2011, the Financial Stability O:ersight Council 

IFSOC) designated eight FMUs as systemically 

important and thus subject to enhanced risk· 

management standards. On July 30, the Federal 

Reserve Board approved a final rule establishing 

enhaoced risk.management standards for designated 

FMUs supervised by the Federal Reserve. The rule 

also establishes processes to review and consult with 

the Saurities and Exchange Commission (SEC) and 

theCorrmxlity Futures Trading Commission (CFTC) 

on any proposed changes to the ru les, Il"ocedures, 

or opetations of certain designated fMUs that could 

materially affect the nature or 1€\Iei of their risk. 

The FSOC has also continued to make progress in 

its work to designate systemica lly important nonbank 

financial companies for consolidated supetllision by 

the federal Reserve. Relying primarily 011 data from 

publicly a\'ailable reports, the fSOC is evaluating 

the potential systemic importance of a nurrber 0/ 

nonbank firms that meet the quantitative criteria 

for a flrst.stage review; to date, it has concluded 

that some firms warranted further consideration 

and has advanced them to the third and final stage 

of the determination process. Meanwhile, the 

International Association 0/ Insuraoce Supetvisors, 

under the oversight of the Financial Stability 

Board, has continued to move forward on crafting 

a methooology to identify global systemically 

important insurers and developing policy measures 

that would be applicable to those institutions. 

In addition, efforts to increase the resilience 

of NshadoY.t banking," which refers to credit 

intermediation that occurs at least partly outside 

of the traditional banking system, are continuing. 

In November 2012, the FSCX: proposed 

recommendations for structural reforms of U.S. 

money market funds to reduce their vulnerability to 

runs and mitigate associated risks to the financia l 

system. Another set 0/ reforms has been aimed 

at the triparty repurchase agreement markets, 

including efforts by the federal Reserve to reduce 

the vulnerabilities created by the large amounts of 
78 


inlraday credil provided by clearing wnks in these 

markels.lnlemaliona l regulalory groups have also 

been addressing the financial slabilily risks of 

shadow wnking. 

Supervision 

The Federal Reserve has conlinued to work 10 

enDed its superlisory lXactices wilhin a broader 

macroprudenlial framework. Annual stress tests. 

which assess the internal capilal planning processes 

and capilal adequacy of Ihe largesl SHCs, conlinue 

to be an i~rtanl element in its strengthened. 

cross·firm supervisory approach. The latest 

ComlXehensi\l€ Capital Analysis and Review (Co\R 

1013), which covers the 18 largest SHCs (and is 

being conducted in a modified form for 11 other 

large SHCs), is IlOW under way. In O::tober 2012, 

the Soard published final stress·testing rules under 

the Dodd-frank Act, and it released the economic 

and financia l market stress scenarios for CO\R 

1013 in November.' Co\R 2013 results will be 

released in March of this year. 

The Federal Reserve has also been working 

to impro\l€ the resolvability of the largest, most 

cOITfllex banking firm;. The Dodd-frank Act 

created the Orderly Liquidation Authority (OLA) to 

improve the prospects for an orderly liquidalion of 

a systemic financial firm and requires that al l large 

BHes submit resolution plans to their supervisors. 

The Federal Deposit Insurance Corporation (FDIC) 

has been developing a single-lX!int.of.entry strategy 

for resolving systemic financial firm; under OLA, 

and the federal Reserve, working closely with the 

FDIC, has been carefully revieo.'1ing the resolution 

plans (the so·called living wil ls) submilled in the 

sUn1ll"'er and fall of 2012 by the largest and most 

cOITfllex BHCs and FBOs. 

In line with a joint agency report to the Congress 

in July 2011, the Federal Reserve has continued 

I. Information on the Dodd-FrankAcl >tr~ teSIS 

and CO\.R areal\lilable on the Federal Reser"", Board·! 

website at www.federalre;erve.govlbankinforeg!stres~ 

tests<api!.ll-planning.htm. 

MONETARY POlICY REPORT: FEBRUARY 2013 31 

to work with the SEC and the CfTC to develop 

and implement effective supervisory practices 

and techniques for designated fMUs, including 

appropriate information.sharing arrangements and 

Federal Reserve participalion in SEC and CfTC 

examinations of designated FMUs. 

Monitoring 

The Federal Reserve has continued to pursue 

an acti\'€ program of research and data col lection, 

often in conjunclion with other u.s. and foreign 

regulators and supervisors, and to work on 

deo.'eloping a framework and infrastructure for 

monitoring risks to financial stability. It continues 

to regularly monitor a variety of items that measure 

key financial vulnerabilities, such as leverage, 

maturity m'smatch, interconnectedness, and 

complexity of financ ial institutions, markets, and 

products. In a context of ad\'€fS€ shocks, such 

IlUlnerabilities could lead to fire sales and an 

adverse feedback loop with credit availability, 

which could, in turn, inflict harm on the real 

economy. 

The Federal Reserve pays special attention 

to de\l€lopments at the largest, most complex 

financial firms, using both information gathered 

through supervision and indicators 01 financial 

conditions and systemic risk from financia l markets. 

It has been analyzing the consequences for firms 

and markets resulting from the ongoing strains 

in European financial markets as well as those 

associated with the fiscal situation in the United 

States. Another issue that the Federal Reserve is 

monitoring closely is the potential incentive for 

some investors and institutions to take on excessive 

risk- for example, by inaeasing I€'.'€rage, credit 

risk, and duration risk- in an allemptto reach for 

yield in a susta ined 1(1,'1 interest rate environment. 

Moreover, efforts are ongoing, both at the Federal 

Reserve and elsewhere, to evaluate and develop 

neo.'1 macroprudential tools that could help limit 

buildups of systemic risk or increase the resilience 

of financial institutions and markets to potential 

adverse shocks. 
79 


32 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

An Update on the European Fiscal and Banking Crisis 

In the second half of 2012, European 

policymakers stepped up efforts 10 supporl 

vulnerable euro·area economies, strengthefl 

domestic public finances and banking systems, 

and reinforce the monetary union. As a result, 

European financial stresses have moderated over 

the past severa l months. Neverthdess, they remain 

elevated, and European policymakers still face 

significant challenges as they sed to improve fiscal 

positions, implemeflt growth-augmenting structural 

reforms, and bolster regiona l integration in a difficult 

economic environment. 

A key turning point in the euro·area crisis 

occurred in late Ju ly, when Mario Draghi, the 

European Central Bank (ECB) presideflt, stated, 

'Within oUI mandate, the ECB is ready to do 

whatever it takes to preser:e the euro."' The ECB 

subsequeflily unveiled a frame'lvork for Outright 

Monetary Transactions (DMT) to address distortions 

in euro·area government bond markets that 

underrrine the transmission 01 monetary po1icy. 

Under certain conditions, the ECB can purchase 

potentially unlimited amounts of government 

bonds.2 To date, the ECB has not purchased any 

bonds under the OMT frame\vork. Neverthdess, 

the announcement of the framework has rritigated 

investors' concerns about the adequacy of financial 

backstops for the Italian and Spanish governments 

and, more generally, about the integrity of the euro 

area. 

Vulnerable euro·area countries have made 

progress in strengthening their banking systems 

and public finances in recent months. The 

governments of Ireland and Portugal have been 

I. See Mario Draghi (20121. 'Verbatim oftoc Remnb 

Made by Mario Draghi: speech delivered at theGkbal 

tnves!merlt Confereoce, london, July 26, www.ecb.intl 

prew1;ey/datel201 2/html/SP I 10726.erJ.htrrl. 

2. The EeB's purchases wil l focus ongo~rnment 

oonds with maturities of OJlE' tothree years. The ECB will 

have fu ll discretion over thesepurchases. A necessary 

condition for ECB purchases is that a go'I('fnment reqllt'St 

a full or precaution.Jry financial a~sta cE'program from 

the Eurcvean Financial Stability racili!)' or the European 

Stlbility Meo:hanism.A goo.'E'lnment that already has 

such a program must r€gain mark€! access. In addition, 

governments must fulfoll their policycommitmenlS under 

their programs and the elJro-ared govf>lnancE' framE'WOO:. 

generally fulfilling their pol icy comnitments under 

Iheir official financial assistance programs. In 

Spain, the government secured euro·area official 

approval and financing for its bank restructuring and 

recapita lization plans. In Greece, the government 

reinvigorated its long-stalled austerity and reform 

initiatives. In response, European authorities resumed 

financia l assistance to the Greek govE'rnment and 

look steps to address Greece's public debt burden, 

including E'asing thE' terms 01 euro·area official 

financing and funding a discounted buyback 

of roughly £30 billion in privately hE'ld Greek 

government debt. More generally, offICia l financial 

assistance is continuing to provide vulnerable 

countries with brE'athing room to make the difficu lt 

adjustments needed to resolve their crises. 

European governments have also made some 

progress toward a European banking union. After 

protracted nE'gotiations, European leaders agreed 

in December on key details of a single supervisory 

mechanism (SSM) for European banks with the 

ECB at its center. The SSM is E.>Xpected to be 

established sometime this spring and should enter 

into force in early 2014. The ECB will directly 

supervise large euro·area banks and will be able 

to assume (from national authorities) super~ision 

of any euro-arE'a bank whE'n necessary to ensure 

consistent application of high supervisory standards. 

Establishment 01 the SSM is ~iewed as a necessary 

precondition for euro·arE'a governments to share 

more directly the fiscal burden of resolVing 

national banking crises. In addition, European 

governments recently set objecti\l€S to accelerate 

the harmonization of national policy frame'lvorks for 

bank resolution and deposit insurance and, further 

down the road, to create a single mechanism for 

bank resolution and recovery. 

In part because of the positil'e de~'elopments 

highlighted previously, financial stresses facing 

yulner.lble European governments and banksthough still elellated-mcxlerated substantially in the 

second half of 2012 and E'arly 2013. Sovereign yields 

declined signifICantly evE'n as the Italian and Spanish 

governments issued substantial armunts 01 debt. 

In addition, the Irish and Portuguese governments 

began returning to bond markets; elch conducted a 

limited, yet successiul, sale of bonds in January. 
80 


Reduced concerns about the European crisis 

contributed to an easing of funding conditions 

for European banks. Euro-area banks have 

relied somewhat less on ECB funding in 

recent months, and use of cemral bank dollar 

liquidity S\\'ap lines declined significantly. 

ReSecting market vie .... -s of the decreased 

risk of default, CDS premiums on the debt 

of many large banks in Europe dropped 

significantly, on net, especially for Italy and 

Spain, and euro-area bank stocks increased 

about 30 percent since mid-2012 (figure 43). 

As risk sentimem improved, foreign equity 

indexes rose significantly: Over the second half 

of 2012 and into early 2013, equity indexes 

increased about 10 percent for the United 

Kingdom and Canada, about 15 percent in 

the eUfO area, and about 25 percent in Japan; 

equity indexes in EMEs also moved up across 

the board, as shown in figure 43. Likewise, 

yields on IO-year government bonds in many 

countries increased moderately, though 

Japanese yields remained below I percent. 

Spreads of peripheral European sovereign 

yields over German bond yields of comparable 

maturity declined significantly as overall 

euro-area financial strains abated (figure 44). 

Corporate credit spreads also declined, and 

bond issuance picked up. 

The U.S. dollar depreciated nearly I percent 

against a broad set of currencies over the 

second half of 2012 and into early 2013 

(figure 45). Some of this depreciation reflected 

a reversal of fligh t-to-safety flows, in pan 

stemming from the reduction in European 

financial stress. Indeed, the dollar depreciated 

4 percent against the euro. In contrast, the 

dollar appreciated 17 percent against the 

Japanese yen. Most of this rise came in recent 

months, as Shinzo Abe, the newly elected 

prime minister of Japan, called for the Bank 

of Japan to employ "unlimited easing" of 

monetary policy to overcome deflation. 

MONETARY POl ICY REPORT: FEBRUARY 1Q13 33 

43. Equity indexes for selected foreign ecooomies, 

2009 13 

_30.bM - lOO 

, I 

Nm: Tho dala .,. doily. Tho lui observol .... fOf .. "h se:i .. is 

fdm:uy 20, 2013. E.....wog "'unto .... Bm;il, Cl:il ,. Chilli, C .. oM;'" C=h Rq>UbI;". Eg)l'I. Hung&y, Jru!i>, Ic&:.n.<ia. Malay<io. Maim, 

M",""""" PmI, til< Phjuppincs, Poland, Russi .. So\llh Afuc: .. Soulh Kom, 

nillu, lb!ib::d, and Turk'}" 

Sou.CII; For""'"'Zintroarhu,M.'g" S1anltyE:n<rgingMo.rI:'1S~DEf 

C ... it&t IIlkx; fo:- th: <UN .,. .. Dow Jm .. Eu:o sroxx Indo<: for 

ouro-atU be.nk:s, Dow Jonn Ell," STOXX Bel: Indo<; ftt I"""" T<i-yo 

S1O<'kExcl:ant:o(TOPL\); aUviaBIoo:Ii>trg. 

44 Gl:Ivemment debt spreads for peripheral 

El.IJopean ~oooomies, 2009-13 

----------------~----~~ 

-n 

- u 

- u 

- w 

- " 

- " 

I , I I , ." 20t2 2(llJ 

NOll: Tho dr .. are .. ~<ldy. Tho tast ob>.......:ioo. for ...,h se:i .. is 

Feb:uaIy IS, 20ll. Tho 'llftods ~n.,. th: yi.l<!> ... 10·y.a: bonds 10" 

th: IO.yoa:-Gtrroanbo.:>:ly;..td. 

Sow:Ii: For G,...,., ttaly, PmrugaJ, a:.rl SJ-,in. Sloont>trg; for Irdand, 

.toft" .. :imateJ \!SCi trad<d bwd Jri..~ Ii"", Ibo:>l"", R",tm II!Id 

Bl'">:obtrz. 
81 


34 PART I: RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

4S U.S mllar exchange mte against broad index 

and selected maj(J£ clUTCllCies, 2010 13 

ll«<d>erll,Z009-I00 

! I I I I! 

2010 ." 2012 2013 

Ncm:: Tho daa, whim .... in foreign oum:ry wts perdollar, are d.!ily 

Thotal1observatimfQaoc:b..n.." Frilruary2t, 20t3, 

Soutc!: fodml Res.,." &oro, Stotist".1 R.I/Z$< H.10, "fo:.ign 

El<d:ang.Raus," 

46. Real gross domestic product gro"th in selected 

advanced fOKign ecooomies, 2010-12 

I I 

2010 2012 

" 

-" 

I I 

NQll: 1'bo <IOto IIr'Q~lyond.xtrnd thm.Igh101IQ3 forCIII:lI.da on! 

2012:Q4forlho __ ...... Jq:u, ondthoUnMlKingdom. 

Soma: fill" CIlIOda, S:'l~ti", Caaada; for tho .. .:ro ...... Eurosto~ ro: 

kpan, Collioot O/f.,. of 1'fllIl; cd f.:tt l!l. Unit", K.i::!¢o.:n, Oflj" fo: 

ti<m.tStot~ti"" 

. .. but economic activity in the advanced 

foreign economies continued to 

weaken . . . 

Despite the easing of financial stresses in the 

euro area and some improvement in global 

financial markets, activity in the advanced 

foreign economies (AFEs) continued to lose 

stearn in the second half of 2012 (figure 46). 

The euro area fell further into recession, as 

fiscal austerity, rising unemployment, and 

depressed confidence restrained spending, 

especially in the countries al the center of the 

crisis, Real GOP also contracted in Japan, 

reflecting plummeting exports. In the United 

Kingdom, real GOP growth resumed in the 

third quarter, partly thanks to a temporary 

boost to demand from the London Olympics, 

but contracted again in the fourth quarter. 

Canadian real GOP growth remained positive 

but also weakened, largely owing to lower 

external demand. Survey indicators suggest 

that conditions in the AFEs improved only 

marginally around the turn of the year. Amid 

this weakness in economic activity and limited 

pressures from commodity prices, inflation 

readings for most AFEs remained contained. 

Several foreign cemral banks expanded their 

balance sheets further and took other actions 

to support their economies (figure 47). In 

addition to its introduction of the OMT, the 

EeB lowered its main policy rate. The Bank 

of England completed its latest round of asset 

purchases, bringing its holdings to £375 billion, 

and began the implementation of its Funding 

for Lending Scheme, designed to boost lending 

to households and firms. The Bank of Japan 

took a number of steps. It introduced a new 

Stimulating Bank Lending Facility in October 

and raised its inflation target from I percent to 

2 percent in January. In addition, it increased 

the size of its Asset Purchase Program by 

¥30 trillion, to ¥lOltrillion, by the end of 2013 

and announced tbat purcbases would be open 

ended beginning in 2014. 
82 


· .. even as economic growth stabilized in 

emerging market economies 

After slowing earlier in the year, in part 

because of headwinds associated with Europe's 

troubles, economic growth in EMEs stabilized 

in the third quarter and appeared to pick up 

in the fourth. This modest pickup in economic 

activity in the face of continued v.eakness in 

e.xports to advanced economies was supported 

by monetary and fiscal policy stimulus. 

In China, following slO\>,er growth in the 

first half of 2012, stimulus measures helped 

boost the pace of real GDP growth in the 

second half of the year. Improved economic 

conditions in China also provided a lift 

to other emerging Asian economies. GDP 

accelerated in Hong Kong and Tai\\'<ln in the 

third quarter; in the fourth quarter, exports 

and purchasing managers indexes moved 

higher in most of the region, and GDP growth 

rebounded in a number of economies. 

After stagnating for about a year, economic 

activity in Brazil picked up in the third quarter 

to a still-lackluster pace of 2Y:z percent. 

Indicators for the fourth quarter suggest 

a further modest pickup, supported by 

accommodative policies. In contrast, GDP 

growth in Mexico continued to fall in the third 

quarter as the growth of U.S. manufacturing 

production slowed; however, Mexican 

gro\\1h picked up to 3 percent in the fourth 

quarter, boosted by services and the volatile 

agricultural sector. 

Despite occasional spikes in food price~ 

inflation in most emerging Asian economies 

remained \\eU contained as moderate output 

growth limited broader price pressures. India 

was a notable exception, with 12-month 

inflation around 10 percent in recent months. 

In some Latin American economies., increases 

in food prices had a greater effect on inflation 

than in Asia, leading to 12-month price 

increases of around 5Y:z percent in Brazil and 

around 4Y. percent in Mexico over the second 

half of last year. 

MONETARY POlICY REPORT: FEBRUARY 2013 35 

47 Central bank assets in selected advanced 

I!CrnJ(Jrnies., 200S-12 

- w 

- " 

- " - , I I , II , , , , I! ' I 

100& 2009 1010 1011 1012 

NOTIi: Ib, datunqua:urlycdox1Olld1hrougb 2Il12:Q3 forlho""" ..... 

trullhoUoittd King~"",ond2012Q.\forJ:IpIIIL 

s..:mc.: F"'Iho"""L ..... Eutop<anC':O~lBank oodEuro:!to!:forj1pOll, 

BalIk of J...." 0!Id Clbe..! Off ... of J..,.n; owl for tho u"i".o<l Ki::g~orII, 

Bank tiEnglt:>d andOrr.,. for r;.~"",,1 Stlti"-,,," 
83 


PART 2 

MONETARY POLICY 

37 

To promote the objectives given to it by the Congress, the Federal Open Market CommWee (FOMe) 

provided additional monetary accommodation al its September 20 12 and December 20 12 meetings, 

by both strengthening its forward gUidance regarding the federal funds rale and initiating additional 

asset purchases. 

As discussed in Pan 1, incoming economic 

data throughout the second half of 2012 

and into 2013 indicated that economic 

activity was expanding at a moderate pace. 

Employment gains v .. ere modest, and although 

the unemployment rate declined somewhat 

over the period, it remained elevated relative to 

le\~ls Ihat almost all members of the FOMe 

viev.'ed as consistent with the Committee's dual 

mandate. Inilation remained sutxlued, apan 

from some temporary variations that largely 

reflected fluctuations in commodities prices. 

Members generally anached an unusually 

high level of uncenainty to their assessments 

of the economic outlook. Moreover, they 

continued to judge that the risks to economic 

grov.1h were tilted to the downside because 

of strains in financial markets stemming from 

the sovereign debt and banking situation in 

Europe, as well as the potential for a significant 

slov.'dov.'n in global economic grov.1h and for a 

48. Se ~lcd interest rates. 2008- 13 

sharper-than-anticipated fiscal contraction in 

the United States. With longer-term inflation 

expectations stable and still-considerable slack 

in resource markets, most members anticipated 

that inflation over the medium term would run 

at or below the Comminee's longer-run goal of 

2 percent. 

Accordingly, to promote the FOMCs objectives 

of maximum employment and price stability, 

the Comminee maintained a target range 

for the federal funds rate of 0 to Y. percent 

throughout the second half of 2012 and 

provided additional monetary accommodation 

at its September and December meetings, 

by both strengthening its forward guidance 

regarding the federal funds rate and initiating 

additional purchases of longer-term securities 

(figure 48). The Committee also completed 

at year-end the continuation of the program 

to extend the average maturity of its holdings 

- s 

-, 

______________ IIIIIIiI ____-_ : , 

, , , , " """"" " , , , , , 

IOO<M 1IIl 1M9lm oll2SO mll"lm ~ li IOIl~II2I","",l " III.! II2l <I2l lillM4 11!O 

-------------------- 200S 2009 20tO 2011 2012 2013 

Ncm: Th< data ... daity md atml th=gh F.bnwy 2t. 2OtJ. Tho 2-yarmd to-yur rra.."')' lit .. ore tho constant-moruri:), yi.1d! buod", tho ", .. I 

octivdymd<d .<=iIa. Tho dalai QlI U"lawiw.t:..t .... ore thos. of "gcl.,.1y ",l1<d-.:l.d FedeII1 Op.o M.,\::I:t Cw.:nitt .. m«ti:lp. 

So\ru:t:: D<panm<:nofIheT"osurymdtbe Ftdaot R ......... 
84 


38 PART 2: MONETARY POLICY 

of Treasury securities that was announced 

in June 2012 and continued its policy of 

reinvesting principal payments from its holdings 

of agency debt and agency-guaranteed 

mortgage-backed securities (MilS) into agency 

MBS. 

At the September 12- 13 meeting, the 

Comminee agreed that the outlook called for 

additional monetary accommodation, and 

that such accommodation should be provided 

by both strengthening its forward guidance 

regarding the federal funds rate and initiating 

additional purchases of agency MBS at a 

pace of $40 billion per month. Along with the 

ongoing purchases of $45 billion per month 

of longer-term Treasury securities under the 

maturity extension program announced in June, 

these purchases increased the Committee's 

holdings of longer-term securities by about 

$85 billion each month through the end of the 

year. These actions were taken to put downward 

pressure on longer-term interest rates, sllppon 

mortgage markets, and help make broader 

financial conditions more accommodative (see 

the box "Efficacy and Costs of Large-Scale 

A&<>et Purchases"). The Committee agreed that 

it would closely monitor incoming information 

on economic and financial developments in 

coming months, and that if the outlook for the 

labor market did not improve substantially, it 

would continue its purchases of agency MBS, 

undenake additional asset purchases, and 

employ its other policy tools as appropriate 

until such improvement is achieved in a 

context of price stability_ The Comminee also 

agreed that in determining the size, pace, and 

composition of its asset purchases, it would, 

as alv.ays, take appropriate account of the 

likely eflicacy and costs of such purchases. 

This llexible approach was seen as allowing 

the Committee to tailor its policy o\'er time 

in response to incoming information while 

clarifying its intention to improve labor market 

conditions, thereby enhancing the effectiveness 

of the action by helping to bolster business and 

consumer confidence. 

The Comminee also modified its forward 

guidance regarding the federal funds rate at the 

September meeting, noting that exceptionally 

low levels for the federal funds rate were 

likely to be v.arranted at least through mid2015, longer than had been indicated in 

previous FOMC statements. Moreover, the 

Committee stated its expeaation that a highly 

accommodative stance of monetary policy 

would remain appropriate for a considerable 

time after the economic reco\'ery strengthens. 

The new language was meant to clarify that 

the Committee's anticipation that exceptionally 

low levels for the federal funds rate v.-ere likely 

to be warranted at least through mid-2015 did 

not reflect an expeaation that the economy 

would remain weak, but rather reflected the 

Committee's determination to suppon a 

stronger economic recovery. 

At the December 11- 12 meeting, members 

judged that continued provision of monetary 

accommodation was warranted in order 

10 support further progress toward the 

Committee's goals of maximum employment 

and price stability. TheCommineejudged 

that, following the completion of the maturity 

e.'{tension program at the end of the year, 

such accommodation should be provided in 

part by continuing to purchase agency MilS 

at a pace of $40 billion per month and by 

purchasing longer-term Treasury securities at 

a pace initially set at $45 billion per month. 

The Comminee also decided that, starting in 

January, il would resume rolling o\'er maturing 

Treasury securities at auction. 

With regard to its forv.ard rate guidance, the 

Committee decided to indicate in thestatemem 

that it e.xpects the highly accommodative stance 

of monetary policy to remain appropriate for 

a considerable time after the asset purchase 

program ends and the economic recovery 

strengthens. In addition, it replaced the 

date-based guidance for the federal funds 

rate with numerical thresholds linked to the 

unemployment rate and projected inflation. 
85 


MONETARY POLICY REPORT: FEBRUARY 2013 39 

Efficacy and Costs of large.Scale Asset Purchases 

In order to provide additional monetary stimulus 

when short-term interest rates are near zero, the 

Federal Reserve has undertakeo a series of largescale asset purchase (lSAP) programs. Between late 

2008 and early 2010, the Federal Reserve purchased 

approximately $1.7 trillion in longer.term Treasury 

S€<urities, agency deb~ and ageocy mortgage-backed 

S€<urities (MBS). From late 2010 to mid·10l1, a 

S€<ond round of LSAPs was implemented, consisting 

of purchases of S600 billion in longer-term Treasury 

S€<urities. Bet\",een September 2011 and the end of 

2012, the Federal Reserve implemented the maturity 

extension program and its continuation, under which 

it purchased approximately $700 billion in longer. 

term Treasury securities and sold or allowed to run off 

an equal amount of shorter·term Treasury securities. 

And in September and December 2012, the Federal 

Reserve announced flow·based purchases of agency 

MBS and longer-term Treasury securities at initial paces 

of $40 billion and S45 billion per m::mth, respectively. 

These purchases were undertaken in order to put 

downward pressure on longer.term interest rates, 

support mortgage markets, and help to make broader 

financial conditions more accommodative, thereby 

supporting the economic recovery. One mechanism 

through which asset purchases can affect financial 

conditions is the "portfolio balance channel: which 

is based on the premise that different financial assets 

may be reasonably close but imperfect substitutes 

in im'€Slors' portfolios. Th is assumption implies that 

changes in the supplies of various assets available 

to private investors may affect the prices or yields 

of those assets and tne prices of assets that may be 

reasonably close substitutes. As a result, the Federal 

Reserve's asset purchases can push up the prices 

and lower the yields on the securities purchased 

and influence other asset prices as we ll. As investors 

furtner rebalance their portfolios, overall financial 

conditions should ease more generally, stirrulating 

economic activity through channels similar to those 

for conventional monetary policy. In addition, asset 

purchases could also Signal that the central bank 

intends to pursue a more accomrmdative policy 

stance than previously thought, thereby lowering 

investor expectations about the future path of the 

federal funds rate and putting additional dC1.vnwa rd 

pressure on longer-term yields.. 

A substantial body of empirical research finds that 

the Federal Reserve's asset purchase programs have 

Significantly lowered longer.term Treasury yields.' 

More important, the effects of LSAPs do not S€€Il) to be 

restricted to Treasury yields. In particular, LSAPs have 

been found to be associated with Significant declines 

in MBS yields and corporate bond yields as well as 

with increases in equity prices. 

Continued on nex( page 

I. for a selective lislof releJeI1ces regarding theelfect of the firstlSAp, S€(' thebox "The Effects 04 Federal R(>'.('fVe 

AS>e\ Pu rchases' in Board of Go_nors oithe fffiE-ra1 

ReserveSystem {2011), MOl1etary Policy Rfpon (0 rhe 

COtlgIl'S5 (\Vashington: Board of Governors, March), "'v.w. 

ledera reserve.gov monet.lrypolicy ~r_2011 0301_partl .hIm. 

For additional references, including lOOse thai ana lyze the effectol thesecood LSAP as ",eH as the maturity extension 

prograrT\. see, forexa~le, Stelania D'Arrico, William [nglish, David lOpez·Salido, and Edward Nelson (2012), "The 

Federal Res-efl'!"s Large-Scale Asset Purchase Progr.tJTJTll>S: Rationaleaoo Effects,' Economic Joumal, vol. 122 

(NOI'eni>et), pp. F415-45; Arvind KrishnalllJMY and Annette 

Vissing.JOIJ:leo>en (20111, "The Effec!S of Quantitative Easing 

on Interest Rates: Channels and 1~lications for Policy,' !irookif18S Papers OIl ECOf1(tI1i( AaNity, Fall, pp. 21 5-(;5; Canlin Li and Min Wei (l012), "Tetm Stwcture Modelling 

with S~ly factors and the Federal R(>'.('fVe's la'ge Scale Asset Purchase PrograJT6: FinallCeand Ecooomi~ 

Dis.cLlSsion Series 2012·37 (Wash ington: Boord 0/ GOI't'I"nors of the Federal R(>'.('fVe SysterT\. May), www.lederalreser"",. 

gOl',pubsJIedsl101112012371201237pap.pdf; and re/t'I"ences 

in those studies. For work that >pe<: ifically eovhasizes the signaling channel ofLSAPs, S€(', for e)(,)~le, Michael D. 

Bauer and Glenn D. RudEtlus.ch (2012). "The Signaling 

Channel lor Federal R(>'.('fVe Bond Purcha>e-i,' Working P.!Pt'l" Series 2011·21 (San Francisro: Federal Reserve Bank of San 

FrallCis.co, Auguw, \\wwJlbsf.orglptblications/economicsi 

papersl2Olllwpll.2Ibk.pdl. For work that focuseson theelfec!S 00 credit delault ris.k. see. for exarrple, Simon Gilchrist and [goo Zakraj~{lOll), "The Irrpact 0/ the 

Federal Reser"",'s large-Scale Asset Purchase Progr.tJT6 on 

Df'lault Risk: paper presented at 'Macroeconomics and FinallCiallntemlediation: Directions sillC€ theCrisis,' a 

conference held at theNational Bank 04 Belgium, B'ussels, 

Decf.>lTber 9-10. 2011.Although the rn.Jjority of rese.Jrch 

on the effec!S 0/ LSAPs appears to s~ort a signifICant innuence OIl asset prices, theo\'f'fall resultol sllCh prograJT6 

is generally difficu lt to estirn.Jte precisely: [1If'()\ studies can 

rn.Jkeonly \.harp predictions on theelfec!S \I"itllin a relatively short ti1l"E! horizon, where.J\ approaches based on time· 

series models tend 10 face challenges in i§Oiating theelf~ 

of theprograJT6 from other economic develcprren!S. for a more skEPtical \~ew 00 the f'lfecl 04 LSAPs, see, for e)(,)~le, 

Daniell. Thornton (l012), Evi~llCe on the Portfolio BalallCe 

Channel of Quantitati"", [a,iog.' Working P.!per Selies 2012-

015A (St loui,: federa l Reser"", Bank 04 St louis, October), 

http://research.stiouisfed.orgNipl2012nOI2-015.pdf. 
86 


40 PART 2: MONETARY POLICY 

Efficacy and Costs of Large-Scale Asset Purchases, continued 

While there seems to be substlntial evidence that 

lSAPs have 10IVered longer-term yields and eased 

broader financial conditions, obtaining accurate 

estimates 01 the effects 01 LSAPs on the macroewnomy 

is inherently difficul t, as the counteriactual case-holV 

the economy would have performed without LSAPscannot be directly observed. However, econometric 

models can be used to estimate the effects 01 lSAPs 

on the economy under the aSSUfTlltion that the 

economic effects of the easier finandal conditions 

that are induced by LSAPs are simila r to those that 

are induced by conventional m:metary policy easing. 

Model simulations conducted at the Federal Reserve 

have geflerally found that asset purchases provide 

a signifICant boost to the economy. For example, 

a $\udy based on the Federal Reserve Boord's 

FRBlUS model estimated that, as of 2012, the first 

two rounds of LSAPs had raised real gross domestic 

product almost 3 percent and increased fXivate pa)lfoH 

efTllloyment by about 3 million jobs, while 1000ering 

the unem~oy~nt rate about 1.5 percentage points, 

relative 10 what would have been expected other.vise. 

These simulations also sLJgg€St that the program 

materially reduced the risk of deflation.' 

Of course, all model-based es~mates of the 

macroeconomic effects of LSAPs are subject to 

coosiderable statistical and modeling uncertainty 

and thus should be treated with caution. Indeed, 

while some other stooies also report signifICant 

macroewnomic effects from asset purchases, 

other research finds smaller effects.' Nonetheless, 

2. These resullS are discussed further in Hess Chung. 

JE'.ln-l'Ililippe laforte, David Reifschneider, andJohn C. 

William; (2012), "Hal'eWe UnderestiITLlted the ti~elillOOd 

and SeverityofZero LOII-er Boo nd Evenl5?' Journalol Moo€')', 

Credit and 8Jnking, voL 44 (fEbruaryso..wlemenO, pp.47---{12. 

3. For studies reponingsignificantmacroecooomic effeclS 

from asset purchases, see, lor e~fIlIle, Jeffrey C. Fuh rer and 

Giov.mni P. Olivei (2011), "The Es~ITLlted Macroeconomic 

E/feclS of the Federal Reserve's Large-Scale TrE'.lsury Purchas.e 

Prograll\" Public Po licy Brie(s 11-{)2 (Boston: Federal Reserve Bankol Boston,April), lIWoI'.bosJrb.orgiecooomidppMOlll 

f'Pbl I 2.pdf; and Christiane Baumeister and luca Benati 

(2012), ' Unconventional Monetary Policy and the Greal 

Recession: EstiITLlting the Macroeconomic EffeclS of a Spread 

Compression at the Zero Lower Boond: Working ""pers 

2012-21 (Ol\awa: Bank of Canada, July), www.b.Jnkofcanada. calwp·conteOOuploads!2012107/lIp2012-21.pd1. Also, the 

Bankor Eng1and has ifllliemeoted LSAPs similar to those 

undertaken by the Federal Reserve, and its stafl research finds 

that the effeclS appear to he quantitatively simila r to thas<> in 

the United States. 

fur ~tudies reporting smaller elleclSlrom asset purchases, see, for exaflllle, Michael T. Kiley (2012), 

a balanced reading of the evidence supports the 

conclusion that LSAPs have prol'ided meaningful 

support to the econorric recovery while rritigating 

deflationary risks. 

The potential benefits of lSAPs fTlJst be considered 

alongside their possible costs. One potential cost of 

conducting additional LSAPs is that the operatiof"6 

coold lead to a deterioration in market functioning 

or liquidity in markets where the Federal Reserve 

is eflgaged in purchasing. More specifical ly, if the 

Federal Resefl'e becomes too dominant a bu)'er in 

a certain market, trading among private participants 

coold decrease eflough that market liquidity and 

price discovery become irrpaired. As the global 

financial system relies on deep and liquid markets 

for U.S. Treasury securities, significant impairment of 

this market would be especia lly costly; impairment 

of this market could also impede the transmission of 

monetary policy. Although the large volume of the 

Federal Resefl,€'s purchases relative to the size of 

the markets for Treasury or agency securities could 

ultimately become an issue, few if any problems have 

been observed in those markets thus far. 

A second potential cost of LSAPs is that they may 

undernine public confidence in the Federal Reserve's 

ability to exit smoothly from its accommodative 

policies at the appropriate ti~. Such a reduction 

in confidence might increase the risk that long-term 

inflation expeclJlions beco~ unanchored. The 

Federal Resefl'€ is certainly aware 01 these concems 

and accordingly has placed great emphasis on 

developing the necessary tools to ef"6ure that policy 

accommodation can be removed when appropriate. 

For example, the Federal Reserve will be able to 

put upward pressure on short-term interest rates at 

the appropriate time by raising the interest rate it 

pays on resel"l'€s, using draining tools like reverse 

repurchase agreements or term deposits with 

depository institutions, or selling securities from the 

Federal Resefl,€'s portfoliO. To date, the expansion of 

the balance sheet does not appear to have materially 

affected long-term inflation expeclJlions. 

A third cost to be weighed is that of risks to 

financial stability. for example, some observers have 

"TheAggregale Demilnd Effects of Short- and Loog-Term Interest Rates, ' Financeand Economics Discus>ion Series 

2012-54 (\Vash ington: Boo rd of Governors of the Federal 

Resefl'e System, August), www.federalreserve.govlpubsl 

fedsl2012n012541201254pap.pdi; and Han Chen, Vasco Curdia, and AndrE'.l Ferrero (2012), "The Macroeconomic 

ElfeclS of large-Scale Asset Purchase Prograrrrnes: Economic 

Journal, vol. I n (Noverrber), pp. F289-31S. 
87 


raised concerns that, by dril'ing longer.term yields 

lower, nontraditional policies could induce imprudent 

risk.taking by some investors. 0/ course, some risk· 

taking is a necessary element 01 a hea lthy economic 

recovery, and accommodative moneta!)' policies 

could el'€11 se"'e to reduce the risk in the system 

by strengthe!1ing the overa ll economy. Nonetheless, 

the federal Reserve has substantial ly expanded its 

monitoring of the financial s)'stem and modified 

its supelVisory approach to take a more systenlc 

perspective. 

There has been limited evidence so far of excessil'e 

buildups of duration, credit risk, or leverage, but the 

Federal ReselVe will continue both its careful oversight 

and its implementation of financial regulatory reforms 

designed to reduce systemic risk.' 

The Federal Reserve has remitted substantial 

income to the Treasury from its earnings on securities, 

totali ng some $290 billion since 2009. However, 

if the economy continues to strengthen and policy 

accorrmodation is withdrawn, remittances will likely 

4, For additional detail" see the box "The Federa l Reserve', 

ActiorD to Foster Finaocial Stability" in f'.ln L 

MONETARY POlICY REPORT: FEBRUARY 2013 41 

decline in coming years. Indeed, in some scenarios, 

particularly if interest rates were to rise quickly, 

remittances to the Treasury could be quite low for 

a time. ~ EVe!1 in such scenarios, however, average 

annual remittances Oller the period affected by the 

federal Reserve's purchases are highly li ke ly to be 

greater than the pre-crisis nOfm, perhaps substantially 

so. Moreover, if monetary policy promotes a stronger 

recOliery, the associated reduction in the federa l 

defICit would fa r exceed any variation in the Federal 

Reserve's remittances to the Treasury. That said, the 

Federal Reserve conducts monetary policy to rreeI 

its congressionally mandated objectil'eS of maximum 

employment and price stabil ity and nol primarily for 

the purpose of turning a of~ for the U.S. Department 

of the Treasury. 

5. For additional detail" see Seth B. Ca rpenter, Jane E. Ih rig. Elizabeth C. Klee, Daniel W. Quinn, aooAlexandef 

H. Boote (2013), "The federa l Reserve', Balance Sheet and 

Earnings: A Primer and Projection>: Finaoce and [Conomi03 

Oi5(u55lon Series 1013·01 (Washington: Boo rd 01 Governors 

01 the Federa l ReserveSystem, January), www.federalreseIW. 

govlpwslleds!2013120 13011201301 ab,.html. 
88 


42 PART 2: MONETARY POLICY 

In panicular, the Commil1ee indicated that it 

expected that the exceptionally low range for 

the federal funds rate \\'Ould be appropriate 

at least as long as the unemployment rate 

remains above 6Y;. percent, inflation between 

one and 1\.\'0 years ahead is projected to be 

no more than Y2 percentage point abo\'e the 

Comminee's 2 percent longer-run goal, and 

longer-term inflation f.'ipectations continue to 

be well anchored, These thresholds were seen as 

helping the public to more readily understand 

how the likely timing of an eventual increase in 

the federal funds rate would shift in response to 

unanticipated changes in economic conditions 

and the outlook. Accordingly, thresholds could 

increase the probability that market reactions 

to economic developments \.\'Ould move longerterm interest rates m a manner consIstent 

with the Comminee's assessment of the likely 

future path of shon-term interest rates. The 

Comminee indicated in its December statement 

that il viewed the economic thresholds, at 

least initially, as consistent with its earlier, 

date-based guidance. The new language noted 

that the Committee would also consider other 

information when determining how long to 

maintain the highly accommodative stance of 

monetary policy, including additional measures 

of labor market conditions, indicators of 

inflation pre~ures and inflation expectations, 

and reading<; on financial developments. 

At the conclusion of its January 29-30 meeting, 

the Committee made no changes to its target 

range for the federal funds rate, its asset 

purchase program, or its forward guidance for 

the federal funds rate. The Committee stated 

that, with appropriate policy accommodation, it 

expected that economic gro\.l/th would proceed 

at a moderate pace and the unemployment 

rate would gradually decline toward levels 

the Committee judges consistent with its 

dual mandate. It noted that strains in global 

financial markets had eased somewhat, but 

that it continued to see downside risks to the 

economic outlook. The Committee continued 

to anticipate that inflation over the medium 

term likely would run at or below its 2 percent 

objective. 
89 


43 

PART 3 

SUMMARY OF ECONOMIC PROJECTIONS 

The {ollowing malerial appeared as an addendum to the minutes of the December 11- 12,2012, 

meeting of the Federal Open Market Commillee. 

In conjunction wilh the December 11-12, 

2012, Federal Open Market Committee 

(FOMq meeting, meeting participants-the 

7 members of the Board of Governors and the 

12 presidents of the Federal Reserve Banks, 

all of whom participate in the deliberations of 

the FOMC-submined their assessments of 

real output gro\\'th, the unemployment rate, 

inflation, and the target federal funds rale for 

each year from 2012 through 2015 and over 

the longer run. Each participant'S assessment 

was based on information available at the time 

of the meeting plus his Of her judgment of 

appropriate monetary policy and assumptions 

about the factors likely to affect economic 

outcomes. The longer-run projections 

represent each participant'S judgment of the 

value to which each variable would be expected 

to converge, over time, under appropriate 

monetary policy and in the absence of 

further shocks to the economy. "Appropriate 

monetary policy" is defined as the future 

path of policy that each participant deems 

most likely to foster outcomes for economic 

activily and inflation that best satisfy his or 

her individual interpretation of the Federal 

Reserve's objecti,·es of maximum employment 

and stable prices. 

Overall, the assessments submitted in 

December indicated that FOMe participants 

projected that, under appropriate monetary 

policy, the pace of economic recovery would 

gradually pick up over the 2012- 15 period 

and inflation would remain subdued (table I 

and figure 1). Participants anticipated that the 

growth rate of real gross domestic product 

(ODP) would increase somewhat in 2013 and 

again in 2014, and that economic gro\l:th in 

2014 and 2015 would exceed their est imates 

of the longer -run sustainable rate of growth, 

while the unemployment rate would decline 

gradually through 2015. Participants projected 

that each year's inflation, as measured by the 

annual change in the price index for personal 

consumption expenditures (PCE), would run 

Table I. Eoonomk projections of Federal Resent Board members and Federal Resen-e Bank presidents, December 2012 

~~. 

Cbant"'in .. aIGDP ... 

Stp .. rnbtr projoctio. 

U ... mploj.",.nlrlltt 

Stp,"rnbtr projoctio •... 

PCEi.ll:olio. 

Stp,"rnbtrprojoctiol ... 

eo .. PCE mllalio.' ... Stptrmbtr projection 

lO ll I lOll I 2014 I 2015 I Lo~r 

1.1101.8 

1.7102.0 

7.810 7.9 

8.0108.2 

1.6 to l.l 

1.1101.8 

1.6101.7 

1.7101.9 

2.3103.0 3.O1~3.5 

2.510>.0 >.Olo1.8 

7.410 1.1 6.8t~13 

7.610 1.9 6.110J.> 

1.311>20 1.S102.0 

1.61020 1.6102.0 

1.6101.9 l.61~2 .0 

1.71020 I.8t~2.0 

3.0103.1 ! 2.31025 

>.01I>H ! 2Jt025 

6.0106.6 i 52106_0 

:.::::: 1

5

.2::6.0 

1.8102.0 i 20 , 1.8102.0 ! 1.911>20 i 

R.,., 2012 I lOll I ))14 I :!(lIS I Lonter Rln 

1.6IOU UIOU UtoU UIO~IUIo3.0 

1.61020 lJto15 2.1 1041 25104.21 U lolO 

1.1108 0 6911>18 6.11014 

8.0108.3 1.0108.0 6.3101.5 

1.61Ol.8 UiolO 1.41022 15lo2.2l 20 

15101.9 151021 1.6102.2 1.8102.l i 20 

1.61Ol.8 

L61020 

1.5102.0 

1.61022 

, 1.1102.2 ! 18102.3 i 

NoT-!; Pro)<CIK>U of~." "oJ groadoD<~~ prod"" (GN') .. d P"'J"' .... fu, botl .. """" of "lI>oo • • ~ fro., the ~ q .. ~,,~f Il>.. p''''''''y''' '" Il>.. fu .. 1l>. q ... _ 

,,, of '1.'),,11 ;'d""o:1. PC!! ~I1> ,, .... d "''' PC!! "lI>t"" .... Il>.. pert<Dtage "'" of "''''go ;,. '''P'~""Iy. ,b. pr'" i.d", fu, P""""""""""P'''' "I'''dLlIlJU (pcE)lOd ,I.. 

ptic< ild", fu, PC!! _d~a Jood U<I "''il'- l'rojoot" .. fu, II., ""'''P~''I ,u. "" f>' ,b, ''"'''S' <i>ilil. ""'"i»>Y»''' "" i.lb, f>iltlb q ...... , of ". )Ur ild~,lOd . £0 .. PO~ "'poa'-' proj,." ...... b",d •• bil " bOT ..-,,' of 'PPIOj>, .... "''''''l'poIi'l'. Lo'ge ~"" !'fOP' .... rep,,,,,,.&011 pl1tiapu'-' _" .... I of til, It" I.""'~b .... 

..n.bk ""Ill:! '" .. pe<1«l to ""'"''B' \lid" 'Pproprio" .... ""YpoJi'l' .. d,, ,h. , l.sa«of f",tII.,.bod.,.,b. '''''0"", Th. Sop"""" P"joctio .......... d.,. ",.ju"""'-

... !II lb. "'''~iI of lU Fool .... Ope. ", .. rIoot eo,,"'tt .... s.p~,,"" 11.-1l. 1011 

J. Th. "",,,,J,,.d,,oyoxd"",,l., ,b~.l.ip •• U<I!II", _p/"O!"'i> .. fi>' ...... "obloi •• oobl"" 

l. n. ""ge fu, • ..,,&1>1< i • • gift. )'n, lI<b:I"ol po~iap"'''' P"'I''' .... froID t-~ '" kigl.,,~ fu, til .. "';"b~ in "''' ,. ... 

1. Lo'l" -I\III proj",,,,,fu, "'"' PC!! i.II>'" ..... .." ",i",o:! 
90 


44 PART 3: SUMM.I,RY OF ECONOMIC PROJEalONS 

figure 1. Central tendencies and range. of economic projections, 2012-15 and over the longer run 

,.- _ OJaDge in real GDP _ • Ctnlrlllttndcocy<>fprojoctiollI 

~ ii!ii I Rrmge{)fprt;ectiooi 

iiiiI!ii ;;.I;; 

-- Aclual 

I I 

"" 2008 ",. ~10 Wll W12 2M3 ~14 WIS too", 

,~ 

,- UnempJ~nt rale - ll 

..... ~ ~ iiijiii !I!II!! 

I I 

"" 2008 ",. WIO Wll ~12 2013 ~14 WIS too", 

,~ 

,-- PCEinHatioll 

~ = • Ii iIijiii 

11 I I 

"" 2008 "" WIO Wll 2012 2J)1J 2014 2015 too~, 

,~ 

,- Core PCE iutlalion 

~ = iiiiI!ii ~ ~ 

I I I I 2001 2008 "" WI. 2J)1l 2012 2013 2014 2015 Longer 

,~ 

Note: Definitions of variables are in the gellt'ral note to table L The data forthe actual values of the ,miabies are annual 
91 


close to or below the FOMes longer-run 

inflation objective of 2 percent. 

As shown in figure 2, most panicipants judged 

that highly accommodative monetary policy 

was likely to be warranted over the next few 

years. In particular, 14 participants thought 

that it would be appropriate for the first 

increase in the target federal funds rate to 

occur during 2015 or later. Most panicipants 

judged that appropriate monetary ]Xllicy 

would include purchasing agency mortgagebacked securities (MBS) and longer-term 

Treasury securities after the completion of the 

maturity extension program at the end of 2012. 

As in September, participants judged the 

uncenainty associated with the outlook 

for real activity and the unemployment 

rate to be unusually high compared with 

historical norms, with the risks weighted 

mainly toward slower economic growth 

and a higher unemployment rate. While a 

number of participants viewed the uncertainty 

surrounding their projections for inflation 

to be unusually high, more saw the level of 

uncenainty to be broadly similar to historical 

norms; most considered the risks to inBation 

to be roughly balanced. 

The Outlook for Economic Activity 

Participants judged that the economy grew 

at a moderate pace over the second half of 

2012 and projected that, conditional on their 

individual assumptions about appropriate 

monetary ]Xllicy, the economy would grow 

at a somewhat faster pace in 2013 before 

expanding in 20\4 and 20 \5 at a rate above 

what panicipantssaw as the longer-run rate 

of output growth. The central tendency of 

their projections for the change in real GDP 

in 2012 v.'3S 1.7 to 1.8 percent, slightly lower 

than in September. A number of participants 

mentioned that last summer's drought and 

the efiects of Hurricane Sandy likely had held 

down economic activity in the second half of 

this year. Many panicipants also noted that, 

MONETARY POLICY REPORT: fEBRUARY 1013 45 

while conditions in the housing and labor 

markets appeared to have improved recently, 

uncenainty about fiscal policy appeared to 

be holding back business and household 

spending. Participants' projections for 2013 

through 2015 were generally linie changed 

relative to their September projections. The 

central tendency of participants' projections 

for real GDP growth in 2013 was 2.3 to 

3.0 percent, followed by a central tendency of 

3.0 to 3.5 percent for 2014 and one of 3.0 to 

3.7 percent for 2015. The central tendency 

for the longer-run rate of increase of real 

GDP remained 2.3 to 2.5 percent, unchanged 

from September. Most participants noted 

that the high degree of monetary policy 

accommodation a§umed in their projections 

would help promote the economic recovery 

over the forecast period; however, they also 

judged that several factors would likely 

hold back the pace of economic expansion, 

including slower growth abroad, a stillweak housing market, the difficult fiscal 

and financial situation in Europe, and fiscal 

restraint in the United States. 

Participants projected the unemployment 

rate for the final quaner of 2012 to be close 

to its average level in October and November, 

implying a rate some\l.'hat below that projected 

in September. Participants anticipated a 

gradual decline in the unemployment rate over 

the forecast period; even so, they generally 

thought that the unemployment rate at the 

end of 2015 would still be well above their 

individual estimates of its longer-run normal 

level. The central tendencies of participants' 

forecasts for the unemployment rate were 

7.4 to 7.7 percent at the end of 2013, 6.8 to 

7.3 percent at the end of 2014, and 6.0 to 

6.6 percent at the end of 2015. The central 

tendency of participants' estimates of the 

longer-run normal rate of unemployment that 

would prevail under appropriate monetary 

policy and in the absence of further shocks to 

the economy was 5.2 to 6.0 percent, unchanged 

from September. Most participants projected 

that the unemployment rate would converge 
92 


46 PART 3: SUMM.I,RY OF ECONOMIC I'ROJEalONS 

figure 2. Onl""iew of roMe participants' assessments of appropriate monetary policy, December 2012 

Nod>erolpuhcip ... to 

Awopriale liming of policy fuming 

2013 20[4 2015 ~16 

Awopriale pace of policy fuming 

Target federal funds rate aI year.e)d , ••••• "1". ......... ~ 6 

...................................................... ···············································

• ···1······

--········ 4 

• • 

· • • - • 

......................................• .. ·····························. ··········1············· , ............ ~ 1 

................................................................................................. --

• ·· 1 ······· ................. ~ 0 

~12 ~lJ 2{1[4 ~15 Longer run 

Nott: Iu the U[lpfr panel, tbe height of each bar dfDO~S the number of FOMC participants who judge that, under 

appropriale monetary policy, tbe filit increase in the target federal funds rate from its CllJTfDt mge of 0 to Y. perctot 

\\ill oocuriu tbespecifJed caleodar lear [u September 2012, tbe numbersof FOMC palticipants who judged thal the 

first increase in thelilrget federal funds rate would oocurin 2012, 2013, 2014, 20[5, and 2016 \\ere,re;~ti\"e1y, 1,3, 

2, 12, and I. In the I~r panel, each shaded circle indicales the ,alue (rounded to the nearest Y. perctlliage point) of 

an inw,idual participant's judgment of the appropriate lew[ of the target federal funds rate aI the end of the specified 

.:aIendar )\'"3J or over the 1000ger J"\IIl 

1 
93 


to their estimates of its longer-run normal rate 

in five or six rears, while a few judged that less 

time would be needed. 

Figures 3.A and 3.B provide details on the 

diversity of panicipants' views regarding the 

likely outcomes for real GOP growth and 

the unemployment rate over the next three 

years and o\'er the longer run. The dispersion 

in these projections reflects differences in 

participants' assessmentS of many factors, 

including appropriate monetary policy 

and its etfects on tbe economy, the rate 

of improvement in the housing sector, the 

spillo"er effects of the fiscal atxl financial 

situation in Europe, the prospective path for 

U.S. fiscal policy, the extent of structural 

dislocations in the labor market, the likely 

evolution of credit and financial market 

conditions, and longer-term trends in 

productivity and the labor force. With the data 

for much of 20 12 now in hand, the dispersion 

of participants' projections of real GOP 

growth and the unemployment rate this year 

narro",:ed compared with their September 

submissions. Meanwhile, the distribution 

of participants' forecasts for tile change in 

real GOP in 2013 shifted down a bit, and 

that for 2014 narrowed slightly. Hov.'e\"er, the 

range of projections for real GOP growth 

in 2015 was little changed from September. 

The distributions of the unemployment rate 

projections at the end of 2012, 2013, and 2014 

all shifted lower, wllile the range of projections 

for the unemplo:yment rate for 2015, at 5.1 to 

6.8 percent, remained close to its September 

level. The dispersion of estimates for the 

longer-run rate of output growth sla}'ed fairly 

narrow, with all but one between 2.2 and 

2.5 percent. The range of participants' 

estimates of the longer-run rate of 

unemployment, at 5.0 to 6.0 percent, narrowed 

relatht: 10 September. This range reflected 

different judgments among participants about 

several factors, including the outlook for labor 

force participation and the structure of tbe 

labor market. 

MONITARY POLICY RtPORT: fEBRUARY 2013 47 

The Outlook for Inflation 

Participants' views on the broad outlook for 

inflation under appropriate monetary policy 

were little changed from September. Most 

anticipated that inflation for 2012 as a whole 

would be close to 1.6 percent, somewhat lov.t:r 

than projected in September. A number of 

participants remarked that recent inflation 

readings had come in below their expectations. 

Almost all of the participants judged that 

bolh headline and core inAation would remain 

sulxlued over the 2013- 15 period, running al 

rates equal to or below the FOMe's longerrun objective of 2 percent. Specifically, the 

central tendency of participants' projections 

for inflation, as measured by the PeE price 

index, mo\'ed down to 1.3102.0 percent for 

2013 and v.~ little changed for 2014 and 2015 

at 1.5 to 2.0 percent and 1.7 10 2.0 percent, 

respecti\'ely. The central tendencies of the 

forecasts for core inflation wl;!re broadly similar 

to those for the headline measure for 2013 

through 2015. In discussing factors likely to 

sustain low inAation, several participants cited 

stable inBation expectations and expectations 

for continued sizable resource slack. 

Figures lC and 3.0 provide information 

aboul the diversity of participants' views 

about the outlook for inflation. The range of 

participants' projections for headline inAation 

for 2012 narro\'.'ed from 1.5 to 1.9 percent 

in September to 1.6 to L8 percent in 

December; nearly all participants' projections 

in December were at 1.6 percent or 1.7 percent, 

broadly in line with recent infiation readings. 

The distributions of participants' projections 

for headline inflation in 2013 and 2014 shifted 

lower compared with the corresponding 

distributions for September, while Ihe range of 

projections for core inAation narrowed slightly 

for both years. The distributions for core and 

on:rall infiation in 2015 were concentrated 

near the Committee's longer-run inflation 

objective of 2 percent, although somewhat less 

so than in September, 
94 


48 PART 3: SUMM.I,RY OF ECONOMIC I'ROJEalONS 

Flgul'l! 3A . Dis(ribu(ioo of participants' projwtions for (he change in l'I!aJ GDp, 2012-15 and over (he longer run 

2012 C Deoo""", projection' _. Sepltmbor project",'" 

~ -" -" -" ->2 

-w - , - 6 - , ~~~~~ , •. "-,c,c.--~"c.--~,.~-c,~,.--c,oo.---,c,c.--~"c-~,.c.--c,7,--c,o,---,c,c.--' 2 11 U U U U 11 U ~ U U '1 U 

c 

c 

c 

Wll 

" " 

" " 

WI> 

" " 

Pen:ult range 

_ -- :1 ,.-, ..... - , .. t l- H - 12- u- 16- 11- J.O- J.lII 11 U U U U 11 U 

Perceot ratlge 

- -. 1. 1.6- 11 1.7 " H 

t l- .. - •• ''''':''''-=--'';'';I 

" 

H· 

" 

2.'- 2_';' 2_1- J.O- 11- H- lb- H- I~- 12-

U 11 U II 1) II 1.1 J~ '1 '.1 

Percent range 

~ - IS 

- " -- " >2 - w - , - 6 - , -,2 

Nod>"orp"'dp .... 

_ Longerrun 

c I';' IIII II 

J.OPerceot ratlge " 

Note: DclmitioDI of variabks areiD tile geDerai note to table I 

n 

,., 1. -

" H· " u· " H· " 
95 


MONETARY POLICY REPORT: fEBRUARY 2013 49 

Figure lB. Distribution of participants' projectioos for the unempbyment rate, 2012- 15 and oYer the longer rw] 

2012 = D n..:am.r projections 

_ -- SoplO mborprojectiOll' 

• 

- " I'" -'= jij - _I 1=: 

I 1_ 4 

c I =:: 

_ ,_ , --,2 

In· ~~ ~ ~t· ~~ ~ u· ~ ~ u· J. J~ IA' J6- J,t. u· I.l· 

Sol I.! 15 l.J H 6.1 6.) 6.1 6,1 63 1-1 J,) IS n J!} l.\ IJ 

Percent rn.nge 

.. , •• ' L. _ _ I"''';'&.. _ , __ 1 

In· 1.1· H· H· ~ ~ u· ~ ~ O· 3 1~ u· U 

),] Sol 1,1 ).J H 6,1 6.J 6.1 6.1 63 7.1 ),J IJ JJ 

Percen'rn.nge 

2015 

_ , _ [3B_;;':': 

". " ~ H· ~ ~ u· ~ ~ u· a lJl.JH6,1636.16.1631-l 

_iDD: I~ Sol- 1.'- H 

),] H 1,1 l.l 

Percent =ge 

\.1- 6.(1-

~., 62 6.'- 66- 6t 

H 6,1 6J 61 6.1 63 

Percent rn.nge 

Note: DefilliuOlIs of l"ariabieS are in the ge!leral note to lable 1 

1.0-

n 

),)-

" 

1,)-

" " " 

.. 

" 

,. 

" 

a· 

, .• 

" , .• .. •. , 1.)-

n 

w 

- " -" 

--n " 

-. - '" -, 

- , --, ' 
96 


50 PART 3: SUMM.I,RY OF ECONOMIC I'ROJEalONS 

Figure lC. Distribution of participants' projections for PCE inflation, 2012- 15 and om the longer run 

2012 = [] n.o._ projocliollS 

_ •• s.pltmbtrprojec~OII' r----' " - 18 

- " - " -- " 10 

L____ -- . , - 4 

~~~~ __ ~ ______ ", __ l 

" Percent range 

WIJ 

== - "---- ______ ----~ 

cJIIIII U , \.1- \1 \, -----~ \ 

IA I' tl 2] U 

Percent range 

W14 

Pero'nt range 

2015 

.. ----, 

I 

Percent range 

loDger rllD 

" " " " Percent range 

Note: Definitions of Iwiableureio lhegeneral DOte \0 table I 

" " 

" 

" ,. 

" - " - " -- " 10 - , -, 

-, ,l 
97 


MONETARY POLICY REPORT: fEBRUARY 2013 51 

Figure 1D. Distribution of participants' projections for core PCE inflation, 2012- 15 

~"Qf p>rti:ipu " 

- 21HZ 

- 0 0.0._ p<oj<cti"'" 

_ •• S<pt<mb<Tproj<clioo, 

r-----' I L _____ _ 

Per«ntrange 

- 2013 

_____ J-- - - - -, 

I 

- 20[4 

Per«ntrange 

N,.erofpll10p0.I, 

- 20[5 - " -I< 

- " r-----' - I< 

- 12 

- IQ 

- , -, 

, 

" 

--':.IIII,I~~ ; 

" Per«ntrn.ge " 

Note, DdinitiOllS of\'anablesare in the general note to table [ 
98 


52 PART 3: SUMM,>,RY OF ECONOMIC PROJECTIONS 

Appropriate Monetary Policy 

As indicated in figure 2, most participants 

judged that e.xceptionally [ow levels of the 

federal funds rate would remain appropriate 

for several more years. In particular, 

13 participants thought that the first increase 

in the target federal funds rate v.'Ou[d nOI be 

warranted until 2015, and 1 judged that policy 

firming would likely not be appropriate until 

2016 (upper panel), The 13 participants who 

expected that the target federal funds rate 

would not move above ils effective lower 

bound until 2015 1houghllhe federal funds 

rate would be 1 Y. percent or lower at the 

end of that year, while the I participant who 

expected that policy firming would commence 

in 2016 sav.' the federal funds rate target at 

50 basis points at the end of that year. Five 

participants judged that an earlier increase in 

the federal funds rate, in 2013 or 2014, would 

be most consistent with the Committee's 

statutory mandate. Those participants judged 

that the appropriate value for the federal funds 

rate would range from ~ to 20/. percent at the 

end of 2014 and from 2to 4Y2 percent at the 

end of 2015. 

Among the participants who saw a later 

tightening of policy, a majority indicated that 

they believed it was appropriate to maintain 

the current [evel of the federal funds rate 

until the unemployment rate is less than or 

equal to 6~ percent. In contrast, a majority 

of those who favored an earlier tightening of 

policy pointed to concerns about inflation as 

a primary reason for expecting that it would 

be appropriate to tighten policy sooner. 

Participants were about evenly split between 

those who judged the appropriate path for the 

federal funds rate to be unchanged relative to 

September and those who saw the appropriate 

path as [ov.-er. 

Nearly all participants saw the appropriate 

target for the federal funds rate at the end of 

2015 as still well below its expected [ongerrun value. Estimates of the longer-run target 

federal funds rate ranged from 3 to 4~ percent, 

reflecting the Committee's inflation objective 

of 2 percent and participants' judgments about 

the longer -run equilibrium le'·el of the real 

federal funds rate. 

Participants also provided information on 

their views regarding the appropriate path 

of the Federal Reserve's balance sheet. Most 

participants thought it was appropriate for 

the Committee to continue purchasing MBS 

and longer-term Treasury securities after 

completing the maturity extension program 

at the end of this year. In their projections, 

taking imo account the likely benefits and 

costs of purchases as v.-ell as the expected 

evolution of the outlook, these participants 

v.-ere approximately evenly divided between 

those who judged that it would likely be 

appropriate for the Committee to complete its 

asset purchases sometime around the middle 

of 2013 and those who judged that it would 

likely be appropriate for the asset purchases 

to continue beyond that date. In contrast, 

several participants believed the Committee 

would beSt foster its dual objectives by ending 

its purcbases of Treasury securities or all of 

its asset purchases at the end of this year 

when tbe maturity extension program was 

completed. 

Key factors informing participants' 

views of tbe economic outlook and the 

appropriate setting for monetary policy 

include their judgments regarding labor 

market conditions that would be consistent 

with maximum employment, the extenl to 

which employment currently deviated from 

maximum employmem, the extent to which 

projected inflation om the medium term 

deviated from tbe Committee's longer-term 

objective of 2 percent, and participants' 

projections of the likely time horizon necessary 

to return employment and inflation to 

mandate-consistentleve\s. Many participants 

mentioned economic thresholds based on the 

unemployment rate and the inflation outlook 

that were consistent with their judgments 
99 


of when it would be appropriate to consider 

beginning to raise the federal funds rate. 

A couple of participants noted that their 

assessments of the appropriate path for the 

federal funds rate took into account the 

likelihood that the neutral level of the federal 

funds rate was somewhat below its historical 

norm. There was some concern expressed that 

a protracted period of very accommodative 

monetary PJlicy could lead to imbalances in 

the financial system. It v.'aS also noted that 

because the appropriate stance of monetary 

policy is conditional on the evolution of real 

activity and inflation over time, a&')essments 

of the appropriate future path of the federal 

funds rate and the balance sheet could change 

if economic conditions were to evolve in an 

unexpected manner. 

Figure 3.E details the distribution of 

participants' judgments regarding the 

appropriate level of the target federal funds 

rate at the end of each calendar year from 

201210 2015 and over the longer run. As 

previously noted, most participants judged 

that economic conditions would warrant 

maintaining the current low level of the 

federa l funds rate until 2015. Views on the 

appropriate level of the federal funds rate by 

the end of 2015 varied, with 12 participants 

seeing the appropriate level of the federal 

funds rate as 1 percent or lower and 4 of them 

seeing the appropriate level as 21f:. percent or 

higher. Generally, the participants who judged 

that a longer period of \·ery accommodative 

monetary PJlicy would be appropriate were 

those who projected that a sizable gap between 

the unemployment rate and the longer-run 

normal level of the unemployment rate would 

persist until 2015 or later. in contrast, the 

majority of the 5 panicipants who judged that 

policy firming should begin in 2013 or 2014 

indicated that the Committee would need to 

act relatively soon in order to keep inflation 

near the FOMCs longer-run objective of 

2 percent and to prevent a rise in inflation 

expectations. 

MONETARY POLICY REPORT: fEBRUARY 1013 53 

Table 2. AWJ1Ige historical projection enor I1IIlges 

""",,nto!')OpoIn" 

Variable "" ." "" "" Ch'ny i. ,"IODI" ±0.6 ±1.4 ±1.7 fl.? 

U ...... pkl)lIlOmru .. ±0.2 10.9 ±1.5 !l.9 

Tau.lc""'Ill"'''prioer' .. ±05 J:O.9 J: I.I no 

Nt.m: Error "'II#' ,.""'" ... """,..-..:I os pl., "r min., rlit roo! 

"",an oq.aro<! .""r"r projoc!io., for 1992 1brougb :!(Ill rhal ...... 

.. It""'" in tho raU ~. "orio ... privlr. . 0<1 t",.....,.,.1 r.....,.".". A. 

dacribod ill tho I><I< "For«aR U"",rWDly.-.odtr",rW. iJO.mJl!io.~ 

tho .. i. about a 70 po""'"t probabilirylhlU octuol """"'""" ilr ,..1 GDP, 

u..",p~monl, a,.j ""."",." pr>:.. will bo in n OV' implied by tho 

""'"'"Y ,i,. " r projection .""" made ill tho post, fuothor ior"rmati"" 

maybo il.o<I in [)a..'id R.il1d ... i<l,raod P<l<fTulip (:l(JQ7j, ··aauy.t tho U..-:mai.ory "r tho Eco.<lII1ic u~ook from Hiororical ror«aRint; 

Erro", * FiII~1U ao<l Ecooomb Di.co";"n S<rirs ))(I?-60 (\\'""hi.gtoo 

!loanl "r Go-.mI .... "r rho Fo.kral R ....... S)~ltm, N"",mbtr). 

1,o.fiDitio .. "r,...riorblo.a .. i.th.r:<D<r1l1ooto-totorblt 1 

2, Mt3<ure i,lb. "",,,,Ueoo,umo, pn.:., iodt .. tho pnc. """" .. that 

... boo. most "ideIy .oed in t"", .. .,..11IIId pri": ... ""'." .. ,, r"r«aR~ 

P'ojoctio. is I""".r cha"", rounh qua,lt, of tho pmi"",)'eor to tho 

r""'tbqlllr tt rortho) or~ 

Uncertainty and Risks 

Nearly all of the participants judged their 

current levels of uncertainty about real GDP 

grov.1h and unemployment to be higher than 

was the norm during the previous 20 years 

(figure 4).1 Se\'en participants judged that the 

levels of uncertainty associated with their 

forecasts of total PCE inflation were higher 

as well, while another 10 participants viewed 

uncertainty about inflation as broadly similar 

to historical norms. The main factors cited 

as contributing to the elevated uncertainty 

aboul economic outcomes were the difficulties 

invoh'ed in predicting fiscal policy in the 

United States, the continuing potential for 

European developments to threaten financial 

stability, and the possibility of a general 

slol,l,TIown in global economic growth. As in 

September, participants noted the challenges 

associated with forecasting the path of the 

I. Table 2 plUlides estimates of the forecast 

uncertainty for the change in real GDp, the 

unemplO}ment rate, and total conswner price inflation 

om the pericd frem 1992 through 2011. At the end 

of this swnmary, the box "Fomast Uncertainty" 

discusses the sources and interpretation of IUlcertainty 

in the economic forecasts and explains the approach 

used 10 assess the Wlcertaintyand risks attending the 

participants' projections. 
100 


54 PART 3: SUMM.I,RY OF ECONOMIC I'ROJEalONS 

Figure 3.E. Distribution of participants' projections for the target federal fund. rate, 2012-15 and over the longer run 

Wil 

=UI o Deuoi>erp.-oject.,,. 

., StplOruberproj«otion. :: i: ::1 1 

=. I C L _, 0_00· 1)jI:. u)· O,a!' 11)· 1)!' 16J· lat· :UJ· :1.)1:' H)' rn ~ W I,U I,D 1M 11. :1.11 m w w lat· )1). ))1:. HJ· ),3t .• 1)· j_)l:. 

)Il )D )Q 111 ,.12 j_D '62 

Wll 

WI' 

WI5 

Pen:tnt rallge 

1.1l· 1.!!. -I.;;: , HI· 2.11· 2.)1:. I.6J· ll8· 1.13· 1.)1:. J.6J. J,3t. '11· ,,)1:. 

1.17 1.62 \,11 :1.11 :1.11 2.61 211 ),\1 ),17 ),62 311 ' ,11 '11 '6) 

Perceolrallge 

1!IjjQ=-=' US - 11J- 1,)1 - \.6J. \ lIS· 

U2 1.D 1.62 III 2.11 

.. rO' PO " .. 

:1.11 - :I.!I- l.6)- U:S· ),13 - ),)1:. 3.63 - ),3t. '11· '!I. 

I_D 1.61 211 1. U 1.D 1.Q JJ1 '11 ',D '62 

Pen:tnt range 

-" -" 

- " =: 

'J' 

-. 

- " = 1! -" -" 

- . =! 

'J' 

::i: -" -" 

- ,. - . = ! ---- - ,=]' )IJ· lJI· HJ· lD· '11· . _)1:. 

),17 ),62 H1 ' ,11 .n '6) 

Loogernm 

-. 

- " - " -" 

= li - . _ .. iji._ i 

0.00 031 U)- US - U3 - 1.!1 - 1.63 1.1IS - :1.11 - :I.!I 

rn m W III lD I. \n :1.11 m w l.6)- 118- ),1)- ),Ji - J.63 - J.IIS ,11 '!I 

211 III )D )62 )11 .11 .D .62 

NOle: The target federal fWlds rare is measured as lIie Ie>'eJ of tile target Tate at the rod of the caleudar year or 

io the 1000ger nm 
101 


figure 4. Uncerlainty and risks in economic projections 

- Uncertaintyaoout GDP growth 

_ 1:1 ~p<o.ie<ti"", 

_ •• StplOmberproj«otioA' 

Bmadly 

""" 

- U~rtaiuty aboUllhe uneruplO)"rotll t rate - 2t) 

r 

Ihoadly 

stllIIlar 

- Uoctrtaiuty all-out PCE in8atioD 

,....-.."" 

Bmadly 

snullar 

rr--.... ·=:! 

-----

Higher 

1-14 

1- 12 

1= l~ ,-, ,-, 

;1' 

- Uncertainty about core PCEinilatiOll 

Ihoadly 

SUlIIlar Higher 

MONETARY POLICY REPORT: fEBRUARY 2013 55 

- Risks toGDP gr0\\1h _ 1:1 D=ri>orproj."6,,o. 

_ •• StplOmbeT projection, 

Weighted to d(lYonslde Ihoadly 

.. , .... 

_ Risks tOlhe unemplo)ment rate 

r 

\\'e!ghted to d(M"DSlde Broadly 

oola1lCed 

-Risks to PCE inIIatioD 

W~ gltltd to d(M"Ds!de Broadly 

.. ,""'" 

- Risks tocore peE inllatiOll 

Weiglttedto 

d(M"DSlde Ihoadly 

.. ,""'" 

-" 

-" 

-" 

-" -12 

->0 

- . - , 

- , -,-:::---,-,----' ' Weighted to upside 

WeIghted to upside 

-" -" -" -" -12 

- >0 

- . - , 1. ____ - 4 

~1ILJ 2 

Weigltledto UpsIde 

-" -" 

-" 

-" - 12 

- >0 

- . - , I.----, -~ 

Weighted to Upllde 

Note: For deliDitiOlls oflWCtrtaiuty 3lld risks in OCOItoruic p-ojeoiOllS, set the box ·forecasl U~rtaiD\(·DeliuitiOilS of variables are in the getICr&1 note to I3bIe 1 
102 


56 PART 3: SUMM,>,RY OF ECONOMIC PROJEalONS 

u.s. economic recovery following a financial 

crisis and recession that difi'ered markedly 

from recent historical experience. A number 

of participants also commented that in the 

aftermath of the financial crisis, they were 

more uncertain about the level of potential 

output and its rate of growth. It was noted 

that some of the uncertainty about potential 

output arose from the risk that a continuation 

of elevated levels of long-term unemployment 

might impair the skills of the affected 

individuals or cause some of them to drop out 

of the labor force, thereby reducing potential 

output in the medium term. 

A majority of participants reported that they 

saw the risks to their forecasts of real GDP 

growth as weighted tov.'<lrd the downside and, 

accordingly, the risks to their projections 

of the unemployment rate as tilted to the 

upside. The most frequently identified sources 

of risk were U.S. fiscal policy, which many 

participants thought had the potential to slow 

economic activity significantly over the near 

term, and the situation in Europe. 

Most participants cominued to judge the risks 

to their projections for inflation as broadly 

balanced, with several highlighting the recent 

stability of longer-term inl1ation expectations. 

Howewr, three participants saw the risks to 

inflation as tilted to the dov.llside, reflecting, 

for example, risks of disinl1atiollthat could 

arise from ad\'erse shocks to the economy that 

policy would have limited scope 10 offset. A 

couple of participants saw the risks to inflation 

as weighted to the upside in light of concerns 

about U.S. fiscal imbalances, the current highly 

accommodative stance of monetary policy, 

and uncertainty about the Committee's ability 

to shift to a less accommodative policy stance 

when it becomes appropriate to do so, 
103 


Forecast Uncertainty 

The economc projections provided by the 

members of the Board of Governors and the 

presidents of the Federal Reserve Banks inform 

discussions of moneliry policy among policymakers 

and can aid public understanding of the basis for 

policy actions. Considerable uncertainty attends 

these projections, howel'€r. The economic and 

statistical models and relationships used to help 

produce economic forecasts are necessarily 

imperfect descriptions of the rea l world, and the 

future path of the economy can be affected by 

myriad unforeseen del'€lopments and events, Thus, 

in setting the stance of monetary policy, participants 

consider not only what appears to be the most likely 

economic outcome as erIDodied in their projections, 

but also the range of alternative possibilities, the 

likelihood of their occurring, and the potential costs 

to the economy should they occur. 

Table 2 summarizes the average historical 

accuracy of a range of forecasts, including those 

reported in past Monel.ary Policy Reports and those 

preraroo by the Fooeral Reser\'€ Boord's staff in 

advance of meetings of the Fooeral Open Marlce! 

Committee. The projection error ranges shewn in 

the table illustrate the considerable uncertainty 

associated with economc forecasts. For example, 

suppose a participant projects that real gross 

domestic product (GOP) and total consumer prices 

will rise steadily at annual rates of, respectively, 

3 percent and 2 percent. If the uncerta inty attending 

those projections is similar to that experienced in 

the past and the risks around the projections are 

broadly balanced, the numbers reported in table 2 

would imply a probability of about 70 percent that 

actual GOP would eKpaod within a range of 2.4 to 

3.6 percent in the current year, 1.6 to 4.4 percent in 

the second year, and 1 J to 4.7 percent in the third 

MONETARY POLICY REPORT: fEBRUARY 1013 57 

and fourth years. The corresponding 70 percent 

confidence intervals for overall inflation would 

be 1.5 to 2.S percent in the current year, 1.1 to 

2.9 percent in the second year, 0.9 to 3.1 percent in 

the third year, and 1.0 to 3,0 percent in the fourth 

year. 

Because current conditions may differ from 

those that prevailed, on average, over history, 

participants provide judgments as to whether the 

uncertainty attached to their projections of each 

variable is greater than, smaller than, or broadly 

similar to typical levels of forecast uncertainty 

in the past, as shewn in table 2. Participants also 

provide judgments as to whether the risks to their 

projections are weighted to the upside, are weightoo 

to the da.vnside, or are broadly balanced. That is, 

participants judge whether each variable is more 

likely to be above or belew their projections of the 

most likely outcome. These judgments about the 

uncertainty and the risks attending each participant's 

projections are distiflCt from the diversity of 

participants' \'iews about the most likely outcomes. 

Forecast uncertainty is concerned with the risks 

associatoo with a particular projection rather than 

10th divergences across a number of different 

projections. 

As with real activity and inflation, the outlook 

for the future path of the federal funds rate is subject 

to considerable uncertainty. Th is uncertainty arises 

primarily because each participant's assessment of 

the awropriate stance of rmnetary policy depends 

importantly on the evolution of real activity and 

inflation over time. tf economic conditions evolve 

in an unexpectoo manner, then assessments of the 

appropriate setting of the fooera l funds rate would 

change from that point forward. 
104 


ABBREVIATIONS 

ABCP 

AFE 

BHC 

CDS 

C&I 

CMBS 

CP 

CRE 

DPI 

ECB 

EME 

E&S 

FOMe 

GDP 

MBS 

MEP 

MMF 

NI PA 

OMT 

PCE 

REIT 

repo 

SEP 

SLOOS 

S&P 

TALF 

asset·backed commercial paper 

advanced foreign economy 

bank holding company 

credit default ~v:aps 

commercial and industrial 

commercial mortgage-backed securities 

C{)mmercial paper 

commercial real estate 

disposable personal income 

European Central Bank 

emerging market economy 

equipment and software 

Federal Open Market Committee; also, the Committee 

gross domestic product 

mortgage-backed securities 

matunty exlenslOO program 

money market fund 

nalional income and product accounts 

Outright Monetary Transactions 

personal consumption e.xpenditures 

real estate investment trust 

repurchase agreement 

Summary of Economic Projections 

Seoior Loan Officer Opinion Survey on Bank Lending Practices 

Standard and Poor's 

Term Asset-Backed Securities Loan Facility 

59