Ben S Bernanke: Semiannual Monetary Policy Report to the Congress
Testimony by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal
Reserve System, before the Committee on Banking, Housing, and Urban Affairs, US Senate,
Washington DC, 1 March 2011.
* * *
Chairman Johnson, Ranking Member Shelby, and other members of the Committee, I am
Monetary Policy Report to the
pleased to present the Federal Reserve's semiannual
Congress. I will begin with a discussion of economic conditions and the outlook before
turning to monetary policy.
The economic outlook
Following the stabilization of economic activity in mid-2009, the U.S. economy is now in its
seventh quarter of growth; last quarter, for the first time in this expansion, our nation's real
gross domestic product (GDP) matched its pre-crisis peak. Nevertheless, job growth remains
relatively weak and the unemployment rate is still high.
In its early stages, the economic recovery was largely attributable to the stabilization of the
financial system, the effects of expansionary monetary and fiscal policies, and a strong boost
to production from businesses rebuilding their depleted inventories. Economic growth slowed
significantly in the spring and early summer of 2010, as the impetus from inventory building
and fiscal stimulus diminished and as Europe's debt problems roiled global financial markets.
More recently, however, we have seen increased evidence that a self-sustaining recovery in
consumer and business spending may be taking hold. Notably, real consumer spending has
grown at a solid pace since last fall, and business investment in new equipment and software
has continued to expand. Stronger demand, both domestic and foreign, has supported
steady gains in U.S. manufacturing output.
The combination of rising household and business confidence, accommodative monetary
policy, and improving credit conditions seems likely to lead to a somewhat more rapid pace
of economic recovery in 2011 than we saw last year. The most recent economic projections
by Federal Reserve Board members and Reserve Bank presidents, prepared in conjunction
with the Federal Open Market Committee (FOMC) meeting in late January, are for real GDP
to increase 3-1/2 to 4 percent in 2011, about one-half percentage point higher than our
projections made in November.1 Private forecasters' projections for 2011 are broadly
consistent with those of the FOMC participants and have also moved up in recent months.2
While indicators of spending and production have been encouraging on balance, the job
market has improved only slowly. Following the loss of about 8-3/4 million jobs from early
2008 through 2009, private-sector employment expanded by only a little more than 1 million
during 2010, a gain barely sufficient to accommodate the inflow of recent graduates and
other entrants to the labor force. We do see some grounds for optimism about the job market
over the next few quarters, including notable declines in the unemployment rate in December
and January, a drop in new claims for unemployment insurance, and an improvement in
firms' hiring plans. Even so, if the rate of economic growth remains moderate, as projected, it
could be several years before the unemployment rate has returned to a more normal level.
Indeed, FOMC participants generally see the unemployment rate still in the range of 7-1/2 to
8 percent at the end of 2012. Until we see a sustained period of stronger job creation, we
cannot consider the recovery to be truly established.
Likewise, the housing sector remains exceptionally weak. The overhang of vacant and
foreclosed houses is still weighing heavily on prices of new and existing homes, and sales
and construction of new single-family homes remain depressed. Although mortgage rates are
low and house prices have reached more affordable levels, many potential homebuyers are
still finding mortgages difficult to obtain and remain concerned about possible further
declines in home values.
Inflation has declined, on balance, since the onset of the financial crisis, reflecting high levels
of resource slack and stable longer-term inflation expectations. Indeed, over the 12 months
ending in January, prices for all of the goods and services consumed by households (as
measured by the price index for personal consumption expenditures (PCE)) increased by
only 1.2 percent, down from 2.5 percent in the year-earlier period. Wage growth has slowed
as well, with average hourly earnings increasing only 1.9 percent over the year ending in
January. In combination with productivity increases, slow wage growth has implied very tight
restraint on labor costs per unit of output.
FOMC participants see inflation remaining low; most project that overall inflation will be about
1-1/4 to 1-3/4 percent this year and in the range of 1 to 2 percent next year and in 2013.
Private-sector forecasters generally also anticipate subdued inflation over the next few
years.3 Measures of medium- and long-term inflation compensation derived from
inflationindexed Treasury bonds appear broadly consistent with these forecasts. Surveys of
households suggest that the public's longer-term inflation expectations also remain stable.
Although overall inflation is low, since summer we have seen significant increases in some
highly visible prices, including those of gasoline and other commodities. Notably, in the past
few weeks, concerns about unrest in the Middle East and North Africa and the possible
effects on global oil supplies have led oil and gasoline prices to rise further. More broadly,
the increases in commodity prices in recent months have largely reflected rising global
demand for raw materials, particularly in some fast-growing emerging market economies,
coupled with constraints on global supply in some cases. Commodity prices have risen
significantly in terms of all major currencies, suggesting that changes in the foreign exchange
value of the dollar are unlikely to have been an important driver of the increases seen in
recent months.
The rate of pass-through from commodity price increases to broad indexes of U.S. consumer
prices has been quite low in recent decades, partly reflecting the relatively small weight of
materials inputs in total production costs as well as the stability of longer-term inflation
expectations. Currently, the cost pressures from higher commodity prices are also being
offset by the stability in unit labor costs. Thus, the most likely outcome is that the recent rise
in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S.
consumer price inflation - an outlook consistent with the projections of both FOMC
participants and most private forecasters. That said, sustained rises in the prices of oil or
other commodities would represent a threat both to economic growth and to overall price
stability, particularly if they were to cause inflation expectations to become less well
anchored. We will continue to monitor these developments closely and are prepared to
respond as necessary to best support the ongoing recovery in a context of price stability.
Monetary policy
As I noted earlier, the pace of recovery slowed last spring - to a rate that, if sustained, would
have been insufficient to make meaningful progress against unemployment. With job creation
stalling, concerns about the sustainability of the recovery increased. At the same time,
inflation - already at very low levels - continued to drift downward, and market-based
measures of inflation compensation moved lower as investors appeared to become more
concerned about the possibility of deflation, or falling prices.4
Under such conditions, the Federal Reserve would normally ease monetary policy by
reducing the target for its short-term policy interest rate, the federal funds rate. However, the
target range for the federal funds rate has been near zero since December 2008, and the
Federal Reserve has indicated that economic conditions are likely to warrant an
exceptionally low target rate for an extended period. Consequently, another means of
providing monetary accommodation has been necessary since that time. In particular, over
the past two years the Federal Reserve has eased monetary conditions by purchasing
longer-term Treasury securities, agency debt, and agency mortgage-backed securities
(MBS) on the open market. The largest program of purchases, which lasted from December
2008 through March 2010, appears to have contributed to an improvement in financial
conditions and a strengthening of the recovery. Notably, the substantial expansion of the
program announced in March 2009 was followed by financial and economic stabilization and
a significant pickup in the growth of economic activity in the second half of that year.
In August 2010, in response to the already-mentioned concerns about the sustainability of
the recovery and the continuing declines in inflation to very low levels, the FOMC authorized
a policy of reinvesting principal payments on our holdings of agency debt and agency MBS
into longer-term Treasury securities. By reinvesting agency securities, rather than allowing
them to continue to run off as our previous policy had dictated, the FOMC ensured that a
high level of monetary accommodation would be maintained. Over subsequent weeks,
Federal Reserve officials noted in public remarks that we were considering providing
additional monetary accommodation through further asset purchases. In November, the
Committee announced that it intended to purchase an additional $600 billion in longer-term
Treasury securities by the middle of this year.
Large-scale purchases of longer-term securities are a less familiar means of providing
monetary policy stimulus than reducing the federal funds rate, but the two approaches affect
the economy in similar ways. Conventional monetary policy easing works by lowering market
expectations for the future path of short-term interest rates, which, in turn, reduces the
current level of longer-term interest rates and contributes to both lower borrowing costs and
higher asset prices. This easing in financial conditions bolsters household and business
spending and thus increases economic activity. By comparison, the Federal Reserve's
purchases of longer-term securities, by lowering term premiums, put downward pressure
directly on longer-term interest rates. By easing conditions in credit and financial markets,
these actions encourage spending by households and businesses through essentially the
same channels as conventional monetary policy.
A wide range of market indicators supports the view that the Federal Reserve's recent
actions have been effective. For example, since August, when we announced our policy of
reinvesting principal payments on agency debt and agency MBS and indicated that we were
considering more securities purchases, equity prices have risen significantly, volatility in the
equity market has fallen, corporate bond spreads have narrowed, and inflation compensation
as measured in the market for inflation-indexed securities has risen to historically more
normal levels. Yields on 5- to 10-year nominal Treasury securities initially declined markedly
as markets priced in prospective Fed purchases; these yields subsequently rose, however,
as investors became more optimistic about economic growth and as traders scaled back
their expectations of future securities purchases. All of these developments are what one
would expect to see when monetary policy becomes more accommodative, whether through
conventional or less conventional means. Interestingly, these market responses are almost
identical to those that occurred during the earlier episode of policy easing, notably in the
months following our March 2009 announcement. In addition, as I already noted, most
forecasters see the economic outlook as having improved since our actions in August;
downside risks to the recovery have receded, and the risk of deflation has become negligible.
Of course, it is too early to make any firm judgment about how much of the recent
improvement in the outlook can be attributed to monetary policy, but these developments are
consistent with it having had a beneficial effect.
My colleagues and I continue to regularly review the asset purchase program in light of
incoming information, and we will adjust it as needed to promote the achievement of our
mandate from the Congress of maximum employment and stable prices. We also continue to
plan for the eventual exit from unusually accommodative monetary policies and the
normalization of the Federal Reserve's balance sheet. We have all the tools we need to
achieve a smooth and effective exit at the appropriate time. Currently, because the Federal
Reserve's asset purchases are settled through the banking system, depository institutions
hold a very high level of reserve balances with the Federal Reserve. Even if bank reserves
remain high, however, our ability to pay interest on reserve balances will allow us to put
upward pressure on short-term market interest rates and thus to tighten monetary policy
when required. Moreover, we have developed and tested additional tools that will allow us to
drain or immobilize bank reserves to the extent needed to tighten the relationship between
the interest rate paid on reserves and other short-term interest rates.5 If necessary, the
Federal Reserve can also drain reserves by ceasing the reinvestment of principal payments
on the securities it holds or by selling some of those securities in the open market. The
FOMC remains unwaveringly committed to price stability and, in particular, to achieving a
rate of inflation in the medium term that is consistent with the Federal Reserve's mandate.
Federal Reserve transparency
The Congress established the Federal Reserve, set its monetary policy objectives, and
provided it with operational independence to pursue those objectives. The Federal Reserve's
operational independence is critical, as it allows the FOMC to make monetary policy
decisions based solely on the longer-term needs of the economy, not in response to short-
term political pressures. Considerable evidence supports the view that countries with
independent central banks enjoy better economic performance over time.6
However, in our democratic society, the Federal Reserve's independence brings with it the
obligation to be accountable and transparent. The Congress and the public must have all the
information needed to understand our decisions, to be assured of the integrity of our operations,
and to be confident that our actions are consistent with the mandate given to us by the Congress.
On matters related to the conduct of monetary policy, the Federal Reserve is one of the most
transparent central banks in the world, making available extensive records and materials to
Monetary Policy Report
explain its policy decisions. For example, beyond the semiannual I
am presenting today, the FOMC provides a post-meeting statement, a detailed set of
minutes three weeks after each policy meeting, quarterly economic projections together with
an accompanying narrative, and, with a five-year lag, a transcript of each meeting and its
supporting materials. In addition, FOMC participants often discuss the economy and
monetary policy in public forums, and Board members testify frequently before the Congress.
In recent years the Federal Reserve has also substantially increased the information it
provides about its operations and its balance sheet. In particular, for some time the Federal
Reserve has been voluntarily providing extensive financial and operational information
regarding the special credit and liquidity facilities put in place during the financial crisis,
including full descriptions of the terms and conditions of each facility; monthly reports on,
among other things, the types of collateral posted and the mix of participants using each
facility; weekly updates about borrowings and repayments at each facility; and many other
details.7 Further, on December 1, as provided by the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010, the Federal Reserve Board posted on its public website
the details of more than 21,000 individual credit and other transactions conducted to stabilize
markets and support the economic recovery during the crisis. This transaction-level
information demonstrated the breadth of these operations and the care that was taken to
protect the interests of the taxpayer; indeed, despite the scope of these actions, the Federal
Reserve has incurred no credit losses to date on any of the programs and expects no credit
losses in any of the few programs that still have loans outstanding. Moreover, we are fully
confident that independent assessments of these programs will show that they were highly
effective in helping to stabilize financial markets, thus strengthening the economy. Overall,
the operational effectiveness of the programs was recently supported as part of a
comprehensive review of six lending facilities by the Board's independent Office of Inspector
General.8 In addition, we have been working closely with the Government Accountability
Office, the Office of the Special Inspector General for the Troubled Asset Relief Program, the
Congressional Oversight Panel, the Congress, and private-sector auditors on reviews of
these facilities as well as a range of matters relating to the Federal Reserve's operations and
governance. We will continue to seek ways of enhancing our transparency without
compromising our ability to conduct policy in the public interest.
Thank you. I would be pleased to take your questions.