Ben S Bernanke: Semiannual Monetary Report to the Congress
Testimony by Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal
Reserve System, before the Committee on Financial Services, US House of
Representatives, Washington, DC, 21 July 2009.
The original speech, which contains various links to the documents mentioned, can be found on the US Federal
Reserve System's website.
* * *
Chairman Frank, Ranking Member Bachus, and other members of the Committee, I am
pleased to present the Federal Reserve's semiannual Monetary Policy Report to the
Congress.
Economic and financial developments in the first half of 2009
Aggressive policy actions taken around the world last fall may well have averted the collapse
of the global financial system, an event that would have had extremely adverse and
protracted consequences for the world economy. Even so, the financial shocks that hit the
global economy in September and October were the worst since the 1930s, and they helped
push the global economy into the deepest recession since World War II. The U.S. economy
contracted sharply in the fourth quarter of last year and the first quarter of this year. More
recently, the pace of decline appears to have slowed significantly, and final demand and
production have shown tentative signs of stabilization. The labor market, however, has
continued to weaken. Consumer price inflation, which fell to low levels late last year,
remained subdued in the first six months of 2009.
To promote economic recovery and foster price stability, the Federal Open Market
Committee (FOMC) last year brought its target for the federal funds rate to a historically low
range of 0 to 1/4 percent, where it remains today. The FOMC anticipates that economic
conditions are likely to warrant maintaining the federal funds rate at exceptionally low levels
for an extended period.
At the time of our February report, financial markets at home and abroad were under intense
strains, with equity prices at multiyear lows, risk spreads for private borrowers at very
elevated levels, and some important financial markets essentially shut. Today, financial
conditions remain stressed, and many households and businesses are finding credit difficult
to obtain. Nevertheless, on net, the past few months have seen some notable improvements.
For example, interest rate spreads in short-term money markets, such as the interbank
market and the commercial paper market, have continued to narrow. The extreme risk
aversion of last fall has eased somewhat, and investors are returning to private credit
markets. Reflecting this greater investor receptivity, corporate bond issuance has been
strong. Many markets are functioning more normally, with increased liquidity and lower
bidasked spreads. Equity prices, which hit a low point in March, have recovered to roughly their
levels at the end of last year, and banks have raised significant amounts of new capital.
Many of the improvements in financial conditions can be traced, in part, to policy actions
taken by the Federal Reserve to encourage the flow of credit. For example, the decline in
interbank lending rates and spreads was facilitated by the actions of the Federal Reserve
and other central banks to ensure that financial institutions have adequate access to
shortterm liquidity, which in turn has increased the stability of the banking system and the ability of
banks to lend. Interest rates and spreads on commercial paper dropped significantly as a
result of the backstop liquidity facilities that the Federal Reserve introduced last fall for that
market. Our purchases of agency mortgage-backed securities and other longer-term assets
have helped lower conforming fixed mortgage rates. And the Term Asset-Backed Securities
Loan Facility (TALF), which was implemented this year, has helped restart the securitization
markets for various classes of consumer and small business credit.
Earlier this year, the Federal Reserve and other federal banking regulatory agencies
undertook the Supervisory Capital Assessment Program (SCAP), popularly known as the
stress test, to determine the capital needs of the largest financial institutions. The results of
the SCAP were reported in May, and they appeared to increase investor confidence in the
U.S. banking system. Subsequently, the great majority of institutions that underwent the
assessment have raised equity in public markets. And, on June 17, 10 of the largest U.S.
bank holding companies - all but one of which participated in the SCAP - repaid a total of
nearly $70 billion to the Treasury.
Better conditions in financial markets have been accompanied by some improvement in
economic prospects. Consumer spending has been relatively stable so far this year, and the
decline in housing activity appears to have moderated. Businesses have continued to cut
capital spending and liquidate inventories, but the likely slowdown in the pace of inventory
liquidation in coming quarters represents another factor that may support a turnaround in
activity. Although the recession in the rest of the world led to a steep drop in the demand for
U.S. exports, this drag on our economy also appears to be waning, as many of our trading
partners are also seeing signs of stabilization.
Despite these positive signs, the rate of job loss remains high and the unemployment rate
has continued its steep rise. Job insecurity, together with declines in home values and tight
credit, is likely to limit gains in consumer spending. The possibility that the recent stabilization
in household spending will prove transient is an important downside risk to the outlook.
In conjunction with the June FOMC meeting, Board members and Reserve Bank presidents
prepared economic projections covering the years 2009 through 2011. FOMC participants
generally expect that, after declining in the first half of this year, output will increase slightly
over the remainder of 2009. The recovery is expected to be gradual in 2010, with some
acceleration in activity in 2011. Although the unemployment rate is projected to peak at the
end of this year, the projected declines in 2010 and 2011 would still leave unemployment
well above FOMC participants' views of the longer-run sustainable rate. All participants
expect that inflation will be somewhat lower this year than in recent years, and most expect it
to remain subdued over the next two years.
Policy challenges
Monetary policy
In light of the substantial economic slack and limited inflation pressures, monetary policy
remains focused on fostering economic recovery. Accordingly, as I mentioned earlier, the
FOMC believes that a highly accommodative stance of monetary policy will be appropriate
for an extended period. However, we also believe that it is important to assure the public and
the markets that the extraordinary policy measures we have taken in response to the
financial crisis and the recession can be withdrawn in a smooth and timely manner as
needed, thereby avoiding the risk that policy stimulus could lead to a future rise in inflation.1
The FOMC has been devoting considerable attention to issues relating to its exit strategy,
and we are confident that we have the necessary tools to implement that strategy when
appropriate.
To some extent, our policy measures will unwind automatically as the economy recovers and
financial strains ease, because most of our extraordinary liquidity facilities are priced at a
premium over normal interest rate spreads. Indeed, total Federal Reserve credit extended to
banks and other market participants has declined from roughly $1.5 trillion at the end of 2008
to less than $600 billion, reflecting the improvement in financial conditions that has already
occurred. In addition, bank reserves held at the Fed will decline as the longer-term assets
that we own mature or are prepaid. Nevertheless, should economic conditions warrant a
tightening of monetary policy before this process of unwinding is complete, we have a
number of tools that will enable us to raise market interest rates as needed.
Perhaps the most important such tool is the authority that the Congress granted the Federal
Reserve last fall to pay interest on balances held at the Fed by depository institutions.
Raising the rate of interest paid on reserve balances will give us substantial leverage over
the federal funds rate and other short-term market interest rates, because banks generally
will not supply funds to the market at an interest rate significantly lower than they can earn
risk free by holding balances at the Federal Reserve. Indeed, many foreign central banks use
the ability to pay interest on reserves to help set a floor on market interest rates. The
attractiveness to banks of leaving their excess reserve balances with the Federal Reserve
can be further increased by offering banks a choice of maturities for their deposits.
But interest on reserves is by no means the only tool we have to influence market interest
rates. For example, we can drain liquidity from the system by conducting reverse repurchase
agreements, in which we sell securities from our portfolio with an agreement to buy them
back at a later date. Reverse repurchase agreements, which can be executed with primary
dealers, government-sponsored enterprises, and a range of other counterparties, are a
traditional and well-understood method of managing the level of bank reserves. If necessary,
another means of tightening policy is outright sales of our holdings of longer-term securities.
Not only would such sales drain reserves and raise short-term interest rates, but they also
could put upward pressure on longer-term interest rates by expanding the supply of
longerterm assets. In sum, we are confident that we have the tools to raise interest rates when that
becomes necessary to achieve our objectives of maximum employment and price stability.
Fiscal policy
Our economy and financial markets have faced extraordinary near-term challenges, and
strong and timely actions to respond to those challenges have been necessary and
appropriate. I have discussed some of the measures taken by the Federal Reserve to
promote economic growth and financial stability. The Congress also has taken substantial
actions, including the passage of a fiscal stimulus package. Nevertheless, even as important
steps have been taken to address the recession and the intense threats to financial stability,
maintaining the confidence of the public and financial markets requires that policymakers
begin planning now for the restoration of fiscal balance. Prompt attention to questions of
fiscal sustainability is particularly critical because of the coming budgetary and economic
challenges associated with the retirement of the baby-boom generation and continued
increases in the costs of Medicare and Medicaid. Addressing the country's fiscal problems
will require difficult choices, but postponing those choices will only make them more difficult.
Moreover, agreeing on a sustainable long-run fiscal path now could yield considerable
nearterm economic benefits in the form of lower long-term interest rates and increased consumer
and business confidence. Unless we demonstrate a strong commitment to fiscal
sustainability, we risk having neither financial stability nor durable economic growth.
Regulatory reform
A clear lesson of the recent financial turmoil is that we must make our system of financial
supervision and regulation more effective, both in the United States and abroad. In my view,
comprehensive reform should include at least the following key elements:
•
a prudential approach that focuses on the stability of the financial system as a whole,
not just the safety and soundness of individual institutions, and that includes formal
mechanisms for identifying and dealing with emerging systemic risks;
•
stronger capital and liquidity standards for financial firms, with more-stringent
standards for large, complex, and financially interconnected firms;
•
the extension and enhancement of supervisory oversight, including effective
consolidated supervision, to all financial organizations that could pose a significant
risk to the overall financial system;
•
an enhanced bankruptcy or resolution regime, modeled on the current system for
depository institutions, that would allow financially troubled, systemically important
nonbank financial institutions to be wound down without broad disruption to the
financial system and the economy;
•
enhanced protections for consumers and investors in their financial dealings;
•
measures to ensure that critical payment, clearing, and settlement arrangements are
resilient to financial shocks, and that practices related to the trading and clearing of
derivatives and other financial instruments do not pose risks to the financial system
as a whole; and
•
improved coordination across countries in the development of regulations and in the
supervision of internationally active firms.
The Federal Reserve has taken and will continue to take important steps to strengthen
supervision, improve the resiliency of the financial system, and to increase the
macroprudential orientation of our oversight. For example, we are expanding our use of
horizontal reviews of financial firms to provide a more comprehensive understanding of
practices and risks in the financial system.
The Federal Reserve also remains strongly committed to effectively carrying out our
responsibilities for consumer protection. Over the past three years, the Federal Reserve has
written rules providing strong protections for mortgage borrowers and credit card users,
among many other substantive actions. Later this week, the Board will issue a proposal using
our authority under the Truth in Lending Act, which will include new, consumer-tested
disclosures as well as rule changes applying to mortgages and home equity lines of credit; in
addition, the proposal includes new rules governing the compensation of mortgage
originators. We are expanding our supervisory activities to include risk-focused reviews of
consumer compliance in nonbank subsidiaries of holding companies. Our community affairs
and research areas have provided support and assistance for organizations specializing in
foreclosure mitigation, and we have worked with nonprofit groups on strategies for
neighborhood stabilization. The Federal Reserve's combination of expertise in financial
markets, payment systems, and supervision positions us well to protect the interests of
consumers in their financial transactions. We look forward to discussing with the Congress
ways to further formalize our institution's strong commitment to consumer protection.
Transparency and accountability
The Congress and the American people have a right to know how the Federal Reserve is
carrying out its responsibilities and how we are using taxpayers' resources. The Federal
Reserve is committed to transparency and accountability in its operations. We report on our
activities in a variety of ways, including reports like the one I am presenting to the Congress
today, other testimonies, and speeches. The FOMC releases a statement immediately after
each regularly scheduled meeting and detailed minutes of each meeting on a timely basis.
We have increased the frequency and scope of the published economic forecasts of FOMC
participants. We provide the public with detailed annual reports on the financial activities of
the Federal Reserve System that are audited by an independent public accounting firm. We
also publish a complete balance sheet each week.
We have recently taken additional steps to better inform the public about the programs we
have instituted to combat the financial crisis. We expanded our website this year to bring
together already available information as well as considerable new information on our policy
programs and financial activities.2 In June, we initiated a monthly report to the Congress
(also posted on our website) that provides even more information on Federal Reserve
liquidity programs, including breakdowns of our lending, the associated collateral, and other
facets of programs established to address the financial crisis.3 These steps should help the
public understand the efforts that we have taken to protect the taxpayer as we supply liquidity
to the financial system and support the functioning of key credit markets.
The Congress has recently discussed proposals to expand the audit authority of the
Government Accountability Office (GAO) over the Federal Reserve. As you know, the
Federal Reserve is already subject to frequent reviews by the GAO. The GAO has broad
authority to audit our operations and functions. The Congress recently granted the GAO new
authority to conduct audits of the credit facilities extended by the Federal Reserve to "single
and specific" companies under the authority provided by section 13(3) of the Federal
Reserve Act, including the loan facilities provided to, or created for, American International
Group and Bear Stearns. The GAO and the Special Inspector General have the right to audit
our TALF program, which uses funds from the Troubled Assets Relief Program.
The Congress, however, purposefully - and for good reason - excluded from the scope of
potential GAO reviews some highly sensitive areas, notably monetary policy deliberations
and operations, including open market and discount window operations. In doing so, the
Congress carefully balanced the need for public accountability with the strong public policy
benefits that flow from maintaining an appropriate degree of independence for the central
bank in the making and execution of monetary policy. Financial markets, in particular, likely
would see a grant of review authority in these areas to the GAO as a serious weakening of
monetary policy independence. Because GAO reviews may be initiated at the request of
members of Congress, reviews or the threat of reviews in these areas could be seen as
efforts to try to influence monetary policy decisions. A perceived loss of monetary policy
independence could raise fears about future inflation, leading to higher long-term interest
rates and reduced economic and financial stability. We will continue to work with the
Congress to provide the information it needs to oversee our activities effectively, yet in a way
that does not compromise monetary policy independence.