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, 17 July 2012.
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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 current economic conditions and the outlook
before turning to monetary policy.
The economic outlook
The U.S. economy has continued to recover, but economic activity appears to have
decelerated somewhat during the first half of this year. After rising at an annual rate of
2-1/2 percent in the second half of 2011, real gross domestic product (GDP) increased at a
2 percent pace in the first quarter of 2012, and available indicators point to a still-smaller gain
in the second quarter.
Conditions in the labor market improved during the latter part of 2011 and early this year,
with the unemployment rate falling about a percentage point over that period. However, after
running at nearly 200,000 per month during the fourth and first quarters, the average
increase in payroll employment shrank to 75,000 per month during the second quarter.
Issues related to seasonal adjustment and the unusually warm weather this past winter can
account for a part, but only a part, of this loss of momentum in job creation. At the same time,
the jobless rate has recently leveled out at just over 8 percent.
Household spending has continued to advance, but recent data indicate a somewhat slower
rate of growth in the second quarter. Although declines in energy prices are now providing
some support to consumers' purchasing power, households remain concerned about their
employment and income prospects and their overall level of confidence remains relatively
low.
We have seen modest signs of improvement in housing. In part because of historically low
mortgage rates, both new and existing home sales have been gradually trending upward
since last summer, and some measures of house prices have turned up in recent months.
Construction has increased, especially in the multifamily sector. Still, a number of factors
continue to impede progress in the housing market. On the demand side, many would-be
buyers are deterred by worries about their own finances or about the economy more
generally. Other prospective homebuyers cannot obtain mortgages due to tight lending
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standards, impaired creditworthiness, or because their current mortgages are underwater
that is, they owe more than their homes are worth. On the supply side, the large number of
vacant homes, boosted by the ongoing inflow of foreclosed properties, continues to divert
demand from new construction.
After posting strong gains over the second half of 2011 and into the first quarter of 2012,
manufacturing production has slowed in recent months. Similarly, the rise in real business
spending on equipment and software appears to have decelerated from the double-digit pace
seen over the second half of 2011 to a more moderate rate of growth over the first part of this
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year. Forward-looking indicators of investment demand such as surveys of business
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conditions and capital spending plans suggest further weakness ahead. In part, slowing
growth in production and capital investment appears to reflect economic stresses in Europe,
which, together with some cooling in the economies of other trading partners, is restraining
the demand for U.S. exports.
At the time of the June meeting of the Federal Open Market Committee (FOMC), my
colleagues and I projected that, under the assumption of appropriate monetary policy,
economic growth will likely continue at a moderate pace over coming quarters and then pick
up very gradually. Specifically, our projections for growth in real GDP prepared for the
meeting had a central tendency of 1.9 to 2.4 percent for this year and 2.2 to 2.8 percent for
2013.1 These forecasts are lower than those we made in January, reflecting the generally
disappointing tone of the recent incoming data.2 In addition, financial strains associated
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with the crisis in Europe have increased since earlier in the year, which as I already
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noted are weighing on both global and domestic economic activity. The recovery in the
United States continues to be held back by a number of other headwinds, including
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stilltight borrowing conditions for some businesses and households, and as I will discuss in
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more detail shortly the restraining effects of fiscal policy and fiscal uncertainty.
Moreover, although the housing market has shown improvement, the contribution of this
sector to the recovery is less than has been typical of previous recoveries. These
headwinds should fade over time, allowing the economy to grow somewhat more rapidly
and the unemployment rate to decline toward a more normal level. However, given that
growth is projected to be not much above the rate needed to absorb new entrants to the
labor force, the reduction in the unemployment rate seems likely to be frustratingly slow.
Indeed, the central tendency of participants' forecasts now has the unemployment rate at
7 percent or higher at the end of 2014.
The Committee made comparatively small changes in June to its projections for inflation.
Over the first three months of 2012, the price index for personal consumption expenditures
(PCE) rose about 3-1/2 percent at an annual rate, boosted by a large increase in retail
energy prices that in turn reflected the higher cost of crude oil. However, the sharp drop in
crude oil prices in the past few months has brought inflation down. In all, the PCE price index
rose at an annual rate of 1-1/2 percent over the first five months of this year, compared with
a 2-1/2 percent rise over 2011 as a whole. The central tendency of the Committee's
projections is that inflation will be 1.2 to 1.7 percent this year, and at or below the 2 percent
level that the Committee judges to be consistent with its statutory mandate in 2013 and 2014.
Risks to the outlook
Participants at the June FOMC meeting indicated that they see a higher degree of
uncertainty about their forecasts than normal and that the risks to economic growth have
increased. I would like to highlight two main sources of risk: The first is the euro-area fiscal
and banking crisis; the second is the U.S. fiscal situation.
Earlier this year, financial strains in the euro area moderated in response to a number of
constructive steps by the European authorities, including the provision of three-year bank
financing by the European Central Bank. However, tensions in euro-area financial markets
intensified again more recently, reflecting political uncertainties in Greece and news of losses
at Spanish banks, which in turn raised questions about Spain's fiscal position and the
resilience of the euro-area banking system more broadly. Euro-area authorities have
responded by announcing a number of measures, including funding for the recapitalization of
Spain's troubled banks, greater flexibility in the use of the European financial backstops
(including, potentially, the flexibility to recapitalize banks directly rather than through loans to
sovereigns), and movement toward unified supervision of euro-area banks. Even with these
announcements, however, Europe's financial markets and economy remain under significant
stress, with spillover effects on financial and economic conditions in the rest of the world,
including the United States. Moreover, the possibility that the situation in Europe will worsen
further remains a significant risk to the outlook.
The Federal Reserve remains in close communication with our European counterparts.
Although the politics are complex, we believe that the European authorities have both strong
incentives and sufficient resources to resolve the crisis. At the same time, we have been
focusing on improving the resilience of our financial system to severe shocks, including those
that might emanate from Europe. The capital and liquidity positions of U.S. banking
institutions have improved substantially in recent years, and we have been working with U.S.
financial firms to ensure they are taking steps to manage the risks associated with their
exposures to Europe. That said, European developments that resulted in a significant
disruption in global financial markets would inevitably pose significant challenges for our
financial system and our economy.
The second important risk to our recovery, as I mentioned, is the domestic fiscal situation. As
is well known, U.S. fiscal policies are on an unsustainable path, and the development of a
credible medium-term plan for controlling deficits should be a high priority. At the same time,
fiscal decisions should take into account the fragility of the recovery. That recovery could be
endangered by the confluence of tax increases and spending reductions that will take effect
early next year if no legislative action is taken. The Congressional Budget Office has
estimated that, if the full range of tax increases and spending cuts were allowed to take effect
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a scenario widely referred to as the fiscal cliff a shallow recession would occur early next
year and about 1-1/4 million fewer jobs would be created in 2013.3 These estimates do not
incorporate the additional negative effects likely to result from public uncertainty about how
these matters will be resolved. As you recall, market volatility spiked and confidence fell last
summer, in part as a result of the protracted debate about the necessary increase in the debt
ceiling. Similar effects could ensue as the debt ceiling and other difficult fiscal issues come
into clearer view toward the end of this year.
The most effective way that the Congress could help to support the economy right now would
be to work to address the nation's fiscal challenges in a way that takes into account both the
need for long-run sustainability and the fragility of the recovery. Doing so earlier rather than
later would help reduce uncertainty and boost household and business confidence.
Monetary policy
In view of the weaker economic outlook, subdued projected path for inflation, and significant
downside risks to economic growth, the FOMC decided to ease monetary policy at its June
meeting by continuing its maturity extension program (or MEP) through the end of this year.
The MEP combines sales of short-term Treasury securities with an equivalent amount of
purchases of longer-term Treasury securities. As a result, it decreases the supply of
longerterm Treasury securities available to the public, putting upward pressure on the prices of
those securities and downward pressure on their yields, without affecting the overall size of
the Federal Reserve's balance sheet. By removing additional longer-term Treasury securities
from the market, the Fed's asset purchases also induce private investors to acquire other
longer-term assets, such as corporate bonds and mortgage backed-securities, helping to
raise their prices and lower their yields and thereby making broader financial conditions more
accommodative.
Economic growth is also being supported by the exceptionally low level of the target range
for the federal funds rate of 0 to 1/4 percent and the Committee's forward guidance regarding
the anticipated path of the funds rate. As I reported in my February testimony, the FOMC
extended its forward guidance at its January meeting, noting that it expects that economic
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conditions including low rates of resource utilization and a subdued outlook for inflation
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over the medium run are likely to warrant exceptionally low levels for the federal funds rate
at least through late 2014. The Committee has maintained this conditional forward guidance
at its subsequent meetings. Reflecting its concerns about the slow pace of progress in
reducing unemployment and the downside risks to the economic outlook, the Committee
made clear at its June meeting that it is prepared to take further action as appropriate to
promote a stronger economic recovery and sustained improvement in labor market
conditions in a context of price stability.
Thank you. I would be pleased to take your questions.