Ben S Bernanke: Frequently asked questions
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal Reserve
System, at the Economic Club of Washington DC, Washington DC, 7 December 2009.
The original speech, which contains various links to the documents mentioned, can be found on the US Federal
Reserve System's website.
* * *
It is a pleasure to speak once again before the Economic Club of Washington. Having faced
the most serious financial crisis and the worst recession since the Great Depression, our
economy has made important progress during the past year. Although the economic stress
faced by many families and businesses remains intense, with job openings scarce and credit
still hard to come by, the financial system and the economy have moved back from the brink
of collapse, economic growth has returned, and the signs of recovery have become more
widespread.
Understandably, in a situation as complicated as this one, people have many questions
about the current situation and the path forward. Accordingly, taking inspiration from the
ubiquitous frequently-asked-questions lists, or FAQs, on Internet websites, in my remarks
today I'd like to address four important FAQs about the economy and the Federal Reserve.
They are:
1. Where is the economy headed?
2. What has the Federal Reserve been doing to support the economy and the financial
system?
3. Will the Federal Reserve's actions lead to higher inflation down the road?
4. How can we avoid a similar crisis in the future?
Where is the economy headed?
First, to understand where the economy might be headed, we should take a look at where it
has been recently.1 A year ago, our economy - indeed, all of the world's major economies -
were reeling from the effects of a devastating financial crisis. Policymakers here and abroad
had undertaken an extraordinary series of actions aimed at stabilizing the financial system
and cushioning the economic impact of the crisis. Critically, these policy interventions
succeeded in averting a global financial meltdown that could have plunged the world into a
second Great Depression. But although a global economic cataclysm was avoided, the crisis
nevertheless had widespread and severe economic consequences, including deep
recessions in most of the world's major economies. In the United States, the unemployment
rate, which was as low as 4.4 percent in March 2007, currently stands at 10 percent.
Recently we have seen some pickup in economic activity, reflecting, in part, the waning of
some forces that had been restraining the economy during the preceding several quarters.
The collapse of final demand that accelerated in the latter part of 2008 left many firms with
excessive inventories of unsold goods, which in turn led them to cut production and
employment aggressively. This phenomenon was especially evident in the motor vehicle
industry, where automakers, a number of whom were facing severe financial pressures,
temporarily suspended production at many plants. By the middle of this year, however,
inventories had been sufficiently reduced to encourage firms in a wide range of industries to
begin increasing output again, contributing to the recent upturn in the nation's gross domestic
product (GDP).2
Although the working down of inventories has encouraged production, a sustainable recovery
requires renewed growth in final sales. It is encouraging that we have begun to see some
evidence of stronger demand for homes and consumer goods and services. In the housing
sector, sales of new and existing homes have moved up appreciably over the course of this
year, and prices have firmed a bit. Meanwhile, the inventory of unsold new homes has been
shrinking. Reflecting these developments, homebuilders have somewhat increased the rate
of new construction - a marked change from the steep declines that have characterized the
past few years.
Consumer spending also has been rising since midyear. Part of this increase reflected a
temporary surge in auto purchases that resulted from the "cash for clunkers" program, but
spending in categories other than motor vehicles has increased as well. In the business
sector, outlays for new equipment and software are showing tentative signs of stabilizing,
and improving economic conditions abroad have buoyed the demand for U.S. exports.
Though we have begun to see some improvement in economic activity, we still have some
way to go before we can be assured that the recovery will be self-sustaining. Also at issue is
whether the recovery will be strong enough to create the large number of jobs that will be
needed to materially bring down the unemployment rate. Economic forecasts are subject to
great uncertainty, but my best guess at this point is that we will continue to see modest
economic growth next year - sufficient to bring down the unemployment rate, but at a pace
slower than we would like.
A number of factors support the view that the recovery will continue next year. Importantly,
financial conditions continue to improve: Corporations are having relatively little difficulty
raising funds in the bond and stock markets, stock prices and other asset values have
recovered significantly from their lows, and a variety of indicators suggest that fears of
systemic collapse have receded substantially. Monetary and fiscal policies are supportive.
And I have already mentioned what appear to be improving conditions in housing, consumer
expenditure, business investment, and global economic activity.
On the other hand, the economy confronts some formidable headwinds that seem likely to
keep the pace of expansion moderate. Despite the general improvement in financial
conditions, credit remains tight for many borrowers, particularly bank-dependent borrowers
such as households and small businesses. And the job market, though no longer contracting
at the pace we saw in 2008 and earlier this year, remains weak. Household spending is
unlikely to grow rapidly when people remain worried about job security and have limited
access to credit.
Inflation is affected by a number of crosscurrents. High rates of resource slack are
contributing to a slowing in underlying wage and price trends, and longer-run inflation
expectations are stable. Commodities prices have risen lately, likely reflecting the pickup in
global economic activity and the depreciation of the dollar. Although we will continue to
monitor inflation closely, on net it appears likely to remain subdued for some time.
What has the Federal Reserve been doing to support the economy and the financial
system?
The discussion of where the economy is headed brings us to our second question: What has
the Federal Reserve been doing to support the economy and the financial system?
The Federal Reserve has been, and still is, doing a great deal to foster financial stability and
to spur recovery in jobs and economic activity.3 Notably, we began the process of easing
monetary policy in September 2007, shortly after the crisis began. By mid-December 2008,
our target rate was effectively as low as it could go - within a range of 0 to 1/4 percent,
compared with 5-1/4 percent before the crisis - and we have maintained that very low rate
for the past year.
Our efforts to support the economy have gone well beyond conventional monetary policy,
however. I have already alluded to the Federal Reserve's close cooperation with the
Treasury, the Federal Deposit Insurance Corporation (FDIC), and other domestic and foreign
authorities in a concerted and ultimately successful effort to stabilize the global banking
system, which verged on collapse following the extraordinary events of September and
October 2008. We subsequently took strong measures, independently or in conjunction with
other agencies, to help normalize key financial institutions and credit markets disrupted by
the crisis. Among these were the money market mutual fund industry, in which large
numbers of American households, businesses, and municipalities make short-term
investments; and the commercial paper market, which many firms tap to finance their
day-today operations. We also established and subsequently expanded special arrangements with
other central banks to provide dollars to global funding markets, as we found that disruptions
in dollar-based markets abroad were spilling over to our own markets.
More recently, we have played an important part in helping to re-start the markets for
assetbacked securities that finance auto loans, credit card loans, small business loans, student
loans, loans to finance commercial real estate, and other types of credit. By working to revive
these markets, which allow banks to tap the broader securities markets to finance their
lending, we have helped banks make room on their balance sheets for new credit to
households and businesses. In addition, we have supported the overall functioning of private
credit markets and helped to lower interest rates on bonds, mortgages, and other loans by
purchasing unprecedented volumes of mortgage-related securities and Treasury debt.
In all of these efforts, our objective has not been to support specific financial institutions or
markets for their own sake. Rather, recognizing that a healthy economy requires
wellfunctioning financial markets, we have moved always with the single aim of promoting
economic recovery and economic opportunity. In that respect, our means and goals have
been fully consistent with the traditional functions of a central bank and with the mandate
given to the Federal Reserve by the Congress to promote price stability and maximum
employment.
In addition to easing monetary policy and acting to stabilize financial markets, we have
worked in our role as a bank supervisor to encourage bank lending. In November 2008 we
joined with other banking regulators to urge banks to continue lending to creditworthy
borrowers - to the benefit of both the economy and the banks - and we have recently
provided guidelines to banks for working constructively with troubled commercial real estate
loans.4 This spring, we led a coordinated, comprehensive examination of 19 of the country's
largest banks, an exercise formally known as the Supervisory Capital Assessment Program,
or SCAP, but more informally as the "stress test". This assessment was designed to ensure
that these banks, which collectively hold about two-thirds of the assets of the banking
system, would remain well capitalized and able to lend to creditworthy borrowers even if
economic conditions turned out to be even worse than expected. The release of the
assessment results in May provided sorely needed clarity about the banks' condition and
marked a turning point in the restoration of confidence in our banking system.5 In the months
since then, and with the strong encouragement of the federal banking supervisors, many of
these largest institutions have raised billions of dollars in new capital, improving their ability
to withstand possible future losses and to extend loans as demand for credit recovers.
Meanwhile, we have also continued our efforts to ensure fair treatment for the customers of
financial firms. During the past year and a half, we have comprehensively overhauled the
regulations protecting mortgage borrowers, credit card holders, and users of overdraft
protection plans, among others.
In navigating through the crisis, the Federal Reserve has been greatly aided by the regional
structure established by the Congress when it created the Federal Reserve in 1913. The
more than 270 business people, bankers, nonprofit executives, academics, and community,
agricultural, and labor leaders who serve on the boards of the 12 Reserve Banks and their
24 Branches provide valuable insights into current economic and financial conditions that
statistics alone cannot. Thus, the structure of the Federal Reserve ensures that our
policymaking is informed not just by a Washington perspective, or a Wall Street perspective,
but also a Main Street perspective. Indeed, our Reserve Banks and Branches have deep
roots in the nation's communities and do much good work there. They have, to give just a
couple of examples, assisted organizations specializing in foreclosure mitigation and worked
with nonprofit groups to help stabilize neighborhoods hit by high rates of foreclosure. They
(as well as the Board) are also much involved in financial and economic education, helping
people to make better financial decisions and to better understand how the economy works.
All told, the Federal Reserve's actions - in combination with those of other policymakers here
and abroad - have helped restore financial stability and pull the economy back from the
brink. Because of our programs, auto buyers have obtained loans they would not have
otherwise obtained, college students are financing their educations through credit they
otherwise likely would not have received, and home buyers have secured mortgages on
more affordable and sustainable terms than they would have otherwise. These
improvements in credit conditions in turn are supporting a broader economic recovery.
Will the Federal Reserve's actions lead to higher inflation down the road?
The scope and scale of our actions, however, while necessary and helpful in my view, have
left some uneasy. In all, our asset purchases and lending have caused the Federal
Reserve's balance sheet to more than double, from less than $900 billion before the crisis
began to about $2.2 trillion today. Unprecedented balance sheet expansion and near-zero
overnight interest rates raise our third frequently asked question: Will the Federal Reserve's
actions to combat the crisis lead to higher inflation down the road?
The answer is no; the Federal Reserve is committed to keeping inflation low and will be able
to do so. In the near term, elevated unemployment and stable inflation expectations should
keep inflation subdued, and indeed, inflation could move lower from here. However, as the
recovery strengthens, the time will come when it is appropriate to begin withdrawing the
unprecedented monetary stimulus that is helping to support economic activity. For that
reason, we have been giving careful thought to our exit strategy. We are confident that we
have all the tools necessary to withdraw monetary stimulus in a timely and effective way.6
Indeed, our balance sheet is already beginning to adjust, because improving financial
conditions are leading to substantially reduced use of our lending facilities. The balance
sheet will also shrink over time as the mortgage-backed securities and other assets we hold
mature or are prepaid. However, even if our balance sheet stays large for a while, we will be
able to raise our target short-term interest rate - which is the rate at which banks lend to
each other overnight - and thus tighten financial conditions appropriately.
Operationally, an important tool for adjusting the stance of monetary policy will be the
authority, granted to us by the Congress last year, to pay banks interest on balances they
hold at the Federal Reserve. When the time comes to raise short-term interest rates and
thereby tighten policy, we can do so by raising the rate that we offer banks on their balances
with us. Banks will be unwilling to make overnight loans to each other at a rate lower than the
rate that they can earn risk-free from the Fed, and so the interest rate we pay on banks'
balances will tend to set a floor below our target overnight loan rate and other short-term
interest rates.
Additional upward pressure on short-term interest rates can be achieved by measures to
reduce the supply of funds that banks have available to lend to each other. We have a
number of tools to accomplish this. For example, through the use of a short-term funding
method known as reverse repurchase agreements, we can act directly to reduce the quantity
of reserves held by the banking system. By paying a slightly higher rate of interest, we could
induce banks to lock up their balances in longer-term accounts with us, making those
balances unavailable for lending in the overnight market. And, if necessary, we always have
the option of reducing the size of our balance sheet by selling some of our securities holdings
on the open market.
As always, the most difficult challenge for the Federal Open Market Committee will not be
devising the technical means of unwinding monetary stimulus. Rather, it will be the challenge
that faces central banks in every economic recovery, which is correctly judging the best time
to tighten policy. Because monetary policy affects the economy with a lag, we will need to
base our decision on our best forecast of how the economy will develop. As I said a few
moments ago, we currently expect inflation to remain subdued for some time. It is also
reassuring that longer-term inflation expectations appear stable. Nevertheless, we will keep a
close eye on inflation risks and will do whatever is necessary to meet our mandate to foster
both price stability and maximum employment.
How can we avoid a similar crisis in the future?
As we at the Federal Reserve and others work to build on the progress already made toward
securing a sustained economic recovery with price stability, we must also continue to
address the weaknesses that led to the current crisis. Thus, our final question this afternoon
is: How can we avoid a similar crisis in the future?7
Although the sources of the crisis were extraordinarily complex and numerous, a
fundamental cause was that many financial firms simply did not appreciate the risks they
were taking. Their risk-management systems were inadequate and their capital and liquidity
buffers insufficient. Unfortunately, neither the firms nor the regulators identified and remedied
many of the weaknesses soon enough. Thus, all financial regulators, including the Federal
Reserve, must undertake unsparing self-assessments. At the Federal Reserve, we have
extensively reviewed our performance and moved to strengthen our oversight of banks.
Working cooperatively with other agencies, we are toughening our banking regulations to
help constrain excessive risk-taking and enhance the ability of banks to withstand financial
stress. For example, we have been among the leaders of international efforts, through
organizations such as the Basel Committee on Bank Supervision, to increase the quantities
of capital and liquidity that banks must hold. At home, we are implementing standards that
require banking organizations to adopt compensation policies that link pay to the institutions'
long-term performance and avoid encouraging excessive risk-taking.
I mentioned the SCAP, otherwise known as the stress tests. We are applying the lessons
learned in that exercise to reorient our approach to the supervision of large, interconnected
banking organizations that are critical to the stability of the financial system. In particular, we
are taking a more "macroprudential" approach, one that goes beyond supervisors' traditional
focus on the health of individual institutions and scrutinizes the interrelationships among
firms and markets to better anticipate sources of financial contagion. To do that, we are
expanding our use of the kind of simultaneous and comparative cross-firm examinations that
we used to such good effect in the SCAP. The Federal Reserve's ability to draw on a range
of disciplines - using economists, market experts, accountants, and lawyers, in addition to
bank examiners - was essential to the success of the SCAP, and a multidisciplinary
approach will be a central feature of our supervision in the future. For example, we are
complementing our traditional onsite examinations with enhanced off-site surveillance
programs, under which multidisciplinary teams will combine supervisory information,
firmspecific data analysis, and market-based indicators to identify problems that may affect one
or more banking institutions.
Although regulators can do a great deal on their own to improve financial oversight, the
Congress also must act to fix gaps and weaknesses in the structure of the regulatory system
and, in so doing, address the very serious problem posed by firms perceived as "too big to
fail". No firm, by virtue of its size and complexity, should be permitted to hold the financial
system, the economy, or the American taxpayer hostage. To eliminate that possibility, a
number of steps are required.
First, all systemically important financial institutions, not only banks, should be subject to
strong and comprehensive supervision on a consolidated, or firmwide, basis. Such
institutions should be subject to tougher capital, liquidity, and risk-management requirements
than other firms - both to reduce their chance of failing and to remove their incentive to grow
simply in order to be perceived as too big to fail. Neither AIG, an insurance company, nor
Bear Stearns, an investment firm, was subject to strong consolidated supervision. The
Federal Reserve, as the regulator of bank holding companies, already supervises many of
the largest and most complex institutions in the world. That experience, together with our
broad knowledge of the financial markets, makes us well suited to serve as the consolidated
supervisor for systemically important nonbank institutions as well. In addition, our
involvement in supervision is critical for ensuring that we have the necessary expertise,
information, and authorities to carry out our essential functions of promoting financial stability
and making monetary policy.
Second, when a systemically important institution does approach failure, government
policymakers must have an option other than a bailout or a disorderly, confidence-shattering
bankruptcy. The Congress should create a new resolution regime, analogous to the regime
currently used by the FDIC for failing banks, that would permit the government to wind down
a troubled systemically important firm in a way that protects financial stability but that also
imposes losses on shareholders and creditors of the failed firm, without costs to the
taxpayer. Imposing losses on creditors of troubled, systemically critical firms would help
address the too-big-to-fail problem by restoring market discipline and leveling the playing
field for smaller firms, while minimizing the disruptive effects of a failure on the financial
system and the economy.
Third, our regulatory structure requires a better mechanism for monitoring and addressing
emerging risks to the financial system as a whole. Because of the size, diversity, and
complexity of our financial system, that task may exceed the capacity of any individual
agency. The Federal Reserve therefore supports the creation of a systemic oversight council,
made up of the principal financial regulators, to identify developments that may pose
systemic risks, recommend approaches for dealing with them, and coordinate the responses
of its member agencies.
Conclusion
In closing, I will again note that in the fall of last year, the United States, indeed the world,
confronted a financial crisis of a magnitude unseen for generations. Concerted actions by the
Federal Reserve and other policymakers here and abroad helped avoid the worst outcomes.
Nevertheless, the turmoil dealt a severe blow to our economy from which we have only
recently begun to recover. The improvement in financial conditions this year and the
resumption of growth over the summer offer the hope and expectation of continued recovery
in the new year. However, significant headwinds remain, including tight credit conditions and
a weak job market.
The Federal Reserve has been aggressive in its efforts to stabilize our financial system and
to support economic activity. At some point, however, we will need to unwind our
accommodative policies in order to avoid higher inflation in the future. I am confident we
have both the tools and the commitment to make that adjustment when it is needed and in a
manner consistent with our mandate to foster employment and price stability.
In the meantime, financial firms must do a better job of managing the risks of their business,
regulators - the Federal Reserve included - must complete a thoroughgoing overhaul of their
approach to supervision, and the Congress should move forward in making needed changes
to our system of financial regulation to avoid a similar crisis in the future. In particular, we
must solve the problem of "too big to fail".
In sum, we have come a long way from the darkest period of the crisis, but we have some
distance yet to go. In the midst of some of the toughest days, in October 2008, I said in a
speech that I was confident that the American economy, with its great intrinsic vitality, would
emerge from that period with renewed vigor.8 I remain equally confident today.