Ben S Bernanke: The Federal Reserve - looking back, looking forward
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal
Reserve System, at the Annual Meeting of the American Economic Association,
Philadelphia, Pennsylvania, 3 January 2014.
* * *
In less than a month my term as Fed Chairman will end. Needless to say, my tenure has
been eventful - for the Federal Reserve, for the country, and for me personally. I thought it
appropriate today to reflect on some accomplishments of the past eight years, as well as
some uncompleted tasks. I will briefly cover three areas in my remarks: (1) the Federal
Reserve's commitment to transparency and accountability, (2) financial stability and financial
reform, and (3) monetary policy. I will close by discussing the prospects for the U.S. and
global economies.
Transparency and accountability
Fostering transparency and accountability at the Federal Reserve was one of my principal
objectives when I became Chairman in February 2006. I had long advocated increased
transparency and, in particular, a more explicit policy framework as ways to make monetary
policy more predictable and more effective. Our efforts to enhance transparency and
communication have indeed made monetary policy more effective, but, as I'll discuss, these
steps have proved important in other spheres as well.
When I began my term I expected to build on the monetary policy framework I had inherited
from Paul Volcker and Alan Greenspan. My predecessors had solidified the Fed's
commitment to low and stable inflation as a foundation of broader economic stability, and
they gradually increased the transparency of monetary policy deliberations and plans. For
example, Chairman Volcker introduced a money-targeting framework to help guide the Fed's
attack on high inflation in the early 1980s, and the practice of issuing a statement after each
meeting of the Federal Open Market Committee (FOMC) began under Chairman Greenspan.
I believed that a still more transparent approach would make monetary policy even more
effective and further strengthen the Fed's institutional credibility. In particular, as an
academic I had written favorably about the flexible inflation-targeting approach used by the
Bank of England and a number of other central banks. By making public considerable
information about policy goals and strategies, together with their economic forecasts, these
central banks provided a clear framework to help the public and market participants
understand and anticipate policy actions. The provision of numerical goals and policy plans
also helped make these central banks more accountable for achieving their stated objectives.
I was confident that we could adapt this type of framework to the Federal Reserve's dual
mandate to promote both maximum employment and price stability. Indeed, central banks
using this framework were already, in practice, often pursuing economic objectives in
addition to low and stable inflation - hence the term, "flexible" inflation targeting.
Because the financial crisis and its aftermath naturally occupied so much of policymakers'
attention, progress toward a more explicit policy framework at the Federal Reserve was
slower than I had hoped. Nevertheless, progress was made. In the minutes of its October
2007 meeting, the FOMC introduced its quarterly Summary of Economic Projections (SEP),
which included FOMC participants' projections of key macroeconomic variables such as
inflation, gross domestic product (GDP) growth, and the unemployment rate.1 Over time, we
added long-run projections of inflation, growth, and unemployment, as well as projections of
the path of the target federal funds rate consistent with each individual's views of appropriate
monetary policy. These additions have better informed the public about participants' views on
both the long-run objectives of policy and the path of interest rates most consistent with
achieving those objectives.
We took another important step in January 2012, when the FOMC issued a statement laying
out its longer-run goals and policy strategy.2 The statement established, for the first time, an
explicit longer-run goal for inflation of 2 percent, and it pointed to the SEP to provide
information about Committee participants' assessments of the longer-run normal
unemployment rate, currently between 5.2 and 6 percent. The statement also indicated that
the Committee would take a balanced approach to its price stability and employment
objectives. We adopted additional measures aimed at clarifying the rationales for our
decisions, including my quarterly postmeeting press conference. The increases in policy
transparency that were achieved proved valuable during a very difficult period for monetary
policy.
As it happened, during the crisis and its aftermath the Federal Reserve's transparency and
accountability proved critical in a quite different sphere - namely, in supporting the
institution's democratic legitimacy. The Federal Reserve, like other central banks, wields
powerful tools; democratic accountability requires that the public be able to see how and for
what purposes those tools are being used. Transparency is particularly important in a period
like the recent one in which the Federal Reserve has been compelled to take unusual and
dramatic actions - including the provision of liquidity to a wide range of financial institutions
and markets that did not normally have access to the Fed's discount window - to help
stabilize the financial system and the economy.
What types of transparency are needed to preserve public confidence? At the most basic
level, a central bank must be clear and open about its actions and operations, particularly
when they involve the deployment of public funds. The Federal Reserve routinely makes
public extensive information on all aspects of its activities, and since the crisis it has greatly
increased the quantity and detail of its regular reports to the Congress and the public.3
Importantly, contrary to what is sometimes asserted, all of the Fed's financial transactions
and operations are subject to regular, intensive audits - by the Government Accountability
Office, an independent Inspector General, and a private accounting firm, as well as by our
from semiannual to quarterly frequency, (2) the addition of projections for overall inflation (projections of
nominal GDP growth were dropped), (3) the extension by two years of the projection horizon, (4) the inclusion
of participants' views about the risks to and the uncertainty surrounding the outlook for each projected
variable, (5) the inclusion of the full distribution of participants' projections, not just the range and central
tendency, and 6) a write-up of the rationales provided by participants for their projections. As noted in the text,
further innovations, including interest rate projections and long-run projections of economic growth,
unemployment, inflation, and the federal funds rate were added over time. The role of the projections in policy
communication was also significantly increased after October 2007; for example, they were regularly
referenced in the Chairman's semiannual Humphrey-Hawkins testimony before the Congress (see Board of
Governors, 2007a, 2007b).
2
See Board of Governors (2012b).
3
For example, the Board has regularly published detailed information about the Federal Reserve's balance
sheet and the special liquidity facilities that were introduced during the crisis. We created a section on our
website devoted to these issues and initiated a regular public report as well. (See the webpage "Credit and
Liquidity Programs and the Balance Sheet ").
own internal auditors.4 It is a testament to the dedication of the Federal Reserve's
management team that these thorough audits have consistently produced assessments of
the Fed's accounting and financial controls that most public companies would envy.
Transparency and accountability are about more than just opening up the books, however;
they also require thoughtful explanations of what we are doing and why. In this regard, our
first responsibility is to the Congress, which established the Federal Reserve almost exactly
a century ago and determined its structure, objectives, and powers. Federal Reserve Board
members, including the Chairman, of course, as well as senior staff, testify frequently before
congressional committees on a wide range of topics. When I became Chairman, I anticipated
the obligation to appear regularly before the Congress. I had not entirely anticipated, though,
that I would spend so much time meeting with legislators outside of hearings - individually
and in groups. But I quickly came to realize the importance of these relationships with
legislators in keeping open the channels of communication. As part of the Fed's interaction
with the Congress, we have also routinely provided staff briefings on request and conducted
programs at the Board for the benefit of congressional staff interested in Federal Reserve
issues. I likewise maintained regular contact with both the Bush and Obama Administrations,
principally through meetings with the Secretary of the Treasury and other economic officials.
The crisis and its aftermath, however, raised the need for communication and explanation by
the Federal Reserve to a new level. We took extraordinary measures to meet extraordinary
economic challenges, and we had to explain those measures to earn the public's support
and confidence. Talking only to the Congress and to market participants would not have
been enough. The effort to inform the public engaged the whole institution, including both
Board members and the staff. As Chairman, I did my part, by appearing on television
programs, holding town halls, taking student questions at universities, and visiting a military
base to talk to soldiers and their families. The Federal Reserve Banks also played key roles
in providing public information in their Districts, through programs, publications, speeches,
and other media.
The crisis has passed, but I think the Fed's need to educate and explain will only grow. When
Paul Volcker first sat in the Chairman's office in 1979, there were no financial news channels
on cable TV, no Bloomberg screens, no blogs, no Twitter. Today, news, ideas, and rumors
circulate almost instantaneously. The Fed must continue to find ways to navigate this
changing environment while providing clear, objective, and reliable information to the public.
Financial stability
For the U.S. and global economies, the most important event of the past eight years was, of
course, the global financial crisis and the deep recession that it triggered. As I have observed
on other occasions, the crisis bore a strong family resemblance to a classic financial panic,
4
While the Government Accountability Office (GAO) has access to all aspects of the Fed's operations and is
free to criticize or make recommendations, there is one important exception: monetary policymaking. In the
1970s, the Congress deliberately excluded monetary policy deliberations, decisions, and actions from the
scope of GAO reviews. In doing so, the Congress carefully balanced the need for democratic accountability
with the benefits that flow from keeping monetary policy free from short-term political pressures.
However, there have been recent proposals (so-called Audit the Fed measures) to expand the authority of the
GAO over the Federal Reserve to include reviews of monetary policy decisions. Because the GAO is the
investigative arm of the Congress and GAO reviews may be initiated at the request of members of the
Congress, these reviews (or the prospect of reviews) of individual policy decisions could be seen, with good
reason, as efforts to bring political pressure to bear on monetary policymakers. A perceived politicization of
monetary policy would reduce public confidence in the ability of the Federal Reserve to make its policy
decisions based strictly on what is good for the economy in the longer term. Balancing the need for
accountability against the goal of insulating monetary policy from short-term political pressures is very
important, and I believe that the Congress had it right in the 1970s when it explicitly chose to protect monetary
policy decision-making from the possibility of politically motivated reviews.
except that it took place in the complex environment of the 21st century global financial
system.5 Likewise, the tools used to fight the panic, though adapted to the modern context,
were analogous to those that would have been used a century ago, including liquidity
provision by the central bank, liability guarantees, recapitalization, and the provision of
assurances and information to the public.
The immediate trigger of the crisis, as you know, was a sharp decline in house prices, which
reversed a previous run-up that had been fueled by irresponsible mortgage lending and
securitization practices. Policymakers at the time, including myself, certainly appreciated that
house prices might decline, although we disagreed about how much decline was likely;
indeed, prices were already moving down when I took office in 2006. However, to a
significant extent, our expectations about the possible macroeconomic effects of house price
declines were shaped by the apparent analogy to the bursting of the dot-com bubble a few
years earlier. That earlier bust also involved a large reduction in paper wealth but was
followed by only a mild recession. In the event, of course, the bursting of the housing bubble
helped trigger the most severe financial crisis since the Great Depression. It did so because,
unlike the earlier decline in equity prices, it interacted with critical vulnerabilities in the
financial system and in government regulation that allowed what were initially moderate
aggregate losses to subprime mortgage holders to cascade through the financial system. In
the private sector, key vulnerabilities included high levels of leverage, excessive dependence
on unstable short-term funding, deficiencies in risk measurement and management, and the
use of exotic financial instruments that redistributed risk in nontransparent ways. In the public
sector, vulnerabilities included gaps in the regulatory structure that allowed some
systemically important firms and markets to escape comprehensive supervision, failures of
supervisors to effectively use their existing powers, and insufficient attention to threats to the
stability of the system as a whole.
The Federal Reserve responded forcefully to the liquidity pressures during the crisis in a
manner consistent with the lessons that central banks had learned from financial panics over
more than 150 years and summarized in the writings of the 19th century British journalist
Walter Bagehot: Lend early and freely to solvent institutions.6 However, the institutional
context had changed substantially since Bagehot wrote. The panics of the 19th and early
20th centuries typically involved runs on commercial banks and other depository institutions.
Prior to the recent crisis, in contrast, credit extension had progressively migrated outside of
traditional banking to so-called shadow banking entities, which relied heavily on short-term
wholesale funding that proved vulnerable to runs.7 Accordingly, to help calm the panic, the
Federal Reserve provided liquidity not only to commercial banks, but also to other types of
financial institutions such as investment banks and money market funds, as well as to key
financial markets such as those for commercial paper and asset-backed securities.8 Because
5
For more on the recent financial crisis as a classic financial panic, see Bernanke (2013).
6
As noted in Lombard Street, by Bagehot ([1873] 1897). For a more extensive discussion of the manner in
which the Federal Reserve's actions during the crisis followed traditional prescriptions regarding the proper
response to liquidity strains, see Madigan (2009).
7
Shadow banking, as usually defined, comprises a diverse set of institutions and markets that, collectively,
carry out traditional banking functions - but do so outside, or in ways only loosely linked to, the traditional
system of regulated depository institutions. Examples of important components of the shadow banking system
include securitization vehicles, asset-backed commercial paper conduits, money market funds, markets for
repurchase agreements, investment banks, and nonbank mortgage companies.
8
Liquidity tools employed by the Federal Reserve that were closely tied to the central bank's traditional role as
lender of last resort involved the provision of short-term liquidity to depository and other financial institutions
and included the traditional discount window, the Term Auction Facility (TAF), the Primary Dealer Credit
Facility (PDCF), and the Term Securities Lending Facility (TSLF). A second set of tools involved the provision
of liquidity directly to borrowers and investors in those credit markets key to households and businesses
where the expanding crisis threatened to materially impede the availability of financing. The Asset-Backed
Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), the Commercial Paper Funding
funding markets are global in scope and U.S. borrowers depend importantly on foreign
lenders, the Federal Reserve also approved currency swap agreements with 14 foreign
central banks.
Providing liquidity represented only the first step in stabilizing the financial system.
Subsequent efforts focused on rebuilding the public's confidence, notably including public
guarantees of bank debt by the Federal Deposit Insurance Corporation and of money market
funds by the Treasury Department, as well as the injection of public capital into banking
institutions. The bank stress test that the Federal Reserve led in the spring of 2009, which
included detailed public disclosure of information regarding the solvency of our largest banks,
further buttressed confidence in the banking system. The success of the stress-test
disclosures, by the way, was yet another example of the benefits of transparency.
The subsequent efforts to reform our regulatory framework have been focused on limiting the
reemergence of the vulnerabilities that precipitated and exacerbated the crisis. Changes in
bank capital regulation under Basel III have significantly increased requirements for
lossabsorbing capital at global banking firms - including a surcharge for systemically important
institutions and a ceiling on leverage. The Federal Reserve's Comprehensive Capital
Analysis and Review, or CCAR, process, a descendant of the 2009 stress test, requires that
large financial institutions maintain sufficient capital to weather extreme shocks, and that they
demonstrate that their internal planning processes are effective; in addition, public disclosure
of the results facilitates market discipline. The Basel III framework also includes liquidity
requirements designed to mitigate excessive reliance by global banks on short-term
wholesale funding and to otherwise constrain risks at those banks. Further steps are under
way to toughen the oversight of large institutions and to strengthen the financial
infrastructure, for example, by requiring central clearing with greater transparency for the
trading of most standardized derivatives.
Oversight of the shadow banking system also has been strengthened. For example, the new
Financial Stability Oversight Council has designated some nonbank firms as systemically
important financial institutions, or SIFIs, subject to consolidated supervision by the Federal
Reserve. In addition, measures are being undertaken to address the potential instability of
short-term wholesale funding markets, including reforms to money market funds and the
triparty repo market.9
Of course, in a highly integrated global financial system, no country can effectively implement
the financial reforms I have described in isolation. The good news is that similar reforms are
being pursued throughout the world, with the full support of the United States and with
international bodies such as the Basel Committee and the Financial Stability Board providing
coordination.
More broadly, the approach to regulation and supervision at the Federal Reserve has
evolved to include a substantial macroprudential, or systemic, orientation in addition to the
traditional focus on individual institutions. For example, the Federal Reserve created the
Office of Financial Stability Policy and Research, which coordinates System efforts to monitor
the interaction of financial institutions, financial markets, and economic developments to
identify emerging vulnerabilities and systemic risks.10 Enhanced monitoring of this type is
especially important as the changes in regulatory structure and financial innovation may lead
risks to manifest in new ways or to migrate outside the perimeter of the current regulatory
structure.
Much progress has been made, but more remains to be done. In addition to completing the
efforts I have already mentioned, including the full implementation of new rules and
supervisory responsibilities, the agenda still includes further domestic and international
cooperation to ensure the effectiveness of mechanisms to allow the orderly resolution of
insolvent institutions and thereby increase market discipline on large institutions.11 The
evaluation of potential macroprudential tools that might be used to address emerging
financial imbalances is another high priority. For example, the new Basel III regulatory capital
framework includes a countercyclical capital buffer, which may help build additional resilience
within the financial sector during periods of buoyant credit creation. Staff members are
investigating the potential of this and other regulatory tools, such as cyclically sensitive
loanto-value requirements for mortgages, to improve financial stability. A number of countries,
including both advanced and emerging-market economies, have already deployed such
measures, and their experiences should be instructive. Although, in principle, monetary
policy can be used to address financial imbalances, the presumption remains that
macroprudential tools, together with well-focused traditional regulation and supervision,
should serve as the first line of defense against emerging threats to financial stability.
However, more remains to be done to better understand how to design and implement more
effective macroprudential tools and how these tools interact with monetary policy.
Monetary policy
While liquidity provision and other emergency steps were critical to stemming the financial
panic, a rapid shift in the stance of monetary policy was necessary to counteract the massive
economic blow delivered by the crisis. The FOMC reduced the target federal funds rate from
5-1/4 percent in the summer of 2007 to a range of 0 to 1/4 percent by the end of 2008, a
very rapid easing. The federal funds rate has been at its effective lower bound since then.
To provide additional monetary policy accommodation despite the constraint imposed by the
effective lower bound on interest rates, the Federal Reserve turned to two alternative tools:
enhanced forward guidance regarding the likely path of the federal funds rate and large-scale
purchases of longer-term securities for the Federal Reserve's portfolio. Other major central
banks have responded to developments since 2008 in roughly similar ways. For example,
the Bank of England and the Bank of Japan have employed detailed forward guidance and
conducted large-scale asset purchases, while the European Central Bank has moved to
reduce the perceived risk of sovereign debt, provided banks with substantial liquidity, and
offered qualitative guidance regarding the future path of interest rates.
With short-term rates near zero, expanded guidance about intentions for future policy has
helped to shape market expectations, which in turn has eased financial conditions by putting
downward pressure on longer-term interest rates and helped support economic activity.
Forward guidance about the short-term interest rate supplements the broader policy
framework I described earlier, by providing information about how the Committee expects to
achieve its stated policy objectives despite the complications created by the zero lower
bound on the policy interest rate and uncertainties about the costs and efficacy of the
available policy tools. Beginning with qualitative guidance, the Committee's communication
about its anticipated future policy has evolved through several stages. In December 2012,
the Committee introduced state-contingent guidance, announcing for the first time that no
increase in the federal funds rate target should be anticipated so long as unemployment
remained above 6-1/2 percent, inflation between one and two years ahead was projected to
be no more than a half percentage point above the Committee's 2 percent longer-run goal,
and longer-term inflation expectations continued to be well anchored.12 My colleagues and I
emphasized that the conditions stated in that guidance were thresholds, not triggers. That is,
crossing one of the thresholds would not automatically give rise to an increase in the federal
funds rate target; instead, it would signal only that it would be appropriate for the Committee
to begin considering, based on a wider range of indicators, whether and when an increase in
the target might be warranted.
Large-scale asset purchases also provide monetary accommodation by lowering long-term
interest rates. Working through the portfolio-balance channel, asset purchases reduce the
supply of long-duration assets in the hands of the public, depressing term premiums and thus
reducing longer-term yields. At times, the decision to begin or extend an asset-purchase
program may also have a signaling effect, to the extent that market participants see that
decision as indicative of policymakers' commitment to an accommodative policy stance.
However, it is important to recognize that the potential signaling aspect of asset purchases
depends on the broader economic and policy context. In particular, the FOMC's decision to
modestly reduce the pace of asset purchases at its December meeting did not indicate any
diminution of its commitment to maintain a highly accommodative monetary policy for as long
as needed; rather, it reflected the progress we have made toward our goal of substantial
improvement in the labor market outlook that we set out when we began the current
purchase program in September 2012. At its most recent meeting, the Committee reaffirmed
and clarified its guidance on rates, stating that it expects to maintain the current target range
for the federal funds rate well past the time that the unemployment threshold of
6-1/2 percent is crossed, especially if projected inflation continues to run below the
Committee's 2 percent longer-run goal.13
Have these unconventional tools been effective? Skeptics have pointed out that the pace of
recovery has been disappointingly slow, with inflation-adjusted GDP growth averaging only
slightly higher than a 2 percent annual rate over the past few years and inflation below the
Committee's 2 percent longer-term target. However, as I will discuss, the recovery has faced
powerful headwinds, suggesting that economic growth might well have been considerably
weaker, or even negative, without substantial monetary policy support. For the most part,
research supports the conclusion that the combination of forward guidance and large-scale
asset purchases has helped promote the recovery. For example, changes in guidance
appear to shift interest rate expectations, and the preponderance of studies show that asset
purchases push down longer-term interest rates and boost asset prices.14 These changes in
financial conditions in turn appear to have provided material support to the economy.15
Once the economy improves sufficiently so that unconventional tools are no longer needed,
the Committee will face issues of policy implementation and, ultimately, the design of the
policy framework. Large-scale asset purchases have increased the size of our balance sheet
and created substantial excess reserves in the banking system. Under the operating
procedures used prior to the crisis, the presence of large quantities of excess reserves likely
would have impeded the FOMC's ability to raise short-term nominal interest rates when
appropriate. However, the Federal Reserve now has effective tools to normalize the stance
of policy when conditions warrant, without reliance on asset sales. The interest rate on
excess reserves can be raised, which will put upward pressure on short-term rates; in
addition, the Federal Reserve will be able to employ other tools, such as fixed-rate overnight
reverse repurchase agreements, term deposits, or term repurchase agreements, to drain
bank reserves and tighten its control over money market rates if this proves necessary. As a
result, at the appropriate time, the FOMC will be able to return to conducting monetary policy
primarily through adjustments in the short-term policy rate. It is possible, however, that some
specific aspects of the Federal Reserve's operating framework will change; the Committee
will be considering this question in the future, taking into account what it learned from its
experience with an expanded balance sheet and new tools for managing interest rates.
Economic prospects
In the remainder of my remarks, I will reflect on the state of the U.S. economic recovery and
its prospects.
The economy has made considerable progress since the recovery officially began some four
and a half years ago. Payroll employment has risen by 7-1/2 million jobs from its trough.
Real GDP has grown in 16 of 17 quarters, and the level of real GDP in the third quarter of
2013 was 5-1/2 percent above its pre-recession peak. The unemployment rate has fallen
from 10 percent in the fall of 2009 to 7 percent recently. Industrial production and equipment
investment have matched or exceeded pre-recession peaks. The banking system has been
recapitalized, and the financial system is safer. When the economy was in free fall in late
2008 and early 2009, such improvement was far from certain, as indicated at the time by
stock prices that were nearly 60 percent below current levels and very wide credit spreads.
Despite this progress, the recovery clearly remains incomplete. At 7 percent, the
unemployment rate still is elevated. The number of long-term unemployed remains unusually
high, and other measures of labor underutilization, such as the number of people who are
working part time for economic reasons, have improved less than the unemployment rate.
Labor force participation has continued to decline, and, although some of this decline reflects
longer-term trends that were in place prior to the crisis, some of it likely reflects potential
workers' discouragement about job prospects.
In retrospect, at least, many of the factors that held back the recovery can be identified.
Some of these factors were difficult or impossible to anticipate, such as the resurgence in
financial volatility associated with the European sovereign debt and banking crisis and the
economic effects of natural disasters in Japan and elsewhere. Other factors were more
predictable; in particular, we appreciated early on, though perhaps to a lesser extent than we
might have, that the boom and bust left severe imbalances that would take time to work off.
As Carmen Reinhart and Ken Rogoff noted in their prescient research, economic activity
following financial crises tends to be anemic, especially when the preceding economic
expansion was accompanied by rapid growth in credit and real estate prices.16 Weak
recoveries from financial crises reflect, in part, the process of deleveraging and balance
sheet repair: Households pull back on spending to recoup lost wealth and reduce debt
burdens, while financial institutions restrict credit to restore capital ratios and reduce the
riskiness of their portfolios. In addition to these financial factors, the weakness of the
recovery reflects the overbuilding of housing (and, to some extent, commercial real estate)
prior to the crisis, together with tight mortgage credit; indeed, recent activity in these areas is
especially tepid in comparison to the rapid gains in construction more typically seen in
recoveries.
Although the Federal Reserve, like other forecasters, has tended to be overoptimistic in its
forecasts of real GDP during this recovery, we have also, at times, been too pessimistic in
our forecasts of the unemployment rate. For example, over the past year unemployment has
declined notab