Ben S Bernanke: Semiannual Monetary Policy Report to the Congress
Speech 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, 26 February 2013.
* * *
Chairman Johnson, Ranking Member Crapo, and other members of the Committee, I am
Monetary Policy
pleased to present the Federal Reserve's semiannual Report. I will begin
with a short summary of current economic conditions and then discuss aspects of monetary
and fiscal policy.
Current economic conditions
Since I last reported to this Committee in mid-2012, economic activity in the United States
has continued to expand at a moderate if somewhat uneven pace. In particular, real gross
domestic product (GDP) is estimated to have risen at an annual rate of about 3 percent in the
third quarter but to have been essentially flat in the fourth quarter.1 The pause in real GDP
growth last quarter does not appear to reflect a stalling-out of the recovery. Rather, economic
activity was temporarily restrained by weather-related disruptions and by transitory declines
in a few volatile categories of spending, even as demand by U.S. households and
businesses continued to expand. Available information suggests that economic growth has
picked up again this year.
Consistent with the moderate pace of economic growth, conditions in the labor market have
been improving gradually. Since July, nonfarm payroll employment has increased by
175,000 jobs per month on average, and the unemployment rate declined 0.3 percentage
point to 7.9 percent over the same period. Cumulatively, private-sector payrolls have now
grown by about 6.1 million jobs since their low point in early 2010, and the unemployment
rate has fallen a bit more than 2 percentage points since its cyclical peak in late 2009.
Despite these gains, however, the job market remains generally weak, with the
unemployment rate well above its longer-run normal level. About 4.7 million of the
unemployed have been without a job for six months or more, and millions more would like
full-time employment but are able to find only part-time work. High unemployment has
substantial costs, including not only the hardship faced by the unemployed and their families,
but also the harm done to the vitality and productive potential of our economy as a whole.
Lengthy periods of unemployment and underemployment can erode workers' skills and
attachment to the labor force or prevent young people from gaining skills and experience in
the first place - developments that could significantly reduce their productivity and earnings
in the longer term. The loss of output and earnings associated with high unemployment also
reduces government revenues and increases spending, thereby leading to larger deficits and
higher levels of debt.
The recent increase in gasoline prices, which reflects both higher crude oil prices and wider
refining margins, is hitting family budgets. However, overall inflation remains low. Over the
second half of 2012, the price index for personal consumption expenditures rose at an
annual rate of 1-1/2 percent, similar to the rate of increase in the first half of the year.
Measures of longer-term inflation expectations have remained in the narrow ranges seen
over the past several years. Against this backdrop, the Federal Open Market Committee
(FOMC) anticipates that inflation over the medium term likely will run at or below its 2 percent
objective.
Monetary policy
With unemployment well above normal levels and inflation subdued, progress toward the
Federal Reserve's mandated objectives of maximum employment and price stability has
required a highly accommodative monetary policy. Under normal circumstances, policy
accommodation would be provided through reductions in the FOMC's target for the federal
funds rate - the interest rate on overnight loans between banks. However, as this rate has
been close to zero since December 2008, the Federal Reserve has had to use alternative
policy tools.
These alternative tools have fallen into two categories. The first is "forward guidance"
regarding the FOMC's anticipated path for the federal funds rate. Since longer-term interest
rates reflect market expectations for shorter-term rates over time, our guidance influences
longer-term rates and thus supports a stronger recovery. The formulation of this guidance
has evolved over time. Between August 2011 and December 2012, the Committee used
calendar dates to indicate how long it expected economic conditions to warrant exceptionally
low levels for the federal funds rate. At its December 2012 meeting, the FOMC agreed to
shift to providing more explicit guidance on how it expects the policy rate to respond to
economic developments. Specifically, the December postmeeting statement indicated that
the current exceptionally low range for the federal funds rate "will be appropriate at least as
long as the unemployment rate remains above 6-1/2 percent, inflation between one and two
years ahead is projected to be no more than a half percentage point above the Committee's
2 percent longer-run goal, and longer-term inflation expectations continue to be well
anchored."2 An advantage of the new formulation, relative to the previous date-based
guidance, is that it allows market participants and the public to update their monetary policy
expectations more accurately in response to new information about the economic outlook.
The new guidance also serves to underscore the Committee's intention to maintain
accommodation as long as needed to promote a stronger economic recovery with stable
prices.3
The second type of nontraditional policy tool employed by the FOMC is large-scale
purchases of longer-term securities, which, like our forward guidance, are intended to
support economic growth by putting downward pressure on longer-term interest rates. The
Federal Reserve has engaged in several rounds of such purchases since late 2008. Last
September the FOMC announced that it would purchase agency mortgage-backed securities
at a pace of $40 billion per month, and in December the Committee stated that, in addition,
beginning in January it would purchase longer-term Treasury securities at an initial pace of
$45 billion per month.4 These additional purchases of longer-term Treasury securities replace
the purchases we were conducting under our now-completed maturity extension program,
2
See Board of Governors of the Federal Reserve System (2012), "Federal Reserve Issues FOMC Statement,"
press release, December 12.
3
The numerical values for unemployment and inflation included in the guidance are thresholds, not triggers;
that is, depending on economic circumstances at the time, the Committee may judge that it is not appropriate
to begin raising its target for the federal funds rate as soon as one or both of the thresholds is reached. The
6-1/2 percent threshold for the unemployment rate should not be interpreted as the Committee's longer-term
objective for unemployment; because monetary policy affects the economy with a lag, the first increase in the
target for the funds rate will likely have to occur when the unemployment rate is still above its longer-run
normal level. Likewise, the Committee has not altered its longer-run goal for inflation of 2 percent, and it
neither seeks nor expects a persistent increase in inflation above that target.
4
See Board of Governors of the Federal Reserve System (2012), "Federal Reserve Issues FOMC Statement,"
press release, September 13; and Board of Governors, "FOMC Statement," December 12, in note 2.
which lengthened the maturity of our securities portfolio without increasing its size. The
FOMC has indicated that it will continue purchases until it observes a substantial
improvement in the outlook for the labor market in a context of price stability.
The Committee also stated that in determining the size, pace, and composition of its asset
purchases, it will take appropriate account of their likely efficacy and costs. In other words, as
with all of its policy decisions, the Committee continues to assess its program of asset
purchases within a cost-benefit framework. In the current economic environment, the benefits
of asset purchases, and of policy accommodation more generally, are clear: Monetary policy
is providing important support to the recovery while keeping inflation close to the FOMC's
2 percent objective. Notably, keeping longer-term interest rates low has helped spark
recovery in the housing market and led to increased sales and production of automobiles and
other durable goods. By raising employment and household wealth - for example, through
higher home prices - these developments have in turn supported consumer sentiment and
spending.
Highly accommodative monetary policy also has several potential costs and risks, which the
Committee is monitoring closely. For example, if further expansion of the Federal Reserve's
balance sheet were to undermine public confidence in our ability to exit smoothly from our
accommodative policies at the appropriate time, inflation expectations could rise, putting the
FOMC's price-stability objective at risk. However, the Committee remains confident that it
has the tools necessary to tighten monetary policy when the time comes to do so. As I noted,
inflation is currently subdued, and inflation expectations appear well anchored; neither the
FOMC nor private forecasters are projecting the development of significant inflation
pressures.
Another potential cost that the Committee takes very seriously is the possibility that very low
interest rates, if maintained for a considerable time, could impair financial stability. For
example, portfolio managers dissatisfied with low returns may "reach for yield" by taking on
more credit risk, duration risk, or leverage. On the other hand, some risk-taking - such as
when an entrepreneur takes out a loan to start a new business or an existing firm expands
capacity - is a necessary element of a healthy economic recovery. Moreover, although
accommodative monetary policies may increase certain types of risk-taking, in the present
circumstances they also serve in some ways to reduce risk in the system, most importantly
by strengthening the overall economy, but also by encouraging firms to rely more on
longerterm funding, and by reducing debt service costs for households and businesses. In any
case, the Federal Reserve is responding actively to financial stability concerns through
substantially expanded monitoring of emerging risks in the financial system, an approach to
the supervision of financial firms that takes a more systemic perspective, and the ongoing
implementation of reforms to make the financial system more transparent and resilient.
Although a long period of low rates could encourage excessive risk-taking, and continued
close attention to such developments is certainly warranted, to this point we do not see the
potential costs of the increased risk-taking in some financial markets as outweighing the
benefits of promoting a stronger economic recovery and more-rapid job creation.5
Another aspect of the Federal Reserve's policies that has been discussed is their
implications for the federal budget. The Federal Reserve earns substantial interest on the
assets it holds in its portfolio, and, other than the amount needed to fund our cost of
operations, all net income is remitted to the Treasury. With the expansion of the Federal
Reserve's balance sheet, yearly remittances have roughly tripled in recent years, with
payments to the Treasury totaling approximately $290 billion between 2009 and 2012.6
However, if the economy continues to strengthen, as we anticipate, and policy
accommodation is accordingly reduced, these remittances would likely decline in coming
years. Federal Reserve analysis shows that remittances to the Treasury could be quite low
for a time in some scenarios, particularly if interest rates were to rise quickly.7 However, even
in such scenarios, it is highly likely that average annual remittances over the period affected
by the Federal Reserve's purchases will remain higher than the pre-crisis norm, perhaps
substantially so. Moreover, to the extent that monetary policy promotes growth and job
creation, the resulting reduction in the federal deficit would dwarf any variation in the Federal
Reserve's remittances to the Treasury.
Thoughts on fiscal policy
Although monetary policy is working to promote a more robust recovery, it cannot carry the
entire burden of ensuring a speedier return to economic health. The economy's performance
both over the near term and in the longer run will depend importantly on the course of fiscal
policy. The challenge for the Congress and the Administration is to put the federal budget on
a sustainable long-run path that promotes economic growth and stability without
unnecessarily impeding the current recovery.
Significant progress has been made recently toward reducing the federal budget deficit over
the next few years. The projections released earlier this month by the Congressional Budget
Office (CBO) indicate that, under current law, the federal deficit will narrow from 7 percent of
GDP last year to 2-1/2 percent in fiscal year 2015.8 As a result, the federal debt held by the
public (including that held by the Federal Reserve) is projected to remain roughly 75 percent
of GDP through much of the current decade.
However, a substantial portion of the recent progress in lowering the deficit has been
concentrated in near-term budget changes, which, taken together, could create a significant
headwind for the economic recovery. The CBO estimates that deficit-reduction policies in
current law will slow the pace of real GDP growth by about 1-1/2 percentage points this year,
relative to what it would have been otherwise. A significant portion of this effect is related to
the automatic spending sequestration that is scheduled to begin on March 1, which,
according to the CBO's estimates, will contribute about 0.6 percentage point to the fiscal
drag on economic growth this year. Given the still-moderate underlying pace of economic
growth, this additional near-term burden on the recovery is significant. Moreover, besides
having adverse effects on jobs and incomes, a slower recovery would lead to less actual
deficit reduction in the short run for any given set of fiscal actions.
At the same time, and despite progress in reducing near-term budget deficits, the difficult
process of addressing longer-term fiscal imbalances has only begun. Indeed, the CBO
projects that the federal deficit and debt as a percentage of GDP will begin rising again in the
latter part of this decade, reflecting in large part the aging of the population and fast-rising
health-care costs. To promote economic growth in the longer term, and to preserve
economic and financial stability, fiscal policymakers will have to put the federal budget on a
sustainable long-run path that first stabilizes the ratio of federal debt to GDP and, given the
current elevated level of debt, eventually places that ratio on a downward trajectory. Between
1960 and the onset of the financial crisis, federal debt averaged less than 40 percent of
GDP. This relatively low level of debt provided the nation much-needed flexibility to meet the
economic challenges of the past few years. Replenishing this fiscal capacity will give future
Congresses and Administrations greater scope to deal with unforeseen events.
To address both the near- and longer-term issues, the Congress and the Administration
should consider replacing the sharp, frontloaded spending cuts required by the sequestration
with policies that reduce the federal deficit more gradually in the near term but more
substantially in the longer run. Such an approach could lessen the near-term fiscal
headwinds facing the recovery while more effectively addressing the longer-term imbalances
in the federal budget.
The sizes of deficits and debt matter, of course, but not all tax and spending programs are
created equal with respect to their effects on the economy. To the greatest extent possible, in
their efforts to achieve sound public finances, fiscal policymakers should not lose sight of the
need for federal tax and spending policies that increase incentives to work and save,
encourage investments in workforce skills, advance private capital formation, promote
research and development, and provide necessary and productive public infrastructure.
Although economic growth alone cannot eliminate federal budget imbalances, in either the
short or longer term, a more rapidly expanding economic pie will ease the difficult choices we
face.