Ben S Bernanke: Semiannual Monetary Policy Report to the Congress
Testimony of 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, 27 February 2008.
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Chairman Frank, Ranking Member Bachus, and other members of the Committee, I am
pleased to present the Federal Reserve's Monetary Policy Report to the Congress. In my
testimony this morning I will briefly review the economic situation and outlook, beginning with
developments in real activity and inflation, then turn to monetary policy. I will conclude with a
quick update on the Federal Reserve's recent actions to help protect consumers in their
financial dealings.
The economic situation has become distinctly less favorable since the time of our July report.
Strains in financial markets, which first became evident late last summer, have persisted; and
pressures on bank capital and the continued poor functioning of markets for securitized credit
have led to tighter credit conditions for many households and businesses. The growth of real
gross domestic product (GDP) held up well through the third quarter despite the financial
turmoil, but it has since slowed sharply. Labor market conditions have similarly softened, as
job creation has slowed and the unemployment rate - at 4.9 percent in January - has moved
up somewhat.
Many of the challenges now facing our economy stem from the continuing contraction of the
U.S. housing market. In 2006, after a multiyear boom in residential construction and house
prices, the housing market reversed course. Housing starts and sales of new homes are now
less than half of their respective peaks, and house prices have flattened or declined in most
areas. Changes in the availability of mortgage credit amplified the swings in the housing
market. During the housing sector's expansion phase, increasingly lax lending standards,
particularly in the subprime market, raised the effective demand for housing, pushing up
prices and stimulating construction activity. As the housing market began to turn down,
however, the slump in subprime mortgage originations, together with a more general
tightening of credit conditions, has served to increase the severity of the downturn. Weaker
house prices in turn have contributed to the deterioration in the performance of
mortgagerelated securities and reduced the availability of mortgage credit.
The housing market is expected to continue to weigh on economic activity in coming
quarters. Homebuilders, still faced with abnormally high inventories of unsold homes, are
likely to cut the pace of their building activity further, which will subtract from overall growth
and reduce employment in residential construction and closely related industries.
Consumer spending continued to increase at a solid pace through much of the second half of
2007, despite the problems in the housing market, but it appears to have slowed significantly
toward the end of the year. The jump in the price of imported energy, which eroded real
incomes and wages, likely contributed to the slowdown in spending, as did the declines in
household wealth associated with the weakness in house prices and equity prices. Slowing
job creation is yet another potential drag on household spending, as gains in payroll
employment averaged little more than 40,000 per month during the three months ending in
January, compared with an average increase of almost 100,000 per month over the previous
three months. However, the recently enacted fiscal stimulus package should provide some
support for household spending during the second half of this year and into next year.
The business sector has also displayed signs of being affected by the difficulties in the
housing and credit markets. Reflecting a downshift in the growth of final demand and tighter
credit conditions for some firms, available indicators suggest that investment in equipment
and software will be subdued during the first half of 2008. Likewise, after growing robustly
through much of 2007, nonresidential construction is likely to decelerate sharply in coming
quarters as business activity slows and funding becomes harder to obtain, especially for
more speculative projects. On a more encouraging note, we see few signs of any serious
imbalances in business inventories aside from the overhang of unsold homes. And, as a
whole, the nonfinancial business sector remains in good financial condition, with strong
profits, liquid balance sheets, and corporate leverage near historical lows.
In addition, the vigor of the global economy has offset some of the weakening of domestic
demand. U.S. real exports of goods and services increased at an annual rate of about 11
percent in the second half of last year, boosted by continuing economic growth abroad and
the lower foreign exchange value of the dollar. Strengthening exports, together with
moderating imports, have in turn led to some improvement in the U.S. current account deficit,
which likely narrowed in 2007 (on an annual basis) for the first time since 2001. Although
recent indicators point to some slowing of foreign economic growth, U.S. exports should
continue to expand at a healthy pace in coming quarters, providing some impetus to
domestic economic activity and employment.
As I have mentioned, financial markets continue to be under considerable stress. Heightened
investor concerns about the credit quality of mortgages, especially subprime mortgages with
adjustable interest rates, triggered the financial turmoil. However, other factors, including a
broader retrenchment in the willingness of investors to bear risk, difficulties in valuing
complex or illiquid financial products, uncertainties about the exposures of major financial
institutions to credit losses, and concerns about the weaker outlook for economic growth,
have also roiled the financial markets in recent months. To help relieve the pressures in the
market for interbank lending, the Federal Reserve - among other actions - recently
introduced a term auction facility (TAF), through which prespecified amounts of discount
window credit are auctioned to eligible borrowers, and we have been working with other
central banks to address market strains that could hamper the achievement of our broader
economic objectives. These efforts appear to have contributed to some improvement in
short-term funding markets. We will continue to monitor financial developments closely.
As part of its ongoing commitment to improving the accountability and public understanding
of monetary policy making, the Federal Open Market Committee (FOMC) recently increased
the frequency and expanded the content of the economic projections made by Federal
Reserve Board members and Reserve Bank presidents and released to the public. The latest
economic projections, which were submitted in conjunction with the FOMC meeting at the
end of January and which are based on each participant's assessment of appropriate
monetary policy, show that real GDP was expected to grow only sluggishly in the next few
quarters and that the unemployment rate was seen as likely to increase somewhat. In
particular, the central tendency of the projections was for real GDP to grow between 1.3
percent and 2.0 percent in 2008, down from 2-1/2 percent to 2-3/4 percent projected in our
report last July. FOMC participants' projections for the unemployment rate in the fourth
quarter of 2008 have a central tendency of 5.2 percent to 5.3 percent, up from the level of
about 4-3/4 percent projected last July for the same period. The downgrade in our
projections for economic activity in 2008 since our report last July reflects the effects of the
financial turmoil on real activity and a housing contraction that has been more severe than
previously expected. By 2010, our most recent projections show output growth picking up to
rates close to or a little above its longer-term trend and the unemployment rate edging lower;
the improvement reflects the effects of policy stimulus and an anticipated moderation of the
contraction in housing and the strains in financial and credit markets. The incoming
information since our January meeting continues to suggest sluggish economic activity in the
near term.
The risks to this outlook remain to the downside. The risks include the possibilities that the
housing market or labor market may deteriorate more than is currently anticipated and that
credit conditions may tighten substantially further.
Consumer price inflation has increased since our previous report, in substantial part because
of the steep run-up in the price of oil. Last year, food prices also increased significantly, and
the dollar depreciated. Reflecting these influences, the price index for personal consumption
expenditures (PCE) increased 3.4 percent over the four quarters of 2007, up from 1.9
percent in 2006. Core price inflation - that is, inflation excluding food and energy prices -
also firmed toward the end of the year. The higher recent readings likely reflected some
pass-through of energy costs to the prices of core consumer goods and services as well as
the effect of the depreciation of the dollar on import prices. Moreover, core inflation in the first
half of 2007 was damped by a number of transitory factors - notably, unusually soft prices for
apparel and for financial services - which subsequently reversed. For the year as a whole,
however, core PCE prices increased 2.1 percent, down slightly from 2006.
The projections recently submitted by FOMC participants indicate that overall PCE inflation
was expected to moderate significantly in 2008, to between 2.1 percent and 2.4 percent (the
central tendency of the projections). A key assumption underlying those projections was that
energy and food prices would begin to flatten out, as was implied by quotes on futures
markets. In addition, diminishing pressure on resources is also consistent with the projected
slowing in inflation. The central tendency of the projections for core PCE inflation in 2008, at
2.0 percent to 2.2 percent, was a bit higher than in our July report, largely because of some
higher-than-expected recent readings on prices. Beyond 2008, both overall and core inflation
were projected to edge lower, as participants expected inflation expectations to remain
reasonably well-anchored and pressures on resource utilization to be muted. The inflation
projections submitted by FOMC participants for 2010 - which ranged from 1.5 percent to 2.0
percent for overall PCE inflation - were importantly influenced by participants' judgments
about the measured rates of inflation consistent with the Federal Reserve's dual mandate
and about the time frame over which policy should aim to attain those rates.
The rate of inflation that is actually realized will of course depend on a variety of factors.
Inflation could be lower than we anticipate if slower-than-expected global growth moderates
the pressure on the prices of energy and other commodities or if rates of domestic resource
utilization fall more than we currently expect. Upside risks to the inflation projection are also
present, however, including the possibilities that energy and food prices do not flatten out or
that the pass-through to core prices from higher commodity prices and from the weaker
dollar may be greater than we anticipate. Indeed, the further increases in the prices of energy
and other commodities in recent weeks, together with the latest data on consumer prices,
suggest slightly greater upside risks to the projections of both overall and core inflation than
we saw last month. Should high rates of overall inflation persist, the possibility also exists
that inflation expectations could become less well anchored. Any tendency of inflation
expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded
could greatly complicate the task of sustaining price stability and could reduce the flexibility
of the FOMC to counter shortfalls in growth in the future. Accordingly, in the months ahead,
the Federal Reserve will continue to monitor closely inflation and inflation expectations.
Let me turn now to the implications of these developments for monetary policy. The FOMC
has responded aggressively to the weaker outlook for economic activity, having reduced its
target for the federal funds rate by 225 basis points since last summer. As the Committee
noted in its most recent post-meeting statement, the intent of those actions has been to help
promote moderate growth over time and to mitigate the risks to economic activity.
A critical task for the Federal Reserve over the course of this year will be to assess whether
the stance of monetary policy is properly calibrated to foster our mandated objectives of
maximum employment and price stability in an environment of downside risks to growth,
stressed financial conditions, and inflation pressures. In particular, the FOMC will need to
judge whether the policy actions taken thus far are having their intended effects. Monetary
policy works with a lag. Therefore, our policy stance must be determined in light of the
medium-term forecast for real activity and inflation as well as the risks to that forecast.
Although the FOMC participants' economic projections envision an improving economic
picture, it is important to recognize that downside risks to growth remain. The FOMC will be
carefully evaluating incoming information bearing on the economic outlook and will act in a
timely manner as needed to support growth and to provide adequate insurance against
downside risks.
Finally, I would like to say a few words about the Federal Reserve's recent actions to protect
consumers in their financial transactions. In December, following up on a commitment I made
at the time of our report last July, the Board issued for public comment a comprehensive set
of new regulations to prohibit unfair or deceptive practices in the mortgage market, under the
authority granted us by the Home Ownership and Equity Protection Act of 1994. The
proposed rules would apply to all mortgage lenders and would establish lending standards to
help ensure that consumers who seek mortgage credit receive loans whose terms are clearly
disclosed and that can reasonably be expected to be repaid. Accordingly, the rules would
prohibit lenders from engaging in a pattern or practice of making higher-priced mortgage
loans without due regard to consumers' ability to make the scheduled payments. In each
case, a lender making a higher-priced loan would have to use third-party documents to verify
the income relied on to make the credit decision. For higher-priced loans, the proposed rules
would require the lender to establish an escrow account for the payment of property taxes
and homeowners' insurance and would prevent the use of prepayment penalties in
circumstances where they might trap borrowers in unaffordable loans. In addition, for all
mortgage loans, our proposal addresses misleading and deceptive advertising practices,
requires borrowers and brokers to agree in advance on the maximum fee that the broker may
receive, bans certain practices by servicers that harm borrowers, and prohibits coercion of
appraisers by lenders. We expect substantial public comment on our proposal, and we will
carefully consider all information and viewpoints while moving expeditiously to adopt final
rules.
The effectiveness of the new regulations, however, will depend critically on strong
enforcement. To that end, in conjunction with other federal and state agencies, we are
conducting compliance reviews of a range of mortgage lenders, including nondepository
lenders. The agencies will collaborate in determining the lessons learned and in seeking
ways to better cooperate in ensuring effective and consistent examinations of, and improved
enforcement for, all categories of mortgage lenders.
The Federal Reserve continues to work with financial institutions, public officials, and
community groups around the country to help homeowners avoid foreclosures. We have
called on mortgage lenders and servicers to pursue prudent loan workouts and have
supported the development of streamlined, systematic approaches to expedite the loan
modification process. We also have been providing community groups, counseling agencies,
regulators, and others with detailed analyses to help identify neighborhoods at high risk from
foreclosures so that local outreach efforts to help troubled borrowers can be as focused and
effective as possible. We are actively pursuing other ways to leverage the Federal Reserve's
analytical resources, regional presence, and community connections to address this critical
issue.
In addition to our consumer protection efforts in the mortgage area, we are working toward
finalizing rules under the Truth in Lending Act that will require new, more informative, and
consumer-tested disclosures by credit card issuers. Separately, we are actively reviewing
potentially unfair and deceptive practices by issuers of credit cards. Using the Board's
authority under the Federal Trade Commission Act, we expect to issue proposed rules
regarding these practices this spring.
Thank you. I would be pleased to take your questions.