Ben S Bernanke: Semiannual Monetary Policy Report to the Congress
Testimony by Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal
Reserve System, before the Committee on Banking, Housing and Urban Affairs, US Senate,
Washington, DC, 24 February 2009.
The original speech, which contains various links to the documents mentioned, can be found on the US Federal Reserve
System's website.
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Chairman Dodd, Senator Shelby, and members of the Committee, I appreciate the
opportunity to discuss monetary policy and the economic situation and to present the Federal
Monetary Policy Report to the Congress.
Reserve's
Recent economic and financial developments and the policy responses
As you are aware, the U.S. economy is undergoing a severe contraction. Employment has
fallen steeply since last autumn, and the unemployment rate has moved up to 7.6 percent.
The deteriorating job market, considerable losses of equity and housing wealth, and tight
lending conditions have weighed down consumer sentiment and spending. In addition,
businesses have cut back capital outlays in response to the softening outlook for sales as
well as the difficulty of obtaining credit. In contrast to the first half of last year, when robust
foreign demand for U.S. goods and services provided some offset to weakness in domestic
spending, exports slumped in the second half as our major trading partners fell into recession
and some measures of global growth turned negative for the first time in more than 25 years.
In all, U.S. real gross domestic product (GDP) declined slightly in the third quarter of 2008,
and that decline steepened considerably in the fourth quarter. The sharp contraction in
economic activity appears to have continued into the first quarter of 2009.
The substantial declines in the prices of energy and other commodities last year and the
growing margin of economic slack have contributed to a substantial lessening of inflation
pressures. Indeed, overall consumer price inflation measured on a 12-month basis was close
to zero last month. Core inflation, which excludes the direct effects of food and energy prices,
also has declined significantly.
The principal cause of the economic slowdown was the collapse of the global credit boom
and the ensuing financial crisis, which has affected asset values, credit conditions, and
consumer and business confidence around the world. The immediate trigger of the crisis was
the end of housing booms in the United States and other countries and the associated
problems in mortgage markets, notably the collapse of the U.S. subprime mortgage market.
Conditions in housing and mortgage markets have proved a serious drag on the broader
economy both directly, through their impact on residential construction and related industries
and on household wealth, and indirectly, through the effects of rising mortgage delinquencies
on the health of financial institutions. Recent data show that residential construction and
sales continue to be very weak, house prices continue to fall, and foreclosure starts remain
at very high levels.
The financial crisis intensified significantly in September and October. In September, the
Treasury and the Federal Housing Finance Agency placed the government-sponsored
enterprises, Fannie Mae and Freddie Mac, into conservatorship, and Lehman Brothers
Holdings filed for bankruptcy. In the following weeks, several other large financial institutions
failed, came to the brink of failure, or were acquired by competitors under distressed
circumstances. Losses at a prominent money market mutual fund prompted investors, who
had traditionally considered money market mutual funds to be virtually risk-free, to withdraw
large amounts from such funds. The resulting outflows threatened the stability of short-term
funding markets, particularly the commercial paper market, upon which corporations rely
heavily for their short-term borrowing needs. Concerns about potential losses also
undermined confidence in wholesale bank funding markets, leading to further increases in
bank borrowing costs and a tightening of credit availability from banks.
Recognizing the critical importance of the provision of credit to businesses and households
from financial institutions, the Congress passed the Emergency Economic Stabilization Act
last fall. Under the authority granted by this act, the Treasury purchased preferred shares in
a broad range of depository institutions to shore up their capital bases. During this period, the
Federal Deposit Insurance Corporation (FDIC) introduced its Temporary Liquidity Guarantee
Program, which expanded its guarantees of bank liabilities to include selected senior
unsecured obligations and all non-interest-bearing transactions deposits. The Treasury--in
concert with the Federal Reserve and the FDIC--provided packages of loans and guarantees
to ensure the continued stability of Citigroup and Bank of America, two of the world's largest
banks. Over this period, governments in many foreign countries also announced plans to
stabilize their financial institutions, including through large-scale capital injections,
expansions of deposit insurance, and guarantees of some forms of bank debt.
Faced with the significant deterioration in financial market conditions and a substantial
worsening of the economic outlook, the Federal Open Market Committee (FOMC) continued
to ease monetary policy aggressively in the final months of 2008, including a rate cut
coordinated with five other major central banks. In December the FOMC brought its target for
the federal funds rate to a historically low range of 0 to 1/4 percent, where it remains today.
The FOMC anticipates that economic conditions are likely to warrant exceptionally low levels
of the federal funds rate for some time.
With the federal funds rate near its floor, the Federal Reserve has taken additional steps to
ease credit conditions. To support housing markets and economic activity more broadly, and
to improve mortgage market functioning, the Federal Reserve has begun to purchase large
amounts of agency debt and agency mortgage-backed securities. Since the announcement
of this program last November, the conforming fixed mortgage rate has fallen nearly 1
percentage point. The Federal Reserve also established new lending facilities and expanded
existing facilities to enhance the flow of credit to businesses and households. In response to
heightened stress in bank funding markets, we increased the size of the Term Auction
Facility to help ensure that banks could obtain the funds they need to provide credit to their
customers, and we expanded our network of swap lines with foreign central banks to ease
conditions in interconnected dollar funding markets at home and abroad. We also
established new lending facilities to support the functioning of the commercial paper market
and to ease pressures on money market mutual funds. In an effort to restart securitization
markets to support the extension of credit to consumers and small businesses, we joined
with the Treasury to announce the Term Asset-Backed Securities Loan Facility (TALF). The
TALF is expected to begin extending loans soon.
The measures taken by the Federal Reserve, other U.S. government entities, and foreign
governments since September have helped to restore a degree of stability to some financial
markets. In particular, strains in short-term funding markets have eased notably since the fall,
and London interbank offered rates (Libor)--upon which borrowing costs for many
households and businesses are based--have decreased sharply. Conditions in the
commercial paper market also have improved, even for lower-rated borrowers, and the sharp
outflows from money market mutual funds seen in September have been replaced by modest
inflows. Corporate risk spreads have declined somewhat from extraordinarily high levels,
although these spreads remain elevated by historical standards. Likely spurred by the
improvements in pricing and liquidity, issuance of investment-grade corporate bonds has
been strong, and speculative-grade issuance, which was near zero in the fourth quarter, has
picked up somewhat. As I mentioned earlier, conforming fixed mortgage rates for households
have declined. Nevertheless, despite these favorable developments, significant stresses
persist in many markets. Notably, most securitization markets remain shut, other than that for
conforming mortgages, and some financial institutions remain under pressure.
In light of ongoing concerns over the health of financial institutions, the Secretary of the
Treasury recently announced a plan for further actions. This plan includes four principal
elements: First, a new capital assistance program will be established to ensure that banks
have adequate buffers of high-quality capital, based on the results of comprehensive stress
tests to be conducted by the financial regulators, including the Federal Reserve. Second is a
public-private investment fund in which private capital will be leveraged with public funds to
purchase legacy assets from financial institutions. Third, the Federal Reserve, using capital
provided by the Treasury, plans to expand the size and scope of the TALF to include
securities backed by commercial real estate loans and potentially other types of
assetbacked securities as well. Fourth, the plan includes a range of measures to help prevent
unnecessary foreclosures. Together, over time these initiatives should further stabilize our
financial institutions and markets, improving confidence and helping to restore the flow of
credit needed to promote economic recovery.
Federal Reserve transparency
The Federal Reserve is committed to keeping the Congress and the public informed about its
lending programs and balance sheet. For example, we continue to add to the information
shown in the Fed's H.4.1 statistical release, which provides weekly detail on the balance
sheet and the amounts outstanding for each of the Federal Reserve's lending facilities.
Extensive additional information about each of the Federal Reserve's lending programs is
available online.1 The Fed also provides bimonthly reports to the Congress on each of its
programs that rely on the section 13(3) authorities. Generally, our disclosure policies reflect
the current best practices of major central banks around the world. In addition, the Federal
Reserve's internal controls and management practices are closely monitored by an
independent inspector general, outside private-sector auditors, and internal management
and operations divisions, and through periodic reviews by the Government Accountability
Office.
All that said, we recognize that recent developments have led to a substantial increase in the
public's interest in the Fed's programs and balance sheet. For this reason, we at the Fed
have begun a thorough review of our disclosure policies and the effectiveness of our
communication. Today I would like to highlight two initiatives.
First, to improve public access to information concerning Fed policies and programs, we
recently unveiled a new section of our website that brings together in a systematic and
comprehensive way the full range of information that the Federal Reserve already makes
available, supplemented by explanations, discussions, and analyses.2 We will use that
website as one means of keeping the public and the Congress fully informed about Fed
programs.
Second, at my request, Board Vice Chairman Donald Kohn is leading a committee that will
review our current publications and disclosure policies relating to the Fed's balance sheet
and lending policies. The presumption of the committee will be that the public has a right to
know, and that the nondisclosure of information must be affirmatively justified by clearly
articulated criteria for confidentiality, based on factors such as reasonable claims to privacy,
the confidentiality of supervisory information, and the need to ensure the effectiveness of
policy.
The economic outlook and the FOMC's quarterly projections
In their economic projections for the January FOMC meeting, monetary policy makers
substantially marked down their forecasts for real GDP this year relative to the forecasts they
had prepared in October. The central tendency of their most recent projections for real GDP
implies a decline of 1/2 percent to 1-1/4 percent over the four quarters of 2009. These
projections reflect an expected significant contraction in the first half of this year combined
with an anticipated gradual resumption of growth in the second half. The central tendency for
the unemployment rate in the fourth quarter of 2009 was marked up to a range of 8-1/2
percent to 8-3/4 percent. Federal Reserve policymakers continued to expect moderate
expansion next year, with a central tendency of 2-1/2 percent to 3-1/4 percent growth in real
GDP and a decline in the unemployment rate by the end of 2010 to a central tendency of 8
percent to 8-1/4 percent. FOMC participants marked down their projections for overall
inflation in 2009 to a central tendency of 1/4 percent to 1 percent, reflecting expected
weakness in commodity prices and the disinflationary effects of significant economic slack.
The projections for core inflation also were marked down, to a central tendency bracketing 1
percent. Both overall and core inflation are expected to remain low over the next two years.
This outlook for economic activity is subject to considerable uncertainty, and I believe that,
overall, the downside risks probably outweigh those on the upside. One risk arises from the
global nature of the slowdown, which could adversely affect U.S. exports and financial
conditions to an even greater degree than currently expected. Another risk derives from the
destructive power of the so-called adverse feedback loop, in which weakening economic and
financial conditions become mutually reinforcing. To break the adverse feedback loop, it is
essential that we continue to complement fiscal stimulus with strong government action to
stabilize financial institutions and financial markets. If actions taken by the Administration, the
Congress, and the Federal Reserve are successful in restoring some measure of financial
stability--and only if that is the case, in my view--there is a reasonable prospect that the
current recession will end in 2009 and that 2010 will be a year of recovery. If financial
conditions improve, the economy will be increasingly supported by fiscal and monetary
stimulus, the salutary effects of the steep decline in energy prices since last summer, and the
better alignment of business inventories and final sales, as well as the increased availability
of credit.
To further increase the information conveyed by the quarterly projections, FOMC participants
agreed in January to begin publishing their estimates of the values to which they expect key
economic variables to converge over the longer run (say, at a horizon of five or six years),
under the assumption of appropriate monetary policy and in the absence of new shocks to
the economy. The central tendency for the participants' estimates of the longer-run growth
rate of real GDP is 2-1/2 percent to 2-3/4 percent; the central tendency for the longer-run rate
of unemployment is 4-3/4 percent to 5 percent; and the central tendency for the longer-run
rate of inflation is 1-3/4 percent to 2 percent, with the majority of participants looking for 2
percent inflation in the long run. These values are all notably different from the central
tendencies of the projections for 2010 and 2011, reflecting the view of policymakers that a
full recovery of the economy from the current recession is likely to take more than two or
three years.
The longer-run projections for output growth and unemployment may be interpreted as the
Committee's estimates of the rate of growth of output and the unemployment rate that are
sustainable in the long run in the United States, taking into account important influences such
as the trend growth rates of productivity and the labor force, improvements in worker
education and skills, the efficiency of the labor market at matching workers and jobs,
government policies affecting technological development or the labor market, and other
factors. The longer-run projections of inflation may be interpreted, in turn, as the rate of
inflation that FOMC participants see as most consistent with the dual mandate given to it by
the Congress--that is, the rate of inflation that promotes maximum sustainable employment
while also delivering reasonable price stability. This further extension of the quarterly
projections should provide the public a clearer picture of the FOMC's policy strategy for
promoting maximum employment and price stability over time. Also, increased clarity about
the FOMC's views regarding longer-run inflation should help to better stabilize the public's
inflation expectations, thus contributing to keeping actual inflation from rising too high or
falling too low.
At the time of our last Monetary Policy Report, the Federal Reserve was confronted with both
high inflation and rising unemployment. Since that report, however, inflation pressures have
receded dramatically while the rise in the unemployment rate has accelerated and financial
conditions have deteriorated. In light of these developments, the Federal Reserve is
committed to using all available tools to stimulate economic activity and to improve financial
market functioning. Toward that end, we have reduced the target for the federal funds rate
close to zero and we have established a number of programs to increase the flow of credit to
key sectors of the economy. We believe that these actions, combined with the broad range of
other fiscal and financial measures being put in place, will contribute to a gradual resumption
of economic growth and improvement in labor market conditions in a context of low inflation.
We will continue to work closely with the Congress and the Administration to explore means
of fulfilling our mission of promoting maximum employment and price stability.