Congressional Testimony

S. HRG. 113–77 FEDERAL RESERVE’S SECOND MONETARY POLICY REPORT FOR 2013 HEARING BEFORETHE COMMITTEE ON BANKING, HOUSING, ANDURBANAFFAIRS UNITED STATES SENATE ONE HUNDRED THIRTEENTH CONGRESS FIRST SESSION ON OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU- ANTTOTHEFULLEMPLOYMENTANDBALANCEDGROWTHACTOF1978 JULY 18, 2013 Printed for the use of the Committee on Banking, Housing, and Urban Affairs ( Available at: http://www.fdsys.gov/ U.S. GOVERNMENT PRINTING OFFICE 82–735 PDF WASHINGTON : 2014 For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800 Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001 VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS TIM JOHNSON, South Dakota, Chairman JACK REED, Rhode Island MIKE CRAPO, Idaho CHARLES E. SCHUMER, New York RICHARD C. SHELBY, Alabama ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee SHERROD BROWN, Ohio DAVID VITTER, Louisiana JON TESTER, Montana MIKE JOHANNS, Nebraska MARK R. WARNER, Virginia PATRICK J. TOOMEY, Pennsylvania JEFF MERKLEY, Oregon MARK KIRK, Illinois KAY HAGAN, North Carolina JERRY MORAN, Kansas JOE MANCHIN III, West Virginia TOM COBURN, Oklahoma ELIZABETH WARREN, Massachusetts DEAN HELLER, Nevada HEIDI HEITKAMP, North Dakota CHARLES YI, Staff Director GREGG RICHARD, Republican Staff Director LAURA SWANSON, Deputy Staff Director GLEN SEARS, Deputy Policy Director KRISHNA PATEL, FDIC Detailee RIKER VERMILYE, Legislative Assistant GREG DEAN, Republican Chief Counsel CHAD DAVIS, Republican Professional Staff Member MIKE LEE, Republican Professional Staff Member DAWN RATLIFF, Chief Clerk KELLY WISMER, Hearing Clerk SHELVIN SIMMONS, IT Director JIM CROWELL, Editor (II) VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00002 Fmt 0486 Sfmt 0486 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

C O N T E N T S THURSDAY, JULY 18, 2013 Page Opening statement of Chairman Johnson ............................................................. 1 Opening statements, comments, or prepared statements of: Senator Crapo ................................................................................................... 2 WITNESS Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve System ................................................................................................................... 3 Prepared statement .......................................................................................... 28 Responses to written questions of: Chairman Johnson .................................................................................... 32 Senator Crapo ............................................................................................ 35 Senator Reed .............................................................................................. 37 Senator Hagan ........................................................................................... 38 SenatorWarren .......................................................................................... 39 Senator Heitkamp ..................................................................................... 41 ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD Monetary Policy Report to the Congress dated July 18, 2013 ............................. 43 (III) VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

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FEDERAL RESERVE’S SECOND MONETARY POLICY REPORT FOR 2013 THURSDAY, JULY 18, 2013 U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. The Committee met at 10:45 a.m., in room SD–538, Dirksen Senate Office Building, Hon. Tim Johnson, Chairman of the Committee, presiding. OPENING STATEMENT OF CHAIRMAN TIM JOHNSON Chairman JOHNSON. Good morning. I call this hearing to order. Today we welcome Chairman Bernanke back to the Committee to deliver the Federal Reserve’s semiannual Monetary Policy Report. Nearly 5 years after the worst financial crisis since the Great Depression, the U.S. economy continues to show signs of improvement. Recently, we have seen the housing market strengthen and payroll employment firm up. Private sector job growth strengthened this year to around 200,000 jobs per month. The economy has shown signs of resilience despite fiscal tightening. On housing, I am pleased to see that the recovery is gaining momentum, with solid home price gains nationwide. New home construction has seen double-digit growth, and single-family home sales have also picked up. Many homeowners remain underwater, but overall numbers continue to decline. Going forward, I would encourage the Fed to be thoughtful in its actions to make sure these positive trends in housing continue. Congress has a role to play, too. To address FHA’s short-term challenges, Ranking Member Crapo and I released details this week of bipartisan legislation to get FHA back on stable footing and strengthen a program important to many Americans. Following this effort, we will turn to comprehensive housing finance reform legislation. Much progress has been made, but the labor market has not fully recovered from the Great Recession. Labor force participation remains low even when accounting for retiring baby boomers, and long-term unemployment remains near historic levels. Moreover, youth unemployment remains high, and even many young college graduates struggle to find gainful employment. These trends have lasting effects on the economy. Over the longer term, skill erosion from prolonged unemployment would reduce our economy’s potential. It is important that we help, not hurt, young Americans’ prospects and why it is so important that Congress finds a reasonable solution to the recent increase in student loan rates. (1) VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

2 To fulfill its dual mandate, the Fed should not prematurely step on the brakes. With consumer price inflation low and the unemployment rate unacceptably high, the Fed must continue to take action to support employment. When the time comes, it is important that monetary policy adjustments are gradual and do not disrupt financial stability and economic growth. Chairman Bernanke, I thank you for your years of service and leadership at the Federal Reserve during a challenging period in our Nation’s history, and I look forward to hearing your testimony. I now turn to Ranking Member Crapo. STATEMENT OF SENATOR MIKE CRAPO Senator CRAPO. Thank you very much, Mr. Chairman. And Chairman Bernanke, welcome. I welcome our Federal Reserve Chairman Ben Bernanke back to the Banking Committee to testify at the semiannual Humphrey- Hawkins hearing regarding the Federal Reserve’s monetary policy and the state of the economy. In recent weeks, the prudential banking regulators have been very active on a number of regulatory fronts, including releasing final regulations to implement the Basel III capital rules and proposed regulations on capital leverage ratios. I thank Chairman Bernanke personally for addressing the concerns that Chairman Johnson and I raised in our February letter about the unique characteristics of community banks and insurance companies. A onesize-fits-all approach regarding capital rules does not work for these types of entities. With regard to monetary policy, we have experienced a period where the Fed has pushed the short-term interest rate down to zero more than 4 years ago. The Fed pursued quantitative easing, or what has become known as ‘‘QE’’, in order to suppress long-term interest rates. As a result, the Fed’s balance sheet now stands at nearly $3.5 trillion, with an additional $85 billion every month in long-term assets being added. Recently released FOMC minutes from the June meeting indicate that several members of the Board felt that a reduction in asset purchases would likely soon be warranted. Several noted economists have called into question whether the benefits of these purchases outweigh the risks. The negative reaction by equity markets to the June FOMC statement on tapering indicates that some of the increase in the prices of equities and other assets recently is attributable to the Fed’s balance sheet expansion and not to purely economic fundamentals. In fact, June marked the worst month on record for bond fund outflows. The reaction indicates that markets are still heavily reliant on Government intervention, which is not good for the long-term health of the economy. I am interested to hear from Chairman Bernanke to what extent the Fed anticipates the inevitable tapering process will cause in terms of additional periods of market volatility. Because the official stance of the Fed is that the decision to taper remains data dependent, I am interested in hearing if the Chairman believes laying out specific data would improve both the Fed’s commitment to the policy and the market’s reaction to it. VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

3 Beyond tapering, which is simply slowing the rate of growth of the Fed’s balance sheet, is the more important issue of winding down the Fed’s massive balance sheet. The Fed has indicated that it may continue to roll over its holdings of long-term assets, which means that its balance sheet may not shrink for some time. A key element of the exit strategy adopted by the FOMC in June of 2011 is a 3- to 5-year period over which the Fed expected that it could completely eliminate its holdings of agency securities. This was done for the purpose of minimizing the extent to which the agency securities portfolio might affect the allocation of credit across sectors of the economy. Since then, the balance sheet has increased in size by more than 20 percent to, as I said, almost $3.5 trillion, and the Fed’s holding of agency securities has increased by more than 30 percent to about $1.2 trillion. Why does the Fed see the need for such accommodative policy to continue into the future? In light of the Fed’s large portfolio increases, the dominant role that the GSEs play in today’s mortgage market and the recent increases in the level and volatility of mortgage rates, will the Fed revise its balance sheet exit strategy principles? In particular, will the Fed be revising the time period over which it expects to eliminate its holdings of agency securities? It is my hope that this hearing gives us additional insight into the Fed’s plans for the future reduction of asset purchases and a road map for a return to normalized, rules-based monetary policy. Thank you, Mr. Chairman. Chairman JOHNSON. Thank you, Senator Crapo. To preserve time for questions, opening statements will be limited to the Chair and Ranking Member. I would like to remind my colleagues that the record will be open for the next 7 days for additional statements and any other materials. I would like to welcome Chairman Bernanke. Dr. Bernanke is currently serving a second term as Chairman of the Board of Governors of the Federal Reserve System. His first term began under President Bush in 2006. Before that, Dr. Bernanke was Chairman of the Council of Economic Advisers and served as a member of the Board of Governors of the Federal Reserve System. Chairman Bernanke, please being your testimony. STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Mr. BERNANKE. Thank you, Mr. Chairman, Ranking Member Crapo, and other Members of the Committee. I am pleased to present the Federal Reserve’s semiannual Monetary Policy Report to the Congress. In my brief remarks I will discuss current economic conditions and the outlook and then turn to monetary policy, and I will finish with a short summary of our ongoing work on regulatory reform. With respect to the outlook, the economic recovery has continued at a moderate pace in recent quarters despite the strong headwinds created by Federal fiscal policy. Housing has contributed significantly to recent gains in economic activity. Home sales, house prices, and residential construction have moved up over the past year, supported by low mortgage VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

4 rates and improved confidence in both the housing market and the economy. Rising housing construction and home sales are adding to job growth, and substantial increases in home prices are bolstering household finances and consumer spending while reducing the number of homeowners with underwater mortgages. Housing activity and prices seem likely to continue to recover, notwithstanding the recent increases in mortgage rates, but it will be important to monitor developments in this sector carefully. Conditions in the labor market are improving gradually. The unemployment rate stood at 7.6 percent in June, about a half percentage point lower than in the months before the Federal Open Market Committee initiated its current asset purchase program in September. Nonfarm payroll employment has increased by an average of about 200,000 jobs per month so far this year. Despite these gains, the jobs situation is far from satisfactory, as the unemployment rate remains well above its longer-run normal level, and rates of underemployment and long-term unemployment are still much too high. Meanwhile, consumer price inflation has been running below the Committee’s longer-run objective of 2 percent. The price index for personal consumption expenditures rose only 1 percent over the year ending in May. This softness reflects in part some factors that are likely to be transitory. Moreover, measures of longer-term inflation expectations have generally remained stable, which should help move inflation back up toward 2 percent. However, the Committee is certainly aware that very low inflation poses risks to economic performance—for example, by raising the real cost of capital investment—and increases the risk of outright deflation. Consequently, we will monitor this situation closely as well, and we will act as needed to ensure that inflation moves back toward our 2-percent objective over time. At the June FOMC meeting, my colleagues and I projected that economic growth would pick up in coming quarters, resulting in gradual progress toward the levels of unemployment and inflation consistent with the Federal Reserve’s statutory mandate to foster maximum employment and price stability. Specifically, most participants saw real GDP growth beginning to step up during the second half of this year, eventually reaching a pace between 2.9 and 3.6 percent in 2015. They projected the unemployment rate to decline to between 5.8 and 6.2 percent by the final quarter of 2015. And they saw inflation gradually increasing toward the Committee’s 2-percent objective. The pickup in economic growth projected by most Committee participants partly reflects their view that Federal fiscal policy will exert somewhat less drag over time, as the effects of the tax increases and the spending sequestration diminish. The Committee also believes that risks to the economy have diminished since the fall, reflecting some easing of financial stresses in Europe, the gains in housing and labor markets that I mentioned earlier, the better budgetary positions of State and local governments, and stronger household and business balance sheets. That said, the risks remain that tight Federal fiscal policy will restrain economic growth over the next few quarters by more than we currently expect, or that the debate concerning other fiscal policy issues, such VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

5 as the status of the debt ceiling, will evolve in a way that could hamper recovery. More generally, with the recovery still proceeding at only a moderate pace, the economy remains vulnerable to unanticipated shocks, including the possibility that global economic growth may be slower than currently anticipated. With unemployment still high and declining only gradually, and with inflation running below the Committee’s longer-run objective, a highly accommodative monetary policy will remain appropriate for the foreseeable future. In normal circumstances, the Committee’s basic tool for providing monetary accommodation is its target for the Federal funds rate. However, the target range for the Federal funds rate has been close to zero since late 2008 and cannot be reduced meaningfully further. Instead, we are providing additional policy accommodation through two distinct yet complementary policy tools. The first tool is expanding the Federal Reserve’s portfolio of longer-term Treasury securities and agency mortgage-backed securities; we are currently purchasing $40 billion per month in agency MBS and $45 billion per month in Treasuries. The second tool is ‘‘forward guidance’’ about the Committee’s plans for setting the Federal funds rate target over the medium term. Within our overall policy framework, we think of these two tools as having somewhat different roles. We are using asset purchases and the resulting expansion of the Federal Reserve’s balance sheet primarily to increase the near-term momentum of the economy, with the specific goal of achieving a substantial improvement in the outlook for the labor market in a context of price stability. We have made some progress toward this goal, and with inflation subdued, we intend to continue our purchases until a substantial improvement in the labor market outlook has been realized. In addition, even after purchases end, the Federal Reserve will be holding its stock of Treasury and agency securities off the market and reinvesting the proceeds from maturing securities, which will continue to put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative. We are relying on near-zero short-term interest rates, together with our forward guidance that rates will continue to be exceptionally low—this is our second tool—to help maintain a high degree of monetary accommodation for an extended period after asset purchases end, even as the economic recovery strengthens and unemployment declines toward more normal levels. In appropriate combination, these two tools can provide the high level of policy accommodation needed to promote a stronger economic recovery with price stability. In the interest of transparency, Committee participants agreed in June that it would be helpful to lay out more details about our thinking regarding the asset purchase program—specifically, to provide additional information on our assessment of progress to date, as well as of the likely trajectory of the program if the economy evolves as projected. This agreement to provide additional information did not reflect a change in policy. The Committee’s decisions regarding the asset purchase program (and the overall stance of monetary policy) depend on our assess- VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

6 ment of the economic outlook and of the cumulative progress toward our objectives. Of course, economic forecasts must be revised when new information arrives and thus are necessarily provisional. As I noted, the economic outcomes that Committee participants saw as most likely in their June projections involved continuing gains in labor markets, supported by moderate growth that picks up over the next several quarters as the restraint from fiscal policy diminishes. Committee participants also saw inflation moving back toward our 2-percent objective over time. If the incoming data were to be broadly consistent with these projections, we anticipated that it would be appropriate to begin to moderate the monthly pace of purchases later this year. And if the subsequent data continued to confirm this pattern of ongoing economic improvement and normalizing inflation, we expected to continue to reduce the pace of purchases in measured steps through the first half of next year, ending them around midyear. At that point, if the economy had evolved along the lines we anticipated, the recovery would have gained further momentum, unemployment would be in the vicinity of 7 percent, and inflation would be moving toward our 2-percent objective. Such outcomes would be fully consistent with the goals of the asset purchase program that we established in September. I emphasize that, because our asset purchases depend on economic and financial developments, they are by no means on a preset course. On the one hand, if economic conditions were to improve faster than expected and inflation appeared to be rising decisively back toward our objective, the pace of asset purchases could be reduced somewhat more quickly. On the other hand, if the outlook for employment were to become relatively less favorable, if inflation did not appear to be moving back toward 2 percent, or if financial conditions—which have tightened recently—were judged to be insufficiently accommodative to allow us to attain our mandated objectives, the current pace of purchases could be maintained for longer. Indeed, if needed, the Committee would be prepared to employ all of its tools, including an increase the pace of purchases for a time, to promote a return to maximum employment in a context of price stability. As I noted, the second tool the Committee is using to support the recovery is forward guidance regarding the path of the Federal funds rate. The Committee has said it intends to maintain a high degree of monetary accommodation for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee anticipates that its current exceptionally low target range for the Federal funds rate will be appropriate at least as long as the unemployment rate remains above 61⁄ 2 percent and inflation and inflation expectations remain well behaved in the sense described in the FOMC’s statement. As I have observed on several occasions, the phrase ‘‘at least as long as’’ is a key component of the policy rate guidance. These words indicate that the specific numbers for unemployment and inflation in the guidance are thresholds, not triggers. Reaching one of the thresholds would not automatically result in an increase in the Federal funds rate target; rather, it would lead the Committee to consider whether the outlook for the labor market, inflation, and the broader economy justified such an increase. For example, if a VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

7 substantial part of the reductions in measured unemployment were judged to reflect cyclical declines in labor force participation rather than gains in employment, the Committee would be unlikely to view a decline in unemployment to 61⁄ 2 percent as a sufficient reason to raise its target for the Federal funds rate. Likewise, the Committee would be unlikely to raise the funds rate if inflation remained persistently below our longer-run objective. Moreover, so long as the economy remains short of maximum employment, inflation remains near our longer-run objective, and inflation expectations remain well anchored, increases in the target for the Federal funds rate, once they begin, are likely to be gradual. Let me finish by providing you with a brief update on progress on reforms to reduce the systemic risk at our largest financial firms. As Governor Tarullo discussed in his testimony last week before this Committee, the Federal Reserve, with the other Federal banking agencies, adopted a final rule earlier this month to implement the Basel III capital reforms. The final rule increases the quantity and quality of required regulatory capital by establishing a new minimum common equity tier 1 capital ratio and implementing a capital conservation buffer. The rule also contains a supplementary leverage ratio and a countercyclical capital buffer that apply only to large and internationally active banking organizations, consistent with their systemic importance. In addition, the Federal Reserve will propose capital surcharges on firms that pose the greatest systemic risk and will issue a proposal to implement the Basel III quantitative liquidity requirements as they are phased in over the next few years. The Federal Reserve is considering further measures to strengthen the capital positions of large, internationally active banks, including the proposed rule issued last week that would increase the required leverage ratios for such firms. The Fed also is working to finalize the enhanced prudential standards set out in sections 165 and 166 of the Dodd-Frank Act. Among these standards, rules relating to stress testing and resolution planning already are in place, and we have been actively engaged in stress tests and reviewing the ‘‘first-wave’’ resolution plans. In coordination with other agencies, we have made significant progress on the key substantive issues relating to the Volcker rule and are hoping to complete it by year-end. Finally, the Federal Reserve is preparing to regulate and supervise systemically important nonbank financial firms. Last week, the Financial Stability Oversight Council designated two nonbank financial firms; it has proposed the designation of a third firm, which has requested a hearing before the Council. We are developing a supervisory and regulatory framework that can be tailored to each firm’s business mix, risk profile, and systemic footprint, consistent with the Collins amendment and other legal requirements under the Dodd-Frank Act. Thank you. I would be pleased to take your questions. Chairman JOHNSON. Thank you, Chairman Bernanke. As we begin questions, I will ask the clerk to put 5 minutes on the clock for each Member. Chairman Bernanke, with inflation low and unemployment still high, what trends in the data would you need to see before deciding VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

8 to begin unwinding monetary policy measures? Would unwinding too early threaten the economy and the financial system? Mr. BERNANKE. Well, certainly we face the same issues that are always faced when monetary policy begins to normalize after a period of recession and expansion, which is if we tighten too soon, we risk not letting the economy getting back to full employment; if we tighten too late, we risk having some inflation. So, as always, there are going to be issues of judgment there that are unavoidable in any monetary policy normalization. That being said, we have laid out essentially a three-stage process for our normalization. The first, which is dependent on the economy strengthening, the labor market continuing to normalize, and inflation beginning to move back toward 2 percent, is a process of moderating the pace of our asset purchases and eventually bringing those to zero, additional purchases, at the point that we can say that we have made substantial improvement in the outlook for the labor market. And we have given some guidelines about how that process would go forward. The second stage would be a potentially lengthy period in which we are watching the economy for continued improvement, continued reduction in unemployment, normalization of inflation; and as I described in my testimony, when unemployment gets to 6.5 percent, and not before, and when inflation is looking closer to target, at that point we would consider whether tightening in the form of raising short-term interest rates is appropriate. So that would be the second stage. The final stage would be the ultimate normalization of policy, the raising of short-term interest rates, and eventually the normalization of our balance sheet. As I noted in my testimony, assuming that the economy remains in a slow-growth mode, as we have been seeing, that process will be a very gradual process. Chairman JOHNSON. What explains the recent rise in long-term interest rates? And how much more of an increase in rates could cause the recovery to falter? And what would the Federal Reserve do to respond if interest rates spike? Mr. BERNANKE. Well, there are essentially three reasons why we have seen some increase in longer-term rates, although I would emphasize they remain relatively low. The first is that there has been some better economic news. As investors see brighter prospects ahead, interest rates tend to rise. For example, we saw a relatively good labor market report, which was accompanied by a pretty sharp increase in interest rates on that day. The second reason for the increase in rates is probably the unwinding of leveraged and perhaps excessively risky positions in the market. It is probably a good thing to have that happen, although the tightening that is associated with that is unwelcome. But at least the benefit of it is that some concerns about building financial risks are mitigated in that way and probably make some FOMC participants more comfortable with using this tool going forward. The third reason for the increase in rates has to do with Federal Reserve communications and market interpretations of Fed policy. We have tried to be very clear from the beginning and I have reit- VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

9 erated again today that we have not changed policy. We are not talking about tightening monetary policy. Merely we have been trying to lay out the same sequence which I just described to you about how we are going to move going forward and how that will be tied to the economy. But I want to emphasize that none of that implies that monetary policy will be tighter at any time within the foreseeable future. Chairman JOHNSON. What do you currently see as the biggest threat to the housing market recovery as we continue housing finance reform? Mr. BERNANKE. Well, certainly we have to keep our eyes open to pay attention to mortgage rates and affordability. That is our job at the Fed. But I think it is very important for us to get our housing institutions, our regulatory structure cleared up and in working order. I am glad to see that the Congress is now looking at reforms of Fannie and Freddie, the mortgage securitization system. We still have rules to do about skin in the game and other aspects of the mortgage market. I think as there is greater clarity about the rules of the game for mortgage making and mortgage securitization that we will see less tightness in the market for mortgages for first-time home buyers and people with less than perfect credit scores. And I think one of the risks that we face now is that there is still a pretty significant part of the population that is having considerable difficulty accessing mortgage credit even though they may have the financial wherewithal to be worthy of that credit. Chairman JOHNSON. Senator Crapo. Senator CRAPO. Thank you, Mr. Chairman. Chairman Bernanke, you have previously indicated that the Fed wants to see substantial improvement in the labor market before cutting off QE. And in your June press conference, you noted that ‘‘substantial’’ is in the eye of the beholder. If I understood you today, you indicated that if all goes as expected, we could expect to see this wound down completely by midyear next year. Is that correct? Mr. BERNANKE. If all goes as expected, yes. Senator CRAPO. And I guess the flip side of that is you said if all does not go as expected, we could see QE continue for the indefinite future? Mr. BERNANKE. I suspect that at some point the economy will reach that substantial improvement in the outlook given the way we have seen progress to this point. Exactly whether it is a little bit later or a little bit earlier, that remains to be seen. Senator CRAPO. I guess my question is I assume you would agree that there is a risk in continuing QE indefinitely. Would you agree with that? Mr. BERNANKE. Yes, there are costs and risks to QE, and we are watching those carefully. We have said in our statement that one of the considerations that we are looking at at every meeting is the efficiency and costs of this program. And we do a benefit/cost analysis as we discuss the benefits of additional purchases. Senator CRAPO. Well, given the notion that ‘‘substantial’’ is really in the eye of the beholder, I do not think it is very easy for the markets to understand exactly how and when we are going to see VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

10 the winding down occur. And to me, it appears that possibly communicating more specific targets rather than thresholds would help to reduce that risk. Do you agree, or do you think it is just not possible to get more specific? Mr. BERNANKE. Well, this is an issue that the Committee will continue to discuss. I would say first that we have given some fairly specific qualitative guidance about what we are looking for, and I did say that unemployment in the general vicinity of 7 percent with inflation moving back toward the 2-percent objective was indicative of the kind of progress that we were trying to achieve. The thresholds are tied to rate increases, and there, while reaching that threshold does not necessarily mean that we will raise rates, we are quite confident that we will not raise rates before we get to those points. In that sense we are providing a reassurance to the public and to the markets. Senator CRAPO. Thank you. And with regard to winding down the Fed’s balance sheet, you and others have indicated a willingness to keep the Fed’s QE securities on the balance sheet, rolling over maturing securities and keeping them out of the market. Governor Tarullo said on Monday that, ‘‘No one is talking about unwinding or selling the securities we have been buying,’’ which would mean then that the Fed’s balance sheet could be over $3 trillion for some time. Correct? Mr. BERNANKE. Well, not necessarily, because, of course, ultimately we will stop rolling over and reinvesting the securities, and then they will begin to run off. Then the balance sheet will start to come down. We have done a lot of scenario analysis, of course, and allowing the securities to run off at a certain point when the economy is strong enough does not delay normalization by very much. Senator CRAPO. But you are not expecting the winding down of the balance sheet at any time soon. Is that correct? Mr. BERNANKE. Certainly not until we get to the rate increase part of the three-part sequence that I described to you, and there, again, we are not planning at this point to sell any MBS. At some point we would be allowing the maturing securities just to run off and not replacing them. Senator CRAPO. But as long as you continue to hold and not wind down the balance sheet, doesn’t this lead to credit mispricing and increased investor risk undertaking? Mr. BERNANKE. I do not think so, particularly when we are winding down. I do not see that there is any real difference between, for example, our holding mortgage-backed securities, which is intended to strengthen the housing market, and usual monetary policy, which lowers long-term interest rates through short-term rate cuts, which is also intended to strengthen the housing market. The housing market is always an important channel of monetary policy, and so I do not really see that there is any significant misallocation going on there. Senator CRAPO. All right. Thank you. Chairman JOHNSON. Senator Menendez. Senator MENENDEZ. Thank you, Mr. Chairman. Chairman Bernanke, I understand this may be your final Monetary Policy Report hearing before the Committee before the end of VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

11 your term as Chairman of the Federal Reserve, and I am sure you will miss us. But I want to thank you for your hard work and dedication and your service to our country, especially during a time of crisis, and I appreciate your service. We seem to be experiencing a trend right now where our economy and employment are growing and recovering, but we still have, from my perspective, a ways to dig ourselves out from the deep hole caused by the financial crisis. Unemployment is coming down, but it is still 7.6 percent. More than a third of the people who are unemployed are long-term unemployed, which is a true crisis for those more than 4 million individuals and families caught in this situation. And as you have discussed with this Committee in the past, long-term unemployment can have serious consequences, make it harder for people to maintain skills and networks to reenter the workforce. So my question is: While the economy is recovering, we still have a lot of work to do to get full employment and strong broad-based growth. With core inflation well below the Fed’s target and weak demand suggesting that inflation is unlikely to be a problem anytime soon, isn’t it still way too soon to consider any kind of policy tightening? Mr. BERNANKE. Well, again, I have distinguished between changing the mix of our two tools and the overall thrust of monetary policy. And I agree with you that with inflation below target and with unemployment still quite high, and by some measures with unemployment in some ways being even too optimistic a measure of the state of the labor market, given some of the other statistics that you have cited, that both sides of our statutory mandate are suggesting that we need to maintain a highly accommodative monetary policy for the foreseeable future, and that is what we intend to do. But I think that we will be able to maintain that high level of accommodation ultimately through rate policy and by holding a very large balance sheet. But in making that transition to a different stage of this process, we again are intending to keep policy highly accommodative. Senator MENENDEZ. Let me just follow up on that. As the Reserve has engaged in measures to strengthen our economy, some critics have argued that any growth that results might somehow be artificial or that low interest rates and cheaper credit might lead to financial instability or asset bubbles if investors make riskier investments in order to ‘‘reach for the yield.’’ In the current environment, though, isn’t weak demand the greater concern? If consumers are pulling back on their spending because of high debt burdens and underwater mortgages from the financial crisis, and businesses are holding off on investing because of the weaker consumer demand, doesn’t that change the relative cost, benefits, and risks of different monetary policy actions? Mr. BERNANKE. Yes, it can. On the first point about artificial growth, during the 1930s there was this view called a ‘‘liquidationist view’’ which held that recessions and depressions were healthy, they purged the evils out of the system. I do not think we accept that point of view anymore. We think our economy is producing below its potential, and what monetary policy is trying VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

12 to do is help the economy return to its potential, and that would be real and sustainable growth that we could achieve. On financial stability, obviously given recent experience, we want to be very careful that we understand what is going on and pay close attention to these issues. The relationship between monetary policy and financial stability is a complicated one. On the one hand, very low rates for a sustained period can lead to reach for yield and other risky behavior. We are trying to address that primarily through regulation, through oversight, through monitoring, and that is our first line of defense certainly for dealing with those sorts of issues. But you correctly point out that it is not a simple relationship because, of course, a weak economy also is bad for financial stability because it means weaker credit quality, less lending opportunities, more defaults and delinquencies. So, again, our strategy is to try to focus on inflation and unemployment using monetary policy, but to pay close attention to any developments in the financial stability sphere and use the regulatory and supervisory tools we have as the first line of defense in that case. Senator MENENDEZ. I appreciate that. The reason I asked those specific questions is because there has been a great deal written and said about expansionary austerity. And as I look at what is happening in Europe, I am not sure that all the measures taken under that guise produce either the economic results that we would like to see and certainly the consequential human results that we have seen in Europe. And I do not want us making those mistakes here. Thank you, Mr. Chairman. Chairman JOHNSON. Senator Corker. Senator CORKER. Thank you, Mr. Chairman. And, Mr. Chairman, thank you for being here. We were just talking. This second day of this Humphrey-Hawkins meeting is about like drinking day-old coffee, and maybe even worse, accompanied by a stale doughnut. But certainly I am here today—and I do not really have any questions; I read your testimony yesterday—but really to thank you for your service. I know we have had our differences on some issues, but I really do especially appreciate the way you handled the crisis. I think that our country was under extreme duress. I do not know how many people could have handled that crisis and the complexities that came with it in the way that you did. So I want to thank you for that. Mr. BERNANKE. Thank you. Senator CORKER. Obviously we have had discussions, both publicly and privately, about some of the quantitative easing, and I know we had differences. But I would wonder—I know that, you know, there is a whole industry of folks out there who watch every word that you say and people right now are doing calculations as to whether to buy this instrument or that, and I know that you have to be very cautious in what you say sometimes. But this is a little bit of a step back. I guess, you know, some of the concerns that I have had, and I think Members on this side of the dais, have just been the hyperactivity of the Fed and the Fed almost acting as an enabler for Congress, which had very bad behavior for a long time, our inability to do the things fiscally and in other ways that would stimulate VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

13 our economy. And I think you are well aware of those. You do a pretty decent job of staying away from that, although sometimes I wish you weigh in more. But I do wonder if you have any possibly parting comments—I do not know what your future is and none of us do at this moment. But I wonder if you have any comments about that, about any concerns about over time because of the hyperactivity that the Fed has been engaged in, and in some ways because Congress has been so feckless in living up to its responsibilities and dealing with the issues that we have to deal with, if that is of any concern to you. And is there any similarities, if you will, to a person who knows that they need to do certain things, to eat right and exercise, and instead relying on the Fed for amphetamines and other kinds of activities to get in a place that the economy needs to be in our Nation and, candidly, the world. But, again, as you potentially contemplate those, I do want to again thank you for your service, thank you for friendship, and whatever happens I wish you well. Mr. BERNANKE. Thank you very much for those comments, Senator. On hyperactivity, I think what we learned during the crisis was that we did not have the right tools. We did not have a way to address a failing investment bank that would not create a huge amount of bad effects in financial markets. We did not have appropriate oversight of the shadow banking system. There were a lot of weaknesses in our oversight, our regulatory system, and our response tools to the crisis, and that is why it sometimes seemed frenetic, because the Fed was trying to improvise in many cases. And I think we have made some progress in setting up a more orderly framework for both strengthening our financial system, monitoring the system, and responding in case of another emergency. So I hope that that is the case. It is true that monetary policy I think has carried an awful lot of the burden for this recovery, and we would be more than happy to share that burden more equally with fiscal policy and other policy makers. But I recognize it has been a difficult time politically for people to come to agreement on some very important issues, and I do not think—you mentioned the enabler idea. I do not think it is my place or the Federal Reserve’s place to try to force Congress to come to any particular outcome. I mean, it is Congress ultimately who is responsible, and our role is to take what Congress does as given and to try to figure out how best to meet our mandate given Congress’ actions. I do not think we should be in a position of trying to threaten Congress with higher interest rates or something like that. Senator CORKER. Yes, and I know that is not your place, and I know that you operate under our mandates. I would think, though, that most people would ration that, you know, the fact that the Fed is there and does have to do what it does in some ways acts as a cover for us in our inability to act responsibly. I mean, I think that goes without saying, doesn’t it? Mr. BERNANKE. Well, I think as you can see, our acting alone is not producing the kind of results we all would like. Growth is going in the right direction, unemployment is going in the right direction, VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

14 but it still is a very slow process. And as I have said many times, monetary policy is not a panacea, so there is still plenty of room for Congress to address some of these problems that Senator Menendez and others referred to. Senator CORKER. Thank you. Chairman JOHNSON. Senator Reed. Senator REED. Well, thank you very much, Mr. Chairman. And let me join Senator Corker, Mr. Chairman, and commend you and thank you for your service to the Nation. I witnessed your innovative, improvisational, and very thoughtful approach to problems that were potentially devastating to the economy. I think through your service we avoided a much worse situation, and I thank you for that. One of the things reflecting back, though, you know, the 20/20 hindsight, there were a few Governors of the Fed who were talking about a housing bubble as the next sort of great crisis, but it did not get the traction. Perhaps not identically, but in a similar vein, you have got some of your colleagues are now talking about the huge growing student debt that could have macroeconomic effects, slowing down home purchases, slowing down sort of what we assume was the normal course, that by your late 20s you buy the home, you settle down, et cetera. Also, I think, in a way, underscoring another huge problem in the economy, which is the inequality, growing inequality of income. Our sort of American solution to inequality is education. That is the engine. We have reports, for example, from Georgetown University that there is already a 5 million projected gap between jobs available that will be there and skills available to fill them. And yet as we increase the cost of borrowing—and all the proposals that we are talking about currently do increase the cost—that I think will cut down on opportunities for a lot of people. So can you comment, one, on this potential sort of crisis in student debt, its macroeconomic effects, and whether if we do not provide some type of support both directly and also refinancing support, that this could be the next big problem we face? Mr. BERNANKE. Well, first, it should be acknowledged that the ability to borrow to build your own human capital, to get an education, is extremely important and a good thing. You know, there was a time when a poor student, no matter how qualified, was unable to finance an education, and the fact that we now can do that is very good for our economy as well as for individuals. The amount of student debt is large. It is over $1 trillion at this point. I think that it is not particularly likely to cause any sharp instability of the sort we saw in the last few years. It has a couple of consequences. One, of course, is it represents a potential fiscal risk for the U.S. Government to the extent that some of it is not repaid. Second, to the extent that there are people who have taken out a lot of debt and the economy is not serving them well, they are not finding opportunities, then obviously over time—this is not something that is a big issue at any given moment, but over a number of years they will not be able to buy the home and do other things that they otherwise would be able to because they are paying off the debt. VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

15 So I think the answer to it is, first, of course, to have a strong economy that provides job opportunities, and that is something we are trying to do, and I am sure you are trying to do as well. But the other is I think we need to make sure that students are better informed about the market, the labor market, and their opportunities and what different options they have. We know of cases of certain—you know, some of the private sector universities, online universities and so on, which do not have very good graduation or placement rates. People are still borrowing to take those courses. I think if there was better counseling, better information, that would certainly be an important step. But I do not want us to step back from doing everything we can to give young people a chance to get whatever skills are appropriate. Senator REED. Let me just ask a broader question, which is, your comment, this growing documented inequality in income in the United States, does it pose both economic and social risks to the country? And how do we deal with it other than through education and many different ways? Mr. BERNANKE. It is a very, very tough problem. It is not restricted to the United States. It is a global phenomenon. It has been going on for a very long time. There are a number of factors behind it. I think, though, that one of the most important is that the new technologies we are seeing are what is called ‘‘skill bias’’, they favor the most skilled workers, and they reduce opportunities for people of medium or low skills, particularly in competition with the global labor force. So I do not have an easy answer. I do think that related to your question about student debt, I think that focused skill enhancement, not everybody should necessarily be doing a 4-year B.A. Some people would be better off working specifically toward a job in industry where there is an understanding in advance that this is what is needed, this is the opening. Community college prepares those kinds of courses, so more focused job-oriented training for some students who are interested in that might be helpful. But this is a long-term trend, and I do not have an easy solution for it. Senator REED. Thank you, Mr. Chairman. Chairman JOHNSON. Senator Toomey. Senator TOOMEY. Thank you, Mr. Chairman, and I, too, want to thank Chairman Bernanke not just for being with us today but also for his years of service. And we have had our disagreements over the years, but not without, on my part, a great deal of respect for the way you have approached this work and the work that you have done. I have a few questions that I hope we would be able to mow through. One has to do with the efficacy of the quantitative easing, and more specifically there are a number of very thoughtful folks who have done analyses that suggest that the benefit of the quantitative easing we have had might be quite modest. And specifically I think the suggestion has been that conventional understanding of the transmission mechanism of the increase in household net worth to consumer spending would suggest a very modest increase to GDP that has resulted from the pretty significant increase recently in household net worth, even if you attributed all of that increase VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

16 to the Fed, which is itself a questionable premise. And then your own previous testimony—I think it was at Joint Economic—to a question that I asked, if I understood you correctly, you acknowledged that the nature of the impact that monetary policy tends to have on economic growth might be more a matter of timing rather than a net increase. So accommodative policy can accelerate, can move forward economic activity, might not increase economic activity in total. So I guess what I am saying is if the magnitude of the benefit has been very modest and, at that, it might be just a shift in timing anyway, that would suggest pretty modest benefits, and yet the costs and the risks keep mounting, in my view, the risks of asset bubbles, mispricing assets, the risks of whether or not we will have an orderly exit. So I guess my question would be, number one, how do you quantify the benefits that have been occurring, especially near-term marginal benefits going forward? And can you and do you systematically attempt to quantify the risks of what you have done? Mr. BERNANKE. Yes, that is a very good question. There is a very large literature, academic and within central banks, trying to figure out how big the effects are of quantitative easing, and it is quite difficult to know for sure. But the preponderance of the evidence is that while this is not as powerful a tool as ordinary monetary policy, rate policy, that it does have meaningful impact on jobs and on the economy. And in particular, since 2008, where we have had no ability to move short-term rates and we have had some periods where became somewhat more concerned about deflation, we think that QE has provided an important boost at critical times to help the economy continue to move forward. So I do not want to overstate it, and, again, there is a lot of uncertainty, but there is a lot of work on this, and the preponderance of the work suggests that the effects, while not huge, are quite meaningful. Also, in terms of timing, it is true that no monetary policy can do very much about the long-term growth potential of the economy. But in a situation where we are well below that potential, if we can get back to that potential more quickly, that is a net gain that is enjoyed by the economy. In terms of costs and risks, I have identified in speeches and other places some of these risks, and as I said, it is in our statement that we look at this carefully. I think the one that we have paid the most attention to is financial stability, and we have tried to greatly increase our vigilance, our monitoring, our use of supervisory tools and the like. And as Senator Menendez actually pointed out, though, there are also risks on both sides because, of course, as the economy does very poorly, then that also creates risks to financial stability because of the effect on default, delinquency, and so on. So let me just acknowledge that this is an issue that is an important one. We believe the first line of defense should be monitoring, supervision, regulation, and other similar tools, but we do take into account these costs and risks when we debate our monetary policy. Senator TOOMEY. Do you attempt to quantify it? Or is it all subjective? VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

17 Mr. BERNANKE. We try to quantify it. It is very difficult, of course, to know exactly what the size of the risk is. But what we do is we do a lot of work, both qualitative and quantitative, trying to measure—for example, we might be looking at covenants on loans and whether or not those covenants are becoming less restrictive, which is suggestive of poor underwriting, for example. So we monitor those kinds of things, and we report those to the FOMC at essentially every meeting so that they can understand where there may be sectors where financial risks are building and try to gauge those risks. Senator TOOMEY. Thank you. I have other questions, but I see my time has expired. Thanks, Mr. Chairman. Chairman JOHNSON. Senator Schumer. Senator SCHUMER. Thank you, Mr. Chairman. I want to thank you as well, Chairman Bernanke, as you endure your second marathon on 2 days and echo the views of many of my colleagues in the House and Senate who have thanked you for your service during such a critical period. Your quiet but strong leadership has been instrumental in keeping our economy from falling into an abyss and repeating the devastation of a Great Depression, and we are now, because of your leadership, on the path toward turning that economy around. My view is that 2014 and 2015 will be stronger economically than our present time, and that will be in large part because of the building blocks that you put into place, even if you are no longer Chairman of the Fed. I am not prejudging anything, of course. So here are my questions. You have been as clear as I think you can be that the timing and pace of any tapering—these are monetary—timing and tapering of your asset purchases will be dependent on economic and financial conditions. That is logical. In June, the Committee projected that economic growth would pick up in coming quarters, but since then economic data has been mixed. We have had decent job numbers, but many signs of weakening growth. We found out that the baseline for your June outlook was worse than we first thought. First quarter GDP numbers were revised downward. So the economy is worse than you thought in June, but the markets appear to think that you are still set to begin tapering in September. So if the economy did not change, were exactly as it is today on September 18th, would the Fed be announcing a moderation in the pace of its assets? And just one subsidiary question, you have often said that asset purchases will continue until the Fed sees ‘‘substantial improvement in the labor market outlook.’’ Does weakening data regarding growth change your outlook with respect to the strength of the labor market? In other words, can labor markets continue to improve in relative growth? So first about September 18th, and then about the labor markets. Mr. BERNANKE. Well, the June FOMC meeting was only a few weeks ago. There have been some data points since then, and as you say, they have been mixed. So I think it is way too early to make any judgment. We will be obviously reviewing the data, and what we are looking for is a pickup as the year progresses, because our theory of the case, if you will, is that one of the reasons that VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

18 the economy has been so slow in the early part of 2013 is because of fiscal factors. It is hard to judge how long those factors will last, but if the economy begins to move beyond that point and fiscal restraint becomes somewhat less pronounced, then we should see, as you suggested yourself, a pickup in growth. And so that is what we will be looking for. It is too early to—— Senator SCHUMER. OK. But the September 18th deadline of beginning tapering is not immutable. You are going to look at the data. Mr. BERNANKE. We are going to obviously look at the data. It is a Committee decision. And it is going to depend on whether we see the improvement which I described. Senator SCHUMER. Right. And the second question, does the weakening data regarding growth change your outlook with respect to the strength of labor markets? Mr. BERNANKE. Yes. So we specifically set as a goal an improvement in the outlook for the labor market as opposed to the labor market per se. And what that means is that we want to see improvement in labor market indicators, but we also want to have a sense that improvement will continue. And, of course, for improvement to continue, you need to have a broader-based growth. And so of the three conditions which I described, one of them is a pickup in growth which will be sufficient to provide continued improvement—— Senator SCHUMER. You think we still could be on the path to labor markets improving even with this relatively weak growth in terms of outlook. Mr. BERNANKE. It is possible. Again, it has only been a few weeks since the June meeting, and I think we have new data—— Senator SCHUMER. OK. My first question was about the tapering. My second is when you might end asset purchases altogether. The minutes of your last meeting said that, ‘‘About half of the participants indicated that it likely would be appropriate to end asset purchases late this year.’’ Yet you yourself said in guidance that was approved by the Committee based on current projections, you expect asset purchases to end sometime in the middle of next year when you currently anticipate unemployment will be down around 7 percent. That is the level of unemployment you say represents the amount of improvement that would warrant a moderation in Fed policy. Do those other members have a different definition of ‘‘substantial improvement in the labor market’’—there seems to be some disparity between the other members and you, and if you are not there come next year, there is a worry there—or a different view of the likely path of the labor market? Do they think unemployment will be 7 percent this year? Or do they have different assessments about the relative cost and benefit of QE? Mr. BERNANKE. Well, there are diverse views obviously on this program, and in particular, people could see an early wind-down because they are optimistic about the economy or because they do not think that QE is very effective. I mean, there are a lot of different reasons why you might have that view. Let me just assure you that we have a very careful discussion at the meeting. We have what is called a ‘‘go-round’’ where every per- VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

19 son, including the nonvoters, gets to express for several minutes their view on policy, both current and prospective, and the general scenario, which I described in my press conference, is broadly supported by people on the Committee, including both voters and nonvoters. Senator SCHUMER. Good. That is good to hear, and it gives me a little belief. Thank you, Mr. Chairman. Chairman JOHNSON. Senator Coburn. Senator COBURN. Mr. Bernanke, I appreciate the service that you have given our country, and we had nobody to compare you to because we have never been in the situation we were in before. But I think basically you have done some significant work for the average American, and I appreciate it. I have a couple of questions in terms of your balance with your mandate, both in terms of inflation and employment and growth. One of the things that concerns me is that, since 1980, we have changed the way we measure inflation 20 times. And if you use the same measure of inflation that we had in 1980, our inflation rate would be over 8 percent right now. And the other thing that concerns me is median family income in real dollars is the same as it was in 1989. So if I had a criticism of anything you have done in the last few years, it would really go along and align more with Senator Corker’s thoughts. We have let you down. The kindergarten of Congress has let you down by not doing the things to create the confidence, to create the certainty in the business community that will allow the significant capital that is sitting on the sidelines to be invested, which would create some of the growth that you are hoping to do. So for that, I apologize. But would you care to comment, since in your testimony inflation is under control but the average American over the last 10 years has seen significant inflation and in the last few years has seen significant inflation in the things that really matter? And let me talk about it: the cost of an education, transportation, electricity, rents, food, plus out of what we have done, not intentionally, we have gotten a commodity bubble in many areas in terms of raw commodities. Would you comment on both the changing metrics that we use for inflation as well as maybe what we could have done, looking backwards, that might have accentuated and augmented what you have done? Mr. BERNANKE. Well, on inflation, the inflation statistics are calculated by the Bureau of Labor Statistics, as you know, which is made up of highly qualified professional economists—there is no partisan influence—and their efforts are always to try to make the inflation numbers better, make them more accurate. And that is my sense of what has been happening there in terms of changes. There was a bipartisan commission on inflation measurements a few years ago which concluded that the official inflation numbers overstated, not understated, inflation. And so some of the changes they recommended have been included. VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

20 So there is a distinction between prices being high and prices being rising. It is true that gas prices and food prices—all these prices relative to people’s wages—wages are not going up much. Senator COBURN. That is right, so the cost of living is going up—— Mr. BERNANKE. No, it is not going up. It is high. It is not going up. In other words, real wages—— Senator COBURN. Are going down. Mr. BERNANKE. Real wages have been going down because even though inflation is very low, wages have been growing slower than inflation. So—— Senator COBURN. So discretionary income has decreased, so consumer spending is not rising at the rate at which you would like to see it. Mr. BERNANKE. That is true, but that is not an issue of inflation. That is an issue of real living standards, and that has to do with the productivity of the economy and the distribution of income. And the Fed really cannot do a whole lot about that. So I guess I would just respectfully disagree that inflation is badly undermeasured. I think the professionals are doing as good a job as they can to measure inflation, and if you look at a lot of prices, including rents, food, gasoline, and so on, again, while they may be high, they are not much different from where they were a year ago, and that is what inflation is about. It is the rate of change over time. In terms of what Congress could do, I mean, I think, you know, I can only go so far in recommending, but I do think that an attempt to focus the budget consolidation efforts more on the longer term—— Senator COBURN. I agree. Mr. BERNANKE. ——would have been a more productive way— rather than putting so much of the tax increases and spending cuts in a front-loaded way, would have been more helpful. That would have been one suggestion. Senator COBURN. So if, in fact, Congress had behaved appropriately and helped create a certainty in the long term, especially with our entitlement programs, but also in terms of some of the waste, the effectiveness of some of the things you have done with monetary policy might have been greater. Mr. BERNANKE. Certainly. Senator COBURN. Thank you. Chairman JOHNSON. Senator Brown. Senator BROWN. Thank you, Mr. Chairman. Chairman Bernanke, I thank you for your service, as others have done, and we all mean that. And thank you for the new rules on capital standards that you have issued with the OCC and FDIC. I urge you to hold fast on them when the megabanks fight to weaken those standards, and I hope that you will do that. Some financial institutions argue, as we have discussed, that we should not get out ahead of Europe in our financial regulation. On Monday, Governor Tarullo said, and I want to quote at some length: ‘‘I think it is very dangerous that some have tried to characterize Basel agreements as the ceiling and not the floor. So for us in the United States, those of us who are charged with financial VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

21 stability of the United States need to make the judgment as to what levels of capital will most ensure financial stability in the country without unduly affecting the flow of credit. Ever since the publication of our proposed reg, I have had calls from my counterparts around the world,’’ Governor Tarullo says. ‘‘That is really interesting. They are saying, ‘Tell me the reasoning on this, how you are thinking about it. Explain to me more why you think 3 percent is inadequate.’’’ What I hear Governor Tarullo saying is that we should do what we think is best for our financial stability, and if we lead by example, the rest of the world will follow. Do you agree with Governor Tarullo? Mr. BERNANKE. I certainly agree with the first part, which is that Basel III is a floor, it is not a ceiling. It is really a least common denominator because these agreements are made essentially by unanimous consensus. And, therefore, if there are a few countries that are very resistant for whatever reason, you know, that makes it tougher to get the higher standard. So we view them as a floor, and we are prepared to do whatever additional steps are needed in order to make our financial system safe. I do not know whether all countries will follow us, but there are other countries—Switzerland comes to mind, U.K.—that have thought hard about this and have made additional—taken additional steps to strengthen their banking systems. And we do have a leadership position, and I hope that will happen. But I do not think it will be universal. I think that you will see different responses from different countries. Senator BROWN. But the most important countries with financial systems will follow as Governor Tarullo suggests? Mr. BERNANKE. I do not know whether they will follow the exact same things, but they have all got the same—the key financial centers which recognize how important banks are to their economy, but also the fact that in some cases the banks are bigger than their economy, recognize that it is very important to have stability, and they have been particularly willing to consider additional steps. Senator BROWN. So we should not shrink from doing the right thing for stability of our country because some megabanks say that we will be an outlier and other countries will not follow. Do you agree? Mr. BERNANKE. Well, the other countries may or may not follow. Some will. But whether they do or not, I do agree that we should do whatever we need to do to make sure that the U.S. financial system is safe. Senator BROWN. Thank you. Let me ask another question. It is bank earning season again, as you know, and it is no surprise that megabanks are doing quite well. Yet they continue to claim that regulations, new regulations and pending regulations, are killing them. Tuesday’s Financial Times said, ‘‘Here is the problem: banks have spent a lot of time, energy, and money warning of the potential ill effects of ramping up regulation. But since the crisis, international regulators have kept demanding more capital, including a surcharge for the bigger banks’’—as you have said. ‘‘Lenders have doubled their capital levels as a result, hitting the new Basel III targets 6 years early in some cases and, yet,’’ the Financial Times VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

22 asks, ‘‘where are the ill effects? The best of them continue to set new profit records . . . with every earnings season, warnings of calamity look more and more hollow.’’ The debate about the Fed’s new proposed supplementary leverage ratio reminds me that when we think about costs, we as policy makers, regulators, and elected officials, when we think about costs and benefits, industry wants us only to think about costs to them. Steel companies dump waste into our rivers, and then they argue that it will be costly to clean it up. It has a higher human cost to the minors and the children who get sick from the pollution. It passes more health care costs on to our society, clearly, as they fail to internalize those costs. Those who believe in a society with rules understand that auto safety might cost car companies a little bit more for air bags and seat belts and other safety features, but these protections save lives. The same with financial rules. They might cost bank executives a little bit more in smaller bonuses and maybe even in dividends, but they will help prevent a repeat of what we had 5 years ago where the costs obviously were shifted to the broad public in retirement savings, in lost jobs, in every way imaginable, and certainly people’s lost homes. If these are the costs of a safer financial system, aren’t they worth it? Mr. BERNANKE. The crisis was an enormous waste of resources, and unsafe practices by large financial institutions pose a risk not just to themselves but to the rest of society, and in setting policy we should look at the social costs and not just the cost to the firms. And that is what we are attempting to do. Senator BROWN. And if it means the bonuses are a little smaller and that dividends are a little less and the earnings reports of the banks are not quite up to what they were this quarter, which was a pretty lucrative quarter for them, that is a price we should pay as a society? Mr. BERNANKE. From a cost point of view, I think what we should be looking at is whether there is any effect on credit availability, things of that sort that affect our economy more broadly. But I certainly agree that, again, given the enormous cost of the crisis, strong measures to prevent a repeat are obviously well justified on a cost/benefit—— Senator BROWN. Are you concerned that these higher capital standards will result in less credit available? Mr. BERNANKE. I do not think so—no, I am not concerned about it. You know, we have done some analysis of that, and there is not much evidence that that—— Senator BROWN. So there is not really much downside if you said that higher capital—you said that the biggest potential problem with rules is does it mean less credit available. If it does not mean less credit available, there is no real downside for strong capital standards. Mr. BERNANKE. The only downside I can think of is that if banks are finding it very costly to make loans, then credit may start flowing through other less regulated channels, and those have to be monitored. VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

23 Senator BROWN. But you are not implying at all that we are there yet, even close to that situation with capital standards. Mr. BERNANKE. No, we are not there yet, but we have to watch the shadow banking system and other parts of the system and make sure that risks are not being offloaded into other parts of the financial system. Senator BROWN. OK. Thank you. And, Mr. Chairman, thank you for your generosity of time. Chairman JOHNSON. Senator Heller. Senator HELLER. Thank you, Mr. Chairman, and I certainly appreciate the questioning of Senator Brown. And, Chairman Bernanke, thank you for being here and taking time, because I was pleased to hear that Basel III is the floor. And the question—I think you answered the question. I was going to ask you to give me some insight why we came to Basel III as opposed to a former FDIC Chair who wants that percentage to be closer to 8 percent, and we have legislation around here that wants it as high as 15 percent. So I was looking for some insight as to where we came to those Basel III capital rates, and it appears the answer may be risk, unless you have more to add to it. Mr. BERNANKE. Well, we have a program for building up capital, and I described part of it, which was Basel III itself, which triples the amount of high-quality capital, then the surcharges, then the higher leverage ratio, and, in addition, we were looking at things like capital charges for wholesale funding if firms rely on less reliable wholesale funding. And we have discussed also the possibility of requiring large firms to have unsecured senior debt in their capital structure which could also provide some buffer in the event the firm fails. So we are in a variety of ways trying to buildup the buffer that these large firms have, yes. Senator HELLER. Let me change the topic real quick here to housing. The Wall Street Journal recently had an article on the city of Las Vegas and the difficulty of moving homes. We have had 300,000 people in Las Vegas receive foreclosure notices, not be foreclosed on but receive notices. Over 50 percent of the homes are underwater. And I know you have played an important role in trying to reverse this situation. What are we doing wrong? And what can we do, what can we do as a Congress to help move and change the situation we have not only in Nevada but Arizona, Florida, and some of these other States? Mr. BERNANKE. Well, as I was saying earlier, I think that from Congress’ point of view, getting the mortgage finance system working better in terms of reforming Fannie and Freddie and helping to clarify the rules—some of that is on us as regulators to do that— so that there is greater access to credit and more people can buy homes, because ultimately the solution is to find a demand side for the market so that demand for homes will support prices and help us get out of this housing problem we have. Senator HELLER. I was not here earlier in the discussion of the reforms for Fannie and Freddie. I have signed on to the bill here in the Senate side. I now the House rolled out theirs yesterday. Do you have a preference? Mr. BERNANKE. I think it is very important that the Congress move forward on this, and I think it is time to do that. VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

24 Senator HELLER. Your insight on a secondary market or Government involvement in mortgage securities? Mr. BERNANKE. I think a key issue is going to be not so much making mortgages cheaper but, rather, making sure that there is some kind of backstop or protection for situations where the financial markets are in distress, like they were recently. And then the question is, the Government is one way to do that. There may be other ways to do that. But if the Government is involved, I think it would be very important to make sure, first of all, that the Government is appropriately compensated for whatever insurance or backing it provides; and, second, that firms that are securitizing hold enough capital, again, to protect the taxpayer from losses. If that is done, I think those would be very helpful if you come to a solution that involves a Government role. Senator HELLER. Let me talk about one other topic because I do not have a lot of time. Sorry to jump around so much, but gold prices. You know, we had gold prices almost $2,000 an ounce. It has dropped about $600 an ounce, trading, I think, today around $1,275, somewhere around there. Do you have any insight on why this volatility? What quantitative easing would have—what long-term impact it will have as you ratchet back? Mr. BERNANKE. Gold is an unusual asset. It is an asset that people hold as sort of disaster insurance. You know, they feel if things go really badly wrong, at least they will have some gold in their portfolio. So—— Senator HELLER. Is that an accurate—— Mr. BERNANKE. Sorry? Senator HELLER. Is that an accurate feeling? Mr. BERNANKE. It is not all that accurate. I mean, for example, a lot of people hold gold as an inflation hedge, but the movements of gold prices do not predict inflation very well, actually. But, anyway, the perception is that by holding gold you have a hard asset that protects you in case of some kind of major problem. And I suppose that one reason that gold prices are lower is that people are less concerned about extreme outcomes, either, you know, particularly negative outcomes, and therefore they feel less need for whatever protection gold affords. Senator HELLER. Do you believe it is an indication, perhaps psychologically, the direction of the economy for investors? Mr. BERNANKE. I think psychologically the gold price going down is not necessarily a bad thing from that perspective. It suggests people has somewhat more confidence and are less concerned about really bad outcomes. But let me just end by saying that nobody really understands gold prices, and I do not pretend to really understand them either. Senator HELLER. Thank you. Mr. Chairman, thank you very much. Chairman JOHNSON. Senator Warren. Senator WARREN. Thank you, Mr. Chairman. And, Chairman Bernanke, thank you for all your service during very hard times. I still want to ask about some other risks to the economy. The biggest banks in the country have reported huge profits over the last couple of years. But just this week they reported some stag- VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

25 gering numbers. Wells Fargo’s profits jumped 19 percent from last year, JPMorgan Chase’s profits jumped 31 percent, and Citigroup’s profits jumped 42 percent. Now, some reports have indicated that a big part of those profits have come from the banks’ trading activity—in other words, not from boring banking but from trading on Wall Street and elsewhere. So are you concerned that these biggest banks are loading up on big risks again? Or is there another explanation for this spike in profits? Mr. BERNANKE. Well, let me just say that we are quite aware of these portfolios, and we are addressing them in at least two ways— or more than two, really, but one of them is that we have just finalized new capital requirements that banks have to hold against these assets for sale, these securities, which should provide protection. We have done stress tests where we assume that a December 2008 type of financial shock hits and so there is a huge drop in asset values. And we have stress-tested the banks again to see if they have enough capital to protect themselves against big losses in their securities books. The other thing, as of course you know, is that we are working hard with our colleagues to put the Volcker rule into place, and that will restrict proprietary trading. Senator WARREN. Let me just say, though, Mr. Chairman, that the question I am trying to ask about is whether this indicates they are loading up on risk. And I very much appreciate that what you are telling me about are the ways we are trying to regulate the risk when the banks take it on. Maybe I could ask this slightly differently, and that is, yesterday Secretary of Treasury Jack Lew said, and I want to get the quote right: ‘‘If we get to the end of this year and we cannot with an honest, straight face say that we have ended too big to fail, we are going to have to look at other options.’’ Do you agree with the Secretary of the Treasury? Mr. BERNANKE. I do not know about the timing. Maybe I would take another year from now. But I have said to you in an earlier hearing that there is a strategy. Dodd-Frank lays out a strategy. Basel III provides additional support through capital, et cetera. But if those things do not make us comfortable about the status of these largest firms, yes, I do think additional steps would be appropriate. Senator WARREN. Then we need to look at other steps. As you know, I have introduced, along with Senator McCain, Senator Cantwell, and Senator King, a Glass-Steagall bill, another tool in the toolbox to deal with too big to fail. But I think at least now we have got some time on this. The Secretary of the Treasury says by the end of the year; you say maybe a year longer. But we have got to keep this one under examination. Fair enough? Mr. BERNANKE. Yes, I think we obviously want to look at all tools. I think that there is probably more scope for capital if we are not comfortable with the status of these firms. Senator WARREN. Good, and fair enough on that. I want to ask you, as you know, the Federal Reserve and the OCC announced last January that they were stopping their inves- VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

26 tigation into the system foreclosure fraud and that you had reached a settlement with the largest mortgage servicers in the country. And just last week, the OCC announced that 52,048 people just in Massachusetts received checks so far under this settlement, and it was an aggregate total of $41 million in compensation, or about $800 a family. Now, that is $800 a family in a State, Massachusetts, where the median home income is $324,500. I will do the math for you. That is about 2⁄ 10 of 1 percent of the purchase price of the average home in the Commonwealth of Massachusetts. Now, it is my job to look out for families in Massachusetts, including helping them get basic information about whether settlements made on their behalf by the Government are fair. And to do that, 6 months ago I started asking for basic documents about the investigation and to see what the foreclosure fraud investigation had uncovered, how many people had lost their chance to save their home, just really how bad the damage was. So far, the Fed and the OCC have disclosed very little of what I have asked for. So the question I have is how the people I represent in Massachusetts who believe they were cheated or the 4 million people who received checks around the country, how they know that the payments they are receiving are fair if the Fed and the OCC will not disclose details about what they uncovered in the investigation. Mr. BERNANKE. Well, as you know, we stopped the investigation well before all 4.2 million borrowers were analyzed, so we do not have that information for everybody, but we do have it for some folks, and we are looking to see if we can find a way to get that information to the individuals whose files were evaluated by the independent consultants. Senator WARREN. Good. So we are talking about getting that information to them and releasing more information about what you did find in the aggregate? Mr. BERNANKE. Yes. We hope to have a report on this whole thing within the next couple of months that will lay out basically all the information we have. Some of the things that you have requested frankly we just did not collect. But we will try to provide as much transparency as we can. Senator WARREN. I would be very grateful for that, Mr. Chairman. You know my concerns in this area generally that if the regulators are not aggressive enough, if they do not require admission of guilt, if they never take large financial institutions to trial, then the resulting settlements are too weak. And so I know you appreciate that a slap on the wrist is not enough, and if the OCC and the Fed are confident that these are good settlements, I think it helps everyone if the information is out there. So thank you, Mr. Chairman. I appreciate it. Mr. BERNANKE. I would like to add that, of course, the people who received checks have not yielded their legal rights, and they could pursue this further if they wish. Senator WARREN. Yes, and I hope that by revealing this information they will be able to better evaluate whether or not that is appropriate for them. Thank you. Chairman JOHNSON. Senator Crapo has a brief statement to make. VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

27 Senator CRAPO. Yes, thank you, Mr. Chairman. I have a number of additional questions, but we are coming up against a vote right away. So, Chairman Bernanke, if it is OK with you and with the Chairman, I will submit these questions to you and ask you to respond later. The questions that I have, among others, are some further inquiries about the short-term interest rate policy, the actions right now at the FSOC, the Financial stability Oversight Council, in particular in relationship to nonbank, systemically important financial institutions. And as you might guess, on GSE reform, I would love to get some further information from your perspective on that. But I will submit those questions, Mr. Chairman, in light of the fact that we do have a vote pending. Thank you. Chairman JOHNSON. Chairman Bernanke, I want to thank you for your extraordinary service to our Nation. Mr. BERNANKE. Thank you. Chairman JOHNSON. And I want to thank you for your testimony. This hearing is adjourned. [Whereupon, at 12:12 p.m., the hearing was adjourned.] [Prepared statements, responses to written questions, and additional material supplied for the record follow:] VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

28 PREPARED STATEMENT OF BEN S. BERNANKE CHAIRMAN, BOARDOFGOVERNORSOFTHEFEDERALRESERVESYSTEM JULY18, 2013 Chairman Johnson, Ranking Member Crapo, and other Members of the Committee, I am pleased to present the Federal Reserve’s Semiannual Monetary Policy Report to the Congress. I will discuss current economic conditions and the outlook and then turn to monetary policy. I’ll finish with a short summary of our ongoing work on regulatory reform. The Economic Outlook The economic recovery has continued at a moderate pace in recent quarters despite the strong headwinds created by Federal fiscal policy. Housing has contributed significantly to recent gains in economic activity. Home sales, house prices, and residential construction have moved up over the past year, supported by low mortgage rates and improved confidence in both the housing market and the economy. Rising housing construction and home sales are adding to job growth, and substantial increases in home prices are bolstering household finances and consumer spending while reducing the number of homeowners with underwater mortgages. Housing activity and prices seem likely to continue to recover, notwithstanding the recent increases in mortgage rates, but it will be important to monitor developments in this sector carefully. Conditions in the labor market are improving gradually. The unemployment rate stood at 7.6 percent in June, about a half percentage point lower than in the months before the Federal Open Market Committee (FOMC) initiated its current asset purchase program in September. Nonfarm payroll employment has increased by an average of about 200,000 jobs per month so far this year. Despite these gains, the jobs situation is far from satisfactory, as the unemployment rate remains well above its longer-run normal level, and rates of underemployment and long-term unemployment are still much too high. Meanwhile, consumer price inflation has been running below the Committee’s longer-run objective of 2 percent. The price index for personal consumption expenditures rose only 1 percent over the year ending in May. This softness reflects in part some factors that are likely to be transitory. Moreover, measures of longer-term inflation expectations have generally remained stable, which should help move inflation back up toward 2 percent. However, the Committee is certainly aware that very low inflation poses risks to economic performance—for example, by raising the real cost of capital investment—and increases the risk of outright deflation. Consequently, we will monitor this situation closely as well, and we will act as needed to ensure that inflation moves back toward our 2 percent objective over time. At the June FOMC meeting, my colleagues and I projected that economic growth would pick up in coming quarters, resulting in gradual progress toward the levels of unemployment and inflation consistent with the Federal Reserve’s statutory mandate to foster maximum employment and price stability. Specifically, most participants saw real GDP growth beginning to step up during the second half of this year, eventually reaching a pace between 2.9 and 3.6 percent in 2015. They projected the unemployment rate to decline to between 5.8 and 6.2 percent by the final quarter of 2015. And they saw inflation gradually increasing toward the Committee’s 2 percent objective.1 The pickup in economic growth projected by most Committee participants partly reflects their view that Federal fiscal policy will exert somewhat less drag over time, as the effects of the tax increases and the spending sequestration diminish. The Committee also believes that risks to the economy have diminished since the fall, reflecting some easing of financial stresses in Europe, the gains in housing and labor markets that I mentioned earlier, the better budgetary positions of State and local governments, and stronger household and business balance sheets. That said, the risks remain that tight Federal fiscal policy will restrain economic growth over the next few quarters by more than we currently expect, or that the debate concerning other fiscal policy issues, such as the status of the debt ceiling, will evolve in a way that could hamper the recovery. More generally, with the recovery still proceeding at only a moderate pace, the economy remains vulnerable to unanticipated shocks, including the possibility that global economic growth may be slower than currently anticipated. 1These projections reflect FOMC participants’ assessments based on their individual judgments regarding appropriate monetary policy. VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00032 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

29 Monetary Policy With unemployment still high and declining only gradually, and with inflation running below the Committee’s longer-run objective, a highly accommodative monetary policy will remain appropriate for the foreseeable future. In normal circumstances, the Committee’s basic tool for providing monetary accommodation is its target for the Federal funds rate. However, the target range for the Federal funds rate has been close to zero since late 2008 and cannot be reduced meaningfully further. Instead, we are providing additional policy accommodation through two distinct yet complementary policy tools. The first tool is expanding the Federal Reserve’s portfolio of longer-term Treasury securities and agency mortgagebacked securities (MBS); we are currently purchasing $40 billion per month in agency MBS and $45 billion per month in Treasuries. The second tool is ‘‘forward guidance’’ about the Committee’s plans for setting the Federal funds rate target over the medium term. Within our overall policy framework, we think of these two tools as having somewhat different roles. We are using asset purchases and the resulting expansion of the Federal Reserve’s balance sheet primarily to increase the near-term momentum of the economy, with the specific goal of achieving a substantial improvement in the outlook for the labor market in a context of price stability. We have made some progress toward this goal, and, with inflation subdued, we intend to continue our purchases until a substantial improvement in the labor market outlook has been realized. In addition, even after purchases end, the Federal Reserve will be holding its stock of Treasury and agency securities off the market and reinvesting the proceeds from maturing securities, which will continue to put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative. We are relying on near-zero short-term interest rates, together with our forward guidance that rates will continue to be exceptionally low—our second tool—to help maintain a high degree of monetary accommodation for an extended period after asset purchases end, even as the economic recovery strengthens and unemployment declines toward more-normal levels. In appropriate combination, these two tools can provide the high level of policy accommodation needed to promote a stronger economic recovery with price stability. In the interest of transparency, Committee participants agreed in June that it would be helpful to lay out more details about our thinking regarding the asset purchase program—specifically, to provide additional information on our assessment of progress to date, as well as of the likely trajectory of the program if the economy evolves as projected. This agreement to provide additional information did not reflect a change in policy. The Committee’s decisions regarding the asset purchase program (and the overall stance of monetary policy) depend on our assessment of the economic outlook and of the cumulative progress toward our objectives. Of course, economic forecasts must be revised when new information arrives and are thus necessarily provisional. As I noted, the economic outcomes that Committee participants saw as most likely in their June projections involved continuing gains in labor markets, supported by moderate growth that picks up over the next several quarters as the restraint from fiscal policy diminishes. Committee participants also saw inflation moving back toward our 2 percent objective over time. If the incoming data were to be broadly consistent with these projections, we anticipated that it would be appropriate to begin to moderate the monthly pace of purchases later this year. And if the subsequent data continued to confirm this pattern of ongoing economic improvement and normalizing inflation, we expected to continue to reduce the pace of purchases in measured steps through the first half of next year, ending them around midyear. At that point, if the economy had evolved along the lines we anticipated, the recovery would have gained further momentum, unemployment would be in the vicinity of 7 percent, and inflation would be moving toward our 2 percent objective. Such outcomes would be fully consistent with the goals of the asset purchase program that we established in September. I emphasize that, because our asset purchases depend on economic and financial developments, they are by no means on a preset course. On the one hand, if economic conditions were to improve faster than expected, and inflation appeared to be rising decisively back toward our objective, the pace of asset purchases could be reduced somewhat more quickly. On the other hand, if the outlook for employment were to become relatively less favorable, if inflation did not appear to be moving back toward 2 percent, or if financial conditions—which have tightened recently— were judged to be insufficiently accommodative to allow us to attain our mandated objectives, the current pace of purchases could be maintained for longer. Indeed, if needed, the Committee would be prepared to employ all of its tools, including an VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00033 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

30 increase the pace of purchases for a time, to promote a return to maximum employment in a context of price stability. As I noted, the second tool the Committee is using to support the recovery is forward guidance regarding the path of the Federal funds rate. The Committee has said it intends to maintain a high degree of monetary accommodation for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee anticipates that its current exceptionally low target range for the Federal funds rate will be appropriate at least as long as the unemployment rate remains above 61⁄2percent and inflation and inflation expectations remain well behaved in the sense described in the FOMC’s statement. As I have observed on several occasions, the phrase ‘‘at least as long as’’ is a key component of the policy rate guidance. These words indicate that the specific numbers for unemployment and inflation in the guidance are thresholds, not triggers. Reaching one of the thresholds would not automatically result in an increase in the Federal funds rate target; rather, it would lead the Committee to consider whether the outlook for the labor market, inflation, and the broader economy justified such an increase. For example, if a substantial part of the reductions in measured unemployment were judged to reflect cyclical declines in labor force participation rather than gains in employment, the Committee would be unlikely to view a decline in unemployment to 61⁄2 percent as a sufficient reason to raise its target for the Federal funds rate. Likewise, the Committee would be unlikely to raise the funds rate if inflation remained persistently below our longer-run objective. Moreover, so long as the economy remains short of maximum employment, inflation remains near our longer-run objective, and inflation expectations remain well anchored, increases in the target for the Federal funds rate, once they begin, are likely to be gradual. Regulatory Reform I will finish by providing you with a brief update on progress on reforms to reduce the systemic risk of the largest financial firms. As Governor Tarullo discussed in his testimony last week before this Committee, the Federal Reserve, with the other Federal banking agencies, adopted a final rule earlier this month to implement the Basel III capital reforms.2 The final rule increases the quantity and quality of required regulatory capital by establishing a new minimum common equity tier 1 capital ratio and implementing a capital conservation buffer. The rule also contains a supplementary leverage ratio and a countercyclical capital buffer that apply only to large and internationally active banking organizations, consistent with their systemic importance. In addition, the Federal Reserve will propose capital surcharges on firms that pose the greatest systemic risk and will issue a proposal to implement the Basel III quantitative liquidity requirements as they are phased in over the next few years. The Federal Reserve is considering further measures to strengthen the capital positions of large, internationally active banks, including the proposed rule issued last week that would increase the required leverage ratios for such firms.3 The Fed also is working to finalize the enhanced prudential standards set out in sections 165 and 166 of the Dodd-Frank Act. Among these standards, rules relating to stress testing and resolution planning already are in place, and we have been actively engaged in stress tests and reviewing the ‘‘first-wave’’ resolution plans. In coordination with other agencies, we have made significant progress on the key substantive issues relating to the Volcker rule and are hoping to complete it by yearend. Finally, the Federal Reserve is preparing to regulate and supervise systemically important nonbank financial firms. Last week, the Financial Stability Oversight Council designated two nonbank financial firms; it has proposed the designation of a third firm, which has requested a hearing before the council.4 We are developing a supervisory and regulatory framework that can be tailored to each firm’s business 2See, Daniel K. Tarullo (2013), ‘‘Dodd-Frank Implementation’’, statement before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, July 11, www.federalreserve.gov/ newsevents/testimony/tarullo20130711a.htm; and Board of Governors of the Federal Reserve System (2013), ‘‘Federal Reserve Board Approves Final Rule To Help Ensure Banks Maintain Strong Capital Positions’’, press release, July 2, www.federalreserve.gov/newsevents/press/ bcreg/20130702a.htm. 3See, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency (2013), ‘‘Agencies Adopt Supplementary Leverage Ratio Notice of Proposed Rulemaking’’, joint press release, July 9, www.federalreserve.gov/newsevents/press/bcreg/20130709a.htm. 4U.S. Department of the Treasury (2013), ‘‘Financial Stability Oversight Council Makes First Nonbank Financial Company Designations to Address Potential Threats to Financial Stability’’, press release, July 9, www.treasury.gov/press-center/press-releases/Pages/jl2004.aspx. 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31 mix, risk profile, and systemic footprint, consistent with the Collins amendment and other legal requirements under the Dodd-Frank Act. Thank you. I would be pleased to take your questions. VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00035 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

32 RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON FROM BEN S. BERNANKE Q.1. I am concerned about the long-term impact of youth unemployment. What more can the Federal Reserve do to help promote youth employment? A.1. Your concerns about the long-term impact of youth unemployment are well-founded. The unemployment rate for 16–24 year olds was 15.1 percent in October 2013, down from its peak of 19 percent in late 2009, but still 5 percentage points above its level prior to the recession. A persistent lack of job opportunities for young people inhibits many of them from gaining valuable work experience and may cause lasting damage to their future employment and earnings prospects. The Federal Reserve can best help to promote youth employment—and indeed to enhance the economic well-being of all Americans—through our efforts to promote a stronger economy and a further improvement in labor market conditions. To this end, the Federal Reserve—consistent with its congressional mandate—will continue to provide the policy accommodation that is needed to foster maximum employment and price stability. Q.2. As we approach the 5 year anniversary of the financial crisis, what lessons should we never forget regarding appropriate regulation and supervision? A.2. The primary lesson for financial regulation and supervision of the financial crisis and the ensuing Great Recession is that financial instability can do grave damage to the broader economy. This is a lesson that was also learned following other severe crises, such as the Great Depression. To a certain extent, policy makers forgot this lesson in the decades of prosperity that followed the end of World War II. Thus, it is important that financial institutions are well-capitalized, have sufficient liquidity on hand to meet a range of contingencies, and that counterparties, regulators and others are prepared for the failure of any given firm. The Federal Reserve, working with other regulatory agencies, has made great progress putting in place enhanced standards for capital, liquidity, risk management, and resolution for the largest financial institutions. However, while financial crises share many features, they happen infrequently enough that each has its own unique aspects. Thus, regulators must be flexible in their consideration of the key risks facing the financial system. To this end, the Federal Reserve’s annual stress testing exercise uses scenarios designed to stress the most salient risks. In addition, the Federal Reserve has devoted increased resources to monitoring the evolution of the financial system and emerging threats to better ensure that policy makers have the information necessary to preserve financial stability. Such efforts and increased interagency focus on systemic issues through the FSOC represent an important shift toward a macroprudential approach to regulation and supervision of the financial system. Q.3. It was recently announced that the New York Stock Exchange Euronext would administer LIBOR rates. What steps are needed to ensure that LIBOR and other benchmarks are appropriately structured and regulated going forward? VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00036 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

33 A.3. While the announcement of Euronext as the administrator is an important step, we do not yet know the details of Euronext’s plan for its system of oversight or how it will link the submission of rates to transactions. We look forward to learning more. Another important step to ensure that LIBOR and other benchmarks are appropriately structured and regulated is the work that has been undertaken by the Financial Stability Board (FSB) to review existing reference rates and to examine possible complements or alternatives to existing rates. The FSB commissioned the International Organization of Securities Commissions (IOSCO) to undertake the review of existing rates, including LIBOR, EURIBOR, and TIBOR; and it is our understanding that IOSCO has convened a group of regulators to come up with the parameters for that review. The reviews of those rates are expected to be completed sometime next year. The FSB report on possible alternatives is due to be completed in the second quarter of 2014. Q.4. How is the Federal Reserve preparing the financial institutions it regulates for higher interest rates? A.4. From a policy perspective, the Federal Banking agencies have established guidance in place on interest rate risk (IRR) since 1996 (Joint Policy Statement on Interest Rate Risk SR 96-13) with more recent guidance in 2010 (Interagency Advisory on Interest Rate Risk SR 10-1) and in 2012 (Questions and Answers on Interagency Advisory on Interest Rate Risk Management SR 12-2). Together these documents outline supervisory expectations for effective interest rate risk management. Through on-site examinations, ongoing monitoring, and analysis of bank supplied information and/or regulatory filings, the Federal Reserve assesses and monitors the level of interest rate risk and the quality of interest rate risk management. Institutions that are found to contain outsized levels of interest rate risk and/or poor quality interest rate risk management routines may be subject to enforcement actions to reduce interest rate risk, improve available capital levels, or improve their interest rate risk management process. Over the past few years, the FRB has taken additional action steps to strengthen the supervisory oversight with regard to interest rate risk. As part of this, we have devoted more resources to interest rate risk teams that continuously monitor cross-institution risk and keep abreast of emerging risk issues affecting the largest firms. In addition, we have conducted, when necessary, in-depth on-site examinations targeting IRR in order to assess firms’ preparedness for potential interest rate shocks. The Federal Reserve has also undertaken a number of outreach efforts to raise awareness of interest rate risk. Some recent topics include: • Essentials of Effective Interest Rate Risk Measurement • Effective Asset/Liability Management: A View From the Top • Interest Rate Risk Management at Community Banks • Managing Interest Rate Risk in a Rising Rate Environment Q.5. As you know, on July 21 the 3-year moratorium on Industrial Loan Company (ILC) charters mandated by Wall Street Reform expired. Do you believe there will be any impact on the banking system now that the moratorium has expired? Do you believe the reg- VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00037 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

34 ulators have sufficient supervisory and enforcement authority to appropriately regulate firms that own ILCs? If not, what supervisory gaps exist? A.5. Industrial loan companies (ILCs) are State-chartered banks that have virtually all of the powers and privileges of other insured commercial banks, including the protections of the Federal safety net—deposit insurance and access to the Federal Reserve’s discount window and payments system. Nonetheless, ILCs operate under a special exception to the Federal Bank Holding Company Act (BHC Act). This special exception allows any type of firm, including a commercial firm or foreign bank, to acquire and operate an ILC chartered in one of a handful of States—principally Utah and California—without complying with the standards that Congress has established for bank holding companies to maintain the separation of banking and commerce and to protect insured banks, the Federal safety net and, ultimately, the taxpayer. The Board believes the best way to prevent this exception from further undermining the general policies that Congress has established and further promoting competitive and regulatory imbalances within the banking system is to close the loophole in current law to new acquirers of ILCs. This is precisely the approach that Congress has taken on previous occasions when earlier loopholes began to be used in unintended and potentially damaging ways. It is important to keep in mind that the exception currently is open-ended and subject to very few statutory restrictions. Although only a handful of States have the ability to charter exempt ILCs, there is no limit on the number of exempt ILCs that these States may charter. Moreover, Federal law places no limit on how large an ILC may become and only one restriction on the types of activities that an ILC may conduct. That restriction prevents most ILCs from accepting demand deposits that the depositor may withdraw by check or similar means for payment to third parties. This Federal restriction has lost much of its meaning as ILCs have entered the world of retail banking by offering retail customers negotiable order of withdrawal (NOW) accounts—transaction accounts that are functionally indistinguishable from demand deposit accounts. The ILC exception also fosters an unfair and unlevel competitive and regulatory playing field by allowing firms that acquire an insured ILC in a handful of States to operate outside the activity restrictions and consolidated supervisory and regulatory framework that apply to other community-based, regional, and diversified organizations that own a similarly situated bank. Addressing these matters will only become more difficult if additional companies are permitted to acquire and operate ILCs under this special exception. The ILC exception in current law undermines the supervisory framework that Congress has established for the corporate owners of insured banks. ILCs are regulated and supervised by the FDIC and their chartering State in the same manner as other types of State-chartered, nonmember insured banks and the Board has no concerns about the adequacy of this existing supervisory framework for ILCs themselves. However, due to the special exception in current law, the parent company of an ILC is not considered a bank holding company. This creates special supervisory risks be- VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00038 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

35 cause the ILC’s parent company and nonbank affiliates may not be subject to supervision on a consolidated basis by a Federal agency. RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM BEN S. BERNANKE Q.1. You mentioned in your testimony that the Fed is developing the regulatory framework for the two nonbank systemically important financial institutions designated by the FSOC. These companies by definition are not banks. They have different assets and liabilities than the entities traditionally regulated by the Fed. How will the Fed address the unique characteristics of nonbank financial institutions that are designated as systemically important? If the idea is to have a general framework for nonbank SIFIs, what specific steps is the Fed planning to undertake to ensure that the diverse nature of these companies is accounted for while also ensuring they remain competitive in their industries? How long will that process take? A.1. The Dodd-Frank Act requires the Board to apply enhanced prudential standards and early remediation requirements to bank holding companies with at least $50 billion in consolidated assets and to nonbank financial companies designated by the FSOC for supervision by the Board (designated companies). The Act authorizes the Board to tailor the application of these standards and requirements to different companies on an individual basis or by category. In so doing we can consider any factor we deem appropriate, including capital structure, nature of financial activities, riskiness, size, and complexity. In our proposed rulemaking, we noted that this tailoring authority would be particularly important in applying the standards and requirements to designated companies that are organized and operated differently from banking organizations. We sought and received comment on how the standards should be applied to designated companies. Staff has carefully reviewed the comments and met with interested members of the public, including the designated companies and other financial firms. As we indicated in the proposal, following the recent designations by the FSOC of AIG, GECC, and Prudential, we are assessing the business model, capital structure, and the risk profile of each company to determine how the standards and requirements should apply. The Federal Reserve currently supervises AIG and GECC as savings and loan holding companies and formerly supervised Prudential in this capacity. We intend to design a supervisory program for these firms as designated companies that is consistent with the approach we use for the largest financial holding companies but tailored to account for different material characteristics of each firm. We intend to utilize expertise gained from our prior and current supervisory activities and from the designation process, to leverage our strong working relationships with State insurance supervisors (in the case of AIG and Prudential), and to include a focus on threats to financial stability posed by each firm. Q.2. After completing work on FHA reform, the Banking Committee will move to the issue of reforming the GSEs. As we begin this process, what are the guiding principles that we ought to con- VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00039 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

36 sider? If there is a Government guarantee, how do we make sure that it is priced accordingly? A.2. The historical experience with mortgage-backed securities provides three principles for successful mortgage securitization. First, for the ultimate investors to be willing to acquire and trade mortgage-backed securities, they must be persuaded that the credit quality of the underlying mortgages is high and that the origination-to-distribution process is managed so that originators, such as mortgage brokers and bankers, have an incentive to undertake careful underwriting. Second, because the pools of assets underlying mortgage-backed securities have highly correlated risks, including interest rate, prepayment, and credit risks, the institutions and other investors that hold these securities must have the capacity to manage their risks carefully. Finally, because mortgagebacked securities are complex amalgamations of underlying mortgages that may themselves be complex to price, transparency about both the underlying assets and the mortgage-backed security itself is essential. From a public policy perspective, the question arises whether fully privatized mortgage securitization would continue under highly stressed financial conditions. Government-backed insurance for any form of bond or securities financing used to provide funding to mortgage markets should be explicitly priced and transparent, so that the taxpayers’ risks can be fully understood. Pricing such insurance is difficult unless the Congress provides an objective for the Government insurer. If there is a Government guarantee, Congress needs to establish a standard for when it should be used and provide sufficient authority and clarity so that the Government catastrophic insurer knows how to balance concerns about taxpayer risk and credit availability. Q.3. Beyond the discussion of tapering and winding down the Fed’s balance sheet is the fact that short-term rates are still being held close to zero. In fact, it has been more than 4 years since the Fed Funds Rate was reduced to near zero. Some have suggested the Fed should commit to leave the rate low for a period of time after the economy begins improving, while others are concerned that any delay would provoke inflation. Given the limits of the accuracy of real-time economic data and economic forecasting, how confident are you that the Fed will be able to move from a zero-interest rate policy at the right time? A.3. The Committee is firmly committed to its price stability objective, and, as affirmed in its statement of Longer-Run Goals and Policy Strategy, its policy decisions will be aimed at achieving its longer-run goal of 2 percent inflation (as measured by the deflator for personal consumption expenditures). The FOMC has stated that it will be appropriate to keep its target range for the Federal funds rate at its current very low level at least as long as the unemployment rate remains above 61⁄ 2 percent, inflation between one and two years ahead is projected to be no more than a half percent about the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In any set of circumstances, it is difficult to accurately judge the ideal timing of a shift in the direction of monetary policy and one cannot rule out VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00040 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

37 the risk that inflation could at some point increase unexpectedly. However, policy makers carefully and continuously monitor a range of inflation indicators and will adjust the stance of policy as appropriate to achieve low and stable inflation as well as maximum employment. RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED FROM BEN S. BERNANKE Q.1. In February you testified before this Committee that monetary and fiscal policy were working at ‘‘cross-purposes.’’ Many more Americans would have jobs and be much better off if Congress passed sensible fiscal policy—policies that are good investments with high bang for the buck like infrastructure projects, tax relief for low and middle-income Americans, and incentives to companies to hire and expand their payroll. Could you describe how the Fed’s policy would be different, in size or scope, if there was sensible fiscal support? And how many more Americans would have a job? Would a stronger recovery, supported by fiscal policy, help the Fed manage its monetary policy as employment increases and the economy nears the thresholds laid out by the FOMC? A.1. As I have suggested to the Congress in the past, a fiscal policy that was less focused on near-term consolidation and more focused on long-run sustainability would be preferable to the current policy. According to the CBO, the near-term policies embodied in current law—such as sequestration, tax increases and other measures—are cutting an estimated 1.5 percentage points off GDP growth this year, or approximately 750,000 jobs. Although Fed policies are working to support the labor market and offset some of this drag, monetary policy is not a panacea, and we would surely see stronger labor market conditions if fiscal policy were not imposing strong headwinds on the economy this year. By the same token, it is imperative that Congress come to grips in a compelling, credible way with the fact that fiscal policy as encoded in current law is not sustainable in the long term. These two objectives are not contradictory; on the contrary, they could be mutually reinforcing. A less restrictive fiscal policy in the near term that supported a stronger economic recovery would help improve the sustainability of the Federal Government’s overall fiscal position over the long term. At the same time, a credible and growth-oriented long-term plan for sustainability, enacted into law, would alleviate widespread concerns and reduce uncertainty—both of which could add to the vigor of aggregate demand in the near term. I am confident that we have the tools to manage monetary policy effectively once we get to the point where the economy is nearing the thresholds laid out by the Federal Open Market Committee. Q.2. The United States just concluded the first round of negotiations with the European Union on the Transatlantic Trade and Investment Partnership (T–TIP) agreement. There is some concern that these negotiations and the resulting FTA could adversely affect financial regulatory reforms made by the Fed and other domestic prudential regulators. VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00041 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

38 Has the Federal Reserve been consulted by or weighed in with the United States Trade Representative on whether this trade agreement would affect your rulemaking? Would an FTA with significant financial regulatory changes frustrate your ongoing rulemaking and multilateral efforts with the G20? A.2. Federal Reserve staff works closely with the staff of the Treasury Department and other agencies to keep abreast of the status of trade negotiations to assure that any agreement would not interfere with U.S. prudential regulation. We are aware that there has been interest on the part of the EU to negotiate financial regulations in the context of the T–TIP agreement. However, the U.S. agencies working on the T–TIP, including USTR, are in agreement that the negotiations will not include prudential or financial regulations or attempt to set standards for such regulations. The Federal Reserve will continue to monitor the negotiations to assure that its ability to establish appropriate prudential regulations is not compromised. The Federal Reserve has long supported including the financial services sector itself in trade negotiations in the interest of opening markets, reducing trade barriers, and encouraging the free flow of trade, but only subject to prudential considerations. As the financial crisis demonstrated, market discipline alone is not sufficient to ensure a healthy and stable economy. Financial institutions must be held to rigorous prudential standards. Efforts to restore and strengthen the health and stability of the U.S. financial sector could be undermined if prudential or financial regulations are subject to exemptions or modifications through trade agreements. It could also undermine other multilateral efforts to agree on international financial standards, already underway in such fora as the FSB, Basel Committee, IOSCO, and the IAIS. RESPONSES TO WRITTEN QUESTIONS OF SENATOR HAGAN FROM BEN S. BERNANKE Q.1. There has been a significant sell-off in the fixed income markets in recent weeks, with substantial outflows from bond mutual funds. Are you at all concerned you that markets are too driven by the speeches and official pronouncements from central banks around the world? If the suggestion of tapering has been contributing to volatility in asset prices, can we expect more volatility as policy action nears? A.1. The recent rise in interest rates appears to partly reflect shifts in investor expectations about monetary policy, but other factors likely played important roles as well. In particular, incoming data appears to have led investors to mark up their expectations for economic activity relative to earlier in the year. Yield movements were also reportedly exacerbated by an unwinding of leveraged and risky trading positions that had been predicated on highly optimistic investor expectations of persistently low and stable interest rates. Notably, an unwinding of such positions, while having the unfortunate effect of tightening financial conditions, may also have removed some of the risks to financial stability posed by those overextended positions, putting financial markets on a firmer footing. VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00042 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

39 RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN FROM BEN S. BERNANKE Q.1. The Federal Reserve proposes to end its asset purchases by the middle of next year, assuming that the recovery has gained momentum, unemployment is near 7 percent, and inflation is moving toward 2 percent. However, unemployment of 7 percent would be well above the so-called ‘‘natural’’ rate of unemployment (http://research.stlouisfed.org/fred2/series/NROUST), suggesting that inflation would not be a concern, and many households would still be in considerable distress because of the slack labor market. Why does the Federal Reserve plan to abandon a tool that you say helps ‘‘to increase the near-term momentum of the economy, with the specific goal of achieving substantial improvement in the outlook for the labor market in the context of price stability’’ when macroeconomic conditions remain far from normal? A.1. The FOMC is currently providing monetary stimulus to the economy using two tools: large scale asset purchases and communications about its expectations for the path of the Federal funds rate, or ‘‘forward guidance.’’ Asset purchases help to lower longerterm interest rates by reducing the stock of available longer term securities, thereby helping to raise their price in the open market, and reduce their yield. Thus, a cessation of asset purchases would not imply a reduction in monetary stimulus because the Federal Reserve will continue to hold the assets it has purchased in its portfolio and thereby maintain downward pressure on long-term interest rates. Moreover, as the Committee has indicated in its most recent post-meeting statement, it expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends. In particular, the Committee sees its asset purchases as providing near-term momentum to the economy with the specific goal of achieving a substantial improvement in the labor market in a context of price stability. However, even after this goal has been achieved, the Committee expects that it will be appropriate to maintain the current low range for the Federal funds rate at least as long as the unemployment rate remains above 61⁄ 2 percent, inflation between 1 and 2 years is projected to be no more than half a percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. Q.2. In a recent Notice of Proposed Rulemaking the Federal Reserve proposes to treat branches and agencies of foreign banking organizations as if they were insured depositories for purposes of section 716 of the Dodd-Frank Act (http://www.gpo.gov/fdsys/ pkg/FR-2013-06-10/pdf/2013-13670.pdf). This rule would allow branches and agencies to act as a swaps entity for certain types of swaps, and to use swaps for hedging, while retaining access to the Federal Reserve discount window and emergency lending. This change is described in the rule proposal being, ‘‘ . . . consistent with the purpose and legislative history of section 716. Section 716 and Title VII of the Dodd-Frank Act generally are intended to reduce systemic risks from derivatives activities.’’ Can you explain how extending the Federal safety net to swaps entities located in branches and agencies—which are not subject to the full range of VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00043 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

40 U.S. banking regulation—reduces the systemic risks created by derivatives activities? A.2. The Board’s interim final rule treats an uninsured U.S. branch or agency of a foreign bank as an insured depository institution for purposes of section 716 of the Dodd-Frank Act. The interim final rule does not extend the Federal safety net to these branches and agencies. Under the Federal Reserve Act, both uninsured and insured U.S. branches and agencies of foreign banks may receive Federal Reserve advances on the same terms and conditions that apply to domestic insured State member banks.1 In section 716, Congress also determined to permit insured depository institutions to continue to conduct certain limited hedging and bank permissible activities. It made this determination to allow insured depository institutions to manage the risk from their activities in a safe and sound manner. This treatment is consistent with congressional intent as reflected in a colloquy between Senator Lincoln, the sponsor of section 716 and Senator Dodd, the Chairman of the Senate Committee on Banking, Housing, and Urban Affairs. During Senate consideration of the Dodd-Frank Act Conference Report, Senators Lincoln and Dodd had a colloquy during which they expressed the view that uninsured U.S. branches and agencies should be treated in the same manner as insured depository institutions.2 The Board’s rule allows uninsured branches of foreign banks to engage in the same bank permissible activities so that they too can better manage risk. Q.3. During the financial crisis, the unprecedented use of emergency lending powers under Section 13(3) of the Federal Reserve Act raised important questions about moral hazard in the financial sector. In response to these concerns, Section 1101 of the Dodd- Frank Act placed important new restrictions on the Federal Reserve’s use of its emergency lending powers. Section 1101(a)(6) required the Federal Reserve to write rules ‘‘as soon as is practicable after the enactment of this subparagraph’’ establishing policies and procedures for emergency lending that implement these restrictions. It has been 3 years since Dodd-Frank was enacted but I am not aware that any rules have been issued or proposed establishing policies and procedures for emergency lending under Section 13(3). If any rules implementing the new Dodd-Frank restrictions on emergency lending been proposed, can you please provide them to my office? If such regulations have not been proposed, what explains the failure to issue them ‘‘as soon as is practicable’’ and when do you expect these regulations to be issued? A.3. The Dodd-Frank Act imposed numerous requirements upon the Board for rulemakings, both on its own as well as in consultation with other agencies, as well as requirements for process changes and development, studies, consultations, and reports. The Board has taken its obligations under the Dodd-Frank Act very seriously. As of last month, the Board had completed 27 final rulemakings, 12 proposed rulemakings, and 12 studies and reports (on its own or jointly with other agencies). The Board has under- 1Section 13(14) of the Federal Reserve Act; 12 U.S.C. 347d. 2See, 156 Cong. Rec. S5904 (daily ed. July 15, 2010) (statement of Senator Lincoln). VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00044 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

41 taken substantial work both internally and with other agencies where required on other Dodd-Frank Act requirements, including on the policies and procedures intended to implement the Dodd- Frank Act amendments to section 13(3). The Board expects to issue a proposal for public comment on the section 13(3) policies and procedures shortly. Q.4. Given the statutory directive to issue detailed policies and procedures restricting 13(3) powers, do you believe that the Federal Reserve would be legally authorized to use its emergency lending powers in the absence of the mandated regulation? A.4. The Dodd-Frank Act made several major changes to the statutory text of section 13(3). The Board believes that the provisions enacted in the Dodd-Frank Act governing its emergency lending authority have governed the use of that authority since enactment of that act. RESPONSES TO WRITTEN QUESTIONS OF SENATOR HEITKAMP FROM BEN S. BERNANKE Q.1. How are the unpredictability in taxes and regulation that businesses face affecting our economic recovery and future growth? A.1. Economic research suggests that uncertainty about Federal Government policies, including those for taxes and regulation, can restrain business investment and hiring, although there is not a consensus on the magnitude of these effects. Policy makers can help alleviate this uncertainty by putting in place a stable and sustainable set of policies. It is important that taxes are set in order to raise sufficient tax revenue for a given amount of Federal Government spending and that Federal regulations are set in order to achieve key economic and social goals. The decisions made about the size and structure of Federal taxes and regulations have important effects on the future performance of the economy. These decisions entail balancing many factors to implement policies that reflect our values and priorities as a Nation. Q.2. How can we improve the development of our future workforce to ensure we have the human capital necessary for the economy they will enter? A.2. The skills and talents of the American workforce are important determinants of the long-run growth potential of the U.S. economy and of the standard of living of the population. Both to promote economic growth and to enhance the well-being of future generations, it is important that we provide our young people and our future workers more generally with the resources and opportunities they need to build their human capital and succeed in the modern economy. A first step toward achieving this goal is to make our education system as strong and accessible as possible. If we are to successfully navigate such challenges as the retirement of the baby boom generation, technological change, and increasing globalization, we must work diligently to maintain the quality of our educational system where it is strong and strive to improve it where it is not. Our efforts need to focus on all levels of education, from preschool on up. And even though higher education currently represents the VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00045 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

42 strongest part of the U.S. educational system, we must find ways to move more of our students, especially minorities and students from disadvantaged backgrounds, into educational opportunities after high school. Of course, not everybody should necessarily be pursuing a 4-year college degree. Indeed, there are many educational opportunities that lie outside the traditional route of a kindergarten-throughtwelfth-grade education followed by 4 years of college. For example, some individuals would be better off looking specifically towards a job in an industry where there is an understanding in advance that workers are needed with particular sets of skills. For students interested in that career path, support for focused job-oriented training programs such as those offered by many community colleges may be helpful. A third set of policies relates to those who are already in the workforce but need to adapt to a changing economic environment. In this regard, policies targeted towards providing those workers with the resources they need to upgrade their skills and find new jobs can be helpful. For example, community college and other adult education programs have been effective in helping workers advance their careers, as well as helping those who have lost their jobs to obtain new skills that strengthen their qualifications for available jobs. Similarly, innovative workforce development programs can play an important role in anticipating future job market demands, and by helping workers improve their skills to meet the requirements of businesses as they adopt more advanced technologies. Finally, promoting a strong economy that provides job opportunities for our future workforce is, of course, critical to the success of future generations. In this regard, the Federal Reserve remains firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. VerDate Nov 24 2008 13:05 Jan 30, 2014 Jkt 046629 PO 00000 Frm 00046 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\07-18 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON

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