[Senate Hearing 114-87]
[From the U.S. Government Publishing Office]
S. Hrg. 114-87
FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2015
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU-
ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978
__________
JULY 16, 2015
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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U.S. GOVERNMENT PUBLISHING OFFICE
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
MICHAEL CRAPO, Idaho SHERROD BROWN, Ohio
BOB CORKER, Tennessee JACK REED, Rhode Island
DAVID VITTER, Louisiana CHARLES E. SCHUMER, New York
PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey
MARK KIRK, Illinois JON TESTER, Montana
DEAN HELLER, Nevada MARK R. WARNER, Virginia
TIM SCOTT, South Carolina JEFF MERKLEY, Oregon
BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana
JERRY MORAN, Kansas
William D. Duhnke III, Staff Director and Counsel
Mark Powden, Democratic Staff Director
Dana Wade, Deputy Staff Director
Jelena McWilliams, Chief Counsel
Thomas Hogan, Chief Economist
Laura Swanson, Democratic Deputy Staff Director
Graham Steele, Democratic Chief Counsel
Phil Rudd, Democratic Legislative Assistant
Dawn Ratliff, Chief Clerk
Troy Cornell, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
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THURSDAY, JULY 16, 2015
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Brown................................................ 2
WITNESS
Janet L. Yellen, Chair, Board of Governors of the Federal Reserve
System......................................................... 3
Prepared statement........................................... 29
Responses to written questions of:
Chairman Shelby.......................................... 32
Senator Crapo............................................ 173
Senator Vitter........................................... 175
Senator Heller........................................... 175
Senator Sasse............................................ 176
Senator Menendez......................................... 183
Senator Donnelly......................................... 184
Additional Material Supplied for the Record
Monetary Policy Report to the Congress dated July 15, 2015....... 186
(iii)
FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2015
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THURSDAY, JULY 16, 2015
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 2:32 p.m., in room SD-538, Dirksen
Senate Office Building, Hon. Richard Shelby, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
Chairman Shelby. The Committee will come to order.
Today we will receive testimony from Federal Reserve Chair
Janet Yellen. These semiannual hearings are an important part
of the Committee's oversight of the Fed and are among the few
opportunities that we have for public discussion with the Chair
of the Federal Reserve.
The Fed, as we all know, plays an important role in the
overall economy, both in managing the supply of money and
monitoring the health of the financial system. Through its
quantitative easing and other special programs, the Fed's
balance sheet has expanded to an unprecedented size of $4.5
trillion.
To put it in perspective, nearly 20 percent of all Treasury
securities--20 percent--are held on the Fed's balance sheet.
Furthermore, rather than using the proceeds from matured
mortgage-backed securities to reduce its balance sheet, the
Federal Reserve continues to reinvest these proceeds into even
more mortgage-backed securities.
In addition, the Federal Reserve continues to hold down
interest rates despite potential adverse effects on the U.S.
economy, including the negative impact on household savings.
Past announcements by the Federal Open Market Committee
have stated that it would adjust its interest rate policy once
unemployment fell to 5.6 percent. The Fed's estimates, however,
show an unemployment rate of 5.3 percent or lower for 2015, and
yet interest rates remain unchanged.
The Monetary Policy Report released yesterday states that
the Fed will keep rates low, even though ``the unemployment
rate [will soon] be at or below its longer-run normal level''--
whatever that means. This is concerning to a lot of people
because pushing the economy beyond its normal level can have
negative effects, as we have seen with economic bubbles in
recent history.
More than ever, the financial markets have become heavily
dependent on the Fed's monetary policy decisions, which makes
transparency I believe even more important.
The Fed is often described by its own officials as the
world's most transparent central bank--or at least one of the
most transparent. But it is worth noting that in several
respects, Federal Open Market Committee monetary policy
decisions are less transparent than at other central banks,
including the European Central Bank and the Bank of England.
For example, the Bank of England has more annual meetings
and a shorter delay in publishing its minutes than the Federal
Reserve, and both banks issue more monetary reports per year.
In addition, the European Central Bank has twice the number of
press conferences. So it seems that some aspects of the Fed's
transparency can be improved.
Similar concerns exist regarding the Fed's regulatory
authority. The Federal Reserve's Dodd-Frank and CCAR stress
tests determine the fate of U.S. banks, but the Fed does not
reveal exactly how the banks will be tested or in what ways
they have fallen short.
Similarly, many banks have been forced to file and refile
their living wills without a thorough explanation from the Fed
on why the submissions failed. I believe the Federal Reserve
must provide more complete explanations of its actions in order
for the financial system and the U.S. economy to function
effectively.
Chair Yellen, we look forward to your testimony here today
and your appearance and hope that you will be able to shed more
light on some of the questions I have raised.
Senator Brown.
STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. Thank you, Mr. Chairman, and welcome back to
the Committee, Chair Yellen. Nice to see you again.
Five years ago next week, July 21st, the Wall Street Reform
Act became law. That anniversary serves as an important and
ever present reminder of the costs of the financial crisis. The
costs of the crisis were 9 million jobs lost, an unemployment
rate that reached 10 percent, 5 million Americans who lost
their homes, $13 trillion in household wealth erased.
In Ohio alone, unemployment was over 10 percent, and half a
million homes were foreclosed upon between 2006 and 2011. My
wife and I live in Zip code 44105 in the city of Cleveland. In
2007, I believe, that Zip code had the highest number of
foreclosures of any Zip code in the United States. My State
suffered 14 years in a row of one foreclosure--my entire State,
foreclosures more one year to the next year, every year an
increased number of foreclosures for 14 years.
As the Chair of the Federal Reserve, Ms. Janet Yellen, has
said, the unemployed are more than just statistics. Behind each
job loss, behind each foreclosure were painful conversations,
parents telling their children they are going to have to share
a house with their relatives, leaving their neighborhoods,
schools, and friends, or that they could no longer afford their
child's education. Think what that would be like.
The crisis took a devastating financial and psychological
toll on a generation of workers and their families. We cannot
forget that is why we passed the Wall Street reform law.
Today's hearing is a reminder how far we have come in 5
years. After unprecedented actions by the Government to
stabilize the economy and the creation of a new regulatory
framework to maintain financial stability and protect
consumers, the private sector has created almost 13 million new
jobs; household wealth has grown by some $30 trillion,
exceeding precrisis levels; and business lending has climbed
over 30 percent.
This hearing is also a reminder of how important it is that
our financial system remains well regulated for financial
stability, for consumer protection, and to prevent the next
crisis. No one wants to return to the days of 2008 and 2009.
Yet opponents of Wall Street reform continue to say that
the law has not stabilized the economy and even that new
regulations will cause--will bring on the next financial
crisis. Wall Street reform did not ruin the economy. Wall
Street gambling did, along with the failure of regulators to
take away the punch bowl.
Since Wall Street reform's passage, the economy has
strengthened. We have made it less likely taxpayers will get
stuck with a tab for another bailout. Polling released last
week shows that Americans agree with that assessment. They
overwhelmingly support strong financial rules.
Some of the behavior in the economy is the product of the
extraordinary interest rate environment of the past 7 years. So
it is no surprise that all eyes are on the Fed as it considers
its first interest rate increase since 2008. There are real
risks in tightening monetary policy too soon because although
the economy has made progress since the crisis, we still have a
ways to go.
The recovery has been uneven. There are many groups of
Americans who have not benefited from it. Premature rate
increases could mean these people do not see new jobs, wage
increases, or have access to credit. The current economic
problems in Greece and China also remind us that any progress
that our economy makes cannot be divorced from what is
happening overseas. Our manufacturers and our exporters are
already contending with a very strong dollar.
Chair Yellen, I look forward to your assessment of our
Nation's economy as well as your appraisal of the progress made
from the enactment and the implementation of Wall Street
reform. Thank you again for joining us.
Chairman Shelby. Madam Chair, welcome again to the
Committee. Your written statement will be made part of the
record in its totality. You proceed as you wish.
STATEMENT OF JANET L. YELLEN, CHAIR, BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Ms. Yellen. Thank you. Chairman Shelby, Ranking Member
Brown, and Members of the Committee, I am pleased to present
the Federal Reserve's semiannual Monetary Policy Report to the
Congress. In my remarks today, I will discuss the current
economic situation and outlook before turning to monetary
policy.
Since my appearance before this Committee in February, the
economy has made further progress toward the Federal Reserve's
objective of maximum employment, while inflation has continued
to run below the level that the Federal Open Market Committee
judges to be most consistent over the longer run with the
Federal Reserve's statutory mandate to promote maximum
employment and price stability.
In the labor market, the unemployment rate now stands at
5.3 percent, slightly below its level at the end of last year
and down more than 4\1/2\ percentage points from its 10-percent
peak in late 2009. Meanwhile, monthly gains in nonfarm payroll
employment averaged about 210,000 over the first half of this
year, somewhat less than the robust 260,000 average seen in
2014 but still sufficient to bring the total increase in
employment since its trough to more than 12 million jobs.
Other measures of job market health are also trending in
the right direction, with noticeable declines over the past
year in the number of people suffering long-term unemployment
and in the numbers working part time who would prefer full-time
employment. However, these measures--as well as the
unemployment rate--continue to indicate that there is still
some slack in labor markets. For example, too many people are
not searching for a job but would likely do so if the labor
market was stronger. And although there are tentative signs
that wage growth has picked up, it continues to be relatively
subdued, consistent with other indications of slack. Thus,
while labor market conditions have improved substantially, they
are, in the FOMC's judgment, not yet consistent with maximum
employment.
Even as the labor market was improving, domestic spending
and production softened notably during the first half of this
year. Real GDP is now estimated to have been little changed in
the first quarter after having risen at an average annual rate
of 3\1/2\ percent over the second half of last year, and
industrial production has declined a bit, on balance, since the
turn of the year. While these developments bear watching, some
of this sluggishness seems to be the result of transitory
factors, including unusually severe winter weather, labor
disruptions at West Coast ports, and statistical noise. The
available data suggest a moderate pace of GDP growth in the
second quarter as these influences dissipate. Notably, consumer
spending has picked up, and sales of motor vehicles in May and
June were strong, suggesting that many households have both the
wherewithal and the confidence to purchase big-ticket items. In
addition, homebuilding has picked up somewhat lately, although
the demand for housing is still being restrained by limited
availability of mortgage loans to many potential homebuyers.
Business investment has been soft this year, partly reflecting
the plunge in oil drilling. And net exports are being held down
by weak economic growth in several of our major trading
partners and the appreciation of the dollar.
Looking forward, prospects are favorable for further
improvement in the U.S. labor market and the economy more
broadly. Low oil prices and ongoing employment gains should
continue to bolster consumer spending, financial conditions
generally remain supportive of growth, and the highly
accommodative monetary policies abroad should work to
strengthen global growth. In addition, some of the headwinds
restraining economic growth, including the effects of dollar
appreciation on net exports and the effect of lower oil prices
on capital spending, should diminish over time. As a result,
the FOMC expects U.S. GDP growth to strengthen over the
remainder of this year and the unemployment rate to decline
gradually.
As always, however, there are some uncertainties in the
economic outlook. Foreign developments, in particular, pose
some risks to U.S. growth. Most notably, although the recovery
in the euro area appears to have gained a firmer footing, the
situation in Greece remains difficult. And China continues to
grapple with the challenges posed by high debt, weak property
markets, and volatile financial conditions. But economic growth
abroad could also pick up more quickly than observers generally
anticipate, providing additional support for U.S. economic
activity. The U.S. economy also might snap back more quickly as
the transitory influences holding down first-half growth fade
and the boost to consumer spending from low oil prices shows
through more definitively.
As I noted earlier, inflation continues to run below the
Committee's 2-percent objective, with the personal consumption
expenditures, or PCE, price index up only \1/4\ percent over
the 12 months ending in May and the core index, which excludes
the volatile food and energy components, up only 1\1/4\ percent
over the same period. To a significant extent, the recent low
readings on total PCE inflation reflect influences that are
likely to be transitory, particularly the earlier steep
declines in oil prices and in the prices of non-energy imported
goods. Indeed, energy prices appear to have stabilized
recently.
Although monthly inflation readings have firmed lately, the
12-month change in the PCE price index is likely to remain near
its recent low level in the near term. My colleagues and I
continue to expect that as the effects of these transitory
factors dissipate and as the labor market improves further,
inflation will move gradually back toward our 2-percent
objective over the medium term. Market-based measures of
inflation compensation remain low--although they have risen
some from their levels earlier this year--and survey-based
measures of longer-term inflation expectations have remained
stable. The Committee will continue to monitor inflation
developments carefully.
Regarding monetary policy, the FOMC conducts policy to
promote maximum employment and price stability, as required by
our statutory mandate from the Congress. Given the economic
situation that I just described, the Committee has judged that
a high degree of monetary policy accommodation remains
appropriate. Consistent with that assessment, we have continued
to maintain the target range for the Federal funds rate at 0 to
\1/4\ percent and have kept the Federal Reserve's holdings of
longer-term securities at their current elevated level to help
maintain accommodative financial conditions.
In its most recent statement, the FOMC again noted that it
judged it would be appropriate to raise the target range for
the Federal funds rate when it has seen further improvement in
the labor market and is reasonably confident that inflation
will move back to its 2-percent objective over the medium term.
The Committee will determine the timing of the initial increase
in the Federal funds rate on a meeting-by-meeting basis,
depending on its assessment of realized and expected progress
toward its objectives of maximum employment and 2-percent
inflation. If the economy evolves as we expect, economic
conditions likely would make it appropriate at some point this
year to raise the Federal funds rate target, thereby beginning
to normalize the stance of monetary policy. Indeed, most
participants in June projected that an increase in the Federal
funds target range would likely become appropriate before year-
end. But let me emphasize again that these are projections
based on the anticipated path of the economy, not statements of
intent to raise rates at any particular time.
A decision by the Committee to raise its target range for
the Federal funds rate will signal how much progress the
economy has made in healing from the trauma of the financial
crisis. That said, the importance of the initial step to raise
the Federal funds rate target should not be overemphasized.
What matters for financial conditions and the broader economy
is the entire expected path of interest rates, not any
particular move, including the initial increase, in the Federal
funds rate. Indeed, the stance of monetary policy will likely
remain highly accommodative for quite some time after the first
increase in the Federal funds rate in order to support
continued progress toward our objectives of maximum employment
and 2-percent inflation. In the projections prepared for our
June meeting, most FOMC participants anticipated that economic
conditions would evolve over time in a way that will warrant
gradual increases in the Federal funds rate as the headwinds
that still restrain real activity continue to diminish and
inflation rises. Of course, if the expansion proves to be more
vigorous than currently anticipated and inflation moves higher
than expected, then the appropriate path would likely follow a
higher and steeper trajectory; conversely, if conditions were
to prove weaker, then the appropriate trajectory would be lower
and less steep than currently projected. As always, we will
regularly reassess what level of the Federal funds rate is
consistent with achieving and maintaining the Committee's dual
mandate.
I would also like to note that the Federal Reserve has
continued to refine its operational plans pertaining to the
deployment of our various policy tools when the Committee
judges it appropriate to begin normalizing the stance of
policy. Last fall, the Committee issued a detailed statement
concerning its plans for policy normalization and, over the
past few months, we have announced a number of additional
details regarding the approach the Committee intends to use
when it decides to raise the target range for the Federal funds
rate.
These statements pertaining to policy normalization
constitute recent examples of the many steps the Federal
Reserve has taken over the years to improve our public
communications concerning monetary policy. As this Committee
well knows, the Board has for many years delivered an extensive
report on monetary policy and economic developments at its
semiannual hearings such as this one. And the FOMC has long
announced its monetary policy decisions by issuing statements
shortly after its meetings, followed by minutes of its meetings
with a full account of policy discussions and, with an
appropriate lag, complete meeting transcripts. Innovations in
recent years have included quarterly press conferences and the
quarterly release of FOMC participants' projections for
economic growth, unemployment, inflation, and the appropriate
path for the Committee's interest rate target. In addition, the
Committee adopted a statement in 2012 concerning its longer-run
goals and monetary policy strategy that included a specific 2-
percent longer-run objective for inflation and a commitment to
follow a balanced approach in pursuing our mandated goals.
Transparency concerning the Federal Reserve's conduct of
monetary policy is desirable because better public
understanding enhances the effectiveness of policy. More
important, however, is that transparent communications reflect
the Federal Reserve's commitment to accountability within our
democratic system of Government. Our various communications
tools are important means of implementing monetary policy and
have many technical elements. Each step forward in our
communications practices has been taken with the goal of
enhancing the effectiveness of monetary policy and avoiding
unintended consequences. Effective communication is also
crucial to ensuring that the Federal Reserve remains
accountable, but measures that affect the ability of
policymakers to make decisions about monetary policy free of
short-term political pressure, in the name of transparency,
should be avoided.
The Federal Reserve ranks among the most transparent
central banks. We publish a summary of our balance sheet every
week. Our financial statements are audited annually by an
outside auditor and made public. Every security we hold is
listed on the Web site of the Federal Reserve Bank of New York.
And, in conformance with the Dodd-Frank Act, transaction-level
data on all of our lending--including the identity of borrowers
and the amounts borrowed--are published with a 2-year lag.
Efforts to further increase transparency, no matter how well
intentioned, must avoid unintended consequences that could
undermine the Federal Reserve's ability to make policy in the
long-run best interest of American families and businesses.
In sum, since the February 2015 Monetary Policy Report, we
have seen, despite the soft patch in economic activity in the
first quarter, that the labor market has continued to show
progress toward our objective of maximum employment. Inflation
has continued to run below our longer-run objective, but we
believe transitory factors have played a major role. We
continue to anticipate that it will be appropriate to raise the
target range for the Federal funds rate when the Committee has
seen further improvement in the labor market and is reasonably
confident that inflation will move back to its 2-percent
objective over the medium term. As always, the Federal Reserve
remains committed to employing its tools to best promote the
attainment of its dual mandate.
Thank you, and I would be pleased to take your questions.
Chairman Shelby. Thank you, Madam Chair.
Madam Chair, recently some of us have raised concerns over
a proposal to reduce the statutory dividend paid to member
banks on the shares that they hold in their respective reserve
banks to help pay for a new transportation bill. Are you aware
of some of these proposals? And do you have some concerns?
Ms. Yellen. Chair Shelby, I have heard about this proposal,
and I guess I would say I would be concerned that reducing the
dividend could have unintended consequences for banks'
willingness to be part of the Federal Reserve System, and this
might particularly apply to smaller institutions.
I would also say that this is a change that likely would be
a significant concern to the many small banks that receive this
dividend.
So I suppose I would say that this is a change to the law
that could conceivably have unintended consequences, and I
think it deserves some serious thought and analysis.
Chairman Shelby. I agree with you, and I do not see any
nexus between the dividends coming from members of the Federal
Reserve System, which are a lot of small- and medium-size
banks, and funding the highway or transportation system. I
think that is a pretty far reach, but, you know, people look
for money everywhere they can get it. But that is something
that I think we better be working together on, I hope.
In another area, the impact of regulation on liquidity, the
issue of liquidity in the fixed-income market has become a
daily topic in the news and in the markets. Last month,
Secretary Lew testified in the U.S. House that he does not--and
I will quote him, he ``does not believe that Federal regulation
is a significant factor contributing to any liquidity issues.''
It is interesting.
So you think that Federal regulation is a significant
factor impacting market liquidity in any respect? And what work
has the Federal Reserve done to determine the impact of
regulation on liquidity, if you have, in our markets?
Ms. Yellen. So I would say that we are studying this issue
very carefully. We have certainly heard the market concerns on
this topic. At this point I can give you a list of factors that
may be causing this phenomenon.
Chairman Shelby. OK.
Ms. Yellen. I should say you see this decline in liquidity
in some measures but not in others. So the extent of the
decline----
Chairman Shelby. But isn't the decline in liquidity an
important issue to be watching?
Ms. Yellen. So there are a number of things that might be
involved. First of all, there have been changes in the
structure of the market. A larger share of bonds are held by
buy-and-hold investors such as insurers and pension funds that
may do less trading than leveraged firms that used to be more
dominant in this market. We have had higher capital
requirements and other regulatory changes, but firms are also
changing their own risk management practices, in some cases in
a more conservative direction.
We have seen an increase in algorithmic and high-frequency
trading, and that may be leading to changes in market trading
practices. In addition, in the corporate bond market, there
have been increased reporting requirements that may be reducing
the desired sizes of trades. And I think all of these factors
could potentially account for what is going on, but we have not
really yet been able to figure out what the contribution of
each is or just how serious.
I think a concern is that while day-to-day in normal times
most measures of liquidity seem to be roughly unchanged, there
is a concern that in stress situations it may be, and we have
seen some cases where it is less available.
Chairman Shelby. But in any market, you need risk and you
need liquidity, do you not?
Ms. Yellen. Yes, you----
Chairman Shelby. You do not have a market without it, do
you?
Ms. Yellen. Well, we do need liquidity in markets. There
may be changes, however, that precrisis it was leveraged, even
highly leveraged banks that were exposed to providing liquidity
and vulnerable if liquidity were to be reduced. And now it
seems like more of that risk has moved to unleveraged, low-
leveraged investors, and that may be a safer situation. So
there are two sides, I think, to this.
Chairman Shelby. In the area of reducing systemic risk,
which we all are interested in, do you believe that having
fewer systemically risky financial institutions would be a good
thing?
Ms. Yellen. Arguably, yes.
Chairman Shelby. OK. And should banks through regulation,
like the Fed, be encouraged to reduce systemic risk everywhere
they can?
Ms. Yellen. Well, we are certainly trying to put in place a
set of incentives that will reduce the systemic footprint and
risk of firms. I think higher capital requirements, we plan to
impose surcharges, capital surcharges on the most systemic
firms, and other regulations that will diminish the risks,
create incentives for their footprints to be reduced in ways
that will reduce their systemic risk to the financial system.
Chairman Shelby. Senator Brown.
Senator Brown. Thank you, Mr. Chairman.
Madam Chair, I continue to be concerned, as I know you are,
that the economic recovery has not taken hold for all
Americans, notably large numbers of women and in communities of
color. I know that confirmation bias can be a problem in
investing, and some might think it is a bit--it might exist on
Capitol Hill, too, but I see lots of evidence of
underemployment, unemployment, virtually no evidence of
inflation, and lots of sources of headwinds for our economy.
What are the risks of tightening monetary policy too soon?
And once rates are increased, what would be the impact of the
gradual rate increases on working Americans?
Ms. Yellen. So, of course, there are risks to the recovery
of tightening too soon, and we have been highly focused on
those risks. That is an important reason why we have left rates
as low as they are for as long as they have been. Over 6 years
they have been at effectively zero.
We have had a recovery that has been slow to take hold.
Growth has been slower than in most U.S. recoveries following a
severe financial crisis. We have clearly made progress. I agree
with you that there remain groups that are struggling in the
labor market, and as we try to show in the Monetary Policy
Report, arguably the standard unemployment rate that we look at
that is 5.3 percent may somewhat understate the real degree of
slack that exists in the labor market. So we clearly want to
see continued improvement in the labor market, and we want to
do nothing that would threaten that.
On the other hand, the labor market is getting demonstrably
closer, in my view, by almost any metric to a more normal
state, and the degree of monetary accommodation has been
sufficient over a long period of time to generate pretty
significant improvement in the labor market. And as the
headwinds that are holding the economy diminish--and I believe
they are diminishing--I think it does become appropriate to
begin--we are not talking about tightening monetary policy. I
think we are talking about slightly diminishing the very high
degree of accommodation that we have in place. And, of course,
we would not want to do so in a way or at a pace that would
threaten continued progress in the labor market.
At the same time, inflation is very low, and while we have
indicated that a good share of that is for reasons we believe
will be transitory and we expect inflation--headline inflation
to rise to much closer to core levels, that is another reason
why we can be patient in removing accommodation. But I think it
is also important there are risks on both sides. Just as we do
not want to tighten too soon to threaten the recovery or to
jeopardize the return of inflation back to our 2-percent
target, we also want to be careful not to tighten too late
because, if we do that, arguably we could overshoot both of our
goals and be faced with a situation where we would then need to
tighten monetary policy in a very sharp way that could be
disruptive.
My own preference would be to be able to proceed to tighten
in a prudent and gradual manner, and there are many reasons why
I would like to be able to do that. So I agree that there are
certainly risks to the recovery and to the labor market of
tightening too soon, but there are risks on the other side as
well. We are trying to balance those.
Senator Brown. Thank you. Some people have suggested
recently that American workers need to be willing to work
longer hours. I do not think many Americans work fewer hours by
choice unless, of course, there are health issues or child care
limitations or other responsibilities. I think most or at least
many Americans working part time would like to work full time.
This slack in the labor market seems to indicate we still have
a ways to go.
Discuss with us your concern about the number of workers
who are only working part time but would like to be more in the
labor force, if you would.
Ms. Yellen. Yes. Well, we have an unusually large share of
the labor force--I believe it is around 4.5 percent--that
report themselves as working part time for economic reasons.
That means they would like to be working more hours than they
are able to work. And broader measures, the measure of the
unemployment rate that we normally look at, it is referred to
as the U-3 measure, that is 5.3 percent. But broader measures
that capture that part time for economic reasons, a measure
like U-6, we have a picture in the Monetary Policy Report, and
we show how high that is. And we show that although, of course,
it is always higher than the narrower concept of unemployment,
it is very much higher than you would expect historically given
the narrower measure of unemployment.
So to my mind, this really suggests that our standard
unemployment rate does understate the degree of slack we still
have in the labor market.
Senator Brown. Thank you.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Corker.
Senator Corker. Thank you, Mr. Chairman, Ranking Member. I
appreciate it.
Madam Chairman, thank you for being here. I spent a lot of
time with you when you were getting ready to be confirmed, and
I enjoyed that, and I appreciated talking about views on
monetary policy. And this is a not a pejorative statement, but
I know as you were coming in, you were acclaimed to be the
first ``dove'' coming in as head of the Federal Reserve. I know
we had numbers of conversations about that, and I know you
supported all of the rate hikes, on the other hand, that took
place as we were leading up.
Ms. Yellen. That is true.
Senator Corker. So I want to make sure everybody
understands that.
Ms. Yellen. Thank you.
Senator Corker. But we did talk a lot about this moment in
time we are in, and it seems that many are getting--let me put
it this way--the impression, many who are spending their daily
lives dealing with the stock market, that the Fed has become
very affected by the market swings, and that much of that may
actually be driving monetary policy, not just the stats. You
know, we have had--this is the first--I guess we have had two
other times in modern history where we have had negative
interest rates, or at least times that I am aware of, from 1974
to 1976, and 2002 to 2004. And so we have had this long period
of time where, in essence, we have negative interest rates, and
yet it seems the Fed continues to watch not just the stats, but
is very affected by the markets and worried about disruptions
in the stock market.
I am wondering if you might address that.
Ms. Yellen. So I would push back against the notion that we
are unduly affected by the ups and downs of the stock market.
We are certainly very focused on the fundamentals and the
economic statistics that describe where the economy is and in
terms of the labor market and inflation, which are the two
goals assigned to us by Congress, and a lot of different kinds
of economic information go into the forecasts that drive our
decision making, our forecasts about where the labor market and
inflation will be moving. But financial conditions broadly--and
I am not talking about the stock market here uniquely, but a
wide range of financial variables that I would say go into
assessing financial conditions, the ease for households and
businesses of borrowing that affect their spending patterns,
whether it is consumer spending or investment or our ability,
our competitive position in the global economy that affects our
ability to export and the competitiveness of import competing
goods. The state of financial, conditions broadly speaking, is
one variable that does affect our forecast of the economy.
So we cannot completely ignore what is happening in the
markets to housing prices, to equity prices, to longer-term
interest rates, to credit spreads that influence borrowing
costs, to the exchange that affects the competitiveness of U.S.
goods and services. All those factors feed into financial
conditions, and they are relevant to forecasting the economy.
So it is one element of our evaluation, but I do not think we
pay undue attention to it, and I do not think we should.
Senator Corker. Yes, I agree. Thank you.
The living will process is something that--I know the
Ranking Member alluded to Dodd-Frank, and Senator Warner and
myself were assigned to work on those particular areas, Title 1
and Title 2, came to an agreement, and actually Senator Shelby,
I think, offered an amendment on the floor that passed by 95
votes to make it even stronger, if I remember correctly. Or at
least alter it to some degree, but certainly make sure it
became law.
We have had some questions about the living wills as they
have come up. The last round, there was a little bit of
concern, at least on my part and I think a few others, that
there was a little regulatory capture taking place, that really
these living wills were way lacking in substance, and yet maybe
the Fed really was not, you know, putting the pressure on these
organizations to deliver as they should.
I had a good meeting this week with Mr. Tarullo, and my
understanding is the substance of these living wills--I know
you all have sent out some statements regarding what has
happened. I think they are much better than they have been. But
it is pretty clear these living wills have to be able to
resolve an institution under bankruptcy, and I just wonder if
you might speak to that for a moment.
Ms. Yellen. I agree with you. We worked closely with the
FDIC in this last round a year ago to set out a clear set of
expectations for what we want to see in the current round of
submissions. We have worked closely with the FDIC and the
banking organizations to make sure that they have been very
clear about what we expect in this round of submissions. We
have instructed them to enhance their disclosure in the public
part of the documents that they produce, and it looks like
preliminary reads suggest they have made progress there, and we
are going to be evaluating them in the coming months, and we
indicated that if we continued to see shortcomings in the
living wills, we will use our authority to determine that these
resolution plans do not meet Dodd-Frank requirements. And that
is where we stand, and that is what we are going to do.
Senator Corker. Thank you very much for your service. I
appreciate it.
Ms. Yellen. Thank you.
Senator Corker. Thank you, Chairman.
Chairman Shelby. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
Madam Chair, thank you for your service to our country. I
appreciate the work you have been doing.
Ms. Yellen. Thank you.
Senator Menendez. As you know and have stated many times,
the Fed's dual mandate directs it to pursue maximum employment
and stable prices. Now, how the Fed chooses to balance these
goals has significant consequences for the quality of life of
millions of Americans.
On the first element, our labor market is improving, but
most Americans feel like they have a lot of catching up to do
from the deep hole the financial crisis put us in. They do not
feel that their personal circumstances have certainly risen at
all, and they feel enormous challenges.
Meanwhile, inflation continues to run well below target, as
it has for an extended period of time, so it would be a mistake
in my view for the Fed to shift its focus away from jobs at
this critical time. With interest rates near zero, the Fed has
essentially no room for error if it tightens too soon. If it
tightens too late, I think the risks are much lower, and the
Fed has plenty of ammunition to keep inflation anchored.
So as a follow-up to Senator Brown's question, I would like
to know, in order to avoid choking off economic growth
prematurely, will the Fed wait to raise interest rates until
after it has seen signs of actual inflation rather than based
on some intangible fear of future inflation, which may or may
not ever actually materialize?
Ms. Yellen. So, Senator, I agree with your characterization
of the risks that if there is a negative shock to the economy
within interest rates pinned at zero, we do not have great
scope to respond by loosening policy further; whereas, with a
positive shock, of course, we can tighten monetary policy. We
have the tools, and we know how to do that. That is a
consideration that has been weighing on our decision making for
quite some time and has led us in part to hold interest rates
at these very low levels for as long as we have.
So that has been a factor we have been taking into account,
and it partly explains the policy that we have been following.
But there are lags in the effect of monetary policy. We need to
be forward-looking. And on the other side, there are risks from
waiting too long to act as well. We have to balance those
risks.
You asked me if we would likely raise rates before
inflation has risen substantially, and there I would point you
to Section 3 of the report that we gave to you where we show
each summary of their forecast for the economy and for policy.
And as I mentioned in my testimony, most participants, as of
our June meeting, envisioned that economic developments would
proceed in a way for the rest of this year that would, in their
view for almost all of them, make it appropriate to begin the
process of normalizing policy sometime this year.
And if you look at their inflation forecasts, at the end of
the year, on a year-over-year basis, most participants
envisioned that total inflation would be running a little bit
under 1 percent, so that is well below our 2-percent objective.
And they envisioned core inflation, that is, for the year as a
whole, at the end of 2015 as running in the neighborhood of 1.3
to 1.4 percent. So in that sense, you can see in their
projections that they are envisioning its being appropriate to
begin tightening policy within inflation below our objective.
But what we have said is we want to have reasonable confidence
before we tighten that inflation over the medium term will move
back to 2 percent. And what is going on here is that we think
that there are transitory influences--namely, the marked
decline in oil prices and the strengthening of the dollar--that
are holding inflation down, and that underlying inflation, even
with core inflation, that low import prices and declining
import prices are a transitory factor holding that down, that
as we see the labor market improve and these transitory
influences wash out, that we believe that inflation will move
back to 2 percent. And so if we have that confidence, the
Committee would be likely to begin before seeing inflation go
back up to our target.
Senator Menendez. Now, normally in my experience here I
would have interrupted you a long time ago because my time has
expired. But because your response was so interesting and I am
trying to grasp where your policy view is from it, I let it go.
Let me, if I may, just make one very brief comment, Mr.
Chairman, and that is, from my--I listened to you intently.
From my perspective, I think it is much less of a problem that
inflation may run high a little bit--I did not say significant
inflation, which you referenced--to run high for a little bit,
for a short period of time until the Fed's response to it takes
effect than the alternative, which is cutting off much needed
job growth and income growth, too, which would have been my
second question, but I will submit that for the record.
Ms. Yellen. We do not want to cutoff job growth and income
growth, and we do want to see inflation move up to 2 percent.
We would not be pleased to see it linger indefinitely below 2
percent.
Senator Menendez. Thank you, Mr. Chairman.
Chairman Shelby. Senator Rounds.
Senator Rounds. Thank you, Mr. Chairman.
Madam Chair, recently the Senate Banking Committee held a
hearing that examined the role of the Financial Stability Board
in the U.S. regulatory framework. A lot of concern was
expressed about international decision making on regulation
overtaking U.S. decision making. I am just curious if you would
agree that it is important for the United States to set its own
insurance capital and other regulatory standards before
agreeing to any such standards internationally.
Ms. Yellen. Well, we are working on U.S. standards. Nothing
applies to U.S. firms until we have gone through a formal
rulemaking process or process with orders in the United States.
So no international discussion or agreement applies to U.S.
firms unless they are consistent with U.S. law and we have gone
through a full-blown rulemaking process.
But discussions are taking place internationally about
appropriate standards. I think it is very important that we
weigh in on those discussions so that the standards that other
countries adopt work for our markets and for our firms, and
that we end up with a playing field that is competitive for our
own firms to compete in. So we participate in those
international discussions, but within an understanding that
nothing applies to U.S. firms until we have gone through a full
rulemaking process here.
Senator Rounds. Thank you. I would like to follow up just a
little bit on what the Chairman was visiting with earlier, and
that is with regard to SIFI designations, literally in the
spirit of reducing systemic risk. Do you support giving
designated firms a specific road map for de-designation, like
an off ramp or an approach that would allow them to basically
de-certify?
Ms. Yellen. So I think firms should have the ability to de-
certify, and the FSOC every year has to review designations to
make sure that they remain appropriate. That is an annual
procedure.
Now, firms are given very detailed information and interact
a great deal with FSOC during the process of designation, and
they understand very clearly what it is about their business
model and strategy that has caused them to be designated. So it
is not a mystery to those firms what about their business
activities is responsible for designation.
I do not think it is appropriate for FSOC or for the
regulators to try to run these businesses, to try to
micromanage what these firms do. I do not think there is any
single, appropriate off ramp. We should not be telling them
exactly do the following list of things. They understand what
they need to do to change their profile in a way that would
change FSOC's evaluation. And if they were seriously
contemplating making those kinds of substantial changes, I am
sure there would be many opportunities to interact with FSOC
and staff to gain some perspective on whether or not the kinds
of changes they were thinking of would significantly change
their systemic footprint.
Senator Rounds. Thank you.
One last question. As you know, Madam Chair, when you talk,
the markets clearly listen. As you work with the Federal
Reserve's Open Markets Committee, you look at a balanced
approach, and you are looking at several goals. You have
clearly defined that your goal is a 2-percent inflation rate.
What about when we talk about maximum employment? Where do we
go, and what do you lay out as the firms look at it in terms of
what to expect from the Committee? What is your goal in terms
of the maximum employment?
Ms. Yellen. So as we say in our statement of longer-run
goals and monetary policy strategies, there is something
different about the two goals. We have a goal for inflation, 2
percent, and maximum employment. A central bank can choose or
determine what its inflation target should be. We chose 2
percent. We are in good company. That is what most advanced
central banks have chosen.
Maximum employment is different. We cannot just decide what
do we want that to be in the long run. We think there is some
normal longer-run rate of unemployment or level of maximum
employment that is consistent with stable inflation, and for us
it is not something we can say we would like it to be this or
we would like it to be that. It is something we are trying to
determine. It can change over time. It is not easy to know
exactly what is possible given technology and demographics and
the way the institutions of the labor market function. So we
are trying to estimate it, not determine it.
But participants in the Committee are asked every 3 months,
when they submit their forecasts, to write down their own
current views on the unemployment rate that corresponds to what
they regard as normal in the longer run or consistent with
maximum employment. And most members of our Committee or
participants currently regard that as an unemployment rate in
the neighborhood of 5.2 to 5.3. And that is something that can
change over time. It has changed over time, and we report that
publicly.
Senator Rounds. Thank you.
Thank you, Mr. Chairman.
Chairman Shelby. Thank you, Senator Rounds.
Senator Donnelly.
Senator Donnelly. Thank you, Mr. Chairman, and thank you,
Madam Chair.
Madam Chair, I know you share my concerns with income
inequality and the continuing trend of middle-class wage
stagnation. In your testimony, you said, `` . . . although
there are tentative signs that wage growth has picked up, it
continues to be relatively subdued . . . .''
So as the economy improves, how do you expect middle-class
wages to show substantial improvement? What are you looking at?
Ms. Yellen. Well, we look at several different measures of
wage growth. Three aggregate measures that we look at are the
Employment Cost Index, hourly compensation, and average hourly
earnings. They do not always tell exactly the same story. I
think we have seen a meaningful pickup over the last year in
the growth in the Employment Cost Index but less movement in
the other two measures. So there are early indications or
conflicting indications there.
The levels of increase are still relatively low, and in
real or inflation-adjusted terms, compensation or wages are
increasing less rapidly than productivity.
Senator Donnelly. What do you expect to see in the next
year----
Ms. Yellen. I would expect to see----
Senator Donnelly. ----with regard to middle-class wages?
Ms. Yellen. ----a pickup in--so I am not going to say
``middle-class wages'' but aggregate wages in the economy. I
would expect to see some further upward movement. Where they
can go depends in part on productivity growth. For example, if
productivity growth--and there is a lot of uncertainty about
what it is, but if it were at a trend rate running, say, around
1.5 percent with a 2-percent inflation, we would expect to see
wage growth----
Senator Donnelly. And I guess the key to that is that there
would actually be some correlation between productivity growth
and the growth in wages as well.
Ms. Yellen. There tends to be over long periods of time,
but it is not always true over shorter periods. So there is
some uncertainty about this, and we have been through a period
in which wages have been in real terms----
Senator Donnelly. We have not seen a closer link----
Ms. Yellen. ----growing less rapidly than productivity. I
would expect to see a pickup. It is not a certainty here, but
it is--and to my mind, it is evidence of some remaining slack
in the labor market. So that is--my forecast is that we will
see some pickup in wage growth.
But it is important to remember that there has been
increasing wage inequality in the United States over a long
period of time, certainly going back to the mid-to-late 1970s,
and that reflects a deeper set of structural factors that the
Federal Reserve does not have tools to combat. What we are
looking for is an overall job market that is functioning in
some sense well, but we see increasing gaps between the wages
or compensation of more skilled and less skilled workers, and
that has been holding down middle-class wage growth for a long
time for other reasons.
Senator Donnelly. Let me ask you about a little bit
different subject. You know, I voted for Dodd-Frank because I
wanted to see safety and stability in the system. It was not a
desire to load it up with regulations, but it was a desire to
make sure we had safety and stability. But now what we have
seen is a growing shadow banking system, which brings other
concerns, and so as you look at this, since shadow banking
entities are not subject to the same regulatory oversight, how
concerned should we be with the potential risk involved here?
Because that is what we are trying to drive at in the first
place with Dodd-Frank, was to eliminate some of the systemic
risk.
Ms. Yellen. Well, I think you have put your finger on a
very important phenomenon, and we were well aware when we put
these regulations in place in Dodd-Frank that wherever you draw
the regulatory perimeter, there will be a tendency for activity
to migrate beyond it to what we call ``the shadow banking
system.'' So we clearly need to be very vigilant about
monitoring risks that are migrating to that system, and
certainly in the Federal Reserve, we have hugely ramped up our
attention to the shadow banking system.
The FSOC is focused on risks developing broadly through the
financial system in shadow banking, and the Financial Stability
Board has a large work program devoted to shadow banking. We
are thinking about regulations that might address--like minimum
margin requirements that would apply not only to banking
organizations but more broadly, that might address some
potential risks in the shadow banking system.
Of course, we have seen some heightened attention to risks
by the SEC in money market funds, which was an important piece
of the shadow banking system where risks developed leading to
the crisis. But you are absolutely right to focus on that, and
we are attempting to address those risks as best we can.
Senator Donnelly. Thank you, Madam Chair.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Scott.
Senator Scott. Thank you, Mr. Chairman. Chair Yellen, thank
you for being here today.
Ms. Yellen. Thank you.
Senator Scott. As I travel across South Carolina, people
express concerns about America leading from behind, whether my
conversations with folks have been about the Administration's
failure to enforce their own red lines in Syria or more
recently about the ill-advised nuclear deal with Iran, South
Carolinians have the sense that our Nation is timid, that it is
comfortable sitting back and taking cues from foreign actors
rather than occupying our traditional role a leader of the
world.
Now, I am certainly not suggesting that you somehow are in
charge of military policy or Middle East diplomacy, but you are
in charge of our regulatory policy for some of our country's
most successful businesses. And sometimes it seems to me like
our U.S. regulators are leading from behind, especially when it
comes to our involvement in international regulatory bodies
like the Financial Stability Board or the International
Association of Insurance Supervisors.
For example, the FSOC designated domestic insurers as SIFIs
shortly after the FSB did, suggesting that the FSOC was happy
to follow FSB's lead.
We saw something very similar happen with capital buffers
for money market mutual funds. The FSOC and SEC seemed to take
their cues from the FSB.
Madam Chair, now that the Fed is writing a capital rule for
insurance companies, I would encourage you to break from the
tradition of leading from behind by developing a capital
standard that first works for our domestic insurance companies
rather than letting international standard-setting bodies like
the ones I have mentioned already write rules and export them
back to our country.
I would also encourage you in your capacity as a member of
the IAIS to take the lead in that body in promoting activity-
based regulations of insurers as the group reconsiders its G-
SII designation methodology later this year. It appears that
Governor Tarullo has committed the Fed to an activities-based
approach for asset managers, but I have not yet heard him say
that he would do the same for insurers.
Can you commit today that the Fed will take the lead and
follow these two courses of action both on insurance company
capital standards and on promoting the replacement of entity-
based regulation of insurance with activity-based regulation? I
think Senator Rounds really was starting down this road when he
was asking his question. It appears to me that the European
regulators are concerned about the creditor protections. We at
home are far more concerned about protecting the policy
holders. The difference yields different capital philosophies.
I would like a commitment to use our domestic approach and
export it as opposed to importing their philosophical
disposition on capital standards based on creditor protections.
Ms. Yellen. So I guess all I can really say is that we are
playing an active role internationally in insurance, which is
why we joined the IAIS. We are participating jointly with the
Federal Insurance Office and the State Insurance Commissioners.
We are collaborating to think through what is an appropriate
system of capital and liquidity standards for globally active
firms.
We have a strong interest in doing that, and it is
important for us to have our voices heard in that process. So I
do not think it is accurate to say we are sitting back and not
trying to play a leadership role. I think we are.
Domestically, we have been given increased flexibility
through the Collins fix to design and tailor a set of insurance
regulations, capital standards that we think are appropriate
for our institutions. We want to carefully tailor them to the
unique characteristics of the firms that we supervise, and we
are taking the time and interacting with those firms to make
sure we understand what an appropriate insurance-centric, well-
tailored set of capital standards would look like.
Senator Scott. Thank you. I think at the end of the day all
of the Washington regulators speak and sound pretty academic,
but what it ultimately boils down to is a price that Americans
will pay for their retirement. One of the things that we are
trying to do is make sure that that price goes down and not up
as we find ourselves, from my perspective, adopting
international standards as opposed to taking ours and exporting
them.
Thank you.
Chairman Shelby. Senator Warren.
Senator Warren. Thank you, Mr. Chairman, and it is good to
see you again, Chair Yellen.
I want to follow up on Senator Corker's question. As you
know, Dodd-Frank requires big financial institutions to submit
living wills, a plan for how they could be liquidated--and I
want to quote the statute here--``in a rapid and orderly
fashion'' in bankruptcy without bringing down the economy or
needing a taxpayer bailout.
Now, by law, the Fed and the FDIC are supposed to determine
whether these plans are credible or not, and then if they are
not credible, the agencies can order the institutions either to
simplify their structures or eventually to sell off assets.
So last August, the Fed and the FDIC identified significant
problems with the living wills submitted by 11 of the biggest
banks in the country. The FDIC determine that these living
wills were not credible. But the Fed did not. Instead, the Fed
said that if the banks did not ``take immediate action to
improve their resolvability and reflect those improvements'' in
their new living wills, the Fed ``expected'' to find the new
living wills were not credible.
Now, the 11 banks submitted their new living wills at the
beginning of this month, and I know you have not completed
reviewing them yet. But I just want to make sure we are really
clear on this point. Will the Fed find living wills not
credible if the bank has not fixed each of the problems that
the agencies identified last August?
Ms. Yellen. We are certainly prepared to make those
determinations. We will work jointly with the FDIC, as we have
been doing, to analyze the living wills and see whether or not
we feel that the responses to the directions that we gave to
these firms are satisfactory or not. And if we find that they
are not, we are certainly prepared to say that they are not
credible.
Senator Warren. OK. Good. I am glad to hear that.
Two of the issues the agencies directed the banks to
address were ``establishing a rational and less complex legal
structure and developing a holding company structure that
supports resolvability.''
Now, JPMorgan Chase, just to pick one example, has over
3,000 subsidiaries. It will take a lot of work to establish a
rational structure that permits JPMorgan to be resolved quickly
as required by law. But to be clear again, the Fed will find
JPMorgan's living will not credible, and the living wills of
the other 10 banks not credible, if they have not taken
concrete steps to significantly simplify their structures and
are not sleek enough to be resolved quickly?
Ms. Yellen. Well, we have given them those directions, and
we will evaluate that. I would simply say that the regulatory
reports that we receive indicate that these firms since 2009
have reduced the number of legal entities in their structures
by approximately a fifth. I guess we will be looking for----
Senator Warren. You will note that number I gave you is not
from 2009. It is over 3,000 subsidiaries at latest count that I
have seen. So I just want to be clear that you are willing to
say not credible if they do not meet the legal standards that
they could quickly be resolved, and that includes how complex
their structure is.
Ms. Yellen. Well, agreed that they need to be less complex,
and we have given them that direction. But I am not sure we can
determine exactly how complex they are by just counting the
number of legal entities----
Senator Warren. Fair enough. I am glad to have----
Ms. Yellen. They are not all----
Senator Warren. ----lots of ways you look at this.
Ms. Yellen. They are not all equal. Some are set up for
very narrow purposes and would not represent serious
impediments to resolving the firms. So I do not want to----
Senator Warren. OK. But----
Ms. Yellen. ----determine this by count of legal entities.
Senator Warren. Count by itself, I understand that. But we
do remember that the statute says ``rapid and orderly
liquidation, and that goes to the question of complexity. I
raise this because the living wills are one of the primary
tools the Fed has to make sure that taxpayers will not be on
the hook if one of these giant banks fails. It is critical that
the Fed uses this authority, and like the FDIC has been willing
to do, to make our financial system safer.
I want to ask you one other question just quickly. In Dodd-
Frank, Congress directed the Fed to impose some tougher rules
on banks with more than $50 billion in assets. That covers
roughly 40 of the biggest banks in the country, about one-half
of 1 percent of the 6,500 banks that we have in the U.S.
Together, this one-half of 1 percent holds more than $14
trillion in assets, about 95 percent of all the banking assets
in this country--40 banks, 95 percent of all the assets.
The tougher scrutiny is designed to direct regulator
attention where serious risk is--in other words, concentrate
regulatory scrutiny on these 40 banks rather than on community
banks and credit unions.
Now, there have been proposals recently about exempting
many of these banks from tougher rules by raising the $50
billion threshold to $100 billion, $250 billion, $500 billion.
The argument I hear is that $50 billion banks just do not pose
systemic risk. So I just want to ask a question on this one.
We learned or should have learned in 2008 that in a crisis
several banks can find themselves on the verge of failure at
the same time. Do you think it could pose a systemic threat if
two or three banks with about $50 billion in assets were on the
verge of failure?
Ms. Yellen. Well, when a significant number of firms is at
the risk of failure, often it is because they have highly
correlated positions. We always have to worry about that
resulting in a drying up of credit to the economy, and, you
know, during the Great Depression, most of the banks that
failed were small. They were a lot smaller than $50 billion or
adjusted for that time. So when many banks fail, of course, we
have to be concerned as well, and that is one reason why for
all institutions, even for community banks, Basel III
regulatory capital requirements are higher. We want to see
safety and soundness throughout the entire financial system,
throughout the banking system, although the most systemic
firms, as you pointed out, of course, need the greatest
scrutiny.
Senator Warren. It is the top 40. So I just want to say
there are two approaches to this issue. The first, which every
Republican on this Committee supported, is to raise the
threshold to $500 billion--that is, cut loose about 30 or so of
the biggest banks in this country, and just hope for the best.
And if it does not work out, the taxpayers can pick up the tab
again.
The other approach is to play it safe. Keep the threshold
where it is and rely on the Fed to tailor the rules to fit the
risks posed by these different banks. That is the approach I
support, and since the American taxpayers are on the hook when
the economy starts to implode, I suspect most of them would
prefer that Congress be careful, too. Thank you, Madam Chair.
Thank you, Mr. Chairman.
Chairman Shelby. Madam Chair, some people have proposed
that we do not have any threshold. You have seen some of that.
But the regulator having the power to do their job properly,
you have seen some of that, I am sure.
Senator Crapo.
Senator Crapo. Thank you very much, Mr. Chairman, and I
want to follow up on exactly the same question that Senator
Warren just finished on.
Last September, I asked Federal Reserve Governor Tarullo
about legislatively raising the trigger when a bank is
systemically important from the $50 billion level. In hearings,
we have heard that the asset threshold should be raised or
changed because it is arbitrary, includes institutions that are
not systemically important, focuses only on size, and produces
undesirable incentives. Governor Tarullo said that several
years of testing and assessment have given regulators a better
understanding of the designation threshold. Given the intensity
and complexity of work around stress testing, he said that
regulators have not felt that the additional safety and
soundness benefits of SIFI regulation are really substantial
enough to warrant the kinds of compliance and resource
expenditures required of banks that are above $50 billion in
assets, but well below the largest systemically important
institutions.
And so I guess my question to you, which is sort of another
way of asking the same question that Senator Warren just asked,
is: Do you agree with Governor Tarullo's analysis that there
would be a benefit if Congress changed the current threshold
and focused more on substantive evaluations of true risk rather
than on an arbitrary number?
Ms. Yellen. So like Governor Tarullo, I would be open to a
modest increase in the threshold. And I guess the reason that I
would be open to it is, as he indicated and as you just stated,
we do have some smaller institutions that under Section 165 are
required to do, for example, supervisory stress testing and
resolution planning. And for some of those institutions, it
does look from our experience like the costs exceed the
benefits.
But if there were to be a modest increase in the threshold,
I think what is essential is that the Federal Reserve retain
the discretionary to subject an institution that might fall
below the new threshold to higher supervisory requires, for
example, that we would be able to insist that it perform
supervisory stress testing if, in our view, the risk profile of
that firm, in spite of its size, led us to believe that it had
systemic import that made us think it was appropriate, and that
is possible that we might feel we would need that discretion.
But at present, every firm over $50 billion has to do things
like supervisory stress testing, and I think what we have found
is in some cases the burden associated with that for many of
those firms really exceeds the benefit to systemic stability.
But retaining the discretion to, as supervisors require them
to, do that if we thought it appropriate, that would be very
important for me to support that change.
Senator Crapo. Thank you. I appreciate your openness to
increasing the threshold and focusing on the flexibility that
we need there. What I am hearing you say--well, let me put this
differently. It seems to me that a principle we should follow
is that banks with similar risk profiles should not be subject
to different regulatory standards, and that applies on both
sides of any arbitrary number which we might pick. The question
that I--what I think I heard you say was that the real issue is
the risk profile, and that the regulators should have the
authority to evaluate the risk profile of our financial
institutions and regulate them appropriately. Did I hear you
correctly?
Ms. Yellen. I think that is a fair summary.
Senator Crapo. Thank you. And the last question I have is:
The Office of Financial Research recently published a study
this past February that uses a multifactored approach to
grading the systemic risk of each of the institutions subjected
to Section 165 of Dodd-Frank. Are you familiar with that study?
Do you know what I am referring to?
Ms. Yellen. I am sorry. I have not really had a chance to
review the study. I apologize.
Senator Crapo. Fair enough. I get asked by reporters all
the time about things, and I have learned, if I do not know
about it, to tell them, and I appreciate that.
The point is this study showed that different banks who are
subject to the $50 billion--who are on the upside of the $50
billion trigger have vastly different risk profiles. And I
guess the question I was going to ask you is whether this study
has validity in showing that there are vastly different risk
profiles among the different banks who are above the $50
billion trigger. So let me ask that question without
referencing the study.
Isn't it correct that there are very, very different risk
profiles in this pool of banks that are above the $50 billion
trigger?
Ms. Yellen. Yes, they have very different risk profiles.
Some are essentially large community banks that are not
especially risky. But, on the other hand, we have a couple of
U.S. firms that are designated as G-SIBs now. They are a lot
above 50, but they are certainly a lot smaller than the largest
U.S. firms. But they have business models that make their
activities systemically important. And so firms of the same
size can have very different risk profiles and the appropriate
supervision of those firms can be quite different.
Senator Crapo. Well, thank you. And this is not a question.
I will just conclude with this comment, and that is, I think we
would be much better served if our regulatory system allowed
our regulators to focus on risk and regulate to that rather
than forcing them to utilize arbitrary numbers.
Chairman Shelby. Thank you, Senator Crapo.
Senator Reed.
Senator Reed. Well, thank you very much, Mr. Chairman. Just
quickly, because I have had the opportunity to listen to these
questions, your position would be that a threshold is
appropriate, but then discretion to look at different banks
over that threshold differently is what really you think is the
ideal?
Ms. Yellen. Well, within limits, we can tailor our
supervision to the profiles of the firms. I guess I would be
concerned if the threshold is raised, we are now saying that
banks that used to be above the threshold now fall below the
new threshold. They are no longer automatically subject to a
number of requirements.
Senator Reed. And they might be engaged in risky behaviors
that----
Ms. Yellen. Yeah, and we might want to, as supervisors, say
no, no, no. But those two firms, they really need to continue
doing that. We know they are now below the threshold, but we
want to subject them to it anyhow because it is right for them.
Now, there may be many other firms that have now been
relieved from what was a burden that is not appropriate for
them.
Senator Reed. So just to be clear, this issue of threshold
is not to essentially if you get below a threshold, you do not
have any responsibility. What you want to be able is to follow
risk even if it is below the threshold.
Ms. Yellen. That is right. But we have observed that, for
example, quite a number of firms that are just above the $50
billion threshold, we are really imposing some burdens on them
that it is not clear that the benefits exceed the costs there.
Senator Reed. Just a final point. There is sort of a
functional value of having a threshold.
Ms. Yellen. Yes.
Senator Reed. However you want to characterize it, because
if you do not, then you have to have sort of a contest with
each institution about whether they fit within your criteria,
whether they truly have risk, and you do not have the entree
you need to basically make your valuation. You know, you have
to fight your way through the door. Is that correct?
Ms. Yellen. That is right. And I used the words ``modest
increase in the threshold.''
Senator Reed. All right. Thank you.
My real question is with the now ubiquitous issue of
cybersecurity. First, a two-pronged question. One is the
cybersecurity of the Federal Reserve, and then as importantly,
maybe more importantly, how effective you are in ensuring that
your regulated institutions have cybersecurity protections that
are effective, because this is the issue of the moment and of
the next decade or more--millennium maybe.
Ms. Yellen. Absolutely agreed. We internally are highly
focused on cybersecurity. I believe we have a robust and
comprehensive cybersecurity system in place. We realize that
the nature of the threats we face are constantly evolving. We
are routinely doing self-evaluations of our vulnerabilities and
engaging third parties to review what we are doing.
We have a National Incident Response Team that is
constantly 24/7 responsible for looking at intrusion detection,
incident response, vulnerable assessments, trying to do their
own penetration tests to see how secure we are. We have
business continuity plans for all of our business lines,
including our most systemically important payment systems like
Fedwire and for our open market operations. If the primary
operators of these systems were to suffer an attack, we have
backup facilities that could take over the operations. So that
is sort of a----
Senator Reed. Madam Chair, switching to your regulated
industry, are you testing them as hard? Are you going in with
teams to assess? Are you trying to sort of break in--I mean, in
terms of as a regulator looking to see if they are conducting
operations appropriately?
Ms. Yellen. So I do not think we are breaking in and doing
our own detection tests. But it is an important aspect of our
supervision to ensure financial institutions have appropriate
measures in place. We have specialized teams of supervisors
that are trained in IT security who examine the institutions to
make sure that they are appropriately--taking the appropriate
steps, and we work jointly with other regulators through the
FFIEC for the financial sector more broadly under the
leadership of Treasury. And we support efforts throughout the
Government to make sure that we are addressing these threats.
Senator Reed. Thank you very much. I think the nature of
the threat is we will be having this conversation for a long
time.
Ms. Yellen. We will.
Chairman Shelby. Senator Warner, finally.
Senator Warner. Thank you, Mr. Chairman. I will go ahead
and start.
Chairman Shelby. I am sorry. If I could, Senator Schumer
came back.
Senator Schumer. I will let Senator Warner go.
Chairman Shelby. He was here earlier. He came back.
Senator Warner. Senator Schumer was hoping to learn from
some of my comments, and then he can follow up on them.
Chairman Shelby. He yielded to you, so maybe we will----
Senator Schumer. Mark, do not mess with me.
[Laughter.]
Senator Warner. I want to start by complimenting the
Chairman on one of his first questions to Chair Yellen about
the notion of taking some of these funds that are used to shore
up the financial system and using them for purposes not related
to the financial system, the way I believe some people have
proposed related to highways.
This is what happens when you skip the line in the
hierarchy on the Democratic side.
[Laughter.]
Senator Schumer. Those are the big banks.
Senator Warner. Although I would acknowledge that while I
have great sympathy, you know, for the fact that our community-
based banks, close to 7,000 of them, are buying into this,
getting the 6-percent return, you know, some of the money
market funds that can access the emergency window at 50, 60,
70, 80 basis points, if they have to then get this ability to
invest at 6 percent, that is a pretty good trade for the money
center banks that the community banks do not have----
Senator Schumer. I am going to forgo my line of
questioning.
[Laughter.]
Senator Warner. The one thing I know that I think Senator
Warren and probably Senator Brown offered, I actually do
believe on the resolution plans that we have made progress and
that we are seeing plans with greater rigor and, candidly, even
some of the plans in terms of the capital standards that are
being put in place might even get close to meeting Senator
Brown and Senator Vitter's requirements.
The one area that we still do not have the regs out on,
though, is the regs on the long-term debt and how we have got
to make sure that that long-term debt is clear, that it could
be convertible in the event of a challenge so that we can use
bankruptcy, so that we can meet the goals that Senator Brown so
carefully articulated.
I think what I would love to just hear is some assurance
that we are going to see those final regs by the end of the
year so that we can have this full guidance out about these
resolution plans.
Ms. Yellen. So I cannot give you a specific date, but I
want to assure you it is a very high priority item for us. We
have not----
Senator Warner. Chair Yellen, I did not say specific date.
I am just saying end of the year. You know, that gives you half
the year.
Ms. Yellen. I am loath to promise a date. This is really
important to us. This is not something that we are just letting
slip. It is right at the top of our agenda----
Senator Warner. But when we look at----
Ms. Yellen. ----to get this done.
Senator Warner. ----the capital structures and the kind of
increased ability for these large banks to withstand trauma,
having those rules out on the long-term debt and that
conversion component really, you know----
Ms. Yellen. Agreed. I totally agree.
Senator Warner. Because I really want to be able to respond
to Senator Brown in an artful and complete way that his
approach maybe has been solved by those of us who thought Title
1 and Title 2 got at this issue.
Ms. Yellen. So we completely agree. It is very important
for there to be a long-term debt requirement. Most of these
firms in their living wills propose a resolution strategy that
is similar to the FDIC's single point of entry strategy that
they would use under Title 2.
Senator Warner. Right.
Ms. Yellen. In either case, it requires adequate long-term
debt. We are working jointly with the FDIC trying to figure out
the right parameters. We are working through the FSB. There is
a TLAC agreement. We want to see this globally. I promise to
get it done just as soon as we can. I am not going to let it--
--
Senator Warner. It sounds like--end of the year sounds like
a great time. But let me----
Ms. Yellen. I promise to make every effort to do so.
Senator Schumer. He has spoken.
[Laughter.]
Senator Warner. You know, one of the things that we have
seen--let us switch to kind of world monetary policy for a
moment. You know, as we see the Bank of Japan and the ECB
continue to deal with their currencies, which indirectly
obviously makes their products cheaper, our products more
expensive, do you worry at all that the actions of these other
central banks are putting even more undue pressure on America
to be the engine that drives and affects the whole world's
economy because of their monetary policy actions?
Ms. Yellen. Well, monetary policy for domestic purposes
often has some impact on a country's exchange rate. So the fact
that we have a stronger economy, are likely to raise rates
sooner, and they are continuing to ease monetary policy, those
factors have tended to push up the dollar. That has tended to
create a drag for net exports and to diminish our growth
prospects, and that is something that affects the stance and
appropriate future stance of monetary policy.
Now, even taking all of that into account, the very
significant appreciation we have seen of the dollar, we need to
put that in the context of the overall strength in domestic
spending in the U.S. economy. Our committee concluded that even
taking that into account, the continuing drag there, we still
think the U.S. economy is going to grow and will probably
remain appropriate.
Senator Warner. But this will be a factor--and my time is
up.
Ms. Yellen. It is a factor----
Senator Warner. This will be a factor the FOMC will look at
since----
Ms. Yellen. Absolutely, always looking at----
Senator Warner. ----in effect, they are continuing to put
all these burdens on our country's economy to kind of carry the
whole world forward.
Ms. Yellen. It is a factor. We are constantly looking at
it. That is essentially what is happening.
Chairman Shelby. Before I recognize Senator Schumer, I
would like to clarify the record. The bill that was reported
out of here, our banking legislation, back in May does not
raise the threshold in Section 165 of Dodd-Frank to $500
billion, as a lot of people think. In fact, the legislation
keeps the $50 billion threshold in place for all institutions
to be considered for enhanced prudential regulation and gives
the regulators--the Fed, generally--the discretion to determine
what institutions above $50 billion should be subject to it.
Banks above $500 billion would receive no such discretion. I
just wanted to clear the record on this.
Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman----
Senator Brown. Could I speak for a moment?
Chairman Shelby. Yes, sir, Senator Brown.
Senator Brown. While the Chairman technically is correct,
the difficulty for FSOC designation was made much greater, so
the--I believe that what Senator Warren said is correct, that
it does not protect the safety and soundness of our--that
legislation can threaten the safety and soundness of our
banking system. I will leave it at that, and we can debate this
for a long time.
Chairman Shelby. We will.
[Laughter.]
Chairman Shelby. Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman.
Chairman Shelby. Thank you for your----
Senator Schumer. No problem. Thank you. And thank you,
Chairman.
As you stated in your testimony, the FOMC will likely look
to raise the Federal funds rate at some point before the end of
the year, and you and the others on the FOMC must ultimately
make this decision, weighing all the information at your
disposal. I understand that.
But as we have discussed previously, I am still troubled by
sluggish wage growth in America. Along with tepid wage growth,
we continue to see depressed labor force participation,
inflation continues to run well below the 2-percent target. So
I am left to question whether there is still significant slack
in the labor market.
Views may differ here. I have heard from experts on both
sides. But I refuse to let the loud voices of those screaming
for the Fed to act to drown out the voices of middle-class
working families who continue to wait quietly for economic
recovery to show up in their take-home pay. And so the question
of when the Fed will raise rates has received a lot of
attention, but as I have said before, I believe the single
biggest problem facing this country is the decline of middle-
class income. And as you know, middle-class incomes have
decreased by 6.5 percent. Median income adjusted for inflation
is $3,600 lower than when President Bush took office.
So my question is a simple one: What more can be done? How
can we create better individuals to increase productivity? What
do you see as critical catalysts for stronger wage growth?
Because it almost seems we are pushing on a wet noodle?
Ms. Yellen. Well, we have seen structural forces over a
long period of time push down on middle-class wages, and the
economic research that has been done suggests a continuing high
demand for skilled labor and declining demand for less skilled
labor. We see an increasing wage gap between those who are more
skilled and less skilled, partly reflecting the nature of
technological change and globalization. And productivity
growth, as you mentioned, has certainly slowed down since 2007.
We point this out in the Monetary Policy Report. It has been
decidedly slower than before that. And I think it is important
to focus on policies that would improve productivity growth.
They have to do with making sure that every American child is
able to get a really world-class education and is really able
to succeed in this economy, and that we take actions to promote
innovation and entrepreneurship and capital investment, both
public and private, that are necessary to drive innovation.
I think those are the kinds of policies that Congress and
the public need to consider to address these. These are deeper
structural trends that are not just related to the cyclical
state of the economy, and they have been around for a long
time, and it is appropriate----
Senator Schumer. And there is certainly a limit what
monetary policy----
Ms. Yellen. There is.
Senator Schumer. We understand that. But here we are facing
sequestration here in the Congress, and current spending bills
proposed by my colleagues on the other side of the aisle would
slash funding for key resources--supplemental opportunity
grants, Pell grants, $300 million from employment and job
training programs, cuts to education. These are the kinds of
programs you mentioned in part as catalysts to stronger wage
growth. So I do not want you to weigh in on specific programs.
Obviously, that is not your job. But let me ask you this: As we
look toward the end of the year, can you talk about the broader
impact to our economic recovery that drastic, automatically
triggered budget cuts may have as well as the potential for a
Government shutdown and the uncertainty surrounding the debt
ceiling? Do you believe these events could create fiscal
headwinds for our recovery?
Ms. Yellen. Well, in recent years, fiscal policy has gone
from creating a significant drag on the economy to being
roughly neutral, and that shift in a favorable direction I
think has helped to promote economic recovery. So I would be
concerned about something that was a large fiscal shift. I do
not know whether or not this would be. But policies or
governmental actions that create uncertainty, whether it is a
Government shutdown or running up against the debt ceiling,
that reduce the confidence of households and businesses on the
ability of their Government to function in an effective way and
create fear and loss of confidence obviously are not helpful to
recovery.
Senator Schumer. And just getting to the wage growth
conundrum, wouldn't cutting education and cutting training
programs that make workers more able to be productive be
counter to that?
Ms. Yellen. So I do not want to, as you indicated, weigh in
on specific programs, but I do think that education programs,
programs to promote training and skills acquisition are very
critical in addressing wage inequality.
Senator Schumer. Thank you.
Thank you, Mr. Chairman.
Chairman Shelby. Madam Chair, we thank you again for your
appearance and your willingness to come, and we hope we can
work with you on some of the proposed legislation because I
think there are some misperceptions of what we are trying to
do. We are trying to give you a lot of power--you already have
a lot of power--and some discretion, but none of us wants to
weaken the banking system.
Thank you.
Ms. Yellen. Thank you, Chair Shelby. I look forward to
working with you and the Committee.
Chairman Shelby. Thank you. This hearing is adjourned.
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF JANET L. YELLEN
Chair, Board of Governors of the Federal Reserve System
July 16, 2015
Chairman Shelby, Ranking Member Brown, and Members of the
Committee, I am pleased to present the Federal Reserve's semiannual
Monetary Policy Report to the Congress. In my remarks today, I will
discuss the current economic situation and outlook before turning to
monetary policy.
Current Economic Situation and Outlook
Since my appearance before this Committee in February, the economy
has made further progress toward the Federal Reserve's objective of
maximum employment, while inflation has continued to run below the
level that the Federal Open Market Committee (FOMC) judges to be most
consistent over the longer run with the Federal Reserve's statutory
mandate to promote maximum employment and price stability.
In the labor market, the unemployment rate now stands at 5.3
percent, slightly below its level at the end of last year and down more
than 4\1/2\ percentage points from its 10 percent peak in late 2009.
Meanwhile, monthly gains in nonfarm payroll employment averaged about
210,000 over the first half of this year, somewhat less than the robust
260,000 average seen in 2014 but still sufficient to bring the total
increase in employment since its trough to more than 12 million jobs.
Other measures of job market health are also trending in the right
direction, with noticeable declines over the past year in the number of
people suffering long-term unemployment and in the numbers working part
time who would prefer full-time employment. However, these measures--as
well as the unemployment rate--continue to indicate that there is still
some slack in labor markets. For example, too many people are not
searching for a job but would likely do so if the labor market was
stronger. And, although there are tentative signs that wage growth has
picked up, it continues to be relatively subdued, consistent with other
indications of slack. Thus, while labor market conditions have improved
substantially, they are, in the FOMC's judgment, not yet consistent
with maximum employment.
Even as the labor market was improving, domestic spending and
production softened notably during the first half of this year. Real
gross domestic product (GDP) is now estimated to have been little
changed in the first quarter after having risen at an average annual
rate of 3\1/2\ percent over the second half of last year, and
industrial production has declined a bit, on balance, since the turn of
the year. While these developments bear watching, some of this
sluggishness seems to be the result of transitory factors, including
unusually severe winter weather, labor disruptions at West Coast ports,
and statistical noise. The available data suggest a moderate pace of
GDP growth in the second quarter as these influences dissipate.
Notably, consumer spending has picked up, and sales of motor vehicles
in May and June were strong, suggesting that many households have both
the wherewithal and the confidence to purchase big-ticket items. In
addition, homebuilding has picked up somewhat lately, although the
demand for housing is still being restrained by limited availability of
mortgage loans to many potential homebuyers. Business investment has
been soft this year, partly reflecting the plunge in oil drilling. And
net exports are being held down by weak economic growth in several of
our major trading partners and the appreciation of the dollar.
Looking forward, prospects are favorable for further improvement in
the U.S. labor market and the economy more broadly. Low oil prices and
ongoing employment gains should continue to bolster consumer spending,
financial conditions generally remain supportive of growth, and the
highly accommodative monetary policies abroad should work to strengthen
global growth. In addition, some of the headwinds restraining economic
growth, including the effects of dollar appreciation on net exports and
the effect of lower oil prices on capital spending, should diminish
over time. As a result, the FOMC expects U.S. GDP growth to strengthen
over the remainder of this year and the unemployment rate to decline
gradually.
As always, however, there are some uncertainties in the economic
outlook. Foreign developments, in particular, pose some risks to U.S.
growth. Most notably, although the recovery in the euro area appears to
have gained a firmer footing, the situation in Greece remains
difficult. And China continues to grapple with the challenges posed by
high debt, weak property markets, and volatile financial conditions.
But economic growth abroad could also pick up more quickly than
observers generally anticipate, providing additional support for U.S.
economic activity. The U.S. economy also might snap back more quickly
as the transitory influences holding down first-half growth fade and
the boost to consumer spending from low oil prices shows through more
definitively.
As I noted earlier, inflation continues to run below the
Committee's 2-percent objective, with the personal consumption
expenditures (PCE) price index up only \1/4\ percent over the 12 months
ending in May and the core index, which excludes the volatile food and
energy components, up only 1\1/4\ percent over the same period. To a
significant extent, the recent low readings on total PCE inflation
reflect influences that are likely to be transitory, particularly the
earlier steep declines in oil prices and in the prices of non-energy
imported goods. Indeed, energy prices appear to have stabilized
recently.
Although monthly inflation readings have firmed lately, the 12-
month change in the PCE price index is likely to remain near its recent
low level in the near term. My colleagues and I continue to expect that
as the effects of these transitory factors dissipate and as the labor
market improves further, inflation will move gradually back toward our
2-percent objective over the medium term. Market-based measures of
inflation compensation remain low--although they have risen some from
their levels earlier this year--and survey-based measures of longer-
term inflation expectations have remained stable. The Committee will
continue to monitor inflation developments carefully.
Monetary Policy
Regarding monetary policy, the FOMC conducts policy to promote
maximum employment and price stability, as required by our statutory
mandate from the Congress. Given the economic situation that I just
described, the Committee has judged that a high degree of monetary
policy accommodation remains appropriate. Consistent with that
assessment, we have continued to maintain the target range for the
Federal funds rate at 0 to \1/4\ percent and have kept the Federal
Reserve's holdings of longer-term securities at their current elevated
level to help maintain accommodative financial conditions.
In its most recent statement, the FOMC again noted that it judged
it would be appropriate to raise the target range for the Federal funds
rate when it has seen further improvement in the labor market and is
reasonably confident that inflation will move back to its 2-percent
objective over the medium term. The Committee will determine the timing
of the initial increase in the Federal funds rate on a meeting-by-
meeting basis, depending on its assessment of realized and expected
progress toward its objectives of maximum employment and 2-percent
inflation. If the economy evolves as we expect, economic conditions
likely would make it appropriate at some point this year to raise the
Federal funds rate target, thereby beginning to normalize the stance of
monetary policy. Indeed, most participants in June projected that an
increase in the Federal funds target range would likely become
appropriate before year-end. But let me emphasize again that these are
projections based on the anticipated path of the economy, not
statements of intent to raise rates at any particular time.
A decision by the Committee to raise its target range for the
Federal funds rate will signal how much progress the economy has made
in healing from the trauma of the financial crisis. That said, the
importance of the initial step to raise the Federal funds rate target
should not be overemphasized. What matters for financial conditions and
the broader economy is the entire expected path of interest rates, not
any particular move, including the initial increase, in the Federal
funds rate. Indeed, the stance of monetary policy will likely remain
highly accommodative for quite some time after the first increase in
the Federal funds rate in order to support continued progress toward
our objectives of maximum employment and 2-percent inflation. In the
projections prepared for our June meeting, most FOMC participants
anticipated that economic conditions would evolve over time in a way
that will warrant gradual increases in the Federal funds rate as the
headwinds that still restrain real activity continue to diminish and
inflation rises. Of course, if the expansion proves to be more vigorous
than currently anticipated and inflation moves higher than expected,
then the appropriate path would likely follow a higher and steeper
trajectory; conversely, if conditions were to prove weaker, then the
appropriate trajectory would be lower and less steep than currently
projected. As always, we will regularly reassess what level of the
Federal funds rate is consistent with achieving and maintaining the
Committee's dual mandate.
I would also like to note that the Federal Reserve has continued to
refine its operational plans pertaining to the deployment of our
various policy tools when the Committee judges it appropriate to begin
normalizing the stance of policy. Last fall, the Committee issued a
detailed statement concerning its plans for policy normalization and,
over the past few months, we have announced a number of additional
details regarding the approach the Committee intends to use when it
decides to raise the target range for the Federal funds rate.
Federal Reserve Transparency and Accountability
These statements pertaining to policy normalization constitute
recent examples of the many steps the Federal Reserve has taken over
the years to improve our public communications concerning monetary
policy. As this Committee well knows, the Board has for many years
delivered an extensive report on monetary policy and economic
developments at semiannual hearings such as this one. And the FOMC has
long announced its monetary policy decisions by issuing statements
shortly after its meetings, followed by minutes of its meetings with a
full account of policy discussions and, with an appropriate lag,
complete meeting transcripts. Innovations in recent years have included
quarterly press conferences and the quarterly release of FOMC
participants' projections for economic growth, unemployment, inflation,
and the appropriate path for the Committee's interest rate target. In
addition, the Committee adopted a statement in 2012 concerning its
longer-run goals and monetary policy strategy that included a specific
2-percent longer-run objective for inflation and a commitment to follow
a balanced approach in pursuing our mandated goals.
Transparency concerning the Federal Reserve's conduct of monetary
policy is desirable because better public understanding enhances the
effectiveness of policy. More important, however, is that transparent
communications reflect the Federal Reserve's commitment to
accountability within our democratic system of Government. Our various
communications tools are important means of implementing monetary
policy and have many technical elements. Each step forward in our
communications practices has been taken with the goal of enhancing the
effectiveness of monetary policy and avoiding unintended consequences.
Effective communication is also crucial to ensuring that the Federal
Reserve remains accountable, but measures that affect the ability of
policymakers to make decisions about monetary policy free of short-term
political pressure, in the name of transparency, should be avoided.
The Federal Reserve ranks among the most transparent central banks.
We publish a summary of our balance sheet every week. Our financial
statements are audited annually by an outside auditor and made public.
Every security we hold is listed on the Web site of the Federal Reserve
Bank of New York. And, in conformance with the Dodd-Frank Act,
transaction-level data on all of our lending--including the identity of
borrowers and the amounts borrowed--are published with a 2-year lag.
Efforts to further increase transparency, no matter how well
intentioned, must avoid unintended consequences that could undermine
the Federal Reserve's ability to make policy in the long-run best
interest of American families and businesses.
Summary
In sum, since the February 2015 Monetary Policy Report, we have
seen, despite the soft patch in economic activity in the first quarter,
that the labor market has continued to show progress toward our
objective of maximum employment. Inflation has continued to run below
our longer-run objective, but we believe transitory factors have played
a major role. We continue to anticipate that it will be appropriate to
raise the target range for the Federal funds rate when the Committee
has seen further improvement in the labor market and is reasonably
confident that inflation will move back to its 2-percent objective over
the medium term. As always, the Federal Reserve remains committed to
employing its tools to best promote the attainment of its dual mandate.
Thank you. I would be pleased to take your questions.
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN SHELBY
FROM JANET L. YELLEN
Q.1. Many economists have proposed that the Federal Reserve
should adopt a strategy of targeting the growth rate of nominal
GDP, which would create a countercyclical monetary policy to
offset booms and downturns in the economy while also reducing
uncertainty.
Does the Federal Open Market Committee (FOMC) consider the
rate of nominal GDP growth as a priority in its monetary policy
decisions?
A.1. The Federal Reserve's mandate, as established by Congress
in the Federal Reserve Act, is ``to promote effectively the
goals of maximum employment, stable prices, and moderate long-
term interest rates.'' \1\ To assess progress toward these
statutory objectives, the FOMC considers information about a
wide range of variables, including the rate of nominal GDP
growth. This information encompasses indicators of inflation
pressures, measures of labor market conditions and real
economic activity, and readings on financial and international
developments. Nominal GDP growth, by itself, does not give a
complete picture of the economy's performance; moderate nominal
GDP growth could reflect, for example, strong growth of real
economic activity with low inflation, or weak economic growth
with high inflation.
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\1\ The FOMC judges that moderate longer-term interest rates would
follow if the Federal Reserve achieves its objectives of maximum
employment and stable prices; hence the FOMC often refers to its
statutory objectives as the ``dual mandate.'' The FOMC also judges that
inflation at the rate of 2 percent, as measured by the annual change in
the price index for personal consumption expenditures, is most
consistent over the longer run with the Federal Reserve's statutory
mandate. In setting monetary policy, the FOMC seeks to mitigate
deviations of inflation from this 2 percent longer-run goal and
deviations of employment from the committee's assessments of its
maximum level. See Board of Governors (2015), ``Statement on Longer-Run
Goals and Monetary Policy Strategy'', press release, January 27, http:/
/www.federalreserve.gov/monetarypolicy/files/FOMC_LongerRunGoals.pdf.
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Q.2. Could the FOMC adopt a strategy of targeting nominal GDP?
A.2. While, conceptually, the FOMC could adopt a strategy of
targeting nominal GDP, there are a number considerations
regarding the satisfaction of the Federal Reserve's statutory
objectives and the balance of prospective benefits and costs
that such strategy would entail relative to other policy
frameworks.
The expression ``nominal GDP targeting'' has been used to
refer to two distinct policy strategies. First, a central bank
could target the growth rate of nominal GDP. \2\ As pointed out
by Bernanke and Mishkin (1997), and as illustrated by the
international experience, modern inflation targeting frameworks
generally allow policymakers ample flexibility to stabilize
economic activity in the near term or to look beyond transitory
movements in inflation due to swings in global energy and trade
prices. The research literature suggests that the macroeconomic
outcomes achieved by central banks pursuing an inflation
objective tend to be similar to those they would have achieved
had they targeted the growth rate of nominal GDP. \3\ Second,
nominal GDP targeting can be understood as a monetary policy
strategy in which the central bank seeks to stabilize the level
of nominal GDP around a preannounced trend path in order to
achieve its longer-run statutory objectives.
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\2\ For early arguments in favor of targeting the growth rate of
nominal GDP, see Taylor (1985), ``What Would Nominal GDP Targeting Do
to the Business Cycle?'' Carnegie-Rochester Conference Series on Public
Policy, Amsterdam: North-Holland, vol. 22, pp. 61-84.
\3\ See Ben S. Bernanke and Frederic S. Mishkin (1997),
``Inflation Targeting: A New Framework for Monetary Policy?'' Journal
of Economic Perspectives, vol. 11(2), pp. 97-116. For arguments that
policymakers under inflation targeting regimes afforded considerable
flexibility to respond to the slump in output during the financial
crisis, see Ben S. Bernanke (2011), ``The Effects of the Great
Recession on Central Bank Doctrine and Practice'', speech delivered at
Federal Reserve Bank of Boston 56th Economic Conference, Boston,
Massachusetts, October 18.
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Because the difference between nominal GDP and its targeted
value can be expressed as the sum of a price gap and a real
activity gap, nominal GDP targeting recognizes, albeit
imperfectly, elements on both sides of the FOMC's dual mandate.
\4\ At least in theory, monetary policy that targets nominal
GDP can help correct the effects of aggregate demand shocks on
both real GDP and the price level. For instance, under nominal
GDP level targeting, the central bank would respond to a
shortfall in the level of nominal GDP by easing monetary policy
to generate a period of above-trend nominal GDP growth in order
to bring nominal GDP back to the original trend path; that
policy easing would increase both real activity and the price
level. A credible expectation that monetary policy will be
accommodative in the future, in turn, helps to mitigate the
initial fall in output and inflation. The theoretical benefits
of targeting the level of nominal GDP hinge on the credibility
of the promise to stimulate the economy down the road, the
public's ability to form accurate expectations of the policy
response and its effects, and, more generally, the public's
understanding of the way the economy operates and interacts
with monetary policy.
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\4\ Output prices cover a broader set of goods and services prices
than the index of personal consumption expenditures that the FOMC uses
to assess progress toward its longer-run inflation objective. Moreover,
the real activity gap is only imperfectly related to the gap between
employment and the statutory goal of maximum employment.
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There are, however, some important practical considerations
with the pursuit of nominal GDP targeting. First, when faced
with a very large fall in nominal GDP, as occurred during the
2008-2009 recession, a central bank committed to a nominal GDP
target would promise to eventually lower the unemployment rate
well below the natural rate of unemployment and to raise
inflation above its longer-run average for some time in order
to lift nominal GDP back to its targeted level. When that
promise comes due, it is not obvious that the central bank and
the public would judge that running the economy that hot--
possibly over a period of several years after the initial shock
has come to pass--is desirable. \5\
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\5\ This phenomenon is known as the time-consistency problem. It
arises because the benefits of nominal GDP targeting are frontloaded
whereas the costs are postponed and can be avoided by reneging on the
promise.
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Second, if the central bank is intent on delivering the
promised period of very low unemployment and temporarily high
inflation, there can be risks to the potency and credibility of
monetary policy from adverse movements in expectations. Once
resource slack has been reabsorbed, the maintenance of monetary
conditions that are sufficiently accommodative to lift
inflation above the longer-run objective could be
misinterpreted by the public as evidence that the central bank
is not committed to its price stability mandate, thus
heightening the risk that longer-run inflation expectations
could become unanchored.
Third, data on nominal GDP are not available as timely and
frequently as, say, data on inflation and the unemployment
rate. Moreover, nominal GDP data are subject to revisions,
which can be large and occur several quarters or even years
after the release of the initial estimates. These revisions
directly alter the size of the gap between current nominal GDP
and its targeted level, and so might call for a change in the
stance of monetary policy even if the public perceives economic
conditions as unchanged. Furthermore, nominal GDP is influenced
by a number of nonmonetary factors such as population growth,
the labor force participation rate, the pace of technological
advances, and measurement issues such as price adjustments for
quality changes. Innovations to these nonmonetary factors
affect the price level or inflation rate that is consistent
with the achievement of a given nominal GDP target. \6\ For all
these reasons, the demands on the public's attention and
comprehension imposed by nominal GDP targeting are arguably
nontrivial.
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\6\ Given a fixed nominal GDP target, volatility in these
nonmonetary factors thus directly translates into volatility in the
level of inflation consistent with achieving the target. This
volatility could conflict with the Federal Reserve's statutory mandate
of promoting ``stable prices.'' To be sure, the FOMC could offset the
effects on inflation of movements in these nonmonetary factors by
adjusting the nominal GDP target. However, occasional adjustments to
the target could create some communication challenges.
Q.3. A recent report from the Bank of International Settlements
(BIS) found that the prolonged period of low interest rates is
damaging the U.S. economy, resulting in ``too much debt and too
little growth.'' In addition, the report states that ``low
rates may in part have contributed to . . . costly financial
booms and busts.'' Do you agree with the BIS that persistently
low interest rates can have negative effects on the U.S.
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economy? Please explain.
A.3. The accommodative monetary policy of the Federal Reserve
is designed to fulfill the dual mandates of maximum employment
and price stability set for us by the Congress. In particular,
low interest rates are currently needed to provide support for
a return to full employment and for inflation to return to the
FOMC's longer run objective over time. When the economy has
strengthened, interest rates will rise in a sustainable way. In
particular, the FOMC has indicated that it anticipates that it
will be appropriate to raise the target range for the Federal
funds rate when it has seen some further improvement in the
labor market and is reasonably confident that inflation will
move back to its 2-percent objective over the medium term.
However, the Federal Reserve is also mindful that a
prolonged period of low rates could encourage imprudent risk
taking by some investors and eventually undermine financial
stability, with negative effects on the U.S. economy. For this
reason, the Federal Reserve, on its own and with other domestic
and international regulators, has taken steps to boost the
resilience of the financial system and has increased its
efforts to comprehensively monitor the financial system for
building vulnerabilities and to guide actions to mitigate those
risks.
Q.4. In your previous testimony before this Committee on
February 24th, you stated that in the FOMC's monetary policy
decisionmaking process, ``it is useful for us to consult the
recommendations of rules of the Taylor type. We do so
routinely, and they are an important input into what ultimately
is a decision that requires sound judgment.''
Which monetary policy rules are used by the FOMC?
A.4. The FOMC treats the prescriptions of monetary policy rules
as useful benchmarks for setting the Federal funds rate.
Accordingly, ahead of every FOMC meeting, Federal Reserve staff
prepare a discussion of policy prescriptions from several
policy rules for the committee's consideration. For example,
the most recent staff briefing materials that are available to
the public, which cover FOMC meetings in 2009, considered
prescriptions from the following five simple rules: the
canonical Taylor (1993) rule, the Taylor (1999) rule, a first-
difference rule, an empirical rule approximating past FOMC
behavior, and an estimated forecast-based rule. Those materials
also discussed ``optimal control'' policy prescriptions, which
are simulations of the path for the Federal funds rate that
delivers the best macroeconomic outcomes given the Federal
Reserve staffs baseline economic outlook and a ``loss
function'' that considers larger deviations of real GDP from
the level consistent with full employment to be appreciably
more costly than smaller deviations, and similarly for
deviations of inflation from the longer-run objective and for
volatility in the Federal funds rate. \7\ In addition, FOMC
discussion of monetary policy rules is informed by in-depth
technical memos and working papers that are periodically
prepared by Federal Reserve staff, as well as by contributions
from the academic literature. \8\
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\7\ For an example of policy prescriptions from simple rules and
optimal control exercises, along with a discussion of how they inform
policy, see Janet Yellen (2012), ``Perspectives on Monetary Policy'',
speech delivered at the Boston Economic Club Dinner, Boston,
Massachusetts, June 6. Complete model code of the Federal Reserve's
FRB/US model and illustrative simulation programs, including sample
code for optimal control policy, are publicly available on the Federal
Reserve's Web site.
\8\ Some of the staff's technical analysis reviewed by FOMC
participants may be made public in the form of technical working
papers, staff notes, and publications in academic journals. For an
illustration of in-depth staff analysis using simple policy rules,
including nominal GDP targeting rules, see William B. English, David
Lopez-Salido, and Robert J. Tetlow, ``The Federal Reserve's Framework
for Monetary Policy: Recent Changes and New Questions'', IMF Economic
Review, vol. 63(1), pp. 22-70.
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The FOMC considers the prescriptions of a variety of
monetary policy rules because no single rule has been shown to
be fully satisfactory given the complexity of the economy and
constantly evolving economic relationships. Many studies have
shown that in normal times, when the economy is buffeted by
typical shocks, simple rules can deliver outcomes that are
close to those under optimal policies. However, the simple
rules that perform well under ordinary circumstances may
disappoint during periods of, say, persistently strong
headwinds restraining recovery. \9\ Moreover, simple rules that
perform well in some economic environments may perform poorly
when economic relationships are unstable, because such rules do
not quickly adapt to changes in potential output growth or fail
to incorporate financial stability concerns in times of crisis.
\10\
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\9\ For a discussion and an illustration of the shortcomings of
simple Taylor-type rules in the wake of the Great Recession, see Janet
Yellen (2012), ``Revolution and Evolution in Central Bank
Communications'', speech delivered at the Haas School of Business,
University of California, Berkeley, Berkeley, California, November 13.
\10\ For studies of rule robustness, see, among others, John B.
Taylor and John C. William (2011), ``Simple and Robust Rules for
Monetary Policy'', in John C. Williams, Benjamin Friedman, and Michael
Woodford (Eds.), Handbook of Monetary Economics, vol. 3, pp. 829-859.
Q.5. Please submit to us a list of each rule discussed by the
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FOMC at its most recent meeting.
A.5. Please see response to Question 4.
Q.6. Federal Reserve officials have stated that the Federal
Reserve's practice of paying interest on banks' reserve
balances has become an important tool of monetary policy. If
that is the case, should this rate be set by the FOMC, which is
responsible for monetary policy, rather than by the Federal
Reserve Board of Governors? Please explain.
A.6. By statute, both the Federal Reserve and FOMC play
important roles in the conduct of monetary policy, with the
Federal Reserve being responsible for some policy tools and the
FOMC being responsible for the others. The Federal Reserve and
FOMC have worked collaboratively for decades to employ these
policy tools in concert to effectively promote the Federal
Reserve's long-run goals of maximum employment and stable
prices.
Under the Federal Reserve Act, the Federal Reserve has
authority over changes in reserve requirements and on interest
on reserves. In addition, any change in the discount rate
initiated by a Federal Reserve Bank is subject to review and
determination by the Federal Reserve. Reserve requirements and
the discount rate have been employed for many years as key
elements of the framework that the FOMC has relied upon in
managing the level of the Federal funds rate.
The interest rate paid on banks' reserve balances is an
important new tool of monetary policy that is determined by the
Federal Reserve. Following the examples of the discount rate
and reserve requirements, the Federal Reserve has indicated
that the interest on excess reserves rate will be set in a way
to keep the Federal funds rate in the range established by the
FOMC. Indeed, the FOMC noted in its September 2014 Policy
Normalization Principles and Plans that the Federal Reserve
intends to move the Federal funds rate into the target range
set by the FOMC primarily by adjusting the interest rate it
pays on excess reserve balances. The collaborative approach to
monetary policy implementation to achieve overall monetary
policy objectives was reiterated in the June 2015 FOMC meeting
minutes, which noted that operational decisions regarding
policy tools will be made in concert by the Federal Reserve and
the FOMC.
Q.7. A Federal judge recently ruled in Starr International Co.
v. U.S. that the actions in the bailout of AIG were beyond the
authority of the Federal Reserve since ``Section 13(3) did not
authorize the Federal Reserve Bank to acquire a borrower's
equity as consideration for the loan.'' The Board of Governors
responded in a press release that its ``actions in the AIG
rescue during the height of the financial crisis in 2008 were
legal, proper and effective.''
Did the Federal Reserve conduct a legal analysis to reach
this conclusion?
A.7. A comprehensive legal analysis supporting the conclusion
that the Federal Reserve's actions in the American
International Group (AIG) rescue were consistent with all
applicable laws can be found in the United States' Post-Trial
Brief in the Starr International court case, filed on March 23,
2015. Starr International Co. v. U.S., No. 11-779C, U.S. Court
of Federal Claims (Docket No. 434, pages 6-19). Attached is a
copy of that brief, along with two internal Federal Reserve
memoranda cited in it that relate to the issue of authority
(JX-13 and DX-484). Some other publicly available filings in
this case that also address the authority issue are Docket Nos.
55, 63, 248-1, 279, and 426; these can be found through the
Federal Judiciary's system, ``Public Access to Court's
Electronic Records'' or PACER, at www.pacer.gov. As you may be
aware, the Department of Justice has cross-appealed the Court
of Federal Claims decision in Starr, and we expect that the
issue of the Federal Reserve' s authority will be addressed by
the Federal Circuit.
Q.8. Please provide a copy of this analysis and all memoranda
and related documents.
A.8. Please see response to question 5a.
Q.9. Market-based indicators of future economic activity are
often more accurate than research-based predictions.
Does the FOMC use any market-based indicators (such as TIPS
spreads) in its monetary policy decisions?
A.9. The FOMC is firmly committed to fulfilling its statutory
mandate of promoting maximum employment and stable prices. The
FOMC recognizes that the inflation expectations of those who
set prices in the economy are an important determinant of the
behavior of actual inflation. Consequently, the FOMC monitors
both inflation expectations and the actual inflation rate in
setting monetary policy.
The FOMC follows various measures of inflation
expectations. One set of measures is based on financial
instruments whose payouts are linked to inflation. For example,
Treasury inflation protection securities (TIPS)--implied
inflation compensation (or the TIPS break even inflation rate)
is defined as the difference at comparable maturities between
yields on nominal Treasury securities and yields on Treasury
securities that are indexed to headline CPI inflation (or
TIPS). Inflation swaps--contracts in which one party pays a
certain fixed amount in exchange--for cash flows that are
indexed to cumulative CPI inflation over some horizon--provide
alternative measures of inflation compensation. These market-
based measures provide information about market participants'
expectations of inflation. However, extracting that information
generally requires the application of economic theory and
statistical models because these market-based measures reflect
not only expected inflation, but also an inflation risk
premium--the compensation that holders of nominal securities
demand for bearing inflation risk--as well as other premiums
driven by liquidity differences and shifts in the relative
supply and demand of nominal versus inflation-indexed
securities. Staff in the Federal Reserve System maintain
several term structure models aimed at providing estimates of
the inflation expectations and risk premiums that make up
inflation compensation but results from those decompositions
are sensitive to model specification.
In addition, the FOMC monitors measures of inflation
expectations that are based on surveys of households, market
participants, and professional forecasters. These measures
elicit respondents' inflation expectations directly, although
survey participants are not necessarily the price setters in
the economy.
As none of available measures of inflation expectations is
perfect, staff in the Federal Reserve System keep track of a
wide array of such measures and continue their efforts to
develop deeper understanding of the measures' behavior.
Q.10. Does the Federal Reserve have the authority to create a
prediction market for economic indicators to help inform its
monetary policy decisions?
A.10. A predictions market is a market where investors purchase
financial contracts--futures or options for example--with real
funds and the contract payoffs depend on the outcome of events,
such as economic data releases or events. The Federal Reserve
Act does not expressly provide the Federal Reserve with
authority to establish and operate a predictions market. The
Federal Reserve has not considered whether it has inherent
authority or authority under other more general provisions of
law to establish and operate a predictions market.
From time to time, there have been private sector efforts
to create prediction markets for economic variables but they
have not attracted widespread interest from investors. Indeed,
some financial firms have experimented with running prediction
markets for major economic releases. This information was
useful in gauging market expectations ahead of economic
releases but those markets are no longer active.
More broadly, the Federal Reserve regularly reviews
information from financial markets to gauge market expectations
about economic variables such as inflation or the Federal funds
rate.
Q.11. If not, what clarification or authorization would be
necessary from Congress to assure the Federal Reserve that
predictions markets are an authorized tool for its economic
research?
A.11. As noted above, the Federal Reserve regularly reviews
financial data to gauge market participants' outlook for
economic variables such as inflation or the Federal funds rate.
If there were actively traded instruments based on other
economic variables, the Federal Reserve would use that
information for economic research and policy analysis as well.
The Federal Reserve is not requesting specific authority to
establish and operate a predictions market. In effect,
establishing a predictions market would amount to establishing
a futures and options exchange for special types of derivatives
contracts. This is an undertaking that would involve many
important operational and policy challenges for the Federal
Reserve. Perhaps more importantly, the fact that existing
futures and options exchanges and other large financial
institutions have been unable to launch successful financial
contracts of this type suggests that investor interest in such
instruments is limited.
Q.12. On July 20, 2015, the Federal Reserve finalized the G-SIB
surcharge proposal. The final rule adopts the proposed rule's
methodology to identify whether a bank holding company is a G-
SIB by considering the institution's size, interconnectedness,
substitutability, complexity, and cross-jurisdictional
activity. The final rule states that there ``is general global
consensus that each category included in the BCBS framework is
a contributor to the risk a banking organization poses to
financial stability.'' Please explain why the Federal Reserve
believes that this multifactor approach is an appropriate way
to measure systemic importance.
A.12. The Federal Reserve believes that the multifactor
approach used in the final G-SIB surcharge rule (final rule) is
appropriate because it closely aligns with the considerations
that the Federal Reserve may consider under section 165 of the
Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act). Section 165 of the Dodd-Frank Act (12 U.S.C.
5365) directs the Federal Reserve to implement enhanced
prudential standards for certain bank holdings companies and
nonbank financial companies. In prescribing more stringent
prudential standards, the Federal Reserve may differentiate
among companies on an individual basis or by category, capital
structure, riskiness, complexity, financial activities
(including the financial activities of their subsidiaries),
size, and any other risk-related factors that the Federal
Reserve deems appropriate. \11\ Similarly, the final rule takes
into account leverage, off-balance sheet exposures,
interconnectedness with significant financial counterparties,
the nature, scope, size, scale and mix of activities, degree of
regulation, and liabilities. Consistent with that requirement,
under the final rule, a firm's method 1 and method 2 scores are
calculated using a measure of each firm's nature, scope, size,
scale, concentration, interconnectedness, and mix of the
activities. Global systemically important bank holding company
(G-SIB) capital surcharges are established using these scores,
and G-SIBs with higher scores are subject to higher G-SIB
capital surcharges.
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\11\ 12 U.S.C. 5365(a)(2)(A).
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In addition, the Federal Reserve, along with other central
banks, informed and contributed to the preparation of the 2009
Report to the G20 Finance Ministers and Central Bank Governors,
titled ``Guidance to Assess the Systemic Importance of
Financial Institutions, Markets and Instruments: Initial
Considerations--Background Paper'' (available at http://
www.bis.org/publ/othp07b.pdf) by participating in a
comprehensive survey on what factors contribute to the
classification of systemic importance. This report identified
size, interconnectedness, substitutability, complexity, and
cross-jurisdictional activity as trends in countries'
assessments of systemic importance.
Q.13. It is my understanding that custodial banks have faced
increasing difficulty in accepting cash deposits from their
clients such as investment funds and institutional investors,
in part due to regulatory requirements that provide
disincentive for custodial banks to hold cash. Nonetheless,
custodial banks play an important role of handling cash for
investment funds and now face a multitude of regulations that
inhibit their core activities.
Please provide a copy of any analysis the Federal Reserve
has conducted to evaluate the impact of new regulations on
custody banks' ability to accept cash deposits.
Please provide a copy of each analysis conducted by the
Federal Reserve which considers the impact that such
regulations would have on a custody bank during times of
financial stress.
Please explain policy rationale for disincentivizing cash
holdings by custodial banks.
A.13. I will first respond to your last inquiry, then to the
first two. With regards to part (c), regulatory requirements
that have been established by the Federal Reserve since the
financial crisis are meant to address risks to which banking
organizations are exposed, including the risks associated with
funding in the form of cash deposits. The requirements were
designed to increase the resiliency of banking organizations,
enabling them to continue serving as financial intermediaries
for the U.S. financial system and as sources of credit to
households, businesses, State governments, and low-income,
minority, or underserved communities during times of stress.
The supplementary leverage ratio rule (SLR rule), which
requires internationally active banking organizations to hold
at least 3 percent of total leverage exposure in tier 1
capital, calculates total leverage exposure as the sum of
certain off-balance sheet items and all on-balance sheet
assets. \12\ The on-balance sheet portion does not take into
account the level of risk of each type of exposure and includes
cash. As designed, the SLR rule requires a banking organization
to hold a minimum amount of capital against on-balance sheet
assets and off-balance sheet exposures, regardless of the risk
associated with the individual exposures. This leverage
requirement is designed to recognize that the risk a banking
organization poses to the financial system is a factor of its
size as well as the composition of its assets. Excluding select
categories of on-balance sheet assets, such as cash, from the
total leverage exposure would generally be inconsistent with
this principle.
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\12\ See 79 FR 57725 (September 26, 2014), available at http://
www.gpo.gov/fdsys/pkg/FR-2014-09-26/pdf/2014-22083.pdf.
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Moreover, in some instances the regulatory requirements
regarding liquidity and liquidity risk management provide a
favorable treatment to specific types of cash deposits. For
example, the outflow rates for deposits under the Liquidity
Coverage Ratio: Liquidity Risk Management Standards rule (LCR
rule) are based on factors such as counterparty type and tenor.
\13\ Relevant to the activities of custodial banks, the LCR
rule provides favorable outflow treatment to operational
deposits because the LCR rule acknowledges that these types of
deposits exhibit a more stable funding profile than non-
operational funding. \14\ To be afforded this favorable
treatment, the deposits must meet a set of specific criteria
associated with such increased stability. \15\ In this way, the
LCR rule takes into account the risk that is inherent in the
particular type of deposit held at the bank.
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\13\ See 79 FR 61440 (October 10, 2014), available at http://
www.gpo.gov/fdsys/pkg/FR-2014-10-10/pdf/201422520.pdf.
\14\ See page 61502 of 79 FR 61440 (October 10, 2014), available
at http://www.gpo.gov/fdsys/pkg/FR-2014-1010/pdf/2014-22520.pdf.
\15\ See page 61498 of 79 FR 61440 (October 10, 2014), available
at: http://www.gpo.gov/fdsys/pkg/FR-2014-1010/pdf/2014-22520.pdf.
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With regard to parts (a) and (b) of Question 13, as part of
several rulemakings that are applicable to U.S. banking
organizations identified as global systemically important
banking organizations (G-SIBs), which includes the largest U.S.
custodial banking organizations, Federal Reserve staff
estimated the impact that such rulemakings would have on these
firms' regulatory capital ratios, including on the leverage
ratio.
For example, in April 2014, the Federal Reserve issued a
final rule that would require U.S. top-tier bank holding
companies identified as G-SIBs to maintain an SLR of more than
5 percent to avoid restrictions on capital distributions and
discretionary bonus payments to executive officers. \16\
Insured depository institutions of these BHCs must maintain at
least a 6 percent SLR to be ``well-capitalized'' under the
Federal banking agencies' prompt corrective action framework.
Prior to finalizing these requirements, the staff of the
Federal banking agencies, including the Federal Reserve,
analyzed regulatory and confidential supervisory data to
determine the quantitative impact of these rules on subject
firms. Federal Reserve staff estimated a tier 1 capital
shortfall across U.S. G-SIBs of approximately $68 billion to
meet a 5 percent SLR, but all internationally active banking
organizations firms were estimated to already meet the minimum
3 percent SLR requirement. \17\ The SLR rule requires public
disclosures beginning in 2015, and provides a transitional
period until January 1, 2018, for firms to comply with these
standards. According to their public disclosures, U.S. G-SIBs
have made significant progress in complying with the enhanced
SLR standards that take effect in 2018.
---------------------------------------------------------------------------
\16\ See 79 FR 24528 (May 1, 2014), available athttp://
www.gpo.gov/fdsys/pkg/FR-2014-05-0l/pdf/2014-09367.pdf.
\17\ See Staff memo to the Board ``Draft Final Rule on Enhanced
Supplementary Leverage Ratio (SLR) Standards''; p. 2, available at
http://www.federalreserve.gov/aboutthefed/boardmeetings/
20140408openmaterials.htm.
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As another example, more recently, in July 2015, the
Federal Reserve finalized a rule that would implement risk-
based capital surcharges for U.S. G-SIBs. \18\ Federal Reserve
staff estimated the capital surcharges that would apply to the
eight U.S. bank holding companies identified as G-SIBs under
the final rule. Based upon these estimates, seven of the eight
G-SIBs already meet their G-SIB surcharges on a fully phased-in
basis, and all such firms are on their way to meeting their
surcharges over the 3-year phase-in period from January 1,
2016, to fully phased in on January 1, 2019. Therefore, it is
likely that the immediate costs of the final rule on individual
institutions are significantly mitigated by the implementation
timeframe. \19\
---------------------------------------------------------------------------
\18\ See 80 FR 49107 (August 14, 2015), available at http://
www.gpo.gov/fdsys/pkg/FR-2015-08-14/pdf/201518702.pdf.
\19\ See Staff memo to the Board ``Draft Final Rule Regarding
Risk-Based Capital Surcharges for Systemically Important U.S. Bank
Holding Companies''; p. 9, available at http://www.federalreserve.gov/
aboutthefed/boardmeetings/board-memo-gsib-20150720.pdf.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM JANET L. YELLEN
Q.1. I submitted a question for the record at your last hearing
that focuses on the Federal Reserve's waiver authority under
the advanced approaches regulation. In the response, you noted
there were five criteria against which the Federal Reserve
would judge a waiver application. Please provide information on
how you define those criteria and how you would apply them.
A.1. As set forth in the advanced approaches risk-based capital
rule (the advanced approaches rule), the Board of Governors of
the Federal Reserve System (Board) may determine that the
application of the advanced approaches rule to a particular
firm is not appropriate in light of the firm's asset size,
level of complexity, risk profile, or scope of operations. \1\
Based on these criteria, the Board has exempted from, or
determined not to apply, the advanced approaches rule to two
State member banks, certain U.S. subsidiaries of foreign
banking organizations, and GE Capital Corporation (GECC).
---------------------------------------------------------------------------
\1\ 12 CFR 217.100(b)(2).
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Exemption for Two State Member Banks
The Board has exempted from the advanced approaches rule
two special purpose State member banks that were subsidiaries
of bank holding companies. \2\ In each case, the State member
bank was subject to the advanced approaches rule because the
parent bank holding company was subject to the advanced
approaches rule. Each of the banks had limited credit risk
because each engaged in a narrow range of deposit, loan, and
other banking services. One of the banks was a limited purpose
trust bank with no FDIC-insured deposits. The other bank
engaged primarily in back-office operations and maintained very
high capital levels. In addition, each bank's total assets
represented less than 1 percent of the total consolidated
assets of its bank holding company.
---------------------------------------------------------------------------
\2\ The advanced approaches rule applies to a State member bank
that has total consolidated assets equal to $250 billion or more, that
has consolidated total on-balance sheet foreign exposure equal to $10
billion or more, or that is a subsidiary of a holding company or
depository institution that is subject to the advanced approaches rule.
See 12 CFR 217.100(b)(1)(ii).
---------------------------------------------------------------------------
In exempting these banks from the advanced approaches rule,
the Board considered the limited activities and operations of
the banks, risks posed by the banks to the overall banking
organization, and the enterprise-wide risk-management practices
and ongoing implementation of the advanced approaches rule by
the holding company. After the Board granted the exemptions,
each of the bank holding companies continued to be required to
capture the risks of its subsidiary bank in its advanced
systems and to hold capital at the consolidated level against
these risks.
Certain U.S. Subsidiaries of Foreign Banking Organizations
The Board also has exempted certain U.S. subsidiaries of
foreign banking organizations from the requirements of the
advanced approaches rule. Under the enhanced prudential
standards regulation (Regulation YY, 12 CFR part 252), a
foreign banking organization with U.S. nonbranch assets of $50
billion or more is required to form or designate a U.S.
intermediate holding company (IHC) to hold its interests in its
U.S. subsidiaries. \3\ While an IHC is generally subject to the
same risk-based and leverage capital rules that apply to a bank
holding company, the IHC is not required to comply with the
Board's advanced approaches rule. \4\ Prior to IHC formation, a
bank holding company that is a subsidiary of a foreign banking
organization and that currently is subject to the advanced
approaches rules may, with the Board's prior written approval,
elect not to comply with the advanced approaches rule. \5\
---------------------------------------------------------------------------
\3\ See 12 CFR 252.153.
\4\ 12 CFR 252.153(e)(2)(i)(A).
\5\ 12 CFR 252.153(e)(2)(i)(C).
---------------------------------------------------------------------------
As with the exemptions for the two limited purpose State
member banks, the risks of the IHCs are captured in the
consolidated capital requirements and risk management systems
of its parent foreign banking organization. In addition, each
IHC will remain subject to the Board's standardized risk-based
capital rules, leverage capital rules, and capital planning and
supervisory stress testing requirements.
GECC
Section 165 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act generally requires the Board to apply
enhanced prudential standards, including risk-based capital
requirements, to nonbank financial companies supervised by the
Board. \6\ In the case of GECC, the Board applied the same
risk-based capital requirements that apply to bank holding
companies, except for the advanced approaches rule. \7\ In
particular, as noted in the Board's draft order applying
enhanced prudential standards to GECC, the advanced approaches
rule requires the development of models for calculating
advanced approaches risk-weighted assets, and can require a
lengthy parallel run period of no less than four consecutive
calendar quarters during which the firm must submit its models
for supervisory approval. \8\ While GECC exceeds the threshold
for application of the requirements that apply to advanced
approaches banking organizations, GECC had not previously been
subject to regulatory capital requirements and had not
developed the infrastructure and systems required to begin
calculating its capital ratios under the advanced approaches
rule. \9\ Moreover, GECC is undergoing a substantial
reorganization. The Board determined to apply to GECC the same
minimum capital requirements that apply to all bank holding
companies under the Board's Regulation Q (12 CFR part 217)
through December 31, 2017, and the Board's regulatory capital
framework applicable to advanced approaches banking
organizations, except for the advanced approaches rule,
thereafter unless GECC is no longer designated for Board
supervision at that time. \10\
---------------------------------------------------------------------------
\6\ 12 U.S.C. 5365.
\7\ 79 FR 71768, 71772 (Dec. 3, 2014).
\8\ Id. The Board referenced these considerations in the final
order applying enhanced prudential standards to GECC. See 80 FR 44111,
44117 (July 24, 2015).
\9\ 79 FR at 71772.
\10\ See 80 FR at 44125.
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Other Firms
In determining whether to apply the advanced approaches
rule to other firms, the Board would, in each case, make a
determination based on the relevant facts and circumstances,
consistent with the safety and soundness of the firm. As shown
in these examples, this would include, among other things,
consideration of the firm's size, complexity, risk profile, and
scope of operations, including its capacity to implement the
advanced approaches rule; a balancing of the cost to implement
advanced approaches systems against the added risk management
value; whether the firm's risks are captured by a parent
banking organization's systems; and other relevant facts.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM JANET L. YELLEN
Q.1. Ms. Yellen, is the Federal Reserve Board involved in
negotiating international insurance standards for entities
beyond those you supervise?
A.1. The Federal Reserve participates in the International
Association of lnsurance Supervisors (IAIS) as the supervisor
of nonbank systemically important financial institutions and
savings and loan holding companies with significant insurance
activities. Along with members from the Federal Insurance
Office and the National Association of lnsurance Commissioners,
we advocate for the development of international standards at
the IAIS that meet the needs of the our domestic insurance
market and consumers. Standards developed at the IAIS are not
self-executing, or binding on the U.S. insurance companies
unless adopted by the appropriate U.S. regulators in accordance
with applicable domestic laws and rulemaking procedures. The
IAIS standards could apply to entities that we do not supervise
if they were adopted as law or regulation by the appropriate
authorities in a particular jurisdiction. This is true of all
supervisors who participate at the IAIS since no insurance
supervisor has global authority.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HELLER
FROM JANET L. YELLEN
Q.1. During your July 15, 2015, testimony in the House
Committee on Financial Services you briefly indicated some
vagueness on the path forward regarding the development of
domestic insurance capital standards for companies in the
United States. On April 1, 2015, you wrote a letter to me
stating: ``we are committed to inviting public comment on a
draft proposal through a formal rulemaking process.'' I request
your confirmation that it is your final decision to develop
domestic insurance capital standards through formal rulemaking
and public comment and not by an order.
A.1. Thank you for the opportunity to clarify. The response
provided to you in my letter dated April 1, 2015, is accurate.
We are committed to a formal rulemaking process in the
development of a domestic insurance capital standard. Issuance
of a final rule will commence after we assess the feedback
given during the Notice of Proposed Rulemaking.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE
FROM JANET L. YELLEN
Q.1. In 2013, Senator Crapo asked then Chairman Bernanke to
list bipartisan financial regulatory reforms that Congress
should consider enacting. Bernanke responded by mentioning end-
user issues, the swaps push out, and regulatory relief for
small financial institutions. Certainly everyone can agree that
Dodd-Frank is not perfect. Can you list bipartisan financial
regulatory reforms that you believe Congress should enact?
A.1. The core Dodd-Frank Act and Basel III reforms have made
the global and U.S. financial systems more resilient. These
core reforms include much stronger capital requirements and
stress testing for large banking firms; strong liquidity
requirements for large banking firms; a new resolution regime
for systemically important financial institutions (SIFIs) and
improvements to the resolvability of SIFIs; central clearing
and margin requirements for over-the-counter derivatives; and
the creation of the Financial Stability Oversight Council.
I believe these reforms have made the financial system
significantly more stable, but we have more work to do. Some of
the remaining steps include: (i) finalization of a few
remaining Dodd-Frank Act reforms, such as swap margin rules and
single-counterparty credit limits for large bank holding
companies; implementation of the Net Stable Funding Ratio
(NSFR) in the United States to reduce risks from short-term
wholesale funding in our banking system; and continued
improvements to the resolvability of our largest and most
complex firms, including through issuance by the Board of a
long-term debt proposal and continuing work by the Board and
the FDIC to improve resolution planning by these firms.
The Board has supported targeted financial regulatory
reforms in the past few years, including amendments to the
Dodd-Frank Act provisions that address treatment of end users
in the swap margin rules and changes to the Collins Amendment
of the Dodd-Frank Act to better enable the Board to design
capital requirements for insurance holding companies as well as
provisions to expand the scope of coverage of our Small Bank
Holding Company Policy Statement. The Board continues to
support additional targeted relief for small banking
organizations, such as exempting banking firms with less than
$10 billion in assets from the Volcker rule and the incentive
compensation provisions of the Dodd-Frank Act. As I have
previously stated, I would also support a modest increase in
the $50 billion threshold in section 165 of the Dodd-Frank Act,
so long as such modest increase did not reduce the Board's
authority to apply an appropriate set of prudential standards
on any firms that fell below the new threshold.
Q.2. I'm very concerned about the troubling developments in
Greece, including their inability to keep their fiscal house in
order. Over the long-term horizon, are there parallels that
exist now or that could develop between the United States and
Greece that would trouble you? What steps could we take now to
prevent these parallels from developing?
A.2. Greece's current fiscal and economic situations are
difficult. However, there are no real parallels between Greece
and the United States. Greece's precarious fiscal position
prior to the crisis left it ill-equipped to use fiscal policy
to buffer the effects of the recession, which was particularly
problematic as Greece could not avail itself of its own
monetary policy because it is a member of the euro area. In
addition, its access to financial markets was hampered by a
lack of trust in Greek fiscal institutions. It is important to
note that Greece's troubles reflect much more than just its
fiscal position. In sum, the events in underscore the value of
sound structural policies, Government finances, and
macroeconomic institutions.
Q.3. My understanding is that the Financial Stability Board's
proposed methodologies for designating asset manager companies
and mutual funds as G-SIFIs, as proposed in the FSB's March
2015 report, ``Assessment Methodologies for Identifying Non-
Bank NonInsurer Global Systemically Important Financial
Institutions'' uses size thresholds that singles out only U.S.
entities. Is this true and is there a risk that designating
only U.S. entities would create competitiveness concerns for
the U.S.?
A.3. Under the March 2015 report of the Financial Stability
Board (FSB), materiality thresholds would be used to provide an
initial filter of nonbank, non-insurance (NBNI) entities that
would be subject to further analysis to determine whether such
entities should be designated as NBNI global systemically
important financial institutions (NBNI G-SIFls). Thus, while
NBNI entities that exceed the thresholds would be subject to
further analysis, they would not necessarily be designated as
NBNI G-SIFIs. It is important to note that none of the
thresholds are tied to a firm's place of domicile or
incorporation; an entity from any jurisdiction could qualify
for further analysis.
The March 2015 proposal described two possible materiality
thresholds that could be used exclusively or in combination to
evaluate asset management companies. Under the first option, an
asset manager would be subject to further assessment if its
balance sheet exceeded a particular threshold (e.g., $100
billion). Under the second option, an asset manager would be
subject to further assessment if it had more than a particular
amount of assets under management (e.g., $1 trillion).
Two possible materiality thresholders were also proposed
for traditional investment funds. Under the first option, a
traditional investment fund would be subject to further
assessment if (1) its net asset value (NAV) exceeded $30
billion and it had balance sheet leverage of three times NAV or
(2) the assets under management of the fund exceeded $100
billion. Under the second option, a traditional investment fund
would be subject to further analysis if its gross assets under
management exceeded $200 billion, unless it can be demonstrated
that the fund is not a dominant player in relevant markets.
On July 30, 2015, the FSB announced that it will wait to
finalize the assessment methodologies for NBNI G-SIFIs until
further work on financial stability risks from asset management
activities is completed. This will allow further analysis of
potential financial stability issues associated with asset
management entities and activities to inform the revised NBNI
methodology.
Q.4. I am concerned that international regulators do not
understand the unique aspects of our financial system. For
example, Basel III's capital framework severely limits the
amount of mortgage servicing asset banks can hold without
paying a significant capital charge. Many think it doesn't make
sense to draw such an arbitrary line, especially when it comes
at such a cost to community banks. Banks in my State tell me
that the Basel III negotiators ignored or failed to understand
the important role of community banks in the United States
financial system. That's cause for deep concern. Are there
areas where you believe the FSB has ignored or failed to
understand aspects of our U.S. financial system, for example in
Basel III's treatment of community banks?
A.4. The Federal Reserve recognizes the critical role community
banking organizations play in the U.S. economy, and the revised
regulatory capital rule (rule) puts in place a regulatory
regime that takes into account their business model and
economic function, as well as the reduced risks to U.S.
financial stability presented by community banks.
Prior to issuing the final rule, the agencies conducted a
pro forma impact analysis as of March 31, 2012. The analysis,
which incorporated the rule's revised treatment of mortgage
servicing assets (MSAs), indicated that more than 90 percent of
bank holding companies with assets under $10 billion that met
the existing capital requirements at the time would meet the
minimum common equity tier 1 (CET1) capital ratio of 4\1/2\
percent and that more than 80 percent of such bank holding
companies would meet the fully phased-in common equity plus
capital conservation buffer level of 7 percent. \1\ Based on
data publicly reported from these institutions on the
Consolidated Financial Statements for Holding Companies (FR Y-
9C), as of July 31, 2015, more than 95 percent of these bank
holding companies would exceed a 7 percent CET1 capital ratio.
\2\
---------------------------------------------------------------------------
\1\ See Attachment A ``FRB Impact, Methodology, and Assumptions''
to Michael S. Gibson's testimony on Basel III before the Committee on
Banking, Housing, and Urban Affairs on November 14, 2012, available at
http://www.federalreserve.gov/newsevents/testimony/
gibson20121l14a2.pdf. The final rule implementing the Regulatory
Capital Rules, 78 FR 62018 (October 11, 2013) is available at: http://
www.gpo.gov/fdsys/pkg/FR2013-11-29/pdf/2013-27082.pdf.
\2\ FR Y-9C data is publicly available from the National
Information Center, available at: http://www.ffiec.gov/nicpubweb/
nicweb/nichome.aspx.
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With regard to MSAs in particular, as noted in the preamble
to the final rule, the Federal banking agencies' capital rules
have long limited the inclusion of MSAs and other intangible
assets in regulatory capital. This is because of the high level
of uncertainty regarding the ability of banking organizations
to realize value from these assets, especially under adverse
financial conditions.
Under the final rule, certain deferred tax assets (DTAs)
arising from temporary differences, MSAs, and significant
investments in the capital of unconsolidated financial
institutions in the form of common stock are each subject to an
individual limit of 10 percent of CET1 capital elements and are
subject to an aggregate limit of 15 percent of CET1 capital
elements. The amount of these items in excess of the 10 and 15
percent thresholds are to be deducted from CET1 capital.
Amounts of MSAs, DTAs, and significant investments in
unconsolidated financial institutions that are not deducted due
to the aforementioned 10 and 15 percent thresholds must be
assigned to the 250 percent risk weight. \3\
---------------------------------------------------------------------------
\3\ See 79 FR 62018 (October 11, 2013), available at http://
www.gpo.gov/fdsys/pkg/FR-2013-11-29/pdf/201327082.pdf. See also ``Final
Rule on Enhanced Regulatory Capital Standards--Implications for
Community Banking Organizations'', available at http://www.gpo.gov/
fdsys/pkg/FR-2013-11-29/pdf/2013-27082.pdf.
---------------------------------------------------------------------------
The rule's treatment of MSAs contributes to the safety and
soundness of banking organizations by mitigating against MSA
market value fluctuations that may adversely affect banking
organizations' regulatory capital base.
Moreover, the financial crisis demonstrated that the
liquidity--in the form of sales, exchanges, or transfers--of
MSAs may become unreliable at a time when banking organizations
are especially in need of such liquidity. Furthermore, the
Federal Deposit Insurance Corporation, as receiver of failed
insured depository institutions, has generally found MSAs to be
unmarketable during periods of adverse economic and financial
conditions for a variety of reasons related to the size of the
mortgage portfolio and contingent liabilities arising from
selling representations and warranties associated with MSAs.
\4\
---------------------------------------------------------------------------
\4\ See 79 FR 62018 (October 11, 2013), available at http://
www.gpo.gov/fdsys/pkg/FR-2013-11-29/pdf/201327082.pdf.
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The Federal Reserve is mindful of community banking
organizations' concerns about aggregate regulatory burden,
including both safety and soundness and consumer regulation. In
that regard, several elements of the revised capital rule only
apply to large banking organizations and do not apply to
community banking organizations. Specifically, banking
organizations that qualify as advanced approaches Board-
regulated institutions (those with $250 billion or more in
consolidated total assets or $10 billion or more in
consolidated total on-balance-sheet foreign exposures) are
subject to the countercyclical capital buffer, supplementary
leverage ratio, capital requirements for credit valuation
adjustments, and disclosure requirements. \5\ Banking
organizations with trading assets and liabilities of at least
$1 billion or 10 percent of its total assets are subject to
market risk capital requirements. \6\ Community banking
organizations also are not subject to the enhanced standards
that larger bank holding companies face related to capital
plans, stress testing, liquidity and risk management
requirements, and the global systemically important banking
organization surcharge. In addition, consistent with recent
statutory changes, the Federal Reserve expanded the
applicability of its Small Bank Holding Company Policy
Statement, which has the effect of exempting virtually all bank
holding companies and savings and loan holding companies with
less than $1 billion in total consolidated assets from the
Federal Reserve's regulatory capital rules. \7\
---------------------------------------------------------------------------
\5\ Id.
\6\ See 78 FR 76521 (December 18, 2013), available at http://
www.gpo.gov/fdsys/pkg/FR-2013-12-18/pdf/201329785.pdf.
\7\ See 80 FR 20153 (April 15, 2015) available at: http://
www.gpo.gov/fdsys/pkg/FR-2015-04-15/pdf/201508513.pdf.
Q.5. Securities and Exchange Commissioner Dan Gallagher
recently argued that ``it remains the height of regulatory
hubris to assume that not only is there a single regulatory
solution to any given problem facing our markets, but that a
handful of mandarins working in an opaque international forum
can find those perfect solutions.'' He argues that when
regulators get things wrong, they risk things going wrong
everywhere because of the regulatory international cooperation.
He cites Basel's classification of residential mortgage backed
securities as lower-risk as an example, which partially led to
the housing bubble and subsequent financial crisis. Given this
example, is there a risk that increasing international
regulations actually increases systemic risk by creating a firm
homogeneity that's shaped by regulation?
If firms are all subjected to similar regulatory
standards--a ``one-size-fits-all approach''--won't their
balance sheets end up looking the same, and thus subject to the
same risk?
A.5. It is important for financial regulation to be tailored to
the business mix, risk profile, size, and systemic footprint of
individual financial firms.
The Federal Reserve is a strong supporter of gradating the
stringency of supervision and regulation to the size and
systemic footprint of individual banking firms. And we have
been doing what we can with our existing legal authority to do
that kind of tailoring, including with respect to the enhanced
prudential standards for large bank holding companies in
section 165 of the Dodd-Frank Act. We have already done quite a
bit of tailoring in this area to make sure that the most
systemic banking firms are subject to a much tougher regulatory
and supervisory framework than regional banking firms, and we
are analyzing whether there is more that we can do.
The Federal Reserve's commitment to regulatory tailoring is
also manifest in our support of Congressional efforts to modify
the Collins Amendment in the Dodd-Frank Act to better enable us
to design a regulatory framework for insurance holding
companies that is appropriately tailored to the business of
insurance. We appreciate the work of Congress to give us this
flexibility through the passage of The Insurance Capital
Standards Clarification Act of 2014. Similarly, we would not
support any international insurance capital standard that is
not appropriately tailored to the business of insurance.
The Federal Reserve participates in various international
standard setting and policymaking bodies--including the Basel
Committee on Banking Supervision (BCBS), the Financial
Stability Board (FSB), and the International Association of
Insurance Supervisors (IAIS). Our work in these organizations
is designed in significant part to achieve greater
comparability across jurisdictions in the core prudential
supervisory and regulatory frameworks that apply to
internationally active financial firms. Well-designed
international prudential frameworks for large, globally active
financial firms should promote global and U.S. financial
stability, provide a more level playing field for
internationally active U.S. financial firms, and enhance
supervisory cooperation and coordination among global
supervisors. The Federal Reserve is committed in its
international regulatory work to ensure that any global
standards work well for U.S. financial firms and U.S. financial
markets. Moreover, no global standard has binding effect in the
United States unless and until a U.S. regulatory authority goes
through appropriate domestic notice-and-comment processes.
Q.6. Capital regulations for insurance companies is an
important issue that has a significant impact on insurance
policyholders in my State.
This April, Mark Van Der Weide, Deputy Director for the
Federal Reserve's Division of Banking Supervision and
Regulation, explained that the Federal Reserve supports
developing an International Capital Standard (JCS) because it
can promote financial stability and ``help provide a level
playing field for global financial institutions.''
I'm concerned that efforts to ``level the playing field,''
will ``level'' the field by hurting U.S. insurance companies
and their policyholders, by forcing them to comply with
Europe's overly stringent insurance regulations. As Dr. Adam
Posen recently argued at a hearing with the Senate Banking
Committee, the FSB's efforts to ``extend Solvency II, the
European Commission's regulation for insurance firms, to global
application'' will be harmful for U.S. insurance policyholders,
because it ``tries to add on capital holding requirements of
Government bonds and short-term assets akin to what is
(rightly) required for banks.'' He goes on to argue that
European insurers are now ``using the FSB to impose it on the
U.S., Japanese, and other competing insurers.''
Are there aspects of Solvency II would be harmful if they
were imposed on U.S. insurers?
Are there other areas where you believe the FSB has ignored
or failed to understand aspects of our State-based insurance
regulatory system?
What is the Federal Reserve doing to ensure that
international insurance standards do not encroach on the U.S.
State-based insurance system and that other countries don't use
the FSB and the IAIS to impose stringent and senseless
regulations on U.S.-based insurers?
A.6. The Federal Reserve participates as a member of the
Financial Stability Board (FSB) and International Association
of Insurance Supervisors (IAIS). Along with other organizations
from the United States including the Federal Insurance Office
and the National Association of Insurance Commissioners, the
Federal Reserve advocates for the development of international
standards that best meet the needs of the U.S. insurance
market. The details of these international standards are still
being determined. The FSB's work to date has primarily focused
on the identification and development of policy measures for
Globally Systemically Important Insurers (G-SIIs) including
through the adoption of an assessment methodology built by the
IAIS. The IAIS continues to work on developing policy measures
to be applied to G-SIIs.
The Federal Reserve would not support any international
insurance standard that is not appropriately tailored to the
business of insurance and in the best interest of the United
States insurance market. Aspects of Solvency II that could be
problematic include its reliance on models built by the
regulated companies and its accounting systems market value
basis.
The international insurance standards currently under
development at the IAIS are not self-executing or binding on
the U.S., either at the State or the Federal level. They would
only apply in the U.S. if adopted by the appropriate U.S.
regulators in accordance with applicable domestic rulemaking
procedures. The Federal Reserve is working to ensure that any
standard adopted allows for the equitable treatment of U.S.-
based insurers operating abroad. None of the standards are
intended to replace the existing legal entity risk-based
capital requirements that are already in place within the
State-based regulatory regime.
Q.7. Insurance experts have levied a number of criticisms
against the Financial Stability Board as it relates to the
international regulatory process. This includes that the FSB
designates insurance companies as globally systemically
important before the FSOC designates them as systemically
important, concerns about the unaccountable process by which
the FSB arrives at its decision to label global systemically
important insurers, the lack of a clear ``off-ramp'' for
companies to lose their designation, and the risk that
international regulations undermine our State-based regulatory
system.
What FSOC or FSB reforms are you prepared to support on
these issues?
A.7. The IAIS, in coordination with the FSB, developed a
proposed methodology and framework for measuring the systemic
footprint of global insurers. IAIS made public its proposed
designation framework and methodology for global systemically
important insurers (G-SIIs) multiple times for public comment.
Any insurance company, and any member of the public, had the
opportunity to comment on the proposal. The Federal Reserve
strongly supports public transparency in the methods and
processes that international organizations use to identify
systemically important financial firms.
Importantly, IAIS and FSB decisions about the
identification of global systemically important insurers are
not binding on the United States. FSOC makes its own
independent decisions on designating nonbank financial firms,
using the statutory standards set forth in the Dodd-Frank Act.
I would note that the IAIS and FSB use a somewhat different
standard to make designation decisions than does the FSOC. The
international organizations focus on a firm's global systemic
footprint and primarily use an algorithm to make their
decisions, whereas the FSOC focuses on impact on U.S. financial
stability and uses a more judgment-based, firm-specific
approach.
With respect to the FSOC, I am firmly committed to
promoting transparency and accountability in connection with
the FSOC's activities. To implement its designation authority,
FSOC initially developed a framework and criteria and sought
public comments twice on the framework. After publishing
guidance, FSOC began the process of assessing individual
companies from a list of companies that met the quantitative
criteria set out in the guidance. Throughout the fall of 2014,
FSOC engaged in outreach to stakeholders regarding the
designations process. Based on that outreach, FSOC identified
changes to the designations process that would enable earlier
engagement with companies under review and increase
transparency to the public, without compromising the FSOC's
ability to conduct its work and protect confidential company
information. These new processes went into effect in February.
We will continue to work with the FSOC and the Congress to
ensure that the process for designations is transparent and
accountable.
The FSOC's designation of a nonbank financial firm is not
intended to be permanent. Dodd-Frank Act provides that FSOC
annually review designations to make sure that they remain
appropriate, and take into account significant changes at the
firms. At the time of designation, firms are given a detailed
explanation as to the specific factors that led to their
designation. Firms can use that information, as well as the
public criteria set forth by FSOC, to guide their efforts to
reduce their systemic footprint.
------
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR MENENDEZ FROM JANET L. YELLEN
Q.1. Before the financial crisis under President Bush, our
country saw policies of ``trickle-down economics,'' focused on
tax benefits for individuals at the top of the distribution and
budget cuts for everyone else. The results were predictable--
incomes grew at the very top, but stagnated for everyone else.
Then, during the crisis and recession, families in the
middle and at the bottom were hit particularly hard. So for the
vast majority of families, it's been a long time since they've
seen a meaningful raise. Now, our economy is recovering, but we
haven't reached the point yet where growth feels truly broad-
based.
Like most Americans, I don't begrudge financial success,
but I'm concerned when the vast majority of people in our
country feel they are not sharing in economic growth, and when
widening disparity makes it harder for ordinary working
families to move up the ladder.
In balancing the Fed's dual mandate of creating jobs and
fighting inflation, how does the Fed account for the very
different ways Americans are experiencing the same economy,
depending on where they are on the income and wealth spectrum?
A.1. The Congress has instructed the Federal Reserve to pursue
a dual mandate, which involves promoting both maximum
employment and price stability. Generally speaking, these
objectives pertain to the overall national situation. The
Federal Reserve will aim, to the best of its ability, to
deliver the strongest labor market consistent with its 2
percent inflation objective. In doing so, we will be setting
the best possible macroeconomic backdrop for all groups to
attain the greatest prosperity that can be sustained. To be
sure, a range of other policy steps outside the realm of
monetary policy may be appropriate to achieve additional
objectives, but such policy steps are not within the remit of
the Federal Reserve.
Q.2. How does the Fed factor in wage history when looking for
signs of when to tighten? Meaning, if average working families
have gone a long period without real wage growth, would that
call for waiting longer to tighten instead of raising rates at
the first sign of an increase?
A.2. Wage data are one of many sets of indicators that we
consult in determining the appropriate stance of monetary
policy. In principle, wage behavior can be informative about
both aspects of our dual mandate--price stability and maximum
employment. If wage growth is weak, that may be a sign both
that labor markets are in a relatively slack condition, and
thus that the maximum employment aspect of our mandate is not
fulfilled; and it may be a sign that inflation pressures will
be less intense. The symmetric statements could be made if wage
growth were strong. That said, many factors affect wages,
including productivity growth, global competition, the nature
of technological change, and trends in unionization, that are
outside of the Federal Reserve's control. For such reasons,
wages are but one of many indicators that policymakers consult
for evidence of how close or far we are from achieving our dual
mandate.
------
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR DONNELLY FROM JANET L. YELLEN
Q.1. Chair Yellen, in addition to your comments about the
shadow banking system, are there other developments in the
global or domestic economy that you are monitoring for
potential risks to financial stability?
Many people are rightly focused on Greece and China, but I
worry about the economic obstacles we do not see coming. Should
we be worried about increasing corporate debt, a liquidity
crisis, or is it something else entirely? In other words, what
are the less obvious threats to economic and financial
stability that you are watching closely?
A.1. As you know, since the financial crisis and recession of
2007-2009, we have put in place a comprehensive system to
monitor the financial system for building vulnerabilities. The
financial system and the broader economy will always be
buffeted by shocks that are unexpected or that cannot be
mitigated by policymakers, including, as you point out, events
abroad. However, the potential for these shocks to grow and
spread is greater when the financial system is more vulnerable.
This effect was on full display during the last recession, when
losses on risky mortgages led to problems in the financial
system that ultimately impeded the ability of creditworthy
businesses and households to finance investments.
We judge that financial vulnerabilities in the U.S.
financial system overall continue to be about where they have
been for the past 6 months--at a moderate level. Factors
suggesting that the financial system remains robust include the
extremely strong capital and liquidity positions of the largest
banking organizations relative to recent history and modest
debt growth among households. Among factors suggesting
increasing vulnerabilities are, as you pointed out, the
continued rapid clip of borrowing by lower-rated businesses and
stretched valuations among a number of assets, including
commercial real estate.
Liquidity has indeed been an issue raised by policymakers,
market participants, academics and others. In particular, the
concern is that liquidity, especially in fixed-income markets,
is now more likely to deteriorate significantly even under
moderate stress. However, a variety of metrics do not suggest a
deterioration in day-to-day liquidity, with some mixed evidence
that may point to less resilient liquidity. This evidence is
described in greater detail in July's Monetary Policy Report.
\1\ In addition, on July 13, 2015, the Federal Reserve,
together with the Commodity Futures Trading Commission, the
Securities and Exchange Commission, and the Department of
Treasury published a joint report examining the events in the
Treasury market on October 15, 2014--an episode when Treasury
yields moved dramatically over a brief span of time. \2\ The
Federal Reserve, together with other financial regulatory
agencies, is continuing to study and monitor developments in
market liquidity.
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\1\ See http://www.federalreserve.gov/monetarypolicy/files/
20150715_mprfullreport.pdf.
\2\ See http://www.treasury.gov/press-center/press-releases/
Documents/Joint_Staff_Report_Treasury_10-15-2015.pdf.
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