[Senate Hearing 114-231]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 114-231


        FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2016

=======================================================================

                                HEARING

                               BEFORE THE

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                    ONE HUNDRED FOURTEENTH CONGRESS

                             SECOND SESSION

                                   ON

      OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU- 
       ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978

                               __________

                           FEBRUARY 11, 2016

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs
                                
                                
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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

MIKE 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

                Shelby Begany, Professional Staff Member

            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

                              ----------                              

                      THURSDAY, FEBRUARY 11, 2016

                                                                   Page

Opening statement of Chairman Shelby.............................     1

Opening statements, comments, or prepared statements of:
    Senator Brown................................................     3

                                WITNESS

Janet L. Yellen, Chair, Board of Governors of the Federal Reserve 
  System.........................................................     5
    Prepared statement...........................................    47
    Responses to written questions of:
        Chairman Shelby..........................................    50
        Senator Toomey...........................................    54
        Senator Kirk.............................................    62
        Senator Heller...........................................    64
        Senator Sasse............................................    70
        Senator Cotton...........................................    80
        Senator Rounds...........................................    83
        Senator Moran............................................    86
        Senator Menendez.........................................    90

              Additional Material Supplied for the Record

Monetary Policy Report to the Congress dated February 10, 2016...    96
``Reducing the IOER Rate: An Analysis of Options'' Memo submitted 
  by Senator Toomey..............................................   148
Statement of the Financial Innovation Now Coalition submitted by 
  Senator Brown..................................................   159

                                 (iii)

 
        FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2016

                              ----------                              


                      THURSDAY, FEBRUARY 11, 2016

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:01 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Richard C. 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. The semiannual Monetary Policy Report to the 
Congress is an important statutory tool for oversight of the 
Federal Reserve, which was created by Congress over 100 years 
ago as part of the Federal Reserve Act.
    The act grants the Fed a certain degree of independence, 
but in no way does it preclude congressional oversight or 
accountability to the American people. There is broad consensus 
that the Fed should communicate in a manner that helps Congress 
and the public understand its monetary policy decision making.
    How the Federal Open Market Committee makes its decisions 
remains a point of contention, however. Some argue for 
unfettered discretion, while others advocate a rule-based 
construct.
    Recently, a statement released by 24 distinguished 
economists and other officials, including John Taylor, George 
Shultz, Allan Meltzer, and three Nobel Prize winners, disputes 
the idea that adherence to a clearer, more predictable rule or 
strategy would reduce Fed independence.
    In fact, their statement argues, and I will quote, that 
``publicly reporting a strategy helps prevent policymakers from 
bending under pressure and sacrificing independence.''
    Last year, this Committee favorably reported the Financial 
Regulatory Improvement Act, which included a provision that 
would not establish a rule but, rather, require the Fed to 
disclose to Congress any rule it may happen to use in its 
decision making process.
    I believe this represents a reasonable step toward 
increased transparency and accountability. It is my hope that 
this year we will be able to reach some kind of agreement on 
this and other banking reforms.
    Never before has it been more important for Congress to 
consider ways to strengthen Fed transparency and 
accountability. Since the financial crisis, the Fed has 
expanded its monetary policy actions to an extent that would 
have been unthinkable 10 years ago.
    As former Fed Chairman Paul Volcker described, during the 
crisis, the Fed took, and I will quote him, ``actions that 
extend the very edge of its lawful and implied powers, 
transcending certain long-embedded principles and practices.''
    We are all too familiar with the successive rounds of 
quantitative easing that brought the Fed's balance sheet to 
over $4 trillion, with no wind-down in sight.
    I think it begs the question: How will the Fed shrink a 
balance sheet that exceeds 20 percent of the entire U.S. 
economy?
    Some also worry that the Fed may have assumed economic 
responsibilities beyond its statutory mandates of price 
stability and full employment. To the extent that the Federal 
Reserve has done so, it should be disclosed and justified.
    While I agree that the Fed should be free to make 
independent decisions, it should not be completely shielded 
from explaining its decisions and the factors that it uses to 
guide them. At times, it seems that Federal Reserve officials 
resist even sensible reforms designed to improve economic 
performance, congressional oversight, or public understanding 
of the Federal Reserve's actions.
    The need to preserve Fed independence is very real, but 
surely it does not justify objection to any reform. 
Independence and accountability should not be viewed as 
mutually exclusive concepts.
    In fact, accountability is even more crucial given the 
Federal Reserve's role as a financial regulator. Never before 
has a single entity held so much power over the direction of 
our financial system.
    Notably, Dodd-Frank expanded the Fed's regulatory authority 
over large sectors of the economy, including insurance 
companies and other nonbank financial institutions. Such 
regulatory authority and the rulemakings issued as a result of 
it raise significant questions.
    Recently, the Federal Reserve has issued a number of new 
regulations stemming from the Basel III bank capital rules, 
such as total loss-absorbing capital, the liquidity coverage 
ratio, and high-quality liquid asset ratings. These rulemakings 
are based on the requirements set by the Bank for International 
Settlements and its Basel Committee on Banking Supervision.
    But instead of allowing international bodies to serve as de 
facto U.S. regulators, the Fed should appropriately vet these 
rules and answer important questions.
    For example, are those international requirements 
appropriately tailored for our domestic financial institutions? 
Are they even necessary given existing rules? Are they harming 
our economy or placing U.S. firms at a disadvantage?
    I continue to encourage the Federal Reserve to further 
exercise its regulatory discretion to tailor enhanced 
prudential standards according to the systemic risk profile of 
each institution, not arbitrary factors. And where it does not 
have the authority to do so, Congress should step in with 
legislative changes. None of the Federal Reserve's authorities 
are immune from reform, and many of us believe that reform is 
long overdue.
    Madam Chairman, I look forward to your testimony today and 
your thoughts on these important issues.
    Senator Brown.

               STATEMENT OF SENATOR SHERROD BROWN

    Senator Brown. Thank you, Mr. Chairman. Thank you, Madam 
Chair. It is so nice to have you back here. It is good to see 
everyone back in this hearing room. This is our first gathering 
since October, and I welcome all of you back.
    I cannot help but think back to February 2009 when then-
Chair Ben Bernanke told this Committee that our economy was 
suffering a severe contraction. President Obama had just taken 
the reins in the middle of a financial crisis that would become 
the worst since the Great Depression. American taxpayers had 
just rescued the banking and auto industries. By the time we 
hit bottom, 9 million jobs had disappeared. The unemployment 
rate soared to 10 percent. In some places that we all represent 
it was higher. Five million families lost their home to 
foreclosure. I mentioned to Chair Yellen that my wife and I 
live in Zip code 44105 in Cleveland, which had more 
foreclosures in the first half of 2007 than any Zip code in the 
United States. Thirteen trillion dollars in household wealth 
was wiped out. It was one of the darkest periods in our 
Nation's economic history.
    Seven years later, it is clear we have come a long way 
since the financial crisis. Our economy has added 13 million 
jobs since 2010. We have had 71 consecutive months--that is 
almost 6 years--of job growth. The unemployment rate has 
dropped to below 5 percent, the lowest level since 2008. 
Average hourly earnings are up 0.5 percent since December, the 
second strongest monthly gain since the crisis, up 2.5 percent 
in the last year. And the Fed, as we know, increased rates for 
the first time in a decade. That is the good news.
    But we still face severe challenges. Wages have been too 
flat for too long. Too many workers are still looking for jobs. 
Those that have one are not making as much as they should be, 
and some are benefiting from the recovery. Mostly the top 5 
percent are benefiting from the recovery far more than average 
workers.
    International economies are slowing. American exports are 
challenged by the strong dollar. Oil prices are at all-time 
lows, though they have not provided the economic boost that 
many analysts expected. Inflation remains very low.
    The slow and steady progress of the economy has given rise 
to what I fear--and I see that in this room--what I fear is a 
collective amnesia for many on Wall Street and many in 
Congress, as if they forgot what happened in 2006, 2007, and 
2008, as if they did not know about the human suffering in 
every one of our States, the lost wealth, the lost jobs, the 
foreclosed homes.
    I think that few of us, and none of us enough, spend time 
talking to people who have lost their homes and have to explain 
to their child that they are going to have to move to a new 
neighborhood in a less nice house and go to a different school, 
and the pain that caused to the millions of people who have 
seen their homes foreclosed on.
    They seem to have forgotten--this collective amnesia 
suggests that far too many people that sit on this side of this 
dais have forgotten just how devastating the crisis was for an 
entire generation of working and middle-class Americans. 
Instead of working to strengthen our economy and to bolster the 
financial system safeguards, some Republicans want to unleash 
the forces that almost destroyed the economy in the first 
place. They want to go back to business as usual with Wall 
Street.
    Instead of conducting oversight hearings to push for 
implementation of the Wall Street Reform Act, we all remember 
when President Obama signed Dodd-Frank that chief financial 
services lobbyists in this town said, ``Now it is half-time,'' 
meaning they were going to go to work to try to stop the Fed 
and weaken the FDIC rules and do whatever they could do on 
behalf of Wall Street. So instead of conducting hearings to 
push for implementation of Wall Street reform, this Committee 
instead has been holding hearings on weakening the law for 
banks and nonbanks and how to make it impossible for regulators 
to finalize their rules.
    The Banking Committee has not in 13 months held a single 
hearing on strengthening consumer protections. We have not 
talked about improving credit reporting and debt collection. We 
have not examined how to curtail payday lending or make rental 
housing more accessible, affordable, and safe.
    There is a lot of work to do to ensure we do not repeat the 
mistakes that led to the Great Recession. I sent a letter to 
Chair Yellen this week urging the Federal Reserve to do more to 
reduce the risks posed by big banks' involvement in the 
commodities business. The Fed and the FDIC need to make public 
determinations if individual firms have not provided credible 
living wills that demonstrate that they could go out of 
business without wrecking the financial system. This is one of 
the ways we determine if too big to fail still actually exists.
    The regulators should finish rules relating to compensation 
incentives on Wall Street, understanding when Americans who 
have not had a raise for years are just barely making it when 
they see this kind of compensation on Wall Street and these 
kinds of bonuses for executives in many cases who helped to get 
us into the bad situation we are in.
    If we have learned anything from the crisis, it is that 
Wall Street encouraged behavior that caused the crisis at a 
steep price to American homeowners and American renters. The 
Fed still has work remaining on its regulatory framework for 
the nonbanks that it supervises as well as insurance companies 
that own savings and loan holding companies, and I hope you 
will pay close attention, Madam Chair, to those business 
models.
    And while regulators have taken important steps to rein in 
risks in money market mutual funds and the tri-party repo 
market, policymakers should continue to examine these and other 
potential threats in the nonbank sector.
    To those that say that the reforms that have taken place in 
the U.S. will put us at a competitive disadvantage, this week 
has shown us that they actually benefit our financial system. 
It is clear to me that as a result of the new regulations, U.S. 
financial institutions are more resilient than their 
counterparts in other parts of the world.
    Chair Yellen, I look forward to your assessment of both the 
economy and where we are with efforts to strengthen and more 
stabilize our financial system. All of us must do the necessary 
work to promote financial stability, to protect consumers, to 
help prevent what could be the next crisis. There is far too 
much at stake for American families to do otherwise.
    Thank you.
    Chairman Shelby. Madam Chair, your written testimony will 
be made part of the record in its entirety. You proceed as you 
wish. Welcome to the Committee again.

STATEMENT OF JANET L. YELLEN, CHAIR, BOARD OF GOVERNORS OF THE 
                     FEDERAL RESERVE SYSTEM

    Ms. Yellen. Thank you. Chairman Shelby, Ranking Member 
Brown, and other 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 last July, the 
economy has made further progress toward the Federal Reserve's 
objective of maximum employment. And while inflation is 
expected to remain low in the near term, in part because of the 
further declines in energy prices, the Federal Open Market 
Committee expects that inflation will rise to its 2-percent 
objective over the medium term.
    In the labor market, the number of nonfarm payroll jobs 
rose 2.7 million in 2015 and posted a further gain of 150,000 
in January of this year. The cumulative increase in employment 
since its trough in early 2010 is now more than 13 million 
jobs. Meanwhile, the unemployment rate fell to 4.9 percent in 
January, 0.8 percentage point below its level a year ago and in 
line with the median of FOMC participants' most recent 
estimates of its longer-run normal level. Other measures of 
labor market conditions have also shown solid improvement, with 
noticeable declines over the past year in the number of 
individuals who want and are available to work but have not 
actively searched recently, and in the number of people who are 
working part-time but would rather work full-time. However, 
these measures remain above the levels seen prior to the 
recession, suggesting that some slack in labor markets remains. 
Thus, while labor market conditions have improved 
substantially, there is still room for further sustainable 
improvement.
    The strong gains in the job market last year were 
accompanied by a continued moderate expansion in economic 
activity. U.S. real gross domestic product is estimated to have 
increased about 1-\3/4\ percent in 2015. Over the course of the 
year, subdued foreign growth and the appreciation of the dollar 
restrained net exports. In the fourth quarter of last year, 
growth in the gross domestic product is reported to have slowed 
more sharply, to an annual rate of just \3/4\ of a percent; 
again, growth was held back by weak net exports as well as by a 
negative contribution from inventory investment. Although 
private domestic final demand appears to have slowed somewhat 
in the fourth quarter, it has continued to advance. Household 
spending has been supported by steady job gains and solid 
growth in real disposable income--aided in part by the declines 
in oil prices. One area of particular strength has been 
purchases of cars and light trucks; sales of these vehicles in 
2015 reached their highest level ever. In the drilling and 
mining sector, lower oil prices have caused companies to slash 
jobs and sharply cut capital outlays, but in most other 
sectors, business investment rose over the second half of last 
year. And homebuilding activity has continued to move up, on 
balance, although the level of new construction remains well 
below the longer-run levels implied by demographic trends.
    Financial conditions in the United States have recently 
become less supportive of growth, with declines in broad 
measures of equity prices, higher borrowing rates for riskier 
borrowers, and a further appreciation of the dollar. These 
developments, if they prove persistent, could weigh on the 
outlook for economic activity and the labor market, although 
declines in longer-term interest rates and oil prices provide 
some offset. Still, ongoing employment gains and faster wage 
growth should support the growth of real incomes and, 
therefore, consumer spending, and global economic growth should 
pick up over time, supported by highly accommodative monetary 
policies abroad. Against this backdrop, the Committee expects 
that with gradual adjustments in the stance of monetary policy, 
economic activity will expand at a moderate pace in coming 
years and that labor market indicators will continue to 
strengthen.
    As is always the case, the economic outlook is uncertain. 
Foreign economic developments, in particular, pose risks to 
U.S. economic growth. Most notably, although recent economic 
indicators do not suggest a sharp slowdown in Chinese growth, 
declines in the foreign exchange value of the renminbi have 
intensified uncertainty about China's exchange rate policy and 
the prospects for its economy. This uncertainty has led to 
increased volatility in global financial markets and, against 
the background of persistent weakness abroad, exacerbated 
concerns about the outlook for global growth. These growth 
concerns, along with strong supply conditions and high 
inventories, contributed to the recent fall in the prices of 
oil and other commodities. In turn, low commodity prices could 
trigger financial stresses in commodity-exporting economies, 
particularly in vulnerable emerging market economies, and for 
commodity-producing firms in many countries. Should any of 
these downside risks materialize, foreign activity and demand 
for U.S. exports could weaken, and financial market conditions 
could tighten further.
    Of course, economic growth could also exceed our 
projections for a number of reasons, including the possibility 
that low oil prices will boost U.S. economic growth more than 
we expect. At present, the Committee is closely monitoring 
global economic and financial developments, as well as 
assessing their implications for the labor market and inflation 
and the balance of risks to the outlook.
    As I noted earlier, inflation continues to run below the 
Committee's 2-percent objective. Overall consumer prices, as 
measured by the price index for personal consumption 
expenditures, increased just \1/2\ percent over the 12 months 
of 2015. To a large extent, the low average pace of inflation 
last year can be traced to the earlier steep declines in oil 
prices and in the prices of other imported goods. And given the 
recent further declines in the prices of oil and other 
commodities, as well as the further appreciation of the dollar, 
the Committee expects inflation to remain low in the near term. 
However, once oil and import prices stop falling, the downward 
pressure on domestic inflation from those sources should wane, 
and as the labor market strengthens further, inflation is 
expected to rise gradually to 2 percent over the medium term. 
In light of the current shortfall of inflation from 2 percent, 
the Committee is carefully monitoring actual and expected 
progress toward its inflation goal.
    Of course, inflation expectations play an important role in 
the inflation process, and the Committee's confidence in the 
inflation outlook depends importantly on the degree to which 
longer-run inflation expectations remain well anchored. It is 
worth noting, in this regard, that market-based measures of 
inflation compensation have moved down to historically low 
levels; our analysis suggests that changes in risk and 
liquidity premiums over the past year-and-a-half contributed 
significantly to these declines. Some survey measures of 
longer-run inflation expectations are also at the low end of 
their recent ranges; overall, however, they seem reasonably 
stable.
    Turning to monetary policy, the FOMC conducts policy to 
promote maximum employment and price stability, as required by 
our statutory mandate from Congress. Last March, the Committee 
stated that it would be appropriate to raise the target range 
for the Federal funds rate when it had seen further improvement 
in the labor market and was reasonably confident that inflation 
would move back to its 2-percent objective over the medium 
term. In December, the Committee judged that these two criteria 
had been satisfied and decided to raise the target range for 
the Federal funds rate \1/4\ percentage point, to between \1/4\ 
and \1/2\ percent. This increase marked the end of a 7-year 
period during which the Federal funds rate was held near zero. 
The Committee did not adjust the target range in January.
    The decision in December to raise the Federal funds rate 
reflected the Committee's assessment that, even after a modest 
reduction in policy accommodation, economic activity would 
continue to expand at a moderate pace and labor market 
indicators would continue to strengthen. Although inflation was 
running below the Committee's longer-run objective, the FOMC 
judged that much of the softness in inflation was attributable 
to transitory factors that are likely to abate over time, and 
that diminishing slack in labor and product markets would help 
move inflation toward 2 percent. In addition, the Committee 
recognized that it takes time for monetary policy actions to 
affect economic conditions. If the FOMC delayed the start of 
policy normalization for too long, it might have to tighten 
policy relatively abruptly in the future to keep the economy 
from overheating and inflation from significantly overshooting 
its objective. Such an abrupt tightening could increase the 
risk of pushing the economy into recession.
    It is important to note that even after this increase, the 
stance of monetary policy remains accommodative. The FOMC 
anticipates that economic conditions will evolve in a manner 
that will warrant only gradual increases in the Federal funds 
rate. In addition, the Committee expects that the Federal funds 
rate is likely to remain, for some time, below the levels that 
are expected to prevail in the longer run. This expectation is 
consistent with the view that the neutral nominal Federal funds 
rate--defined as the value of the Federal funds rate that would 
be neither expansionary nor contractionary if the economy was 
operating near potential--is currently low by historical 
standards and is likely to rise only gradually over time. The 
low level of the neutral Federal funds rate may be partially 
attributable to a range of persistent economic headwinds--such 
as limited access to credit for some borrowers, weak growth 
abroad, and a significant appreciation of the dollar--that have 
weighed on aggregate demand.
    Of course, monetary policy is by no means on a preset 
course. The actual path of the Federal funds rate will depend 
on what incoming data tell us about the economic outlook, and 
we will regularly reassess what level of the Federal funds rate 
is consistent with achieving and maintaining maximum employment 
and 2 percent inflation. In doing so, we will take into account 
a wide range of information, including measures of labor market 
conditions, indicators of inflation pressures and inflation 
expectations, and readings on financial and international 
developments. In particular, stronger growth or a more rapid 
increase in inflation than the Committee currently anticipates 
would suggest that the neutral Federal funds rate was rising 
more quickly than expected, making it appropriate to raise the 
Federal funds rate more quickly as well. But, conversely, if 
the economy were to disappoint, a lower path of the Federal 
funds rate would be appropriate. We are committed to our dual 
objectives, and we will adjust policy as appropriate to foster 
financial conditions consistent with their attainment over 
time.
    Consistent with its previous communications, the Federal 
Reserve used interest on excess reserves, or IOER, and 
overnight reverse repurchase, or RRP, operations to move the 
Federal funds rate into the new target range. The adjustment to 
the IOER rate has been particularly important in raising the 
Federal funds rate and short-term interest rates more generally 
in an environment of abundant bank reserves. Meanwhile, 
overnight RRP operations complement the IOER rate by 
establishing a soft floor on money market interest rates. The 
IOER rate and the overnight RRP operations allowed the FOMC to 
control the Federal funds rate effectively without having to 
first shrink its balance sheet by selling a large part of its 
holdings of longer-term securities. The Committee judged that 
removing monetary policy accommodation by the traditional 
approach of raising short-term interest rates is preferable to 
selling longer-term assets because such sales could be 
difficult to calibrate and could generate unexpected financial 
market reactions.
    The Committee is continuing its policy of reinvesting 
proceeds from maturing Treasury securities and principal 
payments from agency debt and mortgage-backed securities. As 
highlighted in the December statement, the FOMC anticipates 
continuing this policy ``until normalization of the level of 
the Federal funds rate is well under way.'' Maintaining our 
sizable holdings of longer-term securities should help maintain 
accommodative financial conditions and reduce the risk that we 
might need to return the Federal funds rate target to the 
effective lower bound in response to future adverse shocks.
    Thank you. I would be pleased to take your questions.
    Chairman Shelby. Madam Chair, we have talked about this 
privately before, but does the Fed still use the Phillips rule 
in a lot of its deliberations?
    Ms. Yellen. Well, the----
    Chairman Shelby. Is that an important tool? Or is it just 
one of many tools?
    Ms. Yellen. It is essentially a theory that fits 
reasonably, but certainly not perfect, explaining the inflation 
process. And it is a theory that says first that inflation 
expectations play a key role in determining inflation; second, 
that various supply shocks, such as movements in the price of 
oil or commodities or import prices, also play an important 
role; and, third, that the degree of slack in the labor market 
or the degree more generally of pressure on resources in the 
economy as a whole exert an influence on inflation as well; and 
that theory underlines the kind of statement that I have made 
that, if inflation expectations remain well anchored and the 
transitory influence of energy prices and the dollar fade over 
time, that in a tightening labor market with higher resource 
utilization, I expect inflation to move back up to 2 percent. 
It is consistent with that Phillips curve theory.
    So, in essence, yes, I want to make clear that all of those 
elements play a role. And, of course, there can be other 
factors, idiosyncratic factors or other factors not captured by 
that model that make a difference. So that model in part 
underlies an expectation inflation will return to 2 percent. 
But in our statement in December and January, the Committee 
indicated that we will continue to assess actual developments 
with inflation and see whether they are in alignment with our 
expectations because, after all, this is not a theory that is 
perfect.
    Chairman Shelby. Would you say today that the precipitous 
decline in the price of oil and gas plus the rise of the dollar 
has surprised the Fed to some extent? Or could you have 
predicted all of this?
    Ms. Yellen. So I think we have been--markets have been and 
we have been quite surprised by movements in oil prices. I 
think in part they reflect supply influences, but demand may 
also play a role.
    The stronger dollar is partly something that we anticipated 
because the U.S. economy has been performing more strongly than 
many foreign economies, and we have a divergence in the stance 
of monetary policy that influences capital flows in the dollar. 
Nevertheless, the strength of the dollar and the extent to 
which it has moved up since mid-2014 is not something that we 
anticipated.
    So, yes, we have been surprised in part by those 
developments, and they have played a significant role in 
holding down inflation.
    Chairman Shelby. Do you believe this economy, although it 
is a number of years old, as you would say, has peaked or is 
near peaking or will start declining and put us into a 
recession of some type? Or you just do not know, it is 
something you are watching?
    Ms. Yellen. Well, we are watching developments very 
carefully. I would say there is always some chance of a 
recession in any year, but the evidence suggests that 
expansions do not die of old age. We are, as I mentioned in my 
testimony, looking very carefully at global financial market 
and economic developments that create risks to the economy, and 
we are evaluating them, recognizing that these factors may well 
influence the balance of risks or the trajectory of the 
economy, and thereby might affect the appropriate stance of 
monetary policy. But at this point I think it is premature to 
make a judgment. We will meet in March, and our Committee will 
carefully deliberate about what impact these developments have 
had. Today I think it is premature to render a judgment on 
that.
    Chairman Shelby. Are you saying basically the Fed will be 
careful, looking at every aspect of the economy and the 
international economy, before it raises the Federal funds rate? 
Is that what you are saying?
    Ms. Yellen. Yes, certainly, we will. We will evaluate the 
outlook, certainly taking these developments into account, and 
I want to emphasize that, as I said, monetary policy is not on 
a preset course. We want to set the path of policy that will 
achieve the objectives that Congress has assigned to us, and 
that certainly entails doing what we can to make sure that the 
expansion continues.
    Chairman Shelby. Could you just take a couple of minutes 
and share with us your view as to the strength of our banking 
system today if we were to--we hope we will not go into a 
recession, but we do have cycles, and we know that. What is the 
condition of our banking system? Do you feel comfortable about 
our banking system? Or is it work you are working every day on?
    Ms. Yellen. I think the steps that we have taken over the 
last 7 years have had very substantial payoffs in the form of a 
much more resilient and stronger, better capitalized, more 
liquid banking system. We have not only raised capital and 
liquidity standards, including especially ramping those up for 
the most systemic firms; we have also used stress test 
methodology to see whether we think those firms--and we do 
think that they can--continue to support the credit needs of 
our economy, even in this scenario of very significant stress. 
So I think we do have a strong banking system, and we have seen 
marked improvement.
    Chairman Shelby. Senator Brown.
    Senator Brown. Thank you, Mr. Chairman.
    You said in your testimony and in your response to Chairman 
Shelby, Madam Chair, you said that in regards to monetary 
policy the Committee is by no means on a preset course, and 
then you later said if the economy were to disappoint that you 
would--you suggested it would be less likely to raise interest 
rates. And I want to make just one comment, and then I have 
three questions--or a couple questions about wages, that the 
dual mandate is so important, I so appreciate your emphasis 
always on it, on, of course, restraining inflation, but also 
equally importantly, and to many of our constituents, I think 
maybe even more importantly, the importance of job growth. And 
I also appreciate the importance to you of wage growth as you 
deliberate on these questions of raising interest rates. And 
while job growth has been better than some might have expected 
with 71 consecutive months, wage growth has not, as you know, 
and with some good signs recently but not enough. Data released 
earlier this month show average hourly earnings increased in 
2015.
    My questions are these: Are other wage growth--and just 
three questions, and answer them together, if you would. Are 
other wage growth indicators showing the same increases? Are 
wage increases occurring across race and gender and across 
economic sectors, or are certain groups doing better than 
others in that wage growth? And, finally, can the economy reach 
full employment without labor force participation increases for 
women and minorities and have widespread wage growth? So if you 
would sort of pull those together and answer, Madam Chair.
    Ms. Yellen. So you asked about other wage indicators. As 
you indicated, average hourly earnings have picked up, but it 
is a series that is volatile. And while I think we see some 
evidence of faster wage growth there, I would still refer to 
that evidence as tentative.
    In compensation per hour, we also see a somewhat slightly 
higher pace over the last 12 months in its growth, but, again, 
this is a very volatile series.
    And in terms of the employment cost index, compensation 
growth has really not shown any sustained pickup, and that is a 
significant series.
    So at best, I would say the evidence of a pickup is 
tentative. I do continue to envision that if the labor market 
continues to improve, as we certainly hope it will, that there 
is scope and we will likely see some further pickup in wage 
growth.
    In terms of particular groups in the economy, I cannot give 
you recent evidence on developments by--I think you asked for 
race and gender, but----
    Senator Brown. And sector.
    Ms. Yellen. So I do not have that data at my fingertips, 
but, we know that in the U.S. we have had a longstanding trend 
toward rising inequality, rising wage inequality in this 
country, and that more educated people have seen faster wage 
growth than those in the middle and at the bottom, and I 
believe that trend continues. A lot of jobs during the 
downturn, middle-income jobs, were lost. And although jobs 
across the occupational distribution have been created, job 
creation has perhaps been more heavily skewed toward sectors 
that have lower pay. And I think that there are deeper 
structural reasons that these trends continue. They predate the 
downturn in the economy, but the downturn probably accelerated 
those trends that perhaps relate to globalization and 
technological change that are demanding increased skill.
    Senator Brown. Thank you, and I think you cannot--and I 
just have one comment. I think we cannot be satisfied that we 
have full employment without full employment across demographic 
lines, meaning women and minorities, especially. We do not 
really have full employment until it is full for them also, and 
I know that you recognize that.
    Let me shift--and I know we do not have a lot of time 
because there is a vote called--to a question on living wills. 
We have discussed that process. Last year, you said you felt 
that the Fed and FDIC have provided companies with clear 
feedback on the deficiencies in the submissions to you, and 
that you would be willing to make formal determinations that 
certain plans are not credible.
    Three questions. When do you anticipate providing feedback 
on last year's submissions? Are you still committed to making 
formal determinations about insufficient plans? And will you 
differentiate between and among firms when you provide feedback 
or make determinations?
    Ms. Yellen. So, when, we are actively engaged and far along 
in evaluating these plans. The Board has met regularly since 
August. I believe we have had seven Board meetings to discuss 
these plans. We have worked closely with the FDIC. We have not 
made final determinations, so it is premature for me to give 
you a definite time, but we will make these determinations in 
the not too distant future. We are very actively engaged.
    And, yes, we are still committed, as I indicated, to 
finding that plans that do not meet the specifications we 
outlined, we are certainly prepared to find them deficient and 
to specify what those deficiencies are.
    Senator Brown. And one more quick one. Does an aggressive, 
thorough living will process answer the question of too big to 
fail?
    Ms. Yellen. It certainly helps. We have also put in place 
requirements for adequate--our so-called TLAC rules for 
adequate loss absorbency. We certainly are requiring that firms 
have workable plans for how they would be resolved under 
bankruptcy. And Dodd-Frank--so we want to make sure that there 
is a way that they could be resolvable under bankruptcy, and 
that the resources are there so that the taxpayer would not be 
at risk. And Dodd-Frank provided as a backup authority Title 2, 
which would be, if it is necessary, an additional tool that we 
can use.
    So I think it is premature to say we have solved too big to 
fail, but I do think we have made very substantial strides 
toward dealing with it, toward addressing it.
    Chairman Shelby. Thank you.
    Senator Crapo.
    Senator Crapo. Thank you, Mr. Chairman.
    Chair Yellen, I appreciated your comments at our last 
Humphrey-Hawkins hearing when we discussed the $50 billion 
trigger being used to determine when a bank is systemically 
important and your openness to increasing the threshold and 
focusing on the flexibility that we need there.
    While Congress continues to make progress on this effort--
and hopefully we will make some progress soon--you have 
previously noted that the Federal Reserve has the authority and 
discretion on its own to tailor the application of these rules 
as they apply to systemically important designated banks, those 
covered by Section 165 of Dodd-Frank.
    My question is: Can you give us some specific examples of 
the kind of tailoring that might be in the works as the Federal 
Reserve works on this? And will there be relief on stress 
testing and resolution planning?
    Ms. Yellen. So we are, for example, actively engaged in 
reviewing our stress test testing and capital planning 
framework for the bank holding companies above $50 billion, and 
we are considering ways in which we can make that less 
burdensome for the bank holding companies that are close to the 
$50 billion asset line.
    Along with that, we might make it somewhat stricter for 
some of the GCIBs. We are considering that as well, and I think 
that would be tailoring appropriately, I think--at both ends of 
the spectrum. We are paying close attention to the costs and 
benefits of particular changes, how they affect those 
institutions.
    So we have not made final decisions, but that is certainly 
something on the drawing board where I hope we can make 
progress.
    Senator Crapo. Do you believe we will see any of that 
tailoring announced soon or applied soon?
    Ms. Yellen. Certainly this year, but I think if we were to 
make changes, they would not take effect until the 2017 cycle 
of stress testing.
    Senator Crapo. Thank you. And shifting topics, because of 
the liquidity issues that occurred on October 15, 2014, in the 
Treasury market, there has been a lot of effort by the Federal 
Reserve and others to better understand the factors that impact 
the liquidity of the Treasury market, especially during 
stressed market conditions.
    The concern that I heard is that several factors, including 
new regulations, may have reduced market-making capacity in the 
market, and that during stressed market conditions, liquidity 
may be more prone to disappearing at times when it is most 
needed, as it seemed to do on October 15th.
    Are you concerned that liquidity in the bond markets may be 
less available in stressed market conditions and that we need 
to better understand and analyze all the factors, including the 
impact of regulations on this?
    Ms. Yellen. Senator, yes, I agree with what you said. You 
know, normal metrics, the ones we typically monitor on 
liquidity conditions in these markets, have not changed that 
much, but the perception and, of course, some experiences, as 
you cited, suggest that under stressed conditions liquidity may 
disappear when it is most needed. So we are looking very 
carefully at that and at all of the factors that may be 
involved. Regulation is on the list, but there are other things 
as well. The prevalence of high-frequency trading has 
increased. Broker-dealers have reconsidered in the aftermath of 
the crisis the appropriate models they want to use to run their 
businesses. There have been changes in disclosure that affect 
corporate bond markets, and we want to recently to disentangle 
the impact of all of those different influences.
    Senator Crapo. Well, thank you. And one last question. 
There have been several hearings on the Financial Stability 
Oversight Council that focused on ways to improve transparency, 
accountability, and communications. In the April Subcommittee 
hearing that Senator Warner and I held, the witnesses agreed 
that the Financial Stability Oversight Council needed to 
provide actionable guidance to designated systemically 
important financial institutions on how they could de-risk and 
ultimately shed their designation label.
    What has been done--this has been referred to as an ``off 
ramp.'' Do you agree that further progress in this area is 
appropriate? And wouldn't our financial system be safer if 
companies knew what they could do to address the risks and had 
an incentive to become less systemically risky?
    Ms. Yellen. So I would certainly agree with you, it would 
be good if they became less systemically risky, and designation 
is not intended to be permanent. The FSOC reviews these 
designations every year, and it is, of course, important for 
firms to understand the kinds of steps that they could take to 
shed their designation and to become less risky.
    But I think the FSOC needs to be very careful not to 
micromanage these firms and to try to tell them exactly what 
their business models ought to be. Those firms know exactly why 
they were designated. They have received detailed letters and 
analysis explaining what the factors were about their 
businesses that would give rise to systemic risk in the event 
of their failure. So they do understand why they have been 
designated and the things that they would need to address.
    So designation is not intended to be permanent. We do have 
regular reviews, and I think those firms do have an 
understanding of the kinds of things they would need to be 
prepared to do. So I just do not think it is appropriate for 
the FSOC to say, ``We want you to do the following business 
plans.'' There are a lot of different ways in which a firm 
might decide to address those issues.
    Senator Crapo. Thank you. My time has expired. I would like 
to discuss this with you further. Thank you.
    Ms. Yellen. Certainly.
    Senator Corker. [Presiding.] Senator Tester.
    Senator Tester. Thank you, Senator Corker.
    Thank you, Chairman Yellen, for being here today. I want to 
follow up with Senator Crapo's questions a little bit because 
there is some new information that you just gave that I was not 
aware of, and that is that--and correct me if I am wrong--you 
just said that the companies understand why they are designated 
as a SIFI and, therefore, they understand what they have to do 
to get undesignated. Is that what you just said? Because that 
is new information for me.
    Ms. Yellen. Well, in the sense that they have been given 
very detailed explanations of what aspects of their business 
give rise to the systemic risks that have caused them to be 
designated.
    Senator Tester. And so is that information given as the 
process goes on or after the process of designation is done?
    Ms. Yellen. Well, there is a three-stage process.
    Senator Tester. Yeah.
    Ms. Yellen. And there is a great deal of interaction with 
FSOC during that process.
    Senator Tester. OK.
    Ms. Yellen. So I believe before they are designated, there 
is a sufficient amount of interaction that they well understand 
the aspects----
    Senator Tester. Why they are being designated?
    Ms. Yellen. ----that are leading them to be designated, and 
then they are given a very detailed----
    Senator Tester. Would they have the opportunity as that 
process goes on to make changes so they would change the 
direction the FSOC is going? If that information is--what I am 
getting at is if that information is being given out early 
enough so the company can say, well, we are going to make some 
changes--not changes that the FSOC demands of them to make, but 
they have chosen to make some changes to stop the designation, 
do you believe they have time to do that before the designation 
is made?
    Ms. Yellen. So they certainly have lots of opportunities to 
interact with FSOC and to explain----
    Senator Tester. OK.
    Ms. Yellen. ----their business model and the direction it 
is going.
    Senator Tester. I think that is good. Thank you, Chairman.
    I want to talk a little bit about the housing sector just 
very, very briefly. Could you give us your perspective on what 
the Fed is seeing in the housing sector right now and what a 
hiccup in that sector would mean for the American taxpayer?
    Ms. Yellen. So we are seeing a recovery, I would say, in 
housing. It has gone on now for a number of years, but it is 
very, very gradual.
    Senator Tester. Yeah.
    Ms. Yellen. House prices are recovering. They have 
increased quite a bit, and I think that is helping the 
financial situation of many households.
    Senator Tester. Yeah.
    Ms. Yellen. The level of new construction of residential 
investment remains quite low relative to underlying demographic 
trends. So it seems to me there is quite a significant way for 
housing to go before we could say it is at levels consistent 
with demographic trends. So I think it will continue to 
improve.
    Senator Tester. OK.
    Ms. Yellen. And it is a support to the economy.
    Senator Tester. All right. And a hiccup in the housing 
industry, what would that mean for the taxpayer right now?
    Ms. Yellen. For the taxpayer.
    Senator Tester. The American taxpayer, what would a housing 
slowdown or perhaps not a collapse but a decrease in their 
growth mean to the American taxpayer vis-a-vis Fannie Mae and 
Freddie Mac?
    Ms. Yellen. Oh, vis-a-vis Fannie Mae and Freddie Mac?
    Senator Tester. Yeah.
    Ms. Yellen. So I am not----
    Senator Tester. OK.
    Ms. Yellen. I do not have----
    Senator Tester. We are probably going down a line that we--
--
    Ms. Yellen. I am sorry. I do not have numbers on----
    Senator Tester. Tell me, can you give me a sense of what 
the Fed is doing to ensure that we are protecting consumers 
while at the same time differentiating between community banks 
and the big banks----
    Ms. Yellen. Well, when you say that we are protecting 
consumers----
    Senator Tester. Yes, while at the same time differentiating 
the regulations that impact the small banks versus the big 
guys.
    Ms. Yellen. So consumer protection is a very important part 
of our supervision, and the CFPB examines the larger banks in 
terms of their consumer compliance, and our responsibility is 
now with the smaller banks in community banks where we have 
consumer protection enforcement.
    We try to tailor our examinations, our consumer exams of 
the community banks so that they are not too burdensome and 
they are focused on real risks.
    Senator Tester. Do you feel you have been successful in 
that tailoring from a community bank standpoint?
    Ms. Yellen. We are very focused on regulatory burden on 
community banks, and we are trying to do both in the safety and 
soundness side and on the consumer compliance side everything 
that we can to reduce burden while still making sure that banks 
abide by consumer protection.
    Senator Tester. OK. If I might, Mr. Chair, just very 
quickly, we are seeing consolidation in banks in Montana pretty 
rapid. Is that true throughout the country? And are you 
concerned about that?
    Ms. Yellen. Well, there has been consolidation. We are 
concerned about the burdens on community banks and trying to 
relieve that. In a low-interest-rate environment, net interest 
margins are also squeezed for many of these banks, and that is 
a factor also here.
    Senator Tester. Thank, Mr. Chairman. Thank you, Janet.
    Senator Corker. Thank you.
    Madam Chairman, thank you for being here. I know when we 
went through our confirmation hearings, I noted that you were 
the first avowed dove to head the Fed, and yet you honored the 
statements you made, which were at the time that if the data 
showed that you needed to raise interest rates, you were going 
to do so, and you just did that recently. And I noticed during 
this hearing you were talking about 2 percent inflation and 
full employment. I think the question by many is: Are there any 
other rules at the Fed other than 2 percent inflation and full 
employment as you look at data that guide where you are going? 
I would like not a particularly long answer to that.
    Ms. Yellen. Well, those are----
    Senator Corker. I think there has been--as you know, there 
have been criticisms about whether there really is a rule-based 
system that people understand so that it is not like the Fed is 
the Wizard of Oz and no one really knows what is going to 
happen. And, you know, markets have fallen 500 points, which is 
unusual, in the last couple days after testimony, which I 
thought was good yesterday. But is there some other rule-based 
system that those of us who care about these kind of things 
could count on relative to what the Fed's actions are?
    Ms. Yellen. So, Senator, if I might, I would like to 
distinguish between a systematic approach to monetary policy, 
which I believe we have put in place, and a system that we use 
that is in line with what other advanced central banks do and a 
mechanical, mathematical rule-based approach, which I do not 
support and no central bank that I am aware of follows.
    We have articulated in a clear statement what our 
objectives are: 2 percent inflation and our interpretation of 
maximum employment. Every 3 months, all members, all 
participants in the FOMC set out their explicit projections for 
key variables and also the monetary policy path that they 
regard as appropriate to achieve those variables, and we 
publish these projections.
    Now, it is not a single Committee-endorsed view, but it 
does show the range of forecasts and assessments of what 
appropriate policy would be in line with those forecasts, and 
we update those projections every 3 months in line with 
incoming data. And I would regard that as quite a bit of 
information and a systematic approach. We are telling the 
public what the range of opinion is about appropriate policy 
and the associated path for the economy. And, of course, there 
is uncertainty. So policy is not on----
    Senator Corker. I got it.
    Ms. Yellen. ----a preset path. We update those projections, 
but we are showing what we think in a systematic way.
    Senator Corker. I would think--we had a nice conversation 
the other day at length, and I think that one of the things the 
Fed could do--you asked me questions along those lines--would 
be to maybe come in here in an off-the-record meeting and lay 
that out, and then contrast that with a rule-based system. I 
think that would be very helpful to the Fed and I think very 
helpful to the Committee Members here.
    Let me ask you this: Just briefly on the $4.5 trillion 
balance sheet that the Fed now has, as we look at where we are 
today, has there been any thought, looking in the rearview 
mirror, that it might have been good to unload some of that 
earlier so there was additional ammunition should that be 
needed in the future?
    Ms. Yellen. Well, so I think the thinking about additional 
ammunition is that the best ammunition we have and the single 
most reliable and predictable tool for affecting the stance of 
monetary policy is variations in short-term interest rates. So 
as the economy has now gotten to a point where we are slowly 
reducing accommodation, we have a choice between selling off 
assets or raising short-term interest rates.
    Senator Corker. I am talking about as the economy goes the 
other direction, and I guess the question then is--so you have 
got a pretty loaded up balance sheet, and I think people are 
beginning to observe that the Fed is probably out of 
ammunition, unless you decided to go to negative rates. And if 
you could, briefly--I am not proposing this. I am just 
observing what is happening around the world and what is 
happening here in our own country. I think people are waking up 
and realizing that the Fed really has no real ammunition left. 
You alluded to this some yesterday, but--and I have one more 
question, so I do not want this to be too long. But are you 
considering if things go south, which none of us hope do, are 
you considering negative rates? I know you had that question 
yesterday. Yes or no?
    Ms. Yellen. So the answer is that we had previously 
considered them and decided that they would not work well to 
foster accommodation back in 2010. In light of the experience 
of European countries and others that have gone to negative 
rates, we are taking a look at them again because we would want 
to be prepared in the event that we needed to add 
accommodation. We have not finished that evaluation. We need to 
consider the U.S. institutional context and whether they would 
work well here. It is not automatic.
    Senator Corker. Yeah.
    Ms. Yellen. There are a number of things to consider. We 
have not----
    Senator Corker. I got it.
    Ms. Yellen. So I would not take those off the table, but we 
would have work to do to judge whether they would be workable 
here. And I would say we have----
    Senator Corker. I would have thought that where we would be 
is that we were out of ammunition. And it would be good for the 
markets to understand that we are out of ammunition, and now it 
is up to other factors. But now, as I hear it, potentially 
negative rates are something that could affect things over 
time.
    If I could just go down one more path, productivity. You 
have talked about that as the greatest driver for wage 
increases. And I appreciated some of Senator Brown's opening 
comments, and I want to say that, you know, the concern that we 
all have is the most vulnerable in our society are the ones 
that are hurt most when we have downturns and the slowest to 
regain, and there is no question there is a wealth gap in our 
country. The question is: What do we do about it?
    You have mentioned the most important factor determining 
productivity in advances in living--advances in living 
standards is productivity growth, defined as the rate of 
increase on how much a worker can produce in an hour of work. 
Over time, sustained increases in productivity are necessary to 
support rising household incomes. And then later on, we do know 
that productivity ultimately depends upon many factors, 
including our workforce knowledge and skills. By the way, does 
monetary policy affect knowledge or skills? The answer is no.
    Does the quality of capital equipment--monetary policy does 
not affect that. Is that correct?
    Ms. Yellen. Well, the only qualification I would make is 
that during a long, deep downturn like we had, capital 
investment, in part because it was not needed, was very slow. 
And that leaves a legacy that has a negative impact. And when 
people are out of work for a long period of time, their skills 
can erode to the point where it becomes difficult for them----
    Senator Corker. I am trying to help you here. The teacher 
has now showed up, and he is going to reprimand me for going 
over. So is there anything about monetary policy that----
    Chairman Shelby. Senator Corker knows that would not be in 
order.
    Senator Corker. Does monetary policy affect infrastructure 
investment?
    Ms. Yellen. No.
    Senator Corker. OK. So the point is productivity is sort of 
on this side of the dais. Is that correct?
    Ms. Yellen. Yes.
    Senator Corker. And when people try to look at the Fed 
through monetary policy to increase productivity, it is a 
ridiculous notion, is it not?
    Ms. Yellen. Fundamentally, it is not something we control.
    Senator Corker. And that is our job, and we are not doing 
our job.
    Let me just ask one last question, and the Chairman has 
been very nice. He came in today in a very good mood.
    [Laughter.]
    Senator Corker. Last year, in a budget meeting, the head 
of--Doug Elmendorf came in and said that because Federal 
borrowing reduces total saving in the economy over time, the 
Nation's capital stock would ultimately be smaller than it 
would be if debt was smaller, and productivity and total wages 
would be lower. So as we accumulate debt, we are actually 
hurting many of the people in this room that came today because 
they care about this, because we are really hurting 
productivity. Is that a true statement?
    Ms. Yellen. Well, over long periods of time, yes, I would 
agree with that.
    Senator Corker. Thank, Madam Chairman.
    Thank you, Chairman.
    Chairman Shelby. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman.
    Madam Chairman, let me talk about the challenges of 
families who still, notwithstanding the numbers, do not see 
their incomes rising. I know that in some respects the numbers 
are indisputable. The unemployment rate is at 4.9 percent, the 
lowest since we have seen since February 2008, less than half 
of what it was at the peak in October 2010, 14 million jobs 
over 71 straight months. But those numbers in my mind do not 
tell the whole story. Long-term unemployment persists with 
people unemployed for 27 weeks or longer, compromising more 
than a quarter of all of the total number of jobless 
individuals. Hardworking families throughout the country have 
been waiting too long for income increases to materialize. And 
those the economy has partially healed and hopefully will 
continue to heal, to me there is a clear indicator of how much 
harm was inflicted by the financial crisis.
    Many employers due to market conditions are paying low 
wages and offering limited benefits to their employees with 
little concern that these employees will leave because of the 
slack in the job market. Employers have a sea of prospects 
every time an employee jumps ship.
    So talk to me about what needs to be done at the Fed and 
elsewhere to address long-term unemployment and to foster 
policies that transform economic growth into growth for 
hardworking families.
    Ms. Yellen. Well, I think what we are trying to do to 
contribute to the solution of that problem is to keep the 
economy growing at a steady pace, to keep the labor market 
improving in the hope and expectation that a stronger labor 
market will improve the status of all groups in the labor 
market and begin to bring down long-term unemployment, 
involuntary part-time employment, and we have seen that.
    So unemployment rates have come down for almost all 
demographic groups. As high as it is, the incidence of long-
term unemployment has declined. Involuntary part-time 
unemployment has also declined as the economy has improved. But 
these are longstanding adverse trends, including structural 
factors like globalization, the very slow growth in middle-
income jobs, technological trends that have favored higher-
skilled workers. I mean, I think for Congress there are any 
number of things that you might consider and might do that 
would be helpful in addressing these trends. Some of them, many 
of them would be related to training, education, increasing 
opportunity to make sure that those skills can be more readily 
acquired.
    Senator Menendez. Let me ask you, just before I turn to 
another subject, how can the Fed better account for full 
employment and, thus, enhanced efficiency and production in its 
analysis and planning?
    Ms. Yellen. Well, from my point of view, and I think from 
the point of view of the FOMC, more jobs are always good, 
employment is good. And when we think about maximum employment, 
we are really considering is there a point at which pursuing 
that goal would lead to higher inflation and inflation above 
our 2-percent objective.
    So we try to estimate, and, in fact, all participants in 
the FOMC every 3 months write down their estimate of the 
unemployment rate in the economy that would be sustainable and 
consistent with our inflation objective. At the moment the 
median of those estimates is 4.9 percent, but most of us 
recognize that there are additional forms of slack that we 
would certainly like to see diminished.
    Senator Menendez. Well, as a corollary, and a final point I 
would like to hear from you on, context matters. When I sit on 
the Senate Foreign Relations Committee and I see what is 
happening with China and other places in the world, context 
matters. And here in the United States and in Europe and Asia, 
we have seen the combination of fiscal austerity and tight 
monetary policy can be toxic for an economy that is recovering. 
And so I know that there is this sense among--I think there is 
a sense among Fed policymakers that they are eager to reach the 
point in the economy where we can ``normalize'' monetary policy 
by raising rates. But can you describe the risks to the 
economy--and this is always a calibration, I understand--of 
tightening too soon? And do you take this global context into 
consideration when you are looking at that?
    Ms. Yellen. We absolutely take the global context into 
consideration, and normalization is not something we want to 
pursue and accomplish for its own sake. We only want to move to 
more normal levels of interest rates if it is consistent with 
achieving our objectives of 2 percent inflation and maximum 
employment. We want to and intend to put in place the monetary 
policy that is consistent with achieving those objectives.
    In an economy that has been recovering, the Committee felt 
that it could be on a path and would likely be on a path where 
short-term rates would gradually rise over time consistent with 
that objective. But I want to emphasize that monetary policy is 
not on some preset course. Monetary policy will be set and 
calibrated to do the best we can to achieve our congressionally 
mandated objectives.
    Senator Menendez. All right. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Toomey.
    Senator Toomey. Thank you, Mr. Chairman. And, Madam 
Chairman, thanks for joining us again.
    I want to follow up on the line of discussion that Senator 
Corker was discussing, and, Madam Chairman, we have had this 
conversation before. You may recall I have been advocating that 
the Fed normalize interest rates for a long time now. One of my 
deep concerns is that central banks around the world, very much 
including our own, seem to be trying to compensate for an 
inability of the political class around the world to address 
what is really holding back economic growth, which are fiscally 
unsustainable budgets, in our case and I would argue in much of 
the rest of the world, an avalanche of new regulations that is 
holding back economic growth, high marginal tax rates that 
discourage savings, work, investment. And the fact is central 
banks' monetary policy cannot make up for those problems.
    In fact, you could argue in some cases they can make it 
worse.
    Now we see the markets as of this morning appear to be 
pricing in an expectation that there will be no further 
increases in the interest rates that the central bank controls. 
They may be right, they may be wrong, but that is the 
expectation now. And there is this discussion, since the rest 
of the world is pursuing ever further this new chapter in 
radical monetary policy, we have this discussion about negative 
interest rates. And I appreciate the fact that you in your 
discussion with Senator Corker pointed out that there might be 
some serious concerns.
    I find it very, very disturbing to even seriously consider 
moving in that direction, and I hope we could talk about some 
of the potential risks of negative interest rates, because I 
think there is a qualitative difference, and I would like to 
get your thought on this between, say, a 25-basis-point 
movement in Fed-controlled rates, a movement that takes you 
from a low-positive rate to another low-positive rate, versus 
one that crosses the threshold into the negative.
    Above and beyond the psychological effect--I think most of 
us have grown up our entire life with the expectation that 
there is an absolute floor to interest rates. That would be 
shattered, and that might have unanticipated consequences. But 
there are practical consequences, too, and I am hoping you 
could comment on some.
    For instance, it would seem that it would crush net 
interest margins for banks and perhaps dramatically diminish 
their ability to provide capital. I do not know how a money 
market business survives at all if there is a sustained period 
of negative interest rates.
    I could see an adverse effect on business investments. 
Investors would be pressured to move further out the risk 
curve, even further than they have already been pressured. It 
would put the U.S. deep in the midst of a global currency war, 
which is won by he who debases his currency the most.
    And I would suggest that the results where it has been 
tried have not gone so well. Sweden has had negative interest 
rates since 2009. They have got a massive property bubble. The 
eurozone area generally has had negative interest rates since 
June of 2014. GDP growth has been very, very weak. Japan 
recently instituted negative interest rates, and as you saw, 
among other problems, they recently had a completely failed 
auction. They had to give up on auctioning off JGBs, so I guess 
we just monetize the debt.
    It seems to me there are a lot of potential problems, and I 
wonder if you could, first, confirm that, for a layman, when we 
talk about negative interest rates, if that is imposed on 
savers, we are talking about savers having to pay a bank in 
order to take their money on deposit. Isn't that equivalent to 
a tax on savings? And could you just comment on some of these 
other problems?
    Ms. Yellen. So in the European countries that have taken 
rates to negative territory, while I will say I was surprised 
that it was possible to move rates as negative as some 
countries have done, I think we have not in those countries 
seen actual fees levied on depositors. I may be wrong about--
there may be some experiences there that I am not aware of, but 
I do not think there has been broad-based passthrough of 
negative rates to at least small depositors. But----
    Senator Toomey. And if banks resist that, then that just 
means their margins are crushed.
    Ms. Yellen. Their margins have been squeezed. A low 
interest rate environment generally tends to push down net 
Internet margins.
    Now, they adopted it because they were concerned about 
inflation running very much below their objectives and wanted 
to stimulate the economy in order to achieve those objectives, 
so there were reasons that they adopted it. In our own context, 
when we considered this in 2010, we were concerned about 
potential impacts on money market functioning and did not 
really think it was be possible to bring them to very negative 
levels. And before we were to take a step like that, we would 
have to think through all of the institutional details and how 
they would work in the U.S. context.
    I think as a matter of due diligence and preparedness, 
these are things we need to work through, but we do not even 
know if payments and clearing and settlement systems in our 
context would be able to easily handle negative rates. So we 
have not studied that.
    Senator Toomey. And just a very quick follow-up, Mr. 
Chairman, and I will be finished, but isn't it also true that 
there is an internal memo at the Fed from, I think it was, 
August of 2010 that raises doubts about whether the Fed has the 
legal authority to impose negative interest rates?
    Ms. Yellen. No. So there is a memo from 2010, and what it 
really said is that the legal issues have not been studied. It 
was silent on the legality. It was a memo that discussed market 
functioning and economic issues connected with it, and the 
legal issues had not been vetted.
    I am not aware of any legal restriction that would mean 
that we could not establish negative rates, but I will say that 
we have not looked carefully at the legal side of this.
    Senator Toomey. I would like to submit that memo to the 
record, Mr. Chairman, and just quote very briefly from----
    Chairman Shelby. Without objection, it will be made part of 
the record.
    Senator Toomey. Thank you, Mr. Chairman. Among other 
things, the memo does say, and I quote, ``There are several 
potentially substantial legal and practical constraints.'' In 
another part of the letter it says, and I quote, ``It is not at 
all clear that the Federal Reserve Act permits negative IOER 
rates.''
    So, obviously, there was a question in somebody's mind.
    Ms. Yellen. Right. It had not been seriously studied, and 
at this point I am not aware of a legal constraint. But, again, 
we have not run that through a careful legal analysis.
    Senator Toomey. Thank you very much.
    Chairman Shelby. Thank you.
    Senator Warner.
    Senator Warner. Thank you, Mr. Chairman.
    Chairwoman Yellen, it is great to see you, and thank you 
for your service. As we kind of go back and forth about effects 
of monetary policy or not--and I share some of Senator Toomey's 
concerns about negative interest rates--I would, a little 
tongue in cheek, make mention of one of your comments in reply 
earlier to Senator Menendez, which I think would actually have 
100 percent approval on this panel, where you said more jobs 
are good for the economy. How we get those more jobs is some 
question, and we can debate monetary policy or not. But one of 
the things--and we were talking about productivity, and, again, 
I share your views on productivity. Productivity gains often 
are driven by knowledge and skills, and I think one of the 
things that we have talked about before, but unfortunately this 
Congress has not fully addressed, is the rising challenge 
around student debt, now at $1.3 trillion and rising, greater 
than credit card debt, and the ripple effect that has across 
our whole economy, not just to those individual students or 
recent graduates and their families, but I would like you to 
comment upon that kind of wage box you are caught in with 
rents, student debts, not enough rising wages, and the effect 
that has both on startups, as someone--we all know 80 percent 
of our net new jobs have been created by startups over the last 
30 years. Startup entrepreneur numbers are down, a lot of that, 
I believe, due to student debt. First-time home buyers are 
down, often times due to student debt. I know you and other 
regulatory entities have looked at this, but I would like you 
to comment on the effect if we continue to have this number 
grow and do not take a more comprehensive approach to student 
debt, what kind of drag that will be on the economy, because, 
again, echoing your comments that more jobs are better for the 
economy, driving down that student debt I believe would lead to 
further growth in the housing market and further growth in 
entrepreneurial activities.
    Ms. Yellen. So, on the one hand, taking on that student 
debt, to the extent it is successful in building skills that 
put people in higher-wage jobs and qualify them for better work 
is really critical to their getting ahead.
    You know, on the other hand, there is a lot to worry about 
with student debt, with people attending colleges or gaining 
education where they do not finish, the reward is not there, to 
me a major concern is that people may not be well-informed 
about what the benefits are of what they are taking on. And if 
an individual finds themselves in difficult financial straits 
for any reason, that debt, because it is not dischargeable in 
bankruptcy, can be a very severe burden that really holds 
people back.
    In terms of studies, there has been, it would appear, a 
decline in new business formation. I have not seen anything 
myself, but I might not be aware of studies that link it to 
student debt. I have not seen that. It is certainly possible, 
but I am not aware of that.
    With respect to housing, some economists at the Fed have 
tried to look at that, and others have, and I think the results 
are mixed. It is not clear that student debt is a major factor 
responsible for inability to buy homes or get ahead in the 
housing market, although I understand it is quite logical that 
a heavy student debt burden would make it difficult----
    Senator Warner. I would simply note that home builders 
across all sectors are indicating particularly the weakest part 
of the housing market is first-time home buyers, oftentimes 
people who, because they are otherwise burdened with student 
debt, do not make those investments.
    And I think I would just urge my colleagues there are 
comprehensive approaches that Senator Warren and others have 
suggested in terms of total refinancing. But there are other 
steps that can be taken, whether it is better transparency--we 
all know higher education next to buying a house may be your 
most expensive item you purchase. Better transparency about 
outcomes, that would force higher education to come clean a 
little more. Clearly, the problem of not finishing is a huge 
issue. But we do not have very much transparency in higher 
education. On top of that, income-based repayment, the 
Administration has made some movements there. I think there are 
more. I mean, there is low-hanging fruit.
    Ms. Yellen. Yes.
    Senator Warner. Businesses already can provide ongoing 
education to employees on a pre-tax basis. I scratch my head, 
and I have got bipartisan legislation that would say if you can 
go ahead and continue your education on a pre-tax basis, why 
shouldn't an employer be able, in concert with an employee, to 
use pre-tax dollars to pay down student debt on both sides of 
the balance sheet? Good for retention, good obviously for the 
employees as well.
    I will not go ahead and take the additional 3 or 4 minutes 
that most of my colleagues have had beyond the timeline in 
respect to my other colleagues, but I would like to submit for 
the record a couple of questions about what happens as we draw 
down this capital surplus account, and obviously the Fed has 
kicked in about $517 billion over the last 6 years. As you wind 
down that portfolio, we could see, obviously, those dollars go 
down. And I know that you share some of the concerns. As we 
unwind that $4 trillion balance sheet, how much cushion does 
the central banking system need, particularly when Congress 
most recently has raided part of that cushion, and I would take 
that for the record.
    Thank you, Mr. Chairman.
    Chairman Shelby. Thank you.
    Senator Cotton.
    Senator Cotton. Thank you. Since Senator Warner graciously 
yielded back his extra 3 or 4 minutes, I will just add that to 
my extra 3 or 4 minutes to get 8 or 9 extra minutes maybe.
    [Laughter.]
    Chairman Shelby. Chair Yellen is not up here every day.
    Senator Cotton. I will try to be brief. Madam Chair, 
welcome back. Throughout much of history, the Federal Reserve 
has raised interest rates when economic growth is strong and 
accompanying inflation is growing--hence, the cliche that the 
Federal Reserve takes the punch bowl away right as the party is 
getting going.
    In December, we were in the middle of a quarter with seven-
tenths of a percent economic growth and inflation was below the 
stated target. The Open Market Committee raised interest rates. 
Could you explain why this historical anomaly occurred?
    Ms. Yellen. Well, our focus is on the labor market and the 
path that it is on and the fact that economic growth has been 
very slow and this has been true for quite some time and yet 
the labor market has made more or less continuous improvements 
is a reflection of slow pace of productivity growth, I would 
say. So we saw a labor market where jobs were being created at 
a pace of around 225,000 or so a month. The unemployment rate 
had fell to very close to levels we would regard as sustainable 
in the longer run, although in my view there remains slack. 
There did and still remains some slack in the labor market.
    Monetary policy was highly accommodative. The funds rate 
had been at zero for 7 years, and we had a large balance sheet, 
so we were not talking about moving to a restrictive stance of 
policies simply diminishing accommodation by a modest amount. 
And while inflation was running below our 2-percent objective, 
the Committee judged that transitory factors, particularly 
energy prices and the appreciation of the dollar, were placing 
significant downward pressure, that that would ebb over time, 
and as the labor market continued to improve, that inflation 
would move back up to 2 percent. And we want to make sure, 
given the lags in monetary policy, that we do not wait so long 
to begin the process of modest adjustments in the Fed funds 
rate that we end up significantly overshooting both of our 
objectives and allowing inflation to rise to the point where we 
would have to tighten policy in a more precipitate manner, 
which could potentially place ongoing sustainable economic 
growth and improvement in the labor market in jeopardy.
    So we wanted to be able to move in a very gradual way and 
to make sure that the economy remained on a sustainable course 
of improvement.
    Senator Cotton. Thank you. You used a term there, 
``transitory factors,'' that you also cite on page 5 of your 
testimony where you say the Committee ``judged that much of the 
softness in inflation was attributable to transitory factors 
that are likely to abate over time,'' without specifying in the 
written testimony, you just cited energy prices and 
appreciation of the dollar. Are there any other transitory 
factors that you----
    Ms. Yellen. Those are the main ones, and, you know, of 
course, energy prices have continued to move down.
    Senator Cotton. So now 2 months on, do you still expect 
that energy prices and the appreciation of the dollar will halt 
or even turn around on their current trajectory?
    Ms. Yellen. So, you know, energy prices have continued to 
move down. I feel eventually they will stop moving down and 
stabilize. Exactly when that will be, when that happens, when 
that eventually happens and the dollar stabilizes, inflation 
will begin to move up, it is hard to predict exactly when that 
will be, and there can be and have been surprises.
    Senator Cotton. Thank you.
    I want to turn briefly to wages. Several Members of this 
Committee have expressed their concern about stagnant wages, 
especially for working-class men and women in this country. I 
share that concern, as do apparently many people in the 
audience, judging by their T-shirts.
    One point we have not touched upon is immigration, and here 
I do not mean illegal immigration but legal immigration. We are 
now at record-high levels of foreign-born residents in this 
country. Something like one-seventh of all American residents 
were born in a foreign country. Do you think that that level of 
mass legal immigration has put downward pressure on the wages 
of working men and women in this country, native-born 
Americans?
    Ms. Yellen. I am not aware of evidence that suggests it 
has, but I would need to look into it. I am not aware of 
evidence on that.
    Senator Cotton. OK. Thank you.
    Chairman Shelby. Senator Warren.
    Senator Warren. Thank you, Mr. Chairman. And it is good to 
see you again here, Chair Yellen. And it is also good to see 
people here from across the country, people who are fed up.
    I know that as Chair you have done a lot of outreach, but 
seeing people here who have come in from a lot of different 
places is a strong reminder that every Fed decision affects 
every person in this country. And the Fed has plenty of 
opportunities to hear from giant banks. It is good to hear from 
real people and get that reminder, so thank you.
    Now, I want to go back to another question here. As you 
know, Dodd-Frank requires giant financial institutions to 
submit living wills. These are the documents that describe how 
these banks could be liquidated in a rapid and orderly fashion 
in bankruptcy without either bringing down the economy or 
needing a taxpayer bailout.
    If the Fed and the FDIC find that those living wills are 
not credible, the agencies can take steps to reduce the risks 
poses by these banks by imposing higher capital standards, by 
lowering leverage ratios, or by breaking up the banks by 
forcing them to sell off assets.
    A year-and-a-half ago, in August of 2014, the Fed and the 
FDIC identified several problems with the living wills 
submitted by 11 of the biggest banks in this country. The FDIC 
found that all 11 of those wills were not credible, while the 
Fed agreed about the problems but then refused to make any 
determination about whether the wills met the legal standard 
about credibility. In other words, the Fed did not say they 
were credible, but the Fed did not say they were not credible 
either.
    Now, that mattered a lot because it is only a joint 
determination by the agencies that has any legal force. The 
Fed's refusal to call the plans ``not credible'' meant the 
agencies could not use statutory tools to push these risky 
banks in the right direction. So I want to start by looking 
back at that decision by the Fed.
    The FDIC stands behind insured deposits, so its main 
mission is to stop bank failures before they happen so 
taxpayers will not be on the hook for some kind of bank 
failure. Of all the regulators, the FDIC has the most expertise 
in liquidating failed banks. So if the FDIC found that the 
banks' liquidation plans were not credible and the Fed agreed 
with the FDIC on the basic problems with each of these plans, 
why did the Fed refuse to join the FDIC and designate these 
plans as not credible?
    Ms. Yellen. Well, looking back to the decision we made last 
year, we had set out in the guidance pertaining to these living 
wills that we expected to go through a few rounds of 
submissions to clarify. It is a completely new process, and we 
felt the banks needed to understand what expectations were in 
terms of what we wanted to see, and we felt that we had not 
given sufficiently clear guidance to make the decision at that 
time.
    We worked very closely with the FDIC. As you noted, we have 
given detailed guidance to these firms about what we want to 
see in this round of living wills. We are spending a great deal 
of time, we have had seven full Board meetings so far since 
August to discuss and work through these living wills. We are 
working closely with the FDIC in evaluating them, and we did 
make clear and it continues to be the case that if a living 
will does not satisfactorily address the shortcomings that we 
identified last year, that we are prepared to make findings 
that a living will is deficient.
    Senator Warren. OK. So let me go then to where you are 
going here. The FDIC already thought that the facts established 
that the plans were not credible for 11 of the largest 
financial institutions. In August of 2014, the Fed and the FDIC 
required those 11 firms to resubmit living wills that addressed 
the problems they had identified, and the firms resubmitted 
their plans last July. And as you say, it is my understanding 
that you are just about finished reviewing those plans. So once 
again I want to underline only joint determinations by both the 
FDIC and the Fed will carry the force of law.
    So can you say today that you will work with the FDIC to 
ensure that the agencies issue joint determinations of 
credibility on each of the 11 living wills that were 
resubmitted?
    Ms. Yellen. We are working very closely with them to 
evaluate these living wills, and----
    Senator Warren. Well, I assume you did that last time, that 
you worked closely with them. I think that is what you said in 
your testimony.
    Ms. Yellen. We did, and we wrote joint letters to these 
firms, and we will certainly try to do that again to identify 
shortcomings that the living wills have and further steps that 
we want to see. Each member of the Board of Governors and 
members of the FDIC Board are charged with arriving at our own 
individual judgments as to whether or not these living wills 
are credible or facilitate resolution, and I cannot guarantee 
you that we will arrive at identical conclusions.
    Senator Warren. OK. Fair----
    Ms. Yellen. ----we have each been vested by Congress into 
making a judgment based on the merits.
    Senator Warren. OK. If you cannot ensure that the agencies 
will issue joint determinations, which is how we get to the 
effect of the law, let me ask if you will make another 
commitment, and that is, will you at least commit that if the 
Fed finds a living will credible and the FDIC does not find a 
living will credible, that the Fed will issue a written public 
explanation for why it is reaching a different conclusion? It 
seems like that is the least that the Fed can do to help the 
public understand its position.
    Ms. Yellen. Well, my expectation is that we will release 
the letters that we send to the firms giving our evaluations of 
their living will.
    Senator Warren. So you will be explaining--if there is a 
difference between the Fed and the FDIC, you will be issuing a 
written statement about why the Fed decided something was 
credible that the FDIC found was not credible?
    Ms. Yellen. Well, I want to be careful exactly what I say 
about this.
    Senator Warren. Good.
    Ms. Yellen. We expect to send letters; hopefully they will 
be joint letters; hopefully we will be able to agree on what 
the shortcomings are of the living wills and if either agency 
finds that they are not credible, we need to identify specific 
deficiencies that we wish to see remedied. And my strong hope 
and expectation is that we will arrive at joint agreement with 
the FDIC on those deficiencies and release letters that explain 
what we find them to be.
    Senator Warren. Well, I very much hope that the Fed and the 
FDIC are on the same page. That is the only way we get the 
impact of this law. Living wills are one of the primary tools 
that Congress gave to regulators to make sure that the 
taxpayers will not be on the hook if another giant bank fails, 
and it is critical that the Fed use this authority, like the 
FDIC has been willing to do, to make sure our financial system 
safer.
    Thank you.
    Ms. Yellen. I agree with you on that, and we have been 
working with them all along through our supervisory process as 
well, which is separate, but we are also emphasizing recovery 
planning and resolution through our supervision.
    Senator Warren. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Thank you, Senator Warren.
    Senator Rounds.
    Senator Rounds. Thank you, Mr. Chairman. And welcome. I 
suspect now that you have had more than 60 different 
individuals asking questions. Most of them perhaps have been 
asked.
    In looking at today's testimony, I think a lot of attention 
was paid to the discussion on negative interest rates, and I 
noted that there were a couple of items that I suspect, as you 
have shared, you have indicated that while you would be looking 
at negative rates, the analysis is not yet done, and that it is 
not off the table. But you have also indicated that the 
variations in short-term interest rates is one of the key tools 
that you have.
    Would it be fair, though, to say that today, as you have 
answered these questions, the current discussion and the 
current focus is not so much on reducing the interest rates 
that we have in effect today but, rather, whether they should 
remain stable or move up?
    Ms. Yellen. Well, yes. We certainly felt in December when 
we made our decision to raise rates that the economy was 
recovering, that inflation would move up, and it would likely 
be appropriate to gradually continue to raise rates, not to cut 
them.
    A lot has happened since then. As I have indicated, global 
economic and financial developments impinge on the outlook. We 
are in the process of evaluating how those developments should 
affect our outlook or our assessment of the balance of risks. 
We will meet in March and provide a new set of projections that 
will sort of update markets on our thinking on the outlook and 
the risks. But I have not thought that a downturn sufficient to 
cause the next move to be a cut was a likely possibility. And 
we have not yet seen, I would say, a shift in the economic 
outlook that is sufficient to make that highly likely. But in 
saying that, I also want to make clear that policy is not on a 
preset course, and if our perception of the risks and the 
outlook changes in a manner that did make that appropriate, 
certainly that is something the Committee would have to take 
into account in order to meet its objectives. It is not what I 
think is the most likely scenario.
    Senator Rounds. Very good. Let me just change focus a 
little bit and move into basically the regulatory side of the 
responsibilities which you carry.
    When the Federal Reserve writes its rules, I think it is 
important for the Board to do a thorough cost-benefit analysis 
before it creates any new red tape or negotiates international 
agreements like insurance capital standards. We talked a little 
bit in here about the fact that there is a regulatory impact on 
productivity, and the one thing that on our side of the dais we 
talk about is what we can do most certainly to provide 
opportunity for productivity to increase within our economy. 
There are some areas in which you do have on the regulatory 
side an impact as well.
    With regard to the issue of international agreements, 
specifically on insurance capital standards, is the Fed 
currently working on any cost-benefit analysis related to the 
insurance industry either in the context of regulation or for 
international agreements?
    Ms. Yellen. So we are very carefully considering what 
capital standards we should impose on the designated firms that 
we need to create standards for or S&L holding companies that 
are primarily insurance-focused.
    Senator Rounds. But will you do a cost-benefit analysis to 
those rules?
    Ms. Yellen. We are charged with putting in place 
appropriate standards to mitigate systemic risk in the event 
that one of those firms would have failed, to make it operate 
in a safer and sounder way, and that is our charge. We will put 
rules out for comment. We will consider regulatory burden. And 
we will consider various ways of designing rules which might be 
least burdensome, and----
    Senator Rounds. But would that mean that you would consider 
then doing a cost-benefit analysis and the burden that these 
may place on the individual entities that you are regulating?
    Ms. Yellen. Well, we will certainly put out a Notice of 
Proposed Rulemaking and consider comments on it, including 
those that pertain to costs.
    Senator Rounds. So the answer is, ``I would rather not 
answer the question on whether or not there is a cost-benefit 
analysis included''?
    Ms. Yellen. Well, I am not going to commit to a cost-
benefit analysis of those rules.
    Senator Rounds. OK. Very good. One of the major concerns 
about the current insurance SIFIs designation process is that 
there is no real comparison with banks to determine systemic 
risk because--I would suspect that we are in rather uncharted 
waters with regard to adding the insurance companies in with 
the banks and considering them as SIFIs. I am concerned that we 
may not have the reliable data to compare banks to insurance 
companies in this regard.
    What has either the Federal Reserve or the FSOC done 
compare the systemic risk of bank SIFIs and nonbank companies 
against each other? Has there been an analysis?
    Ms. Yellen. So in the case of each of those designations, a 
very detailed analysis was done asking what would be the 
systemic consequences of the failure of that organization. And 
in the case of the insurance companies that were designated--
MetLife, Prudential, and AIG--the FSOC did determine and judge 
with very careful work done that the failure of those 
organizations would potentially have systemic consequences that 
needed to be addressed.
    Senator Rounds. Are those publicly available analyses?
    Ms. Yellen. They are on the FSOC Web site. You can find the 
analysis, and they do not include confidential firm 
information. The firms themselves were provided with greater 
detail than what is on the Web site, but there is detailed 
information available.
    Senator Rounds. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Donnelly.
    Senator Donnelly. Thank you, Mr. Chairman. Madam Chair, 
thank you.
    Yesterday was a really bad day for my home State of 
Indiana. We had over 2,100 workers who were given pink slips 
yesterday. They lost their jobs at a company that had been in 
Indiana since the early 1950s. Carrier's Indianapolis plant 
will be closing, and UTEC is moving their manufacturing 
department from Huntington, Indiana, both part of United 
Technologies, over 2,100 jobs. All of those jobs are being 
shipped to Mexico.
    Last year, Carrier had $58 billion in sales and $6.1 
billion in earnings. So we have 2,100 people who have lost 
their jobs because apparently $6.1 billion in earnings is not 
enough.
    Now, the promise of America has always been you work hard, 
you do your job, you help your company be profitable. And then 
in return you hope to have a decent retirement, to be able to 
maybe get a fishing boat, see your kids go to school.
    So how do we tell workers who have put their whole heart 
and soul into a company, who have provided them with over $6.1 
billion in sales, that that is not enough?
    I mean, the reasons folks are here is because there has 
always been a promise if you work hard that the company in 
return will stand up and do right by you. So how is doing right 
having $6.1 billion in earnings and shipping 2,100 Indiana jobs 
off to Mexico when we also in Indiana have said you have one of 
the best business climates in America? And these same folks 
said if we put in tax extenders, things like bonus 
depreciation, research credit, Eximbank--I sat here and fought 
for Eximbank because these folks came and said this will help 
American jobs stay in America.
    So how do you provide the confidence to these workers and 
others that this compact even exists anymore?
    Ms. Yellen. A great deal has changed in the job market, and 
many families during the downturn particularly but on a longer-
term basis have faced the kind of miserable situation that you 
have described of losing a job that they held for the better 
part of their career and expected would provide them a secure 
retirement. And this is a miserable and burdensome situation 
that many households have faced.
    For our part, what we are trying to do and have tried to do 
is make sure that there are enough jobs overall in the economy 
that those workers can find another job. And, of course, we 
know----
    Senator Donnelly. I understand, but I am just asking you--
and maybe this is not as the Fed Chair. Why should they have to 
find another job when they produced over $6.1 billion in 
earnings for a company that is doing extraordinarily well but 
it is still not enough? ``We are going to ship your job to 
Mexico because you created huge profits for us. You created 
incredible success for us. You created the opportunity for this 
company to grow and for our shareholders to do really, really 
well, but we just do not have room for you as the worker 
anymore.''
    Ms. Yellen. Many firms have made that decision, that moving 
their activities elsewhere is a profitable course and have made 
those decisions.
    Senator Donnelly. And the question becomes: Profitable for 
who? For an America that we have forever had the promise that 
you do your job, like I said, you work hard--I mean, that is 
what my dad did every day. He took the train to work every day 
so he could feed us kids. I was the fifth of five. But his 
company never told him, ``Sorry. You made a ton of dough for 
us. We are moving to Mexico.'' And if they did, I do not know 
what we would have done.
    And now we are facing the same thing in the steel industry 
as well. We have been facing it for a while, and you have 
probably heard there are actually questions about the ongoing 
viability of a number of the American steel companies. And a 
big part of that is currency manipulation, illegal dumping, all 
of these kind of things.
    And so, you know, as we look at this, I know the Treasury 
Department monitors currency manipulation. Other agencies 
monitor illegal trade activities. But as head of the Fed, are 
you concerned that the United States tries to play by the rules 
while other countries dump steel here, dump other products 
here, manipulate currency, and we seem to be unable to provide 
our companies who are doing with a level playing field?
    Ms. Yellen. Well, U.S. policymakers--the Treasury has prime 
responsibility for exchange rate policy, but they have made 
clear and the G7 has made very clear that currency manipulation 
to attempt to gain advantage for a country's products in global 
markets and to shift the playing field through currency 
manipulation is unacceptable policy. And I know that the 
Treasury Department in their conversations with foreign 
officials in other countries is vigilant about looking for and 
addressing currency manipulation.
    On the other hand, we all recognize that countries should 
be allowed to use tools of domestic policy like monetary policy 
to stimulate domestic demand in situations where inflation is 
running well below a country's inflation objective or domestic 
spending, unemployment is high and domestic spending is weak. 
We have used monetary policy for this purpose. Other countries 
have done the same. And there is some impact of monetary 
policies on exchange rates. We recognize that. But it also 
works through other channels that tend to have broadly shared 
benefits.
    Senator Donnelly. Well, as Fed Chair, I hope you keep in 
mind, as you set rates, as you set other things, the importance 
to our families of the chance to go to work. And I feel in 
particular very burned today, after having fought so hard for 
the Eximbank, that some of the very same folks who told me it 
was critical for jobs in the United States, to be there when 
they needed something, and then to walk away now. Thank you, 
Madam Chair.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Heller.
    Senator Heller. Mr. Chairman, thank you, and thanks for 
holding this hearing. I want to thank the Chairwoman for being 
here also and taking the time.
    I want to raise some questions about how the Fed 
communicates with the general public, specifically their 
policies and specifically how you communicate those. Let me 
give you an example here, and it led up to the increase of the 
interest rates back in December.
    You had people from the Fed like the head of the San 
Francisco Fed saying that they were pretty hawkish that 
interest rates were going to be increased and that those 
increases were coming, and the market reacted to it.
    Then there were others like the head of the Chicago Fed 
calling for rates to stay near zero, and the markets reacted to 
it.
    Then we had some Fed officials implying that any rate 
increases would be data-driven, and the markets responded to 
that. And then we had some saying there was no formula. Even 
today, we seem to have a new person each day giving their 
thoughts about future rates.
    Now, I do not have a problem with broad questions and a 
variety of viewpoints coming from Fed members, but what it is 
causing, though, is confusion and instability in the markets 
today every time someone has something to say, feeling like 
they have got to walk in front of a mic and make a comment.
    My question to you is: Do you think there is a problem here 
and how these markets are reflecting every time one of these 
Fed members opens their mouth by hundreds of points? Hundreds 
of points. And, in general, I am not sure most of them know 
what they are talking about.
    Ms. Yellen. So I would say that Congress purposely created 
a system with a large monetary policymaking committee where 
there would be a diversity of views so that we did not fall 
into a group think type of mentality, and we do have at the 
moment 17 members who come to the table with a range of views. 
They----
    Senator Heller. So you are comfortable? You are comfortable 
where we are today?
    Ms. Yellen. We have guidelines for communications because 
it is important to explain to the public what our policy is 
about.
    Senator Heller. Could I see a copy of that guideline? I 
would sure like that.
    Ms. Yellen. Yes, I would be glad to----
    Senator Heller. OK.
    Ms. Yellen. First of all, the guideline says that everyone 
shares a joint objective of explaining the Committee's 
decisions. They can explain their own views, but should be 
explaining that they are not speaking for the Committee, that 
they are speaking for themselves. And the person who speaks----
    Senator Heller. But they do have an official capacity, 
and----
    Ms. Yellen. ----for the Committee is the Chair.
    Senator Heller. ----it clearly carries water. It carries 
water. You raised rates on December 16th by a quarter of a 
point. At that time the markets closed--the S&P 500 closed at 
2,073. Yesterday, it closed at 1,851, and I think it is down 
another 34 or 35-plus points today. Do you feel that you or the 
Fed is responsible for this decline?
    Ms. Yellen. Well, the immediate market response, and for a 
number of weeks, to the Fed decision was quite tranquil. It was 
a decision that I believe had been well communicated and was 
expected, and there was very little market reaction.
    Around the turn of the year, we began to see more 
volatility in financial markets. Some of the precipitating 
factors seemed to be the movement in Chinese currency and the 
downward move in oil prices. I think those things have been the 
drivers and have been associated with broader fears that have 
developed in the market about the potential for weakening 
global growth----
    Senator Heller. OK. Let me----
    Ms. Yellen. ----with spillovers to inflation----
    Senator Heller. Thank you.
    Ms. Yellen. ----so I do not think it is mainly our policy.
    Senator Heller. Let us go back to oil prices again since it 
is not your policies that are causing the market decline. You 
told us last year here in this meeting that a drop in oil 
prices was a good thing for the economy and for the consumer. 
That is what you said a year ago. And yet since then we have 
seen thousands of jobs lost. We see oil companies in bankruptcy 
and consumers that are not spending their gas savings. Do you 
still feel the same way about oil prices?
    Ms. Yellen. Well, clearly, declining oil prices have had 
some negative consequences. There have been sharp job cuts and 
cutback in drilling activity and capital spending, and that has 
been----
    Senator Heller. Do you think you made a mistake? Do you 
think you made a mistake a year ago when you said it would be 
good for the economy and good for the consumers?
    Ms. Yellen. On balance, I would say it is still true for 
the United States. We are net importer of oil, in spite of our 
large production, and the gains to households from lower oil 
prices, they average about $1,000 per household.
    Now, whether they spend or do not spend those gains, those 
are substantial gains. From the standpoint of growth, what has 
been dominant so far I would say is the negative consequences 
on spending from----
    Senator Heller. OK.
    Ms. Yellen. ----the cutback in drilling activity.
    Senator Heller. Let me get your feeling on a question. Do 
you think that banks here in America are overregulated or 
underregulated?
    Ms. Yellen. I recognize that regulatory burden is a 
significant issue for many banks, and it is something we will 
do our very best and have been working to mitigate, 
particularly for community banks that are vital to the health 
of their communities. But I do think for the larger banks whose 
failure would have systemic consequences, it is critically 
important to make sure that they hold more capital liquidity, 
are held to higher standards to address the threats that they 
pose to the financial stability of our country and the global 
economy.
    Senator Heller. So is it fair for me to say that you 
believe smaller banks are overregulated, large banks are 
underregulated?
    Ms. Yellen. I do not want to say as a blanket matter that 
community banks are overregulated. What I do think is that we 
need to do everything in our power to look for ways to simplify 
and control regulatory burdens for them.
    Senator Heller. One more question.
    Chairman Shelby. Go ahead.
    Senator Heller. One more question. Thank you for being----
    Chairman Shelby. We have got a vote, but go ahead. Let him 
ask the question.
    Senator Heller. One more question. In a recent Wall Street 
Journal survey, the odds of a recession in the next 12 months 
have climbed to 21 percent, and that is double what it was a 
year ago. What are your thoughts on that?
    Ms. Yellen. Well, as I mentioned in my testimony and in my 
answers this morning, we have seen global economic and 
financial developments that may well affect the U.S. outlook. 
Financial conditions have tightened, and that can have 
consequences for the outlook. I think it is premature at this 
point to decide exactly what the consequences of those shocks 
will be, and it depends in part on whether they persist. And 
that is something we will be looking at closely going forward.
    Senator Heller. Madam Chairwoman, thank you very much for 
being here. And, Mr. Chairman, thanks for the time.
    Chairman Shelby. Thank you.
    Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman. Thank you, Madam 
Chair, for the good job you do. And now that Brooklyn is in the 
news, I am glad we have another daughter of Brooklyn doing 
well.
    I see that we have some people in the audience from a group 
called ``Fed Up'', many from New York, and I welcome them, 
although it was just my luck the people wearing New York City 
beanies left just before I spoke. Tell them hello. And I see 
that some of the shirts say, ``Let our wages grow'', and that 
is apropos, and that relates to my first question.
    I was pleased to see that wages rose 0.5 percent--oh, they 
came back. Hi, New York City people. I believe I saw that wages 
grew 0.5 percent in the month of January. I hope recent data we 
have seen is a sign that middle class incomes and people trying 
to be in the middle class, their incomes are growing again, 
because wages have been stagnant for too long.
    But I have to be honest with you. Given the fact we are in 
a deflationary environment globally and our own inflation rate 
is continuing to run well below the Fed's 2-percent target, I 
am concerned that further movement by the Fed to raise rates in 
the near term could snuff out the embers of real wage growth 
before they are even given a chance to catch fire.
    If you believe that the flattening and decline of wages is 
the number one problem our economy faces, that it is harder to 
stay in the middle class, it is harder to get to the middle 
class than it has been in a very long time, you make that a 
very high priority--which I do and I know you do.
    So going forward, do you still believe that, given the room 
for growth in the labor market, considerable evidence of 
consistent wage growth is still important for you to see before 
the Fed considers raising rates further? And, second, will the 
FOMC be particularly cautious in its decision making so as to 
protect against the prospect of stifling wage growth before it 
even gets going?
    Ms. Yellen. So Congress has assigned us maximum employment 
and price stability as objectives. Our focus is on inflation 
and trying to achieve a 2-percent objective for inflation. The 
behavior of wages--so, first of all, we have seen substantial 
improvement in the labor market, and we, at the time we raised 
rates, expected that improvement to continue, fully expected as 
that occurred that wages would move up at a somewhat faster 
pace.
    Senator Schumer. We have just begun to see it. I mean, it 
is hardly sufficient. Would you not agree? We have not made up 
for the loss in wage growth over the last decade yet.
    Ms. Yellen. Well, productivity growth has been extremely 
slow, and the state of the labor market and the pace of 
inflation are not the only factors feeding into wage growth. 
For the last eight quarters, productivity in the nonfarm 
business sector has barely grown at a quarter of a percent, and 
that is a substantial drag on wages as well.
    So I would not say that wage growth is a litmus test for 
changes in monetary policy. But it is something that is 
indicative both of likely inflationary pressure going forward. 
It is not a sure sign of it, but it is relevant, and it is also 
relevant in assessing whether or not we are at maximum 
employment.
    Senator Schumer. Well, yeah, but I see it just the other 
way, that I am less worried about inflation and more worried 
about slow wage growth, which has picked up a little bit late. 
But if you look at the last decade or even the last three 
decades, productivity is considerably further up than wage 
growth is. And one of our great challenges is tying the two 
together.
    So I will just say I hope that you and the FOMC will look 
at growth in wages--it may not be the only issue, for sure, but 
it is a very important issue. But I am going to move on here, 
and you can comment further on what I said if you want. But it 
is related.
    Now, another thing that is going on is the strength of the 
dollar, and it has been critical in the interplay, so I want to 
get your specific thoughts. Given the strength of the dollar 
and the influence of the global deflationary environment, 
couldn't one argue that the dollar's strength has essentially 
served as another increase to the Federal funds rate? If you 
look at manufacturing, it is not doing well because of all of 
those issues. And, again, it seems to me that efforts by the 
Fed to raise rates further could end up being a double whammy 
to our economy because here you have the strength of the dollar 
hurting our export businesses, which are still vital to us, and 
another wage rate--wages added onto that.
    So have you seen that the strength of the dollar has 
influence on whether you should raise rates further?
    Ms. Yellen. The strength of the dollar is certainly 
something we take account of in deciding on monetary policy. I 
agree with you net exports have declined. It has been a drag on 
the economy and for that reason does factor into our thinking. 
It is one of the reasons we think that the so-called neutral 
level of the Fed funds rate is low at the moment, but remember 
that in spite of that drag and the impact it is having on 
manufacturing, the economy has continued to create jobs at a 
pace of 220,000 or some a month. And so we cannot just look at 
sectoral impacts. We have to look at the overall performance of 
the labor market. But certainly the dollar and the drag that it 
implies--it is a symptom and in part a signal of the strength 
of the U.S. economy in comparison with many others.
    Senator Schumer. And a drag on the U.S. economy.
    Ms. Yellen. It is both.
    Senator Schumer. Which possibly could make things worse.
    Ms. Yellen. It is both things.
    Senator Schumer. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Reed.
    Senator Reed. Well, thank you very much, Mr. Chairman. And 
thank you, Madam Chairman, and thank you for your leadership 
and your endurance. We expect nothing less from a Brown 
graduate, so I am not at all surprised.
    One of human phenomenon is sometimes when you try to fix a 
problem, you unwittingly create other problems. I know in Dodd-
Frank we were concerned about the bilateral nature of 
derivatives, and so we have now required them to be on a 
clearing platform, which creates not a bilateral issue but a 
multilateral issue. But that in itself introduces the 
possibility of systemic risk. And, frankly, one of the lessons 
of the crisis was always be on watch for the next fault line 
and take proactive steps to prevent it.
    In that context, the Financial Stability Oversight Council 
noted that there are still a number of central clearinghouse 
platform issues. Can you give us your comments now about how 
close you are watching? Is there any developments that concern 
you? And is this going to be a constant area of emphasis and 
investigation?
    Ms. Yellen. So I completely agree with you. Creating those 
central clearing platforms has importantly diminished risk in 
the financial system, but they are a source of risk. FSOC has 
pointed out that this is making sure that they are 
appropriately supervised and operate subject to very high 
standards because they are platforms that concentrate risk. 
This is a very high priority for us. We are very focused on it. 
These platforms are now supervised. The SEC and CFTC have 
significant authority here. We have backup authority. Globally, 
there is a focus on ensuring comprehensive and strong 
supervision of these platforms. So, you know, we are not ready 
to rest and say everything is done, but we are very focused on 
it, and it----
    Senator Reed. Let me underscore the issue the international 
is very important because of the ability and willingness of 
entities to arbitrage sort of regulatory environments, moving 
from here to someplace that does not have quite the same 
oversight.
    Ms. Yellen. That is right.
    Senator Reed. And you are trying, I believe in many ways, 
including margin requirements, to level the playing field 
internationally.
    Ms. Yellen. That is exactly right.
    Senator Reed. Thank you very much, Madam Chairman.
    The issue of Federal Reserve Bank Presidents, we have 
talked about this. I know you have got 12 that are due for 
reassignment or change at the end of February of 2016, a few 
weeks from now. They will be elected by the Class B Directors, 
who are elected by local financial institutions to represent 
the public, and then the Class C Directors appointed by the 
Board.
    A general issue is how do you ensure that there is real 
public participation in this process. One of the impressions 
that we had in 2008 and 2009 crafting Dodd-Frank was this sort 
of is an inside game in which, in fact, the Class A Directors 
appointed by the banks were influential. How do you ensure that 
there is a real public purpose and public scrutiny of these 
Directors?
    Ms. Yellen. So the governance around this was established 
in the Federal Reserve Act, and we tried to make sure that the 
Reserve Banks and the Board adhered to that. We tried to make 
sure that the Class C Directors that are appointed by the Board 
are broadly representative of the public and all sectors 
mentioned in the Federal Reserve Act. I think we have among 
Federal Reserve Bank Directors----
    Senator Reed. I must--I have been rightly corrected by my 
very intelligent staff. Presidents.
    Ms. Yellen. Presidents.
    Senator Reed. The Presidents of the Federal Reserve Banks. 
That is the focus of my question.
    Ms. Yellen. Yes. So the presidents are appointed by the 
Class B and C Directors. We try to make sure that those Class 
Cs and that the Directors more broadly represent not only 
business interests but also community interests, that there is 
sufficient diversity. The Board is constantly attentive in its 
oversight of the Reserve Banks to the issue of diversity of 
representation on those boards, and it has improved 
considerably. At the moment I believe something like 45 percent 
of Bank Directors are either women or minorities.
    Now, they are charged with making recommendations about 
appointment and reappointment of Reserve Bank Presidents, and 
the Board of Governors is charged with reviewing those 
recommendations and deciding. And we will take that obligation 
seriously. We have a regular process, an annual process in 
which the Board through its Oversight Committee. We review each 
Reserve Bank every year and, in particular, the performance of 
the president. And the Members of this Committee discuss with 
the boards of directors, the chair, and deputy chair the 
performance of the president.
    So there is ongoing monitoring of the performance of the 
president. There is feedback to the Boards of Directors on it. 
When we come up to the 5-year point to review these 
appointments, we will act on the recommendations of the Boards 
of Directors, but it is not as though we are just looking at 
that for the first time when we make those decisions.
    Senator Reed. Thank you, Madam Chairman.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Heitkamp.
    Senator Heitkamp. I do not know if they save the best for 
last, but, you know, we are hanging in there.
    The first thing I want to say--and it troubles me every 
time this happens. In your exchange with Senator Warner, Chair 
Yellen, when you talk about working people, you know, the 
answer is always, ``Let us improve their job skills. Let us get 
them more training, and then they will get a better job.''
    Someone has to be a CNA; someone has to drive a garbage 
truck. And they are well trained for those jobs. But those jobs 
do not pay a living wage, and that is why so many people are 
frustrated, because these jobs are not going to go away. These 
jobs are essential, whether it is being wait staff in a 
restaurant or whether it is being a CNA in a nursing home or 
whether it is, in fact, you know, delivering pizza.
    And so, we need to be really careful when the response to 
wage inequality or income inequality is more skills for the 
workers, because I think it does not focus the attention on the 
value of work and what we need to do to improve the 
opportunities for people who work every day. And I know you do 
not intend that, but I just felt like I had to get that off my 
chest.
    The challenge that I have in North Dakota is we are 
countercyclical. As you know, we are fundamentally a commodity-
driven State. Commodity prices have taken a toll, whether it is 
in our agricultural sector or whether it is in the energy 
sector, and that has been exacerbated by a high dollar value.
    I had a gentleman once ask me, said, ``I just cannot figure 
out in North Dakota if a high dollar value is good or bad.'' I 
said, ``Let me help you with that. It is bad,'' because we are 
fundamentally an export State.
    But I will tell you, we are deeply concerned about currency 
manipulation. We are deeply concerned about the challenges of 
having to compete against other currencies in other markets, 
and that has national and, I think, international 
ramifications.
    But I also want to point out that in production--oil 
production, gas production--we have lost probably globally 
about 250,000 and about 100,000 jobs in this country. That is a 
huge hit. And it really was that production sector, whether we 
are talking about agriculture or whether we are talking about 
oil and gas, that buoyed this economy during the tough times.
    There has been so little attention to the challenges of 
commodity producers, not just, you know, people who invest in 
commodities but the challenge of commodity producers. What is 
the Fed doing to analyze the challenges for commodity producers 
and to analyze what the increase in dollar value and potential 
currency manipulation means going forward to production of 
commodities in this country?
    Ms. Yellen. Well, we are looking critically--commodities, 
their prices, and trends are a huge global driver and driver 
for the United States. We look carefully at the factors that 
are resulting in low commodity prices and trying to understand 
the extent to which low prices reflect supply or shifts in 
demand in various emerging markets.
    Senator Heitkamp. What impact do you believe the dollar 
value has had on profitability of commodity production in this 
country?
    Ms. Yellen. When the dollar appreciates, it typically tends 
to push down oil prices. So the link that you are suggesting is 
certainly there. We have a global economy in which there is 
considerable weakness in many parts of the world, including 
Europe and Japan. Countries are adopting expansionary monetary 
policies in order to bring inflation up to their desired target 
levels and to address weakness in their own economies. The 
U.S., with a 4.9 percent unemployment rate, is far more 
advanced in that process of recovery, and the different 
cyclical positions of our different economies, are a factor 
that is pushing up the dollar. The dollar in part reflects 
disproportionate strength in the U.S. economy, and that is a 
natural response to it.
    The U.S. Treasury is responsible for currency policy, and 
currency manipulation is something that they would not 
sanction. The G7 has spoken out against it. But we do believe 
that countries should be able to use tools of policy like 
monetary policy for domestic ends.
    Senator Heitkamp. And, obviously, one person's monetary 
policy is another person's currency manipulation, and I think 
we need to be very cautious in how we characterize monetary 
policy in other countries lest we not limit our access to tools 
that we may need.
    Ms. Yellen. I think that is very important, and we have 
used----
    Senator Heitkamp. I get that. In the time that I have 
remaining--and I want to thank you for your patience, and you 
sat through a lot of hours here. I want to talk about something 
that I have been working on that has caused some concern within 
the Fed organization, and that is cost-benefit analysis and 
review of cost-benefit analysis of independent agencies.
    Senators Warner and Portman have pursued a bill for a 
number of years which, in fact, asks that there be an 
independent review of cost-benefit analysis of independent 
agencies. You have been subject to an Executive order that 
really is advisory, as near as I can tell, and we are trying to 
figure out how we can get a second opinion on your cost-benefit 
analysis. And I think that is an essential piece of this if we 
are going to do the appropriate oversight.
    So I would just like a commitment that the Fed will work 
with us to try and understand your need for independent, but to 
please appreciate and understand our need for legitimate 
oversight and tools that help us with legitimate oversight.
    Ms. Yellen. I am certainly willing to work with you on 
that, but as your comment indicated, you recognize the 
importance of independence for regulatory agencies that we not 
be subject to executive branch review.
    Senator Heitkamp. And we have worked to try and figure out 
how we replace OIRA as the reviewing agency, how we engage even 
to the point we contract with independent economists to 
actually look at this analysis and get a second opinion. And I 
think, you know, you are kind of caught in the middle here, 
people who do not think you do enough and people who think you 
do too much. And one of the ways that I think we can broaden 
support for the Fed is broaden transparency.
    You know, to Elizabeth's point, tell us why you are making 
a decision if you believe that the living will is appropriate. 
Tell us why you made this decision on cost-benefit. And I know, 
Chair Yellen, you have been very interested in being more 
transparent without being disruptive to markets. I appreciate 
the difficulty of the lane that you are in, but we need these 
tools in order to do our oversight, and we need these tools 
kind of going forward.
    So I look forward to working with you. This is not an idea 
that is going to go away. It is an idea that has been 
introduced over and over again, and we would appreciate any 
input so that we can accomplish what we want, which is to not 
set monetary policy but give us the tools that we need to 
review what decisions you make.
    So thank you, Mr. Chairman, and I am done.
    Senator Brown. [Presiding.] Thank you.
    Senator Shelby, the Chairman, will return in a moment. He 
has three or four questions in the second round. I will ask a 
couple of questions now, and then I think we can dismiss you, 
Madam Chair.
    I want to ask a question about Senator Heitkamp's views on 
cost-benefit. A lot of us are very concerned about these 
efforts on cost-benefit analysis and where it could take us as 
a Nation. I recall, as you do--and we have talked about this 
before--when the President signed Dodd-Frank, the leading 
financial services lobbyists said, ``It is halftime.'' And that 
was a call, that sounded an alarm to a lot of us that we knew 
that they were going to do--Wall Street was going to do 
everything possible to slow walk and delay and lobby and push 
back against any of the Dodd-Frank implementation that we all 
cared about and the reason we passed Dodd-Frank. And this whole 
cost-benefit analysis idea, frankly, is--I am not questioning 
anybody's motives, particularly Senator Heitkamp's, but it is, 
you know, the best way to weaken Dodd-Frank, and it is really 
kind of the dream of Wall Street to keep this slow walk going 
and slow it down even more. It is not just financial 
regulation, and you have done good work at the Fed. I wish the 
Fed in the past had done more, but generally, regulators are 
trying but this will undercut your efforts, this cost-benefit 
analysis bill, and ultimately lead to weakening health and 
safety rules, which has been the long-time battle in this 
institution. Emerson would talk about the battle between the 
conservators and the innovators, and the conservators wanted to 
preserve their privilege and power, and the innovators wanted 
to move the country forward. And cost-benefit analysis just 
helps the powerful people in this town resist any kind of 
regulation that makes people's lives better, whether it is 
health, whether it is safety, whether it is safety and 
soundness of the financial system.
    So I want to ask a question about that and about your 
letter. Senator Rounds also asked you a question earlier about 
cost-benefit. It sounds like a good idea. How can you be 
against regulatory reform? How can you be against cost-benefit 
analysis? But it is obviously how do you calculate the benefit 
of a rule that contributes to safety and soundness? It is so 
much harder to quantify the benefits than it is the cost. That 
is not even counting the slow walk that this will require and 
how easy it is to delay things by the cost-benefit analysis.
    So you sent a letter out signed by many other agency heads. 
Just explain why you sent that letter and kind of make your 
case for why that is so important.
    Ms. Yellen. Well, we were very concerned that the bill 
under consideration, first of all, would have a severe impact 
on the independent agencies' ability to put out rules that 
would involve executive branch, Presidential involvement. I 
agree with you, it would cause very significant delays in 
implementing regulations and probably result in unnecessary and 
unwarranted litigation in connection with our rules.
    We are putting our rules very often in situations where 
Congress has decided there is a safety and soundness issue they 
want us to address by imposing safeguards in a particular area, 
and our job is to figure out how to do that where Congress has 
already judged that the benefits are worthwhile. As you said, 
the financial crisis took a huge toll, an amazing economic cost 
to the country and the global economy. And you have directed 
us----
    Senator Brown. And I assume there would have been----
    Ms. Yellen. ----to try to create a safer and sounder 
financial system when we have done--for example, capital rules, 
there has been cost-benefit analysis. While there are some 
costs, the benefits of reducing the probability of a financial 
crisis overwhelm those costs. So our job is to find the least 
burdensome way of putting out rules to implement what Congress 
has told us to do. We publish Advance Notices of Proposed 
Rulemaking, Notices of Proposed Rulemaking, take comments, look 
for and discuss alternative ways that we might approach 
promulgating a rule to reduce burden and take comments into 
account. So it is not as though there is no a weighing of 
benefits and costs that are involved already in what we do.
    Senator Brown. How long typically is that process?
    Ms. Yellen. The process can take years, and especially when 
there are multi-agency rules that have to be put in place. We 
are coming close to completing the Dodd-Frank agenda of 
rulemaking, but it has taken a very long time, and we have been 
very actively engaged in trying to do this as rapidly as we 
possibly can.
    Senator Brown. So if it has taken half a decade for the 
regulators, you and the FDIC and the OCC and others, if it has 
taken half a decade plus to do Dodd-Frank----
    Ms. Yellen. That is right.
    Senator Brown. ----rulemaking, what would it--can you guess 
what it would have taken if there had been a cost-benefit 
analysis like this?
    Ms. Yellen. Well, clearly, it would be much more burdensome 
and take much longer. There is no doubt about it. I cannot give 
you a guess, but as you indicated, attempting to quantify the 
benefits of safety and soundness regulation is very difficult.
    Senator Brown. Well, who would have wanted this to take 
longer?
    Ms. Yellen. You indicated that those who were regulated----
    Senator Brown. Well, what do you think? Do not say what I 
indicated. But who in this town, who in this country would have 
wanted these regulations to have taken longer?
    Ms. Yellen. Well, we know that banking organizations are 
concerned with regulations and the burdens that they impose.
    Senator Brown. OK. Let me shift to another question. I 
think Senator Shelby will be back within a couple of minutes.
    I want to talk about interest on excess reserves. Some have 
suggested repealing or limiting the Fed's authority to pay 
interest on excess reserves. I am concerned this is an attempt 
by those opposed to the unconventional steps the Fed took 
during the crisis to limit the Fed's monetary policy tools. 
What are the implications of repealing or limiting interest on 
reserves?
    Ms. Yellen. It is the most critical tool that we have for 
monetary policy to adjust the level of short-term interest 
rates and the stance of monetary policy. First let me say that 
our knowledge that we had that tool when the time came to raise 
interest rates was critical to the decisions we made throughout 
the financial crisis and thereafter to undertake unconventional 
policies, including large-scale lending programs, and then 
quantitative easing or large-scale asset purchases. The 
knowledge that we, when the time came, would be able to use 
interest on excess reserves to raise the level of short-term 
interest rates was critical in the decisions that we made that 
I believe provided great support to the economy and caused us 
to recover more rapidly.
    Now, if Congress were to repeal our ability to pay interest 
on reserves, we would not be able to control short-term 
interest rates in the way we did before the crisis. So we would 
be forced to contemplate shrinking our balance sheet perhaps 
rapidly, and I would be greatly concerned about the impact that 
that could have on the economy, on the economic recovery.
    For example, selling of mortgage-backed securities could 
raise mortgage rates and have a very adverse impact on the 
housing market, and we purposely decided that we will shrink 
our balance sheet in a predictable and gradual manner through 
diminishing or ceasing reinvestment to avoid the kind of 
unpredictable impacts on financial conditions that could come 
from rapidly selling off our portfolio. But without the ability 
to control short-term interest rates through using interest on 
excess reserves, we would be forced to contemplate those steps, 
and I would worry about their consequences.
    And, finally, if I could just take another second, I would 
like to point out that although we are paying banks interest on 
their accounts with us, the counterpart of those reserves is 
large asset holdings that we have on our balance sheet on which 
we earn considerably more interest income than we are paying to 
the banks, and that differential has resulted in 2015 in 
transfers from the Fed to the Treasury and the American 
taxpayers of $100 billion for the last 2 years, $600 billion 
since 2008. If our balance sheet had to shrink rapidly, those 
transfers would clearly diminish to the far lower levels that 
were typical before the crisis.
    So this is not something that would be a financial winner. 
Our goal is economic performance. I think our top concern 
should be what would be the impact on the economy, which would 
be very negative. But even in the financial sense for the 
taxpayer, it would not be a positive.
    Senator Brown. Good. Thank you, Mr. Chairman. Thanks.
    Chairman Shelby. [Presiding.] Thank you, Senator Brown.
    Madam Chair, I have several questions. I know it has been a 
long morning, and we are in the afternoon now. Recently, a 
House-passed bill would force the Federal Reserve and other 
regulators to consider what you call ``liquid and readily 
marketable municipal bonds'' as Level 2 assets in the 
calculation of the bank's liquidity coverage ratio. The Level 
2A category, it is my understanding, currently includes GSE 
securities, which are considered very liquid and uniform in 
structure. In addition, the Fed has proposed treating eligible 
municipal bonds as Level 2B assets for liquidity purposes.
    My question: Do you support the House bill to treat 
municipal bonds as Level 2 assets? And why or why not?
    Ms. Yellen. So I would not support the legislation to treat 
them as Level 2A assets.
    Chairman Shelby. And explain why.
    Ms. Yellen. Yes. Because this is a liquidity requirement to 
make sure that banks have sufficient liquid assets to cover the 
kinds of outflows they could see----
    Chairman Shelby. You are in stressful times.
    Ms. Yellen. In a stressful situation. So the most liquid 
assets are cash and U.S. Treasuries. Mortgage-backed 
securities, Fannie and Freddie mortgage-backed securities and 
Level 2A assets are quite liquid but not as liquid as cash or 
Treasuries, which is why we have downgraded them. And while we 
have proposed to include some more liquid municipal securities, 
they are not as liquid as those included in 2A, and we have 
tried to recognize that while municipal securities generally 
are not very liquid, some are sufficiently liquid to include 
them in limited amounts but in Category 2B. And I think that 
this bill would interfere with our supervisory judgments about 
what constitutes adequate liquidity.
    Chairman Shelby. Are there two things--we talked about this 
up here many times, and you have talked about it. There are two 
things banks need, capital and they have to have liquidity, 
because you could have capital and no liquidity, and in a 
stressful environment you could be in trouble, could you not?
    Ms. Yellen. Yes.
    Chairman Shelby. So your statement is dealing with 
liquidity. You do not want to weaken the banking system. You 
want to strengthen it. Is that your basic premise?
    Ms. Yellen. Absolutely, yes.
    Chairman Shelby. OK. In the area of reforming the Federal 
Reserve that I talked about in my opening statement, currently 
members of the Board of Governors do not have the ability to 
employ their own staff, instead relying on a shared staff of 
the Board, which you head up. I understand that you oppose a 
policy that would allow a specific member of the Board of 
Governors of the Federal Reserve to employ even a single person 
to work exclusively for them.
    What are your reasons for opposing this policy? Is it 
control or is it--what? What is it?
    Ms. Yellen. Well, I want to be careful. I think that 
Governors certainly are entitled--they have substantial 
responsibilities----
    Chairman Shelby. They do.
    Ms. Yellen. ----and are entitled to adequate support. And 
as Chair, I have worked to make sure--and I think this is true 
that each of the Governors has somebody----
    Chairman Shelby. Well, you were a member of the Board of 
Governors before you were Chair.
    Ms. Yellen. Yes, and it was important to me when I was a 
member and Vice Chair, and I took on a staff--it was a staff 
member, not someone I hired from the outside but a staff member 
who was assigned to work primarily with me to help me with my 
particular work. And most of the Governors now have staff 
members who were working primarily or exclusively with them to 
help them undertake their particular job responsibilities. And 
I am not opposed to that. I have tried to foster it.
    We have pretty complicated agendas and a lot of work to do, 
and we do need help.
    Chairman Shelby. But if you were a member of the Board of 
Governors and you had really no support staff, then there is 
not a heck of a lot you could add to a debate like within the 
Fed at a crucial time. But if you had support, you know, there 
are many voices down there; there should not be just one voice. 
There should be a healthy debate even inside the Federal 
Reserve, should there not?
    Ms. Yellen. Yes, of course there should be, and Board staff 
provides support to all of the Governors, including their 
individualized needs. But it is certainly appropriate for 
Governors who want to have staff specially work with them to 
have that ability. I am not opposed to that.
    Chairman Shelby. In the area of Fed transparency and 
transcript release, you said before that the Fed, and I will 
quote, ``is one of the most transparent central banks in the 
world.'' But, also--and these are your words, too--``there is 
always room for further improvement.''
    I understand that you oppose a policy that would improve 
Fed transparency by shortening the delay in the release of 
Federal Open Market Committee transcripts from 5 years to 3 
years. Now, 5 years to 3, that is not----
    Ms. Yellen. I believe----
    Chairman Shelby. Go ahead.
    Ms. Yellen. Only a few central banks release transcripts at 
all, and we are the shortest lag. I believe the next shortest 
lag is 8 years. When transcripts were first released, it was 
debated what the lag should be, and even with a 5-year lag, I 
think the experience was that fewer people were willing to 
engage actively with others in meetings, expressing their views 
rather than read from prepared remarks. And while I would say 
we have a reasonable degree of interaction in the meetings, the 
knowledge that we will be releasing transcripts in 5 years does 
lead to less interaction in the meetings.
    We really need to be able to engage with one another with 
give-and-take where people feel protected that their 
unvarnished views and exchanges with their colleagues will not 
quickly be exposed to the public. We, after all, release very 
detailed minutes of those discussions within 3 weeks. I would 
simply fear that moving up the release, the timing of the 
release of verbatim transcripts actually would not add very 
much, if anything, to what the public already knows about our 
policies from detailed minutes of the discussions, statements, 
reports, that actually there would not be much additional 
information and it would stifle the level of interaction that 
we have. Clearly, that is a balancing act, but that is my 
concern.
    Chairman Shelby. Well, I could see how a release of 
transcripts in 5 months or 3 months could cause problems in the 
economy, you know, the monetary policy and everything else. But 
5 years, 3 years, I do not buy that. I believe that although--
and I have said this to you privately and publicly here. I 
believe the Fed should be independent, but I do not think that 
you are totally independent, but we ought to know--we should 
not be a member of the Board of Governors. I do not want to be 
a member of the Board of Governors. But, on the other hand, we 
should know what you are doing and why you are doing it.
    Now, do we need to know that immediately? Probably not, for 
a lot of reasons, sometimes. But we do need to know, and to 
move it the transcript release from 5 years to 3 years seems 
overly generous to me. That is my view.
    Reforming the Fed structure in the area there, we have 
talked about this, too, Madam Chairman. When asked yesterday, I 
believe it was in the House, about the structure of the Federal 
Reserve System, you said, and I will quote, ``The current 
structure of the Fed is something Congress decided after a long 
debate and weighing of a whole variety of considerations''--
that is true, like any important--``and while this may be the 
case, I believe the Federal Reserve System was established by 
Congress,'' as we have talked, ``over 100 years ago.'' Since 
then, the country has changed dramatically. Our economy has 
changed dramatically. And as you are aware, the San Francisco 
Federal District now includes approximately 65 million people--
this is the Fed District--while the Minneapolis Fed District 
includes just 9 million people.
    Why, Madam Chair, do you oppose instituting any type of 
review of the structure of the Fed, an outside, healthy study? 
Why do you do that knowing that things are evolving all the 
time, as I pointed out?
    Ms. Yellen. It is, of course, up to Congress to consider 
what the appropriate structure is of the Fed, and I am well 
aware of the fact that history plays a great role in deciding 
what the Fed would be. Probably if we were starting from 
scratch, you would not have the 12th District with 65 million 
people, I think 20 percent of the U.S. economy having one 
Federal Reserve Bank. And Congress can, of course, reconsider 
the appropriate structure.
    I simply mean to say I do not regard the structure as 
broken in the sense that it is failing to put in place good 
monetary policies, failing to collect the information we need 
about what is happening in the economy to craft good policies. 
We do have, as Congress intended, independent-minded people 
sitting around the table crafting policies.
    Of course, the structure could be something different, and 
it is up to Congress to decide that. I certainly respect that. 
I simply mean to say I do not think it is broken the way it is.
    Senator Brown. Mr. Chairman, if I could add----
    Chairman Shelby. Go ahead.
    Senator Brown. The San Francisco Fed has a really, really 
good president for a number of years.
    Ms. Yellen. Oh, yes. Thank you.
    Chairman Shelby. Well, we understand that. But the fact 
remains that since 1913--just since 1950, you have seen greater 
population changes in this country.
    Ms. Yellen. Of course.
    Chairman Shelby. For example, in the South, where I come 
from, from Virginia to Texas and the border States, that is the 
most heavily populated area of the United States, and it is 
slated to grow even more dense. Is that correct?
    Ms. Yellen. Yes, and, you know, when I was in San 
Francisco----
    Chairman Shelby. The same thing in the West. Look at the 
West growth since----
    Ms. Yellen. Of course. You know, we had places like Las 
Vegas or San Diego----
    Chairman Shelby. That is right.
    Ms. Yellen. ----that had no Fed branch or Reserve Bank 
representation that are growing faster and far larger than many 
places that do have branches. So, yes, there is a historical 
legacy that has left the Federal Reserve System in place where 
geographically it no longer represents the distribution of 
economic activity in the country. I would not argue with that.
    Chairman Shelby. And when things change, do you not think 
we should be aware of that to change with it?
    Ms. Yellen. So it is up to Congress to decide----
    Chairman Shelby. That is right.
    Ms. Yellen. ----if changes are necessary. I only mean to 
say that, for example, when I was the president in the 12th 
District, I was highly attentive to making sure, even though we 
have a very large district, that I was aware of developments 
all around our region and made a big effort to collect 
information from the various parts, very diverse parts of our 
district. And I think my colleagues do that as well.
    Chairman Shelby. Thank you. Madam Chair, thank you for your 
patience this morning.
    Ms. Yellen. No problem.
    Chairman Shelby. We appreciate your time today. Thank you 
very much.
    Ms. Yellen. Thank you for having me.
    Chairman Shelby. This hearing is adjourned.
    [Whereupon, at 12:53 p.m., the hearing was 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
                           February 11, 2016
    Chairman Shelby, Ranking Member Brown, and other 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 last July, the economy 
has made further progress toward the Federal Reserve's objective of 
maximum employment. And while inflation is expected to remain low in 
the near term, in part because of the further declines in energy 
prices, the Federal Open Market Committee (FOMC) expects that inflation 
will rise to its 2 percent objective over the medium term.
    In the labor market, the number of nonfarm payroll jobs rose 2.7 
million in 2015, and posted a further gain of 150,000 in January of 
this year. The cumulative increase in employment since its trough in 
early 2010, is now more than 13 million jobs. Meanwhile, the 
unemployment rate fell to 4.9 percent in January, 0.8 percentage point 
below its level a year ago and in line with the median of FOMC 
participants' most recent estimates of its longer-run normal level. 
Other measures of labor market conditions have also shown solid 
improvement, with noticeable declines over the past year in the number 
of individuals who want and are available to work but have not actively 
searched recently, and in the number of people who are working part 
time but would rather work full time. However, these measures remain 
above the levels seen prior to the recession, suggesting that some 
slack in labor markets remains. Thus, while labor market conditions 
have improved substantially, there is still room for further 
sustainable improvement.
    The strong gains in the job market last year were accompanied by a 
continued moderate expansion in economic activity. U.S. real gross 
domestic product is estimated to have increased about 1\3/4\ percent in 
2015. Over the course of the year, subdued foreign growth and the 
appreciation of the dollar restrained net exports. In the fourth 
quarter of last year, growth in the gross domestic product is reported 
to have slowed more sharply, to an annual rate of just \3/4\ percent; 
again, growth was held back by weak net exports as well as by a 
negative contribution from inventory investment. Although private 
domestic final demand appears to have slowed somewhat in the fourth 
quarter, it has continued to advance. Household spending has been 
supported by steady job gains and solid growth in real disposable 
income--aided in part by the declines in oil prices. One area of 
particular strength has been purchases of cars and light trucks; sales 
of these vehicles in 2015, reached their highest level ever. In the 
drilling and mining sector, lower oil prices have caused companies to 
slash jobs and sharply cut capital outlays, but in most other sectors, 
business investment rose over the second half of last year. And 
homebuilding activity has continued to move up, on balance, although 
the level of new construction remains well below the longer-run levels 
implied by demographic trends.
    Financial conditions in the United States have recently become less 
supportive of growth, with declines in broad measures of equity prices, 
higher borrowing rates for riskier borrowers, and a further 
appreciation of the dollar. These developments, if they prove 
persistent, could weigh on the outlook for economic activity and the 
labor market, although declines in longer-term interest rates and oil 
prices provide some offset. Still, ongoing employment gains and faster 
wage growth should support the growth of real incomes and therefore 
consumer spending, and global economic growth should pick up over time, 
supported by highly accommodative monetary policies abroad. Against 
this backdrop, the Committee expects that with gradual adjustments in 
the stance of monetary policy, economic activity will expand at a 
moderate pace in coming years and that labor market indicators will 
continue to strengthen.
    As is always the case, the economic outlook is uncertain. Foreign 
economic developments, in particular, pose risks to U.S. economic 
growth. Most notably, although recent economic indicators do not 
suggest a sharp slowdown in Chinese growth, declines in the foreign 
exchange value of the renminbi have intensified uncertainty about 
China's exchange rate policy and the prospects for its economy. This 
uncertainty led to increased volatility in global financial markets 
and, against the background of persistent weakness abroad, exacerbated 
concerns about the outlook for global growth. These growth concerns, 
along with strong supply conditions and high inventories, contributed 
to the recent fall in the prices of oil and other commodities. In turn, 
low commodity prices could trigger financial stresses in commodity-
exporting economies, particularly in vulnerable emerging market 
economies, and for commodity-producing firms in many countries. Should 
any of these downside risks materialize, foreign activity and demand 
for U.S. exports could weaken and financial market conditions could 
tighten further.
    Of course, economic growth could also exceed our projections for a 
number of reasons, including the possibility that low oil prices will 
boost U.S. economic growth more than we expect. At present, the 
Committee is closely monitoring global economic and financial 
developments, as well as assessing their implications for the labor 
market and inflation and the balance of risks to the outlook.
    As I noted earlier, inflation continues to run below the 
Committee's 2 percent objective. Overall consumer prices, as measured 
by the price index for personal consumption expenditures, increased 
just \1/2\ percent over the 12 months of 2015. To a large extent, the 
low average pace of inflation last year can be traced to the earlier 
steep declines in oil prices and in the prices of other imported goods. 
And, given the recent further declines in the prices of oil and other 
commodities, as well as the further appreciation of the dollar, the 
Committee expects inflation to remain low in the near term. However, 
once oil and import prices stop falling, the downward pressure on 
domestic inflation from those sources should wane, and as the labor 
market strengthens further, inflation is expected to rise gradually to 
2 percent over the medium term. In light of the current shortfall of 
inflation from 2 percent, the Committee is carefully monitoring actual 
and expected progress toward its inflation goal.
    Of course, inflation expectations play an important role in the 
inflation process, and the Committee's confidence in the inflation 
outlook depends importantly on the degree to which longer-run inflation 
expectations remain well anchored. It is worth noting, in this regard, 
that market-based measures of inflation compensation have moved down to 
historically low levels; our analysis suggests that changes in risk and 
liquidity premiums over the past year-and-a-half contributed 
significantly to these declines. Some survey measures of longer-run 
inflation expectations are also at the low end of their recent ranges; 
overall, however, they have been reasonably stable.
Monetary Policy
    Turning to monetary policy, the FOMC conducts policy to promote 
maximum employment and price stability, as required by our statutory 
mandate from the Congress. Last March, the Committee stated that it 
would be appropriate to raise the target range for the Federal funds 
rate when it had seen further improvement in the labor market and was 
reasonably confident that inflation would move back to its 2 percent 
objective over the medium term. In December, the Committee judged that 
these two criteria had been satisfied and decided to raise the target 
range for the Federal funds rate \1/4\ percentage point, to between \1/
4\ and \1/2\ percent. This increase marked the end of a 7-year period 
during which the Federal funds rate was held near zero. The Committee 
did not adjust the target range in January.
    The decision in December to raise the Federal funds rate reflected 
the Committee's assessment that, even after a modest reduction in 
policy accommodation, economic activity would continue to expand at a 
moderate pace and labor market indicators would continue to strengthen. 
Although inflation was running below the Committee's longer-run 
objective, the FOMC judged that much of the softness in inflation was 
attributable to transitory factors that are likely to abate over time, 
and that diminishing slack in labor and product markets would help move 
inflation toward 2 percent. In addition, the Committee recognized that 
it takes time for monetary policy actions to affect economic 
conditions. If the FOMC delayed the start of policy normalization for 
too long, it might have to tighten policy relatively abruptly in the 
future to keep the economy from overheating and inflation from 
significantly overshooting its objective. Such an abrupt tightening 
could increase the risk of pushing the economy into recession.
    It is important to note that even after this increase, the stance 
of monetary policy remains accommodative. The FOMC anticipates that 
economic conditions will evolve in a manner that will warrant only 
gradual increases in the Federal funds rate. In addition, the Committee 
expects that the Federal funds rate is likely to remain, for some time, 
below the levels that are expected to prevail in the longer run. This 
expectation is consistent with the view that the neutral nominal 
Federal funds rate--defined as the value of the Federal funds rate that 
would be neither expansionary nor contractionary if the economy was 
operating near potential--is currently low by historical standards and 
is likely to rise only gradually over time. The low level of the 
neutral Federal funds rate may be partially attributable to a range of 
persistent economic headwinds--such as limited access to credit for 
some borrowers, weak growth abroad, and a significant appreciation of 
the dollar--that have weighed on aggregate demand.
    Of course, monetary policy is by no means on a preset course. The 
actual path of the Federal funds rate will depend on what incoming data 
tell us about the economic outlook, and we will regularly reassess what 
level of the Federal funds rate is consistent with achieving and 
maintaining maximum employment and 2 percent inflation. In doing so, we 
will take into account a wide range of information, including measures 
of labor market conditions, indicators of inflation pressures and 
inflation expectations, and readings on financial and international 
developments. In particular, stronger growth or a more rapid increase 
in inflation than the Committee currently anticipates would suggest 
that the neutral Federal funds rate was rising more quickly than 
expected, making it appropriate to raise the Federal funds rate more 
quickly as well. Conversely, if the economy were to disappoint, a lower 
path of the Federal funds rate would be appropriate. We are committed 
to our dual objectives, and we will adjust policy as appropriate to 
foster financial conditions consistent with the attainment of our 
objectives over time.
    Consistent with its previous communications, the Federal Reserve 
used interest on excess reserves (IOER) and overnight reverse 
repurchase (RRP) operations to move the Federal funds rate into the new 
target range. The adjustment to the IOER rate has been particularly 
important in raising the Federal funds rate and short-term interest 
rates more generally in an environment of abundant bank reserves. 
Meanwhile, overnight RRP operations complement the IOER rate by 
establishing a soft floor on money market interest rates. The IOER rate 
and the overnight RRP operations allowed the FOMC to control the 
Federal funds rate effectively without having to first shrink its 
balance sheet by selling a large part of its holdings of longer-term 
securities. The Committee judged that removing monetary policy 
accommodation by the traditional approach of raising short-term 
interest rates is preferable to selling longer-term assets because such 
sales could be difficult to calibrate and could generate unexpected 
financial market reactions.
    The Committee is continuing its policy of reinvesting proceeds from 
maturing Treasury securities and principal payments from agency debt 
and mortgage-backed securities. As highlighted in the December 
statement, the FOMC anticipates continuing this policy ``until 
normalization of the level of the Federal funds rate is well under 
way.'' Maintaining our sizable holdings of longer-term securities 
should help maintain accommodative financial conditions and reduce the 
risk that we might need to return the Federal funds rate target to the 
effective lower bound in response to future adverse shocks.
    Thank you. I would be pleased to take your questions.
       RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN SHELBY
                      FROM JANET L. YELLEN

Q.1. At a hearing before the House Financial Services Committee 
on November 4, you stated, ``we are looking at further ways in 
which we can tailor our supervisory approach, in particular, 
the CCAR process . . . We have some ideas about how we might 
tailor it, particularly [as it applies] to smaller firms.'' On 
December 18, the Federal Reserve Board released CCAR guidance 
that clarified existing practices, and did not introduce new 
tailoring, according to a briefing by Federal Reserve Board 
staff. Will the Board tailor CCAR expectations in a meaningful 
way that reflects the relative systemic risk of financial 
institutions? If so, when do you anticipate commencing and 
finalizing that effort?

A.1. The Federal Reserve's capital plan rule and related 
Comprehensive Capital Analysis and Review (CCAR) apply only to 
bank holding companies (BHCs) with total consolidated assets 
greater than $50 billion, not small- to mid-size banking 
organizations.
    As you note, on December 18, 2016, the Federal Reserve 
published two supervisory guidance letters that set forth 
supervisory expectations for large BHCs' capital planning 
processes. SR letter 15-18 (Federal Reserve Supervisory 
Assessment of Capital Planning and Positions for Large 
Institution Supervision Coordination Committee (LIS CC) Firms 
and Large and Complex Firms) sets forth supervisory 
expectations for capital planning for firms subject to the 
Federal Reserve's LISCC framework and other large and complex 
firms, and SR letter 15-19 (Federal Reserve Supervisory 
Assessment of Capital Planning and Positions for Large and 
Noncomplex Firms) details the supervisory expectations for 
capital planning for firms with total consolidated assets of 
$50 billion or more that are not large and complex. \1\ The 
guidance consolidated supervisory expectations that were 
previously communicated to the industry, and it formalizes the 
differences in expectations for firms of different size and 
complexity. Supervisory expectations applicable to SR 15-19 
firms are less intensive than those applicable to SR 15-18 
firms, particularly in the expectations for model use and 
controls, scenario design, and governance.
---------------------------------------------------------------------------
     \1\ Large and complex firms are U.S. BHCs and intermediate holding 
companies of foreign banking organizations that are either (i) subject 
to the Federal Reserve's LISCC framework or (ii) have total 
consolidated assets of $250 billion or more or consolidated total on-
balance sheet foreign exposure of $10 billion or more.
---------------------------------------------------------------------------
    Currently, the Board is considering a broad range of issues 
related to the capital plan and stress testing rules and 
whether any modifications may be appropriate, including any 
modifications to the rules to reduce burden on firms that pose 
less systemic risk. The Board would publish a notice of 
proposed rulemaking for public comment in connection with any 
proposed change to the capital plan or stress testing rules.

Q.2. You have stated in the past that the Federal Reserve Board 
has limited ability to tailor certain requirements under 
Section 165 of Dodd-Frank. However, Section 165(a)(2) states 
that the Board may ``differentiate among companies on an 
individual basis or by category,'' taking various factors into 
consideration. Has the Board done all it can do under the 
statute to appropriately tailor its regulations?

A.2. Under section 165 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, the Board is authorized to tailor the 
application of enhanced prudential standards. \2\ In 
implementing section 165, the Federal Reserve has identified 
three categories of bank holding companies with $50 billion or 
more in total consolidated assets based not only on their size 
but also based on complexity and other indicators of systemic 
risk. Specifically, all bank holding companies with $50 billion 
or more in consolidated assets are subject to certain enhanced 
prudential standards, including risk-based and leverage capital 
requirements, \3\ company-run and supervisory stress tests, \4\ 
liquidity riskmanagement requirements, \5\ resolution plan 
requirements, \6\ and risk management requirements. \7\ Bank 
holding companies with $250 billion or more in total 
consolidated assets or $10 billion or more in on-balance-sheet 
foreign assets are also subject to the advanced approaches 
risk-based capital requirements, \8\ a supplementary leverage 
ratio, \9\ more stringent liquidity requirements, \10\ and a 
countercyclical capital buffer. \11\ In identifying global 
systemically important banks, the Federal Reserve considers 
measures of size, interconnectedness, cross-jurisdictional 
activity, substitutability, complexity, and short-term 
wholesale funding. The eight U.S. firms identified as global 
systemically important banks (GSIBs) are subject to additional 
requirements including risk-based capital surcharges, \12\ 
enhanced supplementary leverage ratio standards, \13\ and more 
specific recovery planning guidance. \14\
---------------------------------------------------------------------------
     \2\ 12 U.S.C. 5365(a)(2).
     \3\ 12 CFR 252.32.
     \4\ 12 CFR part 252, subparts E and F.
     \5\ 12 CFR part 252.34.
     \6\ 12 CFR part 243.
     \7\ 12 CFR 252.33.
     \8\ 12 CFR part 217, subpart E.
     \9\ 12 CFR 217.10(c)(4).
     \10\ See 12 CFR part 249.
     \11\ 12 CFR 217.11(b).
     \12\ 12 CFR part 217, subpart H.
     \13\ 12 CFR 217.11(a)(2)(v), (a)(2)(vi), and (c) (effective 
January 1, 2018).
     \14\ Federal Reserve supervisory letter 14-8, available at http://
www.federalreserve.gov/bankinforeg/srletters/sr1408.htm.

Q.3. The Federal Reserve recently introduced and enhanced a 
variety of regulations including: more detailed Basel III 
capital requirements, a minimum Liquidity Coverage Ratio, 
margin trading rules, and Total Loss-Absorbing Capital 
requirements. While the stated goals of these rules are to 
ensure that banks have sufficient capital and liquidity 
cushions, it is not clear what the combined impact of such 
rules is on the economy. Has the Board conducted any studies to 
estimate the cumulative impact of these regulations? If not, do 
---------------------------------------------------------------------------
you believe that the Board should be doing so?

A.3. The Federal Reserve conducts a variety of economic 
analyses and assessments to support the rulemaking process. In 
the context of rulemakings that have been specifically 
referenced, the Federal Reserve included economic cost and 
impact assessments in its margin trading and Total Loss-
Absorbing Capacity (TLAC) proposals. As these proposals relate 
to a specific regulation or requirement, the impact analyses 
naturally focus on the impact of the specific regulation in 
question, though impact and cost estimates can generally be 
aggregated across different regulatory initiatives. More 
broadly, the Federal Reserve engages in a regular quantitative 
impact assessment and monitoring program that is coordinated 
with other global regulators through the Basel Committee on 
Banking Supervision to assess the overall impact of prudential 
capital and liquidity requirements. This impact assessment has 
been conducted and made public regularly since 2012, and 
continues to inform the Federal Reserve's understanding of the 
cost and impact of capital and liquidity regulation.
    More broadly, the Federal Reserve participates in a global 
effort through its participation on the Financial Stability 
Board (FSB) and the Basel Committee on Banking Supervision's 
Macroeconomic Assessment Group. The group published a study in 
2010 that assessed the overall macroeconomic impact of stronger 
capital and liquidity requirements.
    The Federal Reserve seriously considers the overall costs 
and benefits of all of the regulations it promulgates. The 
overarching goal of the Federal Reserve's regulatory program is 
to enhance financial stability while at the same time not 
creating any undue costs or burdens for the rest of the 
economy. The Federal Reserve is committed to engaging in an 
ongoing assessment program to better understand how post-crisis 
reform is influencing financial stability as well as the 
economic costs of enhanced regulation.

Q.4. Members of this Committee have raised concerns that U.S. 
regulators at the Financial Stability Board (FSB) and the 
International Association of Insurance Supervisors (IAIS) are 
not representing the United States in a coordinated, cohesive 
and centralized manner.
    Have you ever represented the Federal Reserve at an FSB or 
IAIS meeting?
    If not you, then who represents the Federal Reserve at 
these meetings?
    Have you had any meetings with the Treasury Secretary or 
the SEC Chair in advance of these meetings to develop a 
cohesive and unified strategy?

A.4. As members of the FSB and International Association of 
Insurance Supervisors (IAIS), participation in these for a 
require certain commitments of staff and resources. Governor 
Daniel Tarullo or senior employees of the Federal Reserve, such 
as Mark Van Der Weide and Thomas Sullivan, represent the 
Federal Reserve at meetings of the FSB and IAIS. The Federal 
Reserve's representatives are supported by various staff 
members.
    The Federal Reserve confers with other agencies regularly 
on many FSB and IAIS topics. With regards to U.S. 
representation at the FSB and IAIS, several U.S. agencies 
participate in the work of the FSB and the IAIS, and provide 
input that considers implications for U.S. domiciled firms that 
we supervise. The Federal Reserve, the U.S. Securities and 
Exchange Commission, and the U.S. Department of Treasury are 
all members of the FSB and engage in the FSB's global financial 
stability work. Related to the work of the IAIS, the Federal 
Reserve is participating alongside the Federal Insurance Office 
(FIO), the National Association of Insurance Commissioners 
(NAIC), and State insurance regulators in the development of 
international insurance standards that best meet the needs of 
the U.S. insurance market and consumers. The Federal Reserve, 
along with other members of the U.S. delegation at the FIO and 
the NAIC, actively engage U.S. interested parties on issues 
being considered by the IAIS.
    Additionally, the FSB and the IAIS have public consultation 
processes designed to facilitate stakeholder participation and 
solicit industry and public views on key issues. The U.S. 
agencies ensure that U.S. comments are considered in the final 
deliberation process on such issues. However, it is important 
to note that neither the FSB, nor the IAIS, has the ability to 
impose requirements in any national jurisdiction. 
Implementation in the United States would have to be consistent 
with U.S. law and comply with the U.S. administrative 
rulemaking process, which would include issuing proposed rules 
for public comment.

Q.5. A recent report by the Office of Financial Research 
discussed the risk of a downturn in the credit markets, noting 
that ``nonfinancial corporate balance sheet leverage is close 
to peak levels . . . and weak underwriting standards have 
persisted.'' In your opinion, has the low interest rate 
environment contributed to increased leverage and reductions in 
credit quality? What other factors are involved?

A.5. Corporate bond yields have been very low in recent years 
by historical standards, which has made borrowing through debt 
markets more attractive for corporations and has likely 
contributed to the notable increase in corporate borrowing. A 
substantial amount of the recent debt issuance has been used by 
firms to refinance existing debt into lower rates and longer 
maturities. In addition though, outstanding debt has grown and 
aggregate leverage ratios for the corporate sector have 
increased noticeably over the past few years and are now close 
to the top of their range during previous economic expansions. 
Even so, cash flow coverage ratios for the nonfinancial 
corporate sector remain fairly moderate.
    A large part of the deterioration in credit quality in the 
corporate sector can be attributed to the steep downturn in oil 
prices and the resultant outlook for the energy sector, which 
had borrowed heavily from debt markets before the sharp drop in 
oil prices since mid-2014. Indeed, rating downgrades on 
corporate bonds over the past year have been particularly 
concentrated in the energy sector. Signs of some deterioration 
in credit quality in other industries are also apparent but 
notably smaller.

Q.6. The Federal Reserve Board's Total Loss Absorbing Capacity 
(TLAC) rule would require U.S. subsidiaries of foreign banks to 
include certain contractual provisions in their long-term debt 
instruments, including a contractual clause providing that the 
Federal Reserve can convert the debt into equity of the bank or 
cancel the debt, even if the bank is not in resolution 
proceedings. It is unclear if such long-term debt will be 
treated as debt or equity for tax purposes.
    Is the intended outcome of the Federal Reserve's proposal 
that long-term debt should be treated as equity for tax 
purposes?
    If so, does the Board intend to take the same approach for 
U.S. banks?
    Has the Board consulted with the Treasury Department on 
this issue?

A.6. With regard to the Federal Reserve's proposed TLAC rule, 
the purpose of the proposed internal long-term debt requirement 
is generally to protect the financial stability of the United 
States and, if applicable, to facilitate the single-point-of-
entry resolution of the foreign GSIB parent of a given U.S. 
intermediate holding company. To accomplish these goals, it is 
important that the U.S. intermediate holding company be 
recapitalized (if necessary) on a going-concern basis, without 
entering a resolution proceeding and without disruption to the 
foreign GSIB's U.S. operations. To make such a going-concern 
recapitalization possible, the proposed rule would require the 
U.S. intermediate holding companies of foreign GSIBs to issue 
to a foreign parent entity a minimum amount of long-term debt 
instruments with a contractual provision providing for the 
Federal Reserve to convert that long-term debt into equity 
under specified conditions. Under the proposal, one of the 
required preconditions for conversion would be a determination 
by the Federal Reserve that the U.S. intermediate holding 
company is in default or in danger of default.
    By contrast, the TLAC proposal does not seek to provide for 
the recapitalization of the top-tier holding company of a U.S. 
GSIB on a going-concern basis. Rather, the proposed rule would 
require those entities to issue plain vanilla \15\ long-term 
debt, with no provision for conversion to equity. The 
recapitalization of a U.S. GSIB would be effected only through 
the top-tier parent holding company's entry into a resolution 
proceeding, during which the entity's long-term debt would be 
subject to write-down.
---------------------------------------------------------------------------
     \15\ 80 Federal Register 74929 (November 30, 2015).
---------------------------------------------------------------------------
    The period for public comment on the TLAC proposal has 
ended, and the Federal Reserve is now reviewing the comments 
that it has received. Some of these comments address the 
potential tax treatment of long-term debt instruments that the 
proposed rule would require covered entities to issue. The 
Federal Reserve will give careful consideration to all comments 
as it moves towards the issuance of a final rule.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
                      FROM JANET L. YELLEN

Q.1. As part of the policy tools it is using to normalize 
interest rates, the Federal Reserve has set up reverse 
repurchase facilities. It is my understanding that there are 
two such RRP facilities at the Federal Reserve Bank of New York 
(FRBNY)--one for domestic participants (with a regularly 
updated list of counterparties posted on the FRBNY's Web site) 
and one for foreign central banks (where a list of 
counterparties does not appear to be publicly available). I 
have several questions regarding these facilities.
    Which entities or committees set the policy which the 
foreign RRP facility abides by? Is it the FOMC? The Board of 
Governors? The FRBNY?

A.1. The Federal Open Market Committee (FOMC) authorizes the 
operation of the foreign repurchase (RP) pool for foreign 
central bank and international accounts. The most recent 
authorization language can be found in the Committee's 
Authorization for Domestic Market Operations (ADMO) from 
January of this year. \1\
---------------------------------------------------------------------------
     \1\ See http://www.federalreserve.gov/monetarypolicy/files/
FOMC_DomesticAuthorization.pdf.

Q.2. How is pricing set for the foreign RRP facility? How does 
the policy and process compare to that which is applied to the 
---------------------------------------------------------------------------
domestic RRP facility?

A.2. Pricing for the foreign RP pool is ``undertaken on terms 
comparable to those available in the open market.'' \2\ In 
fact, the rate on the pool has averaged about one basis point 
below the overnight tri-party repo rate and has moved very 
closely over time with market rates. \3\ This policy toward 
pricing for the foreign RP pool has not varied with changes in 
the setting of monetary policy by the FOMC.
---------------------------------------------------------------------------
     \2\ See ADMO, paragraph 4.
     \3\ See figure 16 from Simon Potter's presentation, ``Money 
Markets After Liftoff: Assessment to Date and the Road Ahead'', 
February 22, 2016. https://www.newyorkfed.org/newsevents/speeches/2016/
pot160222. The accompanying figures and data are available at https://
www.newyorkfed.org/medialibrary/media/newsevents/speeches/2016/
pot160222/full-presentation.pdf and https://www.newyorkfed.org/
medialibrary/media/newsevents/speeches/2016/pot160222/data-r.xlsx.
---------------------------------------------------------------------------
    By contrast, the offering rate on the domestic reverse 
repurchase (RRP) facility is set by the FOMC to help maintain 
the Federal funds rate at the FOMC's monetary policy target. As 
such, the FOMC is using the domestic RRP rate as a monetary 
policy tool, which is distinct from the way it uses the foreign 
RP pool, which is as an investment service to foreign central 
banks and other official account holders.

Q.3. Why is the foreign RRP rate, beginning in 2015, relatively 
high given the trend? Why did the Fed feel it was necessary to 
price foreign RRP rates higher than 6-month Treasury bill 
rates?

A.3. The rate offered on the foreign RP pool is tied to a 
comparable-maturity, market-based Treasury repo rate. As such, 
any change in the relation between the rate on the foreign RP 
pool and the rate on 6-month Treasury bills is the result of 
changes in market conditions in the repo and Treasury markets 
and not the result of a change in Federal Reserve policy with 
respect to the foreign RP pool.

Q.4. As expected, foreigners rotated tens of billions of 
dollars out of Treasury bills and instead increased their usage 
of the foreign RRP facility. Was this an intended and 
anticipated effect by the Fed?

A.4. Foreign official holdings of Treasury bills were little 
changed on net in 2015--at $335.3 billion in December 2014 and 
$336.7 billion in December 2015. \4\ Thus, it is not apparent 
that foreign official holders of Treasury bills did reduce 
their holdings.
---------------------------------------------------------------------------
     \4\ From Treasury International Capital System, Major Foreign 
Holders of U.S. Treasury Securities, http://ticdata.treasury.gov/
Publish/mfhhis01.txt.
---------------------------------------------------------------------------
    However, usage of the foreign RP pool has increased 
following a relaxation in restrictions on the size of 
investments in the pool. Official investors have for some time 
wanted to increase their positions in the pool, but, prior to 
2008, participation was restricted because movements in the 
pool affected market interest rates, which could have 
interfered with the implementation of monetary policy. Since 
2008, however, in the environment of reserve abundance, 
movements in the repo pool have had little to no impact on 
market rates. Accordingly, to accommodate the demands of 
account holders, the Federal Reserve eased the constraints on 
the permitted size of the investments in the pool. The Federal 
Reserve was not seeking to increase pool investments, but given 
the previous interest expressed by account holders, it was no 
surprise that investments increased when these constraints were 
lifted.

Q.5. To what extent was the Fed motivated by a desire to 
substitute the use of deposits at U.S. banks with cash pools 
(and the accompanying need for short-term risk-free Treasury 
instruments)?

A.5. As noted above, the Federal Reserve was not seeking to 
increase the size of the pool, nor was it seeking to induce 
official account holders to substitute one type of asset for 
another. Demand for investments in the foreign RP pool has been 
driven solely by the interests of the foreign official account 
holders.

Q.6. It would seem to me that this policy is encouraging 
foreigners to use the Fed's foreign RRP facility rather than 
making use of U.S. money market funds, the largest of which are 
counterparties to the Fed through the domestic RRP facility. 
Was this an intended and anticipated effect by the Fed?
    Additionally, to what extent is the Fed concerned that 
pursuing this policy undermines the health and depth of money 
market funds?

A.6. The foreign RP pool is a long-standing service that the 
Federal Reserve has provided to foreign central banks, foreign 
Governments, and official international institutions, and the 
way in which the interest rate for the pool is calculated has 
not changed. Although the restrictions on the size of 
investments have changed recently, the resulting changes in the 
overall size of the foreign RP pool have had no noticeable 
effect on market interest rates because of the large volume of 
reserves now in the system. \5\ Finally, these account holders 
generally do not hold significant balances with money market 
funds, so shifts into the foreign RP pool are not directly 
affecting the assets under management at money market funds. 
\6\
---------------------------------------------------------------------------
     \5\ See Simon Potter's presentation, p.11, for a discussion of 
this point.
     \6\ As of the fourth quarter of 2015, total foreign holdings of 
money market mutual fund shares, which includes holdings by official 
foreigners, were $114.5 billion, compared to total money market mutual 
fund assets of $2,715.7 billion. See L.206 Money Market Mutual Fund 
Shares, Board of Governors, http://www.federalreserve.gov/apps/fof/
DisplayTable.aspx?t=1.206.

Q.7. The Fed has expressed some reluctance to allow too much 
usage of the domestic RRP facility, fearing that the market 
would become too used to the Fed as a counterparty. 
Additionally, there is concern that the Fed could increase 
systemic risk by creating a single point-of-failure for cash 
markets, rather than a diffused system that has traditionally 
been in place through the interbank market. Does the Fed share 
---------------------------------------------------------------------------
these concerns as it relates to the foreign RRP facility?

A.7. The Federal Reserve closely monitors the impact of its 
operations to determine whether they are having any unintended 
or undesirable impact. If such impact were to be observed, the 
FOMC could then take appropriate action to ameliorate it. The 
Federal Reserve maintains the right to limit the size of the RP 
pool at any time.

Q.8. On October 30, 2015, the Federal Reserve Board proposed 
its Total Loss-Absorbing Capacity (TLAC) rule. As I have 
written to you in the past, I support a strong and workable 
TLAC with the goal of making the failure and resolution of 
large financial institutions more manageable and without 
taxpayer bailouts. However, I have a few questions that I would 
like addressed.
    As I read the rule, bank holding companies (BHCs) 
designated as a global systemically important bank (GSIB), or 
the bridge companies that succeed them, would be prohibited 
from obtaining secured liquidity from the private sector, such 
as debtor-in-possession (DIP) financing, as part of a 
resolution under Title I under Dodd-Frank.
    Did the Fed intend to restrict access to DIP financing?
    Doesn't this contradict Dodd-Frank's stated goal of using 
Title I resolution as a first option if mechanically the BHC 
would find bankruptcy unworkable without short-term liquidity 
provided without taxpayer support?
    Will you commit to explicitly allowing these firms to 
access DIP financing during bankruptcy proceedings?

A.8. The proposed total loss-absorbing capacity (TLAC) rule 
would prohibit global systemically important banking 
organization (GSIB) top-tier holding companies from issuing 
debt instruments with an original maturity of less than one 
year to a third party. The general purpose of this prohibition 
is to mitigate the risk posed to the financial stability of the 
United States by potentially destabilizing short-term funding 
runs on those holding companies.
    The proposed prohibition generally should not prevent a 
GSIB from obtaining needed liquidity, including during 
resolution. This is because the proposed TLAC rule would 
generally require that a GSIB's operations be engaged in by its 
subsidiary legal entities rather than by its top-tier holding 
company, and it would place no restriction on the ability of 
those operating subsidiaries to obtain liquidity themselves 
(including both secured and unsecured and long-term and short-
term liquidity). As discussed in the preamble to the proposed 
TLAC rule, the proposal is intended to mitigate the risk of 
liquidity runs on those subsidiary entities by facilitating 
single-point-of-entry (SPOE) resolution, pursuant to which only 
the top-tier holding company would enter resolution while its 
operating subsidiaries would continue normal operations. By 
enhancing the credibility of SPOE resolution, in which losses 
would be borne by the equity holders and creditors of the top-
tier holding company, the proposal should increase the 
confidence of the creditors of GSIB operating subsidiaries and 
reduce their incentive to run if the GSIB experiences financial 
distress.
    We are committed to making the GSIBs more resolvable under 
the U.S. Bankruptcy Code, consistent with Title I of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act), as well as under the orderly liquidation authority 
(OLA) provided by Title II of the Dodd-Frank Act, and the 
provisions discussed above are intended to facilitate orderly 
resolution under both of those frameworks. As we move forward 
with the process of considering comments and finalizing the 
proposed TLAC rule, we will consider how to address issues 
related to debtor-in-possession funding during a resolution 
under the U.S. Bankruptcy Code.

Q.9. Similarly, provisions restricting the issuance of short-
term debt by intermediate holding companies (IHCs) would 
preclude JHCs from obtaining DIP financing in bankruptcy.
    Was this intended?
    Would the Fed consider making it explicit that IHCs would 
be able to obtain DIP financing if they were to file for 
bankruptcy?

A.9. Similarly, the identical restrictions on the issuance of 
short-term debt by the U.S. intermediate holding companies 
(IHCs) of foreign GSIBs were intended to promote resolvability 
under both the U.S. Bankruptcy Code and the OLA, as well as 
SPOE resolution of the foreign GSIB parent entity in its home 
jurisdiction. As we move forward, we will consider how to 
address issues related to debtor-in-possession funding with 
respect to foreign GSIB IHCs as well as U.S. GSIBs.

Q.10. It seems very clear that the Fed is heavily restricting 
the use of convertible features in the debt instruments 
allowed.
    Is this to maintain flexibility under Title II Orderly 
Resolution Authority? In effect, is this preserving a 
regulator's ability to decide when to place a firm into 
resolution and how to structure the capital stack?
    Wouldn't markets be better at signaling when a firm needs 
to be resolved and wouldn't convertible features strengthen the 
value of that signal?
    Wouldn't having convertible features as an option allow 
BHCs and investors the ability to be explicit and clear of 
creditor rights going in to a resolution?

A.10. The proposed TLAC rule would restrict the use of 
convertible features in eligible long-term debt instruments in 
order to safeguard the fundamental objective of the proposal's 
standalone long-term debt requirement: ensuring that a failed 
GSIB will have at least a fixed minimum amount of loss-
absorbing capacity available to absorb losses at the time that 
its holding company enters resolution. This objective is 
equally important for increasing the prospects for orderly GSIB 
resolution under both the U.S. Bankruptcy Code and the OLA. 
Debt instruments with features that would cause conversion into 
or exchange for equity prior to the holding company's entry 
into resolution would not serve this goal, since the 
instruments could convert into equity--which absorbs losses on 
a going-concern basis--before the firm enters resolution and 
could then be depleted prior to failure, leaving the firm with 
insufficient loss-absorbing capacity for orderly resolution at 
the point of failure. Thus, while convertible debt, like 
equity, could reduce a GSIB's probability of failure, it would 
do little to achieve the proposal's principal goal of reducing 
the harm that a GSIB's failure would do to the financial 
stability of the United States.
    The proposed TLAC rule is intended to promote clarity about 
the consequences of a GSIB's failure for various classes of 
creditors, in particular, by making clear that losses will 
generally be absorbed first by the holding company's TLAC 
holders, and thereby to increase the role of market discipline 
played by the entities that hold the holding company's equity 
and unsecured long-term debt.
    Question 12 of the preamble to the proposed TLAC rule 
invites comment on whether eligible long-term debt instruments 
should be permitted to have any of the features that would be 
prohibited under the proposal (which include provisions for 
conversion). As we move toward finalization, we will consider 
whether allowing eligible long-term debt instruments to include 
any conversion features would be appropriate in light of the 
objectives of the proposed rule.

Q.11. The rule proposes a requirement that internal TLAC be 
issued to a foreign parent.
    Would this outright prohibit a foreign parent's ability to 
use its receivables on internal TLAC to recapitalize a foreign 
affiliate of the IHC?
    If this is an attempt to ring-fence internal TLAC, wouldn't 
this make the preferred single-point-of-entry (SPOE) strategy 
for resolution through bankruptcy or OLA unworkable should 
foreign jurisdictions take the same approach?

A.11. The proposed TLAC rule would require that a foreign GSIB 
IHC's cross-border internal TLAC instruments be issued to a 
foreign parent entity that controls the IHC. The primary 
purpose of including this restriction, rather than permitting 
internal TLAC to be issued to another foreign entity within the 
foreign GSIB or to a third party, is to prevent the conversion 
of internal TLAC into equity from effecting a change in control 
over the IHC. A change in control could create additional 
regulatory and management complexity that would be undesirable 
and potentially disruptive during resolution. Ensuring that 
internal long-term debt instruments are held by a foreign 
parent entity also safeguards the financial stability of the 
United States by ensuring that losses incurred by a foreign 
GSIB IHC will be passed out of the U.S. economy during 
resolution and by ensuring that the foreign GSIB has sufficient 
skin in the game to encourage it to support the IHC rather than 
simply allowing it to fail if its equity stake is depleted.
    Question 32 of the preamble to the proposed TLAC rule 
invites comment on the definition of eligible internal TLAC 
instruments (which includes the requirement that such 
instruments be issued to a foreign parent that controls the 
IHC). We are committed to facilitating GSIB resolution and will 
consider whether a modification to this element of the internal 
TLAC proposal would be appropriate in light of the 
considerations discussed above and the objectives of the 
proposed rule.

Q.12. In 2014, I wrote a letter to you on the Supplementary 
Leverage Ratio (SLR) expressing concern that the rule, at least 
as applied to custody banks, did not reflect their unique 
business model and risks they presented to the financial 
system. At the time I raised concerns that this would harm 
their customers, because custody banks would find it 
economically unattractive to accept cash deposits during times 
of stress.
    Since the rule's adoption and given the state of play in 
short-term markets, have you evaluated the extent to which it 
should be revisited?

A.12. The Federal Reserve, the Office of the Comptroller of the 
Currency, and the Federal Deposit Insurance Corporation (the 
Agencies) finalized he supplementary leverage ratio rule (SLR 
rule) in September 2014, 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. \1\ 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 total leverage 
exposure would generally be inconsistent with this principle.
---------------------------------------------------------------------------
     \1\ See 79 Fed. Reg. 57725 (September 26, 2014), available at 
http://www.gpo.gov/fdsys/pkg/FR-2014-09-26/pdfl2014-22083.pdf.
---------------------------------------------------------------------------
    We understand the concern that certain custody banks, which 
act as intermediaries in high volume, low-risk, low-return 
financial activities, may experience increases in assets as a 
result of macroeconomic factors and monetary policy decisions, 
particularly during periods of financial market stress. \2\ 
Because the SLR is not a risk-based measure, it is possible 
that increases in banking organizations' holdings of low-risk, 
low-return assets, such as deposits, could cause this ratio to 
become the binding regulatory capital constraint. However, when 
choosing an appropriate asset profile, banking organizations 
consider many factors in addition to regulatory capital 
requirements, such as yields available relative to the overall 
cost of funds, the need to preserve financial flexibility and 
liquidity, revenue generation, the maintenance of market share 
and business relationships, and the likelihood that principal 
will be repaid.
---------------------------------------------------------------------------
     \2\ The Agencies have reserved authority under the capital rule to 
require a banking organization to use a different asset amount for an 
exposure included in the SLR to address extraordinary situations. See 
12 CFR 3.l(d)(4) (OCC); 12 CFR 217.1(d)(4) (Federal Reserve); 12 CFR 
324.1(d)(4) (FDIC).
---------------------------------------------------------------------------
    Federal Reserve staff has held meetings with and reviewed 
materials prepared by the custody banks in connection with the 
implementation of the SLR. The Federal Reserve continuously 
considers potential improvements to its regulations based on 
feedback from affected parties and the general public but is 
not considering making any modifications to the SLR at this 
time. The SLR requirement and the enhanced SLR requirements do 
not become effective until January 1, 2018. According to public 
disclosures of firms subject to these requirements, the GSIBs 
have made significant progress in complying with the enhanced 
SLR requirements.

Q.13. It is my understanding that custody banks have been in to 
meet with the Fed on the problems created by the SLR in times 
of stress. What has your response to them been? Where do you 
anticipate their clients placing their cash if custody banks 
are penalized for taking it in on deposit?

A.13. Please see response to Question 12.

Q.14. I remain concerned that despite Congress expressing a 
desire for the Fed and other regulators to reevaluate and 
recalibrate the treatment different-sized banks receive under 
rules promulgated in accordance with Basel III, there has been 
no meaningful improvement. As a result, consumers and small 
business-owners find it harder and more expensive to borrow.
    Given that the asset and foreign activity thresholds used 
to implement Basel are woefully outdated and pre-date the 2008 
Financial Crisis, wouldn't it be better for the Fed to abandon 
these standards in favor of those which more closely reflect 
the current banking landscape and the risks posed by today's 
institutions?

A.14. The financial crisis showed there was a need for higher 
quantities of higher quality capital for banks of all sizes so 
that they could continue operating and lending to their 
communities during periods of stress. To this end, the revised 
regulatory capital rules adopted by the Agencies strengthen the 
quantity and quality of banking organizations' capital, thus 
enhancing their ability to continue functioning as financial 
intermediaries during stressful periods, reducing risks to the 
deposit insurance fund and the chances of taxpayer bailouts, 
and improving the overall resilience of the U.S. financial 
system. \3\ Consistent with section 171 of the Dodd-Frank Act, 
the Agencies' capital rules apply to all insured depository 
institutions and depository institution holding companies that 
have $1 billion or more in total consolidated assets or that 
engage in significant nonbanking activities. \4\
---------------------------------------------------------------------------
     \3\  See, for example, 12 CFR part 217 (Federal Reserve).
     \4\ 12 U.S.C. 5371.
---------------------------------------------------------------------------
    In addition, the Agencies have tailored the application of 
certain components of the capital rules. Certain large and more 
complex banking organizations are subject to additional capital 
requirements in light of their size and increased risk profile. 
For example, banking organizations that have $250 billion in 
total consolidated assets or total consolidated on-balance 
sheet foreign exposure of $10 billion or more are subject to 
the advanced approaches capital rules, a supplementary leverage 
ratio requirement, and the requirement to recognize most 
elements of accumulated other comprehensive income in 
regulatory capital. \5\ In addition, the eight U.S. firms 
identified as global systemically important banks (GSIBs) are 
subject to risk-based capital surcharges, \6\ enhanced 
supplementary leverage ratio standards, \7\ and more specific 
recovery planning guidance. \8\
---------------------------------------------------------------------------
     \5\ 12 CFR part 217, subpart E.
     \6\ 12 CFR part 217, subpart H.
     \7\ 12 CFR 217.11(a)(2)(v), (a)(2)(vi), and (c) (effective January 
1, 2018).
     \8\ Federal Reserve supervisory letter 14-8, available at http://
www.federalreserve.gov/bankinforeg/srletters/sr1408.htm.
---------------------------------------------------------------------------
    Underlying this tailoring was the principle that 
progressively more stringent regulation should apply to the 
different firms based on their relative importance to the 
financial system, and thus the harm that could be expected to 
the system if they failed. The Federal Reserve continues to 
consider ways to further tailor the capital standards and 
related requirements to reflect differences in risk among 
firms.

Q.15. Has the Fed considered using the Fed's own systemic 
indicator approach? Currently the systemic indicator approach 
is applied for some rules but not for others.

A.15. As indicated in the response to Question 14, the Federal 
Reserve has established tailored regulatory requirements and 
supervisory expectations since the recent financial crisis for 
the large banking organizations that take into account 
macroprudential considerations and systemic risk. These include 
various enhanced prudential standards under section 165 of the 
Dodd-Frank Act. \9\
---------------------------------------------------------------------------
     \9\ 12 U.S.C. 5365.

Q.16. Would you agree that a more holistic approach, such as 
that guided by the Fed's systemic indicators, would assist in 
better calibrating rules, such as the LCR, than simple asset 
---------------------------------------------------------------------------
thresholds?

A.16. As I have stated in the past, one-size-fits-all should 
not be the model for regulation. The Federal Reserve has made 
it a top priority to ensure that we appropriately tailor our 
regulation and supervision of banks to their size, complexity, 
and risk. As indicated in the responses to Questions 14 and 15, 
the Federal Reserve has used a variety of measures to tailor 
its prudential requirements. The Federal Reserve continues to 
consider ways to further tailor the standards to reflect 
differences in risk among firms.
                                ------                                


         RESPONSES TO WRITTEN QUESTIONS OF SENATOR KIRK
                      FROM JANET L. YELLEN

Q.1. In 2009, the Federal Reserve expressly recognized that the 
insurance premium finance industry was an essential source of 
credit to the Nation's small business community and vital to 
the restoration of the Nation's economy when it designated 
insurance premium finance loans as one of the select categories 
of collateral eligible for its Term Asset Backed Securities 
Loan Facility (TALF). Today, the insurance premium finance 
industry provides loans to finance the purchase of commercial 
insurance coverage worth more than $40-45 billion in annual 
premiums.
    I am writing specifically to ask how the Fed intends to 
enforce a forthcoming final rule, entitled ``Customer Due 
Diligence Requirements for Financial Institutions'', that is to 
be issued by the Department of the Treasury and the Financial 
Crimes Enforcement Network (FinCEN) imminently. I am concerned 
that this rule could adversely affect the ability of bank-owned 
insurance premium finance companies to provide financing for 
small businesses that is critical to their day-to-day 
operations. The Fed should work closely with Treasury and 
FinCEN when the rule comes out to avoid any unintended 
consequences of implementation.
    In light of the Fed's recognition of this industry's 
significance as a source of affordable, essential credit to 
small businesses, I would respectfully ask the following:
    FinCEN long ago determined that purchases of property and 
casualty insurance policies by insureds from insurance 
companies in and of themselves do not present any appreciable 
risk of money laundering or other financial crimes and have 
therefore been excluded from applicable FinCEN regulations. 
Accordingly, there does not appear to be any appreciable risk 
that insurance premium financing will be used to launder money 
or fund terrorism. What is the basis for the Fed applying CIP 
requirements to premium finance companies and when specifically 
can we expect to hear specific guidelines on how Fed 
enforcement will look?

A.1. We understand the concerns that have been raised by some 
in the insurance premium finance industry regarding the 
requirement to collect customer identification information 
under the Bank Secrecy Act (BSA). In 2003, Financial Crimes 
Enforcement Network (FinCEN) and the Federal banking agencies 
issued an interagency Customer Identification Program (CIP) 
rule implementing section 326 of the USA PATRIOT Act. The CIP 
rule requires banks and other financial institutions to form a 
reasonable belief regarding a customer's identity when opening 
an account. \1\ The CIP rule applies to any ``formal banking 
relationship established to provide or engage in services, 
dealings, or other financial transactions including a deposit 
account, a transaction or asset account, a credit account, or 
other extension of credit.'' \2\ The CIP rule does not exempt 
accounts established for the purpose of insurance premium 
financing. The CIP rule applies equally to banks and their 
subsidiaries when opening an account within the meaning of the 
rule. \3\
---------------------------------------------------------------------------
     \1\ 31 CFR 1020.100(c), (a).
     \2\ 31 CFR 103.121(a)(i).
     \3\ Interagency Interpretive Guidance on Customer Identification 
Program Requirements Under Section 326 of the USA PATRIOT Act, FAQs 
Final CIP Rule (April 28, 2005).
---------------------------------------------------------------------------
    The requirements of the CIP rule are typically satisfied by 
adopting risk-based procedures at account opening that enable 
the bank to verify the customer's identity to the extent 
reasonable and practicable. First, a bank's CIP must obtain a 
name, date of birth, address, and identification number from a 
customer who is an individual. \4\ Second, the bank must adopt 
identity verification procedures that describe when and how the 
bank will verify the customer's identity using documentary or 
nondocumentary methods. \5\ Finally, the CIP rule has specific 
account record keeping and notice requirements. \6\ The 
procedures used by the Federal Reserve and other banking 
agencies to examine a bank's compliance with the CIP rule are 
identified in the Bank Secrecy Act/Anti-Money Laundering (BSA/
AML) manual published by the Federal Financial Institutions 
Examination Council member agencies. \7\
---------------------------------------------------------------------------
     \4\ 31 CFR 1020.220(a)(2)(i).
     \5\ 31 CFR 1020.220(a)(2)(ii).
     \6\ 31 CFR 1020.220(a)(3) and (a)(5).
     \7\ See generally, Federal Financial Institution Examination 
Counsel, Bank Secrecy Act/Anti-Money Laundering Examination Manual 
(2014) (available at: https://www.ffiec.gov/bsa--am1--infobase/pages--
manual/manual--online.htm). The FFIEC member agencies include the 
Federal Deposit Insurance Corporation, National Credit Union 
Administration, Office of the Comptroller of the Currency, and the 
Consumer Financial Protection Bureau, as well as the Federal Reserve 
Board.
---------------------------------------------------------------------------
    In 2014, separate from the CIP rule, FinCEN issued a 
proposed rule that establishes customer due diligence (CDD) 
requirements for banks and other financial institutions with 
obligations under BSA. As proposed, the CDD rule requires banks 
to identify the beneficial owner(s) of any legal entity 
customer who opens an ``account'' within the meaning of the CIP 
rule. Although the proposed CDD rule exempts certain customers, 
these exemptions do not extend to customers who establish an 
insurance premium financing relationship with a bank or its 
subsidiary. The Federal Reserve does not have the authority to 
exempt insurance premium finance companies from any increased 
costs associated with FinCEN's proposed CDD rule. The Federal 
Reserve's responsibility is limited to examining banks under 
its supervision for compliance with the CDD rule once FinCEN 
reaches its final determination. Indeed, only FinCEN retains 
the authority to determine whether the final CDD rule will 
apply to the insurance premium financing industry.

Q.2. I am concerned that the Fed's application of CIP 
requirements, once the rule is finalized, to bank-owned premium 
finance companies will result in higher costs to small 
businesses that depend on affordable premium financing to 
operate. How would the Fed propose to address this presumably 
unintended consequence of applying CIP requirements to bank-
owned premium finance lenders?

A.2. Please see response to Question 1.

Q.3. Since it is not clear that even the existing CIP 
requirements should apply to the premium finance industry, will 
you please confirm that the Fed will not apply the proposed 
incremental CIP requirements (if such rules become final) to 
the insurance premium finance industry? Absent such 
confirmation, please explain the rationale for application of 
incremental CIP requirements to bank-owned insurance premium 
finance companies.

A.3. Please see response to Question 1.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR HELLER
                      FROM JANET L. YELLEN

Q.1. Through our previous correspondence you have stated that, 
``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.''
    Do you expect that proposed rulemaking will be issued in 
2016, and if so when?

A.1. The Federal Reserve remains committed to tailoring its 
approach to consolidated supervision of insurance firms, 
including the development and application of a domestic 
regulatory capital framework and other insurance prudential 
standards, to the business of insurance, reflecting insurers' 
different business models and systemic importance compared to 
other firms supervised by the Federal Reserve. Moreover, as you 
note, we are committed to a formal rulemaking process in the 
development of a domestic insurance capital standard. We are 
approaching our mandate carefully and are engaged in a 
deliberative process. We are committed to following a 
transparent rulemaking process that will include a public 
comment period on a concrete proposal.

Q.2. You have stated that the Board is committed to a capital 
approach that is tailored to the unique risks of insurers and 
one that is appropriate for the U.S. market, insurers, and 
consumers. Please provide specific decisions that have been 
made on how the Board may tailor regulations to account for the 
difference between insurance businesses and the banking sector.

A.2. As stated in the answer above, in our consolidated 
supervision of insurance firms, the Federal Reserve remains 
committed to tailoring its supervisory approach, including a 
domestic regulatory capital framework and other insurance 
prudential standards, to the business of insurance, reflecting 
insurers' different business models and systemic importance 
compared to other firms supervised by the Federal Reserve. The 
Federal Reserve appreciates that insurance involves unique 
risks among financial institutions, encompassing both 
liabilities and assets, and it is important to keep in mind the 
liability structure of firms in determining capital 
requirements for insurance companies, particularly with regard 
to the mix of the insurers' activities. It would be premature 
to comment on how the Federal Reserve may treat the unique 
risks of certain insurance lines, mix of business and the like, 
before we have fully evaluated the potential options and 
complicated our deliberations. We are, however, approaching our 
mandate carefully and with proper deliberation. In our 
development of domestic standards, we continue to solicit views 
from external parties and engage in internal deliberation as we 
develop the domestic capital frameworks as well as rulemaking 
regarding other aspects of the Federal Reserve's mandate and 
authority as set out in the Dodd-Frank Wall Street Reform and 
Consumer Protection Act. Moreover, The Insurance Capital 
Standards Clarification Act of 2014 gave the Federal Reserve 
further flexibility to tailor a capital standard to the 
business of insurance.

Q.3. Will the Board issue one proposed domestic capital rule 
for all insurers it supervises? If the Board is currently 
exploring multiple domestic capital standards what are the 
possible benefits and detriments to this approach based on the 
Board's evaluations so far?

A.3. The Federal Reserve is considering a variety of options 
for the domestic capital standards that reflect the unique 
risks of certain insurance lines, mix of business, and other 
factors. However, the Federal Reserve has not fully evaluated 
these options and has not completed its deliberations, so it 
would be premature to comment on these matters. In our 
consolidated supervision of insurance firms, the Federal 
Reserve remains committed to tailoring its supervisory 
approach, including a domestic regulatory capital framework and 
other insurance prudential standards, to the business of 
insurance, reflecting insurers' different business models and 
systemic importance compared to other firms supervised by the 
Federal Reserve. Moreover, we are committed to a formal 
rulemaking process in the development of insurance prudential 
standards.

Q.4. As a member of the Financial Stability Oversight Council 
what information does the Board provide to systemically 
important financial institutions on how they can de-risk and 
de-designate? Do you support providing a clear roadmap or 
analysis on actions a company can take to be less of a 
potential risk to the financial system?

A.4. The Federal Reserve Board's (Board) regulations and 
supervisory guidance applicable to the largest U.S. bank 
holding companies and nonbank financial companies that are 
designated by the Financial Stability Oversight Council (FSOC) 
are intended to reduce the threat that could be posed to U.S. 
financial stability by the material financial distress or 
failure of these organizations and promote their safe and sound 
operations. Such regulations are designed to increase the 
resilience of systemically important financial institutions and 
foster such firms' ability to provide credit and other 
financial services in times of financial stress. Through 
speeches and testimony, the Board and its staff also provide 
information on how financial institutions, both banks and 
nonbanks, can reduce the risk they could pose to U.S. financial 
stability.
    FSOC designation of nonbanks is not intended to be 
permanent. The Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Dodd-Frank Act) provides that the FSOC annually 
review designations to make sure that they remain appropriate 
and take into account significant changes at the firms that 
materially affect the FSOC's determination. At the time of 
designation, nonbank financial companies are given a detailed 
basis for the determination that a nonbank financial company 
should be subject to supervision by the Board. Factors include 
the extent of short-term funding activities at those 
organizations, the firms' products and associated short-term 
liabilities, their capital markets activities, securities 
lending, over the counter derivatives, and interconnectedness 
with the rest of the financial system. Firms can use that 
information, as well as factors the FSOC is required to 
consider under the Dodd-Frank Act, to guide their efforts to 
reduce their systemic footprint.

Q.5. During your testimony you stated to me that you recognize 
that regulatory burden is a significant issue for many banks 
and it is something the Board will do its best to mitigate 
particularly for community banks. You also stated the Board 
will do everything in its power to look for ways to simplify 
and control regulatory burdens for community banks. What 
specific actions will the Board take to tailor or simplify 
regulations specifically for community lenders this year?

A.5. The Federal Reserve has long maintained that our 
regulatory efforts should be designed to minimize regulatory 
burden consistent with the effective implementation of our 
statutory responsibilities. In addition, the Federal Reserve 
and the other banking agencies have developed a number of 
compliance guides that are specifically designed to assist 
community banks' understanding of applicable regulatory 
requirements.
    Generally, the Federal Reserve strives to balance efforts 
to ensure that supervision and regulation are calibrated 
appropriately for smaller and less risky institutions with our 
responsibility to ensure that consumer financial transactions 
are fair and transparent, regardless of the size and type of 
supervised institutions involved. The Federal Reserve has 
worked to minimize regulatory burdens for community banks, by 
fashioning simpler compliance requirements and clearly 
identifying which provisions of new regulations are of 
relevance to smaller banks.
    In February, the Federal Reserve, Federal Deposit Insurance 
Corporation, and the Office of the Comptroller of the Currency 
(the Agencies) increased the number of small banks and savings 
associations eligible for an 18-month examination cycle rather 
than a 12-month exam cycle. Upon authorization provided in the 
Fixing America's Surface Transportation Act, enacted on 
December 14, 2015, the Agencies moved quickly to raise the 
asset threshold from $500 million to $1 billion in total assets 
for banks and savings associations that are well-capitalized 
and well-managed to be eligible for an 18-month examination 
cycle.
    In April, the Board implemented new procedures for 
examiners to conduct off-site loan reviews for community and 
small regional banks. State member banks and U.S. branches and 
agencies for foreign banking organizations with less than $50 
billion in total assets can opt to allow Federal Reserve 
examiners to review loan files off-site, so long as loan 
documents can be sent securely and with the required 
information. Banks may still select to have on-site loan 
reviews if they prefer.
    Continued efforts to reduce burden include a new consumer 
compliance examination framework for community banks instituted 
by the Board that more explicitly bases examination intensity 
on the individual bank's risk profile, weighted against the 
effectiveness of the bank's compliance controls. The Board also 
revised its consumer compliance examination frequency policy to 
lengthen the time between on-site consumer compliance and 
Community Reinvestment Act examinations for many community 
banks with less than $1 billion in total consolidated assets.
    Also in April, the Board approved a final rule raising the 
asset threshold of the Board's Small Bank Holding Company and 
Savings and Loan Holding Company Policy Statement (Policy 
Statement) from $500 million to $1 billion and expanding its 
application to savings and loan holding companies. As a result 
of this action, 89 percent of all bank holding companies and 81 
percent of all savings and loan holding companies are now 
covered under the scope of the Policy Statement. The Policy 
Statement reduces regulatory burden by excluding these small 
organizations from certain consolidated capital requirements. 
In addition to reducing capital burden, the action 
significantly reduced the reporting burden associated with 
capital requirements by eliminating the more complex quarterly 
consolidated financial reporting requirements and replacing 
them with semiannual parent-only financial statements for 470 
institutions. In addition, raising the asset threshold allowed 
more bank holding companies to take advantage of expedited 
applications processing procedures.
    To deepen its understanding of community banks and the 
specific challenges facing these institutions, the Board meets 
twice a year with the Community Depository Institutions 
Advisory Council (CDIAC) to discuss the economic conditions and 
issues that are of greatest concern to community institutions. 
The CDIAC members are selected from representatives of 
community banks, thrift institutions, and credit unions who 
serve on local advisory councils at the 12 Federal Reserve 
Banks. The Board also has launched a number of outreach 
initiatives, including the establishment of its ``Community 
Banking Connections'' program, which is designed to enhance the 
dialogue between the Board and community banks. In addition, 
this program highlights key elements of the Board's supervisory 
process for community banks and provides clarity on supervisory 
expectations.
    Under the auspices of the Federal Financial Institution 
Examination Council (FFIEC), the Board is participating in the 
decennial review of regulations as required by the Economic 
Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA). 
Four Federal Register notices have been released requesting 
comments on the regulations that are applicable to insured 
depository institutions and their holding companies in 12 
substantive categories: Applications and Reporting; Powers and 
Activities; International Operations; Banking Operations; 
Capital; the Community Reinvestment Act; Consumer Protection; 
Directors, Officers and Employees; Money Laundering; Rules of 
Procedure; Safety and Soundness; and Securities. The final 
comment period closed on March 22, 2016, and produced over 160 
written comment letters. Additionally, the Federal Reserve 
participated in six outreach events across the country with 
over 1,030 participants attending in person, by telephone, or 
via live stream. The member agencies of the FFIEC are carefully 
reviewing the comments and a final report will be provided to 
Congress later in the year.
    Additionally, under the auspices of the FFIEC, public 
notice was issued in September 2015 that established a 
multistep process for streamlining Call Report requirements. 
The notice included proposals to eliminate or revise several 
Call Report data items, announced an accelerated start of a 
statutorily required review of the Call Report, and began an 
assessment of the feasibility of creating a streamlined 
community bank Call Report. In addition to the formal EGRPRA 
process, efforts continue for engaging in industry dialogue and 
outreach, to better understand significant sources of Call 
Report burden.

Q.6. Coming from a State where we have lost many community 
lenders, are you worried about credit availability? Will the 
Board do any specific research on how regulations are impacting 
credit availability in our economy?

A.6. The Board recognizes the unique and important role that 
community banks play, particularly by lending to small- and 
medium-sized businesses in local economies. The Board is 
committed to establishing a deep understanding of the role of 
community banks in providing credit, and of the impact of 
economic conditions and regulation on community bank activity.
    As part of our surveillance function, the Board produces 
regular reports on profitability, risks, and lending activity 
for each of its supervisory portfolios, including Community 
Banking Organizations. There is a challenge to monitoring 
community banks, in that the Board must strike a balance 
between the desire for more information and the burden of 
increased regulatory reporting for the banks.
    As mandated by the EGRPRA, the Board submits a report to 
Congress every 5 years on the availability of credit to small 
businesses. The last such report was submitted in 2012, and 
detailed the substantial changes in credit conditions during 
the financial crisis of 2007-2008, as well as the improvements 
in credit availability that had occurred as of 2012. The next 
report on small business credit availability will be submitted 
in 2017.
    Since 2013, the Board, in partnership with the Conference 
of State Bank Supervisors (CSBS), has hosted an annual 
conference on community banking research and policy. The 
conference brings together researchers from the Board and 
academic institutions, and consists of 2 days of research 
presentations and panels. Governor Brainard and I provided 
keynote addresses to the 2015 event.
    Coinciding with the conference, the Board and CSBS have 
issued an annual report on community banking. \1\ The report is 
based largely on a survey conducted by the CSBS and State 
regulators. The survey seeks to provide an understanding of the 
profile of community banks, including their product and 
customer mix, as well as a view of bankers' impressions on key 
issues facing the industry, including the cost impact of 
regulatory compliance.
---------------------------------------------------------------------------
     \1\ See ``Community Banking in the 21st Century: Policy and 
Research Conference'', Sept. 31-Oct. 1, 2015, https://www.csbs.org/
news/press-releases/pr2015/Pages/PR-100115b.aspx.
---------------------------------------------------------------------------
    The Board also recognizes that regulatory compliance often 
represents a fixed cost, and as such community banks can be at 
a disadvantage to their larger counterparts in shouldering the 
burden of compliance. For this and other reasons, the Board is 
convinced committed to tailoring banking supervision and 
regulation based on the size and complexities of firms. Among 
our efforts to reduce regulatory burden for small banks, the 
Board is currently participating in the decennial review under 
EGRPRA, as previously noted. The review has included numerous 
public comments and outreach sessions, and has helped identify 
a number of themes on which the Board and other agencies have 
already taken action. In addition, the Board is acting along 
with other regulators to reduce the burden of various 
examinations for small banks.

Q.7. Specifically, what is the Board's plan to unwind the 
Federal Reserve's nearly $4.5 trillion dollar balance sheet and 
when will that happen?

A.7. The size and composition of the Federal Reserve's balance 
sheet reflects the policy actions the Federal Open Market 
Committee (FOMC) has taken over recent years to achieve its 
statutory objectives for monetary policy--maximum employment 
and stable prices. In September 2014, as part of prudent 
planning, the FOMC released Policy Normalization Principles and 
Plans \2\ (Principles and Plans) that provided information 
regarding its strategy to reduce the size of the Federal 
Reserve's securities holdings once it began normalizing the 
stance of monetary policy.
---------------------------------------------------------------------------
     \2\ https://www.federalreserve.gov/newsevents/press/monetary/
20140917c.htm
---------------------------------------------------------------------------
    As stated in the Principles and Plans, the FOMC intends to 
reduce the Federal Reserve's securities holdings in a gradual 
and predictable manner primarily by ceasing to reinvest 
repayments of principal on securities holdings. In its most 
recent statement, the FOMC again noted that it is maintaining 
its existing policy of reinvesting principal payments from its 
holdings of agency debt and agency mortgage-backed securities 
in agency mortgage-backed securities and of rolling over 
maturing Treasury securities at auction, and it anticipates 
doing so until normalization of the level of the Federal funds 
rate is well under way.
    The FOMC also noted in the Principles and Plans that it 
currently does not anticipate selling agency mortgage-backed 
securities as part of the normalization process, although 
limited sales might be warranted in the longer run to reduce or 
eliminate residual holdings. In addition, the timing and pace 
of any sales would be communicated to the public in advance. Of 
course, all of these balance sheet plans can be adjusted in 
light of economic and financial developments.

Q.8. During your testimony you responded to Senator Crapo's 
question regarding liquidity conditions and stated that you are 
looking very carefully at that the factors that may be 
affecting liquidity in the markets. Will you please further 
elaborate on what specific studies or evaluations are currently 
being conducted by the Federal Reserve regarding liquidity 
conditions in the fixed income market?

A.8. Federal Reserve staff have been involved in several 
projects on market liquidity both internally and with other 
U.S. Government agencies. Internally, staff have studied and 
are continuing to study whether there has been a decline in 
secondary market liquidity in the fixed income markets. 
Although we have not found strong evidence of a significant 
deterioration in day-to-day liquidity, it is possible that 
changes in the structure of markets have made liquidity less 
resilient. This is more difficult to analyze because it 
involves the study of relatively infrequent events. Among the 
factors we have looked at, algorithmic traders have become more 
prevalent in the Treasury market, and the share of bond 
holdings held by open-end mutual funds, some of which provide 
significant liquidity transformation, has grown significantly 
in the postcrisis period. We have explored the importance of 
these factors, and focused on changes in the broker dealer 
business model and on the potential impact of regulatory 
changes on market liquidity. We note that staff at the Federal 
Reserve Bank of New York have also done a number of studies on 
market liquidity and have recently published some of this work 
online. \3\
---------------------------------------------------------------------------
     \3\ http://libertystreeteconomics.newyorkfed.org/2016/02/
continuing-the-conversation-on-liquidity.html#.Vs3HdXIUWmR
---------------------------------------------------------------------------
    Federal Reserve staff have also played a key role in the 
interagency work on the events of October 15, 2014, when fixed 
income markets experienced a sudden and extreme increase in 
market volatility. \4\ Staff also continue to engage actively 
with the U.S. Treasury, the Commodity Futures Trading 
Commission, and the Securities and Exchange Commission on work 
examining longer term changes in fixed income market structure 
and their potential impact on market liquidity.
---------------------------------------------------------------------------
     \4\ http://www.federalreserve.gov/newsevents/press/other/
20150713a.htm
---------------------------------------------------------------------------
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE
                      FROM JANET L. YELLEN

Q.1. State of the Economy--I'd like you to elaborate on your 
statement during the February 11, 2016, Senate Banking 
Committee hearing that ``job creation has perhaps been more 
heavily skewed toward sectors that have lower pay,'' and that 
``the downturn probably accelerated those trends that perhaps 
relate to globalization and technological change that are 
demanding increased skill.'' This is an important concept to 
grapple with because our economy is facing a crisis in the 
nature of work. If we think about the history of economics, we 
had the ``old economy,'' which evolved from hunter gatherers, 
to settled farmers and big tool manufacturing economies. Now 
we're entering into a ``new economy'' which exists within a 
global economy and a fast, technology-based, information age.
    With this old and new economy framework in mind, in what 
sectors do you find the unemployment rate is lower? Where is it 
increasing or decreasing more quickly?

A.1. The Bureau of Labor Statistics collects data on the 
previous industry and occupation of people who are unemployed. 
These data indicate that the unemployment rates of highly 
skilled workers, including managers and professionals (around 2 
to 3 percent) are lower than the unemployment rates for lower-
skilled service workers and workers in goods producing 
industries (typically around 4\1/2\ to 6\1/2\ percent). By 
sector, the unemployment rates for workers in the information 
and professional, and business services industries are lower 
than for workers in the construction and leisure and 
hospitality industries. These findings are indicative of the 
patterns of job creation that I mentioned in my remarks.
    However, the unemployment rate data can be difficult to 
interpret, because they reflect not only the long-term changes 
in the demand for certain types of workers that you mentioned, 
but also the state of the business cycle and transitory sector-
specific factors. For instance, unemployment rates for those in 
lower-skilled occupations have been falling, likely reflecting 
the further progress in cyclical recovery. And while the 
unemployment rate is high among former construction workers, 
this is likely a holdover from the housing market collapse and 
subsequent slow recovery in residential investment. Similarly 
the high (and rising) unemployment rate among workers in the 
mining industry is largely the result of the contraction in oil 
extraction due to the decline in oil prices, rather than longer 
run trends.
    Another way to appreciate the shift in job creation that I 
mentioned is to look at an occupation's share of civilian 
employment. For instance, the share of total employment made up 
by managers, professionals, and related workers has risen from 
less than 30 percent in the mid-1980s to nearly 40 percent. In 
contrast, the share of employment constituted by office and 
administrative workers has fallen from 16 percent to 12 percent 
over that same time period, while the production worker share 
of employment has fallen from 9 percent to less than 6 percent.

Q.2. In what sectors are wages higher? Where are they 
increasing more and less quickly?

A.2. Data from the Bureau of Labor Statistics' Employer Costs 
for Employee Compensation survey indicate that compensation is 
higher for workers in industries, such as professional and 
business services, financial activities, educational services 
and information, that could be thought to have many high-
skilled workers (compensation at $40 per hour or more, on 
average). Industries such as manufacturing and transportation 
and warehousing also pay their workers relatively well 
(compensation between $35 and $40 per hour, on average). Low-
paying industries include leisure and hospitality and retail 
trade (compensation under $20 per hour). One thing to note is 
that all these industries include workers with varying skill 
levels.
    It is difficult to discern trends in wages over short 
periods of time, since these movements can be dominated by 
cyclical forces and idiosyncratic shocks. Looking at the Bureau 
of Labor Statistics' Employment Cost Index, over the past 
decade, compensation growth for most industries has averaged 
around 2\1/2\ percent. However, if you look over longer time 
periods, workers with higher skills, for instance, as measured 
by higher levels of education, have experienced greater wage 
gains than other workers.

Q.3. In what sectors, if any, have workers stopped looking for 
jobs?

A.3. Useful data on this topic come from the Bureau of Labor 
Statistics' Displaced Workers' Survey, which surveys workers 
who had been in their jobs for at least 3 years and who ``lost 
or left jobs because their plant or company closed or moved, 
there was insufficient work for them to do, or their position 
or shift was abolished.'' \1\ In interpreting these data, it is 
useful to keep in mind that these job losses and any labor 
force exits could be due to cyclical as well as structural 
factors.
---------------------------------------------------------------------------
     \1\ http://www.bls.gov/news.release/disp.nr0.htm
---------------------------------------------------------------------------
    Over the period from 2011 to 2013, former workers in some 
manufacturing industries, including transportation equipment 
and many nondurable manufacturing industries, were more likely 
than average to have left the labor force, as were former 
workers in retail trade, finance and insurance, and management, 
administrative, and waste services. Looking by occupation, 
according to the most recent data, former workers in the 
production, transportation, and material moving occupations 
were the most likely to have left the labor force, followed by 
individuals leaving sales and office occupations. Workers in 
occupations requiring higher skills were less likely to exit 
the labor force.

Q.4. How do observations about unemployment and labor force 
participation in the old and new economy affect the Fed's 
interest rate policy decisions?

A.4. One of the Federal Reserve's mandates from the Congress is 
to conduct monetary policy so as to promote the maximum level 
of employment that can be sustained without leading to higher 
inflation. In assessing its employment objective, policymakers 
must evaluate how changes in the economy, such as globalization 
and technological change, affect the types of jobs and skills 
needed in the workforce. In addition, policymakers need to 
consider how trends in the size and makeup of the labor force--
for example, its composition by age, education, and skills--
affect the longer-run normal rate of unemployment and the 
maximum sustainable level of employment. Because of the factors 
influencing the demand and supply of labor evolve over time, 
the Federal Open Market Committee (FOMC) cannot specify a fixed 
longer-run goal for employment or the unemployment rate. 
Policymakers update their assessments of the longer-run 
economic outlook regularly using a wide range of information 
and present their views four times each year in their Summary 
of Economic Projections (SEP). In the SEP projections prepared 
in connection with the March 2016 meeting, FOMC participants 
reported estimates of the longer-run normal rate of 
unemployment that ranged from 4.7 to 5.8 percent, with a median 
estimate of 4.8 percent. Conditional on appropriate monetary 
policy, participants projected that the unemployment rate would 
be at or below their individual estimates of the longer-run 
normal rate from 2016 to 2018, and that inflation would 
gradually rise over that period, reaching a level at or close 
to the FOMC's longer-run objective in 2018.

Q.5. I'd like to briefly turn to Iran, which recently demanded 
that Iranian oil purchasers transact in euros instead of 
dollars. What volume--if any--of oil transactions would have to 
be denominated in euros instead of dollars for such a shift to 
impact the Federal Reserve's monetary policy or macroeconomic 
projections?

A.5. Iran currently exports about 1.6 million barrels of oil 
per day, which is higher than the roughly 1 million barrels per 
day averaged over 2014 to 2015, but still below the 2.2 million 
barrels per day pace before the limited States and the European 
Union tightened sanctions targeting Iran's oil sector in 2012. 
\2\ However, even if Iranian exports were to move back up to 
pre-sanction levels and oil prices to rise to $50 a barrel, 
their share of global oil trade would only be around 3 percent 
and of overall global trade only about 0.2 percent. \3\
---------------------------------------------------------------------------
     \2\ According to the International Energy Agency's March estimate.
     \3\ Total world trade is about $19 trillion dollars. At least 40 
percent of world trade is denominated in dollars, which is about 4 
times greater than the U.S. share of global exports and imports. Total 
global exports of oil are about 64 million barrels per day.
---------------------------------------------------------------------------
    Most oil prices are quoted in dollars, and would continue 
to be, as having a common currency likely facilitates 
transparency and communication. Moreover, many of the benefits 
that are said to accrue to the United States because of dollar 
invoicing, such as the stability of prices in the face of 
exchange rate movements, are less relevant for oil markets 
because oil prices are very responsive to market conditions, 
including exchange rate changes.

Q.6. Entitlement Spending--I'd like you to elaborate on your 
statement to Representative Andy Barr that ``Every Fed chair 
that I can remember has come and told Congress that [mandatory 
entitlement spending] is a looming problem with serious 
economic consequences.''
    In July of 2015, former Federal Reserve Chairman Alan 
Greenspan said that the ``extraordinary rise in entitlements'' 
is ``extremely dangerous.'' Do you agree with this sentiment? 
Why?

A.6. As do most economists, I agree with the assessment that 
the Federal Government budget is on an unsustainable path, 
given current fiscal policies. The Congressional Budget Office 
(CBO) projects that Federal budget deficits and Federal 
Government debt will be increasing, relative to the size of the 
economy, over the next decade and in the longer run. \4\ In the 
CBO's projections, growth in Federal spending--particularly for 
mandatory entitlement programs and interest payments on Federal 
debt--outpaces growth in revenues in the coming years. The 
increases in entitlement programs, such as Social Security and 
programs providing health care, are mainly attributable to the 
aging of the population and rising health care costs per 
person. For fiscal sustainability to be achieved, whatever 
level of spending is chosen, revenues must be sufficient to 
sustain that spending in the long run.
---------------------------------------------------------------------------
     \4\ Congressional Budget Office, ``The Budget and Economic 
Outlook: 2016 to 2026'', January 2016, and ``The 2015 Long-Term Budget 
Outlook'', June 2015.

Q.7. Please describe the ``serious economic consequences'' of 
---------------------------------------------------------------------------
failing to address entitlement spending.

A.7. I believe the CBO appropriately describes several reasons 
why high and rising Federal Government debt would have serious 
negative consequences for the economy. \5\ First, because 
Federal borrowing reduces total saving in the economy over 
time, the Nation's capital stock would ultimately be smaller 
than it would be if debt was lower; as a result, productivity 
and overall economic growth would be slower. Second, fiscal 
policymakers would have less flexibility to use tax and 
spending policies to respond to unexpected negative shocks to 
the economy. Third, the likelihood of a fiscal crisis in the 
United States would increase.
---------------------------------------------------------------------------
     \5\ Congressional Budget Office, ``The Budget and Economic 
Outlook: 2016 to 2026'', January 2016.

Q.8. How soon does the United States need to address our 
entitlement spending, before there are, as you put it, 
---------------------------------------------------------------------------
``serious economic consequences''?

A.8. Neither experience nor economic theory clearly indicate 
the threshold at which Government debt would begin to impose 
substantial costs on the U.S. economy. \6\ But given the 
significant costs and risks associated with a rapidly rising 
Federal debt, fiscal policymakers should soon put in place a 
credible plan for reducing deficits to sustainable levels over 
time. Doing so earlier rather than later would ultimately prove 
less costly by avoiding abrupt shifts in policy and by giving 
those affected by budget changes more time to adapt.
---------------------------------------------------------------------------
     \6\ See, for example, Congressional Budget Office, ``Federal Debt 
and the Risk of a Fiscal Crisis'', July 27, 2010.
---------------------------------------------------------------------------
Q.9. How would a failure to address entitlement spending affect 
the way in which the Federal Reserve conducts monetary policy?

A.9. The Federal Reserve adjusts monetary policy as appropriate 
to maintain or to make progress toward our statutory goals of 
maximum employment and price stability; both the direction and 
size of those adjustments could depend on the implications of a 
failure to address entitlement spending for the economic 
outlook. For example, it is possible that a failure to put 
entitlement programs on a sustainable longer-term path could 
result in an increase in the yields that investors demand on 
longer-term U.S. Treasury securities. To the extent those 
increased yields pass through into higher interest rates on 
corporate bonds, mortgages, and bank loans, the increase in 
rates would tend to restrain economic activity in the United 
States and could require the Federal Reserve to ease policy to 
achieve its economic objectives. In other scenarios, concerns 
that entitlement programs were not on a sustainable course 
could contribute to inflationary pressures that could require 
the Federal Reserve to tighten policy to achieve its 
objectives. Of course, these are not the only possible 
outcomes. In judging the appropriate stance of monetary policy, 
the Federal Reserve constantly assesses incoming economic and 
financial data and their implications for the economic outlook.

Q.10. How would a failure to act affect the amount of interest 
the Federal Government pays on the debt? How early could we 
start to see this affect?

A.10. With a high level of Federal debt and a forecast of 
increasing budget deficits, as interest rates rise from their 
current levels to more typical ones, the CBO projects that 
Federal spending on interest payments will soon begin to rise 
considerably. \7\
---------------------------------------------------------------------------
     \7\ Congressional Budget Office, ``The Budget and Economic 
Outlook: 2016 to 2026'', January 2016.

Q.11. Could a failure to address entitlement spending ever 
---------------------------------------------------------------------------
affect the dollar's status as a reserve currency?

A.11. The U.S. dollar has been considered the world's reserve 
currency on a consistent basis for quite a while, and 
projections showing that the Federal budget is unsustainable 
over the long run have also been known for some time. Thus, it 
is uncertain what circumstances could change that status. There 
is no way to predict with any confidence whether and when such 
a change might occur; in particular, there is no identifiable 
level of Federal debt, relative to the size of the economy, 
indicating that this would be likely or imminent.

Q.12. Could a failure to address entitlement spending ever 
cause markets to significantly question the Treasury bill's 
status as a risk-free instrument? What would the consequences 
be if this were to occur?

A.12. U.S. Treasury securities have generally been considered 
risk-free because of the size and strength of our economy. And 
as I stated in my response above, at the same time, projections 
showing that the Federal budget is unsustainable over the long 
run have been known for some time. Similarly, there is no way 
to predict with any confidence whether and when a change in the 
risk-free status of Treasury securities might occur. In 
particular, there is no threshold level of debt, relative to 
the size of the economy, indicating that investors would become 
unwilling to finance all of the Federal Government's borrowing 
needs unless they were compensated with very high interest 
rates. But all else being equal, the higher the ratio of 
Federal debt to GDP, the greater the risk of this happening. 
\8\
---------------------------------------------------------------------------
     \8\ See, for example, Congressional Budget Office, ``Federal Debt 
and the Risk of a Fiscal Crisis'', July 27, 2010.

Q.13. Regional Banks--I'd like to ask about the Federal 
Reserve's implementation of Section 165 of Dodd-Frank, which 
provides for enhanced prudential standards for banks with $50 
billion in assets or higher. As you know, these standards 
include stress tests, which require banks to evaluate how they 
would fare under unfavorable economic conditions, and 
resolution plans, which require banks to provide a plan for 
winding down during a crisis. I'm concerned about the 
unnecessary damage that these prudential standards could have 
on regional banks, which play a key role in expanding capital 
to small- and medium-size businesses.
    Do regional banks pose the same risk as large banks with a 
trillion or more in assets?

A.13. As I have stated in the past, one-size-fits-all should 
not be the model for regulation. The Federal Reserve has made 
it a top priority to ensure that we appropriately tailor our 
regulation and supervision of banks to their size, complexity, 
and risk. By statute, all banking organizations above $50 
billion in assets are subject to enhanced prudential standards. 
However, the Federal Reserve recognizes that very large, 
complex firms pose a greater risk to the financial system than 
smaller, noncomplex firms, and we have differentiated our 
implementation of the enhanced prudential standards as a 
result. The eight globally systemic banks are overseen by the 
Large Institution Supervision Coordinating Committee (LISCC) 
and are subject to the highest supervisory standards relative 
to firms outside this portfolio. \9\ LISCC firms are subject to 
additional capital and leverage surcharges and more stringent 
liquidity requirements. In addition, the LISCC firms are 
subject to the highest supervisory standards across all 
assessment areas to include governance, risk management, 
internal controls, capital policy, scenario design, and the use 
of models.
---------------------------------------------------------------------------
     \9\ The eight domestic banks classified as global systemically 
important financial institutions supervised by LISCC are: Bank of 
America Corporation, The Bank of New York Mellon Corporation, Citigroup 
Inc., The Goldman Sachs Group, Inc., JP Morgan Chase & Co., Morgan 
Stanley, State Street Corporation, and Wells Fargo & Company.
---------------------------------------------------------------------------
    The Federal Reserve has further differentiated between 
large, complex super-regional institutions and other large 
banking organizations with smaller regional footprints. The 
large, complex firms while subject to tailored expectations as 
opposed to the LISCC firms, are subject to heightened standards 
relative to the smaller, noncomplex firms. This distinction was 
outlined in the publication of guidance \10\ in which the 
Federal Reserve set expectations for capital planning for LISCC 
Firms and Large and Complex Firms (with assets in excess of 
$250 billion and onbalance sheet foreign exposure in excess of 
$10 billion) that are higher than the expectations for their 
smaller counterparts.
---------------------------------------------------------------------------
     \10\ SR Letter 15-18 (Federal Reserve Supervisory Assessment of 
Capital Planning and Positions for LISCC Firms and Large and Complex 
Firms) and SR Letter 15-19 (Federal Reserve Supervisory Assessment of 
Capital Planning and Positions for Large and Noncomplex Firms).
---------------------------------------------------------------------------
    In addition to tailoring guidance, the Federal Reserve 
continues to explore ways to improve our supervision process 
around capital planning to ensure that our supervisory 
approaches and methodologies are appropriate and consistent as 
possible for similar sized institutions.

Q.14. I'm concerned that our Federal banking regulatory regime 
arbitrarily relies upon asset thresholds to impose prudential 
regulations, instead of independently analyzing the risk 
profile of financial institutions. Should a bank's asset size 
be dispositive in assessing a bank's risk profile for the 
purposes of imposing prudential regulations? For example, would 
a bank with less than a half-trillion in assets typically have 
the same complexity and conduct the same kind of financial 
activities as a bank with over $2 trillion in assets?

A.14. Under section 165 of the Dodd-Frank Wall Street Reform 
and Consumer Protection Act (Dodd-Frank Act), the Federal 
Reserve is authorized to tailor the application of enhanced 
prudential standards. In implementing section 165, the Federal 
Reserve has identified three categories of bank holding 
companies with $50 billion or more in total consolidated assets 
based not only on their size, but also based on complexity and 
other indicators of systemic risk. Specifically, all such bank 
holding companies are subject to certain enhanced prudential 
standards, including risk-based and leverage capital 
requirements, company-run and supervisory stress tests, 
liquidity risk-management requirements, resolution plan 
requirements, and risk management requirements. Bank holding 
companies with $250 billion or more in total consolidated 
assets or $10 billion or more in on-balance-sheet foreign 
assets are also subject to the advanced approaches risk-based 
capital requirements, a supplementary leverage ratio, more 
stringent liquidity requirements, and a countercyclical capital 
buffer.
    In identifying global systemically important banks, the 
Federal Reserve considers measures of size, interconnectedness, 
cross-jurisdictional activity, substitutability, complexity, 
and short-term wholesale funding. The eight U.S. firms 
identified as global systemically important banks (GSIBs) are 
subject to risk-based capital surcharges, an enhanced 
supplementary leverage ratio, and more specific recovery 
planning guidance.
    In addition, the Federal Reserve tailored the application 
of the enhanced prudential standards required under section 165 
to General Electric Capital Corporation (GECC), a nonbank 
financial company designated by the Financial Stability 
Oversight Council (FSOC) for supervision by the Federal 
Reserve. Because of the substantial similarity of GECC's 
current activities and risk profile to that of a large bank 
holding company, the enhanced prudential standards that would 
be applied to GECC are similar to those that apply to large 
bank holding companies, but they are tailored to reflect the 
unique characteristics of GECC. The standards include (1) 
capital requirements; (2) capital-planning and stress-testing 
requirements; (3) liquidity requirements; and (4) risk-
management and risk-committee requirements.

Q.15. Please describe in detail how the Federal Reserve will 
meaningfully tailor Section 165 prudential standards to match a 
particular bank's ``capital structure, riskiness, complexity, 
financial activities . . . [and] size,'' as allowed for under 
Section 165, including with regards to stress testing and 
resolution planning?

A.15. The Federal Reserve has tailored resolution planning 
requirements for firms subject to section 165 of the Dodd-Frank 
Act where it has permitted firms with limited nonbanking 
operations to file a tailored plan that exempts it from many 
informational requirements. Additionally, the Federal Reserve 
and the Federal Deposit Insurance Corporation have exempted 90 
firms with limited U.S. operations from most plan requirements. 
These firms may file plans that focus on material changes to 
their initial resolution plan filed in 2014, actions taken to 
strengthen the effectiveness of those plans, and, where 
applicable, actions to ensure any subsidiary insured depository 
institution is adequately protected from the risk arising from 
the activities of nonbank affiliates of the firm. The Federal 
Reserve's recovery planning guidance focuses only on the eight 
U.S. GSIBs.
    Bank holding companies with more than $50 billion in total 
consolidated assets are subject to the Federal Reserve's 
Comprehensive Capital Analysis and Review (CCAR), which 
evaluates the capital planning processes and capital adequacy 
of the largest U.S.-based bank holding companies, including the 
firms' planned capital actions such as dividend payments and 
share buybacks and issuances. Strong capital levels absorb 
losses and help ensure that banking organizations have the 
ability to lend to households and businesses even in times of 
financial and economic stress. In December 2015, the Federal 
Reserve released guidance to its examiners and banking 
institutions that consolidates the capital planning 
expectations for all large financial institutions and clarifies 
differences in those expectations based on firm size and 
complexity. The guidance is designed to tailor the Federal 
Reserve's expectations for large financial institutions.
    For the largest and most complex firms, the guidance 
clarifies expectations that have been previously communicated 
to firms, including through past CCAR exercises and related 
supervisory reviews. These firms are bank holding companies and 
intermediate holding companies of foreign banks subject to the 
Federal Reserve's LISCC framework, or firms with $250 billion 
or more in total consolidated assets or $10 billion or more in 
foreign exposures.
    For firms with more than $50 billion, but less than $250 
billion in total consolidated assets, as well as less than $10 
billion in foreign exposures, the guidance clarifies the 
supervisory expectations to be applied for the firms' capital 
planning processes. In general, the guidance is tailored to 
reflect the lower systemic risk profile and less complex 
operations of these firms, as compared to the largest and most 
complex firms.

Q.16. In testimony to the Senate Banking Committee, you noted 
that the Federal Reserve is ``actively engaged in reviewing our 
stress-test testing in capital planning framework'' and that 
the Federal Reserve is ``considering ways in which we can make 
that less burdensome for the bank holding companies that are 
close to the $50 billion asset line.'' How close to $50 billion 
in assets must a bank be for the Federal Reserve to consider 
tailoring the stress test regime?

A.16. Please see response to Question 13.

Q.17. Is the Federal Reserve considering tailoring Section 165 
prudential standards for banks with assets that are not merely 
``close'' to $50 billion in assets? For instance, according to 
Basel Systemic Risk Indicators from 2013, the systemic risk 
score of almost every bank with less than $500 billion in 
assets is 4 times less than every bank with more than $500 
billion in assets.

A.17. As indicated in the responses to Questions 14 and 15, the 
Federal Reserve has tailored meaningfully the application of 
the enhanced prudential standards under section 165 to both 
bank holding companies and GECC. Underlying this tailoring was 
the principle that progressively more stringent regulation 
should apply to firms based on their relative importance to the 
financial system, and thus the harm that could be expected to 
the system if they failed. The Federal Reserve continues to 
consider ways to further tailor the enhanced prudential 
standards to reflect differences in risk among firms.

Q.18. Insurance--I'd like to ask about the Federal Reserve's 
development of insurance capital standards.
    What steps has the Federal Reserve taken to ensure that the 
minimum capital standards are tailored to the business of 
insurance?

A.18. The Federal Reserve is committed to developing capital 
standards in accordance with its statutory mandate and 
authority in a way that is appropriate and tailored to the 
insurance industry. The Federal Reserve appreciates that 
insurance involves unique risks among financial institutions, 
encompassing both liabilities and assets, and it is important 
to keep in mind the liability structure of firms in determining 
capital requirements for insurance companies, particularly with 
regard to the mix of the insurers' activities. We are 
approaching our mandate carefully and with proper deliberation. 
In our development of domestic standards, we are consulting 
with the industry, State commissioners and other key external 
parties on several aspects of the standards to achieve the 
Federal Reserve's mandate under the authority as set out in the 
Dodd-Frank Act. Moreover, the Federal Reserve intends to make 
full use of the flexibility provided by the Insurance Capital 
Standards Clarification Act of 2014 to tailor the capital 
standards to the business of insurance.

Q.19. How much deference will the Federal Reserve give to State 
insurance regulators in developing these insurance standards? 
Will State insurance standards provide the broad basis for the 
Federal Reserve's new regulations? Why or why not?

A.19. With the enactment of the Dodd-Frank Act, the Federal 
Reserve was assigned responsibility as the consolidated 
supervisor of insurance holding companies that own thrifts, as 
well as insurance companies designated by the FSOC. The Federal 
Reserve's principal supervisory objectives for the insurance 
firms that it oversees include protecting the safety and 
soundness of the consolidated firms, as well as mitigating 
risks to financial stability. The Federal Reserve continues to 
engage extensively with State insurance regulators, the 
National Association of Insurance Commissioners, and other 
interested stakeholders to solicit feedback on insurance 
prudential standards that would comport with the Federal 
Reserve's statutory authority.
    The Federal Reserve's consolidated supervision supplements 
existing State based legal-entity supervision, which focuses on 
policyholder protection, with a perspective that considers the 
risks across the entire firm. Moreover, the Federal Reserve's 
insurance prudential standards will not alter or replace the 
existing State-based framework, including capital requirements 
at the legal entity level, that are already in place. We 
continue to coordinate with State insurance regulators in their 
protection of policyholders and aim to avoid duplications of 
their supervision. We leverage the work of State insurance 
regulators where possible and continue to look for 
opportunities to further coordinate with them.
    It would be premature to comment on how the Federal Reserve 
will treat the unique risks of certain insurance lines, mix of 
business and the like, before we have fully evaluated the 
potential options for insurance prudential standards, including 
those that rely, in part, on the State-based capital 
requirements of regulated insurance companies. In our 
supervision of insurance firms, the Federal Reserve remains 
committed to tailoring our supervisory approach, including a 
domestic regulatory capital framework and other insurance 
prudential standards, to the business of insurance, reflecting 
insurers' different business models and systemic importance 
compared to other firms supervised by the Federal Reserve. 
Moreover, we are committed to a formal rulemaking process in 
the development of insurance prudential standards.

Q.20. Has the Federal Reserve conducted cost benefit analysis 
to develop these insurance standards? If not, why? If so, 
please share the results of these studies?

A.20. With respect to the insurance standards and all other 
rulemakings, the Federal Reserve follows the Administrative 
Procedures Act and other applicable administrative laws that 
govern the various aspects of rulemakings, including the 
consideration of costs and benefits. The Federal Reserve 
regularly conducts economic analyses in connection with 
rulemakings, including considering the potential economic 
impact of a rule on small depository institutions consistent 
with the Regulatory Flexibility Act, and considering the 
anticipated cost of paperwork consistent with the Economic 
Growth and Regulatory Paperwork Reduction Act. To inform our 
rulemaking, in 2014, the Federal Reserve conducted an extensive 
quantitative impact study. The data we collected helps us to 
understand the insurance risks of the firms that participated 
in the study.
    To the extent possible, the Federal Reserve attempts to 
minimize regulatory burden in its rulemakings consistent with 
the effective implementation of our statutory responsibilities. 
The Federal Reserve is charged by Congress to promulgate rules 
largely designed to improve the safe and sound operation of 
financial organizations and safeguard financial stability. As 
part of the rulemaking process, the Federal Reserve 
specifically seeks comment from the public on the burdens and 
benefits of our proposed approach as well as on alternative 
approaches and, in adopting final rules, the Federal Reserve 
seeks to adopt a regulatory alternative that faithfully 
implements the statutory provisions while minimizing regulatory 
burden. It would be premature for the Federal Reserve to 
disclose the cost benefit analysis of the insurance standards 
rulemaking since it is still in the development stage and we 
have yet to conclude our deliberations.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR COTTON
                      FROM JANET L. YELLEN

Q.1. You testified at your confirmation hearing that even a 
positive rate close to zero could disrupt money markets that 
help fund financial institutions. By extension, isn't it 
logical to conclude that a negative interest rate would be even 
more disruptive?

A.1. As noted in its most recent statement, the FOMC 
anticipates further improvement in labor market conditions with 
inflation returning to 2 percent over the medium term. This 
economic outlook is expected to be associated with gradual 
increases in the Federal funds rate. That said, if the economic 
outlook weakened appreciably, the FOMC would need to consider 
actions to provide additional policy accommodation to foster 
progress toward its statutory objectives of maximum employment 
and price stability. The experience of foreign countries 
suggests that negative interest rates have provided additional 
monetary policy accommodation in those countries without 
significant disruptions in money markets. However, it is 
unclear whether the same would be true for the United States. 
At a minimum, any consideration of negative interest rates in 
the United States would require careful study of the 
implications of negative rates for U.S. financial markets and 
institutions and U.S. households and businesses along with the 
potential for unintended consequences.

Q.2. How long can the wholesale banking system withstand a 
global environment of negative interest rate policies from the 
major central banks?

A.2. The long-run effects of negative interest rate policies on 
banks' profitability are uncertain. In a number of economies 
where the policy has been introduced, banks' profits have been 
reduced by lower interest income, but have been supported by 
lower funding costs, capital gains on bond holdings, and lower 
provisions for loan losses. At the same time, negative interest 
rate policies may be providing economic stimulus, and that 
stimulus may ultimately improve the overall economy and 
subsequently bank's income.

Q.3. What incentive effect would you expect negative interest 
rates to have on fiscal consolidation?

A.3. During the most recent recession and financial crisis, the 
Federal Reserve did not respond with a monetary policy that 
included a target for the Federal funds rate that was negative. 
As a result, without the experience of using a negative policy 
rate, it is difficult and speculative to describe the effects 
that it might have on the U.S. economy and the Federal 
Government budget. That said, if economic conditions were such 
that the Federal Reserve decided that it was appropriate to 
implement a negative policy rate, then the effects on the 
economy and the Federal Government budget could be 
qualitatively similar to the effects of our traditional 
monetary policy response of lowering the target for the Federal 
funds rate when the economy goes into a downturn. To the degree 
that a negative rate policy helped reduce long-term borrowing 
costs for households and businesses that, in turn, boosted 
economic activity and employment above where it otherwise would 
have been, the Federal Government budget would also be in a 
better position. If a stronger economy was the result of such a 
policy, then tax revenues would be higher and there would be 
less Government spending for income-support programs, such as 
unemployment insurance benefits.

Q.4. What would a further drop in discount rates, driven by 
NIRP, do to unfunded pension liabilities in the public and 
private sectors?

A.4. In general, lower discount rates mechanically increase the 
present value calculation for future pension liabilities. 
However, pension funding status is heavily dependent on the 
rate of return on pension assets, as well as the calculation of 
liabilities. As a result, the effect of monetary policy on 
pension funding status is difficult to ascertain, because 
monetary policy likely affects the rate of return on pension 
assets as well as the calculation of the liabilities. In 
addition, there is not a direct connection between monetary 
policy and the discount rate used by pension systems to 
calculate their liabilities. For example, the median discount 
rate being used by State and local retirement systems in their 
financial reports, as reported in ``Wilshire Consulting's 2016 
Report on State Retirement Systems'', was 7.5 percent, well 
above the Federal Open Market Committee's Federal funds rate 
target range of 0.25-0.50 percent.

Q.5. Last year, an official from the Bank of International 
Settlements said: For central banks, [NIRP] policies raise the 
risk of financial dominance, exchange rate dominance, and 
fiscal dominance--that is, the danger that monetary policy 
becomes subordinated to the demands of propping up financial 
markets, massaging the exchange rate downwards, and keeping 
public refinancing costs low in the face of unprecedented 
public debt burdens. Do you disagree?
    If you believe this might be a risk worth taking for the 
Fed that implies some temporal trade-off. But, as you know, 
pulling growth forward is not sustainable. How long would you 
expect a hypothetical NIRP environment to take to generate the 
real economic growth necessary to meet the Fed's dual mandate?

A.5. The Congress established the Federal Reserve as an 
independent central bank tasked with conducting policy to 
promote progress toward the statutory goals of maximum 
employment and stable prices. As part of this framework, the 
Federal Reserve is accountable to the Congress and the American 
people for its actions. The Federal Reserve supports 
appropriate accountability through many steps that foster a 
transparent monetary policy process. For example, the Federal 
Reserve regularly reports detailed descriptions of its analysis 
of economic and financial developments, the policy outlook, and 
policy deliberations in the minutes of every FOMC meeting. 
Additionally, I formally report to Congress twice each year on 
the economic and monetary policy outlook and typically testify 
on many other occasions as well. These and many other steps 
ensure that monetary policy actions undertaken by the Federal 
Reserve can be understood and scrutinized by the public. That 
process, in turn, ensures that monetary policy is directed 
solely at achieving the Federal Reserve's statutory objectives 
of maximum employment and stable prices.
    The current stance of monetary policy remains very 
accommodative and, as noted in the answer to Question 1 above, 
the Federal Reserve anticipates that economic conditions will 
warrant gradual increases in the Federal funds rate over time. 
Regarding hypothetical situations in which additional policy 
accommodation could be needed, recent foreign experience 
suggests that negative interest rates have provided additional 
policy accommodation in those countries. However, it is unclear 
whether the same would be the case in the United States. Any 
consideration of the use of negative rates in the United States 
to provide additional policy accommodation would require 
careful study of many complicated issues.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR ROUNDS
                      FROM JANET L. YELLEN

Q.1. The purpose of the Systemically Important Financial 
Institution designation process is to reduce risk, but I am 
concerned that it's a lot easier for firms to become designated 
a SIFI than it is for firms to de-risk and de-designate. What 
has the Federal Reserve done and what do can the Federal 
Reserve do going forward to make it easier for firms to de-
designate?

A.1. The Federal Reserve Board's (Board) regulations and 
supervisory guidance applicable to the largest U.S. bank-
holding companies and nonbank financial companies that are 
designated by the Financial Stability Oversight Council (FSOC) 
are intended to reduce the threat that could be posed to U.S. 
financial stability by the material financial distress or 
failure of these organizations and promote their safe and sound 
operations. Such regulations are designed to increase the 
resilience of systemically important financial institutions and 
foster such firms' ability to provide credit and other 
financial services in times of financial stress. Through 
speeches and testimony, the Board and its staff also provide 
information on how financial institutions, both banks and 
nonbanks, can reduce the risk they could pose to U.S. financial 
stability.
    FSOC designation of nonbanks is not intended to be 
permanent. The Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Dodd-Frank Act) provides that the FSOC annually 
review designations to make sure that they remain appropriate 
and take into account significant changes at the firms that 
materially affect the FSOC's determination. At the time of 
designation, nonbank financial companies are given a detailed 
basis for the determination that a nonbank financial company 
should be subject to supervision by the Board. Factors include 
the extent of short-term funding activities at those 
organizations, the firms' products and associated short-term 
liabilities, their capital markets activities, securities 
lending, over-the-counter derivatives, and interconnectedness 
with the rest of the financial system. Firms can use that 
information, as well as factors the FSOC is required to 
consider under the Dodd-Frank Act, to guide their efforts to 
reduce their systemic footprint.

Q.2. Would a clearly marked off-ramp make with specific 
requirements for de-risking make it easier for firms to reduce 
systemic risk?

A.2. As stated above, the FSOC designation of nonbanks is not 
intended to be permanent. Because each firm's systemic 
footprint is different, the FSOC conducts its analysis on a 
company-by-company basis in order to take into account the 
potential risks and mitigating factors that are unique to each 
company. At the time of designation, nonbank financial 
companies are given a detailed basis for the determination that 
a nonbank financial company should be subject to supervision by 
the Board. Firms can use that information, as well as factors 
the FSOC is required to consider under the Dodd-Frank Act, to 
guide their efforts to reduce their systemic footprint.

Q.3. The designation of three insurers as systemically 
important has given the Federal Reserve a large voice in the 
regulation and supervision of the insurance industry. The 
Financial Stability Oversight Council has an independent 
insurance expert and the Federal Reserve has an insurance 
expert, but beyond that, how often and in what way does the 
Federal Reserve communicate with State insurance commissioners 
when making supervisory and regulatory decisions?

A.3. While the Federal Reserve and State insurance regulators, 
together with the National Association of Insurance 
Commissioners (NAIC), have distinct statutory authorities and 
mandates, the Federal Reserve remains committed to working 
cooperatively with the States on a wide range of insurance 
supervisory and regulatory issues. The Federal Reserve respects 
the work of State insurance regulators, collaborating both 
informally and formally through mechanisms such as supervisory 
colleges, the evaluation of supervised insurers' Own Risk and 
Solvency Assessments and other supervisory matters. Federal 
Reserve staff continues to meet regularly with State insurance 
departments to discuss supervisory plans and findings for the 
insurance firms for which the Federal Reserve has consolidated 
supervisory responsibility. We additionally have hosted 
multiple crisis management groups that included participation 
from parties including State insurance departments, as well as 
the Federal Insurance Office and Federal Deposit Insurance 
Corporation. Additionally, the Federal Reserve's examination 
teams leverage the important work of State insurance regulators 
in the evaluation of capital planning and sufficiency. The 
Federal Reserve continues to be committed to working with State 
insurance regulators, the NAIC and other involved regulators in 
the future.

Q.4. Right now, the United States is selling massive amounts of 
debt to finance U.S. deficits and we strongly rely on foreign 
Governments to buy that debt. So far, there has been a strong 
appetite from foreign Governments for our debt, however, at 
some point that may change. Is the Federal Reserve concerned 
about this?

A.4. Foreign entities hold close to half of Federal Government 
debt held by the public, roughly the same share as before the 
most recent recession and subsequent run-up in Federal debt. 
Foreign official entities, which include foreign central banks 
and sovereign wealth funds, hold less than one-third of Federal 
debt held by the public and make up the bulk of all foreign 
holdings. In general, foreign entities often want to hold U.S. 
Treasury securities because of their liquidity and perceived 
safety and soundness. Moreover, foreign holdings of Federal 
debt imply that there is less reliance on domestic sources of 
saving in order to finance Government borrowing, thereby 
keeping interest rates on Treasury securities lower than they 
would be otherwise. At this point, there is no apparent 
evidence that there has been any material decrease in foreign 
demand for Treasury securities, and interest rates on these 
securities remain fairly low.

Q.5. What does the Fed expect will happen to U.S. debt sales 
when we reach this point?

A.5. If, for some reason, foreign and domestic demand for U.S. 
Treasury securities were to decline significantly, then 
interest rates would have to rise such that investors would be 
willing to finance all of the Federal Government's borrowing 
needs. The extent to which interest rates have to increase 
would depend upon the magnitude of any decrease in demand.

Q.6. Does the Federal Reserve have a model that predicts when 
the world will be unable or unwilling to absorb additional debt 
from the U.S.?

A.6. The Federal Reserve does not have a model that currently 
predicts that the world will be unable or unwilling to absorb 
additional Federal Government debt. Indeed, demand for Treasury 
securities has been quite robust recently, even with the 
substantial increase in Federal debt over the past decade and 
projections of further increases in the coming years.

Q.7. Rulemakings by the Federal Reserve must follow the 
requirements of the Administrative Procedure Act, Regulatory 
Flexibility Act, and Paperwork Reduction Act. In addition, the 
Riegle/Neal Community Development and Regulatory Improvement 
Act require the Federal Reserve to consider the administrative 
burdens imposed by new regulations on depository institutions 
as well as the benefits of such regulations. However, recent 
rulemaking by the Federal Reserve has failed to release such 
economic analysis for public comment, which the D.C. Circuit 
Court of Appeals has held to be necessary to comply with the 
required economic analysis under these statutes. Why has the 
Federal Reserve not published the results of its economic 
analysis for public comment? Will you commit to doing so going 
forward?

A.7. With respect to all rulemakings, the Federal Reserve 
follows the Administrative Procedures Act and other applicable 
administrative laws that govern the various aspects of 
rulemakings, including the consideration of costs and benefits. 
The Federal Reserve regularly conducts economic analyses in 
connection with rulemakings, including considering the 
potential economic impact of a rule on small depository 
institutions consistent with the Regulatory Flexibility Act, 
and considering the anticipated cost of paperwork consistent 
with the Economic Growth and Regulatory Paperwork Reduction 
Act.
    To the extent possible, the Federal Reserve attempts to 
minimize regulatory burden in its rulemakings consistent with 
the effective implementation of our statutory responsibilities. 
The Federal Reserve is charged by Congress to promulgate rules 
largely designed to improve the safe and sound operation of 
financial organizations and safeguard financial stability. As 
part of the rulemaking process, the Federal Reserve 
specifically seeks comment from the public on the burdens and 
benefits of our proposed approach as well as on alternative 
approaches and, in adopting final rules, the Federal Reserve 
seeks to adopt a regulatory alternative that faithfully 
implements the statutory provisions while minimizing regulatory 
burden.

Q.8. The Federal Reserve Bank of Kansas City recently issue a 
report on the agricultural sector of the economy which reported 
that depressed crop prices, increased inventories, and 
declining demand for exports caused agricultural lenders and 
the Fed to have, ``increasing concerns about 2016 farm 
finances.'' Are you also concerned about the future of the farm 
economy?

A.8. Developments in the U.S. farm economy warrant close 
monitoring as low agricultural commodity prices have weighed on 
farm income. To support cash flow, short-term lending from 
commercial banks to the farm sector has increased. Although the 
combined balance sheet of the sector remains healthy, primarily 
due to elevated farm real-estate values, some commercial banks 
have reported concerns about repayment rates on agrelated 
loans. Looking ahead, continued low commodity prices and a 
decline in farmland values are key risks to the farm economy.
    That said, some indicators suggest the sector is 
demonstrating resilience. In the fourth quarter of 2015, the 
delinquency rate on agricultural production loans was less than 
1 percent, compared with 2.7 percent 5 years ago. Also, 
agricultural real estate values, which are a significant 
contributor to the health of balance sheets, have remained 
relatively stable--though, they have modestly declined from 
recent peaks.
    To summarize, the downturn in the farm economy has been 
notable and raises concerns that farm borrowers could face 
mounting difficulties in the year ahead as the sector continues 
to adjust to lower commodity prices. The Federal Reserve will 
continue to closely monitor these developments as well as 
potential of spillover effects to sectors closely connected to 
the farm sector, banks and the financial system, or to the U.S. 
economy more generally.

Q.9. When you take a look at the health of America's farmers, 
what indicators do you look at and who do you listen to?

A.9. At the Federal Reserve we follow a wide variety of data on 
the farm sector, related both to farm finances (for instance, 
data on farm land prices and farm credit) and farm output 
(including data on farm product prices, farm income, and farm 
inventories). Moreover, the Federal Reserve Banks provide 
regular updates on a broad array of farm issues. Staff members 
reach out regularly to farm contacts in their districts to 
learn about the health of the sector, and that information is 
included in our ``Summary of Commentary on Current Economic 
Conditions by Federal Reserve District'' commonly known as the 
Beige Book, which is published eight times a year.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR MORAN
                      FROM JANET L. YELLEN

Q.1. During your February 10th testimony in front of the House 
of Representatives Committee on Financial Services, you were 
asked by two members of Congress about how Custody banks could 
be prevented from accepting cash from pension funds and their 
other customers, especially in a period of financial market 
stress, because the Supplemental Leverage Ratio (SLR). You 
replied: ``And the decision was made at the time that the 
leverage ratio is not our main capital tool, but a backup 
capital tool that is intended to, in a crude kind of way, base 
capital requirements on the overall size of a firm's balance 
sheet. And that for that reason, it should be included.'' 
Followed by, ``There were considerations on both sides, and a 
decision was made to include Fed deposits.''
    In the case of the custody banks, it does not appear that 
the SLR is a ``backstop,'' but is instead the binding capital 
constraint, which is impacting these banks ability to accept 
cash deposits from pension plans and other customers 
particularly in a period of financial stress or crisis. Can you 
tell me what your considerations were for including the Fed 
deposits in the SLR and why, given the nature of a custody 
banks business model, they were not exempted?
    Also, if custody banks are unable to accept cash deposits 
in a time a crisis, what do you believe the pensions and other 
institutional investors will do what that cash?

A.1. The supplementary leverage ratio rule (SLR rule) adopted 
by the Federal Reserve, the Office of the Comptroller of the 
Currency, and the Federal Deposit Insurance Corporation (the 
Agencies), requires internationally active banking 
organizations to hold at least 3 percent of total leverage 
exposure in tier 1 capital. The rule calculates total leverage 
exposure as the sum of certain off-balance sheet items and all 
on-balance sheet assets. \1\ 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 total leverage 
exposure would generally be inconsistent with this principle.
---------------------------------------------------------------------------
     \1\ See 79 Fed. Reg. 57725 (September 26, 2014), available at 
http://www.gpo.gov/fdsys/pkg/FR-2014-09-26/pdf/2014-22083.pdf.
---------------------------------------------------------------------------
    The Agencies understand the concern that certain custody 
banks, which act as intermediaries in high-volume, low-risk, 
low-return financial activities, may experience increases in 
assets as a result of macroeconomic factors and monetary policy 
decisions, particularly during periods of financial market 
stress. \2\ Because the SLR is not a risk-based measure, it is 
possible that increases in banking organizations' holdings of 
low-risk, low-return assets, such as deposits, could cause this 
ratio to become the binding regulatory capital constraint. 
However, when choosing an appropriate asset profile, banking 
organizations consider many factors in addition to regulatory 
capital requirements, such as yields available relative to the 
overall cost of funds, the need to preserve financial 
flexibility and liquidity, revenue generation, the maintenance 
of market share and business relationships, and the likelihood 
that principal will be repaid.
---------------------------------------------------------------------------
     \2\ The agencies have reserved authority under the capital rule to 
require a banking organization to use a different asset amount for an 
exposure included in the SLR to address extraordinary situations. See 
12 CFR 3.1(d)(4) (OCC); 12 CFR 217.1(d)(4) (Federal Reserve); 12 CFR 
324.1(d)(4) (FDIC).
---------------------------------------------------------------------------
    Regulatory requirements 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 are 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 SLR requirement and the enhanced SLR standards do 
not become effective until January 1, 2018. According to public 
disclosures of firms subject to these requirements, the custody 
banks and other GSIBs have made significant progress in 
complying with the enhanced SLR requirements.

Q.2. We continue to see consolidation of the banking industry, 
particularly at the community bank level. Some of that has to 
do with market pressures. A lot of that has to do with the 
avalanche of regulation facing these institutions, and their 
lack of resources in coping with it.
    What has the Fed done to tangibly reduce the regulatory 
burden on such institutions?
    What impediments stand in front of regulators in 
aggressively addressing this problem?
    What areas can the Fed--and other bank regulators--attack 
to address this problem?

A.2. The Federal Reserve has long maintained that our 
regulatory efforts should be designed to minimize regulatory 
burden consistent with the effective implementation of our 
statutory responsibilities. In addition, the Federal Reserve 
and the other banking agencies have developed a number of 
compliance guides that are specifically designed to assist 
community banks' understanding of applicable regulatory 
requirements.
    Generally, the Federal Reserve strives to balance efforts 
to ensure that supervision and regulation are calibrated 
appropriately for smaller and less risky institutions with our 
responsibility to ensure that consumer financial transactions 
are fair and transparent, regardless of the size and type of 
supervised institutions involved. The Federal Reserve has 
worked to minimize regulatory burdens for community banks, by 
fashioning simpler compliance requirements and clearly 
identifying which provisions of new regulations are of 
relevance to smaller banks.
    In January 2014, the Federal Reserve Board (Board) 
implemented a new consumer compliance examination framework for 
community banks. The new program more explicitly bases 
examination intensity on the individual bank's risk profile, 
weighted against the effectiveness of the bank's compliance 
controls. The Board also revised its consumer compliance 
examination frequency policy to lengthen the time between on-
site consumer compliance and Community Reinvestment Act 
examinations for many community banks with less than $1 billion 
in total consolidated assets. These changes should increase the 
efficiency of our exam process and reduce regulatory burden on 
many community banks.
    The Board approved a final rule in April 2015 raising the 
asset threshold of the Board's Small Bank Holding Company and 
Savings and Loan Holding Company Policy Statement (Policy 
Statement) from $500 million to $1 billion and expanding its 
application to savings and loan holding companies. As a result 
of this action, 89 percent of all bank holding companies and 81 
percent of all savings and loan holding companies are now 
covered under the scope of the Policy Statement. The Policy 
Statement reduces regulatory burden by excluding these small 
organizations from certain consolidated capital requirements. 
In addition to reducing capital burden, the action 
significantly reduced the reporting burden associated with 
capital requirements by eliminating the more complex quarterly 
consolidated financial reporting requirements and replacing 
them with semiannual parent-only financial statements for 470 
institutions. In addition, raising the asset threshold allowed 
more bank holding companies to take advantage of expedited 
applications processing procedures.
    To deepen its understanding of community banks and the 
specific challenges facing these institutions, the Board meets 
twice a year with the Community Depository Institutions 
Advisory Council (CDIAC) to discuss the economic conditions and 
issues that are of greatest concern to community institutions. 
The CDIAC members are selected from representatives of 
community banks, thrift institutions, and credit unions who 
serve on local advisory councils at the 12 Federal Reserve 
Banks. The Board also has launched a number of outreach 
initiatives, including the establishment of its ``Community 
Banking Connections'' program, which is designed to enhance the 
dialogue between the Board and community banks. In addition, 
this program highlights key elements of the Board's supervisory 
process for community banks and provides clarity on supervisory 
expectations.
    In 2014, under the auspices of the Federal Financial 
Institution Examination Council (FFIEC), the Federal Reserve, 
the Comptroller of the Currency and the Federal Deposit 
Insurance Corporation (the Agencies) began their decennial 
review of regulations as required by the Economic Growth and 
Regulatory Paperwork Reduction Act of 1996 (EGRPRA) with the 
release of four Federal Register notices requesting comments on 
their regulations that are applicable to insured depository 
institutions and their holding companies in 12 substantive 
categories: Applications and Reporting; Powers and Activities; 
International Operations; Banking Operations; Capital; the 
Community Reinvestment Act; Consumer Protection; Directors, 
Officers and Employees; Money Laundering; Rules of Procedure; 
Safety and Soundness; and Securities. The final comment period 
closed on March 22, 2016, and produced over 160 written comment 
letters. Additionally, the Agencies held six outreach events 
across the country with over 1,030 participants attending in 
person, by telephone, or via live stream.
    While the Agencies are in the process of conducting a 
systematic analysis and consideration of these comments in 
order to prioritize recommendations and to adopt changes as 
appropriate, they have already taken action on certain issues. 
For example, upon authorization provided in the Fixing 
America's Surface Transportation Act, enacted on December 14, 
2015, the Agencies moved quickly to raise the asset threshold 
from $500 million to $1 billion in total assets for banks and 
savings associations that are well-capitalized and well-managed 
to be eligible for an 18-month examination cycle.
    Additionally, under the auspices of the FFIEC, the Agencies 
issued a public notice in September 2015 that established a 
multistep process for streamlining Call Report requirements. 
The notice included proposals to eliminate or revise several 
Call Report data items, announced an accelerated start of a 
statutorily required review of the Call Report, and began an 
assessment of the feasibility of creating a streamlined 
community bank Call Report. In addition to the formal EGRPRA 
process, the Agencies are continuing to engage in industry 
dialogue and outreach, to better understand significant sources 
of Call Report burden.
                                ------                                


               RESPONSES TO WRITTEN QUESTIONS OF
             SENATOR MENENDEZ FROM JANET L. YELLEN

Q.1. Last year, the Federal Reserve, in conjunction with the 
OCC, FDIC, SEC, NCUA, and CFPB issued final standards, as 
required by the Wall Street Reform Act, to assess the diversity 
practices of regulated financial institutions. In my view, 
these standards, which changed little since the draft was 
released a few years prior, unfortunately fall short of what is 
necessary to achieve real progress. As I noted in my Corporate 
Diversity Survey last year, it's no secret that the financial 
industry has a long way to go to improve the diversity of its 
leadership, workforce, and supplier base. And as you know, the 
Offices of Minority and Women Inclusion were created to help 
address the lack of diversity within our financial sector, and 
we need much more than voluntary self-assessments to bring 
about transparency and meaningful change.
    This is not some pie-in-the-sky policy--this directly 
connects to the financial health of our families and our 
communities. Lack of attention paid to communities of color 
likely contributed to regulatory neglect of problems that led 
to the crisis.
    Beyond what is contemplated in the OMWI standards issued 
last year, what other concrete steps does the Federal Reserve 
plan to take to advance diversity and inclusion both within the 
Federal Reserve System and in the banking industry in general?

A.1. The Federal Reserve Board (Board) is committed to equal 
employment in all aspects of employment, and to fostering 
diversity and inclusion in the workplace. This includes both 
the letter and spirit of all current law. The Board's 2016-2019 
Strategic Plan includes a strategic objective focusing on the 
recruitment, developments and retention of a highly skilled 
workforce that enables the Board to meet its mission and foster 
and sustain a diverse and inclusive environment.
    The Board has collaborated with the Federal Reserve Banks 
to include in the 2016 Office of Minority and Women Inclusion 
(OMWI) reports core metrics for measuring key workforce 
indicators and procurement awards. The metrics enable the Board 
and Reserve Banks to monitor the effectiveness of diversity 
policies, practices, and programs and adjust activities where 
needed.
    Under a Board management mandate adopted in 2015, 
succession planning, workforce planning, and talent management 
strategic objectives are being established throughout the 
Board. In addition, the Board implemented a Diversity Scorecard 
to assist divisions in pursuing a comprehensive and strategic 
focus on diversity and inclusion as a key metric. The scorecard 
establishes accountability for setting of diversity objectives 
and for actions by divisions to achieve those objectives. The 
scorecard objectives cover four performance areas: Leadership 
Engagement, Talent Acquisition, Talent Management, and Supplier 
Diversity.
    We remain committed to evaluating the Board's personnel 
practices, policies, and other efforts to ensure that the 
workplace is free of discrimination and provides equal 
opportunity and access for minorities and women in hiring, 
promotion, business practices, and retention particularly to 
senior-management level positions.
    The Board continues to collaborate with other financial 
regulatory agencies in the implementation of the ``Final 
Interagency Policy Statement Establishing Joint Standards for 
Assessing the Diversity Policies and Practices of Entities 
Regulated by the Agencies'' (Policy Statement). On February 29, 
2016, the Board, Office of the Comptroller of the Currency, 
Federal Deposit Insurance Corporation, Securities and Exchange 
Commission, National credit Union Administration, and the 
Consumer Financial Protection Bureau (the Agencies) received 
approval from the Office of Management and Budget to collect 
information pursuant to the policy statement. The information 
from the self-assessments may be used to monitor diversity and 
inclusion trends and identify leading policies and practices in 
the financial services industry. In collaboration with the 
other Agencies, the Board will work with regulated entities and 
other stakeholders to monitor progress toward meeting the joint 
standards, and provide technical assistance to the regulated 
entities in addressing diversity.
    To address diversity in the economics profession the Board 
has, under the purview of the American Economic Association's 
Committee on the Status of Minority Groups in the Economics 
Profession, continued to organize, oversee, and participate in 
the three programs intended to foster a long-term strategy in 
the recruitment of minority economists: (1) the Summer 
Economics Fellow Program; (2) the Summer Training Program; and 
(3) the Mentoring Program.
    The Board has also collaborated with Howard University to 
establish a teaching and mentoring program to build 
relationships between Board economists and the university's 
economics faculty and students. In addition, to encouraging the 
study of economics as a major, a team of economic research 
assistants from the Board visited local high schools, focusing 
on schools with demographically diverse populations. We will 
continue to explore new and innovative ways to increase the 
availability of minority and female professional economists in 
the educational and professional pipeline.

Q.2. Nonbank lending has grown steadily in recent years, and as 
you know, nonbank lenders often rely on funding sources that 
are more vulnerable to runs. The 2015 Shared National Credit 
Review of bank loans underwriting standards showed that while 
nonbanks own less than one-quarter of total loans, they own 
two-thirds of the highest-risk loans. And, with the growth of 
nonbank lending, intermediation chains have also lengthened, to 
the point where there are frequently banks and other nonbank 
financial institutions involved. As you know, the failure of a 
large, interconnected nonbank financial institution has the 
potential to wreak havoc on our system and instigating 
contagion among other institutions. From my perspective, 
bringing the largest and most interconnected of these 
institutions are within the wings of prudential regulation and 
supervision has been and will continue to be critical for our 
financial stability.
    What steps is the Fed taking to identify risks to financial 
stability, and in particular those arising from nonbank 
institutions not currently subject to prudential supervision?

A.2. The Federal Reserve continuously monitors risks to 
financial stability from all components of the financial system 
including banks, nonbank financial institutions, financial 
market utilities, and markets themselves. This monitoring 
effort includes the activities and risks of various nonbank 
financial institutions, such as hedge funds, insurance firms, 
mutual funds, pension funds, consumer and business finance 
companies, as well as more opaque markets, such as repo and 
over-the-counter derivatives, and innovations such as 
distributed ledger technology. We also supervise the nonbank 
financial companies that the Financial Stability Oversight 
Council (FSOC) has determined should be subject to Federal 
Reserve supervision and prudential standards--two large 
insurance companies and GE Capital. We are working closely with 
other FSOC participants on initiatives to evaluate potential 
systemic risks arising from activities and products in the 
asset management industry, including liquidity and redemption 
risk, securities lending risk, operational risk, and 
resolvability and transition planning. And, we are consulting 
with the Commodities Futures and Trading Commission (CFTC) to 
better understand and manage risks around central 
counterparties. The Federal Reserve also continues its active 
participation in the Financial Stability Board, engaging in 
issues including shadow banking, supervision of global 
systemically important financial institutions, the development 
of effective resolution regimes for large financial 
institutions, and evaluation of potential systemic risks from 
marketwide asset management activities.
    In addition, we have boosted the visibility into the 
nonbank financial institution sector by obtaining access to 
additional data on those firms through coordination with other 
regulators, purchases from outside vendors, enhanced regulatory 
reporting to better understand the linkages between banks and 
nonbank financial institutions, and voluntary collections from 
industry. For instance, with our colleagues at the Office of 
Financial Research and the Securities and Exchange Commission, 
we have launched a pilot project to collect data on bilateral 
repurchase agreements (see https://financialresearch.gov/data/
repo-data-project/).

Q.3. What data gaps have you identified in analyzing risks of 
nonbank financial institutions?

A.3. Regulators and market participants alike understand the 
role that information gaps played in allowing some of the 
excesses during the run-up to the crisis to go undetected and 
hindering our efforts to contain the effects of the crisis. 
Regulators, including the Federal Reserve, have taken 
significant steps to improve the breadth and depth of our data 
collections. Of course, we recognize that data reporting is 
costly for institutions and we strive to minimize the burden 
consistent with our task of ensuring the safety and soundness 
of individual regulated institutions as well as the ongoing 
stability of the entire system. As noted above, one way in 
which we are filling data gaps is by collaborating with other 
regulators. For instance, with Congress' repeal of the 
indemnification clause in section 728 of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act late last year, we 
are in the process of negotiating with the CFTC to provide our 
staff with direct access to interest rate swaps data. The 
Depository Trust and Clearing Corporation provides us with 
detailed, trade-level data on credit default swap transactions 
for which at least one counterparty is supervised by the 
Federal Reserve. Despite our efforts to expand the range of 
data sources with which we can conduct analysis, our ability to 
collect data from unregulated institutions is still 
constrained. For instance, we have limited visibility into the 
leverage of large hedge funds or to the lending practices of 
certain consumer and business finance companies.

Q.4. What has the Federal Reserve Board or Financial Stability 
Oversight Council done to perform cross-sectoral analyses of 
bank SIFIs and nonbank companies against each other with regard 
to systemic risk?

A.4. As we learned during the global financial crisis, it is 
not sufficient to focus only on risks that are apparent in the 
banking sector. Board staff are continuously monitoring risks 
comprehensively across all financial institutions and markets. 
As an example, we have in place a systemwide effort to bring 
together people who are working on understanding the 
interconnectedness of financial institutions across sectors, 
and they are monitoring and improving indicators of when that 
vulnerability is higher or lower than normal. One such measure 
is ``conditional value at risk'' or CoVaR, which is defined as 
the increase in the value-at-risk of the financial system due 
to an individual firm becoming distressed, and it can be 
calculated for banks and nonbanks. The detailed methodology for 
computing the CoVaR is presented in the Federal Reserve Bank of 
New York Staff Report 348 by Tobias Adrian and Markus 
Brunnermeier titled ``CoVaR'' (http://www.ny.frb.org/research/
staff_reports/sr348.html).
    We communicate our views on key financial vulnerabilities 
identified in our monitoring efforts in speeches and testimony, 
as appropriate, and provide a concise summary in the Monetary 
Policy Report to Congress twice a year. In addition, the FSOC's 
annual report on financial stability provides a comprehensive 
assessment of risks throughout the financial system.

Q.5. To what extent is the Federal Reserve engaged in 
coordination and collaboration with State insurance regulators, 
as well as industry, to ensure that the framework is both 
appropriately tailored to the business of insurance and 
effectively addresses risks to financial stability?

A.5. In its consolidated supervision of insurance firms, the 
Board remains committed to tailoring its supervisory approach 
to the business of insurance, reflecting insurers' different 
business models and systemic importance compared to other firms 
supervised by the Board. The Board's principal supervisory 
objectives for the insurance firms that it oversees include 
protecting the safety and soundness of the consolidated firms, 
as well as mitigating risks to financial stability. The Board 
continues to engage extensively with State insurance 
regulators, the National Association of Insurance 
Commissioners, and other interested stakeholders to solicit 
feedback on insurance prudential standards that would comport 
with the Board's statutory authority. We continue to coordinate 
with State insurance regulators in their protection of 
policyholders and aim to avoid replicating the supervision that 
they already perform. We leverage the work of State insurance 
regulators where possible and continue to look for 
opportunities to further coordinate with them.

Q.6. In a previous hearing, I asked Federal Reserve Governor 
Tarullo and others about a practice known as ``regulatory 
capital relief trades'', in which regulated financial 
institutions purchase credit protection (often using credit 
default swaps) from unregulated entities (often formed offshore 
to avoid regulation) to reduce the amount of capital they need 
to hold against an investment on their books.
    In effect, these trades transfer risk from regulated 
institutions that are subject to capital requirements to 
unregulated entities that are not. Instead of raising equity to 
pay for an investment, a bank takes on exposure to an entity 
that may or may not be able to pay up if the investment goes 
bad.
    As I said to Governor Tarullo, if this story sounds 
familiar, it should--this is strikingly similar to what we saw 
happen with AIG before the financial crisis. And we know how 
that worked out.
    The Treasury's Office of Financial Research released a 
report last year on these capital relief trades, which states 
that ``Regulatory capital relief trades . . . can increase 
banks' interconnectedness with nonbanks and . . . reduce 
transparency for investors and counterparties about a bank's 
capital adequacy,'' and that instead of reducing risk, these 
transactions merely ``transform credit risk into counterparty 
risk.''
    The report goes on to say that more transparency and 
reporting is needed, and that supervisory stress tests do not 
sufficiently account for possible shocks from the failure of a 
counterparty to perform on these transactions.
    What steps is the Fed taking to account for these 
transactions and their risks in its capital requirements, 
stress tests, and other appropriate measures?

A.6. Risk mitigation techniques, such as purchasing credit 
default swap protection, can reduce a firm's level of risk. In 
general, the Board views a firm's engagement in risk-reducing 
transactions as a sound risk management practice. At the same 
time, however, there are certain practices for which the risk-
based capital framework may not fully capture the risks a firm 
faces in these transactions. The Board has issued a supervisory 
letter (SR letter 13-23, ``Risk Transfer Considerations When 
Assessing Capital Adequacy--Supplemental Guidance on 
Consolidated Supervision Framework for Large Financial 
Institutions (SR letter 12-17/CA letter 12-14)'') that provides 
guidance on how these risk-transfer transactions affect 
assessments of capital adequacy. The letter states that 
``supervisors will strongly scrutinize risk-transfer 
transactions that result in substantial reductions in risk-
weighted assets, including in supervisors' assessment of a 
firm's overall capital adequacy, capital planning and risk 
management through CCAR.'' The letter goes on to underscore 
that firms should bring such transactions to the attention of 
supervisors and that the Board may also decide not to recognize 
such transactions for risk-based capital purposes. Accordingly, 
the Board has put in place and widely communicated several 
measures that are intended to ensure that risk-transfer 
transactions which do not result in a significant risk 
reduction are identified and dealt with accordingly.

Q.7. As you know, Congress passed, and the president signed 
into law, a 5-year transportation bill in December. In an 
attempt to avoid substantively addressing the insolvency of the 
Highway Trust Fund, Congress cobbled together a hodge-podge of 
funding sources--including tapping into the Federal Reserve's 
capital surplus account--all the while demonstrating an 
unwillingness to accept the reality that large scale public 
investments can actually have benefits for our society and 
economy, and that sometimes hard choices are necessary to make 
these investments.
    From an economic perspective, with interest rates still low 
and slack still remaining in construction employment, and the 
strong need for new infrastructure investments to prevent even 
greater costs down the road, isn't now a particularly good time 
to fully invest in our transportation infrastructure?

A.7. As noted by the Congressional Budget Office (CBO), 
productive infrastructure investment can provide benefits for 
the economy and society more broadly. \1\ However, the CBO also 
projects that Federal budget deficits and Federal Government 
debt will be increasing, relative to the size of the economy, 
over the next decade and in the longer run, which is an 
unsustainable fiscal policy. \2\ To promote economic growth and 
stability over the long haul, the Federal budget must be put on 
a sustainable long-run path that initially stabilizes the ratio 
of Federal debt to nominal GDP, and, given the current elevated 
level of debt, eventually places that ratio on a downward 
trajectory. An increase in spending that is financed by an 
increase in borrowing would not improve the fiscal position of 
the Federal budget, even if interest rates are low now. When 
fiscal policymakers address the crucial issue of long-run 
fiscal sustainability, their choices should certainly consider 
how to make these necessary policy adjustments in a manner that 
helps make the economy more productive. But, I believe--as did 
my predecessor--that the specific choices made to achieve a 
sustainable fiscal policy are appropriately left to our 
Nation's elected officials and the American public.
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     \1\ See, for example, Congressional Budget Office, ``Public 
Spending on Transportation and Water Infrastructure'', March 2015, and 
``Approaches To Make Federal Highway Spending More Productive'', 
February 2016.
     \2\ Congressional Budget Office, ``The Budget and Economic 
Outlook: 2016 to 2026'', January 2016, and ``The 2015 Long-Term Budget 
Outlook'', June 2015.
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