Chairman Ben S. Bernanke
Semiannual Monetary Policy Report to the Congress
Before the Committee on Financial Services, U.S. House of
Representatives, Washington, D.C.
July 13, 2011 - FRB
Chairman Bachus, Ranking Member Frank, and other members of the Committee, I
am pleased to present the Federal Reserve's semiannual Monetary
Policy Report to the Congress (PDF).
I will begin with a discussion of current economic conditions and the outlook
and then turn to monetary policy.
The Economic Outlook
The U.S. economy
has continued to recover, but the pace of the expansion so far this year has
been modest. After increasing at an annual rate of 2-3/4 percent in the second
half of 2010, real gross domestic product (GDP) rose at about a 2 percent rate
in the first quarter of this year, and incoming data suggest that the pace of
recovery remained soft in the spring. At the same time, the unemployment rate,
which had appeared to be on a downward trajectory at the turn of the year, has
moved back above 9 percent.
In part, the recent weaker-than-expected economic performance appears to have
been the result of several factors that are likely to be temporary. Notably, the
run-up in prices of energy, especially gasoline, and food has reduced consumer
purchasing power. In addition, the supply chain disruptions that occurred
following the earthquake in Japan caused U.S. motor vehicle producers to sharply
curtail assemblies and limited the availability of some models. Looking forward,
however, the apparent stabilization in the prices of oil and other commodities
should ease the pressure on household budgets, and vehicle manufacturers report
that they are making significant progress in overcoming the parts shortages and
expect to increase production substantially this summer.
In light of these developments, the most recent projections by members of the
Federal Reserve Board and presidents of the Federal Reserve Banks, prepared in
conjunction with the Federal Open Market Committee (FOMC) meeting in late June,
reflected their assessment that the pace of the economic recovery will pick up
in coming quarters. Specifically, participants' projections for the increase in
real GDP have a central tendency of 2.7 to 2.9 percent for 2011, inclusive of
the weak first half, and 3.3 to 3.7 percent in 2012--projections that, if
realized, would constitute a notably better performance than we have seen so far
this year.1
FOMC participants continued to see the economic recovery strengthening over
the medium term, with the central tendency of their projections for the increase
in real GDP picking up to 3.5 to 4.2 percent in 2013. At the same time, the
central tendencies of the projections of real GDP growth in 2011 and 2012 were
marked down nearly 1/2 percentage point compared with those reported in April,
suggesting that FOMC participants saw at least some part of the first-half
slowdown as persisting for a while. Among the headwinds facing the economy are
the slow growth in consumer spending, even after accounting for the effects of
higher food and energy prices; the continuing depressed condition of the housing
sector; still-limited access to credit for some households and small businesses;
and fiscal tightening at all levels of government. Consistent with projected
growth in real output modestly above its trend rate, FOMC participants expected
that, over time, the jobless rate will decline--albeit only slowly--toward its
longer-term normal level. The central tendencies of participants' forecasts for
the unemployment rate were 8.6 to 8.9 percent for the fourth quarter of this
year, 7.8 to 8.2 percent at the end of 2012, and 7.0 to 7.5 percent at the end
of 2013.
The most recent data attest to the continuing weakness of the labor market:
The unemployment rate increased to 9.2 percent in June, and gains in nonfarm
payroll employment were below expectations for a second month. To date, of the
more than 8-1/2 million jobs lost in the recession, 1-3/4 million have been
regained. Of those employed, about 6 percent--8.6 million workers--report that
they would like to be working full time but can only obtain part-time work.
Importantly, nearly half of those currently unemployed have been out of work for
more than six months, by far the highest ratio in the post-World War II period.
Long-term unemployment imposes severe economic hardships on the unemployed and
their families, and, by leading to an erosion of skills of those without work,
it both impairs their lifetime employment prospects and reduces the productive
potential of our economy as a whole.
Much of the slowdown in aggregate demand this year has been centered in the
household sector, and the ability and willingness of consumers to spend will be
an important determinant of the pace of the recovery in coming quarters. Real
disposable personal income over the first five months of 2011 was boosted by the
reduction in payroll taxes, but those gains were largely offset by higher prices
for gasoline and other commodities. Households report that they have little
confidence in the durability of the recovery and about their own income
prospects. Moreover, the ongoing weakness in home values is holding down
household wealth and weighing on consumer sentiment. On the positive side,
household debt burdens are declining, delinquency rates on credit card and auto
loans are down significantly, and the number of homeowners missing a mortgage
payment for the first time is decreasing. The anticipated pickups in economic
activity and job creation, together with the expected easing of price pressures,
should bolster real household income, confidence, and spending in the medium
run.
Residential construction activity remains at an extremely low level. The
demand for homes has been depressed by many of the same factors that have held
down consumer spending more generally, including the slowness of the recovery in
jobs and income as well as poor consumer sentiment. Mortgage interest rates are
near record lows, but access to mortgage credit continues to be constrained.
Also, many potential homebuyers remain concerned about buying into a falling
market, as weak demand for homes, the substantial backlog of vacant properties
for sale, and the high proportion of distressed sales are keeping downward
pressure on house prices.
Two bright spots in the recovery have been exports and business investment in
equipment and software. Demand for U.S.-made capital goods from both domestic
and foreign firms has supported manufacturing production throughout the recovery
thus far. Both equipment and software outlays and exports increased solidly in
the first quarter, and the data on new orders received by U.S. producers suggest
that the trend continued in recent months. Corporate profits have been strong,
and larger nonfinancial corporations with access to capital markets have been
able to refinance existing debt and lock in funding at lower yields. Borrowing
conditions for businesses generally have continued to ease, although, as
mentioned, the availability of credit appears to remain relatively limited for
some small firms.
Inflation has picked up so far this year. The price index for personal
consumption expenditures (PCE) rose at an annual rate of more than 4 percent
over the first five months of 2011, and 2-1/2 percent on a 12-month basis. Much
of the acceleration was the result of higher prices for oil and other
commodities and for imported goods. In addition, prices of motor vehicles
increased sharply when supplies of new models were curtailed by parts shortages
associated with the earthquake in Japan. Most of the recent rise in inflation
appears likely to be transitory, and FOMC participants expected inflation to
subside in coming quarters to rates at or below the level of 2 percent or a bit
less that participants view as consistent with our dual mandate of maximum
employment and price stability. The central tendency of participants' forecasts
for the rate of increase in the PCE price index was 2.3 to 2.5 percent for 2011
as a whole, which implies a significant slowing of inflation in the second half
of the year. In 2012 and 2013, the central tendency of the inflation forecasts
was 1.5 to 2.0 percent. Reasons to expect inflation to moderate include the
apparent stabilization in the prices of oil and other commodities, which is
already showing through to retail gasoline and food prices; the
still-substantial slack in U.S. labor and product markets, which has made it
difficult for workers to obtain wage gains and for firms to pass through their
higher costs; and the stability of longer-term inflation expectations, as
measured by surveys of households, the forecasts of professional private-sector
economists, and financial market indicators.
Monetary Policy
FOMC members' judgments that the pace of
the economic recovery over coming quarters will likely remain moderate, that the
unemployment rate will consequently decline only gradually, and that inflation
will subside are the basis for the Committee's decision to maintain a highly
accommodative monetary policy. As you know, that policy currently consists of
two parts. First, the target range for the federal funds rate remains at 0 to
1/4 percent and, as indicated in the statement released after the June meeting,
the Committee expects that economic conditions are likely to warrant
exceptionally low levels of the federal funds rate for an extended period.
The second component of monetary policy has been to increase the Federal
Reserve's holdings of longer-term securities, an approach undertaken because the
target for the federal funds rate could not be lowered meaningfully further. The
Federal Reserve's acquisition of longer-term Treasury securities boosted the
prices of such securities and caused longer-term Treasury yields to be lower
than they would have been otherwise. In addition, by removing substantial
quantities of longer-term Treasury securities from the market, the Fed's
purchases induced private investors to acquire other assets that serve as
substitutes for Treasury securities in the financial marketplace, such as
corporate bonds and mortgage-backed securities. By this means, the Fed's asset
purchase program--like more conventional monetary policy--has served to reduce
the yields and increase the prices of those other assets as well. The net result
of these actions is lower borrowing costs and easier financial conditions
throughout the economy.2 We know from many decades of experience with monetary
policy that, when the economy is operating below its potential, easier financial
conditions tend to promote more rapid economic growth. Estimates based on a
number of recent studies as well as Federal Reserve analyses suggest that, all
else being equal, the second round of asset purchases probably lowered
longer-term interest rates approximately 10 to 30 basis points.3 Our analysis further
indicates that a reduction in longer-term interest rates of this magnitude would
be roughly equivalent in terms of its effect on the economy to a 40 to 120 basis
point reduction in the federal funds rate.
In June, we completed the planned purchases of $600 billion in longer-term
Treasury securities that the Committee initiated in November, while continuing
to reinvest the proceeds of maturing or redeemed longer-term securities in
Treasuries. Although we are no longer expanding our securities holdings, the
evidence suggests that the degree of accommodation delivered by the Federal
Reserve's securities purchase program is determined primarily by the quantity
and mix of securities that the Federal Reserve holds rather than by the current
pace of new purchases. Thus, even with the end of net new purchases, maintaining
our holdings of these securities should continue to put downward pressure on
market interest rates and foster more accommodative financial conditions than
would otherwise be the case. It is worth emphasizing that our program involved
purchases of securities, not government spending, and, as I will discuss later,
when the macroeconomic circumstances call for it, we will unwind those
purchases. In the meantime, interest on those securities is remitted to the U.S.
Treasury.
When we began this program, we certainly did not expect it to be a panacea
for the country's economic problems. However, as the expansion weakened last
summer, developments with respect to both components of our dual mandate implied
that additional monetary accommodation was needed. In that context, we believed
that the program would both help reduce the risk of deflation that had emerged
and provide a needed boost to faltering economic activity and job creation. The
experience to date with the round of securities purchases that just ended
suggests that the program had the intended effects of reducing the risk of
deflation and shoring up economic activity. In the months following the August
announcement of our policy of reinvesting maturing and redeemed securities and
our signal that we were considering more purchases, inflation compensation as
measured in the market for inflation-indexed securities rose from low to more
normal levels, suggesting that the perceived risks of deflation had receded
markedly. This was a significant achievement, as we know from the Japanese
experience that protracted deflation can be quite costly in terms of weaker
economic growth.
With respect to employment, our expectations were relatively modest;
estimates made in the autumn suggested that the additional purchases could boost
employment by about 700,000 jobs over two years, or about 30,000 extra jobs per
month.4 Even
including the disappointing readings for May and June, which reflected in part
the temporary factors discussed earlier, private payroll gains have averaged
160,000 per month in the first half of 2011, compared with average increases of
only about 80,000 private jobs per month from May to August 2010. Not all of the
step-up in hiring was necessarily the result of the asset purchase program, but
the comparison is consistent with our expectations for employment gains. Of
course, we will be monitoring developments in the labor market closely.
Once the temporary shocks that have been holding down economic activity pass,
we expect to again see the effects of policy accommodation reflected in stronger
economic activity and job creation. However, given the range of uncertainties
about the strength of the recovery and prospects for inflation over the medium
term, the Federal Reserve remains prepared to respond should economic
developments indicate that an adjustment in the stance of monetary policy would
be appropriate.
On the one hand, the possibility remains that the recent economic weakness
may prove more persistent than expected and that deflationary risks might
reemerge, implying a need for additional policy support. Even with the federal
funds rate close to zero, we have a number of ways in which we could act to ease
financial conditions further. One option would be to provide more explicit
guidance about the period over which the federal funds rate and the balance
sheet would remain at their current levels. Another approach would be to
initiate more securities purchases or to increase the average maturity of our
holdings. The Federal Reserve could also reduce the 25 basis point rate of
interest it pays to banks on their reserves, thereby putting downward pressure
on short-term rates more generally. Of course, our experience with these
policies remains relatively limited, and employing them would entail potential
risks and costs. However, prudent planning requires that we evaluate the
efficacy of these and other potential alternatives for deploying additional
stimulus if conditions warrant.
On the other hand, the economy could evolve in a way that would warrant a
move toward less-accommodative policy. Accordingly, the Committee has been
giving careful consideration to the elements of its exit strategy, and, as
reported in the minutes of the June FOMC meeting, it has reached a broad
consensus about the sequence of steps that it expects to follow when the
normalization of policy becomes appropriate. In brief, when economic conditions
warrant, the Committee would begin the normalization process by ceasing the
reinvestment of principal payments on its securities, thereby allowing the
Federal Reserve's balance sheet to begin shrinking. At the same time or sometime
thereafter, the Committee would modify the forward guidance in its statement.
Subsequent steps would include the initiation of temporary reserve-draining
operations and, when conditions warrant, increases in the federal funds rate
target. From that point on, changing the level or range of the federal funds
rate target would be our primary means of adjusting the stance of monetary
policy in response to economic developments.
Sometime after the first increase in the federal funds rate target, the
Committee expects to initiate sales of agency securities from its portfolio,
with the timing and pace of sales clearly communicated to the public in advance.
Once sales begin, the pace of sales is anticipated to be relatively gradual and
steady, but it could be adjusted up or down in response to material changes in
the economic outlook or financial conditions. Over time, the securities
portfolio and the associated quantity of bank reserves are expected to be
reduced to the minimum levels consistent with the efficient implementation of
monetary policy. Of course, conditions can change, and in choosing the time to
begin policy normalization as well as the pace of that process, should that be
the next direction for policy, we would carefully consider both parts of our
dual mandate.
Thank you. I would be pleased to take your questions.
1. Note that these projections do not incorporate the
most recent economic news, including last Friday's labor market report. Return to text
2. The Federal Reserve's recently completed securities
purchase program has changed the average maturity of Treasury securities held by
the public only modestly, suggesting that such an effect likely did not
contribute substantially to the reduction in Treasury yields. Rather, the more
important channel of effect was the removal of Treasury securities from the
market, which reduced Treasury yields generally while inducing private investors
to hold alternative assets (the portfolio reallocation effect). The substitution
into alternative assets raised their prices and lowered their yields, easing
overall financial conditions. Return to text
3. Studies that have provided estimates of the effects
of large-scale asset purchases, holding constant other factors, include James D.
Hamilton and Jing (Cynthia) Wu (2011), "The Effectiveness of
Alternative Monetary Policy Tools in a Zero Lower Bound Environment," NBER
Working Paper Series No. 16956 (Cambridge, Mass: National Bureau of Economic
Research, April), and Journal of Money, Credit and Banking
(forthcoming); Arvind Krishnamurthy and Annette Vissing-Jorgensen (2011),
"The Effects of Quantitative Easing on Interest Rates (PDF),"
working paper (Evanston, Ill.: Kellogg School of Management, Northwestern
University, June); Stefania D'Amico and Thomas B. King (2010), "Flow and Stock Effects
of Large-Scale Treasury Purchases," Finance and Economics Discussion Series
2010-52 (Washington: Board of Governors of the Federal Reserve System,
September); Joseph Gagnon, Matthew Raskin, Julie Remache, and Brian Sack (2011),
"Large-Scale Asset Purchases by the Federal Reserve: Did They Work?
(PDF)" Federal Reserve Bank of New York, Economic Policy Review,
vol 17 (May), pp.41-59; and Eric T. Swanson (2011), "Let's Twist Again: A High-Frequency Event-Study Analysis of
Operation Twist and Its Implications for QE2 (PDF)," Working Paper Series
2011-08 (San Francisco: Federal Reserve Bank of San Francisco, February), and
Brookings Papers on Economic Activity (forthcoming). Return to text
4. See Hess Chung, Jean-Philippe Laforte, David
Reifschneider, and John C. Williams (2011), "Have We Underestimated the Likelihood and Severity of Zero Lower
Bound Events? (PDF)" Working Paper Series 2011-01 (San Francisco: Federal
Reserve Bank of San Francisco, January). Return to text