SBC Monetary Policy Report
Senate Committee on Banking, Housing, and Urban Affairs
The Semiannual Monetary Policy Report to Congress
Thursday, July 15, 2021
Chairman Sherrod Brown (D-Ohio)
In his opening statement, Brown said cities and communities need more investment in infrastructure, housing, and urban development as many communities are experiencing investments drying up, storefronts being emptied, and companies closing factories and moving well-paying union jobs abroad. Brown also noted the need to strengthen the Community Reinvestment Act, so that banking institutions serve the most underprivileged communities. Brown closed by stating that low unemployment in and of itself is not satisfactory if jobs do not pay enough and workers have no power. Similarly, he added that GDP growth in and of itself is not satisfactory if it only benefits those at the top and not those workers who create such growth.
Ranking Member Pat Toomey (R-Penn.)
In his opening statement, Toomey noted that with housing prices soaring to high levels, it is unclear why the Federal Reserve (Fed) continues to buy $40 billion in mortgage-backed bonds each month. Toomey said the Fed’s inflation projections have not inspired confidence, arguing they have consistently and systematically underestimated inflation over the last year. Toomey stated that the Fed plays a unique and crucial role in the economy with the ability to direct interest rates and control the money supply, and that Congress has given the Fed a great deal of operational independence, but it also gave the Fed a narrowly defined mission that appears to have been misused in order to wade into politically charged areas like global warming and racial justice.
Jerome H. Powell, Chairman, Federal Reserve Board
In his testimony, Powell stated how the Fed is strongly committed to achieving the monetary policy goals that Congress has given them, specifically maximum employment and price stability. He noted that these goals are pursued solely based on data and objective analysis, using clarity and transparency. Powell noted that over the first half of 2021, ongoing vaccinations have led to a reopening of the economy, with household spending rising at an especially rapid rate, boosted by strong fiscal support and accommodative financial conditions. He stated that supply constraints have been restraining activity in some industries, notably the motor vehicle industry due to the worldwide shortage of semiconductors. Powell continued that conditions in the labor market have continued to improve, and labor demand appears to be very strong with job openings at a record high, noting that employers added 1.7 million workers from April through June, despite the unemployment rate remaining elevated at 5.9 percent as of June. Powell said that to avoid sustained periods of unusually low or high inflation, the Federal Open Market Committee (FOMC) monetary policy framework seeks longer-term inflation expectations that are well anchored at 2 percent. He stated that measures of longer-term inflation expectations have moved up from their pandemic lows and are in a range that is broadly consistent with the FOMC’s long-run inflation goal. Powell noted that the Fed is continuing to increase holdings of treasury securities, at least at their current pace until substantial further progress has been made towards the maximum employment and price stability goals. He stated that the Fed expects this economic progress to continue steadily. Powell closed by noting that the Fed understands how its actions impact communities, families, and businesses across the country, and that everything the Fed performs is consistently in service to its public mission.
Question & Answer
Regulations and Capital Requirements
Brown said individuals could be safer with higher capital requirements in place and asked Powell why he has been against stronger requirements. Powell said the severity of stress tests has remained the same and that generally, the financial institutions are well capitalized. He said the system and banks are strong, and the level of loss observing capital is about right. He added that he would be prepared to deploy the countercyclical capital buffer if need be but does not think it is necessary right now.
Sen. Elizabeth Warren (D-Mass.) asked if the Fed has done anything over the past four years to strengthen either living will requirements or the Volcker rule. Powell said they did not weaken capital requirements for the large banks and argued that the implemented capital buffer and stress tests have actually raised requirements. Sen. Thom Tillis (R-N.C.) asked a follow up question about how the Fed has strengthened or weakened requirements. Powell said the shift from yearly living will reports to once every six years was because it was a labor intensive and taxing issue they had to go through every cycle, and the marginal gains from doing it every year were diminishing. He said they no longer require it yearly but does not think that this change weakened anything. Powell added that they raised capital requirements on the banks through stress tests and capital buffers. He also noted the Fed is fully enforcing the Volcker rule based on Congressional intent.
Sen. Jon Ossoff (D-Ga.) asked how concerned the Fed is about credit committees at major financial institutions and others allocating capital acting with sufficient prudence, given the extraordinary provision of liquidity over the last 15 years. Powell stated that the Fed is focused most on the real economy, including jobs, maximum employment, and price stability, in addition to financial stability and that the Fed has to be careful in tending to its mandate while accounting for financial stability.
Community Reinvestment Act
Brown asked if the Fed is still committed to full CRA modernization. Powell said the Fed is very committed to that outcome and is optimistic it will come out with something that attains broad support. As for timing, he said the Fed is analyzing a lot of comments right now and is unsure when it will be completed.
Sen. Tina Smith (D-Minn.) asked for more about what the Fed has learned from comments on the CRA proposal. Powell said there were many comments and they plan to incorporate improvements. He said that broadly speaking, this proposal seems to have the support of its intended beneficiary community as well as the banks in wanting the CRA to be effective and well-measured. He added that he hopes to get all the banking agencies on board and is optimistic it is going in a good direction.
Sen. Raphael Warnock (D-Ga.) asked Powell to provide a status update on the CRA rule making. Powell stated that the Fed is currently working through the process of reviewing an extensive group of comments and is now engaging with the Office of the Comptroller of the Currency (OCC) to sort through them and produce appropriate changes to what was initially proposed.
Sens. Steve Daines (R-Mont.) and Toomey asked if the labor force participation rate will potentially never return to former record highs and if the government has made it difficult to get back to lower unemployment rates. Powell said people used to stay in their jobs later into their careers, but noted during the pandemic people began retiring early. He said the Fed does not know where that will settle out but added he does not see this as a problem for tapering Fed asset purchases. Powell also noted that if the labor supply is low, we will hit full employment earlier. He explained if there is less labor supply and participation structurally, they will see that in the form of higher wages and higher inflation.
Central Bank Digital Currency (CBDC)
Toomey said he believes the development of a CBDC would require Congressional authorization and that it seems unclear what problem a CBDC would solve. Powell said he is undecided if the benefits outweigh the costs of a CBDC, but believes the best argument in support is that it will appropriately regulate stablecoins. In terms of Congressional authorization, he said they would want broad support in society and Congress.
Sen. Cynthia Lummis (R-Wyo.) noted that stablecoins and a CBDC are more synonymous with dollars as instruments of payment, whereas Bitcoin, Ethereum, and other virtual currencies are more akin to investment commodities. She asked for clarification on Powell’s statement to the House Financial Services Committee that one strong argument in support of a CBDC is its potential to render stablecoins and virtual currencies unnecessary. Powell said that statement is still in alignment with his current views.
Sens. Mike Rounds (R-S.D.) and Richard Shelby (R-Ala.) asked Powell if he is concerned with inflation. Powell said the inflation we have today is well above 2 percent and is a shock going through the system as the economy reopens. He said ideally they want it to average 2 percent overtime but the challenge is how to react to this larger than expected inflation. Powell explained that the extent to which inflation is temporary or not impacts how the Fed needs to respond. He said he is aware of the risks of inflation and assured the Committee the Fed is watching it carefully, and if it moves up in a troubling way they will act accordingly.
Rounds asked what concerns Powell has about the Administration putting more money and payments into the economy. Powell said the Fed’s role is to simply respond to what Congress does, and noted their tools to respond would likely be to raise interest rates and tighten financial conditions more broadly to slow demand if inflation gets worse.
Sen. Bill Haggerty (R-Tenn.) asked why the Fed is still maintaining its emergency monetary policy. Powell said inflation is well above target and that we still have high unemployment but noted the Fed will be assessing the progress of the economy and thinking about its asset purchases.
Sen. Catherine Cortez Masto (D-Nev.) asked if the Fed has the appropriate tools to respond to inflation, how costs today compare to last summer, and if the American Rescue Plan (ARP) is the sole cause for inflation spikes. Powell said he is content with their tools and noted it is better to compare prices to February right before the pandemic where they also saw roughly two to three percent inflation. Powell said ARP is not the sole cause but rather a combination of factors and mostly due to supply and demand being out of balance.
Lummis asked if it is wise to continue to have accommodative policies when there are trillions of dollars in household cash that will float into the economy soon. Powell stated that the main factor driving these results is that people have lately been unable to travel and spend money outside of the house due to the pandemic, combined with the major fiscal transfers that Congress made. He said it is appropriate to continue accommodative policy and for monetary policy to remain accommodative for now, as there are still a lot of unemployed individuals, but that the Fed is in the process of determining when it would be appropriate to taper off such policies.
Tillis referenced a comment by Powell saying Ameribor is a reasonable choice for regional and community institutions and asked if he still stands by that statement. Powell said that statement might have been pulled from a letter he forgot about, but in general he does not like to bless individual rates and emphasized that market participants have a choice.
MDIC / CDFI
Sen. Mark Warner (D-Va.) asked if there is more the Fed can do to support CDFIs in a way similar to the PPP and liquidity facility. Powell said they try to provide whatever resources possible, which is usually in the form of engagement. He said if they could think of more things to do within their mandate, they would do them.
Warner asked if the housing market is overheated. Powell said the price increases are very strong, but there are a number of factors at work. He said the current monetary policy is very supportive of people who want to get mortgages but noted that he believes raw material shortages will abate over time. Cortez Masto asked how much of the housing price increases is due to Fed purchases of mortgage-backed securities (MBS) versus supply issues. Powell said their purchases of treasuries and MBS is contributing to what is happening in the housing market, MBS are contributing a little more than Treasury securities. Sen. Kevin Cramer (R-N.D.) asked why the Fed is continuing to pump liquidity in mortgage purchases through Fannie Mae and Freddie Mac. Powell said they are looking at that right now and having a meeting in a few weeks to discuss the composition of their asset purchases and the path to beginning to reduce them.
Sen. John Kennedy (R-La.) asked at what point do the spending deficits matter. Powell said we are not on a sustainable path and that has been the case for a long time.
Climate Change Risk and Disclosures
Smith asked about the Fed’s role in climate risk disclosure for financial institutions. Powell said the foundations of this is the need to get good data on the implications of climate change and how to think about that in terms of risks that financial institutions are running. He said the Fed can help with data collection and research but that the actual disclosures will come from the jurisdiction of Congress. Powell also mentioned that major European banks have been conducting very valuable climate stress scenarios looking at the effect over a long period of time of reasonable climate outcomes on business.
Ossoff asked what Powell’s assessment is regarding how climate change may pose a risk to financial stability or to the Fed’s dual mandate. Powell stated that there are major risks posed by climate change to financial stability and financial markets. He noted how a transition to a lower carbon economy may lead to sudden repricing of assets or entire industries and that careful analysis is required when it comes to such immediate changes to prevent issues jeopardizing financial stability on a large scale.
Risks to Financial Sector
Ossoff asked for Powell’s stance on the most significant systemic threats to financial stability over the medium term, excluding the influence of COVID-19 over the past 18 months. Powell stated that cyber risk is a constant concern that the Fed has spent much time and resources addressing. Powell also mentioned the possibility of deficiencies in fully vaccinating the global population, which could lead to new strains of viruses that contribute to financial instability. Ossoff asked if there are other risks lurking in the non-bank financial system – hedge funds, private equity, SPACs – given the provision of liquidity and the reduced visibility that regulators have into some of those institutions. Powell stated that there are structural aspects of the non-bank financial system that require better regulation, particularly money market funds that had to be bailed out twice in the acute phase of the crisis. He also referenced how the Treasury market lost functionality significantly during the acute phase of the crisis and that the Fed is conducting careful analysis regrading if structural strengthening needs to be performed.
For more information on this hearing, please click here.