Senate Banking Committee
“The Semiannual Monetary Policy Report to the Congress”
Tuesday, February 24, 2015
Key Topics & Takeaways
- Prudential Regulation: Yellen said the Fed recognizes that the largest banks are quite different from those closer to the SIFI threshold and stated that the Fed has measures to recognize these differences. She commented that the Dodd-Frank Act gave the Fed the ability to tailor its supervision, and that it has done so with measures such as higher capital surcharges and leverage requirements.
- Financial Stability Board: Sen. Shelby (R-Ala.) asked if U.S. regulators have any obligation to follow FSB proposals “verbatim.” Yellen said they do not, and that the Federal Reserve has often put in place tougher standards than those proposed by the FSB.
- Swaps Pushout: Sen. Warren (D-Mass.) said House Republicans “blew a hole in Dodd-Frank protections” last Congress by tacking the repeal of the swaps pushout rule to must-pass legislation. Yellen would not comment specifically on the swaps pushout, saying that she personally considers Dodd-Frank to be an important piece of legislation that gave a roadmap for financial regulation, and that she is not seeking to alter the legislation at this time.
- Audit the Fed: Sen. Brown (D-Ohio) asked Yellen about her views of the “Audit the Fed” bill. “I want to be completely clear that I strongly oppose Audit the Fed,” she answered, explaining that it would politicize monetary policy and bring short-term political pressures to bear on the Fed.
In his opening statement, Chairman Richard Shelby (R-Ala.) noted that some in Congress have been calling for greater accountability and transparency at the Federal Reserve. He said he was interested in hearing Chair Janet Yellen’s view on this discussion, and whether she believes the Fed “should be immune from any reforms.” He stated that there is a need for greater oversight by Congress. Commenting on the Fed’s monetary policy, he warned that too much of a delay in normalization can lead to future problems.
Shelby said the Federal Reserve has been expanding its influence on households and markets, especially as it emerged from the financial crisis as a “super-regulator with unprecedented powers.” He stated that with this delegation of authority, Congress must exercise heightened responsibility to oversee and understand the impacts of regulation.
In his opening statement, Ranking Member Sherrod Brown (D-Ohio) argued that while the economy is recovering, the effects of the recovery are not being felt by all. He pointed to low wage growth, declining workforce participation, and a growing income inequality gap as issues that Congress should work to address.
Brown stated that “we too often hear” the Federal Reserve is a system that benefits the largest banks and recalled a hearing last November on regulatory capture to explore the cultures of banks and regulators. He then lauded the Fed for finalizing strong rules for the largest and riskiest institutions and encouraged it to move forward on outstanding rulemakings such as those relating to physical commodities trading.
Brown closed by commenting that it is “the wrong role for Congress” to play a part in monetary policy, dismissing calls for greater Congressional oversight of this and instead saying the real goal must be to make sure the Federal Reserve works for everyone. He said the Fed’s dual mandate of supporting price stability and maximum employment remains important.
In her testimony, Chair Janet Yellen of the Federal Reserve Board of Governors gave a generally positive report on the current economic situation and outlook, noting declines in unemployment rates and long-term unemployment and increases in domestic spending and production. However, she said long-term interest rates in the U.S. and other developed economies have moved down in a reflection of disappointing foreign growth.
Turning to monetary policy, Yellen commented that the Federal Reserve’s asset purchase program was concluded in light of economic progress and improvements in the labor market outlook, but that accommodative policies such as the low federal funds rate will continue. The Federal Open Markets Committee (FOMC), she said, would continue to provide forward guidance, but she expects to maintain low interest rates to support the Fed’s dual mandate.
Question and Answer
Shelby asked whether the FOMC should incorporate alternative measures of inflation that strip out volatile components such as food and energy. Yellen answered that she did not think it would make sense to focus on a measure that strips out important components, but added that a “core inflation” measure without energy and food costs is used to forecast prices.
Shelby asked if Yellen supports the use of monetary policy rules that the Fed could choose and to modify in times of economic stress. Yellen said she is not a proponent of “chaining the FOMC in its decision-making to any rule whatsoever.” She commented that monetary policy needs to take into account a wide range of factors that can be unusual and require special attention, even in times outside of financial crisis.
Brown asked what steps are being taken to incorporate concerns about job growth in monetary policy decisions. Yellen replied that the Fed has been running a very accommodative monetary policy to promote stronger conditions in the labor market and has been looking at a variety of indicators of the market’s performance.
Sen. Charles Schumer (D-N.Y.) urged Yellen to exercise caution before raising rates, arguing that accommodative policies should remain in place until the Fed sees consistent improvement in wage growth. He asked if Yellen agreed that this should be a central consideration. Yellen said the Fed’s objective is price stability, which it has defined at two percent inflation, and said it will not act until it is reasonably confident that the long-term inflation rate will approach this target. She added that the FOMC does look at wage growth through a range of indicators and has not seen a significant increase.
Sen. Pat Toomey (R-Pa.) said he observed “an obvious paradox” in that the financial crisis is over and has been over for years, yet the Fed is maintaining crisis-level interest rates. Commenting that slow GDP growth is the result of regulation, he warned that there will be a price to pay for the long period of accommodative policy, such as bubbles and budget deficits brought on by low interest rates. He said the policy is, at best, a “timing shift of economic activity” and that normalization is long overdue.
Toomey then rejected the idea that the two percent inflation goal is consistent with the goal of price stability because it really means that savers lose two percent of their purchasing power annually. Yellen said the two percent rate was chosen because price indices typically contain upward biases and because deflation is dangerous and makes it difficult for monetary policy to react to shocks. She said it is wise “to have a small buffer” that gives monetary policy room to operate.
Sen. Robert Menendez (D-N.J.) asked what the risk of raising rates too soon would be, as opposed to waiting. Yellen said a premature increase could undermine an economic recovery that is “really just taking hold” and could hurt the labor market while also undershooting the inflation target. On the other hand, she said waiting too long could mean overshooting the inflation target and lead to financial stability risks.
Audit the Fed
Brown asked Yellen about her views of the “Audit the Fed” bill proposed by Sen. Rand Paul (R-Ky.). “I want to be completely clear that I strongly oppose Audit the Fed,” she answered, explaining that it would politicize monetary policy and bring short-term political pressures to bear on the Fed. She said that “in the normal sense that people understand audits,” the Fed is already extensively audited. She argued that central bank independence is considered a best practice around the world, and that academic studies “establish beyond a shadow of a doubt” that independent central banks perform better.
Sen. Bob Corker (R-Tenn.) commented that “it is obvious” that the Audit the Fed effort is not about conducting an audit, but rather is an attempt to allow Congress to put pressure on the Fed’s monetary policy. He said this would not be a good idea because it would force the Fed to “put off tough decisions for the future” similarly to how Congress has been facing budget matters. Yellen agreed with this assessment and said every case of high inflation around the world has involved a central bank that was pressured to print money by politicians who could not balance budgets.
FOMC Structure and the NY Fed
Shelby cited a call from Richard Fisher of the Federal Reserve Bank of Dallas to reorganize the FOMC with a rotating vice chairmanship and a stronger role for regional banks, and asked if Yellen would support this. Yellen answered that the current structure of the FOMC was decided by Congress a long time ago, and while Congress has the power to revisit the issue, the current structure “has worked very well.” She said the FOMC has a broad range of opinions and active debate, and the decision to appoint the New York Fed president as vice chair reflects the reality of the New York Fed’s “special expertise.”
Sen. Jack Reed (D-R.I.) asked what has been done to promote accountability at the New York Fed. Yellen replied that the Fed has undertaken an internal review which is still in the works. She explained that the process for supervising the largest banks is a “system-wide process” led by Washington and the Board of Governors. She said the review would focus on whether relevant information is being fed up to the highest decision-making levels and whether all voices are being heard.
Shelby said a recent report from the Office of Financial Research (OFR) shows a large disparity in systemic risks between the largest banks and those closer to the $50 billion asset threshold for enhanced prudential supervision. He asked if this should be considered in the determination of whether a bank is considered systemically important. Yellen said the Fed recognizes that the largest banks are quite different from those closer to the threshold in terms of systemic footprint and stated that the Fed has measures to recognize these differences. She commented that the Dodd-Frank Act gave the Fed the ability to tailor its supervision, and that it has done so with measures such as higher capital surcharges and leverage requirements.
Noting that the Fed is going beyond international standards by “roughly doubling the capital surcharge for U.S. banks, Shelby asked if this indicates that the Fed believes foreign banks are not adequately capitalized. Yellen said the Fed’s proposals embody its own analysis of costs to the financial system at times of distress and put higher standards in place because the Fed believes it will make the system safer.
Shelby followed up by asking if foreign banks doing business in the U.S. are held to the same standards. Yellen said a rule has been put in place requiring foreign banking organizations of sufficient size to form intermediate holding companies that are then subject to the same capital liquidity standards and U.S.-based banks.
Shelby asked if Yellen knew of any community or regional banks that have caused systemic risks to the economy, to which Yellen said that “by and large” that has not been the case.
Sen. Tim Scott (R-S.C.) raised the systemic designation of insurance companies and questioned what expertise the Fed has with supervising insurers. Yellen said the Fed has acquired expertise by hiring individuals with experience in insurance regulation, and that it consults with state regulators to understand the unique characteristics of the insurance industry so it can tailor supervision appropriately.
Brown commented that there is “no question” that capital requirements have made for stronger banks and a more stable financial system. He then asked if the Fed is prepared to declare living wills in the next round of submissions to be insufficient, and what actions it might then take. Yellen said the Fed has worked closely with the Federal Deposit Insurance Corporation (FDIC) to give guidance to the largest firms on what they expect to see from the living wills to improve their resolvability. She said these recommendations are significant changes, with some pertaining to legal structure and the sustainability of critical operations during times of stress, but that the Fed and FDIC have been clear on what they expect to see from the submissions in July. Yellen said the Fed is prepared to declare the living wills to be non-credible.
Financial Stability Board
Shelby said the Financial Stability Board (FSB) plays an important role in developing regulations and capital frameworks. Given that the FSB is not accountable to the U.S. government or Congress, he asked how its proposals fit in the U.S. regulatory system and whether the Fed treats them as mandates or suggestions. Yellen answered that a number of U.S. regulators participate in the FSB, but that nothing decided there has any force unless U.S. regulators decide to go through a rulemaking process.
She explained that there is good reason for the U.S. to participate in the FSB because financial markets are global, and if the U.S. takes action to stiffen regulations while other jurisdictions do not, then activity will simply migrate to other countries, creating a more dangerous overall financial system. She said the U.S. should be a part of any international discussions, and that it, in fact, plays a leadership role.
Shelby asked if the U.S. regulators have any obligation to follow FSB proposals “verbatim.” Yellen said they do not, and that the Federal Reserve has often put in place tougher standards than those proposed by the FSB.
Sen. Elizabeth Warren (D-Mass.) said House Republicans “blew a hole in Dodd-Frank protections” last Congress by tacking the repeal of the swaps pushout rule to must-pass legislation. She commented that Federal Reserve General Counsel Scott Alvarez openly criticized the pushout rule at a conference a month before the repeal, as well as rules against conflicts of interest. She asked whether this criticism reflects the opinion of Yellen or of the Board of Governors. Yellen would not comment specifically on the swaps pushout, saying that she personally considers Dodd-Frank to be an important piece of legislation that gave a roadmap for financial regulation, and that she is not seeking to alter the legislation at this time.
Warren questioned whether it is appropriate for Alvarez or other staff to take a public position in disagreement with the Federal Reserve’s official position. She then asked whether Alvarez provided input in the Fed decision to delay implementation of the rule until 2016, which she said gave large banks time to work towards its repeal. Yellen said she did not know, but that phase-ins are common for complicated rules that require adjustments by firms and this has been true of all Dodd-Frank rules the Fed has put into effect.
Reed said Congress is “acutely sensitive to systemic risk” and that Dodd-Frank sought to address this with the creation of clearinghouses. However, he said this itself introduced a degree of risk and that this should be on the Federal Reserve’s “screen.” Yellen said the Fed is “very attune” to the need to be careful in the supervision of clearinghouses and principles for liquidity and risk management standards have been put in place.
Sen. Joe Donnelly (D-Ind.) said cybersecurity always comes up in his discussions with financial organizations as a top concern and asked Yellen about possible risks. Yellen said she believes cybersecurity is “at the top of everyone’s lists of concerns,” and said the Fed is paying a great deal of attention to the issue to address “ever-escalating threats” to its own operations and to the banks its supervises. She said cybersecurity is a larger problem where cooperation across industries will be necessary, and that legislation may be needed as well.
Sen. Mike Crap (R-Idaho) asked about the Economic Growth and Paperwork Reduction Act (EGRPRA), which requires reviews of all existing regulations and new regulations to eliminate duplicative or overly burdensome rules. He pointed out that financial regulators included “remarkable footnotes” in the Federal Register that they would “back off” and not review new regulations, and that the Consumer Financial Protection Bureau (CFPB) would not even be a part of the process. He asked Yellen if she agrees that a thorough EGRPRA process is needed that includes that CFPB, and noted that the Qualified Mortgage Rule and the Volcker Rule would be outside the scope of the review the agencies would be taking.
Yellen said recent rulemakings have gone through a full rulemaking process that included public comments and assessments of costs and burdens, and so in a sense the EGRPRA process has already been fulfilled, as they would be for future rulemakings.
Crapo contested the idea that this satisfies EGRPRA, saying that the law requires a review of all regulations, “not just old ones.”
Corker noted that there is a push to include currency manipulation provisions in the Trans-Pacific Partnership (TPP) and asked if trade negotiations are a good forum for such discussions. Yellen said currency manipulation designed to alter competitive landscapes is inappropriate and needs to be addressed, but that many factors can influences the values of currencies, including monetary policy. She expressed concern about a regime that might impose sanctions for currency manipulation within trade agreements, warning that it might “hamper or hobble” valid monetary policy with legitimate domestic goals.
Sen. Mark Warner (D-Va.) also asked about currency manipulation, and Yellen said the U.S. is “on guard” against the practice in its dealings with other countries. She added that the G7 has agreed to the principle that monetary policy targeted at supporting price stability and employment is valid.
Sen. Heidi Heitkamp (D-N.D.) asked what concerns Yellen has for the next 10-15 years and what advice she has for Congress to address them. Yellen said rising income inequality is her greatest concern, but declined to offer recommendations to address it because “this is the domain of Congress.” She also said long-run issues with the federal budget are a serious concern, especially as it might affect the ability to use fiscal policy as a response to adverse economic shocks.
For more information on this hearing, please click here.
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