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r190307a_FOMC

united states

Navigating Cautiously

brainard

While our economy continues to add jobs at a solid pace, demand appears to have softened against a backdrop of greater downside risks. Prudence counsels a period of watchful waiting--especially with no signs that inflation is picking up. With balance sheet normalization now well advanced, it will be appropriate to wind down asset redemptions later in the year. Let me start by discussing prospects for the U.S. economy. Policymakers tend to distinguish the most likely path, which I will refer to as the "modal" outlook, from risks around that path--events that are not the most likely to happen, but that have some probability of happening and that, if they do materialize, would have a one-sided effect. Both the modal outlook and the risks around it have important implications for monetary policy, but in somewhat different ways. Let me first discuss the modal outlook. While the economy performed very well last year, I have revised down my modal outlook for this year, in part reflecting some softening in the recent spending and sentiment data. This softening could be a harbinger of some slowing in the underlying momentum of domestic demand. In the initial estimate released last week, real gross domestic product (GDP) rose at a 2.6 percent annual rate in the fourth quarter of 2018. However, the latest report on retail sales showed a sharp decline. Analysts note that there is some reason to be skeptical of that report; it is subject to revision, and other data sources suggest a more muted movement. Although the magnitude of the drop may be revised smaller, coming in the last month of the quarter, that decline suggests that growth in consumer spending may be held down in the first quarter of this year. Surveys of consumer sentiment, which may provide some additional insight into the strength of spending in the first quarter, fell on net between November and January and rebounded partially in February. The lengthy government shutdown likely contributed to the January decline. And although recent readings are below those that prevailed for much of 2018, they are still in a range consistent with ongoing spending growth. Other spending indicators have also shown some slowing. Residential construction data have been soft for some time, reflecting in part earlier increases in interest rates, and homebuilders report that supply constraints on available lots, shortages of skilled workers, and tariffs on inputs are also contributing to the slowdown. Business investment registered strong gains last year, including in the latest quarter, but there are some indications of softening there as well. The latest data on capital goods orders, for example, suggest some softening in equipment spending gains. Surveys of businesses, such as the Institute for Supply Management's purchasing managers index and similar regional indexes, have generally moved lower over the past six months, reversing much of the run-up seen in 2017 and late 2016. The National its mid-2018 peak, although it remains well above the levels of 2015 and much of 2016. The weaker foreign outlook also acts as a crosscurrent to the modal outlook. While strong foreign growth provided tailwinds early last year, foreign growth projections have been revised down repeatedly more recently. The slowdown of foreign growth now appears to be more persistent than initially assumed, with growth likely running below potential for most of last year. Economic activity slowed noticeably in the second half of 2018 in China, where policymakers have been trying to achieve a balance between restraining very elevated levels of domestic debt, on the one hand, and maintaining strong aggregate growth, on the other. The protracted trade conflict with the United States has further complicated that challenge. Concerns about China's slowdown are reverberating globally, as was true in 2015-16, although the incidence is somewhat different. While Germany had appeared to be weighed down primarily by transitory factors late last year, some of the weakness in industrial production now appears likely to be more persistent, in part reflecting spillovers from China. The euro area is also seeing slowing in some other large member economies. Global weakness in trade and manufacturing has also weighed on Japan. The slowdown in foreign demand spills over into the United States through a variety of channels. Although the dollar has weakened somewhat lately, its earlier appreciation and slowing foreign growth contributed to a decline in exports and a fall in import prices over the second half of last year. In contrast, the recent step-down in long- term rates and easing in the dollar have lessened pressures on yields in emerging markets and provided more policy space in some cases. In the United States, financial markets saw substantial volatility late last year, which may still be affecting sentiment. From September to December of last year, financial conditions tightened considerably, with the stock market falling as much as 20 percent, and corporate bond premiums rising. This year, much of that tightening has reversed: The S&P 500 has made up more than half of its earlier losses, and corporate risk spreads have reversed much of their earlier tightening. Long-term Treasury yields rose from September through November and have since more than retraced, returning to the levels of early 2018. While the dollar has edged down from the peaks reached in the fall, it is about 7 percent higher than the lows seen early last year. Overall, the softer spending data in the U.S. and the slowdown abroad, along with earlier financial volatility, are likely weighing on the modal outlook and might in turn warrant a softening in the modal path for policy. Risks to the Outlook Let me turn now to the second category of crosscurrents facing the U.S. economy: the risks around the modal outlook. Policy uncertainty has been elevated recently and has been cited as an important factor in the financial volatility late last year. Although some of the risks have been anticipated for some time, recent events have brought them into heightened focus, and the accumulation of these risks could lead to some erosion in sentiment that could in turn feed into activity. Trade dispute escalation remains a risk. The tariffs and trade disruptions that have occurred so far are estimated to have had relatively modest effects on aggregate growth and inflation, although damaging disruptions have been concentrated in some sectors, such as soybeans. While recent reports suggest some progress, the prospect of additional tariffs in the trade conflict with China or on automobiles have been cited frequently as a risk in earnings reports and reports from business contacts. The recent longest-ever government shutdown created hardship for many families and has increased attention on upcoming fiscal negotiations. On current estimates, the debt ceiling will need to be raised around the fall. The Bipartisan Budget Act, which is estimated to boost GDP growth by 0.3 percentage point, on average, per year in 2018 and 2019, is scheduled to expire in 2020. If agreement is not reached, spending levels could fall back to the sequester caps, which would amount to a significant headwind. There are also important downside risks abroad. Most immediately, a "no-deal Brexit" would have adverse consequences for Britain, and potentially more broadly, given London's role as a financial center. Within the euro area, countries such as Italy and France face domestic challenges. And a hard landing in China would have spillovers through financial and trade channels. In contrast to the softening in spending indicators, job gains have remained strong so far. Job gains have averaged 240,000 per month over the past three months--more than twice the pace necessary to absorb new entrants into the labor force. The January unemployment rate of 4 percent is near a multidecade low. The strong labor market has drawn many Americans into productive work, and the overall employment-to-population ratio for workers between the ages of 25 and 54 is now within 1/2 percentage point of its pre-crisis peak. Many of the main measures of wages have been increasing at rates not seen on a sustained basis in almost 10 years, although labor's share of overall income remains stubbornly depressed. Nonetheless, recent data on claims have shown some softening, and I will be watching a broad set of labor market indicators carefully, including the payrolls data for February, which will be released tomorrow. Just as the economy is performing well on the maximum-employment goal set by the Congress, it is also close to meeting our price-stability mandate. Following many years of low readings, the core price index for consumer purchases for the 12 months through December was up 1.9 percent. That reading lines up with the median Summary of Economic Projections (SEP) forecast from a year ago. So inflation is very close to the Committee's 2 percent objective and its earlier expectation. Even so, we will need to be vigilant to ensure inflation achieves 2 percent on a sustained basis. As I have observed for some time, underlying trend inflation may be running slightly below the Committee's 2 percent objective. Many statistical filtering models put underlying inflation modestly below 2 percent, and some survey measures of inflation expectations are running somewhat below pre-crisis levels. Similarly, the difference between the yields on nominal and inflation-indexed Treasury securities is lower than it was before the crisis, and that difference may provide some insight into market participants' views of underlying inflation. The fact that estimates of underlying trend inflation remain a bit on the soft side reinforces the evidence that the Phillips curve is very flat, a key element of the post-crisis new normal that I have noted previously. The responsiveness of price inflation to resource utilization at the national level has been very weak for some time. This raises the possibility that the economy may have room to run. As the unemployment rate has fallen to levels not seen in many decades, we have heard concerns that the steeper Phillips curve of the past might reassert itself, perhaps in a nonlinear manner. But all available evidence suggests inflation expectations remain well anchored to the upside. Indeed, the contours of today's new normal suggest we should be equally attentive to a risk of erosion in inflation expectations to the downside. A range of evidence suggests that the long-run "neutral" rate of interest--the rate of interest consistent with the economy growing at its potential rate and stable inflation--is very low relative to its historical levels. The low long-run neutral rate limits the amount of space available for cutting the federal funds rate to buffer the economy from adverse developments and is likely to increase the frequency or length of periods when the policy rate is pinned at the lower bound. In turn, more frequent or extended episodes when inflation is below target and policy is at the effective lower bound risk pulling down private-sector inflation expectations in a self-reinforcing downward spiral, which could further compress the monetary policy buffer to cushion downside shocks. inflation goal is symmetric. As the median SEP forecasts have indicated, a number of Committee members have previously projected a policy path consistent with inflation rising somewhat above 2 percent for a time, which is in line with the symmetry of the target. There is a separate discussion of policies that would pre-commit to make up for past misses on inflation, such as temporary price-level targeting, which may be important in circumstances with a low long-run neutral rate and more frequent effective-lower- bound episodes. I expect this will be part of our review of monetary policy strategies, tools, and communication practices later this year. Our policy goal now is to preserve the progress we have made on maximum employment and target inflation. Core inflation last year came in around target. It is heartening to see so many American workers coming back into the jobs market with rising wages. Our business contacts note they are currently hiring and investing in training workers who may not have been considered just a few years ago. With regard to policy, modest downward revisions to the baseline outlook for output and employment would call for modest downward revisions to the path for our conventional policy tool, the federal funds rate, helping to offset some of the weakness that would otherwise weigh on the economy. Moreover, basic principles of risk management would suggest that the increase in downside risks warrants a modest downward revision to the modal path for policy. These downside risks, if realized, could weigh on economic activity. So heightened downside risks to output and employment would argue for a softer federal funds rate path even if the modal outlook for the economy were unchanged. At a time when the modal outlook appears to have softened a bit, and risks appear more weighted to the downside than the upside, the best way to safeguard the gains we have made on jobs and inflation is to navigate cautiously on rates. Risk management in an environment of a low long-run neutral rate and an attenuated relationship between resource utilization and overall inflation supports this approach. Watchful waiting will allow us to gather more information about domestic momentum and foreign growth as well as some of the policy risks weighing on sentiment. Let me turn now to the second tool used by the Federal Reserve in recent years-- asset purchases. Recall that, after reducing the federal funds rate to its effective lower bound of zero in the 2008-09 recession, the FOMC sought a mechanism for providing additional stimulus in order to achieve maximum employment and target inflation. Federal Reserve purchased longer-term Treasury securities in an effort to push down longer-term interest rates to support economic activity, an approach sometimes referred to as quantitative easing. It also purchased agency mortgage-backed securities for the same reason, as well as to provide support to the housing sector, which was at the heart of the crisis. Although the empirical estimates vary, most conclude that the asset purchase programs were successful in supporting the recovery. Once recoveries become well established, the Federal Reserve moves its policy settings to more normal levels. Our current extended recovery is no exception: The Federal Reserve first started moving the federal funds rate to more normal values once the expansion was well established, and then it started normalizing the balance sheet once normalization of the federal funds rate was well under way. Of course, the benchmark for normalization has changed since before the financial crisis. Demand has grown for the Fed's liabilities from a variety of sources. The demand for U.S. currency has grown notably relative to nominal GDP, the Treasury Department now holds large balances in its account at the Fed as an important part of its cash management, and foreign central banks hold larger deposits than in the past. In addition, the demand from commercial banks for deposits at the Fed--that is, "reserves"-- appears to have increased substantially. Spurred by new liquidity regulations and their own internal liquidity management practices, the largest banks hold substantial amounts of so-called high-quality liquid assets to protect against the risk of a sudden "run" on their uninsured short-run liabilities, as occurred during the financial crisis. So it appears that the new normal size of the balance sheet is likely to remain greater relative to the size of the economy than it was before the financial crisis. How much larger is still an open question. For the past decade, the Federal Reserve has operated a regime with reserves that are very abundant relative to banks' demand for reserves. The current framework relies on the Federal Reserve's interest rate on reserves to control the federal funds rate, in the context of the provision of ample reserves. In contrast, the pre-crisis framework featured a scarce supply of reserves, which the Federal Reserve would vary on a daily basis to control the federal funds rate by closely matching the demand for reserves. The FOMC recently affirmed that it would continue to operate the current framework. This approach makes sense for a variety of reasons. The current framework has been effective in providing good control of the policy rate and ensuring effective transmission to other money markets and the financial system. Not only is the demand for reserves likely to remain much higher than it was before the crisis, but it is also likely that there will be fluctuations in reserves, along with other elements of the Fed's liabilities, such as the deposits the Treasury holds with the Fed. Accommodating those swings with scarce reserves would require much larger daily open market operations than was the case before the crisis. By remaining in a regime with ample reserves, the Fed is able to control short- term interest rates without the need to conduct daily open market operations. Because there are ample reserves, the federal funds rate and other short-term interest rates are determined along the flat portion of the reserve demand curve. As a result, the system can absorb swings in the demand and supply of reserves with limited need for open market operations. The alternative of pushing reserves close to the transition point between the flat and steep parts of the demand curve would likely lead to active intervention as an ongoing feature, along with volatility in rates. Given that the Committee is now operating with two instruments, it is important to note that the Committee clarified that it would seek to use only one tool actively at a time, and that the preferred active tool would be the federal funds rate when it is above the effective lower bound. I want to make it clear that we would not want our two tools to be working at cross-purposes. For instance, we would not want the balance sheet to be shrinking at a time when the FOMC thought it was appropriate to cut the federal funds rate. After holding the size of the balance sheet roughly flat since mid-2014, once the normalization of the federal funds rate was deemed well under way in October 2017, the Committee started to allow the size of the balance sheet to shrink in line with the pledge to "hold no more securities than necessary to implement monetary policy efficiently and We have made substantial progress, as demonstrated by the level of reserves. Reserves are already down by 40 percent since their peak and are likely to be down by more than half this summer. In my view, asset redemptions should come to an end later in the year, which would provide a sufficient buffer of reserves to meet demand and avoid volatility. We have gathered information from market contacts and have surveyed banks to assess their demand for reserves. I would want to see a healthy cushion on top of that to avoid unnecessary volatility and ensure that the federal funds rate will be largely insulated from daily swings in factors affecting reserves. With regard to the composition of the balance sheet, I favor moving eventually to a portfolio of only Treasury securities--that is, without any agency mortgage-backed securities remaining. It is important to do so in a way that continues to avoid market disruptions. That shift will be under way naturally, albeit slowly, as these securities mature and are replaced by Treasury securities. For the portion of our portfolio in Treasury securities, the Federal Reserve currently holds no Treasury bills, and our portfolio has a much longer weighted-average maturity than the current stock of Treasury securities outstanding in the market or than our pre-crisis portfolio, which was more heavily weighted toward short-dated securities than the holdings of the public. When the Federal Reserve System begins once again purchasing Treasury securities, we will need to decide what maturities to purchase. Given how far out of step the System's current portfolio is from common benchmarks, however, it might make sense to weight those purchases more heavily toward Treasury bills and other shorter-dated Treasury securities for a time. Further into the future, there may be good reasons to shift toward greater holdings of shorter-term securities to provide greater flexibility. However, I want to emphasize that I do not expect this issue to be addressed for some time. The most likely path for the economy appears to have softened against a backdrop of greater downside risks. Our goal now is to safeguard the progress we have made on full employment and target inflation. Prudence counsels a period of watchful waiting. And with balance sheet normalization now well advanced, it will soon be time to wind down our asset redemptions. . . . . . . webpage, Board of Governors, . . . . . . . . . . .

r190308a_FOMC

united states

Monetary Policy: Normalization and the Road Ahead

powell

Thank you for the opportunity to speak here today at the Stanford Institute for Economic Policy Research, a place dedicated to scholarship supporting policies to better peoples' lives. As today is International Women's Day, I would like to preface my remarks by commending the American Economic Association for highlighting the diversity challenges of the economics profession and charting a way forward. Diversity is also a priority at the Fed: I want the Fed to be known within the economics profession as a great place for women, minorities, and others of diverse backgrounds to be respected, listened to, and happy. Committee) lowered the federal funds rate close to zero, which we refer to as the effective lower bound, or ELB. Unable to lower rates further, the Committee turned to two novel tools to promote the recovery. The first was forward guidance, which is communication about the future path of interest rates. The second was large-scale purchases of longer-term securities, which became known as quantitative easing, or QE. There is a range of views, but most studies have found that these tools provided significant support for the recovery. From the outset, the Committee viewed them as extraordinary measures to be unwound, or "normalized," when conditions ultimately warranted. Today I will explore some important features of normalization and then turn to what comes after. In some ways, we are returning to the pre-crisis normal. In other ways, things will be different. The world has moved on in the last decade, and attempting to re-create the past would be neither practical nor wise. As normalization moves into its later stages, my colleagues and I also believe that this is an important moment to take stock of issues raised by the remarkable experiences of the past decade. We are therefore conducting a review of the Fed's monetary policy strategy, tools, and communications practices. I will conclude with some thoughts on the review. $3.7 trillion in longer-term Treasury and agency securities in order to support the economy both by easing dislocations in market functioning and by driving down longer- term interest rates. Consistent with the Committee's long-stated intention, in October 2017 we started the process of balance sheet normalization. We began gradually reducing the reinvestment of payments received as assets matured or were prepaid, allowing our holdings to shrink. The process of reducing the size of the portfolio is now well along. To frame the discussion of the final stages of normalization of the size of the balance sheet, it is useful to consider what the phrase "normal balance sheet" meant in the decades before the crisis. During that period, the main monetary policy decision for the FOMC was choosing a target value for the federal funds rate. Subject to that choice, the Fed allowed the demand for its liabilities to determine the size of the balance sheet. This is a feature of "normal" that we are returning to: After normalization, the size of the Fed's balance sheet will once again be driven by the demand for our liabilities. To see what this means, consider figure 1, which shows the size of the Fed's balance sheet through time, as measured by total liabilities. The values are stated as a percentage of the dollar value of GDP, or gross domestic product. Liabilities began to grow sharply at the end of 2008 and continued to increase until the end of 2014. Since that time, liabilities relative to GDP have fallen appreciably. To understand these changes, it is useful to focus on a snapshot of the balance sheet at three points in time: before the crisis, when the balance sheet was at its largest, and a rough projection for the end of this year (table 1). In 2006, the dominant liability was currency held by the public, and the dominant asset was Treasury securities. The Fed's asset purchase programs increased the balance sheet from just below 6 percent to nearly 25 percent of GDP by the end of 2014. Balance sheets must balance, of course, and the Fed issued reserves as payment for the assets purchased. This action pushed reserves to nearly 15 percent of GDP. The Committee has long said that the size of the balance sheet will be considered normalized when the balance sheet is once again at the smallest level consistent with conducting monetary policy efficiently and effectively. Just how large that will be is uncertain, because we do not yet have a clear sense of the normal level of demand for our liabilities. Current estimates suggest, however, that something in the ballpark of the 2019:Q4 projected values may be the new normal. The normalized balance sheet may be smaller or larger than that estimate and will grow gradually over time as demand for currency rises with the economy. In all plausible cases, the balance sheet will be considerably larger than before the crisis. To understand the differences between the new and old normal, consider the final column in the table, which shows the change, measured in percentage points of GDP, before the crisis, the balance sheet will have grown as a share of GDP by about 10.6 percentage points. Bank reserves account for the biggest part of the growth, or about 5.6 percent of GDP. The crisis revealed that banks, especially the largest and most complex, faced much more liquidity risk than had previously been thought. Because of both new liquidity regulations and improved management, banks now hold much higher levels of high-quality liquid assets than before the crisis. Many banks choose to hold reserves as an important part of their strong liquidity positions. The rest of the increase in liabilities is accounted for by three other categories. First, public currency holdings will have grown by 2.4 percentage points as a share of GDP. Second, the U.S. Treasury maintains an account at the Fed, which has been running 1.4 percentage points higher as a share of GDP. And, third, other liabilities, which are mainly associated with the mechanics of the national and international financial system, will have grown by 1.1 percentage points. As was the case before the crisis, the FOMC's chosen operating regime for controlling short-term interest rates also plays a role in determining the appropriate quantity of reserves. In January, the Committee stated its intention to continue in our current regime in which our main policy rate, the federal funds rate or possibly some successor, is held within its target range by the interest rates we set on reserves and on the overnight reverse repo facility. In this system, active management of the supply of reserves is not required. Thus, the supply of reserves must be "ample," in the sense of being sufficient to satisfy reserve demands even in the face of volatility in factors affecting the reserve market. Put another way, the quantity of reserves will equal the typical reserve demands of depositories plus a buffer to allow for reserve market fluctuations. While the precise level of reserves that will prove ample is uncertain, standard projections, such as those in the table, suggest we could be near that level later this year. As we feel our way cautiously to this goal, we will move transparently and predictably in order to minimize needless market disruption and risks to our dual-mandate objectives. The Committee is now well along in our discussions of a plan to conclude balance sheet runoff later this year. Once balance sheet runoff ends, we may, if appropriate, hold the size of the balance sheet constant for a time to allow reserves to very gradually decline to the desired level as other liabilities, such as currency, increase. We expect to announce further details of this plan reasonably soon. There is no real precedent for the balance sheet normalization process, and we have adapted our approach along the way. In these final phases, we will adjust the details of our normalization plans if economic and financial conditions warrant. After decisions regarding the size of the balance sheet have been made, we will turn to remaining issues, such as the ultimate maturity composition of the portfolio. The Committee has long stated that it intends to return to a portfolio consisting primarily of Treasury securities. The Committee has also been normalizing communication about our policy after a decade of forward guidance. Since December 2008, the FOMC's postmeeting statement had contained ever-evolving forms of guidance about keeping the federal funds rate at the ELB or about the gradual pace at which that rate would return to more normal levels. We removed the last elements of this crisis-era guidance in January. The federal funds rate is now within the broad range of estimates of the neutral rate--the interest rate that tends neither to stimulate nor to restrain the economy. Committee participants generally agree that this policy stance is appropriate to promote our dual mandate of maximum employment and price stability. Future adjustments will depend on what incoming data tell us about the baseline outlook and risks to that outlook. Policy communication will not simply revert to the ways of the early 2000s, however, for transparency advances have continued apace since then. The most significant change from the standpoint of forward guidance is that, since January 2012, funds rate projections reaching up to three years into the future--often referred to as the "dot plot." Returning to a world of little or no explicit forward guidance in the FOMC's postmeeting statement presents a challenge, for the dot plot has, on occasion, been a source of confusion. Until now, forward guidance in the statement has been a main tool for communicating committee intentions and minimizing that confusion. For example, in early 2014, the Committee's intentions were at odds with a common misreading of the dots, and Chair Yellen explained, "[O]ne should not look to the dot plot, so to speak, as the primary way in which the Committee wants to or is speaking about policy to the public at large. The FOMC statement is the device that the Committee as a policymaking group uses to express its opinions . . . about the likely path of rates." If the Committee remains largely out of the business of explicit forward guidance, we will need to find other ways to address the collateral confusion that sometimes surrounds the dots. As readers of the FOMC minutes will know, at our last meeting in January there was an impromptu discussion among some participants of general concerns about the dots. My own view is that, if properly understood, the dot plot can be a constructive element of comprehensive policy communication. Let me follow my two predecessors as Chair in attempting to advance that proper understanding. Each participant's dots reflect that participant's view of the policy that would be appropriate in the scenario that he or she sees as most likely. As someone who has filled out an SEP projection 27 times over the last seven years, I can say that there are times when I feel that something like the "most likely" scenario I write down is, indeed, reasonably likely to happen. At other times, when uncertainty around the outlook is unusually high, I dutifully write down what I see as the appropriate funds rate path in the most likely scenario, but I do so aware that this projection may be easily misinterpreted, for what is "most likely" may not be particularly likely. Very different scenarios may be similarly likely. Further, at times downside risks may deserve significant weight in policy deliberations. In short, as Chairman Bernanke explained, the SEP projections are merely "inputs" to policy that do not convey "the risks, the uncertainties, all the things that inform our collective judgment." Effectively conveying our views about risks and their role in policy projections can be challenging at times, and we are always looking for ways to improve our communications. I have asked the communications subcommittee of the FOMC to explore ways in which we can more effectively communicate about the role of the rate projections. For now, let me leave you with a cautionary tale about focusing too much on dots. Here is a picture composed of different colored dots (figure 2). The meaning of it is not clear, although if you stare at it long enough you might see a pattern. But let's take a step back (figure 3). As you can see, if you are too focused on a few dots, you may miss the larger picture. Delivering on the FOMC's intention to ultimately normalize policy continues to be a major priority at the Fed. Normalization is far along, and, considering the unprecedented nature of the exercise, it is proceeding smoothly. I am confident that we can effectively manage the remaining stages. We live in a time of intense scrutiny and declining trust in public institutions around the world. At the Fed, we are committed to working hard to build and sustain the public's trust. The Fed has special responsibilities in this regard. Our monetary policy independence allows us to serve the public without regard to short-term political considerations, which, as history has shown, is critical for sound monetary policymaking. But that precious grant of independence brings with it a special obligation to be open and transparent, welcoming scrutiny by the public and their elected representatives in Congress. Only in this way can the Fed maintain its legitimacy in our democratic system. Among other initiatives, my colleagues and I on the FOMC are undertaking a year-long review of the Federal Reserve's monetary policy strategy, tools, and communication practices. The review will involve a series of "Fed Listens" events around the country. These will include town-hall-style meetings and a conference where academic and nonacademic experts will share their views. These events will inform staff work and FOMC discussions as we plan for the future. While th is is the first time the Fed has opened itself up in this way, many central banks around the world have conducted similar reviews, and our approach builds on their experiences. We believe that our existing framework for conducting monetary policy has generally served the public well, and the review may or may not produce major changes. Consistent with the experience of other central banks with these reviews, the process is more likely to produce evolution rather than revolution. We seek no changes in law and we are not considering fundamental changes in the structure of the Fed, or in the 2 percent inflation objective. While there is a high bar for adopting fundamental change, it simply seems like good institutional practice to engage broadly with the public as part of a comprehensive approach to enhanced transparency and accountability. Without ruling out other topics, we have highlighted three questions that seem particularly important at present (figure 4): 1. Can the Federal Reserve best meet its statutory objectives with its existing monetary policy strategy, or should it consider strategies that aim to reverse past misses of the inflation objective? 2. Are the existing monetary policy tools adequate to achieve and maintain maximum employment and price stability, or should the toolkit be 3. How can the FOMC's communication of its policy framework and implementation be improved? I would like to spend a few minutes discussing the first topic. Because interest rates around the world have steadily declined for several decades, rates in normal times now tend to be much closer to zero than in the past (figure 5). Thus, when a recession comes, the Fed is likely to have less capacity to cut interest rates to stimulate the economy than in the past, suggesting that trips to the ELB may be more frequent. The post-crisis period has seen many economies around the world stuck for an extended period at the ELB, with slow growth and inflation well below target. Persistently weak inflation could lead inflation expectations to drift downward, which would imply still lower interest rates, leaving even less room for central banks to cut interest rates to support the economy during a downturn. It is therefore very important for central banks to find more effective ways to battle the low-inflation syndrome that seems to accompany proximity to the ELB. In the late 1990s, motivated by the Japanese experience with deflation and sluggish economic performance, economists began developing the argument that a central bank might substantially reduce the economic costs of ELB spells by adopting a makeup strategy. The simplest version goes like this: If a spell with interest rates near the ELB leads to a persistent shortfall of inflation relative to the central bank's goal, once the ELB spell ends, the central bank would deliberately make up for the lost inflation by stimulating the economy and temporarily pushing inflation modestly above the target. In standard macroeconomic models, if households and businesses are confident that this future inflationary stimulus will be coming, that prospect will promote anticipatory consumption and investment. This can substantially reduce the economic costs of ELB spells. Researchers have suggested many variations on makeup strategies. example, the central bank could target average inflation over time, implying that misses on either side of the target would be offset. By the time of the crisis, there was a well-established body of model-based research suggesting that some kind of makeup policy could be beneficial. In light of this research, one might ask why the Fed and other major central banks chose not to pursue such a policy. The answer lies in the uncertain distance between models and reality. For makeup strategies to achieve their stabilizing benefits, households and businesses must be quite confident that the "makeup stimulus" is really coming. This confidence is what prompts them to raise spending and investment in the midst of a downturn. In models, confidence in the policy is merely an assumption. In practice, when policymakers considered these policies in the wake of the crisis, they had major questions about whether a central bank's promise of good times to come would have moved the hearts, minds, and pocketbooks of the public. Part of the problem is that when the time comes to deliver the inflationary stimulus, that policy is likely to be unpopular-- what is known as the time consistency problem in economics. Experience in the United States and around the world suggests that more frequent ELB episodes could prove quite costly in the future. My FOMC colleagues and I believe that we have a responsibility to the American people to consider policies that might promote significantly better economic outcomes. Makeup strategies are probably the most prominent idea and deserve serious attention. They are largely untried, however, and we have reason to question how they would perform in practice. Before they could be successfully implemented, there would have to be widespread societal understanding and acceptance--as I suggested, a high bar for any fundamental change. In this review, we seek to start a discussion about makeup strategies and other policies that might broadly benefit the American people. Tonight I have focused on policy normalization and our efforts to engage the public in what may come after. Before concluding, I will say a few words on current conditions and the outlook. Right now, most measures of the health and strength of the labor market look as favorable as they have in many decades. Inflation will probably run a bit below our objective for a time due to declines in energy prices, but those effects are likely to prove transitory. Core inflation, which is often a reliable indicator of where inflation is headed over time, is quite close to 2 percent. Despite this favorable picture, we have seen some cross-currents in recent months. With nothing in the outlook demanding an immediate policy response and particularly given muted inflation pressures, the Committee has adopted a patient, wait-and-see approach to considering any alteration in the stance of policy. Considering monetary policy more broadly, we are inviting thorough public scrutiny and are hoping to foster conversation regarding how the Fed can best exercise the precious monetary policy independence we have been granted. Our goal is to enhance the public's trust in the Federal Reserve--our most valuable asset. . . . no. 1, . . . . . Journal of , vol. 32

r190311a_FOMC

united states

Brief Remarks

powell

Good evening, and thank you for inviting me to speak to you today. organizations are at the forefront of an important conversation about how to ensure that low- and moderate-income communities are fairly served by the banking industry. The work that you do to promote access to basic banking services, affordable housing, and entrepreneurship opportunities supports the Federal Reserve and other agencies that enforce fair lending laws. The large number and variety of NCRC's local member organizations allow the NCRC to draw a detailed picture of how the Federal Reserve's policies affect lower-income communities, and we deeply appreciate the information that you share with us and the work that it represents. As you know all too well, the current strength of the overall economy masks the struggles many individuals and families face in lower-income urban and rural communities. Low- and moderate-income homeowners saw their wealth stripped away as home values dropped during the financial crisis and have not recovered as quickly or completely as others. Because home equity has been the main source of wealth among low- and moderate-income people, the crisis dealt a particularly severe blow to these households. Most Americans rely on home equity to send their children to college, invest in their own education and training, or start or grow a business. These aspirations are the basis upon which a strong economy is built. That is why your work as NCRC member organizations offering financial counseling, homeownership education, and technical assistance for small businesses is as important as ever. When lower-income individuals and families struggle, it harms their health and well-being and also weakens our economy. When people are connected to education, training, and other resources that help them secure good jobs and other opportunities, they are better prepared to care for themselves and their families and contribute to a strong economy. The Federal Reserve has an extensive community development function, related partnerships between banks and community organizations to address local community and economic development needs. As you know, the CRA requires federal banking regulators--the Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation--to encourage banks to help meet the credit needs of the communities they are chartered to serve, including low- and moderate-income neighborhoods. To complement the work we do with the other regulators to write regulations and guidance implementing CRA, the Federal Reserve System's community development staff help banks understand and meet their responsibilities under the law. Fed staff members also act as liaisons between banks and community organizations to identify local community development needs and solutions. I know that you all are very interested in the agencies' activities related to possible revisions to the current CRA regulations. My colleague, Governor Brainard, who represents the Board in our interagency CRA discussions, will be speaking to you tomorrow, so I will leave it to her to discuss our efforts in detail. But I do want to express my support for an interagency effort to revise the regulations to promote clarity and consistency in our evaluations of banks, particularly in light of the changes in the way bank products and services are delivered. We value the CRA's role in meeting the credit needs of low- and moderate-income neighborhoods and want to be very careful that any revisions serve to strengthen the CRA's purpose. I commend your dedication to ensuring that all Americans have fair access to the economic opportunities that our nation offers. I hope you have a productive conference, and I look forward to our ongoing conversation about how the Federal Reserve can help.

r190312a_FOMC

united states

The Community Reinvestment Act: How Can We Preserve What Works and Make it Better?

brainard

It is a pleasure to have an opportunity to discuss how we can preserve what is working well with the Community Reinvestment Act (CRA) and make it better. recent months, we have seen a high level of engagement from banks and community organizations in discussions and comments about revising the CRA regulations, which serves as testament to the value of the CRA and provides valuable suggestions for improving our regulatory approach. The one message that comes through most clearly is that the CRA is highly valued by bankers and community groups alike. A second message is that the CRA could be even more effective in mobilizing community and economic development. Before offering some thoughts on what we have learned and some possible ways forward, I want to begin by recalling why the CRA was established and what it was designed to achieve, as well as the important role it has played for over 40 years in low- and moderate-income communities across this country. The CRA was one of several landmark pieces of legislation to address inequities in the credit markets in the wake of the civil rights movement. The Fair Housing Act of 1968 and the Equal Credit Opportunity Act of 1974 addressed lending discrimination in mortgage and consumer credit based on race, sex, and other personal characteristics, recognized the importance of data in making these laws enforceable. In 1977, Congress passed the CRA to address the credit needs of low- and moderate-income neighborhoods. With the passage of the CRA, Congress aimed to reverse the urban disinvestment from years of government policies and market actions that deprived lower-income areas of credit by redlining--using red-inked lines to set apart neighborhoods that were deemed too risky. The CRA is unique in important ways. Unlike previous government efforts to address the needs of lower-income areas, the CRA puts decisionmaking about a community's needs and priorities in the hands of local actors. By stipulating that banks have an affirmative and continuing obligation to meet the credit needs of all segments of the local communities they are chartered to serve, including low- and moderate-income communities, the CRA changed the way banks approach their lending and investment decisions in those communities. More than 40 years later, the CRA continues to animate a vibrant community development ecosystem connecting community members with the banks that lend and invest, community organizations that deliver services and develop housing, and state and local governments that direct incentives and subsidies. We participate actively through our community development and examination staff around the country, who help to connect stakeholders, analyze community needs, and assess outcomes. A second unique feature is the public nature of evaluations. The CRA, as amended in 1989, directs federal regulators to evaluate banks' records of helping to meet the credit needs of their local communities and assign one of four statutorily mandated ratings to their performance. Following additional amendments in 1991, the law requires that the agencies make public the banks' ratings and the analysis supporting them. The public nature of CRA evaluations provides a strong incentive for good performance as well as a platform for public input on community needs. Congress largely left it to the banking agencies to describe in regulations how they would evaluate a bank's CRA performance. This flexibility is valuable because it enables the agencies to revise the implementing regulations from time to time to keep the CRA relevant in response to technological innovation and other changes in the landscape for banking and community development financing. The agencies have discussed revising the CRA regulations on and off since 2010, when interagency hearings were held in several locations across the country. Last of Proposed Rulemaking (ANPR) to request comments on a variety of questions related to defining the areas in which regulators evaluate a bank's CRA performance, clarifying and expanding the types of activities that are eligible for CRA consideration, and establishing a metrics-based approach to rating a bank's CRA performance, among other things. The OCC received nearly 1,500 comment letters in response to the ANPR, and we have been reading those letters with great interest. To augment this analysis, since October, the Federal Reserve System has held more than 25 outreach meetings across the country with banks and community organizations, including representation from the other banking agencies, culminating in an in-depth research symposium at the Federal Reserve Bank of Philadelphia. Several themes are emerging from the comment letters and outreach. Perhaps most important, stakeholders overwhelmingly support the CRA and its goals, noting a significant increase in loans and investments in low- and moderate-income communities since the law's enactment. Many commenters emphasize the importance of the CRA in supporting a vital community development ecosystem by bringing together banks, community organizations, state and local governments, educators, foundations, and other stakeholders to address community and economic development needs. Many cautioned the banking agencies to proceed carefully so as not to disturb this important ecosystem. I share this commitment to the CRA and to strengthening its role in community and economic development in the low- and moderate-income communities where it can make the greatest difference. Banks and community organizations agree that the regulations should better reflect the way in which banking products and services are currently delivered. Much has changed since the last major revision to the CRA regulations, which occurred at a time when physical branches were essential for all the deposit and lending needs of bank customers. The current definition of a bank's assessment area--the area in which a bank's performance is assessed--relies on the area around its main branches and deposit- taking automated teller machines (ATMs), which includes a substantial portion of its lending. The internet was just becoming available for commercial use when the current assessment area regulations were finalized. Since that time, technology and changing consumer preferences have led to banks gathering deposits and making loans well outside of their physical branches--for example, online and via mobile devices. So it is fair to ask whether the CRA's current assessment area definition adequately reflects the community a bank serves today. Clearly, it is time to better define the area in which the agencies evaluate a bank's CRA activities, but it is important to retain a focus on the credit needs of local communities. As tempting as it may be to think that digital channels have rendered bank branches unnecessary, my discussions with banks and community stakeholders around the country have underscored the importance of branches as a venue for banks to engage with their communities. Branches are the places that provide the personal face-to-face assistance valued by many consumers and business customers. Moreover, branches provide a local presence for lenders to get to know the borrowers and the communities in which they live, lend, and invest. While technology has much to offer by way of convenience and customer experience, it is often a complement to rather than a replacement for bank branches. For this reason, and to be true to the original intent of the law, I believe that CRA evaluations should retain a focus on the credit needs of the local communities banks serve as indicated by their physical presence in those areas, but not be limited to where they have a physical presence. Each quarter, I have been fortunate to make community visits around the country along with Board and Reserve Bank community development staff. I have seen firsthand the success of the CRA in bringing banks to the table along with community organizations to address complex community needs. Recently, I met with bankers in Denver, Colorado, who were working with local government officials and nonprofits to maintain affordable housing near newly developed public transit lines. In North St. Louis, I met with a community bank that was working with a place-based community development organization called Better Family Life to develop a micro-loan fund that is empowering low-income entrepreneurs. In other places, particularly in high-poverty and rural areas, I saw firsthand how difficult it can be to get access to basic banking services. In a visit to the Mississippi Delta in 2016, I heard from community members about having to drive long distances to deposit a check or access an ATM. The same was true for my visits to Pine Ridge, South Dakota and some towns in the Appalachian region of Kentucky. There is a complex balancing between banks' need to operate branches profitably with communities' needs to connect to the financial mainstream, which we want to recognize in any revisions to the CRA regulations. Bankers and other commenters have emphasized the high value that bank branches have for retail customers and small business owners in underserved communities, and research corroborates this. Similar to banks, community organization commenters support updating the CRA regulations as they relate to a bank's assessment area. They suggest retaining assessment areas around a bank's branches in order to retain the CRA's focus on local low- and moderate-income neighborhoods, while adding areas where banks conduct significant activity without branches. Both bank and community organization commenters were open to having a larger area defined for the purposes of pursuing meaningful community development activities, particularly in cases where banks operate largely without branches. By allowing for more activity in a broader geographic area, they argue that the artificial competition for investments in areas served by several banks (such as New York or Salt Lake City)--so- called credit hot spots--could be mitigated. This could be to the benefit of credit deserts-- those perennially underserved rural areas or small metropolitan areas that may not have a bank branch or, if they do, may not constitute a major market for purposes of banks' CRA evaluations. In reflecting on these suggestions, we have been considering a possible approach that might rework the assessment area definition so that banks of a certain scale would have separate assessment areas for their retail activities and their community development activities. This would retain the law's focus on the credit needs of a bank's local community by evaluating the retail lending and services it offers in the county or other geographic area surrounding its branches , deposit-taking ATMs, and other concentrations of lending and deposit-taking. As part of this approach, a bank would get CRA consideration for community development activities in a more expansive area. Under the current rule, there is no ex ante certainty that a bank's community development activities will receive CRA consideration if they are in the broader statewide or regional area that includes the bank's assessment area. This current approach has proven challenging in practice, as banks sometimes invest in a community development activity only to find that their examiner doesn't agree that the activity is located within the bank's assessment area. Community development activities, in order to achieve an appropriate scale, often operate in larger areas that may not neatly overlap with a bank's assessment area. A more expansive and ex ante clearer community development assessment area definition would afford CRA consideration for any such activity in a state where the bank has an assessment area. This approach would help eliminate uncertainty and could encourage more capital for affordable housing, community facilities, and economic development activities in underserved areas. Moreover, a broader assessment area for community development activities could help address the concentration of investment dollars in metropolitan areas where several banks may have branches, while other smaller metropolitan and rural areas remain chronically underserved. My recent visit to the Pine Ridge Reservation in South Dakota brought home the importance of addressing the problem of credit hot spots and deserts that result from the CRA's current assessment area definition. I met with the Thunder Valley Community Development Corporation and viewed their impressive 34-acre mixed-use project to create a new commercial center for the reservation. When completed, it will include single-family and multifamily housing units, a boarding house for visitors, a community center, and a retail shopping area in a community where residents currently must drive an hour to reach a grocery store. In examining a list of all the project funders, it was noticeable that there were active financing commitments from many foundations, but no banks. Although this is likely to be a very impactful investment, there is only one bank currently whose assessment area may extend to Pine Ridge. In contrast, under the proposed community development assessment area approach, more of the banks with branches in Aberdeen, South Dakota, for instance, might be inclined to make such a community development loan with confidence it would get CRA consideration. By creating separate assessment areas for retail and community development activities, we believe that banks would continue to place their community at the center of their retail lending and service activities while participating in meaningful community development opportunities that may have greater impact due to their broader reach. In reflecting on the comments, listening sessions, and research conference, we have also been contemplating approaches to what community development activities count in order to provide greater predictability and better incentives. Banks and community organizations have noted that the current structure of the large bank performance tests may actually hinder community development financing in a couple of ways. First, under the existing approach, community development loans are considered in the lending test, while community development investments are considered in a separate test. A number of banks and community organizations argue that the form of community financing may be influenced more by the structure of the CRA performance tests than by what makes the most sense for the project. For example, if a bank is concerned about passing its lending test, it might structure financing as a loan rather than an investment to beef up its lending test performance even if an investment would be more effective. Second, a number of banks and community organizations pressed the case for giving CRA consideration to any community development loan outstanding, rather than only those originated since the bank's last CRA evaluation. Under the current rule, banks often make short-term, renewable community development loans simply to ensure that the incremental lending receives CRA consideration at each examination. By contrast, when it comes to investments, all investments on the bank's books at the time of the evaluation are given consideration. Banks and community organizations alike make a compelling argument that all types of community development finance, whether in the form of a loan or an investment, have greater impact when they serve as patient, reliable, committed sources of financing. One possible approach to address these distortions and provide more effective incentives is to create a separate, comprehensive community development test to evaluate community development loans and qualified investments through a similar lens, possibly along with community development services. A separate, comprehensive community development test could encourage banks to provide the patient, committed financing--in the form of loans as well as investments--that community development organizations value the most. This is important because banks are uniquely situated to evaluate the community development finance projects in the states where they operate and to provide the smaller, more complex, and often more impactful, investments that don't attract institutional investors. If banks cannot be confident ex ante that they will get the benefit of CRA consideration for these efforts, which may be time-consuming to evaluate and structure, it is not surprising they would instead gravitate toward activities they know will count. In addition to these broad changes to what and how community development activities should be counted, we recognize there are several definitional issues that merit consideration. For example, many commenters advocated for an expansion of the definition of "community development" to include loans to or investments in community development financial institutions (CDFIs), regardless of the bank's assessment area, because the sole purpose of CDFIs is community development. There are also suggestions that in high-poverty rural areas, where incomes overall may be low relative to federal benchmarks, it may be helpful to adjust the definition of what qualifies as low- and moderate-income so that more CRA activity receives consideration, which we will study. Recognition of the variation in how banks deliver their products and services brings me to the third theme expressed by both banks and community organizations, which is the need for the CRA regulations to be flexible enough to evaluate banks of widely different sizes and business strategies. Different perspectives were offered about some aspects of how to better tailor the regulations, particularly with regards to whether more banks should be considered "small" and, as such, eligible for a streamlined evaluation. Indeed, one of the benefits of creating separate assessment area definitions and performance tests for retail activities and community development activities could be streamlining the tests and applying them in different ways to tailor CRA evaluations to banks based on their size and business strategy. Small banks could have their lending and retail services evaluated under the retail test, while larger banks could be evaluated under both the retail and community development tests. The assessment area definition could be flexible enough to allow banks that conduct most or all of their retail activity online to identify states in which they have a significant level of deposits, lending, or other banking activity in which they would have obligations under either the retail or community development test, as appropriate. There was also wide support for making CRA definitions and evaluation criteria clearer and taking other actions to improve the consistent and predictable application of the regulations during evaluations. Perhaps more important, the commenters strongly supported the agencies continuing the tradition of working together to have one set of rules, consistent interpretive guidance, and regular examiner training to ensure that the CRA is implemented as consistently as possible both within and across the agencies. At the Federal Reserve, we agree that it is important for the banking agencies to take a consistent approach. Finally, there was broad support for expanding the use of metrics in CRA evaluations, where appropriate, especially if they are clearly articulated, are used in tandem with performance context information, and add to the transparency of CRA ratings. We recognize that effective and predictable evaluations rely on good metrics. Metrics, in turn, require good data. Currently, CRA evaluations use HMDA data, which are very useful in understanding where mortgages are made, to whom, and at what cost. Moreover, HMDA data are collected from both banks and non-bank mortgage lenders. But the data collected under CRA to support our analysis of small business and small farm loans are not as comprehensive as mortgage lending data. The Dodd-Frank Wall Bureau with promulgating regulations for the collection of small business loans, and that data should be very helpful when they become available. Separately, the data collected under the CRA on community development loans are not adequate to support the analysis of a separate community development test, so it may be necessary to consider a better reporting system. Collecting data and developing clear metrics will provide the improved clarity and ex ante predictability that banks seek. More and better data will allow for more meaningful metrics by which we can evaluate performance criteria, such as the borrower and geographic distribution of lending and how a bank's performance compares with other similarly situated banks. We may also consider providing more baseline information that describes a bank's performance context, such as the demographic and economic information that helps to describe the credit needs and opportunities present in each assessment area. In addition, there may be ways to more effectively incorporate community engagement into the process--for example, by having the banking agencies develop a joint community contacts database to facilitate access to information from local community stakeholders. Overall, I have been impressed with the number of organizations that took the time to comment on the OCC's ANPR to and attend the Federal Reserve's outreach meetings. It is encouraging to see the high level of commitment to the CRA from banks and community organizations alike. As we think about the path forward, it is important that we retain the CRA's core focus on place while improving upon the regulation's flexibility in order to provide meaningful CRA evaluations of banks that largely deliver their products and services digitally. We want whatever we design to be clear and more predictable for banks in order to promote more and more impactful CRA activity. Taken together, changes to the CRA regulations' definition of assessment areas and performance test structure, along with improved metrics based on better data have the potential to enhance the regulations and better serve its purpose of encouraging banks to help meet the credit needs of low- and moderate-income communities. We understand and appreciate that banks want to be able to make plans and manage their risks carefully through clearer standards regarding what counts, where it will be counted, and how. If we can address these suggestions effectively, banks will be more effective in addressing the needs of their local communities and in some cases extend their activities to benefit chronically underserved communities. I will be interested to hear whether some of the ideas I have shared today resonate with you. I want to assure you that we will continue to engage with bank and community stakeholders to find a path forward that honors the purpose of the CRA by encouraging banks to attend to the credit needs of their local communities and to better address the needs of underserved areas. This engagement will be vital as we join together with the other banking agencies to formulate regulatory changes that preserve what is best about CRA while ensuring its value and relevance for another generation.

r190325a_FOMC

united states

Welcoming Remarks

bowman

Good afternoon. It is a great pleasure for me to join the Federal Reserve Bank of Kansas Conference. For nearly 80 years, these meetings have been at the forefront of important discussions for those with a stake in agricultural lending, with the first National Agricultural Credit meeting held in 1941. At that time and with war looming, there was a clear need to ensure that our nation's farmers had the resources and capability to support the nation in the wake of the great depression, deflation, and the dust bowl. This meeting provided a vital forum for candid conversation, to exchange information, and to forge relationships that would enable lenders to take steps to ensure a sound future for agriculture--a future supported by the efficient and effective provision of credit. In the decades since that first meeting, this conference has seen a number of boom and bust cycles in agriculture, most often the result of volatile swings in commodity prices, land price valuations, and borrowing costs for agricultural business owners. Through all of these challenges, this conference has provided an important opportunity to promote a greater understanding of emerging issues in agricultural finance. Further, the success of these meetings largely depends on the interactions of everyone here today, so I want to thank you for attending and for participating. I am honored to welcome you to the first conference meeting to be held at the Federal Reserve Board. And I'm pleased to support this group's mission to foster discussion on issues pertaining to ag finance, and I look forward to meeting with you and learning from the discussion. Today and tomorrow, we will discuss recent developments in agricultural credit markets. We will also hear from presenters on topics that connect in various ways to the agricultural sector. I am especially pleased to see there is a special focus on rural communities at this year's meeting. As many of you know, this topic holds a special place in my heart. My family has deep roots in rural Kansas and a long history in farming, ranching, and ag banking. I have spent much of my life and career living, working, and raising a family in a rural area. Rural communities are critical for our nation for many reasons including food production and processing, manufacturing, and leading innovation in these industries. According to the U.S. Census Bureau, 97 percent of the country's land mass is rural, and about 60 million Americans call a rural community their home. To put that number in perspective, the rural population of the United States is larger than the combined populations of the New York, Los Angeles, and Chicago metro areas. If we were talking about the economies of those great cities, we'd stress their regional differences, the complexities of demographic change, and the distinct challenges each city faces to remain vibrant and innovative. When the focus shifts to the rural economy, however, the discussion tends to be overly broad and simplistic. The diversity and complexity of our vast rural communities too often gets lost--and I think that needs to change. There are challenges in rural communities. We know them all too well. There is a notable gap in access to broadband. As of 2016, 31 percent of Americans in rural areas were not able to access broadband compared to just 2 percent of Americans in urban areas. This can have a significant business impact on ag producers--for example, limiting access to internet-based cattle auctions or inhibiting the ability of dairies to leverage technology to remotely access animal nutritionists to formulate feed to maximize milk production. Many rural schools struggle to attract and keep qualified teachers who can teach STEM and advanced math classes. These subjects are vital to preparing our children for the opportunities and challenges of a more competitive and technological workplace. One in five people in rural areas have a bachelor's degree, compared to one in three in urban areas. This educational disparity helps explain why the employment-to-population and labor force participation rates in rural areas are lower than in many urban areas. contributing factor to low rural labor force participation is the opioid crisis, which the entire nation is struggling to overcome. Policymakers need to be aware of and be willing to confront these issues. But let me be clear: I am optimistic about the future of rural America. The narrative of rural decline is too sweeping and brushes aside the diversity of the rural experience. Just as many cities thrive while others struggle, there are deteriorating rural communities and rural communities that are thriving and growing. So let's build on these successes and highlight a few of the positives. Following six years of steady population losses, up through 2016, the rural population appears to have stabilized. And while employment is growing more slowly in rural areas than in urban areas, rural unemployment has recovered and is now 1 percentage point below pre- recession levels. The rate of poverty in rural areas is also falling. From a peak in 2013, the rural poverty rate has fallen 2 percentage points to 16.4 percent in 2017. There are also many creative and innovative rural communities. In manufacturing, innovation rates are similar for urban and rural manufacturers, although the services sector in rural areas lags its urban counterparts. And, I am greatly encouraged to see younger generations choosing to live in and return to their roots in rural communities, just as my family and I chose to do. These younger generations are often seeking a rural lifestyle and a deeper connection to a smaller community--a community where they can have a lasting impact. They are bringing with them the same innovative spirit they bring to so many industries. For example, some of these young entrepreneurs and farmers are capitalizing on the recent trend for broader access to locally produced and sourced food. Which brings us back to our focus today: agriculture is the foundation for many rural economies and it is the central topic for this conference. Current conditions in agriculture appear to be stable, though at a low level of income, following sharp declines for several years from the peak in 2013. The prices of major agricultural commodities have also remained low in early 2019. For example, today, the price of corn is about 40 percent less than it was from 2010 to As noted in the Federal Reserve's latest , farmland values are at exceptionally high levels, though down from their 2016 peak. And price-to-rent ratios are at historic highs. At the same time, equity levels at many farms are higher than in the past. We also see above-trend yields are helping to support many operators, though working capital at many farms has fallen along with incomes. Although the increase in problem loans associated with lower incomes has been modest, the Federal Reserve is monitoring the risk that has emerged in recent years. One risk that we are actively monitoring is the recent and devastating flooding in the Midwest and its effect on both agriculture and rural communities across the region. Our thoughts and prayers are with all those who live in the areas affected by this disaster. I would be especially interested to hear your thoughts on how the flooding may affect agricultural operations and how lenders are currently responding. The topics you are discussing today are integral to my role as governor. On Thursday, I will be visiting with and speaking to farmers and community bankers in Deming, New Mexico. An important part of my job is to hear directly from leaders like you and others across this country to better understand current challenges facing your communities, your companies, and your industry. My goal is to bring back the knowledge I gain from these discussions to inform and improve our work to support both the financial sector engaged in agricultural lending and our mission as the central bank of the United States. I hope that conferences like this will help generate a richer discussion about the challenges and unique advantages in rural America so we can develop more creative, effective and direct policy responses. A deeper debate that, for example, distinguishes between low- density and higher-density rural areas, between rural communities that are relatively isolated and those that are connected and close to thriving cities, will help us develop more durable solutions. Before I close, I want to thank you again, as well as the many people at the Federal Reserve Bank of Kansas City and from the Federal Reserve Board who helped organize this year's conference. Thanks to all of you for your work to ensure continued success for American agriculture.

r190328a_FOMC

united states

Agriculture and Community Banking

bowman

Good morning. It is a pleasure to be here today to discuss the important role agriculture plays in our economy, a role that is supported by many community banks. I would like to thank the Independent Community Bankers Association and their New Mexico state association for inviting me to participate in the conversation we will have today. In addition to the bankers and state leaders here, agricultural bankers and other leaders in the industry are listening in from around the country, and I look forward to hearing their views in a few moments. During our time together, I would like to offer some observations on the current state of the farm economy. And because I see community bankers as playing a vital role in this sector, I'll explain why I believe the community banking model is well-suited to supporting agricultural businesses. Finally, I will highlight the Federal Reserve's approach to supervising agricultural banks. As many of you know, before joining the Federal Reserve, I worked at a community bank that primarily served ranchers and farmers and the businesses that support them. More recently, as Kansas state bank commissioner, I supervised many banks whose business and customers were closely connected to the land and the people who work it. I now have the honor of being the first governor to fill the role designated for someone with community banking experience on the Federal Reserve Board, a position that was created by statute in 2015. I plan to fulfill this unique responsibility by traveling widely and listening closely to community bankers, consumers, farmers, ranchers, and dairy farmers--all of the stakeholders with an interest in our work. My goal is to bring back the knowledge I gain from discussions and visits like the one we are having today and use it to improve our work. In doing so, I am confident our work will be more effective and efficient. And in the process, I hope to help you better understand the role of the Federal Reserve and what we are trying to accomplish. The Federal Reserve's monetary policy mandate is twofold: to promote maximum employment and stable prices. To do that, we continuously monitor the health of the U.S. economy in general, and because of its sizable share of overall activity, the agricultural sector in particular. U.S. agriculture and its related industries support about 22 million jobs in the United States and produce close to 10 percent of our exports. healthy farm economy also supports many rural and regional economies. We track commodity prices, ag credit, and exports as factors that influence our outlook on inflation and economic growth. As bank supervisors, we work to ensure safe and sound banking practices. We also monitor trends in asset quality and risk-management practices at agricultural banks as part of our ongoing assessment of the level and direction of risk at these financial institutions and within the agricultural economy. Earlier this week, I had the privilege of welcoming farm sector leaders to the Credit Conference. For nearly 80 years, this conference has brought together leaders in this sector to discuss important issues related to farm credit. Attendees at this year's conference recognized that, while the outlook for the farm economy in 2019 may be similar to a year ago, there are ongoing concerns that increasing stress on producers could lead to repayment difficulties. Farm incomes are expected to remain relatively low this year after declining sharply from the 2013 peak. The price of major agricultural commodities has also remained low in early 2019. For example, today, the price of corn is about 40 percent lower than it was from 2010 to 2013. Dairy producing states like New Mexico are well aware that average milk prices were about 15 percent lower in 2018 than from 2010 to 2013, and well below the highs of 2014. As noted in recent Federal Reserve System Beige Books, higher tariffs on soybeans and other U.S. exports and continued uncertainty over trade policy represent headwinds for American producers. Here in New Mexico, agricultural production rose 5 percent to $3.4 billion in 2017, with strong gains in milk production and livestock. Coming from a ranching family, I'm well aware of the challenges facing livestock producers. New Mexico is also the nation's second largest producer of pecans, producing a record 92 million pounds worth $220 million in 2017. I'm also looking forward to touring a farm later today to learn more about a crop we don't grow a lot of in Kansas--chili peppers. The demand for chili peppers and pecans grown in New Mexico is a good example of the kinds of regional variations we see in agriculture and many other industries. While it is important to understand regional trends, I would like to focus this morning on some overarching themes that have emerged in recent years. Recently, a great deal of attention understandably has been paid to an increase in the number of U.S. farm bankruptcies. While this is, of course, an important indicator to watch, it's equally important to note that the rise over the past few years has been fairly modest. Federal Reserve tracks these developments closely because of their potential implications for both the economy and banking supervision. The challenging outlook has prompted some to wonder if the industry is about to relive the hard times of the 1980s farm crisis. But here, I think, the historical contrast is somewhat reassuring. In the 1970s, farm income in the United States had advanced rapidly as exports surged. The broad increase in farm income led to a significant rise in capital investments in the years that followed. But exports began to soften and fell sharply after the suspension of trade with the then-Soviet Union. Farm incomes dropped, profits declined rapidly, and liquidity in the U.S. farm sector dried up. Other factors turned the sharp downturn into a crisis. High interest rates in the early 1980s, in response to the Great Inflation, contributed to the stress. Despite the reductions in profits and liquidity, capital spending remained elevated in the early 1980s, and was financed with higher levels of debt made possible by rising land values. With debt burdens rising and incomes falling, many farm operations were forced to sell their land, causing the value of farmland to decline rapidly. The result was a sharp increase in farm bankruptcies and a number of bank failures. What about now? There are some similarities. Farm incomes rose rapidly from 2000 before reaching their peak in 2013 at $123 billion. During that time, spurred by rising demand in China and a boom in biofuels, farmers invested heavily in new equipment and technology to meet this rising demand. And, in a troubling echo of the 1980s, farm incomes have now been cut roughly in half. That said, there are some important differences between the 1980s and today. With current inflation low and stable, interest rates are substantially lower than in the 1980s, and overall leverage has been less pronounced. And in contrast to the 1980s, farmland values have declined only modestly in recent years. The combination of relatively low interest rates and modest debt levels has resulted in more-manageable debt service requirements for many agricultural borrowers. Some farm operations have faced significant financial stress, and it is important to recognize that there are still risks. Farmland prices are quite high, and working capital continues to decline. However, returns at banks with a concentration in agriculture have generally remained healthy, as most producers have continued to make loan payments despite weakening revenue streams. Let me shift focus now to the role of banks, particularly community banks, in the U.S. farm economy. Community banks foster strong long-term relationships with farmers, ranchers, and others involved in the local business of agriculture. Often, these relationships are cultivated through community bankers' service on local civic and business organizations or by participation with local farmers and their families in activities to support the local community and economy. Agricultural community banks and agricultural borrowers share a common goal of serving and strengthening their local communities. They are also responsible for providing jobs that maintain the viability of these rural communities. Frequently, community bankers' ties to local agricultural businesses include running family farms, ranches, orchards, and dairies. In other instances, members of the boards of directors that help to oversee community banks are heavily involved in the business of agriculture. These close connections to local agricultural businesses provide community banks with a unique and important perspective in helping to meet local agricultural credit needs. Additionally, community banks can be more agile than their larger competitors, as they employ lenders with a deep understanding of local products and conditions and are able to offer customized funding options in response to changing lending conditions. This agility ultimately allows for better informed lending decisions and provides agricultural borrowers with the means to fund their operations and sustain their communities. As bank supervisors, we pay close attention to the performance of all banks, including agricultural banks. Before we start our conversation today, I would like to discuss how the Federal Reserve approaches bank supervision with a focus on agriculture lending and the challenges our farmers and the community banks that support these operations are facing. which play a vital role in providing rural producers with access to credit. banks hold approximately 50 percent of all agricultural loans outstanding at U.S. commercial banks. As I noted earlier, farm income has declined by approximately 50 percent since 2013, yet agricultural loans have steadily increased. Additionally, agricultural banks have more challenging funding structures given the seasonal funding needs of their agricultural customers and the difficulty of attracting deposits at rural institutions. This combination of a cyclical deposit base, lower inflows of deposits into rural community banks, and growing loan demand from agricultural borrowers has resulted in a greater dependence on borrowed funds to support the recent growth in agricultural lending. Approximately one-third of all agricultural banks are highly concentrated agricultural banks, and the number of these banks has declined slightly over the past are some unique risks and challenges for highly concentrated agricultural banks and their supervisors, these banks also generally remain in sound financial condition. And capital levels and liquidity metrics at most ag banks are generally in line with other banks that do not share these concentrations. While concentrated agricultural banks are currently operating with adequate capital ratios, regulators continue to closely monitor capital levels and to encourage prudent capital planning and concentration risk management, given the potential for unforeseen challenges and emerging risks associated with agricultural lending. With respect to liquidity, as previously noted, rapid asset growth can strain a bank's liquidity position if its funding sources turn out to be unstable. As supervisors, we work with bankers to understand their liquidity planning process, their challenges around attracting deposits, and the risks associated with potentially relying too heavily on noncore sources of funding. We have observed the increasing pressure on community banks to compete for deposits; however, we still see many community banks overcoming this challenge and effectively competing for deposits in their communities. Another key component of all community bank examinations is a focus on asset quality. Financial indicators for agriculture banks remain at manageable levels as highlighted by the nonperforming agricultural loans to total loans ratio of 1.36 percent as In addition to the traditional focus on the financial factors related to agricultural lending, the Federal Reserve has provided examiners with helpful insights into the appropriate treatment of agricultural carryover debt. We understand that bankers need to work constructively with borrowers when problems arise. And this is particularly true for highly concentrated agricultural banks, where maintaining enhanced agricultural credit risk-management practices to facilitate prudent underwriting, early detection of problems, and well-thought-out restructuring plans for agricultural borrowers are imperative to limiting losses and maintaining a sound banking institution. In 2011, the Federal Reserve also issued guidance to the industry on key risk factors in agricultural lending and supervisory expectations for a financial institution's risk-management practices. This guidance applies in all economic environments, but it is especially important in periods of economic stress, because it reminds bankers that the identification of a troubled borrower does not prohibit a banker from working with the borrower. Many banks engaged in agricultural lending are located in communities where farming is the primary economic driver, and simply pushing every borrower with challenges out of the bank does not benefit the long-term interests of the bank or the community it serves. The Federal Reserve recognizes the benefits when lenders work prudently with troubled borrowers in a way that serves the long-term interests of all stakeholders. I would like to conclude by recognizing how fortunate we are to have so many highly skilled and experienced farmers and operators, and agricultural lenders who support them. Modern agriculture is a sophisticated and complex business that requires skilled forecasting of supply and demand, rigorous financial and operational management, and sharp technical expertise. Our farmers and operators are pushing forward the frontiers of agriculture. The integration of robotics, data analytics, geolocation, and advanced sensors holds the promise of a new, more efficient and productive era of "precision agriculture." A close working relationship between farmers and agricultural lenders is essential to the economic growth of agricultural borrowers and the continued success of many rural communities. The outlook for U.S. agriculture is challenging, though agricultural banks remain relatively stable. As such, it is important for the Federal Reserve to continue to tailor effective supervision and regulation to ensure the safety and soundness of agricultural banks, while also making sure that undue burden does not constrain the capacity of these institutions to continue supporting the agricultural communities that they serve.

r190328b_FOMC

united states

Global Shocks and the U.S. Economy

clarida

Good afternoon. It is a pleasure to be here at the Banque de France and take part in this important symposium on the "Euro Area: Staying the Course through Both in the financial press and in international policy circles, one hears a great deal about the spillovers of U.S. monetary policy to other economies. One hears somewhat less, though, about how global shocks affect the U.S. economy. So, in my remarks today, I will discuss how the U.S. economy's increasing integration with the rest of the world has made it more exposed to foreign shocks, and I will focus in particular on the channels of transmission through which these shocks operate. I will close with a few words on current prospects, in which global crosscurrents are again posing challenges for the U.S. economy and monetary policy. Greater Integration between the United States and the Rest of the World The U.S. economy's integration with the rest of the world, both in terms of trade and finance, has risen substantially over the past 60 years. Since the 1960s, both U.S. exports and imports have about tripled as a share of gross domestic product (GDP), with their sum now about 30 percent of GDP--still relatively small by international standards, but certainly notable. Financial linkages have grown enormously as well. The United States has had open capital markets for a long time, but the sum of U.S. external assets and liabilities has grown from about 25 percent of GDP in 1960 to more than 300 percent today. And, reflecting the greater integration of global financial markets, the correlation of U.S. and foreign equity and bond markets has trended broadly upward for several decades. This increased integration I have described has heightened the exposure of the U.S. economy to external shocks. But what are the channels of transmission of these For concreteness, let us consider the case of a negative demand shock originating abroad, such as a foreign recession. First, this shock affects the United States through direct trade links, lowering demand for U.S. exports and, thus, lowering U.S. GDP. Second, the foreign recession leads to lower interest rates abroad and, other things being equal, raises the value of the dollar, which in turn lowers U.S. exports and boosts U.S. imports. The dollar appreciation also puts downward pressure on U.S. import prices and, thereby, inflation. The extent to which foreign worries lead to safe-haven flows may add to the dollar's strength. Finally, there is contagion to U.S financial markets. Let me first elaborate on the exchange rate channel I just mentioned. The traditional determinants of exchange rates-- that is, differentials in expected rates of return--apply to the United States as to other countries. But the U.S. economy is different because of the special role of U.S. government bonds as global safe assets. As a consequence, an adverse foreign shock that damped the demand for risky assets would be expected to trigger safe-haven flows that boost the dollar, weighing on the U.S. economy. The spillover of risk aversion to U.S. markets might well also push down equity prices and widen corporate credit spreads, adding to the contractionary pressures. However, the same safe-haven flows into Treasury securities would cause U.S. long-term yields to fall, mitigating these adverse effects on domestic demand and activity. Let us consider some historical examples of the effect of adverse foreign shocks on the U.S. economy. The Mexican peso crisis of 1994 and '95 and the Asian financial crisis of 1997 through '98 resulted in substantial hits to aggregate emerging market economy (EME) growth, but they had fairly muted effects on U.S. growth. In part, this limited response in previous decades reflected the smaller share of the EMEs in the global economy and, as a related matter, in U.S. trade. Furthermore, the weight of EMEs in the global financial system was lighter in previous decades, so their crises were less disruptive to global markets. Finally, even back then, the safe-haven flows into dollar assets that I highlighted earlier were an important mitigating factor, pushing down U.S. long-term yields. To be sure, the Russian default of August 1998, followed by the collapse of Long-Term Capital Management, had more-substantial effects on global markets and posed greater risk to the U.S. economy, which triggered a policy response by the Fed in which the federal funds rate was cut 75 basis points between September and November of that year. Of note, after economic prospects appeared to stabilize, the Fed reversed those cuts in 1999. In recent times, global shocks have also been consequential for U.S. economic prospects and monetary policy. Examples include the 2011-13 euro-zone recession and the China devaluation and capital flight episode of 2015 and '16, when worries about a hard landing and renminbi depreciation, respectively, roiled world markets. Both of these shocks originated in economies with large footprints in the global economy and financial system, and, as a result, they induced substantial disruptions in global financial markets. During both episodes, U.S. stock markets fell and the dollar appreciated, especially during 2015 and 2016. As ever, these negative shocks were associated with safe-haven flows that pushed U.S. Treasury yields down. Despite the drop in yields, overall financial conditions in the United States tightened, weighing on aggregate demand. Yet, in these episodes, accommodative policy responses in the United States helped ward off actual contractions of U.S. activity. During the 2011-13 euro-zone recession, the United States was already pursuing very accommodative policies in the wake of the Global Financial Crisis, but the timing of the maturity extension program and the third phase of U.S. quantitative easing suggests they were helpful responses to the spillovers to the United States from this downturn. For the China episode of 2015 and concerns about foreign developments and their effect on U.S. financial conditions were a factor contributing to the delay in previously anticipated policy rate increases, thereby supporting the economy. The message from these recent episodes is not just about the importance of timely policy adjustments by the central bank. It is also about the importance of the enhanced resilience of financial institutions that has been achieved since the Global Financial Crisis. Undoubtedly, this resilience helped prevent adverse financial shocks from contributing to a more serious downturn. Let me conclude with some remarks on recent developments. U.S. and other financial markets are attuned to a number of prominent downside global risks, which include Brexit, a sharp slowdown in global growth prospects, and trade tensions. Even though the Fed has been and is committed to a dual mandate to achieve maximum employment and price stability, in today's world, U.S. policymakers can hardly ignore these risks, and three of our most recent FOMC statements have highlighted concerns about global economic and financial developments. In addition, in our policy statements, as well as in other communications, we have indicated that, in the presence of these risks and with inflation pressures muted, we can afford to be patient and data dependent as we assess in future meetings what adjustments in our policy rate might be necessary to sustain growth, employment, and price stability in the U.S. economy. . . . . . . . pdf . Journal of . . w.pdf .

r190328c_FOMC

united states

The Financial Stability Board in 2019

quarles

It is a pleasure to be here today at the European Central Bank in my capacity as chair of anniversary. The broad scope of the JMCB, and the diversity of its scholarship parallels, in some ways, the FSB itself. As we dealt with the global financial crisis, the heads of state and government of the G20 tasked the FSB with identifying and addressing vulnerabilities in the global financial system and developing stronger regulatory and supervisory policies to create a more resilient global financial system in the pursuit of financial stability. Our broad mandate has considerable overlap with the fields that the JMCB covers within its pages. The FSB includes 24 jurisdictions and 73 representatives, including all the members of the G20. Also similar to the JMCB, the FSB is celebrating an anniversary this year, with its creation having occurred 10 years ago. We are a far cry from the JMCB's 50 years, but I hope that in time our continuing work--and not just our response to the late crisis--will prove valuable enough that we one day merit a similar celebration. I am especially pleased to speak at this conference today because the FSB welcomes and encourages the participation of the academic community in tackling issues of global financial stability. I would like to see a greater and more direct contribution of academic subject-matter experts to our work. You may have noticed that the FSB sent out a call for nominations last month for academics to advise our work in evaluating post-crisis reforms--in this particular instance, the evaluation that will examine the effects of the too-big-to-fail reform package that the G20 endorsed in 2010 and that the FSB and other standard setters have implemented since then. In our initiatives to examine the consequences of post-crisis reform, the academic community can help advance the field with analytical tools and critical insight. of The financial crisis exposed fault lines in the financial system that had to be addressed immediately, comprehensively, and vigorously. The body of post-crisis regulation that resulted was founded on the work of academics, including important papers published in the JMCB, and involved the energy and efforts of many standard setters, regulators, supervisors, and central banks. It was an exemplary feat of cooperation and coordination, and it has unquestionably made the financial system safer and more resilient. Today, the post-crisis reform agenda has been largely completed. Basel III is final, the largest global banks have substantially more capital and liquidity, over-the-counter derivatives markets are safer, and steps have been taken to address the risks of too-big-to-fail institutions. Through greater monitoring and policy measures, the FSB is addressing risks from nonbank financial intermediation. And there has been remarkable progress on the difficult and unglamorous task of establishing workable resolution regimes that are consistent with the FSB's clearly defined principles. While we must still work to ensure full, timely, and consistent implementation of the agreed reforms, it is time for the FSB to turn more of its energy and attention to the future. In my time with you today, I would like to do two things. First, I would like to share with you my view on how the work of the FSB must evolve if we are to merit that future celebration and some of the core principles that I think should inform that work. After discussing those principles, I want to focus your attention on some of the work priorities that the FSB will be addressing throughout 2019 and beyond, including nonbank financing, fintech, and evaluating the too-big-to-fail reforms. of Let me turn to the core principles--engagement, rigor, and analysis. These core principles reflect goals that are both inward and outward looking. From within, FSB members have the occasion to reflect on how our work is executed--that is, we must ask ourselves how we can accomplish our mission more effectively, improving the financial sector's ability to support economic growth without threatening financial stability. Outwardly, we will endeavor to reach out to a greater number of constituents and stakeholders for their input on the important financial stability issues they are encountering. This is also a good time to inform a wider public audience on the nature of our mission in a clear, articulate, and jargon-free manner. As the FSB pivots away from the urgency of post-crisis reform development, it is an opportune time to improve our efforts at effective engagement. Recognizing the wide-reaching effects of its work, the FSB must seek input from a broad range of stakeholders, each of whom brings a different perspective to the issues under consideration. While we are directly accountable to the G20, we are, through the G20, accountable to all of the people affected by our actions. In my view, that means we must engage in genuine, substantial dialogue with all of these stakeholders, to a greater and more effective degree than we have in the past. To start, we can strengthen the role of the six regional groups that are a part of the FSB organization. In 2011, the FSB established six consultative groups representing large regions of Commonwealth of Independent States, and Asia. The intent was to expand its outreach program beyond the membership in a systematic manner to better reflect the FSB's global mission. Each group meets once or twice a year and helps the FSB obtain broader input into its policy development agenda. These groups should be re-engineered to not only promote implementation of of international policy initiatives within their respective regions, but also to be in a strong position to keep abreast of developments in financial markets and thus inform FSB policy. We have initiated a study of the operations of the regional groups that will help inform us on ways to upgrade their effectiveness as an outreach and feedback mechanism. I am particularly interested in how we can take lessons learned from this study to move forward with our enhanced engagement. Engagement outside of the FSB is also very important to our mission. We currently engage with businesses, institutions, market participants, and academics on much of our FSB work. For example, we have in the past conducted public consultations on FSB policy recommendations, albeit sometimes with very short timetables. We have now established an expectation that public consultation will be at least 60 days. We need to give the public adequate time to comment on FSB proposals, which can, at times, be quite complex. Beyond public consultation, we must convene more meetings with the private sector and academic community to build a more robust and meaningful dialogue. For example, we kicked off the work we have undertaken at the behest of the Japanese G20 Presidency to study differences in regulatory environments and market conditions across jurisdictions that may have financial stability implications--often referred to as "market fragmentation"--by hosting a workshop with key stakeholders and academics. This was quite successful, and I look forward to such interactions being the rule. In addition, we need to improve our interaction and cooperation with other standard-setting bodies, such as the Basel Committee, the Committee on Payments of in the past, we all owe it to the global community to seek out opportunities for improved cooperation and engagement. To improve FSB transparency, we will be taking a number of important steps. For example, on February 12, 2019, the FSB published a comprehensive work program on its website for the year ahead. This is the first time in the FSB's history that the work program was disseminated publicly. Over the term of my chairmanship, I will continue to look for steps that will allow all stakeholders to have a more open window into the FSB's decisionmaking process and products. I believe improved transparency into the FSB process is critical to our mission. I'm reminded of Lord Hewart's famous--and oft-quoted--remark concerning the importance of jurisprudence to the public: "Not only must justice be done; it must also be seen to be done should be able to apply this concept to the field of global financial standard setting. The second principle I would like to discuss concerns how we assess and mitigate vulnerabilities in the global financial system. The post-crisis reforms addressed the fault lines that led to the crisis and the contagion effects felt around the world, but they will never replace the need for vigilance. If we are not rigorously vigilant, we still risk another crisis. What we need are forward-looking methodologies that use the most advanced analytical tools to spot vulnerabilities well in advance before they lead to widespread financial distress and economic costs. Here the academic community can continue to contribute with cutting-edge and robust modeling techniques. We can only mitigate financial vulnerabilities if we identify them accurately and in a timely manner. As such, the FSB's Standing Committee on Assessment of Vulnerabilities under of the leadership of FSB Vice Chair Klaas Knot of the Dutch National Bank will be directing a considerable amount of energy to developing a cutting-edge framework for the identification and assessment of financial vulnerabilities. Again, the principles of transparency and engagement will shape the work of the group. It is important that a wide spectrum of financial participants be brought into the process, from banks and nonbank financial institutions to financial regulators to national authorities and multilateral standard-setting bodies and the broad academic community. This task is essential to the mission of the FSB; financial developments move at a rapid pace, and being able to quickly and accurately assess vulnerabilities is essential if we are to take action to prevent future crises. Finally, the FSB members must employ a critical eye toward the effects of the regulations that have been put in place. Many of the reforms have been in place long enough for them to be evaluated. We can judge whether reforms are having their intended effects and making the financial system more resilient. Are any regulatory reforms causing unintended, adverse effects? Can we achieve the same, strong level of financial resilience with reforms that are more efficient, simple, transparent, and tailored? The FSB must champion efficient and effective regulation in order to maintain public support for the progress we have made. Now I would like to turn to three prominent issues on the FSB's agenda in 2019. I will start with two relatively new issues that continue to evolve and grow in sophistication: nonbank financing and fintech, and then I will turn to the important work we are beginning on evaluating the effects of reforms aimed at ending too big to fail. of I will loosely define fintech as technology-enabled financial innovation that results in material changes to the provision of financial services. As is often the case when technological innovation meets established business, fintech has attracted a great deal of attention, ranging from utopian claims to hostile skepticism. Claims about fintech's promise abound: it has the power and potential to reduce economic inequality, increase financial inclusion, and boost economic growth. Through the introduction of new methodologies, greater information curation, and reduction in processing costs, fintech could potentially reduce financial volatility and vulnerabilities. We are already seeing significant changes to how many people around the world obtain financial services. For example, in Kenya, a mobile payments technology has introduced mobile wallets to millions of people, many of whom never had a bank account. In the United States, the largest mortgage provider is an online lender. In China, a technology firm started the world's largest money market fund. Yet, alongside this growth in fintech, as my predecessor as FSB chair emphasized, we as regulators must ensure that as we maximize the potential benefits in the development of fintech we minimize the potential risks and costs. The FSB monitors and analyzes the financial stability implications of financial innovation as part of our mandate to identify and address vulnerabilities in the global financial system. Let me outline two areas that we have started to examine in greater detail: the potential effects from the entry of large technology firms into financial services and the potential effects from the growth in decentralized financial technologies. Over the last decade, the world has witnessed an explosion of large technology firms that are weaving themselves into our daily lives: for example, Facebook, Amazon, Apple, Tencent, and Baidu. Some of these firms are increasingly providing some financial services, such as of payments, credit, insurance, and asset management. Their involvement can support financial services broadly. For example, their technology may increase speed and efficiency, and the ubiquity of their presence in our lives may allow them to offer financial services in a more convenient way or at lower cost to consumers. Further, as they are only dipping their toes into the edges of the financial services water, the effects they have on the provision of financial services could grow enormously if they were to dive in. Looking at the technologies that underlie some of the recent innovative financial products, we see a move toward decentralization--that is, a movement toward technologies that connect financial market participants directly without an intermediary. The potential areas of impact are broad: settling interbank payments; verifying and reconciling trade finance invoices; executing, enforcing and verifying the performance of contracts; and keeping an audit trail to deter money laundering. Both the potential entry of large, established technology companies into financial services and the ability of technology to decentralize financial transactions raise a number of issues, some of which may touch on financial stability. Technological innovation offers the promise of a substantially more efficient financial system. But new systems, processes, and types of businesses will bring with them novel fragilities. We continue to be responsible for ensuring that the financial system be sufficiently resilient that businesses and households worldwide need not fear the collapse of the system that serves their needs. These are open questions that need to be addressed, and because they touch on issues of financial stability, the FSB is putting significant resources into understanding these potentially important developments. To be clear, we are not trying to oppose innovation, because innovation, including fintech, offers the world many potential benefits. As the group charged of with ensuring financial stability, however, we have to work to ensure that we can reap the benefits offered by these new technologies without harming financial stability. We hope to offer some answers to these questions in the coming years and to do so in line with the principles I outlined earlier. We will address the questions with discipline and analytical rigor in a way that incorporates the views of the public and key stakeholders and that results in answers that are practical and intelligible. The second issue I would like to discuss is nonbank financing. Since the global financial crisis, nonbank financing has grown relatively rapidly, in both its absolute size and its relative importance in intermediating credit. In the jurisdictions that the FSB closely monitors, nonbank financial assets are just under 50 percent of total global financial assets, a share that has grown by close to 5 percentage points since 2009. Nonbank financial intermediation (the artist formerly known as "shadow banking") provides a valuable alternative to bank financing and helps to support real economic activity. Accordingly, the shift within the financial system toward nonbank financing represents a welcome increase in the diversity of the sources of lending to both firms and households. Even though the core of the financial system is much more resilient than before the global financial crisis, with strengthened bank capital and liquidity requirements, nonbank financing has been a source of systemic risk. Nonbank financing often features high leverage, maturity and liquidity mismatches, opaque structures, and concentrated holdings of risky assets. Nonbank financing can also lead to lower lending standards, bidding up the price of risky assets and sending an encouraging signal to credit underwriters. All of these channels played a role in the recent global financial crisis. More recently, new forms of interconnectedness between of nonbank financial firms and the banking system have emerged that could, in some scenarios, act as channels for domestic and cross-border amplification of risks. Given these potential risks, and the large--and increasing--role for nonbank financing, we need to monitor closely its development. Is the growth of nonbank financing altering the existing market structures? Are there new vulnerabilities in the financial system? How will nonbank financing develop? To answer these important questions, the FSB is progressing on three related tracks. First, the FSB produces an annual report that outlines the developments in nonbank financing, detailing the global trends and potential risks. Second, the FSB promotes the resilience of nonbanks through the development of a range of policies to address systemic vulnerabilities where they arise, while not impeding the growth of sustainable nonbank financing models. In this way, we hope to promote resilient nonbank financial intermediation. The FSB, working alongside other standard-setting bodies such as the Basel Committee and IOSCO, is monitoring the implementation of these policies. Finally, knowing it is arrogant to expect that we got everything right the first time around, it is imperative that we start analyzing the effectiveness of the policies that have been implemented. How should we alter our policies? Have we modelled the risks from nonbank financing accurately? Have we missed a crucial new source of systemic risk? These are all questions that we must ask ourselves. The third issue that I would like to raise is the problem of "too big to fail"--that is, the perception by investors that some institutions will receive support from their governments if they become distressed. This weakens market discipline and allows such firms to become even larger, more leveraged and more complex. To address this challenge, the FSB and other global of standard setters developed a framework and a set of policy measures intended to reduce the moral hazard risks posed by systemically important financial institutions. These measures are intended to make the financial system more resilient, for example through higher capital and liquidity requirements, while simultaneously allowing these institutions to fail without causing disruption to critical services, such as payments. A key element of the FSB's policy measures to address too big to fail is its total loss absorbing capacity standard. Under this standard, the FSB introduced a bail-in (in contrast to a bailout) strategy that necessarily employs a gone concern or post-failure loss-absorbing and recapitalization capacity for the set of global systemically important banks. Crucially, by raising resolution standards, we have improved the potential for non- disruptive bank failure. The implementation of these standards is most advanced in the banking sector, especially for the largest globally important banks. The FSB established crisis management groups, collections of supervisors who monitor resolution plans of the firms. At the same time, we must be conscious that we have not actually tested the failure of a large bank in the marketplace--surely a good thing! Standing over a decade on from the start of the financial crisis, we must ask ourselves, how effective have we been at reducing the problem of too big to fail? Have we achieved our objective to reduce or eliminate the problem? Have we introduced new unintended risks to the financial system or costs to other financial market participants? To start answering these important questions, as part of its broader effort to evaluate the effects of reforms, the FSB is launching an evaluation of the effects of these too-big-to-fail reforms. We intend to bring analytical rigor to these questions, and we recognize that the academic community has undertaken much work in this area. As a result, we will draw of extensively on academic advisors during all phases of the work we are undertaking. I also encourage other experts in this field to look closely to the consultative document that will be coming from the study next year. We welcome the input as we undertake the study of this signature issue from the crisis. Let me conclude by reiterating some of the broad themes I intended to convey today. First, I touched on some of the key principles that I hope will guide the FSB work while I am chair. Those principles include expanded engagement with a broad range of stakeholders and experts, rigorous and careful examination of financial vulnerabilities that may threaten our financial system, and analytical examination of past reforms to ensure that they are making the financial system as resilient as it can be in the most efficient manner possible. Second, I shared some of the key questions we are working on relating to the rise of large technology firms in the financial sector and decentralized financial technologies, the growing importance of the nonbank financial sector, and our burgeoning efforts to look at how well we have addressed too big to fail, the signature issue of the recent financial crisis. Moving forward there will surely be additional issues to address and areas to examine.a During my time as chair of the FSB, I hope to make progress not only on the areas I have outlined but on a range of forward-looking issues and continue to demonstrate the value of the FSB. International standard-setting bodies serve an important role within our global financial sector, and I look forward to the FSB advancing our progress and work in these areas.

r190329a_FOMC

united states

Frameworks for the Countercyclical Capital Buffer

quarles

It is a pleasure to address the Manhattan Institute's Shadow Open Market The SOMC has long served as an important forum for debate regarding the appropriate stance of monetary policy--debates that have often brought alternative perspectives to the challenges facing the Federal Open Market Committee (FOMC) in the pursuit of its dual mandate of maximum employment and stable prices. As Allan Meltzer wrote about his and Karl Brunner's founding of the SOMC, "Our objective at the time and after was not just to complain about the results of policy actions. . . . We hoped also to improve policy discussion." This afternoon, I will briefly remark on the economic outlook and the current stance of monetary policy, and I would then like to devote some time to a discussion of the approach the Federal Reserve has taken on the setting of the countercyclical capital buffer (CCyB) and why I see a setting of 0 percent, as recently affirmed by the Board, as the current appropriate setting for the CCyB. Also, I will review some of the international experience with the CCyB. Given that the CCyB is a relatively new element of our regulatory toolkit, the international experience has the potential to provide useful information on how the CCyB can be made most effective. But first, let me turn to the economic outlook. At last week's meeting, the FOMC left the policy rate unchanged and reiterated its patient approach toward future policy adjustments. I supported this decision. It is prudent at this point to watch the evolution of the incoming data in determining the appropriate stance of policy, particularly given some indication that growth has slowed, at least temporarily, in the most recent data. That said, I remain optimistic about the outlook for the U.S. economy, and I think that we have the potential to maintain growth at a healthy pace in the years ahead. With regard to the recent data, a sharp falloff in some retail sales measures in December suggested a slowing of consumption, the mainstay component of aggregate demand. While I would not suggest ignoring this decline, it does seem rather inconsistent with a number of other indicators, including the continued strength of the labor market and wage gains in recent months. And the labor market does remain strong. Even with a weak reading in February, the three-month average gain in payrolls, at 186,000, remains above most estimates of the pace of job gains needed to maintain downward pressure on an already historically low unemployment rate. As with retail sales, the February payroll number seems a bit odd, especially when measured against the continued strength of the household survey for the same month. That said, weak February payrolls are another reason to continue patiently watching the data to see how economic conditions evolve. Looking past the near-term data, I see many reasons to expect relatively strong growth in the coming years, supported by gains in the productive capacity of the economy. Regarding the inputs of production, I have been encouraged by the increase in labor force participation over the past year. After a period of subdued growth, investment was also strong last year, with spending on equipment and intangibles rising 7 1/2 percent, increasing the capital stock and adding to the productive potential of the economy. Though some recent investment indicators have been less robust, these data are volatile, and I expect continued gains supported by profit growth, continuing impetus from incentives in the tax bill, and a generally favorable business environment. Most important, I have been encouraged by the recent step-up in labor productivity growth. Last year's increase of almost 2 percent marked the strongest growth since the immediate aftermath of the financial crisis and was well above the 1 percent pace that prevailed in the preceding five years. I think there are many reasons to believe that this faster productivity growth could be persistent. My expectation for further increases in capital spending is one. For another, it could be that tight labor markets have played a role in boosting labor productivity growth as employers work to increase efficiency as new workers become harder to find. Turning to inflation, given the volatility and idiosyncrasies of the data, I view the current reading on core PCE (personal consumption expenditures) inflation, at 1.8 percent, as being roughly consistent with our 2 percent objective. Overall, inflation pressures are muted. But I do not believe that the seeming unresponsiveness of inflation to the apparent tightness of the labor market and other aspects of the economy tells the whole story in evaluating slack versus constraint in the economy. Of the many explanations for this phenomenon that have been offered, one possibility that we have to keep in mind is that inflation has remained stable precisely because of the public's confidence that the Fed will maintain a framework that keeps the economy from overheating and inflation from rising significantly above the 2 percent benchmark. Inflation could then for some time remain quite stable in the face of an economy running hot. But if public confidence began to erode because of Fed inaction, a possible consequence could be the de-anchoring of inflation expectations, rather than a gradual and controlled move to an inflation rate sustainably around our 2 percent goal. Of course, there are a variety of alternative explanations for the current surprising relationship between inflation and unemployment, and perhaps all of them are part of a full account. We should also be wary of a material and durable downward drift in inflation expectations below our objective, were we to see that develop, perhaps due to secular changes in the formation of prices or perceived constraints on the ability of monetary policy to react to future downturns. Either way, as a matter of prudent risk management, we must conduct policy in a manner consistent with keeping inflation near target, validating the public's trust in our commitment to our inflation objective and keeping inflation expectations anchored. In regard to policy, I am very comfortable remaining patient at this point and monitoring the incoming data. That said, my sense is that further increases in the policy rate may be necessary at some point, a stance I believe is consistent with my optimistic view of the economy's growth potential and momentum. In the language of central banking, my estimate of the neutral policy rate remains somewhat north of where we are now. Communicating a data-dependent policy framework can be challenging, especially if we do not want to appear to be overly discretionary. It would probably be clearest if we defined what data we are dependent on and how we depended on those data--that is to say, if we adopted a monetary policy rule. Strict rules, however--to achieve their valuable heuristic benefit--are as much about ignoring some data as they are about paying attention to other specific data. Indeed, while rules provide useful and important benchmarks, the complexity and evolving nature of the economy at the current juncture argue for the consideration of a wide range of indicators in assessing the state of that economy. This, in turn, can complicate the communication of data dependence: How can we adopt and convey a clear strategic stance on policy while maintaining our credibility if evolution of the data requires an evolution of that strategy? I prefer a framework where we make it clear that we are focused on broad trends-- elsewhere I have used the aviation analogy that we should not "chase the needles" on the instrument panel. We should be clear that, while we will respond to clear and durable evolution in these broad trends, we are not reacting to every piece of volatile data. Let me now shift gears and return to the CCyB, beginning with how it fits within our broad set of efforts to promote financial stability. The core of that approach has been to establish a set of structural, through-the-cycle regulatory and supervisory standards to ensure resilience against a broad range of shocks. In contrast to the pre-crisis framework, banks, especially the largest and most systemic banks, are now required to maintain substantially higher and higher-quality loss-absorbing capital and other cushions; stress testing examines the resilience of large banks to severely adverse economic conditions; liquidity requirements and regulatory incentives to limit reliance on short-term wholesale funding have reduced funding risk among large banks and their affiliated broker-dealers; and resolution planning requirements reduce the risks that the failure of a large firm would spill into the broader economy. Outside of the banking system, money market mutual fund reform has reduced this sector's susceptibility to destabilizing runs by investors, and requirements that many derivatives be centrally cleared have decreased the opacity and interconnectedness that contributed to the chaos of 2008. In addition to these through-the-cycle measures, the Federal Reserve actively monitors for the buildup of financial stability vulnerabilities and can require large banks to increase their loss-absorbing capacity through increases in the CCyB when systemic vulnerabilities are sufficiently large. While such countercyclical tools are new, their goal is to mitigate the buildup of vulnerabilities during buoyant periods, since experience has proven time and again that vulnerabilities can build during good times as risk appetite grows and memories of earlier instability fade. Effectively mitigating the buildup of risk through the CCyB requires a systematic framework for analyzing vulnerabilities and a mapping of such changes in financial- sector risks into the appropriate level for the CCyB. The Board developed its framework outlining the objectives of the tool and the factors that would influence the determination of its appropriate level through a process of public consultation. Under our policy, the primary objective for activating the CCyB is to build financial-sector resilience during periods when the risks to financial stability have risen to meaningfully above normal levels and there is an elevated possibility of potential losses within the banking sector that could place strains on the supply of credit or otherwise substantially impede economic and financial activity. A secondary objective for using the CCyB is its potential to limit the buildup of financial vulnerabilities by slowing the rate of credit expansion--that is, the possibility that the CCyB may "lean against the wind" of credit fluctuations. This secondary objective, both in the original Basel discussions and in the Federal Reserve's framework, is less central. A notable feature of the Board's current framework is the decision to maintain a 0 percent CCyB when vulnerabilities are within their normal range. Because we set high, through-the-cycle capital requirements in the United States that provide substantial resilience to normal fluctuations in economic and financial conditions, it is appropriate to set the CCyB at zero in a normal risk environment. Thus, our presumption has been that the CCyB would be zero most of the time. When, then, would it be appropriate--given this framework--to activate the CCyB? That is, how do we know when financial vulnerabilities are elevated? The Federal Reserve continuously monitors vulnerabilities, as highlighted in our recent . Our approach is organized around tracking four broad vulnerabilities that academic research and practical experience have shown can amplify negative shocks and result in outsized losses in the real economy. These are asset valuation pressures, household and business debt, funding risk, and financial-sector leverage. As part of this process, the Board considers a number of quantitative indicators--one of which is the credit-to-GDP (gross domestic product) gap proposed in the Basel Committee guidance--that are indicative of potential vulnerabilities. Nonetheless, judgment must play an important role in this process, especially in assessing how interactions between vulnerabilities may serve to mute or amplify the transmission of different kinds of shocks. The framework requires further judgment as to whether the CCyB is the most appropriate tool to address the particular areas of concern, which will depend on, among other things, the extent to which banks subject to the CCyB are exposed to vulnerabilities or contributing to them. Assessing the current state of financial vulnerabilities is thus a critical part of the decision on whether to activate the CCyB. Let me briefly give you my view of each of the four categories in turn. Asset valuations increased to the high end of their historical ranges in many markets over 2017 and the first half of 2018, supported by the solid economic expansion and an apparent increase in investors' appetite for risk. The market volatility and subsequent rebound have muddied the picture somewhat; however, it does seem that valuation pressures have eased to some extent in a particular locus of concern, the market for leveraged loans--that is, syndicated loans to lower-rated or unrated borrowers with already significant debt loads. Now, regarding debt outstanding, borrowing by businesses has reached a historically high level relative to the size of the economy or business assets and there are also signs of deteriorating underwriting standards. Of course, this has happened at a time when corporate profits relative to the size of the economy are also quite high, mitigating some of the concern this might suggest--but the riskiest forms of business debt have increased the most amid such signs. These developments could potentially leave the corporate sector vulnerable to a sharp slowing in economic growth, although we think the banking sector has only limited direct exposures to such borrowers and, to the extent they can be measured, indirect exposures are also limited. The notable levels of vulnerability in asset valuation pressures and business borrowing must be considered alongside modest vulnerabilities associated with household borrowing and the historically low levels of financial-sector leverage and funding risk. Household debt relative to GDP has fallen substantially from the level of a decade ago, and the credit quality of household borrowing remains relatively solid, despite pockets of weakness evident in some areas of auto lending. Even more important, banks now have substantially higher-quality capital and more of it than in the 2000s, owing importantly to the structural reform of capital requirements and stress testing. In fact, under last year's stress tests, capital levels at the largest U.S. banks after a hypothetical severe global recession would have been higher than the actual capital levels of large banks in the years before the crisis. Moreover, around 20 percent of the assets of the most systemically important financial institutions are highly liquid assets that can be sold quickly in the event of stress. And, following reforms to money market mutual funds and other steps, the volume of short-term uninsured funding, most prone to runs, is well below pre-crisis levels. Taken as a whole, financial system vulnerabilities strike me as being not outside their normal range, which is consistent with a zero CCyB under the Board's framework and is why I supported the Board's decision to keep the CCyB at zero earlier this month. While policymakers in the United States have maintained the CCyB at zero since 2016, other countries have adjusted their countercyclical buffers in response to vulnerabilities within their financial sectors. Currently, 13 countries have announced a The CCyB is a novel approach to financial regulation, and I think it is important that we, as regulators, learn from other countries' experiences with the CCyB. I see three important explanations for differences in the CCyB across countries. Perhaps the most important and direct reason for different CCyB levels among different countries is that they face different vulnerabilities. According to national authorities' announcements, the decisions to activate the buffers were generally motivated by credit growth, household debt, and housing prices; in this regard, it is notable that mortgage credit or house prices have expanded rapidly in several countries deploying the CCyB, including Hong Kong and the Nordic countries that have set their increase the CCyB level to 2.5 percent in January 2018 was importantly linked to housing developments. Another explanation for the differences in observed CCyB levels across countries is the range of available macroprudential tools to stem the buildup in financial vulnerabilities in different countries and the degree to which such tools have been the preferred means for addressing identified vulnerabilities. For example, housing market booms, as noted above for Hong Kong, have been a concern in several countries in recent years. Accordingly, some national authorities have used macroprudential tools focused on housing, such as caps on loan-to-value ratios, to try to increase the resilience of borrowers and to indirectly strengthen the resilience of the banks and the financial system should their housing booms turn to busts. For example, policymakers in Canada have not activated the CCyB in response to concerns about housing market risks, but they have lowered the maximum loan-to-value ratio for various mortgage products and capped debt-service-to-income ratios. The availability of such alternative tools for limiting systemic risk may be among the factors influencing the decision to adjust, or not adjust, the CCyB in a number of countries. In this regard, it is notable that the set of macroprudential tools in the United States is limited relative to that in many other countries. Finally, another difference, one that is particular to the United Kingdom, is the with its structural capital requirements. Specifically, under the FPC's framework, the CCyB would equal 1 percent in standard risk conditions--but to avoid having this be a significant increase to already very high levels of capital, the FPC undertook a one-time adjustment to its other capital buffers in order to offset part of this increase. The effect of the policy is that the buffer can be varied--both up and down--in line with the changing risks that the banking system faces over time. This approach is an interesting deviation from the idea in the original Basel discussions and the framework adopted in many other jurisdictions, in which structural capital requirements are set at levels aimed to deliver the desired level of resilience, with the CCyB raised to positive values only at times when vulnerabilities are above normal. In practice, the U.K. framework appears to have provided the FPC with additional flexibility, as it has adjusted the CCyB with evolving financial risks associated with, for example, Brexit. As I examine this experience, systems similar to the United Kingdom's, where the CCyB is positive during normal times, may allow policymakers to react more quickly to economic, financial, or even geopolitical shocks that occur amid otherwise normal conditions, without relying on the slow-moving credit aggregates contemplated in the original Basel proposal. Moreover, this setting of the CCyB permits more gradual adjustments in the CCyB, especially in periods with a high degree of uncertainty about the level of financial vulnerabilities. Another possible benefit of a system that has additional flexibility is the ability to coordinate the setting of the CCyB with the setting of monetary policy in situations where such coordination is valuable. At the same time, I would not expect such situations to be the norm, as the objectives and governance of monetary policy and macroprudential policies are separate for good reasons. In the United States, we have built a substantially safer financial system by focusing on using structural tools that confer through-the-cycle resilience. With that construction work largely behind us, attention naturally turns to the set of time-varying financial regulations--particularly the CCyB. The overall capital framework in the United States has been designed to ensure high capital levels without having to activate the CCyB, with the implication being that the bar for activation would be a high one; but, as a result, much of the time there would not be any buffer to reduce if conditions were to precipitously deteriorate. The United Kingdom's approach to setting the CCyB also relies on having a high overall level of capital during normal times, but, by "swapping" some portion of static capital for CCyB in reaching that high capital level during normal times, and thus making some of that capital part of a releasable buffer, U.K. policymakers have built in more flexibility to move buffers down in times of stress. Other countries provide additional "data points" in terms of possible ways of approaching the CCyB. With the CCyB in active use around the world, I am confident that the academic and policy communities will learn a great deal about how best to use this new tool to build a more resilient financial system.

r190402a_FOMC

united states

Fostering Closer Supervisory Communication

bowman

Federal Reserve Board governor on issues of interest to you and many in your states. I emphasize that word "perspective" because the view from Washington can be very different from how things look in your states and communities. No one knows that better than I do, of course, because not so long ago, I was sitting where you are, enjoying the dinner provided by CSBS and hearing the perspective from Washington. I'm still enjoying the dinner tonight, but find I am now, so to speak, also on the menu. And in this position, as part of the Federal Reserve but also still deeply rooted in my experience as a community banker and state regulator, I'll offer my thoughts on forging a closer relationship and strengthening communication between the Board of Governors and state banking commissioners. First, to establish some context, let me say a few words about the Fed's role and perspective on supervising community banks. The lion's share of community banks are those with total assets of $500 million or less, with the Fed defining the sector as those with up to $10 billion in assets. The Federal Reserve directly supervises 731 state- chartered community banks, which is only a small share of the number of state-chartered banks overseen by CSBS members. The fact that this is only a small share of the total might sound to some people like the Federal Reserve has only a small role in community banking. But it's important to remember that the Fed is the primary federal supervisor responsible for all bank and thrift holding companies, a total of 3,912. This includes the vast majority of all community banking organizations. The Fed also influences the supervision of all community and regional banks by developing both safety and soundness and consumer rules to implement laws passed by Congress, applicable to insured depositories and their holding companies. Typically this is done in collaboration with other federal agencies and after seeking the public's input. I mention Congress and these other agencies to emphasize that the Fed shares responsibility for writing and implementing federal regulations for community banks. Now, let me describe my role. In addition to my broader responsibilities in supervision and regulation, I am Chair of the Board's Smaller Regional and Community Banking subcommittee, which oversees our work in this area. I am also the Chair of the Board's committee tasked with oversight of our rulemaking and supervision on consumer issues. I also participate in carrying out the Federal Reserve's other responsibilities, such as conducting monetary policy and overseeing the payment system. But it's fair to say that my background in community banking was an important reason I was chosen and confirmed by Congress as the first person to fulfill a new requirement that at least one governor have primary experience working in or supervising community banks. My background and commitment to community banking is also some important context for what I have to say about the Fed's interests in improving communication with the members of CSBS. I mentioned a moment ago that the perspective in Washington, and from the Board, can be different from the view from your position as banking commissioners, and that is certainly true. But one thing I have learned, since joining the Board in November, is that my fellow governors, along with the staff at the Board, share your view, as I do, about the vital importance of community banking and the essential role community banks play in our financial system. Community banks are frequently the economic engines supporting and driving the economies of many communities, especially in rural areas. In these communities, they are the primary providers of financial services for individuals and small businesses, and a source of financial advice and civic leadership. They play an indispensable role in areas not served by larger institutions and in other communities of all different sizes, from urban to rural, serving a range of customers, including some that are sometimes not as high a priority for larger banks. I think it is important to note, and too often overlooked, that the vast majority of community banks managed their risks well in the years leading up to and during the financial crisis and were not the source of the excessive risk taking that caused the crisis. For this reason among others, the Federal Reserve has been engaged in an active effort to tailor regulations, including those issued in the wake of the financial crisis, to appropriately reflect the potential risk that an institution might pose to financial stability. I am pleased to see some evidence we are making progress. Last year's CSBS survey found that community banks reported a decrease in regulatory costs in 2017. This was the first reduction in burden reported since the survey began in 2014. The decline was attributed to the implementation of changes stemming from the recent review by the banking agencies under the EGRPRA, the Economic Growth and Regulatory Paperwork Reduction Act of 1996. There has been progress in tailoring regulations that affect community banks, and I believe more progress lies ahead as we implement the changes that Congress included in S. 2155 and explore additional opportunities to reduce burden while maintaining the resiliency and strength of smaller banks. Before I go further, let me give a brief assessment of how community banks are faring. This might seem like an issue that is primarily of interest to community bankers and regulators, but I don't look at it that way at all. One of my most important responsibilities now is voting on the monetary policy decisions of the Federal Open Market Committee, and that requires me to closely and constantly monitor the health of the U.S. economy. And when community banks are the source for more than half of all lending to small businesses, which together account for two-thirds of private sector job creation, then the health of community banking has a big influence on the health of the Since the financial crisis, the health of the community-banking sector has improved significantly. Over those years and today, the large majority of community banks have maintained sound levels of capital. Although the number of community banks in the United States continues to fall due to consolidation, overall the sector continues to post strong earnings, which, in turn, contribute to maintaining healthy capital positions. One measure of this strong financial position is that no community banks failed in 2018. The shared responsibility we have as financial supervisors to ensure the ongoing viability of community banks requires cooperation and coordination. We must continue to ensure that the institutions we supervise are proactively managing their risks to remain strong. It's our job to identify emerging risks to community banks and to ensure bankers are identifying and managing their risks appropriately. We want to ensure that loans are underwritten prudently and that bankers are actively managing the concentrations of credit risk in their portfolios. We welcome the strong lending growth that many community banks are experiencing, which is fueling job creation and sustaining our economic expansion, which in July will become the longest in U.S. history. But strong lending growth must be supported by prudent, well-managed funding plans in order to manage the risk that strains on liquidity may arise more quickly than is sometimes anticipated. Now, let me turn back to my main theme today, which is fostering better communication between CSBS and state banking commissioners and the Board of Governors. Improved communication is a top priority for me for several reasons. First, it is very much my approach to government service, and leadership in particular, to do a lot of listening. A wise person once said that the most effective leaders started a twice-yearly series of roundtables with the chief executives of banks across the state. It was an excellent way for me to better understand the issues that were impacting bankers in a way that was less formal than when banks comment on rules and less fraught than the supervisory process. Sure, it took time away from the office, from consultation with the legislature, and the deadlines all of us have faced. In my case, considering the size of Kansas, it was also time away from home and family. However, I don't have to tell those of you who have also found a lot of merit in such tours that it is an enormous advantage to find out what is on the minds of those in the field. The second, very straightforward reason to foster better communication with all of you is that the nature of financial regulation and supervision in the United States argues strongly for better coordination. To a much greater extent than in other nations, in the United States financial oversight is divided between the federal government and subnational authorities--the states. At the federal level, responsibility is further divided between different agencies, such as the Fed, the FDIC, the Office of Comptroller of the Currency, and the National Credit Union Administration. This system evolved over time, and as things stand, there are some advantages to this specialization. But this division of labor may, at times, inhibit information sharing, and as a general principle, better communication can help overcome this challenge. More specifically, better communication and information sharing between state banking commissioners and the Federal Reserve can further improve the early identification and resolution of emerging issues at community banks. Harnessing and sharing these sometimes divergent views can serve to strengthen a financial regulatory system that shares responsibility among many state and federal agencies. Better communication and information sharing will benefit both you and the Federal Reserve, but my motivation is that the Fed has much to gain here. Because states are responsible for chartering and co-supervising the large majority of community banks, they can provide a broader perspective into local community banking issues and trends. Let me pause here for a moment and say that improving communication doesn't necessarily mean that the Federal Reserve and the CSBS members will always agree. We won't, and perhaps we shouldn't. A diversity of views can be a strength. A robust discussion requires a thorough analysis of differing views, which leads to a more informed understanding of issues. This healthy give and take is the fourth reason for better communication: It leads to better outcomes. I will cite one example that I know is on the minds of many of you--the rulemaking process the agencies are currently engaged in on the community bank leverage ratio (CBLR). Here is an excellent example of where it makes good sense to consult closely. I know you have a lot of knowledge and expertise to bring to bear on this issue, which helps explain why Congress has required the agencies to consult with the states. As you know, the Fed and the other agencies are now gathering and evaluating comments on the CBLR and getting feedback on this interagency proposal. So, now is a good time to re-engage. I am committed to re-engaging with you on the interagency proposal and ways we might be able to improve it. I am eager to hear your thoughts. I have one more reason for better communication, but first I will give you an idea of what I have in mind for that consultation. The formal means by which CSBS and others comment on a rulemaking is important, but I think we would also all benefit from more informal, and more frequent contact. If you have an issue, if you have something to say, just pick up the phone. It is also my intention to be on the road a lot, visiting Federal Reserve Districts and talking to bankers, consumers, and community groups. When I come to your state, I hope to see you, and I promise to make time to talk. My final reason for better communication brings me back to a point I made at the outset: the United States needs a strong community-banking sector. We need strong community banks because they help support strong communities. Strong communities are the building blocks of a strong nation. They provide safety, education and economic opportunities, and help define the values we hold dear. Community banks are vital to the success of communities. They help us save and plan for a better future. The credit they extend helps preserve farming as a way of life for American families, and provides the means for small businesses to start and to thrive, which is so important to the health of communities. This is not an abstract notion for me. As a community banker, I have seen how access to credit and support from a financial institution with deep roots in a community can make a direct and immediate difference in people's lives. I continued to feel that way when I did the job you do, as a state banking commissioner, helping ensure that families and communities have access to financial services that are so important to their success. I enjoyed being a community banker, and I hope you know I've enjoyed working closely with all of you as a banking commissioner, and I now look forward to building a stronger partnership between all of you and the Federal Reserve Board. Thank you for the opportunity to speak to you today. I hope to see you soon in your states, and I wish you a productive and enjoyable visit to Washington.

r190402b_FOMC

united states

The Financial Stability Board: Beyond the Fog of Battle

quarles

Thank you for the opportunity to join you. I am grateful for the chance to speak with such a diverse and distinguished group of academics, industry leaders, and colleagues in regulation and central banking. Conversations like these always remind me that, while we all approach our roles in the financial sector differently, we share a deeper commitment to a common goal: a safe, stable, and resilient financial system, capable of supporting strong and sustainable economic growth. A decade ago, that common goal became an imperative. The financial regulatory community worked frantically to repair the vulnerabilities that the global financial crisis exposed and to address a set of financial risks that failed to respect national borders. The financial system we have today bears the imprint of our response a decade ago. Basel III is now final. Derivatives markets are now safer and better regulated. Levels of capital and liquidity at the largest banks are now higher, and with reforms to recovery and resolution, the risks and potential costs of a catastrophic failure of a major institution are lower. These are profound accomplishments of international cooperation, which returned the global financial system from the brink of collapse to stability and health. But health does not make cooperation or vigilance any less necessary. On the contrary, as the G20 leaders said in creating the Financial Stability The FSB exists to help sustain the common efforts made in the throes of the crisis--to identify and address systemic vulnerabilities, to develop stronger regulatory and supervisory policies, and to create a more resilient global financial system. It is a platform, and a place for its 24 members and 73 representatives to coordinate their work; to identify and address issues that span financial products, intermediaries, and markets; and to avoid the pre-crisis regulatory fragmentation that left financial stability risks unaddressed. The relevance of this platform, to its members and to a changing financial system, is critical to preserving our last 10 years of hard- earned gains. Today, I want to briefly outline three tenets that I believe are essential to preserving the relevance and vitality of the FSB: engagement, vigilance, and analysis. These principles, which I discussed more fully in remarks last week, underlie the most successful elements of the post- crisis reforms. They should remain the foundation of the FSB's work, as we turn from drafting new standards to implementing them and devote more time and attention to the emerging vulnerabilities. Regulatory cooperation has long been essential to financial stability--not only because it fosters consistency in global rules, but also because it fosters trust. When authorities develop new policy together, when they identify common standards and implement them in their home countries, and when they plan and debate the nature of emerging risks, they also develop a common understanding of each other's work and a common approach to addressing new problems. However, trust among regulators means little on its own. It must come with the trust of the constituencies regulators serve, and the trust of those whom our decisions affect. The FSB is a conduit for this trust, as it is accountable to the G20 and to the nations and people the G20 leaders represent. We have an obligation to make the most of that conduit, by engaging in genuine, substantive dialogue with a wide range of stakeholders, to a greater and more effective degree than in the past. We should invite reflection on the design and impact of our efforts, solicit input on risks to financial stability, and better communicate our mission and activities to the public, without the veneer of technical jargon. The FSB can begin this work at home, by strengthening the role of the regional groups that are already part of the organization. In 2011, the FSB established six consultative groups representing large regions of the globe. The intent was to expand our outreach beyond the membership of the G20 and to better reflect the FSB's global mission and impact. Today, the groups meet once or twice a year and help the FSB obtain broader input into its policy development agenda. They can, and should, have the opportunity to do more--not only to promote implementation of international policy initiatives but also to give a clear view of financial stability developments in their respective regions. A study of the groups' operations is now underway, which will shed light on how to upgrade their effectiveness as an outreach and feedback mechanism. We can also engage more effectively outside the FSB--with businesses, public institutions, market participants, and scholars--and give the public the means and the opportunity to provide meaningful feedback on our work. Some steps are already underway. We established a new expectation that all FSB policy recommendations will be open for at least 60 days of public comment, instead of the shorter periods used in the past. We began a recent effort around the differences in regulatory environments and market conditions across jurisdictions--known as "market fragmentation"--by convening key stakeholders and academics for a full-day workshop, which I hope will be the rule for future projects, not the exception. Earlier this year, we released publicly the FSB work program for the first time. This broad engagement is essential to understanding new developments that are relevant to financial stability. Take, for example, the "fintech" trends I discussed in remarks last week, to which the FSB is dedicating significant attention. Claims about fintech run the gamut from the utopian to the apocalyptic--yet the mantle of fintech covers a wide range of new business models, products, and trends. Their contours and their impact also vary across national boundaries, from mobile wallets in Kenya, to online mortgages in the United States, to money market funds founded by technology companies in China. Understanding one of these new uses of technology is not the same as understanding all of them. Identifying the risks and opportunities they pose requires context, information, and insight that can only come from a variety of stakeholders with experience developing, using, and monitoring them. I will continue to seek ways to invite and encourage engagement during my chairmanship, and to give the public a clearer and fuller view of FSB's decisionmaking process. Few efforts are closer to the heart of our collective work or to the accountability and trust that the FSB helps foster. Trust and accountability are also prerequisites for the FSB to pursue its mission. The first prong of our mandate, now a decade old, is to "assess vulnerabilities affecting the global financial system, and identify and review . . . the regulatory, supervisory, and related actions needed to address them . . . ." The FSB's primary role, and its principal contribution to international financial regulation, is to look forward--to see past the issues and practices of the day, and identify new vulnerabilities, long before they lead to widespread economic distress. catalyst for this work. In the months ahead, the committee will develop a new framework for the identification and assessment of financial vulnerabilities. Their efforts will rely on transparent engagement with a wide range of stakeholders--including banks and nonbank financial institutions, the academic community, financial regulators, national authorities, and standard- setting bodies. This kind of broad outreach is essential. The causes of financial crises rarely announce themselves ahead of time, and only a wide range of views can give us the perspective and understanding to address them in advance. The right model for this work is not a small team of detectives--it is a search party. The FSB's efforts on nonbank financial intermediation, which I discussed last week, reflect a similar approach. Nonbank financing has grown since the financial crisis, and it has been a source of systemic risk, often involving high leverage, maturity and liquidity mismatches, opaque structures, and concentrated holdings of risky assets. Nonbank financing can also lead to lower lending standards, bidding up the price of risky assets and sending an encouraging signal to credit underwriters. These channels played a role in the recent global financial crisis, and more recently, new forms of interconnectedness between nonbank financial firms and the banking system have emerged. In some scenarios, both domestically and internationally, such ties could amplify risks. These developments raise important issues. Is the growth of nonbank financing altering existing market structures? Are there new vulnerabilities in the financial system? How will nonbank financing develop, and how should it do so? The FSB is taking a variety of complementary approaches to answering these questions. First, we produce an annual report that outlines the developments in nonbank financing, detailing global trends and potential risks and providing reliable information to foster public discussion. Second, the FSB develops policies to promote the resilience of these firms (without impeding the growth of sustainable nonbank financing models), and we work closely with other multinational organizations to monitor implementation. Finally, and going forward, we must begin analyzing the effectiveness of the policies on nonbank financing that have been implemented. The same spirit of self-reflection should guide the FSB's efforts in other policy areas. Stakeholders trust the FSB to undertake thoughtful, detailed work on emerging risks to financial stability. Yet identifying those risks before a crisis means dealing in uncertainty, and making policy on evolving issues, where no one can claim complete expertise. To maintain that trust, we must be willing to make improvements when the evidence justifies it--to undertake rigorous analysis, before and after issuing new standards, and to follow that analysis where it leads. Many post-crisis policies, including those aimed at the implicit subsidy for "too-big-to- fail" institutions, have been in place long enough to allow for evaluation. We can now begin to ask fundamental, critical questions: What have the effects of these reforms been, whether intended or unintended, salutary or adverse? Have we successfully reduced or eliminated the problem? Has there been a tradeoff, in the form of new, unintended risks or costs? As I have described elsewhere, the FSB is launching a global study with multinational policymakers to start answering these important questions as part of its broader effort to evaluate the effects of post-crisis reforms. We intend to bring analytical rigor to these questions, and we recognize that the academic community has undertaken much work in this area. As a result, we will draw extensively on academic advisors during all phases of the work we are undertaking. I also encourage other experts in this field to look closely to the consultative document that will be coming from the study next year. We welcome the input as we undertake the study of this signature issue from the crisis. The task of this project, like the task of the FSB itself, is to foster insight on the road ahead. The work of the FSB reflects the fact that, in a global financial system, we cannot see and address emerging problems alone. Working as allies and colleagues, we have bound up most of the wounds from the last financial crisis. To avoid reopening them--and returning to a fragmented international regime--we will have to recommit to collaboration, embrace insight where it emerges, and follow evidence where it leads. With broad engagement, rigorous vigilance, and committed analysis, the risks ahead of us can be less dangerous than the ones we left behind.

r190409a_FOMC

united states

The Federal Reserve's Review of Its Monetary Policy Strategy, Tools, and Communication Practices

clarida

I am pleased to attend this event on the distributional consequences of the business cycle and monetary policy. The Opportunity and Inclusive Growth Institute at the Federal Reserve Bank of Minneapolis is a natural venue for discussing this topic in the context of the broad review of our monetary policy framework that we are undertaking this year. In our review, we are examining the policy strategy, tools, and pursue the Fed's dual-mandate goals of maximum employment and price stability. I will speak this evening about the motivation for and scope of our review. We are bringing open minds to it and are seeking perspectives from a broad range of interested individuals and groups, such as the panel of researchers we heard from this afternoon and the community leaders we will hear from tomorrow. To us, it simply seems like good institutional practice to engage broadly with the public in this review as part of a comprehensive approach to enhanced transparency and accountability. Motivation for the Review The Federal Reserve has been charged by the Congress with a dual mandate to achieve maximum employment and price stability, and this review will take this mandate as given. Moreover, the review will take as given that a 2 percent rate of inflation in the price index for personal consumption expenditures (PCE) is the operational goal most consistent with our price stability mandate. While we believe that our existing framework for conducting monetary policy has served the public well, the purpose of this review is to evaluate and assess ways in which our existing framework might be improved so that we can best achieve our dual mandate objectives on a sustained basis. That said, based on the experience of other central banks that have undertaken similar reviews, our review is more likely to produce evolution, not a revolution, in the way that we conduct monetary policy. With the U.S. economy operating at or close to our maximum-employment and price-stability goals, now is an especially opportune time to conduct this review. The unemployment rate is at a 50-year low, and inflation is running close to our 2 percent objective. We want to ensure that we are well positioned to continue to meet our statutory goals in coming years. In addition, the Federal Reserve used new policy tools and enhanced its communication practices in response to the Global Financial Crisis and the Great Recession, and the review will evaluate these changes. Furthermore, the U.S. and foreign economies have evolved significantly since the experience that informed much of the pre-crisis approach. Perhaps most significantly, neutral interest rates appear to have fallen in the United States and abroad. Moreover, this global decline in r* is widely expected to persist for years. The decline in neutral policy rates likely reflects several factors, including aging populations, changes in risk-taking behavior, and a slowdown in technology growth. These factors' contributions are highly uncertain, but, irrespective of their precise role, the policy implications of the decline in neutral rates are important. All else being equal, a fall in neutral rates increases the likelihood that a central bank's policy rate will reach its effective lower bound (ELB) in future economic downturns. That development, in turn, could make it more difficult during downturns for monetary policy to support household spending, business investment, and employment, and keep inflation from falling too low. Another key development in recent decades is that inflation appears less responsive to resource slack. That is, the short-run Phillips curve appears to have flattened, implying a change in the dynamic relationship between inflation and employment. A flatter Phillips curve is, in a sense, a proverbial double-edged sword. It permits the Federal Reserve to support employment more aggressively during downturns--as was the case during and after the Great Recession--because a sustained inflation breakout is less likely when the Phillips curve is flatter. However, a flatter Phillips curve also increases the cost, in terms of economic output, of reversing unwelcome increases in longer-run inflation expectations. Thus, a flatter Phillips curve makes it all the more important that longer-run inflation expectations remain anchored at levels consistent with our 2 percent inflation objective. Finally, the strengthening of the labor market in recent years has highlighted the challenges of assessing the proximity of the labor market to the full employment leg of the Federal Reserve's dual mandate. The unemployment rate, which stood at 3.8 percent in March, has been interpreted by many observers as suggesting that the labor market is currently operating beyond full employment. However, the level of the unemployment rate that is consistent with full employment is not directly observable and thus must be estimated. The range of plausible estimates likely extends at least as low as the current level of the unemployment rate. For example, in the February Blue Chip economic outlook survey, the average estimate of the natural rate of unemployment for the bottom 10 respondents was 3.9 percent, as compared with 4.7 percent for the highest 10 respondents. The decline in the unemployment rate in recent years has been accompanied by an increase in labor force participation, with especially pronounced gains for individuals in their prime working years. These increases in participation have provided employers with a significant source of additional labor input and may be one factor restraining inflationary pressures. As with the unemployment rate, whether participation will continue to increase in a tight labor market remains uncertain. The strong job gains of recent years also has delivered benefits to groups that have historically been disadvantaged in the labor market. For example, African Americans and Hispanics have experienced persistently higher unemployment rates than whites for many decades. However, those unemployment rate gaps have narrowed as the labor market has strengthened, and there is some indication of an extra benefit to these groups as the unemployment rate moves into very low territory. although unemployment rates for less-educated workers are persistently higher than they are for their more-educated counterparts, such gaps appear to narrow as the labor market strengthens. And wage increases in the past couple of years have been strongest for less-educated workers and for those at the lower end of the wage distribution. Scope of the Review Our existing monetary policy strategy is laid out in the Committee's Statement on First adopted in January 2012, the statement has been reaffirmed at the start of each subsequent year, including earlier this year with unanimous support from all 17 FOMC participants. The statement indicates that the Committee seeks to mitigate deviations of inflation from 2 percent and deviations of employment from assessments of its maximum level. In doing so, the FOMC recognizes that these assessments of maximum employment are necessarily uncertain and subject to revision. According to the Federal Reserve Act, the employment objective is on an equal footing with the inflation objective. As a practical matter, our current strategy shares many elements with the policy framework known in the research literature as "flexible inflation targeting." the Fed's mandate is much more explicit about the role of employment than those of most flexible inflation-targeting central banks, and our statement reflects this by stating that when the two sides of the mandate are in conflict, neither one takes precedent over the other. We believe this transparency about the balanced approach the FOMC takes has served us well over the past decade when high unemployment called for extraordinary policies that entailed some risk of inflation. The review of our current framework will be wide ranging, and we will not prejudge where it will take us, but events of the past decade highlight three broad questions. The first question is, "Can the Federal Reserve best meet its statutory objectives with its existing monetary policy strategy, or should it consider strategies that aim to reverse past misses of the inflation objective?" Under our current approach as well as that of many central banks around the world, the persistent shortfalls of inflation from 2 percent that many advanced economies have experienced over most of the past decade are treated as "bygones." This means that policy today is not adjusted to offset past inflation shortfalls with future overshoots of the inflation target (nor do persistent overshoots of inflation trigger policies that aim to undershoot the inflation target). Central banks are generally believed to have effective tools for preventing persistent inflation overshoots, but the effective lower bound on interest rates makes persistent undershoots more likely. Persistent inflation shortfalls carry the risk that longer-term inflation expectations become poorly anchored or become anchored below the stated inflation goal. In part because of that concern, some economists have advocated "makeup" strategies under which policymakers seek to undo, in part or in whole, past inflation deviations from target. Such strategies include targeting average inflation over a multiyear period and price-level targeting, in which policymakers seek to stabilize the price level around a constant growth path. These strategies could be implemented either permanently or as a temporary response to extraordinary circumstances. For example, the central bank could commit, at the time when the policy rate reaches the ELB, to maintain the policy rate at this level until inflation over the ELB period has, on average, run at the target rate. Other makeup strategies seek to reverse shortfalls in policy accommodation at the ELB by keeping the policy rate lower for longer than otherwise would be the case. In many models that incorporate the ELB, these makeup strategies lead to better average performance on both legs of the dual mandate and thereby, viewed over time, provide no conflict between the dual-mandate goals. The benefits of the makeup strategies rest heavily on households and firms believing in advance that the makeup will, in fact, be delivered when the time comes--for example, that a persistent inflation shortfall will be met by future inflation above 2 percent. As is well known from the research literature, makeup strategies, in general, are not time consistent because when the time comes to push inflation above 2 percent, conditions at that time will not warrant doing so. Because of this time inconsistency, the public would have to see a makeup strategy as a credible commitment for it to be successful. That important real-world consideration is often neglected in the academic literature, in which central bank "commitment devices" are simply assumed to exist and be instantly credible on decree. Thus, one of the most challenging questions is whether central banks could, in practice, attain the benefits of makeup strategies that are possible in models. The next question the review will consider is, "Are the existing monetary policy tools adequate to achieve and maintain maximum employment and price stability, or should the toolkit be expanded? And, if so, how?" The FOMC's primary means of changing the stance of monetary policy is by adjusting its target range for the federal funds rate. In the fall of 2008, the FOMC cut that target to just above zero in response to financial turmoil and deteriorating economic conditions. Because the U.S. economy required additional policy accommodation after the ELB was reached, the FOMC deployed two additional tools in the years following the crisis: balance sheet policies and forward guidance about the likely path of the federal funds rate. The FOMC altered the size and composition of the Fed's balance sheet through a sequence of three large-scale securities purchase programs, via a maturity extension program, and by adjusting the reinvestment of principal payments on maturing securities. With regard to forward guidance, the FOMC initially made "calendar based" statements, and, later on, it issued "outcome based" guidance. Overall, the empirical evidence suggests that these added tools helped stem the crisis and support economic recovery by strengthening the labor market and lifting inflation back toward 2 percent. That said, estimates of the effects of these unconventional policies range widely. In addition to assessing the efficacy of these existing tools, we will examine additional tools to ease policy when the ELB is binding. During the crisis and its aftermath, the Federal Reserve considered but ultimately found some of the tools deployed by foreign central banks wanting relative to the alternatives it did pursue. But the review will reassess our earlier findings in light of more recent experience in other countries. The third question the review will consider is, "How can the FOMC's communication of its policy framework and implementation be improved?" Our communication practices have evolved considerably since 1994, when the Federal Reserve released the first statement after an FOMC meeting. Over the past decade or so, the FOMC has enhanced its communication practices to promote public understanding of its policy goals, strategy, and actions, as well as to foster democratic accountability. Strategy; postmeeting press conferences; various statements about principles and strategy guiding the Committee's normalization of monetary policy; and quarterly summaries of individual FOMC participants' economic projections, assessments about the appropriate path of the federal funds rate, and judgments of the uncertainty and balance of risks around their projections. As part of the review, we will assess the Committee's current and past communications and additional forms of communication that could be helpful. For example, there might be ways to improve communication about the coordination of policy tools or the interplay between monetary policy and financial stability. Activities and Timeline for the Review The review will have several components. are currently conducting town hall-style events, in which we are hearing from a broad range of interested individuals and groups, including business and labor leaders, community development advocates, and academics. The conference here at the hosted by the Dallas Fed in February. Several more events will follow in In addition, we are holding a System research conference on June 4-5, 2019, at the Federal Reserve Bank of Chicago, with speakers and panelists from outside the Fed. The program includes overviews by academic experts of themes that are central to the review: the FOMC's monetary policy since the financial crisis, assessments of the maximum sustainable level of employment, alternative policy frameworks and strategies to achieve the dual mandate, policy tools, global considerations, financial stability considerations, and central bank communications. Two sessions will feature panels of community leaders who will share their perspectives on the labor market and the effects of interest rates on their constituencies. We expect to release summaries of the events and to livestream the Chicago conference. Building on the perspectives we hear and on staff analysis, the FOMC will conduct its own assessment of its monetary policy framework, beginning around the middle of the year. We will share our conclusions with the public in the first half 2020. The economy is constantly evolving, bringing with it new policy challenges. So it makes sense for us to remain open minded as we assess current practices and consider ideas that could potentially enhance our ability to deliver on the goals the Congress has assigned us. For this reason, my colleagues and I do not want to preempt or to predict our ultimate finding. What I can say is that any refinements or more material changes to our framework that we might make will be aimed solely at enhancing our ability to achieve and sustain our dual-mandate objectives in the world we live in today. at the Brookings Papers on Economic Activity Conference, held at the Brookings . . vol. 10 . . . . . . . -------- (2019). . . . . . Forum, sponsored by the Initiative on Global Markets at the University of Chicago . vol. 122 . Policy in a Low Journal of . . no. 1, . . . , Fall, held at the . .pdf . . . Journal of . . . vol. 4 . Journal of . vol. 32 . . . symposium sponsored by the Federal Reserve Bank of Kansas City, held in . . .

r190410a_FOMC

united states

Progress on the Transition to Risk-Free Rates

quarles

I am pleased that we have this opportunity to meet with many of the institutions active in helping to achieve a transition from LIBOR to the risk-free rates identified by coordinated the international effort to reform interest rate benchmarks at the direction of the G-20. This is an important effort across the globe, but nowhere is it of more importance than in the jurisdictions relying on LIBOR. Let's review the reasons that we are here. By the time of the financial crisis, much of the global financial system had come to rely on LIBOR. And yet LIBOR was a very poorly structured rate; contributing banks were asked to submit quotes without any requirement of evidence of transactions or other facts to back them up, which made them susceptible to manipulation. Thanks to subsequent reforms, contributors now provide this type of evidence where possible, but LIBOR is based on an underlying market with so few transactions that there is relatively little direct evidence they can provide. Many submitting banks are uncomfortable with this situation, and some sought to stop their participation. As a result, the official sector has had to step in to support LIBOR by securing a voluntary agreement with the remaining banks to continue submitting through 2021. At the same time, the official sector has convened national working groups to help develop alternative risk-free rates and navigate a very complicated transition. Many people have used reference rates with little thought. The experience with LIBOR should teach us that this has to change and that we cannot risk making this kind of mistake again. Banks should conduct at least as much due diligence on the reference rates that they use as they conduct on the creditworthiness of their borrowers. The national working groups convened by many of the FSB member authorities have performed that type of diligence with the Secured Overnight Financing Rate, or SOFR, and the risk-free rates identified in other jurisdictions. That effort has been a clear and positive example of public-private sector cooperation. These alternative risk-free rates have been created or substantially reformed to ensure that robust, transaction-based rates that accurately represent well-defined underlying markets and are consistent with internationally-recognized standards are available. I want to thank the many institutions here today, and the many more that have played equally constructive roles, for their efforts in this process. This month marks the one-year anniversary of SOFR and is close to the one-year anniversary of the other new risk-free rates. Over that year, we have seen the establishment of new futures markets, cleared swap markets, and debt markets based on these new rates. SOFR futures, which did not exist a year ago, have seen more than $7 trillion in cumulative notional volumes. This has been a crucial development for market liquidity and is helping to spur the growth of SOFR swaps and other derivative markets. And SOFR is being used in cash products, with $81 billion in SOFR-linked debt issued over the past year. New markets do not arise overnight--in normal circumstances they can often take decades to develop. What has been accomplished over the past year is remarkable. At the same time, we have only a little over two and a half years until the point at which LIBOR could end, and the transition needs to continue to accelerate. The private sector needs to take on this responsibility, and we expect you to do so. The Federal Reserve's supervisory teams are including the transition away from LIBOR in their monitoring discussions with large firms. The Federal Reserve will expect to see an appropriate level of preparedness at the banks it supervises. As the Alternative Reference Rates Committee (ARRC) continues to make progress on industry-led approaches to the transition, the transition paths away from LIBOR will become clearer for banks of all sizes. While we expect you to take on this responsibility, we in the public sector must also recognize our need to help. The FSB has supported this transition globally, and, in work. It is important that we continue to do so, and I want to thank you all today for the thoughts you have shared with us on this transition and what is needed to make it succeed.

r190411a_FOMC

united states

Community Banking in the Age of Innovation

bowman

Today I would like to share a few observations on innovation as it relates to the business of community banking. In particular, I will focus on opportunities for community banks to innovate through collaboration with fintech firms. I'll also discuss the role our regulatory structure plays in those relationships. Community banks, like just about every other industry, are learning to adapt to a new world of rapid innovation and shifting consumer expectations. Consider the personal loan market. TransUnion estimates that, about a decade ago, fintech lenders generated less than 1 percent of personal loans. Today, fintech firms originate a larger share of personal loans than banks. This is not all bad news for banks, though. And we should not simply assume that gains by fintech lenders are necessarily at the expense of banks. A large share of fintech lending is actually originated by bank partners working with fintech firms. Similarly, the funds that flow between a fintech lender and borrowers almost always travel across the payment services of a bank. So, while the changes in the market pose potential competitive threats to banks, the changes also raise potential new opportunities for banks. This is especially true for community banks, which are frequently the banks working most closely with fintech lenders. Not too long ago commentators were looking at the impact of fintech on community banking as a zero-sum game. In fact, many wondered whether fintech firms would put community banks out of business. Recent surveys show how much the discussion has evolved. Rather than fear fintech, more and more community bankers are trying to determine how to adjust their businesses to make the best use of new technologies. For example, in the 2018 almost universally agreed that fintech firms are not currently their primary competitor. findings are consistent with data from the 2018 Small Business Lending Survey by the Federal In contrast, almost half of large banks identified fintech firms as frequent competitors. The FDIC opined that this was likely because large banks, like fintech firms, rely heavily on data and automated technology when making loans. A much lower percentage of small banks--only about 10 percent--saw fintech firms as current competitors. As I'll discuss later, it's likely that the relationship-driven nature of community bank business models helps insulate these banks from fintech competitors. The most interesting possibilities emerged in survey responses about small banks working together with fintech firms as partners. The community bank respondents to the CSBS survey included numerous anecdotes and observations about the important opportunities fintech offered community banks to diversify their products, extend their reach, and offer more efficient services for their customers. Indeed, fintech firms may complement the activities of community banks well. For example, while small businesses may value the relationships that local bankers offer, they don't like the lengthy process of filling out loan applications, waiting for credit decisions, and the time it takes small banks to make funds available. Those are precisely the types of issues that data- driven, smartphone-based fintech firms are good at addressing. At the same time, community banks' particular advantages, mainly their strong relationships with their small business customers, would be difficult for smartphone-based fintech apps to replicate. Let me give you an example: During last year's community bank research conference held at the Federal Reserve Bank of St. Louis, a community bank based in Santa Barbara described the harrowing months around the end of 2017. As you know all too well, a massive wildfire, followed by a deadly series of mudslides, caused devastating damage and five emergency evacuations of Montecito, California. Within 24 hours of the wildfires and mudslides, the community bank declared an emergency and began executing its disaster response strategy. The bank used a wide range of communication channels, from Facebook to text messaging, to keep in touch with its employees and its customers. It created a disaster assistance package for personal and small business borrowers. The bank offered new lines of credit (including a 24-hour turnaround on small business lines). It made payment deferrals on already- existing loans and provided free safe deposit boxes. The bank even delivered more than 15,000 water bottles and offered more than 1,500 respirators for local residents at its branches. Small businesses value that level of commitment to local customers. And they recognize the benefits of working with local community banks that understand their regions and businesses. The relationship-based nature of community bank lending helps small businesses that often lack the detailed balance sheets or detailed income statements required by larger banks. Even when small businesses do have the right paperwork, large banks are still less likely to engage in lending at small bank levels. That's because the transaction costs for underwriting a $100,000 loan are comparable to a $1 million loan. None of this is lost on small businesses, which, according to the Federal Reserve's Small Business Credit Survey, continue to express greater satisfaction with small banks compared to both big banks and fintech lenders. This is not to say that the community banks' advantages cannot be challenged by technology. Many fintech firms are currently looking to leverage their deep ties with other aspects of small businesses--their payment processing services or accounting software, for instance--to build data-driven lending products that are tied to the day-to-day operations of small businesses. Fintech lenders can provide easy-to-use online applications, rapid loan decisionmaking, and customer service that helps bring low cost, automated decisionmaking to the small loan segment that was previously left to community banks. Partnering with a fintech firm can offer a community bank the best of both worlds. The bank can take advantage of new technology and all the efficiencies that come with it as an extension of the banks' relationship-banking model. In a sense, fintech is just the latest evolution of a long history of community banks leveraging technology to provide financial services. I'm thinking here of technologies, such as ATMs, mobile banking, and remote deposit capture. their part, community banks offer potential fintech partners a consumer-first approach to business and a number of advantages: deposit insurance and liquidity; a stable customer base; credibility in a local community; and settlement and compliance services. I thought one response to the CSBS survey said it best. The banker wrote, "[T]he future of consumer banking seems to be as a participant in the ecosystem of lifestyle technological solutions rather than as a standalone banking relationship." The problem is, as the banker continued, "[I]t's hard to imagine what exactly that will look like and how it will change the banking business model." What can the Federal Reserve do to foster prudent community bank innovation? I believe that if a bank has not started thinking about how innovation may impact its business, it is very late to the game. This does not mean that every bank has to run out this afternoon and partner with a fintech firm--there may be all kinds of thoughtful reasons not to engage with them. What matters is that banks, particularly community banks, have gone through the process of thinking about the relevant issues. But there are many questions about how community banks are adjusting to the changing environment. For instance, about 40 percent of community banks say that they do not currently offer online loan applications and have no immediate plans to do so. That 40 percent may represent bankers who have not gone through the process of thinking about the way innovation impacts their business. But it could just as easily include bankers who have looked at the issue carefully and concluded that online loan applications do not fit within their business model. Most importantly, though, it may indicate that some community banks may feel that they are simply not able to leverage new technology. Most small banks are dependent on partnerships with third parties to make use of new technologies. I am concerned that some banks are not innovating because they feel they lack the ability to navigate the complex regulatory and compliance issues that may arise. Among other requirements, for instance, before a bank partners with a fintech firm, it first has to consider regulatory and supervisory expectations regarding third-party risk management. Written guidance may allow for risk-based or more tailored approaches, but a number of factors contribute to what the Treasury Department recently described as, "more stringent de facto regulation." In particular, Treasury raised concerns that banks that are worried about criticism from examiners might, "adopt a more uniformly stringent vendor oversight approach rather than trying to convince their examiners to permit a more tailored approach to vendor oversight." And this may ultimately deter banks from trying to explore how they should be adapting their business strategies in light of technological change. Given these concerns, what is the Federal Reserve Board's role, as a bank supervisor, in helping community banks chart their way through changing times? Let me be clear. It is management's job, not an examiner's job, to set the bank's innovation strategy. However, I think supervisors need to recognize and be thoughtful about how we might affect the way banks consider innovation. In particular, I think it's important that we fulfill our responsibilities to ensure safety and soundness of banks and consumer protection, while also creating a regulatory environment that does not hinder the integration of responsible innovation into the strategic direction that a bank opts to pursue. Here at the Federal Reserve, I think it's vital that we look closely at our work to make sure we are not hindering prudent innovation between community banks and fintech firms. We need to think about how our guidance sets expectations for the way banks should engage third parties. We should explore more effective ways to interact with banks, including through new types of outreach and education. To begin with, I recognize the need to ensure that our outsourcing risk management guidance appropriately reflects the present-day business realities of the banks that we supervise. For instance, regulators' third-party risk management frameworks discuss particular types of contractual terms and, where appropriate, audit rights by a bank over its service providers. However, when a community bank is in negotiations with large vendors, such as cloud service companies and core service providers, they may not be in a position to make demands. As the largest vendors grow even larger, this will get even harder for small banks. Concerns about compliance can also make it difficult for a community bank to work with small partners. A small fintech firm may lack a traditional financial history, raising questions about how a bank can evaluate the fintech firm's status in the industry, corporate history, or financial condition. It certainly can be difficult for a small bank's staff to evaluate a wide range of potential technology vendors. I am heartened to hear that small banks are increasingly collaborating to vet third-parties. Services are also emerging to help deliver due diligence information to banks and monitor their third-party relationships. Of course, the ultimate responsibility should always lie with bank management, as each relationship involves particular services, for particular needs, for a particular risk profile. However, it seems sensible that a large amount of the vetting, contracting, and onboarding process could be streamlined for banks by collaboration or specialized third-party services. We are also looking to engage industry more frequently and openly so that we understand how they are weighing questions relating to innovation and how bank regulators may or may not impact those considerations. Along those lines, we continue to look for new ways for regulated institutions to interact with the Federal Reserve System outside of the examination process. In particular, supervised institutions, vendors, or consumer advocates are encouraged to contact their local Reserve Bank; talk with us about the issues they face; and, in some cases, ask clarifying questions about relevant legal frameworks and supervisory expectations. As regulators and banks adjust to this post-crisis age of innovation, it is important for us to understand the pain points for community banks. As a regulator, my priority will always be facilitating a banking system that is safe and sound and in which consumers are treated fairly. But regulators also have to ask: How can our approach to supervision be modernized so that it supports responsible innovation by our supervised institutions? The efforts I described today are hopefully just a start. I am looking forward to personally engaging with community bankers, vendors, and consumer advocates to hear their perspectives on the most productive ways for the Federal Reserve Board to help community banks thrive in this age of innovation.

r190411b_FOMC

united states

U.S. Economic Outlook and Monetary Policy

clarida

Thank you for the opportunity to participate in the Institute of International Finance's Washington Policy Summit. Before we begin our conversation, I want to share a few thoughts about the outlook for the economy and monetary policy. The U.S. economy is in a good place and operating close to both of the Federal Reserve's dual-mandate objectives of maximum employment and price stability. Real gross domestic product (GDP) rose about 3 percent last year, and in July, just a few months from now, the current economic expansion almost certainly will become the longest on record. The unemployment rate is near the lowest level recorded in 50 years, and average monthly job gains have continued to outpace the increases needed over the longer run to provide jobs for new entrants to the labor force. Average hourly earnings are showing a welcome increase consistent with a healthy labor market, yet inflation remains near our 2 percent objective. All that said, the incoming data have revealed signs that U.S. economic growth is slowing somewhat from 2018's robust pace. Prospects for foreign economic growth have been marked down, and important international risks, such as Brexit, remain. U.S. inflation as measured by the core personal consumption expenditures (PCE) price index, which excludes volatile food and energy prices and is a better gauge of underlying inflation pressures, has been muted. And some indicators of longer-term inflation expectations remain at the low end of a range that I consider consistent with our price- stability mandate. The considerations I just mentioned have led most private-sector forecasters to project that growth will continue in 2019 but at a somewhat slower pace than in 2018. At the Federal Reserve, in our most recent Summary of Economic Projections, the median growth of 2 percent will be the modal, or most likely, outcome; that core PCE inflation will rise to 2 percent; and that the unemployment rate will fall a bit further, to 3.7 percent, by the end of the year. Again, these are modal outcomes, and, of course, my FOMC colleagues and I should and do factor in risks on either side of these projections in our policy deliberations. Given this outlook for the U.S. economy, we decided at our March meeting that the current stance of monetary policy is appropriate. The federal funds rate is now in the broad range of estimates of neutral--the rate that tends neither to stimulate nor to restrain the economy. Our baseline economic projections see economic growth for the year as a whole running somewhat above the Committee's median estimate of its longer-run trend and core PCE inflation remaining near our 2 percent objective. For these reasons, we have indicated we can be patient as we assess what adjustments, if any, will be appropriate to the stance of monetary policy. At our March meeting, the Committee also released revised Balance Sheet Normalization Principles and Plans, and it announced that the FOMC intends to slow the runoff of our securities starting in May and to cease the runoff entirely in September. This decision is the culmination of discussions that we had over the previous four meetings about our operating framework and reflects our desire to converge to a balance sheet that is no larger than it needs to be to conduct monetary policy efficiently and effectively. In September, reserve balances likely will remain above the minimum level, including a buffer, consistent with this goal. In that case, we anticipate we will likely hold the size of our balance sheet at the level reached in September for a time thereafter and let the gradual increase in other (nonreserve) liabilities, such as currency, slowly shrink the level of reserves. Importantly, with this decision on the size of our balance sheet now taken, we can turn our attention in future meetings to discussing and deciding on the maturity composition of our System Open Market Account portfolio. As you may know, last November the Federal Reserve announced that in 2019 we are undertaking a System review of our monetary policy strategy, tools, and communications practices. Information about this review can be found on the Federal In this review, we will listen to a broad range of stakeholders at public events held around the country, and we will draw on their insights as we assess how best to achieve and maintain maximum employment and price stability in the most robust fashion possible. Taking these viewpoints on board, the FOMC will begin its own discussions this summer on how we might refine our framework, and we will provide a public assessment after the review is complete. Thank you, and I look forward to our conversation.

r190503a_FOMC

united states

Models, Markets, and Monetary Policy

clarida

It is an honor and a privilege to participate once again in this annual Hoover for Monetary Policy," is especially timely. As you know, the Federal Reserve System is conducting a review of the strategy, tools, and communication practices we deploy to pursue our dual-mandate goals of maximum employment and price stability. In this review, we expect to benefit from the insights and perspectives that are presented today, as well as those offered at other conferences devoted to this topic, as we assess possible practical ways in which we might refine our existing monetary policy framework to better achieve our dual-mandate goals on a sustained basis. My talk today will not, however, be devoted to a broad review of the Fed's monetary policy framework--that process is ongoing, and I would not want to prejudge the outcome--but it will instead focus on some of the important ways in which economic models and financial market signals help me think about conducting monetary policy in practice after a career of thinking about it in theory. Let me set the scene with a very brief--and certainly selective--review of the evolution over the past several decades of professional thinking about monetary policy. I This article is, of course, most famous for its message that there is no long-run, exploitable tradeoff between inflation and unemployment. And in this paper, Friedman introduced the concept of the "natural rate of unemployment," which today we call u What is less widely appreciated is that Friedman's article also contains a concise but insightful discussion of Wicksell's "natural rate of interest"-- r * in today's terminology--the real interest rate consistent with price stability. But while u * and r * provide key reference points in Friedman's framework for assessing how far an economy may be from its long-run equilibrium in labor and financial markets, they play absolutely no role in the monetary policy rule he advocates: his well-known k -percent rule that central banks should aim for and deliver a constant rate of growth of a monetary aggregate. This simple rule, he believed, could deliver long-run price stability without requiring the central bank to take a stand on, model, or estimate either r * or u *. Although he acknowledged that shocks would push u away from u r away from r *), Friedman felt the role of monetary policy was to operate with a simple quantity rule that did not itself introduce potential instability into the process by which an economy on its own would converge to u * and r Friedman's policy framework, u * and r * are economic destinations, not policy rule inputs. Of course, I do not need to elaborate for this audience that the history of k -percent rules is that they were rarely tried, and when they were tried in the 1970s and the 1980s, they were found to work much better in theory than in practice. Velocity relationships proved to be empirically unstable, and there was often only a very loose connection between the growth rate of the monetary base--which the central bank could control-- and the growth rate of the broader monetary aggregates, which are more tightly linked to economic activity. Moreover, the macroeconomic priority in the 1980s in the United States, the United Kingdom, and other major countries was to do "whatever it takes" to break the back of inflation and to restore the credibility squandered by central banks that had been unable or unwilling to provide a nominal anchor after the collapse of the By the early 1990s, the back of inflation had been broken (thank you, Paul Volcker), conditions for price stability had been achieved (thank you, Alan Greenspan), and the time was right for something to fill the vacuum in central bank practice left by the realization that monetary aggregate targeting was not, in practice, a workable monetary policy framework. Although it was mostly unspoken, there was a growing sense at the time that a simple, systematic framework for central bank practice was needed to ensure that the hard-won gains from breaking the back of inflation were not given away by short-sighted, discretionary monetary experiments that were poorly executed, such as had been the case in the 1970s. That vacuum, of course, was filled by John Taylor in his classic 1993 paper, remind you of the enormous impact this single paper had not only on the field of monetary economics, but also--and more importantly--on the practice of monetary policy. For our purposes today, I will note that the crucial insight of John's paper was that, whereas a central bank could pick the " k " in a " k -percent" rule on its own, without any reference to the underlying parameters of the economy (including r * and u *), a well- designed rule for setting a short-term interest rate as a policy instrument should, John argued, respect several requirements. First, the rule should anchor the nominal policy rate at a level equal to the sum of its estimate of the neutral real interest rate ( r *) and the inflation target. Second, to achieve this nominal anchor, the central bank should be prepared to raise the nominal policy rate by more than one-for-one when inflation exceeds target (the Taylor principle). And, third, the central bank should lean against the wind when output--or, via an Okun's law relationship, the unemployment rate--deviates from its estimate of potential ( u In other words, whereas in Friedman's k -percent policy rule u * and r * are destinations irrelevant to the choice of k , in the Taylor rule--and most subsequent Taylor-type rules-- u * and r * are necessary inputs. As Woodford (2003) demonstrates theoretically, the first two requirements for a Taylor-type rule are necessary for it to be consistent with the objective of price stability. The third requirement--that monetary policy lean against the wind in response to an output or unemployment gap--not only contributes to the objective of price stability, but is also obviously desirable from the perspective of a central bank like the Fed that has a dual mandate. The Taylor approach to instrument-rule specification has been found to produce good macroeconomic outcomes across a wide range of macroeconomic models. Moreover, in a broad class of both closed and open economy dynamic stochastic general equilibrium, or DSGE, models, Taylor-type rules can be shown to be optimal given the underlying micro foundations of these models. In original formulations of Taylor-type rules, r * was treated as constant and set equal to 2 percent, and potential output was set equal to the Congressional Budget Office (CBO) estimates of potential output, or, in specifications using the unemployment rate as the activity variable, u * was set equal to the CBO's estimate of the natural unemployment rate. These assumptions were reasonable at the time, and I myself wrote a number of papers with coauthors in the years before the Global Financial Crisis that incorporated them. meeting, my colleagues and I consult potential policy rate paths implied by a number of policy rules, as we assess what adjustments, if any, may be required for the stance of monetary policy to achieve and maintain our dual-mandate objectives. A presentation and discussion of several of these rules has been included in the semiannual to the Congress since July 2017. One thing I have come to appreciate is that, as I assess the benefits and costs of alternative policy scenarios based on a set of policy rules and economic projections, it is important to recognize up front that key inputs to this assessment, including and , are unobservable and must be inferred from data via models. I would now like to discuss how I incorporate such considerations into thinking about how to choose among monetary policy alternatives. A monetary policy strategy must find a way to combine incoming data and a model of the economy with a healthy dose of judgment--and humility!--to formulate, and then communicate, a path for the policy rate most consistent with the central bank's objectives. There are two distinct ways in which I think that the path for the federal funds rate should be data dependent. Monetary policy should be data dependent in the sense that incoming data reveal at any point in time where the economy is relative to the ultimate objectives of price stability and maximum employment. This information on where the economy is relative to the goals of monetary policy is an important input into interest rate feedback rules--after all, they have to feed back on something. Data dependence in this sense is well understood, as it is of the type implied by a large family of policy rules, including Taylor-type rules discussed earlier, in which the parameters of the economy needed to formulate such rules are taken as known. But, of course, key parameters needed to formulate such rules, including and , are unknown. As a result, in the real world, monetary policy should be--and in the United States, I believe, is--data dependent in a second sense: Policymakers should and do study incoming data and use models to extract signals that enable them to update and improve estimates of and . As indicated in the Summary of Economic Projections, FOMC participants have, over the past seven years, repeatedly revised down their estimates of both and as unemployment fell and real interest rates remained well below prior estimates of neutral without the rise in inflation those earlier estimates would have predicted (figures 1 and 2). And these revisions to and appeared to have had an important influence on the path for the policy rate actually implemented in recent years. One could interpret any changes in the conduct of policy as a shift in the central bank's reaction function. But in my view, when such changes result from revised estimates of u * or r *, they merely reflect an updating of an existing reaction function. In addition to u * and r *, another important input into any monetary policy assessment is the state of inflation expectations. Since the late 1990s, inflation expectations appear to have been stable and are often said to be "well anchored." However, inflation expectations are not directly observable; they must be inferred from models, other macroeconomic information, market prices, and surveys. Longer-term inflation expectations that are anchored materially above or below the 2 percent inflation objective present a risk to price stability. For this reason, policymakers should and do study incoming data to extract signals that can be used to update and improve estimates of expected inflation. In many theoretical rational expectations models, expected inflation is anchored at the target level by assumption. From a risk-management perspective, it makes sense, I believe, to regularly test this assumption against empirical evidence. Because the true model of the economy is unknown, either because the structure is unknown or because the parameters of a known structure are evolving, I believe policymakers should consult a number and variety of sources of information about neutral real interest rates and expected inflation, to name just two key macroeconomic variables. Because macroeconomic models of r * and long-term inflation expectations are potentially misspecified, seeking out other sources of information that are not derived from the same models can be especially useful. To be sure, financial market signals are inevitably noisy, and day-to-day movements in asset prices are unlikely to tell us much about the cyclical or structural position of the economy. However, persistent shifts in financial market conditions can be informative, and signals derived from financial market data--along with surveys of households, firms, and market participants, data, as well as outside forecasts--can be an important complement to estimates obtained from historically estimated and calibrated macroeconomic models. Interest rate futures and interest rate swaps markets provide one source of high- frequency information about the path and destination for the federal funds rate expected by market participants (figure 3). Interest rate option markets, under certain assumptions, can offer insights about the entire ex ante probability distribution of policy rate outcomes for calendar dates near or far into the future (figure 4). And, indeed, when one reads that a future policy decision by the Fed or any central bank is "fully priced in," this is usually based on a "straight read" of futures and options prices. But these signals from interest rate derivatives markets are only a pure measure of the expected policy rate path under the assumption of a zero risk premium. For this reason, it is useful to compare policy rate paths derived from market prices with the path obtained from surveys of market participants, which, while subject to measurement error, should not be contaminated with a term premium. Market- and survey-based estimates of the policy rate path are often highly correlated. But when there is a divergence between the path or destination for the policy rate implied by the surveys and a straight read of interest rate derivatives prices, I place at least as much weight on the survey evidence (for example, derived from the surveys of primary dealers and market participants conducted by the Federal Reserve Bank of New York) as I do on the estimates obtained from market prices (figure 3). The Treasury yield curve can provide another source of information about the expected path and ultimate longer-run destination of the policy rate. But, again, the yield curve, like the interest rate futures strip, reflects not only expectations of the path of short-term interest rates, but also liquidity and term premium factors Thus, to extract signal about policy from noise in the yield curve, a term structure model is required. But different term structure models can and do produce different estimates of the expected path for policy and thus the term premium. Moreover, fluctuations in the term premium on U.S. Treasury yields are driven in part by a significant "global" factor, which complicates efforts to treat the slope of the yield curve as a sufficient statistic for the participants can provide useful information--for example, about "the expected average federal funds rate over the next 10 years," which provides an alternative way to identify the term premium component in the U.S. Treasury curve. provide valuable information about two key inputs to monetary policy analysis: long-run r * and expected inflation. Direct reads of TIPS spot rates and forward rates are signals of the levels of real interest rates that investors expect at various horizons, and they can be used to complement model-based estimates of r *. In addition, TIPS market data, together with nominal Treasury yields, can be used to construct measures of "breakeven inflation" or inflation compensation that provide a noisy signal of market expectations of future inflation. But, again, a straight read of breakeven inflation needs to be augmented with a model to filter out the liquidity and risk premium components that place a wedge between inflation compensation and expected inflation. As is the case with the yield curve and interest rate futures, it is useful to compare estimates of expected inflation derived from breakeven inflation data with estimates of expected inflation obtained from surveys--for example, the expected inflation over the Market- and survey-based estimates of expected inflation are correlated, but, again, when there is a divergence between the two, I place at least as much weight on the survey evidence as on the market-derived estimates. The examples I have mentioned illustrate the important point that, in practice, there is not typically a clean distinction between "model-based" and "market-based" inference of key economic variables such as r * and expected inflation. The reason is that market prices reflect not only market expectations, but also risk and liquidity premiums that need to be filtered out to recover the object of interest--for example, expected inflation or long-run r *. This filtering almost always requires a model of some sort, so even market-based estimates of key inputs to monetary policy are, to some extent, model dependent. Let me now draw together some implications of the approach to models, markets, and monetary policy I have laid out in these remarks. Macroeconomic models are, of course, an essential tool for monetary policy analysis, but the structure of the economy evolves, and the policy framework must be--and I believe, at the Federal Reserve, is-- nimble enough to respect this evolution. While financial market signals can and sometimes do provide a reality check on the predictions of "a model gone astray," market prices are, at best, noisy signals of the macroeconomic variables of interest, and the process of filtering out the noise itself requires a model--and good judgment. Survey estimates of the long-run destination for key monetary policy inputs can--and, at the Fed, do--complement the predictions from macro models and market prices (figure 6). the Fed's job would be (much) easier if the real world of 2019 satisfied the requirements to run Friedman's k -percent policy rule, but it does not and has not for at least 50 years, and our policy framework must and does reflect this reality. This reality includes the fact that the U.S. economy is in a very good place. The unemployment rate is at a 50-year low, real wages are rising in line with productivity, inflationary pressures are muted, and expected inflation is stable. Moreover, the federal funds rate is now in the range of estimates of its longer-run neutral level, and the unemployment rate is not far below many estimates of u *. Plugging these estimates into a 1993 Taylor rule produces a federal funds rate very close to our current target range for the policy rate. So with the economy operating at or very close to the Fed's dual- mandate objectives and with the policy rate in the range of FOMC participants' estimates of neutral, we can, I believe, afford to be data dependent--in both senses of the term as I have discussed--as we assess what, if any, further adjustments in our policy stance might be required to maintain our dual-mandate objectives of maximum employment and price stability. . . ------ (2019). . . . . vol. 37 Journal of . . vol. 56 f . vol. 58 vol. . Journal of . . . . . . . vol. . , , . . ed., .

r190508a_FOMC

united states

"Fed Listens" in Richmond: How Does Monetary Policy Affect Your Community?

brainard

It is good to be here in Richmond today. I appreciate my colleague, Tom Barkin, leading this event, and it is a pleasure to also be with Sherrie Brach Armstrong, CEO of economic development manager; Shawn Smith, director of workforce development at Goodwill of Central and Coastal Virginia; and Robert Ukrop, chairman and CEO of Today's community listening session is part of a series called "Fed Listens." The Federal Reserve is undertaking a review to make sure we are carrying out the monetary policy goals assigned to us by the Congress in the most effective way we can. conducting this review, we are reaching out to communities around the country in sessions like this to understand how you are experiencing the economy day to day. So what are the monetary policy goals the Congress assigned us? Congress has assigned the Federal Reserve to use monetary policy to achieve maximum employment and price stability. These two goals are what we refer to as our dual mandate. By price stability we mean moderate and stable inflation. Specifically, the Federal Open Market Committee (FOMC)--the group at the Fed responsible for determining monetary policy--has announced that our goal is to keep inflation around 2 percent over time. The maximum employment part of our dual mandate is straightforward: The Congress has directed us to achieve the highest level of employment--and thus the lowest level of unemployment--that is consistent with price stability. While the Congress has specified the goals for monetary policy and a set of tools or authorities to pursue them, it has allowed the FOMC to determine how to best go about achieving those goals. Last year, core inflation was very close to our goal. And the unemployment rate is at a 50-year low. We are undertaking our review to ensure we are well positioned to meet our goals for many years to come. We also want to make sure that the way we are setting monetary policy is keeping up with the way the economy is changing, which I have been referring to as the "new There are a few key features of that new normal. For example, interest rates have stayed very low in recent years not only in the United States, but also in many other advanced economies. For a variety of reasons, it seems likely that equilibrium interest rates will remain low in the future. Low interest rates present a challenge for the traditional ways of conducting monetary policy. That is especially true in recessions when, in the past, the Federal Reserve has typically cut interest rates by 4 to 5 percentage points in order to support household spending and business investment. But when equilibrium interest rates are low, we have less room to cut interest rates and thus less room to buffer the economy using our conventional tool. For example, following the most recent recession in 2008 and 2009, we kept interest rates as low as the Committee thought they could go, which was close to zero, for many years. Another big change in the economy is that inflation doesn't move as much with economic activity and employment as it has in the past. This is what economists mean when they say the Phillips curve is very flat. In many ways, the flatter Phillips curve has advantages: It means that the labor market can strengthen a lot and pull many workers that may have been sidelined back into productive employment without an acceleration in inflation, unlike what we saw in the 1960s and 1970s. Similarly, inflation doesn't fall as much in recessions. But there is an important risk with today's low sensitivity of inflation to slack: It makes it more difficult to boost inflation to our objective of 2 percent on a sustainable basis. And, as we know from other countries, if inflation consistently falls short of the central bank's objective, lower inflation tends to get embedded in people's expectations. Expectations that inflation will remain low in turn can create a self-fulfilling dynamic with actual inflation, making it even more difficult for the central bank to boost inflation. And because inflation is reflected in nominal interest rates, that, in turn, can also reduce the amount of policy space the central bank has available to prevent the economy from slipping into recession. In fact, in recent years, central banks around the world have had to use a larger variety of policy tools than they traditionally used to respond to the financial crisis and support economic expansion. Given the new normal of low equilibrium interest rates and low sensitivity of inflation to slack, it is prudent to assess how well various approaches worked both here and around the world, with a view to identifying the best ways to promote the goals the Congress assigned to us. As such, we will be looking widely at our tools and strategies, assessing not just the various approaches that were undertaken, but also approaches that have been proposed but not tried. One of those is the idea that the Federal Reserve should explicitly promise to "make up" for the fact that interest rates can't be cut as much as during past recessions. The Federal Reserve could hold interest rates lower after a recession is over, perhaps by promising not to raise interest rates until inflation or the unemployment rate have reached a particular level. A related idea is average inflation targeting, meaning the Fed would aim to achieve its inflation objective on average over a longer period of time--perhaps over the business cycle. So if inflation fell short during a recession, the Federal Reserve would aim at inflation above target during the recovery and expansion. This approach would also have aspects of a make-up policy, as policy would likely be kept easier--that is, more accommodative--than otherwise during the period where inflation is above target. While such approaches sound quite appealing on their face, they have not yet been implemented in practice. There is some skepticism that a central bank would in fact prove able to support above-target inflation over a sustained period without becoming concerned that inflation might accelerate and inflation expectations might rise too high. Another idea I would like to hear more about involves targeting the yield on specific securities so that once the short-term interest rates we traditionally target have hit zero, we might turn to targeting slightly longer-term interest rates--initially one-year interest rates, for example, and if more stimulus is needed, perhaps moving out the curve to two-year rates. Under this policy, the Federal Reserve would stand ready to use its balance sheet to hit the targeted interest rate, but unlike the asset purchases that were undertaken in the recent recession, there would be no specific commitments with regard to purchases of Treasury securities. Similar to make-up policies, such an approach could help communicate publicly how long the Federal Reserve is planning to keep rates low. I should emphasize that these are just a few ideas; there may be other good ideas, and part of the process we are engaged in involves looking around for other ideas. Most, if not all, of the ideas have both advantages and disadvantages, and we will have to consider them carefully as our review progresses. Of course, we may find that the preferred approach is modest enhancements to the tools that proved their worth during the crisis. Now, how does today's event fit into all of this? Just as the Federal Reserve Bank of Richmond is sponsoring today's event with representatives of its local community, so too are other Reserve Banks sponsoring similar events. We are making sure to hear from people across the country. We will also hold a national-level conference in Chicago in June. And, in addition to presentations from prominent outside experts, we made sure to add panels to hear from community organizations, training institutions, and other groups that can give us insights on how monetary policy is affecting Main Street. Since I arrived at the Fed, I have put a premium on visiting communities all over the country to get a direct sense of how they are experiencing the economy. In fact, my first such visit was in this District with community development staff from the Federal Reserve Bank of Richmond. Due to the wisdom of the Fed's original architects, the Federal Reserve System derives tremendous value from interacting with communities from all around the country. In 2015, we created a Community Advisory Council at the Federal Reserve Board, where we hear from a broad variety of community groups and others. And many of the regional Federal Reserve Banks have similar councils, including In our review this year, we are listening broadly and are seeking perspectives at the community level. So today we want to hear from you. How is your community experiencing today's economy? Is everyone who wants a job able to get one? Can they get the necessary training? Are businesses finding it relatively easy to hire the workers they need? What about inflation and pricing power? And what about the availability and cost of credit--whether it be to start or expand a small business, buy a car to get to work, or invest in owning a home or getting a degree? I look forward to hearing your views on these and other questions.

r190509a_FOMC

united states

Welcoming Remarks

powell

It is my pleasure to welcome all of you to the Federal Reserve System's development offices of all 12 Federal Reserve Banks and the Board of Governors. These biennial conferences are one manifestation of the Federal Reserve's deep commitment to supporting research that helps policymakers, community development practitioners, and researchers improve the economic well-being of families and communities. These gatherings also inform the Federal Reserve System's work in promoting consumer protection and community development, and I would like to thank all of you for your contributions to this conference. This year our conference focuses on pathways to the middle class. While there are many definitions of "middle class," I think we can agree that achieving a basic level of economic security is fundamental. Surveys suggest that many Americans believe being middle class means having a secure job and the ability to save. In recent decades, income growth for middle-income households has lagged behind that for high-income households. In addition, economic resources differ markedly by race, education, occupation, geography, and other factors. Those circumstances underscore a two-fold challenge for our country: fostering the conditions that will help lower-income families reach the middle class, while ensuring that middle-class status still provides the basic economic security that it has traditionally offered. The conference organizers have sorted through the many research questions that will be addressed today and tomorrow and have taken away three key observations that are fundamental to addressing the challenges related to the middle class. The first observation is to note the long-term decline in relative income growth and upward economic mobility for those in the middle. According to a number of measures, income has grown more slowly for middle-class households since the 1970s than for those with higher incomes, resulting in wider income inequality. The kind of generational improvements in living standards that were long the hallmark of the American middle class have steadily diminished. In the 1950s, better than 80 percent of children born in middle-class households grew up to out-earn their parents, but more recently only around half do. One factor in this decline is the increase in income inequality I just noted, and another is slower productivity growth. This conference will touch on other possible reasons for this decline in upward mobility and relative income, such as changes in the prospects for career advancement that vary by occupation and location. The second observation is the widening gap in economic status and prospects between those with a college degree and those without one. In the 1960s, well over 90 percent of working-age men held a job, and there was very little difference in employment between those with or without a college degree. While the share of college- educated working-age men with a job has fallen from more than 95 percent in 1967 to around 90 percent in 2017, it has plunged for others. Ninety-five percent of male high school graduates were working in 1967, but only about 80 percent of them were working as of 2017. Among working-age men without a high school diploma, about 90 percent had a job in 1967 versus a bit more than 70 percent in 2017. For women of working age, the trends are less clear, but those without a college degree are also less likely to work today. Research presented this morning will discuss some possible explanations for the divergence in employment, income, and other economic prospects between college grads and others. The third observation is that the prospect of moving up the economic ladder depends on factors beyond effort and talent, including your family, the neighborhood you grow up in, and the quality of the primary and secondary schools you attend. Your chances for attending college are much better if you are raised in a higher-income household, and that advantage has increased substantially since the 1980s. Another factor is geography. Some research indicates that economic prospects are better for those who grow up in neighborhoods with less income inequality, less concentrated poverty, and better performing schools. Finally, across so many dimensions, we continue to see disparities in economic outcomes by race and ethnicity. These issues are crucial. Sound public policies can support families and businesses and help more Americans reach and remain in the middle class. I look forward to hearing about your discussions over the next two days, and thank you, again, for your contributions.

r190510a_FOMC

united states

Is the Middle Class within Reach for Middle-Income Families?

brainard

It is good to be here at the Federal Reserve System's Community Development Research Conference. This year, our conference is focusing on renewing the promise of the middle class, a topic that goes to the heart of the American dream and underpins the vibrancy of our democracy and society. Before I dig into the data, I want to touch on what it means to be a part of the middle class, recognizing aspirations differ from person to person. From a purely economic perspective, being middle class commonly means having financial security and the ability to invest for our futures and for our children. In turn, having a strong middle class implies that families with average incomes have the purchasing power to consume and the savings to invest. So a strong middle class is often seen as a cornerstone of a vibrant economy and, beyond that, a resilient democracy. In recent years, households at the middle of the income distribution have faced a number of challenges. That raises the question of whether middle-class living standards are within reach for middle-income Americans in today's economy. There are a number of ways to define middle income. I will primarily focus on households between the 40th and 70th percentiles of the income distribution. In 2018, these households had incomes between $40,000 and $85,000. To explore the issues associated with financial resilience and intergenerational financial well-being, it is necessary to go beyond measures of income and better understand household assets and liabilities. Today I will share with you findings from a promising new data resource These accounts combine household-level data on balance sheets, incomes, and demographic characteristics of families in the United States from the triennial Survey of States to track the distribution of these household assets and liabilities on a quarterly basis. The timeliness of the data, which are currently available through the fourth quarter of 2018, can provide valuable insights into how different types of households are faring over the business cycle. I will also share some new results from the 2018 Survey of Household Economics and Decisionmaking (SHED), which deliver further insights on the financial resilience of households, particularly those with low and moderate income, on an annual basis. results are slated for release soon. Let us start by taking a look at how the wealth of middle-income households has evolved over recent years. Over the past three decades, the wealth of middle-income households increased an average of about 1 percent per year, adjusted for inflation (figure That compares with average annual growth of 2.6 percent in real gross domestic income over this period. By comparison, the average wealth of the households in the top decile of the income distribution has increased three times faster per year, on average, than the wealth of middle-income households, more than doubling over the period as a whole. The past decade is even more sobering. Middle-income families still have not fully recovered the wealth they lost in the Great Recession. On average, households at all levels of income lost wealth as a result of the declines in asset prices and rise in unemployment during the crisis (figure 2). But the recovery in wealth since the Great Recession has been much less for middle- and lower-income households than for higher- income households. The wealth of the top 10 percent of households is 19 percent higher than before the recession, even after factoring in the decline in stock prices at the end of last year. In contrast, the wealth of middle-income families still has not returned to its pre-crisis level, and lower-income families have a wealth shortfall of 16 percent. The gap is also large in absolute terms. At the end of 2018, the average middle- income household had wealth of about $340,000, while the average households in the top 10 percent of the income distribution had wealth of about $4.5 million (figure 3). The average wealth of the top income decile is now 13 times higher than that of the middle- income group, while it was 7 times higher in 1989. Given these developments, it is no surprise that the share of wealth held by middle-income households has declined over the past three decades. However, the extent of the decline is nonetheless striking: Today the 30 percent of households between the 40th and 70th percentiles of the income distribution hold 13 percent of all wealth, down from 19 percent over the past three decades (figure 4). The top 10 percent of households by income now own 57 percent of all wealth--up from 47 percent 30 years ago. The 10 percent of households with the highest income hold more of the national wealth than the remaining 90 percent of households combined. Having sketched out the contours of the overall level and growth of wealth owned by middle-income households, let us now turn to economic security. Basic financial security is one important marker of the middle class. Wealth is an important source of economic resilience for households, allowing them to handle unexpected expenses as well as providing them with the financial security to manage the usual changes in income over a lifetime. When we dig into the various liquid savings, assets, and liabilities that underlie the overall wealth numbers for middle-income households, the picture suggests limited room to absorb volatility in cash flows. Many middle-income families have relatively little in easily accessible, or liquid, savings, carry a significant amount of debt, and are concerned about the adequacy of their retirement savings. Liquid savings By drawing from several household surveys conducted by the Federal Reserve, we can gain important insights into how assets and liabilities of middle-income households affect their economic security. Research based on the 2016 SCF shows that only about one-fourth of middle-income households have enough liquid savings to cover six months of expenses--the amount often recommended by financial advisers--and only 4 in 10 could cover three months of expenses. The majority of middle-income households thus do not have sufficient liquid savings to weather a typical material financial disruption--for instance, one associated with a temporary job loss or illness. Even modest unexpected expenses could be disruptive for many middle-income families. According to the forthcoming results from the 2018 SHED, one-third of middle-income adults said that they would borrow money, sell something, or not be able to pay an unexpected $400 expense (figure 5). Drilling down further indicates that while 6 percent of middle-income adults said they would not be able to pay the expense using any means, 27 percent would borrow or sell something to pay the expense. The reliance on credit to meet unexpected expenses is pronounced among those already carrying a balance on their credit cards. Nearly 3 in 10 middle-income adults carry a balance on their credit card most or all of the time, and the same households are five times as likely to borrow if faced with a $400 expense as those who never carry a balance. Borrowing money is not the only way that middle-income households cope with unexpected expenses. In 2018, one-fourth of middle-income adults said they skipped some kind of medical care because of its cost, suggesting insufficient savings can have implications for physical health as well as financial health. Thus, low levels of savings can create a challenging cycle when material disruptions in income, or even smaller unexpected expenses, spiral into a broader financial setback. Financial security in retirement A key component of middle-class financial security is the cushion of savings to cover retirement. Here, the DFAs suggest some progress. One of the innovations of the DFAs is that they include defined benefit plans from the Financial Accounts in addition to defined contribution plans, whereas measures of household pension wealth in the SCF are confined to the latter. The balances in defined contribution plans, such as 401(k)s, in which retirement savings accumulate in an account, are typically simpler to measure. By contrast, the value of defined benefit plans requires estimating how much the future fixed payments each year in retirement are worth today. These future payments are a sizable asset for households, currently estimated at about $15 trillion, or about 70 percent of total pension assets. The DFAs indicate that the average pension wealth for middle-income households--including both types of plans--has increased 2.5 percent per year over the past three decades (figure 6). Pension assets are now the largest asset held by middle- income households, representing 40 percent of their wealth, substantially exceeding the 22 percent share of home equity in their wealth. In part, the growth in pension balances reflects the sustained decrease in long- term interest rates over this period, which has boosted the value of the future fixed payments associated with defined benefit pensions. It reflects the aging of the population, since households near or in retirement age have the largest accumulated levels of pension savings and are also likely hold a relatively greater share of defined How do we square the growth in pension assets with survey evidence indicating that many households in the middle of the income distribution are concerned that they will not have enough to live on in retirement? Only 35 percent of middle-income adults, who are not retired, say that their retirement saving is on track, and 16 percent of middle- income adults do not have any money saved for retirement. In part, this may reflect the long-term shift by employers to defined contribution plans and away from defined benefit plans, especially in the private sector. While in 1989 more middle-income households had a defined benefit pension than a defined contribution plan, the reverse has been true since 1989. With defined contribution plans, employees have to decide how much they will save and how they will invest, and they face uncertainty regarding how much savings will be available in retirement. Those who save and invest effectively can help secure their retirement. But those who opt out, save too little, or make investment choices that turn out to yield low returns may find themselves unprepared as retirement approaches, despite years of hard work. Two-thirds of middle-income adults who hold self-directed accounts, including defined contribution plans and individual retirement accounts, say that they have little or no comfort in managing the investments. Assets and liabilities Stepping back, it is instructive to look at the evolution of the underlying assets and liabilities of middle-class households more broadly. The liabilities of the average middle-income household have nearly doubled over the past three decades, while assets have increased only 50 percent (figure 8). The gap between the relative growth of liabilities and assets peaked during the financial crisis and has narrowed somewhat for middle-income households more recently. While mortgages rose and fell sharply around the Great Recession, the rise in consumer debt, such as credit cards, auto loans, and student loans, has been relatively steady. The rapid growth in liabilities reflects both short-term cash flow management and longer-term investments. Taking on debt is an important way for middle-income families to help buffer unexpected expenses or a temporary loss of income, as indicated by the 8 in 10 middle-income adults who are at least somewhat confident that they could obtain an additional credit card if they applied for it. Debt is also a critical mechanism for making key middle-class investments, which I turn to next. Investing in the Future There is a palpable sense that the opportunity to reach the middle class and remain in it is receding for many middle-income households. Many households find it challenging to make key middle-class investments because incomes at the middle are not keeping up with the rising costs of education and homeownership, and it is difficult to save enough. Often, making these investments requires having some savings in the first place--for instance, to make a down payment on a home, forgo income for a few years while paying tuition, or secure credit for a small business. Disparities by race and ethnicity This challenge is compounded for some racial and ethnic minority groups that have experienced large and persistent racial gaps in wealth. In 2016, the average wealth of white households ($933,700) was seven times the average wealth of black households households at the middle of the income distribution, the average wealth in 2016 of white households ($277,200) was roughly one and a half times that of black households in educational attainment cannot fully account for these disparities: The average wealth of black households in which the head had a bachelor's degree ($271,200) was 26 percent less than that of white households in which the head did not attend college ($367,800). This matters not least because disparities in wealth often are inherited. prospects that a young person will reach the middle class often depend on attributes he or she inherits--such as the income, wealth, education, age, race, and ethnicity of his or her parents. Beyond financial wealth, children inherit intangible assets that affect their ability to access information and social networks that help in obtaining jobs and taking advantage of educational and other wealth-building opportunities. Owning a home has been a key marker of middle-class status for many Americans. The accumulation of equity in a home is the primary form of wealth building and economic security for many middle-class families. Homeownership is valued for nonfinancial reasons as well, such as protection against unwanted moves and the freedom to make alterations and investments in the home. However, the financial crisis brought into focus that there are also risks associated with homeownership. Home equity--defined as the difference between the house value and the mortgage balance--for an average middle-income household peaked at $90,200 in late 2005, then declined by almost two-thirds through 2011 (figure 9). By the end of 2018, after several years of rising house prices, the home equity of the average middle- income family was still below the pre-recession peak and not much above the value in Middle-income households saw such steep declines in their average home equity during the Great Recession because they had taken on a high level of mortgage debt relative to their house values. This high leverage amplified the effect of the fall in house prices on their wealth. Moreover, the homeownership rates of middle-income households also declined during the recession, so they did not benefit as much from the subsequent rebound in house prices since 2013 as did higher-income families. The recent decline in homeownership rates does not appear to reflect a change in attitudes toward homeownership, as recent surveys show that the desire to own a home remains strong. Instead, it appears house prices are rising faster than income for many middle-income families, putting homeownership out of reach. By 2017, the median sales price for a single-family home was about four times median household income, up from three times median income in 1988. The homeownership rate for middle-income families was 68 percent in 2016, down from its peak in 2004 of 74 percent. For black households, the declines during and after the recession erased a decade of increases in homeownership--the homeownership rate for black households across the income spectrum was 42 percent in 2018, the same as the rate in the mid-1990s. homeownership rate of Hispanics also declined with the recession but has recovered somewhat, reaching 47 percent in 2018. With homeownership lower and home prices rising faster than incomes, renting is also taking a bigger slice of many middle-income households' earnings, leaving less savings for a down payment, an unexpected expense, or other investments. From 2007 to 2018, the share of income spent on rent rose from 18 percent to 25 percent for middle- income renters. Many middle-income families struggle to afford rent, particularly in the high- demand areas where jobs are most available, underscoring the need for more workforce housing. One way to increase the supply of middle-income housing is to reduce exclusionary zoning and other land-use restrictions that limit the supply of housing and keep prices high. Often put in place in areas with single-family homes to block the development of affordable, multifamily housing, these policies also have contributed to the persistence of racially segregated neighborhoods. The challenge is to increase accessibility to workforce and affordable housing in ways that address legacy disparities. Skills, education, and student debt Manufacturing and the skilled trades have provided an important pathway to the middle class for many workers, enabling them to own their homes, educate their children, and retire securely. Today, though, many face uncertainties associated with the decline in manufacturing jobs, the erosion of employee benefits, and reduced bargaining power. Increasingly, the onus is on individuals to ensure that their skills are marketable and up- to-date in a highly competitive global marketplace with growing automation. Juan Salgado, the chancellor of the City Colleges of Chicago and our closing keynote speaker, has emphasized the role of community colleges in offering affordable, quality education and training. Students can begin with a certificate program in advanced manufacturing and continue either to a bachelor's degree in engineering at a nearby public university or to the workplace, acquiring marketable skills likely at lower cost than if they had started at a four-year college. Similar programs around the country help provide accessible pathways to the middle class. For others, college is seen as an important pathway to middle-class economic security. The average wealth of households with a college degree significantly exceeds the average wealth of those without a college degree (figure 10). A key reason is that college graduates generally have higher incomes. Graduates with a bachelor's degree have median weekly earnings that are about 65 percent higher than high school graduates and unemployment rates that are 2 percentage points lower, and they are often better positioned to adapt to changes in the labor market. However, the cost of higher education has been rising, placing an increasing financial burden on many middle-income households. Between 2008 and 2018, tuition and fees at four-year public colleges rose more than six times faster than real median incomes. while there are benefits associated with attending college, there are also some financial risks, and the returns to education vary widely. While two-thirds of individuals with a bachelor's degree or more say that the lifetime financial benefits of their education exceed its costs, those who do not complete their degree are half as likely to report net benefits from their studies. And some groups face higher barriers in accessing college: Children of parents who did not attend college are far less likely to attend college due to financial and informational barriers, and those who do start college are more likely to drop out. For many middle-income families, affording post-secondary education means taking on a sobering amount of student debt. Total student loan debt, in inflation- adjusted terms, more than doubled from 2006 to 2018 (figure 11). Repayment of student loans can be challenging. In 2018, 2 in 10 middle-income adults with education debt were behind on their payments, and those who did not complete a degree were nearly twice as likely to be behind. Repayment status also differs by the type of institution attended. Among middle-income adults with education debt, 30 percent who attended for-profit institutions were behind on student loan payments, compared with 17 percent of those who attended public institutions and 12 percent who attended not-for- profit private institutions. Investing in higher education may come at the cost of deferring or forgoing other investments. For example, higher tuition costs--reflected in increasing student loan debt--together with the rising costs of homeownership, have left many middle-income households in a poor position to save for a down payment or handle a mortgage. Researchers at the Fed have estimated that roughly 20 percent of the decline in homeownership among young adults can be attributed to their increased student loans since 2005. This suggests that more than 400,000 young individuals would have owned a home in 2014 had it not been for the rise in student debt. Businesses and stock ownership Another concern is that high debt may hinder people seeking to start a business. Starting a business is a classic pathway to securing a foothold in the middle class. This has been particularly true for members of some groups that historically have faced challenges in the labor market, particularly minorities and first-generation Americans. Aspiring small business owners with student loans may lack the financial ability to invest in starting a business while staying current on payments. One study found that individuals with student loan debt are less likely to start a business, and those who do are more likely to fall behind on their loan payments. Another study found that growth in student loan debt resulted in a 14 percent reduction in small business formation in counties over a 10-year period. The personal assets of small business owners have been an important source of capital for entrepreneurs as they seek to start and sustain a small business. As wealth for middle-income households has stagnated, reliance on this source of capital has declined in recent years. Very small firms depend heavily on personal debt for start-up and working capital. Owners of smaller firms often struggle to qualify for bank credit, and among those that apply and are denied, low credit scores and insufficient credit history are the most frequently cited reasons. More broadly, a key reason that middle-income households have not seen wealth increases commensurate with high-income households is that they have not benefited as much from the strong performance of stocks and privately held businesses. In inflation- adjusted terms, total business assets (including corporate stocks, mutual funds, and unincorporated businesses) have more than tripled since 1989. Similarly, the average business assets of top-income households have more than tripled since 1989. But the average business assets of middle-income families have grown only 31 percent since 1989 and are lower than they were before the Great Recession (figure 12). Stock market participation fell for middle-income families after the Great Recession, so they have not benefited as much from the subsequent rise in stock prices. By 2018, the 30 percent of households in the middle of the income distribution held only 6 percent of aggregate business assets, while the top 10 percent of households held over three-fourths. With lower net worth and financial assets, the livelihoods of most middle-income families, other than retirees, depend primarily on compensation from working. So the robustness of labor income over time is central to the ability of middle-income families to achieve and maintain middle-class financial security. While the strengthening of the labor market over the course of this extended recovery has benefited middle-income families, the long-term decline in the share of national income going to wage earners is concerning. The Congress put maximum employment right at the heart of the Federal Reserve's mandate, alongside price stability. In fact, we are one of only a handful of central banks that have the explicit responsibility to promote maximum employment. Given that households at the middle of the income distribution rely primarily on wage income, our full employment mandate has served the country well during this extended recovery. The gains to workers, including those in the middle class, from the strong labor market are clear. Unemployment is now at 3.6 percent--its lowest level in 50 years. Employment rates of adults in their prime working years (ages 25 to 54) have been rising steadily during the expansion and recently reached their pre-recession peak of 80 percent. Importantly, wage growth has begun to pick up after years of slow gains. It is notable that the near recovery in middle-class wealth from the Great Recession did not take hold until the labor market began to strengthen. While higher- income households saw their wealth begin to recover as soon as financial markets stabilized in early 2009, middle-income households did not see their wealth begin to recover until 2010, when the unemployment rate began to decline (figure 13). Even as we welcome the many benefits of the current strong job market, longer- term trends raise concerns. Labor market disparities by race have been an enduring feature of the labor market for decades. The unemployment rate of blacks, while near its historical low, remains at about 7 percent, twice the unemployment rate of whites. Recent research suggests that the strong labor market may be helping to narrow some of the long-standing disparities for some racial minorities and women, although the results are tentative and very modest. The progressive long-term decline in the share of national income that goes to workers through wages is concerning for middle-income households. The share going to workers--which economists call the labor share--translates into how much of our economic output shows up in people's paychecks. The decline in the labor share goes to the heart of the rising inequality of wealth and the unequal sharing of prosperity. Several explanations have been put forward for the decline in the labor share. The increasing concentration of industries into the hands of a few firms has likely reduced the bargaining power of workers. Increasing automation in the workplace is also a factor, along with the ongoing effects of globalization and offshoring. Earnings have declined as the job market has shifted away from important middle-income occupations. Manufacturing, for example, employs vastly fewer people now than it has historically. It is important to understand the relative importance of these different drivers, as they have different implications for the overall health of the economy and for policies to support middle-income families. Monetary policy aims to influence employment and inflation over the business cycle, as opposed to addressing these longer-run structural changes. But the distribution of income and wealth may have important implications for macroeconomic developments, such as the evolution of consumption, which is the single biggest engine of growth in our economy. That is why the Federal Reserve has a significant interest in understanding distributional developments and their implications. Recent research finds that households with lower levels of wealth spend a larger fraction of any income gains than households with higher levels of wealth. Consequently, an economy that delivers an increasing share of income gains to high- wealth households could result in less growth in consumer demand than one in which the gains are distributed more equally. In fact, the recovery of consumer spending after the Great Recession was slower than the recovery in aggregate household income and net worth would previously have suggested, and rising inequality is one plausible explanation. The discrepancy between slow growth in income and wealth, on the one hand, and rising costs of housing, health care, and education, on the other, may be making it more difficult for middle-income families to achieve middle-class financial security. Long-term, the shifting of wealth and income to the top of the distribution and away from the middle could pose challenges to the health and resilience of our economy. These are important questions, and I am pleased that this conference is bringing to light interesting research to shed light on them.

r190513a_FOMC

united states

The Federal Reserve’s Review of Its Monetary Policy Strategy, Tools, and Communication Practices

clarida

I am pleased to attend this event providing a New England perspective for the Federal Reserve's review of our monetary policy strategy, tools, and communication practices. We are bringing open minds to our review and are seeking a broad range of perspectives. To us, it simply seems like good institutional practice to engage with a wide range of interested individuals and groups as part of a comprehensive approach to enhanced transparency and accountability. Motivation for the Review The Congress charged the Federal Reserve with achieving a dual mandate-- maximum employment and price stability--and this review will take this mandate as given. We will also take as given that a 2 percent rate of inflation in the price index for personal consumption expenditures is the operational goal most consistent with our price- stability mandate. While we believe that our existing strategy, tools, and communications practices have generally served the public well, we are eager to evaluate ways they might be improved. That said, based on the experience of other central banks that have undertaken similar reviews, our review is more likely to produce evolution, not a revolution, in the way we conduct monetary policy. With the U.S. economy operating at or close to our maximum-employment and price-stability goals, now is an especially opportune time for this review. The unemployment rate is at a 50-year low, and inflation is running close to our 2 percent objective. We want to ensure that we continue to meet our statutory goals in coming years. In addition, we will evaluate the new policy tools and enhanced communication practices the Federal Reserve deployed in response to the Global Financial Crisis and the Great Recession. Furthermore, the U.S. and foreign economies have evolved significantly since before the crisis. Perhaps most importantly, neutral interest rates appear to have fallen in the United States and abroad. This global decline in neutral rates is widely expected to persist for years and likely reflects several factors, including aging populations, changes in risk- taking behavior, and a slowdown in technology growth. These factors' contributions are highly uncertain, but, irrespective of their precise role, the policy implications of the decline in neutral rates are important. All else being equal, a fall in neutral rates increases the likelihood that a central bank's policy rate will reach its effective lower bound in future economic downturns. That development, in turn, could make it more difficult during downturns for monetary policy to support household spending, business investment, and employment and keep inflation from falling too low. Another key development in recent decades is that inflation appears less responsive to resource slack, implying a change in the dynamic relationship between inflation and employment. This change is, in a sense, a proverbial double-edged sword. It permits the Federal Reserve to support employment more aggressively during downturns--as was the case during and after the Great Recession--because a sustained inflation breakout is less likely when inflation is less responsive to employment conditions. However, that dynamic also increases the cost, in terms of economic output, of reversing unwelcome increases in longer-run inflation expectations. Thus, it is all the more important that longer-run inflation expectations remain anchored at levels consistent with our 2 percent inflation objective. Activities and Timeline for the Review Our monetary policy review will have several components. The Board and the Reserve Banks are hosting events--such as this one in Boston--in which we are hearing from, among others, business and labor leaders, community development advocates, and academics. Next month, we are holding a System research conference at the Federal Reserve Bank of Chicago, with speakers and panelists from outside the Fed. The program includes overviews by academic experts of themes that are central to the review. Building on the perspectives we hear and on staff analysis, the Federal Open Market Committee will perform its own assessment of how it conducts monetary policy, beginning around the middle of the year. We expect to make our conclusions public in the first half of 2020. The economy is constantly evolving, bringing with it new policy challenges. So it makes sense for us to remain open minded as we assess current practices and consider ideas that could potentially enhance our ability to deliver on the goals the Congress has assigned us. For this reason, my colleagues and I do not want to preempt or to predict our ultimate finding. What I can say is that any changes to our conduct of monetary policy that we might make will be aimed solely at improving our ability to achieve and sustain our dual-mandate objectives in the world we live in today. . . . . Forum, sponsored by the Initiative on Global Markets at the University of Chicago . . . , Fall, held at the . Journal of . . . . .

r190516a_FOMC

united states

The Disconnect between Inflation and Employment in the New Normal

brainard

It is a pleasure to be here at the National Tax Association Annual Spring Symposium. Just as it may take the tax experts and practitioners here today some time to disentangle the longer-term implications of recent major changes to tax policy, so, too, we are in the process of analyzing the lessons for monetary policy of apparent post-crisis changes in the relationships among employment, inflation, and interest rates. The Congress has assigned the Federal Reserve the job of using monetary policy to achieve maximum employment and price stability. Price stability means moderate and stable inflation, which the Federal Reserve has defined to be 2 percent inflation. Maximum employment is understood as the highest level of employment consistent with price stability. In the aftermath of the Great Recession, which had deep and persistent effects, it is important to understand whether there have been long-lasting changes in the relationships among employment, inflation, and interest rates in order to ensure our policy framework remains effective. This expansion will soon become the longest on record in the United States. Growth has persisted throughout the past decade, overcoming downdrafts from abroad and pullbacks in fiscal support earlier in the expansion and benefiting last year from a large fiscal boost. Recent data confirm that consumers remain confident, workers are productive, and businesses are hiring, although trade conflict is creating uncertainty. The job market is strong. At 3.6 percent, the unemployment rate is now lower than it was before the crisis. At 80 percent, the employment rate for workers in their prime working-age years--a more comprehensive measure of slack that includes shifts in labor force participation as well as unemployment--has recently risen close to its pre-crisis level. In contrast, the picture on inflation is puzzling this far into an expansion. Despite the strengthening of the labor market, the measure of core inflation excluding volatile food and energy prices did not move up to 2 percent on a sustained basis until last year, and in the most recent reading, the 12-month change has moved down to 1.6 percent. Other inflation measures paint a somewhat more reassuring picture. The Dallas Fed's trimmed mean measure of inflation, which provides a different way to filter out idiosyncratic movements in various components of inflation, has increased 2 percent in the past 12 months, slightly higher than its level of 1.9 percent for the two previous years. Since the Great Recession, there have been several changes in macroeconomic relationships, which I refer to as the new normal. Now is a good time to assess the characteristics of the new normal and what they mean for monetary policy. The emerging contours of today's new normal are defined by low sensitivity of inflation to changes in labor market slack, a low long-term neutral rate of interest, and low underlying trend inflation. Let me take each in turn. In today's new normal, price inflation has not moved up consistently as the labor market has strengthened considerably over the course of the long expansion. This is what economists mean when they say the Phillips curve is very flat: The historical relationship between resource slack and price inflation appears to have broken down. Although wage growth has been moving progressively higher as labor market slack has diminished, broader price inflation has remained muted. Another important feature of today's new normal is that the long-run neutral interest rate seems to be lower than it was historically. The neutral rate of interest refers to the level of the federal funds rate that would maintain the economy at full employment and 2 percent inflation if no tailwinds or headwinds were buffeting the economy. The decline in the neutral rate likely reflects a variety of forces globally, such as the aging of the population in many large economies, some slowing in the rate of productivity growth, and increases in the demand for safe assets. that over the past five years, since the SEP interest rate projections first became available, the median estimate of the long-run federal funds rate has declined 1-1/2 percentage points, from 4-1/4 percent to 2-3/4 percent. Going back further to the two decades before the crisis shows a similar decline in today's long-run neutral rate relative to earlier Blue Chip consensus forecasts of the long-run federal funds rate. Third, underlying trend inflation--the trend in inflation after filtering out idiosyncratic and transitory factors--appears to be somewhat below the Federal Reserve's goal of 2 percent. This raises the risk that households and businesses could come to expect inflation to run persistently below the Federal Reserve's target and could change their behavior in a way that reinforces that expectation. Expectations are an important determinant of actual inflation because wage and price behavior by businesses and households is partly based on expectations of future inflation. While low inflation and low interest rates have many benefits, the new normal presents a challenge for the conventional approach to monetary policy, in which the Federal Reserve could rely on changes in the level of the federal funds rate to achieve its inflation and employment goals. In past recessions, the Federal Reserve has typically cut interest rates by 4 to 5 percentage points in order to support household and business spending and hiring. With the long-run neutral rate low and with underlying trend inflation somewhat below target, nominal interest rates are likely to remain below those levels, which therefore leaves less room to cut rates as much as needed. With less room to ease financial conditions and support economic activity using our conventional policy tool, the economy may endure prolonged periods during and after recessions with short-term interest rates pinned at their effective lower bound. That, of course, was what happened following the financial crisis, when the Federal Reserve kept interest rates close to That constraint limits the Federal Reserve's ability to provide stimulus through its conventional tool and thus could tend to leave inflation lower than it would otherwise be, and unemployment higher. The experience of several years with the federal funds rate pinned at its effective lower bound and actual inflation below our target could weigh on expectations for future inflation and thereby influence the behavior of households and businesses that helps determine wages and prices. The experience of a sustained period of low inflation could depress underlying trend inflation by feeding into lower inflation expectations, further reducing nominal interest rates and the space to cut interest rates in what could become a downward spiral. So we need to be especially careful to preserve as much of our conventional policy space as we can, while exploring mechanisms to augment the effectiveness of our framework. The new normal has some important benefits. With subdued inflation, the sustained expansion has drawn workers back into the labor market after a damaging recession. The unemployment rate is approaching a 50-year low, and the overall labor force participation rate has remained constant despite the long-term aging of the population that would otherwise be pushing participation lower. Like the overall unemployment rate, broader measures of labor market slack are also lower than their pre-crisis levels. The Bureau of Labor Statistics' U-6 measure shows that two groups have recently shrunk to pre-crisis levels after rising considerably during the recession: those working part time who would prefer full-time employment and people marginally attached to the labor force who have looked for work in the previous year but stopped looking more recently. The strong labor market is leading to employment gains among workers with disabilities. Research suggests it may be helping to narrow some of the long-standing disparities for some racial minorities, although this development is tentative and modest. We hear from business contacts that they are now hiring workers they may not previously have considered. During the recession, the evidence suggests that many employers raised their requirements for many job categories. As labor markets have tightened, employers in certain sectors, occupations, and areas of the country report they are loosening requirements and investing more in training. That means today's economy is providing opportunities for workers who might previously have been left on the sidelines--including those with records of past incarceration or who lack a particular certification or degree. Given that the large majority of working-age households, those at the middle and lower ends of the income distribution, rely primarily on wage income, advancing our employment mandate has served the country well. In today's new normal, with the low responsiveness of inflation to labor market tightness, there appears to be little evidence so far of a tradeoff with our price-stability objective. The sustained strengthening of the labor market also adds to the productive capacity of the economy by attracting people on the sidelines to join or rejoin the labor force and move into employment. Of course, there are also risks. The past three downturns were precipitated not by rising inflation pressure, but rather by the buildup of financial imbalances. Extended periods of above- potential growth and low interest rates tend to be accompanied by rapid credit growth and elevated asset valuations, which tend to boost downside risks to the economy. It is not hard to see why a high-pressure economy might be associated with elevated financial imbalances, especially late in the cycle. As an expansion continues, the memory of the previous recession fades. Profits tend to rise, experienced loss rates on loans are low, and people tend to project recent trends into the future, which leads financial market participants and borrowers to become overly optimistic. Risk appetite rises, asset valuations become stretched, and credit is available on easier terms and to riskier borrowers than earlier in the cycle when memories of losses were still fresh. Historically, when the Phillips curve was steeper, inflation tended to rise as the economy heated up, which naturally prompted the Federal Reserve to raise interest rates. In turn, the interest rate increases would have the collateral effect of damping increases in asset prices and risk appetites. With a flat Phillips curve, inflation does not rise as much as resource utilization tightens, and, accordingly, provides less necessity for the Federal Reserve to raise rates to restrictive levels. At the same time, low interest rates along with sustained strong economic conditions are conducive to increasing risk appetites prompting reach-for-yield behavior and boosting financial excesses late in an expansion. With the forces holding down interest rates likely to persist, valuation pressures and risky corporate debt, such as leveraged lending, could well remain at elevated levels. Elevated valuations and corporate debt could leave the economy more vulnerable to negative shocks. The market volatility in December is a reminder of how sensitive markets can be to downside surprises. A key implication of the weakening in the relationship between inflation and employment, then, is that we should not assume monetary policy will act to restrain the financial cycle as much as previously. As a consequence, policymakers may need to think differently about the interplay of the financial and business cycles due to the combination of a low neutral rate, a flat Phillips curve, and low underlying inflation. With financial stability risks likely to be more tightly linked to the business cycle than in the past, it may make sense to take actions other than tightening monetary policy to temper the financial cycle. In order to enable monetary policy to focus on supporting the return of inflation to our symmetric 2 percent target on a sustained basis along with maximum employment, we should be looking to countercyclical tools to temper the financial cycle. One tool other central banks have been using to help temper the financial cycle is the require large banks to build up an extra capital buffer as financial risks mount. Although the CCyB was authorized as part of the post-crisis package of reforms, so far, the Federal Reserve has chosen not to use it. Turning on the CCyB would build an extra layer of resilience and signal restraint, helping to damp the rising vulnerability of the overall system. Moreover, because the CCyB is explicitly countercyclical, it is intended to be cut if the outlook deteriorates, boosting the ability of banks to make loans when extending credit is most needed and providing a valuable signal about policymakers' intentions. This feature proved to be valuable in the United Kingdom in the wake of the Brexit referendum. If countercyclical tools and other regulatory safeguards are not adequate over the cycle, monetary policy will need to carry a greater burden in leaning against financial excesses. That would be unfortunate, because adding financial stability concerns to the burden of conventional monetary policy might undermine sustained achievement of our employment and inflation goals. Because the financial cycle is today likely to be tempered less than in the past by material increases in interest rates as the economy expands, the appropriate level of bank capital for today's conditions is unlikely to be the same as in past business cycles: Because interest rates likely will do less than in past cycles, regulatory buffers will need to do more. As a consequence, now is a bad time to be weakening the core resilience of our largest banking institutions or to be weakening oversight over the nonbank financial system. Instead, we should be safeguarding the capital and liquidity buffers of banks at the center of the system, carefully monitoring risks in the nonbank sector, and making good use of the countercyclical tool that we have. Finally, let us turn to the apparent softness in underlying trend inflation. One hypothesis for the flat Phillips curve is that central banks have been so effective in anchoring inflation expectations that tightening resource utilization is no longer transmitted to price inflation. Another possibility is that structural factors such as administrative changes to health care costs, globalization, or technological-enabled disruption have been dominant in recent years, masking the operation of cyclical forces. Regardless, because inflation is ultimately a monetary phenomenon, the Federal Reserve has the capacity and the responsibility to ensure inflation expectations are firmly anchored at--and not below--our target. As I have argued in the past, the fact that inflation has been running somewhat below our longer-run goal of 2 percent may not be entirely due to labor market slack or to transitory shocks; it also likely reflects some softening in inflation's underlying trend. First, estimates of underlying inflation based on statistical filters are lower than they were before the financial crisis and are currently below 2 percent. Second, estimates of longer-run inflation expectations based on the University of Michigan Surveys of Consumers and on inflation compensation from financial market pricing are also running lower than before the financial crisis. Our goal now is to get underlying trend inflation around our target on a sustained basis. What would this take? We can get some sense from statistical models. Although there is no one widely agreed-upon method of measuring underlying inflation, one statistical approach that has received attention in recent years captures the idea that underlying inflation responds to the experience with actual inflation, and that this responsiveness varies over time. We can use such an approach to get an idea of how much, and how quickly, underlying inflation might respond to any particular path for actual inflation. It provides some reassurance that our goal may be achievable if inflation moves only slightly above 2 percent for a couple of years. The SEP inflation projections of Committee members suggest that many have, over the past year or so, envisaged a few years of a mild overshoot. Of course, it is not entirely clear how to move underlying trend inflation smoothly to our target on a sustained basis in the presence of a very flat Phillips curve. One possibility we might refer to as "opportunistic reflation" would be to take advantage of a modest increase in actual inflation to demonstrate to the public our commitment to our inflation goal on a symmetric basis. For example, suppose that an unexpected increase in core import price inflation drove overall inflation modestly above 2 percent for a couple of years. The Federal Reserve could use that opportunity to communicate that a mild overshooting of inflation is consistent with our goals and to align policy with that statement. Such an approach could help demonstrate to the public that the Committee is serious about achieving its 2 percent inflation objective on a sustained basis. In today's new normal, it is important to achieve inflation and inflation expectations around our 2 percent target on a sustained basis while guarding against financial imbalances through active use of countercyclical tools. We want to be mindful of the risk of financial imbalances that could amplify any shock and help tip the economy into recession, which the Federal Reserve has less conventional space to address in today's low interest rate environment. In my view, it is therefore wise to proceed cautiously, helping to sustain the expansion and further gains in employment and with appropriate regulatory safeguards that reduce the risk of dangerous financial imbalances.

r190517a_FOMC

united states

The Federal Reserve’s Review of Its Monetary Policy Strategy, Tools, and Communication Practices

clarida

I am pleased to participate in this event, part of the listening tour that Reserve Banks are hosting around the country and a key input into the Federal Reserve's review of our monetary policy strategy, tools, and communication practices. We are bringing open minds to our review and are seeking a broad range of perspectives. To us, it simply seems like good institutional practice to engage with a wide range of interested individuals and groups as part of a comprehensive approach to enhanced transparency and accountability. President Harker already mentioned the Federal Reserve's statutory goals of maximum employment and price stability. Our review will take these dual mandate goals as given. We will also take as given that a 2 percent rate of inflation in the price index for personal consumption expenditures is the operational goal most consistent with our price-stability mandate. While we believe that our existing strategy, tools, and communications practices have generally served the public well, we are eager to evaluate ways they might be improved. That said, based on the experience of other central banks that have undertaken similar reviews, our review is more likely to produce evolution, not a revolution, in the way we conduct monetary policy. With the U.S. economy operating at or close to our maximum-employment and price-stability goals, now is an especially opportune time for this review. The unemployment rate is at a 50-year low, and inflation is running close to our 2 percent objective. We want to ensure that we continue to meet our statutory goals in coming years. Furthermore, the U.S. and foreign economies have evolved significantly since before the Global Financial Crisis. The review will afford us the opportunity to evaluate the new policy tools and enhanced communication practices the Federal Reserve deployed in response to the crisis and the recession that followed it. Our monetary policy review will have several components. Listening sessions-- such as today's--give us an opportunity to hear from the people and communities affected by monetary policy. Next month, we are holding a System research conference at the Federal Reserve Bank of Chicago, with academic experts and panelists from outside the Fed. Building on the perspectives we hear and on staff analysis, the Federal Open Market Committee will perform its own assessment of how it conducts monetary policy, beginning around the middle of the year. We expect to make our conclusions public in the first half of 2020. The economy is constantly evolving, bringing with it new policy challenges. So it makes sense for us to remain open minded as we assess current practices and consider ideas that could potentially enhance our ability to deliver on the goals the Congress has assigned us. For this reason, my colleagues and I do not want to preempt or to predict our ultimate findings. What I can say is that any changes to our conduct of monetary policy that we might make will be aimed solely at improving our ability to achieve and sustain our dual-mandate objectives in the world we live in today.

r190520b_FOMC

united states

The Federal Reserve's Review of Its Monetary Policy Strategy, Tools, and Communication Practices

clarida

I am pleased to attend this event providing the New York perspective for the Federal Reserve's review of our monetary policy strategy, tools, and communication practices. We are bringing open minds to our review and are seeking a broad range of perspectives. To us, it simply seems like good institutional practice to engage with a wide range of interested individuals and groups as part of a comprehensive approach to enhanced transparency and accountability. Motivation for the Review The Congress charged the Federal Reserve with achieving a dual mandate-- maximum employment and price stability--and this review will take this mandate as given. We will also take as given that a 2 percent rate of inflation in the price index for personal consumption expenditures is the operational goal most consistent with our price- stability mandate. While we believe that our existing strategy, tools, and communications practices have generally served the public well, we are eager to evaluate ways they might be improved. With the U.S. economy operating at or close to our maximum-employment and price-stability goals, now is an especially opportune time for this review. The unemployment rate is at a 50-year low, and inflation is running close to our 2 percent objective. We want to ensure that we continue to meet our statutory goals in coming years. In addition, we will evaluate the new policy tools and enhanced communication practices the Federal Reserve deployed in response to the Global Financial Crisis and the Great Recession. Furthermore, the U.S. and foreign economies have evolved significantly since before the crisis. Perhaps most importantly, neutral interest rates appear to have fallen in the United States and abroad. This global decline in neutral rates is widely expected to persist for years and likely reflects several factors, including aging populations, changes in risk- taking behavior, and a slowdown in technology growth. These factors' contributions are highly uncertain, but, irrespective of their precise role, the policy implications of the decline in neutral rates are important. All else being equal, a fall in neutral rates increases the likelihood that a central bank's policy rate will reach its effective lower bound in future economic downturns. That development, in turn, could make it more difficult during downturns for monetary policy to support household spending, business investment, and employment and keep inflation from falling too low. Another key development in recent decades is that inflation appears less responsive to resource slack, implying a change in the dynamic relationship between inflation and employment. This change is, in a sense, a proverbial double-edged sword. It permits the Federal Reserve to support employment more aggressively during downturns--as was the case during and after the Great Recession--because a sustained inflation breakout is less likely when inflation is less responsive to employment conditions. However, that dynamic also increases the cost, in terms of economic output, of reversing unwelcome increases in longer-run inflation expectations. Thus, it is all the more important that longer-run inflation expectations remain anchored at levels consistent with our 2 percent inflation objective. Finally, the strengthening of the labor market in recent years has highlighted the challenges of assessing the proximity of the labor market to the full employment leg of the Federal Reserve's dual mandate. The unemployment rate, which stood at 3.6 percent in April, has been interpreted by many observers as suggesting that the labor market is currently operating beyond full employment. However, the level of the unemployment rate that is consistent with full employment is not directly observable and thus must be estimated. The range of plausible estimates likely extends at least as low as the current level of the unemployment rate. For example, in the March Blue Chip economic outlook survey, the average estimate of the natural rate of unemployment for the bottom 10 respondents was 3.9 percent, as compared with 4.7 percent for the highest 10 respondents. The decline in the unemployment rate in recent years has been accompanied by a pronounced increase in labor force participation for individuals in their prime working years. These increases in participation have provided employers with a significant source of additional labor input and may be one factor restraining inflationary pressures. As with the unemployment rate, whether participation will continue to increase in a tight labor market remains uncertain. The strong job gains of recent years also has delivered benefits to groups that have historically been disadvantaged in the labor market. For example, African Americans and Hispanics have experienced persistently higher unemployment rates than whites for many decades. However, those unemployment rate gaps have narrowed as the labor market has strengthened, and there is some indication of an extra benefit to these groups as the unemployment rate moves into very low territory. although unemployment rates for less-educated workers are persistently higher than they are for their more-educated counterparts, these gaps appear to narrow as the labor market strengthens. And wage increases in the past couple of years have been strongest for less-educated workers and for those at the lower end of the wage distribution. Activities and Timeline for the Review Our monetary policy review will have several components. The Board and the Reserve Banks are hosting events--such as this one in New York--in which we are hearing from, among others, business and labor leaders, community development advocates, and academics. Next month, we are holding a System research conference at the Federal Reserve Bank of Chicago, with speakers and panelists from outside the Fed. The program includes overviews by academic experts of themes that are central to the review. Building on the perspectives we hear and on staff analysis, the Federal Open Market Committee will perform its own assessment of how it conducts monetary policy, beginning around the middle of the year. We expect to make our conclusions public in the first half of 2020. The economy is constantly evolving, bringing with it new policy challenges. So it makes sense for us to remain open minded as we assess current practices and consider ideas that could potentially enhance our ability to deliver on the goals the Congress has assigned us. For this reason, my colleagues and I do not want to preempt or to predict our ultimate finding. What I can say is that any changes to our conduct of monetary policy that we might make will be aimed solely at improving our ability to achieve and sustain our dual-mandate objectives in the world we live in today. at the Brookings Papers on Economic Activity Conference, held at the Brookings . . . . . -------- (2019). . . . . Forum, sponsored by the Initiative on Global Markets at the University of Chicago . . . . , Fall, held at the . Journal of . . . . . .

r190520a_FOMC

united states

Business Debt and Our Dynamic Financial System

powell

For release on delivery Remarks by at It is a pleasure to be here at this important annual event sponsored and organized The risks in our financial system are constantly evolving. Fifteen years ago, everyone was talking about whether households were borrowing too much. Today everyone is talking about whether businesses are borrowing too much. This evening, I will focus on the implications of the increase in business debt over the past decade and review the steps the Federal Reserve and other agencies are taking to understand and limit the associated risks. In public discussion of this issue, views seem to range from "This is a rerun of the subprime mortgage crisis" to "Nothing to worry about here." At the moment, the truth is likely somewhere in the middle. To preview my conclusions, as of now, business debt does not present the kind of elevated risks to the stability of the financial system that would lead to broad harm to households and businesses should conditions deteriorate. At the same time, the level of debt certainly could stress borrowers if the economy weakens. The Federal Reserve continues to assess the potential amplification of such stresses on borrowers to the broader economy through possible vulnerabilities in the financial system, and I currently see such risks as moderate. Many commentators have observed with a sense of deja vu the buildup of risky business debt over the past few years. The acronyms have changed a bit--"CLOs" example--but once again, we see a category of debt that is growing faster than the income of the borrowers even as lenders loosen underwriting standards. Likewise, much of the borrowing is financed opaquely, outside the banking system. Many are asking whether these developments pose a new threat to financial stability. At the Federal Reserve, we take this possibility seriously. The Fed and other regulators are using our supervisory tools and closely monitoring risks from the buildup of risky business debt. Business debt has clearly reached a level that should give businesses and investors reason to pause and reflect. If financial and economic conditions were to deteriorate, overly indebted firms could well face severe strains. However, the parallels to the mortgage boom that led to the Global Financial Crisis are not fully convincing. Most importantly, the financial system today appears strong enough to handle potential business-sector losses, which was manifestly not the case a decade ago with subprime mortgages. And there are other differences: Increases in business borrowing are not outsized for such a long expansion, in contrast to the mortgage boom; business credit is not fueled by a dramatic asset price bubble, as mortgage debt was; and CLO structures are much sounder than the structures that were in use during the mortgage credit bubble. Could the increase in business debt pose greater risks to the financial system than currently appreciated? My colleagues and I continually ask ourselves that question. We are also taking multiple steps to better understand and address the potential risks. In conjunction with other U.S. regulatory agencies, both domestically through the Financial Board (FSB), we are monitoring developments, assessing unknowns, and working to develop a clearer picture. We are also using our supervisory tools to hold the banks we supervise to strong risk-management standards. And we are using our stress tests to ensure banks' resilience even in severely adverse business conditions. Let's start with the basic facts. Many measures confirm that the business sector has significantly increased its borrowing as the economy has expanded over the past decade. Business debt relative to the size of the economy is at historic highs. Corporate debt relative to the book value of assets is at the upper end of its range over the past few decades (figure 1). And investment-grade corporate debt has shifted closer to the edge of speculative grade. At the moment, the business sector is quite healthy overall. Business income is strong, reflecting healthy profit margins. And because interest rates are quite low by historical standards, the costs of servicing today's higher levels of debt remain low relative to business income (figure 2). Despite crosscurrents, the economy is showing continued growth, strong job creation, and rising wages, all in a context of muted inflation pressures. But if a downturn were to arrive unexpectedly, some firms would face challenges. Not only is the volume of debt high, but recent growth has also been concentrated in the riskier forms of debt. Among investment-grade bonds, a near-record fraction is at the lowest rating--a phenomenon known as the "triple-B cliff." In a downturn, some of these borrowers could be downgraded into high-yield territory, which would require some investors to sell their holdings, thereby confronting traditional high-yield investors with a sudden influx of bonds. There have also been sizable shifts within the non-investment-grade, or riskier, debt universe. Higher-risk businesses have traditionally funded themselves with a mix of high-yield bonds and leveraged loans. Over time, the balance between the two has swung back and forth because of investor demand, the interest rate environment, and other factors. In the past few years, leveraged loans have grown far more quickly (figure 3). In fact, while net new issuance of high-yield bonds in 2018 was close to nil, leveraged loans outstanding rose 20 percent and now stand at more than $1 trillion. So far this year, issuance of high-yield bonds and leveraged loans has been more balanced. In addition, underwriting standards have weakened. With leveraged loans, covenants intended to protect lenders may be an endangered species; more loans now feature high debt-to- earnings ratios; and the use of optimistic projections including "earnings add-backs" is becoming more common. The rise in riskier business borrowing has been funded principally by nonbank lenders. Collateralized loan obligations are now the largest lenders, with about 62 percent of outstanding leveraged loans (figure 4). These lenders are actively managed securitization vehicles that mostly buy higher-risk assets like leveraged loans. CLOs, in turn, are funded by a slice of equity and layers of debt of varying seniority. After CLOs, mutual funds are the next-largest vehicle for holding leveraged loans, with about 20 percent of the market. These funds allow investors to redeem their shares daily, although the underlying loans take longer to sell. As a result, investors may react to financial stress by trying to redeem their shares before the funds have sold their most liquid assets. Widespread redemptions by investors, in turn, could lead to widespread price pressures, which could affect all holders of loans, including CLOs and those that hold CLOs. As you can see, there are similarities to the subprime mortgage crisis. As with the mortgage boom, the business debt story begins with rapid growth of debt to new highs and a surge in lending to risky borrowers made possible by aggressive underwriting using securitization vehicles. But there are also important differences. One difference is that financial authorities now closely monitor financial stability vulnerabilities on an ongoing basis, armed with lessons learned from the crisis. The Board of Governors meets at least four times a year to assess threats to the financial system and is constantly monitoring developments. We use a checklist of potential financial vulnerabilities that we have described elsewhere, most recently in the we published earlier this month. This approach gives us a way to organize and weigh the mass of facts, anecdotes, and speculation we confront as we monitor financial stability. In assessing financial stability risks, we constantly consult our four-point checklist: borrowing by businesses and households, valuation pressures, leverage in the financial system, and funding risk. If households or businesses have borrowed too much, they will be forced to cut back spending and investing or even default if their incomes fall or the value of the collateral backing their loans declines. Valuation pressures give us a sense of overall risk appetite and, should investors lose that appetite, how far prices could fall. If lenders face defaulting borrowers and have too little loss-absorbing capacity, they risk insolvency. At best, they will cut back on lending to other borrowers, dragging the economy down. At worst, they will fail, which can lead to severe economic damage to households and businesses. Finally, when the financial system funds long-maturity assets with short-maturity liabilities, we risk a classic "fast burn" crisis--a bank run, or its equivalent involving investors and institutions outside traditional banking. In our framework, the story of the mid-2000s goes something like this: Amid a self-reinforcing cycle of house price gains and mortgage credit expansion, households borrowed (and lenders lent) far too much, and property prices rose far too high. Financial institutions of all shapes and sizes also borrowed too much. And the financial sector was highly susceptible to a run because it funded risky, long-maturity mortgages with extended chains of fragile and opaque financing structures that ultimately rested on short- maturity liabilities. Let's compare this story with the current situation using our four-point checklist, beginning with borrowing by businesses and households. Business debt has grown faster than gross domestic product (GDP) for several years and today is high. But the growth in the ratio of business debt to GDP in the past decade is much less than the growth in household debt to GDP that we saw in the run-up to the Global Financial Crisis. Back then, household debt grew from 60 percent of GDP to 90 percent, or by half (figure 5). At its recent low, business debt was 65 percent of GDP. Now, even after rapid growth, it is still below 75 percent of GDP. Overall, the increase in business debt relative to the size of the economy is one-third the increase in household debt seen in the previous decade. Business debt rises in expansions. It is a steady upward plod in borrowing over the long expansion--not a rapid expansion--that has now brought business debt to GDP back to historic highs. Seen this way, the current situation looks typical of business cycles. The mortgage credit boom was, because of its magnitude and speed, far outside historical norms. As for household debt, we see that household debt-to-income ratios have steadily declined post-crisis. Moreover, a high and rising fraction of this debt is rated prime. All told, household debt burdens appear much more manageable. Our second factor--valuation pressures--also points to moderate risks to financial stability. Valuations are high across several financial markets. Equity prices have recently reached new highs, and corporate bond and loan spreads are narrow. Both commercial and residential property prices have moved above their long-run relationship with rents, although price gains slowed substantially last year. All of these developments point to strong risk appetite--as might be expected given the strong economy. But there does not appear to be a feedback loop between borrowing and asset prices, as was the case in the run-up to the financial crisis. While borrowing by businesses has been strong, it is not fueling excessive prices or investment in a critical sector such as housing, whose collapse would undermine collateral values and lead to outsized losses. Instead, the increase in business borrowing has been broad based across sectors, including technology, oil and gas production, and manufacturing. Regarding the third factor--leverage in the financial system--today banks at the core of the financial system are fundamentally stronger and more resilient. Our post- crisis regulatory framework is based on robust capital requirements backed by strong stress tests, resulting in much higher levels of capital in the banking system (figure 6). These stress tests are a way to estimate the direct and indirect effects of extremely bad macroeconomic and financial developments on our banking system. We publish the scenarios that describe the macro and financial developments every year by mid-February and release the test results in June. In the pre-crisis environment, supervisors focused more on the most likely outcomes, not on these tail risks. Since we began routine stress- testing in 2011, the scenarios we use have featured severe global recessions characterized by major stress in the corporate sector, where large numbers of firms default on their loans and bonds. As actual economic conditions have improved, the scenarios have gotten tougher. The most recent stress tests indicate that, even after the losses from the scenario, capital levels at the largest banks would remain above the levels those banks had before the crisis. Loss-absorbing capacity elsewhere in the financial system is also much improved. Leverage at broker-dealers is far below levels before the crisis and remains low relative to the norms of the past several decades. Insurers also appear well capitalized. As for our fourth factor--funding risk--the susceptibility of the financial system to runs also appears low. In part because of the post-crisis regulatory regime, large banks hold substantial amounts of highly liquid assets and rely relatively little on short-term wholesale funding (figure 7). Money market funds hold much safer assets. And CLOs, which have facilitated the growth of leveraged loans, have stable funding: Investors commit funds for lengthy periods, so they cannot, through withdrawals, force CLOs to sell assets at distressed prices. Overall, vulnerabilities to financial stability from business debt and other factors do not appear elevated. We take the risks from business debt seriously but think that the financial system appears strong enough to handle potential losses. We also know that our dynamic financial system does not stand still. We can always learn more about financial markets, and we will always act to address emerging risks. Together with our domestic and international counterparts, we are monitoring developments in business debt markets, working to develop and share data on how these markets operate, studying ways to further strengthen the system, and working to ensure that banks are properly managing the business debt risks they have taken on. Through the FSOC, the banking and market regulators coordinate our monitoring of financial conditions. In recent meetings, the FSOC has discussed leveraged lending in depth. We recognize that each regulator directly sees only a part of the larger picture, and we are working to stitch these parts together so we can collectively see that larger picture and the risks it holds. For example, the Securities and Exchange Commission is examining the potential for liquidity strains at mutual funds, and the Commodity Futures Trading Commission is working to understand the use of derivatives to hedge risks associated with leveraged loans. What else are we watching for? Business debt growth has moderated somewhat since early 2018, but this might be just a pause. Another sharp increase in debt, unless supported by strong fundamentals, could increase vulnerabilities appreciably. Businesses, investors, and lenders need to focus on these vulnerabilities--as will the In addition, regulators, investors, and market participants around the world would benefit greatly from more information on who is bearing the ultimate risk associated with CLOs. We know that the U.S. CLO market spans the globe, involving foreign banks and asset managers. But right now, we mainly know where the CLOs are not--only $90 billion of the roughly $700 billion in total CLOs are held by the largest U.S. banks. That is certainly good news for domestic banks, but in a downturn institutions anywhere could find themselves under pressure, especially those with inadequate loss-absorbing capacity or runnable short-term financing. The Federal Reserve is participating in international efforts, under the auspices of the FSB, to improve our knowledge of these key issues. Through the FSB, we are focused on determining the size of the global leveraged loan market and the holders of the loans as an important step toward a better understanding of the underlying risks. Beyond monitoring markets and collecting new data, several supervisory efforts are also under way. To complement the quantitative analysis in our stress tests, our supervisors have been qualitatively assessing how well banks are managing the risks associated with leveraged lending. Through the Shared National Credit Program, which evaluates large syndicated loans, our supervisors are continuing to work with their counterparts at the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation to ensure that banks are properly managing the risks of losses they face from participating in the leveraged lending market. Let me wrap up with three thoughts. First, business debt is near record levels, and recent issuance has been concentrated in the riskiest segments. As a result, some businesses may come under severe financial strain if the economy deteriorates. A highly leveraged business sector could amplify any economic downturn as companies are forced to lay off workers and cut back on investments. Investors, financial institutions, and regulators need to focus on this risk today, while times are good. Second, today business debt does not appear to present notable risks to financial stability. The debt-to-GDP ratio has moved up at a steady pace, in line with previous expansions and neither fueled by nor fueling an asset bubble. Moreover, banks and other financial institutions have sizable loss-absorbing buffers. The growth in business debt does not rely on short-term funding, and overall funding risk in the financial system is moderate. Third, we cannot be satisfied with our current level of knowledge about these markets, particularly the vulnerability of financial institutions to potential losses and the possible strains on market liquidity and prices should investors exit investment vehicles holding leveraged loans. We are committed to better understanding the areas where our information is incomplete. This commitment includes coordination with other domestic and international agencies to understand who is participating in business lending and how their behavior could potentially amplify stress events. . . . . vol. 31 . Assessing the Macroeconomic Impact of the .

r190530b_FOMC

united states

Sustaining Maximum Employment and Price Stability

clarida

Thank you for that generous introduction. I have attended Economic Club of New York events many times over the years and have always enjoyed the programs that feature engaging speakers sharing important insights on timely topics. It is a distinct honor to appear before you today from this side of the podium, and I do hope my remarks will contribute to this proud tradition. In July, the current U.S. economic expansion will become the longest on record-- or at least the record since the 1850s, which is as far back as the National Bureau of In anticipation of that milestone, I would like to take stock of where the U.S. economy is today, to assess its future trajectory, to review some important structural changes in the economy that have occurred over the past decade, and to explore what all of this might mean for U.S. monetary policy. The Federal Reserve has a specific mandate assigned to it in statute by the Congress, which is the dual mandate of maximum employment and price stability. As I speak today, the economy is as close to achieving both legs of this dual mandate as it has been in 20 years. My colleagues and I understand that our responsibility is to conduct a monetary policy that not only is supportive of and consistent with achieving maximum employment and price stability, but also, once achieved, is appropriate, nimble, and consistent with sustaining maximum employment and price stability for as long as possible. And thus, the title of my talk today is "Sustaining Maximum Employment and Midway through the second quarter of 2019, the U.S. economy is in a good place. Over the past four quarters, gross domestic product (GDP) growth has averaged 3.2 percent, which compares with an average growth rate of 2.3 percent since the recovery began in the summer of 2009. By most estimates, fiscal policy played an important role in boosting growth in 2018, and I expect that fiscal policies will continue to support growth in 2019. Over the same four quarters, the unemployment rate has averaged 3.8 percent, and the most recent reading, at 3.6 percent, is near its lowest level in 50 years. Moreover, average monthly job gains have continued to outpace the increases needed to provide jobs for new entrants to the labor force. Wages have been rising broadly in line with productivity and prices and thus, at present, do not signal rising cost-push pressure. Notwithstanding strong growth and low unemployment, U.S. inflation remains muted--currently, it is somewhat below our 2 percent longer-run objective for the personal consumption expenditures (PCE) price deflator--and inflation expectations, according to a variety of measures, continue to be stable. As we look ahead, in our March Summary of Economic Projections, the median of around 2 percent as the modal, or most likely, outcome over the next three years, for PCE inflation to rise to 2 percent, and for the unemployment rate to edge up to Before I discuss the outlook for monetary policy, allow me to review some important structural changes that have taken place in the economy over the past decade that will be particularly relevant for our monetary policy decisions. Perhaps the most significant structural change relevant to monetary policy is that the real, or inflation-adjusted, rate of interest consistent with full employment and price stability, often referred to as the neutral rate, or r*, appears to have fallen in the United States and abroad from more than 2 percent before the crisis to less than 1 percent today. The decline in neutral policy rates likely reflects several factors, including aging populations, higher private saving, a greater demand for safe assets, and a slowdown in global productivity growth. The policy implications of the decline in neutral rates are important. All else being equal, a lower neutral rate increases the likelihood that a central bank's policy rate will reach its effective lower bound in a future economic downturn. Such a development, in turn, could make it more difficult during a future downturn for monetary policy to provide sufficient accommodation to rapidly return employment and inflation to mandate-consistent levels. Another important potential change in the U.S. economy has been the steady decline in estimates of the structural rate of unemployment consistent with "maximum" employment, often referred to as u*. This decline in u* may be due in part to higher educational attainment and a larger proportion of older workers in the workforce today relative to the workforce of past decades. If u* is lower than historical estimates suggest, this would imply that, even with today's historically low unemployment rate, the labor market would not be as tight--and inflationary pressures would not be as strong-- as one would expect, based on historical estimates of u*. Indeed, I believe the range of plausible estimates for u* may extend to 4 percent or even below. I also note that the decline in the unemployment rate in recent years has been accompanied by a pronounced increase in labor force participation for individuals in their prime working years. It has also been accompanied since 2014 by a rise in labor's share of national income. As I have documented previously, in the past several U.S. business cycles, labor's share has risen as those expansions proceeded because workers command higher wages in a stronger labor market; notably, in those cycles, the rise in labor's share did not pass through to faster price inflation. The previously mentioned increase in prime-age labor force participation has provided employers with a source of additional labor input and has been one factor restraining inflationary pressures. Notwithstanding these recent gains, prime-age participation rates remain somewhat below levels achieved in the 1990s and may still have some more room to run. If so, then potential output could be higher than many current estimates suggest. Over the past few years, we have also seen evidence of a pickup in U.S. productivity growth, albeit from the very depressed average pace that prevailed throughout most of the expansion. Indeed, as of the first quarter of this year, productivity in the nonfarm business sector rose 2.4 percent over the previous four quarters, its fastest pace since 2010 when the U.S. economy was coming out of the Great Recession. By contrast, in both the 2001-07 and 1982-90 economic expansions, productivity growth was actually slowing relative to its average pace during those expansions. That said, while identifying inflection points in trend productivity growth in real time is notoriously difficult, a pickup in trend productivity growth relative to the pace that prevailed earlier in the expansion is a possibility that we should not, I believe, dismiss. Another structural change relevant for monetary policy is that price inflation appears less responsive to resource slack than it did in the past. That is, the short-run price Phillips curve appears to have flattened, implying a change in the dynamic relationship between inflation and employment. A flatter Phillips curve is, in a sense, a proverbial double-edged sword. It permits the Federal Reserve to support employment more aggressively during downturns--as was the case during and after the Great Recession--because a sustained inflation breakout is less likely when the Phillips curve is flatter. However, a flatter Phillips curve also increases the cost, in terms of economic output, of reversing unwelcome increases in longer-run inflation expectations. Thus, a flatter Phillips curve makes it all the more important that longer-run inflation expectations remain anchored at levels consistent with our 2 percent inflation objective. Textbook macroeconomics teaches us that understanding the economy and getting monetary policy right requires that we do our best to understand if--and if so, how--the forces of aggregate demand and supply are evolving relative to historical experience and the predictions of our models. While predicting the future is difficult, with available data it appears that in 2018 and in the first quarter of 2019, the supply side of the economy-- employment, participation, and productivity--expanded faster than most forecasters outside and inside the Fed expected. Notwithstanding robust growth in demand over these five quarters, PCE price inflation fell somewhat short of the Fed's 2 percent objective. With this background, let me now turn to the outlook for U.S. monetary policy. As I mentioned earlier, my colleagues and I on the FOMC understand that our priority today is to put in place policies that will help sustain maximum employment and price stability in an economy that appears to be operating close to both of our dual- mandate objectives. In our most recent statements, we have indicated that "the Committee will be patient as it determines what future adjustments to the . . . federal funds rate may be appropriate to support" our dual-mandate objectives. What does this mean in practice? To me, it means that we should allow the data on the U.S. economy to flow in and inform our future decisions. I believe that the path for the federal funds rate should be data dependent in two distinct ways. Monetary policy should be data dependent in the sense that incoming data reveal at any point in time where the economy is relative to the ultimate objectives of price stability and maximum employment. This information on where the economy is relative to the goals of monetary policy is an important input into interest rate feedback rules. Data dependence in this sense is well understood, as it is of the type implied by a large family of policy rules, including Taylor-type rules, in which the parameters of the economy needed to formulate such rules are taken as known. But, of course, key parameters needed to formulate such rules, including u* and r*, are unknown. As a result, in the real world, monetary policy should be--and in the United States, I believe, is--data dependent in a second sense: Policymakers should and do study incoming data and use models to extract signals that enable them to update and improve estimates of r* and u*. Consistent with my earlier discussion, in the Summary of Economic Projections, FOMC participants have, over the past seven years, repeatedly revised down their estimates of both u* and r* as unemployment fell and real interest rates remained well below previous estimates of neutral without the rise in inflation those earlier estimates would have predicted. And these revisions to u* and r* appeared to have had an important influence on the path for the policy rate actually implemented in recent years. In addition to u* and r*, another important input into any monetary policy assessment is the state of inflation expectations. Indeed, I believe price stability requires that not only actual inflation be centered at our 2 percent objective, but also that expected inflation be equal to our 2 percent inflation objective. Unlike realized inflation, inflation expectations themselves are not directly observable; they must be inferred from econometric models, market prices, and surveys of households and firms. As I assess the totality of the evidence, I judge that, at present, indicators suggest that longer-term inflation expectations sit at the low end of a range that I consider consistent with our price-stability mandate. Where does this leave us today? As I already noted, the U.S. economy is in a very good place, with the unemployment rate near a 50-year low, inflationary pressures muted, expected inflation stable, and GDP growth solid and projected to remain so. Moreover, the federal funds rate is now in the range of estimates of its longer-run neutral level, and the unemployment rate is not far below many estimates of u*. Plugging these inputs into a 1993 Taylor-type rule produces a federal funds rate between 2.25 and 2.5 percent, which is the range for the policy rate that the FOMC has reaffirmed since our January meeting. Most recently, the Committee judged at our May meeting that the current stance of policy remains appropriate, and that decision reflects our view that some of the softness in recent inflation data will prove to be transitory. This judgment aligns with some private-sector forecasts, which now project PCE inflation to return to 2 percent by 2020. However, if the incoming data were to show a persistent shortfall in inflation below our 2 percent objective or were it to indicate that global economic and financial developments present a material downside risk to our baseline outlook, then these are developments that the Committee would take into account in assessing the appropriate stance for monetary policy. Since the beginning of the year, the FOMC has made several important decisions about how it will implement monetary policy and how it will conclude the process of normalizing the size of its balance sheet. These decisions have been made over several meetings and have been part of an ongoing process of the Committee's deliberations. Please allow me to summarize them now. The FOMC decided at its January meeting to continue to implement monetary policy in a regime with an ample supply of reserves--a regime often referred to as a floor system. Such a system, which has been in place since late 2008, does not require the active management of reserves through daily open market operations. Instead, with an ample level of reserves in the banking system, the effective federal funds rate will settle at or slightly above the rate of interest paid on excess reserves (IOER). This system has proven to be an efficient means of controlling the policy rate and effectively transmitting the stance of policy to a wide array of other money market instruments and to broader financial conditions. The FOMC continues to view the target range for the federal funds rate as its primary means of adjusting and communicating the stance of monetary policy, although in doing so, we must and do take into account how our balance sheet size, composition, and trajectory impact broader financial conditions. And as we stated in January, although adjustments in the target range for the federal funds rate are our primary tool for adjusting the stance of monetary policy, we are prepared to adjust the details of the plans for balance sheet normalization based on economic and financial developments. At its March meeting, the Committee announced that it would slow the pace of the runoff of the securities holdings in its SOMA portfolio, and that it plans to cease balance sheet runoff entirely by September. Since starting the process of balance sheet normalization in 2017, the Federal Reserve's securities portfolio has shrunk by about $500 billion (roughly 2-1/2 percent of GDP) and the level of reserve balances has declined about $700 billion. Consistent with our decision in March, we began to slow the pace of runoff of our balance sheet earlier this month. When the process of normalizing the size of our balance sheet concludes in September, we expect that our reserves liabilities will, for a time, likely remain somewhat above the level necessary for an efficient and effective implementation of monetary policy. If so, we plan after September to hold the size of our securities holdings constant for a while. During this period, reserve balances will continue to decline gradually as currency and other nonreserve liabilities increase. At the point that the Committee judges that reserve balances have declined to the level consistent with the efficient and effective implementation of monetary policy, we plan to resume periodic open market operations to accommodate the normal trend growth in the demand for our liabilities. As balance sheet normalization has progressed, the effective federal funds rate has firmed relative to the IOER rate. Last year, after the federal funds rate moved up closer to the top of the target range set by the FOMC, we made technical adjustments in our operations by lowering the IOER rate relative to the top of the target range by 5 basis points in June and then again in December to keep the federal funds rate well within its target range. At our May FOMC meeting, we made another technical adjustment in the IOER rate, reducing it by another 5 basis points to 2.35 percent. Since then, the effective federal funds rate has been trading close to the level where it began the year. Before I conclude my prepared remarks, allow me to say a few words about our review of our monetary policy strategy, tools, and communication practices. While we believe that our existing approach to conducting monetary policy has served the public well, the purpose of this review is to evaluate and assess possible refinements that might help us best achieve our dual-mandate objectives on a sustained basis. With the U.S. economy operating at or close to our maximum-employment and price-stability goals, now is an especially opportune time to conduct this review. We want to ensure that we are well positioned to continue to meet our statutory goals in coming years. Furthermore, the shifts in r* and u*, as well as the flattening of the Phillips curve that I discussed earlier, suggest that the U.S. and foreign economies have evolved in significant ways relative to the pre-crisis experience. events, in which we are hearing from a broad range of interested individuals and groups, including business and labor leaders, community development advocates, and academics. In addition, we are holding a System research conference next week at the Federal Reserve Bank of Chicago that will feature speakers and panelists from outside the Fed. Building on both the perspectives we hear and staff analysis, the FOMC will conduct its own assessment of its monetary policy framework, beginning around the middle of the year. We will share our conclusions with the public in the first half of 2020. The economy is constantly evolving, bringing with it new policy challenges. So it makes sense for us to remain open minded as we assess current practices and consider ideas that could potentially enhance our ability to deliver on the goals the Congress has assigned us. For this reason, my colleagues and I do not want to prejudge or predict our ultimate findings. What I can say is that any refinements or more-material changes to our framework that we might make will be aimed solely at enhancing our ability to achieve and sustain our dual-mandate objectives of maximum employment and stable prices. Thank you very much, and I look forward to your questions. . . . . m. m. m . . pp. 23-57; an earlier version is available at . . Forum, sponsored by the Initiative on Global Markets at the University of Chicago . . . . . and Allan Timmermann, eds., Journal of . . . . . . .

r190530a_FOMC

united states

Monetary Policy and Financial Stability

quarles

Thank you for the opportunity to take part in today's "Developments in Empirical Macroeconomics" conference. I would like to use my time here to talk about a topic of interest to many central bankers and macroeconomists: the interaction of monetary policy and financial stability. As you well know, monetary policy has powerful effects on financial markets, the financial system, and the broader economy. Conversely, financial instability, by impairing the provision of credit and other financial services, can depress economic growth, cause job losses, and push inflation too low. Accordingly, financial stability, through its effects on the Federal Reserve's dual-mandate goals of maximum employment and stable prices, must be a consideration in the setting of monetary policy. Against this backdrop, a natural--yet quite complex--question is whether monetary policy should be used to promote financial stability. This question is hotly debated in a large and growing academic literature, and any serious answer has to be subject to considerable nuance. At the same time, my sense is that the balance is clearly tilted toward the conclusion that macroprudential policies--through-the-cycle resilience, stress tests, and the countercyclical capital buffer (CCyB)--may be better targeted to promoting financial stability than monetary policy. Before I wade into the lessons from past research and experience, I would like to highlight that this question is not just academic. As you know, the economy, monetary policy, and financial stability are intertwined. For example, the past three recessions were preceded by some combination of elevated asset prices, rapid increases in borrowing by businesses and households, and excessive risk-taking in the financial sector. These financial vulnerabilities have amplified adverse shocks to the overall economy time and again. Such concerns have resurfaced among some observers, as the current long expansion has brought business borrowing to new heights. My own assessment is that even though business debt is elevated, at least by some measures, overall financial stability risks are not, as the financial sector has substantial loss- absorbing capacity and is not overly reliant on unstable short-term funding. Yet, even if the risk of financial system disruption does not seem high, it well remain true that if the economy weakens, some businesses may default on this debt, potentially leading to a contraction in investment, a slow-down in hiring, and possibly to an unusual tightening in financial conditions. These concerns highlight how cyclical factors influencing monetary policy borrowers may overlap with financial stability considerations. Let me begin by laying out how monetary policy can influence financial stability. Monetary policy, operating primarily through adjustments in the level of short-term interest rates, has powerful effects on the entire financial system. A more accommodative monetary policy lowers interest rates across the maturity spectrum. The textbook result is that mortgage rates and corporate borrowing rates, among others, decline; equity prices rise; and the dollar exchange rate depreciates. In other words, financial conditions broadly ease, spurring households to buy more and businesses to invest and hire, thereby supporting economic growth and price stability. Monetary policy, however, if too accommodative, may lead to a buildup of financial vulnerabilities. These incentives arrive through a number of channels. For instance, low interest rates reduce the cost of borrowing, and so may prompt businesses and households to overborrow. Low rates may lead to a speculative bubble by compressing risk premiums for assets--such as equity, corporate bonds, and housing-- and potentially leading investors to extrapolate price gains into the future in a bout of irrational exuberance. Low rates may also squeeze the profitability of financial intermediaries through narrow interest margins and other factors. In turn, these intermediaries as well as investors that had promised fixed nominal rates of return--such as insurance companies and pension funds--may "reach for yield," or take on more credit or duration risk in their portfolios in order to maintain high returns. Taken to extremes, this story often does not end well. Periods of excessive leverage, rapid credit growth, or buoyant credit market sentiment increase the risk to economic growth. These dynamics point to the possibility that accommodative monetary policy, while necessary to support activity during the early stages of an economic expansion, may also increase vulnerabilities in the financial system, especially if maintained for too long. These vulnerabilities weaken the financial system's ability to absorb negative shocks, and so when a shock arrives, losses mount, the financial system weakens, lending slows, and economic activity slows by more than it would have otherwise, potentially leading to an economic downturn or a more severe recession. These observations lead to the important question of whether and how financial vulnerabilities should affect the setting of monetary policy. One simple framework for evaluating the tradeoffs associated with actively setting monetary policy to lean against the buildup of financial vulnerabilities is to examine the costs and benefits of such a policy in terms of unemployment and inflation. In this approach, the costs of tightening monetary policy in response to a buildup of financial vulnerabilities are lower employment and potentially below target inflation in the near term. The benefits are possibly reducing the risk of a future financial crisis, an event likely associated with a much larger fall in employment and inflation. One view is that monetary policy curbs household and business borrowing only modestly but can boost the unemployment rate notably. And so using monetary policy to damp borrowing does more harm than good. According to this view, using monetary policy to lean against financial vulnerabilities does not generate significant net benefits and may be counterproductive--increasing unemployment and decreasing inflation below a desired level with little reduction in risks to financial stability. At the same time, some research has identified circumstances under which the benefits of using monetary policy to lean against financial vulnerabilities could outweigh the costs. A key consideration is the estimated amount of economic activity lost in a financial crisis--and some research suggests such losses may be quite large, which raises the benefits of leaning against imbalances. Similarly, monetary policy may affect a broad range of financial imbalances--excessively high house or equity prices and leverage within the financial sector--and the full set of these effects could shift the risk of financial instability sufficiently, at least under some circumstances, to make leaning against financial vulnerabilities with monetary policy desirable. The broader point is that we do not fully understand the cost-benefit tradeoff and whether monetary policy adjustments for financial stability reasons may be appropriate at some times. Of course, there is one additional and critical factor to consider when weighing adjustments to the stance of monetary policy for financial stability reasons: the availability and efficacy of other instruments to promote financial stability. After all, the pursuit of multiple goals--full employment, price stability, and financial stability, for example--likely requires multiple tools. This is just common sense. Economists have a name for this common-sense notion: the Tinbergen principle. Effective supervisory, regulatory, and macroprudential policy tools appear to be well placed to address financial vulnerabilities. In particular, these tools may be used to increase the resilience of the financial sector against a broad range of adverse shocks and, perhaps, lean against the buildup of specific financial vulnerabilities. At the Federal Reserve, we have emphasized a set of structural, or through-the-cycle, regulatory and supervisory policies as our primary macroprudential tools to promote financial stability. These measures include strong capital and liquidity requirements for banks, especially the largest and most systemic institutions. In addition, our supervisory stress tests evaluate the ability of large banks to weather severe economic stress and the failure of their largest counterparty as well as examining the risk-management practices of the firms. Moreover, the stress-test scenarios are designed to generally be more severe during buoyant economic periods when vulnerabilities may build. Furthermore, our stress tests consider the potential effects of specific risks we have identified in our financial stability monitoring work. For example, the tests in recent years have included hypothetical severe strains in corporate debt markets, exploring the resilience of the participating banks to the risks associated with the increase in business borrowing. In addition, the Federal Reserve monitors a wide range of indicators for signs of potential risks to financial stability that may merit a policy response, and we now publish a summary of this monitoring in our semiannual vulnerabilities are identified as being meaningfully above normal, the Federal Reserve can require large banks to increase their loss-absorbing capacity through increases in the Despite all of these efforts, we understand that these tools have limitations. First, central bankers' experience with macroprudential tools, including the CCyB, is limited. Second, regulation and macropudential tools can reduce economic efficiency and hamper economic growth by limiting the ability of the market to allocate financial resources. For this reason, the Federal Reserve has been evaluating ways in which our supervisory and financial stability goals can be achieved more efficiently, and it has been participating in global efforts to evaluate the effects of reforms under the auspices of the Financial Stability Board. Third, macroprudential policies that are targeted to banks may create an incentive for financial intermediation to migrate outside of the regulated banking system. The vulnerabilities may still emerge, albeit elsewhere in the financial system--perhaps in institutions or structures that are less stable and resilient than our banks. In part reflecting these incentives, we regularly monitor financial intermediation both inside and outside of the banking system. To sum up, while there is evidence that financial vulnerabilities have the potential to translate into macroeconomic risks, a general consensus has emerged that monetary policy should be guided primarily by the outlook for unemployment and inflation and not by the state of financial vulnerabilities. Financial system resilience, supported by strong through-the-cycle regulatory and supervisory policies, remains a key defense against financial system and macroeconomic shocks. There is a clear need for new theory and empirics to address the questions about monetary policy and financial stability I have posed today. I encourage you to continue to contribute to these answers. By engaging the help of the wider academic community, conferences such as this one provide an invaluable opportunity to make progress on issues of great importance for economic policy. vol. 9 1st ed., vol. 3. . vol. 132 Journal of

r190603a_FOMC

united states

The Next Stage in the LIBOR Transition (via prerecorded video)

quarles

Good morning to you all. I am sorry I cannot be present at the Alternative remarks with you at what is the start of the next critical stage in the transition away from Since 2014, the official sector has publicly warned that LIBOR could become unstable. Not everyone paid attention to those warnings, but the risks that we pointed to LIBOR's stability only through the end of 2021. Despite that development, some continue to speculate that LIBOR can remain in production indefinitely. My key message to you today is that you should take the warnings seriously. Clarity on the exact timing and nature of the LIBOR stop is still to come, but the regulator of LIBOR has said that it is a matter of how LIBOR will end rather than if it will end, and it is hard to see how one could be clearer than that. The Federal Reserve convened the ARRC based on our concerns about the stability of LIBOR. The ARRC was charged with providing the market with the tools that would be needed for a transition from LIBOR: an alternative rate that did not share the same structural instabilities that have led LIBOR to this point, a plan to develop liquidity in the derivatives market for this new rate so that cash users could hedge their interest rate risk, and models of better contract language that helped limit the risk from a LIBOR disruption. The ARRC has provided these tools. Now it is up to you to begin using them. With only two and a half years of further guaranteed stability for LIBOR, the transition should begin happening in earnest. I believe that the ARRC has chosen the most viable path forward and that most will benefit from following it, but regardless of how you choose to transition, beginning that transition now would be consistent with prudent risk management and the duty that you owe to your shareholders and clients. The ARRC's work began by focusing on creating a derivatives market for the LIBOR, because end users require derivatives markets to hedge their cash exposures. The CME Group, LCH, and Intercontinental Exchange, or ICE, all now offer futures or swaps markets on SOFR, and participation in these markets is growing. As liquidity in these markets continues to develop, my hope is that many of you will avail yourselves of them to close out your LIBOR positions. In the meantime, it will be crucial in ensuring global financial stability that everyone participate in the International Swaps and derivatives and then sign the ISDA protocol so that these fallbacks apply to the legacy book of derivatives. Likewise, the ARRC has now offered better fallback language for new issuance of cash products that refer to LIBOR. It seems clear that much of the contract language being used currently did not envisage and is not designed for a permanent end to LIBOR. The ARRC's fallback recommendations represent a significant body of work on the part of a wide set of market participants and set out a robust and well-considered set of steps that expressly consider an end to LIBOR. I urge everyone to avail themselves of this work; it is, again, important for prudent risk management and your fiduciary responsibilities that you incorporate better fallback language. Issuers should demand it of themselves, and investors should demand it of issuers. There is, however, also another and easier path, which is simply to stop using LIBOR. At this moment, many seem to take comfort in continuing to use LIBOR--it is familiar, and it remains liquid. But history may not view that decision kindly; after LIBOR stops, it may be fairly difficult to explain to those who may ask exactly why it made sense to continue using a rate that you had been clearly informed had such significant risks attached to it. And make no mistake--as good as the fallback language may be, simply relying on fallback language to transition brings a number of operational risks and economic risks. Firms should be incorporating these factors into their projected cost of continuing to use LIBOR, and investors and borrowers should consider them when they are offered LIBOR instruments. If you do consider these factors, then I believe you will see that it is in your interest to move away from LIBOR. In convening the ARRC, we have set a model of public-private sector cooperation to address a key financial stability risk. Ultimately, the private sector must drive this transition--these are private contracts, and each of you must choose how you can best address this risk--but the public sector must help. At a recent roundtable on the LIBOR transition held by the Financial Stability Board, we heard calls from the private sector to provide greater clarity on regulatory and tax implications of the transition and also calls for a more "muscular" regulatory approach. It is incumbent on the official sector to take these requests seriously, and we are. For example, the Federal Reserve is working with the Commodity Futures Trading Commission and other U.S. prudential regulators to provide greater clarity on the treatment of margin requirements for legacy derivatives instruments. Agency staff are developing proposed changes to the margin rules for non-cleared swaps to ensure that changes to legacy swaps to incorporate a move away from LIBOR, including adherence to the ISDA protocol, would not affect the grandfathered status of those legacy swaps under the margin rules. This has been a key request of the ARRC, and we will look forward to public comment on the proposal. The Federal Reserve's supervisory teams have already included a number of detailed questions about plans for the transition away from LIBOR in their monitoring discussions with large firms. The Federal Reserve will expect to see an appropriate level of preparedness at the banks we supervise, and that level must increase as the end of 2021 grows closer. Our supervisory approach will continue to be tailored to the size of institution and the complexity of LIBOR exposure, but the largest firms should be prepared to see our expectations for them increase. As we consider the answers we have received from these firms, we will assess how our supervisory expectations for them should evolve in the coming year. Let me address one additional point relating to our supervisory stress tests, in an effort to provide further clarity. Some have recently claimed that the Federal Reserve's supervisory stress tests would penalize a bank that replaces LIBOR with SOFR in loan contracts by lowering projections of net interest income under stress. As can be seen in our recently published enhanced descriptions of the supervisory stress-test models, the interest rate variables that drive projections of net interest income under stress are the yield on 10-year Treasury bonds, the yield on 3-month Treasury bills, and the 10-year triple-B corporate yield. That is, the supervisory projections of net interest income are primarily based on models that implicitly assume that other rates such as LIBOR or SOFR move passively with short-term Treasury rates. Given these mechanics, choosing to lend at SOFR rather than LIBOR will not result in lower projections of net interest income under stress in the stress-test calculations of the Federal Reserve. I hope I have been able to provide you with some further clarity today. I am sure that the rest of the roundtable will do so as well. I want to applaud the members of the ARRC who are working hard to make sure this threat to financial stability is avoided.

r190604a_FOMC

united states

Opening Remarks

powell

Good morning. I am very pleased to welcome you here today. This conference is part of a first-ever public review by the Federal Open Market Committee of our monetary policy strategy, tools, and communications. We have a distinguished group of experts from academics and other walks of life here to share perspectives on how monetary policy can best serve the public. I'd like first to say a word about recent developments involving trade negotiations and other matters. We do not know how or when these issues will be resolved. We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective. My comments today, like this conference, will focus on longer-run issues that will remain even as the issues of the moment evolve. While central banks face a challenging environment today, those challenges are not entirely new. In fact, in 1999 the Federal Reserve System hosted a conference titled new challenges that were emerging after the then-recent victory over the Great Inflation. They focused on many questions posed by low inflation and, in particular, on what unconventional tools a central bank might use to support the economy if interest rates fell to what we now call the effective lower bound (ELB). Even though the Bank of Japan was grappling with the ELB as the conference met, the issue seemed remote for the United States. The conference received little coverage in the financial press, but a emphasized the remoteness of the risk. Participants at the conference could not have anticipated that only 10 years later, the world would be engulfed in a deep financial crisis, with unemployment soaring and central banks around the world making extensive use of new strategies, tools, and ways to communicate. The next time policy rates hit the ELB--and there will be a next time--it will not be a surprise. We are now well aware of the challenges the ELB presents, and we have the painful experience of the Global Financial Crisis and its aftermath to guide us. Our obligation to the public we serve is to take those measures now that will put us in the best position deal with our next encounter with the ELB. And with the economy growing, unemployment low, and inflation low and stable, this is the right time to engage the public broadly on these topics. The review has several parts, all of which are intended to open our monetary policy to critical examination. We are holding a series of events around the country to help us understand the perspectives of people from diverse backgrounds and with varied interests. This conference and many other engagements will help us bring to bear the best thinking from policymakers and experts. Beginning later this year, the FOMC will devote time at a series of our regular meetings to assess lessons from these events, supported by staff analysis performed throughout the Federal Reserve System. We will publicly report the outcome of our discussions. In the meantime, anyone who is interested in participating or learning more can find information on the Federal Reserve Board's website. Before turning to the specifics of the review, I want to focus a little more closely on the challenges we face today. For a reference point, at the time of the 1999 conference, the United States was eight years into an expansion; core inflation was 1.4 percent, and the unemployment rate was 4.1 percent--not so different from today. Macroeconomists were puzzling over the flatness of the Phillips curve, the level of the natural rate of unemployment, and a possible acceleration in productivity growth-- questions that are also with us today. The big difference between then and now is that the federal funds rate was 5.2 percent--which, to underscore the point, put the rate 20 quarter-point rate cuts away from the ELB. Since then, standard estimates of the longer-run normal or neutral rate of interest have declined between 2 and 3 percentage points, and some argue that the effective decline is even larger. The combination of lower real interest rates and low inflation translates into lower nominal rates and a much higher likelihood that rates will fall to the ELB in a downturn. As the experience of the past decade showed, extended ELB episodes can be associated with painfully high unemployment and slow growth or recession. Economic weakness puts downward pressure on inflation, which can raise real interest rates and reinforce the challenge of supporting needed job growth. In addition, over time, inflation has become much less sensitive to tightness in resource utilization. This insensitivity can be a blessing in avoiding deflation when unemployment is high, but it means that much greater labor market tightness may ultimately be required to bring inflation back to target in a recovery. Using monetary policy to push sufficiently hard on labor markets to lift inflation could pose risks of destabilizing excesses in financial markets or elsewhere. In short, the proximity of interest rates to the ELB has become the preeminent monetary policy challenge of our time, tainting all manner of issues with ELB risk and imbuing many old challenges with greater significance. For example, the behavior of inflation now draws much sharper focus. When nominal interest rates were around 4 or 5 percent, a low-side surprise of a few tenths on inflation did not raise the specter of the ELB. But the world has changed. Core inflation is currently running a bit below 2 percent on a trailing 12-month basis. In this setting, a similar low-side surprise, if it were to persist, would bring us uncomfortably closer to the ELB. My FOMC colleagues and I must--and do--take seriously the risk that inflation shortfalls that persist even in a robust economy could precipitate a difficult-to-arrest downward drift in inflation expectations. At the heart of the review is the evaluation of potential changes to our strategy designed to strengthen the credibility of our symmetric 2 percent inflation objective. The ELB problem also complicates the FOMC's efforts to achieve transparency and accountability. The Fed, like most major central banks, is insulated from short-term political pressures. In our democracy, that insulation carries with it an obligation for us to be transparent and publicly accountable. When policy rates reached the ELB during the crisis, central banks resorted to what were then new, untested tools to pursue their mandated goals. These tools are no longer new, but their efficacy, costs, and risks remain less well understood than the traditional approaches to central banking. My FOMC colleagues and I are committed to explaining why the use of these tools in the wake of the crisis was a prudent and effective approach to pursuing our congressional mandate and why tools like these are likely to be needed again. Our review is but one part of our efforts to engage with the public on these matters. Let me turn to the specifics of the review, which is focused on three questions: Can the Federal Reserve best meet its statutory objectives with its existing monetary policy strategy, or should it consider strategies that aim to reverse past misses of the inflation objective? Are the existing monetary policy tools adequate to achieve and maintain maximum employment and price stability, or should the toolkit be expanded? How can the FOMC's communication of its policy framework and implementation be improved? These questions are quite broad, and my colleagues and I come to them with open minds. We believe our current policy framework is working well, and we have made no decisions about particular changes. In fact, the review is still in its early stages. The first question raises the issue of whether the FOMC should use makeup strategies in response to ELB risks. By the time of the 1999 conference, research was beginning to show that--in models, at least--such strategies could substantially reduce the unemployment and other costs of ELB spells. The simplest version goes like this: Suppose that a spell with interest rates near the ELB leads to a persistent shortfall of inflation relative to the central bank's goal. But what if the central bank promised credibly that it would deliberately make up for any lost inflation by stimulating the economy and temporarily pushing inflation modestly above the target? In the models, the prospect of future stimulus promotes anticipatory consumption and investment that could greatly reduce the pain of being at the ELB. Policymakers discussed this reasoning in the wake of the crisis, but neither the Fed nor any other major central bank chose to pursue such a policy. Why? For makeup strategies to work, households and businesses must go out on a limb, so to speak, raising spending in the midst of a downturn. In theory, they would do this based on their confidence that the central bank will deliver the makeup stimulus at some point--perhaps years in the future. In models, great confidence in central bankers is achieved by assumption. Despite the flattering nature of this assumption, crisis-era policymakers had major questions about whether their promise of good times to come would really have moved the hearts, minds, and pocketbooks of the public. Part of the problem was that the groundwork had not been laid in advance of the downturn--a problem we could hope to fix well before next time. Policymakers also had deeper concerns about the legitimacy and effectiveness of attempting to bind some future FOMC to take actions that could be objectionable from a short-term perspective when the time came to deliver. Research on makeup strategies has begun to grapple more seriously with the credibility questions. But important questions remain. To achieve buy-in by households and businesses, a comprehensible, credible, and actionable makeup strategy will need to be followed by years of central bank policy consistent with that strategy. The second question asks about the adequacy of the Fed's toolkit for providing stimulus when facing the ELB. In the United States, we used several different formulations of both forward guidance and large-scale purchases of longer-term securities. While views differ on the effectiveness of these policies, with their use, the unemployment rate fell steadily and inflation expectations remained well anchored, outcomes that were favorable overall when viewed against the recoveries of many other advanced economies. My own view is that these policies provided meaningful support for demand, but that they should not be thought of as a perfect substitute for our traditional interest rate tool. In any case, we have a responsibility to thoroughly evaluate what mix of these tools is likely to work best when the next ELB episode arrives. Perhaps it is time to retire the term "unconventional" when referring to tools that were used in the crisis. We know that tools like these are likely to be needed in some form in future ELB spells, which we hope will be rare. We now have a significant body of evidence regarding the effectiveness, costs, and risks of these tools, including those used by the FOMC and others tried elsewhere. Our plans must take advantage of this growing understanding as assessments are refined. The third question concerns improving communication, which I discussed earlier from the standpoint of governance and accountability. But transparency also plays a central role in policy effectiveness through its effects on the expectations of households and businesses. Of course, this was the major insight behind the transparency revolution in central banking over the past few decades. Today, central banks publicly share a large and ever-increasing amount of information about policy. But policymakers and commentators inside and outside central banks sometimes question whether all of the transparency adds up to effective communication. The FOMC's famous dot plot is one example. A focus on the median forecast amounts to emphasizing what the typical FOMC participant would do if things go as expected. But we have been living in times characterized by large, frequent, unexpected changes in the underlying structure of the economy. In this environment, the most important policy message may be about how the central bank will respond to the unexpected rather than what it will do if there are no surprises. Unfortunately, at times the dot plot has distracted attention from the more important topic of how the FOMC will react to unexpected economic developments. In times of high uncertainty, the median dot might best be thought of as the least unlikely outcome. Let me conclude by saying that I look forward to our discussions here and to the ongoing work of the review that lies ahead. We need the best tools and strategies possible for dealing with the challenges we now face, and we must communicate them in a clear and credible way. My colleagues and I welcome your best thinking on these issues. . . . no. 1, . . . . . Journal of , . site at symposium sponsored by the Federal Reserve Bank of Kansas City, held in . Fiscal Policy, and the Risk of Secular Stagnation," paper presented at the . vol. 32

r190605a_FOMC

united states

The Federal Reserve's Review of Its Monetary Policy Strategy, Tools, and Communication Practices

clarida

Good morning, and welcome to day two of the Federal Reserve System I think you will have to agree that the presentations and discussion yesterday were uniformly thoughtful, substantive, and stimulating, and today we will have another impressive lineup of speakers and panelists addressing timely topics that are relevant to our review. And let me convey on behalf of Chair Powell, the Board of Governors, and the Reserve Bank Presidents, a sincere and deep appreciation to all the participants on this program, especially the authors of the seven outstanding papers, for the time, thought, and energy that went into preparing their contributions. Yesterday Professors Eberly, Stock, and Wright provided us with a thorough and thoughtful evaluation of the Federal Reserve's monetary policy strategy, tools, and communications since 2009. They conclude that the policy tools that the Federal Open terminology--helped restore the U.S. economy to health and bring it close to the statutory goals of maximum employment and price stability assigned to us by the As was noted several times yesterday, in recent years forecasters and policymakers have been surprised by the decline in the unemployment rate and the size of the sustained ongoing gains in payroll employment. FOMC participants' estimates of the longer-run normal rate of unemployment in the Summary of Economic Projections illustrate this point--they have drifted lower over time as labor market conditions have improved and inflation has remained quiescent. The paper by Professors Abraham and Haltiwanger provided us with an innovative search-and-matching model to estimate labor market slack--which complements the standard estimates based on unemployment gaps and Phillips curve relationships. On that same general topic, the panel discussion of national and community leaders moderated by Governor Brainard provided a valuable perspective on the labor market that could not otherwise be gleaned from the aggregate statistics we often consult. Of course, notwithstanding what is taught in many U.S. macroeconomics courses, the United States is not a closed economy but is one of many nations engaged in global finance and economic commerce. Professor Obstfeld's paper examined the ways that global economic integration affects inflation and the neutral rate of interest--or --and the role played by the U.S. dollar in transmitting the Federal Reserve's monetary policy to other countries. In our final session yesterday, Professors Cecchetti and Schoenholtz assessed the Federal Reserve's communication practices. Based on interviews and conversations with market participants, academics, and former policymakers, Professors Cecchetti and Schoenholtz offered concrete suggestions for improving our most important communications vehicles. Our program today will feature papers by Lars Svensson on alternative monetary policy strategies, by Eric Sims and Cynthia Wu on the policy toolkit, and by Anil Kashyap and Caspar Siegert on the interplay between financial stability considerations and monetary policy. Our featured panel of national and community leaders moderated by President Rosengren will I'm sure offer valuable perspectives about how the monetary levers we pull and push affect communities, credit availability, and small businesses. Aside from being an intellectually stimulating two days, how does this week's conference fit into the FOMC's review of its monetary policy strategy, tools, and communications? Let me describe briefly how the review is structured. Over the past several months, the individual Reserve Banks have been hosting a series of events--seven so far including this conference--with at least five more to follow in coming months. Each event is organized with a format and list of participants that works best for that District but with two common elements: that Fed officials do most of the listening and that, when feasible, the events be live streamed. In Dallas, we heard from local leaders about the challenges facing lower-income communities. In Minneapolis, we listened to researchers discuss the distributional consequences of the economic cycle and of monetary policy. In Boston, we heard from small businesses, labor leaders, and groups that work in underserved communities about the effects of the Fed's policymaking on New England residents. In Camden, New Jersey, we learned about the workforce training initiatives of a local manufacturing firm. In Richmond, a panel of local business and community leaders discussed the ways the Fed's monetary policy affects the regional economy. In New York, panelists representing labor, local government, and community organizations offered their perspectives on the relative importance of the Fed's dual mandate goals. As I and my Fed colleagues who have participated in these events will attest, they have provided us with valuable perspectives on the economy that we would not otherwise be able to glean from aggregate economic statistics. In coming regularly scheduled meetings, the FOMC will undertake its assessment of our monetary policy strategy, tools, and communication practices. This assessment will be informed by what we've heard at this conference, by our listening sessions in the Federal Reserve Districts, and by the work of System staff. When the Committee tackles important issues, we take the time for wide-ranging and candid discussions, and so I expect our deliberations will continue over several meetings for the remainder of this year. We will share our findings with the public when we have completed our review, likely during the first half of next year. Thank you and let's move directly to our first session.

r190621a_FOMC

united states

Fed Listens in Cincinnati: How Does Monetary Policy Affect Your Community?

brainard

It is good to be here in Cincinnati. I want to thank my colleague, Loretta Mester, for inviting me to participate today, and it is a pleasure to participate in the Federal Today's session is part of a series called reaching out to communities around the country to hear how Americans are experiencing the economy day to day and to make sure we are carrying out the monetary policy goals assigned to us by the Congress in the most effective way we can. The Congress has assigned the Federal Reserve to use monetary policy to achieve maximum employment and price stability. These two goals are what we refer to as our dual mandate. By price stability, we mean moderate and stable inflation. The Federal monetary policy--has announced that our goal is to keep inflation around 2 percent over time. The maximum-employment part of our dual mandate means that the Congress has directed us to achieve the highest level of employment that is consistent with price stability. Earlier this week, President Mester and I participated in the meeting of the FOMC, where we had the opportunity to share our views on the economy and policy. My own assessment is that the most likely path for the economy remains solid. The latest data suggest that consumer spending is robust, and consumer confidence is high. Although the pace of payroll gains has moderated recently, unemployment is at a 50-year low, wages are growing, participation in the labor force has expanded, and unemployment insurance claims are at cycle lows. Despite recent volatility, financial conditions overall remain supportive. Recent weeks, however, have seen important downside risks. Crosscurrents from policy uncertainty have risen since early May, crimping business investment plans, raising concerns in some financial market segments, and weighing on global growth prospects. Foreign authorities are seeking additional policy space to address growth and inflation shortfalls. In addition, recent indicators of inflation and inflation expectations have been disappointing, making it all the more important to sustain the economy's momentum. The downside risks, if they materialize, could weigh on economic activity. Basic principles of risk management in a low neutral rate environment with compressed conventional policy space would argue for softening the expected path of policy when risks shift to the downside. With recent indicators suggesting the expansion is continuing at a solid pace and unemployment at a 50-year low, inflation has not yet moved to our goal on a sustained basis. In many ways, that can be viewed as an opportunity, with the sustained expansion providing critical job opportunities to a broader set of applicants. In parallel, it is also vital that a central bank meets its inflation target on a sustained basis, which will provide more capacity to buffer the economy if it encounters headwinds. We are undertaking our review to ensure we are well positioned to meet our goals for many years to come, especially in light of the way the economy is changing, which I have been referring to as the "new normal." There are a few key features of that new normal. First, interest rates have stayed very low in recent years in the United States and in many other advanced economies, and it seems likely that equilibrium interest rates will remain low in the future. Low interest rates present a challenge for traditional monetary policy in recessions. In the past, the Federal Reserve has typically cut interest rates 4 to 5 percentage points in order to support household spending and business investment. However, when equilibrium interest rates are low, we have less room to cut interest rates and less room to buffer the economy using our conventional tool. Another big change in the economy is that inflation does not move as much with economic activity and employment as it has in the past, which is what economists mean when they say the Phillips curve is very flat. A flat Phillips curve has important advantages: The labor market can strengthen a lot and pull many workers who may have been sidelined back into productive employment without an acceleration in inflation, unlike what we saw in the 1960s and 1970s. On the other hand, today's low sensitivity of inflation to slack, along with the limited ability to cut interest rates in a recession, means it can be more difficult to achieve our 2 percent inflation objective on a sustainable basis. The limited ability to cut interest rates could provide less ability to buffer the economy in a downturn, while the very flat Phillips curve could make it harder to boost inflation during an expansion. And that could further compress policy space in a negative spiral. As we have seen in other countries, if inflation consistently falls short of the central bank's objective, consumers, workers, and businesses start to expect lower inflation to continue. Expectations of low inflation can create a self-fulfilling dynamic with actual inflation, making it even more difficult for the central bank to boost inflation. And because inflation is reflected in nominal interest rates, that, in turn, can reduce the amount of policy space the central bank has available to prevent the economy from slipping into recession. In fact, in recent years, central banks around the world have had to use a larger variety of policy tools than they have traditionally used to support the recovery. Given the new normal of low equilibrium interest rates and low sensitivity of inflation to slack, it is prudent to assess how well various approaches worked both here and around the world, with a view to identifying the best ways to promote the goals the Congress assigned to us. Earlier this month, we held a conference in Chicago where we heard from experts as well as community organizations, small businesses, labor organizations, and retirees. We are looking at our tools and strategies, assessing not just the various approaches that were undertaken, but also approaches that have been proposed but not tried. One of the ideas discussed in Chicago is that the Federal Reserve should explicitly promise to "make up" for misses on inflation during a downturn. The Federal Reserve could hold interest rates lower after a recession is over, perhaps by promising not to raise interest rates until inflation or the unemployment rate have reached particular levels. A related idea discussed in Chicago is average inflation targeting, meaning the Federal Reserve would aim to achieve its inflation objective, on average, over a longer period of time--perhaps over the business cycle. This approach could also have aspects of a makeup policy, depending on how it is designed. While such approaches sound quite appealing on their face, they have not yet been implemented in practice. There is some skepticism that a central bank would in fact prove able to support above-target inflation over a sustained period without becoming concerned that inflation might accelerate, and inflation expectations might rise too high. At the Chicago conference, we also heard how difficult it can be to estimate with any precision the "maximum employment" leg of our dual mandate. There is no fixed destination point for maximum employment--no single number where we can be sure we are "there." Maximum employment is something that we must learn about by seeing how the job market is operating. That is very different from the longer-run level of inflation, which central banks are presumed able to determine over time. At our conference in Chicago, we also asked the panelists about our communications with the public, and the responses were humbling. The Federal Reserve communicates with the public about monetary policy through a variety of channels. At each of our policy-setting meetings, the FOMC issues a statement, and Chair Jerome Powell holds a press conference. Three weeks after the meeting, the minutes of the meeting are published. Twice a year, the Federal Reserve submits a to the Congress. We heard in Chicago that most members of the public care a lot about the job market and the cost of credit, but they are not aware of our communications about monetary policy. Of course, the media plays an important role in communicating our monetary policy actions and how they affect the economy. And the Congress, which plays an important role in overseeing the Fed, is a key audience as well. Nonetheless, considering how we can provide greater visibility to the public about what we do will be one of the issues we will be considering as our policy review continues. Now, how does today's event fit into all of this? Since I arrived at the Fed, I have derived tremendous benefit from visiting communities all over the country to hear from them how they are experiencing the economy. Today President Mester and I want to hear from you. How is your community experiencing today's economy? Is everyone who wants a job able to get one? Can they get the necessary training? Are businesses finding it relatively easy to hire the workers they need? How does price inflation and wage growth affect you? What about the availability and cost of credit--whether to start or expand a small business, buy a car to get to work, or invest in owning a home or getting a degree? And are there ways we can better communicate with you? I look forward to hearing your views on these and other questions.

r190625b_FOMC

united states

Minority Depository Institutions

bowman

Thank you, Makada. Good morning and let me also welcome everyone to the Seidman Center. I am very pleased to join you today for this discussion, which highlights the important role that minority depository institutions (MDIs) and Community presence in these communities and the services you offer that support local businesses, jobs, and economic growth. I know this because before joining the Federal Reserve, I was a community banker in a small rural town and more recently served as Kansas' State Bank Commissioner. I understand what it means to try to meet the financial needs of a community, whose needs are varied and can present unique challenges to a credit underwriter. I remember working with a customer on a mortgage loan for less than $20,000 with a first-time homebuyer's credit to purchase a mobile home. It was one of the most complicated and time consuming loans that I made during my time as a banker. Some larger banks might not be able or even be interested in putting that together, but community bankers know how important this kind of service is to their lower-income customers. I'm proud to bring that perspective to the Federal Reserve Board as the first governor to fill the role designated for someone with community banking experience. One way to fulfill my responsibilities is by meeting with and listening closely to minority and community bankers, consumers, small business owners, and local leaders-- all of the stakeholders with an interest in their communities. MDIs and their staff play a key role, and I will use the knowledge we gain from these interactions to improve our work at the Federal Reserve. We aim to help MDIs in three ways: by finding ways to ease your regulatory burden, by sponsoring valuable and actionable research on your contributions to your communities, and by seeking to better support you through outreach and hands-on technical assistance. To achieve these goals, the Fed has developed an extensive outreach program, the challenges, cultivate safe banking practices, and compete more effectively in the marketplace--all topics that I expect will be addressed today. One of the most important ways to help MDIs is by reducing regulatory burden. We are acting to implement provisions of a new law, S-2155, and reviewing comments on several proposals made in 2018 to ensure they do not unduly burden community banks. Our community bank leverage ratio proposal would allow qualifying banks to opt out of a more complicated risk-based capital framework. Other proposals include raising to $400,000 the threshold for when an appraisal is required for a residential real estate transaction and narrowing the Volcker rule to banks engaged in riskier activities. We raised the threshold from $1 billion to $3 billion in assets for banks that could qualify for an 18-month examination cycle. Further, we raised the asset threshold to $3 billion for Statement. This change, which exempts small holding companies from consolidated risk- based capital rules, fosters local ownership of small banks by allowing more banking companies with limited access to capital markets to use debt in bank acquisitions. With respect to supervision, the Federal Reserve continues to tailor and reduce burden by conducting portions of examinations offsite for community banks that prefer conversely, high-risk activities within state member banks and appropriately streamlines or expands examination work programs commensurate with the identified risk. This minimizes the burden for banks that are well managed and directs supervisory resources to higher-risk activities where they are most needed. Related to regulatory burden is an important initiative, in concert with the Federal Deposit Insurance Corporation, to identify healthy minority banking organizations capable of acquiring or merging with MDIs in troubled condition. Our PFP team has assisted with the process for establishing new MDIs and worked with MDIs to identify advantageous federally sponsored programs with which to collaborate. I note that today's agenda includes a session on this topic. The Board and Reserve Banks also conduct valuable research on the impact of MDIs on underserved households and communities. Last November, we held a webinar, which I hope some of you were able to participate in, on recent research on MDIs. All of our MDI research is available on the Partnership for Progress website. The PFP continues to seek to sponsor high-quality research to enhance our understanding of the MDI business model and how MDIs serve their communities. We welcome your input on research topics you find interesting and helpful. Through this biennial conference and several PFP conferences and outreach events each year, the Federal Reserve facilitates networking among MDI institutions. District coordinators from each Federal Reserve Bank will serve on local exam teams during examinations, and collect feedback from MDIs on how the PFP can provide additional assistance. District coordinators meet regularly with MDI management to discuss emerging issues and provide technical assistance, especially to those in troubled condition, to explain supervisory guidance, discuss challenges, and respond to management concerns and inquiries. High-interest items include the Community Reinvestment Act, IT and cybersecurity, concentrations in commercial real estate, interest-rate risk, capital planning and rules, anti-money-laundering compliance, and third-party vendor management. We want to help MDIs navigate supervisory and regulatory requirements. To do that well, we want to continue to develop an open dialogue so we can better understand the challenges you face and how we can best help you wherever we have the ability to do so. Personal contact and relationship building are important to community banking and, I believe, also to community bank oversight. We want, and need, to hear your questions and concerns. Last April, we invited the leaders of all Fed-supervised MDIs to a Leaders Forum so we could spend a day and a half building relationships and talking about the needs of MDIs. We also encourage staff to reach out to MDIs and ensure that you are aware of our outreach meetings and research. Let's keep this communication going. We engage is these efforts because your institutions are vital to your communities and to the American economy. On behalf of the Federal Reserve, I'd like to once again thank you for the work you do in your communities and welcome you to this year's conference.

r190625a_FOMC

united states

Economic Outlook and Monetary Policy Review

powell

Good afternoon. It is a pleasure to speak at the Council on Foreign Relations. I will begin with a progress report on the broad public review my Federal Reserve colleagues and I are conducting of the strategy, tools, and communication practices we use to achieve the objectives Congress has assigned to us by law--maximum employment and price stability, or the dual mandate. Then I will discuss the outlook for the U.S. economy and monetary policy. I look forward to the discussion that will follow. During our public review, we are seeking perspectives from people across the nation, and we are doing so through open public meetings live-streamed on the internet. Let me share some of the thinking behind this review, which is the first of its nature we have undertaken. The Fed is insulated from short-term political pressures--what is often referred to as our "independence." Congress chose to insulate the Fed this way because it had seen the damage that often arises when policy bends to short-term political interests. Central banks in major democracies around the world have similar independence. Along with this independence comes the obligation to explain clearly what we are doing and why we are doing it, so that the public and their elected representatives in Congress can hold us accountable. But real accountability demands more of us than clear explanation: We must listen. We must actively engage those we serve to understand how we can more effectively and faithfully use the powers they have entrusted to us. That is why we are formally and publicly opening our decisionmaking to suggestions, scrutiny, and critique. With unemployment low, the economy growing, and inflation near our symmetric 2 percent objective, this is a good time to undertake such a review. Another factor motivating the review is that the challenges of monetary policymaking have changed in a fundamental way in recent years. Interest rates are lower than in the past, and likely to remain so. The persistence of lower rates means that, when the economy turns down, interest rates will more likely fall close to zero--their effective lower bound (ELB). Proximity to the ELB poses new problems to central banks and calls for new ideas. We hope to benefit from the best thinking on these issues. At the heart of the review are our events, which include town hall- style meetings in all 12 Federal Reserve Districts. These meetings bring together people with wide-ranging perspectives, interests, and expertise. We also want to benefit from the insights of leading economic researchers. We recently held a conference at the Federal Reserve Bank of Chicago that combined research presentations by top scholars with roundtable discussions among leaders of organizations that serve union workers, low- and moderate-income communities, small businesses, and people struggling to find work. We have been listening. What have we heard? Scholars at the Chicago event offered a range of views on how well our monetary policy tools have effectively promoted our dual mandate. We learned more about cutting-edge ways to measure job market conditions. We heard the latest perspectives on what financial and trade links with the rest of the world mean for the conduct of monetary policy. We heard scholarly views on the interplay between monetary policy and financial stability. And we heard a review of the clarity and the efficacy of our communications. Like many others at the conference, I was particularly struck by two panels that included people who work every day in low- and middle-income communities. What we heard, loud and clear, was that today's tight labor markets mean that the benefits of this long recovery are now reaching these communities to a degree that has not been felt for many years. We heard of companies, communities, and schools working together to bring employers the productive workers they need--and of employers working creatively to structure jobs so that employees can do their jobs while coping with the demands of family and life beyond the workplace. We heard that many people who, in the past, struggled to stay in the workforce are now getting an opportunity to add new and better chapters to their life stories. All of this underscores how important it is to sustain this expansion. The conference generated vibrant discussions. We heard that we are doing many things well, that we have much we can improve, and that there are different views about which is which. That disagreement is neither surprising nor unwelcome. The questions we are confronting about monetary policymaking and communication, particularly those relating to the ELB, are difficult ones that have grown in urgency over the past two decades. That is why it is so important that we actively seek opinions, ideas, and critiques from people throughout the economy to refine our understanding of how best to use the monetary policy powers Congress has granted us. its regular meetings to assess the lessons from these events, supported by analysis by staff from around the Federal Reserve System. We will publicly report the conclusions of our discussions, likely during the first half of next year. In the meantime, anyone who is interested in learning more can find information on the Federal Reserve Board's website. Let me turn now from the longer-term issues that are the focus of the review to the nearer-term outlook for the economy and for monetary policy. Since then, the picture has changed. The crosscurrents have reemerged, with apparent progress on trade turning to greater uncertainty and with incoming data raising renewed concerns about the strength of the global economy. Our contacts in business and agriculture report heightened concerns over trade developments. These concerns may have contributed to the drop in business confidence in some recent surveys and may be starting to show through to incoming data. For example, the limited available evidence we have suggests that investment by businesses has slowed from the pace earlier in the year. Against the backdrop of heightened uncertainties, the baseline outlook of my FOMC colleagues, like that of many other forecasters, remains favorable, with unemployment remaining near historic lows. Inflation is expected to return to 2 percent over time, but at a somewhat slower pace than we foresaw earlier in the year. However, the risks to this favorable baseline outlook appear to have grown. Last week, my FOMC colleagues and I held our regular meeting to assess the stance of monetary policy. We did not change the setting for our main policy tool, the target range for the federal funds rate, but we did make significant changes in our policy statement. Since the beginning of the year, we had been taking a patient stance toward assessing the need for any policy change. We now state t The question my colleagues and I are grappling with is whether these uncertainties will continue to weigh on the outlook and thus call for additional policy accommodation. Many FOMC participants judge that the case for somewhat more accommodative policy has strengthened. But we are also mindful that monetary policy should not overreact to any individual data point or short-term swing in sentiment. Doing so would risk adding even more uncertainty to the outlook. We will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.

r190701a_FOMC

united states

The Federal Reserve's Review of Its Monetary Policy Strategy, Tools, and Communication Practices

clarida

I am delighted to be in Helsinki at this important conference on monetary policy and the future of Europe's monetary union. Today I would like to discuss the broad review of the Federal Reserve's monetary policy framework that my fellow policymakers and I are undertaking this year. We are examining the policy strategy, tools, and communication practices that we use to pursue our dual-mandate goals of maximum employment and price stability. In my remarks, I will describe the motivation for and scope of this review and discuss some of the events that are taking place. In our review, we are being transparent and open minded, and we are seeking perspectives from a broad range of interested individuals and groups, including academics, other specialists, and the public at large. Motivation for the Review The fact that the Federal Reserve is conducting this review does not suggest that we are dissatisfied with the existing policy framework. Indeed, we believe our existing framework has served us well, helping us effectively achieve our statutorily assigned dual-mandate goals. Nonetheless, in light of the unprecedented events of the past decade, we believe it is a good time to step back and assess whether, and in what possible ways, we can refine our strategy, tools, and communication practices to achieve and maintain these goals as consistently and robustly as possible. I note that central banks in other countries have conducted periodic reviews of their monetary policy frameworks, and their experience has informed the approach we are pursuing. With the U.S. economy operating at or close to maximum employment and price stability, now is an especially opportune time to conduct this review. The unemployment rate is near a 50-year low, and inflation is running close to our 2 percent objective. By conducting this review, we are ensuring that we are well positioned to continue to meet our statutory goals in coming years. In addition, the Federal Reserve used new policy tools and enhanced its communications in response to the Global Financial Crisis and the Great Recession, and the review is evaluating these changes. Furthermore, U.S. and foreign economies have significantly evolved since the pre-crisis experience that informed much of the research that provided the foundation for our current approach. Perhaps most significantly, neutral interest rates--or r*--appear to have fallen in the United States and abroad. Moreover, this global decline in r* is widely expected to persist for years. The decline in neutral policy rates likely reflects several factors, including aging populations, changes in risk-taking behavior, and a slowdown in technology growth. These factors' contributions are highly uncertain, but, irrespective of their precise role, the policy implications of the decline in neutral rates are important. All else being equal, a fall in neutral rates increases the likelihood that a central bank's policy rate will reach its effective lower bound (ELB) in future economic downturns. That development, in turn, could make it more difficult during downturns for monetary policy to support spending and employment, and keep inflation from falling too low. Another key development in recent decades is that inflation appears less responsive to resource slack. That is, the short-run Phillips curve appears to have flattened, implying a change in the dynamic relationship between inflation and employment. A flatter Phillips curve is, in a sense, a proverbial double-edged sword. It permits the Federal Reserve to support employment more aggressively during downturns--as was the case during and after the Great Recession--because a sustained inflation breakout is less likely when the Phillips curve is flatter. However, a flatter Phillips curve also increases the cost, in terms of economic output, of reversing unwelcome increases in longer-run inflation expectations. Thus, a flatter Phillips curve makes it all the more important that longer-run inflation expectations remain anchored at levels consistent with our 2 percent inflation objective. Finally, the strengthening of the labor market in recent years has highlighted the challenges of assessing the proximity of the labor market to full employment. The unemployment rate, which stood at 3.6 percent in May, has been interpreted by many as suggesting that the labor market is currently operating beyond full employment. However, the level of the unemployment rate that is consistent with full employment is not directly observable and thus must be estimated. I believe the range of plausible estimates extends to 4 percent or below. For example, in the Summary of Economic Projections submitted in conjunction with the June meeting of the Federal Open Market Committee (FOMC), the range of estimates for the longer-run normal unemployment rate The decline in the unemployment rate in recent years has been accompanied by a pronounced increase in labor force participation for individuals in their prime working years. These increases in prime-age participation have provided employers with a source of additional labor input and have been one factor restraining inflationary pressures. As with the unemployment rate, whether participation will continue to increase in a tight labor market remains uncertain. The strong job gains of recent years also have delivered benefits to groups that have historically been disadvantaged in the labor market. For example, African Americans and Hispanics have experienced persistently higher unemployment rates than whites for many decades. However, those unemployment rate gaps have narrowed as the labor market has strengthened, and there is some indication of an extra benefit to these groups as the unemployment rate moves into very low territory. although unemployment rates for less-educated workers are persistently higher than they are for their more-educated counterparts, such gaps appear to narrow as the labor market strengthens. And wage increases in the past couple of years have been strongest for less-educated workers and for those at the lower end of the wage distribution. Scope of the Review responsibility to conduct monetary policy "so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." review this year takes this statutory mandate as given and also takes as given that inflation at a rate of 2 percent is most consistent over the longer run with the congressional mandate. Our existing monetary policy strategy is laid out in the Committee's Statement on First adopted in January 2012, the statement has been reaffirmed at the start of each subsequent year, including at the FOMC's meeting this past January with unanimous support from all 17 FOMC participants. The statement indicates that the Committee seeks to mitigate deviations of inflation from 2 percent and deviations of employment from assessments of its maximum level. In doing so, the FOMC recognizes that these assessments of maximum employment are necessarily uncertain and subject to revision. According to the Federal Reserve Act, the employment objective is on an equal footing with the inflation objective. As a practical matter, our current strategy shares many elements with the policy framework known in the research literature as "flexible inflation targeting." the Fed's mandate is much more explicit about the role of employment than that of most flexible inflation-targeting central banks, and our statement reflects this by stating that when the two sides of the mandate are in conflict, neither one takes precedent over the other. We believe this transparency about the balanced approach the FOMC takes has served us well over the past decade when high unemployment called for extraordinary policies that entailed some risk of inflation. The review of our current framework is wide ranging, and we are not prejudging where it will take us, but events of the past decade highlight three broad questions. The first question is, "Can the Federal Reserve best meet its statutory objectives with its existing monetary policy strategy, or should it consider strategies that aim to reverse past misses of the inflation objective?" Under our current approach as well as that of most flexible inflation-targeting central banks around the world, the persistent shortfalls of inflation from 2 percent that many advanced economies have experienced over most of the past decade are treated as "bygones." This means that policy today is not adjusted to offset past inflation shortfalls with future overshoots of the inflation target (nor do persistent overshoots of inflation trigger policies that aim to undershoot the inflation target). Central banks are generally believed to have effective tools for preventing persistent inflation overshoots, but the ELB on interest rates makes persistent undershoots more likely. Persistent inflation shortfalls carry the risk that longer-term inflation expectations become poorly anchored or become anchored below the stated inflation goal. In part because of that concern, some economists have advocated "makeup" strategies under which policymakers seek to undo, in part or in whole, past inflation deviations from target. Such strategies include targeting average inflation over a multiyear period and price-level targeting, in which policymakers seek to stabilize the price level around a constant growth path. These strategies could be implemented either permanently or as a temporary response to extraordinary circumstances. For example, the central bank could commit, at the time when the policy rate reaches the ELB, to maintain the policy rate at this level until inflation over the ELB period has, on average, run at the target rate. Other makeup strategies seek to reverse shortfalls in policy accommodation at the ELB by keeping the policy rate lower for longer than otherwise would be the case. In many models that incorporate the ELB, these makeup strategies lead to better average performance on both legs of the dual mandate and thereby, viewed over time, provide no conflict between the dual-mandate goals. The benefits of the makeup strategies rest heavily on households and firms believing in advance that the makeup will, in fact, be delivered when the time comes-- for example, that a persistent inflation shortfall will be met by future inflation above 2 percent. As is well known from the research literature, makeup strategies, in general, are not time consistent because when the time comes to push inflation above 2 percent, conditions at that time will not warrant doing so. Because of this time inconsistency, any makeup strategy, to be successful, would have to be understood by the public to represent a credible commitment. That important real-world consideration is often neglected in the academic literature, in which central bank "commitment devices" are simply assumed to exist and be instantly credible on decree. Thus, one of the most challenging questions is whether the Fed could, in practice, attain the benefits of makeup strategies that are possible in models. The next question the review will consider is, "Are the existing monetary policy tools adequate to achieve and maintain maximum employment and price stability, or should the toolkit be expanded? And, if so, how?" The FOMC's primary means of changing the stance of monetary policy is by adjusting its target range for the federal funds rate. In December 2008, the FOMC cut that target to just above zero in response to financial turmoil and deteriorating economic conditions. Because the U.S. economy required additional policy accommodation after the ELB was reached, the FOMC deployed two additional tools in the years following the crisis: balance sheet policies and forward guidance about the likely path of the federal funds rate. The FOMC altered the size and composition of the Fed's balance sheet through a sequence of three large-scale securities purchase programs, via a maturity extension program, and by adjusting the reinvestment of principal payments on maturing securities. With regard to forward guidance, the FOMC initially made "calendar based" statements, and, later on, it issued "outcome based" guidance. Overall, the empirical evidence suggests that these added tools helped stem the crisis and support economic recovery by strengthening the labor market and lifting inflation back toward 2 percent. That said, estimates of the effects of these unconventional policies range widely. In addition to assessing the efficacy of these existing tools, we will examine additional tools to ease policy when the ELB is binding. During the crisis and its aftermath, the Federal Reserve considered but ultimately found some of the tools deployed by foreign central banks wanting relative to the alternatives it did pursue. But the review will reassess the case for these and other tools in light of more recent experience in other countries. The third question the review will consider is, "How can the FOMC's communication of its policy framework and implementation be improved?" Our communication practices have evolved considerably since 1994, when the Federal Reserve released the first statement after an FOMC meeting. Over the past decade or so, the FOMC has enhanced its communication practices both to promote public understanding of its policy goals, strategy, and actions and to foster democratic accountability. These enhancements include the Statement on Longer-Run Goals and Monetary Policy Strategy; postmeeting press conferences; various statements about the principles and strategy guiding the Committee's normalization of monetary policy; and quarterly summaries of individual FOMC participants' economic projections, assessments about the appropriate path of the federal funds rate, and judgments of the uncertainty and balance of risks around their projections. As part of the review, we will assess the Committee's current and past communications and additional forms of communication that could be helpful. For example, there might be ways to improve communication about the coordination of policy tools or the interplay between monetary policy and financial stability. Activities and Timeline for the Review Let me turn now to our review process. conducting events, during which we are hearing from a broad range of interested individuals and groups, including business and labor leaders, community development professionals, and academics. One of our events was a research conference at the Federal Reserve Bank of Chicago in early June, with speakers and panelists from outside the Fed. I would like to give a brief summary of what we heard there: Janice Eberly, James Stock, and Jonathan Wright provided a thorough and thoughtful evaluation of the Federal Reserve's monetary policy strategy, tools, and communications since 2009. Lars Svensson evaluated the pros and cons of several monetary policy strategies that have makeup features, and argued that average inflation targeting could be more likely than price-level targeting to be understood by the public and garner credibility. Cynthia Wu and Eric Sims used a dynamic stochastic general equilibrium model to analyze the efficacy of several policy tools at the ELB--forward guidance, negative interest rates, and asset purchases--and the interactions between them. Stephen Cecchetti and Kermit Schoenholtz assessed the Federal Reserve's communication practices and offered suggestions for improving our most important communication vehicles. In other sessions, Katharine Abraham and John Haltiwanger developed an innovative search-and-matching model to estimate labor market slack--which complements the standard estimates based on unemployment gaps and Phillips curve relationships. Maurice Obstfeld examined the ways that global economic integration affects inflation and the neutral rate of interest, and the role played by the U.S. dollar in transmitting the Federal Reserve's monetary policy to other countries. Anil Kashyap and Caspar Siegert spoke about the interplay between financial stability considerations and monetary policy. Our conference also included two sessions with national and community leaders. A panel discussion moderated by Fed Governor Lael Brainard provided a valuable perspective on the labor market that could not otherwise be gleaned from the aggregate statistics we often consult. Another panel discussion moderated by Federal Reserve Bank of Boston President Eric Rosengren offered valuable perspectives about how the monetary levers we pull and push affect communities, credit availability, and small businesses. In addition to the Chicago conference, 7 of the 12 Reserve Banks have hosted sessions, and other events are planned for later this year. From these listening sessions, we have heard about innovative partnerships involving employers, workforce development groups, and community colleges to fill training gaps, and about greater flexibility in the workplace around entry requirements and working arrangements. This innovation and flexibility are coming when the labor market is tight and qualified workers are scarce, and so are welcome developments from the perspective of job creation and retention. All of our events are being conducted with a high degree of transparency. (You can view videos of the events or read the summaries on our In coming regularly scheduled FOMC meetings, we will begin our own assessment of our monetary policy strategy, tools, and communication practices, informed by what we heard at the conference and during our listening sessions in the Federal Reserve Districts and by the work of our staff. When the Committee tackles important issues, we take the time for wide-ranging and candid discussions, and so I expect our deliberations will continue over several meetings for the remainder of this year. We will share our findings with the public when we have completed our review, likely during the first half of next year. The economy is constantly evolving, bringing with it new policy challenges. So it makes sense for us to remain open minded as we assess current practices and consider ideas that could potentially enhance our ability to deliver on the goals the Congress has assigned us. For this reason, my colleagues and I do not want to preempt or to predict our ultimate finding. What I can say is that any refinements or more material changes to our framework that we might make will be aimed solely at enhancing our ability to achieve and sustain our dual-mandate objectives in the world we live in today. at the Brookings Papers on Economic Activity Conference, held at the Brookings . vol. . vol. 10 . . . . . . . ------ (2019). . . . . . Forum, sponsored by the Initiative on Global Markets at the University of Chicago . vol. 122 . Policy in a Low Journal of . . no. 1, . . . presented at the Brookings Papers on Economic Activity Conference, Fall, held at .pdf . . . Journal of . . . . vol. 4 . Journal of . vol. 32 . . . ," a symposium sponsored by the Federal Reserve Bank of Kansas City, held in . . .

r190709b_FOMC

united states

Welcoming Remarks (via prerecorded video)

powell

Good morning everyone and thank you to President Rosengren and the Boston Fed for hosting this conference. The Federal Reserve is strongly committed to stress testing as a cornerstone of our bank supervisory and financial stability missions. Stress testing is perhaps the most successful supervisory innovation of the post-crisis era. But if stress tests are to continue to serve their critical function, they will need to evolve in the years ahead to keep pace with the ever-changing financial system, as they have since the first round of tests in 2009. Before looking to the future, let me recall a bit of history. A little more than 10 years ago, the United States and the world teetered on the brink of economic catastrophe. What was urgently needed was a way to restore confidence in the financial system--a daunting challenge. Neither the banks, nor the regulators, nor the public had a reliable sense of the strength and resilience of our major banks. The announcement of forward-looking stress-testing results in May 2009 helped restore confidence and stabilize banks by providing a credible and independent picture of their finances. original stress tests evolved into the Comprehensive Capital Analysis and Review, or CCAR, program, which has served to institutionalize capital planning by firms, and supervision by the Fed, as a forward-looking endeavor. Since 2009, large banks have added more than $800 billion in common equity capital, giving them a much thicker cushion to deal with losses. Banks have gotten much better at assessing and managing their risks, effectively tracking commitments across their organizations, anticipating capital needs, and planning for different scenarios. The stress tests of the future--5 and 10 years from now--will need to continue to ensure that banks remain able, even in a severe downturn, to provide the credit that households and businesses depend on. As financial institutions and the financial system evolve, stress testing will need to keep up. When the next episode of financial instability presents itself, it may do so in a messy and unexpected way. Banks will need to be ready not just for expected risks, but for unexpected ones. Thus, the tests will need to vary from year to year, and to explore even quite unlikely scenarios. If the stress tests do not evolve, they risk becoming a compliance exercise, breeding complacency from both supervisors and banks. We might also, inadvertently, encourage the development of a banking system where, over time, all banks would look much alike rather than the banking system we want and need, one with diverse institutions with different business models. We simply can't let these things happen. The purpose of today's gathering is to help us think about how to ensure the tests continue to foster a dynamic banking system, financial stability, and a healthy and growing economy. We have invited a wide range participants--fellow regulators, bankers, analysts, academics, and community groups--with diverse perspectives. Because we do not claim a monopoly on knowledge or wisdom, we have invited many who have disagreed with us in the past. I strongly believe that diverse perspectives and healthy debate will sharpen our thinking and lead us to better answers. I'm sorry I'm not able to be with you today. And I want to particularly thank all of the speakers, discussants, and other participants for helping us grapple with the challenges of ensuring that tomorrow's stress tests remain as effective and vigorous as they are today. Thank you.

r190709a_FOMC

united states

Stress Testing: A Decade of Continuity and Change

quarles

Thank you Eric, and thank you to everyone at the Boston Fed and throughout the system who have contributed to this conference. This gathering comes a few weeks after the announcement of this year's stress test results, so let me begin by recounting the highlights of those results. They show that our financial system remains resilient and that capital planning by banks continues to improve. The largest and most complex banks were tested against a severe hypothetical recession and retained strong capital levels, well above their minimum requirements. They demonstrated the ability to withstand a severe and lasting economic downturn and still be able to lend to households and businesses. Additionally, most firms are now meeting the high expectations we have set to make sure capital planning takes into account their specific risks and vulnerabilities. This is an improvement from last year. Overall, these results are good news that confirm our financial system is significantly stronger than before the crisis. Now let me turn to the purpose of this conference, which is to sharpen our understanding of the experience gained from stress testing and apply these lessons to think about the future. And let me begin by acknowledging that--notwithstanding our openness to learning from the collective experience of all of us in this room--the future of stress testing will, in a number of important ways, necessarily resemble the past. For example, we're still going to have them. Over the course of the last 18 months, I have heard overwhelmingly--from academics, from think tanks of every stripe, from banks of every size, from regulatory colleagues both domestic and foreign--that stress tests should continue to be a key element of the Federal Reserve's supervision of systemically important banks and a key aspect of the Fed's efforts to promote financial stability. Stress tests should be regular, rigorous, and dynamic. And the banks' performance on these tests will continue to be the most risk sensitive and consequential assessment of the affected banks' capital requirements. Transparency around the stress testing process and results was a fundamental principle of the first stress test and every one that has followed, and it will remain a primary goal. Stress tests, as ever, will provide the public with essential information to assess the health of banks and the overall financial system. To be credible, stress tests will also continue to provide significant information about how the Fed does its work, so the public can understand the rigor and independence of our assessment process and how we come to our judgment of the firms we test. Fidelity to these principles, embraced in the depths of the crisis by the first stress test a decade ago, does not mean that stress testing should never change or that it hasn't changed over the years. We have learned from our experiences with the early tests and added useful features and adjustments. These include a counterparty default scenario, as well as a number of policy statements that more explicitly convey the principles we find important in a sensible stress testing program. Stress testing has evolved, and must continue to evolve, to take on what we as supervisors learn from our work and what we can learn from others. Each year, we have refined both the substance and the process of the stress tests, guided by our own experience and by critiques and suggestions from others. This feedback comes from a variety sources, including conferences such as this one, and I am confident that the presentations today will provide insights that result in improvements in our stress tests. If stress tests are to continue to be relevant and effective, I strongly believe that they must continue to change: they must respond to changes in the economy, the financial system, and the risk-management capabilities of firms. Evolutionary change has been a consistent principle of stress testing since the beginning, embraced by my predecessors at the Board of Governors and our supervisory staff and reflected in each cycle of tests. Without such adjustments, regulators, banks, and the broader public cannot get a clear and dynamic view of the capital positions of the largest banks. Stress tests each year have upheld the original principle of transparency around the capital adequacy of our largest banks. Stress tests results should allow investors, counterparties, analysts and markets to make more informed judgments about the condition of banks. Along with other regulatory measures, this transparency increases market discipline and it subjects the Federal Reserve to greater outside scrutiny and analysis. Accountability is important not only for the usual reasons that apply in a democracy but also, in this case, because stress tests can only be effective when the public has confidence in the Fed's evaluation of the capital adequacy of banks. In effect, stress tests are also a test of the Fed's supervision of large banks. In these remarks, I will first sketch out how changes in regulation, risk management, the economy, and overall financial stability have prompted alterations to stress tests over the past decade. Much of that change has enhanced transparency, which is a founding principle for stress tests. I will then suggest some ways in which the effectiveness of stress testing can be further enhanced with greater transparency. Ten years ago, in May of 2009, the Fed and the Treasury Department released the that moment, the U.S. economy was in free fall. The United States had lost an astonishing three million jobs in the previous four months. One significant reason for these losses was that many businesses were severely constrained in their access to funding and found it impossible to predict when that access might improve. The goal of the first test was urgent and simple: to restore confidence in the 19 large banks that then accounted for two-thirds of the assets in the banking system. In fact, simply announcing in March that there would be tests helped stabilize bank finances. That improvement continued after the results in May outlined the quite feasible steps for raising additional capital that the banks would need to take, and did take, to be able to continue lending if adverse conditions continued. Challenging conditions did continue, but the stress tests and other actions taken in the first half of 2009 marked a turning point. The recovery from the Great Recession began in July, as the financial system came back to life, and then steadily strengthened. The principles that made that first test so effective were independence and transparency. For the first time, an independent authority, the Federal Reserve, would seek to independently assess risks. Just as important, the details of that assessment would be shared with the public, an extent of transparency that until then wasn't characteristic of bank supervision but would become the hallmark of the regulatory framework erected in response to the crisis. The first tests relied heavily on banks' internal risk models, but they still represented a huge step in independence in providing the public with an assessment of the health and resiliency of large banks. Transparency facilitated both market discipline and accountability. The information provided to the public under the SCAP stress test reinforced the entire enterprise of estimating the capital shortfall faced by major banks. It held the banks accountable for information on their capital adequacy and required them to fill the capital hole. The next big step for stress testing came with its integration with the Federal One big change from the initial SCAP test was that stress tests were no longer a one-time emergency measure intended to restore confidence in major financial institutions. Instead, they became a recurring, ongoing process intended to maintain confidence in major institutions. Second, stress tests were no longer a discretionary exercise by supervisors--under Dodd-Frank, they became the law of the land. And third, when they were integrated into CCAR, stress tests became part of a comprehensive --it's the first C in CCAR--framework for capital planning that more closely connected capital regulation to risk management of banks and overall supervision. These were changes, but with the effect of reinforcing the founding principles of the SCAP test. Transparency was enhanced when stress tests became mandatory, recurring events and the public could depend on continuing to have access to information about banks' capital adequacy. Also, the independence of those judgments was enhanced when Congress made them a statutory responsibility for the Fed and when they were integrated into our CCAR framework. Further changes to stress testing have likewise reinforced the original goals. Stress testing scenarios have become richer and more challenging, providing more information about how banks would deal with a range of adverse developments and, for example, exploring the effects of more differentiated risks that are not tied to the business cycle. Large trading banks now face an instantaneous shock to their trading assets, and many participants in the stress tests now must address how they would respond to the failure of their largest counterparty. Our stress tests demonstrate that banks have now built enough capital to withstand a severe recession. The capital-building phase of the post-crisis era is now complete, but as part of CCAR, stress testing continues to contribute to the significant and ongoing improvement since 2009 in risk management by banks. The original reason for the qualitative objection aspect of stress testing was to provide incentives for banks to address the risk-management shortcomings that the Federal Reserve had observed during the financial crisis. For example, many firms supervised by the Federal Reserve had substantial deficiencies in their ability to measure, monitor, and manage their risks. These shortcomings made it difficult for banks to accurately report their risk exposures to the Board, and consequently, threatened to undermine the credibility of the stress tests, which were, and remain, dependent on data from the banks. Since the beginning of CCAR in 2011, large banks have significantly improved their risk-management and capital-planning processes. The qualitative assessment conducted as part of the 2018 and 2019 CCAR cycles found that most firms either meet or are very close to meeting the Federal Reserve's supervisory expectations for capital planning. Large banks have improved the methods they use to identify their unique risks, now use sound practices for identifying and addressing model weaknesses, and have strong processes in place to evaluate their capital positions on a forward-looking basis. While we continue to perform a qualitative assessment and ensure that progress is retained, the improvements led the Federal Reserve to conclude that for most banks this assessment can be incorporated into our regular supervisory practices. The evolution of our qualitative assessment reflects the experience of the past 10 years of stress testing, and in particular, the great improvement in risk management by large banks and the cumulative effect of the Fed's improved supervision of large institutions. As I said earlier, for stress testing to remain effective, it must respond to changes in the economy, the financial system, and risk-management capabilities. The changes to CCAR have occurred in the context of a similarly dramatic improvement in the strength and resilience of the financial system. The firms have more than doubled their capital since the first round of stress tests in 2009. Since that time, the common equity of the largest 18 firms has increased by more than $650 billion. Let me now turn to the most recent changes to CCAR and stress testing and put them in the context of the history I have just related. Congress revisited large bank supervision last year in S. 2155, yet the legislation it passed reaffirmed the important role of stress testing. This shouldn't be surprising, because the experience of stress testing over the last 10 years has demonstrated that it is a highly useful element of large bank supervision and the promotion of financial stability. Something else that shouldn't be surprising is that this experience has revealed that periodic stress testing has turned out to be a less useful supervisory tool to evaluate the risks of smaller and less complex financial institutions. Congress made use of this experience by raising the threshold for stress testing to $100 billion in assets and providing more flexibility for the Fed to tailor stress testing for all firms. This step has, once again, advanced the principles demonstrated in the first stress test and ever since. It has increased transparency because incorporating and disclosing what we have learned about the varying effectiveness of stress testing at different types of institutions is making stress testing more effective. The accountability of the Fed is enhanced when we are seen taking on board what we have learned through successive cycles of stress tests, and this strengthens the independence and credibility of our judgments. For those of us who believe stress testing should remain central to supervision and promoting financial stability, it is vital that an adjustment such as this takes place as appropriate. With that in mind, let me review recent changes and proposed changes to the Federal Reserve's stress testing. These changes are designed to make CCAR more transparent and simple and to feature less unnecessary volatility. The first principle is transparency. We have taken a number of recent steps to enhance the transparency around our models and the stress testing process more generally. Earlier this year, the Board published enhanced disclosures on two of the key models that we use in stress testing. In addition, the Board published estimated loss rates for groups of loans with distinct characteristics, to show how supervisory models treat specific assets under stress. We will publish disclosures about two additional models in 2020 and each year thereafter until we have provided transparency about all our stress test models. At the same time, we published a new policy statement on our approach to supervisory stress testing. Among other things, the statement emphasizes the importance of independence and stability to the credibility of our stress tests. We are currently considering options to provide additional transparency regarding scenarios and scenario design and I expect that the Board will seek comment on the advisability of, and possible approaches to, gathering the public's input on scenarios and salient risks facing the banking system each year. Such a proposal may also provide additional details about the scenario design features that underpins each year's scenarios, and a range of other enhancements. Some argue that the greater transparency and disclosure promoted by recent changes and proposed changes to stress testing amounts to providing banks with the answers to the tests. This both overstates the extent of disclosure involved and misunderstands what we are trying to accomplish in stress testing--goals that haven't changed since the spring of 2009. If the goal were only to conduct a test that was difficult to pass--like the qualifying exams for some of the more esoteric and restrictive high-IQ societies--then trying to explain principles, scenario design, and how models work would be inappropriate. If the measure of success for the Fed in administering a stress test was simply how many banks failed, then greater transparency would indeed be a mistake. But that is not the purpose of stress testing, and it never has been. The vitally important goal is to improve and sustain good risk management and capital planning at the individual institutions we supervise and to promote the stability of the financial system. Like a teacher, we don't want banks to fail, we want them to learn. In this case, we want them to learn good risk management in the context of forward- looking capital planning. This will provide the public with more information about the capital planning of major banks, and about how the Federal Reserve views good capital planning and risk management, bolstering our credibility. evidence on the opaqueness of banking firms' assets," . The second principle reflected in recent changes to stress testing is simplicity. One important proposal--what we are calling the stress capital buffer--would simplify the Fed's large bank capital rule by integrating the stress testing process with our traditional regulatory capital rules. Our regulatory capital rule includes both minimum capital requirements and a buffer that sits on top of those minimum requirements. The buffer serves as an early warning to a firm and to supervisors, and it requires the firm to reduce its capital distributions as the firm approaches the minimum requirements. Integrating these two standards is a natural evolution of CCAR away from its origins during the crisis, when such tailoring was impractical and policy makers had not yet considered the approach of a regulatory capital buffer on top of a regulatory capital minimum. The stress capital buffer would result in a more transparent and simplified system of regulatory capital requirements because a firm will be held to a single, integrated capital regime. The stress capital buffer would not reduce the stringency of the regulatory capital framework for large banks, but it would effect a substantial simplification of that framework. By my math, the number of different capital requirements applicable to large banks would fall from 18 to eight and the number of different total loss absorbing capacity requirements for large banks would fall from 24 to 14. I expect that we will move forward with a revised stress capital buffer proposal in the near future, reflecting many of the comments received on our original proposal. The third principle addressed by the recent changes is volatility. When I think about volatility in stress testing, I want to distinguish what I consider to be useful variation in the tests, in the form of exploration of salient risks, from what I consider to be less useful variation, in the form of unexpected swings in capital requirements that don't have any particular relationship to changing risks at individual firms. In addition, one source of volatility in the tests comes from the fact that banks are forced to do their capital planning before they get the results of our tests. I will address each of these concerns in turn. In distinguishing useful from less useful volatility, one option to address the year- over-year volatility of the tests would be to average the results of the tests from the previous year or years. This would not affect the overall stringency of the tests but, mathematically, would mean that no single year could have an outsized influence on the amount of capital that a bank is required to maintain. The potential downsides to this approach include the reduced risk sensitivity that a bank may experience to a particular test and potential technical challenges associated with changes to a bank's balance sheet and earnings. Bearing in mind these potential challenges, I believe more thinking and discussion of this issue would be fruitful. With respect to the second concern, as I have said before, I believe it more rational and logical for firms to be able to plan for their capital needs with the benefit of the results of our tests. Given the huge strides that the banks have made in their capital planning and in meeting our expectations, I view the risk of banks backsliding in this regard to be minimal because it would be evident in the next test. Our capital-planning expectations will not decline, and we will continue to use the supervisory process to enforce these expectations. It is my hope that greater transparency can play a role in other parts of our supervisory process--for example, by allowing other aspects of bank supervision to benefit from public input. Greater transparency for supervision is in keeping with one of the biggest improvements to the regulatory framework and to stress testing since the financial crisis. I believe the changes and proposed changes to stress testing that I have discussed today reinforce the founding principles of the first test, administered in the challenging and uncertain spring of 2009, and reflect what we have learned each year over the decade since then. That process of learning and refining should and must continue in order to keep stress tests as relevant and effective as they have been in helping to reduce the chances of another severe crisis.

r190711a_FOMC

united states

Perspectives on the Economy from Scranton

brainard

Thank you to my colleague Pat Harker for the invitation to join him here this evening. In my time at the Federal Reserve, I have found that hearing directly from people around the country about how their communities are experiencing the economy is vital to carrying out my responsibilities. It helps me to understand what is working well and what the challenges are, and it provides ideas on how to improve economic opportunities. Today I look forward to hearing your perspective on the economy and the banking business in and around Scranton. Before hearing from you, I was asked to provide my perspective on the national economy. Recent data suggest the economy is growing solidly. Consumer spending is robust, buoyed by the strong labor market and continued strong confidence. Last week's strong jobs report provided reassurance that employment has continued to expand at a healthy pace. Payrolls have risen at a 170,000 monthly pace over the past three months--more than enough to provide jobs for new entrants to the labor force. The unemployment rate remains near a 50-year low, wages are growing at a moderate pace, the percentage of prime-age adults who are employed is close to its pre-crisis peak, and claims have been hovering around historic lows. Furthermore, financial conditions overall remain quite supportive of continued employment and output growth. By contrast, capital spending by businesses has been lackluster, and indicators of business sentiment have been soft. The recent G-20 summit provided a constructive change in tone about trade discussions, but business sentiment and investment plans will likely remain sensitive to uncertainty around trade and the global outlook. Fiscal policy is also a source of uncertainty, with both the debt ceiling and the federal budget needing to be resolved. Over the past year, inflation has fallen short of the Federal Reserve's 2 percent objective, and that has been the case more often than not in recent years. On the one hand, that means the economy can continue to grow without pushing inflation too high. On the other hand, inflation that runs too low for long periods can pose difficult challenges. Below-target inflation reduces the amount of room the Federal Reserve has to cut the federal funds rate to cushion the economy from negative developments. And it could lead people to lower their expectations for future inflation, which in turn could lead to an increasing shortfall of inflation from our objective. Indeed, some indicators of longer-run inflation expectations have been on the soft side in recent months. Putting all of the pieces together, it appears the economy has been doing well so far this year, bolstered by confident consumers and a strong job market. And after fluctuations earlier in the year, financial markets currently appear supportive of growth, with borrowing rates low and the stock market at all-time highs. While the modal outlook is solid, the downside risks, if they materialize, could weigh on economic activity. Taking into account the downside risks at a time when inflation is on the soft side would argue for softening the expected path of monetary policy according to basic principles of risk management. Of course, my judgment about the actual path of policy will continue to be influenced by the evolution of the data and the risks. I am mindful that low spreads on corporate credit, together with risky corporate debt at historic highs, suggest financial imbalances are growing. We should be addressing these financial imbalances by activation of the countercyclical capital buffer, more rigorous use of stress tests, and active monitoring of leveraged lending. So what does this mean for you and the families and businesses you serve in and around Scranton? I hope and expect that the progress you have made in transforming the region's economy will continue as the expansion extends into its 11th year. I am well aware of the challenges this area has been working to overcome since the Great Recession. And I am impressed by how much has been accomplished here. You have had important success in attracting new logistics jobs to take advantage of Northeastern Pennsylvania's proximity to major cities. You are making important investments in the forward-looking "eds and meds" (education and health-care) sectors by leveraging the 19 colleges and universities in and around Scranton. There are signs that these investments are paying off. Household incomes in Scranton are growing again. The area's unemployment rate is close to its lowest level in the past 40 years. I look forward to hearing from the community bankers gathered here today about the outlook for families and businesses in Northeastern Pennsylvania and how you are helping the region invest and grow. And I am looking forward to continuing the discussions tomorrow, when I will visit with the Scranton Area Community Foundation to discuss the Northeastern Pennsylvania equitable transportation initiative, NEPA Moves, that is working on transportation solutions to connect residents with opportunity. I look forward to visiting Geisinger Fresh Food Farmacy and meeting with patients to hear about the innovative "food as medicine" program. I also look forward to visiting the Cedar Avenue corridor with the United Neighborhood Centers of Northeastern Pennsylvania to hear about the resident-driven revitalization there. Let me again thank Pat Harker and all of you for having me here today. I look forward to our discussion.

r190716a_FOMC

united states

Monetary Policy in the Post-Crisis Era

powell

Seventy-five years ago this month, the foremost economic and policy minds of their generation gathered in a sleepy mountain town in New England. While World War II still raged, they envisioned a new international monetary system with rules, World Bank--to promote recovery and stability in a war-ravaged world. Today we gather in Paris, the City of Light, to recognize their vision. The Bretton Woods institutions played a pivotal role after the war in rebuilding economies and in facilitating the international economic relations that are essential to prosperity. Generations later, the World Bank and the IMF continue to play important roles in fostering global monetary cooperation, financial stability, and international trade, as well as in promoting sustainable economic growth and reducing poverty. In 1944, those who sat around the table at the Mount Washington Hotel knew that the trauma and tragedy of the war and the Great Depression had fundamentally altered the economic systems that preceded them. For us, around our dinner tables tonight, a decade has passed since the Global Financial Crisis. Although in no way comparable to the devastating events of the 1930s and 1940s, the crisis represents the deepest and broadest financial upheaval since that era, and in many ways, we, too, are grappling with a changed world. Today's conference has looked at this post-crisis environment and the issues we now face from many angles. I am grateful to the Banque de France for organizing this important event and to the outstanding speakers for their deep insights. Tonight I will offer some thoughts on this new environment. I will begin with a discussion of current economic conditions in the United States, and then highlight some significant structural changes in the environment facing monetary policymakers in the post-crisis era. Finally, I will consider how these structural changes are affecting the framework in which we conduct monetary policy, highlighting the Federal Reserve System's ongoing review of our monetary policy strategy, tools, and communications. The U.S. economy is now in its 11th consecutive year of growth. Unemployment has steadily declined from its 10 percent post-crisis peak and has now remained at or below 4 percent for more than a year, the longest stretch in a half century. A strong labor market with plentiful job openings has supported labor force participation. After rising only grudgingly early in the recovery, wages have moved up the past few years. Some groups, such as African Americans, Hispanics, and rural Americans, continue to face long-standing challenges, but the benefits of this strong job market are increasingly widely shared. At outreach events we are holding across the United States, we are hearing loud and clear that this long recovery is now benefiting low- and moderate- income communities to a greater extent than has been felt for decades. Many people who have struggled to stay in the workforce are now getting an opportunity to add new and better chapters to their life stories. Solid growth has sustained this strong labor market. Most recently, U.S. gross domestic product (GDP) increased at an annual rate of just over 3 percent in the first quarter, similar to last year's strong pace. But first-quarter growth was driven largely by net exports and inventories--two volatile spending categories that are typically not dependable indicators of ongoing momentum. Indeed, overall growth in the second quarter appears to have moderated. Growth in consumer spending, which was soft in the first quarter, looks to have bounced back, but business fixed investment growth seems to have slowed notably. Moreover, the manufacturing sector has been weak since the beginning of the year, in part weighed down by the softer business spending, weaker growth in the global economy, and, as our business contacts tell us, concerns about trade tensions. Despite low unemployment and solid overall growth, inflation pressures remain 2 percent objective over much of last year, both overall consumer price inflation and core inflation moved down earlier this year. We currently estimate that the change in the core personal consumption expenditures (PCE) price index was 1.7 percent over the 12 months ending in June. In our baseline outlook, we expect growth in the United States to remain solid, labor markets to stay strong, and inflation to move back up and run near 2 percent. Uncertainties about this outlook have increased, however, particularly regarding trade developments and global growth. In addition, issues such as the U.S. federal debt ceiling and Brexit remain unresolved. FOMC participants have also raised concerns about a more prolonged shortfall in inflation below our 2 percent target. Market-based measures of inflation compensation have shifted down, and some survey-based expectations measures are near the bottom of their historical ranges. Many FOMC participants judged at the time of our most recent meeting in June that the combination of these factors strengthens the case for a somewhat more accommodative stance of policy. We are carefully monitoring these developments and assessing their implications for the U.S economic outlook and inflation, and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective. We will also assess these developments in the context of the broader structural changes monetary policymakers have been facing since the Great Recession. I will focus on three tonight: the changed macroeconomic backdrop, the expanded toolkit, and the heightened focus on communication and transparency. In the United States, from the mid-1980s to right before the Great Recession, PCE inflation averaged 2.6 percent a year, GDP growth 3.4 percent, and the interest rate on a inflation and output growth are around 1 percentage point lower, and the 10-year Treasury rate has averaged 2.4 percent. These declines are not unique to the United States. Average inflation rates for the other major advanced economies have declined by almost half, while the inflation rates of major emerging market economies are less than one-fifth of what they were. Indeed, with few exceptions, we are all facing lower rates of interest, growth, and inflation. In a number of countries, including the United States, these declines have been accompanied by strong labor markets and a much lower unemployment rate. Such changes in the macroeconomic environment are significant because the long-run normal levels of inflation, output, interest rates, and the unemployment rate are important structural features by which we guide policy. Standard estimates of the natural rate of unemployment--u*--and the neutral rate of interest--r*--have been declining for 2 decades, and particularly since the crisis. Many factors are contributing to these changes--well-anchored inflation expectations in the context of improved monetary policy, demographics, globalization, slower productivity growth, greater demand for safe assets, and weaker links between unemployment and inflation. And these factors seem likely to persist. If that happens, the neutral rate of interest will remain low, and policymakers will continue to operate in an environment in which the risk of hitting the effective lower bound is much higher than before the crisis. This proximity to the lower bound poses new complications for central banks and calls for new ideas. It is true that many of these features have been with us for some time. Trend inflation, productivity, and interest rates were declining well before the crisis. But, for monetary policymakers in that era, the threat of high inflation felt proximate, the hard- fought battle to control high inflation having been just recently won. Technological progress seemed likely to continue to sustain rapid increases in productivity--an outcome we continue to await. And the effective lower bound for interest rates was mainly a theoretical concern, except of course in Japan. The changes to the macroeconomic environment may have been in train earlier, but the crisis seems to have accelerated the process. The world in which policymakers are now operating is discretely different in important ways from the one before the Great Recession. I should also note, as is fitting given this event and this audience, that since the crisis policymakers are even more keenly aware of the relevance of global factors to our policies. The global nature of the financial crisis and the channels through which it spread sharply highlight the interconnectedness of our economic, financial, and policy environments. U.S. economic developments affect the rest of the world, and the reverse is also true. For example, the stresses surrounding the euro crisis and, later, the China- related volatility events in 2015 and 2016 led to a general pullback in demand for risky assets that put downward pressure on U.S. interest rates and weighed on U.S. confidence and growth. In addition, we have seen how monetary policy in one country can influence economic and financial conditions in others through financial markets, trade, and confidence channels. Pursuing our domestic mandates in this new world requires that we understand the anticipated effects of these interconnections and incorporate them into our policy decisionmaking. A second important feature of this new world is the tools central bankers now have to fight recessions. In the face of the dramatic economic and financial collapse during the crisis, policymakers quickly exhausted conventional monetary policy tools and employed a range of unconventional measures to support their economies. In the United States, these measures included new forms of forward guidance and a range of balance sheet policies. Broadly across different economies, so-called unconventional monetary policies have generally been successful at lowering interest rates and supporting economic recovery, though cyclical and structural headwinds have made achieving our inflation targets a challenge. A legacy of the crisis is that policymakers now have a broader range of tested tools to turn to the next time the effective lower bound is reached. We must continue to assess additional strategies and tools to bolster our economies and meet our inflation and employment mandates. Finally, the crisis and Great Recession brought into stark relief the need for transparency and accountability for central banks. Central bank communication is increasingly important and increasingly challenging. It is important because clear, transparent communication about the economy, the risks, and our policy responses is critical for the effectiveness of our tools and for our accountability to the public in a democratic society. It is challenging, because we are operating in a changing macroeconomic environment with tools that, while no longer new, remain less familiar to the public. Moreover, our audience has become more varied, more attuned to our actions, and less trusting of public institutions. Gone are the days when the Federal Reserve Chair could joke, as my predecessor Alan Greenspan did, "If I turn out to be particularly clear, you've probably misunderstood what I said." Central banks must speak to Main Street, as well as Wall Street, in ways we have not in the past, and Main Street is listening and engaged. Where does this leave us, and how should policymakers adapt to this new environment? Recognizing challenges posed by the changing structure of the economy, the need for effective policy responses, and the importance of clear communication, central banks are taking a closer look at their strategies and the range of tools currently at their disposal. For example, the Bank of Canada examines its framework every five years as part of the renewal of its inflation-control agreement with the federal government. Canadian officials have announced the bank will "assess a broad range of monetary policy frameworks ahead of the renewal in 2021" of this agreement. Bank of England commissioned a review over the past year of the future of the United Kingdom's financial system and what it might mean for the bank's agenda, toolkit, and capabilities. For our part, the Federal Reserve is conducting, for the first time, a public review of the strategy, tools, and communications that we use to promote our goals of maximum employment and price stability. The heart of this review has been a series of events around the country, in every Reserve Bank District, to hear directly from the constituencies we serve. These events have been live-streamed on the internet. Last month, we hosted a research conference at the Federal Reserve Bank of Chicago to explore ways to more effectively and sustainably achieve our mandated goals. Beginning soon, the FOMC will devote time at its regular meetings to assessing the lessons from these events. We will publicly report the conclusions of our discussions, likely during the first half of next year. Other central banks, many represented in this room, are also looking deeply at the challenges posed by the current environment and assessing tools and strategies. I look forward to learning from your experiences and sharing ours in the coming months and years as we face the trials and opportunities of this new era. For all of us, the turmoil that preceded this new world was severe, although not as extreme as that faced by those around the table in Bretton Woods 75 years ago. Tonight let us celebrate their success and strive so that our vision for the future of the global economic and financial system proves as durable and as effective.

r190805a_FOMC

united states

Delivering Fast Payments for All

brainard

It is a pleasure to be here in Kansas City with Federal Reserve Bank President Esther George to talk about the future of America's payment system. Our payment system is a vital part of America's infrastructure that touches everyone. The choices we make about our payment infrastructure today will affect all Americans many years into the future. Today I am excited to announce the Federal Reserve will invest in a new service to help ensure that real-time payments are available to everyone. The Federal Reserve will , a real-time payment and settlement service for the future. Everyone deserves the same ability to make and receive payments immediately and securely, and every bank deserves the same opportunity to offer that service to its community. FedNow will permit banks of every size in every community across the country to provide real-time payments to their customers. Today, whether you are relying on ACH, a debit card, or a check, it can take as much as a few days to get access to your funds. With a Federal Reserve real-time retail payment infrastructure, the funds would be available immediately--to pay utility bills or split the rent with roommates, or for small business owners to pay their suppliers. Immediate access to funds could be especially important for households on fixed incomes or living paycheck to paycheck, when waiting days for the funds to be available to pay a bill can mean overdraft fees or late fees that can compound. Similarly, getting immediate access to funds from a sale in order to pay for supplies can be a game changer for small businesses, potentially avoiding the need for costly short-term financing. Last November, we asked the public about possible actions the Federal Reserve could take to support interbank settlement of faster payments. We received more than 350 comments on a Federal Reserve faster payment service, representing nearly 800 organizations. Fully 90 percent of these comments called for the Federal Reserve to operate a real-time service for faster payments. Support came from a wide range of stakeholders, including individuals, merchants, fintech firms, and banks. Commenters noted that the Federal Reserve would ensure equitable access to banks of all sizes nationwide by operating a real-time service for faster payments alongside the private-sector system. Commenters highlighted the importance of safety in faster payments and noted the Federal Reserve's record of resiliency, especially during periods of stress. Commenters observed that a Federal Reserve real-time retail payment service would increase competition, decrease market concentration, and provide a neutral platform for innovation. This broad support echoes and expands on the conclusions of the Faster Payments Task quickly to facilitate a faster retail payment system, such as through the development of a real- time settlement service that would also allow for more efficient and widespread access to innovative payment capabilities." In determining the path forward, we are building on the Federal Reserve's long history of operating payment systems as a core part of the nation's payment infrastructure. Since they opened for business around the country in 1914, as directed by the Congress, the Federal Reserve Banks have provided payment and settlement services--in healthy competition with private- sector providers--to achieve public benefits ranging from resiliency to innovation to equal access. When you look across the current payment infrastructure, whether in check processing, automated clearinghouse (ACH) services, or funds transfers, you will see a Federal Reserve service operating alongside private-sector providers. The General Accountability Office has concluded that the Federal Reserve's provision of payment services has benefited the U.S. payment system and its users. The Federal Reserve does not have regulatory authority over the pricing set by a private- sector system or to require a private-sector system to extend the service to banks of all sizes, particularly the last mile. In some other countries, central banks have been assigned the responsibility for regulating payment systems. However, this is not the approach that Congress has taken. Instead, the Federal Reserve's role as an operator has long been seen as an effective approach to promote accessible, safe, and efficient payments in the United States. Through the FedNow Service, we will provide a foundation for the future--a modern payment infrastructure that allows innovation and competition to flourish and delivers faster payments safely and securely for all. To ensure fast payments are available to everyone, FedNow will be accessible to all banks, no matter the size. Given our long-standing service connections with more than 10,000 banks across the country, the Federal Reserve is uniquely placed to deliver this outcome. The bar is high when we assess whether the Federal Reserve should provide a new payment and settlement service, as it should be. We have carefully analyzed the criteria of the Monetary Control Act and long-standing Federal Reserve policies, considered the comments provided by a wide range of stakeholders, and studied the experiences of foreign central banks. We are not making this decision lightly. On balance, after carefully weighing important considerations on both sides, we have concluded it is our responsibility to take action in support of a real-time payment infrastructure accessible to all. While we will work hard to stand up the FedNow Service in a timely manner, our most important goal is to achieve nationwide access for all, reflecting our public mission. A key foundation of the payment infrastructure is interbank clearing and settlement--the movement of funds and the associated information between banks. Today, the U.S. retail payment infrastructure lags behind many other countries. Europe, Mexico, and Australia have already implemented real-time interbank clearing and settlement capabilities. In contrast, here in the United States, the gap between the transaction capabilities in the digital economy and the underlying payment and settlement capabilities continues to grow. Early adopters of fast payment services rely on a legacy infrastructure that was not designed to support faster payments. For example, some services offer real-time funds availability to certain consumers, but they conduct interbank settlement on a deferred basis using legacy systems. This type of settlement entails a buildup of obligations--like IOUs between banks--that could present real risks to the financial system in times of stress. These are not resilient long-term solutions for our dynamic economy and the banks that support it. We are seeing some companies looking to establish a payment system that bypasses our banks and our currency. Facebook's Libra project raises numerous concerns that will take time to assess and address. But one thing is clear: consumers and businesses across the country want and expect real-time payments, and the banks they trust should be able to provide this service securely--whatever their size. To provide everyone with the ability to send and receive funds securely on a 24x7x365 basis, banks need to embrace and invest in real-time innovations, and the Federal Reserve needs to provide a safe and efficient real-time interbank clearing and settlement service accessible to all banks. We are proud of our strong record of cooperating with and supporting private-sector services, while fostering competition for public benefit. We have provided vital support to the sole private-sector provider of real-time settlement for faster payments, and we will continue to do so. The Federal Reserve provided a joint account to enable the private-sector operator to offer real-time payments. Moreover, today we are announcing our intent to explore the expansion of Fedwire Funds Service and National Settlement Service operating hours to support the efficiency of the joint account structure for the private-sector real-time gross settlement (RTGS) service and provide broader benefits. That said, the joint account structure, with its requirement of prefunding and settlement on a private ledger, is fundamentally different from the approach the Federal Reserve will use to settle transactions directly between banks. The Federal Reserve is committed to fulfilling our public policy goals in a spirit of cooperation and competitive fairness. We are pleased that the private-sector faster payment service is in the market, and we see important benefits from the resilient and competitive market that would result from the FedNow Service providing an alternative consistent with the requirements of the Monetary Control Act. The requirement to consider the best way to make our payment and settlement services accessible to banks across the country, along with long-standing principles including cost recovery over the long run, guides our assessment of when the Federal Reserve should engage in the payment system. In setting fees, the Federal Reserve is required by statute to "give due regard to competitive factors and the provision of an adequate level of such services nationwide." I want to share with you some of the analysis--viewed through the prism of our public policy goals of accessibility, safety, and efficiency--that we considered in making today's decision. means serving more than 10,000 banks of varying sizes and missions that are in communities all around the country. It turns out no single private-sector provider of any U.S. payment system has ever achieved nationwide reach on its own, whether it be checks, ACH, cards, or wire transfers. Acting alone, a single private-sector RTGS service will face significant challenges in establishing an accessible infrastructure for faster payments with nationwide reach. In contrast, because of our experience with providing other services, the Federal Reserve already has invested in connections and customer service relationships with nearly every bank, small and large, across the country. Currently, we provide payment services to nearly all banks either directly or indirectly. With our 12 regional Reserve Banks, we have the capacity to meet the needs of banks serving different communities and with different needs and operating models. For that reason, commenters stated that the Federal Reserve is uniquely positioned to offer nationwide access to a new payment and settlement service for faster payments. FedNow will allow faster payments to reach banks of all sizes and their customers across the country, which is especially important for rural communities, who often struggle with access to financial services. Guided by our public mission, the Federal Reserve serves the needs of all banks, no matter how small or challenging to reach, and with competitive fairness. In response to our request for feedback last November, several commenters emphasized how much they value the Federal Reserve's mission of providing nationwide access on fair, transparent terms and expressed concern that a sole private-sector RTGS service provider may be less likely to exhibit the same commitment over the long run. Safety is also vital. If the Federal Reserve does not establish the FedNow Service, there will be a single provider of real-time retail payment services. We are mindful of the serious safety issues associated with a single point of failure, a risk that will rise as faster payments grow. Stakeholders have noted the importance of having access to more than one real-time payment service for back-up purposes in order to provide resiliency through redundancy. In fact, many banks already take advantage of having connections to multiple operators today in check, ACH, and wire services. The Federal Reserve has always had a vital role in promoting the safety and stability of the U.S. payment system by providing liquidity and operational continuity especially in times of stress. The FedNow Service would allow the Federal Reserve to extend this role into the real-time retail payment market. Finally, competition will promote efficiency and innovation. The U.S. real-time retail payment infrastructure stands to gain from competition, including through higher service quality and lower prices over the long run, which in turn should support wider adoption. The FedNow Service will provide a neutral foundation for innovation and competition in end-user faster payment services. In response to the request for feedback, merchants and fintech companies commented that a Federal Reserve real-time retail payment service could broaden the scope for innovation in faster payments. They noted that a single provider that is owned and operated by one segment of the payment industry may focus on a narrow set of use cases that do not reflect the full breadth of possible use cases for faster payments. Recognizing the vibrancy of our payment industry, the addition of the FedNow Service could provide a springboard for broader private-sector participation in the development of innovative end-user services. With the announcement of the Federal Reserve real-time payment service, we are embracing a path that will bring transformative, rather than incremental, change to the retail payment infrastructure in the United States. The FedNow Service will run continuously at all times of the day, every day of the week, consistent with the needs of faster payments and will be designed to process large volumes of payments rapidly. In the months ahead, we intend to explore a variety of approaches to achieving a real- time retail payment infrastructure with nationwide reach. One such approach might be for different payment services to interoperate by exchanging payments among the services directly. Such interoperability is an important goal that we will pursue as standards, technology, and industry practices change over time, although it is not yet clear whether it will be an initial feature. The Federal Reserve plans to devote the necessary resources to deliver the highest quality FedNow Service in a timely manner. We are working to streamline our internal processes to move quickly in the market. President George will play an integral role in this new process, and the Conference of Reserve Bank Presidents has pledged its support. It is important for the Federal Reserve, working with the payment industry, to act quickly in finalizing the initial business requirements of the FedNow Service. We will need to hear the views of payment system stakeholders on the features of the FedNow Service, as discussed in the notice announced today. We will engage with the industry through groups and forums to finalize the design and features of the service. We hope that these conversations will provide an opportunity for stakeholders to work together to shape the evolution of the U.S. payment system. Earlier this month, I joined my Reserve Bank colleagues for a visit with bankers and community organizations in Scranton, Pennsylvania, to hear about the biggest challenges they are facing. The head of a bank that has been serving the Scranton area for more than a century told me that for his community bank to remain competitive in its payment offerings, it is vital to be able to rely on the Federal Reserve for real-time payments just as he does for check, ACH, and wire transfer. I appreciate the importance of community banks to the economic health of our communities, and I recognize the role of the Federal Reserve in enabling community banks to offer payment services on a competitive basis. I am confident that by working together with all payment system stakeholders, we can collectively achieve widespread, safe, and efficient faster payments that will benefit all.

r190820a_FOMC

united states

A Decade of Building Stronger Communities

quarles

Thank you for the kind introduction and for this opportunity to recognize the our state's communities. Over its 10 years, UCNS has improved the lives of many aspiring homeowners, renters, and small business owners and helped to build a more healthy and vibrant Utah. As some of you may know, I grew up in Roy, not too far from here, and have lived in either the Ogden or Salt Lake City areas for many decades. Although I spent a lot of my professional career in New York and London, and these days spend a good deal of my time in Washington, D.C., this is still my home, as it is yours. Like many others, I'm thankful for the work of UCNS and its affiliates, which are investing in the betterment of this city and other Utah communities and working to ensure that the benefits of those investments extend to everyone living here. I've spent most of my career in the private sector, and as I think about the approach of UCNS as a nonprofit organization, I am struck by the extent of entrepreneurship you bring to your work. Like many kinds of businesses, you deploy technical expertise and management skill to make investments, with either debt or equity financing, to generate healthy returns. Some of those returns, measured in dollars, help you continue to carry out your mission, but some of them also come in the form of promoting small businesses, affordable housing, and community facilities such as recreation centers, health-care clinics, and childcare facilities, among other things that build stronger communities. Private- and public-sector partners who support community development value entrepreneurship, and it also makes for a healthier and more sustainable organization, which allows you to continue your important work. By all evidence, UCNS is advancing its goals in spectacular fashion. I expect a large part of this success comes from the collaborative approach that you take to those efforts. It seems that collaboration is a common thread that runs through your programs. For example, that is apparent in UCNS's dedication to working closely with developers to finance affordable housing near high-capacity transit. These important investments help workers get access to the transportation they need to get to work, without a longer commute that strains finances and detracts from family life. Housing affordability is a growing challenge in Utah, and promoting mass transit--among UCNS's other objectives--has a role to play in keeping housing and transportation affordable. A collaborative approach also shows up in the close partnership that UCNS has had with local governments to establish and maintain the Utah Small Business Growth Initiative, which supports economic development and job creation by helping small businesses qualify for financing with banks or other financial institutions. And collaboration is apparent in your work with lenders and affordable housing providers to facilitate the acquisition, rehab, and sale of foreclosed homes to lower- income borrowers, which helps those families secure the dignity and wealth-building opportunity that comes with stable homeownership. This kind of cross-sector collaboration between the private, public, and nonprofit sectors is critically important to extending economic opportunity and access to financial services to low- and moderate-income families. I am happy to report that organizations like UCNS have an active partner in the Federal Reserve, through our community development function, when it comes to supporting these types of partnerships. I will highlight just a few examples of work the Fed has recently undertaken that intersects with the work of UCNS. As is the case in Utah, families in many states across the country face challenges in finding good quality housing they can afford. The Federal Reserve is actively engaged on this issue, and has conducted research and brought together stakeholders to understand it better and consider solutions. As many of you in this room probably know, Utah is located within the district of the Federal Reserve Bank of San Francisco. In September 2014, the San Francisco Fed co-hosted a symposium that explored innovative models for supporting equitable development, including the development of affordable housing, around public transit investment. The event brought together community development financial institutions, local transit authorities, banks, policymakers, and other stakeholders and included participants from Salt Lake City. More recently, in August 2018, the San Francisco Fed hosted a roundtable here to gather key decisionmakers to discuss ways the city and county could reduce barriers and provide more incentives for the development of housing that is affordable to lower-income families. In March of this year, the San Francisco Fed published an analysis of public-private loan funds for the construction and preservation of affordable housing. The study spells out the relative advantages of different types of funds for different kinds of projects--preservation versus development, for example--and details which funds are best for the early, middle, or late stages of a project. Turning to support for small businesses, community development staffers across the Federal Reserve conduct extensive research and analysis of the challenges and opportunities facing small business owners. For example, the 12 Federal Reserve Banks collaborate on the annual Small Business Credit Survey, which surveys business owners about their financing needs and experiences to provide timely insights to policymakers, service providers, and lenders. In addition to providing information on small business credit conditions, the Federal Reserve is trying to advance understanding of the best economic development strategies for supporting small businesses. The Kansas City Fed has helped lead on these issues through its "Grow Your Own" entrepreneurship-based economic development guidebook, and its 2018 Growing Entrepreneurial Communities These are just a few of the ways that Federal Reserve Banks and the Board of Governors support the efforts of community development organizations. I hope that our work will be useful as you chart a path forward for your second decade of service to Utah, and I look forward to continued collaboration between the Federal Reserve and community development organizations such as UCNS. Together, we can help support thriving communities across the Wasatch Front, the state of Utah, and across our nation. Thank you again for inviting me to speak, and congratulations again for 10 years of building stronger communities in Utah.

r190823a_FOMC

united states

Challenges for Monetary Policy

powell

This year's symposium topic is "Challenges for Monetary Policy," and for the Federal Reserve those challenges flow from our mandate to foster maximum employment and price stability. From this perspective, our economy is now in a favorable place, and I will describe how we are working to sustain these conditions in the face of significant risks we have been monitoring. The current U.S. expansion has entered its 11th year and is now the longest on record. The unemployment rate has fallen steadily throughout the expansion and has been near half-century lows since early 2018. But that rate alone does not fully capture the benefits of this historically strong job market. Labor force participation by people in their prime working years has been rising. While unemployment for minorities generally remains higher than for the workforce as a whole, the rate for African Americans, at 6 percent, is the lowest since the government began tracking it in 1972. For the past few years, wages have been increasing the most for people at the lower end of the wage scale. People who live and work in low- and middle-income communities tell us that this job market is the best anyone can recall. We increasingly hear reports that employers are training workers who lack required skills, adapting jobs to the needs of employees with family responsibilities, and offering second chances to people who need one. Inflation has been surprisingly stable during the expansion: not falling much when the economy was weak and not rising much as the expansion gained strength. Inflation ran close to our symmetric 2 percent objective for most of last year but has been running somewhat below 2 percent this year. Thus, after a decade of progress toward maximum employment and price stability, the economy is close to both goals. Our challenge now is to do what monetary policy can do to sustain the expansion so that the benefits of the strong jobs market extend to more of those still left behind, and so that inflation is centered firmly around 2 percent. Today I will explore what history tells us about sustaining long, steady expansions. A good place to start is with the passage of the Employment Act of 1946, which stated that it is the "continuing policy and responsibility of the Federal Government . . . to promote maximum employment, production, and purchasing power." Some version of these goals has been in place ever since. I will divide the history since World War II into three eras organized around some well-known "Greats." The first era comprises the postwar years through the Great Inflation. The second era brought the Great Moderation but ended in the Great Recession. The third era is still under way, and time will tell what "Greats" may emerge. Each era presents a key question for the Fed and for society more generally. The first era raises the question whether a central bank can resist the temptations that led to the Great Inflation. The second era raises the question whether long expansions supported by better monetary policy inevitably lead to destabilizing financial excesses like those seen in the Great Moderation. The third era confronts us with the question of . how best to promote sustained prosperity in a world of slow global growth, low inflation, and low interest rates. Near the end of my remarks, I will discuss the current context, and the ways these questions are shaping policy. The late 1940s were a period of adjustment to a peacetime economy. As the 1940s turned to the 1950s, the state of knowledge about how best to promote macroeconomic stability was limited. The 1950s and early 1960s saw the economy oscillating sharply between recession and growth above 6 percent (figure 1, panel A). Three expansions and contractions came in quick succession. With the benefit of hindsight, the lack of stability is generally attributed to "stop and go" stabilization policy, as monetary and fiscal authorities grappled with how best to modulate the use of their blunt but powerful tools. Beginning in the mid-1960s, "stop and go" policy gave way to "too much go and not enough stop"--not enough, that is, to quell rising inflation pressures. Both inflation and inflation expectations ratcheted upward through four expansions until the Fed, under Chairman Paul Volcker, engineered a definitive stop in the early 1980s (figure 1, panel C). Each of the expansions in the Great Inflation period ended with monetary policy tightening in response to rising inflation. Policymakers came out of the Great Inflation era with a clear understanding that it was essential to anchor inflation expectations at some low level. But many believed that central bankers would find it difficult to ignore the temptation of short-term employment gains at the cost of higher inflation down the road. As the second era began, inflation was falling, and it continued to fall for about a decade (figure 2, panel C). In 1993, core inflation, which omits the volatile food and energy components, first fell below 2.5 percent, and has since remained in the narrow Greater success on price stability came with greater success on employment. Expansions in this era were longer and more stable than before (figure 2, panel A). The era saw two of the three longest U.S. expansions up to that point in history. Anchored inflation expectations helped make this win-win outcome possible, by giving the Fed latitude to support employment when necessary without destabilizing inflation. The Fed was cutting, not raising, rates in the months prior to the end of the first two expansions in this era, and the ensuing recessions were mild by historical standards. And twice during the long expansion of the 1990s, the Federal Open Market Committee (FOMC) eased policy in response to threats to growth. In 1995, responding to evidence of slowing in the United States and abroad, the FOMC reduced the federal funds rate over a few months. In 1998, the Russian debt default and the related collapse of the hedge fund Long-Term Capital Management rocked financial markets that were already fragile from the Asian financial crisis. Given the risks posed to the U.S. economy, the FOMC again lowered the federal funds rate over a period of months until events quieted. The 10-year expansion weathered both events with no discernible inflation cost. By the turn of the century, it was beginning to look like financial excesses and global events would pose the main threats to stability in this new era rather than overheating and rising inflation. The collapse of the tech stock bubble in 2000 and the September 11, 2001, terrorist attacks played key roles in precipitating a slowdown that turned into a recession. And the next expansion, as we are all painfully aware, ended with the collapse of a housing bubble and the Global Financial Crisis. Thus, this second era provided good reason for optimism about the Fed's ability to deliver stable inflation, but also raised a question about whether long expansions inevitably lead to destabilizing financial excesses. The third era began in 2010 as the recovery from the Great Recession was taking hold. My focus in discussing this era will be on a "new normal" that is becoming apparent in the wake of the crisis. I will fast-forward past the early years of the expansion and pick up the story in December 2015. The unemployment rate had fallen from a peak of 10 percent to 5 percent, roughly equal to the median FOMC participant's estimate of the natural rate of unemployment at the time. At this point, the Committee decided that it was prudent to begin gradually raising the federal funds rate based on the closely monitored premise that the increasingly healthy economy called for more-normal interest rates. The premise was generally borne out: Growth from the end of 2015 to the end of 2018 averaged 2.5 percent, a bit above the 2.2 percent rate over the previous five years (figure 2, panel A). The unemployment rate fell below 4 percent, and inflation moved up and remained close to our 2 percent objective through much of 2018 (figure 2, That brings us to 2019. Before turning to issues occupying center stage at present, I want to address a long-running issue that I discussed here last year: tracking the "stars" that serve as guideposts for monetary policy. These include u*, the natural rate of unemployment, and r*, the neutral real rate of interest. Unlike celestial stars, these stars move unpredictably and cannot be directly observed. We must judge their locations as best we can based on incoming data and then add an element of risk management to be able to use them as guides. Since 2012, declining unemployment has had surprisingly little effect on inflation, prompting a steady decline in estimates of u* (figure 3). Standard estimates of r* have declined between 2 and 3 percentage points over the past two decades. Some argue that the effective decline is even larger. Incorporating a lower value of u* into policymaking does not require a significant change in our approach. The significant fall in r*, however, may demand more fundamental change. A lower r* combined with low inflation means that interest rates will run, on average, significantly closer to their effective lower bound. The key question raised by this era, then, is how we can best support maximum employment and price stability in a world with a low neutral interest rate. Let me turn now to the current implications for monetary policy of the questions raised by these three eras. The first era raised the question of whether the Fed can avoid excessive inflation. Inflation has averaged less than 2 percent over the past 25 years, and low inflation has been the main concern for the past decade. Low inflation seems to be the problem of this era, not high inflation. Nonetheless, in the unlikely event that signs of too-high inflation return, we have proven tools to address such a situation. The second era's question--whether long expansions inevitably breed financial excesses--is a challenging and timely one. Hyman Minsky long argued that, as an expansion continues and memories of the previous downturn fade, financial risk management deteriorates and risks are increasingly underappreciated. This observation has spurred much discussion. At the end of the day, we cannot prevent people from finding ways to take excessive financial risks. But we can work to make sure that they bear the costs of their decisions, and that the financial system as a whole continues to function effectively. Since the crisis, Congress, the Fed, and other regulatory authorities here and around the world have taken substantial steps to achieve these goals. Banks and other key institutions have significantly more capital and more stable funding than before the crisis. We comprehensively review financial stability every quarter and release our assessments twice a year to highlight areas of concern and allow oversight of our efforts. We have not seen unsustainable borrowing, financial booms, or other excesses of the sort that occurred at times during the Great Moderation, and I continue to judge overall financial stability risks to be moderate. But we remain vigilant. That leaves the third question of how, in this low r* world, the Fed can best support the economy. A low neutral interest rate presents both near-term and longer-term challenges. I will begin with the current context. Because today's setting is both challenging and unique in many ways, it may be useful to lay out some general principles for assessing and implementing appropriate policy and to describe how we have been applying those principles. Through the FOMC's setting of the federal funds rate target range and our communications about the likely path forward for policy and the economy, we seek to influence broader financial conditions to promote maximum employment and price stability. In forming judgments about the appropriate stance of policy, the Committee digests a broad range of data and other information to assess the current state of the economy, the most likely outlook for the future, and meaningful risks to that outlook. Because the most important effects of monetary policy are felt with uncertain lags of a year or more, the Committee must attempt to look through what may be passing developments and focus on things that seem likely to affect the outlook over time or that pose a material risk of doing so. Risk management enters our decisionmaking because of both the uncertainty about the effects of recent developments and the uncertainty we face regarding structural aspects of the economy, including the natural rate of unemployment and the neutral rate of interest. It will at times be appropriate for us to tilt policy one way or the other because of prominent risks. Finally, we have a responsibility to explain what we are doing and why we are doing it so the American people and their elected representatives in Congress can provide oversight and hold us accountable. We have much experience in addressing typical macroeconomic developments under this framework. But fitting trade policy uncertainty into this framework is a new challenge. Setting trade policy is the business of Congress and the Administration, not that of the Fed. Our assignment is to use monetary policy to foster our statutory goals. In principle, anything that affects the outlook for employment and inflation could also affect the appropriate stance of monetary policy, and that could include uncertainty about trade policy. There are, however, no recent precedents to guide any policy response to the current situation. Moreover, while monetary policy is a powerful tool that works to support consumer spending, business investment, and public confidence, it cannot provide a settled rulebook for international trade. We can, however, try to look through what may be passing events, focus on how trade developments are affecting the outlook, and adjust policy to promote our objectives. This approach is illustrated by the way incoming data have shaped the likely path of policy this year. The outlook for the U.S. economy since the start of the year has continued to be a favorable one. Business investment and manufacturing have weakened, but solid job growth and rising wages have been driving robust consumption and supporting moderate growth overall. As the year has progressed, we have been monitoring three factors that are weighing on this favorable outlook: slowing global growth, trade policy uncertainty, and muted inflation. The global growth outlook has been deteriorating since the middle of last year. Trade policy uncertainty seems to be playing a role in the global slowdown and in weak manufacturing and capital spending in the United States. Inflation fell below our objective at the start of the year. It appears to be moving back up closer to our symmetric 2 percent objective, but there are concerns about a more prolonged shortfall. Committee participants have generally reacted to these developments and the risks they pose by shifting down their projections of the appropriate federal funds rate path. Along with July's rate cut, the shifts in the anticipated path of policy have eased financial conditions and help explain why the outlook for inflation and employment remains largely favorable. Turning to the current context, we are carefully watching developments as we assess their implications for the U.S. outlook and the path of monetary policy. The three weeks since our July FOMC meeting have been eventful, beginning with the announcement of new tariffs on imports from China. We have seen further evidence of a global slowdown, notably in Germany and China. Geopolitical events have been much in the news, including the growing possibility of a hard Brexit, rising tensions in Hong Kong, and the dissolution of the Italian government. Financial markets have reacted strongly to this complex, turbulent picture. Equity markets have been volatile. Long- term bond rates around the world have moved down sharply to near post-crisis lows. Meanwhile, the U.S. economy has continued to perform well overall, driven by consumer spending. Job creation has slowed from last year's pace but is still above overall labor force growth. Inflation seems to be moving up closer to 2 percent. Based on our assessment of the implications of these developments, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective. Looking back over the three eras, monetary policy has evolved to address new challenges as they have arisen. The inflation targeting regime that emerged after the Great Inflation has led to vastly improved outcomes for employment and price stability around the world. One result has been much longer expansions, which often brought with them the buildup of financial risk. This new pattern has led us to understand that assuring financial stability over time requires much greater resilience in our financial system, particularly for our largest, most complex banks. As we look back over the decade since the end of the financial crisis, we can again see fundamental economic changes that call for a reassessment of our policy framework. The current era has been characterized by much lower neutral interest rates, disinflationary pressures, and slower growth. We face heightened risks of lengthy, difficult-to-escape periods in which our policy interest rate is pinned near zero. To address this new normal, we are conducting a public review of our monetary policy strategy, tools, and communications--the first of its kind for the Federal Reserve. We are evaluating the pros and cons of strategies that aim to reverse past misses of our inflation objective. We are examining the monetary policy tools we have used both in calm times and in crisis, and we are asking whether we should expand our toolkit. In addition, we are looking at how we might improve the communication of our policy framework. Public engagement, unprecedented in scope for the Fed, is at the heart of this effort. Through events live-streamed on the internet, we are hearing a diverse range of perspectives not only from academic experts, but also from representatives of consumer, labor, business, community, and other groups. We have begun a series of FOMC meetings at which we will discuss these questions. We will continue reporting on our discussions in the FOMC minutes and share our conclusions when we finish the review next year. I will conclude by saying that we are deeply committed to fulfilling our mandate in this challenging era, and I look forward to the valuable insights that will, I am confident, be shared at this symposium. . . . . paper presented at the Economics History Seminar, University of California, . symposium sponsored by the Federal Reserve Bank of Kansas City, held in . Fiscal Policy, and the Risk of Secular Stagnation," paper presented at the . .

r190904a_FOMC

united states

Introductory Remarks

bowman

In keeping with the purpose of I would like to spend most of our time in conversation, but I do want to offer a few thoughts about why the Fed is reaching out to seek a broad range of views, and what we are trying to achieve. This kind of comprehensive outreach on monetary policy is new for the Fed. For many decades, there was a sense at the Board that the public wasn't interested or willing to dive into the complexities of monetary policy. That view has changed in a fundamental way, especially in the aftermath of the financial crisis when it was urgently important that the public understand what we were doing. So we began explaining as accessibly and clearly as we could what we were doing and why. Now we are listening broadly as well. Since I became a Board member almost a year ago, it's become clear to me that people not only are willing to engage on complex economic issues, they also want to know that their concerns are being taken into account on issues that affect their financial well-being. The movement toward greater transparency and public engagement is ongoing, and advancing that effort is one of my top priorities. At the same time, we recognize that clear communication of our policies actually helps us achieve our goals. When we communicate our views on the economic outlook and our expectations for where interest rates may be heading, consumers and businesses take that information into account when making decisions on spending, investment, and hiring. For that reason, our policy communications are themselves an important part of the Fed's toolkit for influencing the direction of the economy. is a natural outcome of this commitment to public engagement. We want to hear from people, from different parts of the country and different sectors of the economy, about how monetary policy affects them and their communities. It is our responsibility as a public institution to be accountable to the public. And, hearing a broad range of perspectives on these issues will help us make good decisions as we consider new approaches to monetary policy. This afternoon, individual stakeholders representing different economic sectors will meet to discuss their perspectives. Later, President Bullard and I will do what we came here to do, which is listen. I come from a background in farming and ranching, so, priorities for the monetary policy review. And as a former community banker, I am of course interested in what your Community Depository Institution Council has to share with us today. But I am also eager for other perspectives, and I look forward to all of the presentations. I want to know, for example, how monetary policy affects rural communities, like the one I come from in Kansas, but I also want to know how it affects urban communities. Our monetary policy review will have implications for financial markets, but we also want to know more about what the effect will be on Main Street-- which, by the way, happens to be the name of the street where my family's bank is located, in Council Grove, Kansas. My colleagues and I are keenly aware of our responsibility to focus on how the decisions we make affect the real economy for people in communities all across the country. And we will continue these listening sessions for the rest of this year as we consider possible changes to the Federal Reserve's approach to monetary policy. The two goals for monetary policy--maximum employment and stable prices--are determined by the Congress and are not subject to our review. How we reach those goals is what is up for discussion. One question I hope to explore is whether we need new strategies to more effectively achieve our goals. For many years, inflation has run modestly below our 2 percent objective. Given that, it would be helpful to hear from you whether you think the Federal Open Market Committee should consider strategies that aim to have inflation exceed our target for a time, to make up for the earlier period of time when it fell short. Or would that threaten the decades of success the Fed has had keeping the public's expectations for inflation low and stable? A related question concerns the Fed's existing toolkit for monetary policy. Currently, our policy levers include setting interest rates, adjusting the size and composition of our balance sheet, and communicating the expected future path of policy. Are there other tools we should consider to help us reach and sustain our objectives more effectively? I also want to know how the Federal Open Market Committee's communication of its policy framework to the public might be improved. How can we help you better understand our work so you can hold us accountable? Your perspectives on questions like these are a vital part of this monetary policy review, so I want to thank you, again, for your time and your contribution. Once the policy review is complete, we will share our findings with the public, probably during the first half of next year. And now I look forward to our discussion.

r190905a_FOMC

united states

Refining the Stress Capital Buffer

quarles

Bank for the opportunity to speak to you today. I would like to take as my text today this reflection of the 20th-century philosopher, sociologist, and welterweight champion of the world, Oscar de la Hoya: "There's always room for improvement, no matter how long you've been in the business." As all of you know, 2019 marks the 10-year anniversary of our stress testing program in the United States. In only 10 years, stress tests have developed from an innovative but untested tool to become a well-established element of the Federal Reserve's bank supervision program for large banks. But developing and running those first tests required a willingness to change, and an openness to innovation, which underlie every advance in human endeavor-- whether banking or boxing. In that same spirit of being open to change and innovation, my remarks will include some thoughts that might have seemed novel just a few years ago, but in my view, are ideas whose time has now come. As the Federal Reserve has been considering refinements to our stress testing and capital frameworks, two goals have been at the forefront of our thinking: first, to simplify these frameworks to make them easier to apply and understand, and second, to maintain the overall high level of loss-absorbing capacity in the banking system. Let me expand on those two goals. One of the great challenges of a regulator is to write rules that are comprehensive and detailed enough to be effective while also being consistent and simple enough to be well understood. There is a well-documented tendency for regulation to grow by accretion. And with that, there is always a risk that regulatory regimes will become less effective as they grow, developing redundancies and inconsistences that can obscure initial intentions and impair understanding. This is not a desirable outcome for financial regulation, and indeed, it is the responsibility of any regulator to ensure that the rule frameworks remain well integrated and credible. Congress has been adjusting the Dodd-Frank Act since its enactment, and, likewise, the Federal Reserve and other regulators have been making adjustments in the wake of the financial crisis to innovations such as stress testing, a public process that in my view has helped make financial oversight more effective. The thoughts that I am airing in these remarks, part of a public process of discussion and debate, should be seen as a continuation of the review and adjustment that has been taking place since the financial crisis. The goal is to simplify rules that have grown more complex in the past decade and in some cases redundant and harder to understand. My second goal, in considering these adjustments, is to maintain the high level of loss- absorbing capacity in the U.S. banking system. Our financial system today is far more resilient than it was before the crisis and I want to maintain that resiliency. We are all better served by well-capitalized banks that have the ability to continue lending to households and businesses even during stressful times. Adjusting regulation in measured ways, such as those I will describe, is an appropriate and, in fact, necessary way to preserve the success we have achieved in strengthening the financial system. Before I delve into describing the future direction of our stress testing and capital frameworks, allow me to begin with some background on the origins of the stress testing program and an overview of the changes we have made to our capital requirements since the financial crisis. At the height of the crisis, as a way to help restore confidence in the largest U.S. banks, at those banks, if economic and financial conditions worsened. Building on the success of SCAP, the Board moved to the current stress testing assessment, known as the Comprehensive Capital Analysis and Review (CCAR), to evaluate whether the largest firms have sufficient capital to continue to lend and absorb potential losses under severely adverse conditions. At the same time that we were building our stress testing program, we were also making changes to capital rules to address weaknesses observed during the crisis. These included new minimum capital requirements and a capital buffer on top of these requirements. The buffer puts increasingly strict and automatic limits on capital distributions as a bank's capital declines toward the minimum. Large banks are also subject to a potential countercyclical capital buffer (CCyB), which I will discuss more shortly. And the largest banks are subject to an additional buffer of capital based on a measure of their systemic risk. Stress testing and stronger capital requirements have combined to greatly strengthen the resiliency of the U.S. banking system. At the banks subject to CCAR, risk-based capital ratios have more than doubled since 2009. Combined, these firms now have more than $1 trillion of common equity capital, and a ratio of common equity to risk-weighted assets of 12.1%, which is many multiples over the required ratio of Tier 1 common in 2009. As a result of these changes, large U.S. banks are substantially more resilient to stress than in the past. At the same time, I believe our regulatory measures are most effective when they are as simple and transparent as possible, and it is prudent to periodically review all of our practices to ensure that they are achieving these goals. Importantly, although CCAR and our regulatory capital requirements share similar ends, they were developed separately, due to the exigencies of the crisis, and this has led to significant redundancies, which I will describe in detail in a moment. Just to name one prominent example, we now have 24 different requirements for total loss absorbency, while before the financial crisis we had 3. Perhaps there were some benefits to having overlapping approaches when we were still in the capital-building phase after the crisis. But now that banks have built significant capital stores, I believe the overlapping requirements should be combined for efficiency and simplicity. Last year, the Board issued a proposal to address these redundancies. The proposal-- known as the stress capital buffer--would simplify our regulatory regime by integrating the stress test with our non-stress capital rules. I believe the SCB proposal stands as a good example of how our work can be done more efficiently and effectively, and in a way that maintains the resiliency of the financial system. For large bank holding companies, the SCB would replace the fixed-for-all-times-and- for-all-banks 2.5 percent risk-based capital buffer with a firm-specific buffer based on the firm's most recent stress test results. This would integrate our stress testing capital requirements with our point-in-time capital requirements. And as a result, the two separate capital frameworks would be combined into one. Firms would have to manage according to one integrated set of requirements and, when their capital is insufficient, would be required to rebuild their resiliency through one integrated set of limitations on their capital distributions. Originally, we had planned to make the SCB final for the 2019 stress test cycle. However, we received thorough and insightful feedback on the proposal that we have been considering carefully. Among the comments we received were many that called for further simplification of the SCB framework. Based on this feedback, I first would like to emphasize two elements of the 2018 SCB proposal that, in my more considered judgment, I now believe should not be a part of the final SCB framework. Second, I would like to introduce two new co- equal options, either of which would improve the final product. The first element of the SCB proposal that I believe should be removed is the stress leverage buffer requirement. By its nature, a leverage ratio is a blunt instrument that treats all assets the same and therefore is not risk-sensitive. Thus, I am concerned that explicitly assigning a stressed leverage requirement to a firm on the basis of risk-sensitive post-stress estimates is in conflict with the intellectual underpinnings of the leverage ratio. It is what the analytical philosophers call a category mistake: like saying that, "Freedom has curly hair". Of course, leverage ratios, including the enhanced supplementary leverage requirements, would remain a critical part of our regulatory capital regime, and I believe our existing leverage ratios provide a sufficient backstop to the risk-based capital requirements. For these reasons, it seems out of place and unnecessary to add a separate leverage capital buffer. The second element of the SCB proposal that I believe should be removed is the requirement for banks to pre-fund the next four quarters of their planned dividend payments. The stress tests currently require banks to set aside sufficient capital today to "pre-fund" expected capital distributions, both dividends and repurchases, for all nine quarters of the capital planning horizon. Removing the pre-funding of dividend requirement would simplify the SCB proposal. Additionally, the SCB already has a mechanism for curbing dividends and other distributions when a bank's capital ratio falls into the buffer. Requiring pre-funding of dividends is a needless redundancy. Even worse, the pre-funding of dividends could lead to a conflict with the mechanics of the SCB--the SCB could call for a restriction of dividend payments even when those payments had been pre-funded. I believe it is better to focus on the root cause of our concerns and take a comprehensive approach to ensuring that banks have sufficient capital, rather than focus on the individual elements of capital distributions. Some have argued that requiring pre-funding of dividends helps reduce pro-cyclicality. Limiting pro-cyclicality, or being countercyclical, essentially means limiting both the highs and lows of a business cycle. And there can be value in doing so because, among other things, it can help reduce stress on our financial system. With a counter-cyclical stress test, as the economy strengthens, the test should get tougher and be more stringent to mitigate the buildup of vulnerabilities during good times. Experience has shown that vulnerabilities can build during good times as risk appetite grows and memories of earlier instability fade. But likewise, when the economy does slow down, and losses mount at the banks, the tests should moderate so that firms can draw on the buffers built up during good times to absorb those losses while continuing to provide credit to qualified borrowers. As an alternative to requiring pre-funding dividends and in furtherance of the other goals I have mentioned, I would like to suggest two co-equal options that, in my opinion, would simplify our capital requirements while limiting pro-cyclicality. Importantly, these two options also are consistent with our goal of maintaining overall levels of capital in the banking system: The first option would be to set the CCyB at a higher baseline level during normal times. And the second option would be to raise the "floor," or the minimum level, of the SCB. Before I outline how we might modify the CCyB, let me explain what the CCyB is designed to accomplish and how it fits into the Board's overall financial stability efforts. The CCyB, which was part of the original Basel III accord, is a macroprudential tool that allows the Board to dynamically adjust capital levels of large banking firms when the risks to financial stability have meaningfully changed. In 2016, the Board released a policy statement detailing the conceptual framework it would follow to set the CCyB. The policy statement details the range of financial-system vulnerabilities and other factors the Board may take into account as it evaluates settings for the buffer, including but not limited to, leverage in the financial sector, leverage in the nonfinancial sector, maturity and liquidity transformation in the financial sector, and asset valuation pressures. Right now, our policy is to maintain a 0 percent CCyB when vulnerabilities are within the normal range, as they happen to be now. When we determine that vulnerabilities have risen to be meaningfully above normal, the purpose of the CCyB is to increase capital to a level that compensates for those other rising vulnerabilities and thus reduces risks back to a normal level. Some of those vulnerabilities have indeed been rising in recent years, but because of the strength of our capital requirements and CCAR, our assessment of overall vulnerabilities remains moderate. This raises the question of whether our through-the-cycle capital levels in the United States have been set so high, that our CCyB is effectively already "on": we already have capital at a level that compensates for these increases in vulnerability, but because we did not reach that capital level through activation of the CCyB, we have no way of acting countercyclically in a future downturn. I would advocate for revisiting that policy so that the CCyB is more closely integrated into our overall capital framework, allowing greater scope for dynamic adjustments. While the Board has maintained the CCyB at zero since 2016, other countries have adjusted their countercyclical buffers in response to vulnerabilities within their financial sectors or, in the case of the United Kingdom, to integrate its CCyB with its structural capital requirements. For example, I find the U.K. framework, adopted by their Financial Policy Committee, to be quite compelling. Specifically, under the British framework, the CCyB would equal a positive amount--in the British case it's 1 percent--in standard risk conditions. The effect of the policy is that the buffer can be varied in line with the changing risks that the banking system faces over time. I see real merit in application of the U.K. approach in the United States, although the specific percentage would of course be open to analysis. It could provide a flexible mechanism that could complement other modifications to the SCB framework and allow the Board to adjust capital requirements as financial risks are evolving. In addition, making greater use of a countercyclical capital buffer would quite directly advance the goal of making the overall capital regime less pro-cyclical. Ultimately, I would expect that the new baseline for the CCyB would be set at a level that would maintain the overall level of capital in the U.S. banking system throughout the business and financial cycles--that is, taking account of the likelihood that there would be periods where it would be above the baseline as well as below the baseline. To be clear, this shift would require us to revisit our current CCyB policy and would introduce additional layers of decisionmaking complexity to the SCB proposal. On balance, however, I think this kind of shift would provide the Board with a helpful, additional tool that could be adjusted quickly in response to economic, financial, or even geopolitical shocks. I'd also like to preemptively address a potential objection to this option. That is, that it may be a "stealth" cut to our strong capital levels for the largest banks. I reject that characterization, and it is not supported by the approach I have outlined today. As I've said, we would maintain our strong current loss-absorbency levels, and, though I have focused on the ability to reduce the CCyB in times of stress, I also would stand ready to increase the CCyB above the new baseline when it was appropriate to do so. Indeed, the advantage of a truly flexible capital requirement is for it not only to provide additional resilience during a boom, but also to limit the risk of a pullback in credit supply aggravating an economic downturn. Returning to our goals of increasing simplicity, mitigating pro-cyclicality, and maintaining the overall level of loss-absorbency in the system, I would like to advance another equally viable alternative to turning on the CCyB: raising the proposed SCB floor from the fixed 2.5 percent of risk-weighted assets to a somewhat higher level--purely for the sake of illustration, let's say 3 percent. Using 3 percent as an example, we would give each firm a buffer based on the firm's most recent stress test results, but which must be at least 3 percent. For example, if a firm had a capital ratio decline of 2.7 percent during the stress tests, its SCB would nonetheless be sized at 3 percent, rather than 2.7 percent. For firms that have stress test results indicating an SCB greater than 3 percent, this change would have no impact compared to last year's proposal. For firms that have stress test results indicating an SCB at or slightly above 2.5 percent, this change would represent a modest increase in the stringency of the SCB. Raising the floor may help to reduce pro-cyclicality by limiting the reduction in SCB capital buffers when stress test losses decrease during good times. Raising the floor also would help moderate any increase in those buffers at the onset of economic downturn conditions as losses begin to increase. This approach would have three significant benefits as compared to the CCyB option: greater simplicity, transparency, and predictability. Raising the fixed floor would be simpler to execute than the CCyB proposal because raising the floor once and for all times would not require the Board to make complex, real-time decisions about how to adapt the regulatory framework to the evolving vulnerabilities to the economy. Raising the fixed floor also would be more transparent and predictable for the public and the industry because a firm's capital requirement would vary less over time. There are drawbacks to the higher fixed floor option, of course. For firms whose losses are typically close to the existing 2.5 percent floor, this change will affect them more than others and produce a capital regime with slightly less risk sensitivity. I also recognize, in terms of targeting pro-cyclicality, this approach would be much less direct than more actively managing the level of the CCyB. In closing, let me say that it is my hope to have an SCB framework in place for the 2020 stress tests. Of course, we will solicit public comment on potential revisions to the SCB proposal through the standard rulemaking process, and I expect that to occur in the near future. I further expect that we will maintain the basic framework of the SCB while also incorporating some additional refinements, such as to address volatility and provide better notice for firms in planning their capital actions. As I have stated, our goals remain to simplify our capital framework while maintaining the overall amount of capital in the U.S. banking system. The refinements we are considering to the SCB framework would also improve the efficiency, coherence, and transparency of the regulatory capital framework and the core principles of our stress testing program that have proven successful. I look forward to continued feedback on CCAR as we work through the improvements that I described, with a goal of ensuring that we maintain the same incentives for effective stress testing practices that exist today. As I am sure Oscar would agree, there is always room for improvement in the stress testing ring.

r190926b_FOMC

united states

The Federal Reserve’s Review of Its Monetary Policy Strategy, Tools, and Communication Practices

clarida

I am delighted to be in San Francisco today to participate in this events associated with the Federal Reserve's 2019 review of our monetary policy strategy, tools, and communication practices. Motivation for the Review Although I will have more to say about the review in a moment, let me state at the outset that we believe our existing framework, which has been in place since 2012, has served us well and has enabled us to achieve and sustain our statutorily assigned goals of maximum employment and price stability. However, we also believe now is a good time to step back and assess whether, and in what possible ways, we can refine our strategy, tools, and communication practices to achieve and maintain our goals as consistently and robustly as possible. With the U.S. economy operating at or close to maximum employment and price stability, now is an especially opportune time to conduct this review. The unemployment rate is near a 50-year low, and inflation is running close to our 2 percent objective. With this review, we hope to ensure that we are well positioned to continue to meet our statutory goals in coming years. The U.S. and foreign economies have changed in some important ways since the Global Financial Crisis. Perhaps most significantly, neutral interest rates appear to have fallen in the United States. A fall in neutral rates increases the likelihood that a central bank's policy rate will hit its effective lower bound (ELB) in future economic downturns. That development, in turn, could make it more difficult during downturns for monetary policy to support spending and employment and to keep inflation from falling too far below the 2 percent objective. Another key development in recent decades is that price inflation appears less responsive to resource slack. That is, the short-run price Phillips curve--if not the wage Phillips curve--appears to have flattened, implying a change in the dynamic relationship between inflation and employment. A flatter Phillips curve permits the Federal Reserve to support employment more aggressively during downturns--as was the case during and after the Great Recession--because a sustained inflation breakout is less likely when the Phillips curve is flatter. However, a flatter Phillips curve also increases the cost, in terms of lost economic output, of reversing unwelcome increases in longer-run inflation expectations. Thus, a flatter Phillips curve makes it all the more important that inflation expectations remain anchored at levels consistent with our 2 percent inflation objective. And let me emphasize that, based on the evidence I have reviewed, I judge that U.S. inflation expectations today do reside in a range I consider consistent with our price-stability mandate. For some time now, price stability in the United States has coincided with a historically low unemployment rate. This low unemployment rate, 3.7 percent in August, has been interpreted by many as suggesting that the labor market is currently operating beyond full employment. However, we cannot directly observe the level of the unemployment rate that is consistent with full employment and price stability, u*, but must infer it from data via models. I myself believe that the range of plausible estimates of u* extends to 4 percent and below and includes the current unemployment rate of 3.7 percent. As the unemployment rate has declined in recent years, labor force participation for people in their prime working years has increased significantly, with the August participation rate at a cycle high of 82.6 percent. Increased prime-age participation has provided employers with additional labor resources and has been one factor, along with a pickup in labor productivity, restraining inflationary pressures. Whether participation will continue to increase in a tight labor market remains to be seen. But I note that prime-age participation still remains below levels seen in previous business cycle expansions. Also, although the labor market is robust, there is no evidence that rising wages are putting upward pressure on price inflation. Wages today are increasing broadly in line with productivity growth and underlying inflation. Also of note, and receiving less attention than it deserves, is the material increase in labor's share of national income that has occurred in recent years as the labor market has tightened. As I have written before, there is a cyclical regularity in U.S. data that labor's share tends to rise as expansions endure and the labor market tightens. In recent cycles--and thus far in this cycle--this rise in labor's share has not put upward pressure on price inflation. The strong job gains of recent years also have delivered benefits to groups that have historically been disadvantaged in the labor market. For example, African Americans and Hispanics have experienced persistently higher unemployment rates than whites for many decades. However, those unemployment rate gaps have narrowed as the labor market has strengthened, and, as President Daly's research shows, there is some indication these groups especially benefit when the unemployment rate remains very low. Likewise, the gaps between unemployment rates for less-educated workers and their more-educated counterparts appear to narrow as the labor market strengthens. Wage increases in the past couple of years have been strongest for less-educated workers and for those at the lower end of the wage distribution. Scope of the Review The Federal Reserve Act assigns to the Fed the responsibility to conduct monetary policy "so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." Our review this year takes this statutory mandate as given and also takes as given that inflation at a rate of 2 percent is most consistent over the longer run with the congressional mandate. Our existing monetary policy strategy is laid out in the Committee's Statement on First adopted in January 2012, the statement indicates that the Committee seeks to mitigate deviations of inflation from 2 percent and deviations of employment from assessments of its maximum level. In assessments of maximum employment are necessarily uncertain and subject to revision. As a practical matter, our current strategy shares many elements with the policy framework known as "flexible inflation targeting." However, the Fed's mandate is much more explicit about the role of employment than that of most flexible inflation- targeting central banks, and our statement reflects this by stating that when the two sides of the mandate are in conflict, neither one takes precedence over the other. The review of our current framework is wide ranging, and we are not prejudging where it will take us, but events of the past decade highlight three broad questions that we will seek to answer with our review. The first question is, "Can the Federal Reserve best meet its statutory objectives with its existing monetary policy strategy, or should it consider strategies that aim to reverse past misses of the inflation objective?" Under our current approach as well as the approaches of many central banks around the world, persistent inflation shortfalls of the target are treated as "bygones." Central banks are generally believed to have effective tools for preventing persistent inflation overshoots, but the ELB on interest rates makes persistent undershoots more of a challenge. Persistent inflation shortfalls carry the risk that longer-term inflation expectations become anchored below the stated inflation goal. In part because of that concern, some economists have advocated "makeup" strategies under which policymakers seek to undo past inflation deviations from target. These strategies include targeting average inflation and price-level targeting, in which policymakers seek to stabilize the price level around a constant growth path. makeup strategies seek to reverse shortfalls in policy accommodation at the ELB by keeping the policy rate lower for longer than otherwise would be the case. In many models that incorporate the ELB, these makeup strategies lead to better average performance on both legs of the dual mandate. The success of makeup strategies relies on households and firms believing in advance that the makeup will, in fact, be delivered when the time comes--for example, that a persistent inflation shortfall will be met by future inflation above 2 percent. As is well known from the research literature, makeup strategies, in general, are not time consistent because when the time comes to push inflation above 2 percent, conditions at that time will not justify that action. Thus, one of the most important questions we will seek to answer in our review is whether the Fed could, in practice, attain the benefits of makeup strategies that are possible in theoretical models. The next question the review will consider is, "Are existing monetary policy tools adequate to achieve and maintain maximum employment and price stability, or should the toolkit be expanded? And, if so, how?" The FOMC's primary monetary policy tool is its target range for the federal funds rate. In December 2008, the FOMC cut that target to just above zero in response to financial turmoil and deteriorating economic conditions. Because the U.S. economy required additional support after the ELB was reached, the FOMC deployed two additional tools in the years following the crisis: balance sheet policies and forward guidance about the likely path of the federal funds rate. In addition to assessing the efficacy of these existing tools, the review will examine additional tools for easing policy when the ELB is binding. During the crisis and its aftermath, the Federal Reserve considered but ultimately found some of the tools deployed by other central banks wanting in the U.S. context. But the review will reassess the case for these and other tools in light of more recent experience with using these tools in other countries. The third question the review will consider is, "How can the FOMC's communication of its policy framework and implementation be improved?" Our communication practices have evolved considerably since 1994, when the Federal Reserve released the first statement after an FOMC meeting. Over the past decade or so, the FOMC has enhanced its communication both to promote public understanding of its policy goals, strategy, and actions and to foster democratic accountability. These Strategy; postmeeting press conferences; various statements about the principles and strategy guiding the Committee's normalization of monetary policy; and quarterly summaries of individual FOMC participants' economic projections, assessments about the appropriate path of the federal funds rate, and judgments of the uncertainty and balance of risks around their projections. As part of the review, we will assess the Committee's current and past communications and additional forms of communication that could be helpful. For example, there might be ways to improve communication about the coordination of policy tools or the interplay between monetary policy and financial stability. Activities and Timeline for the Review Let me turn now to our review process itself. At our events, we are hearing from a broad range of interested individuals and groups, including business and labor leaders, community development professionals, and academics. At a research conference at the Federal Reserve Bank of Chicago in early June, we heard from prominent academic economists as well as national and community leaders. One panel discussion provided a valuable perspective on the labor market that could not otherwise be gleaned from the aggregate statistics we often consult. Another panel discussion offered insights into how the monetary levers we pull and push affect communities, credit availability, and small businesses. In addition to the Chicago conference, all 12 Reserve Banks and the Board of Governors have hosted or will soon host events. This summer, the FOMC began to assess what we have learned at the events and to receive briefings from System staff on topics relevant to the review. our July meeting, FOMC participants agreed that our current framework for monetary policy has served the Committee and the U.S. economy well over the past decade. FOMC participants noted that the Committee's experience with forward guidance and asset purchases has improved its understanding of how these tools operate. As a result, the Committee could proceed more confidently in using these tools in the future if economic circumstances warranted. However, overall, we judged that forward guidance and balance sheet tools, while helpful, did not eliminate the risk of returning to the ELB. If forward guidance or balance sheet actions prove to be insufficient in future episodes, ELB constraints could impede the attainment of the Federal Reserve's dual-mandate objectives over time. At our July meeting, we also noted that the Committee's Statement on Longer-Run Goals and Monetary Policy Strategy has been helpful in articulating and clarifying the Federal Reserve's approach to monetary policy and agreed that any changes we might make to our strategy would likely call for some modification of this consensus statement. We have much still to discuss at upcoming meetings. I expect we will consider various topics, such as alternative policy strategies, options for enhanced use of existing monetary policy tools, possible additions to the policy toolkit, potential changes to communication practices, and the relationship between monetary policy and financial stability. We will share our findings with the public when we have completed our review, likely during the first half of next year. The economy is constantly evolving, bringing with it new policy challenges. So it makes sense for us to remain open minded as we assess current practices and consider ideas that could potentially enhance our ability to deliver on the goals the Congress has assigned us. For this reason, my colleagues and I do not want to preempt or to predict our ultimate findings. What I can say is that any refinements or more material changes to our framework that we might make will be aimed solely at enhancing our ability to achieve and sustain our dual-mandate objectives in the world we live in today. Thank you very much for your time and attention. I look forward to the excellent program President Daly and her team have put together. at the Brookings Papers on Economic Activity Conference, held at the Brookings . . vol. 10 . . . . . . . . press release, August 21, . . . . . Forum, sponsored by the Initiative on Global Markets at the University of Chicago . vol. 122 . Policy in a Low Journal of . . no. 1, . . . presented at the Brookings Papers on Economic Activity Conference, Fall, held at . .pdf . . . Journal of . . . vol. 4 . Journal of . vol. 32 . . . ," a symposium sponsored by the Federal Reserve Bank of Kansas City, held in . . .

r190926a_FOMC

united states

Government of Union: Achieving Certainty in Cross-Border Finance

quarles

Regulatory and supervisory colleagues, members of the Financial Stability private sector: Thank you for being here, and for taking part in today's workshop on pre- positioning, ring-fencing, and market fragmentation. I particularly want to thank Ryozo Himino, our new SRC chair, for his leadership in highlighting these issues; his remarks and efforts around market fragmentation are especially timely, as we begin the difficult task of examining the post-crisis reforms. I also want to recognize and thank Sir Jon Cunliffe, for proposing a workshop where we can explore these issues together; as he recently said, quoting Ben Franklin, "we must all hang together, or most assuredly, we shall all hang separately." Finally, I want to thank the leadership and staff of the Federal Reserve Bank of Philadelphia, for not just accommodating us, but making us feel welcome in the nation's first capital. The Philadelphia Fed is three blocks north, and another three west, from the birthplace of American central banking. That birthplace is not the site of the First or Second Banks of the United States, whose neoclassical headquarters are still standing and open to the public. Instead, the first national bank sat just west of North 3rd Street and Its charter came from a new nation on the verge of bankruptcy. Six years of war had drained an already-short supply of domestic specie, a necessity for international trade. So little specie remained in the treasury that the "continentals," used to finance the war, had depreciated to about two cents on the dollar. The United States lacked a common, sound currency to settle its debts, and without federal authority to levy taxes, it and Reputation, are easily crack'd, and never well mended." In desperation, the Founding Fathers made a successful Philadelphia merchant, Robert Morris, their new superintendent of finance. Drawing on a plan from Alexander Hamilton, Morris proposed a new institution, with the power to issue notes backed by $400,000 in private capital. When it could muster only a fraction of that in subscriptions, the country turned overseas. A substantial loan in French bullion financed the new bank and saved the republic from collapse. America could declare independence, but she could not secure it without credit from abroad. That lesson was both hard earned and short-lived. Four years later, a new Pennsylvania legislature claimed that dividends to foreign creditors were draining much- needed specie from America's shores. James Wilson, Pennsylvania's representative to the Continental Congress, wrote an impassioned legal and political defense of the bank, emphasizing its role in international commerce. He quoted Sir James Steuart, one of the world's first economists, calling banking "that branch of credit which best deserves the attention of a statesman." It wasn't enough. The charter was repealed--a pattern that would repeat with two more national banks, with even more disruptive results. International banking is a very different enterprise than two centuries ago, but it still "best deserves the attention of a statesman." Cross-border finance is an essential part of the international economic infrastructure. It is a conduit to direct financial resources to their most efficient use, regardless of national borders. It channels capital to places and projects it could not otherwise reach, fostering innovation, international ties, and the exchange of ideas. At its best, it is also self-sustaining, extending the financial and technical capacity of emerging economies, and expanding their role in the global economy. America's experience, however, reminds us that the benefits of international banking are not automatic. Cross-border finance is a common good, and like any common good, sustaining it requires collective action from a range of parties. parties are both public and private, elected and appointed--not just central banks and supervisors, but finance ministries, legislatures, and commercial banking organizations. Each has a distinct mission and a duty to serve a distinct set of stakeholders. When those duties conflict, trust alone cannot sustain cooperation; only a careful configuration that recognizes mutual and separate interests can do so. With such a configuration, the cross- border financial system can be open, stable, and safe; without it, the system can become unpredictable and dangerous. "Ring-fencing" often serves as a catch-all for this dynamic, capturing any and all impediments to the free flow of finance, however and whenever they arise. However, as I have noted previously, that term obscures a distinction that plays a vital role in cross- border finance--between prudently placing a constrained amount of capital and liquidity within jurisdictions and legal entities before a crisis, and competitively seizing capital and liquidity during a crisis. This distinction determines more than just the possibility of an orderly cross-border resolution. Pre-positioning of resources--when properly calibrated--can also provide the certainty that lets cross-border finance occur at all. Certainty is the critical ingredient in achieving the careful configuration of interests I described. Financial institutions need some certainty about the requirements they face by participating in cross-border activity. Supervisors need some certainty about safety and soundness, not just of the foreign banks they host, but of their domestic banks operating overseas. Creditors and investors need some certainty that a foreign authority won't abrogate their contracts. Elected officials need certainty that their constituents are not unfairly disadvantaged. All these parties--and the public--need some certainty that the resources promised to them won't disappear at the first sign of stress. Certainty fosters financial stability. It supports clear monitoring and thoughtful planning, by both institutions and their regulators. It signals the clear intention of authorities to cooperate, during normal times and in an emergency. It increases the odds that a cross-border financial institution will keep operating through a crisis. It fosters more and deeper cross-border financial activity, by decreasing its risks and increasing its benefits, both to participants and to the global economy. Certainty does require tradeoffs. None of us has perfect foresight. If we pursue certainty to the complete exclusion of any flexibility to respond to future events, we may end up undermining our ultimate goal: maintaining a financial system that is resilient to unexpected shocks. However, this workshop begins by revisiting the consequences when certainty disappears. These consequences were on full display during the financial crisis--the collapse in cross-border activity, when trust broke down; the rush to secure assets and prioritize domestic claims; the ambiguous relationship between banks' resources and their needs; and the long, halting return to a more integrated financial system. Today's panelists will also revisit the steps that the international community took to address those consequences. The workshop also examines the effect those steps have had on cross- border financial intermediation and the management of global financial institutions. The panelists will provide their views on whether we have achieved the right balance among certainty, the kinds of economic opportunity that cross-border finance promotes, and the flexibility to manage through a future disruption. This decade-long account is the latest chapter in a much older story, whose moral is clear: in regulating cross-border finance, expectations matter. When capital and liquidity requirements are imposed only at the level of the consolidated institution, they create a good deal of flexibility, but they cannot reassure host supervisors that sufficient resources will truly be available in a time of need. Opaque, vague, and uncertain requirements for pre-positioning and reporting, and lack of clarity on when they may be imposed, make compliance difficult, costly, and potentially disruptive. Pre-positioning, at levels that go beyond what may be needed in a given jurisdiction in stress, can also create rigidity and limit growth opportunities. The consequence of getting the balance between these considerations wrong is a less integrated and less resilient global financial system. These details are as complex as they are important, and I commend my FSB colleagues, particularly the ReSG, for exploring them in the context of the too-big-to-fail reforms. The FSB's work brings together a wide range of experts to better understand the intent, implementation, and effects of our post-crisis work. As with market fragmentation, the broader context of this work matters immensely, including the desired impact of the reforms and their anticipated and unanticipated consequences. Within the Federal Reserve Board, we are considering similar questions--not only what level of loss-absorbing capacity is appropriate for the material legal entities within a large, cross-border financial institution, but also what tools we and other supervisors use to ensure such capacity exists. The roles that supervision and regulation play in addressing these issues are important. There are clear advantages to setting liquidity and capital pre-positioning requirements through regulation. Regulation ensures consistency and clarity; provides a conduit for improvement, through public notice and comment; and offers a clear rational basis for any measures imposed. There is also a role for supervision, not just in addressing the particular conditions at a given firm, but in generating and sharing better information on how stress may manifest, not just in the firm overall, but in each jurisdiction where it operates. More information sharing by home to host supervisors may help convince host supervisors that they need fewer pre-positioned resources in their jurisdiction. Today's workshop is a worthy step forward in discussing these issues, and towards preserving and expanding the benefits of cross-border finance. We are all ultimately responsible for creating the conditions where capital can flow freely, giving rise to genuine opportunity and sustainable growth. We should patiently and thoughtfully examine how best to create those conditions. As William Penn put it, "business can never be well done, that is not well understood: Which cannot be without patience." look forward to engaging together, rigorously and openly, in the work ahead.

r190927a_FOMC

united states

Law and Macroeconomics: The Global Evolution of Macroprudential Regulation

quarles

Good morning. I would like to thank Georgetown University Law Center and the conference organizers, Anna Gelpern and Adam Levitin, for the opportunity to speak to you. I was particularly delighted to be asked to speak at today's conference because the topic is law and macroeconomics, a field that my experience has persuaded me is of the first importance, but ill understood, and surprisingly understudied. Now, this may at first blush sound like a beloved former president, venturing into a grocery store--"Golly, can you believe these scanners!?"--because the field of law and economics was already sturdily established when I was in law school back in the Coolidge Administration, and is now well over half a century old. It has been the source of some of the most innovative and influential legal scholarship over the lifetimes of everyone here, and in many ways the insights of the law and economics movement have become the default framework that policy makers and practitioners alike use when we think about the law conceptually, and often even at the level of granular application. Yet, while we have called this law and economics, it would be more precise to call it law and micro economics. Both law and microeconomics are centrally concerned with incentives-- how are they constructed, how do they operate, how do legal or economic actors respond to them--and the interplay between these different ways to think about incentives has been a natural and fruitful focus of investigation in a broad range of legal studies: tort law, property law, criminal law, contract law, corporate law. But both law and economics are also centrally concerned with systems , the performance and relationships of broad aggregates of laws or economic activity. Not merely how do individual actors react to changes in incentives, but how do large-scale combinations of actors respond to changes in systems: how are legal or economic systems constructed, how do they operate, how do those systems constrain wide areas of human activity. The interplay between those two ways of thinking about systems would seem to be as natural and fruitful a focus of investigation as is law and microeconomics, but it is only just beginning to be thought of as a field in itself. For a concrete example, think about the often observed fact that corporate profit margins have been increasing steadily over the last few decades. Law is likely to have been a significant element in this evolution, but not any individual law. Rather an entire system of laws--laws relating to corporate governance, corporate combinations, taxation, litigation, labor--have evolved over an extended period of time. And, under this theory, one outcome of this system--higher corporate profit margins--would likely give firms greater scope to increase wages without increasing prices, thus offering a potential explanation for the flattening of the Phillips curve, the traditional macroeconomic relationship between the unemployment rate and inflation. For a policymaker who accepted this theory, his comfort in maintaining a very low rate of unemployment could depend significantly on his understanding of that underlying legal system and his estimation of how its evolution would likely proceed in the future. Thus, the formal union of law and macroeconomics should seek to examine the interplay between a legal system and macroeconomic outcomes, above and beyond the connections a particular law may have with its impact on human behavior. Scholars and policymakers have spent our time primarily thinking about the impact of single laws, but it is appropriate to focus more broadly, especially since we have in fact repeatedly sought over the past century to revamp our system of laws to improve macroeconomic outcomes. Consider the roaring debate in the half-dozen years after the 1929 market crash that led to the establishment of the foundations of federal financial regulation in the deposit insurance and receivership framework, establishing the Securities and Exchange Commission, and greatly expanding the responsibilities and capabilities of the Federal Reserve System were very purposefully intended to help restore confidence in the U.S. financial system as a necessary condition to foster a recovery from the devastation of the Great Depression. In essence, we designed and implemented a new system of financial regulatory laws to alter macroeconomic outcomes, not only to affect individual behavior. The debate around those laws, in the 1930s, was not an academic one, because the pain and suffering of that era was evident--at the time Congress was debating the Banking Act of 1935, which established the modern framework for the federal bank regulation and supervision, the unemployment rate in the United States was still 20 percent. I will leave to others the question of whether every detail of the laws passed in this period was equally effective, in the short or long term, in promoting macroeconomic stability. But we should recognize that rules to promote financial stability and a healthy economy have deep roots in the American legal tradition. Building upon that strong tradition, I would like to focus this morning's remarks on the role that law and macroeconomics has played since the financial crisis in promoting a more stable economy. I am, of course, referring to macroprudential financial regulation. Let's rewind the tape. After many decades of remarkable financial stability in the United States since the 1930s, the focus of financial oversight had moved away from systemic risks. Prior to the financial crisis, the better part of our regulatory framework was micro prudential in nature--individual laws geared toward mitigating the fallout from idiosyncratic shocks to firms. This framework was designed to protect investors and depositors, viewed negative shocks as not originating from the financial system, and did not take into account risks that might be shared by financial firms. This is not to say that regulators did not understand the consequences of an interconnected system and the potential of contagion. For instance, the U.S. government, under the able leadership of Treasury Secretary Nicholas Brady, recognized and responded to the financial stability risks of the Latin American debt crisis of the 1980s. The United States had interests in stabilizing allies in Latin America, but a central part of the motivation was to contain potential risks to the U.S. economy. The events of 2008-09 redefined our mission by more explicitly connecting macroeconomic and financial stability, as in the 1930s. Congress and the executive branch embraced a sweeping response, designing a system of laws to reflect a recognition that the cumulative, interconnected behavior of financial institutions had implications for financial stability and that even the behavior of a single large and complex institution could have implications for financial stability. This new system was also adopted at the 2008, the global community established the runway for a structural change. The subsequent G20 summit in London led to the establishment of the Financial Stability Board (FSB), with a strengthened mandate as a successor to the Financial Stability Forum. Subsequently, including at the following summit in Pittsburgh, world leaders agreed that the supervision of individual financial institutions had to account for the financial system as a whole, and it was recognized that shocks could originate from within the system and could spread to institutions with common exposures. In other words, the supervisory framework had to be macro prudential--focusing on mitigating systemic risk and accounting for macroeconomic consequences. This reorientation was a defining part of the 2010 Dodd-Frank Act, and internationally, in the Basel III Accord. Section 165 of the Dodd-Frank Act, in particular, requires the Board to implement heightened capital and liquidity standards, concentration limits, and stress testing--all to further the macroprudential purpose of preventing or mitigating risks to the financial stability of the United States. As I will discuss later, the Board has followed through with rules such as the G-SIB surcharge, the liquidity coverage ratio, and single-counterparty credit limits, just to name a few; and, importantly, we have used macroeconomic considerations in calibrating some of these rules. Now, let's fast forward to the present. Over a decade has passed since the migration began toward a renewed focus on macroprudential regulation. Our evolution did not stop with the Pittsburgh G20 summit in 2009. Indeed, global financial standard- setters have continued to adapt and learn as they implemented and updated regulations in line with the global consensus that was reflected in Basel III. I would like to highlight three important regulatory paradigm shifts that follow from this renewed focus on macroprudential regulation. First, in line with the pivot away from microprudential regulation, we have a renewed focus not only on the health of individual financial firms but on the amount of capital in the entire banking sector. Note that the idea of improving the stability of the financial system by regulating individual bank capital has been around for decades. Global policymakers began construction of the modern risk-based, bank capital framework in the 1980s, when the aforementioned Latin American debt crisis increased concerns that the capital held by large international banks was deteriorating. Since then, regulators, such as the Board, have continued to have one eye focused on the capital held at individual firms. Now, over a decade after the crisis, exercises such as stress testing have caused us to have the other eye focused on and assessing the amount of capital in the entire banking system. The second paradigm shift is that regulators have improved their methods of conducting quantitative analysis of regulations. Such analysis, including conventional - cost-benefit analysis, traditionally did not take macroeconomic variables like gross domestic product (GDP) growth or the unemployment rate. That is no longer the case. Since regulators are given the task of maintaining the stability of the system as a whole, they must concern themselves with externalities and spillover effects to the broader economy. At the Federal Reserve, several regulatory initiatives have exemplified this change in quantitative analysis. At the height of the financial crisis, the Federal Reserve created the first stress those banks, if economic and financial conditions worsened. Building on SCAP, the Federal Reserve moved to the current stress testing assessment--the Comprehensive sufficient capital to absorb potential losses and continue to lend under stressful conditions. In the CCAR process, the Federal Reserve simulates macroeconomic scenarios like a recession in which GDP falls and the unemployment rate rises significantly. In the 2019 stress test cycle, for example, we tested banks against a hypothetical global recession in which the unemployment rate in the United States rose to 10 percent. The stressed banks were required to show that they could continue to meet minimum capital requirements in the face of those hypothetical macroeconomic shocks. Aside from CCAR, the FSB compiles an annual list of global systemically important banks (G-SIBs), which are subject to stricter capital requirements in the form of a capital surcharge. These banks must meet this higher capital standard based on the judgement that their potential failure would have a larger, systemwide impact on the economy. The goal, therefore, is to reduce a G-SIB's probability of failure so that its expected impact on the economy would be the same as that of a non-G-SIB. Similarly, to reduce the risks of interconnectedness and contagion, the United States and other jurisdictions have implemented rules that limit the exposure that one bank may have to a single counterparty. Finally, research on optimal bank capital levels by staff at regulatory and supervisory bodies around the world have factored in macroeconomic costs and benefits. Specifically, these models assume that higher capital requirements would reduce the probability of a financial crisis occurring but would increase the cost of bank lending, thereby lowering GDP growth. Not surprisingly, these models have produced a wide range of capital estimates given the wide range of underlying assumptions. The third paradigm shift at the Fed is combatting pro-cyclicality. To be sure, none of the regulatory developments that I have discussed so far screams macroeconomics quite as loudly as a time-varying, discretionary regulatory regime the express goal of which is to fight pro-cyclicality. Cyclicality--in this case, fluctuations in the economy based on the business cycle--is a concept that is near and dear to every macroeconomist's heart. In fact, theoretical studies of economic cycles go back to the business cycle dates economic contractions and expansions back to the 1850s. Quite impressive. There's also more than just a handful of volumes of articles and book chapters written on the business cycle and countercyclical fiscal policy. In the context of macroprudential regulation, pro-cyclicality represents a problem because banks tend to build up excessive credit during an economic expansion. Limiting pro-cyclicality means limiting both the highs and lows of a credit cycle. Along with many other jurisdictions, the United States adopted a countercyclical from zero percent to 2.5 percent of covered institutions' risk-weighted assets. Domestic regulators have discretion to switch the CCyB on or off anywhere within that range in order to prevent or mitigate the overheating of credit markets under their jurisdiction. In setting the buffer, the Federal Reserve takes into account, among other things, leverage in the financial sector, leverage in the nonfinancial sector, maturity and liquidity transformation in the financial sector, and asset valuation pressures. Notably, the CCyB is not calibrated bank-by-bank and is not calibrated asset-class-by-asset-class. Rather, regulators set the buffer based on their perception of the aggregate domestic credit cycle, whether it's too hot, too cold, or just right. Under the Board's current policy, we would activate the CCyB based on "when systemic vulnerabilities are meaningfully above Based on this policy, the CCyB is currently set at zero percent in the United States but has been turned on in France, Hong Kong, Sweden, the United Kingdom, and Norway. It is worth noting that, in the United Kingdom, the CCyB is set equal to a positive level--1 percent--in normal times. As a result, their buffer can be adjusted upward or downward based on the perceived risks of the time-varying credit cycle. As I have recently said, I see real merit in exploring the U.K. approach as a tool to promote financial stability. Let me conclude by offering a few thoughts on three research topics that fall squarely in the intersection of law and macroeconomics. First, while international agreements such as Basel III demonstrate that the international regulatory community has agreed on the high-level systematic changes and developed similar perspectives following the crisis, national governments gave different regulatory powers--in both degree and scope--to their central banks in pursuit of the new post-crisis consensus. In the United States, Congress did not change the Federal Reserve's dual mandate but did provide new responsibilities to promote financial stability. There was no change to the European Central Bank's monetary policy mandate, but it received direct supervisory authority over some of the Eurozone's largest banks through the Single Supervisory Mechanism and also continues to monitor financial sector risks. The Bank of Japan does not control Japan's macroprudential toolkit but does play an active role in monitoring systemic risk. The Bank of England, on the other hand, was explicitly tasked with a new financial stability mandate, and it oversees macroprudential regulation. In line with the debates over central bank independence and macroeconomic outcomes, legal scholars who engage in cutting-edge research on institutional design may have thoughts on which model leads to the best outcomes for financial stability. Second, in addition to giving varying degrees of power to their central banks, national governments also created new bodies that promote financial stability, such as the identify systemically important institutions and activities. For example, the main issues on the FSB agenda for this year were developments in financial technology, nonbank financial intermediation, and evaluation of too-big-to-fail reforms. In the same vein, the FSOC produces annual reports that highlight such threats and vulnerabilities, including news ones such as cybersecurity. Given today's audience, I very much look forward to hearing your thoughts on these issues, particularly suggestions on ways in which our legal framework can be used to mitigate these risks and the extent to which additional macroeconomic tools should be developed to monitor or address evolving risks. Third and finally, since I have spent a good part of this speech talking about issues that are near and dear to every economist, I feel like it is only fair for me to wrap up by discussing an issue of equal, if not greater, emotional import to lawyers: due process. Specifically, I'd like to close by talking about the due process considerations associated with the aforementioned macroprudential policies. There is nothing improper about mitigating negative externalities through regulation, and that is an important purpose of much post-crisis financial regulation. However, it is also well-accepted that due process requires the fair, evenhanded application of laws so that individuals are not at the mercy of the arbitrary exercise of government power. As I have alluded to throughout my remarks, we are currently placing a much greater regulatory burden on a select group of banks--the largest and most complex firms--because we believe their failures would bring down the entire financial system. Some might argue that, during the financial crisis, we dispensed with due process considerations while conducting version 1.0 of the stress tests. This is why I have strongly pushed for the recent shift toward greater transparency around the structure of the stress tests and the models themselves. It affords greater due process to the affected participants. In the same vein, I would welcome greater legal scholarship on the due process considerations associated with bank supervision as a process distinct from bank regulation. By bank supervision, I refer to the processes and activities identified with examining banks, including checking compliance with laws and regulations, assessing bank capital and liquidity levels, assigning supervisory ratings to banks, and taking formal and informal enforcement actions. While it is important for bank supervision to be up to the task of assessing the world's largest banks, especially in light of the financial stability risks that I have been describing today, an equally important task is making sure that supervisors are acting fairly. Although questions of fairness are routine in law and economics, there is ample room to explore these issues as they relate to bank supervision. While transparency and fairness are pillars of due process, I appreciate that there are other approaches worth considering on this matter. With this growing field of law and macroeconomics, I hope to see and implement many interdisciplinary solutions on the path forward.

r191001a_FOMC

united states

Advancing Our Understanding of Community Banking

bowman

For release on delivery Remarks by at It is a special honor for me to be part of this conference and its tradition of advancing our understanding of how banking shapes our economy and our communities. As a community banker, I sought out actionable research that I could leverage to better serve my customers and my community. As a state bank regulator, I conducted my own research to answer questions about issues affecting the banks my agency regulated. I also appreciated learning what researchers thought would provide better insight into the industry. Today I am honored to be here as the first person to serve on the Federal Reserve Board in the role that the Congress designated for someone with community banking or state supervisory experience. My work at the Board has given me an even greater appreciation for how creative, insightful research informs and shapes policy decisions that support our economy. But it also tells me there is still much to be learned and many additional areas that deserve more exploration. More than 10 years on, as the entire banking industry continues to evolve post- crisis, I would like to share with you some of my thoughts and observations on the forces influencing the future of banking, and community banking in particular. I will also suggest some areas where policymakers could use the help of researchers, bankers, and state supervisors to better understand how community banking is changing and how we can better provide a path for the continued viability of this sector and its business model. I hardly need to tell this audience that community banks play a vital role in the financial services industry and in the economy. From my perspective, the Federal Reserve supports community banks as a central component of a strong, resilient, and stable financial system. Our system is made more resilient through a broad and varied range of institutions serving different types of customers, with community banks providing access to credit and other financial services in towns and cities across America. With the support of community bankers, these investments are the building blocks of a strong community and help support a vibrant economy across the country--from here in the Midwest to the coasts on either side. Research on community banking and the accessibility of financial services is incredibly important. Community bankers and policymakers want to better understand how technology, competition, regulation, and other factors are driving decision making, consolidation, and the other challenges and opportunities that are shaping community banking. Existing research provides us with some answers to these questions, but there are many gaps. The lack of a full understanding of these institutions, their functionality, and their needs may limit our ability to identify important areas of focus for research. This is where I would like to ask for your expertise and assistance. We need to challenge ourselves to tackle some questions and issues that have not been fully explored by researchers. If you are a community banker, are involved in economic development or city or county management, or live in a community served by a community bank, your own experiences likely provide anecdotal evidence regarding the answers to these questions, but research can provide more comprehensive and systematic evidence, leading to more definitive answers. So I need your help. To begin, let's look at the questions. Community banks provide a variety of benefits to their communities, but these benefits can be difficult to quantify and measure. Therefore, economists and policymakers would like to be able to define and understand the full economic effects of a community bank in an area that relies on it and identify the different channels by which a community bank finances spending, investment, economic development, and job creation. In addition, what happens to a community when a bank headquartered or chartered in that community is acquired by a financial institution located elsewhere? Can we calculate the cumulative contribution of community banks to U.S. investment, employment, and economic output? I hope that presentations at future community banking research conferences can help answer some of these questions and provide a stronger foundation for policy development. Perhaps as a baseline for this discussion, we can start by looking at what has happened to the structure of the banking industry since the financial crisis. While community banks face considerable challenges, in general they have emerged from the last decade as strong competitors: On average, they have grown somewhat larger and have expanded their geographic footprints. In other words, we have a more resilient, stronger community banking sector, but one with fewer locally headquartered banks. With that in mind, let's look at what leads me to these conclusions. As seen in figure 1, it is true that there are now many fewer small community banks--those with less than $250 million in assets--than there were in 2011. At the same time, the numbers of both large community banks and banks over $10 billion in assets (non- community banks) haven't changed much. What do we find when we dig a little deeper? As shown in figure 2, very few small community banks failed or were liquidated in the past eight years--just over 100 banks, or 2 percent, of the total number in this size category as of 2011. About 2,800 banks, well over half of this original group, had no change in ownership and stayed below $250 million in assets. About 470 banks, or 10 percent of the initial number, had grown and are now above $250 million in assets. And over this time, just over one-fourth of the smallest community banks, nearly 1,200 of them, were acquired by other banks. That is certainly a large number of acquisitions. But, again, let's look a little deeper. A fair share of those acquired banks-- one in five--were acquired by another bank within the same holding company (figure 3). You could consider that more of a reorganization at the holding company level rather than an acquisition by a competitor. The remaining banks--20 percent of the smallest banks operating in 2011--were acquired by another financial institution. Seventeen of the acquisitions, about one and a half percent, were acquisitions of a small community bank by a credit union, while 14, just over one percent, involved a non-community bank acquirer with over $10 billion in assets. In other words, approximately four out of five of the small banks that were acquired during this period, or about 930 banks, were acquired by another community bank. To better understand what is happening with these institutions, we looked at several potential differences between small community banks that have been acquired and those that were not. Was it the smallest community banks, or those with the smallest markets, that were most likely to be acquired? It turns out that the key difference between these banks was not their geographic reach or their size, but rather their profitability. We find that small banks that were acquired by another institution were, on average, about the same size and geographic scope as other small banks but they were less profitable. This fact challenges the notion held by some that small scale or operating in a very limited geographic area is a disadvantage and it shows that many small, locally focused banks are performing well in a changing and challenging marketplace. Bank regulators should understand how the evolving structure of community banking has affected customers and how regulations can be tailored to limit the extent to which consolidation is driven by unnecessary, ineffective, or excessive regulatory burden. Unfortunately, current research does not provide enough evidence to conclusively answer these questions. Earlier research has shown that technological change and the removal of regulatory restrictions on interstate banking in the 1980s and 1990s have played important roles in driving consolidation. We can gain more insight into the factors that underlie changes in community banking by asking community bankers. My former colleagues at the Conference of State Bank Supervisors (CSBS) have done that in their community bank survey and the Results of the 2019 survey will be revealed during the next session, but I don't think I am giving too much away to share that the factors mentioned as driving consolidation this year remain consistent with previous results. The 2018 survey shows that among banks indicating that they had received and seriously considered accepting an acquisition offer from another institution during the previous 12 months, a large majority say the cost of regulations or the lack of economies of scale at their current size are "important" or "very important" in their decision to consider the offer. About half mention succession issues. The survey did not ask which factor bankers consider most important, and there are many possible reasons a bank would consider selling. But it should not be surprising that the cost of regulation is cited as a leading factor by nearly 75 percent of these respondents. What about those who made an offer to buy another bank during the past year? A majority, 8 out of 10, cite economies of scale as a factor in making an acquisition offer. Other common motivations include the desire to enter a new market, the ability to exploit underutilized potential at the target institution and the desire to expand within an existing market. I find these results very encouraging, reflecting an industry that believes in the future of community banking and is taking steps to invest in that future. While it was not addressed in this part of the survey, it seems to me that the cost of regulation could have been a factor in making acquisition offers, possibly based on the theory that there could be efficiency gains by spreading fixed regulatory costs over a larger firm. It is possible these savings may have been a factor for the roughly 80 percent who cited "economies of scale." More detailed questions in future surveys could provide firmer evidence about the effect of regulatory costs on decisions related to consolidation. insights into the forces driving change in community banking. I find this initiative particularly valuable, because it is conducted by state banking commissioners who I know from my experience have deep insights into conditions in their states. Last year, 28 commissioners conducted structured interviews with a small number of community bankers in their states. The results show that bank consolidation is widely viewed as a trend that will continue into the future. Many bankers see that as a concern, but others see consolidation as an opportunity. Bankers from many states cited regulatory burden or compliance costs as major factors driving consolidation. Other frequently mentioned motives for consolidation were the costs of keeping up with technological change and the need to scale up in order to compete in a technology-focused landscape and with non- bank fintech firms in some service areas. Succession planning and finding employees were other common concerns, and bankers in a few states mentioned population decline in some rural areas as a significant issue driving the consolidation trend. The Five Questions interviews provide a wealth of anecdotes about industry trends, and I would encourage researchers to consider utilizing the detailed interview approach in exploring the causes and effects of community bank consolidation. It is important to point out that many of the changes to community banking through consolidation that I have described, in a general sense, are a natural and often desirable consequence of competition in a vibrant market economy. However, consolidation is less desirable when it limits access and choice for customers without other benefits, or when it is an unintended effect of government regulation and the cost of that regulation rather than a result of vigorous competition. This isn't news to community bankers or to community banking researchers. It is not news to many people who live in small towns or urban areas who have lost access to community banks with deep roots in the community. And it is a major challenge for those who live in areas that lack access to service from any bank. Acquiring banks need to consider that when you purchase a community bank and enter into a new market, along with the new customers and opportunities come a responsibility to be a part of and to support that community. That is why I believe it is critical that we work together to find ways to preserve the benefits provided to communities by well-managed, strong financial institutions that are deeply grounded in the areas they serve--including the communities that they expand or merge into. Now let's consider how the changes I have described in the banking industry have affected the benefits provided to local communities across the United States. One might expect that the decline in the number of banks over the past few decades would mean communities would see fewer banks operating within the average local banking market. In fact, when viewing the data in a national perspective, the number of banks per local market has been quite stable over time in both urban and rural areas. There may be two factors that explain this outcome. First, many bank mergers combine firms that do not operate in the same local area, so they don't reduce the number of competitors in any market. Second, many banks continue to expand their geographic scope by opening branches in new markets, leading to an increase in the number of banks in those local areas that offsets the decline from bank mergers in the same market. Of course, stability in the average number of banks across a large number of markets does not imply stability locally within each market. Many local markets have seen declines in the number of banks, while others have experienced increases. And even if the number of banks in a community does not change, there is a difference for customers and communities between a branch of a bank with numerous locations and the headquarters of a bank that is strongly rooted in a community. For example, does bank consolidation influence the availability of credit to local small businesses? A number of studies have addressed this question and have yielded mixed results. The effect of a merger on small business lending depends on a number of factors, including the size of the merging banks, whether the acquirer is focused on small business lending, and the response of other local banks to the merger. Studies have also shown that the post-merger bank tends to be healthier than the target institution was before the merger, which could to lead to an increase in the availability of credit in the community. The bottom line is that some studies find small business lending goes up after mergers, and others find it goes down. Given the wide range of results, this is another topic where policymakers and the public would benefit from further research and analysis. One very clear trend in the United States is a decline in the number of bank headquarters. Acquisitions have resulted in the conversion of many bank headquarters into new branches of the acquiring institution. Unfortunately, some evidence suggests that these conversions may adversely affect the local communities that are no longer home to a headquarters. The impacts extend well beyond the availability of credit. Bank executives and staff who serve on the local chamber of commerce or on the boards of local hospitals or nonprofits may move to the new headquarters location, creating a leadership void in their old hometown. Unfortunately, community involvement like this is difficult to measure. We turned to Community Reinvestment Act (CRA) performance evaluations in the hope that they would offer some insights into local involvement by banks. Because certain institutions are subject to community development tests, their performance evaluations include information on the bank's qualifying loans, investments (including donations) and services, grants, and certain community service activities. Comparing performance evaluations from CRA exam reports before and after an acquisition can provide some limited, case-specific evidence on the potential consequences of the loss of a bank headquarters. Several examples from the past decade show that local donations and community service activity decline in communities that lost a bank headquarters following a merger. Pre-merger CRA evaluations detailed donations to organizations targeting initiatives such as child care, job training, homeless shelters, and scholarship programs for low- and moderate-income (LMI) individuals. Other notable activities included in-kind donations of real estate to Habitat for Humanity and monetary contributions to food pantries, Meals on Wheels, and Big Brothers Big Sisters of America. Bank officers and employees also donated significant time to community service including through financial education to LMI individuals, mentoring programs, and service on the boards of local housing development agencies. Many of these benefits were lost after a merger. The wealth of information that supervisors include in the CRA reports offers a unique look into the type of involvement that communities potentially stand to lose when headquarters move or are eliminated. More research into the effects of losing a bank headquarters could help determine whether these examples are isolated or a predictable result of consolidation. In closing, let me return to the question of what we know and what we would like to know. We know that consolidation accelerated after the Congress removed barriers to interstate banking, and that it has proceeded more or less steadily since that time. We do not know if and to what extent other factors--such as achieving a desired level of economies of scale, for example--have been driving consolidation. We have recently seen a rising number of acquisitions by credit unions, and we do not fully understand the implications of this trend, which seems likely to continue to accelerate. We know that profitability is a more important factor in predicting acquisitions than bank size or geographic area, but more research on why some smaller banks are more profitable than others could be valuable. We know from the CSBS surveys that regulatory costs are motivating banks that are considering selling or merging, and we could learn more about what is motivating buyers. Deeper and more creative research is certainly needed to understand how acquisitions affect many communities, small businesses, and consumers. One factor is the vital leadership and supporting role many small banks play in their communities. While that benefit may be hard to measure, I think it is essential that researchers try to do so. Communities need leaders and institutions that are deeply rooted in their cities, towns, and rural areas. Strong relationships and extensive experience are not easily replaced. Finally, it is important that we understand why so few new banks have been created. Are asset thresholds too high? Are regulations too burdensome? Or have low interest rates meant that net interest rate margins are just too narrow? Understanding the lack of new bank formation is as important as understanding the extent of consolidation and competition. I am sure you have noticed that I have given you more questions than answers today. That was one of my goals, because I am confident that as researchers you have the skills and creativity to focus on the best questions and find the most insightful answers. And when you do uncover new insights, my colleagues and I will always be eager to learn from and act on what you have found.

r191001b_FOMC

united states

Introductory Remarks

clarida

Good morning, and welcome to the Federal Reserve Board's research conference Macroeconomics." Here at the Fed, we are continually assessing the current state of the economy, updating our outlook for economic activity, and estimating the risks around that outlook. In this environment, we assess a broad array of government and private- sector data to determine what they imply for the achievement of the Fed's statutory goals of maximum employment and price stability. As a result, this conference and the range of topics on your agenda for today and tomorrow are highly relevant for us. More timely and accurate information sourced from nontraditional data and the use of new techniques should permit Board staff economists to make better estimates of the evolving news and what it implies for the economic outlook and allow policymakers to make better- informed decisions. Over these next two days, you will hear about the use of new tools and nontraditional data sources and what they say for the assessment of inflation and the labor market; about the use of new methods for forecasting; and about extracting information from text and using textual analysis to evaluate regulatory complexity and understand central bank communications. You no doubt will have many conversations in this room and during breaks about the usefulness of big data and new techniques for macroeconomic analysis. I am pleased to see some former colleagues and important contributors to macroeconomics and measurement on your conference program, such as recently left the Fed for other pastures. I would also like to acknowledge the diversity this conference offers. This conference is interdisciplinary, bringing together people from many different fields of study--economists, computer scientists, and statisticians--as well as people from many different types of institutions, including universities, central bank research departments, statistical agencies, and the private sector. We all stand to benefit from work across disciplines, and the connections forged at conferences such as this one can be highly fruitful. To a large extent, the use of nontraditional data, machine learning, and natural language processing in macroeconomics and for policy is only just in its infancy. In many cases, we are unsure of the efficacy or benefits of these approaches. Coordination between statistical agencies and policymaking institutions will help us achieve our shared goal--a better understanding of the economy. To this end, the discussions on the use of big data and new techniques for central banking and on the possibilities for cooperation between private companies and government agencies should be particularly helpful. Moreover, I strongly encourage you to continue your discussions after the conference ends and to seek opportunities for joint work so that we can further develop our understanding of big data and textual analysis. Now I would like to invite the participants in the session on alternative data on inflation and the labor market to come to the podium. Welcome to the Federal Reserve, and I wish you a successful two days.

r191003a_FOMC

united states

The Financial Stability Board at 10 Years—Looking Back and Looking Ahead

quarles

Thank you for the opportunity to speak to you today. The European Banking Federation is often referred to as the voice of Europe's banks, and I am here in the hopes that you are the ears of those institutions as well. This year, 2019, is the 10th anniversary of the founding of the Financial Stability Board (FSB), which means it has also been 10 years since some of the darker days of the global financial crisis. The FSB was not born on a sunny day; it was born of necessity, with storm clouds still looming. An anniversary--particularly a 10th anniversary--is a good opportunity for reflection. Not far from here, in Antwerp, the artist Peter Paul Rubens painted the "Temple of Janus." Janus was a Roman god who could look both backward and forward in time, and when Rubens painted the work, citizens of Antwerp were at a turning point and were wondering what the future held for them. Today, I would like to take on the role of Janus. I would like to look back on the experiences of the past 10 years, what the FSB has accomplished, and also offer some perspective on just how it contributed to the construction of the post-crisis global financial architecture. As you would expect, I believe the FSB has and will continue to play an important role in our global financial system. I will discuss why that is. I would then like to look ahead to the new challenges facing the global regulatory community, such as innovations in financial technology, shifts in financial globalization and integration, and increasing nonbank financial intermediation. Ten years ago, after the events of the fall of 2008, the G20 nations recognized that the response to the crisis had to be urgent, it had to be credible, and it had to be global. The regulatory community knew it must work to regain the confidence of financial institutions, market participants, and the broader public. They knew that then-existing arrangements for international cooperation were not up to that task. founded by the G7 countries in 1999 after a series of financial crises in the latter part of the 1990s. The group was intended to enhance cooperation among various national and international supervisory bodies and multilateral financial institutions in order to promote stability in the international financial system. Membership was relatively narrow, with only 12 countries and few emerging markets represented. While the group discussed matters related to financial stability, the areas it was asked to study were relatively narrow, and combined with its limited membership, it had relatively little scope to promote regulatory reform. The looseness of this arrangement represented the prevailing view in advanced nations at the time that national regulators and finance ministries were capable of monitoring and dealing with risks to global financial stability. On the one hand, these nations had long recognized that effective capital regulation of banks with a global footprint was only possible with coordination on minimal capital standards--the Basel Committee process. But there was no such consensus about financial stability, perhaps rooted in a belief, rarely expressed but widespread, that a severe global financial crisis was highly unlikely, and that traditional prudential supervision would be enough to prevent it. Major banks in Europe, Japan, and the United States had been affected by debt crises in developing countries in the 1980s and 1990s, but these crises had never seriously threatened advanced economies. In the fall of 2008, G20 leaders recognized that the severity of the emerging global financial crisis required a response that was beyond the capabilities of the FSF. Like that Long Island police chief in the movie "Jaws," ministers and leaders saw what was racing toward them and decided that they were going to need a bigger boat. Specifically, they recognized there was a major deficiency in the FSF that prevented it from being very effective in establishing international financial regulatory standards. The FSF was narrow--geographically, in the number of governments, and substantively, in the range of ministries, central banks, and important regulatory agencies that were not members. Some of the world's largest economies and financial markets were not represented, in particular emerging markets like China, India, Brazil, Mexico, and South Africa. As of 2009, only 58 percent of global gross domestic product (GDP) was represented, compared to 83 percent of GDP under the FSB today. The issue of representation was crucial, because the financial crisis required a fully global response. As a result, in April of 2009 at the G20 summit in London, the heads of state and government called for an organization "with a stronger institutional basis and enhanced capacity" that would allow them to achieve "much greater consistency and systematic cooperation between countries...that a global financial system requires." Behind those simple words was a sea change in the willingness of advanced nations to tackle significant coordination on financial regulation. The crisis that had been raging at that point for over a year made the need for such a commitment inescapable. With the creation of the FSB, the G20 designed a new regulatory organization with global reach dedicated to advancing and coordinating a newly embraced priority for the global economy--far-reaching reform of financial regulation and supervision. The FSB membership spans central banks, ministries of finance, supervisors of financial institutions, international financial organizations, and market regulators. It has a broad mandate centered on financial stability and coordination of responses for those most challenging issues that cut across the traditional mandates of other global standard-setting bodies. In addition, one of the FSB's chief responsibilities is scanning the horizon for financial vulnerabilities, making it an inherently forward-looking body. The exigency of the crisis helped overcome longstanding deficiencies in the structure of the FSF, rooted in differences between the members or ambivalence about international standard setting itself, related to financial stability. The crisis helped bridge differences and reach consensus, so that quick initial progress was made on matters that required urgent action. In addition to those actions, the members also recognized that work must begin immediately to develop new regulatory standards for capital and liquidity, derivatives reform, and issues stemming from the nonbanking sector which would require some time for data gathering and extensive public consultation. Creation of the FSB was one of a number of steps taken at the international level in the spring of 2009 that over the subsequent months helped restore confidence in the banking system and begin the process of recovery. Since the FSB was born with the global economy and financial markets still in turmoil, immediate attention was needed in a number of core areas: over-the-counter (OTC) derivatives, prudential bank standards, resolution, and nonbank finance. Much of the FSB's first 10 years has been focused on these issues, and a great deal has been accomplished, resulting in a significantly strengthened and more resilient global financial system. So let me quickly review our work in these areas. The elements of the FSB's agenda for OTC derivatives fall into four categories: 1) central clearing of standardized OTC derivatives, where appropriate, 2) exchange or electronic platform trading of standardized OTC derivatives, 3) reporting to trade repositories, and 4) higher capital and margin requirements for non-centrally cleared derivatives. The most recent report on implementation progress finds that in the jurisdictions with the largest OTC derivatives markets, there is almost complete implementation of the necessary reforms. That means that today, OTC derivatives markets, which are crucial for the functioning of our financial system, are simpler, more transparent, and generally more resilient. The FSB has endorsed the work of the Basel Committee that is aimed at enhanced prudential standards for internationally active banking organizations, a process known as Basel III. The main elements of Basel III are: a stronger risk-based capital adequacy framework; a leverage ratio requirement; a capital surcharge for global systemically important banks; a liquidity coverage ratio liquidity requirement; a net stable funding ratio liquidity requirement; and a large exposures framework. All 24 member jurisdictions of the FSB have the core elements of Basel III risk- based capital and liquidity measures in place. However, there has been uneven progress on some of the other elements. Some jurisdictions have not yet fully implemented the large exposures framework, the leverage ratio, and the net stable funding ratio. And most jurisdictions are just starting to implement the Basel III "end game" reforms agreed in December 2017. We have some work left to do but I am confident that it will be completed, and the FSB will continue to push all of its members for full completion of these important measures. One of the most important issues the world faced during the financial crisis was the "too-big-to-fail" dilemma. The large and unpopular bailouts that were deployed to help stem the crisis made it clear that an alternative was needed to deal with "too big to which identify the responsibilities, instruments, and powers that national resolution regimes should follow if they have to resolve a failing systemically important financial institution or SIFI. The FSB's resolution work also included a new total loss absorbing capacity requirement to help ensure that authorities are able to conduct a bail-in recapitalization of a failed SIFI. Too big to fail was a defining issue of the crisis, and recognizing the importance of the work that has been done to end it, this year the FSB kicked off an evaluation of the effects of the reforms that have been put in place around the world to deal with the issue. By next year, I hope we will be able to discuss the results of that work. During the crisis, "shadow banking" became the term for any type of financial activity that occurred outside banks that resembled what banks did and that often wasn't completely understood. Within the FSB, we refer to those activities as nonbank financial intermediation, or NBFI. Regardless of its name, a lot of blame for the problems that arose in the global financial crisis centered on risks that emerged from some activities in parts of this sector, and one of the FSB's first jobs was to try to look into these activities to better understand their growing role in financial markets. Among the important steps we took was a global monitoring exercise that results in an annual report on the size of NBFI in the global economy. That work actually goes beyond the membership of the FSB, since a number of important international financial centers also report information to us. With all of that information, we are able to track the overall size of nonbank financial intermediation, which in 2017 grew to $184 trillion, representing nearly half of financial activity in 21 countries plus the euro area. More important, we are now able to more carefully categorize activities in the nonbank sector in order to analyze potential vulnerabilities. In addition to monitoring, we have made a number of other recommendations and are working with fellow global standard setters to implement them. For example, we are working with the International Association of Insurance Supervisors on capital standards for global insurers, and we are working with the International Organization of Securities Commissions (IOSCO) on liquidity and leverage in the funds industry. The funds sector continues to evolve, so we will focus particular attention here as we move forward. The result of 10 years of policy development by the FSB and implementation at the national level has been a stronger, more resilient global financial system. Large banks are better capitalized, less levered, and more liquid. Too-big-to-fail reforms are well-advanced, particularly with the formation of effective resolution regimes for banks. OTC derivatives markets are simpler and more transparent. Nonbank financial intermediation risks are better understood, and steps are being taken to reduce and contain them. While shocks to the system, especially from unanticipated directions, can never be ruled out, these reforms go a long way to reducing the likelihood and severity of future crises. Consequently, the FSB has started to pivot from policy development to evaluating the effectiveness of the reforms it has advocated. I just mentioned that this year the FSB began a two-year evaluation of its too-big-to-fail reform package. We are also completing an evaluation of the effects that reforms have had on infrastructure finance and lending to small- and medium-sized enterprises. Going forward, these evaluations will be critical for assessing where more work needs to be done. Casting my gaze backward, there is much to be proud of in the last decade, success that is reflected in the strength and stability of the global financial system. So now I would like to leave the past behind and turn to the future. But while Janus was the god of beginnings, he was also the god of endings, and as such was able to look both backwards and forwards at the same time. Assessing financial vulnerabilities is a critical part of the FSB mandate, and that is inherently a forward-looking job. The global financial system is constantly evolving, influenced in part by past experience, and by regulation. As I look ahead, I think we must consider whether the ways in which we responded to the financial crisis may not be the most appropriate ones to address the challenges and ongoing changes in the financial system that we currently face. This year the FSB has embarked on an important project to review and update its financial stability surveillance framework. While much of the attention of the FSB in its early years was on post-crisis reforms, members also spent time thinking about new vulnerabilities to the system. As we reach our 10th anniversary, it is a good time to review the ways we monitor the ever-changing financial system. The aim of this review is to ensure that we have a framework that is comprehensive, consistent over time, and effective at identifying relevant vulnerabilities. If we are not at the cutting edge in our ability to assess the state of the financial system, we do a disservice to the public we serve, which relies on a smoothly functioning financial system. In addition, we are looking at how we communicate our understanding of the state of the financial system to the G20 and to the world. We want to be more open about our assessment, but great care has to be taken to avoid a situation where revelations about emerging concerns lead to acceleration of those concerns and becomes a self-fulfilling prophecy. As I look forward and ponder the forces that are shaping the evolution of the global financial system, the FSB is currently grappling with two issues--financial innovation and market fragmentation--that have the potential to profoundly affect financial stability, so let me start there. Owing to our forward-looking orientation, the FSB has been actively engaged in monitoring financial innovation for some time. Starting a little over five years ago, there was an explosion of financial innovation that had a technological component, which we now call fintech. This encompasses peer-to-peer lending, cryptocurrencies like Bitcoin, and the use of new techniques like artificial intelligence and machine learning. In 2017, the FSB issued a report on the implications of fintech for financial stability. The report was careful to note the potential benefits of many of these innovations, including the possibility of greater financial inclusion and increased speed of financial transactions. However, the report also drew attention to several supervisory and regulatory issues, including three priorities where international collaboration is critical: managing operational risk from third-party service providers, mitigating cyber risks, and monitoring macrofinancial risks that could emerge as fintech activities increase. More recently, one particular area of fintech has received a lot of attention-- stablecoins. These are a type of crypto-asset that attempts to address the volatility of some crypto-assets by tying their value to conventional assets, such as the value of the U.S. dollar or a basket of currencies. While it hasn't been created yet, it is Facebook's proposal for a new stablecoin that significantly increased the public's attention to stablecoins. At the FSB, we undertake regular monitoring of the financial stability implications of crypto-assets, and we have had discussions about the regulatory and supervisory approaches to crypto-assets and potential gaps in regulation. The introduction of stablecoins, however, brings a potentially new scale and scope that the financial regulatory community must carefully consider. Although there is a small risk to financial stability today, there is no doubt the potential scale of stablecoins and other crypto-assets yet to emerge may pose regulatory challenges. At present, the G7 is finishing a preliminary assessment of stablecoins, and the G20 has asked the FSB to lead the work going forward, which we are actively undertaking. This is an issue that can potentially affect every country in the world. We have already begun work to identify which regulations exist that apply to stablecoins in our jurisdictions, and once that assessment is complete, we will report to the G20 on any appropriate actions that need to be taken to ensure that financial stability is not negatively affected by their introduction. The FSB is grappling with other challenges beyond fintech. As time has passed since the financial crisis, there is concern about fragmentation of financial markets--a sense that globalization of financial markets may be slowing and differences in the regulatory requirements at the national level may be on the rise. Some forms of market fragmentation may have financial stability benefits, such as reasonable loss absorbency requirements imposed on subsidiaries of global banks, but market fragmentation may also bring about unintended negative consequences, such as increased opportunities for regulatory arbitrage and cumulatively higher regulatory burdens for firms. Over the past year, at the request of the G20, the FSB has been examining the different forms in which market fragmentation is manifest. Following up on that, we recently held a workshop where FSB members met with representatives from the private sector and from academia to discuss the internal allocation of capital and liquidity by global financial institutions. We are also following up in other areas, such as working with IOSCO on issues related to deference and examining improved ways for regulatory and supervisory information sharing. Market fragmentation is an issue that will never disappear, and we will remain vigilant to ensure that it does not pose a threat to financial stability. At the outset today, I said I was going to take the mantle of Janus, who could look backward and forward in time. Janus was also the god of transitions, which makes him doubly appropriate for the FSB at this time, because we find ourselves in transition from a time when we were largely focused on addressing the effects and the lessons of the financial crisis. We now find ourselves with increasingly focused energy on looking forward, with both a strong organization that has been tested through an intense period of policy formulation and implementation and a strong global financial system resulting from those efforts. I hope that 10 years from now, a successor of mine as FSB Chair can point to 10 more years of success in flexibly and adeptly responding to all that the global financial system throws at us. Speaking on behalf of the members of the FSB, we stand ready.

r191004a_FOMC

united states

Opening Remarks

powell

Good afternoon. Welcome to the room where members of the Board of Governors and the presidents of the 12 Reserve Banks meet eight times a year--most recently, two weeks ago--to decide the stance of monetary policy. It's a magnificent, formal--perhaps even imposing--room, with 26-foot ceilings, a monumental marble fireplace, and a 1,000-pound brass and glass chandelier. It's seen a lot of history since Franklin Roosevelt dedicated this building in 1937. British and American military leaders conferred here during World War II. And, through the decades, our Federal Reserve predecessors grappled with financial turmoil and the economy's ups and downs. So when my colleagues and I take our assigned places around this polished mahogany and granite table, the setting and its history lends a certain formality--dare I say, stuffiness--to the proceedings. As we kick off this 12th of 14 events, Bowman, and I hope that today's meeting is anything but stuffy. Candid and serious, yes. But not stuffy. The Reserve Banks and the Board have been holding events around the country as part of a comprehensive and public review of our monetary policy strategy, tools, and communications practices. Almost all of the meetings, like this one, have been open to the press and live-streamed on the internet. Both the breadth and transparency of the review are unprecedented for us. One reason we are conducting this review is that it is always a good practice for any organization to occasionally take a step back and ask if it could be doing its job more effectively. But we must pose that question not just to ourselves. Because Congress has granted the Federal Reserve significant protections from short-term political pressures, we have an obligation to clearly explain what we are doing and why. And we have an obligation to actively engage the people we serve so that they and their elected representatives can hold us accountable. We've invited you here because we want to better understand how monetary policy affects the lives of the people your organizations represent--union members, small business owners, residents of low- and moderate-income communities, retirees, and others. We want to hear your perspective on maximum employment and price stability-- the monetary policy goals Congress has assigned us. Now is a good time to conduct the review. Unemployment is near a half-century low, and inflation is running close to, but a bit below, our 2 percent objective. While not everyone fully shares economic opportunities and the economy faces some risks, overall it is--as I like to say--in a good place. Our job is to keep it there as long as possible. While we believe our strategy and tools have been and remain effective, the U.S. economy, like other advanced economies around the world, is facing some longer-term challenges--from low growth, low inflation, and low interest rates. While slow growth is obviously not good, you may be asking, "What's wrong with low inflation and low interest rates?" Low can be good, but when inflation--and, consequently, interest rates--are too low, the Fed and other central banks have less room to cut rates to support the economy during downturns. So, in this review, we are examining strategies that might better allow us to symmetrically and sustainably achieve 2 percent inflation. Doing so would help prevent inflation expectations among consumers, businesses, and investors from slipping too low, as they appear to have done in several advanced economies. More-firmly anchored expectations, in a virtuous circle, would help keep actual inflation around our target, thus preserving our ability to change interest rates as appropriate to meet our mandate. We are also looking at whether our existing monetary policy tools will be adequate when the next downturn comes. Finally, we are asking whether our communications practices can be improved to better support the effectiveness of our policy. After today, we have two sessions remaining, both later this month: one in Kansas City and another in Chicago. At the July meeting of the Federal Open Market Committee, my colleagues and I began discussing what we've learned so far from the events. We continued that discussion at our September meeting and have a lot left to do. We plan to publicly report our conclusions during the first half of next year. One clear takeaway of the sessions so far is the importance of sustaining our historically strong job market. People from low- and moderate-income communities tell us this long recovery, now in its 11th year, is benefiting them and their neighbors to a degree that has not been felt for many years. Employers are partnering with community colleges and nonprofit organizations to offer training. And people who have struggled to stay in the workforce in the past are getting new opportunities. Once again, welcome. Now it is your turn to speak. We're listening.

r191007a_FOMC

united states

Brief Remarks

powell

Thank you, Randy, for the kind introduction. It is a great pleasure to join you all this morning for the premiere of KUED's documentary It is also a great pleasure to be in Utah. It has been a long time since a Fed Chair made an official visit to Utah. Alan Greenspan spoke in Salt Lake City 22 years ago. All of the Utahns here know about the Eccles family's enormous contributions to building the economies of the state and the region. The documentary will remind us of Marriner's immense contribution not just to the region, but also to our nation during the Great Depression, World War II, and thereafter. Many Eccles family members are present here today. I would like to especially Spencer's daughter, Hope Eccles. Randy was fortunate to marry Hope, and he has a In a way, I feel that I know Marriner, too. I work in a building named after him. I sit in the office where he sat as Chair. And his portrait hangs in a room where I frequently meet with guests, Board colleagues, and staff. When I sit in my usual seat, he stands, looking over my left shoulder, an enigmatic expression--neither approving nor disapproving--on his face. Talk about pressure! More seriously, his legacy endures in much more than a name on a building and a portrait on a wall. As the Depression deepened, he presciently recognized that the federal government should act forcefully to put people back to work and stimulate business. In a speech delivered here in Utah in 1932, Marriner asked what was the purpose of an economic system if not to allow those willing and able to work the opportunity to do so, to "guarantee to them sustenance for their families and protection against want and His ideas helped form the basis of Franklin D. Roosevelt's New Deal and anticipated the not-yet-published tenets of British economist John Maynard Keynes. After World War II, he recognized, again presciently, that high inflation, not contraction, posed the principal threat to the U.S. economy. And, perhaps most importantly from my perspective as Fed Chair, he is responsible more than any other person for the fact that the United States today has an independent central bank--a central bank able to make decisions in the long-term best interest of the economy, without regard to the political pressures of the moment. During his years on the Fed Board, Marriner played a crucial role in two landmark accomplishments that established the modern Federal Reserve--the Banking Act of 1935, near the start of his tenure at the Fed, and the Federal Reserve-Treasury Accord of 1951, at the end. FDR nominated Marriner to lead the Fed Board in 1934. He accepted on the condition that Roosevelt support a restructuring of the Fed, which had failed to counter the contraction gripping the nation's economy. The result was the Banking Act of 1935, which significantly strengthened the structural independence of the Federal Reserve. And, symbolically important, it authorized the Board to move its meetings from the Treasury Department to a new building--the building that now bears Marriner's name-- on Constitution Avenue, across from the Lincoln Memorial. During World War II, the Fed effectively ceded control of monetary policy to the Treasury Department by agreeing to maintain a low interest rate peg on government bonds. The low rates helped the government finance the war, but after the war ended, inflation soared. It subsided for a time but, with the Korean War, spiked again. In 1951, Marriner led other Board members in precipitating a clean break with the peg arrangement, laying the foundation for the modern Fed. The Federal Reserve-Treasury Accord of that year separated government debt management from monetary policy and freed the Fed to combat high inflation and set short-term interest rates based on what was best for the economy. Those are just the highlights of Marriner's Fed career. You will learn much more in the film we are about to see. In closing, I leave you with this statement from Marriner, inscribed on a plaque in the Eccles Building: "The management of the central bank must be absolutely free from the dangers of control by politics and by private interests, singly or combined."

r191008a_FOMC

united states

Data-Dependent Monetary Policy in an Evolving Economy

powell

Thank you for this opportunity to speak at the 61st annual meeting of the National At the Fed, we like to say that monetary policy is data dependent. We say this to emphasize that policy is never on a preset course and will change as appropriate in response to incoming information. But that does not capture the breadth and depth of what data-dependent decisionmaking means to us. From its beginnings more than a century ago, the Federal Reserve has gone to great lengths to collect and rigorously analyze the best information to make sound decisions for the public we serve. 'Old' Economies," captures the essence of a major challenge for data-dependent policymaking. We must sort out in real time, as best we can, what the profound changes underway in the economy mean for issues such as the functioning of labor markets, the pace of productivity growth, and the forces driving inflation. Of course, issues like these have always been with us. Indeed, 100 years ago, some of the first Fed policymakers recognized the need for more timely information on the rapidly evolving state of industry and decided to create and publish production indexes for the United States. Today I will pay tribute to the 100 years of dedicated-- and often behind the scenes--work of those tracking change in the industrial landscape. I will then turn to three challenges our dynamic economy is posing for policy at present: First, what would the consequences of a sharp rise in the price of oil be for the U.S. economy? This question, which never seems far from relevance, is again drawing our attention after recent events in the Persian Gulf. While the question is familiar, technological advances in the energy sector are rapidly changing our assessment of the answer. Second, with terabytes of data increasingly competing with truckloads of goods in economic importance, what are the best ways to measure output and productivity? Put more provocatively, might the recent productivity slowdown be an artifact of antiquated Third, how tight is the labor market? Given our mandate of maximum employment and price stability, this question is at the very core of our work. But answering it in real time in a dynamic economy as jobs are gained in one area but lost in announced that job gains over the year through March were likely a half-million lower than previously reported. I will discuss how we are using big data to improve our grasp of the job market in the face of such revisions. These three quite varied questions highlight the broad range of issues that currently come under the simple heading "data dependent." After exploring them, I will comment briefly on recent developments in money markets and on monetary policy. Our story of data dependence in the face of change begins when the Fed opened for business in 1914. World War I was breaking out in Europe, and over the next four years the war would fuel profound growth and transformation in the U.S. economy. you could not have seen this change in the gross national product data; the Department of Commerce did not publish those until 1942. The Census Bureau had been running a census of manufactures since 1905, but that came only every five years--an eternity in the rapidly changing economy. In need of more timely information, the Fed began creating and publishing a series of industrial output reports that soon evolved into industrial production indexes. The indexes initially comprised 22 basic commodities, chosen in part because they covered the major industrial groups, but also for the practical reason that data were available with less than a one-month lag. The Fed's efforts were among the earliest in creating timely measures of aggregate production. Over the century of its existence, our industrial production team has remained at the frontier of economic measurement, using the most advanced techniques to monitor U.S. industry and nimbly track changes in production. Let's turn now to the first question of the consequences of an oil price spike. Figure 1 shows U.S. oil production since 1920. After rising fairly steadily through the early 1970s, production began a long period of gradual decline. By 2005, production was at about the same level as it had been 50 years earlier. Since then, remarkable advances in the technology for finding and extracting oil have led to a rapid increase in production to levels higher than ever before. In 2018, the United States became the world's largest oil producer. Oil exports have surged, imports have fallen (figure 2), and the U.S. Energy Information Administration projects that this month, for the first time in many decades, the United States will be a net exporter of oil. As monetary policymakers, we closely monitor developments in oil markets because disruptions in these markets have played a role in several U.S. recessions and in the Great Inflation of the 1960s and 1970s. Traditionally, we assessed that a sharp rise in the price of oil would have a strong negative effect on consumers and businesses and, hence, on the U.S. economy. Today a higher oil price would still cause dislocations and hardship for many, but with exports and imports nearly balanced, the higher price paid by consumers is roughly offset by higher earnings of workers and firms in the U.S. oil industry. Moreover, because it is now easier to ramp up oil production, a sustained price rise can quickly boost output, providing a shock absorber in the face of supply disruptions. Thus, setting aside the effects of geopolitical uncertainty that may accompany higher oil prices, we now judge that a price spike would likely have nearly Let's now turn to the second question of how to best measure output and productivity. While there are some subtleties in measuring oil output, we know how to count barrels of oil. Measuring the overall level of goods and services produced in the economy is fundamentally messier, because it requires adding apples and oranges--and automobiles and myriad other goods and services. The hard-working statisticians creating the official statistics regularly adapt the data sources and methods so that, insofar as possible, the measured data provide accurate indicators of the state of the economy. Periods of rapid change present particular challenges, and it can take time for the measurement system to adapt to fully and accurately reflect the changes in the economy. The advance of technology has long presented measurement challenges. In 1987, Nobel Prize-winning economist Robert Solow quipped that "you can see the computer age everywhere but in the productivity statistics." In the second half of the 1990s, this measurement puzzle was at the heart of monetary policymaking. Greenspan famously argued that the United States was experiencing the dawn of a new economy, and that potential and actual output were likely understated in official statistics. Where others saw capacity constraints and incipient inflation, Greenspan saw a productivity boom that would leave room for very low unemployment without inflation pressures. In light of the uncertainty it faced, the Federal Open Market Committee (FOMC) judged that the appropriate risk-management approach called for refraining from interest rate increases unless and until there were clearer signs of rising inflation. Under this policy, unemployment fell near record lows without rising inflation, and later revisions to GDP measurement showed appreciably faster productivity growth. This episode illustrates a key challenge to making data-dependent policy in real time: Good decisions require good data, but the data in hand are seldom as good as we would like. Sound decisionmaking therefore requires the application of good judgment and a healthy dose of risk management. Productivity is again presenting a puzzle. Official statistics currently show productivity growth slowing significantly in recent years, with the growth in output per hour worked falling from more than 3 percent a year from 1995 to 2003 to less than half that pace since then. Analysts are actively debating three alternative explanations for this apparent slowdown: First, the slowdown may be real and may persist indefinitely as productivity growth returns to more-normal levels after a brief golden age. Second, the slowdown may instead be a pause of the sort that often accompanies fundamental technological change, so that productivity gains from recent technology advances will appear over time as society adjusts. Third, the slowdown may be overstated, perhaps greatly, because of measurement issues akin to those at work in the 1990s. At this point, we cannot know which of these views may gain widespread acceptance, and monetary policy will play no significant role in how this puzzle is resolved. As in the late 1990s, however, we are carefully assessing the implications of possibly mismeasured productivity gains. Moreover, productivity growth seems to have moved up over the past year after a long period at very low levels; we do not know whether that welcome trend will be sustained. Recent research suggests that current official statistics may understate productivity growth by missing a significant part of the growing value we derive from fast internet connections and smartphones. These technologies, which were just emerging 15 years ago, are now ubiquitous (figure 3). We can now be constantly connected to the accumulated knowledge of humankind and receive near instantaneous updates on the lives of friends far and wide. And, adding to the measurement challenge, many of these services are free, which is to say, not explicitly priced. How should we value the luxury of never needing to ask for directions? Or the peace and tranquility afforded by speedy resolution of those contentious arguments over the trivia of the Researchers have tried to answer these questions in various ways. For example, Fed researchers have recently proposed a novel approach to measuring the value of services consumers derive from cellphones and other devices based on the volume of data flowing over those connections. Taking their accounting at face value, GDP growth would have been about 1/2 percentage point higher since 2007, which is an appreciable change and would be very good news. Growth over the previous couple of decades would also have been about 1/4 percentage point higher as well, implying that measurement issues of this sort likely account for only part of the productivity slowdown in current statistics. Research in this area is at an early stage, but this example illustrates the depth of analysis supporting our data-dependent decisionmaking. Let me now turn from the measurement issues raised by the information age to an issue that has long been at the center of monetary policymaking: How tight is the labor market? Answering this question is central to our outlook for both of our dual-mandate goals of maximum employment and price stability. While this topic is always front and center in our thinking, I am raising it today to illustrate how we are using big data to inform policymaking. Until recently, the official data showed job gains over the year through March 2019 of about 210,000 a month, which is far higher than necessary to absorb new entrants into the labor force and thus hold the unemployment rate constant. In August, the BLS publicly previewed the benchmark data revision coming in February 2020, and the news was that job gains over this period were more like 170,000 per month--a meaningfully lower number that itself remains subject to revision. The pace of job gains is hard to pin down in real time largely because of the dynamism of our economy: Many new businesses open and others close every month, creating some jobs and ending others, and definitive data on this turnover arrive with a substantial lag. Thus, initial data are, in part, sophisticated guesses based on what is known as the birth-death model of firms. Several years ago, we began a collaboration with the payroll processing firm ADP to construct a measure of payroll employment from their data set, which covers about 20 percent of the nation's private workforce and is available to us with a roughly one- week delay. As described in a recent research paper, we constructed a measure that provides an independent read on payroll employment that complements the official statistics. While experience is still limited with the new measure, we find promising evidence that it can refine our real-time picture of job gains. For example, in the first eight months of 2008, as the Great Recession was getting underway, the official monthly employment data showed total job losses of about 750,000 (figure 4). A later benchmark revision told a much bleaker story, with declines of about 1.5 million. Our new measure, had it been available in 2008, would have been much closer to the revised data, alerting us that the job situation might be considerably worse than the official data suggested. We believe that the new measure may help us better understand job market conditions in real time. The preview of the BLS benchmark revision leaves average job gains over the year through March solidly above the pace required to accommodate growth in the workforce over that time, but where we had seen a booming job market, we now see more-moderate growth. The benchmark revision will not directly affect data for job gains since March, but experience with past revisions suggests that some part of the benchmark will likely carry forward. Thus, the currently reported job gains of 157,000 per month on average over the past three months may well be revised somewhat lower. Based on a range of data and analysis, including our new measure, we now judge that, even allowing for such a revision, job gains remain above the level required to provide jobs for new entrants to the jobs market over time. Of course, the pace of job gains is only one of many job market issues that figure into our assessment of how the economy is performing relative to our maximum-employment mandate and our assessment of any inflationary pressures arising in the job market. In summary, data dependence is, and always has been, at the heart of policymaking at the Federal Reserve. We are always seeking out new and better sources of information and refining our analysis of that information to keep us abreast of conditions as our economy constantly reinvents itself. Before wrapping up, I will discuss recent developments in money markets and the current stance of monetary policy. Our influence on the financial conditions that affect employment and inflation is indirect. The Federal Reserve sets two overnight interest rates: the interest rate paid on banks' reserve balances and the rate on our reverse repurchase agreements. We use these two administered rates to keep a market-determined rate, the federal funds rate, within a target range set by the FOMC. We rely on financial markets to transmit these rates through a variety of channels to the rates paid by households and businesses--and to financial conditions more broadly. In mid-September, an important channel in the transmission process--wholesale funding markets--exhibited unexpectedly intense volatility. Payments to meet corporate tax obligations and to purchase Treasury securities triggered notable liquidity pressures in money markets. Overnight interest rates spiked, and the effective federal funds rate briefly moved above the FOMC's target range. To counter these pressures, we began conducting temporary open market operations. These operations have kept the federal funds rate in the target range and alleviated money market strains more generally. While a range of factors may have contributed to these developments, it is clear that without a sufficient quantity of reserves in the banking system, even routine increases in funding pressures can lead to outsized movements in money market interest rates. This volatility can impede the effective implementation of monetary policy, and we are addressing it. Indeed, my colleagues and I will soon announce measures to add to the supply of reserves over time. Consistent with a decision we made in January, our goal is to provide an ample supply of reserves to ensure that control of the federal funds rate and other short-term interest rates is exercised primarily by setting our administered rates and not through frequent market interventions. Of course, we will not hesitate to conduct temporary operations if needed to foster trading in the federal funds market at rates within the target range. Reserve balances are one among several items on the liability side of the Federal Reserve's balance sheet, and demand for these liabilities--notably, currency in circulation--grows over time. Hence, increasing the supply of reserves or even maintaining a given level over time requires us to increase the size of our balance sheet. As we indicated in our March statement on balance sheet normalization, at some point, we will begin increasing our securities holdings to maintain an appropriate level of reserves. That time is now upon us. I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis. Neither the recent technical issues nor the purchases of Treasury bills we are contemplating to resolve them should materially affect the stance of monetary policy, to which I now turn. Our goal in monetary policy is to promote maximum employment and stable prices, which we interpret as inflation running closely around our symmetric 2 percent objective. At present, the jobs and inflation pictures are favorable. Many indicators show a historically strong labor market, with solid job gains, the unemployment rate at half-century lows, and rising prime-age labor force participation. Wages are rising, especially for those with lower-paying jobs. Inflation is somewhat below our symmetric 2 percent objective but has been gradually firming over the past few months. FOMC participants continue to see a sustained expansion of economic activity, strong labor market conditions, and inflation near our symmetric 2 percent objective as most likely. Many outside forecasters agree. But there are risks to this favorable outlook, principally from global developments. Growth around much of the world has weakened over the past year and a half, and uncertainties around trade, Brexit, and other issues pose risks to the outlook. As those factors have evolved, my colleagues and I have shifted our views about appropriate monetary policy toward a lower path for the federal funds rate and have lowered its target range by 50 basis points. We believe that our policy actions are providing support for the outlook. Looking ahead, policy is not on a preset course. The next FOMC meeting is several weeks away, and we will be carefully monitoring incoming information. We will be data dependent, assessing the outlook and risks to the outlook on a meeting-by- meeting basis. Taking all that into account, we will act as appropriate to support continued growth, a strong job market, and inflation moving back to our symmetric 2 percent objective. Proceedings of the . . . . . vol. 29 . , symposium sponsored by the Federal Reserve Bank of Kansas City, held in . Survey of . available at .

r191009a_FOMC

united states

Opening Remarks

powell

Good morning. I am happy to be here in Kansas City for the 13th of 14 events. I look forward to hearing the perspectives of the community and business leaders participating today. The Reserve Banks and the Board have been holding events around the country as part of a comprehensive and public review of our monetary policy strategy, tools, and communications practices. Almost all of the meetings, like this one, have been open to the press and live-streamed on the internet. Both the breadth and transparency of the review are unprecedented for us. One reason we are conducting this review is that it is always a good practice for any organization to occasionally take a step back and ask if it could be doing its job more effectively. But we must pose that question not just to ourselves. Because Congress has granted the Federal Reserve significant protections from short-term political pressures, we have an obligation to clearly explain what we are doing and why. And we have an obligation to actively engage the people we serve so that they and their elected representatives can hold us accountable. We have invited you here because we want to better understand how monetary policy affects your lives and the lives of the people your organizations represent. We want to hear your perspective on maximum employment and price stability--the monetary policy goals Congress has assigned us. Now is a good time to conduct the review. Unemployment is at a half-century low, and inflation is running close to, but a bit below, our 2 percent objective. While not everyone fully shares economic opportunities and the economy faces some risks, overall, it is--as I like to say--in a good place. Our job is to keep it there as long as possible. While we believe our strategy and tools have been and remain effective, the U.S. economy, like other advanced economies around the world, is facing some longer-term challenges--from low growth, low inflation, and low interest rates. While slow growth is obviously not good, you may be asking, "What's wrong with low inflation and low interest rates?" Low can be good, but when inflation--and, consequently, interest rates--are too low, the Fed and other central banks have less room to cut rates to support the economy during downturns. So, in this review, we are examining strategies that might better allow us to symmetrically and sustainably achieve 2 percent inflation. Doing so would help prevent inflation expectations among consumers, businesses, and investors from slipping too low, as they appear to have done in several advanced economies. More-firmly anchored expectations, in a virtuous circle, would help keep actual inflation around our target, thus preserving our ability to change interest rates as appropriate to meet our mandate. We are also looking at whether our existing monetary policy tools will be adequate when the next downturn comes. Finally, we are asking whether our communications practices can be improved to better support the effectiveness of our policy. After today, we have one session remaining, later this month in Chicago. At the July meeting of the Federal Open Market Committee, my colleagues and I began discussing what we have learned so far from the events. We continued that discussion at our September meeting and have a lot left to do. We plan to publicly report our conclusions during the first half of next year. One clear takeaway of the sessions so far is the importance of sustaining this historically strong job market. People from low- and moderate-income communities tell us that this long recovery, now in its 11th year, is benefiting them and their neighbors to a degree that has not been felt for many years. Employers are partnering with community colleges and nonprofit organizations to offer training. And people who have struggled to stay in the workforce in the past are getting new opportunities. Once again, I'm happy to be here. Now it is your turn to speak. We're listening.

r191016a_FOMC

united states

Digital Currencies, Stablecoins, and the Evolving Payments Landscape

brainard

Technology is driving rapid change in the way we make payments and in the concept of There is a long history of technological advances challenging the prevailing notions of money, from the trading of coins to the use of paper currency, to the electronic debiting and crediting of funds on the accounts of banks. Today, efforts by global stablecoin networks such as Facebook's Libra to establish the next chapter in the story of money are raising threshold questions about legal and regulatory safeguards, financial stability, and monetary policy. Because of its potential global reach, Facebook's Libra imparts urgency to the debate over what form money can take, who or what can issue it, and how payments can be recorded and settled. Money has traditionally served three functions. Money facilitates payments as a medium of exchange, serves as a store of value that can be relied on for future use, and simplifies transactions by providing a common unit of account to compare the value of goods and services. A decade ago, Bitcoin was heralded as a new kind of digital money that would address frictions in payments as well as serve as a unit of account and store of value without the need for centralized governance. Bitcoin's emergence created an entirely new payment instrument and asset class exchanged over a set of payment rails supported by distributed ledger technology. Distributed ledger technology may allow for a shared, tamper-resistant ledger that can be updated by anyone with sufficient computing power, in contrast to traditional recordkeeping systems built on a single ledger managed by a trusted central entity. But Bitcoin and some other early iterations of cryptocurrencies have exhibited extreme volatility, limited throughput capacity, unpredictable transaction costs, limited or no governance, and limited transparency, which have limited their utility as a means of payment and unit of account. Stablecoins were designed specifically to overcome the substantial volatility exhibited by first-generation cryptocurrencies, which limits their reach in payments and their utility as a unit of account. As the name implies, stablecoins aim to maintain stable value by tying the digital currency to an asset or basket of assets, such as commercial bank deposits or government-issued bonds. Stablecoins also differ from the initial set of cryptocurrencies in that they may be issued by a central entity and rely on third-party institutions for some aspects. Just as any currency's value as a medium of exchange increases with the size of the network using it, so too the power of a stablecoin payment system will depend on its ability to achieve widespread adoption, due to the associated network externalities. In light of the 2.7 billion active monthly users on Facebook's platforms, the Libra stablecoin project stands out for the speed with which its network could reach global scale in a payment system. To assess the efforts by stablecoin issuers to provide the three functions of money, it is useful first to consider existing arrangements for the issuance, regulation, and transfer of money. Central bank money and commercial bank money are the foundations of the modern financial system. Central bank money is composed of physical cash and money held in deposits at a central bank. Central bank money is important for payment systems because it represents a safe settlement asset, allowing users to exchange central bank liabilities with confidence in their acceptance and reliability. In addition, central banks can play a critical role as providers of liquidity by lending central bank money at moments of stress. Commercial bank money refers to money held in deposits at commercial banks. It is widely used in part because people are confident that they can convert it on demand to the liability of another commercial bank or the central bank, such as physical cash. This confidence comes in no small part because bank deposits are insured, and commercial banks are subject to supervision, regulation, and deposit insurance requirements. Consumers and businesses also use this money in transactions because of its convenience and availability, which in turn expand with the size of the network using this money. Nonbank private money or assets can also facilitate transactions among a network of users. In some cases, such as airline miles, such assets may have value only within the network. In other cases, the issuer of an asset within a network may guarantee convertibility to a sovereign currency. Consumers trust that the company issuing such money will be able to honor these liabilities. Many U.S. consumers have experience with nonbank private money in the form of gift cards, loyalty points, and virtual gaming currencies. Although many of these are relatively limited in scale and purpose, some nonbank money networks are sizeable. Starbucks reported that it had $1.6 billion in stored value card liabilities as of September 2018--more than the deposits held at many depository institutions. As the scale and scope of such private networks grow, so too do the convenience and benefit of transacting within the network in a self-reinforcing dynamic, called network externalities. These network benefits may be augmented by the active use of network data for a host of purposes, from allocating and pricing credit to sharing reviews to prioritizing information that is pushed to users. In China, consumers and businesses participate in two mobile networks, Alipay and WeChatPay, which by some accounts handled more than $37 trillion in mobile payments last year. These networks operate within China based on the renminbi as the unit of account, and balances are transferable in and out of bank or credit card accounts. Stablecoins may resemble private nonbank liabilities depending on their design and claim structure. Stablecoins aspire to achieve the functions of traditional money without relying on confidence in an issuer--such as a central bank--to stand behind the money. Indeed, for some potential stablecoins, a close assessment suggests users may have no rights with respect to the underlying assets or the system overall. We have seen the growth of massive payments networks on existing digital platforms, such as Alibaba and WeChat, and the issuance of stablecoins on a smaller scale, such as Tether, Gemini, and Paxos. What sets Facebook's Libra apart is the combination of an active-user network representing more than a third of the global population with the issuance of a private digital currency opaquely tied to a basket of sovereign currencies. It should be no surprise that Facebook's Libra is attracting a high level of scrutiny from lawmakers and authorities. Libra, and indeed any stablecoin project with global scale and scope, must address a core set of legal and regulatory challenges before it can facilitate a first payment. I will emphasize a few issues in particular. First, compliance with know-your-customer rules and regulations are essential to ensure stablecoins are not used for illegal activities and illicit finance. Libra's business model is inherently cross-border, and, as such, each participant in the system deemed to be a financial institution would need to ensure compliance with each national jurisdictions' anti-money- laundering laws. Libra's intended global reach would likely necessitate a consistent global anti- money-laundering framework in order to reduce the risk of illicit transactions. Second, issuers of stablecoins designed to facilitate consumer payments must clearly demonstrate how consumer protections would be assured. Consumers will need to be educated on how their rights differ with respect to digital wallets compared to bank accounts. In the United States, as elsewhere, statutory and regulatory protections have been implemented with respect to bank accounts so that consumers can reasonably expect their deposits to be insured up to a limit; fraudulent transactions to be the liability of the bank; transfers to be available within specified periods; and clear, standardized disclosures about account fees and interest payments. Not only is it not clear whether comparable protections will be in place with Libra, or what recourse consumers will have, but it is not even clear how much price risk consumers will face since they do not appear to have rights to the stablecoin's underlying assets. Consumers need to be cautioned that stablecoins are likely to be starkly different from sovereign-issued currency in legal terms. It will be important to get clarity on what legal entity can be held responsible for the security of personally identifiable information and transaction data and how personal data will be stored, accessed, and used. The large number of cyber breaches in the last few years highlight the importance of these issues. Third, it will be necessary to define the financial activities that the various players in the Libra ecosystem are conducting in order for jurisdictions to assess whether existing regulatory and enforcement mechanisms are adequate. As the legal domicile of the Libra Association, Switzerland is of particular interest. Swiss authorities have established three new categories to facilitate their approach of regulating by function: "payment tokens" are cryptocurrencies that are meant for use in payments or value transfers; "utility tokens" are blockchain-based applications; and "asset tokens" are cryptoassets that are analogous to equities, bonds, and derivatives. To the extent that some innovations do not fit neatly within a single category, these classifications may not be mutually exclusive. In the United States, regulators are closely examining the specific functions of particular stablecoins and cryptocurrencies more broadly to determine whether and where they fit in the existing regulatory structure and whether additional authorities or guidance is necessary. U.S. market regulators have authorities for products judged to be securities or commodity futures under relevant law. At the state level, the New York State Department of Financial Services has established a BitLicense for entities associated with virtual currencies. and the other federal banking agencies have supervisory authority over banks, including, in many cases, the ability to regulate and examine companies that provide services to banks. Neither the Federal Reserve nor any other regulator has plenary authority over payment systems operating in the United States. Although the Financial Stability Oversight Council does have the authority to designate systemically important nonbank financial companies; financial market utilities; or payment, clearing, and settlement activities based on the facts of the specific situation, it is not clear at this time whether any cryptocurrency issuer would meet the statutory requirements for designation. Stablecoins, and cryptocurrencies more generally, challenge the long-held premise that payments must be recorded in a central ledger managed by a single entity. In fact, banks were established to perform this central ledger function. Distributed ledger technology allows for the direct peer-to-peer transfer of assets, potentially eliminating the need to transact through intermediaries. While distributed ledger technology could offer advantages by enhancing operational resilience, increasing transparency, and simplifying recordkeeping, the public and immutable nature of the transactions ledger also introduces risks, such as data privacy concerns and legal complexity. Global stablecoin networks also may pose challenges to bank business models. In the extreme, widespread migration to one or more global stablecoin networks could disintermediate the role of banks in payments. If consumers and businesses reduce their deposits at commercial banks in favor of stablecoins held in digital wallets, this could shrink banks' sources of stable funding, as well as their visibility into transactions data, and thereby hinder banks' ability to provide credit to businesses and households. That said, many banks are likely to adapt by offering alternative methods of peer-to-peer settlement and by incorporating stablecoins into their business models, whether by partnering with fintech firms who issue stablecoins or by issuing their own, as some are already doing. Moreover, widespread adoption of stablecoins could have implications for the role of central banks and monetary policy. Payments are the economy's circulatory system. Large- scale migration into a new stablecoin network for purposes of payments may prove to be the leading edge of a broader migration. If a large share of domestic households and businesses come to rely on a global stablecoin not only as a means of payment but also as a store of value, this could shrink demand for physical cash and affect the size of the central bank's balance sheet. The central bank's approach to implementing monetary policy may be complicated to the extent that banks' participation in short-term funding markets is affected. These effects are likely to be more significant for small, open economies or those with weak monetary institutions, where the migration away from the sovereign currency to a global stablecoin could weaken the scope for independent monetary policy through a process that is the digital analogue of dollarization. Large-scale stablecoin use could also affect larger, advanced economies with extensive connections to the global financial system, including by increasing market volatility and by transmitting shocks across borders. Finally, there are likely to be financial stability risks for a stablecoin network with global reach. If not managed effectively, liquidity, credit, market, or operational risks--alone or in combination--could trigger a loss of confidence and a classic run. A global stablecoin network raises complicated issues associated with many legally independent but interdependent operations, and the lack of clarity about the management of reserves and the rights and responsibilities of various market participants in the network. The potential for risks and spillovers could be amplified by potential ambiguity surrounding the ability of official authorities to provide oversight and backstop liquidity and to collaborate across borders. Even before the advent of stablecoins, the rapid migration of payments to digital systems prompted interest in the issuance of central bank digital currencies. In some jurisdictions, there has already been a pronounced migration from cash to digital payments, which naturally prompts monetary authorities to explore moving to digital issuance of their own. The potential for global stablecoin systems has intensified the interest in central bank digital currencies. Proponents argue that central bank digital currencies would be a safer alternative to privately issued stablecoins because they would be a direct liability of the central bank. important arguments. Of course, the Federal Reserve and other central banks already provide money digitally in the form of central bank deposits in traditional reserve or settlement accounts. However, in the current context, central bank digital currency typically refers to a new type of central bank liability that could be held directly by households and businesses without the involvement of a commercial bank intermediary. Under this definition, central bank digital currency could be a flexible form of central bank money that could differ from traditional reserves along three dimensions: a much broader set of institutions and individuals could access it, some types of balances might not pay interest, and it might entail greater government visibility into end users' transactions. In the United States, there are compelling advantages to the current system. First, physical cash in circulation for the U.S. dollar continues to rise, suggesting robust demand. Second, the dollar is an important reserve currency globally, and maintaining public trust in the sovereign currency is paramount. Third, we have a robust banking system that meets the needs of consumers: our banks are many in number, diverse in size, and geographically dispersed. Finally, we have a widely available and expanding variety of digital payment options that build on the existing institutional framework and the applicable safeguards. Moreover, central bank digital currency for general purpose use--that is, for individual consumer use--would raise profound legal, policy, and operational questions. Let's consider the balance between privacy and illicit activity. If it is designed to be financially transparent and provide safeguards against illicit activity, a central bank digital currency for consumer use could conceivably require the central bank to keep a running record of all payment data using the digital currency--a stark difference from cash, for instance. A system in which individual payments information would be recorded by a government entity would mark a dramatic shift. A related question is whether the Federal Reserve has the authority to issue currency in digital form and, if necessary, to establish digital wallets for the public. There could also be profound monetary policy implications. Some economists have argued that a central bank digital currency could address the problems posed by the zero lower bound by potentially transmitting monetary policy directly to the public. Executing monetary policy in such a manner would effectively imply the elimination of all physical cash and the power to impose a negative rate, or a tax, on households' holdings of digital money. My own strong preference is to address the effective lower bound by using our existing tools vigorously, since I view the cost-benefit assessment of negative rates as unattractive for the current U.S. context. Financial stability considerations are also important. The ability to convert commercial bank deposits into central bank digital currency with a simple swipe surely has the potential to be a run accelerant. Here, too, the role of banks in providing financial intermediation services could be fundamentally altered. Finally, there could be operational risks to introducing a central bank digital currency. For starters, this might require the Federal Reserve to develop the operating capacity to access or manage individual accounts, which could number in the hundreds of millions. A myriad of other operational challenges would need to be addressed, including electronic counterfeiting and cyber risks. It is worth noting that the technologies used currently for private-sector digital currencies do not provide the same level of information technology reliability, integrity, and scalability as central bank systems in use today. Many of these technologies do not provide for clear, predictable, and final settlement, which is a core tenet of payment systems. That said, some jurisdictions may move in this direction faster than others, based on the particular attributes of their payments and currency systems. At the Federal Reserve, we will continue to analyze the potential benefits and costs of central bank digital currencies and look forward to learning from other central banks. While prudence cautions against rushing into untested approaches to central bank digital currencies, we are actively investing in our payments infrastructure, so that everyone has access to real-time payments. Every day, U.S. payment and securities settlement systems turn over The Federal Reserve is committed to working closely with the private sector to promote a safer and more efficient payments system. This summer, we announced that the Federal Reserve will launch the first new payment service in more than 40 years to help make real-time payments available to everyone. Service as a platform for consumers and businesses to send and receive payments immediately and securely 24 hours a day, 7 days a week, 365 days a year. This initiative is intended to provide a neutral platform for new private-sector innovation in faster payment services. In addition to FedNow, we are exploring enhancements to same-day settlement of automated clearinghouse (ACH) transactions and expansion of Fedwire Service and National Settlement System operating hours. We are working with the industry to improve the security of the payments system by, for example, increasing understanding of synthetic identity fraud and identifying a fraud classification approach to improve information sharing. As the public and private sectors work to reduce payment frictions, one of the most important use cases is for cross-border payments, such as remittances. Intermediation chains for cross-border payments are long, slow, cumbersome, and opaque. Technology enables e- commerce to transcend national borders, but current cross-border payments solutions often represent complicated workarounds rather than seamless end-to-end solutions. Authorities in different jurisdictions recognize the importance of cooperating across borders with each other and the private sector to address the very real cross-border frictions that exist today. Our nation has rich and varied experiences to draw on as we assess various proposals for private money, from the period in our history when the colonial states each issued their own currencies to the many decades when the circulation of private commercial banknotes stood in for a national currency. The Federal Reserve was created in part to respond to the inability of many of these banks to make good on their obligations for the banknotes they issued and the panics and runs that ensued. Those experiences will help inform us as we potentially enter another phase in the evolution of money and payments. Today, consumers and businesses have a variety of payment options, including physical cash, checks, ACH transfers, debit cards and credit cards, and mobile-based payment solutions, to name a few. These tend to have clearly defined legal rights and responsibilities. We will likely see far-reaching innovation in payments in the coming years, with a plethora of new and emerging options, including stablecoins. The Federal Reserve remains confident in the power of technology and innovation to transform the financial system and reduce frictions and delays, while preserving consumer protections, data privacy and security, financial stability, and monetary policy transmission and guarding against illicit activity and cyber risks. Given the stakes, global stablecoin networks should be expected to meet a high threshold of legal and regulatory safeguards before launching operations. We are monitoring new technologies closely to ensure that the innovations that arise fit with our operational responsibilities and broader public policy goals, as reflected in the Federal Reserve Act. At the same time, we are upgrading our services to support innovation in new ways. And, we will continue to foster a safe and efficient payments system, including where money in all its myriad forms--present and future--is concerned, as we have for over a century.

r191017a_FOMC

united states

Opening Remarks

bowman

Thank you, President Evans, for hosting this event today, and to our moderator and participants for taking part in this valuable discussion. Today's event is the last in our series of events held across the country to learn about how Americans think about monetary policy and how they think about the Federal Reserve. In keeping with the purpose of , I would like to spend most of our time in conversation. But I do want to offer a few thoughts about why the Fed is reaching out to seek a broad range of views, and what we are hoping to accomplish through this initiative. is a new comprehensive outreach to the public on monetary policy. For many decades there was a sense at the Board that the public wasn't interested or even willing to dive into the complexities of monetary policy. That view has changed in a fundamental way, especially in the aftermath of the financial crisis when it was urgently important that the public understand what we were doing. So we began explaining as accessibly and as clearly as we could what we were doing and why. Now we are listening carefully. Since I became a Board member almost a year ago, it has become clear to me that people are not only willing to engage on complex economic issues, but they also want to know that their concerns are being taken into consideration on issues that affect their financial well-being. The Fed's movement toward greater transparency and public engagement is well underway, and advancing that effort is one of my top priorities. At the same time, we recognize that the clear communication of our policies actually helps us achieve our goals. When we communicate our views on the economic outlook and our expectations for where interest rates may be heading, consumers and businesses take that information into account when making decisions on spending, investment, and hiring. For that reason, our policy communications are an important part of the Fed's toolkit for influencing the direction of the economy. is a natural outcome of this commitment to public engagement. We have heard from many people from different parts of the country and from different sectors of the economy about how monetary policy affects them and their communities. It is our responsibility as a public institution to be accountable to the public. Hearing a broad range of perspectives on these issues will help us make good decisions as we consider new approaches to monetary policy. As I mentioned before, this afternoon's discussion is the last in a series of events that we began back in February. Looking at the depth of experience of our panelists and of David Wessel, our distinguished moderator, I think we can make a strong case that we saved the best for last. Our first panel focuses on disadvantaged workers' long-term job prospects. I am eager to hear from our panelists how they think the labor market and our policies are impacting the communities they serve in Illinois, Michigan, and in other states in the Midwest. As a former community banker, I am also very interested to hear from people who are implementing creative strategies to build wealth and support access to credit for low- and moderate-income communities. The panelists in our second session can speak to their experiences doing just that, because they are helping to bring credit and housing opportunities to Appalachia, Indianapolis as well as right here in Chicago. Our monetary policy review will have implications for financial markets, but we also want to know more about what the impact will be on Main Street. My colleagues and I are keenly aware of our responsibility to focus on how the decisions we make affect the real economy for people in communities all across the country. The two goals for monetary policy--maximum employment and stable prices-- are determined by the Congress and are not subject to our framework review. How we reach those goals is the topic for discussion. One question I hope to explore is whether we need new strategies to more effectively achieve our goals. For example, inflation has run modestly below our 2 percent objective for many years. Given that, it would be helpful to hear whether you think the Federal Open Market Committee should consider strategies that aim to have inflation exceed our target for a period of time to make up for the earlier shortfall or whether you think that would threaten the decades of success the Fed has had keeping the public's inflation expectations low and stable. Another question concerns the Fed's existing toolkit for monetary policy. Currently, our available policy tools include setting interest rates, purchasing longer-term assets, and forward guidance about the expected future path of policy. Are there other tools we should consider to help us reach and sustain our objectives more effectively? I also want to know how the Federal Open Market Committee's communication of its policy framework might be improved. How can we help you better understand our work so you can hold us accountable? Your perspectives on questions like these are a vital part of this monetary policy review. So I want to thank you again for your time and your contributions. Once the policy review is complete, we will share our findings with the public, probably during the first half of next year. I look forward to our discussion.

r191018a_FOMC

united states

U.S. Economic Outlook and Monetary Policy

clarida

Thank you for the opportunity to participate in this CFA Institute conference on fixed-income management. Before we begin our conversation, I would like to share a few thoughts about the outlook for the U.S. economy and monetary policy. The U.S. economy is in a good place, and the baseline outlook is favorable. The recent Summary of Economic Projections is for GDP growth to be around 2 percent in 2019, for growth to continue near this pace next year, and for personal consumption expenditures (PCE) inflation to rise gradually to our symmetric 2 percent objective. The unemployment rate, at 3.5 percent, is at a half-century low, and wages are rising broadly in line with productivity growth and underlying inflation. There is no evidence to date that a strong labor market is putting excessive cost-push pressure on price inflation. But despite this favorable baseline outlook, the U.S. economy confronts some evident risks in this the 11th year of economic expansion. Business fixed investment has slowed notably since last year, exports are contracting on a year-over-year basis, and indicators of manufacturing activity are weakening. Global growth estimates continue to be marked down, and global disinflationary pressures cloud the outlook for U.S. inflation. U.S. inflation remains muted. Over the 12 months through August, PCE inflation is running at 1.4 percent, and core PCE inflation, which excludes volatile food and energy prices, is running at 1.8 percent. Turning now to monetary policy, at both its July and September meetings, the FOMC voted to lower the target range for the federal funds rate by 25 basis points. these decisions, the current target range for the federal funds rate is 1.75 to 2 percent, which compares with the range of 2.25 to 2.5 percent that prevailed between December 2018 and July 2019. The Committee took these actions to provide a somewhat more accommodative policy in response to muted inflation pressures and the risks to the outlook I mentioned earlier. Looking ahead, monetary policy is not on a preset course, and the Committee will proceed on a meeting-by-meeting basis to assess the economic outlook as well as the risks to the outlook, and it will act as appropriate to sustain growth, a strong labor market, and a return of inflation to our symmetric 2 percent objective. Turning now to the framework under which the Federal Reserve operates in financial markets, in September of this year, shocks in the repurchase agreement (repo) market put upward pressure on money market rates, and these pressures spilled over into the federal funds market. In response to these developments, the Federal Reserve on September 17 initiated a program of repurchase operations to provide liquidity sufficient to keep the federal funds rate within the desired target range. These operations have been successful in achieving this goal. As the FOMC announced in January 2019, the Committee seeks to operate with a level of bank reserves that is sufficiently ample to ensure that control of the federal funds rate is achieved primarily by the setting of our administered rates and is not, over the longer term, reliant on frequent and large open market operations. concluded the program of balance sheet reduction in place since October 2017 and indicated then that, after a time, it would commence increasing its securities holdings to maintain reserves at a level consistent with an ample-reserves regime. The FOMC announced on October 11 that it would seek to maintain, over time, a level of bank reserves at or somewhat above the level that prevailed in early September, a level that we believe is sufficient to operate an ample-reserves regime. This week, the Federal Reserve Bank of New York began a program of purchasing Treasury bills in the secondary market. This program will continue at least into the second quarter of next year and is designed to achieve--and, over time, maintain--ample reserve balances at or above the level that prevailed in early September. In addition, the Federal Reserve will continue to conduct term and overnight repo operations at least through January to ensure that the supply of reserves remains ample even during periods of temporary, but pronounced, increases in our nonreserve liabilities, and to mitigate the risk that money market pressures adversely affect monetary policy implementation. It is important to note that the open market operations we have announced are technical, "Central Banking 101" operations and should not be conflated with the large- scale asset purchase programs that the Federal Reserve deployed after the financial crisis. In those programs, the Federal Reserve was seeking to ease financial conditions by lowering term premiums via its purchases of long-term Treasury bonds and mortgage- backed securities. By contrast, the program announced on October 11 will concentrate its purchases in Treasury bills. The technical measures we are undertaking do not represent a change in the stance of monetary policy, which we continue to implement by adjusting the target range for the federal funds rate. Finally, I would like to say a few words about the monetary policy framework review we are undertaking this year. This review of our monetary policy strategy, tools, and communications is the first of its kind for the Federal Reserve. Public engagement, unprecedented in scope for the Fed, is an important part of this effort. Through our events, we have been hearing a diverse range of perspectives not only from academic experts, but also from representatives of consumer, labor, business, community, and other groups. We will draw on these insights as we assess how best to achieve and maintain maximum employment and price stability in the most robust fashion possible. In July, we began discussing issues associated with the review at our FOMC meetings. We will continue reporting on our discussions in the meeting minutes and share our conclusions when we finish the review during the first half of next year. Thank you very much for your attention.

r191021a_FOMC

united states

Closing Remarks

bowman

Congratulations on what I have no doubt was a productive and thought-provoking day, though one, I am sure, that also underscored the many remaining challenges for women and minorities in the professions of economics and finance. I want to thank our hosts, the European Central Bank, who put so much work into making this conference a success, as well as the conference organizers from all three sponsoring institutions--the ECB, Federal Reserve, and the Bank of England. I also want to express my appreciation to the many researchers from universities and from other central banks, as well as the members of women's and minority committees of economics and finance associations from around the world, who are attending the conference in Frankfurt. I wish that I could have been there with you to participate in the discussions. I found the conference program to be particularly interesting, and I look forward to Federal Reserve staff coming back to Washington to share what they learned from the research and discussions. At the Federal Reserve, we greatly value this conference, not only for the interactions that our staff have while they are there, but also when they bring back what they learn and share it with our staff. Last year, we had over 200 staff members from across the organization attend summary presentations in DC given by several staff members who had attended the conference in London. In fact, staff in Washington had a "watch party" to view the webcast of today's panels. The topics of today's conference, including papers on the promotion of women, the role of culture and institutions, and the dynamics of publishing, conferences, and seminars, will all spur additional conversations and ideas for action among staff at the Federal In my view, central banks have a responsibility to be leaders in addressing diversity and inclusion, not only for our own institutions, but also because of our influence on the profession as a whole. Part of the value of this conference is that we, as central banks, can promote the study of these issues and discuss concrete steps that we can take together to address them. Certainly, we take diversity and inclusion issues to heart at the Federal Reserve. We believe that the best ideas, policies and, ultimately, service to the public are the result of diverse perspectives, and from a staff that reflects the rich diversity of our nation. Inclusion makes us stronger by providing all employees the assurance that they will be working in an environment that welcomes and values their differences, and that recognizes and rewards people according to the contributions they make in advancing the mission of the organization. That is not to say that we have all of the solutions, or that we do not have considerable progress to make. But we have made efforts in a number of areas. These efforts are consistent with the Congressional directive to establish the Office of Minority and Women Inclusion, and as articulated in the Board of First, we have made a commitment, and have made progress, to make our institution more diverse. That includes efforts to bring greater diversity to the Board of Directors of our Federal Reserve Banks and Branches as well as to senior leadership in the Federal Reserve System. We have also worked to improve our internal culture. These efforts include re-establishing and strengthening employee resource groups. We are working to come up with codes of conduct including efforts to make our meetings more inclusive and set rules around behavior in seminars. We are also providing diversity and inclusion as well as bystander training to both new and existing employees. Second, we have broadened our reach in recruiting to provide a more diverse range of applicants the opportunity to apply for positions at the Federal Reserve--through strengthening our connections to schools that serve diverse populations, hiring an outreach specialist for these communities, establishing a stronger presence at career fairs for diverse students, and hosting career events for students to promote jobs in economics and finance at the Federal Reserve. Third, we are working with high schools and universities to inspire students' interest in economics and finance. We are also working to provide them with the tools they need to enter these fields. This has included partnerships with local high schools to teach economics, and with a local Historically Black University, Howard University, to teach and mentor students in economics and statistical analysis. This last initiative has led to students developing an interest and pursuing careers in economics, including as research assistants at the Federal Reserve, and several are currently employed at the Board as research assistants. Of course, these conferences are also an important part of addressing diversity and inclusion in central banking, and the economics and finance professions. I look forward to welcoming all of you to Washington next fall to attend the third such conference, hosted by the Federal Reserve. We hope these conferences will inspire further work on these important topics and will highlight the issues that researchers are addressing, and more broadly promote the conversations we are having in the economic and finance professions. Thank you for your work, and I look forward to seeing you at the Federal Reserve next year.

r191101b_FOMC

united states

The United States, Japan, and the Global Economy

clarida

I appreciate this opportunity to speak today at the Japan Society, a respected institution dedicated to studying, advocating, and expanding interactions between the While the society's remit is broad and includes arts, culture, and education, I will, perhaps not surprisingly, focus my remarks on our two economies. Japan is an important economic partner of the United States, and our economies are linked through trade in goods and services as well as capital flows that affect interest rates and other aspects of financial markets. Through these channels, developments in Japan can affect economic conditions in the United States, and vice versa. More broadly, beyond bilateral linkages, economic conditions in United States and Japan are tightly linked to global economic developments, and today I will discuss several of the global factors that are relevant to the outlook for both economies. First, I will review the current U.S. outlook and some key global risks to that outlook that we are monitoring at the Federal Reserve. I will next elaborate on the channels through which global factors affect domestic economic conditions in the United States and, in some cases, also Japan. I will conclude with some remarks about the monetary policy decision we announced on Wednesday. By many metrics, the U.S. economy is in a good place. The current economic expansion, now in its 11th year, is the longest on record, and the economy continues to advance at a moderate pace, with real gross domestic product (GDP) growth running at 2 percent over the past year and 1.9 percent in the most recent quarter. Growth has been supported by the continued strength of household consumption, underpinned, in turn, by a thriving labor market. The unemployment rate is near a half-century low, real wages are rising, and workers who had earlier left the labor force are returning to find jobs. There is no sign that cost-push pressures are putting excessive upward force on price inflation, and to me, plausible estimates of the natural rate of unemployment extend from just above 4 percent to the current level. Core personal consumption expenditures (PCE) inflation over the 12 months ending in September, at 1.7 percent, remains muted, and headline inflation, currently running at 1.3 percent, is likely this year to fall somewhat below our 2 percent objective. Price stability, as I see it, requires that inflation expectations as well as actual inflation be stable and consistent with our 2 percent inflation target. We do not directly observe inflation expectations, and I myself consult a wide range of survey and market estimates. Based on these estimates, I judge that measures of inflation expectations reside at the low end of a range I consider consistent with price stability. Although the baseline expectation for the U.S. economy is favorable, there are some evident downside risks to this outlook. Global growth has been sluggish since the middle of 2018. This slowdown in global growth as well as increased uncertainty about the outlook for global trade policy appear to be headwinds for manufacturing activity and investment spending in the United States and abroad. Also another source of uncertainty in the global economy has been and continues to be Brexit. The global growth outlook also depends importantly on the strength and sustainability of continued economic expansion in China. China is balancing its desire to curtail credit growth and promote deleveraging against its understandable aspiration to maintain a rapid pace of economic growth in a country of 1.4 billion people. Finally, global disinflationary forces remain and present ongoing challenges to many central banks in their efforts to achieve and maintain price stability. In sum, global conditions present headwinds for the U.S. outlook, and, as my colleagues and I at the Federal Reserve have emphasized, these headwinds have been a prominent consideration in our recent monetary policy assessments. I would now like to elaborate on some of the channels through which foreign developments more generally might be expected to affect the outlook for the U.S. economy. Perhaps the most direct link between economic conditions abroad and in the United States is foreign demand for U.S. exports. To be sure, exports account for a smaller share of the U.S. economy--about 12 percent--than the global average of about 30 percent. Even so, when foreign demand for U.S. exports falls, the effect on U.S. production is evident. The pace of economic expansion abroad is a key determinant of the foreign GDP growth in 2019 to have slowed to its weakest pace since the financial crisis. Largely as a result, real U.S. exports been about flat over the past year, an unusual development outside of recession. U.S. exports also have slowed as a result of a decline in exports to China following the imposition of tariffs on U.S. goods and also more recently because of production-related disruptions in aircraft deliveries. The pace of economic growth in our major trading partners affects the demand for U.S. exports not only directly, but also indirectly by influencing the value of the dollar. When foreign growth weakens and central banks abroad ease monetary policy to support their domestic economies, returns on dollar assets appear relatively more attractive, capital flows into U.S. markets, and these flows will tend to boost the foreign exchange value of the dollar. In addition, elevated uncertainties about the global outlook and/or other evidence of financial stress abroad can also drive up the value of the dollar, as investors flow into the safe haven traditionally provided by U.S. assets. A stronger dollar, for either reason, makes U.S. exports more expensive for foreign buyers, makes U.S. imports from abroad more attractive to U.S. purchasers, and thereby tends to lower demand for U.S. goods and services. That being said, I would note that the value of the dollar does not appear to play much of a role in explaining the decline in U.S. exports over the past year. The current level of the trade-weighted dollar is about where it has been, on average, over the past few years. However, looking back several years, the 25 percent appreciation of the dollar that occurred in 2014 was an important contributing factor to the previous noticeable decline in U.S. exports that took place in 2015 and 2016. Global financial markets also link the United States to the global economy, and developments abroad can spill over into domestic financial conditions, with material effects on domestic activity. This is particularly evident during episodes of global financial stress, in which "risk-off" shifts in sentiment can depress U.S. equity prices and widen domestic credit spreads even as flight-to-safety flows push down U.S. Treasury yields. These global financial spillovers to the U.S. economy were notably pronounced during the 1998 Russian crisis, the euro-area debt crisis earlier this decade, and the China devaluation episode of 2015-16. Recently, global financial spillovers have contributed to the significant decline in U.S. Treasury yields that we have seen since the spring. Since the market for debt is global, low--and, in many cases, negative--yields abroad encourage capital inflows that put downward pressure on U.S. yields. Equity prices have also reacted to global developments and recently appear particularly sensitive to news about the outlook for U.S. international trade. Global factors have likely also contributed to the estimated decline in the neutral rate of interest, or r*, that we have observed in the United States and many other countries. Slow productivity growth and population aging have lowered potential growth rates in major foreign economies, decreasing demand for investment and increasing desired saving, both of which have contributed to lower equilibrium interest rates abroad, with spillovers to the rest of the world, including in the Global developments influence not only U.S. economic activity and financial markets, but also U.S. inflation. Global factors--through their influences on U.S. aggregate demand and supply that I just described--can alter U.S. inflation dynamics. Foreign factors can also directly affect the prices paid by U.S. firms and consumers, particularly, but not exclusively, for imported goods. An appreciation of the dollar can lower the dollar price of U.S. imports, although empirically, this effect is less than one- for-one, as foreign exporters tend to keep the dollar prices of their goods comparatively stable relative to observed exchange rate fluctuations. In addition, swings in global commodity prices influence U.S. inflation. Over the past year, the rise in the dollar and falling oil prices have been important contributors to the subdued pace of U.S. inflation. Up to now, I have focused on the U.S. economy. However, despite some important differences that I will note, the Japanese economy exhibits some notable similarities to the United States, both in terms of its overall performance and its exposure to the global economy. To begin with, Japanese growth, while slower than in the United States, has been running above the pace needed to absorb new entrants to the labor force, and its strong labor market is operating with an unemployment rate near multidecade lows at 2.2 percent. Also, as in the United States, weak exports have recently been a drag on Japanese growth. But, like the United States, Japan has been less exposed to the global slowdown than many other economies. Exports represent only 17 percent of Japanese GDP, higher than in the United States but well below the 30 percent global average I mentioned earlier. In some respects, however, Japan is more strongly linked to the global economy than is the United States. One example is the relationship between episodes of global financial stress and the exchange rate. In times of stress, the dollar tends to appreciate as investors seek the safety of U.S. markets. The same is even more true for Japan, with the yen often recording even stronger appreciation than the dollar in times of increased risk aversion. Other channels operate differently because of structural differences between the United States and Japan. One difference is in the currency used to invoice trade. In the United States, almost all trade, both imports and exports, is invoiced in dollars. One aspect of this, as mentioned earlier, is that changes in the value of the dollar tend to have a relatively limited effect on U.S. import prices and import demand. Despite the importance of the yen in global financial markets, a significant portion of Japan's trade is also invoiced in dollars rather than yen, including not only Japan's exports to the United States, but also its exports to other countries in Asia. Some scholars have proposed that the importance of the dollar in Japan's trade lessens the responsiveness of Japan's exports to movements in the yen while making exports more sensitive to changes in the value of the dollar and, therefore, U.S. monetary conditions. Regarding inflation, through the considerable efforts of the Bank of Japan's quantitative and qualitative monetary easing program launched in early 2013, Japan has emerged from almost 15 years of modest deflation and is now operating with a positive inflation rate. While the inflation remains below the Bank of Japan's long-run objective of 2 percent, it represents a notable accomplishment given the difficulty of changing public inflation expectations after a long period of modest deflation in consumer prices. Returning to the United States, I would like to wrap up with a brief discussion of our monetary policy decision this week. At our meeting earlier this week, the Federal Open Market Committee (FOMC) lowered the target range for the federal funds rate by reduction this year. As Chair Powell noted in his press conference, the Committee took these actions to help keep the U.S. economy strong in the face of global developments and to provide some insurance against ongoing risks. The policy adjustments we have made since last year are providing--and will continue to provide--meaningful support to the economy. The economy is in a good place, and monetary policy is in a good place. The policy adjustments we have made to date will continue to provide significant support for the economy. Since monetary policy operates with a lag, the full effects of these adjustments on economic growth, the job market, and inflation will be realized over time. We see the current stance of monetary policy as likely to remain appropriate as long as incoming information about the economy remains broadly consistent with our outlook of moderate economic growth, a strong labor market, and inflation near our symmetric 2 percent objective. Of course, if developments emerge that cause a material reassessment of our outlook, we would respond accordingly. Policy is not on a preset course, and we will be monitoring the effects of our policy actions, along with other information bearing on the outlook, as we assess, at each future meeting, the appropriate path of the target range for the federal funds rate. Thank you very much for your time and attention and for the invitation to speak at the Japan Society this afternoon.

r191101a_FOMC

united states

Friedrich Hayek and the Price System

quarles

I am delighted to be back in New Haven and particularly to be in the company of so many students interested in thinking rigorously about ideas. And I am honored to be participating in the William F. Buckley, Jr., Program's conference today on Friedrich Hayek and the future of classical liberalism. Over the course of this afternoon, you will hear a series of presentations that put Hayek's thinking in the context of contemporary developments and that offer a variety of perspectives on his intellectual legacy. Hayek was a prolific--some might even say profligate--thinker. He was at various times, and in various modes, an early neuropsychologist, an epistemologist, a theoretical economist, a political philosopher, a moral philosopher, a philosopher of science, a historian of ideas, a public intellectual, and a social polemicist. This vast range has caused some to undervalue his contributions as an economist, notwithstanding his eventual Nobel Prize--when Hayek moved to the him because, as Milton Friedman said, "At that stage, he really wasn't doing any economics," and Paul Krugman famously said that "the Hayek thing is almost entirely about politics, not economics." Others believe his broader thought, while seminal, was inconsistent across these various areas, and Hayek himself never demonstrated how it all hung together. In my contribution to the discussion today, I want to examine a particular example of the lasting effect that Hayek has had on economic thinking--one pertaining to the importance of freely determined prices for producing efficient economic outcomes--and consider how Hayek's insights in this area can, in fact, tie together the various strands of his larger philosophy. So as not to appear entirely out of touch with more immediate developments, I will end by descending from the empyrean to the terrestrial with a discussion of the from earlier this week. Hayek's contributions to economics ranged widely, and many were important and of lasting influence. Among them were his studies of the relationship between the economic and political arrangements of a society. That body of work included, of course, his celebrated book which was published 75 years ago this year and is a focus of this event, as well as his later monograph, In addition, Hayek contributed prominently to monetary analysis. His work in this area included the theory of the business cycle that was part of the thinking of the Austrian school of economics. It also included Hayek's studies of the feasibility and implications of private-sector currency issuance--contributions that have informed modern-day analyses of the repercussions of electronic money. Today, however, I will be concerned instead with still another key contribution that Hayek made to economic analysis: understanding the operation of the price system. This contribution was formalized in his most famous paper in the economic-research literature: his article "The Use of Knowledge in Society," which was published in the It is worth outlining the basis for the high esteem in which economists hold Hayek's 1945 contribution. In 1974, the press release by the Royal Swedish Academy of the opinion that von Hayek's analysis of the functional efficiency of different economic systems is one of his most significant contributions to economic research in the broader sense. . . . His guiding principle when comparing various systems is to study how efficiently all the knowledge and all the information dispersed among individuals and enterprises [are] utilized. His conclusion is that only by far-reaching decentralization in a market system with competition and free price-fixing is it possible to make full use of knowledge and information." In the research that the academy described, Hayek's 1945 paper was the key article. More recently, this paper received further prominent acclaim when it was categorized by an expert panel as being one of the top 20 articles ever published in the With regard to the paper's contribution to the understanding of economic processes, an illuminating discussion was provided in 2005 by Oliver Williamson-- himself later a Nobel laureate in economics. Williamson cited Hayek's 1945 paper, along with Adam Smith's from the eighteenth century, as forming the core of a "venerated tradition in economics" of studying the notion of "spontaneous order" arising from a freely operating market system. How does Hayek's case for the price system fit in alongside the other work that occasion to note, the argument for the price system that Hayek articulated in 1945 was complementary with, but distinct from, the argument that Adam Smith espoused in Smith focused on how market mechanisms guide producers toward satisfying consumers' wants. Hayek instead stressed how the market mechanism makes, as he put it, "fuller use . . . of the existing knowledge" than a directed economy is able to do. Hayek emphasized that the signals transmitted by the various individual prices in the economy could, together, serve as a useful means of guiding overall resource allocation. The reason is that prices convey messages to consumers and producers even when the information that drives prices is not aggregated or directly observed. example, a large increase or decrease in the price of gasoline conveys information that influences consumer behavior and that also affects the behavior of energy producers, even when neither of these sets of market participants are aware of the precise factor initiating the price change. As a related matter, Hayek recognized that prices transmit information even in a situation in which much of that information is not explicitly disclosed by one market participant to another, or even consciously articulable by any market participant at all. Hayek believed that all of us "know" many things that we cannot articulate but that we nevertheless act on in practical situations, and the price system can therefore aggregate and transmit that knowledge which we could not otherwise convey. Hayek's analysis had implications for the viability of different economic systems. With regard to centrally planned economic systems--which had considerable support in the West in 1945, in light of the increased use of government economic controls in many countries during World War II and the dismal performance of market economies during the Great Depression--Hayek's analysis suggested that these systems would likely exhibit great inefficiency. To Hayek, it was totally unrealistic to expect an economy to operate efficiently if it was based on the "direction of the whole economic system according to one unified plan," as such a plan lacked the valuable information embedded in market-determined prices. The economist Gregory Mankiw has elegantly summed up Hayek's insight here: "Information is very, very dispersed among the population. . . .Nobody can possibly know all the information you need to run a centrally planned economy." economic analysis therefore complemented the philosophical and political arguments he marshaled against centrally planned economies in Again, it is important to recognize that this is not a contingent or technological problem. It is not only that the dispersion of knowledge makes it hard to gather, although that is certainly true--but if that were the only issue, then perhaps future advances in technology such as quantum computing would remove that obstacle. Rather, as already mentioned, we all know many important things that we cannot articulate; and many of these things we come to know precisely through our participation in trade and exchange through the market. This type of knowledge (a) is by its nature not conveyable to a central planner because we are not fully aware of all we know, and (b) would not even exist apart from the social interactions facilitated by the market which a central planner would replace. The flip side of Hayek's analysis was that, while there are insurmountable obstacles to economic efficiency via a central plan, an efficient economy may still be obtainable by letting the price system work. To quote Mankiw again, Hayek's analysis implies that "markets figure out a way to aggregate, in a decentralized way, dispersed information into desirable outcomes." Furthermore, this mechanism does not require the government or any one individual to process that dispersed information into a central network or to be able to aggregate the information into a statistical series. It is, instead, sufficient for the proper operation of the price mechanism that the relevant information be embodied implicitly in the economy's multiplicity of prices of individual goods and factors of production. This information is recorded in such prices because they respond to the behavior of individual buyers and sellers in the economy. Consequently, as recommends the price system to Hayek is the 'economy of knowledge' with which it operates. It is [in Hayek's description] nothing short of a 'marvel.' " Hayek's 1945 paper has had a great influence on subsequent economic research. It has been found to be highly relevant to a variety of areas of economic inquiry. For example, Hayek's analysis has proved valuable in the development of standard microeconomics, since his contribution deepened economists' understanding of the working of the price system and promoted further investigation of the question of how decentralized information is transmitted by markets. Hayek's emphasis on prices as processors of information has also had applications to international trade theory. in macroeconomics and monetary theory, Milton Friedman's Nobel lecture, published in 1977, cited Hayek's 1945 paper when arguing that, because it disrupted the signals arising from relative-price movements, inflation both lowered the efficiency of the economy and led output to deviate from its natural (or full-employment) level. likened the price mechanism to a "system of telecommunications," and Friedman's description of inflation as a form of "static" interrupting price signals was in keeping with this analogy. Hayek's ideas on prices influenced Joseph Stiglitz in his analysis of markets with asymmetric information and Roger Myerson's insights on mechanism design theory. Each of these bodies of work earned a Nobel Prize. I do not want to leave the impression, however, that all of the conclusions in Hayek's 1945 paper have become unchallenged principles chiseled into the economic consensus. On the contrary, one of the reasons why the paper has been so influential is that it remains a benchmark reference for understanding the case for relying primarily on a market system, based on freely determined prices, for determining the production and allocation of resources. The paper has therefore set a high bar for preempting the price system or for other interventions in the market: When economists point to cases in which market mechanisms can be improved on by regulation or other public-sector intervention, or to instances in which price signals do not appear to be operating effectively, they need to identify a specific market failure as the source of the inefficiency. Essentially, they need to establish instances in which the price system can be improved on as a means of processing information. Even Hayek acknowledged that the price mechanism works within an ecosystem of laws and social institutions, and those may evolve in ways that interfere with the signaling of prices. For example, one of the important events that raised doubts about the functioning of the private market's pricing process occurred in the years leading up to the financial crisis. This period featured pricing by financial markets that seemed, in some prominent cases, not to be adequately reflecting information about actual risks. Spreads on risky private-sector debt reached very low levels, and damaging spillovers to the nonfinancial sector occurred in the form of unduly high real estate prices and excessive leverage by borrowers in the housing market. One of my predecessors at the Federal Reserve Board, Donald Kohn, has noted the seeming herd-like behavior of financial markets in the pre-crisis period that generated this situation--an "underpricing of risk." The financial crisis, and the deep recession that followed it, prompted changes in the United States' regulatory framework. These changes have been designed to make the financial system more resilient than it was before the crisis. By creating appropriate incentives and rules, they should also encourage financial markets to price risk more appropriately than they did in the years leading up to the crisis--for example, by reducing the danger of investor complacency regarding the riskiness of their investments and the possibility of adverse scenarios. If we follow Hayek and regard the price system as like a telecommunications network, and then apply that metaphor to the financial sector, we can think of the institutional and regulatory changes to the financial system over the past decade as designed to improve the reliability and signal quality of the transmissions. How does all of this relate to the larger questions of philosophy and social order to which Hayek devoted much of his thought? Hayek's insights about the price system depend importantly on his theory of knowledge: The information that is available to us as a society is the aggregate of the highly dispersed and sometimes inarticulate knowledge possessed by each of us individually. It is not only hard to convey that information to a central authority for processing into a rational decision--it is also conceptually impossible given the nature of that knowledge. And, indeed, important parts of that knowledge will not even be generated except through our interaction with each other through the mechanism of the market. Trying to centralize economic decisionmaking, then, is not just too hard to do as a practical matter. It would actually reduce the amount of knowledge available to us as a society, by replacing those myriad individual interactions in a free marketplace. Thus, even if some technological way to aggregate information other than through prices could be invented, it would lead to less efficient, less humane outcomes because it would be based on less total human information. The price mechanism, then, is not just a matter of economics--it is a matter of social and, indeed, civilizational progress. As Hayek says in Constitution of , "[C]ivilization begins when the individual in pursuit of his ends can make use of more knowledge than he himself acquired and when he can transcend the boundaries of his ignorance by profiting from knowledge that he himself does not possess." I think this ties together the various threads of Hayek's thought throughout a long life: his early work on psychology ("How do we know?"), his later epistemology ("What do we know, and what does it mean to know it?"), his economics ("How do we make knowledge usable?"), and his social and political theory ("What institutions will ensure that the greatest amount of human knowledge will be usable in the pursuit of their human fulfillment?"). Contrary to those polemicists across the ideological spectrum whose tendentious simplifications of Hayek's thought would turn him into a crude icon rather than a complex thinker, this is a deeply human, and a deeply humane, project. I will look forward to the contributions of the others you will hear from today in how Hayek elaborated it and how we can further these principles today. Now I would like to turn to the current economic scene and this week's FOMC decision. Let me start by saying that the U.S. economy is doing well, and I am optimistic about the outlook. Economic conditions are currently very close to meeting our--that is, the FOMC's--dual-mandate objectives of maximum sustainable employment and price stability. A particular source of strength has been the labor market. Setting aside the monthly volatility and, specifically, the effects of the recent strike at General Motors, labor market indicators are as strong as they have been in quite some time. The unemployment rate has been running near a 50-year low, and the proportion of the population currently employed is close to its highest level in a decade. Encouragingly, labor force participation has held up, as the tight labor market has motivated workers to either join or remain in the labor force, halting, at least for the time being, a long-standing downward trend. Although the pace of job gains has slowed this year, we expected some deceleration because of how low the unemployment rate has fallen. A strong job market and high employment have in turn supported economic quarters, a healthy pace by historical standards and a major contributor to overall growth since consumption represents over two-thirds of economic activity. Because the labor market remains tight, I expect wage growth to pick up, which would then in turn underpin further strength in consumption and overall growth. For the other half of our mandate, inflation as measured by the PCE index was 1.3 percent over the 12 months ending in September, while core PCE inflation, which excludes increases in the prices of food and energy, was 1.7 percent. While these readings are below our 2 percent inflation objective, they are fairly close, and my assessment is that inflation will inch toward our objective in the coming months. Outside the near term, I am also optimistic about the longer-term potential of the U.S. economy. I am heartened by a recent pickup in labor productivity growth. A notable development of the post-crisis period has been the abysmal pace of labor productivity growth. After averaging about a 2-1/4 percent pace in the two decades leading up to the crisis, labor productivity growth has been closer to 1 percent, on average, since 2011. While there has been much speculation, it remains to be seen what has driven this slowdown. Consequently, the slowdown could resolve unpredictably. Although the quarterly data are volatile, I have been encouraged by a pickup in labor productivity in the first half of this year, when it grew at a 3 percent annual rate. Further out, I admit to being a bit of techno-enthusiast, and I see the potential for many emerging technologies, including 5G communications, artificial intelligence and machine learning, and 3-D printing, to further boost productivity growth in the coming years. Having established my optimism, I will now circle back to some more worrying signs in the recent data that suggest some headwinds are holding back growth. One prominent factor weighing on a relatively robust domestic economy has been weak growth among our trading partners. The International Monetary Fund projects that global economic growth in 2019 will be the slowest since the financial crisis. Partly as a consequence of weak foreign growth, U.S. exports have been flat over the past year. Another weak spot has been investment. After a strong 2017 and start to 2018, business fixed investment has tailed off this year and fallen outright in the second and third quarters. I find the weakness of investment to be of particular concern because increasing investment and the capital stock are important for raising the potential capacity of the economy. It is likely that some of the weakness in capital spending is a result of elevated uncertainty, for foreign growth generally but also specifically for trade developments. Against this backdrop, at our meeting earlier this week, we decided to lower our target range for the federal funds rate for the third time this year. We took this action to help keep the U.S. economy strong in the face of global developments and to provide some insurance against ongoing risks. By lowering the federal funds rate this year, we are supporting the continued expansion of the economy. Overall, with these policy adjustments, I believe that the economy will remain in a good place, with the labor market remaining strong and inflation staying close to our 2 percent objective. We see the current stance of monetary policy as likely to remain appropriate as long as incoming information about the economy continues to be broadly consistent with our outlook of moderate economic growth, a strong labor market, and inflation near our symmetric 2 percent objective. , vol. 101 , vol. . conference sponsored by the Peterson Institute for International Economics and . . Journal of ------ (1944). vol. ------ (1960). . . speech delivered at the European Banking Federation's . . An Inquiry into the Nature and Causes of the Wealth of Nations, vol. 115 . .

r191108a_FOMC

united states

Why Climate Change Matters for Monetary Policy and Financial Stability

brainard

I want to thank my colleagues at the Federal Reserve Bank of San Francisco, this research conference. The presentations today provide important insights into the many important ways climate-related risks may affect our financial system and broader economy. Similar to many areas around the country, we need not look far from here to see the potentially devastating effects of our changing climate. Less than a hundred miles from here, families have lost their homes and businesses, and entire communities have been devastated by the Kincade fire. Some have described PG&E's bankruptcy as the first climate change bankruptcy. Some insurers have discontinued policies in fire-prone areas, which, in turn, is changing the costs of homeownership and the risk profiles of previously underwritten mortgages. Yet we can also see not far from here the promise of green innovation. So how does climate change fit into the work of the Federal Reserve? To support a strong economy and a stable financial system, the Federal Reserve needs to analyze and adapt to important changes to the economy and financial system. This is no less true for climate change than it was for globalization or the information technology revolution. Climate change is projected to increase the frequency and intensity of extreme weather events, raise average temperatures, and cause sea levels to rise. Climate risks are projected to have profound effects on the U.S. economy and financial system. To fulfill our core responsibilities, it will be important for the Federal Reserve to study the implications of climate change for the economy and the financial system and to adapt our work accordingly. Congress has assigned the Federal Reserve specific responsibilities in monetary policy, financial stability, financial regulation and supervision, community and consumer affairs, and payments. Climate risks may touch each of these. Let's start with monetary policy. Increasingly, it will be important for the Federal Reserve to take into account the effects of climate change and associated policies in setting monetary policy to achieve our objectives of maximum employment and price stability. Monetary policy seeks to buffer the economy from unexpected adverse disruptions, or "shocks." It is generally more challenging for monetary policy to insulate the economy from shocks to the supply side of the economy than to the demand side. So it is vital for monetary policymakers to understand the nature of climate disturbances to the economy, as well as their likely persistence and breadth, in order to respond effectively. For instance, monetary policymakers must accurately assess how disasters such as hurricanes, wildfires, and flooding affect labor markets, household and business spending, output, and prices. In deciding whether to alter monetary policy or, instead, to "look through" such shocks, policymakers need to assess the likely persistence of the effects and how widespread they are. Because there is considerable uncertainty about the persistence, breadth, and magnitude of climate-related shocks to the economy, it could be challenging to assess what adjustments to monetary policy are likely to be most effective at keeping the economy operating at potential with maximum employment and price stability. We need only look back to the oil price shocks of the 1970s and 1980s to see how difficult it was for monetary policymakers to assess accurately the likely persistence of the effects on inflation and output and the appropriate response. To the extent that climate change and the associated policy responses affect productivity and long-run economic growth, there may be implications for the long-run neutral level of the real interest rate, which is a key consideration in monetary policy. As the frequency of heat waves increases, research indicates there could be important effects on output and labor productivity. A shifting energy landscape, rising insurance premiums, and increasing spending on climate change adaptations--such as air conditioning and elevating homes out of floodplains--will have implications for economic activity and inflation. As policies are implemented to mitigate climate change, they will affect prices, productivity, employment, and output in ways that could have implications for monetary policy. Just on its own, the large amount of uncertainty regarding climate-related events and policies could hold back investment and economic activity. Second, the Federal Reserve will need to assess the financial system for vulnerabilities to important climate risks. The Federal Reserve has important responsibilities for safeguarding the stability of our financial system so that it can continue to meet household and business needs for financial services when hit by negative shocks. Similar to other significant risks, such as cyberattacks, we want our financial system to be resilient to the effects of climate change. Although there is substantial uncertainty surrounding how or when shifts in asset valuations might occur, we can begin to identify the factors that could propagate losses from natural disasters, energy disruptions, and sudden shifts in the value of climate- exposed properties. As was the case with mortgages before the financial crisis, correlated risks from these kinds of trends could have an effect that reaches beyond individual banks and borrowers to the broader financial system and economy. As with other financial stability vulnerabilities arising from macroeconomic risks, feedback loops could develop between the effects on the real economy and those on financial markets. For example, if prices of properties do not accurately reflect climate-related risks, a sudden correction could result in losses to financial institutions, which could in turn reduce lending in the economy. The associated declines in wealth could amplify the effects on economic activity, which could have further knock-on effects on financial markets. Beyond these physical risks, policymakers in some jurisdictions are assessing the resilience of the financial system to so-called transition risks: the risks associated with the transition to a policy framework that curtails emissions. The private sector is focused on climate risks. Private-sector businesses-- including insurance companies, ratings agencies, data companies, and actuaries--are actively working to understand climate-related risks and make this information accessible to investors, policymakers, and financial institutions. Although this work is at an early stage, thousands of companies around the world are now reporting climate-related financial exposures to the Carbon Disclosure Project (CDP) under the guidelines of the Based on these disclosures, the CDP estimates that the 500 largest companies by market capitalization are exposed to nearly $1 trillion in risk, half of which is expected to materialize in the next five years. A majority of the reporting companies integrate climate risk into their business strategies and their broader risk-management frameworks. An essential element of our bank supervision and regulation duties is assessing banks' risk-management systems. We expect banks to have systems in place that appropriately identify, measure, control, and monitor all of their material risks. risks may include severe weather events that can disrupt standard clearing and settlement activity and increase the demand for cash. Banks also need to manage risks surrounding potential loan losses resulting from business interruptions and bankruptcies associated with natural disasters, including risks associated with loans to properties that are likely to become uninsurable or activities that are highly exposed to climate risks. The Federal Reserve also has important responsibilities in community reinvestment, which increasingly encompass recovering from and building resilience against natural disasters and severe weather events. Under the Community Reinvestment Act (CRA), banks have an affirmative obligation to meet the needs of their local communities, including low- and moderate-income communities. In recent years, the banking agencies have issued a number of statements to clarify that disaster recovery efforts are CRA-eligible activities. research on the effect of climate change on low- to moderate-income communities in order to help inform more effective responses. Working with local communities, the Federal Reserve staff have highlighted the ways in which lower-income households and underserved areas tend to be particularly vulnerable to natural disasters. With low levels of liquid savings to meet emergency expenditures, these households tend to be less resilient to the temporary loss of income, property damage, and health outcomes they face from disasters. In our community development work, we seek to encourage lenders and their local communities to rebuild in ways that will increase their resilience to future risks. The staff across the Federal Reserve System are researching a wide range of topics related to climate risks, including how weather and natural disasters affect economic and financial outcomes and the economic implications of climate policies, including for the energy sector. We currently assess the effects of severe weather events for all our work--from forecasts for the Federal Open Market Committee to guidance provided to banks in the wake of federal disaster declarations to our efforts to understand the effects on low- to moderate-income communities. Work to understand the implications of climate-related risks for our economy and financial system is at an early stage. That is why we are particularly eager to learn from the work of our colleagues here and abroad. In that regard, the Commodity Futures Subcommittee is noteworthy, and I look forward to their observations. We also benefit from working with international peers who are taking the lead on understanding the effects of climate-related risks on their financial systems. We are participating in climate-related discussions at the FSB and other standard-setting bodies, and we will continue to support the work of the FSB's TCFD in order to improve standardization of financial disclosures related to climate change. Along with other officials with financial stability responsibilities, I have been following the Bank of England's plans to assess climate risks to the financial system, including through their exploratory stress-test scenario. And we are in discussions about how we might participate in the Central Banks and Supervisors Network for Greening the Financial System in order to learn from our international colleagues' approaches to measuring and managing climate risks in the financial system. We also have a lot to learn from the broader research community about the economic and financial effects of climate change. As we have seen today, researchers are making progress on addressing questions regarding how climate change relates to labor markets, trade policy, and monetary policy. By participating more actively in climate- related research and practice, the Federal Reserve can be more effective in supporting a strong economy and a stable financial system.

r191112a_FOMC

united states

Monetary Policy, Price Stability, and Equilibrium Bond Yields: Success and Consequences

clarida

For release on delivery Remarks by at the Good morning. I am honored and delighted to participate in this second annual conference on global risk, uncertainty, and volatility, cosponsored by the Federal Reserve I would like especially to thank the Swiss National Bank for hosting this event. This conference is part of continuing work across all of our institutions and the academic community to better quantify and assess the implications of risk and uncertainty. I am pleased that this year the focus of the conference is on two of my long-standing professional interests-- financial markets and monetary policy. And my remarks today will not stray far from those interests. In particular, I would like to address an issue that has been much in focus--the decline in long-term interest rates--highlighting the role of monetary policy in contributing to that decline and the implications of that decline for the conduct of monetary policy. One of the most remarkable and fundamental changes in the global financial landscape over the past three decades has been the steady and significant decline in global sovereign bond yields. From the late 1980s, when 10-year nominal Treasury yields in the United States and sovereign rates in many other major advanced economies were around 10 percent, global bond yields in the advanced economies have trended To understand and interpret this decline, it is useful to think of the yield on a nominal 10-year bond as the sum of two components: investors' expectation over the next 10 years of the average level of short-term interest rates plus a term premium. The term premium is the additional compensation--relative to investing in and rolling over short-maturity bills--that bondholders require for assuming the risk of holding a long- duration asset with greater exposure to interest rate and inflation volatility. Importantly, according to economic theory the equilibrium term premium can be negative. In this case, which is relevant today in the United States and some other countries, the exposure to interest rate and inflation volatility embedded in a long-maturity bond is more than offset by the potential value of the bond in hedging other risks, such as equity risk. expectation of the average level of future short-term interest rates can, in turn, be decomposed into the expectation of average future real interest rates and the expectation of average future inflation rates. Performing this standard decomposition reveals that the decline in long-term rates reflects declines in all three components: expected real rates, discuss each of these components in turn. With respect to expected real short-term interest rates, one reason investors expect lower future short-term interest rates is that neutral interest rates appear to have declined worldwide and are expected to remain low. This concept of a neutral level for short-term real interest rates is referred to in the academic literature as r* and corresponds to the rate consistent with a level of aggregate demand equal to and growing in pace with aggregate supply at an unchanged rate of inflation. Longer-run secular trends in r* largely, or even entirely, reflect fundamental "real" factors that are outside the control of a central bank. Policymakers and academics alike, including myself, have spent considerable time exploring the reasons for and ramifications of the decline in r* across countries. example, many have pointed to slowing population growth and a moderation in the pace of technological change as consistent with a lower level of r*. Changes in risk tolerance and regulations have led to an increase in savings and in the demand for safe assets, pushing down yields on sovereign bonds. Importantly, economic theory suggests and empirical research confirms that there is a significant common global component This common factor driving individual country r*s not only reflects the influence of common global shocks affecting all economies in a similar way (for example, a slowdown in global productivity and the demographics associated with aging), but also results from international capital flows that respond to and, over time, tend to narrow divergences in rates of return offered across different countries. Other things being equal, a decline in the common factor driving individual country r*s that is evident in the data would be expected to produce a comparable common decline in global bond yields. In addition to the decline in r* around the world, lower long-term bond yields also reflect the influence of the initial downshift and ultimate anchoring of inflation expectations in many countries after the mid-1990s. Unlike the decline in r*, which primarily reflects fundamental "real" factors that are outside the control of a central bank, the decline and ultimate anchoring of inflation and inflation expectations in both major and many emerging economies were the direct consequence of the widespread adoption and commitment to transparent, flexible inflation-targeting monetary policy strategies. For example, in the United States, after the collapse of Bretton Woods, inflation spiraled upward, hitting double-digit rates in the 1970s and early 1980s. But by the mid-1980s, the back of inflation had been broken (thank you, Paul Volcker), and total personal consumption expenditure (PCE) inflation averaged less than 4 percent from 1985 to 1990. Following the 1990-91 recession, inflation fell further, and, by the mid-1990s, the conditions for price stability in the United States had been achieved (thank you, Alan about 2 percent. And, of course, this step-down in inflation has been global, with the other major advanced economies experiencing a similar shift down (table 1, "Average Inflation Rates"). Many major emerging market economies as well have seen a remarkable and very welcome decline in average inflation rates as a result of adopting and delivering on credible inflation-targeting polices. To the extent that the step-down in inflation is expected to persist, which appears to be the case, long-term yields have reflected this decline one-for-one. However, not only has the average level of inflation fallen, but inflation has also become more stable. After considerable volatility in the 1970s and 1980s, over the past few decades, inflation--especially core inflation, which excludes volatile food and energy prices--has, with rare exceptions, moved only within a relatively narrow range in many countries despite significant swings in the prices of oil and other commodities, recessions, the Global Financial Crisis, and unprecedented monetary policy actions. Reflecting this, inflation volatility, as measured by the standard deviation in quarterly What has been behind this global decline in inflation volatility? I would argue, as have many others, that monetary policy played a key role in reducing not only the average rate of inflation, but also the volatility of inflation. Inflation-targeting monetary policy can plausibly influence the variance of inflation through several channels. For example, in a textbook DSGE (dynamic stochastic general equilibrium) model (Clarida, Gali, and Gertler (CGG), 1999) featuring a central bank that implements policy via a Taylor-type rule, the equilibrium variance of inflation will be lower the more aggressively the central bank leans against exogenous shocks that push inflation away from target. So even if the variance of inflation shocks is constant, the variance of inflation itself will be an endogenous function of monetary policy. Another related channel through which monetary policy can influence the variance of inflation is by changing the equilibrium persistence of inflation deviations from target. In the textbook CGG model (1999), augmented with a hybrid Phillips curve that features an inertial backward-looking component, the equilibrium persistence of inflation is an endogenous function of the monetary policy rule such that the more aggressively the central bank leans against exogenous shocks that push inflation away from target, the less persistent are inflation deviations from target in equilibrium. In the simple case in which equilibrium inflation is a first-order autoregressive process (as it is in the CGG (1999) model under optimal policy), the equilibrium unconditional variance of inflation is monotonic in inflation persistence for any given constant variance of inflation shocks. Of course, non-monetary factors may also have contributed to a lower variance of inflation. For example, the variance of underlying exogenous shocks to aggregate supply and demand may have fortuitously and coincidentally fallen in tandem with the adoption of inflation targeting in many countries. I will now turn to a third factor behind the decline in global bond yields, the decline in term premiums that is estimated to have occurred in many countries over the past 20 years. Most studies find that term premiums have fallen substantially in major economies over the past 20 years, and that in the United States term premiums may have been negative for some time. Decomposing the factors that drive equilibrium term premiums is an active area of academic research, and I will not attempt to summarize or synthesize this vast literature. But I would like to emphasize what seems to me to be three contributors to the decline in the term premium in the United States and perhaps in other countries as well. First, the decline in inflation volatility has almost certainly been important in driving the term premium on nominal bonds lower. The real ex-post payoff from holding a nominal bond to maturity is directly exposed to price-level risk, and thus, all else being equal, a decline in inflation volatility makes the real purchasing power of the bond's payoff less risky. Through this channel, the decline in inflation volatility should be reflected in a smaller inflation risk premium in nominal bond yields, which is exactly what is estimated in the Kim, Walsh, and Wei (2019) yield curve model (figure 4, "Term Premium Decomposition"). Indeed, this yield curve model attributes around 100 basis points of the decline in the U.S. 10-year nominal term premium since the early 1990s to a decline in the inflation risk premium. A second likely contributor to the decline in the U.S. term premium over the past decade is the Federal Reserve's substantial purchases of long-duration Treasury securities and mortgage-backed securities in three large-scale asset purchase (LSAP) programs and one maturity extension program between late 2008 and late 2014. These purchases, which were concentrated at the longer end of the U.S. yield curve, took duration out of the market and thus lowered the equilibrium yield required by investors to hold the reduced supply of long-duration assets instead of holding and rolling over short-maturity Treasury bills. Estimates of the cumulative effect of these purchases on the U.S. term premium span a wide range, with some estimates above 100 basis points. the global market for sovereign bonds and currency-hedged duration is tightly integrated, and it seems likely that asset purchase programs in other major economies, such as Japan, the euro area, and the United Kingdom, have contributed as well to reducing the term premium in Treasury securities (and, of course, LSAP programs in the United States likely contributed to lower term premiums abroad). A third contributor to a lower U.S. term premium is much less widely appreciated than lower inflation volatility and LSAPs. This reflects the value that bonds have provided over the past 20 years as a hedge against equity risk. As documented by returns changed sign in the late 1990s from positive to negative (figure 5, "Bond-Stock Covariance in the United States"). In the 1970s and 1980s, the sign of the correlation was positive, which implies that bond and stock returns tended to rise and fall together. In this period, bonds provided a diversification benefit when added to an equity portfolio (the bond return beta to stocks averaged 0.2) but not a hedge against equity risk. Since the late 1990s, the empirical correlation between bond and stock returns has typically been negative (the bond return beta to stocks has averaged negative 0.2). This means that since the late 1990s, bond returns tend to be high and positive when stock returns are low and negative so that nominal bonds have been a valuable outright hedge against equity risk. As such, we would expect the equilibrium yield on bonds to be lower than otherwise, as investors should bid up their price to reflect their value as a hedge against equity risk (relative to their value when the bond beta to stocks was positive). According to CSV, the hedging value of nominal bonds with a negative beta to stocks could substantially lower the equilibrium term premium on bonds. Quoting from their paper "Thus from peak to trough, the realized beta of Treasury bonds has declined by about 0.6 and has changed sign. According to the CAPM [capital asset pricing model], this would imply that term premia on 10- year zero-coupon Treasuries should have declined by 60 percent of the equity premium." As a concrete example, consider the (ex-post) hedging value of bonds for equity risk in minus 37 percent, while the total return of the on-the-run 30-year Treasury bond was There is likely no single explanation for the change in sign of the correlation between equilibrium bond and stock returns in the United States and in other major One recent paper that does rigorously model the changing value of bonds for hedging equity risk is by CPV. This paper develops and estimates a habit persistence consumption asset pricing model in which the sign of the equilibrium covariance between equity and bond returns depends on the reduced-form correlation between inflation and the output gap, the correlation between the federal funds rate and the output gap, as well as the equilibrium persistence of inflation. CPV document in U.S. data, for a sample spanning 1979:Q3 to 2011:Q4, that (1) the correlation between inflation and the output gap changed sign from negative to positive; that (2) the correlation between the federal funds rate and the output gap changed sign, also from negative to positive; and that (3) the evidence of the sign change becomes statistically significant beginning in the late 1990s. CPV also document that the transitory component of inflation becomes much less persistent after the estimated break in their sample. The CPV paper is agnostic as to why the reduced-form correlation between inflation and the output gap and that between the federal funds rate and the output gap both change sign in their sample, but the authors do demonstrate that in their asset pricing model, these reduced-form sign changes are sufficient to generate the sign change in the correlation between equity and bond returns that we observe in the data. I, myself, believe that the change in the U.S. monetary policy regime that began in 1979 under Paul Volcker and that was extended by Alan Greenspan in the 1990s very likely contributed to the change in the sign of the correlation between inflation and the output gap as well as the change in sign of the correlation between the federal funds rate and the output gap that we observe in the data (Clarida, Gali, and Gertler, 2000). These are the sorts of patterns that a simple model of optimal monetary policy would produce when starting from an initial condition in which inflation is well above the (implicit) target, as was the case in 1979. High initial inflation triggers a policy response for the central bank to push up the real policy rate well above inflation in order to push output below potential, which, via the Phillips curve, will, over time, lower inflation toward the target. If this policy succeeds ex post, inflation expectations become anchored at the new lower level of inflation, and policy can, then, respond to demand shocks by adjusting real rates pro-cyclically, the opposite of what is required when initial inflation is too high and inflation expectations are not anchored. Inflation will also be pro-cyclical with well- anchored inflation expectations if demand shocks dominate and inflation expectations remain anchored. By lowering expected inflation, by anchoring expected inflation at a low level, by contributing to a reduction in the volatility of inflation--and thus a reduction in the inflation risk premium--and by contributing to creating a hedging value of long-duration sovereign bonds, inflation-targeting monetary policy has lowered equilibrium bond yields relative to equilibrium short rates substantially compared with the experience of the 1970s and early 1980s. But, as I noted earlier, during the past decade equilibrium short rates have themselves also fallen substantially. These two phenomena, taken together, have resulted in sovereign bond yields that are substantially lower than the pre-crisis experience and thus substantially closer to the effective lower bound for the policy rate than they were before the crisis. But what does this mean for monetary policy? At its most basic level, the answer to this question could depend on how far the nominal policy rate is from the effective lower bound (ELB) and the extent to which the term premium on long-duration bonds can become even more negative than it is at present (at least in While I do not have a precise answer to this question, I will confess that I think it highly unlikely in the next downturn, whenever it is, that 10-year U.S. Treasury yields will fall by the roughly 390 basis points that we observed between June 2007 and July 2016 (the bottom in Treasury yields in this cycle) or even decline by the roughly 360 basis points that we observed between January 2000 and June 2003. The reality of low neutral rates and equilibrium bond yields has motivated us at the Federal Reserve to take a hard look this year at our monetary policy strategy, tools, and communication practices. While we believe our existing framework, in place since 2012, has served us well, we believe now is a good time to step back and assess whether, and in what possible ways, we can refine our strategy, tools, and communication practices to achieve and maintain our goals as consistently and robustly as possible in the world we live in today. As I have noted before, the review of our current framework is wide ranging, and we are not prejudging where it will take us, but events of the past decade highlight three broad questions that we will seek to answer with our review. The first question is, "Can the Federal Reserve best meet its statutory objectives with its existing monetary policy strategy, or should it consider strategies that aim to reverse past misses of the inflation objective?" Central banks are generally believed to have effective tools for preventing persistent inflation overshoots. But persistent inflation shortfalls, such as those associated with the ELB, carry the risk that longer-term inflation expectations become anchored below the stated inflation goal. ELB risks, including "makeup" strategies in which policymakers would promise to make up for past inflation shortfalls with a sustained accommodative stance of policy intended to generate higher future inflation. Such strategies provide accommodation at the ELB by keeping the policy rate low for an extended period. Makeup strategies may also help anchor inflation expectations more firmly at 2 percent than would a policy strategy that does not compensate for past inflation misses. But the benefits of makeup strategies depend importantly on the private sector's understanding of them as well as the belief that future policymakers will follow through on promises to keep policy accommodative. An advantage of our current framework over makeup approaches is that it has provided the Committee with the flexibility to assess a broad range of factors and information in choosing its policy actions, and these actions can vary depending on economic circumstances in order to best achieve our dual-mandate goals. We are also considering whether our existing monetary policy tools are adequate to achieve and maintain maximum employment and price stability, or whether our toolkit should be expanded and, if so, how. Because the U.S. economy required additional support after the ELB was reached in 2008, the FOMC deployed two additional tools beyond changes to the target for the federal funds rate: balance sheet policies and forward guidance about the likely path of the federal funds rate. The review is examining the efficacy of these existing tools, as well as additional tools for easing policy when the ELB is binding, in light of the more recent experiences of other economies. Finally, we are focusing on how the FOMC can improve the communication of its policy framework and actions. Our communication practices have evolved considerably since 1994, when the Federal Reserve released the first statement after an FOMC meeting. As part of the review, we are assessing the Committee's current and past communications and additional forms of communication that could be helpful. In terms of process, we have heard from a broad range of interested individuals and groups in 14 events this year. At our July 2019 FOMC meeting, the Committee began to assess what we have learned from these events and to receive briefings from System staff on topics relevant to the review. But we still have much to discuss at upcoming meetings. We will share our findings with the public when we have completed our review, likely during the first half of 2020. The economy is constantly evolving, bringing with it new opportunities and challenges. One of these challenges is how best to conduct monetary policy in the new world of low equilibrium interest rates. It makes sense for us to remain open minded as we assess current practices and consider ideas that could potentially enhance our ability to deliver on the goals the Congress has assigned us. For this reason, my colleagues and I do not want to preempt or to predict our ultimate findings. What I can say is that any refinements or more material changes to our framework that we might make will be aimed solely at enhancing our ability to achieve and sustain our dual-mandate objectives in the world we live in today. Stepping back, earlier today, speakers at this conference discussed the challenges of making monetary policy in an uncertain and risky environment. In my remarks, I have laid out an important example of the interaction of the macroeconomy, monetary policy, and the market response to risk. The papers you are about to discuss throughout the next two days present cutting-edge research on the effect and measurement of risk and uncertainty and volatility, with a special focus on monetary policy and market behavior. As someone on the front lines, I look forward to learning from your insights and encourage your rich discussion over the next few days and your continued work on how to make my job easier! Thank you, and good luck! vol. vol. 17 . . . . vol. 31 . . vol. 37 . vol. 30 December, available at . vol. . . . . . . . . . in Emerging Markets," unpublished working paper, Board of Governors of the Journal of . . . vol. 4 . Fiscal Policy, and the Risk of Secular Stagnation," paper presented at the . vol. 32 . . .

r191114a_FOMC

united states

The Federal Reserve’s Review of Its Monetary Policy Strategy, Tools, and Communication Practices

clarida

I am delighted to be at the Cato Institute today to participate in your annual monetary conference. The last time I had the privilege of speaking at this conference was Reserve's 2019 review of our monetary policy strategy, tools, and communication practices. This topic is, of course, timely and one to which I and others have devoted much thought over the past year. Motivation for the Review Although I will have more to say about the review in a moment, let me state at the outset that we believe our existing framework, which has been in place since 2012, has served us well and has enabled us to achieve and sustain our statutorily assigned goals of maximum employment and price stability. However, we also believe now is a good time to step back and assess whether, and in what possible ways, we can refine our strategy, tools, and communication practices to achieve and maintain our goals as consistently and robustly as possible. With the U.S. economy operating at or close to maximum employment and price stability, now is an especially opportune time to conduct this review. The unemployment rate is near a 50-year low, and inflation is running close to our 2 percent objective. With this review, we hope to ensure that we are well positioned to continue to meet our statutory goals in coming years. The U.S. and foreign economies have changed in some important ways since the Global Financial Crisis. Perhaps most significantly, neutral interest rates appear to have fallen in the United States. A fall in neutral rates increases the likelihood that a central bank's policy rate will hit its effective lower bound (ELB) in future economic downturns. That development, in turn, could make it more difficult during downturns for monetary policy to support spending and employment and to keep inflation from falling too far below the central bank's objective--2 percent in the case of the Federal Reserve. Another key development in recent decades is that price inflation appears less responsive to resource slack. That is, the short-run price Phillips curve--if not the wage Phillips curve--appears to have flattened, implying a change in the dynamic relationship between inflation and employment. A flatter Phillips curve permits the Federal Reserve to support employment more aggressively during downturns--as was the case during and after the Great Recession--because a sustained inflation breakout is less likely when the Phillips curve is flatter. However, a flatter Phillips curve also increases the cost, in terms of lost economic output, of reversing unwelcome increases in longer-run inflation expectations. Thus, a flatter Phillips curve makes it all the more important that inflation expectations remain anchored at levels consistent with our 2 percent inflation objective. Based on the evidence I have reviewed, I judge that U.S. inflation expectations today do reside at the low end of a range I consider consistent with our price-stability mandate. For some time now, price stability in the United States has coincided with a historically low unemployment rate. This low unemployment rate, 3.6 percent in October, has been interpreted by many as suggesting that the labor market is currently operating beyond full employment. However, we cannot directly observe the level of the unemployment rate that is consistent with full employment and price stability, u*, but must infer it from data via models. I myself believe that the range of plausible estimates of u* extends to 4 percent and below and includes the current unemployment rate of 3.6 percent. As the unemployment rate has declined in recent years, labor force participation for people in their prime working years has increased significantly, with the October participation rate at a cycle high of 82.8 percent. Increased prime-age participation has provided employers with additional labor resources and has been one factor, along with a pickup in labor productivity, restraining inflationary pressures. Whether participation will continue to increase in a tight labor market remains to be seen. But I note that male prime-age participation still remains below levels seen in previous business cycle expansions. Also, although the labor market is robust, there is no evidence that rising wages are putting excessive upward pressure on price inflation. Wages today are increasing broadly in line with productivity growth and underlying inflation. Also of note, and receiving less attention than it deserves, is the material increase in labor's share of national income that has occurred in recent years as the labor market has tightened. As I have written before, labor's share tends to rise as expansions endure and the labor market tightens. In recent cycles--and thus far in this cycle--this rise in labor's share has not put excessive upward pressure on price inflation. Scope of the Review The Federal Reserve Act instructs the Fed to conduct monetary policy "so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." Our review this year takes this statutory mandate as given and also takes as given that inflation at a rate of 2 percent is most consistent over the longer run with the congressional mandate. Our existing monetary policy strategy is laid out in the Committee's Statement on First adopted in January 2012, the statement indicates that the Committee seeks to mitigate deviations of inflation from 2 percent and deviations of employment from assessments of its maximum level. In assessments of maximum employment are necessarily uncertain and subject to revision. As a practical matter, our current strategy shares many elements with the policy framework known as "flexible inflation targeting." However, the Fed's mandate is much more explicit about the role of employment than that of most flexible inflation- targeting central banks, and our statement reflects this by stating that when the two sides of the mandate are in conflict, neither one takes precedence over the other. The review of our current framework is wide ranging, and we are not prejudging where it will take us, but events of the past decade highlight three broad questions that we will seek to answer with our review. The first question is, "Can the Federal Reserve best meet its statutory objectives with its existing monetary policy strategy, or should it consider strategies that aim to reverse past misses of the inflation objective?" Under our current approach as well as the approaches of many central banks around the world, persistent inflation shortfalls of the target are treated as "bygones." Central banks are generally believed to have effective tools for preventing persistent inflation overshoots, but the ELB on interest rates makes persistent undershoots more of a challenge. Persistent inflation shortfalls carry the risk that longer-term inflation expectations become anchored below the stated inflation goal. In part because of that concern, some economists have advocated "makeup" strategies under which policymakers seek to undo past inflation deviations from target. These strategies include targeting average inflation and price-level targeting, in which policymakers seek to stabilize the price level around a constant growth path. makeup strategies seek to reverse shortfalls in policy accommodation at the ELB by keeping the policy rate lower for longer than otherwise would be the case. In many models that incorporate the ELB, these makeup strategies lead to better average performance on both legs of the dual mandate. The success of makeup strategies relies on households and firms believing in advance that the makeup will, in fact, be delivered when the time comes--for example, that a persistent inflation shortfall will be met by future inflation above 2 percent. As is well known from the research literature, makeup strategies, in general, are not time consistent because when the time comes to push inflation above 2 percent, conditions at that time will not justify that action. Thus, one of the most important questions we seek to answer in our review is whether the Fed could, in practice, attain the benefits of makeup strategies that are possible in theoretical models. The next question the review is considering is, "Are existing monetary policy tools adequate to achieve and maintain maximum employment and price stability, or should the toolkit be expanded? And, if so, how?" The FOMC's primary monetary policy tool is its target range for the federal funds rate. In December 2008, the FOMC cut that target to just above zero in response to financial turmoil and deteriorating economic conditions. Because the U.S. economy required additional support after the ELB was reached, the FOMC deployed two additional tools in the years following the crisis: balance sheet policies and forward guidance about the likely path of the federal funds rate. In addition to assessing the efficacy of these existing tools, the review is examining additional tools for easing policy when the ELB is binding. During the crisis and its aftermath, the Federal Reserve considered some of the tools deployed by other central banks but ultimately found them wanting in the U.S. context. But the review is reassessing the case for these and other tools in light of more recent experience in other countries. The third question the review is considering is, "How can the FOMC's communication of its policy framework and implementation be improved?" Our communication practices have evolved considerably since 1994, when the Federal Reserve released the first statement after an FOMC meeting. Over the past decade or so, the FOMC has enhanced its communication both to promote public understanding of its policy goals, strategy, and actions and to foster democratic accountability. These Strategy; postmeeting press conferences; various statements about the principles and strategy guiding the Committee's normalization of monetary policy following the financial crisis; and quarterly summaries of individual FOMC participants' economic projections, assessments about the appropriate path of the federal funds rate, and judgments of the uncertainty and balance of risks around their projections. As part of the review, we are assessing the Committee's current and past communications and additional forms of communication that could be helpful. For example, there might be ways to improve communication about the coordination of policy tools or the interplay between monetary policy and financial stability. Activities and Timeline for the Review Let me turn now to our review process itself. An important piece of this review has been a series of 14 events, hosted by the Board and the Reserve Banks from late February until mid-October. We heard from a broad range of interested individuals and groups, including business and labor leaders, community development professionals, and academics. At a research conference at the Federal Reserve Bank of Chicago in early June, we heard from prominent academic economists as well as national and community leaders. Our events have provided us with a valuable perspective on the labor market that could not otherwise be gleaned from aggregate statistics; these events have also offered insights into how the monetary levers we pull and push affect communities, credit availability, and small businesses. Last summer, the FOMC began to assess what we have learned at the events and to receive briefings from System staff on topics relevant to the review. our July meeting, FOMC participants agreed that our current framework for monetary policy has served the Committee and the U.S. economy well over the past decade. FOMC participants noted that the Committee's experience with forward guidance and asset purchases has improved its understanding of how these tools operate. As a result, the Committee could proceed more confidently in using these tools in the future if economic circumstances warranted. However, overall, we judged that forward guidance and balance sheet tools, while helpful, did not eliminate the risk of returning to the ELB. At our September meeting, we discussed makeup strategies in the context of a lower neutral policy interest rate, a reduction in conventional policy space, and a higher likelihood that future economic downturns will involve a return to the ELB. We generally agreed that our current monetary policy framework is flexible enough to allow the Committee to choose the policy actions that best support our dual-mandate objectives in a wide variety of economic circumstances. Our discussions will continue at future meetings. In particular, we have not yet begun to consider potential changes to communication practices, including the The statement has helped articulate and clarify the Federal Reserve's approach to monetary policy, and we have agreed that any changes we might make to our strategy would likely call for some modification of this consensus statement. We will continue to report on our discussions in the minutes of our meetings and share our conclusions when we finish the review, likely around the middle of next year. The economy is constantly evolving, bringing with it new policy challenges. So it makes sense for us to remain open minded as we assess current practices and consider ideas that could potentially enhance our ability to deliver on the goals the Congress has assigned us. For this reason, my colleagues and I do not want to preempt or to predict our ultimate findings. What I can say is that any refinements or more material changes to our framework that we might make will be aimed solely at enhancing our ability to achieve and sustain our dual-mandate objectives in the world we live in today. Thank you very much for your time and attention. I trust that today's conference will provide stimulating discussion of issues that are central to our review. . . . . . press release, August 21, . . . Forum, sponsored by the Initiative on Global Markets at the University of Chicago . . , Spring, . no. 1, . . presented at the Brookings Papers on Economic Activity Conference, Fall, held at . . . Journal of . . vol. 4 . Journal of . vol. 32 . . . .

r191114b_FOMC

united states

Brief Remarks (via pre-recorded video)

quarles

I greatly regret I couldn't be with you today in Abu Dhabi. You are in a region of the world that's a fitting place to discuss the future of insurance supervision because of its ties to the very origins of insurance. The first written system of laws, the Hammurabic Code, in fact, included the first rules on loss liability. The ancient Arab tribal practice of takaful , a system of guarantees, gave rise to one of the earliest forms of mutual insurance, which was used to protect ship owners and cargo. The Middle East is the cradle of civilization, and civilization itself has always depended on the rules and guarantees that are the basis of insurance. And while I couldn't be part of the your discussions, I am grateful for this opportunity to reach you with a message about how the International Association of promoting a strong and stable global financial system. The FSB was created to gather national and regional authorities together in a forum that considers and addresses financial stability risks. The IAIS's mission, to promote effective supervision of the insurance industry, is in full alignment with the goals of the FSB. The new global financial architecture built in the aftermath of the crisis requires continued cooperation among authorities, standard-setting bodies, and all stakeholders. Such cooperation is the basis of the FSB, and the basis for what the IAIS has achieved in the past quarter century, and what you are striving to achieve in the future. Since becoming Chair of the FSB last December, I have had some time to observe the important work of the IAIS as one of the standard-setting bodies that are essential to the FSB. The IAIS has been an active contributor to the FSB's work through the Plenary and Steering Committees. It's also a valuable part of the work of the FSB Standing FSB members tell me they appreciate the regular updates by IAIS Executive Committee chair Vicky Saporta. Our two organizations have worked together closely on addressing systemic risk related to insurance. In particular, I appreciate the work of the IAIS to develop a Holistic Framework for the assessment and mitigation of systemic risk in the insurance sector. As I indicated a moment ago, I know that the IAIS is celebrating its twenty-fifth anniversary. As we think back to 1994, and the step forward the IAIS represented for cooperation and coordination on insurance oversight, I think we can all marvel at how modest, relative to today, were the demands and the aspirations at that time for international standard-setting. On the one hand, insurance had been a global business for well over a century. On the other, the idea that an insurance company could be at the center of a global financial meltdown would have seem far-fetched. Likewise, even after the financial crises in developing countries in the late 1990s, few people believed that the world's largest and wealthiest economies could all be threatened with ruin by a truly global crisis. It is for this reason that we are not this year also celebrating the twentieth anniversary of the Financial Stability Forum, which was created in that more innocent era. It was replaced by the FSB a decade ago because of the urgent need for a larger and more ambitious organization to deal with the global crisis that few had seen coming. That global financial crisis demanded a global response and the Group of 20 (G20) leaders called on national authorities to cast a wider net for membership than the Financial Stability Forum could offer. The first ten years of the FSB have seen important achievements in promoting global financial standards that have addressed weaknesses revealed by the financial crisis. Today, banks are more resilient due to higher capital and liquidity standards. We are addressing the "too-big-to-fail" problem, including through new statutory resolution frameworks and resolution planning. Over-the-counter derivatives markets are simpler and more transparent. And the risks emanating from non- bank financial intermediation that contributed to the crisis have diminished significantly. But the FSB's policy work needs to advance in a few important areas. While resolution plans are in place for the global, systemically important banks, more work is needed to build effective resolution regimes for insurers. We have to keep up the momentum to ensure that markets have confidence that bailouts using taxpayer funds are a thing of the past. The future, and the prospects for success, of both the FSB and the IAIS will turn on how we address the challenges of the changing nature of financial services that are coming from technological innovation and other sources. Your conference theme this year, "Supervision in a Digital Era" is timely, and the panels you have planned on these topics can inform the supervisory responses that all our governments are weighing. The rapid changes transforming the financial landscape mean we can't rely on the past for answers. The FSB is committed to a forward-looking agenda to address new vulnerabilities and new challenges. Like the IAIS, we are developing a new financial stability surveillance framework. We're also examining possible unintended negative consequences of market fragmentation. And something that is capturing the attention of many regulators are recent proposals to launch stablecoins on a global scale. The FSB has been looking at crypto-assets and has formed a group of experts to examine the implications of these recent proposals. The FSB and IAIS share many common concerns about risks to financial stability--Fintech, cyber risk and operational resilience are just some of them. The IAIS has advanced the effort to tackle these problems with an active and comprehensive program of outreach: by extending the length of public consultations whenever possible; by expanding participation of new stakeholders in public events; by organizing subject matter specific workshops on emerging risks; by expanding efforts to seek input from consumer groups; and, by reaching out to academics with more roundtable discussions with investors and rating agencies. In closing, congratulations again to the IAIS on its silver anniversary, and doubly so for embracing such an ambitious agenda for the future. On behalf of the FSB, we look forward to working with you to set standards for financial regulation and supervision that will promote a strong and stable financial system. Thank you for this opportunity to speak, and I wish you a successful and engaging conference.

r191125a_FOMC

united states

Building on the Gains from the Long Expansion

powell

Over the past year, my colleagues and I on the Federal Open Market Committee (FOMC) have been conducting a first-ever public review of how we make monetary policy. As part of that review, we held events around the country where representatives from a wide range of groups have been telling us how the economy is working for them and the people they represent and how the Federal Reserve might better promote the goals Congress has set for us: maximum employment and price stability. We have heard two messages loud and clear. First, as this expansion continues into its 11th year--the longest in U.S. history--economic conditions are generally good. Second, the benefits of the long expansion are only now reaching many communities, and there is plenty of room to build on the impressive gains achieved so far. These themes show through in many ways in official statistics. For example, more than a decade of steady advances has pushed the jobless rate near a 50-year low, where it has remained for well over a year. But the wealth of middle-income families-- savings, home equity, and other assets--has only recently surpassed levels seen before the Great Recession, and the wealth of people with lower incomes, while growing, has yet to fully recover. Fortunately, the outlook for further progress is good: Forecasters are generally predicting continued growth, a strong job market, and inflation near 2 percent. Tonight I will begin by discussing the Fed's policy actions over the past year to support the favorable outlook. Then I will turn to two important opportunities for further gains from this expansion: maintaining a stable and reliable pace of 2 percent inflation and spreading the benefits of employment more widely. We started 2019 with a favorable outlook, and over the year the outlook has changed only modestly in the eyes of many forecasters (figure 1). For example, in the Survey of Professional Forecasters, the forecast for inflation is a bit lower, but the unemployment forecast is unchanged and the forecast for gross domestic product (GDP) is nearly unchanged. The key to the ongoing favorable outlook is household spending, which represents about 70 percent of the economy and continues to be strong, supported by the healthy job market, rising incomes, and solid consumer confidence. While events of the year have not much changed the outlook, the process of getting from there to here has been far from dull. I will describe how we grappled with incoming information and made important monetary policy changes through the year to help keep the favorable outlook on track. As the year began, growth appeared robust, but the economy faced some risks flowing mainly from weakening global economic growth and trade developments. Foreign growth, which slipped in the second half of last year, slid further as 2019 progressed. While weaker foreign growth does not necessarily translate into similar weakness here, it does hurt our exporters and presents a risk that the weakness may spread more broadly. At the same time, business contacts around the country have been telling us that trade-related uncertainties are weighing on their decisions. These global developments have been holding back overall economic growth. Manufacturing output, which had only recently surpassed its level before the Great Recession, has declined this year and is again below its pre-recession peak. Business investment has also weakened. In addition, inflation pressures proved unexpectedly muted this year. After remaining close to our symmetric 2 percent objective for much of last year, inflation is now running below 2 percent. Some of the softness in overall inflation is the result of a fall in oil prices and should not affect inflation going forward. But core inflation--which omits volatile food and energy prices--is also running somewhat below 2 percent. The main themes of our deliberations this year have been a continuing favorable outlook founded on strength in the household sector, with a few yellow flags including muted inflation and weakness in manufacturing. In addition, global growth and trade have presented ongoing risks and uncertainties. We also faced some less prominent factors that always confront policymakers. Specifically, we never have a crystal clear real-time picture of how the economy is performing. In addition, the precise timing and size of the effects of our policy decisions cannot be known in real time. In August, the Bureau of Labor Statistics previewed a likely revision to its count of payroll job creation for the 12 months ended March 2019. The preview indicated that job gains over that period were about half a million lower than previously reported. On a monthly basis, job gains were likely about 170,000 per month, rather than 210,000. While this news did not dramatically alter our outlook, it pointed to an economy with somewhat less momentum than we had thought. Uncertainty about how our policies are affecting the economy also entered our discussions. As you know, we set our policy interest rate to achieve our goals of maximum employment and stable prices. In doing so, we often refer to certain benchmarks. One of these is the interest rate that would be neutral--neither restraining the economy nor pushing it upward. We call that rate "r*" (pronounced "r star"). A policy rate above r* would tend to restrain economic activity, while a setting below r* would tend to speed up the economy. A second benchmark is the natural rate of unemployment, which is the lowest rate of unemployment that would not create upward pressure on inflation. We call that rate "u*" (pronounced "u star"). You can think of r* and u* as two of the main stars by which we navigate. In an ideal world, policymakers could rely on these stars like mariners before the advent of GPS. But, unlike celestial stars on a clear night, we cannot directly observe these stars, and their values change in ways that are difficult to track in real time. Standard estimates of r* and u* made by policymakers and other analysts have been falling since 2012 (figure 2). Since the end of last year, incoming data--especially muted inflation data--prompted analysts inside and outside the Fed to again revise down their estimates of r* and u*. Taken at face value, a lower r* would suggest that monetary policy is providing somewhat less support for employment and inflation than previously believed, and the fall in u* would suggest that the labor market was less tight than believed. Both could help explain the weakness in inflation. As with the revised jobs data, these revised estimates of the stars were not a game changer for policy, but they provided another reason why a somewhat lower setting of our policy interest rate might be appropriate. How did we add up all of these considerations? To help keep the U.S. economy strong in the face of global developments and to provide some insurance against ongoing risks, we progressively eased the stance of monetary policy over the course of the year. First, we signaled that increases in our short-term interest rate were unlikely. Then, from July to October, we reduced the target range for the federal funds rate by 3/4 percentage point. The full effects of these monetary policy actions will be felt over time, but we believe they are already helping to support consumer and business sentiment and boosting spending in interest-sensitive sectors, such as housing and consumer durable goods. We see the current stance of monetary policy as likely to remain appropriate as long as incoming information about the economy remains broadly consistent with our outlook of moderate economic growth, a strong labor market, and inflation near our symmetric 2 percent objective. Looking ahead, we will be monitoring the effects of our policy actions, along with other information bearing on the outlook, as we assess the appropriate path of the target range for the federal funds rate. Of course, if developments emerge that cause a material reassessment of our outlook, we would respond accordingly. Policy is not on a preset course. I will wrap up with two areas where we have an opportunity to build on our gains. For many years as the economy recovered from the Great Recession, inflation expected that inflation would gradually rise as the expansion continued, and, as I noted, both overall and core inflation ran at rates consistent with our goal for much of 2018. But this year, inflation is again running below 2 percent. It is reasonable to ask why inflation running somewhat below 2 percent is a big deal. We have heard a lot about inflation at our events. People are concerned about the rising cost of medical care, of housing, and of college, but nobody seems to be complaining about overall inflation running below 2 percent. Even central bankers are not concerned about any particular minor fluctuation in inflation. Around the world, however, we have seen that inflation running persistently below target can lead to an unhealthy dynamic in which inflation expectations drift down, pulling actual inflation further down. Lower inflation can, in turn, pull interest rates to ever-lower levels. The experience of Japan, and now the euro area, suggests that this dynamic is very difficult to reverse, and once under way, it can make it harder for a central bank to support its economy by further lowering interest rates. That is why it is essential that we at the Fed use our tools to make sure that we do not permit an unhealthy downward drift in inflation expectations and inflation. We are strongly committed to symmetrically and sustainably achieving our 2 percent inflation objective so that in making long-term plans, households and businesses can reasonably expect 2 percent inflation over time. Many people at our events have told us that this long expansion is now benefiting low- and middle-income communities to a degree that has not been felt for many years. We have heard about companies, communities, and schools working together to help employees build skills--and of employers working creatively to structure jobs so that employees can do their jobs while coping with the demands of family and life beyond the workplace. We have heard that many people who in the past struggled to stay in the workforce are now working and adding new and better chapters to their lives. These stories show clearly in the job market data. Employment gains have been broad based across all racial and ethnic groups and all levels of educational attainment as well as among people with disabilities (figure 4). The strong labor market is also encouraging more people in their prime working years--ages 25 to 54--to rejoin or remain in the labor force, meaning that they either have a job or are actively looking for one. This is a welcome development. For several decades up until the mid-1990s, the share of prime-age people in the labor force rose, as an influx of women more than offset some decline in male participation. In the mid- 1990s, however, prime-age participation began to fall, and the drop-off became steeper in the Great Recession and the early years of the recovery (figure 5). Between 2007 and 2013, falling participation by both men and women contributed to a 2 percentage point overall decline. Our falling participation rate stands out among advanced economies. While the United States was roughly in the middle of the pack among 32 economies as of 1995, in 2018 we ranked near the bottom (figure 6). Fortunately, in the strong job market since 2014, prime-age participation has been staging a comeback. So far, we have made up more than half the loss in the Great Recession, which translates to almost 2 million more people in the labor force. But prime age participation could be still higher. Income growth of low- and middle-income households has shown a pattern similar to that of participation, with two decades of disappointing news turning to better news during the past few years. According to Census data, inflation-adjusted incomes for the lowest 20 percent of households declined slightly over the two decades through 2014, and income for the middle 20 percent rose only modestly. Since then, incomes for these groups have risen more rapidly, as wage growth has picked up--and picked up most for Recent years' data paint a hopeful picture of more people in their prime years in the workforce and wages rising for low- and middle-income workers. But as the people at our events emphasized, this is just a start: There is still plenty of room for building on these gains. The Fed can play a role in this effort by steadfastly pursuing our goals of maximum employment and price stability. The research literature suggests a variety of policies, beyond the scope of monetary policy, that could spur further progress by better preparing people to meet the challenges of technological innovation and global competition and by supporting and rewarding labor force participation. These policies could bring immense benefits both to the lives of workers and families directly affected and to the strength of the economy overall. Of course, the task of evaluating the costs and benefits of these policies falls to our elected representatives. Monetary policy is now well positioned to support a strong labor market and return inflation decisively to our symmetric 2 percent objective. If the outlook changes materially, policy will change as well. At this point in the long expansion, I see the glass as much more than half full. With the right policies, we can fill it further, building on the gains so far and spreading the benefits more broadly to all Americans.

r191126a_FOMC

united states

Federal Reserve Review of Monetary Policy Strategy, Tools, and Communications: Some Preliminary Views

brainard

It is a pleasure to be here with you. It is an honor to join the 45 outstanding economic researchers and practitioners who are past recipients of the William F. Butler Award. I want to express my deep appreciation to the New York Association for I will offer my preliminary views on the Federal Reserve's review of its monetary policy strategy, tools, and communications after first touching briefly on the economic outlook. These remarks represent my own views. The framework review is ongoing and will extend into 2020, and no conclusions have been reached at this time. There are good reasons to expect the economy to grow at a pace modestly above potential over the next year or so, supported by strong consumers and a healthy job market, despite persistent uncertainty about trade conflict and disappointing foreign growth. Recent data provide some reassurance that consumer spending continues to expand at a healthy pace despite some slowing in retail sales. Consumer sentiment remains solid, and the employment picture is positive. Housing seems to have turned a corner and is poised for growth following several weak quarters. Business investment remains downbeat, restrained by weak growth abroad and trade conflict. But there is little sign so far that the softness in trade, manufacturing, and business investment is affecting consumer spending, and the effect on services has been limited. Employment remains strong. The employment-to-population ratio for prime-age adults has moved up to its pre-recession peak, and the three-month moving average of the unemployment rate is near a 50-year low. Monthly job gains remain above the pace needed to absorb new entrants into the labor force despite some slowing since last year. And initial claims for unemployment insurance--a useful real-time indicator historically--remain very low despite some modest increases. Data on inflation have come in about as I expected, on balance, in recent months. Inflation remains below the Federal Reserve's 2 percent symmetric objective, which has been true for most of the past seven years. The price index for core personal consumption expenditures (PCE), which excludes food and energy prices and is a better indicator of future inflation than overall PCE prices, increased 1.7 percent over the 12 months through September. Foreign growth remains subdued. While there are signs that the decline in euro- area manufacturing is stabilizing, the latest indicators on economic activity in China remain sluggish, and the news in Japan and in many emerging markets has been disappointing. Overall, it appears third-quarter foreign growth was weak, and the latest indicators point to little improvement in the fourth quarter. More broadly, the balance of risks remains to the downside, although there has been some improvement in risk sentiment in recent weeks. The risk of a disorderly Brexit in the near future has declined significantly, and there is some hope that a U.S.- China trade truce could avert additional tariffs. While risks remain, financial market indicators suggest market participants see a diminution in such risks, and probabilities of recessions from models using market data have declined. The baseline is for continued moderate expansion, a strong labor market, and inflation moving gradually to our symmetric 2 percent objective. The Federal Open Market Committee (FOMC) has taken significant action to provide insurance against the risks associated with trade conflict and weak foreign growth against a backdrop of muted inflation. Since July, the Committee has lowered the target range for the federal funds some time for the full effect of this accommodation to work its way through economic activity, the labor market, and inflation. I will be watching the data carefully for signs of a material change to the outlook that could prompt me to reassess the appropriate path of policy. The Federal Reserve is conducting a review of our monetary policy strategy, tools, and communications to make sure we are well positioned to advance our statutory goals of maximum employment and price stability. Three key features of today's new normal call for a reassessment of our monetary policy strategy: the neutral rate is very low here and abroad, trend inflation is running below target, and the sensitivity of price inflation to resource utilization is very low. First, trend inflation is below target. Underlying trend inflation appears to be running a few tenths below the Committee's symmetric 2 percent objective, according to various statistical filters. This raises the risk that households and businesses could come to expect inflation to run persistently below our target and change their behavior in a way that reinforces that expectation. Indeed, with inflation having fallen short of 2 percent for most of the past seven years, inflation expectations may have declined, as suggested by some survey-based measures of long-run inflation expectations and by market-based measures of inflation compensation. Second, the sensitivity of price inflation to resource utilization is very low. This is what economists mean when they say that the Phillips curve is flat. A flat Phillips curve has the important advantage of allowing employment to continue expanding for longer without generating inflationary pressures, thereby providing greater opportunities to more people. But it also makes it harder to achieve our 2 percent inflation objective on a sustained basis when inflation expectations have drifted below 2 percent. Third, the long-run neutral rate of interest is very low, which means that we are likely to see more frequent and prolonged episodes when the federal funds rate is stuck at The neutral rate is the level of the federal funds rate that would keep the economy at full employment and 2 percent inflation if no tailwinds or headwinds were buffeting the economy. A variety of forces have likely contributed to a decline in the neutral rate, including demographic trends in many large economies, some slowing in the rate of productivity growth, and increases in the demand for safe it is striking that the Committee's median projection of the longer-run federal funds rate has moved down from 4-1/4 percent to 2-1/2 percent over the past seven years. similar decline can be seen among private forecasts. This decline means the conventional policy buffer is likely to be only about half of the 4-1/2 to 5 percentage points by which the FOMC has typically cut the federal funds rate to counter recessionary pressures over the past five decades. This large loss of policy space will tend to increase the frequency or length of periods when the policy rate is pinned at the ELB, unemployment is elevated, and inflation is below target. In turn, the experience of frequent or extended periods of low inflation at the ELB risks eroding inflation expectations and further compressing the conventional policy space. The risk is a downward spiral where conventional policy space gets compressed even further, the ELB binds even more frequently, and it becomes increasingly difficult to move inflation expectations and inflation back up to target. While consumers and businesses might see very low inflation as having benefits at the individual level, at the aggregate level, inflation that is too low can make it very challenging for monetary policy to cut the short-term nominal interest rate sufficiently to cushion the economy effectively. The experience of Japan and of the euro area more recently suggests that this risk is real. Indeed, the fact that Japan and the euro area are struggling with this challenging triad further complicates our task, because there are important potential spillovers from monetary policy in other major economies to our own economy through exchange rate and yield curve channels. In light of the likelihood of more frequent episodes at the ELB, our monetary policy review should advance two goals. First, monetary policy should achieve average inflation outcomes of 2 percent over time to re-anchor inflation expectations at our target. Second, we need to expand policy space to buffer the economy from adverse developments at the ELB. The apparent slippage in trend inflation below our target calls for some adjustments to our monetary policy strategy and communications. In this context and as part of our review, my colleagues and I have been discussing how to better anchor inflation expectations firmly at our objective. In particular, it may be helpful to specify that policy aims to achieve inflation outcomes that average 2 percent over time or over the cycle. Given the persistent shortfall of inflation from its target over recent years, this would imply supporting inflation a bit above 2 percent for some time to compensate for the period of underperformance. One class of strategies that has been proposed to address this issue are formal "makeup" rules that seek to compensate for past inflation deviations from target. For instance, under price-level targeting, policy seeks to stabilize the price level around a constant growth path that is consistent with the inflation objective. Under average inflation targeting, policy seeks to return the average of inflation to the target over some specified period. To be successful, formal makeup strategies require that financial market participants, households, and businesses understand in advance and believe, to some degree, that policy will compensate for past misses. I suspect policymakers would find communications to be quite challenging with rigid forms of makeup strategies, because of what have been called time-inconsistency problems. For example, if inflation has been running well below--or above--target for a sustained period, when the time arrives to maintain inflation commensurately above--or below--2 percent for the same amount of time, economic conditions will typically be inconsistent with implementing the promised action. Analysis also suggests it could take many years with a formal average inflation targeting framework to return inflation to target following an ELB episode, although this depends on difficult-to-assess modeling assumptions and the particulars of the strategy. Thus, while formal average inflation targeting rules have some attractive properties in theory, they could be challenging to implement in practice. I prefer a more flexible approach that would anchor inflation expectations at 2 percent by achieving inflation outcomes that average 2 percent over time or over the cycle. For instance, following five years when the public has observed inflation outcomes in the range of 1- 1/2 to 2 percent, to avoid a decline in expectations, the Committee would target inflation outcomes in a range of, say, 2 to 2-1/2 percent for the subsequent five years to achieve inflation outcomes of 2 percent on average overall. Flexible inflation averaging could bring some of the benefits of a formal average inflation targeting rule, but it would be simpler to communicate. By committing to achieve inflation outcomes that average 2 percent over time, the Committee would make clear in advance that it would accommodate rather than offset modest upward pressures to inflation in what could be described as a process of opportunistic reflation. Policy at the ELB Second, the Committee is examining what monetary policy tools are likely to be effective in providing accommodation when the federal funds rate is at the ELB. In my view, the review should make clear that the Committee will actively employ its full toolkit so that the ELB is not an impediment to providing accommodation in the face of significant economic disruptions. The importance and challenge of providing accommodation when the policy rate reaches the ELB should not be understated. In my own experience on the international response to the financial crisis, I was struck that the ELB proved to be a severe impediment to the provision of policy accommodation initially. Once conventional policy reached the ELB, the long delays necessitated for policymakers in nearly every jurisdiction to develop consensus and take action on unconventional policy sapped confidence, tightened financial conditions, and weakened recovery. Economic conditions in the euro area and elsewhere suffered for longer than necessary in part because of the lengthy process of building agreement to act decisively with a broader set of tools. Despite delays and uncertainties, the balance of evidence suggests forward guidance and balance sheet policies were effective in easing financial conditions and providing accommodation following the global financial crisis. Accordingly, these tools should remain part of the Committee's toolkit. However, the quantitative asset purchase policies that were used following the crisis proved to be lumpy both to initiate at the ELB and to calibrate over the course of the recovery . This lumpiness tends to create discontinuities in the provision of accommodation that can be costly. To the extent that the public is uncertain about the conditions that might trigger asset purchases and how long the purchases would be sustained, it undercuts the efficacy of the policy. Similarly, significant frictions associated with the normalization process can arise as the end of the asset purchase program approaches. For these reasons, I have been interested in exploring approaches that expand the space for targeting interest rates in a more continuous fashion as an extension of our conventional policy space and in a way that reinforces forward guidance on the policy rate. In particular, there may be advantages to an approach that caps interest rates on Treasury securities at the short-to-medium range of the maturity spectrum--yield curve caps--in tandem with forward guidance that conditions liftoff from the ELB on employment and inflation outcomes. To be specific, once the policy rate declines to the ELB, this approach would smoothly move to capping interest rates on the short-to-medium segment of the yield curve. The yield curve ceilings would transmit additional accommodation through the longer rates that are relevant for households and businesses in a manner that is more continuous than quantitative asset purchases. Moreover, if the horizon on the interest rate caps is set so as to reinforce forward guidance on the policy rate, doing so would augment the credibility of the yield curve caps and thereby diminish concerns about an open-ended balance sheet commitment. In addition, once the targeted outcome is achieved, and the caps expire, any securities that were acquired under the program would roll off organically, unwinding the policy smoothly and predictably. This is important, as it could potentially avoid some of the tantrum dynamics that have led to premature steepening at the long end of the yield curve in several jurisdictions. Forward guidance on the policy rate will also be important in providing accommodation at the ELB. As we saw in the United States at the end of 2015 and again toward the second half of 2016, there tends to be strong pressure to "normalize" or lift off from the ELB preemptively based on historical relationships between inflation and employment. A better alternative would have been to delay liftoff until we had achieved our targets. Indeed, recent research suggests that forward guidance that commits to delay the liftoff from the ELB until full employment and 2 percent inflation have been achieved on a sustained basis--say over the course of a year--could improve performance on our dual-mandate goals. To reinforce this commitment, the forward guidance on the policy rate could be implemented in tandem with yield curve caps. For example, as the federal funds rate approaches the ELB, the Committee could commit to refrain from lifting off the ELB until full employment and 2 percent inflation are sustained for a year. Based on its assessment of how long this is likely take, the Committee would then commit to capping rates out the yield curve for a period consistent with the expected horizon of the outcome- based forward guidance. If the outlook shifts materially, the Committee could reassess how long it will take to get inflation back to 2 percent and adjust policy accordingly. One benefit of this approach is that the forward guidance and the yield curve ceilings would reinforce each other. The combination of a commitment to condition liftoff on the sustained achievement of our employment and inflation objectives with yield curve caps targeted at the same horizon has the potential to work well in many circumstances. For very severe recessions, such as the financial crisis, such an approach could be augmented with purchases of 10-year Treasury securities to provide further accommodation at the long end of the yield curve. Presumably, the requisite scale of such purchases--when combined with medium-term yield curve ceilings and forward guidance on the policy rate--would be relatively smaller than if the longer-term asset purchases were used alone. Before closing, it is important to recall another important lesson of the financial crisis: The stability of the financial system is important to the achievement of the statutory goals of full employment and 2 percent inflation. In that regard, the changes in the macroeconomic environment that underlie our monetary policy review may have some implications for financial stability. Historically, when the Phillips curve was steeper, inflation tended to rise as the economy heated up, which prompted the Federal Reserve to raise interest rates. In turn, the interest rate increases would have the effect of tightening financial conditions more broadly. With a flat Phillips curve, inflation does not rise as much as resource utilization tightens, and interest rates are less likely to rise to restrictive levels. The resulting lower-for-longer interest rates, along with sustained high rates of resource utilization, are conducive to increasing risk appetite, which could prompt reach-for-yield behavior and incentives to take on additional debt, leading to financial imbalances as an expansion extends. To the extent that the combination of a low neutral rate, a flat Phillips curve, and low underlying inflation may lead financial stability risks to become more tightly linked to the business cycle, it would be preferable to use tools other than tightening monetary policy to temper the financial cycle. In particular, active use of macroprudential tools such as the countercyclical buffer is vital to enable monetary policy to stay focused on achieving maximum employment and average inflation of 2 percent on a sustained basis. The Federal Reserve's commitment to adapt our monetary policy strategy to changing circumstances has enabled us to support the U.S. economy throughout the expansion, which is now in its 11th year. In light of the decline in the neutral rate, low trend inflation, and low sensitivity of inflation to slack as well as the consequent greater frequency of the policy rate being at the effective lower bound, this is an important time to review our monetary policy strategy, tools, and communications in order to improve the achievement of our statutory goals. I have offered some preliminary thoughts on how we could bolster inflation expectations by achieving inflation outcomes of 2 percent on average over time and, when policy is constrained by the ELB, how we could combine forward guidance on the policy rate with caps on the short-to-medium segment of the yield curve to buffer the economy against adverse developments.

r191218a_FOMC

united states

Update on Digital Currencies, Stablecoins, and the Challenges Ahead

brainard

For release on delivery Remarks by on the sponsored by the European Central Bank I am honored to be here today to celebrate Benoit Coeure's tenure at the European Central Bank (ECB). I have been working with Benoit now for a decade--starting at our respective Treasuries where we both were drafted as financial firefighters, migrating to our respective central banks to help with stabilization, recovery, and normalization, and most recently preparing for the challenges that lie ahead. Over the course of that decade, I have developed deep admiration for Benoit's keen insights and outstanding judgment. Equally important, Benoit always has a plan. Generally, it is the right plan addressed to the right problem, and he executes it with exceptional efficacy and strong support. That is a rare and invaluable combination in public service. Indeed, Benoit's tenure at the ECB coincided with an incredible turnaround in unemployment and output growth. Both the euro area and the global economy have benefited greatly from Benoit Coeure's outstanding public service. Moreover, Benoit's research interests are forward-looking and extend well beyond the macro economy. When Benoit was appointed chair of the Committee on issues, he doubled its output, resulting in 75 reports. He turned its focus to distributed ledger, stablecoins, and central bank digital currencies long before many other central bankers realized these issues would be transforming their worlds. Indeed, the number of Google searches for "central bank digital currencies" increased sharply over the course of Benoit's tenure as chair of the CPMI. I was asked to provide some brief thoughts about digital developments in the world of monetary policy and central banking. At the start of Benoit's ECB term, bitcoin's market capitalization was small, and only a handful of cryptocurrencies existed. In the eight years since then, bitcoin's market capitalization has grown rapidly and now exceeds 100 billion euros, and thousands of cryptocurrencies have been created. The potential of "global stablecoins" to scale rapidly is evident from the increasingly fast rates of technology adoption and the growth of large networks. Adoption rates for new technologies have accelerated over time. In 1921, 35 percent of U.S. households had telephone service, and it took 40 more years for telephone lines to reach 80 percent of homes. In contrast, the internet achieved the same level of adoption in only 13 years. More recently, smartphones and social media have achieved the same level of U.S. household adoption in less than a decade. Rapid adoption is also evident in the payments landscape, where network externalities figure prominently. Between the first quarter of 2014 and the first quarter of 2019, transactions through Venmo grew over 66 times to $21 billion (18.5 billion euros). Systems in other countries have also scaled rapidly. In China, mobile payments grew over 35 times during the same period to $8.2 trillion (7.2 trillion euros). Payments Interface (UPI) has grown even faster: between the fourth quarter of 2016 and the first quarter of 2019, the transaction value grew nearly 400 times to $49.7 billion Digital currency payments projects from big technology firms that have network advantages have the potential to scale even more rapidly. Because the utility of any medium of exchange increases with the size of the network using it, the power of a stablecoin payment system depends on the breadth of its adoption. With nearly one-third of the global population as active users on Facebook, the Libra stablecoin project stands out for the speed with which its network could reach global scale in payments. Stablecoin networks at global scale are leading us to revisit questions over what form money can take, who or what can issue it, and how payments can be recorded and settled. While central bank money and commercial bank money are the foundations of the modern financial system, nonbank private "money" or assets also facilitate transactions among a network of users. In some cases, such nonbank private assets may have value only within the network, while in other cases, the issuer may promise convertibility to a sovereign currency, such that this becomes a liability of the issuing entity. Stablecoins aspire to achieve the functions of traditional money without relying on confidence in an issuer--such as a central bank--to stand behind the "money." For some potential stablecoins, a close assessment suggests users may have no rights with respect to the underlying assets or any issuer. We have already seen the growth of massive payments networks on existing digital platforms, such as Alibaba and WeChat. So far, these networks operate within a jurisdiction based on the sovereign currency as the unit of account, and balances are transferable in and out of bank or credit card accounts. We have also seen the issuance of stablecoins on a smaller scale, such as Gemini or Paxos. What would set Facebook's Libra apart, if it were to proceed, is the combination of an active-user network representing more than a third of the global population with the issuance of a private digital currency opaquely tied to a basket of sovereign currencies. Libra, like any stablecoin project with global scale and scope, must address a core set of legal and regulatory challenges. A significant concern regarding Facebook's Libra project is the potential for a payment system to be adopted globally in a short time period and to establish itself as a potentially new unit of account. Unlike social media platforms or ridesharing applications, payment systems cannot be designed as they develop, due to the nexus with consumers' financial security. This is why in many jurisdictions, including the European Union, there is a regime to oversee retail payment systems. Without requisite safeguards, stablecoin networks at global scale may put consumers at risk. Cryptocurrencies already pose a number of risks to the financial system, and these could be magnified by a widely accepted stablecoin for general use. Estimated losses from fraud and thefts associated with cryptocurrencies are rising at a billion euros) in 2019, based on one industry estimate. The hacking of exchanges represents a significant source of the theft, followed by the targeting of individual users through scams using QR codes, malware, and ransomware. These estimates reflect only known fraud and thefts; it is likely that not all losses are reported and some amount of cryptocurrencies is lost or forgotten. In most cases, customers bear the losses. By contrast, over many decades, consumers in the United States and euro area have come to expect strong safeguards on their bank accounts and the associated payments. Statutory and regulatory protections on bank accounts in the United States mean that consumers can reasonably expect their deposits to be insured up to a limit; many fraudulent transactions to be the liability of the bank; transfers to be available within specified periods; and clear, standardized disclosures about account fees and interest payments. Not only is it not clear whether comparable protections will be in place with Libra, or what recourse consumers will have, but it is not even clear how much price risk consumers will face since they do not appear to have rights to the stablecoin's underlying assets. customer (KYC) requirements are significant concerns. In one industry report, researchers found that roughly two-thirds of the 120 most popular cryptocurrency exchanges have weak AML, CTF, and KYC practices. Only a third of the most popular exchanges require ID verification and proof of address to make a deposit or withdrawal. This is troubling, since a number of studies conclude that cryptocurrencies support a significant amount of illicit activity. One study estimated that more than a quarter of bitcoin users and roughly half of bitcoin transactions, for example, are associated with illegal activity. There are also questions related to the implications of a widely used stablecoin for financial stability. If not managed effectively, liquidity, credit, market, or operational risks, alone or in combination, could trigger a loss of confidence and run-like behavior. This could be exacerbated by the lack of clarity about the management of reserves and the rights and responsibilities of various market participants in the network. The risks and spillovers could be amplified by potential ambiguity surrounding the ability of official authorities to provide oversight, backstop liquidity, and collaborate across borders. The precise risks would depend on the design of the cryptocurrency as well as the scale of adoption. The effect of a stablecoin on financial stability, for example, would be driven in part by how the stablecoin is tied to an asset (if at all) and the features of the asset itself. A stablecoin tied one-to-one to an individual currency would have different implications than one tied to a basket of currencies. A stablecoin that is built on a permissioned network would have different risk implications than a permissionless network, which may be more vulnerable to money laundering and terrorist financing risks. A stablecoin used solely by commercial banks would have a different risk profile than one for consumer use. Similarly, there are potential implications for monetary policy. For smaller economies, there may be material effects on monetary policy from private sector digital currencies as well as foreign central bank digital currencies. In many respects, these effects may be similar to dollarization aside from the fast pace and wide scope of adoption. The emergence of cryptocurrencies--and particularly stablecoins--has raised important questions for central banks and other authorities, including on the appropriate regulatory framework. In the United States, the regulatory framework for cryptocurrencies is not straightforward. Our current framework is based largely on whether a cryptocurrency is deemed to be a security or has associated derivative financial products and whether the participating institutions have a supervisory agency overseeing their activities. Unlike many other jurisdictions, regulators do not have plenary authority over retail payments in the United States. Moreover, the regulatory challenges are likely to be inherently cross-border in nature. Because stablecoins and other cryptocurrencies are unlikely to be bound by physical borders, regulatory actions in one jurisdiction are unlikely to be fully effective without coordinated action elsewhere. The prospect of global stablecoin payment systems has intensified the interest in central bank digital currencies. Central bank digital currency typically refers to a new type of central bank liability that could be held directly by households and businesses without the involvement of a commercial bank intermediary. Proponents argue that central bank digital currencies would be a safer alternative to privately issued stablecoins because they would be a direct liability of the central bank. A more relevant question may be whether some intermediate solutions may be able to offer the safety and benefits of real-time digital payments based on sovereign currencies without necessitating radical transformation of the financial system. In the United States, there are important advantages associated with current arrangements. Physical cash in circulation for the U.S. dollar continues to rise due to robust demand, and the dollar plays an important role as a reserve currency globally. Moreover, we have a robust and diverse banking system that provides important services along with a widely available and expanding variety of digital payment options that build on the existing institutional framework with its important safeguards. Circumstances where the central bank issues digital currency directly to consumer accounts for general-purpose use would raise profound legal, policy, and operational questions. That said, it is important to study whether we can do more . Some jurisdictions are likely to move in this direction faster than others, based on the particular attributes of their payments and currency systems. At the Federal Reserve, we look forward to collaborating with other jurisdictions as we continue to analyze the potential benefits and costs of central bank digital currencies. Most immediately, the Federal Reserve is actively working to introduce a faster payment system for the United States, to improve the speed and lower the cost of consumer payments. In many countries, consumers are already able to make real-time payments at low cost. This summer, the Federal Reserve announced the first new payment service in more than 40 years--the FedNow Service--to provide a platform for consumers and businesses to send and receive payments immediately and securely 24 hours a day, 365 days a year. As the public and private sectors work to reduce payment frictions, one of the most important use cases is for cross-border payments, such as remittances. Current cross-border payments solutions are often slow, cumbersome, and opaque. Authorities in many jurisdictions, including the United States, recognize the importance of cooperating across borders with each other and the private sector to address these cross-border frictions. Technology will continue driving rapid change in the way we make payments and the concept of "money." As central bankers, we recognize the power of technology and innovation to transform the financial system and reduce frictions and delays, and the importance of preserving consumer protections, data privacy and security, financial stability, and monetary policy transmission and guarding against illicit activity and cyber risks. Given the stakes, any global payments network should be expected to meet a high threshold of legal and regulatory safeguards before launching operations. The work ahead is not easy--the policy issues are complex, the coordination challenges are significant, and there are likely to be few simple fixes. Because the road ahead is complicated and challenging, I am especially pleased that Benoit will continue to help us navigate these issues as the new Head of the Bank for International Settlements'

r200108a_FOMC

united states

Strengthening the Community Reinvestment Act by Staying True to Its Core Purpose

brainard

Good morning. I am pleased to be here at the Urban Institute to discuss how to strengthen the Community Reinvestment Act (CRA), which is a key priority for the Federal Reserve. The CRA plays a vital role in bringing banks together with community members, small businesses, local officials, and community groups to make investments in their community's future. That is why we are committed to getting CRA reform done right. Any successful reform must be grounded in the origins of the CRA and its ongoing importance to low- and moderate-income (LMI) neighborhoods. The CRA was one of several landmark pieces of legislation enacted in the wake of the civil rights movement intended to address inequities in the credit markets. By passing the CRA, Congress aimed to reverse the disinvestment associated with years of government policies and market actions that deprived lower-income areas of credit by redlining--using red-inked lines to separate neighborhoods deemed too risky. By conferring an affirmative and continuing obligation on banks to help meet the credit needs in all of the neighborhoods they serve, the CRA has not only prompted banks to be more active lenders in LMI areas, but also important participants in multisector efforts to revitalize communities across the country. Pursuant to guidance from the Board of Governors, e ach of our Federal Reserve Banks houses a group of dedicated community development professionals and CRA examiners to help banks meet their CRA obligations. We are proud of our work in familiarizing banks with the CRA's provisions, introducing banks to potential partners in their communities, and convening conferences to disseminate research and best practices. The CRA plays a vital role in the ecosystem supporting economic opportunity in LMI communities in both rural and urban areas. Rather than direct funds to specific projects, the CRA encourages banks to engage on the priorities identified by local leaders and more broadly serve credit needs of small businesses and residents of these communities. By being inclusive in their lending and investing, banks help their local communities to thrive, which in turn benefits their core business. The recognition of this mutually beneficial relationship between banks and their local communities is one of the core strengths of the CRA and the reason our effort to revise the CRA regulations must focus on local needs and stakeholder input. For several years, the federal banking regulators have been asking stakeholders for input on strengthening the CRA regulations to help banks better meet the credit needs of the local LMI communities they serve and more closely align with changes in the ways financial products and services are delivered. We also have heard calls from banking and community organizations for the use of metrics to provide greater upfront clarity about evaluation standards. We have heard that branches remain as important as ever to their local communities, even as the growth of mobile and online services has extended the geographic area that banks are serving. The one message we have heard most consistently is that banks and community organizations alike value the activities they undertake under the auspices of the CRA and have invested considerable time and effort in the associated processes and reporting. For that reason, stakeholders have asked the regulators to take care as we contemplate changes to the CRA. If the past is any guide, major updates to the CRA regulations happen once every few decades. So it is much more important to get reform right than to do it quickly. If we only have one opportunity for a few decades, I want to make sure CRA reform is based on the best analysis and ideas and the broadest input available. It is critical to analyze carefully the likely effects of any proposed changes on credit access and community development in LMI communities, as well as any additional reporting and procedural burdens for banks. Last year, we set out several principles to guide our work on CRA reform. Revisions to the CRA regulations should reflect the credit needs of local communities and work consistently through the business cycle. They should be tailored to banks of different sizes and business strategies. They should provide greater clarity in advance about how activities will be evaluated. They should encourage banks to seek opportunities in distressed and underserved areas. And they should recognize that the CRA is one of several related laws to promote an inclusive financial sector. Guided by stakeholder input, we evaluated how to strengthen the regulation by using metrics to provide greater certainty about how activities will be evaluated, while remaining faithful to the core purpose of the CRA to make credit and retail banking services available in local LMI communities. Proposed changes to the CRA regulation must be grounded in analysis and data to avoid unintended consequences. Because consistent data on CRA-eligible activity were not readily available, our research staff set about creating a database based on over 6,000 written public CRA evaluations from a sample of some 3,700 banks of varying asset sizes, business models, geographic areas, and bank regulators. The database includes the location, number, and amount of CRA-eligible loans and investments and the ratings associated with each bank's performance. The data go back to 2005 in order to assess how CRA performance and the associated ratings vary across the economic cycle. So how can we use metrics to provide greater clarity about evaluations? I will sketch out a proposed approach that uses a set of tailored thresholds that are calibrated for local conditions. It starts by creating two tests: a retail test and community development test (figure 1). Broadly speaking, all retail banks would be evaluated under a retail test, which would assess a bank's record of providing retail loans and retail banking services in its assessment areas. Large banks, as well as wholesale and limited-purpose banks, would also be evaluated under a separate community development test that would evaluate a bank's record of providing community development loans, qualified investments, and services. Using bank and other publicly available data, we would be able to provide a bank with a dashboard indicating how its retail lending activity compares to thresholds for presumptive satisfactory performance that reflect the activity of other lenders and credit demand in the local area. Separate metrics reflecting a bank's assessment area can be provided related to the evaluation of its community development performance. Dividing evaluations into separate retail and community development tests is important. First, evaluating all retail banks under a stand-alone retail test is important to stay true to the CRA's core focus on providing credit in underserved communities in an assessment area. In contrast, an approach that combines all activity together runs the risk of encouraging some institutions to meet expectations primarily through a few large community development loans or investments rather than meeting local needs. Second, having separate tests ensures that expectations are tailored for banks of different sizes and business models. Only larger banks would be expected to meet the community development test along with the full retail test. Similar to today, smaller banks would have the option of having their retail banking services and community development activities evaluated in order to achieve an "Outstanding" rating, but it would not be required. Moreover, small banks below some threshold might have the option to be evaluated under the existing methodology. Third, separate retail and community development tests provide greater scope to calibrate the evaluation metrics to the opportunities available in the market, which can differ for retail lending and community development financing. After analyzing ways to use metrics across the board, we concluded that the value of retail services and community development services to a local community do not lend themselves easily to a monetary value metric comparable to the monetary value of loans and investments. The value of these services may vary greatly from community to community. It is difficult to monetize this value in a consistent way relative to the value of lending and investment, thus introducing the risk of skewing incentives inadvertently. For example, the services and leadership provided by a small bank located in a rural community may be vital to the success of that community, even if the dollar value of those services is small compared with a branch in a large city. Because of this concern, we are inclined to propose a set of qualitative standards to evaluate retail services within the retail test, and a separate set of qualitative standards to assess community development services within the community development test. The core of the retail lending test would be to use widely available data to assess two clear objectives: how well a bank is serving LMI borrowers, small businesses, and small farms in its assessment area, and how well a bank is serving LMI neighborhoods in its assessment area. The metrics used to evaluate these two questions would rely on loan counts rather than dollar value in order to avoid inadvertent biases in favor of fewer, higher-dollar value loans. metrics would be evaluated separately for each major product line in a bank's assessment area, which is important to tailor the use of metrics to a bank's business model. The proposed approach measures a bank's performance in serving the needs of both low- and moderate-income borrowers (and small businesses and small farms) and LMI places in the community. For mortgage loans, an LMI borrower distribution metric would calculate the percentage of a bank's number of loans made to LMI borrowers relative to its overall mortgage originations, and assess this percentage against an assessment area threshold determined by local demographics and the aggregate lending of other in-market competitors. A separate LMI neighborhood distribution metric would evaluate the percentage of a bank's number of loans in LMI tracts to its overall loan count and assess this against a threshold determined by local demographics and the aggregate lending of other in-market competitors. A bank that meets or exceeds both the LMI borrower and LMI neighborhood thresholds for each of its major product lines would be presumed to have a satisfactory-or-better level of retail lending performance in that assessment area. Using a customized dashboard, each bank could track its own activity against the threshold on an ongoing basis reflecting recent data, eliminating the lengthy uncertainty associated with the current evaluation methodology, which many banks have highlighted as the most important area for reform (figure 2). Importantly, the CRA database we have constructed confirms that the proposed retail lending metrics correlate well with past ratings of bank performance (figure 3). The specific thresholds that would establish a presumption of satisfactory performance could be informed by current evaluation procedures but need not be set at the same level, and public input will be important. The retail lending metrics would be tailored to the needs of the local community. This tailoring is not possible with a uniform benchmark that applies to all banks and all communities. The large differences between assessment areas illustrate the importance of tailoring thresholds. For example, in Morgan County, Ohio, LMI families are 49 percent of the population, compared empirically sound and avoids imposing arbitrary CRA performance measures on a bank and its community. In order to ensure it meets standards of safety and soundness, CRA lending must be evaluated in the context of the characteristics of the bank and its community. Additionally, the proposed retail lending metric would automatically adjust to changes in the business cycle. As many commenters noted in response to the ANPR, a uniform ratio that does not adjust with the local business cycle could provide too little incentive to make good loans during an expansion and incentives to make unsound loans during a downturn, which could be inconsistent with the safe and sound practices mandated by the CRA statute. Industry commenters also expressed concern that discretionary adjustments to the uniform metric are likely to lag behind the economic cycle and undermine the certainty a metric purports to provide. By contrast, the proposed retail lending metrics are calibrated to contemporaneous changes in market conditions, thereby reducing the risk of providing unsound incentives (figure 5). Finally, the proposed approach would continue to recognize local context in assessing a bank's CRA performance. If a bank receives the presumption of satisfactory by meeting or exceeding the thresholds, an examiner could consider performance context information, including the bank's responsiveness to the community's needs, in determining whether the bank's performance is outstanding at the assessment area level. Likewise, if a bank does not meet or exceed the thresholds, it would undergo a full examination, as it would currently, and could receive any level of rating, including possibly Outstanding, based on the full range of performance context considerations and clear qualitative criteria. The metrics would be designed to provide greater certainty, while avoiding rigidity. Retail services can be extremely important to LMI communities, although they do not easily lend themselves to consistent, comparable metrics. It makes sense to use qualitative criteria related to the responsiveness of a bank's products and services and its delivery systems, which stakeholders highlighted as being particularly important in LMI areas. In terms of delivery systems, we recognize the unique and important role that branches play in providing essential financial services to customers, particularly in underserved areas. Banks would be evaluated on their branch and ATM locations and how well they serve customers using online and mobile access channels. Providing a meaningful evaluation of all customer access channels is essential to ensuring that the CRA remains relevant as more banks adopt digital technology. Recognizing that branches are important community assets, the proposed retail service test would compare a bank's distribution of branches, including any openings or closures, to broader patterns of activity in the region. A recent report on branch access in rural areas found that just over 40 percent of rural counties lost bank branches between 2012 and 2017, with 39 rural communities being "deeply affected" by the loss of more than half of their bank branches. In addition to the challenges associated with higher cost and less convenient access to banking services, community leaders described how branch closures diminished their access to important leadership from branch personnel that was important to their community's success. Next, let's turn to the community development test for large retail banks, as well as wholesale and limited-purpose banks. The establishment of a separate community development test reflects stakeholder feedback emphasizing that the value of community development finance is distinct and not directly comparable to retail activity. A separate test also allows for a broader area to be taken into account for purposes of community development relative to retail lending. Our analysis suggests there are a set of metrics that can be compared to appropriately tailored benchmarks to provide greater certainty regarding community development lending and investment. The proposed metric would aggregate loan and investment dollars that are originated or purchased during the evaluation period with the book value of all other community development loans and investments that are held on the bank's balance sheet (figure 6). Reflecting input from banks and community organizations that patient, committed funding has the greatest effect, this approach avoids the incentives under current practice to provide financing in the form of short-term renewable loans in order to receive CRA credit. The proposed test would compare the combined measure of a bank's community development financing relative to deposits in its local assessment area to a national average, set differently for rural and urban areas, and a local average in the bank's assessment area. The national comparator would be set differently for metropolitan statistical areas and rural areas to reflect the comparatively lower average levels of financial infrastructure in rural communities (figure 7). The use of a national rural/metro comparator in addition to an assessment area comparator is intended to avoid skewing incentives toward financially dense areas that are already hotly competitive and to reflect the value of community development in underserved areas. The use of these comparators would help provide consistency across evaluations and clarity regarding community development expectations for both banks and communities. It is also important to recognize that community development financing is often provided in areas that do not neatly fit within a bank's assessment area. Community development financing opportunities are not always easy for banks to identify and often depend on working with local nonprofits or governments to help identify projects and put together the complex financing required to bring them to fruition. Stakeholder feedback emphasized banks' unique advantages in evaluating community development projects in the states and territories where they operate and providing the smaller-scale, more complex, and often more impactful, investments overlooked by institutional investors. For this reason, and to encourage more activity in underserved areas, it makes sense to give consideration to all of a bank's community development activities in a state or territory where it has an assessment area. Banks want to know in advance that they will get the benefit of CRA consideration in order to invest the time and effort necessary to evaluate and structure community development loans and investments. For that reason , we are sympathetic to requests for a timely process by which banks can seek conditional examiner review of particular activities before making financial commitments, particularly for activities that revitalize and stabilize targeted areas. Our analysis suggests a community development finance metric along the lines outlined here will help to ensure greater predictability and consistency in achieving a Satisfactory rating. However, we also want to make sure that these metrics are supplemented with clear, qualitative standards to ensure that small-scale, high-impact community development activities are rewarded, along with a bank's responsiveness to local needs and priorities. It is also important to evaluate services qualitatively at the assessment-area level as part of the overall community development test. Volunteer and other services provided by banks can provide meaningful support to communities whose value is unlikely to be adequately captured on a comparable basis using aggregative dollar value metrics. In areas with a low density of financial services, a bank officer on the board of local community organizations could provide considerable value to the community that is not accurately reflected by monetizing volunteer hours based on their compensation. This approach to assessing CRA performance would tailor performance metrics to bank size and business strategy, as well as to local and cyclical conditions. The approach would tailor to banks' business models by establishing separate thresholds for substantially different lending products, such as mortgage loans and small business, small farm, and consumer loans, as well as separate retail lending and community development financing metrics. The proposed metrics would also be tailored for different bank sizes. This is facilitated in part by allowing very small banks to retain the current evaluation procedures and in part by creating a separate community development test that would apply only to large banks. Tailoring is also an important consideration in data collection and reporting requirements. The proposed retail lending approach is designed so that it can be implemented in significant part with data that are readily available. In designing the community development approach, we have been mindful of burden as we consider any additional data that might be required to implement certain metrics. Finally, as previously noted, the metrics are tailored for local conditions and cyclical considerations. The proposed threshold for each type of activity is calibrated to local conditions as they evolve over the cycle, and the community development finance metric uses an additional time-varying national rural or urban comparator. Staff across the Federal Reserve System have devoted substantial time and effort to engaging with the other banking agencies in the CRA reform process. The analysis, data, and proposals I have discussed today have all been shared in greater detail with our counterparts at the other banking agencies in an effort to forge a common approach. We were hopeful our proposed approach could be incorporated into the proposed rulemaking that was released last month in order to seek public comment on a range of options. Based on the best available data, we concluded that CRA metrics tailored to local conditions and the different sizes and business models of banks would best serve the credit needs of the communities that are at the heart of the statute. This tailored approach using targeted metrics also yielded more consistent and predictable overall ratings than any comprehensive uniform metric. Our analysis did not find a consistent relationship between CRA ratings and a uniform comprehensive ratio that adds together all of a bank's CRA-eligible activities in an area. Moreover, we want to be attentive to possible unintended consequences: Because a uniform comprehensive ratio would not reflect local conditions, which can vary greatly between communities and over the cycle, a bank could exert the same amount of effort in different areas or different points in the economic cycle with very different outcomes. We continue to believe that a strong common set of interagency standards is the best outcome. By sharing our work publicly, we hope to solicit public input on a broader set of options for reform and find a way toward interagency agreement on the best approach. The process of sharing the data and analysis informing regulatory proposals and seeking public feedback on them is critical to the regulatory process. Given that reforms to the CRA regulations are likely to set expectations for a few decades, it is more important to get the reforms done right than to do them quickly. That requires giving external stakeholders sufficient time and analysis to provide meaningful feedback on a range of options for modernizing the regulations. I will conclude by noting that the high level of engagement and commitment on the part of banks, community organizations, and other important stakeholders give me confidence that we will succeed in strengthening the CRA's core purpose of helping banks affirmatively meet the credit needs of their local LMI communities.

r200109a_FOMC

united states

U.S. Economic Outlook and Monetary Policy

clarida

Thank you for the opportunity to join you bright and early on this January 2020 Thursday morning. As some of you may know, I am a longtime member of the Council on Foreign Relations and have attended and participated in many such events over the past 20 years, although I will point out that in my previous visits to the dais, I was in the somewhat less demanding position of asking the questions rather than answering them. I am really looking forward to this conversation, but I would like first to share with you some thoughts about the outlook for the U.S. economy and monetary policy. The U.S. economy begins the year 2020 in a good place. The unemployment rate is at a 50-year low, inflation is close to our 2 percent objective, gross domestic product for a continuation of this performance in 2020. At present, personal consumption expenditures (PCE) price inflation is running somewhat below our 2 percent objective, but we project that, under appropriate monetary policy, inflation will rise gradually to our symmetric 2 percent objective. Although the unemployment rate is at a 50-year low, wages are rising broadly in line with productivity growth and underlying inflation. We are not seeing any evidence to date that a strong labor market is putting excessive cost- push pressure on price inflation. Committee projections for the U.S. economy are similar to our projections at this time one year ago, but over the course of 2019, the FOMC shifted the stance of U.S. monetary policy to offset some significant global growth headwinds and global disinflationary pressures. In 2019, sluggish growth abroad and global developments weighed on investment, exports, and manufacturing in the United States, although there are some indications that headwinds to global growth may be beginning to abate. U.S. inflation remains muted. Over the 12 months through November, PCE inflation was running at 1.5 percent, and core PCE inflation, which excludes volatile food and energy prices and is a better measure of underlying inflation, was running at 1.6 percent. Moreover, inflation expectations, those measured by both surveys and market prices, have moved lower and reside at the low end of a range I consider consistent with our price-stability mandate. The shift in the stance of monetary policy that we undertook in 2019 was, I believe, well timed and has been providing support to the economy and helping to keep the U.S. outlook on track. I believe that monetary policy is in a good place and should continue to support sustained growth, a strong labor market, and inflation running close to our symmetric 2 percent objective. As long as incoming information about the economy remains broadly consistent with this outlook, the current stance of monetary policy likely will remain appropriate. Looking ahead, monetary policy is not on a preset course. The Committee will proceed on a meeting-by-meeting basis and will be monitoring the effects of our recent policy actions along with other information bearing on the outlook as we assess the appropriate path of the target range for the federal funds rate. Of course, if developments emerge that, in the future, trigger a material reassessment of our outlook, we will respond accordingly. In January 2019, my FOMC colleagues and I affirmed that we aim to operate with an ample level of bank reserves in the U.S. financial system. And in October, we announced and began to implement a program to address pressures in repurchase agreement (repo) markets that became evident in September. To that end, we have been purchasing Treasury bills and conducting both overnight and term repurchase operations, and these efforts were successful in relieving pressures in the repo markets over the year- end. As we enter 2020, let me emphasize that we stand ready to adjust the details of this program as appropriate and in line with our goal, which is to keep the federal funds rate in the target range desired by the FOMC. As the minutes of the December FOMC meeting suggest, it may be appropriate to gradually transition away from active repo operations this year as Treasury bill purchases supply a larger base of reserves, though some repo might be needed at least through April, when tax payments will sharply reduce reserve levels. Finally, allow me to offer a few words about the FOMC review of the strategy, tools, and communication practices that we commenced in February 2019. This review--with public engagement unprecedented in scope for us--is the first of its kind events, including an academic conference in Chicago, we have been hearing a range of perspectives not only from academic experts, but also from representatives of consumer, labor, community, business, and other groups. We are drawing on these insights as we assess how best to achieve and maintain maximum employment and price stability. In July, we began discussing topics associated with the review at regularly scheduled FOMC meetings. We will continue reporting on our discussions in the minutes of FOMC meetings and will share our conclusions with the public when we conclude the review later this year. Thank you very much for your time and attention. I look forward to the conversation and the question-and-answer session to follow.

r200116a_FOMC

united states

The Outlook for Housing

bowman

Few sectors are as central to the success of our economy and the lives of American families as housing. If we include the amount families spend on shelter each month as well as the construction of new houses and apartments, housing generates about 15 cents out of every dollar of economic activity. As homebuilders, you set the foundation that supports the work of architects, bankers, electricians, carpenters, plumbers, furniture makers, and many others. In our time together today, I'd like to discuss the outlook for housing at the national level and also look at the labor force and credit challenges facing your industry. Let me start with just a few words about the overall economic picture. I'm pleased to say that the U.S. economy is currently in a good place, and the baseline moderate growth in gross domestic product (GDP) over the next few years. Unemployment is the lowest it has been in 50 years, and FOMC participants expect it to remain low. Inflation has been muted and is expected to rise gradually to the FOMC's 2 percent objective. One of the most remarkable features of the current economic expansion has been the vitality and resilience of the U.S. job market. More than 22 million jobs have been created since the low point for employment at the end of the last downturn, and the pace of job gains has been amazingly consistent. Until this expansion, even in good times, scarcely a year went by without at least one month when payrolls shrank. Yet during the past 10 years, we haven't had a single month with a decline in the overall number of jobs. I should note that I would not necessarily consider a single month of job losses as saying much about the direction of the economy. But the unbroken string of job gains that we have experienced during this recovery highlights how our economy has kept humming along during this past decade, weathering the occasional lull. Let me also add here that, as good as the national numbers for the job market look, things seem even better here in the Kansas City area, where job growth has been steady and the unemployment rate has consistently run around 1 percentage point below the national average--at last count, it Let me now turn to the main topic of my talk today. My colleagues and I at the Federal Reserve pay close attention to developments in the housing sector, in part because it has historically been such an important driver of economic growth. In the national economic data, the part of GDP that includes homebuilding activity is referred to as residential fixed investment. This measure summarizes a variety of housing-related activities, including spending on the construction of new single-family and multifamily structures, residential remodeling, real estate brokers' fees, and a few other smaller components. If we look at the growth of residential fixed investment in periods since World War II that are defined as economic expansions, we see that this broad category has increased at an average rate of around 7 percent per year, faster than the roughly 4 percent pace of GDP growth in those same periods. And, as many of you know from experience, the opposite is true as well--that housing activity tends to experience relatively large declines in economic downturns. In particular, residential fixed investment declined an average of about 15 percent annually during periods defined as recessions, compared with an average annual rate of decline in GDP of just 2 percent in those same periods. These numbers illustrate that residential fixed investment is particularly sensitive to where we are in the business cycle. The strong economy we are experiencing now has an obvious upside for the housing sector: A robust job market translates into higher incomes, greater confidence, and more people looking to buy a new home or considering whether to make a change from their current home. Yet even though the financial crisis and the bursting of the real estate bubble occurred more than a decade ago, all of us here are no doubt aware of the lasting imprint that those developments left on the housing market. On an annual basis, both new and existing home sales did not increase again until 2012, and they remained at modest levels for several years thereafter. Given the large and persistent inventory overhang of unsold homes in the aftermath of the crisis, the construction of new homes was also sluggish for many years into the recovery. Part of the weak recovery in the housing market during the first few years of this expansion can be traced to extremely tight mortgage credit conditions. Despite the fact that the Fed slashed interest rates and kept them low for many years, many households were underwater on their existing mortgages, with more owed on their housing than their homes were worth, while others were unable to obtain a loan to finance a new purchase. As a result, housing demand remained very weak for an extended period. Another factor that played a role in the slow housing recovery was the low rate of household formation, which dropped significantly during the recession and remained low for most of the following decade. Much of this drop was due to a larger share of young people continuing to live with their parents, though this is not unusual when the economy is weak and jobs are hard to find. In the past few years, though, we have seen some encouraging signs that the broader strength in the economy has eased these housing market headwinds. Along with ongoing improvements in households' balance sheet conditions, mortgage credit conditions appear to be less of a constraint for creditworthy borrowers. I should add that housing activity is also being supported by interest rates that remain quite low by historical standards, with the fixed rate charged on a 30-year mortgage now below 4 percent, substantially lower than the rates observed just before the last recession. As you well know, activity in the housing sector is highly sensitive to interest rates and other factors that have a powerful effect on the overall cost of owning a home. In addition, amid the strong job market of the past few years, we have seen a rise in the rate at which young adults are moving out of their family homes and forming households of their own. Even so, millions of young adults are still living with their parents who likely wouldn't have been before the crisis. While their reasons for doing so are probably varied, there is potential for many more individuals to shift back to forming new households. Although the effects may evolve slowly, the higher rate of household formation will eventually result in higher demand for housing and encourage further increases in homebuilding. Home sales have been rising in recent years, the percentage of homes that are vacant has been falling, and inventories of both new and existing homes for sale have drifted back down to relatively low levels. In fact, at this point, the residential real estate market is quite tight in some areas of the country and by enough that I have heard that the volume of home sales is being restricted by the low inventory of homes on the market. The most recent housing data have been encouraging: Both new and existing home sales moved up strongly in the second half of 2019, and traffic of prospective buyers in new homes for sale and expected sales within the next six months have approached all-time highs. Permits for new residential construction, which had been sluggish early last year, recently moved up to highs for this expansion. In all, the national indicators suggest a positive growth outlook for the housing sector over the next several quarters. Before I conclude, I'd like to address two challenges currently facing the housing sector. The first relates to the difficulties that some employers face, including homebuilders, in finding and retaining qualified and skilled workers. To provide some context, the national data show that the unemployment rate in the private construction industry is now well below the rate we observed in the early 2000s, a time when the housing market was booming. In addition, the ratio of job vacancies to unemployment in the construction industry--a measure of labor market strength--shot up to historic highs at the end of 2018, and it has remained near those levels. These indicators confirm what I have been hearing from construction industry employers during my visits to different parts of the country--it's extremely difficult to find and hire workers, skilled or otherwise. In response to these hiring-related challenges, we have seen a renewed and broad focus on workforce development initiatives by the public and private sector, a development we have followed closely at the Federal Reserve. I recently heard a very encouraging presentation from representatives of vocational training organizations about progress they are making in connecting young adults, students, and high school grads with skilled trades. I am hopeful that these efforts, along with a continued strong job market, will encourage more people to join--or, in some cases, rejoin--the construction trades. The second challenge I want to highlight relates to the declining presence of community banks in the consumer real estate mortgage market. As regulatory burdens have risen, many community banks have significantly scaled back their lending or exited the mortgage market altogether. These developments concern me for several reasons. Home mortgage lending has traditionally been a significant business for smaller banks, and the decline in this business threatens a part of the banking industry that plays a crucial role in communities. Bankers who are present and active in their communities know and understand their customers and the local market better than lenders outside the area. Because of their local knowledge and customer relationships, they are often more willing to help troubled borrowers work their way through difficult times. These two challenges notwithstanding, I remain optimistic about the outlook for housing. I expect construction to continue advancing to meet the underlying expansion in housing demand from population growth and the strong economy. In addition, low interest rates will continue to be a key factor supporting growth in housing activity. As reported in the latest Summary of Economic Projections, released in December, most FOMC participants see the current target range for the federal funds rate as likely to remain appropriate this year as long as incoming information remains broadly consistent with the economic outlook I described earlier. In closing, let me say that I would also appreciate hearing what is on your minds. As a policymaker, I particularly value opportunities to travel outside of Washington to hear your perspectives on the national and local economies. These conversations improve our work at the Fed by helping us make better-informed decisions.

r200117a_FOMC

united states

Spontaneity and Order: Transparency, Accountability, and Fairness in Bank Supervision

quarles

It's a great pleasure to be with you today at the ABA Banking Law Committee's annual meeting. I left the practice of law--and immersion in the company of lawyers-- closing in on 20 years ago now, but there have been many times during my long sojourn among businessmen and economists that I have reflected with fondness and some reformer of the bar, the "most democratic of aristocrats," and the last man to unironically wear a cape in the lobby of the Chase Manhattan Plaza) which most of you can no doubt recite by heart: "I have a high opinion of lawyers. With all their faults, they stack up well against those in every other occupation or profession. They are better to work with or play with or fight with or drink with than most other varieties of mankind." here feels a lot like coming home. This afternoon, I would like to talk with you about the outwardly mundane but increasingly consequential topic of bank supervision. Twenty years ago, when I would have been among your number at this meeting, this would have been my cue to pull out my Blackberry and start checking my emails. The structure and content of regulation was both intellectually interesting and professionally meaningful; I considered bank supervision , by contrast, as both too workaday and too straightforward to merit the commitment of much legal horsepower or personal attention. I could perhaps have been excused by the callowness of youth, yet it was a common view at the time. Having now been immersed for the last two years both in the practice of supervision and in the complementary relationship between the regulatory and supervisory processes, I realize that this wasn't true then, and is certainly not true now. It is not a drafting accident that the Dodd-Frank Act gave my position at the Federal Reserve the title of Vice Chairman for . Notwithstanding the extensive reform of bank regulation after the crisis, which has had much consequence for the industry (most of it salutary) it is the process of examination and supervision that constitutes the bulk of our ongoing engagement with the industry and through which our policy objectives are given effect. This division of labor is important for lawyers and policymakers to think about deeply because the processes of regulation and supervision are necessarily different in crucial respects. Regulation establishes a binding public framework implementing relevant statutory imperatives. Because a rule is designed to apply generally, rules must be based on general principles intended to achieve general aims, rather than reverse- engineered to generate specific effects for specific institutions. Given their general applicability, there must be a general process for all those with an interest--industry, academics, citizens, Congress--to have notice of, and opportunity to comment on all rules, ensuring that all potential effects and points of view are taken into account in the rule's crafting. And given their general function, rules must be clear and public: Those affected must know what to expect and what is expected. Supervision, by contrast, implements the regulatory framework through close engagement with the particular facts about particular firms: their individual capital and liquidity positions, the diverse composition of their distinct portfolios of assets, their business strategies, the nature of their operations, the strengths and weaknesses of their management. Much of the granular information used by supervisors is, accordingly, proprietary and confidential, and many of their judgments and decisions are closely tailored to specific circumstances. Given the strong public interest in the safe, sound, and efficient operation of the financial industry and the potential for hair-raising and widespread adverse social consequences of private misjudgment or misconduct in that industry, close and regular supervision of this sort can help us all sleep restfully. Yet, the confidential and tailored nature of supervision sits uncomfortably with the responsibilities of government in a democracy. In the United States, we have a long-standing, well-articulated framework for ensuring that regulations conform with the principles of generality, predictability, publicity, and consultation described above. Supervision--for good reason, in my view--is not subject to this formal framework. But it is currently not subject to any specific process constraint promoting publicity or universality. This leaves it open to the charge, and sometimes to the fact, of capriciousness, unaccountability, unequal application, and excessive burden. Here, then, is a conundrum. We have a public interest in a confidential, tailored, rapid-acting and closely informed system of bank supervision. And we have a public interest in all governmental processes being fair, predictable, efficient, and accountable. How do we square this circle? In my time with you today, we will not do more than scratch the surface of this question. It is a complex and consequential issue that, for decades now, has received far too little attention from practitioners, academics, policymakers and the public. Evaluating this question will be a significant focus of mine going forward, and I hope that there will be much discussion in many fora from which we at the Fed, and at other regulators, can learn. So today, I simply want to open the exploration of some these conceptual issues, and then offer some specific suggestions-- by no means comprehensive--on some obvious and immediate ways that supervision can become more transparent, efficient, and effective. Let me begin by delving a little more deeply into the distinction between regulation and supervision and the process applicable to both. In delegating to agencies such as the Fed the significant power to write regulations, Congress has codified a regulatory process that emphasizes transparency. This process was born in the 1930s, in the tumult of government expansion that was the New Deal, when Congress began a decade-long debate over how to manage the new regulatory state. The result, the involvement of the American Bar Association. The APA continues to serve as the basis for the public disclosure and participation required for agency rule-writing and for the judicial review affected parties are guaranteed to challenge rules. This transparency is intended to prevent arbitrary, capricious, and thus ineffective regulation by inviting broad public participation and mandating a deliberate public debate over the content of proposed rules. One obvious purpose of this transparency is to provide clarity and predictability: it helps make clear how agencies are considering exercising their discretion. The significant process protections in laws such as the APA are also meant to ensure fairness. The wisdom behind this approach is that fairness both helps bring forth more considered and effective regulations and builds respect for and adherence to the law, which is essential for enforcement. Transparency is central to our ability to assert that our rules are fair. Not everything that government does, however, can be accomplished in exactly the same way that regulations are written. One of these things is bank supervision. Banks are subjected to supervision, in addition to regulation, as an additional form of government oversight because of their complexity, opacity, vulnerability to runs, and indispensable role in the economy, enabling payments, transmitting monetary policy, and providing credit. The government provides a safety net to banks in the form of deposit insurance, and in return, banks are subject to government oversight that mimics some of the monitoring that the private sector would provide, absent the government safety net. The bank regulatory framework sets the core architectural requirements for the banking system, but it isn't enough to set the rules and walk away like Voltaire's god. The potential consequences of disruption in the financial system are so far-reaching, and the erosion of market discipline resulting from the government safety net sufficiently material, that it is neither safe nor reasonable to rely entirely on after-the-fact enforcement to ensure regulatory compliance. Supervisors are in a good position to monitor individual firms' idiosyncratic risks. And in addition to what they do at individual banks, supervisors monitor for risk that may be building among clusters of banks or across the banking system. These "horizontal" exams across multiple banks help highlight new or emerging risks and help examiners understand how banks are managing these risks. Through their engagement with banks, supervisors promote good risk management and thus help banks preemptively avert excessive risk taking that would be costly and inefficient to correct after the fact. Where banks fall materially out of compliance with a regulatory framework or act in a manner that poses a threat to their safety and soundness, supervisors can act rapidly to address the failures that led to the lack of compliance or threat to safety and soundness. This is a crucial point: Supervision is most effective when expectations are clear and supervision promotes an approach to risk management that deters bad behavior and decisions by banks. Clearly communicating those expectations is essential to effective supervision, and in a larger sense, clear two-way communication is the essence of effective supervision. Supervisors rely on banks to be frank and forthcoming, and supervisors in turn can help secure that frankness by explaining what their expectations are and why their expectations are reasonable, not arbitrary or capricious. Greater transparency in supervision about the content of our expectations and about how we form our expectations and judgments can make supervision more effective by building trust and respect for the fairness and rationality of supervision. I don't believe the Federal Reserve has communicated as clearly as it could with the banks we supervise. More transparency and more clarity about what we want to achieve as supervisors and how we approach our work will improve supervision, and I have several specific proposals. Broadly speaking, these actions fall into three categories: (1) large bank supervision, (2) transparency improvements, and (3) overall supervisory process improvements. Last fall, we completed a cornerstone of the recent banking legislation to tailor our rules for regional banks. This was entirely consistent with a principle at the heart of our existing work: Firms that pose greater risks should meet higher standards and receive more scrutiny. Our previous rules relied heavily on a firm's total assets as a proxy for these risks and for the costs the financial system would incur if a firm failed. This simple asset proxy was clear and critical, rough and ready, but neither risk sensitive nor complete. Our new rules employ a broader set of indicators, like short-term wholesale funding and off-balance-sheet exposures, to assess the need for greater supervisory scrutiny. That said, the composition of our supervisory portfolios has not yet been aligned with our recent tailoring rules. For example, the Large Institution Supervision greatest risk profile, along with certain Category II and Category III firms, which are less systemic. Other Category II and Category III firms, on the other hand, are supervised under our large and foreign banking organizations (LFBO) portfolio. Since the crisis, we have been giving significant thought to the composition of our supervisory portfolios, and, in particular to whether and how we should address the significant decrease in size and risk profile of the foreign firms in the LISCC portfolio over the past decade. Because of these changes, which I will describe in more detail momentarily, I believe there is a compelling justification to make changes today to the composition of the foreign banks in the LISCC portfolio. Separately and in keeping with the goal of transparency, I think it is important that all the Fed's supervisory portfolios have a clear and transparent definition. Today nearly all of our supervisory portfolios have such a crisp and clear formulaic definition specified in the public domain, but the LISCC portfolio does not. My goal is to develop, prospectively, a clear and transparent standard for identifying LISCC firms. My preferred approach for achieving this objective would be to align the LISCC portfolio with our recent tailoring categorizations. I believe we should draw the LISCC line to coincide with Category I. The justification for this line-drawing is that Category I firms pose the most systemic risk and require the most supervisory attention. In this state of the world, Category II and III firms would remain subject to heightened supervisory standards that are commensurate with their risk profile. Allow me to draw out what this approach could mean for the foreign banks that currently are in the LISCC portfolio. Since 2010, these four banks have significantly shrunk their U.S. footprint, and their U.S. operations are much less risky than they used to be. Since 2008, the size of the LISCC FBOs' combined U.S. assets has shrunk by about 50 percent, and they have reduced the assets at their broker-dealers from a peak of $1.9 trillion in 2008 to $340 billion today, a reduction of over 80%. In addition, the estimated systemic impact of the LISCC FBOs today is much smaller than the U.S. GSIBs. The average method 1 GSIB score of the combined U.S. operations of the LISCC FBOs is less than a quarter of the average GSIB score of the six non-processing Thus, if any foreign banks move out of the LISCC portfolio based on this de- risking, they would move into the LFBO portfolio, where they would be supervised alongside other foreign and domestic firms with similar risk profiles. Notably, this change in supervisory portfolio would have no effect on the regulatory capital or liquidity requirements that currently apply to the four LISCC FBOs. Similarly, the change would not result in a loss of insight into the activities of these firms. In the same spirit, I think we should consider publishing the internal procedural materials that the Fed uses to supervise the LISCC firms, sometimes referred to as the Program Manual. The Manual contains a description of the main supervisory processes for identifying risks and our approach for addressing them. Publishing the Manual would help the public and the banks better understand why we take the actions that we take as supervisors and would demystify some of our processes. If we took these two simple steps--defining LISCC firms and publishing the Program Manual that governs our supervisory approach--it would go a long way in helping to make our supervisory practices more understandable and accessible without undermining supervisory effectiveness. Let me now turn to the ratings framework that applies to all large holding companies. A firm's supervisory rating, which is confidential, is important because it affects things such as the firm's ability to engage in mergers and acquisitions and to enter new lines of business. Just over a year ago, the Board began implementing a new ratings framework for large holding companies called the large financial institutions (LFI) ratings framework. The LFI ratings framework focuses on three components of a firm's operations: capital, liquidity, and governance and controls. We inaugurated the LFI ratings framework for LISCC firms in January 2019 and for other large holding companies at the beginning of this year. As we gain more experience with LFI, we will be paying close attention to how the new rating system is working and whether it is achieving its intended purpose. There are two features of the ratings system that I will be particularly interested to monitor, and which may well require adjustment. These are the embedding of qualitative "risk management" standards in the capital and liquidity components of the ratings (as opposed to standardized quantitative measures of capital and liquidity adequacy) and the ascetic principle by which a firm's "well managed" status is determined by its lowest component rating, no matter how good the bank is at everything else. Regarding our stress tests under the Comprehensive Capital Analysis and Review (CCAR), I continue to look for ways to make the tests more transparent without making them game-able and without diluting their potency as a supervisory tool. I will mention three of these transparency-enhancing ideas. First, I expect that we will continue to provide more transparency on the models used in CCAR. We started providing improved transparency on models last year, and as I have previously said, we will remain on that path until we have released substantial details on all of our key models. We also continue to consider ways to increase the transparency around the scenarios we use in CCAR, including, for example, by modifying our scenario design policy statement to provide greater transparency on the design of the global market shock component of the stress tests. Second, I expect that as part of the stress capital buffer, we will give banks significantly more time to review their stress test results and understand their capital requirements before we demand their final capital plan. Firms are currently permitted to revise and resubmit their capital plans after receiving their stress test results. But it is done on a short timeframe, and allowing additional time would produce better results without in any way reducing the stringency of the stress tests. Fundamentally, I think banks will be better able to do intelligent capital planning if we provide them with their complete set of regulatory capital requirements before we require submission of a capital plan. Third and finally, we continue to look for ways to reduce the volatility of stress- test requirements from year to year. We are considering a number of options, such as averaging outcomes over multiple years or averaging the results of the current year's stress test with the results of one or more previous years. Again, the goal here is not to make the tests less strenuous but to give banks a greater opportunity to plan for them and to meet our expectations ex ante rather than through an ex post remedial process. The next three actions I'm proposing also relate to improved transparency, and they would improve our processes for supervising all banks. The first would be to create a word-searchable database on the Board's website with the historical interpretations by the Board and its staff of all significant rules. Regulatory interpretations by Board staff have grown piecemeal over the decades and haven't consistently been treated as the valuable resource they are. The Board's website has select interpretations of many laws but does not provide a comprehensive, user-friendly collection of regulatory interpretations, FAQs, and commentary. This project will require some effort of course, as well as vigilance to keep the interpretations up to date, but I believe that the end result will be well worth it. The second of these transparency actions would be putting significant supervisory guidance out for public comment. The Board already invites comments on its regulations, as required under the APA, and regularly invites comment on some supervisory guidance and statements of policy. This practice of seeking comment on guidance leads to better, more informed supervision and better engagement by banks. I would like the Board to seek comment on more supervisory guidance going forward. Third and finally, as another improvement related to guidance, I support submitting significant supervisory guidance to Congress for purposes of the Congressional Review Act. Currently, the Fed does this for rules but not guidance. I support doing so for significant guidance because significant guidance, though nonbinding, can still have a material impact on bank behavior. I believe this step would enhance the Fed's accountability and help build support for supervisory guidance. The last category of proposals includes five areas of improvement that all relate to what we call the "supervisory process"--how we go about conducting our responsibilities. Like my other suggestions, these are all rooted in common sense with a view toward maintaining firm and fair supervision. The first is to increase the ability of supervised firms to share Federal Reserve confidential supervisory information (CSI) with employees, affiliates, service providers, and other government agencies to promote greater compliance with laws and facilitate the response to enforcement actions. We have received feedback that our rules can prevent banks from sharing CSI with a wide variety of relevant parties who need to know this information in order to help the bank remediate identified supervisory issues. We issued a proposal last year to address this shortcoming in our CSI rules, and I expect the Board will be able to issue a final CSI rule later this year. The second process improvement is having the Board adopt a rule on how we use guidance in the supervisory process. I would expect the rule to state that the Board will follow and respect the limits of administrative law in carrying out its supervisory responsibilities. In particular, consistent with the September 2018 interagency statement on guidance, we would affirm the sensible principles that guidance is not binding and "non-compliance" with guidance may not form the basis for an enforcement action (such as a cease-and-desist order) or supervisory criticism (such as a Matter Requiring Attention (MRA)). This rule would be binding on the Board and on all staff of the Federal Reserve System, including bank examiners. The third and fourth process improvements relate to supervisory communication. The third improvement is to restore the "supervisory observation" category for lesser safety and soundness issues. This approach would provide supervisors with a tool-- supervisory recommendations--for continuing to raise concerns about less pressing supervisory matters while focusing a bank's attention on the most urgent matters, those that would receive MRAs. We removed this category of supervisory commentary in 2013 to better focus bank management on deficiencies found during the supervision process. (By way of comparison, both the FDIC and OCC retained this tool.) On reflection, I think there is value in supervisory observations. They allow an examiner to give notice about a supervisory concern even if that concern has not risen to the level of an MRA. The fourth process improvement would be limiting future MRAs to violations of law, violations of regulation, and material safety and soundness issues. MRAs are supervisory communications that identify areas where banks are out of compliance with applicable legal standards or otherwise are engaged in practices that create substantial safety and soundness risks. MRAs identify the source of the compliance failure, deficiency, or safety and soundness weakness and generally include an expected timeframe for remediation. MRAs are not legally binding and are not enforcement actions. Nevertheless, MRAs carry weight because they can affect a bank's supervisory rating. In limiting MRAs to legal violations and significant supervisory concerns, we would take care to clearly define the breadth of what constitutes a "material safety and soundness issue." This distinction is important as a matter of fairness. Banks should be able to understand the line between MRAs significant enough to affect the bank's supervisory rating and less significant matters that don't affect a bank's supervisory rating but raise concerns that should be considered by banks. Greater fairness contributes to greater supervisory effectiveness. Together, the third and fourth process improvements would be calibrated to improve communications so that banks can focus on remediating key weaknesses while maintaining awareness of emerging ones. Ultimately, a bank that promptly corrects its material safety and soundness weaknesses will be better able to serve its customers and intermediate credit through a range of scenarios, including under stress. The final process improvement is to make routine our existing practice of having an independent review of important supervisory communications and guidance documents. We want to make sure that our supervisory communications, including MRAs, focus on violations of law and material safety and soundness issues and that these communications don't mistakenly give the impression that supervisory guidance is binding. We already closely scrutinize MRAs issued to the LISCC firms and in horizontal reviews of other large domestic and foreign banks. This extra scrutiny is a sensible practice that should be regularized and expanded across our supervisory portfolios. With respect to prospectively assessing future guidance, the key goals here would include reassessing the scope of key guidance documents, removing inappropriate bright lines from guidance, and removing any mandatory language from guidance. I will discuss each of these goals in turn. As I mentioned, the Board adopted a final tailoring rule last year that adjusted the regulatory standards applicable to banks, based on their risk profile. I think it would be useful for us to review our guidance in light of this tailoring exercise, such as guidance on stress testing and capital planning, and to update the scope of guidance where appropriate. Regarding bright lines, bright lines tend to carry the implication that the standard they are delineating is binding. For this reason, rules often include bright lines so that it is clear how to stay in compliance with the rule. Putting bright lines in guidance, even when the bright line is phrased as a "should" rather than as a requirement, blurs the line between guidance and rules, and for this reason, it is a practice we should avoid. For the same reason, it is inappropriate to put mandatory language in guidance. This practice can create the same distortions as the use of bright lines. Obviously, the incremental changes to our supervisory processes described above do not completely answer the question with which I began my remarks today: How can we square the public interest in agile supervision with the public interest in transparency and accountability? This should be an ongoing question of high priority, both at the Fed and more broadly among those who care about our system of financial regulation. Equally obviously, however, these suggestions would strengthen our practice of supervision and increase the vigor and credibility of our supervisors. The changes to supervision since the crisis have made the financial system stronger and more resilient than it was before. The incremental changes I have outlined, to increase transparency, accountability, and fairness, would make supervision more efficient and effective, and our financial system stronger and more stable.

r200205a_FOMC

united states

The Digitalization of Payments and Currency: Some Issues for Consideration

brainard

I want to thank Darrell Duffie for inviting me to discuss the future of payments. Digitalization is enabling consumers and businesses to transfer value instantaneously, technology platforms to scale up rapidly in payments, and new digital currencies to facilitate these payments. By transforming payments, digitalization has the potential to deliver greater value and convenience at lower cost. But there are risks. Some of the new players are outside the financial system's regulatory guardrails, and their new currencies could pose challenges in areas such as illicit finance, privacy, financial stability, and monetary policy transmission. Given the stakes, the public sector must engage in order to ensure that the payments infrastructure is safe as well as efficient and fast, assess whether regulatory perimeters need to be redrawn or new approaches are needed in areas such as consumer data and identity authentication, and explore the role of central bank digital currencies in ensuring sovereign currencies stay at the center of each nation's financial system. These issues are complicated and consequential. I will only touch on them today in the spirit of sketching out an agenda for the public sector along with the private sector and research community. of payments. Not only are the new players bringing innovation to the way payments are made between businesses and consumers and peer-to-peer, but they are bringing new business models that bundle payments with other activities in novel ways. Payments have traditionally been a service provided by trusted intermediaries such as banks. The operations of banks and some related financial service providers, such as card companies, are subject to regulatory oversight for sound risk management. Banks offer important consumer protections, including deposit insurance, error resolution, and fraud protection. In addition to providing payments services, banks generally provide credit, with deposits providing stable funding. Many banks rely at least in part on legacy technology. In contrast, BigTechs tend to be established platforms with massive user networks that provide payments in support of core nonfinancial services--ranging from commercial transactions to social engagement to mobile apps to search engines. In China, the majority of consumers and businesses participate in two mobile payment networks, Alipay and WeChat Pay, which by some accounts handled more than $37 trillion in mobile payments in 2018. and FinTechs typically leverage cloud-based platforms and computing power, along with mobile applications, often to provide different combinations of services and enhanced user experiences. They generally benefit from network effects: the more users they have, the more convenience and benefit new users derive from joining. These network benefits may be augmented by leveraging economies of scale and scope in user data for a host of purposes, from prioritizing which information is pushed to users to allocating and pricing credit to sharing reviews. The entrance of BigTech and FinTech into payments may drive competition, enhance product offerings, and lower transactions costs. It has the potential to enhance financial inclusion by expanding the number and diversity of ways people gain access to financial services and by creating more consumer friendly offerings. A Federal Deposit Insurance Corporation (FDIC) study found that 8.4 million households are unbanked and an additional 24 million are underbanked. These households often rely on more-expensive means of payments, including nonbank providers and bank money orders. Many have smartphones, which could facilitate access to payment apps. The entry of big technology networks into payments brings risks as well as benefits. Statutory and regulatory protections on bank accounts in the United States mean that consumers can reasonably expect their deposits to be insured up to a limit; their banks to be held to strong data security standards; many fraudulent transactions to be the liability of the bank; transfers to be available within specified periods; and clear, standardized disclosures about account fees and interest payments to be readily available. Consumers may not appreciate that nonbank providers might not provide the same protections. Further, the integration of payments with a variety of consumer services that rely intensively on user data raises the urgency of questions surrounding data security, how consumers' financial data are used, and the circumstances under which the data are disclosed to third parties. Unlike many foreign central banks, the Federal Reserve does not have plenary authority over payment systems. No federal agency does. The Federal Reserve has broad authority over payment systems that are designated as systemically important by the Financial Stability Oversight Council or that are chartered as entities for which the Federal Reserve is the primary supervisor. These authorities cover two large-value interbank payment systems but no retail payment system to date. The banking agencies may oversee certain aspects of a nonbank payment system to the extent there is a bank nexus, under the Bank Service Company Act, or bank affiliation, under the Federal Deposit Insurance Act. However, this oversight will be quite limited to the extent that nonbank players reduce or eliminate the nexus to banks, such as when technology firms develop payments services connected to digital wallets rather than bank accounts and rely on digital currencies rather than sovereign currencies as the means of exchange. Given the growing role of nonbank technology players in payments, a review of the nation's oversight framework for retail payment systems could be helpful to identify important gaps. A good place to start may be contrasting the U.S. oversight framework for retail payment systems with other jurisdictions. Many foreign central banks, for example, have explicit authority for general retail payments oversight. Moreover, most jurisdictions require that payment systems obtain a license and/or registration before commencing operations. A 2018 World Bank study found that the large majority of jurisdictions have some sort of license and/or registration requirement for mobile money platforms, payment card networks or switches, or clearinghouses. The United States requires registration of a money transmitter at the federal require broader federal oversight of payment system operators. In contrast to other jurisdictions where there is explicit responsibility for broad regulation of payment systems, the Federal Reserve's role as an operator has instead long formed the basis of the U.S. approach to promoting accessible, safe, and efficient payments. Since the Federal Reserve Banks opened for business around the country in 1914, as directed by the Congress, they have provided payment and settlement services in competition with private-sector providers. So let's turn to our retail payments infrastructure, which touches every American. While new players are making important contributions to the digital transformation of payments, it is critical that consumers and businesses can achieve the same speed and efficiency using their trusted deposit account providers with the safety and security they have come to expect. To make this possible, it is vital to invest in real-time retail payments infrastructure with national reach. Today, it can take a few days to get access to your funds. A real-time retail payments infrastructure would ensure the funds are available immediately--to pay utility bills or split the rent with roommates, or for small business owners to pay their suppliers. Immediate access to funds could be especially important for households on fixed incomes or living paycheck to paycheck, when waiting days for the funds to be available to pay a bill can mean overdraft fees or late fees that can compound. Similarly, for small businesses, getting immediate access to funds from a sale in order to pay for supplies can be a game-changer. The latest evolution in the payments infrastructure is faster payments, in which the payment message is transmitted and funds are settled between banks and made irrevocably available to recipients in real (or near-real) time. Consistent with the real-time and anytime nature of faster payments, settlement takes place in real time on a 24-hour, seven-day basis. We are committed to closing the gap between the transaction capabilities in the digital economy and the underlying payment and settlement capabilities. Recognizing that consumers and businesses across the country want and expect real-time payments, and the banks they trust should be able to provide this service securely, this summer, the Federal Reserve announced that it is building its first new payments rail in more than forty years--the FedNow Service. FedNow will facilitate end-to-end faster payment services, increase competition, and ensure equitable and ubiquitous access to banks of all sizes nationwide. real-time retail payments. These systems will enable consumers and businesses to settle retail transactions in real time, at any time, and allow them to manage their money with greater flexibility. RTP and FedNow should significantly increase the speed and efficiency of the U.S. payment system. Given the importance of safety in faster payments, providing access to more than one real-time payment service for back-up purposes will enhance resiliency. The Federal Reserve has always had a vital role in the payment system by providing liquidity and operational continuity in times of stress, and FedNow will extend this role into the real-time retail payments market. The addition of FedNow should also provide a neutral foundation for private sector innovation in developing end-user services. Some stakeholders noted that a single provider that is owned and operated by one segment of the payment industry may focus on a limited set of use cases instead of the full breadth of possible use cases for faster payments. The FedNow team is already hard at work determining initial business requirements. The comment period for the notice seeking public input into FedNow features and designs closed in November, and we are analyzing the nearly 200 letters submitted. understand the urgency among stakeholders to launch FedNow quickly with features that support safe, efficient, and ubiquitous faster payments. Digital transformation of payments extends not only to the systems and players, but also to the medium of exchange. The existing payments system combines central bank money, commercial bank money, and certain kinds of nonbank private money, which provide a medium of exchange based on the U.S. dollar as a unit of account. By contrast, some technology players have payment systems based on their own digital currency rather than the sovereign currency. Depending on their design and scale, private digital-currency-based payment systems could magnify concerns surrounding illicit activity and consumer risk, while potentially creating challenges for the public sector's ability to safeguard financial stability and use monetary policy to buffer the economy. Central bank money is important for payment systems because it represents a safe settlement asset, allowing users to exchange central bank liabilities with confidence in their acceptance and reliability. In the United States, central bank money is composed of paper currency and money held in deposits at the Federal Reserve Banks. Commercial bank money-- money held in deposits at commercial banks--is widely used because consumers and businesses trust that the money they deposit with a commercial bank can be converted, on demand, into a claim on another commercial bank's money or currency. This confidence owes in large part to bank deposit insurance and the fact that commercial banks are supervised and regulated. Nonbank private money based on the U.S. dollar as the unit of account exists on a smaller scale for a variety of consumer uses, particularly in closed-loop payment systems like prepaid cards and digital wallets. In some cases, such nonbank private assets may have value only within the network, while in other cases, the issuer may promise convertibility to a sovereign currency, such that this becomes a liability of the issuing entity. Although various federal and state laws establish protections for users, issuers of nonbank money are not regulated to the same extent as banks, the value stored in these systems is not insured directly by the FDIC, and consumers may be at risk that the issuer will not be able to honor its liabilities. To provide a sense of the scale, Walmart had roughly $1.9 billion in deferred gift card revenue as of October 31, 2019; and Starbucks reported $1.6 billion in stored-value card liabilities as of September 2018--more than the deposits at many banks. In contrast, cryptocurrencies introduce separate units of account. Built using distributed ledger technologies, cryptocurrencies typically allow for peer-to-peer payments without the need for a financial intermediary. The private sector is exploring uses of distributed ledger technologies to create a wide range of payment instruments, some that are designed to resemble traditional commercial bank money, some that look similar to Bitcoin, and some that have attributes more similar to securities. Cryptocurrencies vary across multiple attributes, including whether the arrangement is open to everyone or only approved entities and whether they are intended for general-purpose use or for wholesale use. One important design choice is whether a digital currency is account-based or token- based. From an accounting perspective, there is an account structure for the asset owner and for the asset itself. Individual accounts could take the form of traditional account structures of commercial banks or be pseudo-anonymous. The accounting of the asset itself could take the form of debiting and crediting account balances or tracking of specific "tokens." Another key design consideration is the method for authenticating the asset owner--to open an account and to make transactions. Traditionally, identity authentication is done by the account provider, but new tools, such as biometrics, may be required for decentralized systems. A third important design variant is convertibility. Private-sector digital currencies vary in important ways with regard to whether they are linked in a legally binding way to a sovereign currency. A decade ago, Bitcoin was heralded as a new kind of digital money that would serve as a store of value, means of exchange, and unit of account delinked from any sovereign currencies without the need for centralized governance. Bitcoin has not achieved widespread acceptance as a means of payment or unit of account because of its extreme volatility, as well as limited throughput capacity, unpredictable transaction costs, limited or no governance, and limited transparency. Stablecoins were designed specifically to overcome the volatility of first-generation cryptocurrencies by tying the digital currency to an asset or basket of assets, such as commercial bank deposits or government-issued bonds. Unlike first-generation cryptocurrencies, they may be issued by a central entity and rely on third-party institutions for some aspects. But even within this broad class of digital currencies, stablecoins vary widely in their underlying reference assets and the associated "exchange rate," the ability to redeem the stablecoin claims for the underlying assets, and the extent to which a central issuer is liable for making good on redemption rights. Because Facebook has an active user network of one-third of the global population, the company's Libra global stablecoin project has imparted urgency to the debate over what form money can take, who or what can issue it, and how payments can be recorded and settled. Any stablecoin project with global scale and scope faces a core set of legal and regulatory challenges. Cryptocurrencies already pose risks associated with fraudulent activity, consumer losses, and illicit activity, and these could be magnified by a widely accepted stablecoin for general use. Not only is it not clear what protections or recourse consumers would have with regard to their global stablecoin transactions and balances, but it is also not clear how much price risk consumers will face in cases where they do not appear to have claims on the stablecoin's underlying assets. If not managed effectively, liquidity, credit, market, or operational risks--alone or in combination--could affect financial stability, triggering a loss of confidence and run-like behavior. The precise nature of the risk would be driven in part by how the stablecoin is tied to an asset (if at all), the underlying legal arrangements, and the features of the asset itself. For smaller economies, there may be material effects on monetary policy from private-sector digital currencies as well as foreign central bank digital currencies. In many respects, these effects may be the digital version of "dollarization," with the potential for a faster pace and wider scope of adoption. The prospect for rapid adoption of global stablecoin payment systems has intensified calls for central banks to issue digital currencies in order to maintain the sovereign currency as the anchor of the nation's payment systems. In a Bank for International Settlements survey of 66 central banks, more than 80 percent of central banks report being engaged in some type of central bank digital currency (CBDC) work. The motivations for this work range from payments safety and robustness for advanced economies to payments efficiency for emerging economies. The latest survey suggests there is greater openness to issuing a CBDC than a year ago, and a few central banks report that they are moving forward with issuing a CBDC. Building on the tremendous reach of its mobile payments platforms, China is reported to be moving ahead rapidly on plans to issue a digital currency. Given the dollar's important role, it is essential that we remain on the frontier of research and policy development regarding CBDC. Like other central banks, we are conducting research and experimentation related to distributed ledger technologies and their potential use case for digital currencies, including the potential for a CBDC. We are collaborating with other central banks as we advance our understanding of central bank digital currencies. In assessing CBDC in the U.S. context, there are policy and design issues to explore, as well as legal considerations. It is important to consider whether a new form of digital central bank liability might improve the payment system, taking into account the innovations offered by the private sector. We would need to consider whether adding a new form of central bank liability would reduce operational vulnerabilities from a safety and resilience perspective. Another consideration is whether a CBDC would reduce complexity in payments, improve end- to-end processing, or simplify recordkeeping. With regard to cross-border payments, it is important to consider what would be required in terms of cross-border cooperation for CBDCs to address current frictions and reduce costs. It is also vital to consider the implications for the broader financial system of the issuance of a CBDC. In light of considerations of privacy and guarding against illicit activity, issuance of a digital currency would raise important questions about what kinds of intermediaries might provide CBDC transaction accounts for consumers. While some proposals are centered on commercial bank intermediaries, others propose new types of intermediaries that might develop with a narrow focus on payments. New types of intermediaries in turn could create a need for new types of accounts and new forms of oversight. Related to this, the design of any CBDC needs to address important questions surrounding financial stability. A variety of approaches have been put forward to address the potential run risk associated with the ability to convert commercial bank deposits into CBDC with a simple swipe. There are also important legal considerations. It is important to understand how the existing provisions of the Federal Reserve Act with regard to currency issuance apply to the CBDC. It is also important to consider whether CBDC would have legal tender status, depending on the design. While the legal framework is well-established with regard to the rights and protections for Federal Reserve notes in the current system, it is untested for new instruments such as CBDC and, more generally, other digital currencies. A different approach may be necessary to ensure that holders of CBDC have appropriate protections, including privacy rights, fraud protection, digital identity safeguards, and data protection. These are some of the issues that would need to be addressed before deciding to issue a CBDC in the United States. Some of the motivations for a CBDC cited by other jurisdictions, such as rapidly declining cash use, weak financial institutions, and underdeveloped payment systems, are not shared by the United States. Physical cash in circulation for the U.S. dollar continues to rise because of robust demand, and the dollar plays an important role globally. We have a robust and diverse banking system that provides important services, along with a widely available and expanding variety of digital payment options. The digitalization of currencies and payments is being driven by technology players that are bringing new business models to this space and fresh attention to age-old questions. While the potential for seamlessly integrated and lower-cost transactions brings important benefits, digitalization also brings risks. In the United States no less than in other major economies, the public sector needs to engage actively with the private sector and the research community to consider whether new guardrails need to be established, whether existing regulatory perimeters need to be redrawn, and whether a CBDC would deliver important benefits on net.

r200206a_FOMC

united states

The Economic Outlook, Monetary Policy, and the Demand for Reserves

quarles

I would like to thank the organizers for the opportunity to speak to you today. My plan is to address some topical and important issues, some of which are quite technical but technicalities that I think can have significant consequences. After providing my thoughts on where the economy and monetary policy are now, I will turn to what we can expect from monetary policy in the years to come. Changes in the economic environment since the financial crisis, including an apparent decline in the equilibrium interest rate, have complicated the conduct of monetary policy as we work to achieve our dual mandate of maximum employment and stable prices. monetary policy strategy, tools, and communication practices to make sure we are best positioned to confront the challenges ahead. Since the Committee is still actively discussing the review, I have no intention of front-running the results. Instead, I would like to address a separate but not unrelated topic, the interaction of bank supervision and regulation with monetary policy, and how supervision and regulation might work to make monetary policy implementation more effective in the current environment, particularly as it relates to a bank's demand for reserves. But first, let me start with a brief take on the current economic outlook. There is much to be encouraged by in the nation's current economic performance even as some notable risks require careful monitoring. The labor market continues to perform remarkably well, providing a key pillar of support for the rest of the economy. The unemployment rate is at a 50-year low. The labor force participation rate has been steady for some time now despite continued predictions for its decline premised on an aging population moving into retirement. Taken together, low unemployment and steady participation have boosted the employment-to-population ratio, which has finally surpassed its pre-crisis level. A strong labor market, in turn, supports a healthy pace of consumption growth and the economy more generally. There has been some public discussion about what constitutes a tight labor market. I am in the camp that believes that some additional slack remains in the market, particularly in the potential for higher labor force participation. I have spoken for some time about my confidence that a strong labor market will continue to draw in workers--and lead other workers to delay retirement or otherwise remain in the labor force--and, so far, I remain optimistic. Although I feel good about the outlook, a few developments give me pause. Significantly, investment continues to be weak, declining over the course of 2019. Increasing the capital stock and investing in new technologies are important for productivity growth, rising living standards, and the economy's long-run growth rate, so reversing the recent downward trend is essential for the overall health of the economy. In part, the fall in investment likely reflects business concerns over the pace of global growth and risks to the outlook. In particular, 2019 was a bad year for economic growth among U.S. trading partners, and, as a consequence, our exports suffered. Recently, I have been encouraged by the progress in U.S. trade negotiations. I am hopeful that the recently signed phase-one deal with China will boost U.S. exports and lead to considerable reduction in the uncertainty that has been weighing on businesses, as will the continued progress in enacting the trade agreement with Canada and Mexico. While the recent progress on trade should boost business confidence, the outbreak of the Wuhan coronavirus introduces a new element of uncertainty. In addition to the human toll, the virus also threatens significant economic disruption, particularly for China and its neighbors, as workers and consumers stay home and normal activities are otherwise disrupted. It is too early to say what the full economic effect of the outbreak will be, and this situation will require careful monitoring. In summary, I remain optimistic about the outlook, but I am also highly aware that some notable risks still threaten growth, both overseas and at home. A few words on inflation. Both headline and core inflation, as measured by the price index for personal consumption expenditures, or PCE, came in at 1.6 percent in December, somewhat below the FOMC's 2 percent objective. This deviation does not worry me that much, in part because I expect inflation to move back to target over the medium term, in part as some unusually low readings in early 2019 pass out of the data. Already, various trimmed price indexes are running much closer to 2 percent. I view the current stance of monetary policy as appropriate given the economic outlook and relatively muted inflation pressures. Policy is in a good place to support continued economic growth, strong labor market conditions, and inflation returning to target. That said, now is a good time to be thinking about the challenges that monetary policy is likely to face in the coming years. One important development, as I mentioned at the start, is that interest rates at home and abroad have declined significantly from their pre-recession levels. Policymakers, economists, and market participants see much of this decline as reflecting a permanent fall in the equilibrium rate of interest--that is, the level of the federal funds rate that keeps the economy at full employment with stable inflation in the longer run. For example, in the most recent Summary of Economic Projections compiling the individual forecasts of FOMC participants, the median estimate of the longer-run federal funds rate, a value that incorporates policymakers' assessments of the equilibrium rate, was 2-1/2 percent, down All else being equal, a fall in the equilibrium rate of interest lessens the scope for the FOMC to cut rates in response to a significant economic downturn, as the distance to zero shrinks. In the absence of compensating policy actions, this situation may aggravate economic downturns. Thankfully, in practice policymakers have several additional tools to ease financial conditions and support the economy. One such tool is forward guidance: By credibly conveying to the public that policymakers will likely pursue a path for the policy rate that is lower than previously anticipated, policymakers can put downward pressure on longer-term interest rates. In addition, policymakers can implement policies such as large-scale asset purchases (LSAPs) that affect the size and composition of the balance sheet: By purchasing longer-term securities in the open market, the Federal Reserve reduces the quantity of such assets available for purchase. The increased scarcity tends to raise the price of these securities and depress their yields. Balance sheet policies can put further downward pressure on longer-term yields by reinforcing the credibility of the forward guidance if these policies are seen as a signal that policymakers intend to keep the policy rate low for an extended period. The FOMC used both forward guidance and balance sheet policies in response to the financial crisis. Some observers argue that forward guidance and asset purchases fully offset the shortfall in policy accommodation caused by a lack of space to cut interest rates further, so that the limits on the Fed's policy rate did not ultimately constrain our policy response to the financial crisis. Other observers see these policy tools as having had, at best, a small positive effect on the economy. Somewhere between these two extremes, the majority view is that forward guidance and balance sheet polices likely made up for some, though not all, of the shortfall. The experience gained with these tools during and after the financial crisis will likely facilitate their prompt and effective deployment in future episodes when there is no longer space for further cuts in the policy rate. In retrospect, many of the potential negative effects associated with forward guidance and LSAPs did not materialize. In particular, inflation remained contained, and longer-run inflation expectations did not become unanchored. A large balance sheet did not prevent the FOMC from raising the policy rate when it deemed such action was appropriate. To gain the full benefit of our toolkit, it will be important to continue to communicate clearly about our willingness to use all of our tools in future downturns. The greater the public confidence that policymakers will use these tools in response to episodes when the ability to cut the policy rate is constrained, the more real longer-term interest rates will systematically decline in response to negative economic developments, providing an automatic stabilizer to the economy. Moreover, public confidence in the FOMC's ability to react to economic downturns--even when the policy rate is very low-- will support the resilience of longer-term inflation expectations at levels consistent with the FOMC's objective. Keeping inflation expectations anchored will in turn further support the FOMC's ability to lower real interest rates if the economy were to weaken substantially. Taking stock, I note that one approach to the constraints on policy imposed by the current low level of interest rates is to make what were previously unconventional tools-- balance sheet policies and forward guidance--as conventional as possible. Although I fully support the FOMC's current plan to purchase Treasury bills and increase the size of the balance sheet in the very short term, over the longer-term, I believe that the viability of balance sheet policies is enhanced if we can show that we can meaningfully shrink the size of the balance sheet relative to gross domestic product following a recession-induced balance sheet expansion. In effect, I believe that balance sheet policies are more credible if we can show that there is not a persistent ratcheting-up effect in the size of the Fed's asset holdings. Of course, the balance sheet is not going back to pre-crisis levels, when the size was primarily determined by the Fed's currency liabilities. As the FOMC announced in January of 2019, the Committee intends to implement monetary policy in an ample- reserves regime. With that approach, control over the level of the federal funds rate and other short-term interest rates is exercised primarily through the setting of the Federal Reserve's administered rates and is not, over the longer term, reliant on frequent and large open market operations. The Committee also reiterated that it would assess the level of reserves most consistent with efficient and effective monetary policy implementation. Questions about this level have moved to the forefront following market dislocations and money market pressure amid a temporary, but pronounced, reduction in the supply of reserves as a result of an increase in our nonreserve liabilities in September. Indeed, this episode has been cited by a number of firms and analysts who estimate that the amount of reserves consistent with an ample framework was higher than they previously had thought. Following the mid-September volatility, the Committee stated that it would seek to maintain, over time, a level of bank reserves at or above the level that prevailed in early September, a level that we believe is sufficient to operate an ample-reserves regime. Looking ahead, I judge that it is reasonable that we ask ourselves whether it may be possible to operate with a lower level of reserves and remain consistent with the ample framework. I will spend the remainder of my time exploring possible means to enhance the efficiency of our monetary policy implementation, including reserve provision, through adjustments to our existing regulatory and supervisory regime. In particular, I will focus on liquidity regulation and supervision as well as interactions with monetary policy tools. And I will suggest a policy-based approach to some of the issues I identify. Before going into more detail about what I mean, let me emphasize that I will be touching on some issues that the Federal Reserve is in the process of observing and evaluating and, in some cases, may be far from reaching any final decisions. As such, my thoughts on these issues are my own and are likely to evolve, benefiting from further analysis and monitoring of bank behavior and financial markets over time. Let me take a step back to highlight some of the key features of the current liquidity regulation and supervision regime, features that have resulted in significant increases in the liquidity resilience and risk-management capabilities of our largest institutions. Taken enhanced prudential standards, and resolution planning--require large firms to demonstrate that they hold sufficient liquid assets to meet outflows in stressed scenarios and in resolution. In short, we expect firms to manage their liquidity risk prudently-- to self-insure -- so they can withstand the types of runs we saw during the crisis without relying on taxpayer support. This outcome has contributed to a more resilient financial system and leaves taxpayers in a much better place today. Following the implementation of these requirements, large banks have more than doubled their buffers of liquid assets. More specifically, our largest banks have significantly increased their holdings of assets known as Level 1 high-quality liquid assets Mae securities. As discussed in the original design for the LCR, all forms of Level 1 HQLA are treated as substitutes. There is no preference for reserves versus, say, Treasury securities in the calculation of the ratio. Despite the regulatory text's equal treatment of Level 1 HQLA, we know that reserves have special characteristics when it comes to stress. Even though the Treasury market is the most liquid in the world, in an actual stress event, banks would still need to take steps to monetize Treasury securities to meet cash outflows. However, it may be difficult to liquidate a large stock of Treasury securities to meet large "day one" outflows. For firms with significant capital market activities, wholesale operations, and institutional clients (such as hedge funds), this scenario is not just theoretical. In the global financial crisis, several firms experienced outflows exceeding tens of billions of dollars in a single day. The LCR does not capture these on-the-ground realities. But supervision does. Under Regulation YY's enhanced prudential standards, large firms are required to conduct internal liquidity stress tests (ILSTs). Supervisors expect firms to estimate day-one outflows and to ensure that their liquidity buffers can cover those outflows without reliance on the Federal Reserve. For firms with large day-one outflows, reserves can meet this need most clearly. Yet it is worth remembering that a principal reason for the Federal Reserve's creation was to facilitate the movement of reserves when needed from banks with an excess reserve position to those in need of reserves. Indeed, it is the reason we are called the Federal Reserve. I do not think that is a fact of purely historical interest. Excessive friction in the movement of cash in the financial system was likely a contributor to the market dislocations of last September. In that regard, I think it is worth considering whether financial system efficiency may be improved if reserves and Treasury securities' liquidity characteristics were regarded as more similar than they are today--that is to say, that reserves and Treasury securities were more easily substitutable in the context of liquidity buffers. To be clear, the ideas I will discuss do not involve any decrease in banks' liquidity buffers. Rather, I want to explore options that would maintain at least the level of resilience today while also facilitating the use of HQLA beyond reserves to meet the immediate liquidity needs projected in banks' stress scenarios. My suggested options are grounded in the principle that the Federal Reserve has an important role in providing liquidity to depository institutions. Today this role is played by the discount window, through which Reserve Banks provide fully collateralized loans to healthy institutions. While the range of eligible collateral for such liquidity provision is very broad, it may be worthwhile to focus for the moment on the Federal Reserve's potential to provide liquidity that is collateralized only by Level 1 HQLA. With firms posting Level 1 assets as collateral, the Fed would be well positioned to provide liquidity to bridge the monetization characteristics of HQLA securities versus reserves. Acknowledging this potential role in stress scenarios, the Fed may promote efficient market functioning while assuming very limited risk. If firms could assume that this traditional form of liquidity provision from the Fed was available in their stress-planning scenarios, the liquidity characteristics of Treasury securities could be the same as reserves, and both assets would be available to meet same-day needs. There are a variety of ways we could achieve this outcome. One approach would be to adopt a policy whereby firms are permitted to assume that the discount window can be used in their liquidity-planning stress scenarios under certain conditions. The discount window is meant to be used by healthy banks when it is needed. While there has long been discussion about how the discount window is "broken" because of stigma about using it, we know it is still an important part of firms' contingency planning and preparations. Banks currently pledge over $1.6 trillion in collateral to the discount window, which means that banks have gone to the trouble of working with their local Reserve Bank to make sure they have access to the window, if needed, and they have set aside a portion of their balance sheets as collateral to do so. We have also already publicly clarified in the 2019 resolution planning guidance that firms can assume discount window access in their Title 1 plans if they can meet the terms for borrowing, such as recapitalizing the bank subsidiary. We could build on this approach by also allowing firms to rely on the discount window in their ILSTs as a means of monetizing, for example, Treasury securities in their scenarios. This approach would acknowledge a role for the discount window in stress planning, improve the substitutability of reserves and Treasury securities in firms' HQLA buffers, and maintain the overall level of HQLA that firms need to hold. Such an approach could improve the efficiency of monetary policy implementation, as firms might show a greater willingness to reallocate to Treasury securities, reducing reserve demand and improving market functioning. An additional advantage of such an approach is that it could further improve the incentives of firms to be prepared to use the discount window, which we already know is important for contingency planning. If firms were to include the discount window in their plans for how they will weather a stress scenario, they would also need to demonstrate to supervisors that they are prepared to use it to ensure that their plans are credible. Also, with this approach, we would not need to set up any new programs. In connection with this, we are closely examining how international counterparts treat the equivalent of discount window access in their banks' stress-planning scenarios. Another approach could be to set up a new program or facility: For example, there has been much discussion among market participants, as well as policymakers, about the potential benefits of setting up a standing repurchase agreement, or repo, facility for banks and how such a facility could improve the substitutability of reserves and Treasury securities for these firms. While this option is still of interest, there may be benefits to working first with the tools we already have at our immediate disposal. Finally, some firms and industry observers have pointed to the surcharge for global systemically important banks, and its partial dependence on year-end inputs, as potentially exacerbating the issues I have discussed today. Preliminary analysis suggests that changing those inputs to averages may be helpful. If we were to propose that change, it would not alter the stringency of the surcharge. As such, this option is something that we are actively considering. In summary, there are great benefits to safety and soundness and to financial stability for firms holding sufficient buffers of HQLA to meet potential outflows in stress. I am not proposing any changes to this basic framework. What I am proposing is that we can potentially improve the efficiency of monetary policy implementation by improving the substitutability of reserves and Treasury securities through adjusting our expectations for firms in stress-planning scenarios. There are a variety of approaches we could take, but I think the Fed has a role to play. . . . . . . . Event), held at the . .

r200210a_FOMC

united states

Empowering Community Banks

bowman

Thank you to the American Bankers Association for inviting me to address this year's Conference for Community Bankers. I am delighted to be here with you again. Let me begin by stating that the views I express today are my own, and not necessarily those of the Federal Reserve. As community bankers, you have worked hard to develop a deep understanding of your local economies, while also keeping perspective on the broader economic picture. There is little I could tell you about your local communities that you do not already know, but I thought I might say a few words on the national economic outlook before turning to my main topic for today. My colleagues and I on the Federal Open Market Committee had our most recent meeting about two weeks ago, when we decided to keep our target range for the federal funds rate unchanged at 1-1/2 to 1-3/4 percent. This policy setting should help support the economic expansion, which is now in its 11th year. My outlook for the U.S. economy is for continued growth at a moderate pace, with the unemployment rate--which is the lowest it has been in 50 years--remaining low. I also see inflation gradually rising to the Committee's 2 percent objective. So on the whole, the national economic backdrop looks very favorable, which should be broadly supportive of your local economies. And of course, by ensuring that consumers and businesses in your communities have access to financial services, you are key contributors to the health of our national economy. Let me now turn to my main topic for today, the interaction between innovation and regulation for community banks. As the Federal Reserve Board's first designated governor with experience in community banking, I am committed to maintaining a strong and thriving community bank sector. Small banks are the lifeblood of their communities--and they ensure that consumers and businesses have access to financial services. This capacity to address local needs is fundamental to a strong and stable financial system. To community bankers, customers are much more than their credit score or their annual income, and small businesses are far more than their most recent revenues. By extending credit and offering specialized products and services that meet the needs of their borrowers, these banks empower communities to thrive. We live in an exciting time, when the face of banking is changing faster and perhaps more fundamentally than it ever has. The first digital banks appeared on the scene about 25 years ago. Since then, financial technology has evolved rapidly. Technology puts more information in the hands of both the customer and the bank. As financial institutions succeed in digitizing more of their offerings, customers are able to monitor cash flows, make direct payments, understand changes in their credit scores, track spending, and budget more easily. Technologies like predictive analytics, when supported with appropriate consumer protections, can improve bank services and performance by enabling continuous tailoring of the customer experience. It also helps banks identify products that are best suited for their customers and their business model and strategy. For those account holders who are willing, an analysis of spending habits may indicate that they could benefit from services they hadn't yet considered. But successful innovation is not just about adopting the latest technologies. Successful innovation has always required strategic vision and creativity. Community banks thrive when they find creative ways to serve their communities, using everything they know to build relationships, offer solutions, and make lending decisions. We need only look to the performance of community banks during the financial crisis to see how well they leverage this local knowledge and their relationships to make lending decisions. After the onset of the crisis, community banks' superior loan quality resulted in lower aggregate delinquency and charge-off rates compared to the largest banks. This superior performance was widespread--community banks in the vast majority of states outperformed the largest banks in this way. Even today, community banks continue to perform with distinction. In the third quarter of 2019, community banks' pre-tax return on average assets was 1.5 percent, marking the highest pre-tax return on assets ratio reported by community banks since 2006. Asset quality also remains strong for community banks and is better than for larger banks. The community bank net charge-off rate for total loans and leases was less than 0.2 percent at the end of the third quarter 2019. Let me state that again--the net charge- off rate was less than 0.2 percent, less than half of the industry average. Community bank capital levels remain at continued high and increasing levels. Community banks reported a total risk-based capital ratio of nearly 16 percent, as compared to the industry average of less than 15 percent. This type of performance positions the community banking sector for continued success this year and well into the future, helping ensure the preservation of the community bank model for future generations of Americans. Community banks understand their borrowers and their specific needs. While technology continues to evolve and change the way we live and bank for the better, it still cannot by itself fulfill that unique and vital role. Today, there are more than 4,800 community banks in the United States. 80 percent of these have assets totaling less than $500 million, with roughly 40 full- and part-time employees, on average. The vast majority of these community banks are financially strong, and are the backbone of the towns and cities they serve, providing loans to individuals and businesses in the local area. But as customers' needs and goals evolve, community banks will need to evolve to meet them. The successful integration of financial technology into the community bank business model is proving to be enormously valuable to enable community banks to enhance the services they've already proven they can deliver effectively. Access to technology and services to meet customer needs is critical to ensuring community banks remain vibrant. For the remainder of my remarks, I will focus on my vision for creating pathways to responsible community bank innovation. In particular, I will discuss the promise and the challenges that smaller banks face in identifying, integrating, and deploying transformative new technologies, and I will offer some ideas for how the Federal Reserve can help community banks find and manage their relationships with service providers. Community banks have always been innovators, but rapid technology adoption is challenging for banks of all sizes. In most cases, realizing the potential that technology offers requires community banks to obtain services from other companies or products from core service providers, which I will refer to collectively as third-party providers. As I noted earlier, banks with less than $500 million in assets employ roughly 40 people on average--nowhere near the number required to exhaustively develop, test, and manage every element of novel technologies. In my discussions with bankers, they note that the process of selecting, initially vetting, and continuing to evaluate third-party service providers is onerous and presents obstacles to successful innovation. I agree that the cost of complying with some of our regulations and expectations for third-party relationships can pose an outsized and undue burden on smaller banks. These compliance costs are in some instances disproportionate to bank size, complexity, risk, and capacity and can be the same for a bank with $10 million in assets and a bank with $10 billion in assets. Further, expectations of due diligence when applied to a potential fintech partner may require more financial history or information than that partner can provide. Due diligence for new third-party relationships, even those that are not start-ups, can require a community bank to collect and analyze a significant amount of complex information. Also, the annual monitoring that is required adds an additional significant and ongoing burden. The process for managing the annual collection and review of the financials, audit results, and other operational compliance materials for multiple vendors can take weeks of time for several employees. Bank employees must review thousands of pages of documentation, and the workload per vendor can be the same for all banks, regardless of their asset size and number of employees. And as someone who has been involved in this compliance work, I know that it's not as if other responsibilities can wait--community bank employees often wear several hats. Community banks must weigh the benefit of any third-party relationship against the additional work required to evaluate the third party. And even when new product offerings emerge from service providers that already serve the bank, contract terms can be complicated to adjust, adding to the costs of obtaining technologies, which may ultimately be prohibitive. Flexible core systems are important for this reason. Collaboration between a bank and its core system provider is critical to ensure that technology solutions can be integrated quickly and cost effectively within the core system. Responsible innovation, especially for smaller institutions, requires two key aspects: a clear idea of how the technology serves a bank's strategic objectives and a regulatory environment that supports innovation. I will touch today on the important interplay between these factors, and in particular, the role that regulators can play in creating a regulatory environment that is conducive to innovation, preserves the safety and soundness of the financial system, and protects consumers. As regulators, we need to ensure that banks uphold sound risk-management practices. Yet we also have information that can help community banks meet those standards. We should closely examine opportunities to share that knowledge, subject to appropriate safeguards, in order to support innovation. Responsible innovation begins with a bank's strategy. Banks need to identify their goals and then look to identify the kinds of products and services that can help them move forward to implement that strategy. In the past, I have spoken about the importance of considering the impact of new technologies and finding ways to leverage them, if a bank feels that it fits into its business model and strategy. For community banks, a decision to embrace a new technology or innovation is almost always synonymous with third-party engagement. Regulators and supervisors can contribute to an environment where banks are empowered to achieve these strategic objectives, simplifying and clarifying the process of third-party selection, due diligence, and monitoring. A bank may decide that its business model should evolve, and that offering a new product or partnering with a fintech company will help it position itself for future growth. This decision is an essential one, but what comes next? This is a new world for most community banks, and supervisors and regulators can lend their expertise to those banks seeking to navigate the unfamiliar landscape. To that end, the Federal Reserve recently launched a web page on innovation and announced several upcoming Reserve Bank events. The innovation page on our website ) is intended to be a one-stop shop for supervisory information, publications, research, and international work that is related to technology innovation. Most importantly, the web page also facilitates interaction with Federal Reserve System specialists, to enable bankers and tech industry participants to submit questions about all aspects of technology in the financial services industry, or to request an in-person meeting. Essentially, to open a dialogue. We have also launched a series of Innovation Office Hours events hosted by Reserve Banks. These events incorporate panel discussions and face-to-face meetings for bankers with regulators and supervisors, which are intended to be a resource for both state member banks and fintech companies seeking partnerships with or offering services to banks. During these meetings, banks that attend the office hours will have an opportunity to share specific projects or proposed partnerships and learn about how regulators approach and consider risk management in those contexts. Regulators can also share their observations about effective implementation and risk-management practices across the sector. Equally important, the events provide regulators an opportunity to hear directly from banks and fintech companies about challenges to innovation. The office hours events will also include a panel discussion on innovation topics that will help to provide additional insights into new financial technologies. Our first office hours event will be held at the Federal Reserve Bank of Atlanta later this month. Additional events are planned later in the spring and throughout the rest of the year. These are an important opportunity for us to learn, and I look forward to hearing your feedback on these events. I'd like to turn next to another step in this process--the selection of a third-party provider. This step can be challenging given a lack of information about potential partners when many firms, and their product offerings, are new. Notably, in the 2019 National Survey of Community Banks, community bankers voiced a desire for more transparency into third-party service providers, to inform decisions about whether to enter into contracts with these providers and the type of contract that may be appropriate. In this regard, I believe the Federal Reserve should consider several possible steps. First, we should explore the possibility of publishing the list of service providers subject to supervision by the agencies. This could provide a starting point for community banks by sharing information about the types of companies providing services to a large number of financial institutions. Second, I believe we should increase transparency around our own practices. Through the banking agencies' service provider program, we regularly conduct examinations for and produce independent evaluations of certain providers of critical services. These exams are focused on risk management, audit, and internal controls. The Fed and other agencies have the statutory authority to oversee third-party providers that serve the banks they supervise. Providers that represent a significant level of risk to their clients are part of an interagency supervisory program. The agencies make the outcomes of those exams available to banks that are clients of a supervised service provider. I believe we can take a step further with increasing transparency on our supervisory program by making information that may be useful about our supervision of key service providers available to banks. This could take a number of forms, such as being more transparent about who and what we evaluate. Of course, moving forward in these areas requires careful consideration and interagency collaboration, and I have asked our staff to work with other agencies to develop and propose workable options for giving banks the benefit of the knowledge that supervisors have about their potential providers in an appropriate manner. Once banks seeking to innovate have navigated the selection process and identified a partner, they now face a complicated due-diligence process. I believe that regulators and supervisors have a role in easing the burden of that process for community banks in several respects. First, we could help by implementing clear third-party guidance that is consistent across all regulatory agencies. The Federal Reserve is in the process of working with the other banking agencies to update our third-party guidance. I believe that the banking agencies should all have consistent expectations for third-party relationships, and that the Federal Reserve should, as a starting point, move toward adopting the Office of the Comptroller of the Currency's (OCC) guidance. It is incredibly inefficient to have banks and their potential fintech partners and other vendors try to navigate unnecessary differences and inconsistencies in guidance across agencies. Second, this guidance should allow banks to conduct shared due diligence on potential partners. If several banks use the same third-party service provider and are open to collaborating, they should be allowed to pool resources instead of duplicating one another's work. Third, the guidance should explain what due diligence looks like for a potential fintech partner, because the standards applied to other third parties may not be universally applicable. For example, many fintech companies lack the kind of long financial history associated with more traditional bank vendors. Perhaps a fintech company has been around for only a few years. On its own, the fact that a bank cannot evaluate more than five years of the company's financials should not necessarily stop this company from being considered as a partner. Every bank has different objectives, and potential partnerships are not one-size-fits-all. Regulators should especially support partnerships that combine the strengths of community banks and fintech companies, which have a track record of success. The guidance should reflect some supervisory flexibility, and not impede prudent, strategic partnerships between community banks and potential partners. Fourth, in order to give community banks a better picture of what success in due diligence looks like, and where it begins and ends, I also believe that we should release more information on its necessary elements. This change would provide clarity and assist community banks in completing their work. In particular, I believe that regulators can provide more clarity on the types of questions that should be asked of a prospective third- party provider and our view of a satisfactory answer. Such a handbook would not only have the benefit of increasing transparency for community banks but could also be beneficial for fintech companies that hope to become third-party providers. Finally, I know from experience that once due diligence has concluded, the evaluation of third-party relationships is not over. As I noted earlier, monitoring can take weeks of work every year for community bank employees. To be sure, this work is an important part of risk management. But I believe regulators and supervisors have a role to play in ensuring that the burden is tailored to bank size, risk, complexity, and capacity. Knowing the burden that third-party monitoring can present to employees of the smallest banks, I have encouraged Federal Reserve staff to consider options for further tailoring our expectations for community banks with assets under $1 billion in this area. We should be mindful that when we apply the same expectations to banks with starkly different asset sizes, we are creating the same workload for a bank with about 30 employees as for a bank with roughly 180 employees, even though their resources and risk profiles are quite different. To conclude, I believe that we can create a regulatory environment in which community banks are empowered to innovate, in which supervisors leverage their own knowledge to help banks understand what to look for in a service provider. It's a regulatory environment in which guidance is clear and supervisors are appropriately flexible, and due diligence and third-party evaluations are appropriately scaled. Every bank must decide for itself whether and how to adapt their business models to new technologies, but supervisors and regulators can facilitate innovation at a few key milestones on that path forward. First, supervisors and regulators can serve as a resource for banks navigating the financial technology landscape for the first time, and make subject-matter experts accessible. Second, we can make the process of selecting a partner appropriate for a bank's business strategy a more informed one, by being more transparent about our own supervisory program for certain service providers. Third, we can facilitate vetting of potential partners by allowing shared due diligence, providing in our guidance specific expectations for partnerships with fintech companies, and publishing a handbook of sound practices in due diligence. Finally, we can reduce burden on banks as they continue to evaluate risk at third-party providers, by rightsizing our expectations and sharing more information about our supervisory program. Capacity, in addition to complexity and size, should be considered as we continue to tailor supervisory expectations. As we work toward the environment I described, communication between regulators, supervisors, banks, and fintech partners must be frequent, and confusion about compliance requirements must not be an impediment to banks who wish to partner with third parties. I believe the steps I have laid out today are a promising beginning to making this regulatory environment a reality.

r200211a_FOMC

united states

Spontaneity and Order: Transparency, Accountability, and Fairness in Bank Supervision

quarles

It's a great pleasure to be with you today at Yale Law School to deliver this I first arrived here at the Yale Law School on a sunny September afternoon almost 40 years ago, and I have a very clear memory of the first time I sat in this hall, not long after, to hear a lecture from a worthy public servant come to deliver wisdom to those who thought they might one day follow in his footsteps. It was Gene Rostow, former Dean of the Law School, former Under Secretary of State, then serving as head of the Arms impression of erudition and experience he conveyed. I remember the sense of tradition, sitting here in these wood-paneled surroundings, being addressed with respect on issues of consequence. There was a sense then, in the early 1980's--which turned out to be correct -- that the Cold War could be reaching its climax, and widespread concern among the great and good in the country (not least among them the Yale Law School faculty) that the more aggressive stance of the Reaganites (not least among them Gene Rostow) greatly increased the odds of a miscalculation. And here was the man himself, patiently but boldly discussing the state of the world with a group of first-year law students. I remember that he referred more than once to Don Quixote, and this Brooklyn- born American pronounced it in the British way--Dun Quixit--which I found oddly both affected and endearing at the same time. And I remember absolutely nothing else of what he said. Not a word. Which puts me in a properly humble frame of mind for my own remarks today. You won't remember for very long anything I say here today, but I hope your time at the Law School gives you the same experience of patiently but boldly examining matters of consequence that I found to be the most valuable and lasting legacy of my own time here in New Haven. The themes and goals of this speech are objectives I will be pursuing over the next year and should resonate for this audience. I trust they will be helpful to you all and foster further discussions about the importance of transparency, accountability, and fairness in regulation generally and also in the increasingly important and increasingly consequential topic of bank supervision. Twenty years ago when I was in private practice, a lecture on bank supervision would have been my cue to pull out my BlackBerry and start checking my emails. The structure and content of regulation was both intellectually interesting and professionally meaningful; I considered bank supervision , by contrast, as both too workaday and too straightforward to merit the commitment of much legal horsepower or personal attention. I could perhaps have been excused by the callowness of youth, yet it was a common view at the time. Having now been immersed for the last two years both in the practice of supervision and in the complementary relationship between the regulatory and supervisory processes, I realize that this wasn't true then, and is certainly not true now. It is not a drafting accident that the Dodd Frank Act gave my position at the Federal Reserve the title of Vice Chairman for . Notwithstanding the extensive reform of bank regulation after the crisis, which has had much consequence for the industry (most of it salutary), it is the process of examination and supervision that constitutes the bulk of our ongoing engagement with the industry and through which our policy objectives are given effect. This division of labor is important for lawyers and policymakers to think about deeply because the processes of regulation and supervision are necessarily different in crucial respects. Regulation establishes a binding public framework implementing relevant statutory imperatives. Because a rule is designed to apply generally, rules must be based on general principles intended to achieve general aims, rather than reverse- engineered to generate specific effects for specific institutions. Given their general applicability, there must be a general process for all those with an interest--industry, academics, citizens, Congress--to have notice of, and opportunity to comment on all rules, ensuring that all potential effects and points of view are taken into account in the rule's crafting. And given their general function, rules must be clear and public: those affected must know what to expect and what is expected. Supervision, by contrast, implements the regulatory framework through close engagement with the particular facts about particular firms: their individual capital and liquidity positions, the diverse composition of their distinct portfolios of assets, their business strategies, the nature of their operations, and the strengths and weaknesses of their management. Bank supervisors review and analyze bank information and interact with bank management, enabling them to make necessary judgments about the bank's safety and soundness. Much of the granular information used by supervisors is, accordingly, proprietary and confidential, and many of their judgments and decisions are closely tailored to specific circumstances. Given the strong public interest in the safe, sound, and efficient operation of the financial industry and the potential for hair-raising and widespread adverse social consequences of private misjudgment or misconduct in that industry, close and regular supervision of this sort can help us all sleep restfully. Yet, the confidential and tailored nature of supervision sits uncomfortably with the responsibilities of government in a democracy. In the United States, we have a long-standing, well-articulated framework for ensuring that regulations conform with the principles of generality, predictability, publicity, and consultation described above. Supervision--for good reason, in my view--is not subject to this formal framework. But it is currently not subject to any specific process constraint promoting publicity or universality. This leaves it open to the charge, and sometimes to the fact, of capriciousness, unaccountability, unequal application, and excessive burden. Here, then, is a conundrum. We have a public interest in a confidential, tailored, rapid-acting, and closely informed system of bank supervision. And we have a public interest in all governmental processes being fair, predictable, efficient, and accountable. How do we square this circle? In my time with you today, we will not do more than scratch the surface of this question. It is a complex and consequential issue that, for decades now, has received far too little attention from practitioners, academics, policymakers, and the public. Evaluating this question will be a significant focus of mine going forward, and I hope that there will be much discussion in many fora from which we at the Fed, and at other regulators, can learn. So today, I simply want to open the exploration of some these conceptual issues, and then offer some specific suggestions-- by no means comprehensive--on some obvious and immediate ways that supervision can become more transparent, efficient, and effective. Let me begin by delving a little more deeply into the distinction between regulation and supervision and the process applicable to both. In granting to agencies such as the Fed the significant power to write regulations, Congress has codified a regulatory process that emphasizes transparency. This process was born in the 1930s, in the tumult of government expansion that was the New Deal, when Congress began a decade-long debate over how to manage the new regulatory state. The result was the public disclosure and participation required for agency rule-writing and for the judicial review affected parties are guaranteed to challenge rules. This transparency is intended to prevent arbitrary, capricious, and thus ineffective regulation by inviting broad public participation and mandating a deliberate public debate over the content of proposed rules. One obvious purpose of this transparency is to provide clarity and predictability: it helps make clear how agencies are considering exercising their discretion. The significant process protections in laws such as the APA are also meant to ensure fairness. The wisdom behind this approach is that fairness both helps bring forth more considered and effective regulations and builds respect for and adherence to the law, which is essential for enforcement. Transparency is central to our ability to assert that our rules are fair. Not everything that government does, however, can be accomplished in exactly the same way that regulations are written. One of these things is bank supervision. Banks are subjected to supervision, in addition to regulation, as an additional form of government oversight because of their complexity, opacity, vulnerability to runs, and indispensable role in the economy, enabling payments, transmitting monetary policy, and providing credit. The government provides a safety net to banks in the form of deposit insurance, and in return, banks are subject to government oversight that mimics some of the monitoring that the private sector would provide, absent the government safety net. The bank regulatory framework sets the core architectural requirements for the banking system, but it isn't enough to set the rules and walk away like Voltaire's god. The potential consequences of disruption in the financial system are so far-reaching, and the erosion of market discipline resulting from the government safety net sufficiently material, that it is neither safe nor reasonable to rely entirely on after-the-fact enforcement to ensure regulatory compliance. Supervisors are in a good position to monitor individual firms' idiosyncratic risks. And in addition to what they do at individual banks, supervisors monitor for risk that may be building among clusters of banks or across the banking system. These "horizontal" exams across multiple banks help highlight new or emerging risks and help examiners understand how banks are managing these risks. Through their engagement with banks, supervisors promote good risk management and thus help banks preemptively avert excessive risk taking that would be costly and inefficient to correct after the fact. Where banks fall materially out of compliance with a regulatory framework or act in a manner that poses a threat to their safety and soundness, supervisors can act rapidly to address the failures that led to the lack of compliance or threat to safety and soundness. This is a crucial point: supervision is most effective when expectations are clear and supervision promotes an approach to risk management that deters bad behavior and decisions by banks. Clearly communicating those expectations is essential to effective supervision, and in a larger sense, clear two-way communication is the essence of effective supervision. Supervisors rely on banks to be frank and forthcoming, and supervisors in turn can help secure that frankness by explaining what their expectations are and why their expectations are reasonable, not arbitrary or capricious. Greater transparency in supervision about the content of our expectations and about how we form our expectations and judgments can make supervision more effective by building trust and respect for the fairness and rationality of supervision. I don't believe the Federal Reserve has communicated as clearly as it could with the banks we supervise. More transparency and more clarity about what we want to achieve as supervisors and how we approach our work will improve supervision, and I have several specific proposals, which I have discussed in more detail than I will get into today and plan to implement expeditiously. Broadly speaking, these actions fall into three categories: (1) large bank supervision, (2) transparency improvements, and (3) overall supervisory process improvements. Let me briefly touch on some of the specific changes I will pursue, and which flow from the themes I have just discussed. And as a disclaimer, I should note that previously I have mentioned more specifics, so this abbreviated list should not be taken as a ranking or indication that certain ideas have fallen out of favor. First, I would mention that we should pursue a clear and transparent standard that aligns our supervisory portfolios, and by extension the intensity of our supervision, with categories established in our recent regulatory tailoring rules. Last fall, we completed a cornerstone of the recent banking legislation to tailor our rules for large banks. This change would be entirely consistent with a principle at the heart of our existing work: Firms that pose greater risks should meet higher standards and receive more scrutiny. To carry forward this work aligning supervision with the regulatory tailoring rules, I believe there is a compelling justification to make changes today to the composition of foreign banks in our portfolio of the largest banks, known as LISCC. Second, as I have discussed throughout my time at the Board, I continue to look for ways to make our stress tests more transparent without making them game-able and without diluting their potency as a supervisory tool. I expect that we will continue to provide more transparency on the models we use for the stress tests, and on the hypothetical scenarios. Additionally, I am advocating changes to our capital plan rule that will allow banks to receive and study their supervisory stress testing results prior to submitting their capital plans. Currently, banks have a very limited time to adjust their capital distribution plans and only under limited circumstance. Third, and principally as a transparency endeavor, I would endorse creating a word-searchable database on the Board's website with the historical interpretations by the Board and its staff of all significant rules. Regulatory interpretations by Board staff have grown piecemeal over the decades and haven't consistently been treated as the valuable resource they are. The Board's website has select interpretations of many laws but does not provide a comprehensive, user-friendly collection of regulatory interpretations, FAQs, and commentary. Fourth, I endorse putting significant supervisory guidance out for public comment. The Board already invites comments on its regulations, as required under the APA, and regularly invites comment on some supervisory guidance and statements of policy. This practice of seeking comment on significant guidance leads to better, more informed supervision and better engagement by banks. And fifth, the Board should adopt a rule on how we use guidance in the supervisory process. I would expect the rule to state that the Board will follow and respect the limits of administrative law in carrying out its supervisory responsibilities. In particular, consistent with the September 2018 interagency statement on guidance, we would affirm the sensible principles that guidance is not binding and "non-compliance" with guidance may not form the basis for an enforcement action (such as a cease-and- This rule would be binding on the Board and on all staff of the Federal Reserve System, including bank examiners. There are of course other ideas I have mentioned and will be pursuing, but this partial list should be informative and helpful in illustrating the earlier themes I mentioned. The changes to supervision since the crisis have made the financial system stronger and more resilient than it was before. The incremental changes I am considering, to increase transparency, accountability, and fairness, would make supervision more efficient and effective, and our financial system stronger and more stable. Obviously, the incremental changes to our supervisory processes I am considering do not completely answer the question with which I began my remarks today: how can we square the public interest in agile supervision with the public interest in transparency and accountability? This should be an ongoing question of high priority, both at the Fed and more broadly among those who care about our system of financial regulation. Equally obviously, however, these suggestions would strengthen our practice of supervision and increase the vigor and credibility of our supervisors.

r200221b_FOMC

united states

Monetary Policy Strategies and Tools When Inflation and Interest Rates Are Low

brainard

I want to thank Anil Kashyap and the Initiative on Global Markets for inviting me, along with my colleague Raphael Bostic, to comment on this year's U.S. Monetary Policy Forum report by a distinguished set of authors. This year's report addresses the challenges that monetary policy is likely to encounter in the next downturn. This topic is under active review by the Federal Reserve and our peers in many other economies. The report explores the important question of whether the new monetary policy tools are likely to be sufficiently powerful in the next downturn. The report assesses how unconventional tools--including forward guidance, balance sheet policies, negative nominal interest rates, yield curve control, and exchange rate policies--have performed over the past few decades. It employs a novel approach by examining the effect on an index of financial conditions the authors construct. This approach adds to what we have learned from earlier papers that have examined the performance of unconventional policy tools with respect to individual components of financial conditions--most notably, long- term sovereign yields, but also mortgage rates, equities, exchange rates, and corporate debt spreads. Empirically assessing the question in the report is not only important, but also challenging, as the report readily acknowledges. There are a host of difficult endogeneity and omitted-variable issues, which the authors endeavor to address. The authors conclude that unconventional monetary policies worked during the crisis but did not fully offset a significant tightening in financial conditions. This finding leads the authors to conclude that these policies should be deployed quickly and aggressively in the future through a plan that is communicated in advance. This point is very important, so it will be the focus of my discussion. Looking back at the international experience, the evidence suggests that forward guidance and balance sheet policies were broadly effective in providing accommodation following the financial crisis. But they were less effective when there were long delays in implementation or apparent inconsistencies among policy tools. It is important to distill key lessons from the past use of these tools in order to make them more effective in the future. First, in some cases around the world, unconventional tools were implemented only after long delays and debate, which sapped confidence, tightened financial conditions, and weakened recovery. The delays often reflected concerns about the putative costs and risks of these policies, such as stoking high inflation and impairing market functioning. These costs and risks did not materialize or proved manageable, and I expect these tools to be deployed more forcefully and readily in the future. Second, forward guidance proved to be vital during the crisis, but it took some time to recognize the importance of conditioning forward guidance on specific outcomes or dates and to align the full set of policy tools. In several cases, the targeted outcomes set too low a bar, which in turn diminished market expectations regarding monetary accommodation. In some cases, expectations regarding the timing of liftoff and asset purchase tapering worked at cross-purposes. In addition, in some cases, it proved difficult to calibrate asset purchase programs smoothly over the course of the recovery. To the extent that the public is uncertain about the conditions that might trigger asset purchases, the scale of purchases, and how long the purchases might be sustained, it could undercut the efficacy of the policy. Furthermore, the cessation of asset purchases and subsequent balance sheet normalization can present challenges in communications and implementation. Finally, in the fog of war, it was difficult for policymakers to distinguish clearly between temporary headwinds associated with the crisis and emerging structural features of the new normal. In part as a result, it took some time to integrate forward guidance and other unconventional policies seamlessly, and it took even longer to recognize that policy settings were unlikely to return to pre-crisis norms. The current generation of central bankers faces a different core challenge than the last generation, with substantially smaller scope for cutting interest rates to buffer the economy and inflation that is low and relatively unresponsive to resource utilization. With trend inflation running below the symmetric 2 percent objective, there is a risk that inflation expectations have slipped. With price inflation showing little sensitivity to resource utilization, policy may have to remain accommodative for a long time to achieve 2 percent inflation following a period of undershooting. With the equilibrium interest rate very low, the Federal Open Market Committee can cut the federal funds rate by only about half as much as it has done historically to buffer the economy from recession. Consequently, the policy rate is likely to be constrained by the lower bound more frequently, likely at times when inflation is below target and unemployment is elevated. The likelihood that the policy rate will be stuck at the lower bound more frequently risks eroding expected inflation and actual inflation, which could further compress the room to cut nominal interest rates in a downward spiral. Japan's experience illustrates the challenges associated with such a downward spiral. Today's new normal calls not only for a broader set of tools, but also a different strategy. We should clarify in advance that we will deploy a broader set of tools proactively to provide accommodation when shocks are likely to push the policy rate to its lower bound. Equally important, we should adopt a strategy that successfully achieves maximum employment and average inflation outcomes of 2 percent over time. The lessons from the crisis would argue for an approach that commits to maintain policy at the lower bound until full employment and target inflation are achieved. This forward guidance could be reinforced by interest rate caps on short-term Treasury securities over the same horizon. To have the greatest effect, it will be important to communicate and explain the framework in advance so that the public anticipates the approach and takes it into account in their spending and investment decisions. Forward guidance that commits to refrain from lifting the policy rate from its lower bound until full employment and 2 percent inflation are achieved is vital to ensure achievement of our dual-mandate goals with compressed conventional policy space. strengthen the credibility of the forward guidance, interest rate caps could be implemented in tandem as a commitment mechanism. Based on its assessment of how long it is likely to take to achieve full employment and target inflation, the Committee would commit to capping rates out the yield curve for a period consistent with its expectation for the duration of the outcome-based forward guidance. Of course, if the outlook shifted materially, the Committee could reassess how long it will take to reach its goals and adjust policy accordingly. One important benefit is that this approach would smoothly move to capping interest rates on the short-to-medium segment of the yield curve once the policy rate moves to the lower bound and avoid the risk of delays or uncertainty that could be associated with asset purchases regarding the scale and timeframe. The interest rate caps would transmit additional accommodation through the longer rates that are relevant for households and businesses in a manner that is more akin to conventional policy and more continuous than quantitative asset purchases. Another important benefit is that the forward guidance and the yield curve caps would reinforce each other. Setting the horizon on the interest rate caps to reinforce forward guidance on the policy rate would augment the credibility of the yield curve caps and thereby diminish concerns about an open-ended balance sheet commitment. Once target inflation and full employment are achieved, and the caps expire, any short-to- medium-term Treasury securities that were acquired under the program would roll off organically, unwinding the policy smoothly and predictably. This approach should avoid some of the tantrum dynamics that have led to premature steepening of the yield curve in several jurisdictions. Today's low-inflation, low interest rate environment requires not only new recession-fighting tools but also a new strategy to address the persistent undershooting of the inflation target--and the risk to inflation expectations--well before a downturn. Various strategies have been proposed that seek to make up for past inflation deviations from target. To be successful, formal makeup strategies, such as an average-inflation- targeting rule, require that market participants, households, and businesses understand the policy in advance and find it credible. While formal average-inflation-targeting rules have some attractive properties in theory, they could be difficult to communicate and implement in practice due to time-inconsistency problems as well as uncertainty about underlying economic parameters. I prefer flexible inflation averaging that would aim to achieve inflation outcomes that average 2 percent over time. Flexible inflation averaging would imply supporting inflation a bit above 2 percent for some time to compensate for the inflation shortfall over previous years and anchor inflation expectations at 2 percent. Flexible inflation averaging would bring some of the benefits of a formal average-inflation-targeting rule, but it could be more robust and simpler to communicate and implement. Following several years when inflation has remained in the range of 1-1/2 to 2 percent, the Committee could target inflation outcomes in a range of 2 to 2-1/2 percent for a period to achieve inflation outcomes of 2 percent, on average, overall. By committing to achieve inflation outcomes that average 2 percent over time, the Committee would make clear in advance that it would accommodate rather than offset modest upward pressures to inflation in what could be described as a process of opportunistic reflation. This approach will help move inflation expectations back to our 2 percent objective, which is critical to preserve conventional policy space. It is important to emphasize that for monetary policy to be effective, it will be key for policymakers to communicate their strategy clearly in advance to the public, to act early and decisively, and to commit to providing the requisite accommodation until full employment and target inflation are sustainably achieved. This was one of the important Even with a revamped monetary policy strategy and expanded tools, there are risks. As the authors note, persistent very low levels of long-run rates could hamper the ability of monetary policy to support the economy in a downturn through the traditional mechanism of pushing down long-term rates. Moreover, the equilibrium interest rate or, possibly, inflation expectations could be lower than most current estimates, with the implication that unconventional policies would need to compensate for a larger reduction in the conventional policy buffer. Accordingly, in addition to a forceful response from monetary policy, robust countercyclical fiscal policy is vital. The reduced conventional monetary policy buffer makes the importance of fiscal support during a downturn even greater than it has been in the past, and the case for fiscal support is especially compelling in the context of very low long-term interest rates. Not only is fiscal policy more vital when monetary policy is constrained by the lower bound, but research suggests it is also more powerful. Whereas monetary policy is powerful but blunt, fiscal policy can be more targeted in its effects. This is especially important today, when a large share of American households have low liquid savings and are particularly vulnerable to periods of unemployment or underemployment. The appropriate design of a more automatic, faster-acting countercyclical fiscal approach requires study and development. Just as monetary policymakers are actively reviewing their tools and strategies, now is the time to undertake a review of fiscal tools and strategies to ensure they are ready and effective. Financial stability is central to the achievement of our dual-mandate goals. The new normal of low interest rates and inflation also has implications for the interplay between financial stability and monetary policy. In the decades when the Phillips curve was steeper, inflation tended to rise as the economy heated up, which would prompt the Committee to raise interest rates to restrictive levels. These interest rate increases would have the effect of tightening financial conditions more broadly, thereby naturally damping financial imbalances as the expansion extends. With trend inflation persistently below target and a flat Phillips curve, not only is the policy rate expected be low for long due to the decline in the neutral rate, but the policy rate may also remain below the neutral rate for longer in order to move inflation back to target sustainably. The expectation of a long period of accommodative monetary policy and low rates, during a period with sustained high rates of resource utilization, is conducive to risk-taking, providing incentives to reach for yield and take on additional debt. To the extent that the combination of a low neutral rate, a flat Phillips curve, and low underlying inflation may lead financial imbalances to become more tightly linked to the business cycle, it is important to use tools other than monetary policy to temper the financial cycle. In today's new normal, a combination of strengthened structural safeguards along with countercyclical macroprudential tools is important to enable monetary policy to stay focused on achieving maximum employment and target inflation. The countercyclical capital buffer, which was not available before the crisis, is particularly well designed to address financial imbalances over the cycle. With the policy rate more likely to be constrained by the lower bound, the core challenge facing the current generation of central bankers is different than the last generation. The authors of the report emphasize the importance of deploying an expanded toolkit proactively, avoiding costly delays, and communicating clearly to the public. To be fully effective, proactive use of an expanded toolkit needs to be coupled with a new strategy that achieves average inflation outcomes of 2 percent along with maximum employment over time.

r200221a_FOMC

united states

Financial Markets and Monetary Policy: Is There a Hall of Mirrors Problem?

clarida

Thank you to the conference organizers for inviting me here to discuss what former Chair Bernanke has famously referred to as a "hall of mirrors" problem: a situation in which a central bank's reaction function and financial market prices interact in economically suboptimal and potentially destabilizing ways. In my remarks today, I will lay out the way I think about the interplay between financial markets and monetary policy, with a focus on how I myself seek to integrate noisy but often correlated signals about the economy that I glean from models, surveys, and financial markets. I begin with three unobjectionable observations. First, because of Friedman's long and variable lags, monetary policy should be--and, at the Fed, is--forward looking. Policy decisions made today will have no effect on today's inflation or unemployment rates, so good policy needs to assess where the economic fundamentals are going tomorrow to calibrate appropriate policy today. Of course, financial markets are also forward looking. An asset's value today depends upon its expected future cash flows discounted by a rate that reflects the expected path of the policy rate plus an appropriate risk premium. Thus, central banks and financial markets are looking at the same data on macro fundamentals to make inferences about the future path of the economy, and, of course, any decisions on the policy path made by the central bank will influence asset prices through the discount factor. So optimal monetary policy will (almost) always be correlated with asset prices. Correlation is not evidence of causation, and the hall of mirrors problem at its essence is about inferring causation from correlation. Second, because key variables that are crucial inputs for conducting monetary policy--such as r*, u*, and expected inflation, to name just three--are both unobserved and time varying, responsible monetary policy requires informed views about how these variables evolve over time as well as a humility and an appreciation for the uncertainties surrounding baseline views, however well informed they might be. Third, when trying to make an inference about unobserved variables like r* or expected inflation, it is generally a good idea to seek data from multiple signals correlated with the variable of interest, so long as the signals themselves are not perfectly correlated with one another. Think of this third unobjectionable observation as a sort of "model averaging" or "triangulation" principle of robust inference in a noisy and complex environment. As I have written before, monetary policy needs to be--and, at the Fed, is-- "data dependent" in two distinct ways. Policy should be data dependent in the sense that incoming data indicate the position of the economy relative to the ultimate objectives of price stability and maximum employment. This information on where the economy is relative to the goals of monetary policy is an important input into standard interest rate feedback rules, such as those introduced by John Taylor in 1993 and ones that continue today to inform monetary policy decisions at the Fed and at other central banks. Monetary policy, however, also needs to be data dependent in the second sense-- that incoming data contain signals--that can enable the central bank to update its estimates of r* and u* in order to obtain its best estimate of the destination to which the economy is heading. As I mentioned a moment ago, a challenge for policymakers is that key variables that are essential inputs to monetary policy--such as u*, r*, and expected inflation--cannot be observed directly and must be inferred from observed data. And as (FOMC) participants have, over the past seven years, repeatedly revised down their estimates of both u* and r* as unemployment fell and as real interest rates remained well below previous estimates of neutral without the rise in inflation those earlier estimates would have predicted. I would argue that these revisions to u* and r* indicate that the FOMC has been data dependent in this second sense and that these updated assessments of u* and r* have had an important influence on the path for the policy rate actually implemented in recent years. Indeed, had the Fed not been data dependent in this second sense and remained closed to the possibility that the economy had changed and historical estimates of r* and u* needed to be revised, that stubbornness would have represented a material policy mistake. In addition to u* and r*, an important input into any monetary policy assessment is the state of inflation expectations. One of the robust messages from the DSGE (dynamic stochastic general equilibrium) literature on optimal monetary policy is that, away from the effective lower bound, optimal monetary policy will not eliminate all inflation volatility--there are always shocks--but will, under rational expectations (RE), deliver average, and under RE, expected, inflation equal to the target. Since the late 1990s, inflation expectations appear to have been stable and well anchored in the neighborhood of our 2 percent goal. However, like r* and u*, inflation expectations are not directly observable and so must be inferred from data. But which data? Let me now discuss in more detail how I use a form of model averaging to combine financial market data with data from surveys and econometric models to inform my thinking about the evolution of two key inputs to monetary policy: r* and long-run expected inflation. To be sure, financial market signals are noisy, and day-to-day movements in asset prices are unlikely to tell us much about the cyclical or structural position of the economy, let alone r* and expected inflation. However, persistent shifts in financial market conditions can be informative. Signals derived from financial market data, when combined with signals revealed from surveys of households and firms along with the filtered estimates from econometric models, can together provide valuable and reasonably robust foundations for real-time inference about the direction of travel in r* and expected inflation. For example, a "straight read" of interest rate futures prices provides one source of high-frequency information about the destination for the federal funds rate expected by market participants. The destination for the federal funds rate implied by a straight read of futures prices is in turn the sum of the market-implied r* plus market-implied expected inflation. But these signals from interest rate futures are only a pure measure of the expected policy rate path under the assumption of a zero risk premium. For this reason, it is useful to compare policy rate paths derived from market prices with the path obtained from surveys of market participants, which, while subject to measurement error, should not be contaminated with a term premium. Market- and survey-based estimates of the policy rate path are often highly correlated. But when there is a divergence between the path or destination for the policy rate implied by the surveys and a straight read of interest rate derivatives prices, I place at least as much weight on the survey evidence-- for example, derived from the surveys of primary dealers and market participants conducted by the Federal Reserve Bank of New York--as I do on the estimates obtained from market prices. Finally, as another reality check, I, of course, always consult the latest estimate of r* produced by the Laubach and Williams (2003) unobservable components state-space model, which, I should point out, includes no information on asset prices other than the short-term nominal interest rate itself. provide valuable information about both r* and expected inflation. TIPS market data, together with nominal Treasury yields, can be used to construct measures of "breakeven inflation" or inflation compensation that provide a noisy signal of market expectations of future inflation. But, again, a straight read of breakeven inflation based on TIPS curve forward real rates needs to be augmented with a model to filter out the liquidity and risk premium components that place a wedge between inflation compensation and expected inflation. It is again useful to compare estimates of expected inflation derived from breakeven inflation data with estimates of expected inflation obtained from surveys--for example, the expected inflation over the next 5 to 10 years from the University of Michigan Surveys of Consumers. Market- and survey-based estimates of expected inflation are correlated, but, again, when there is a divergence between the two, I place at least as much weight on the survey evidence as on the market-derived estimates. Again, here I also consult time-series models of underlying inflation, such as Stock and Watson At the Fed, the staff have estimated a state-space model decomposition of the common factor that drives a number of different measures of inflation expectations. State-space econometrics is one formal way to do model averaging. As I look at all of this evidence from market signals, surveys, and econometric models, I judge that inflation expectations reside at the low end of the range I consider consistent with our price-stability goal of 2 percent personal consumption expenditure inflation in the long run. In both of the examples I have just discussed, the medium-frequency evolution of market-based, survey-based, and model-based estimates of r* and expected inflation have, over time, tended to move broadly together. When high-frequency market signals diverge from the survey- and model-based estimates, the potential benefit from increasing the weight on a signal derived from a forward-looking asset price versus backward estimates from models and slowly evolving surveys must be balanced against the cost of treating the noise in the asset price as a signal. There is no unique way to do this, and judgment is required. In conclusion, while my colleagues and I are attuned to the potential for a hall of mirrors problem, in my experience this affliction is one the Federal Reserve guards against and does not suffer from. My colleagues and I do look at developments in asset markets, but never in isolation and always in the context of balancing asset market signals with complementary signals from surveys and econometric models. It is fair to say that when signals from all three sources line up in the same direction--as, for example, has been the case with market-, survey-, and model-based estimates of r*--the effect of those combined signals, at least on my thinking about the policy path, is more material than when the signals provide conflicting interpretations. Thank you for your attention. I look forward to hearing from the other panelists and to our discussion.

r200225a_FOMC

united states

U.S. Economic Outlook and Monetary Policy

clarida

Thank you for the opportunity to participate again this year in the Annual really looking forward to this conversation. But first, I would like to share with you some thoughts about the outlook for the U.S. economy and monetary policy. In its 11th year of a record expansion, the U.S. economy is in a good place. The labor market remains strong, economic activity is increasing at a moderate pace, and the performance in 2020. At present, personal consumption expenditures, or PCE, price inflation is running somewhat below the Committee's 2 percent objective, but we project that, under appropriate monetary policy, inflation will rise gradually to our symmetric 2 percent objective. Although the unemployment rate is around a 50-year low, wages are rising broadly in line with productivity growth and underlying inflation. We are not seeing any evidence to date that a strong labor market is putting excessive cost-push pressure on price inflation. Although the fundamentals supporting household consumption remain solid, over 2019, sluggish growth abroad and global developments weighed on investment, exports, and manufacturing in the United States. Coming into this year, indications suggested that headwinds to global growth had begun to abate, and uncertainties around trade policy had diminished. However, risks to the outlook remain. In particular, we are closely monitoring the emergence of the coronavirus, which is likely to have a noticeable impact on Chinese growth, at least in the first quarter of this year. The disruption there could spill over to the rest of the global economy. But it is still too soon to even speculate about either the size or the persistence of these effects, or whether they will lead to a material change in the outlook. In addition, U.S. inflation remains muted. And inflation expectations--those measured by surveys, market prices, and econometric models-- reside at the low end of a range I consider consistent with our price-stability mandate. Over the course of 2019, the FOMC undertook a shift in the stance of monetary policy to offset some significant global growth headwinds and global disinflationary pressures. I believe this shift was well timed and has been providing support to the economy and helping to keep the U.S. outlook on track. Monetary policy is in a good place and should continue to support sustained growth, a strong labor market, and inflation returning to our symmetric 2 percent objective. As long as incoming information about the economy remains broadly consistent with this outlook, the current stance of monetary policy likely will remain appropriate. That said, monetary policy is not on a preset course. The Committee will proceed on a meeting-by-meeting basis and will be monitoring the effects of our recent policy actions along with other information bearing on the outlook as we assess the appropriate path of the target range for the federal funds rate. Of course, if developments emerge that, in the future, trigger a material reassessment of our outlook, we will respond accordingly. In January 2019, my FOMC colleagues and I affirmed that we aim to operate with an ample level of bank reserves in the U.S. financial system. And in October, we announced and began to implement a program to address pressures in repurchase agreement (repo) markets that became evident in September. To that end, we have been purchasing Treasury bills and conducting both overnight and term repurchase operations. These efforts have been successful in achieving stable money market conditions, including over the year-end. As our bill purchases continue to build reserves toward levels that we associate with ample conditions, we intend to gradually transition away from the active use of repo operations. And as reserves reach durably ample levels, we intend to slow the pace of purchases such that our balance sheet grows in line with trend demand for our liabilities. Let me emphasize that we stand ready to adjust the details of this program as appropriate and in line with our goal, which is to keep the federal funds rate in the target range desired by the FOMC, and that these operations are technical measures not intended to change the stance of monetary policy. Finally, allow me to offer a few words about the FOMC's review of the monetary policy strategy, tools, and communication practices that we commenced in 2019. This review--with public engagement unprecedented in scope for us--is the first of its kind events, including a research conference in Chicago, we have been hearing a range of perspectives not only from academic experts, but also from representatives of consumer, labor, community, business, and other groups. We are drawing on these insights as we assess how best to achieve and maintain maximum employment and price stability. In July, we began discussing topics associated with the review at regularly scheduled FOMC meetings. We will continue reporting on our discussions in the minutes of FOMC meetings and will share our conclusions with the public when we complete the review later this year. Thank you very much for your time and attention. I look forward to the conversation and the question-and-answer session to follow.

r200227a_FOMC

united states

Direction of Supervision: Impact of Payment System Innovation on Community Banks

bowman

It is a pleasure to be here today. I appreciate the invitation to speak to you as part think this year's theme, , captures the dynamic and evolving landscape of our country's financial system well. Advances in technology are occurring at a rapid pace and present the opportunity to make our financial system safer and more efficient for more Americans. From faster payments to artificial intelligence, technological advancements touch nearly every aspect of our financial system and affect institutions of every type. As the first Federal Reserve governor to serve in the role designated by Congress for someone with community banking experience, I am especially interested in the impact these kinds of advancements may have on community banks. I am also committed to ensuring that as policymakers and supervisors navigate the intricacies of today's digital world, we do so in a way that considers the important role of community banks in cities and towns and rural communities across the country, and our nation's financial system more broadly. To that end, I believe the Federal Reserve is well positioned to support innovation and the future of banking in a way that ensures our nation's evolving financial system works for community banks and the customers they serve. So I would like to spend my time with you today focusing on how the Federal Reserve can achieve this objective in one specific area, that of our nation's payment system. As many of you may know, before joining the Federal Reserve, I was a community banker and more recently had the privilege to serve as the Kansas State Bank Commissioner. I have seen firsthand the vital role that our nation's community banks play in the financial industry and in the economy more broadly. Through the services they provide, community banks help support strong cities, towns, and rural communities across the country, which are central to a vibrant economy. For example, small business lending is an essential part of community bank portfolios. Many community banks often specialize in serving small businesses, which account for the majority of new job creation in the country. In fact, community banks hold 48 percent of all loans to small businesses and farms in the United States. Community banks are also often seen by their customers as an important source of financial advice and a source of civic leadership. Community banks have a deep understanding of their local areas. They also have close relationships with those living in the communities they serve and the organizations that serve those communities. In many instances, community banks are also serving markets that tend to be neglected by larger banks. These connections allow community banks to focus on specific local needs to provide a variety of services, which often include tailored and innovative products. Payment services in particular are a key component of these relationships and are essential to the role of banks in their communities. Community banks help ensure that consumers and businesses can safely and efficiently access and move their money. By doing so, the payment services they provide act as the foundation for economic activities that help cities, towns, and rural communities grow and thrive, which in turn is essential to a strong and stable financial system. A strong and stable financial system also depends on the smooth functioning of the nation's payment system. Today, many Americans take the ability to move money across the country safely and efficiently for granted, but history shows that payment system disruptions can affect the economy more broadly. In the past, our nation's payment system was fragmented and inefficient, creating costs for consumers, merchants, banks, and, ultimately, the U.S. economy. For example, before the Federal Reserve was established, check clearing fees and banks' efforts to avoid them often led to circuitous check routing, with recipients facing long, unpredictable delays in receiving their money. When they did eventually receive their money, fees had often consumed a considerable portion of what they were expecting. In extreme instances, this led to checks moving from city to city before eventually ending up at their destination. One often-cited example described a check that started in Rochester, New York, and traveled to Jacksonville, Florida, then to Philadelphia, Baltimore, and Cincinnati before it finally reached its final destination in Birmingham, Alabama. To put that in terms of miles traveled, if the check had gone directly from New York to Alabama, it would have traveled about 1,000 miles. Instead, it traveled 3,000 miles up and down the east coast, likely for days, before it finally reached its destination. The distance from Atlanta to Los Angeles is shorter than the route that check took. These kinds of inefficiencies were so significant that one of Congress's motivations in creating the Federal Reserve was ensuring a safe and efficient nationwide payment infrastructure. Shortly after they opened for business, the Reserve Banks began providing a nationwide check collection service. This service helped speed up payments by reducing circuitous routing. It also facilitated access to more-efficient payment services for banks across the nation. Since then, the Federal Reserve has continued to support ongoing efficiency improvements in the nation's payment system, including the development of the Fedwire funds transfer system and the implementation of the automated clearinghouse, or ACH system, in partnership with the private sector. This operational role has allowed the Federal Reserve to support the goal of a safe and efficient payment system throughout its history. It has also contributed to widespread public confidence in the nation's payment infrastructure. At times, the Federal Reserve has taken extraordinary steps to ensure the payment system can function reliably. After planes were grounded on September 11, 2001, in the aftermath of the terrorist attacks in for millions of checks that normally would have moved across the country by plane. The Federal Reserve also started giving immediate credit for all checks that it received. This provided a key source of liquidity for the payment system and temporarily caused the daily float held by the Federal Reserve to increase over 6,000 percent. 11, the Federal Reserve also took steps to improve the future efficiency of the nation's check collection system by working with Congress on the passage of the Check 21 Act in A safe and efficient payment system also needs to be accessible, because payment services are most valuable when you can pay anyone regardless of where balances are held. The ultimate success of any effort to modernize the U.S. payment system depends on adoption across the entire banking industry. Therefore, in considering the Federal Reserve's provision of payment services, Congress took steps to try to ensure access to services across the country. As a result, Congress specifically tasked the Federal Reserve with taking into account an adequate level of services nationwide when providing and setting fees for payment services. The United States has a highly complex banking system with more than 10,000 depository institutions spread over wide areas with differing payment needs. Over 4,800 of those are community banks. In many areas, particularly rural areas, community banks may be the primary providers of banking services for individuals and small businesses. Community banks are, therefore, essential in ensuring access to safe and efficient payment services in towns, cities, and rural communities nationwide so that payments can move across the country regardless of geography--from here in the South, to the Midwest, and coast to coast. A diverse banking system where institutions of all sizes are able to innovate and meet evolving customer needs is essential to ensure access to safe, efficient, and modern payment services for communities across the nation. At the Federal Reserve, we support the responsible use of technology and innovation to transform the financial system and reduce frictions and delays, while preserving consumer protections, data privacy and security, and financial stability. But as technology continues to advance, the intricacies of our digital world become more complex, and I believe we can help ensure that banks are well positioned to take advantage of these technology advancements and innovations. Like the rest of the financial industry, community banks are investing in new technologies and innovations to meet the growing expectations of their customers. With their considerable understanding of local needs, community banks are able to put these kinds of innovations to use in meeting the specific needs of their communities. At the Federal Reserve, we are actively engaging with the banking industry to encourage responsible innovation in the community-banking sector. But I also firmly believe that we cannot just say community banks need to engage in responsible innovation, we need to empower community banks to do just that, and I am committed to working with my colleagues to realize this objective. I believe it is our responsibility as a payment service provider and supervisor to ensure that our nation's evolving financial system works for community banks. Because by empowering them to provide modern and innovative services to their customers, we also ensure that Americans across the country can make payments safely and efficiently. First, as a provider of payment services, the Federal Reserve has a long history of supporting community banks. We have long-standing relationships with, and the nationwide infrastructure to provide services to, thousands of community banks across the country. While the existing payment infrastructure provided by the Federal Reserve has generally served community banks and the nation's economy well, advances in technology have also created opportunities to modernize these payment services. Collectively, these efforts will create a modern payment infrastructure that provides community banks the ability to meet customer expectations in offering innovative services with the same effectiveness and efficiency as other providers. This in turn will provide consumers the ability to better manage their financial lives by accessing accounts when and where they choose and providing more flexibility to manage money and make time-sensitive payments. To start, the Board has supported changes to existing Federal Reserve services. For example, at the end of last year, the Board announced changes to support adoption of an additional same-day ACH window available later in the day. When it was adopted in 2015, same-day ACH allowed for faster processing and return of recurring, low-cost payments such as payroll and bill payments. This additional window will help to make the benefits of same-day ACH more broadly accessible. More specifically, it will allow banks and their customers, particularly those located outside the eastern time zone, to use same-day ACH services during a greater portion of the business day. Our modernization efforts do not stop with existing services, though. The Service, announced last August, will create a new payment infrastructure for institutions of all sizes to offer innovative faster payment services. Community banks in particular were strong supporters of developing the FedNow Service. Many of them emphasized that the Federal Reserve's long-standing policy commitment to promoting nationwide access would result in a service that is accessible to banks of all sizes. They felt that this in turn would ultimately increase the long-term likelihood of being able to offer faster payment services in their communities. Community banks continued to voice strong support in response to our most recent request for comment on the design of the FedNow Service. At the same time, they raised a number of important issues, including interoperability, time to market, and use of volume-based pricing. These issues are important to community banks, and as such, they are important to me. I intend to work with my colleagues so that the FedNow Service meets the needs of community banks and their customers. I hope that you will continue to engage with us, continue to provide your feedback, and continue to be patient as we undertake this effort to develop the FedNow Service. Because with your input, I believe the Federal Reserve can continue its long history--which started with bank notes and checks, then continued with ACH--of providing infrastructure that supports the independence and success of community banks for the long term. It is also important to understand that technology advancements affect more than just the payment infrastructure behind-the-scenes. Innovations in consumer and other end-user experiences, such as those facilitated by fintech firms, can also transform the way that consumers interact with their financial institutions, offering community banks additional opportunities to serve their customers in the future. For instance, I have previously discussed how working with fintech firms may offer community banks potential partnerships that leverage the latest technology to provide customer-first, community-focused financial services and provide customers with efficiencies, such as easy-to-use online applications or rapid loan decisionmaking. These kinds of strategic partnerships harness the indispensable knowledge and trust that community banks have built with retail customers and local small businesses. For example, we have seen community banks experience significant growth after partnering with fintech companies to offer checking accounts for online investors, personal loans, and debit cards. We have also seen such partnerships increase efficiency in service offerings, such as significantly reducing loan approval processing time. We expect that the efforts to modernize our payment infrastructure that I outlined earlier, such as FedNow, will serve as a foundation for this kind of innovation to flourish, and will support new opportunities for community banks and the communities they serve. Of course, new technology is also subject to many of the traditional risks banks have managed in the past with more-traditional consumer services, and implementation of new technology should be driven by banks' business strategies and customer needs. Ultimately, banks remain responsible for conducting due diligence and understanding the risks faced by their organization. But technology advances quickly, and new developments inevitably raise new questions. That is why I believe that the Federal Reserve also needs to take steps as a supervisor to ensure our nation's evolving financial system works for community banks. First and foremost, it is essential we continue to meaningfully engage with stakeholders on these issues. For example, we recently launched an innovation web page (www.federalreserve.gov/innovate) that will serve as an accessible central hub for stakeholders interested in learning about and engaging with the Federal Reserve on innovation-related matters. The web page can serve as a starting point for members of the industry to engage with Federal Reserve specialists, submit questions, and request in- person meetings. We also announced a series of "fintech innovation office hours" across the country. The first of these was held just yesterday here in Atlanta, and some of you may have even had the opportunity to participate. These are also an important opportunity for us to learn, and I encourage you to provide your feedback. For community banks and their potential fintech partners, I hope that these sessions will serve as a resource to meet one-on-one with Federal Reserve staff members with relevant expertise, discuss fintech developments, share specific projects, and ask questions. They also provide us an opportunity to hear directly from banks and fintech companies about challenges to innovation. Another important area of focus for me is community banks' relationships with their vendors and third-party service providers. As a former community banker, I am acutely aware that community banks are often reliant on outside service providers and vendors to access new technologies and provide payment services. I also know that supervisory expectations in these areas can be challenging, and I have experienced it myself. There are several things I believe we can do to help provide clarity and transparency, reduce confusion, and simplify and remove some of the burden community banks face in this area. First, in order to give community banks a better picture of what success in due diligence of third-party providers looks like, and where it begins and ends, I believe that we should release more information on its necessary elements. This change would provide clarity and assist community banks in completing their work. In particular, I believe that regulators can provide more clarity on the types of questions that should be asked of a prospective third-party provider and our view of a satisfactory answer. I also believe our guidance should explain what due diligence looks like for a potential fintech partner, because the standards applied to other third parties may not be universally applicable. Potential partnerships are not one-size-fits-all. Every bank has different objectives, and guidance should reflect some supervisory flexibility so that we do not impede prudent, strategic partnerships between community banks and potential partners. Regulators should especially support partnerships that combine the strengths of community banks and fintech companies, which have a track record of success. I also believe the Federal Reserve should allow banks to conduct shared due diligence on potential partners. If several banks use the same third-party service provider and are open to collaborating, they should be allowed to pool resources instead of duplicating one another's work. These approaches would not only have the benefit of increasing clarity and transparency for community banks, but could also be beneficial for fintech companies that hope to become third-party providers. Second, clear and transparent guidance is most helpful when it is consistent. I have previously discussed my view that guidance on third-party relationships should be consistent across banking agencies. No one benefits when banks and their potential partners or other vendors have to navigate unnecessary differences in guidance between agencies. To that end, the Federal Reserve is in the process of working with the other banking agencies to update our third-party guidance. As part of this process, I believe that the banking agencies should all have consistent expectations for third-party relationships, and that the Federal Reserve should, as a starting point, move toward adopting the Office of the Comptroller of the Currency's guidance. Third, I believe we can improve transparency with regard to our supervision of third parties. Through our service provider supervision program, we regularly conduct exams of many third-party service providers. While we make the outcomes available to banks that are clients of a supervised service provider, I believe we can go a step further to increase transparency by also making information that may be useful about our supervision of key service providers available to banks. This could take a number of forms, such as being more transparent about who and what we evaluate. Of course, moving forward in these areas requires careful consideration and interagency collaboration, and I have asked our staff to work with other agencies to develop and propose workable options for giving banks the benefit of the knowledge that supervisors have about their potential providers in an appropriate manner. Finally, I believe regulators and supervisors have a role to play in ensuring that regulatory burden is tailored to bank size, risk, complexity, and capacity. Knowing the burden that third-party monitoring in particular can present to employees of the smallest banks, I have also encouraged Federal Reserve staff to consider options for further tailoring our expectations for community banks with assets under $1 billion in this area. Collectively, I view these as important steps to improve the ability of community banks to manage their third-party relationships effectively. By doing so, I believe we will be able to better support the ability of community banks to access innovative new technology and offer modern services to customers. The kinds of advances in technology we are discussing here today present challenges and opportunities for banks of all sizes, including community banks. Investments in new technology are likely to create implementation costs, and payment system innovations are no exception. Testing new technology, upgrading software and processing systems, and integrating new systems with existing systems will require banks to incur costs and dedicate resources to implementation. Community banks in particular may incur additional costs, for example to extend operating hours in order to facilitate payments during nonstandard business hours. However, technological advances also present opportunities for community banks to continue serving their neighbors, and payment services are a key component of this. Since I joined the Federal Reserve, I have been on the road a lot, visiting Federal Reserve Districts and talking to bankers, consumers, and community groups. I have been struck in particular by stories I have heard about younger generations of Americans moving back to rural areas. These individuals may be returning to their hometown or moving out of urban centers, but they still have the same expectations for services like those that may be offered by larger banks with nationwide footprints. Technological developments, like the payment system modernization efforts we have discussed today, allow banks across the country to meet these customer expectations and provide payment services on a competitive basis. I believe the Federal Reserve is uniquely positioned as a provider of payment services and as a supervisor of banks to ensure that our nation's evolving financial system works for community banks. As a provider of payment services, our efforts to modernize the nation's payment system through services like FedNow and same-day ACH will ensure community banks and their customers have access to today's financial technology nationwide. As a supervisor of banks, we can support responsible innovation by reducing regulatory burden where we can, clarifying expectations, and improving the ability of community banks to manage their relationships effectively. Collectively, I believe these efforts will help support a community banking sector that is well positioned to thrive and offer modern, innovative services to their customers. By providing such services, community banks can help ensure all Americans can make payments safely and efficiently regardless of their location and that families across the country have access to financial services that are so important to their success and the success of our communities in today's age of advancement.

r200409a_FOMC

united states

COVID-19 and the Economy

powell

Good morning. The challenge we face today is different in scope and character from those we have faced before. The coronavirus has spread quickly around the world, leaving a tragic and growing toll of illness and lost lives. This is first and foremost a public health crisis, and the most important response is coming from those on the front lines in hospitals, emergency services, and care facilities. We watch in collective awe and gratitude as these dedicated individuals put themselves at risk in service to others and to our nation. Like other countries, we are taking forceful measures to control the spread of the virus. Businesses have shuttered, workers are staying home, and we have suspended many basic social interactions. People have been asked to put their lives and livelihoods on hold, at significant economic and personal cost. We are moving with alarming speed from 50-year lows in unemployment to what will likely be very high, although temporary, levels. All of us are affected, but the burdens are falling most heavily on those least able to carry them. It is worth remembering that the measures we are taking to contain the virus represent an essential investment in our individual and collective health. As a society, we should do everything we can to provide relief to those who are suffering for the public good. The recently passed Cares Act is an important step in honoring that commitment, providing $2.2 trillion in relief to those who have lost their jobs, to low- and middle- income households, to employers of all sizes, to hospitals and health-care providers, and to state and local governments. And there are reports of additional legislation in the works. The critical task of delivering financial support directly to those most affected falls to elected officials, who use their powers of taxation and spending to make decisions about where we, as a society, should direct our collective resources. The Fed can also contribute in important ways: by providing a measure of relief and stability during this period of constrained economic activity, and by using our tools to ensure that the eventual recovery is as vigorous as possible. To those ends, we have lowered interest rates to near zero in order to bring down borrowing costs. We have also committed to keeping rates at this low level until we are confident that the economy has weathered the storm and is on track to achieve our maximum-employment and price-stability goals. Even more importantly, we have acted to safeguard financial markets in order to provide stability to the financial system and support the flow of credit in the economy. As a result of the economic dislocations caused by the virus, some essential financial markets had begun to sink into dysfunction, and many channels that households, businesses, and state and local governments rely on for credit had simply stopped working. We acted forcefully to get our markets working again, and, as a result, market conditions have generally improved. Many of the programs we are undertaking to support the flow of credit rely on emergency lending powers that are available only in very unusual circumstances--such as those we find ourselves in today--and only with the consent of the Secretary of the Treasury. We are deploying these lending powers to an unprecedented extent, enabled in large part by the financial backing from Congress and the Treasury. We will continue to use these powers forcefully, proactively, and aggressively until we are confident that we are solidly on the road to recovery. I would stress that these are lending powers, not spending powers. The Fed is not authorized to grant money to particular beneficiaries. The Fed can only make secured loans to solvent entities with the expectation that the loans will be fully repaid. In the situation we face today, many borrowers will benefit from these programs, as will the overall economy. But there will also be entities of various kinds that need direct fiscal support rather than a loan they would struggle to repay. Our emergency measures are reserved for truly rare circumstances, such as those we face today. When the economy is well on its way back to recovery, and private markets and institutions are once again able to perform their vital functions of channeling credit and supporting economic growth, we will put these emergency tools away. None of us has the luxury of choosing our challenges; fate and history provide them for us. Our job is to meet the tests we are presented. At the Fed, we are doing all we can to help shepherd the economy through this difficult time. When the spread of the virus is under control, businesses will reopen, and people will come back to work. There is every reason to believe that the economic rebound, when it comes, can be robust. We entered this turbulent period on a strong economic footing, and that should help support the recovery. In the meantime, we are using our tools to help build a bridge from the solid economic foundation on which we entered this crisis to a position of regained economic strength on the other side. I want to close by thanking the millions on the front lines: those working in health care, sanitation, transportation, grocery stores, warehouses, deliveries, security-- including our own team at the Federal Reserve--and countless others. Day after day, you have put yourselves in harm's way for others: to care for us, to ensure we have access to the things we need, and to help us through this difficult time.

r200505a_FOMC

united states

Welcoming Remarks for Investment Connection – Response to COVID-19: Colorado

brainard

Good afternoon everyone. I greatly appreciate this opportunity to participate in the virtual Investment Connection. As many of you are aware, the Federal Reserve Bank of Kansas City started this initiative in 2011 with a goal of helping funders find community and economic development opportunities in the 10th District. Investment Connection has attracted a wide range of proposals to meet community development needs, including asset building and financial education, community facilities, small business development/microlending, neighborhood stabilization/affordable housing, and workforce development. Since its inception, seven additional Reserve Banks have held or plan to hold Investment Connection events in their respective districts. The COVID-19 pandemic has created an economic and public health crisis, which has caused tremendous hardship, in particular for our most vulnerable communities. The devastation is demanding that government, nonprofits, and other organizations think broadly and creatively to address the growing needs of households and businesses across stakeholders together to find solutions that serve the needs of low- and moderate-income communities. As we collectively pursue efforts to address the challenges of this crisis, our work on CRA modernization also reminds us how critical it is to take into account the unique needs and opportunities in different communities. To better understand what is happening on the ground, and how the Federal Reserve can use its full range of tools to address this crisis, it is important to hear from direct service providers. That is why I join you here today. I would like to thank you for your commitment to meeting the needs of low- and moderate-income communities, especially in these extraordinary times. I am proud that the Federal Reserve has been supporting your work, and we are always open to hearing how we can continue to do so going forward.

r200513a_FOMC

united states

Current Economic Issues

powell

The coronavirus has left a devastating human and economic toll in its wake as it has spread around the globe. This is a worldwide public health crisis, and health-care workers have been the first responders, showing courage and determination and earning our lasting gratitude. So have the legions of other essential workers who put themselves at risk every day on our behalf. As a nation, we have temporarily withdrawn from many kinds of economic and social activity to help slow the spread of the virus. Some sectors of the economy have been effectively closed since mid-March. People have put their lives and livelihoods on hold, making enormous sacrifices to protect not just their own health and that of their loved ones, but also their neighbors and the broader community. While we are all affected, the burden has fallen most heavily on those least able to bear it. The scope and speed of this downturn are without modern precedent, significantly worse than any recession since World War II. We are seeing a severe decline in economic activity and in employment, and already the job gains of the past decade have been erased. Since the pandemic arrived in force just two months ago, more than 20 million people have lost their jobs. A Fed survey being released tomorrow reflects findings similar to many others: Among people who were working in February, almost 40 percent of those in households making less than $40,000 a year had lost a job in This reversal of economic fortune has caused a level of pain that is hard to capture in words, as lives are upended amid great uncertainty about the future. This downturn is different from those that came before it. Earlier in the post- World War II period, recessions were sometimes linked to a cycle of high inflation followed by Fed tightening. The lower inflation levels of recent decades have brought a series of long expansions, often accompanied by the buildup of imbalances over time-- asset prices that reached unsupportable levels, for instance, or important sectors of the economy, such as housing, that boomed unsustainably. The current downturn is unique in that it is attributable to the virus and the steps taken to limit its fallout. This time, high inflation was not a problem. There was no economy-threatening bubble to pop and no unsustainable boom to bust. The virus is the cause, not the usual suspects--something worth keeping in mind as we respond. Today I will briefly discuss the measures taken so far to offset the economic effects of the virus, and the path ahead. Governments around the world have responded quickly with measures to support workers who have lost income and businesses that have either closed or seen a sharp drop in activity. The response here in the United States has been particularly swift and forceful. To date, Congress has provided roughly $2.9 trillion in fiscal support for households, businesses, health-care providers, and state and local governments--about 14 percent of gross domestic product. While the coronavirus economic shock appears to be the largest on record, the fiscal response has also been the fastest and largest response for any postwar downturn. At the Fed, we have also acted with unprecedented speed and force. After rapidly cutting the federal funds rate to close to zero, we took a wide array of additional measures to facilitate the flow of credit in the economy, which can be grouped into four areas. First, outright purchases of Treasuries and agency mortgage-backed securities to restore functionality in these critical markets. Second, liquidity and funding measures, including discount window measures, expanded swap lines with foreign central banks, and several facilities with Treasury backing to support smooth functioning in money markets. Third, with additional backing from the Treasury, facilities to more directly support the flow of credit to households, businesses, and state and local governments. And fourth, temporary regulatory adjustments to encourage and allow banks to expand their balance sheets to support their household and business customers. The Fed takes actions such as these only in extraordinary circumstances, like those we face today. For example, our authority to extend credit directly to private nonfinancial businesses and state and local governments exists only in "unusual and exigent circumstances" and with the consent of the Secretary of the Treasury. When this crisis is behind us, we will put these emergency tools away. While the economic response has been both timely and appropriately large, it may not be the final chapter, given that the path ahead is both highly uncertain and subject to significant downside risks. Economic forecasts are uncertain in the best of times, and today the virus raises a new set of questions: How quickly and sustainably will it be brought under control? Can new outbreaks be avoided as social-distancing measures lapse? How long will it take for confidence to return and normal spending to resume? And what will be the scope and timing of new therapies, testing, or a vaccine? The answers to these questions will go a long way toward setting the timing and pace of the economic recovery. Since the answers are currently unknowable, policies will need to be ready to address a range of possible outcomes. The overall policy response to date has provided a measure of relief and stability, and will provide some support to the recovery when it comes. But the coronavirus crisis raises longer-term concerns as well. The record shows that deeper and longer recessions can leave behind lasting damage to the productive capacity of the economy. household and business insolvencies can weigh on growth for years to come. Long stretches of unemployment can damage or end workers' careers as their skills lose value and professional networks dry up, and leave families in greater debt. The loss of thousands of small- and medium-sized businesses across the country would destroy the life's work and family legacy of many business and community leaders and limit the strength of the recovery when it comes. These businesses are a principal source of job creation--something we will sorely need as people seek to return to work. A prolonged recession and weak recovery could also discourage business investment and expansion, further limiting the resurgence of jobs as well as the growth of capital stock and the pace of technological advancement. The result could be an extended period of low productivity growth and stagnant incomes. We ought to do what we can to avoid these outcomes, and that may require additional policy measures. At the Fed, we will continue to use our tools to their fullest until the crisis has passed and the economic recovery is well under way. Recall that the Fed has lending powers, not spending powers. A loan from a Fed facility can provide a bridge across temporary interruptions to liquidity, and those loans will help many borrowers get through the current crisis. But the recovery may take some time to gather momentum, and the passage of time can turn liquidity problems into solvency problems. Additional fiscal support could be costly, but worth it if it helps avoid long-term economic damage and leaves us with a stronger recovery. This tradeoff is one for our elected representatives, who wield powers of taxation and spending. Thank you. I look forward to our discussion. . . . . .

r200521a_FOMC

united states

Introductory remarks for the Fed Listens panel on the COVID-19 pandemic

brainard

For release on delivery Remarks for the Panel on the by at sponsored by the Board of Governors of the Federal Reserve System This will be the 15th event the Federal Reserve has conducted over 16 months. We have listened to diverse voices from every type of community in every sector and every district of our country. This rich set of perspectives is helping bring alive for us the importance of the review of our monetary policy strategy, tools, and communication practices led by Vice Chair Richard Clarida. We have heard that maximum employment is not captured in a single national average, it brings vital benefits, and it takes a very long time to arrive in many neighborhoods. We have heard that inflation matters: Households at different life stages and in different places are balancing the cost of living against their earnings, while businesses are balancing wages and other costs against their pricing power. We have heard that access to credit matters, and that it is important to use the full range of tools to support the economy. When we embarked on this listening journey, little did we know that our nation would experience the heartache and hardship associated with the COVID-19 pandemic-- an emergency unprecedented in modern times. Last year, we heard from small businesses that were expanding their workforces and investing in their communities. Today, many of those same businesses are running low on cash reserves and struggling to make rent and payroll--especially those in consumer services, such as restaurants and retail. Last year, national unemployment had fallen to its lowest point in over five decades. Today, unemployment has surged to levels not seen since the Great Depression. Last year, historically challenged groups were gaining a foothold in the workforce, and employers were investing in training and loosening job eligibility requirements. Today, the fallout from the COVID pandemic has cruelly hit groups with thinner financial cushions the hardest--workers in the lowest quarter of earnings, people of color, low and moderate income communities, and women disproportionately employed in services jobs. As we think about how the Federal Reserve's tools and presence in communities around the country could best provide stability at this trying time and strong support for the recovery to come, we are turning again to many of the same voices we heard from earlier to learn how the COVID pandemic has affected your communities and what lies ahead.

r200521c_FOMC

united states

U.S. Economic Outlook and Monetary Policy

clarida

It is my pleasure to meet virtually with you today at the New York Association I have been looking forward to this session, and I am sorry that I cannot join you in person, as I always value my opportunities for dialogue with business and market economists. Since mid-March, along with my Federal Open Market the opportunities for face-to-face interactions along the corridors of the Board's Eccles Building, I am grateful to be able to work from home and want to convey my deep gratitude to all of those on the frontlines of the crisis, who are working outside the comfort of their homes in hospitals, emergency services, and care facilities. While the coronavirus (COVID-19) pandemic has taken a tragic human toll measured in terms of lives lost and suffering inflicted, as a direct result of the necessary public health policies put in place to mitigate and control the spread of the virus, the pandemic has also inflicted a heavy toll on the levels of activity and employment in the in the first quarter of the year and will almost surely continue to contract at an unprecedented pace in the second quarter. The unemployment rate, which was at a 50-year low of 3.5 percent as recently as February, surged in April by more than 10 percentage points to 14.7 percent, an 80-year high, and it is likely to rise further in May. To put the numbers in some context, more jobs were lost in March and April of this year than had been created in the previous nine years. But while the economic news has been unremittingly awful in recent weeks, financial conditions since the middle of March have eased--and considerably so in many markets. I believe--and most outside observers agree--that this easing of financial conditions is, at least in part, a direct consequence of the actions the Federal Reserve took at our March 15 meeting, the subsequent announcements over the following days of the creation of nine new credit facilities to support the flow of credit to households and companies, the robust expansion of our existing foreign exchange swap arrangements with major foreign central banks, and the establishment of a new FIMA (Foreign and range of countries. While this easing of financial conditions is, of course, welcome, whether it proves to be durable will depend importantly on the course that the coronavirus contagion takes and the duration of the downturn that it causes. At a minimum, the easing of financial conditions is buying some time until the economy can begin to recover, growth resumes, and unemployment begins to fall. As I speak to you today, there is extraordinary uncertainty about both the depth and the duration of the economic downturn. Because the course of the economy will depend on the course of the virus and the public health policies put in place to mitigate and contain it, there is an unusually wide range of scenarios for the evolution of the economy that could plausibly play out over the next several years. In my baseline view, while I do believe it will likely take some time for economic activity and the labor market to fully recover from the pandemic shock, I do project right now that the economy will begin to grow and that the unemployment rate will begin to decline starting in the second half of this year. In terms of inflation, my projection is for the COVID-19 contagion shock to be disinflationary, not inflationary, and the data we are seeing so far are consistent with this projection. For example, core CPI (consumer price inflation) prices fell 0.45 percent in April, the largest monthly decrease since the beginning of the series in 1957. While the COVID-19 shock is disrupting both aggregate demand and supply, the net effect, I believe, will be for aggregate demand to decline relative to aggregate supply, both in the near term and over the medium term. If so, this decrease will put downward pressure on core inflation, which was already running somewhat below our 2 percent objective when the downturn began in March. Moreover, as I have indicated previously, I judge that measures of longer-term inflation expectations were, when the downturn began, at the low end of a range that I consider consistent with our 2 percent inflation objective. At the Federal Reserve, we take our dual-mandate obligations of maximum employment and price stability very seriously, and, since March 3, we have deployed our entire toolkit to provide critical support to the economy during this challenging time. In two unscheduled meetings, we voted on March 3 and 15 to cut the target range for the federal funds rate by a total of 150 basis points to its current range of 0 to 25 basis points. In our FOMC statements, we have indicated we expect to maintain the target range at this level until we are confident that the economy has weathered recent events and is on track to achieve our maximum-employment and price-stability goals. On March 16, we launched a program to purchase Treasury securities and agency mortgage-backed securities in whatever amounts needed to support smooth market functioning, thereby fostering effective transmission of monetary policy to broader financial conditions. To date, these purchases have totaled more than $2 trillion, and, as we indicated following our April FOMC meeting, they are continuing but at a reduced pace, reflecting the substantial improvement in market functioning that has occurred since the program was launched two months ago. Since March 17, the Federal Reserve Board has announced the establishment of no fewer than nine new facilities to support the flow of credit to households and businesses. These programs are authorized under emergency lending powers granted to the Fed under section 13(3) of the Federal Reserve Act and are available only in "unusual and exigent" circumstances and with the consent of the Secretary of Treasury. I think you will agree that today we face circumstances that are both exigent and unusual. These facilities are supported with money invested by the Department of the Treasury, drawing on appropriations of more than $450 billion authorized by the Congress in the Cares Act investing in Fed programs to sustain the flow of credit to households, firms, and communities during the coronavirus pandemic. With these facilities, we are providing a bridge by stepping in and supporting lending throughout the economy until the recovery takes hold. These programs are designed to offer backstop sources of funding to the private sector, and just the announcement that these backstop facilities would soon be launched appears to have bolstered confidence in capital markets, allowing many companies to finance themselves privately even before the facilities were up and running. But importantly, these are, after all, emergency facilities, and someday--hopefully soon--the emergency will pass. When that day comes and we are confident the economy is solidly on the road to recovery, we will wind down these lending facilities at such time as we determine the circumstances we confront are no longer unusual or exigent. Not only is the Federal Reserve using its full range of tools to support the economy through this challenging time, but our policies will also help ensure that the rebound in activity when it commences will be as robust as possible. That said, it is important to note that the Fed's statutory authority grants us lending powers, not spending powers. The Fed is not authorized to grant money to particular beneficiaries, to meet the payroll expenses of small businesses, or to underwrite the unemployment benefits of displaced workers. Programs to support such worthy goals reside squarely in the domain of fiscal policy. The Fed can only make loans to solvent entities with the expectation the loans will be paid back. Direct fiscal support for the economy is thus also essential to sustain economic activity and complement what monetary policy cannot accomplish on its own. Direct fiscal support can make a critical difference, not just in helping families and businesses stay afloat in a time of need, but also in sustaining the productive capacity of the economy after we emerge from this downturn. Fortunately, the fiscal policy response in the United States to the coronavirus shock has been both robust and timely. In four pieces of legislation passed in just over two months, the Congress has voted $2.9 trillion in coronavirus relief, about 14 percent of GDP. This total includes nearly $700 billion for the Paycheck Protection Program to support worker retention at small companies and more than $450 billion for the U.S. Treasury to provide first-loss equity funding for the Fed credit facilities that I discussed earlier. While the scale, scope, and timing of the monetary and fiscal policy responses to the coronavirus pandemic are unprecedented and will certainly cushion the blow the shock inflicts on the economy, the shock is severe. Depending on the course the virus takes and the depth and duration of the downturn it causes, additional support from both monetary and fiscal policies may be called for. The coronavirus pandemic poses the most serious threat to maximum employment and, potentially, to price stability that the United States has faced in our lifetimes. There is much that policymakers--and epidemiologists--simply do not know right now about the potential course that the virus, and thus the economy, will take. But there is one thing that I am certain about: The Federal Reserve will continue to act forcefully, proactively, and aggressively as we deploy our toolkit--including our balance sheet, forward guidance, and lending facilities--to provide critical support to the economy during this challenging time and to do all we can to make sure that the recovery from this downturn, once it commences, is as robust as possible.

r200521b_FOMC

united states

Opening Remarks

powell

Good afternoon. I just want to say a few words of welcome and thank everyone for being here--albeit in much different circumstances than would otherwise be expected. We've held many events over the past 16 months, and it's important to note that these conversations aren't just a nice way to talk to people from around the country, although they are that. What they provide--what you provide--is insight that we just can't get anywhere else. You add depth and definition to the flood of data that flows through the Fed each day. You give us perspective on the economic realities that don't show up on a spreadsheet. You help us see those complex sets of data that analyze the American economy through the eyes of the people, businesses, and communities that make up the American economy. And that information is very helpful to us as we make our policy decisions. So this is a valuable exercise for us. And an enjoyable one as well, so we truly do appreciate it on a number of levels. The Reserve Banks are also continuing to host conversations in communities across the country to help capture economic realities on the ground. We are in the midst of an economic downturn without modern precedent. It was sudden, and it is severe. It has already erased the job gains of the past decade and has inflicted acute pain across the country. And while the burden is widespread, it is not evenly spread. Those taking the brunt of the fallout are those least able to bear it. The pain of this downturn is compounded by the upending of normal life, along with great uncertainty about the future. In the best of times, predicting the path of the economy with any certainty is difficult. John Kenneth Galbraith famously said that economic forecasting exists to make astrology look respectable. We are now experiencing a whole new level of uncertainty, as questions only the virus can answer complicate the outlook. Policies that address the resumption of economic activity are the province of elected officials at all levels of government, in close consultation with public health and medical professionals. But all of us have our own decisions to make as well, and those decisions will depend on public confidence that it is again safe to undertake various activities. From an economic perspective, we hope to learn a lot from your experiences and from what you're hearing from your colleagues, customers, and communities: How they're coping with that uncertainty now, how they're thinking about a future that's harder to plan for, and what matters most as they navigate the path. The feedback we get from our community and business contacts has always been crucial in how we conduct monetary policy. In extraordinary times such as these, it takes on even greater importance. I want to thank you again for providing that insight and look forward to the conversation. Thank you.

r200616a_FOMC

united states

U.S. Economic Outlook and Monetary Policy (via prerecorded video)

clarida

It is my pleasure to meet virtually this evening with the members and invited I am truly honored to receive the (FOMC) colleague John Williams--and so with this award, I am indeed in select company. Although I have been very much looking forward to receiving this award in person, that, of course, is not possible tonight, but I greatly look forward to attending a future dinner to convey in person my genuine appreciation to the members of the FPA for this special honor. Since mid-March, I, along with my FOMC colleagues, have been working from home. Indeed, just last week, we held our scheduled June meeting via secure teleconference. And while I certainly miss the opportunities for face-to-face interactions along the corridors of the Board's Eccles Building, I am grateful to have the ability to work from home and want to convey my deep gratitude to all of those on the frontlines of the crisis, who are working outside the comfort of their homes in grocery stores, hospitals, and other businesses that provide essential services. While the coronavirus (COVID-19) pandemic has taken a tragic human toll measured in terms of lives lost and suffering inflicted, the pandemic has also inflicted a heavy toll on the levels of activity and employment in the U.S. economy, as a direct result of the necessary public health policies put in place to mitigate and control the spread of the virus. Real gross domestic product (GDP) declined at a 5 percent annual rate in the first quarter of the year and will almost surely continue to contract at an unprecedented pace in the second quarter. The unemployment rate, which reached a 50- year low of 3.5 percent as recently as February of this year, surged to 14.7 percent in April, an 80-year high. In May, there was a notable rebound in employment and decline in unemployment, and these developments are certainly welcome. Moreover, in recent weeks, some other indicators suggest a stabilization or even a modest rebound in some segments of the economy. But activity in many parts of the economy has yet to pick up, and GDP is falling deeply below its recent peak. And, of course, despite the improvements seen in the May jobs report, the unemployment rate, at 13.3 percent, remains historically high. After the extreme turbulence witnessed in March, financial markets across many sectors have normalized and are again serving their essential role of intermediating flows of savings and investment among borrowers and lenders. Bank credit lines are providing liquidity to companies, and corporations with debt rated investment grade and high yield are able to issue, and in size, in the corporate bond market. I believe--and most outside observers agree--that this easing of financial conditions since March is, at least in part, the direct consequence of economic policy responses to the crisis, including the actions the Federal Reserve took at our March 15 meeting and the subsequent announcement and sequential launch of 11 new facilities to support the flow of credit to households and companies. While this easing of financial conditions is, of course, welcome to the extent that it supports the flow of credit to households and firms during this challenging period, it may not prove to be durable, depending on the course that the coronavirus contagion takes and the duration of the recession that it causes. At minimum, the easing of financial conditions is buying some time until the economy begins to recover. As I speak to you today, there is extraordinary uncertainty about both the depth and the duration of the economic downturn. Because the course of the economy will depend on the course of the virus and the public health policies put in place to mitigate and contain it, there is an unusually wide range of scenarios for the evolution of the economy that could plausibly play out over the next several years. In my baseline view, while I do believe it will likely take some time for economic activity and the labor market to fully recover from the pandemic shock, I do project right now that the economy will resume growth starting in the third quarter. In terms of inflation, my projection is for the COVID-19 contagion shock to be disinflationary, not inflationary, and the data we are seeing so far are consistent with this projection. For example, core CPI (consumer price inflation) prices fell 0.4 percent in April, the largest monthly decrease since the beginning of the series in 1957. Although the decline in core CPI was smaller in May, on a year- over-year basis, core CPI is running at 1.2 percent, the slowest pace in nine years. While the COVID-19 shock is disrupting both aggregate demand and supply, the net effect, I believe, will be for aggregate demand to decline relative to aggregate supply, both in the near term and over the medium term. If so, downward pressure on PCE (personal consumption expenditures) inflation, which was already running somewhat below our 2 percent objective when the downturn began in March, will continue. Moreover, I judge that measures of longer-term inflation expectations were, when the downturn began, at the low end of a range that I consider consistent with our 2 percent inflation objective and, given the likely depth of this downturn, are at risk of falling below that range. The Federal Reserve has a dual mandate from the Congress to pursue policies that aim to achieve and sustain maximum employment and price stability. To me, price stability requires that inflation expectations remain well anchored at our 2 percent objective, and I will place a high priority on advocating policies that will be directed at achieving not only maximum employment, but also well-anchored inflation expectations consistent with our 2 percent objective. At the Federal Reserve, we take our dual-mandate obligations of maximum employment and price stability very seriously, and, since March 3, we have deployed our entire toolkit to provide critical support to the economy during this challenging time. In two unscheduled meetings, we voted on March 3 and March 15 to cut the target range for the federal funds rate by a total of 150 basis points to its current range of 0 to 25 basis points. In our FOMC statements, we have indicated we expect to maintain the target range at this level until we are confident that the economy has weathered recent events and is on track to achieve our maximum-employment and price-stability goals. On March 16, we launched a program to purchase Treasury securities and agency mortgage-backed securities in whatever amounts needed to support smooth market functioning, thereby fostering effective transmission of monetary policy to broader financial conditions. To date, these purchases have totaled more than $2.3 trillion, and, as we indicated at our June meeting, they will continue in coming months at least at the current pace, which should sustain smooth market functioning, thereby fostering effective transmission of monetary policy to broader financial conditions. Since March 17, the Board has announced the establishment of no fewer than 11 new facilities to support the flow of credit to households and businesses. These programs are authorized under emergency lending powers granted to the Fed under section 13(3) of the Federal Reserve Act and are available only in "unusual and exigent" circumstances and with the consent of the Secretary of Treasury. These facilities are supported with money invested by the Department of the Treasury, drawing on appropriations of more Relief, and Economic Security Act) for the specific purpose of investing in Fed programs to sustain the flow of credit to households, firms, and communities during the coronavirus pandemic. With these facilities, we are providing a bridge by stepping in and supporting lending throughout the economy until the recovery takes hold. These programs are designed to offer backstop sources of funding to the private sector, and just the announcement that these backstop facilities would soon be launched appears to have bolstered confidence in capital markets, allowing many companies to finance themselves privately even before the facilities were up and running. But importantly, these are, after all, emergency facilities, and someday--hopefully soon--the emergency will pass. When that day comes and we are confident the economy is solidly on the road to recovery, we will wind down these lending facilities at such time as we determine the circumstances we confront are no longer unusual or exigent. The Federal Reserve has played a leading role in the global economic policy response to the coronavirus pandemic. Foreign financial institutions borrow and lend in U.S. dollars, and these dollar funding markets seized up when COVID-19 emerged. In globally integrated financial markets such as ours, these strains in dollar funding markets outside the United States affect the flow of credit to U.S. households and businesses. As such, during the week of March 15, the Federal Reserve coordinated with five foreign central banks to enhance its standing dollar liquidity swap lines. In addition, temporary swap lines were reestablished with the nine central banks that had temporary agreements Moreover, to support dollar liquidity to a broad range of countries, the Federal Reserve announced a new program on March 31, the this facility, FIMA account holders at the Federal Reserve Bank of New York (which include central banks and other monetary authorities) can enter into overnight repos securities in their accounts for U.S. dollars, which can then be provided to institutions in their respective jurisdictions. All of these facilities have had a very constructive effect in calming down dollar funding markets and supporting a return to more normal conditions in global financial markets more generally. Of course, as members of the FPA, you are well aware that developments in the U.S. economy do not happen in isolation from the rest of the world. We live in a globally integrated economy. With COVID-19, all countries have been hit by a global common shock, not only directly by the virus and the measures necessary to combat it, but also by the economic spillovers from those actions around the world. As in the United States, many foreign authorities have taken swift and forceful actions in response. My colleagues and I have worked closely with others--bilaterally and in international forums Organisation for Economic Co-operation and Development--to monitor and address the effects of the pandemic. The forcefulness and synchronized timing of actions by fiscal authorities, central banks, and regulators have helped support the incomes of households and firms and reduce market stresses that could have amplified the shock. Not only is the Federal Reserve using its full range of tools to support the economy through this challenging time, but our policies will also help ensure that the rebound in activity when it commences will be as robust as possible. That said, it is important to note that the Fed's statutory authority grants us lending powers, not spending powers. The Fed is not authorized to grant money to particular beneficiaries, to meet the payroll expenses of small businesses, or to underwrite the unemployment benefits of displaced workers. Programs to support such worthy goals reside squarely in the domain of fiscal policy. The Fed can only make loans to solvent entities with the expectation the loans will be paid back. Direct fiscal support for the economy is thus also essential to sustain economic activity and complement what monetary policy cannot accomplish on its own. Direct fiscal support can make a critical difference, not just in helping families and businesses stay afloat in a time of need, but also in sustaining the productive capacity of the economy after we emerge from this downturn. Fortunately, the fiscal policy response in the United States to the coronavirus shock has been both robust and timely. In four pieces of legislation passed in just over two months, the Congress voted $2.9 trillion in coronavirus relief, about 14 percent of GDP. Depending on the course of the virus and the course of the economy, more support from both fiscal and monetary policy may be called for. The coronavirus pandemic poses the most serious threat to maximum employment and, potentially, to price stability that the United States has faced in our lifetimes. There is much that policymakers--and epidemiologists--simply do not know right now about the potential course that the virus, and thus the economy, will take. But there is one thing that I am certain about: The Federal Reserve will continue to act forcefully, proactively, and aggressively as we deploy our toolkit--including our balance sheet, forward guidance, and lending facilities--to provide critical support to the economy during this challenging time and to do all we can to make sure that the recovery from this downturn, once it commences, is as robust as possible.

r200619a_FOMC

united states

Introductory Comments

powell

Thank you, President Mester and Treye Johnson, and thanks to everyone for joining us. My job today is to listen, so I will keep my remarks short. But I do want to say that these conversations are incredibly valuable. They give context to reams of data and definition to a huge and complex economic picture. They also help solve problems on a practical level. Feedback from our Investing in America's Workforce initiative found a pronounced need for workforce and economic development programs to more closely align, for instance. And employers' input has influenced work across the Fed System, including the Cleveland Fed, as they look at how skills on the lower end of the pay scale can transfer to higher-earning jobs. So from me, and on behalf of my colleagues: Thank you for your time today and for your ongoing insight. It is not lost on me that we are meeting on Juneteenth amid a renewed reckoning of racial injustice. The pandemic has again exposed a range of troubling inequalities, most of them of long standing. As the national discussion continues, it is critical to remember that equity includes access to education, work, and economic opportunity. I am reminded that Dr. King delivered his "I Have a Dream" speech, just a few short blocks from the Federal Reserve, at a rally whose full title was the March on Washington for Jobs and Freedom. We meet today amid the immense hardship and suffering the coronavirus has caused. Lives and livelihoods have been lost, and uncertainty looms large. We are all grateful to our frontline health-care workers who put themselves in harm's way every day and to the essential workers helping us meet our needs. While we are all affected, the burden has fallen disproportionately on those least able to bear it. Before the virus swept across the globe, the American economy was in a good place. We were experiencing the longest expansion on record, and unemployment had reached historic lows. However, that is a national average that can gloss over stark realities. That economic good fortune had eluded pockets across the country, including Youngstown. A particular cruelty of the pandemic has been its disproportionate effects on many areas that were already suffering. We will make our way back from this, but it will take time and work. Some of the most valuable information we get from these discussions is how people are working to create growth. Your feedback can be an invaluable example for other communities with similar challenges. The Lordstown closure served as a reminder of how interconnected local economies can be, and other areas have experienced similar losses. Your work on diversifying the economy, on skills development, on small business support programs, and in so many other areas can all serve as models for others to replicate. The path ahead is likely to be challenging. But given the opportunity, I'll always bet on the American people and on the kind of community resolve and dedication we're hearing about today. I'm looking forward to your insight and to hearing more about how you've been working to revitalize Youngstown's economy. Thank you.

r200619b_FOMC

united states

The Adaptability of Stress Testing

quarles

Thank you for the opportunity to again address this group, which has played such an important role encouraging diversity, and a diversity of perspectives, in housing and finance. I gave my first speech to Women in Housing and Finance almost 30 years ago. You've been kind enough to invite me back in each of my tours of duty in public service since then, and throughout that time you have been an exemplar of the adage that diversity is the art of thinking independently together. Today, I'd like to talk to you about how banking regulation and supervision is adjusting to the unprecedented economic challenges posed by the coronavirus outbreak and especially the containment measures taken in response, which together we call the "COVID event." In particular, I will discuss how the COVID event is affecting a cornerstone of the Federal Reserve's oversight of large banks--our periodic stress tests, which verify that banks are prepared to deal with severe economic and financial conditions. Although our stress tests were not designed to test specifically against the effects of the COVID event on the economy and on our banks, they were designed to be flexible. I will describe modifications we've made to the stress test process this year, including expansions in stress testing appropriate to the unique circumstances we face, and preview our approach to the results the Fed will release next week. Let me start with some more general background on stress tests, among other steps the Federal Reserve Board has taken since the 2007-2009 financial crisis to strengthen the financial system and increase its resiliency. Since the financial crisis, we have mandated a substantial increase in the quantity and quality of capital in the banking system, including specially targeted higher capital requirements for the largest banks critical to overall financial stability. Capital provides a cushion to ensure that banks are prepared to face financial stress and other unexpected circumstances. Our requirements include capital buffers that are designed to be drawn down in periods of stress, in addition to minimum capital requirements. We have also established periodic stress tests to examine how banks would respond to hypothetical adverse financial and economic conditions. The Fed took these steps so that, during a crisis, banks would be in a position of strength and would not be forced to curtail lending to preserve capital, which would only worsen the crisis. In early March, in a move unrelated to the COVID event, the Board simplified its capital rules by finalizing a stress capital buffer requirement. This new framework uses our stress tests to set capital requirements for large banks and has the same goal as the previous framework: using forward-looking analysis to help ensure that banks have sufficient capital to survive a severe recession while still being able to lend to households and businesses. This year, as every year, the stress test began in February with the publication of a hypothetical scenario. This scenario, however, predated the serious economic effects of the COVID event, which began in March. This timing presented challenges and demanded changes to our usual process, and we responded with an approach that required more extensive analysis than normal. We simply would not have been doing our jobs if we had just run the test using a scenario framed before the economy began to deteriorate in March. . One reason for changing course hearkens back to the first stress test in 2009, the conducted in the midst of a crisis. One goal was to provide information, transparency and market discipline. But another goal was to restore and maintain public confidence in the financial system. In that sense, ever since then stress testing has acted to stabilize and strengthen the financial system, and it is this ongoing benefit that would be put at risk if we failed to alter our approach to make it relevant to the unique circumstances we face. While the first test likewise was conducted during a crisis, the current situation is unlike what we have faced in subsequent stress tests. In normal circumstances, we can take our time to carefully examine data and make a deliberate judgement about the capital planning of banks. This time, we have had to act much more quickly to be timely and relevant. That necessarily means a different approach. We didn't have the time or the comprehensive data to run a complete and updated COVID event stress test. Normally, we publish our scenarios, which serve as the hypothetical basis for the test, two months before the start of the process, and we take two months to run the test. We use data that banks submit around six weeks after the end of each quarter, so the test we run beginning in April normally uses data submitted in February and March reflecting bank balance sheets as of December. We also normally ask banks to complete their own stress tests using our scenarios before we begin our stress test. Another consideration was preserving the forward-looking benefits of stress tests. As we weighed how to proceed on this year's stress testing process, it was clear that the starting point was a lot less important than the considerable uncertainty we continue to face about the course of the COVID event and thus the path of the recovery. For that reason, we decided to stick with the February 2020 severely adverse scenario as the starting point for a different approach. We are calling this forward- looking approach a sensitivity analysis, and now I'll try to explain how that differs from a focus on just one severely adverse scenario. Based on past experience and our standing policies, our February scenario assumed stress in corporate debt and real estate markets, among other details, and an increase in unemployment considerably larger than occurred in the Great Recession. Compared to what we are now experiencing, this scenario was less severe than the unprecedented drop in employment and output in the second quarter of 2020 but more severe than the extent of stress we're seeing in debt markets. It also didn't include the unprecedented extent of fiscal stimulus. But the larger issue is the unprecedented uncertainty about the course of the COVID event and the economy. The range of plausible forecasts is high and continues to shift. We don't know about the pace of reopening, how consumers will behave, or the prospects for a new round of containment. There's probably never been more uncertainty about the economic outlook. Although our policies on stress testing emphasize the value of not increasing capital requirements under stress and thus exacerbating a downturn, our first priority must be--and is--to understand the implications of quite plausible downside scenarios from our current position for bank capital. In light of that uncertainty, our sensitivity analysis considers three distinct downside risk paths for the economy: first, a rapid V-shaped recovery that regains much of the output and employment lost by the end of this year; second, a slower, more U-shaped recovery in which only a small share of lost output and employment is regained in 2020; and third, a W-shaped double dip recession with a short-lived recovery followed by a severe drop in activity later this year due to a second wave of containment measures. Let me emphasize that these are not forecasts by the Fed or me, only plausible scenarios that span the range of where many private forecasters think the economy could be headed. While using the same models as our regular stress tests, our sensitivity analysis is different from our normal use of a severely adverse scenario in several ways. First, there are three possible paths instead of one because we must consider this range of outcomes. While we retained the basic structure of the February 2020 scenario, we swapped out a few key variables such as the unemployment rate, change in economic output, and Treasury bill rates. We also didn't follow our scenario design policy statement in formulating these three alternative paths. We chose rough approximations of economic paths rather than detailed scenarios, which means that the usual set of detailed variable data that we use will not be available. Finally, the analysis is still based on year-end 2019 data but with targeted adjustments to account for the most material changes to banks' balance sheets in the first quarter related to the COVID event, such as sizeable credit-line drawdowns by corporations. Given the changing economic circumstances and the need to act quickly, we didn't publish these three economic paths in advance and ask banks to model their exposures to them. The targeted adjustments to banks' balance sheets include the substantial growth in corporate loan balances and stress on borrowers in certain industry sectors that are most exposed to a sharp drop in demand. Although we didn't run our full stress test on these three possible downside risk paths for the economy, and while our adjustments only capture the most material changes in balance sheets since last year, this sensitivity analysis has helped sharpen our understanding of how banks may fare in the wide range of possible outcomes. We think it makes the most sense to share with the public some of what we have learned when we publish the results of our stress testing process on Thursday of next week. Let me lay out what that announcement will entail. First, as a point of reference, we will disclose stress test results using the February 2020 scenario, run against bank exposures as of December 2019. As in past years, this will include both firm-specific and aggregate results. To be more precise, this portion of our disclosure, based on the results of the February 2020 scenario, will be identical in all material ways to last year's stress test disclosure. This approach provides continuity and comparability with past stress tests. For the sensitivity analysis, we will provide key details about the three downside risk paths for the economy and targeted adjustments. We will also provide results aggregated across banks that will compare how the banking system as a whole would fare under the three distinct views of the future. Because of the limitations I described in examining the three downside risk paths for the economy, our disclosure of the sensitivity analysis will not provide firm-specific results. This adapted stress test, based on December 2019 exposures, will still give detailed information about the vulnerabilities of firms to the range of stresses that may play out. As a next step, we plan to move ahead and provide all banks subject to stress testing with a stress capital buffer requirement based on the February 2020 scenario, under our new approach integrating stress testing with capital requirements. Our new framework for establishing capital requirements was calibrated based on the assumption that we would set these requirements using a full stress test based on published scenarios. Indeed, the overall severity of the February scenario and our V-shaped sensitivity analysis are roughly the same. And, as I noted earlier, we kept in mind the principle that if possible we should avoid measures that tighten minimum capital levels during a crisis, to avoid intensifying that crisis. Should our assessment of the COVID event's likely evolution change, of course, we will act expeditiously to resize the buffer or take other appropriate actions. Let me take a minute to explain how and when we will disclose those stress capital buffer requirements. In prior years, the results from Dodd-Frank Act stress tests and the related Comprehensive Capital Analysis and Review were released over a two- week period. But in a change, we will be releasing the results from both exercises at the same time. We are able to do this because the new capital framework uses the results of the stress tests to establish the size of banks' stress capital buffers, which they can draw down in times of stress, and allows the banks to adjust their capital plans after receiving those results. By giving the firms their effective capital buffer requirement for the coming year and allowing them to adjust their capital plans to that buffer, the change will result in a more thoughtful assessment of risks. Once the banks have determined their final capital plans, the Board will publicly release the final capital requirements for each individual firm later this year, before they take effect in the fourth quarter, as planned. In addition, given the special circumstances this year we will use the results of our sensitivity analysis to inform our overall stance on capital distributions and in ongoing bank supervision. The sensitivity analysis will help us judge whether banks would have enough capital if economic and financial conditions were to worsen. As I have noted, our largest banks entered the COVID event in a position of strength, with high levels of capital and liquidity, and they have demonstrated that strength in the support they have provided to the economy during a crisis. In addition, I will note that almost all of our large banks have suspended share repurchases for the second quarter. In light of the ongoing economic uncertainty, I consider this move for the second quarter a prudent step as a very substantial capital conservation measure. Before the COVID event over 70 percent of the capital distributions of global systemically important banks, for example, came in form of share repurchases, which Some banks may determine that they are required, for purposes of compliance with the securities laws, to publicly disclose their stress capital buffer requirement before the Board publicly releases this information later in the year. In order to give all banks subject to this year's exercise sufficient time to understand their stress test results and make any necessary changes to their capital plans, we expect banks to wait until after U.S. markets close on June 29, 2020, to publicly disclose any information about their planned capital actions and stress capital buffer requirements. Doing so will provide for a more orderly dissemination of information to the public. ceased in March. The sensitivity analysis will help the Board assess whether additional measures are advisable for certain banks or certain future developments. Let me conclude by reiterating that stress tests remain a valuable tool, even in this time of extreme uncertainty. Our use of the sensitivity analysis is an acknowledgement that the path ahead is unusually uncertain, but that the work of verifying the resiliency of banks must continue, to aid the recovery by bolstering public confidence in the financial system. The new stress capital buffer framework will likewise aid capital planning and risk management by banks, leaving them better prepared to maintain lending to households and businesses. We will closely monitor the condition of these banks and the broader financial system in the coming months, including through additional COVID- related analysis. We will not hesitate to take additional policy actions should they be warranted under the then-prevailing economic conditions. Thank you, and I am happy to respond to your questions.

r200707a_FOMC

united states

Global in Life and Orderly in Death: Post-Crisis Reforms and the Too-Big-to-Fail Question

quarles

Good afternoon ladies and gentlemen. I would like to thank the Exchequer Club for hosting this event, and I look forward to future events taking us back to the luncheon discussions at the Mayflower Hotel, as has been the club's tradition now for over half a century. This afternoon I will consider the challenges that the outbreak of the COVID-19 virus and, especially, the containment measures taken by many governments in response (which together I will call the "COVID event") pose for the financial system and international cooperation on financial stability. I will do so in the context of a report that the Financial Stability Board--the FSB--published last week, evaluating the progress we have made in addressing the too-big-to-fail problem for banks. The evaluation has relevant and timely things to say about the resilience of banks, and the financial system more generally, during this time. Let me start with the challenges posed by the COVID event for financial stability. The containment measures of the COVID event represent the biggest test that the financial system has faced since the global financial crisis of 2007-08. After years of reforms, we now face a real life stress test even more severe than those previously hypothesized. But unlike the global financial crisis, this shock originated from outside the financial system. The first phase of the impact of the COVID event on the financial system was the market turmoil we experienced in March. This was the result of severe uncertainty triggering major re- pricing and volatility in global financial markets, disrupting the flow of credit to the economy. We saw many examples of a "dash for cash," with firms drawing down their lines of credit with banks, and the indiscriminate sale of assets by investors in order to obtain liquidity. The policy response by central banks and governments to this liquidity shock was rapid and decisive. The authorities worked together to address the problem through a combination of monetary, fiscal, and regulatory measures. These interventions led to rapid improvements in financial markets. Credit spreads have narrowed for both investment-grade and high-yield bonds, markets are functioning in an orderly manner, and credit provision to the economy has held up. However, the COVID event is not behind us yet. Many households and businesses remain under pressure. According to the latest International Monetary Fund forecast, the global economy is projected to contract sharply by 4.9 percent in 2020, a much worse outcome than during the 2007-08 financial crisis. While some indicators suggest a rebound in activity, the path of recovery remains highly uncertain. Banks entered the current crisis in a much stronger position than they did the global financial crisis. They are much better capitalized and more liquid than back in 2008. This is a direct outcome of the G20 regulatory reforms adopted in the aftermath of that crisis and measures taken by the banking industry, which have improved the resilience of the core of the financial system. This has allowed the banking system to absorb rather than amplify the current macroeconomic shock. It has also enabled banks to play a central role in measures to support the flow of credit to the economy. A number of stress tests carried out recently in FSB jurisdictions have confirmed that banks are able to continue lending even in the face of this extreme shock. Less than two weeks ago, we at the Federal Reserve concluded that our banks would generally remain well capitalized under a range of extremely harsh hypothetical downside scenarios stemming from the COVID event. Even with that demonstrated strength, however-- given the high levels of uncertainty--we took a number of prudent steps to help conserve the capital in the banking system. We know that the financial system will face more challenges. The corporate sector entered the crisis with high levels of debt and has necessarily borrowed more during the event. And many households are facing bleak employment prospects. The next phase will inevitably involve an increase in non-performing loans and provisions as demand falls and some borrowers fail. The official sector is providing a rapid and coordinated response to support the real economy, maintain financial stability, and minimize the risk of market fragmentation. The FSB is overseeing international cooperation and coordination of the responses of financial authorities to the COVID event. This brings us to the FSB's evaluation of too-big-to fail reforms. I should note at the outset that the analysis was conducted before the onset of the COVID event. Nevertheless, a number of its conclusions are relevant to policymakers and market participants in the current situation. We should first cast our minds back to the global financial crisis. While the issue of "too big to fail" had occupied regulators and finance professionals for decades, it was in the 2008 crisis that the contours of the too-big-to-fail problem in a globalized world became clear. In 2010 Mervyn King, the then Governor the Bank of England, noted that "most large complex financial institutions are global--at least in life if not in death." In this pithy sentence, he summed up the challenge policymakers faced. Decades of bank expansion and cross-border integration had provided many economic and social benefits, such as the ability to finance global supply chains. However, the web of relationships and exposures had become complex and opaque. When big banks ran into trouble during the financial crisis, regulators faced a stark choice: disorderly failure or taxpayer-funded bailouts. At the heart of the problems faced by authorities at the time were two issues: The problem before: The market had assumed that banks would not be allowed to fail. Banks and their creditors did not bear all the downside risk, and so they took on too much risk. This tendency--moral hazard--caused substantial economic distortions. The problem after: Authorities did not have the capacity to resolve a failing large international bank and were compelled to rescue banks at a significant cost to the taxpayer. Drawing on the lessons from the crisis, the G20 Leaders endorsed a package of reforms to tackle these two problems for systemically important banks. This package Standards for additional loss absorbency through capital surcharges and total loss- absorbing capacity requirements; Recommendations for improved supervision; and Policies to put in place effective resolution regimes and resolution planning. I mentioned earlier that banks have entered this crisis in a position of strength. Bank capital has increased significantly. For global systemically important banks--G-SIBs--tier 1 capital ratios have doubled since 2011 to 14 percent. This is a combined a result both of the Basel III reforms agreed in 2010 and of independently improved decision-making at our large banks. But the too-big-to-fail evaluation also finds that the capital surcharges for systemically important banks have contributed to enhanced resilience. Moreover, banks in advanced economies have built up significant loss-absorbing and recapitalization capacity by issuing instruments that can bear losses in the event of resolution. Supervisors and firms are better equipped to deal with problems that occur. Supervisory oversight of systemically important banks has learned the lessons of the crisis and has added a macroprudential perspective. The Basel III framework introduced additional capital and liquidity buffers, which are intended to be usable in a downturn to help maintain the flow of credit to the real economy. Before the global financial crisis, the resolution of failing banks was a niche subject. In hindsight, most authorities around the world had given it far too little attention. This was the main reason why authorities had so few options for our global systemic banks in the middle of the crisis. Things have changed, and for the better. Resolution authorities have sprung up or have been strengthened around the world. And resolution frameworks provide these authorities with the powers to resolve a systemically important bank in a manner that maintains financial stability and reduces taxpayer exposure. The FSB's evaluation shows that investors increasingly expect failing banks to be resolved rather than bailed out. The funding cost advantages enjoyed by systemically important banks have fallen. Market prices suggest that investors are now pricing the risk of having losses imposed on them in the event of a bank failure. For most jurisdictions that are home to G-SIBs, credit rating agencies no longer assume governments will bail them out. Recovery and resolution planning has improved banks' capabilities to produce timely, accurate and granular information. Timely information in a crisis is key to assessing the scale of a problem and to deciding what to do about it. This additional information has already proved helpful to both banks and authorities during the pandemic. Taken together, these resilience and resolution reforms lower the probability of banks failing, reduce the consequences and costs of a bank failure, and provide additional options for dealing with failing banks that simply did not exist before the global financial crisis. We have to ask ourselves, however, whether we have addressed the problem set out by Mervyn King in the wake of the global financial crisis. Can authorities now resolve complex international banks without recourse to public funds, while maintaining financial stability? And does the coordinated international approach we have now adopted provide for effective resolution of banks, by ensuring that while they are global in life, we also have a global solution in death? The FSB evaluation provides evidence that the reforms are indeed achieving their objectives. We are moving to a world in which G-SIBs can be global in life and orderly in death. We think that we are getting closer to a solution to the problem framed by Mervyn King. We have an internationally coordinated response grounded in national law. By pre- positioning loss-absorbing resources in life, and planning for an orderly resolution in the event of failure, we can provide the policymakers who come after us with more options than they had in the great financial crisis if they are faced with future systemic financial stress. There is, of course, more to do. The benefits of reforms cannot be realized unless they are operationalized. All FSB jurisdictions need to implement resolution reforms and to improve their resolution capabilities so they are fully prepared to respond to a bank failure or a crisis. The FSB's evaluation shows that systemically important banks remain very complex, highlighting the importance of resolution planning. The evaluation also highlights gaps in the information available to public authorities and to the FSB and standard setters, which reduces their ability to monitor and evaluate the effectiveness of resolution regimes. The FSB continues its work to ensure that banks, other financial institutions and market infrastructures can be effectively and safely resolved. These are issues on which we will need to reflect and work further. The financial landscape is also changing, and the FSB needs to be responsive. The FSB's monitoring shows that the share of bank assets as a percentage of total financial assets has dropped from 46 percent in 2008 to 39 percent in 2018. As non-bank financial institutions increase their market share, risks have moved outside the banking system. The market turmoil in March underlines the need to better understand the risks in non-bank financial intermediation and reap the benefits of this dynamic part of the financial system without undermining financial stability. There may be lessons for us to learn about the framework that we need to apply to this sector, which is different from--and less developed than--the one used for banks. At the FSB, we established earlier this year a balanced working group of bank and nonbank authorities to look closely and concretely at these issues, and the COVID event has given focus and vitality to this effort. Separately, we have already announced that our next evaluation will examine the post-crisis reforms to money market funds, which were once again front and center in the COVID event. Finally, we want to hear from you. Our consultation closes on 30 September. We are keen to receive responses from a wide range of stakeholders. I would highlight the need for responses to be grounded in evidence. The FSB will take account of feedback to the consultation and publish a final report in early 2021. This will also provide us with additional evidence on how banks have responded to the pandemic and any lessons learned for our evaluation. I look forward to your questions.

r200714a_FOMC

united states

Navigating Monetary Policy through the Fog of COVID

brainard

The COVID-19 contraction is unprecedented in modern times for its severity and speed. Following the deepest plunge since the Great Depression, employment and activity rebounded faster and more sharply than anticipated. But the recent resurgence in COVID cases is a sober reminder that the pandemic remains the key driver of the economy's course. A thick fog of uncertainty still surrounds us, and downside risks predominate. The recovery is likely to face headwinds even if the downside risks do not materialize, and a second wave would magnify that challenge. Fiscal support will remain vital. Looking ahead, it likely will be appropriate to shift the focus of monetary policy from stabilization to accommodation by supporting a full recovery in employment and a sustained return of inflation to its 2 percent objective. A variety of data suggest the economy bottomed out in April and rebounded in May and June. Payroll employment rebounded strongly in May and June. Retail sales jumped 18 percent in May, exceeding market expectations, and real personal consumption expenditures (PCE) are estimated to have increased 8 percent. Consumer sentiment improved in May and June. And both the manufacturing and nonmanufacturing Institute for Supply Management indexes jumped into expansionary territory last month. Financing conditions remain broadly accommodative on balance: They continued to ease over recent weeks for nonfinancial corporations and municipalities, although they remained stable or tightened slightly for small businesses and households. The earlier-than-anticipated resumption in activity has been accompanied by a sharp increase in the virus spread in many areas. Uncertainty will remain elevated as long as the pandemic hangs over the economy. Even if the virus spread flattens, the recovery is likely to face headwinds from diminished activity and costly adjustments in some sectors, along with impaired incomes among many consumers and businesses. On top of that, rolling flare-ups or a broad second wave of the virus may lead to widespread social distancing--whether mandatory or voluntary--which could weigh on the pace of the recovery and could even presage a second dip in activity. A broad second wave could re-ignite financial market volatility and market disruptions at a time of greater vulnerability. Nonbank financial institutions could again come under pressure, as they did in March, and some banks might pull back on lending if they face rising losses or weaker capital positions. A closer look at the labor market data hints at the complexity. The improvement in the labor market started earlier, and has been stronger, than had been anticipated. Over May and June, payroll employment increased by 7.5 million, the unemployment rate fell 3.6 percentage points, and the labor force participation rate rose 1.3 percentage points. The large bounceback is a sharp contrast to the Global Financial Crisis, when the initial employment decline was shallower and it took much longer before a similar share of the initial job losses was recouped. The job gains in the past two months were concentrated among workers who were on temporary layoff. They likely were driven by an earlier-than-expected rollback of COVID-related restrictions as businesses ramped up hiring and consumers exhibited more comfort engaging in commercial activities, as well as by a boost to employment from the Paycheck Protection Program. While nearly all industries experienced increases, the improvement was especially notable in the leisure and hospitality sector, which had been particularly hard hit by COVID-related closures in April. It is unclear whether the rapid pace of labor market recovery will be sustained going forward, and risks are to the downside. The pace of improvement may slow if a large portion of the easiest gains from the lifting of mandated closures and easing of capacity constraints has already occurred. Moreover, weekly COVID case counts have been rising, and some states are ramping up restrictions. These developments mostly occurred after the reference period for the June employment report. After declining at a fast clip through early June, initial claims for unemployment insurance have moved roughly sideways in recent weeks and remained at a still elevated level of 1.3 million in the week ending July 4. Some high-frequency indicators tracked by Federal Reserve Board staff (including mobility data and employment in small businesses) suggest that the strong pace of improvement in May and the first half of June may not be sustained. The pandemic's harm to lives and livelihoods is falling disproportionately on black and Hispanic families. After finally seeing welcome progress narrowing the gaps in labor market outcomes by race and ethnicity in the late stage of the previous recovery, the COVID shock is inflicting a disproportionate share of job losses on African American and Hispanic workers. According to the Current Population Survey, the number of employed persons fell by 14.2 percent from February to June among African Americans and by 13.4 percent among Hispanics--significantly worse than the 10.4 percent decline for the population overall. Separately, on the other side of our dual mandate, inflation has receded further below its 2 percent objective--reflecting weaker demand along with lower oil prices in recent months. Both core and total PCE price inflation measures have weakened, with the 12-month percent changes through May standing at 1.0 percent and 0.5 percent, respectively. Measures of inflation expectations are mixed; while market-based measures have moved below their typical ranges of recent years, survey measures have remained relatively stable within their recent historical ranges. Nonetheless, with inflation coming in below its 2 percent objective for many years, the risk that inflation expectations could drift lower complicates the task of monetary policy. The strong early rebound in activity is due in no small part to rapid and sizable fiscal support. Several daily and weekly retail spending indicators tracked by Federal Reserve Board staff suggest that household spending increased quickly in response to stimulus payments and expanded unemployment insurance benefits. Household spending stepped up in mid-April, coinciding with the first disbursement of stimulus payments to households and a ramp-up in the payout of unemployment benefits, and showed the most pronounced increases in the states that received more benefits. With some of the fiscal support measures either provided as one-off payments or slated to come to an end in July, the strength of the recovery will depend importantly on the timing, magnitude, and distribution of additional fiscal support. At the sectoral level, there is substantial heterogeneity in the effect of COVID. Recent data suggest that the recoveries in sectors such as manufacturing, residential construction, and consumer goods are likely to be relatively more resilient, while consumer services are more likely to remain hostage to social distancing. Manufacturing production jumped nearly 4 percent in May (following a historic drop in April), and forward-looking indicators point to another solid increase in June. Pending home sales and single-family permits rose more than anticipated in May. In the consumer sector, the rebound in spending has been concentrated in goods categories--especially those sold online--whereas most services categories have remained quite depressed. A similar concern may apply to the commercial real estate (CRE) sector and to equipment investment. Some parts of the CRE market--most notably, the lodging and retail segment--are experiencing significant distress and have seen sharp increases in delinquency rates along with tighter bank lending standards. For equipment investment, production and supply chain disruptions and high levels of uncertainty continue to weigh on expenditures. In addition to the headwinds facing demand, there could be persistent effects on the supply side of the economy. The cross-border distancing associated with the virus raises the possibility of persistent changes to global supply chains. Within the U.S. economy, the virus may cause durable changes to business models in a variety of activities, resulting in greater reliance on remote work, reductions in nonessential travel, and changes to CRE usage and valuations. In downside scenarios, there could be some persistent damage to the productive capacity of the economy from the loss of valuable employment relationships, depressed investment, and the destruction of intangible business capital. A wave of insolvencies is highlighted, the nonfinancial business sector started the year with historically elevated levels of debt. Already this year, we have seen about $800 billion in downgrades of investment- grade debt and $55 billion in corporate defaults--a faster pace than in the initial months of the Global Financial Crisis. Several measures of default probabilities are somewhat elevated. It remains vitally important to make our emergency credit facilities as broadly accessible as we can in order to avoid the costly insolvencies of otherwise viable employers and the associated hardship from permanent layoffs. Finally, in keeping with the global nature of the pandemic, foreign developments could impinge on the U.S. recovery. The International Monetary Fund estimates that real global gross domestic product dropped at an annual rate of about 18 percent in the second quarter after falling nearly 13 percent in the first quarter. While the potential for a fiscal response across the euro area is positive and important, there has been some renewal of tensions between the United States and China, and the outlook for many emerging markets remains fragile. The Federal Reserve moved rapidly and aggressively to restore the normal functioning of markets and the flow of credit to households and businesses. The forceful response was appropriate in light of the extraordinary nature of the crisis and the importance of minimizing harm to the livelihoods of so many Americans. With the restoration of smooth market functioning and credit flows, our emergency facilities are appropriately moving into the background, providing confidence that they remain available as an insurance policy if storm clouds again move in. While it is welcome news that 7.5 million jobs were added in the past two months, it is critical to stay the course in light of the remaining 14.7 million job losses that have not been restored since the COVID crisis started. The healing in the labor market is likely to take some time. Last month, a majority of Federal Open Market Committee (FOMC) participants indicated they expect economic activity to decline notably this year and recover only gradually over the following two years. A majority of FOMC participants indicated that they expect core inflation to remain below our 2 percent objective and employment to fall short of its maximum level at least through the end of 2022. Looking ahead, it will be important for monetary policy to pivot from stabilization to accommodation by supporting a full recovery in employment and returning inflation to its 2 percent objective on a sustained basis. As we move to the next phase of monetary policy, we will be guided not only by the exigencies of the COVID crisis, but also by our evolving understanding of the key longer-run features of the economy, so as to avoid the premature withdrawal of necessary support. Because the long-run neutral rate of interest is quite low by historical standards, there is less room to cut the policy rate in order to cushion the economy from COVID and other shocks. The likelihood that the policy rate is at the lower bound more frequently risks eroding expected and actual inflation, which could further compress the room to cut nominal interest rates in a downward spiral. With underlying inflation running below 2 percent for many years and COVID contributing to a further decline, it is important that monetary policy support inflation expectations that are consistent with inflation centered on 2 percent over time. And with inflation exhibiting low sensitivity to labor market tightness, policy should not preemptively withdraw support based on a historically steeper Phillips curve that is not currently in evidence. Instead, policy should seek to achieve employment outcomes with the kind of breadth and depth that were only achieved late in the previous recovery. With the policy rate constrained by the effective lower bound, forward guidance constitutes a vital way to provide the necessary accommodation. For instance, research suggests that refraining from liftoff until inflation reaches 2 percent could lead to some modest temporary overshooting, which would help offset the previous underperformance. Balance sheet policies can help extend accommodation by more directly influencing the interest rates that are relevant for household and business borrowing and investment. Forward guidance and asset purchases were road-tested in the previous crisis, so there is a high degree of familiarity with their use. Given the downside risks to the outlook, there may come a time when it is helpful to reinforce the credibility of forward guidance and lessen the burden on the balance sheet with the addition of targets on the . short-to-medium end of the yield curve. Given the lack of familiarity with front-end yield curve targets in the United States, such an approach would likely come into focus only after additional analysis and discussion. The Federal Reserve remains actively committed to supporting the flow of credit to households and businesses and providing a backstop if downside risks materialize. With a dense fog of COVID-related uncertainty shrouding the outlook, the recovery likely will face headwinds for some time, calling for a sustained commitment to accommodation, along with additional fiscal support.

r200806a_FOMC

united states

The Future of Retail Payments in the United States

brainard

It is a pleasure to be here today with Esther George and Ken Montgomery to talk about the future of America's retail payment system. Recognizing that the retail payment infrastructure touches every American, a year ago, the Federal Reserve committed to build its first major new payment system in four decades. At that time, no one anticipated the challenges our nation would soon face. The COVID-19 pandemic has heightened the urgency and importance of delivering a resilient instant payment system that is accessible to all Americans. The COVID-19 pandemic is taking a tremendous toll on communities across America, especially households and small businesses with the least liquid resources to weather the storm. Emergency relief payments authorized in the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, provided a vital lifeline for many households. The rapid expenditure of the COVID emergency relief payments highlights the critical urgency of immediate access to funds for the many households and businesses managing cash-flow constraints. After sharply reducing their spending early in the COVID crisis, many households increased their spending starting on the day they received the emergency relief payments and continued for the following 10 days. The rapid increase in spending was greatest for households with lower incomes, greater income declines, and lower liquid savings. The urgency with which the emergency payments were spent underscores the importance of rapid access to funds for many households and businesses that face cash flow constraints. The of the CARES Act payments to households using direct deposit, prepaid debit cards, and checks, which can take several days between the time the funds are sent and the time recipients get access to their funds. By contrast, the ability to disburse funds via instant payments could have helped reduce the strain for those who needed the funds quickly in order to meet financial obligations. The same is true for other payments intended to provide immediate assistance, for example, in the wake of natural disasters. In good times as well as bad, instant payments will enable millions of American households and small businesses to get instant access to funds, rather than waiting days for checks to clear. An instant payment infrastructure ensures the funds are available immediately, which could be especially important for households on fixed incomes or living paycheck to paycheck, when waiting days for the funds to be available to pay a bill can mean overdraft fees or late fees that can compound, or reliance on costly sources of credit. For small businesses, the ability to receive customer payments instantly could help them manage cash flows when working capital is tied up in materials or inventory. And for the 1 in 10 Americans who regularly work in the gig economy, getting immediate access to the payments for their work could help address cash-flow constraints when money is tight. Consumers and businesses across the country want and expect instant payments, and the banks they trust should be able to provide this service securely. One year ago, the Federal Reserve announced we would build the FedNow Service to enable banks of every size and in every community in America to provide safe and efficient instant payment services around the clock, every day of the year. The FedNow Service will facilitate end-to-end instant payment services for consumers and businesses, increase competition, and ensure equitable access to banks of all sizes nationwide. The Federal Reserve is uniquely positioned to build an instant payment infrastructure, given our long history of operating payment systems to promote a safe, efficient, and broadly accessible payment infrastructure. The decision to build an instant payment infrastructure reflected support from a broad set of stakeholders, including the vast majority of over 400 commenters that responded to the Board's 2018 notice, as well as the U.S. Treasury. Our public mission in providing payment services is built on the proposition that all banks and the communities they serve, no matter their size or geographic location, should have equitable access to the U.S. payment system. Through the direct connections that we have with more than 10,000 banks, the FedNow Service will be broadly accessible to banks and the communities they serve across the country. The FedNow Service will not only expand but also strengthen the U.S. payment infrastructure by operating alongside the private-sector instant payment service, the Clearing House's RTP network. As they do for other payment services, many banks may choose to maintain access to more than one instant payment service to attain resiliency through redundancy. Moreover, the Federal Reserve has always had a vital role in the payment system by providing liquidity and operational continuity in times of stress, and the FedNow Service will extend this role directly into the instant payment market. Together, the FedNow and RTP services should significantly increase the speed and efficiency of the U.S. payment system. The presence of more than one service provider also brings the efficiency benefits associated with competition and benefits consumers, according to analysis from the U.S. Government Since last August, the Federal Reserve has made substantial strides in developing the FedNow Service, including on the evaluation of prototypes of the core clearing and settlement functionality. Across the Federal Reserve System, work has continued apace, commensurate with the high priority of the initiative, even as we have mobilized an unprecedented response to the COVID-19 shock. We have a team of over 100 people working on the program, including experts drawn from across the Federal Reserve System and key external hires. Since we initiated the FedNow Service one year ago, we have been meeting our project milestones, and today I am pleased to announce the Federal Reserve Board has approved the core features and functionality based on extensive input from stakeholders. The FedNow Service design we are announcing today benefited tremendously from industry feedback, including almost 200 comment letters responding to our notice regarding desired features and functionality. In addition to the core interbank clearing and settlement functionality that will enable consumers and businesses to send and receive instant payments through participating banks, the FedNow Service will include features that enhance the usability of the service. We heard loud and clear from stakeholders the primary importance of getting this service to the market as quickly as possible. To meet this goal, we are announcing a phased approach that will enable the FedNow Service to get to market expeditiously with a core set of features and to expand available features over time in response to changes in technology and market needs. Let me highlight several key features of the initial service offering. First, we heard strong support for fraud tools within the FedNow Service to support banks' efforts to mitigate the risk of fraud with instant payments. Accordingly, upon implementation, banks will be able proactively to set parameters that limit transaction activity in the FedNow Service based on banks' knowledge of their own customers. As we gain insights from banks' experience with the initial set of fraud tools, we will explore other tools that may be valuable, including centralized Second, banks told us they want to be able to ensure they have adequate funds in their Federal Reserve accounts on a 24x7x365 basis to cover outflows related to instant payments, especially during hours when existing payment services are not open and funds cannot be transferred into Federal Reserve accounts to cover intraday overdrafts. Accordingly, we will develop a liquidity management tool that allows a participant with excess funds in its Federal Reserve account to transfer funds to another participant who needs the funds on weekends, holidays, and after hours. Moreover, we will make the liquidity management tool available for instant payments broadly, including to banks that choose not to participate in the FedNow Service. Participants in a private-sector instant payments service will be able to use the tool to transfer funds from their Federal Reserve accounts to the joint account at a Reserve Bank that backs settlement in that service. Third, it will be important for the FedNow Service to be interoperable with the private- sector instant payment service to accomplish the goal of nationwide reach for instant payments. As we have learned from experience with our other payment services, the form and timeline for achieving interoperability will depend on the level of commitment and engagement from stakeholders across the industry, including the operators of other instant payment settlement services, both present and future. In part to facilitate interoperability, the FedNow Service design will use the widely accepted ISO 20022 message standard and other industry best practices. To the extent other instant payment services fully adopt the same publicly available, widely accepted standards, this approach would enable a form of interoperability where banks can route payments through either the FedNow Service or other instant payment services based on the available path to the receiver. This is similar to the prevailing approach in payment card transactions, for instance. We are also open to collaborating on a form of interoperability where messages can be exchanged between the FedNow Service and private-sector instant payment service operators, similar to the approach used in automated clearinghouse (ACH) systems. Implementing this approach would significantly increase the required level of commitment and active engagement of the private-sector instant payment service operator from the outset. In order to minimize time to market, additional features of the FedNow Service would be introduced in phases after launch. It will be important for the FedNow Service to support alias- based payments, whereby a payment can be sent to a recipient using an alias, such as an email address or phone number, rather than requiring an account number. But providing this feature securely requires addressing legal, operational, and security challenges that would increase the time to market for the core service. Balancing these considerations, we will explore the best ways to add a directory service or other approach to alias-based payments with the goal of providing this feature as a high priority following the initial launch. As we proceed with the development of the FedNow Service, we will continue our engagement with a broad set of stakeholders to gain input on desired features and to work with banks and their service providers on preparations to adopt the service. In May, the Federal Reserve Banks announced the formation of the FedNow Community for stakeholders who would like to help inform the development of the FedNow Service. The Community currently has over 500 members from all segments of the payment ecosystem. We are working with service providers, recognizing their importance in providing essential payment processing services for thousands of banks in this country. We are also engaging directly with the fintech and software companies who provide customer-facing services that will help banks build innovative instant payment products to serve their communities. The readiness of these stakeholders to support banks' participation in the FedNow Service and expand potential uses through value-added services is key to widespread adoption of instant payments. We look forward to our continued partnership with banks and other stakeholders in this transformative initiative to deliver a safe and efficient instant payment system with national reach. It has been an eventful year for retail payments with technology players introducing new business models and accelerating the pace of digitalization. As the central bank, our focus on the safety and integrity of the payment system means we need to ensure that payment innovations do not come at the cost of security, reliability, or consumer protections. Some newer payment services, while providing what has the look and feel of an instant payment experience for consumers, in fact rely on legacy infrastructure that actually settles transactions on a deferred basis, creating risk for consumers, banks, and the payment system overall. In contrast, the FedNow Service will offer real-time gross settlement of transactions, an approach that involves each transaction being processed individually and immediately, which avoids interbank credit risk. Efforts by global stablecoin networks such as Facebook's Libra project to drive the next stage of payment innovation have raised other fundamental questions about legal and regulatory safeguards, financial stability, and the appropriate role of private money. remains optimistic about the power of technology and innovation to deliver payments safely, immediately, and efficiently when the appropriate safeguards are in place. We are committed to building an instant payment system that delivers the payment speed that users want without bypassing the legal and regulatory protections they have come to expect from banking relationships. Ultimately, the FedNow Service can be a catalyst for innovation in the market by providing a neutral platform on which the private sector can build to offer safe, efficient instant payment services to users across the country. The promise of the FedNow Service is that it will provide a modern payment infrastructure for the future, bringing the benefits of instant payments to communities across America and improving the way households, businesses, and government agencies make payments for many years to come.

r200813a_FOMC

united states

An Update on Digital Currencies

brainard

Reserve Bank of San Francisco is a leader of our engagement with the tech community. And the Federal Reserve's Innovation Office Hours serve as an important forum to engage on innovation in the financial system with financial institutions, fintechs, technology companies, nonprofits, and other stakeholders. We have benefited from learning about the work you are doing to promote healthy innovation in financial services and payments. This event covered a number of important topics, including regulatory technology, blockchain, cybersecurity, and digital banking. The breadth of topics and the range of participants speak to the scale and scope of technological innovation in financial services. It is a testament to widespread investments in technology that we are able to proceed with these kinds of engagements and maintain our operations seamlessly despite the unprecedented shock associated with the COVID-19 crisis. The COVID-19 pandemic is taking a tremendous toll on communities across America, especially households and small businesses with the least resources to weather the storm. COVID-19 crisis is a dramatic reminder of the importance of a resilient and trusted payments infrastructure that is accessible to all Americans. It was notable that after a sharp reduction in spending early in the COVID-19 crisis, many households increased their spending starting on the day they received emergency relief payments under the Coronavirus Aid, Relief, and Economic lower incomes, greater income declines, and lower liquid savings. The urgency with which the CARES Act emergency payments were spent underscores the importance of immediate and trusted access to funds for the many households and businesses that face cash-flow constraints. That is why the Federal Reserve remains committed to delivering on the FedNow which will enable millions of American households and small businesses to get instant access to funds rather than waiting days for checks to clear. More broadly, banks, fintech companies, and technology firms are all exploring the use of innovative technologies to enhance payments efficiency, expand financial inclusion, speed up settlement flows, and reduce end-user costs. Digital currencies, including central bank digital currencies (CBDCs), present opportunities but also risks associated with privacy, illicit activity, and financial stability. The introduction of Bitcoin and the subsequent emergence of stablecoins with potentially global reach, such as Facebook's Libra, have raised fundamental questions about legal and regulatory safeguards, financial stability, and the role of currency in society. This prospect has intensified calls for to maintain the sovereign currency as the anchor of the nation's payment systems. Moreover, China has moved ahead rapidly on its version of a CBDC. With these important issues in mind, the Federal Reserve is active in conducting research and experimentation related to distributed ledger technologies and the potential use cases for digital currencies. Given the dollar's important role, it is essential that the Federal Reserve remain on the frontier of research and policy development regarding CBDCs. As part of this research, central banks are exploring the potential of innovative technologies to offer a digital equivalent of cash. Like other central banks, we are continuing to assess the opportunities and challenges of, as well as the use cases for, a CBDC, as a complement to cash and other payments options. There continues to be strong demand for U.S. currency, and we remain committed to ensuring the public has access to a range of payments options. We have been conducting in-house experiments for the last few years, through means that include the Board's Technology Lab, which has been building and testing a range of distributed ledger platforms to understand their potential opportunity and risk. This multidisciplinary team, with application developers from the Federal Reserve Banks of Cleveland, Dallas, and New York, supports a policy team at the Board that is studying the implications of digital currencies on the payments ecosystem, monetary policy, financial stability, banking and finance, and consumer protection. To enhance the Federal Reserve's understanding of digital currencies, the Federal Reserve Bank of Boston is collaborating with researchers at the Massachusetts Institute of Technology in a multiyear effort to build and test a hypothetical digital currency oriented to central bank uses. The research project will explore the use of existing and new technologies as needed. Lessons from this collaboration will be published, and any codebase that is developed through this effort will be offered as open-source software for anyone to use for experimentation. The objectives of our research and experimentation across the Federal Reserve System are to assess the safety and efficiency of digital currency systems, to inform our understanding of private-sector arrangements, and to give us hands-on experience to understand the opportunities and limitations of possible technologies for digital forms of central bank money These efforts are intended to ensure that we fully understand the potential as well as the associated risks and possible unintended consequences that new technologies present in the payments arena. Separately, a significant policy process would be required to consider the issuance of a CBDC, along with extensive deliberations and engagement with other parts of the federal government and a broad set of other stakeholders. There are also important legal considerations. It is important to understand how the existing provisions of the Federal Reserve Act with regard to currency issuance apply to a CBDC and whether a CBDC would have legal tender status, depending on the design. The Federal Reserve has not made a decision whether to undertake such a significant policy process, as we are taking the time and effort to understand the significant implications of digital currencies and CBDCs around the globe. In addition to these experiments, the Federal Reserve continues to collaborate with and learn from other central banks. We are participating in the CBDC coalition of central banks. While each country will make decisions on whether to issue and how to design a CBDC based on its own domestic legal framework and financial and economic context, we benefit from collaboration on CBDC research. Sharing lessons learned, jointly conducting experiments, and bringing diverse expertise to bear helps us make progress in developing potential approaches to address challenging hurdles, such as threats to cybersecurity, counterfeiting and fraud, and anti- money laundering, to name a few, as well as on shared goals, such as increasing the ease and efficiency of cross-border transactions. Since financial and payments systems share extensive cross-border linkages, a poorly designed CBDC issued in one jurisdiction could create financial stability issues in another jurisdiction. A cyberattack on a CBDC arrangement in one jurisdiction could create domestic financial stress, which could, in turn, affect linked economies or have broader effects if confidence in certain technologies or payment mechanisms is eroded. More broadly, the Federal Reserve looks forward to increased international engagement on matters related to innovation and technological change that impact central banks and those we serve. Our new initiative with the Bank of International Settlement's Innovation Hub, through an innovation center at the Federal Reserve Bank of New York, will provide a useful venue for increased cooperation and exchange. Let me conclude by noting that innovation is central to our work. We remain committed to understanding how technological advances can help the Federal Reserve carry out our core missions, as well as how they are changing the ways that banks, payments, and financial markets operate. For example, we are leveraging machine learning, natural language processing, and other artificial intelligence tools to help us analyze data, and we are monitoring how financial institutions use these tools in their decisionmaking. We are expanding our use of cloud computing to enhance our operations, and we continue to enhance our cybersecurity tools to strengthen our cyber posture. These and other technologies are fundamentally changing every aspect of our work, and the Federal Reserve remains optimistic about the power of healthy innovation to improve the resilience, efficiency, and inclusiveness of our financial system when the appropriate safeguards are in place.

r200819a_FOMC

united states

Brief Remarks

bowman

We are here today because of the tireless efforts of brave women--including Kansas women--demanding that men and women have an equal right to vote and shape their destiny. The suffragettes didn't only achieve something for women. Through their efforts, our country became a stronger democracy by extending the full opportunity for women to be counted and to take part in the political process. The passage of the 19th Amendment in 1920 enabled women to directly participate in selecting our country's leaders. It paved the way for women to take part on equal terms, including by serving as leaders themselves. None of us singled out today would be here without the extraordinary efforts of those who secured the vote for women. In my case, it was serving as Kansas's first female State Bank Commissioner, and the first person to serve on the Federal Reserve Board in the role designated by Congress for someone with community banking experience. The sacrifice and persistence of those women more than a century ago set an example for future generations of women and allows our daughters to dream that anything is possible with hard work, commitment, and determination. That legacy has deep roots in Kansas. As many here know, in 1861, Kansas granted women a limited right to vote in school district elections; and, by 1867, Kansas became the first U.S. state to hold a statewide referendum on women's suffrage. Even though this first referendum was defeated, it reflected and contributed to a new way of thinking about what it meant to be a woman and citizen. In 1887, Kansas elected the first female mayor in America. And in 1912, Kansas became the eighth state to approve women's voting rights in all elections. I could not be more proud of my Kansas heritage. The participation of women in the political and policymaking process brings a broader perspective. Throughout my career, and as an attorney and a public servant, I have found that the inclusion of individuals with a broad range of experiences deepens our understanding of the issues and results in better discussions and more thoughtful decisionmaking. In my current role, I bring the perspective of someone from a small, rural, agricultural community, who has worked as a community banker and as a state regulator. Those aren't typical experiences for a Fed policymaker. This diversity is a strength, as Congress recognized by creating a role on the Federal Reserve Board designated for someone with community banking experience. I am the first to serve in this capacity, and I strongly believe that our economic and financial system is strengthened when we consider the implications of our regulatory decisions for bankers on Main Street as well as on Wall Street. I approach our monetary policy deliberations in a similar way. Our actions in response to the recent pandemic have clearly benefited from this perspective, as we understand how the varying state and local approaches have affected economic conditions across the nation. In closing, it is appropriate that during this election season we honor the women who secured that right, first in Kansas, and then through their campaign to ratify the 19th amendment. The greatest tribute to those women, and the best way to honor their legacy, is to vote. Another way is through public service, and I would strongly encourage all-- but in particular women--to consider serving in government at the local, state, or federal level. It is the most challenging, but by far the most rewarding work that I have done, and I hope you will consider serving as well. Thank you again for this honor.

r200826a_FOMC

united states

The Pandemic’s Effect on the Economy and Banking

bowman

Good afternoon. It's great to be with you, and I look forward to our discussion. As you all know, the COVID-19 pandemic has caused significant disruption and hardship in nearly every aspect of our lives, and it continues to weigh heavily on our national economy, which is why it will be the central focus of my remarks here today. Let me set the stage for our discussion by outlining the economic effects of the pandemic most relevant to the banking sector, describing the Federal Reserve's response to the crisis, and then making some observations about conditions for smaller banks. We began this year with the economy in excellent shape--by some measures the strongest in decades. From my seat as a monetary policymaker, we appeared to be in a good position regarding both legs of our dual mandate, which are maximum employment and stable prices. But that picture was dramatically altered with the onset of the COVID-19 pandemic. Efforts to contain the spread of the virus caused a sudden stop in economic activity during March and April. While the extent of the closures and shutdowns varied widely throughout the country, the sudden loss of employment and the contraction in output were like nothing our nation has experienced before. The decline in activity was mostly due to temporary business closures, and the economy has bounced back noticeably in recent months as businesses reopen and fiscal support was distributed to many Americans. Even so, the economy is still far from back to normal. The future course and timing of the recovery is still highly uncertain, and its pace and intensity are likely to vary across areas of the country--heavily influenced by the decisions of state and local governments. That speaks to another aspect of this episode that is unusual--how the timing and severity of the pandemic's impact seem to differ greatly from one area to the next. Among Kansas's major industries, oil and gas production and equipment manufacturing have been hurt by the worldwide slump in energy demand. Aviation manufacturing has been hit hard by the downturn and by the uncertainty over the recovery in air travel. Agriculture continues to face challenges but is faring somewhat better than many sectors of the economy. Ag producers are still facing tough financial conditions, including the low commodity price environment. While most indications are that agriculture land prices continue to hold fairly steady, I have seen some reports that less-productive land has been showing some hints of cracks in valuations. Turning to employment, nationwide, we know that the initial job losses were heavily concentrated among the most financially vulnerable, including lower-wage workers, young people, women, and minority groups. According to the Fed's latest , 20 percent of people surveyed in April reported a recent job loss. Among those surveyed who live in households with annual incomes below $40,000, the reported job loss was nearly double that, at around 40 percent. That said, both of those figures are likely to include a number of layoffs due to pandemic-related shutdowns of businesses that were hopefully only temporary. Households were in a generally strong financial position at the beginning of this year, but the restrictions implemented to fight COVID-19 resulted in an unprecedented spike in unemployment, which likely led to a number of families finding it difficult to keep up with their payment obligations. That is especially true for lower-income households, which may have had much less of a financial cushion before the onset of the crisis. Along with our monetary policy actions, stimulus checks and enhanced unemployment benefits provided in the CARES Act have been a substantial and timely source of financial support to households during this difficult time. Understanding the financial stress this could place on many borrowers, the Fed and other federal regulators implemented guidance to encourage banks to work with their borrowers. By mid-July, only around 8 percent of outstanding residential mortgage loans were in forbearance, well below what many industry observers had feared. It remains possible that the economic challenges will persist beyond the forbearance time period provided in the CARES Act, and if so, we would almost certainly see some of these loans transition into longer-term delinquency status or enter into renewed deferment periods. Thus far, however, the data have been encouraging. Turning to the impact on businesses, we know the effects have been most severe in the services sector, especially travel, leisure, and hospitality. To give some sense of the losses, employment in the leisure and hospitality sectors nationwide was down nearly 40 percent in the 12 months through May and still down about 25 percent through July. Retail employment fell 15 percent over March and April, though it has recovered substantially since then, and in July it was 6 percent below the pre-COVID level. It is encouraging to see that even those sectors most heavily affected by the crisis are finding ways to innovate. Stores are adjusting hours and ramping up delivery, restaurants are changing menus and creating outdoor space, distilleries shifted from making bourbon to hand sanitizers, and independent businesses that hadn't previously relied heavily on technology are now using it to stay connected to customers and regulate workflow. Timely and supportive fiscal and monetary policy measures also have helped, but with the progress of the recovery still tentative, I expect that many businesses will continue to fight for survival in the months ahead, with the support of their lenders and communities. Looking ahead, the economic outlook will continue to evolve quickly. We experienced a pronounced and very welcome bounceback in national retail spending and housing activity over the early summer months. We also saw positive news on progress toward a vaccine and in the effective treatment of patients. Even so, positive cases and hospitalizations have risen in some areas and continue to weigh on some regions and the overall economy. As Chair Powell has noted, the timeline for the recovery is highly uncertain and will depend heavily on the course of the pandemic. We must therefore recognize that progress toward a full recovery in economic activity may well be slow and uneven Now let me turn to the Federal Reserve's role in the government's response to the pandemic. During the initial phase of the crisis, we took a number of actions to stabilize financial markets that came under intense stress, including purchasing sizable amounts of Treasury and mortgage-backed securities. To support households and businesses, the Fed quickly lowered our target for the federal funds rate, which has helped to lower borrowing costs but created a different challenge for financial institutions--depressed net interest margins. The Fed has also supported actions by Congress and the administration by creating a number of new emergency lending programs. These programs were designed to restore and sustain proper functioning in certain financial markets that had seized up in March and to facilitate the continued flow of credit from banks to households and businesses. One federal stimulus program that relied heavily on the participation and through banks, the PPP program has delivered more than $500 billion to small businesses to help them weather the storm. Community bankers played a crucial role in getting these funds to businesses that needed it, showing once again how essential community banks are to the customers they serve. And in response to feedback we received from a number of community bankers, the Fed created the PPP lending facility to alleviate balance-sheet capacity issues for banks that otherwise would not have been able to provide PPP loans to their small-business customers. The PPP was created to help small businesses keep their employees on staff, and the Main Street Lending program is designed to support lending to mid-sized businesses through the recovery. The Federal Reserve has not engaged in lending directly to businesses before, but it was a step that seemed appropriate considering the breadth and depth of the challenges we face. We continue to solicit feedback and make adjustments to the program based on the suggestions received from bankers and other stakeholders, and we continue to welcome your thoughts and ideas on how we can make Main Street more effective. I would be interested to visit with those who may already have experience with this new loan program, and I would also be interested to hear about how you plan to use it to meet the needs of your business customers. Together, these policy actions have helped stabilize financial markets, boost consumer and business sentiment, and assist millions of households and thousands of businesses harmed by the response to the pandemic. Credit markets, which had seized up earlier this year, have resumed functioning. In our other role as a prudential regulator and bank supervisor, the Federal Reserve took several steps intended to reduce burden on banks and help them focus on the needs of their customers and communities. Together, with our fellow federal regulators, we delayed the impact of the CECL accounting standard in our capital rules and temporarily eased the leverage ratio requirement for community banks. We also delayed reporting dates for Call Reports and other data collections. In addition, to address concerns about real estate appraisal delays, we provided temporary relief from certain appraisal requirements. From a supervisory perspective, beginning in late March the Fed paused examinations for most small banks and took steps to lengthen remediation timeframes for outstanding issues. We considered the exam pause an important step to provide bankers time to adjust operations to protect the health of customers and employees, to prioritize the financial needs of their customers and communities, and to play an essential and vital role in implementing critical relief programs like the PPP. As we continue to support the recovery and work to ensure that supervision and examination is as effective and efficient as possible, I think it's important to hear directly from you, who are actually working in the economy, about the conditions facing your communities and any challenges impeding your ability to meet the needs of your customers. In addition to my regular outreach to community banks, I am currently engaged in an effort to speak with every CEO of the more than 650 community banks supervised by the Fed. I want to hear directly from bankers about what you are seeing and your thoughts and ideas about the recovery. These conversations are incredibly valuable to me as a bank regulator and policymaker. They give context to the mountains of data we analyze and a unique perspective with real-world local examples to a complex and dynamic economic picture. For those of you from Fed member banks who I have not yet had the opportunity to meet or speak with by phone in these times of COVID, I look forward to our conversation. Your local Reserve Bank will be in contact to find a convenient time for us to meet. This audience knows better than most that smaller banks entered the pandemic in strong condition. At the end of 2019, over 95 percent of community and regional banks supervised by the Fed were rated a 1 or 2 under the CAMELS rating system. After coming through the last financial crisis in generally stronger condition than larger banks, smaller institutions had strengthened their capital positions and substantially improved asset quality in the years since, leaving them better positioned to deal with the current stress related to the pandemic. Likewise, credit concentrations, especially in construction and commercial real estate, were lower for smaller banks than at the outset of the last financial crisis, and risk management of concentrations improved over the last decade. Smaller banks also entered the pandemic with high levels of liquidity, and this liquidity has further improved with deposit inflows associated with pandemic-related stimulus programs. Overall, community and regional banks remain well positioned to continue to extend credit and play an essential role in supporting our nation's recovery from the With this in mind, on June 15 the Federal Reserve announced our plan to resume bank examinations. We recognize the unique and challenging conditions under which the industry has been operating, and we will certainly consider that as we resume examinations. Our initial focus will be to assess higher risk banks, particularly those with credit concentrations in higher risk or stressed industries. Finally, we will continue to be sensitive to the capacity of each bank to participate in examinations and strive to prevent undue burden on banks struggling with crisis-related operational challenges. Like many native Kansans, I am an eternal optimist, so let me end my formal remarks on a hopeful note. While the road ahead is highly uncertain, and we don't yet know when the economy will return to its previous strength, America will recover from this crisis, as it has from all of our past challenges. Our economic fundamentals are strong, and we have the solid foundation of the entrepreneurial spirit and resiliency of the American people. For its part, the Federal Reserve will continue to monitor progress and respond promptly and flexibly to support the recovery. We will closely watch economic and financial conditions, and we will use our monetary policy tools to respond as appropriate to pursue our dual mandate of maximum employment and price stability. We will also remain open to further adjustments to supervisory schedules and expectations, as needed. Thank you for the opportunity to speak with you today. I look forward to our discussion.

r200827a_FOMC

united states

New Economic Challenges and the Fed's Monetary Policy Review

powell

Thank you, Esther, for that introduction, and good morning. The Kansas City Fed's Economic Policy Symposiums have consistently served as a vital platform for discussing the most challenging economic issues of the day. Judging by the agenda and the papers, this year will be no exception. For the past year and a half, my colleagues and I on the Federal Open Market Committee (FOMC) have been conducting the first-ever public review of our monetary policy framework. Earlier today we released a revised Statement on Longer-Run Goals and Monetary Policy Strategy, a document that lays out our goals, articulates our framework for monetary policy, and serves as the foundation for our policy actions. Today I will discuss our review, the changes in the economy that motivated us to undertake it, and our revised statement, which encapsulates the main conclusions of the review. We began this public review in early 2019 to assess the monetary policy strategy, tools, and communications that would best foster achievement of our congressionally assigned goals of maximum employment and price stability over the years ahead in service to the American people. Because the economy is always evolving, the FOMC's strategy for achieving its goals--our policy framework--must adapt to meet the new challenges that arise. Forty years ago, the biggest problem our economy faced was high and rising inflation. The Great Inflation demanded a clear focus on restoring the credibility of the FOMC's commitment to price stability. Chair Paul Volcker brought that focus to bear, and the "Volcker disinflation," with the continuing stewardship of Alan Greenspan, led to the stabilization of inflation and inflation expectations in the 1990s at around 2 percent. The monetary policies of the Volcker era laid the foundation for the long period of economic stability known as the Great Moderation. This new era brought new challenges to the conduct of monetary policy. Before the Great Moderation, expansions typically ended in overheating and rising inflation. Since then, prior to the current pandemic-induced downturn, a series of historically long expansions had been more likely to end with episodes of financial instability, prompting essential efforts to substantially increase the strength and resilience of the financial system. By the early 2000s, many central banks around the world had adopted a monetary policy framework known as inflation targeting. Although the precise features of inflation targeting differed from country to country, the core framework always articulated an inflation goal as a primary objective of monetary policy. Inflation targeting was also associated with increased communication and transparency designed to clarify the central bank's policy intentions. This emphasis on transparency reflected what was then a new appreciation that policy is most effective when it is clearly understood by the public. Inflation-targeting central banks generally do not focus solely on inflation: Those with "flexible" inflation targets take into account economic stabilization in addition to their inflation objective. Under Ben Bernanke's leadership, the Federal Reserve adopted many of the features associated with flexible inflation targeting. We made great advances in transparency and communications, with the initiation of quarterly press conferences and led an effort on behalf of the FOMC to codify the Committee's approach to monetary and Monetary Policy Strategy, which we often refer to as the consensus statement. A central part of this statement was the articulation of a longer-run inflation goal of 2 percent. Because the structure of the labor market is strongly influenced by nonmonetary factors that can change over time, the Committee did not set a numerical objective for maximum employment. However, the statement affirmed the Committee's commitment to fulfilling both of its congressionally mandated goals. The 2012 statement was a significant milestone, reflecting lessons learned from fighting high inflation as well as from experience around the world with flexible inflation targeting. The statement largely articulated the policy framework the Committee had been following for some time. Motivation for the Review The completion of the original consensus statement in January 2012 occurred early on in the recovery from the Global Financial Crisis, when notions of what the "new normal" might bring were quite uncertain. Since then, our understanding of the economy has evolved in ways that are central to monetary policy. Of course, the conduct of monetary policy has also evolved. A key purpose of our review has been to take stock of the lessons learned over this period and identify any further changes in our monetary policy framework that could enhance our ability to achieve our maximum-employment and price-stability objectives in the years ahead. Our evolving understanding of four key economic developments motivated our review. First, assessments of the potential, or longer-run, growth rate of the economy have declined. For example, since January 2012, the median estimate of potential growth slowing in growth relative to earlier decades was to be expected, reflecting slowing population growth and the aging of the population. More troubling has been the decline in productivity growth, which is the primary driver of improving living standards over time. Second, the general level of interest rates has fallen both here in the United States and around the world. Estimates of the neutral federal funds rate, which is the rate consistent with the economy operating at full strength and with stable inflation, have fallen substantially, in large part reflecting a fall in the equilibrium real interest rate, or "r-star." This rate is not affected by monetary policy but instead is driven by fundamental factors in the economy, including demographics and productivity growth-- the same factors that drive potential economic growth. The median estimate from FOMC participants of the neutral federal funds rate has fallen by nearly half since early This decline in assessments of the neutral federal funds rate has profound implications for monetary policy. With interest rates generally running closer to their effective lower bound even in good times, the Fed has less scope to support the economy during an economic downturn by simply cutting the federal funds rate. The result can be worse economic outcomes in terms of both employment and price stability, with the costs of such outcomes likely falling hardest on those least able to bear them. Third, and on a happier note, the record-long expansion that ended earlier this year led to the best labor market we had seen in some time. The unemployment rate hovered near 50-year lows for roughly 2 years, well below most estimates of its sustainable level. And the unemployment rate captures only part of the story. Having declined significantly in the five years following the crisis, the labor force participation rate flattened out and began rising even though the aging of the population suggested that it should keep falling. For individuals in their prime working years, the participation rate fully retraced its post-crisis decline, defying earlier assessments that the Global Financial Crisis might cause permanent structural damage to the labor market. Moreover, as the long expansion continued, the gains began to be shared more widely across society. The Black and Hispanic unemployment rates reached record lows, and the differentials between these rates and the white unemployment rate narrowed to their lowest levels on record. As we heard repeatedly in our events, the robust job market was delivering life-changing gains for many individuals, families, and communities, particularly at the lower end of the income spectrum. In addition, many who had been left behind for too long were finding jobs, benefiting their families and communities, and increasing the productive capacity of our economy. Before the pandemic, there was every reason to expect that these gains would continue. It is hard to overstate the benefits of sustaining a strong labor market, a key national goal that will require a range of policies in addition to supportive monetary policy. Fourth, the historically strong labor market did not trigger a significant rise in inflation. Over the years, forecasts from FOMC participants and private-sector analysts routinely showed a return to 2 percent inflation, but these forecasts were never realized on a sustained basis (see figure 3). Inflation forecasts are typically predicated on estimates of the natural rate of unemployment, or "u-star," and of how much upward pressure on inflation arises when the unemployment rate falls relative to u-star. As the unemployment rate moved lower and inflation remained muted, estimates of u-star were revised down. For example, the median estimate from FOMC participants declined from inflation to labor market tightness, which we refer to as the flattening of the Phillips curve, also contributed to low inflation outcomes. In addition, longer-term inflation expectations, which we have long seen as an important driver of actual inflation, and global disinflationary pressures may have been holding down inflation more than was generally anticipated. Other advanced economies have also struggled to achieve their inflation goals in recent decades. The persistent undershoot of inflation from our 2 percent longer-run objective is a cause for concern. Many find it counterintuitive that the Fed would want to push up inflation. After all, low and stable inflation is essential for a well-functioning economy. And we are certainly mindful that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes. However, inflation that is persistently too low can pose serious risks to the economy. Inflation that runs below its desired level can lead to an unwelcome fall in longer-term inflation expectations, which, in turn, can pull actual inflation even lower, resulting in an adverse cycle of ever-lower inflation and inflation expectations. This dynamic is a problem because expected inflation feeds directly into the general level of interest rates. Well-anchored inflation expectations are critical for giving the Fed the latitude to support employment when necessary without destabilizing inflation. But if inflation expectations fall below our 2 percent objective, interest rates would decline in tandem. In turn, we would have less scope to cut interest rates to boost employment during an economic downturn, further diminishing our capacity to stabilize the economy through cutting interest rates. We have seen this adverse dynamic play out in other major economies around the world and have learned that once it sets in, it can be very difficult to overcome. We want to do what we can to prevent such a dynamic from happening here. Elements of the Review We began our review with these changes in the economy in mind. The review had three pillars: a series of events held around the country, a flagship research conference, and a series of Committee discussions supported by rigorous staff analysis. As is appropriate in our democratic society, we have sought extensive engagement with the public throughout the review. events built on a long-standing practice around the Federal Reserve System of engaging with community groups. The 15 events involved a wide range of participants--workforce development groups, union members, small business owners, residents of low- and moderate-income communities, retirees, and others--to hear about how our policies affect peoples' daily lives and livelihoods. The stories we heard at events became a potent vehicle for us to connect with the people and communities that our policies are intended to benefit. One of the clear messages we heard was that the strong labor market that prevailed before the pandemic was generating employment opportunities for many Americans who in the past had not found jobs readily available. A clear takeaway from these events was the importance of achieving and sustaining a strong job market, particularly for people from low- and moderate- income communities. The research conference brought together some of the world's leading academic experts to address topics central to our review, and the presentations and robust discussion we engaged in were an important input to our review process. Finally, the Committee explored the range of issues that were brought to light during the course of the review in five consecutive meetings beginning in July 2019. Analytical staff work put together by teams across the Federal Reserve System provided essential background for each of the Committee's discussions. Our plans to conclude the review earlier this year were, like so many things, delayed by the arrival of the pandemic. When we resumed our discussions last month, we turned our attention to distilling the most important lessons of the review in a revised The federated structure of the Federal Reserve, reflected in the FOMC, ensures that we always have a diverse range of perspectives on monetary policy, and that is certainly the case today. Nonetheless, I am pleased to say that the revised consensus statement was adopted today with the unanimous support of Committee participants. Our new consensus statement, like its predecessor, explains how we interpret the mandate Congress has given us and describes the broad framework that we believe will best promote our maximum-employment and price-stability goals. Before addressing the key changes in our statement, let me highlight some areas of continuity. We continue to believe that specifying a numerical goal for employment is unwise, because the maximum level of employment is not directly measurable and changes over time for reasons unrelated to monetary policy. The significant shifts in estimates of the natural rate of unemployment over the past decade reinforce this point. In addition, we have not changed our view that a longer-run inflation rate of 2 percent is most consistent with our mandate to promote both maximum employment and price stability. Finally, we continue to believe that monetary policy must be forward looking, taking into account the expectations of households and businesses and the lags in monetary policy's effect on the economy. Thus, our policy actions continue to depend on the economic outlook as well as the risks to the outlook, including potential risks to the financial system that could impede the attainment of our goals. The key innovations in our new consensus statement reflect the changes in the economy I described. Our new statement explicitly acknowledges the challenges posed by the proximity of interest rates to the effective lower bound. By reducing our scope to support the economy by cutting interest rates, the lower bound increases downward risks to employment and inflation. To counter these risks, we are prepared to use our full range of tools to support the economy. With regard to the employment side of our mandate, our revised statement emphasizes that maximum employment is a broad-based and inclusive goal. This change reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities. In addition, our revised statement says that our policy decision will be informed by our "assessments of the shortfalls of employment from its maximum level" rather than by " deviations from its maximum level" as in our previous statement. This change may appear subtle, but it reflects our view that a robust job market can be sustained without causing an outbreak of inflation. In earlier decades when the Phillips curve was steeper, inflation tended to rise noticeably in response to a strengthening labor market. It was sometimes appropriate for the Fed to tighten monetary policy as employment rose toward its estimated maximum level in order to stave off an unwelcome rise in inflation. The change to "shortfalls" clarifies that, going forward, employment can run at or above real-time estimates of its maximum level without causing concern, unless accompanied by signs of unwanted increases in inflation or the emergence of other risks that could impede the attainment of our goals. Of course, when employment is below its maximum level, as is clearly the case now, we will actively seek to minimize that shortfall by using our tools to support economic growth and job creation. We have also made important changes with regard to the price-stability side of our mandate. Our longer-run goal continues to be an inflation rate of 2 percent. Our statement emphasizes that our actions to achieve both sides of our dual mandate will be most effective if longer-term inflation expectations remain well anchored at 2 percent. However, if inflation runs below 2 percent following economic downturns but never moves above 2 percent even when the economy is strong, then, over time, inflation will average less than 2 percent. Households and businesses will come to expect this result, meaning that inflation expectations would tend to move below our inflation goal and pull realized inflation down. To prevent this outcome and the adverse dynamics that could ensue, our new statement indicates that we will seek to achieve inflation that averages 2 percent over time. Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time. In seeking to achieve inflation that averages 2 percent over time, we are not tying ourselves to a particular mathematical formula that defines the average. Thus, our approach could be viewed as a flexible form of average inflation targeting. decisions about appropriate monetary policy will continue to reflect a broad array of considerations and will not be dictated by any formula. Of course, if excessive inflationary pressures were to build or inflation expectations were to ratchet above levels consistent with our goal, we would not hesitate to act. The revisions to our statement add up to a robust updating of our monetary policy framework. To an extent, these revisions reflect the way we have been conducting policy in recent years. At the same time, however, there are some important new features. our continued strong commitment to achieving our goals, given the difficult challenges presented by the proximity of interest rates to the effective lower bound. In conducting monetary policy, we will remain highly focused on fostering as strong a labor market as possible for the benefit of all Americans. And we will steadfastly seek to achieve a 2 percent inflation rate over time. Our review has provided a platform for productive discussion and engagement with the public we serve. The events helped us connect with our core constituency, the American people, and hear directly how their everyday lives are affected by our policies. We believe that conducting a review at regular intervals is a good institutional practice, providing valuable feedback and enhancing transparency and accountability. And with the ever-changing economy, future reviews will allow us to take a step back, reflect on what we have learned, and adapt our practices as we strive to achieve our dual-mandate goals. As our statement indicates, we plan to undertake a thorough public review of our monetary policy strategy, tools, and communication practices roughly every five years. . . . . vol. 11 . . . . . . Monetary Policy Forum, sponsored by the Initiative on Global Markets at the . . . . . vol. 29 . , . . Journal of . vol. 11 . . . . and the Threat to American Leadership.

r200831a_FOMC

united states

The Federal Reserve’s New Monetary Policy Framework: A Robust Evolution

clarida

Last week, the Federal Reserve reached an important milestone in its ongoing review of its monetary policy strategy, tools, and communication practices with the unanimous approval and release of a new Statement on Longer-Run Goals and Monetary In my remarks today, I will discuss our new framework and highlight some important policy implications that flow from the revised statement and our new strategy. I believe that this new statement and strategy represent a critical and robust evolution of our framework that will best equip the Federal Reserve to achieve our dual- mandate objectives on a sustained basis in the world in which we conduct policy today and for the foreseeable future. I will divide my remarks into four parts. First, I will discuss the factors that motivated the Federal Reserve in November 2018 to announce it would undertake in 2019 the first-ever public review of its monetary policy strategy, tools, and communication practices. Second, I will discuss the review process itself, with particular focus on the economic analysis and public input the Federal Open Market Committee (FOMC) drew on as it contemplated, over the past 18 months, potential changes to its policy framework. Third, I will briefly summarize the flexible inflation-targeting strategy that has been guiding U.S. monetary policy since 2012 in the context of some important changes in the economic landscape that have become evident since 2012. Fourth, I will discuss the major findings of the review as codified in our new Statement on Longer-Run Goals and Monetary Policy Strategy and highlight some important policy implications that flow from them. Finally, I will offer some brief concluding remarks before joining in conversation with my good friend Adam Posen, which, as always, I very much look forward to. Motivation for the Review As my FOMC colleagues and I indicated from the outset, the fact that the Federal Reserve System chose to conduct this review does not indicate that we believed we have been poorly served by the framework in place since 2012. Indeed, I would argue that over the past eight years, the framework served us well and supported the Federal Reserve's efforts after the Global Financial Crisis (GFC) first to achieve and then, for several years, to sustain--until cut short this spring by the COVID-19 pandemic--the operation of the economy at or close to both our statutorily assigned goals of maximum employment and price stability in what became the longest economic expansion in U.S. history. Nonetheless, both the U.S. economy--and, equally importantly, our understanding of the economy--have clearly evolved along several crucial dimensions since 2012, and we believed that in 2019 it made sense to step back and assess whether, and in what possible ways, we might refine and rethink our strategy, tools, and communication practices to achieve and sustain our goals as consistently and robustly as possible in the global economy in which we operate today and for the foreseeable future. Perhaps the most significant change since 2012 in our understanding of the economy is our reassessment of the neutral real interest rate, r*, that, over the longer run, is consistent with our maximum-employment and price-stability mandates. In January 2012, the median FOMC participant projected a long-run r* of 2.25 percent, which, in tandem with the inflation goal of 2 percent, indicated a neutral setting for the federal funds rate of 4.25 percent. However, in the eight years since 2012, members of the Committee--as well as outside forecasters and financial market participants--have repeatedly marked down their estimates of longer-run r* and, thus, the neutral nominal policy rate. released in June, the median FOMC participant currently projects a longer-run r* equal to just 0.5 percent, which implies a neutral setting for the federal funds rate of 2.5 percent. Moreover, as is well appreciated, the decline in neutral policy rates since the GFC is a global phenomenon that is widely expected by forecasters and financial markets to persist for years to come. The substantial decline in the neutral policy rate since 2012 has critical implications for the design, implementation, and communication of Federal Reserve monetary policy because it leaves the FOMC with less conventional policy space to cut rates to offset adverse shocks to aggregate demand. With a diminished reservoir of conventional policy space, it is much more likely than was appreciated in 2012 that, in economic downturns, the effective lower bound (ELB) will constrain the ability of the FOMC to rely solely on the federal funds rate instrument to offset adverse shocks. development, in turn, makes it more likely that recessions will impart elevated risks of more persistent downward pressure on inflation and upward pressure on unemployment that the Federal Reserve's monetary policy should, in design and implementation, seek to offset throughout the business cycle and not just in downturns themselves. Two other, related developments that have also become more evident than they appeared in 2012 are that price inflation seems less responsive to resource slack, and also, that estimates of resource slack based on historically estimated price Phillips curve relationships are less reliable and subject to more material revision than was once commonly believed. For example, in the face of declining unemployment rates that did not result in excessive cost-push pressure to price inflation, the median of the Committee's projections of u*--the rate of unemployment consistent in the longer run with the 2 percent inflation objective--has been repeatedly revised lower, from Projections of u* by the Congressional Budget Office and professional forecasters show a similar decline during this same period and for the same reason. In the past several years of the previous expansion, declines in the unemployment rate occurred in tandem with a notable and, to me, welcome increase in real wages that was accompanied by an increase in labor's share of national income, but not a surge in price inflation to a pace inconsistent with our price-stability mandate and well-anchored inflation expectations. Indeed, this pattern of mid-cycle declines in unemployment coincident with noninflationary increases in real wages has been evident in the U.S. data since the 1990s. With regard to inflation expectations, there is broad agreement among academics and policymakers that achieving price stability on a sustainable basis requires that inflation expectations be well anchored at the rate of inflation consistent with the price- stability goal. This is especially true in the world that prevails today, with flat Phillips curves in which the primary determinant of actual inflation is expected inflation. pre-GFC academic literature derived the important result that a credible inflation- targeting monetary policy strategy that is not constrained by the ELB can deliver, under rational expectations, inflation expectations that themselves are well anchored at the inflation target. In other words, absent a binding ELB constraint, a policy that targets actual inflation in these models delivers long-run inflation expectations well anchored at the target "for free." But this "copacetic coincidence" no longer holds in a world of low r* in which adverse aggregate demand shocks are expected to drive the economy in at least some downturns to the ELB. In this case, which is obviously relevant today, economic analysis indicates that flexible inflation-targeting monetary policy cannot be relied on to deliver inflation expectations that are anchored at the target, but instead will tend to deliver inflation expectations that, in each business cycle, become anchored at a level below the target. This is the crucial insight in my colleague John Williams' research with Thomas Mertens. Indeed John's research over the past 20 years on r* estimation and monetary policy design at the ELB have been enormously influential, not only in the profession but also at Fed and certainly in my own thinking about how our framework should evolve. This downward bias in inflation expectations under inflation targeting in an ELB world can in turn reduce already scarce policy space--because nominal interest rates reflect both real rates and expected inflation--and it can open up the risk of the downward spiral in both actual and expected inflation that has been observed in some other major economies. Inflation expectations are, of course, not directly observed and must be imperfectly inferred from surveys, financial market data, and econometric models. Each of these sources contains noise as well as signal, and they can and sometimes do give contradictory readings. But, at minimum, the failure of actual PCE (personal consumption expenditures) inflation--core or headline--over the past eight years to reach the 2 percent goal on a sustained basis cannot have contributed favorably to keeping inflation expectations anchored at 2 percent. Indeed, my reading of the evidence is that the various measures of inflation expectations I follow reside at the low end of a range I consider consistent with our 2 percent inflation goal. With this brief overview of important changes in the economic landscape since 2012, I would now like to discuss the review process itself. In November 2018, the Federal Reserve announced that in 2019 the System would undertake a wide-ranging, public review of its monetary policy strategy, tools, and communication practices. This initiative would be the first-ever public review of monetary policy strategy ever undertaken by the Fed. From the outset, it was conceived that the review would build on three pillars: a series of livestreamed events hosted by each of the Reserve Banks and the Board, a flagship research conference hosted by the Federal Reserve Bank of Chicago, and a series of 13 rigorous briefings for the Committee by System staff at a succession of five consecutive FOMC meetings commencing in July 2019 and running through January 2020. series built on a long-standing practice at the Reserve Banks and the Board of hosting outreach events that included a wide range of community groups, but, by focusing on a common format in which representatives of these groups were encouraged to tell their stories about our policies' effect on their communities and daily lives, it became a potent vehicle for us to better connect with the people our policies are meant to benefit. Although many people across the System were involved in making the success it was, I would be more than remiss if I did not single out Ellen Meade for her indefatigable contributions and attention to detail and organization that were essential to pulling the whole thing off. A report on the series is available on the Board's web site. The second pillar of our review, a research conference hosted by the Federal Reserve Bank of Chicago, brought together some of the world's leading academic experts in monetary economics to present bespoke papers on a range of topics central to the review. These papers and the robust discussion at the conference that they stimulated were an important input to the review process. The proceedings of the Chicago conference are available as a special January 2020 issue of the The third important pillar of the review is a collection of 13 memos prepared by System staff and discussed by the Committee at a number of FOMC meetings over the past 18 months. These memos were commissioned by a System steering committee that Reeve. Thomas Laubach chaired the steering committee, and I must note that we simply would not be here today discussing this significant evolution of our framework without Thomas and the insights, inspiration, and good judgment that he brought to the project and the review process. A collection of the staff memos prepared for the review is now available on the Board's website. As I mentioned earlier, the Committee devoted five consecutive FOMC meetings between July 2019 and January 2020 to presentations by the staff and Committee discussions of memos touching on various aspects of the framework review, and it held a lengthy discussion at the July 2020 FOMC meeting about the new Statement on Longer- While it is fair to say that these Committee discussions revealed among the 17 participants a healthy range of views about and priorities for refining our framework and strategy, some common themes did emerge, and these provided the foundation for the revised Statement on Longer-Run Goals and Monetary Policy Strategy that the Committee discussed in July, approved last week, and Broadly, we agreed that the economic landscape has changed in important ways since 2012 and that, as a result, the existing statement and the monetary policy strategy that flows from it need as well to evolve along several dimensions. For example, under our previous flexible inflation-targeting framework, the Federal Reserve declared that the 2 percent inflation objective is "symmetric." This term has been interpreted by many observers to mean that the Committee's reaction function aimed to be symmetric on either side of the 2 percent inflation goal, and that the FOMC set policy with the (ex ante) aim that the 2 percent goal should represent an inflation ceiling in economic expansions following economic downturns in which inflation falls below target. Regarding the ELB, the previous statement was silent on the global decline in neutral policy rates, the likelihood that the ELB will constrain monetary policy space in economic downturns, and the implications of this constraint for our ability to achieve our dual-mandate goals. As for inflation expectations, the previous statement did discuss expected inflation, but only in the context of mentioning that the announcement of a 2 percent goal helps anchor inflation expectations. While this is certainly true, it does beg the deeper question of how well anchored inflation expectations can be if the 2 percent goal is seen by the public as--and turns out ex post to be--a ceiling. Regarding the maximum-employment leg of the dual mandate, the previous statement's discussion of minimizing "deviations" of employment from its maximum level does not adequately reflect how the FOMC has actually conducted monetary policy in recent years--before the pandemic--as the actual unemployment rate was declining and, for several years, remained below SEP median projections of u* (although, to be sure, the earlier statement did acknowledge that it can be difficult to estimate the maximum level of employment with precision). Strategy has evolved, let me highlight some important elements that remain unchanged. First and foremost, our policy framework and strategy remain focused exclusively on meeting the dual mandate assigned to us by the Congress. Second, our statement continues to note that the maximum level of employment that we are mandated to achieve is not directly measurable and changes over time for reasons unrelated to monetary policy. Hence, we continue not to specify a numerical goal for our employment objective as we do for inflation. Third, we continue to state that an inflation rate of 2 percent over the longer run is most consistent with our mandate to promote both maximum employment and price stability. Finally, because the effect of monetary policy on the economy operates with a lag, our strategy remains forward looking. As a result, our policy actions depend on the economic outlook as well as the risks to the outlook, and we continue in the new statement to highlight potential risks to the financial system that could impede the attainment of our dual-mandate goals on a sustained basis. With respect to the new framework itself, the statement now notes that the neutral level of the federal funds rate has declined relative to its historical average and therefore that the policy rate is more likely than in the past to be constrained by its ELB, and, moreover, that this binding ELB constraint is likely to impart downside risks to inflation and employment that the Committee needs to consider in implementing its monetary policy strategy. In this regard, the statement now highlights that the Committee is prepared to use its full range of tools to achieve its dual-mandate objectives. Regarding the maximum-employment mandate, the new statement now acknowledges that maximum employment is a "broad-based and inclusive goal" and continues to state that the FOMC considers a wide range of indicators to assess the level of maximum employment consistent with this broad-based goal. However, under our new framework, policy decisions going forward will be based on the FOMC's estimates of " shortfalls of employment from its maximum level"--not "deviations." This change conveys our judgment that a low unemployment rate by itself, in the absence of evidence that price inflation is running or is likely to run persistently above mandate-consistent levels or pressing financial stability concerns, will not, under our new framework, be a sufficient trigger for policy action. This is a robust evolution in the Federal Reserve's policy framework and, to me, reflects the reality that econometric models of maximum employment, while essential inputs to monetary policy, can be and have been wrong, and, moreover, that a decision to tighten monetary policy based solely on a model without any other evidence of excessive cost-push pressure that puts the price-stability mandate at risk is difficult to justify, given the significant cost to the economy if the model turns out to be wrong and given the ability of monetary policy to respond if the model were eventually to turn out to be right. With regard to the price-stability mandate, while the new statement maintains our definition that the longer-run goal for inflation is 2 percent, it elevates the importance-- and the challenge--of keeping inflation expectations "well anchored at 2 percent not just "well anchored") in a world of low r* and an ELB constraint that is binding in downturns. To this end, the new statement conveys the Committee's judgment that, in order to anchor expectations at 2 percent, it "seeks to achieve inflation that averages 2 percent over time," and--in the same sentence--that therefore "following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time." This is the second robust evolution of our framework, and it reflects the inherent asymmetry of conducting monetary policy in a low r* world with an ELB constraint that binds in economic downturns. As discussed earlier, if policy seeks only to return inflation to 2 percent following a downturn in which the ELB has constrained policy, an inflation- targeting monetary policy will tend to generate inflation that averages less than 2 percent, which, in turn, will tend to put persistent downward pressure on inflation expectations and, potentially, on available policy space. In order to offset this downward bias, our new framework recognizes that monetary policy during economic expansions needs to "aim to achieve inflation moderately above 2 percent for some time." In other words, the aim to achieve symmetric outcomes for inflation (as would be the case under flexible inflation targeting in the absence of the ELB constraint) requires an asymmetric monetary policy reaction function in a low r* world with binding ELB constraints in economic downturns. It is for this reason that while our new statement no longer refers to the 2 percent inflation goal as symmetric, it does now say that the Committee "seeks to achieve inflation that averages 2 percent over time." To be clear, "inflation that averages 2 percent over time" represents an ex ante aspiration, not a description of a mechanical reaction function--nor is it a commitment to conduct monetary policy tethered to any particular formula or rule. Indeed, as summarized in the minutes of the September FOMC meeting, the Committee (and, certainly, I) was skeptical about the benefit, credibility, or practicality of adopting a formal numerical price level or average inflation target rule, just as it has been unwilling to implement its existing flexible inflation- targeting strategy via any sort of mechanical rule. So in practice, what, then, is the policy implication of this stated desire "to achieve inflation that averages 2 percent over time"? Again, the implication of our new strategy for monetary policy is stated explicitly in the new statement, and, at the risk of repeating myself, let me restate it verbatim: "... following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time." Full stop. As Chair Powell indicated in his remarks last week, we think of this new strategy as an evolution from flexible inflation targeting to flexible average inflation targeting. My remarks today have been focused on our new framework and flexible average inflation targeting strategy. Of course, our review has also explored ways in which we might add to our toolkit and refine our communication practices. With regard to our toolkit, e believe that forward guidance and large-scale asset purchases have been and continue to be effective sources of support to the economy when the federal funds rate is at the ELB, and, of course, both were deployed promptly in our March 2020 policy response to the pandemic. With regard to other monetary policy tools, and as we have made clear previously in the minutes to our October 2019 FOMC meeting, we do not see negative policy rates as an attractive policy option in the U.S. context. As for targeting the yield curve, our general view is that with credible forward guidance and asset purchases, the potential benefits from such an approach may be modest. At the same time, the approach brings complications in terms of implementation and communications. Hence, as noted in the minutes from our previous meeting (July 2020), most of my colleagues judged that yield caps and targets were not warranted in the current environment but should remain an option that the Committee could reassess in the future if circumstances changed markedly. Regarding communication practices, our new consensus statement does bring greater clarity and transparency to the way we will conduct policy going forward, and in that regard I note that Michelle Smith is leading our efforts to make immediately and readily available on the web a bounty of content that will be invaluable to those who desire a more granular understanding of the review process. Finally, now that we have ratified our new statement, the Committee can assess possible refinements to our SEP with the aim of reaching a decision on any potential changes by the end of this year. In closing, let me say that while I was not a member of the Committee in 2012, had I been I would have voted enthusiastically for the January 2012 statement. It was the right statement, and flexible inflation targeting was the right strategy, at that time and for the next eight years. The existing framework served us well by supporting the Federal Reserve's efforts after the GFC first to achieve and then, for several years, to sustain the operation of the economy at or close to both our statutorily assigned goals of maximum employment and price stability. But times change, as has the economic landscape, and our framework and strategy need to change as well. My colleagues and I believe that this new framework represents a critical and robust evolution of our monetary policy strategy that will best equip the Federal Reserve to achieve our dual-mandate objectives on a sustained basis in the world in which we conduct policy today and for the foreseeable future. Thank you very much for your time and attention, and I look forward now to my conversation with Adam. . . . . . vol. 109 . . from the Public. . . . . Forum, sponsored by the Initiative on Global Markets at the University of Chicago . event), held at the . . . , Spring, . . . Policy Forum, sponsored by the Initiative on Global Markets at the University of . . by the Initiative on Global Markets at the University of Chicago Booth School of . vol. 37 . . . . , no. 1, . . . . . . . . . Journal of . . . . . . . . . . . . . . . . . .

r200901a_FOMC

united states

Bringing the Statement on Longer-Run Goals and Monetary Policy Strategy into Alignment with Longer-Run Changes in the Economy

brainard

I want to thank David Wessel for hosting this event. It is an honor to be here with Goals and Monetary Policy Strategy in 2012. It is a pleasure to discuss the new week. By bringing our longer-run goals and strategy into alignment with key longer-run changes in the economy, the new statement will strengthen our support for the recovery. In my view, the new statement breaks important ground and will serve the country well as we respond to the economic repercussions of the COVID-19 crisis. Three related features of the economy's new normal called for the reassessment of the Committee's longer-run goals and strategy. First, the equilibrium interest rate has fallen to low levels, which implies a large decline in how much we can cut interest rates to support the economy. That was abundantly clear in March, when we were able to cut the policy rate by only 1 1/2 percentage points before hitting the effective lower bound--in contrast to previous decades when the policy rate would have been cut by 4 1/2 to 5 percentage points, on average, to buffer the economy from an adverse shock. reduced scope to cut the interest rate could increase the frequency and duration of periods when the policy rate is pinned close to zero, unemployment is elevated, and inflation is below target. In turn, the greater likelihood of extended periods of low inflation at the lower bound risks eroding inflation expectations and further compressing the scope for cutting the interest rate. The risk here is a downward spiral where the scope for cutting the interest rate gets compressed even further, the lower bound binds even more frequently, and it becomes increasingly difficult to move inflation expectations and inflation back up to target. The experience of some foreign central banks illustrates the challenges associated with such a downward spiral. Second, underlying trend inflation appears to be somewhat below the Committee's 2 percent objective, according to various statistical filters. The near decade of inflation persistently short of 2 percent creates the risk that households and businesses come to expect inflation to run persistently below target and change their behavior in a way that fulfills that expectation, which greatly complicates the task of monetary policy. While inflation expectations are difficult to measure with precision, some market-based and survey-based indicators show signs of a downward drift. Ensuring that longer-term inflation expectations are well-anchored at 2 percent is critical to achieving target inflation. Finally, the sensitivity of price inflation to labor market tightness is very low relative to earlier decades, which is what economists mean when they say that the Phillips curve is flat. A flat Phillips curve has the important advantage of allowing employment to continue expanding for longer without generating inflationary pressures, thereby providing job opportunities to people that might not otherwise have them. It also means that it is harder to achieve our 2 percent inflation objective on a sustained basis when inflation expectations have drifted below 2 percent. The new statement on goals and strategy responds to these features of the new normal in a compelling and pragmatic way by making four important changes. First, the statement defines the statutory maximum level of employment as a broad-based and inclusive goal and eliminates the reference to a numerical estimate of the longer-run normal unemployment rate. The longstanding presumption that accommodation should be reduced preemptively when the unemployment rate nears the neutral rate in anticipation of high inflation that is unlikely to materialize risks an unwarranted loss of opportunity for many Americans. llow the labor market to continue healing after the unemployment rate effectively reached the 5 percent median Summary of Economic Projections (SEP) estimate of the normal unemployment rate in the fourth quarter of 2015 supported a further decrease of 3 1/2 percentage points in the Black unemployment rate and of 2 1/4 percentage points in the Hispanic unemployment rate, as well as an increase of nearly 3 percentage points in the labor force participation rate of prime-age women. It also created conditions for the entry of a further 3 1/2 million prime- age Americans into the labor force, a movement of nearly 1 million people out of long- term unemployment, and opportunities for 2 million involuntary part-time workers to secure full-time jobs. Beyond that, had the changes to monetary policy goals and strategy we made in the new statement been in place several years ago, it is likely that accommodation would have been withdrawn later, and the gains would have been greater. Instead of an aggregate "normal" unemployment rate, the Committee's commitment to defining the maximum level of employment as a broad-based and inclusive goal, together with our continued commitment to consider a wide range of indicators, may be particularly significant for the groups that are most vulnerable to employment fluctuations. Both research and experience suggest the groups that face the greatest structural challenges in the labor market are likely to be the first to experience layoffs during downturns and the last to experience employment gains during recoveries. Research by the Federal Reserve Board staff finds that unemployment rates, as well as patterns of job loss and labor force entry and exit, are more cyclically sensitive for Blacks and Hispanics than for whites, and observable worker characteristics can explain very little of these differentials. A similar observation was one of the key takeaways from the sessions we held around the country. Juan Salgado, chancellor of the City Colleges of Chicago, described how last year's tight labor market was finally giving his students, who are largely Black and Latinx, the opportunity to apprentice with local businesses in jobs that historically have not been open to them. Moreover, earnings from wages are particularly important for these groups, who have large and persistent wealth gaps and derive a smaller share of their income from financial asset holdings or from business ownership. Second, to address the downward bias to inflation associated with the proximity to the effective lower bound, the statement adopts a flexible inflation averaging strategy that seeks to achieve inflation that averages 2 percent over time in order to ensure longer- term inflation expectations are well anchored at 2 percent. Flexible average inflation targeting (FAIT) is a consequential change in strategy. By committing to seek inflation that averages 2 percent over time, FAIT means that appropriate monetary policy would likely aim to achieve inflation moderately above 2 percent for a time to compensate for a period, such as the present, when it has been persistently below 2 percent. with this, I would expect the Committee to accommodate rather than offset inflationary pressures moderately above 2 percent, in a process of opportunistic reflation. Flexible average inflation targeting is a pragmatic way to implement a makeup strategy, which is essential to arrest any downward drift in inflation expectations. While a formal average inflation target (AIT) rule is appealing in theory, there are likely to be communications and implementation challenges in practice related to time- consistency and the mechanical nature of such rules. Analysis suggests it could take many years with a formal AIT rule to return the price level to target following a lower- bound episode, and a mechanical AIT rule is likely to become increasingly difficult to explain and implement as conditions change over time. In contrast, FAIT is better suited for the highly uncertain and dynamic context in which policymaking takes place. In my mind, the commitment to undertake a review of the new strategy and goals in roughly five years is a necessary complement to the flexibility embedded in the new inflation averaging strategy. Since the Committee is adopting a new approach, it is prudent and pragmatic to review it after gaining some practical experience with it over five years. As such, the five-year review will provide a vital checkpoint to see how well flexible average inflation targeting is working and, in my thinking, provide some insights into an appropriate makeup period. Depending on conditions at the time of the review, the Committee will have the opportunity to tweak FAIT or to make a more fundamental change, if deemed necessary. Third, the statement highlights an important change in the Committee's reaction function. Whereas previously it sought to mitigate deviations of employment and inflation from their targets in either direction, the Committee will now seek "to mitigate shortfalls of employment from the Committee's assessment of its maximum level and deviations of inflation from its longer-run goal." This change implies that the Committee effectively will set monetary policy to minimize the welfare costs of shortfalls of employment from its maximum and not preemptively withdraw support based on a historically steeper Phillips curve that is not currently in evidence and inflation that is correspondingly much less likely to materialize. Consistent with this, the statement drops language about a "balanced approach" that might be interpreted as calling for the preemptive withdrawal of accommodation and replaces it with a more accurate description of how we pursue our dual-mandate goals in parallel. Fourth and finally, the statement codifies the key lesson from the Global Financial Crisis--that financial stability is necessary for the achievement of our statutory goals of maximum employment and price stability. The same changes in the macroeconomic environment that prompted our monetary policy review have important implications for financial stability. Historically, when the Phillips curve was steeper, inflation tended to rise as the economy heated up. The rise in inflation would prompt the Federal Reserve to raise interest rates to restrictive levels, which would have the effect of tightening financial conditions more broadly. In contrast, the past few cycles did not see this kind of behavior, and in each case, financial imbalances, rather than goods and services inflation, were notably elevated at the onset of the downturn. With a flat Phillips curve and low inflation, the Committee would have to sustain the federal funds rate below the neutral rate for much longer in order to push inflation back to target sustainably. The resulting expectation of lower-for-longer interest rates, along with sustained high rates of resource utilization, is conducive to increasing risk appetite, reach-for-yield behavior, and incentives for leverage--which can boost financial imbalances as an expansion extends. In this way, the combination of a low neutral rate, a flat Phillips curve, and low underlying inflation can lead to more cyclical volatility in asset prices. With financial stability risks more tightly linked to the business cycle, it is vital to use macroprudential as well as standard prudential tools as the first line of defense in order to allow monetary policy to remain focused on achieving maximum employment and 2 percent average inflation. The Committee's new statement on goals and strategy will put us in a stronger position to support a full and timely recovery in employment and average inflation of 2 percent. Overall financial conditions are supportive. Encouragingly, the housing sector has rebounded strongly from its initial decline, supported by historically low mortgage rates, and consumer spending on goods has held up well, in part reflecting earlier fiscal support. At the same time, however, the strong pace of improvement in employment in May and June, which was importantly driven by recall hiring out of temporary layoffs, appears to have slowed. And on the inflation front, despite some bounceback in July, inflation remains weaker than pre-crisis, and it is likely to take some time to return closer to target. Looking ahead, the economy continues to face considerable uncertainty associated with the vagaries of the COVID-19 pandemic, and risks are tilted to the downside. The longer COVID-19-related uncertainty persists, the greater the risk of shuttered businesses and permanent layoffs in some sectors. While the virus remains the most important factor, the magnitude and timing of further fiscal support is a key factor for the outlook. As was true in the first phase of the crisis, fiscal support will remain essential to sustaining many families and businesses. With the recovery likely to face COVID-19-related headwinds for some time, in coming months, it will be important for monetary policy to pivot from stabilization to accommodation. As we move to the next phase of monetary policy, we will be guided by the Committee's new goals and strategy statement. It will be important to provide the requisite accommodation to achieve maximum employment and average inflation of 2 percent over time, following persistent underperformance. While the Committee did not anticipate the unprecedented challenge of the COVID-19 pandemic when the review was launched, the new statement puts us in a stronger position to support a full and timely recovery.

r200921a_FOMC

united states

Strengthening the CRA to Meet the Challenges of Our Time

brainard

It is a pleasure to be back at the Urban Institute with Sarah Rosen Wartell to discuss the Today the Federal Reserve Board unanimously approved an advance notice of proposed rulemaking (ANPR) that would strengthen, clarify, and tailor the CRA regulation to better meet the law's core purpose. The CRA was one of several landmark civil rights laws to address systemic inequities in credit access. The CRA was intended to reinforce the other statutes in addressing redlining, wherein banks declined to make loans or extend other financial services in neighborhoods of largely Black and other minority households, in part based on government maps that literally delimited these neighborhoods in red as high credit risks (figure 1). By enacting the CRA, lawmakers aimed to reverse the disinvestment associated with years of government policies and market actions that deprived lower-income and predominantly minority areas of credit and investment. Even with these critical laws, the legacy of discriminatory lending and systemic inequity in credit access remains in evidence today. The typically minority neighborhoods demarcated in red in the old color-coded maps tend to be characterized by worse economic performance and opportunity even today. Beyond these specific neighborhoods, research and surveys indicate that there are ongoing racial disparities in access to credit. As of 2019, small businesses with Black ownership were only half as likely as those with White ownership to have obtained bank financing in the previous five years (figure 2). In 2016, the "wealth gap [was] roughly the same as in 1962, two years before the passage of the Civil Rights Act of 1964." And the gap in homeownership rates between Black and White households remains significant today, even when controlling for differences in income and education. Recent events have highlighted and exacerbated these challenges. When I last joined you at the Urban Institute to discuss the CRA, we did not know the tremendous hardship and heartache the COVID-19 pandemic would cause, especially for groups with thin financial buffers, including many low- and moderate-income (LMI) neighborhoods, Black and Latinx workers, and workers and entrepreneurs affiliated with small businesses. In parallel, the tragic death of George Floyd has ignited a national discussion about racial injustice and a renewed commitment to take action to address systemic inequity. The CRA is a seminal statute that remains as important as ever as the nation confronts challenges associated with racial equity and the COVID-19 pandemic. We must ensure that the CRA is a strong and effective tool to address ongoing systemic inequities in access to credit and financial services for LMI and minority individuals and communities. By conferring an affirmative obligation on banks to help meet the credit needs in all of the neighborhoods they serve, the CRA prompts banks to be not only more active lenders in LMI areas but also important participants in broader efforts to revitalize communities across the country. Research shows the CRA has positive effects on access to capital and financial services for communities, including home mortgages, small business loans, and services offered at local bank branches. Reforms to the CRA should strengthen the engagement between banks and their communities and advance the law's core purpose of addressing disinvestment and unequal access to credit. The ANPR that the Federal Reserve released today incorporates ideas from public comments on past rulemaking notices, research, and our discussions with the other banking agencies. Our proposal also reflects extensive outreach through the 29 CRA roundtables we held across the country with community and industry leaders and community members. I traveled to Colorado to participate in the first roundtable and to hear from women and minority small business owners about the loans that are enabling their businesses to thrive and the bankers who are providing credit and community development activities in their communities. I made similar visits to communities in areas ranging from El Paso's colonias to Kansas City, from Pine Kentucky, to Rochester, New York. Despite wide variations, in all of these places, I met people working to strengthen their communities. To ensure its continued effectiveness in supporting these efforts, the CRA regulation must evolve along with the landscape of banking and community development. To that end, the Board's ANPR seeks to advance the CRA's core purpose of addressing inequities in credit access and ensuring an inclusive financial services industry. In addition, the ANPR seeks to provide more certainty and consistency, tailor expectations to local conditions and bank business models, and minimize burden. Finally, we intend for the feedback on the ANPR to provide a foundation for the banking agencies to converge on a consistent regulatory approach that has broad support among stakeholders. Guided by these broad goals, I will discuss the key changes we are proposing. We seek to modernize the CRA in a way that significantly expands financial inclusion. By being inclusive in their lending and investing, banks help their local communities to thrive, which in turn benefits their core business. The recognition of this mutually beneficial relationship between banks and their local communities is one of the core strengths of the CRA. To strengthen the CRA's role in financial inclusion, the ANPR proposes to expand and clarify CRA-eligible activities that support minority depository institutions (MDIs), community development financial institutions (CDFIs), women-owned financial institutions, and low- income credit unions. Given the disproportionate impact of COVID-19 on communities of color, it is important to support the institutions that have a mission to serve the families, entrepreneurs, and homeowners in these communities. In May, Governor Miki Bowman and I heard from leaders of Federal Reserve-regulated MDIs about how COVID had hit their communities and the proactive efforts MDIs were taking to bolster their communities' resilience by extending credit to existing and new customers, calling each borrower that applied for a Paycheck Protection Program loan to help them navigate the process, and working with customers to modify and defer payments on existing loans. The Board's proposal would clarify that banks can receive credit for partnerships with MDIs and other mission-oriented institutions on a nationwide basis, and that such activities would be considered as part of a potential pathway to an "outstanding" rating. Furthermore, for regulated MDIs, investments in other MDIs and in their own institutions could be considered as enhancing their CRA performance. Moreover, the ANPR proposes to designate certain areas, based on persistent inequities, where banks could receive credit for community development activities that often lie beyond the boundaries of a bank's branches. For instance, many of the places that I have visited, such as in the colonias, the Mississippi Delta, Appalachia, and Indian Country, have few bank branches and are located outside of branch-based assessment areas. Banks need to be confident about receiving CRA credit to seek out activities and investments in these areas. The ANPR raises a variety of additional ideas that could be significant for financial inclusion. It proposes giving banks greater certainty that their community development activities will be considered in broader statewide and regional areas, in addition to activities within their local communities, so that banks could help address needs in "credit deserts" if they have the capacity to do so. In considering economic development, the ANPR considers that loans to the smallest businesses, smallest farms, and minority-owned small businesses might be considered impactful and responsive to community needs. In addition, the ANPR proposes elevating the focus on the availability of checking account and savings account products in serving LMI communities. Finally, in considering how the CRA's purpose and history relate to the nation's current challenges, the Board seeks feedback on what other modifications and approaches would strengthen the CRA regulation in addressing systemic inequities in credit access for minority individuals and communities. It is important for the CRA to ensure that a wide range of LMI banking needs are met. We heard from stakeholder feedback that both retail and community development activities are important in meeting LMI banking needs. Accordingly, we propose to assess large retail banks using a separate Retail Test and a Community Development Test with separate financing and services subtests (figure 3). Separate assessments of retail lending, retail services, community development financing, and community development services will support robust bank engagement with communities through a variety of channels. Stakeholder feedback has highlighted that each of these areas is essential to LMI communities. The standalone Retail Lending Test is important to stay true to the CRA's core focus on providing credit in underserved communities. Retail lending is the channel through which a family can get a mortgage to buy its first house and an entrepreneur can get a loan for a small business. Retail services are the channel through which an LMI household might get access to essential services from a local bank branch, such as a low-cost checking account. Community development financing captures bank lending and investments that create and maintain affordable housing, promote economic development, and revitalize and stabilize LMI communities. Community development services include financial counseling for low-income families and important volunteer activities undertaken by bank staff, such as serving on the board of a local nonprofit. Some of these activities lend themselves primarily to a qualitative review. For example, the ANPR highlights essential banking services that are responsive to community needs, such as customer support that is provided in multiple languages and flexible branch hours to accommodate LMI customers' work schedules. Although we concluded that the value of services to a local community does not lend itself easily to a monetary value metric, the ANPR proposes introducing quantitative benchmarks where appropriate, such as indicators of whether branch locations are maintained or increased in underserved areas. The ANPR proposes to modernize CRA assessment areas in recognition that reliance on mobile and internet banking has increased in the 25 years since the CRA regulation was last substantially revised. The ANPR still maintains a focus on branches, given their importance to individuals and communities. It also proposes to tailor the facility-based assessment area definition based on bank size. For large banks that conduct a significant amount of lending and deposit-taking outside of their facility-based assessment areas, the ANPR presents options for determining where banks should be assessed outside of where their branches are located. Defining lending-based assessment areas is one option, but the preliminary analysis of this approach provided in the ANPR finds that banks' lending outside of their current assessment areas is widely dispersed and often occurs in places that are already well served. Defining deposit-based assessment areas is another option, but it would entail some additional data reporting burden, and we do not currently have the data to analyze this option closely. For internet banks, which lend across a broad area with few or no branch locations, a nationwide assessment area may advance the CRA's goals more effectively than the current practice of assessing these banks solely where they have a headquarters office. The ANPR seeks to provide greater clarity and consistency through tailored performance evaluations. Responding to calls for greater certainty regarding how banks are assessed and rated, the ANPR introduces a metrics-based approach that is calibrated based on over 6,000 written public CRA evaluations. Test provides greater scope to tailor the metrics to local market conditions, which often differ for retail lending and community development financing. This approach would create clear quantitative thresholds for the level of retail lending and community development financing that is needed to achieve a "satisfactory" CRA rating. For the Retail Lending Subtest, which would apply to large retail banks and any small banks that choose to opt in, banks could earn a presumption of a "satisfactory" performance conclusion in an assessment area by reaching clear thresholds of lending to LMI borrowers and neighborhoods in each of their major product lines. The thresholds would be tailored to local market conditions and adjust automatically to reflect changes over the business cycle. They would be based on local data that reflect the credit needs and opportunities among LMI individuals, communities, small businesses, and small farms and on market data that reflect the level of LMI lending in the area by all lenders. Federal Reserve analysis confirms there are large differences in LMI lending opportunities among assessment areas, which illustrates the importance of tailoring the retail lending thresholds to the needs of the local community (figure 4). The ANPR also considers using the same metrics relative to performance ranges to produce a improve," or "substantial noncompliance." We encourage commenters to make use of the CRA Analytics Data Tables that we published in March in order to evaluate the presumption threshold options and performance ranges and provide feedback. For the Community Development Financing Subtest, the Board is proposing to measure a large retail bank's community development loans and investments relative to its deposits in each assessment area. The thresholds for the Community Development Financing Subtest would be calibrated using local and national data. When we looked at past performance evaluations, we found that community development financing varies widely across different assessment areas, likely reflecting different levels of community development capacity and the unique needs and challenges of different communities. For example, in San Diego, California, the total dollar amount of banks' community financing activities relative to their deposits is three times higher than in Little Rock, Arkansas (figure 5). In addition, metropolitan areas overall have a higher level of community development financing relative to deposits than rural areas overall. For these reasons, it is important to tailor the Community Development Financing Subtest using thresholds that account for these differences and adjust automatically to changes over time. To provide certainty and transparency, the retail lending and community development financing thresholds would be made available in simple, regularly updated dashboards that banks could use to compare their level of activity to the thresholds in each assessment area (figure 6). For example, a dashboard for the Retail Lending Subtest could show the thresholds that a large retail bank should reach for each of its major product lines to receive the presumption of "satisfactory," including the percentage of loans to LMI borrowers and the percentage of loans to LMI neighborhoods. The proposed separate subtests would also ensure expectations are tailored to the size and business models of different banks. It is important for smaller banks to be able to remain under the current more qualitative approach if they so choose. Accordingly, small retail banks could continue to be evaluated under the current CRA framework, but they would have the option to have their retail lending evaluated under the metrics-based Retail Lending Subtest. Small banks could also elect to have their retail services and community development activities evaluated. Wholesale and limited purpose banks would be evaluated only on their community development activities. The ANPR solicits feedback on options for additional tailoring and flexibility for these institutions, which do not lend themselves to evaluation under the same metrics that would be applicable to large retail banks. The ANPR seeks comment on striking an appropriate balance between providing greater certainty for how banks are assessed through the increased use of metrics and minimizing the associated data collection and reporting burden. In an effort to reduce burden, the proposed metrics would rely to the greatest extent possible on existing data collections and public data sources, and the approach would exempt small banks from deposit and certain other data collection requirements. Large banks currently report community development loans at an aggregated level. A bank may also share information with its examiner on its community development loans and investments in a specific assessment area during a CRA exam. However, the bank does not formally report data on these activities for each assessment area, nor are the data currently available through other sources. Without reporting data more consistently to provide the basis for comparison, it would be difficult to measure and evaluate a large bank's community development performance in a more consistent and predictable way. The ANPR proposes updating and clarifying which community development activities qualify in order to provide greater certainty to banks and communities about what counts. The ANPR proposes to publish and regularly update an illustrative, but not necessarily exhaustive, list of qualifying activities. To provide additional certainty, the Board also seeks feedback on a preapproval process, so that banks can propose a community development activity to their examiner to determine whether it will qualify before proceeding with the loan, investment, or service activity. This additional certainty could help promote greater investment by banks while retaining a focus on LMI communities. In addition, the ANPR seeks feedback about clarifying the definitions of qualifying activities and broadening certain definitions in targeted ways. For example, the Board is considering defining CRA-eligible activities that create or preserve naturally occurring affordable housing and is considering whether to broaden the set of volunteer activities that would qualify in rural areas. The Board is also clarifying when a government or tribal plan is required to qualify activities that revitalize and stabilize communities. This is especially important in Indian Country, where we want to encourage banks to make impactful investments that have the support of tribal governments and to increase certainty about how these activities qualify for CRA credit. Stakeholder feedback emphasized that smaller retail banks play a vital role in many underserved communities, such as in rural areas. Accordingly, the ANPR provides small banks in rural areas operating in just a portion of a large county greater clarity and flexibility in tailoring the facility-based assessment area definition. The ANPR proposes that a small bank would not be required to expand the delineation of an assessment area to include parts of counties where it does not have a physical presence and where it either engages in a de minimis amount of lending or there is substantial competition from other institutions, except in limited circumstances. In addition, the ANPR proposes to revise the definition of community development services to include a wider range of volunteer activities to address the particular needs of rural areas. It has been 25 years since the last significant revision to the CRA regulation, so it is important to get reform right. We are providing an extended 120-day comment period to allow ample time for thoughtful feedback from a broad set of stakeholders. The input from stakeholders thus far has been tremendously valuable, and we appreciate the care and concern expressed in the many comment letters and other forms of input on this important regulation. In the weeks and months ahead, we look forward to reviewing your comments and analyzing options for greater impact, including changes to address the inequities and challenges faced by minority communities and individuals. This feedback is critically important, and we are ready to listen. Stakeholders have expressed strong support for the agencies to work together to modernize the CRA. By reflecting stakeholder views and providing a long period for public comment, the ANPR is intended to build a foundation for the banking agencies to converge on a consistent approach to strengthening the CRA that has broad support among stakeholders. With your continued ideas and engagement, I am confident we can come together on a stronger, transparent, and tailored approach to the CRA that will benefit LMI communities across the country for years to come.

r200923a_FOMC

united states

Optimism in the Time of COVID

quarles

I want to thank the Institute of International Bankers for inviting me to discuss the outlook for the global and U.S. economies at what I believe is an important juncture in the evolution of what I refer to as the "COVID event": the outbreak of COVID-19 and the government and social response to it. First, I will discuss the global economy before turning to our domestic economy and its outlook. From there, I will discuss my views on monetary policy, including the new long-run monetary policy strategy recently announced by the Federal Open Market Committee (FOMC). And I will wrap up with a brief discussion on financial stability and regulatory issues. Let me start with a picture of the global economy. Although challenges remain, especially among some emerging market economies, significant support to households and businesses from central banks and fiscal authorities has contributed to a strong rebound in a number of advanced and some emerging Asian economies since those countries began to loosen restrictions. In these economies, the reopening of factories has led to a resurgence of industrial production. Retail sales are rebounding and in some countries are already above levels seen before the COVID event. However, international trade has been slower to increase. The extent of the recovery in some jurisdictions has been surprisingly robust compared to many analysts' expectations earlier this year. The momentum is feeding into many private-sector forecasts that suggest prospects are good for strong economic growth in the United States and other advanced economies over the rest of this year and next. However, the hole that countries are in remains deep, and significant downside risks still exist. Perhaps the most discussed risk has been that a "second wave" of the virus could trigger a return to widespread mobility restrictions and business closures. Several countries, including some portions of the United States, have seen a substantial resurgence of infections in recent months. This has been accompanied, however, by substantially lower hospitalization and death rates in most cases, and so far most countries have been able to address the resurgence without reinstituting severe restrictive practices. Mobility indexes have been little changed in Europe and the United States, and the declines in Asia have been modest. Businesses--which have adjusted operations and, in some cases, changed business models--seem much better adapted to remaining open. I am also hopeful that better testing, tracing, and treatment regimens, as well as improved understanding by the public about how to manage the risks of the disease, will allow firms, individuals, and governments to address public concerns about the virus while avoiding a second severe downturn or a protracted stagnation. Still, the economic fortunes of households and businesses around the world remain at risk. Incomes and employment are likely to lag below pre-COVID event levels for some time, which would put stress on the finances of many families. Some people may remain reluctant to return to full engagement in social and economic life, weighing especially on the service sector. Even with support from monetary and fiscal policy, large numbers of businesses may close. These closures may lead to some longer-term scarring of the economy through lower investment, reduced capacity, and long-term unemployment leading some to drop out of the labor force altogether. While I am optimistic that recovery is underway and the worst outcomes can be avoided, these concerns suggest that policymakers around the world need to remain watchful and ready to act further. Now let me focus on U.S. economic conditions and the outlook. The historic collapse in economic activity in March and April will take time to reverse. However, the economy has rebounded more strongly than almost any forecaster expected. That resilience reflects the economy's underlying strength upon entering the recession and demonstrates its inherent flexibility, as well as the dynamism of the American people. For example, the Census Bureau reports that applications by people seeking to start new businesses have surged this summer. The median of projections for 2020 by FOMC participants in September showed that both gross domestic product (GDP) and inflation had been revised up significantly from the median in the June projections. I expect that robust GDP growth over the rest of this year and in 2021 will lead to strong employment gains and move inflation closer to 2 percent. I would still caution that there is an unusually large amount of uncertainty now about any outlook, and I see the risks to the outlook as weighted to the downside. However, given the trends I previously discussed in the way countries are adjusting to the COVID event, I am optimistic that the United States can avoid the highly adverse outcomes that many feared would materialize. Turning now to the labor market, unemployment was still at 8.4 percent in August and the labor force participation rate still down significantly from February. The extraordinary package of fiscal support in the CARES Act (Coronavirus Aid, Relief, and Economic Security Act) helped to support household incomes and to offset the effect of the huge job losses in March and April. But the act's unemployment provisions have expired, and most of the businesses that received Paycheck Protection Program (PPP) loans report that they have exhausted those funds. In addition, one area where increased understanding of the disease has, in many places, not led to general changes in practice is in the widespread school closures this fall. Many parents with children will be forced to work less, or not at all, which is going to be a hardship for them and weigh on the economy. So, I agree with Chair Powell that it will take continued support to sustain a robust recovery. Although still unacceptably high, an 8.4 percent unemployment rate represents a considerable improvement from 14.7 percent in April and is already much lower than many thought possible this year. By comparison, after the onset of the Great Recession, it took more than two years to reduce unemployment from the peak of 10 percent to 8.4 percent. One reason for the faster turnaround this time is that many of the initial job losses, and subsequent job gains, were due to temporary disruptions that many businesses have overcome. However, some indicators point to slower improvement in the job market going forward. Like employment, consumer spending has been much stronger than expected, even though spending on travel and many other categories of in-person services remains depressed. Retail sales were extremely strong from May through August, driven by demand for consumer durables such as automobiles, furniture, and home improvement. Home sales and construction also have increased sharply since then. For instance, new home sales rose in July to an annual pace of over 900,000 units, which is 16 percent above the recent peak in January 2020 and the fastest pace since December 2006. All of these facts lead me to believe the momentum in household spending is strong. Although consumer confidence remains lower than early this year, the resilience in big-ticket purchases indicates some underlying confidence among households that the economy will continue to improve. The strength in the consumer and housing sectors is being supported by Fed action to lower interest rates and support credit availability for creditworthy borrowers. In addition, the recent high rate of household savings likely represents a significant source of pent-up demand. Now let me turn to the business sector, where the picture is more mixed. As in the household sector, the decline in many measures of business spending last spring turned out to be much less than was feared, and some indicators of business investment have turned around dramatically in recent months. However, there is considerable uncertainty over how businesses will deal with the cumulative effects of the COVID event on the economy. As we all know, medium and small enterprises were, and continue to be, heavily affected by the COVID event. The PPP disbursed $525 billion in loans to businesses through August 8, most of which will be forgiven when businesses are found to have met the requirements for keeping workers on the job at previous pay rates. Working with the Treasury Department, the Federal Reserve created several facilities that are providing support to large, mid-size, and small firms. These programs have improved credit market functioning through direct support to borrowers and lenders that use them and indirect support by creating a backstop against worsening conditions that boosts the willingness of private-sector lenders to extend credit. Despite those efforts and the pickup in household spending, many businesses are still under strain, representing an important source of downside risk. One concern is that many businesses already were highly leveraged going into the crisis, and taking on more debt as a bridge until commerce normalizes may not be a viable option, even with favorable repayment terms. Many corporate bonds and leveraged syndicated loans were downgraded between March and June, and default rates on corporate bonds rose significantly over that period as well. However, corporate defaults have slowed in the past couple of months, and, so far, delinquency rates on business loans at banks have increased only marginally. This development, in part, highlights banks' ability to work with borrowers that have been hurt by the COVID event as laid out in supervisory guidance provided by the federal banking agencies. Another downside risk in the business sector is the strains to commercial real estate (CRE), particularly in retail and hospitality properties. CRE was a prominent concern before COVID, although one that seemed quite manageable. Since then, vacancy rates have risen significantly and rents have fallen sharply, putting at risk the high valuations that our May flagged as a vulnerability. The sharp decrease in output and employment, as well as continued slack in the economy, have put downward pressure on wages and the prices of goods and services affected by the COVID event. The 12-month increase in the price index for personal recovery since then has helped prices retrace some of those declines, PCE inflation was still only 1 percent for the 12 months ended in July and is likely to end 2020 well below our 2 percent longer-run target. Indicators of future inflation do not point to rapid acceleration. Market measures of inflation expectations decreased sharply earlier this year before recovering to their previous levels recently, and inflation expectations in some surveys of professional forecasters have ticked down. The Committee will be closely watching for a further recovery of inflation and signs that inflation expectations remain well anchored as we set monetary policy. In the near term, with both employment and inflation significantly short of the FOMC's economic goals, the prescription is for a sustained aggressive use of monetary policy to support the economy. In March, the FOMC cut the federal funds rate effectively to zero and began purchasing large quantities of Treasury and agency mortgage-backed securities. Over the following weeks, the Federal Reserve Board used our emergency authority to establish 13 lending facilities to provide support to households, financial firms, nonfinancial businesses, nonprofit organizations, and municipal governments. We also took steps, including extending dollar swap lines to other central banks, to address strains in global dollar funding markets. Taking a step back, beginning in 2019, the FOMC undertook a public review of the conceptual framework for how we approach monetary policy. And last month, the I will call the "consensus statement." I want to emphasize the very public and deliberative nature of this policy review under the leadership of Chair Powell and Vice Chair Richard Clarida. Through a series of 15 public events, we received input from a broad spectrum of people: small business leaders, union workers, retirees, prominent outside researchers, and others. The FOMC also had the benefit of extensive research and analysis from Fed staff and debated the issues at a series of FOMC meetings. This process set a new and very high standard for transparency and accountability for the Fed, and we have committed to conducting such reviews roughly every five years. I believe the new consensus statement lays out a strategy that is suited to the demands of setting monetary policy in our constantly changing economy. Let me begin by focusing on two key conclusions. First, over the past two decades, the prevailing level of interest rates in many advanced economies has declined, leaving central bankers with less room to cut interest rates when the economy slows. In addition, experience over the past few decades has shown us that the traditionally strong relationship between unemployment and inflation has weakened, perhaps considerably. We saw this weakening relationship in the United States, as the robust expansion before the COVID event led to historic and broad-based labor market gains. Not only did the unemployment rate drop to long-time lows, but the wages of low- and moderate-income workers also accelerated, and unemployment rates for historically disadvantaged groups fell to record lows. Yet inflation continued to run modestly below our symmetric 2 percent target, for almost the entire period, and long-term interest rates remained very low by historical standards. This recent experience in the United States, which has also played out elsewhere, has led to a growing consensus in the economics profession that the relationship between unemployment and inflation--commonly known as the Phillips curve--has flattened. Therefore, given the considerable benefits that we observed when unemployment fell to very low levels in recent years, the Committee determined that a low unemployment rate, unless accompanied by worrisome developments in inflation or other risks that could impede the attainment of our goals, would not necessitate a policy response. We capture this change in the revised consensus statement by tying future policy decisions to "shortfalls of employment from its maximum level" rather than to "deviations" from the maximum level as in the previous statement. The new framework statement also highlights that the maximum level of employment is a broad-based and inclusive goal, and it reiterates that the Committee will review a wide range of indicators--not just the unemployment rate--in its assessments of that level. I believe these changes to the way the FOMC responds to labor market conditions will result in a stronger economy without jeopardizing our commitment to low and stable inflation. In fact, I think that meeting our longer-run goal of 2 percent inflation as defined by the 12- month change in the overall PCE price index, which is unchanged by this revision, will help achieve the kind of labor market outcomes we have experienced in recent years. And that is a good segue into the other major change in the consensus statement that I want to address today. Even before the COVID event pushed inflation down to very low levels this year, PCE inflation had been running modestly below 2 percent for some time, and some measures of inflation expectations had decreased to the low ends of their historical ranges. These developments certainly bear watching, especially if inflation were to remain lower than it had been in previous years or if inflation expectations were to decrease further. A decrease in inflation expectations can lead to a downward spiral in actual inflation, which would further reduce already low equilibrium nominal interest rates and, among other consequences, leave the FOMC with less flexibility to address future economic slowdowns. In order to better anchor long-run inflation expectations at 2 percent, the consensus statement makes a distinct change from the old approach. The Committee will seek to achieve inflation that averages 2 percent over time, which means that we will aim to achieve inflation moderately above 2 percent for some time following periods when inflation has been persistently below 2 percent. In the previous consensus statement, the FOMC committed to a 2 percent longer- run goal for inflation that was to be "symmetric." This wording already suggested some tolerance for inflation above 2 percent when it was consistent with meeting our employment mandate, and I certainly never viewed 2 percent inflation as a ceiling. One reason to be comfortable with inflation at times running moderately above 2 percent is that defining and measuring inflation are very much an inexact science. For that reason, I have always considered alternative indicators of inflation--such as the Dallas Fed trimmed mean and, of course, core inflation--in my assessment of the likely longer-run path for the headline PCE price index. As a result, as long as inflation expectations remain well anchored close to 2 percent, modest deviations of any particular measure of inflation around 2 percent are not a first-order concern in my decision framework. In fact, I likely will be even more patient in reacting to small upward deviations, given the Committee's move to focus on shortfalls of employment from maximum employment rather than deviations. For those reasons, I supported the action that the FOMC took last week at our September meeting to update the forward guidance to be consistent with the consensus statement for these extraordinary times. Although we have seen the beginnings of a strong recovery, even optimistic forecasts suggest that it will take a long time to recover fully from this shock. Evidence suggests that our actions to date have had significant stimulative effects. By providing additional monetary policy accommodation through stronger, outcomes-based forward guidance, the Committee hopes to quicken the pace of the recovery. Now let us consider some of the implications of the COVID event for banks and for financial stability. Large U.S. banks entered this crisis in strong condition, and the Federal Reserve has taken a number of important steps to help bolster banks' resilience. We took the unprecedented step of prohibiting share repurchases in the third quarter for large banks while also capping dividends. In addition, we required all banks to reassess their capital needs in the face of continued uncertainty and resubmit their capital plans. Last week, we released a baseline and two hypothetical recession scenarios that will be used by banks and the Fed to assess the resilience of the sector, and we will release bank- specific results from our independent assessment before the end of the year. Nonbank financial firms, especially those engaged in liquidity transformation, experienced acute strains in March. Despite the apparent success of some nonbank regulatory reforms in the United States, such as efforts to increase the resilience of money funds, the Board of Governors again needed to provide significant emergency support. This is why, at the Financial Stability Board, I have put together a senior group of market regulators and central bank governors to develop a holistic review of the March stresses in nonbank finance. We will deliver that review to the G20 in November, together with a work plan on potential methods to address the vulnerabilities that may amplify stresses in funding markets. In conclusion, the COVID event was an enormous economic shock in the first half of 2020, but a recovery is underway, and the world seems to be adjusting in ways that allow us to address public concerns about the virus without sudden stops in economic activity. A full recovery is still a good way off, however, and risks remain weighted to the downside. Policymakers will need to remain vigilant.

r200930a_FOMC

united states

Community Banks Rise to the Challenge

bowman

Thank you, it is a pleasure to join you virtually today and share a few thoughts on what I am hearing from community banks in the wake of the pandemic, and what the Federal Reserve is doing to assist in the recovery. When I addressed this conference exactly a year ago, the world was a very different place. COVID-19 has brought hardship and disruption to nearly every aspect of our lives, and even as economic conditions improve, the pandemic continues to weigh on households, businesses, and the economy. Today, I would like to offer some of my observations on current conditions and share with you what I have learned in discussions with community bankers across the nation. This input has shaped my views of how supervision and regulation are affecting community banks in these challenging times-- what is working, and what needs to improve. In addition to the Fed's usual consultation with community banks, I have separately embarked on an effort to meet directly with the CEOs of all 685 community banks supervised by the Fed, an undertaking that has already provided valuable insights that I will relate in these remarks. America has never experienced a health and economic crisis like the one we are facing. The measures taken to contain the virus and the ensuing sudden stop to the economy beginning in March were unprecedented, just as some aspects of the downturn. One of these is the extent to which small businesses have been affected. Small businesses tend to be service-oriented and clustered in retail and food services, with many less able than larger companies to maintain operations via remote work. Because community banks are a major source of credit and financial services for small businesses, this crisis has had a heavy impact on their customers, and in their communities. Another unusual aspect of this event, which I have noted before, is the geographic variation in the timing and severity of the pandemic's effect. Given the widely varying rates of infection, and the distinct approaches of states and localities in dealing with the virus, we are seeing divergent experiences in economic performance in different areas of the country. As a result, and to a greater extent than in the past, this slowdown is being felt differently from community to community, and is being responded to differently from community to community. So it is no surprise that community banks are standing shoulder to shoulder with their customers, on the front lines. You have done this before, of course, during past recessions, but for the reasons I've outlined, your role this time has never been more critical. That is why one of the government's first responses to the pandemic was the Paycheck Protection Program (PPP), geared to small business, and necessarily dependent on community banks. So let me start there, and review what has been accomplished through PPP and discuss the role of community banks in that program. Based on preliminary results, it appears PPP was timely and effective in helping millions of businesses weather the lockdown period. It was also designed in a way that made community banks integral to its success. The first funds reached businesses roughly three weeks after the need for that relief was recognized. To provide perspective, $525 billion, or roughly 19 times the value of all Small Business Administration lending in fiscal year 2019, was distributed in the four months from April through August 8. Community banks with $10 billion or less in assets made about 40 percent of the overall number and value of PPP loans. Community banks were absolutely essential to the success of this program. This outcome is probably not surprising to this audience, because when it comes to lending to small businesses, community banks have always been an outsized source of credit, relative to their size in the banking system. Before the pandemic, community banks accounted for over 40 percent of all small business lending, while they only accounted for roughly 15 percent of total assets in the banking system. Community banks know their individual and small business customers, and they know their communities. In my conversations with community bank CEOs, several reported to me that early in the pandemic they directly contacted every single one of their business and consumer loan customers, taking the time to check in with each one to see how they were doing, and what they needed. They encouraged customers to keep in touch with the bank, and they noted the available opportunities for payment deferrals that customers might not have been aware of. They asked, "Do you need us and how can we help?" In this pandemic, it means going further, than other banks could or would. According to the 2020 national survey conducted by the Conference of State Bank Supervisors, more than one-third of community banks reduced or eliminated penalties or fees on credit cards, loans, or deposits. One banker in Colorado told me that his bank called 3,700 individual borrowers offering deferrals--and that 2,000 of them accepted. Let me highlight the role of smaller community banks in the PPP, because they demonstrate the agility and close relationships with customers that was so important in connecting with the businesses most threatened by the lockdowns. Banks with less than $1 billion in assets have made a million loans under the PPP, about one-fifth the total, delivering $85 billion in relief to their customers. Additionally, as shown in figure 1, the smallest banks made the smallest PPP loans on average, illustrating that these banks play a key role in serving businesses that may be outside the focus of larger banks. The average PPP loan size at banks with total assets under $500 million was just $72,000, about half the size of the average loan at banks with total assets between $10 billion and $100 billion. Additionally, preliminary data based on an Independent Community Bankers of America report indicates that community banks have been the main source of lending for minority-owned small businesses during the pandemic, accounting for 73 percent of all PPP loans made to small businesses owned by non-whites. Early estimates also suggest that community banks provided 64 percent of PPP loans to majority veteran-owned businesses. Within the broader community banking sector, there are banks that have the mission to serve low-income and minority communities. Specifically, I am referring to minority depository institutions (MDIs) and community development financial institutions (CDFIs). These institutions had previously established relationships with minority and low-income small business owners and were quickly able to provide them access to PPP loans. Additionally, as trusted institutions in their communities, new businesses sought them out as lenders who understood their unique, and sometimes challenging, business needs. The Cleveland Fed recently published an article entitled "I can't believe I got a real person," which describes one minority-owned small business's experience successfully getting a PPP loan from an MDI in Los Angeles. The title alone captures why community banks were so important for small businesses seeking PPP loans--small banks offer a personalized level of customer service that big banks do not. It is also striking that smaller community banks were the predominant lenders despite having a smaller staff and while facing lobby closures and other workforce challenges due to COVID-19. Several of the bankers I spoke with worked from home, when they couldn't open their banks. They worked overtime in drive-through facilities. They worked, in one case, inside a makeshift "disaster recovery site." Through all the ups and downs and closures and reopenings, they persevered. "We closed lobbies," a banker from Nebraska told me, "but we never closed the bank." Actions like these highlight the importance and value of relationship banking, which is so central to the mission of community banks. According to the Call Report data, community banks held roughly $400 billion in small business loans in June 2020, as shown in figure 2. Loans made under the PPP totaled $197 billion--an amount representing about 40 percent of all funding provided under this program. A banker from Virginia told me, "It was a great opportunity for the community banks to show their small businesses turn to small banks for their lending needs. The survey data indicate that these borrowers are far more satisfied with their banks than the businesses who borrowed from other sources, and three out of five small businesses cite an existing relationship as a key reason they continue to do business with their bank. The PPP program strengthened many preexisting relationships between community banks and their borrowers, but community banks also met the needs of new customers facing stress loan originations. Over time, the establishment of these new relationships is likely to benefit both the community bank and the small businesses they serve. Now let me turn to the question of how the Federal Reserve is approaching community bank supervision during the pandemic, and how that aligns with my philosophy about how the Fed should always conduct supervision. As you well know, community banks form a critical part of a strong and stable financial system, and they are vital to their surrounding communities. Supervising community banks requires us to strike a delicate balance between ensuring their safety and soundness and ensuring that they are able to continue serving those vital functions. This is especially true now, when community banks are supporting the businesses bearing the brunt of the economic effects of the pandemic. This situation strongly argues for flexibility in supervision. In each of my conversations with community bank CEOs, I ask what they are experiencing and what they need, while sharing a very clear message about the Fed's flexibility: Given the challenging environment, the Fed will take into account good faith efforts by banks affected by COVID-19. In this pandemic, our common goal is to support individuals, businesses, and communities. This approach is reflected in an April 2020 statement issued by the Fed and other bank supervisors. In that statement, we instructed bank examiners not to criticize bank management for taking prudent steps to support their communities, and we underscored that we would not expect to take a consumer compliance public enforcement action against an institution that has made good faith efforts to comply. This message has been getting through to examiners. One community banker in Texas that I spoke to recently said he had been feeling the justifiable concern that granting the kind of forbearances that everyone recognizes are essential to keep businesses open will eventually come back to haunt him in an examination. When he aired this concern to the Fed, he said he felt "incredible support" when the message he received back was, "Bank your customers." This assistance is helping homeowners. A recent Federal Reserve survey found that 5 percent of homeowners with a mortgage had received a payment deferral from their lender. So let me extend the same message to others who might be worried: "Bank your Now let me tell you how these actions fit into my overall view of how to conduct effective bank supervision. Our goal as regulators is to ensure that each institution under our supervision is successful in managing the risks present within its operations and product offerings. Effective supervisory practices are not static. They evolve over time as lessons are learned. That includes learning by supervisors. As one example, the volume of PPP lending has driven meaningful asset growth, especially for smaller banks. We recognize that for some institutions, this asset growth has caused many banks to exceed or nearly exceed certain asset-based thresholds contained in statutes, regulations, and reporting requirements. We are currently exploring how to address regulatory and supervisory challenges caused by this temporary asset growth. Supervisors encourage banks to adopt best practices, and I believe that we should also seek to achieve the highest supervisory standards. First, we should clearly communicate our expectations. It is wasteful, costly, and unnecessary when compliance activity occurs because expectations have not been clearly articulated or understood. Examiners should always be able and available to explain written guidance. A second consideration is that communication must also be timely. Supervisors should promptly communicate the findings of off- and on-site analyses, which will further improve the process of answering questions and addressing issues thereby improving compliance. A third principle is transparency. The key goal here is to promote a clear and transparent supervisory process so bankers know and understand how we form our expectations and judgments, and that they will receive this information in a timely manner. Overall, I think it is entirely appropriate to regularly ask whether our approaches to supervision are consistent with the stated policy objectives of efficiency, safety and soundness, and financial stability. One of those objectives is a healthy community banking sector that can continue to serve its customers. The pandemic has emphasized just how important that is. Another theme I have heard repeatedly from CEOs is the strong message that they are struggling with the cost and burdens of regulatory compliance. Many bankers have said they consider this the most significant threat to their existence. According to the CSBS National Survey, relative compliance costs actually decreased modestly in 2019, which may be a sign that some of the steps we are taking are helping. This is consistent with what I heard from one Oklahoma banker, who said the biggest threat to his long- term survival was regulatory burden--but "not so much in the last few years." We know examinations are top of mind for every community banker, and we are aware some bankers are also concerned with the length of time associated with the examination process. Community bank exams generally consist of phases--pre-exam contact, scoping, conducting the exam, and, finally, the drafting and delivery of the report. From a banker's perspective, the exam begins with the first day letter or perhaps the first contact of an examiner with the bank, and ends with receipt of the report of exam. From a banker's perspective, exams can seem as though they last for many months, which can strain resources for community banks that are unable to dedicate staff exclusively to managing the examination process. This is a valid concern, and achieving an appropriate timeframe for the length of exams, whether that be safety and soundness or consumer compliance, is very important to me. We are committed to evaluating our policies, practices, and implementation processes to understand and identify opportunities to address these concerns. There are other significant concerns for community bankers, but these only compound the challenge posed by regulatory burden. Bankers worry about competition from larger banks with economies of scale that are sufficient to drive consolidation. One of the biggest advantages from scale comes in regulatory compliance. As one banker in Wyoming told me: "Consolidation is a huge threat as larger banks can deliver at a far lower cost." One of the biggest costs, of course, is regulatory compliance. Researchers from the St. Louis Fed found that compliance expenses averaged nearly 10 percent of total non-interest expenses for banks with less than $100 million in total assets. For banks with between $1 billion and $10 billion in total assets, compliance expenses averaged 5.3 percent of total non-interest expense. This suggests that the regulatory cost burden for the smallest community banks is nearly double that of the largest community banks. In a speech about community banking regulation, it is entirely appropriate to point out our work on tailoring efforts. However, on its own, tailoring does not ensure that existing regulations are not unduly burdensome for smaller banks. These banks may benefit from further regulatory relief, without undermining the goals of safety and soundness, consumer protection, and financial stability. Regulatory burden can be manifested in multiple ways, including the attitude that examiners have in their interactions with banks. That is why the supervision principles I outlined earlier are so important. Supervisors need to communicate intentions clearly, in a timely manner, and in a transparent way. Doing so consistently can significantly lighten the regulatory burden that is such a challenge for banks. I will conclude with a few comments about economic and financial conditions as they affect community banks. Our nation has suffered the sharpest drop in economic activity in U.S. history, and while unemployment remains quite high, the recent economic data have been encouraging and suggest that our national economy has been recovering at a rapid pace. The substantial and timely fiscal stimulus provided by Congress and the Administration has made a meaningful contribution to this recovery. Looking ahead, continued monetary and targeted fiscal policy support will likely be needed. Even with this support, however, I anticipate that the path toward full recovery will be bumpy, and that our progress will likely be uneven. Asset prices in particular, remain vulnerable to significant price declines should the pandemic seriously worsen. Some hotels and other businesses are in arrears on rent and debt service payments, and we are watching the commercial real estate market closely for signs of further stress. I also expect the pace of the recovery will continue to vary from area to area, and will be heavily influenced by not only the course of the virus, but also the public policy decisions made across all levels of government. Before the COVID-19 pandemic began, all of the data told us that community banks began this year in excellent shape--by some measures the strongest in decades. Ninety-six percent of community banks were profitable; nonperforming assets neared historical lows, and capital ratios were strong. More than 95 percent of small banks were rated as 1 or 2 under the CAMELS rating system. These banks built strong capital positions and substantially improved asset quality metrics in the years following the last crisis. They also entered the pandemic with high levels of liquidity that have been augmented by deposit inflows associated with the pandemic-related stimulus programs. Finally, credit concentrations were generally much lower, especially in construction and commercial real estate, and broadly speaking, concentration risk management practices significantly improved since the financial crisis. Following a weak first quarter that included higher credit loss provisions, second- quarter earnings showed improvement. Aggregate return on assets recovered more than two-thirds of the decline reported during the first quarter, driven by higher noninterest income and lower operating expenses. Origination fees and interest income from PPP lending fueled some of this improvement, with many community banks reporting substantial loan growth as a result of the program, and a few actually doubling their balance sheets. As seen in figure 3, the quarter-over-quarter loan growth would have been negative, absent the PPP loans. As origination fees and interest income are generally recognized over the life of these loans or when they are forgiven, PPP loans will continue to push up bank earnings in the next several quarters. The origination fees earned by community banks this year will mitigate the impact of provisions for credit losses, and in turn, may support further lending by these banks. Despite improvement in these areas, the operating environment remains challenging. The average net interest margin at community banks tightened during the second quarter, and it is likely that margins will remain under pressure given the low interest rate environment. But community banks have historically performed well even when interest margins were under pressure, and they entered into the pandemic in sound financial condition. So what do we take away from this review of bank numbers and performance? In all, I expect community banks will face challenges during what could be a slow return to a full economic recovery, but I also expect that this sector is well prepared to deal with these challenges and will continue to perform the vital role it has played during the response to the pandemic. My hope is that at next year's conference we will have additional data and research that paint a fuller picture of the role community banks played in our nation's response to and recovery from COVID-19, and that we have gained further insights into the role of all community banks, including MDIs and CDFIs, in ensuring access by all to credit and financial services.

r201001a_FOMC

united states

Mortgage Market Regulation and Access to Mortgage Credit

bowman

It is wonderful to see the success of your Community Banking Program here at MSU and your commitment to investing in the education of future generations of community bankers. Throughout the response to the pandemic, community bankers have continued to serve as the primary source of credit to small businesses and have continued to provide economic and financial support to communities across our nation. Young people, like all of you engaged in this program, will very likely become the future leaders of these institutions, which are critical to their communities and to our economy and financial system. One of the most significant challenges facing community bankers today is navigating the complex regulatory framework. One area that has become more complicated is a line of business that has traditionally been the foundation for community banking, home mortgage lending. Community bank leaders consistently tell me that significant regulatory burden related to making home mortgages has been a major reason they have scaled back their mortgage lending activities or exited the market altogether. Along with tightened lending standards, this trend has made it harder for middle- and lower-income borrowers to obtain mortgage credit since the global financial crisis. Fortunately, work is under way to relieve that burden, and I will highlight one effort in particular. But before I do, let me provide some context by reviewing the current state of the economy and its effect on homeowners and would-be homeowners. The COVID-19 pandemic is having a profound effect on individuals and families across the U.S. and throughout the world. While a strong recovery has begun, it is clear that there is still a way to go before we are back to the robust economy we experienced at the beginning of the year. These challenges are affecting homeowners and the lenders that provide credit to support them. Many homeowners who have lost a job or have had their income affected by economic conditions have been able to work with their lenders, but such help may not be a long-term solution for many borrowers. Fortunately, the housing market as a whole is a bright spot for the economy. Higher home prices are improving the balance sheets of many households, even those that may face income and employment challenges, and new construction activity is generating new job opportunities. While affordability remains an important consideration, it is encouraging that housing has performed well in response to low interest rates. However, even during this period of strong performance in the housing market, access to affordable mortgage credit remains a barrier to homeownership for some borrowers, due in part to regulatory burden. Since the last financial crisis more than a decade ago, there have been a number of new mortgage regulations that added requirements for both borrowers and lenders. While many of these requirements have contributed to a safer and more consumer-friendly mortgage market, they have also introduced significant paperwork and delays that can present roadblocks for many borrowers. These new rules have also made it more difficult and costly for small banks to originate mortgage loans, leading many community banks to scale back on home lending activity or abandon it altogether. Homeownership is as important to communities as it is to individuals, and access to credit for rural and low-to-moderate income communities often depends on community banks. In many communities, especially rural communities, if the local bank has been forced out of mortgage lending due to burdensome regulation, it means little or no access to mortgage credit, preventing buyers from financing home purchases and homeowners from selling their homes. Many leaders of small community banks have told me that the compliance costs for originating smaller mortgages are prohibitive, and that the staffing and training required to meet the strict requirements are extraordinary in relation to the limited number of mortgages they originate. As one state banking commissioner said to me recently, "It doesn't make a lot of sense that you can make an $80,000 truck loan on two sides of a sheet of paper, but that many, many pages of paperwork are required to make a $40,000 loan on a mobile home or trailer." In fact, I have been told by community bankers that they are sometimes compelled to make loans for lower-priced home purchases that are backed by other collateral, such as a car or equipment, because of the excessive burden of complying with the many residential home mortgage regulations and time frames for such small transactions. As a result, these consumers may not have the benefit of the important consumer protections that having a home mortgage loan provides. Reducing mortgage compliance burden would allow community banks to better meet the critical need for home lending in their communities. Because of their local knowledge and strong customer relationships, community banks are often more willing to work with borrowers to get through difficult times. Taking steps to simplify and lower this regulatory burden for small community banks and their customers would help to ensure that homeowners can stay in their homes during times of stress, like the one we are facing currently due to COVID-19. The TILA-RESPA Integrated Disclosure, or TRID, is one of the real estate regulatory requirements that smaller banks cite most frequently as creating a heavy particularly helpful in highlighting the importance of this issue. Therefore, I am very pleased that the Independent Community Bankers of America is engaged in ongoing conversations and activities to address the more burdensome aspects of this requirement on community banks while importantly retaining key consumer protections. Efforts like these that aim to reduce the compliance burden for critically important services will enable many community banks to return to doing what they do best: meeting the needs of their communities. Again, thank you for inviting me to join you today, and I look forward to engaging on this important topic.

r201001b_FOMC

united states

Modernizing and Strengthening CRA Regulations: Hearing from Community Banks

brainard

Thank you for inviting me here today to take part in your Fall Leadership We recognize that community banks play a vital role in the communities you serve. Your insights into local conditions and your long-standing customer relationships afford you a deep understanding of the needs and characteristics of the households and small businesses in your communities, and enable you to meet their credit needs effectively. The value of these relationships has never been more evident than during this crisis--a fact that my colleague, Governor Michelle Bowman, highlighted yesterday when she said "it is no surprise that community banks are standing shoulder to shoulder with their customers, on the front lines." Governor Bowman referred to an Independent Community Bankers of America (ICBA) report that cites preliminary data on the Paycheck Protection Program that community banks have been the main source of lending for minority-owned small businesses during the pandemic and noted the same is true for veteran-owned businesses. As you know, last week, the Federal Reserve Board unanimously voted to The ANPR is built on ideas advanced by stakeholders. Throughout this process, the ICBA has been an important source of information, which has provided the Federal Reserve valuable insights into the unique role and needs of community banks as you invest in your communities. We have benefited from the ICBA's engagement on CRA both in the form of detailed comment letters and through a number of meetings to discuss different aspects of CRA reform. We thank you for your robust engagement and trust that you see your input reflected in the ANPR. Throughout our outreach, we consistently heard from both bankers and community groups that they value the CRA and that they want to see it improved and updated. This was important feedback as we contemplated how to modernize the regulations, while still staying true to the core purpose of the statute to meet the broad range of banking needs in low- and moderate-income (LMI) communities and address inequities in credit access. Our first major goal for the ANPR was to strengthen the regulations in alignment with the CRA statute. This means strengthening the regulations to ensure that a wide range of LMI banking needs are being met. It also entails promoting financial inclusion by, among other things, providing credit for activities in areas with unmet needs outside of assessment areas, such as Indian Country. Additionally, we aim to create incentives for investment in minority depository institutions and community development financial institutions, many of whom are ICBA members. We know that banking has evolved over the past 25 years, so we also sought to update standards in light of changes to banking over time, including mobile and internet banking. Lastly, we wanted to continue to promote community engagement to inform the examination process. Our second major goal for the ANPR was to provide greater certainty, tailor regulations, and minimize burden. The ANPR seeks feedback on several approaches designed to make the rules clearer, more transparent, and less subjective. For example, the proposed metrics for the retail test and the community development test would provide more clarity and transparency on how bank ratings are determined. In talking with community banks, Federal Reserve staff and I also heard about the need for clearer standards and greater limitations on the size of assessment areas--especially for small banks operating just in a portion of a large county or only making a few loans in a part of a county. The ANPR offers ideas to provide greater clarity in response to these concerns. Importantly, the ANPR proposes to tailor CRA to bank size and business model. In discussing CRA reform with bankers and community organizations, it has been clear that there is a need for a tailored approach for small banks and better outcomes for rural communities. I am encouraged that the ANPR offers ideas that advance these objectives. So let me say a bit more about the proposals in the ANPR that are tailored to small banks. Small retail banks could continue to have their retail lending activities evaluated under the current framework, or they could elect to be evaluated under the proposed retail lending metric. Small banks that opt for the retail lending metric can also elect to have other activities considered. Additionally, the ANPR minimizes data collection and reporting burden by relying on existing data as much as possible, as well as exempting small banks from deposit and certain other data collection requirements. We also heard from stakeholders like ICBA that rural areas, and banks in rural areas, have particular needs. Therefore, the ANPR proposes providing incentives for banks in rural areas to participate in beneficial civic and other nonprofit activities (e.g., serving on a board of a civic institution) that may not have a primary purpose of community development. In rural areas, bank participation in these kinds of activities can make a difference in supporting economic development. The ANPR also seeks feedback on providing CRA credit for bank volunteer activities in rural areas that do not involve the provision of financial or related services but have a clear community development purpose and greatly impact local communities, like helping to build affordable housing. Our final major goal of the ANPR is to provide a foundation for the agencies to converge on a consistent approach that has broad support among stakeholders. Stakeholders such as the ICBA have expressed strong support for the agencies to work together to modernize CRA. By reflecting stakeholder views and providing an appropriately long period for public comment, we hope the ANPR advances the goal of building a foundation for the banking agencies to converge on a consistent approach that has the broad support of stakeholders. All three regulators have benefited from stakeholder input provided through comment letters, roundtables, and meetings. There is significant interagency agreement on the objectives of CRA reform, and many of the ideas in the ANPR reflect interagency discussions and regulatory proposals. In closing, we look forward to modernizing the CRA in a way that strengthens the regulations to advance the core purposes of the statute, while providing greater certainty, tailoring regulations, and minimizing burden. We have appreciated the ICBA's strong engagement throughout this process, and we look forward to your continued engagement as we seek to converge on a consistent approach that has broad stakeholder support. Thank you.