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r201006a_FOMC

united states

Recent Economic Developments and the Challenges Ahead

powell

Good morning. It has been just eight months since the pandemic first gained a foothold on our shores, bringing with it the sharpest downturn on record, as well as the most forceful policy response in living memory. Although it is too early for definitive conclusions, today I will offer a current assessment of the response to the economic fallout of this historic event and discuss the path ahead. As the coronavirus spread across the globe, the U.S. economy was in its 128th month of expansion--the longest in our recorded history--and was generally in a strong position. Moderate growth continued at a slightly above-trend pace. Labor market conditions were strong across a range of measures. The unemployment rate was running at 50-year lows. PCE (personal consumption expenditures) inflation was running just below our 2 percent target. The economy did face longer-term challenges, as all economies do. Labor force participation among people in their prime working years had been trending down since the turn of the millennium, and productivity gains during the expansion were disappointing. Income and wealth disparities had been growing for several decades. As the expansion continued its long run, however, productivity started to pick up, the labor market strengthened, and the benefits of growth began to be more widely shared. In particular, improved labor market conditions during the past few years encouraged more prime-age workers to rejoin or remain in the labor force. Meanwhile, real wage gains for all workers picked up, especially for those in lower paying jobs. Most economic forecasters expected the expansion and its benefits to continue, and with good reason. There was no economy-threatening asset bubble to pop and no unsustainable boom to bust. While nonfinancial business leverage appeared to be elevated, leverage in the household sector was moderate. The banking system was strong, with robust levels of capital and liquidity. The COVID-19 recession was unusual in that it was not triggered by a buildup of financial or economic imbalances. Instead, the pandemic shock was essentially a case of a natural disaster hitting a healthy economy. Given the condition of the economy, in the early stages of the crisis it seemed plausible that, with a rapid, forceful, and sustained policy response, many sectors of the economy would be able to bounce back strongly once the virus was under control. That response would need to come from actions across all levels of government, from health and fiscal authorities, and from the Federal Reserve. It also seemed likely that the sectors most affected by the pandemic--those relying on extensive in-person contact--would face a long and difficult path to recovery. These sectors and people working in them would likely need targeted and sustained policy support. Some asked what the Fed could do to address what was essentially a medical emergency. We identified three ways that our tools could help limit the economic damage from the pandemic: providing stability and relief during the acute phase of the crisis when much of the economy was shut down; vigorously supporting the expansion when it came; and doing what we could to limit longer-run damage to the productive capacity of the economy. When it became clear in late February that the disease was spreading worldwide, financial markets were roiled by a global flight to cash. By the end of the month, many important markets were faltering, raising the threat of a financial crisis that could exacerbate the economic fallout of the pandemic. Widespread economic shutdowns began in March, and in the United States, with many sectors shut down or operating well below capacity, real GDP fell 31 percent in the second quarter on an annualized basis. Employers slashed payrolls by 22 million, with those on temporary layoff rising by 17 million. Broader measures of labor market conditions, such as labor force participation and those working part time for economic reasons, showed further damage. In response, we deployed the full range of tools at our disposal, cutting rates to their effective lower bound; conducting unprecedented quantities of asset purchases; and establishing a range of emergency lending facilities to restore market function and support the flow of credit to households, businesses, and state and local governments. We also implemented targeted and temporary measures to allow banks to better support their customers. The fiscal response was truly extraordinary. The unanimous passage of the CARES Act and three other bills passed with broad support in March and April established wide-ranging programs that are expected to provide roughly $3 trillion in economic support overall--by far the largest and most innovative fiscal response to an economic crisis since the Great Depression. What have these policies managed to accomplish so far? First, the substantial fiscal aid has given vital support to households. The rise in transfers supported necessary spending and contributed to a sharp increase in household saving. Goods consumption is now above its pre-pandemic level. Services consumption remains low, although it seems likely that much of this weakness is the byproduct of health concerns and social distancing, rather than reductions in income and wealth. Consumption held up well through August after the expiration of expanded unemployment insurance benefits, indicating that savings from transfer payments continue to support economic activity. A recent Fed survey showed that households in July had surprisingly upbeat views of their current financial well-being, with 77 percent of adults either "doing okay" or "living comfortably," an improvement even over the reading immediately preceding the pandemic. Still, since it appears that many will undergo extended periods of unemployment, there is likely to be a need for further support. Second, aid to firms--in particular, the Paycheck Protection Program--and the general boost to aggregate demand have so far partly forestalled an expected wave of bankruptcies and lessened permanent layoffs. Business investment appears to be on a renewed upward trajectory and new business formation similarly appears to be rebounding, pointing to some confidence in the path ahead. Third, after briefly seizing up in March, financial markets have largely returned to normal functioning, albeit in the context of extensive ongoing policy support. Financial conditions are highly accommodative, and credit is available on reasonable terms for many--though not all--households and businesses. Interest-sensitive spending has been relatively strong, as shown in the housing and auto sectors. Taken together, fiscal and monetary policy actions have so far supported a strong but incomplete recovery in demand and have--for now--substantially muted the normal recessionary dynamics that occur in a downturn. In a typical recession, there is a downward spiral in which layoffs lead to still lower demand, and subsequent additional layoffs. This dynamic was disrupted by the infusion of funds to households and businesses. Prompt and forceful policy actions were also likely responsible for reducing risk aversion in financial markets and business decisions more broadly. While the combined effects of fiscal and monetary policy have aided the solid recovery of the labor market so far, there is still a long way to go. Payrolls have now recovered roughly half of the 22 million decline. After rising to 14.7 percent in April, the unemployment rate is back to 7.9 percent, clearly a significant and rapid rebound. A broader measure that better captures current labor market conditions--by adjusting for mistaken characterizations of job status, and for the decline in labor force participation since February--is running around 11 percent. The burdens of the downturn have not been evenly shared. The initial job losses fell most heavily on lower-wage workers in service industries facing the public--job categories in which minorities and women are overrepresented. In August, employment of those in the bottom quartile of the wage distribution was still 21 percent below its February level, while it was only 4 percent lower for other workers. Combined with the disproportionate effects of COVID on communities of color, and the overwhelming burden of childcare during quarantine and distance learning, which has fallen mostly on women, the pandemic is further widening divides in wealth and economic mobility. I will now turn to the outlook. The recovery has progressed more quickly than Committee) participants at our September meeting show the recovery continuing at a solid pace. The median participant saw unemployment declining to 4 percent and inflation reaching 2 percent by the end of 2023. Of course, the economy may perform better or worse than expected. The outlook remains highly uncertain, in part because it depends on controlling the spread and effects of the virus. There is a risk that the rapid initial gains from reopening may transition to a longer than expected slog back to full recovery as some segments struggle with the pandemic's continued fallout. The pace of economic improvement has moderated since the outsize gains of May and June, as is evident in employment, income, and spending data. The increase in permanent job loss, as well as recent layoffs, are also notable. We should continue do what we can to manage downside risks to the outlook. One such risk is that COVID-19 cases might again rise to levels that more significantly limit economic activity, not to mention the tragic effects on lives and well-being. Managing this risk as the expansion continues will require following medical experts' guidance, including using masks and social-distancing measures. A second risk is that a prolonged slowing in the pace of improvement over time could trigger typical recessionary dynamics, as weakness feeds on weakness. A long period of unnecessarily slow progress could continue to exacerbate existing disparities in our economy. That would be tragic, especially in light of our country's progress on these issues in the years leading up to the pandemic. The expansion is still far from complete. At this early stage, I would argue that the risks of policy intervention are still asymmetric. Too little support would lead to a weak recovery, creating unnecessary hardship for households and businesses. Over time, household insolvencies and business bankruptcies would rise, harming the productive capacity of the economy, and holding back wage growth. By contrast, the risks of overdoing it seem, for now, to be smaller. Even if policy actions ultimately prove to be greater than needed, they will not go to waste. The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods. Given this audience, I would be remiss were I not to mention our review of our monetary policy strategy, tools, and communications, which concluded recently with our adoption of a flexible average inflation-targeting regime. My colleagues and I have discussed this new framework in detail in recent remarks. Today I will just note that the underlying structure of the economy changes over time, and that the FOMC's framework for conducting monetary policy must keep pace. The recent changes to our consensus statement reflect our evolving understanding of several important developments. There has been a decline in estimates of the potential or longer-run growth rate of the economy and in the general level of interest rates, presenting challenges for the ability of monetary policy to respond to a downturn. On a more positive note, we have seen that the economy can sustain historically high levels of employment, bringing significant societal benefits and without causing a troubling rise in inflation. The new consensus statement acknowledges these developments and makes appropriate changes in our monetary policy framework to position the FOMC to best achieve its statutory goals. The forward rate guidance adopted at our September meeting reflects our new consensus statement. The new guidance says that, with inflation running persistently below our longer-run 2 percent goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an accommodative stance of policy until these outcomes are achieved. The Committee also left the target range for the federal funds rate unchanged at 0 to 1/4 percent, and it expects it will be appropriate to maintain this target range until labor market conditions have reached levels that are consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. We expect that the new framework and guidance will support our efforts in pursuit of a strong economic recovery. Thank you. I look forward to our discussion.

r201014b_FOMC

united states

U.S. Economic Outlook and Monetary Policy

clarida

It is my pleasure to meet virtually with you today at the 2020 Annual Membership I regret that we are not doing this session in person, and I hope the next time Tim Adams invites me back, we will be gathering together in Washington. I look forward, as always, to my conversation with Tim, but first, please allow me to offer a few remarks on the economic outlook, Federal Reserve monetary policy, and our new monetary policy framework. In the first half of this year, the COVID-19 (coronavirus disease 2019) pandemic and the mitigation efforts put in place to contain it delivered the most severe blow to the an almost 32 percent annual rate in the second quarter, and more than 22 million jobs were lost in March and April. This recession was by far the deepest one in postwar history, but it also may go into the record books as the briefest recession in U.S. history. The flow of macrodata received since May has been surprisingly strong, and GDP growth in the third quarter is estimated by many forecasters to have rebounded at perhaps a 25 to 30 percent annual rate. This development is especially noteworthy when set in relief against the surge in new COVID-19 cases that were reported this summer in a number of U.S. states and the coincident flatlining in a number of high-frequency activity indicators that we follow to track the effect of the virus on economic activity. Although spending on many services continues to lag, the rebound in the GDP data has been broad based across indicators of goods consumption, housing, and investment. These components of aggregate demand have benefited from robust fiscal support--including the Paycheck Protection Program and expanded unemployment benefits--as well as low interest rates and efforts by the Federal Reserve to sustain the flow of credit to households and firms. In the labor market, about half of the 22 million jobs that were lost in the spring have been restored, and the unemployment rate has fallen since April by nearly 7 percentage points to 7.9 percent as of September. I remind you that in the spring, many voices questioned what good rate cuts, forward guidance, asset purchases, and lending programs could do in an economy in which people do not venture out to buy cars or build houses and in which companies do not invest to augment their capital stock. Well, the data show us that with rates low, credit available, and incomes supported by fiscal transfers, the answer is--at least so far--that they do build houses, buy cars, and order equipment and software. That said, the COVID-19 recession threw the economy into a very deep hole, and it will take some time, perhaps another year, for the level of GDP to fully recover to its previous 2019 peak. It will likely take even longer than that for the unemployment rate to return to a level consistent with our maximum-employment mandate. However, it is worth highlighting that the Committee's baseline projections summarized in the most recent Summary of Economic Projections foresee a relatively rapid return to mandate-consistent levels of employment and inflation as compared with the recovery from the Global (FOMC) participant projects that by the end of 2023--a little more than three years from now--the unemployment rate will have fallen to 4 percent, and PCE (personal consumption expenditures) inflation will have returned to 2 percent. Following the GFC, it took more than eight years for employment and inflation to return to similar mandate- consistent levels. My baseline outlook is close to these projections, but I must also acknowledge that the economic outlook is unusually uncertain, and, moreover, that the ultimate course the economy follows will depend on the course of the virus, social- distancing norms, and mitigation efforts put in place to contain it. At our September FOMC meeting, the Committee made important changes to our policy statement that upgraded our forward guidance about the future path of the federal funds rate, and that also provided unprecedented information about our policy reaction function. We indicated that, with inflation running persistently below 2 percent, our policy will aim to achieve inflation outcomes that keep inflation expectations well anchored at our 2 percent longer-run goal. We said that we expect to maintain an accommodative stance of monetary policy until these outcomes--as well as our maximum-employment mandate--are achieved, and also that we expect it will be appropriate to maintain the current 0 to 1/4 percent target range for the federal funds rate until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment, until inflation has risen to 2 percent, and until inflation is on track to moderately exceed 2 percent for some time. We also stated that the Federal Reserve will, over coming months, continue to increase our holdings of Treasury securities and agency mortgage-backed securities at least at the current pace to sustain smooth market functioning and help foster accommodative financial conditions, thereby supporting the flow of credit to households and businesses. The September FOMC meeting was the first since the Committee approved in adopted a new policy framework. The changes we made in our September FOMC statement bring our policy guidance in line with this new framework. In our new framework, we acknowledge that policy decisions going forward will be based on the FOMC's estimates of " shortfalls [emphasis added] of employment from its maximum level"--not "deviations." This language means that going forward, a low unemployment rate, in and of itself, will not be sufficient to trigger a tightening of monetary policy absent any evidence from other indicators that inflation is at risk of moving above mandate-consistent levels. With regard to our 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 in a world in which an effective-lower-bound constraint is, in downturns, binding on the federal funds rate. To this end, the new statement conveys the Committee's judgment that, in order to anchor expectations at the 2 percent level consistent with price stability, 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." As Chair Powell indicated in his Jackson Hole remarks, we think of our new framework as an evolution from "flexible inflation targeting" to "flexible average inflation targeting." While this new framework represents a robust evolution in our monetary policy strategy, this strategy is in service to the dual-mandate goals of monetary policy assigned to the Federal Reserve by the Congress--maximum employment and price stability--which remain unchanged. While economic recovery since the spring collapse has been robust, let us not forget that full economic recovery from the COVID-19 recession has a long way to go. Although the unemployment rate has declined sharply since April, it remains elevated as of September at 7.9 percent and would be about 3 percentage points higher if labor force participation remained at February 2020 levels. Moreover, despite a recent uptick, inflation is still running below our 2 percent longer-run objective. It will take some time to return to the levels of economic activity and employment that prevailed at the business cycle peak in February, and additional support from monetary--and likely fiscal--policy will be needed. Speaking for the Fed, I can assure you that we are committed to using our full range of tools to support the economy and to help ensure that the recovery from this difficult period will be as robust and rapid as possible.

r201014a_FOMC

united states

Remarks at the Hoover Institution

quarles

I want to thank John Taylor and the Hoover Institution for inviting me to speak today. I will start with some brief remarks about the current economic situation and monetary policy and then turn to the actions that the Federal Reserve has taken this year to help ensure that the banking system remains a source of strength during the recovery from the COVID event, the term I use for the complex set of responses in both the private and public sectors to the outbreak of COVID-19. I will close with some thoughts on nonbank financial institutions and international coordination. Although the COVID event put the U.S. economy in a deep hole, the recovery since the economy began reopening in May has been stronger than almost any forecaster predicted back in the spring. Spurred in part by record fiscal stimulus, both business and household spending appear to have bounced back significantly through the third quarter, and we have regained about half of the jobs lost in March and April. I attribute a good portion of that strength to the inherent dynamism and flexibility of the American economy. Although the COVID event continues to stress businesses, many businesses adjusted their operations to remain open, and applications for new businesses surged over the summer. Meanwhile, better treatments and more-targeted containment measures focused on protecting the most vulnerable have resulted in falling rates of hospitalization and mortality. Therefore, I am optimistic that the recovery from the COVID event will continue to be robust. Of course, while we're doing better than expected, we still have a ways to go. The labor market remains deeply depressed, and employment is far short of the Federal Reserve's maximum employment goal. We are also keenly aware that the harm from higher unemployment has fallen even more than usual on those low-income households least able to bear it. Some businesses, particularly those in high-contact and personal-service industries, largely have been left out of the recovery. Inflation is well below our 2 percent longer-run goal, and some measures of inflation expectations have ticked down. in favor of the new and clearer forward guidance for monetary policy because it will provide additional support for the recovery. Indeed, interest-rate and credit-sensitive sectors--business spending, home sales, auto sales, and other "big-ticket" items--have helped fuel that recovery. This spending was supported by our timely and forceful moves to cut the federal funds rate to its effective lower bound, restore market functioning, and provide emergency support to households and businesses through 13(3) emergency lending facilities. Which leads me to the banking industry. For monetary policy to fully support Main Street, we need a well-capitalized, stable banking system that is lending to creditworthy focused on building the resiliency of banks so that they would be a source of strength during the next downturn. Thus far, that plan has borne a great deal of fruit. As the crisis intensified in early March, banks stepped into the breach and met the massive demands for cash from businesses that drew on their preexisting credit lines. Banks also funded the bulk of the more than $500 billion in Paycheck Protection Program (PPP) loans. According to our weekly bank credit data, commercial and industrial loans increased $715 billion between the week of February 26th and their peak on May 13th. For millions of struggling households, banks have agreed to forbear interest and principal payments on their loans. In addition, through September, banks absorbed more than $1.2 trillion of central bank reserves and received about $2.5 trillion of core deposits from investors who sought the safe haven of the U.S. dollar and insured bank accounts. As supervisors, we recognized that these actions strained the balance-sheet capacity of banks and so have taken a number of steps to allow them to continue to support their customers during this unprecedented time. A number of those steps--such as encouraging banks to work with their customers until the emergency subsides--are consistent with what we do whenever there is a natural disaster that disrupts normal commerce. But the COVID event has affected the entire country at the same time, requiring a broad set of extraordinary actions. For instance, we have temporarily exempted reserves and Treasury securities from the Supplementary Leverage Ratio so that banks do not become constrained by growing Treasury issuance and central bank reserves and can support businesses and households. More broadly, we have reintroduced and added numerous funding facilities through our 13(3) authority to support the continued flow of credit in the economy. Throughout all this, U.S. banks have remained financially healthy. Second-quarter data showed that most banks were profitable, aggregate capital ratios increased, and banks continued to maintain ample levels of liquidity. In addition, banks added substantially to their loan loss reserves over the first half of 2020, providing additional resilience. This week, some of the largest institutions have begun to report that their profitability held up again in the third quarter, partly because their robust provisions for loan losses earlier this year limited the need for additional provisions this quarter. Going forward, we will want to be sure that banks remain a source of strength and support for the economy. Even with the economic recovery being stronger and faster than expected, there are certainly reasons to be vigilant. Interest rates are likely to remain very low for quite some time, putting downward pressure on banks' net interest margins and their profitability more generally. The high level of corporate debt and elevated valuations in commercial real estate going into this crisis, combined with prolonged uncertainties and changes in the way we shop and work, could lead to higher-than-expected losses on loans to some of these businesses. Consumer lending and residential mortgages seem to be holding up well so far, which may reflect the relatively high quality of household credit going into the COVID event. However, the performance of these loans also needs to be watched closely in light of the forbearance policymakers have encouraged and the possibility of a reduction in fiscal support for households. For the past decade, robust stress testing has been at the core of our strategy for ensuring that our largest banks have sufficient capital to meet the credit needs of their customers while weathering an extreme downturn. In making decisions about our stress tests this year, I have been guided by three principles: First, we want to make sure that our supervisory and regulatory actions do not exacerbate the fallout from what was the most extreme deterioration in economic conditions on record. Second, we want to jealously guard the credibility of our stress tests, which restored confidence in banks during the GFC and have helped maintain that confidence since. Third, we want to establish the precedent that our response to a crisis would remain as deliberate, data driven, and bank specific as could be done prudently. Therefore, once it was apparent that our initial stress test scenarios for 2020--which were released before the pandemic--had been overtaken by events, we conducted a suite of additional analyses to assess the sensitivity of this year's results. This comprehensive analysis included consideration of banks' vulnerabilities under three additional downside scenarios that were very severe even given how gloomy the picture looked this spring. The staff also incorporated a number of conservative assumptions about the balance sheet changes that we saw at the end of the first quarter. This analysis found that the banking system would experience substantial losses under those highly adverse conditions but remain well capitalized in the aggregate. However, individual bank outcomes across the three scenarios varied significantly. The variation in those outcomes highlighted the considerable uncertainty in the economic outlook at the time and how that would translate to banking conditions in coming quarters. Accordingly, we required banks to resubmit their capital plans and took several actions to preserve capital in the interim. For the third quarter, the Board required large banks to suspend all stock repurchases, capped their dividends, and placed a second limit based on individual banks earnings. The limitation of share repurchases, which accounted for 70 percent of all capital distributions at large banks in recent years, by itself led to a meaningful preservation of capital among large banks. The dividend restrictions guarded against capital depletion in the event that some banks experienced unexpectedly large losses, while still allowing firms that could support them to pay out dividends. Late last month, the Board extended the distribution limitations onto the fourth quarter amid the continued uncertainty. The Federal Reserve is currently conducting another round of stress tests, using two new severe downside scenarios published last month, and will release bank-specific results from both scenarios before the end of the year. Taken together, these actions will preserve capital in the system during this highly uncertain time. As I noted, I also hope that the process we followed to arrive at these decisions will affirm that our actions, even in a crisis, will be dictated by the most comprehensive analysis we can do in a timely manner and will be as tailored to individual institutions' condition as is feasible given the circumstances. While banks so far have been resilient to the shock from the COVID event, the same cannot be said for important parts of the system of nonbank financial intermediation (NBFI). Starting in March, Federal Reserve facilities were needed to contain pressures in some prime money market funds, as well as, to a lesser extent, in certain long-term mutual funds that invest in corporate debt. Other types of NBFI also struggled during that period, including nonbank mortgage servicers and real estate investment trusts, the latter of which received support from the Board's decision to, for the first time, purchase agency commercial mortgage-backed securities. The vulnerabilities of NBFI are also at the top of the mind of international regulators. now almost 50 percent of total financial intermediation, and many NBFIs rely on the banking system for credit and backstop liquidity. Thus, late last year, I formed a high-level steering group of central bankers, market regulators, and international organizations to oversee the FSB work on nonbank finance and to help coordinate work across the range of global standard setting bodies that oversee the financial sector. The group is currently completing a holistic review of the COVID event to better understand the role that vulnerabilities stemming from the NBFI sector played in those events. In the wake of the COVID event, we have made good progress in arriving at a shared diagnosis of the market turmoil that happened during the onset of the event in March. Our discussions have surfaced a number of issues associated with particular types of market participants and mechanisms that may have caused liquidity imbalances and propagated stress. They include: vulnerabilities in money market funds (as I discussed earlier); dealers' capacity and willingness to intermediate; market structure in the core government bond markets and, potentially, the role of leveraged investors; and fragilities in US dollar cross-border funding. We are looking at the role that each of these factors may have played, but we are not yet prepared to say "J'accuse" to any one of them. This is because our work has also reinforced the point that one needs to examine the system as a whole and take into account the various linkages within nonbank financial intermediation and between nonbanks and banks. We will provide to the G20 Summit next month our holistic review of the turmoil and a concrete set of proposals for follow-up work on NBFI. This will provide a basis for a work plan for 2021, focused on better understanding this critical sector, vulnerabilities related to it, and how we might take a more macroprudential approach to supervising and regulating at least some parts of this sector. Thanks again to the Hoover Institution for having me, and I look forward to the discussion that follows.

r201015a_FOMC

united states

Modernizing and Strengthening CRA Regulations: A Conversation with Minority Depository Institutions

brainard

I want to thank Kim Saunders and Kenneth Kelly for inviting me to join members As mission-driven financial institutions with a focus on serving minority households and businesses, you see the significant racial disparities in our economy every day. Going into the crisis, Black and Latinx households had significantly smaller wealth cushions to fall back on than the average American household. For instance, Federal Reserve research based on the Survey of Consumer Finances notes that, in 2019 "the typical White family has eight times the wealth of the typical Black family and five times the wealth as the typical Hispanic family." The COVID-19 crisis has made existing racial disparities even worse. Low-wage and minority workers have experienced disproportionate harm to both their lives and livelihoods as a result of the COVID-19 crisis. As you know from the communities you serve, the crisis has exacerbated pre-existing disparities in the labor market. Black employment, in particular, is recovering at a much slower pace than employment in the overall population, and unemployment for Black and Hispanic/Latinx workers remains higher than for the workforce as a whole. As of last month, the overall unemployment rate had come down to 7.9 percent, which was a marked improvement from 14.7 percent percent, more than 4 percentage points higher than the overall unemployment rate. Research confirms that the COVID-19 pandemic has inflicted substantial harm on small businesses, particularly minority-owned businesses. For example, recent research documented that the number of working Black and Latinx small business owners declined in the early months of the crisis by even more than White small business owners. According to this research, the nation saw a 22 percent decline in small business owners between February and April overall, as compared with an even more precipitous 41 percent decline in Black business owners and 32 percent decline in Latinx business owners. Contributing to this perfect storm, minority individuals are suffering worse health (CDC) report significant disparities in the infection rate of COVID-19 by race and over two and a half times the rate of White, non-Hispanic individuals. For those who do contract COVID-19, African Americans are suffering twice the mortality rate of White, non-Hispanic individuals. The disparities in COVID-19 health risk reflect in part differences in the ability to work remotely, with minority individuals more likely to work in front line jobs that put their health at risk. Black and Latinx workers are overrepresented in the fields of work that entail high contact and pose greater risks of exposure to infection. For example, Black and Latinx workers are overrepresented in most essential positions, including nursing home staff, grocery store workers, bus drivers, postal workers, and warehouse workers. Against that challenging backdrop, the national conversation we are having right now about racial justice and racial equity ignited by the tragic death of George Floyd could not be more urgent. And the NBA's "mission of creating an inclusive financial services industry and a vibrant business environment for minority business institutions, their customers and the communities they serve" could not be more important. depository institutions (MDIs) are important actors in serving the financial needs of minority customers and small businesses, as well as providing community development resources to invest in minority communities. The COVID-19 pandemic only heightens the importance of the role you are playing. Your firsthand experiences of working with minority borrowers and your knowledge of local communities make you essential partners in better targeting our tools to assist low-income and minority small businesses and communities. You have provided valuable input on Federal Reserve programs, from the Paycheck Protection Over the last month alone, the Federal Reserve Board has held three sessions with representatives of MDIs, community development financial institutions (CDFIs), and vulnerable groups to discuss the challenges faced by underserved communities. We have heard about the extraordinary measures MDIs have taken to keep their banks accessible, modify loans, and extend Paycheck Protection Program (PPP) loans to new and existing customers, predominantly small, minority-owned businesses. Preliminary data from an Independent Community Bankers of America report indicate that your work, and the work of other community banks, has been a critical source of lending to minority-owned small businesses, accounting for 73 percent of all PPP loans made to minority-owned small businesses. In addition, some mission-focused institutions have participated in the Main Street New Loan Facility, and we continue to welcome your feedback on how to support institutions reaching the businesses and communities most in need. In addition, we are hearing of greater commitments to promote MDIs and CDFIs on the part of large institutions. A number of Black-owned banks, including NBA member banks, are involved in new partnerships to address racial disparities in access to credit and provide wealth-building opportunities. These recent developments are only the latest chapter in how your sector continues to grow and lean into the challenges this nation faces. have for addressing systemic inequities in credit access for minority individuals and communities. Last month, the Federal Reserve Board unanimously voted to approve an ideas advanced by a broad set of stakeholders, including the NBA and MDIs. It has been 25 years since we last reformed CRA, so it is important that we get it done right. The CRA is a critical law, enacted along with other complementary federal civil rights laws during the late 1960s and 1970s, to address redlining and systemic inequities in access to credit and other financial services for minority communities that contributed to dramatic differences in economic access and overall financial well-being. Even with these critical laws, the legacy of discriminatory lending and systemic inequity in credit access remains in evidence today. A foundational goal for the ANPR is to advance the core purpose of the CRA statute. Right at the outset, the ANPR asks for open-ended feedback on a foundational question: how should CRA's regulatory implementation be modified or changed to address systemic inequity in credit access to minority individuals and communities? As leaders in this field, we welcome your feedback on how to strengthen CRA implementation to further the statute's core purpose. Advancing the CRA's core purpose includes strengthening the regulations to ensure that a wide range of low-income and minority banking needs are being met. As part of this objective, CRA modernization provides a unique opportunity to carefully examine the MDI provisions in the CRA statute to ensure proposed changes to the regulation maximize the benefit and impact for MDI banks and the customers and communities they serve. In the ANPR, we placed a priority on strengthening the special consideration for MDIs, women-owned financial institutions, and low-income credit unions in the current regulation, as well as adding new proposals based on your feedback. The Board believes that any provisions to assist MDIs should be clearly defined and applied in CRA performance assessments. We consistently heard from MDIs and larger banks that there is a lack of awareness of the existing MDI provisions in the CRA regulations or a lack of understanding of how collaboration with MDIs ultimately "count" in a CRA examination. In response, the Board plans to highlight all MDI special provisions and make the credit they receive more prominent and clear in revised regulation, examination guidance, and other public documentation. In addition, in the ANPR, we proposed four specific new MDI provisions. First, the ANPR proposes giving banks credit for activities with MDIs, women-owned financial institutions, and low-income credit unions located outside their assessment areas at either the state or institution level, which would ensure that there is a clear "place" for such activities to be counted. Though majority-owned institutions currently can get CRA consideration for activities with MDIs outside of the majority-owned institution's assessment areas(s), we have heard feedback that there can be a lack of clarity about where and how these activities will count in their CRA rating. As a result, stakeholders like NBA have indicated that such activities are not common. The second proposal would explicitly designate activities in MDIs, women-owned financial institutions, and low-income credit unions as a potential pathway to achieving an "outstanding" CRA rating. The purpose of this provision would be to elevate the profile of and create more incentives for activities with these mission-oriented institutions. The third proposal would provide credit for MDIs and women-owned financial institutions investing in other MDIs, women-owned financial institutions, and low- income credit unions. Currently, only majority-owned institutions can receive CRA consideration for investing in MDIs. We know that MDIs vary greatly in size, and we have heard from MDIs that there could be mutually beneficial partnerships between Finally, the ANPR proposes providing credit for MDIs and women-owned financial institutions investing in limited activities to improve their own banks. Eligibility could be limited to activities that demonstrate meaningful investment in the business, such as staff training, hiring new staff, opening new branches in minority neighborhoods, or expanding products and services. In addition to activities specific to MDIs, the ANPR seeks to strengthen CRA's core purpose in other ways. This includes proposals to promote greater financial inclusion, such as allowing banks to get credit for community development activities outside of assessment areas but in designated areas with persistent unmet needs. An example mentioned in the ANPR is activities in Indian Country. Native American MDIs have been working diligently to serve Indian Country for years with limited resources; we hope that our proposals will bring additional capital into Indian Country to complement the work of Native American MDIs. Our second major goal for the ANPR is to provide greater certainty, tailor regulations based on bank size and business model, and minimize burden. There are a number of proposals to advance these objectives. Most MDIs are small banks, so let me say a bit more about the proposals in the ANPR that are tailored to small banks. Under the ANPR proposals, small retail banks would continue to have their retail lending activities evaluated under the current CRA framework unless they elect to be evaluated under the proposed Retail Lending Subtest using a metrics-based approach. Small banks that opt for the metrics-based approach would also have the option to submit retail services and community development activities for consideration, and we are interested in feedback on how to do this. Additionally, the ANPR proposes ways to minimize 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. Our third major goal for the ANPR is to provide a foundation for the agencies to converge on a consistent approach that has broad support among stakeholders. Stakeholders like NBA 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, 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 benefitted from the stakeholder comments 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 purpose of the statute, while providing greater certainty, tailoring regulations, and minimizing burden. We have appreciated the NBA'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. Our Partnership for Progress Program seeks ways to preserve and promote MDIs through engagement, technical assistance, and research in recognition of your institutions' continued innovation and flexibility in adapting to the ever-changing financial needs of your communities. We see CRA modernization as a significant opportunity to strengthen further the ability of MDIs to serve their communities, and we hope that you will provide us with feedback on how to modernize the CRA regulations in a way that supports MDIs and the communities you serve. Thank you.

r201015b_FOMC

united states

What Happened? What Have We Learned From It? Lessons from COVID-19 Stress on the Financial System

quarles

Thank you to the Institute of International Finance, for the opportunity to speak today. It has been eight months since COVID-19 appeared in the US and the attendant containment measures began to have severe effects on the U.S. economy and financial system (the "COVID event"). While the economy is recovering faster than we originally expected, and the financial sector returned pretty quickly to stable functioning-- in significant part due to strong action from governments and central banks around the world--the shock of the COVID event was by many measures the strongest in recorded history, and for a while in the spring the outcome was--as the Duke of Wellington said For some time, those closest to the events were too involved in fighting the fire to pull together an account of what had happened and what lessons we might learn. But at this point, it is now possible, and I believe valuable, to assess what happened in the financial system in March and April, which parts of the system came under stress, and why. The COVID event resulted in a large and uniquely exogenous shock to the economy and the financial system, and for that reason alone it can't tell us everything about what might happen in every future financial crisis. But as the first real life test of the regulatory framework erected after the global financial crisis (GFC), I believe it can tell us a lot about what is working and what aspects of our framework may need strengthening. It seems like a very long time ago, but early this year, the U.S. economy was in vibrant good health. Output growth was solid, and unemployment was at a 50-year low. Equity markets reached record highs on February 19, and in financial markets generally we saw high and in some cases stretched valuations. Business debt had been rising for a while, while household borrowing was more moderate. At the core of the financial system, large banks were in a strong position, with much higher capital ratios and liquid assets than in decades. We had seen some notable volatility in short-term funding markets, including some spikes in repo rates in 2019, but overall vulnerabilities stemming from liquidity and maturity mismatches in the financial sector still appeared low-- especially so at large banks, which had substantially reduced their reliance on short-term wholesale funding from pre-crisis levels. In late 2019, market participants were telling us that the most salient risks to the U.S. economy were from trade frictions, the challenges facing monetary policy given the proximity of interest rates to their effective lower bound, and market liquidity. Then the COVID event unfolded. On February 21, while we were with the Italian authorities in Riyadh for the G20 meetings, Italy announced quarantines of the northern towns being hardest hit by the new virus. This was a trigger for what became a rapid change in market sentiment, as investors began to prepare for what was beginning to seem might be a significant slowdown in economic activity. Volatility rose; selling pressure rose. As other European governments began to adopt travel bans, lockdowns, and school closures, there was a surging demand for safe assets. With fears of a widespread economic slowdown proliferating in late February and early March, Treasury prices rose and yields fell sharply, as usually happens when the economic outlook worsens. And as often happens when a shock leads to a surging demand for safe assets, some risky assets became very difficult to sell. Then on March 11, roughly two weeks after the first Italian quarantines, the WHO declared COVID-19 a global pandemic, and several new countries announced lockdowns and border closings. This was the trigger that turned what up to then had been a reasonably familiar, if concerning, flight to safety into a historically unprecedented dash for cash. Corporates preparing for a potentially extended disruption in revenues began seeking cash reserves en masse, while financial firms uncertain about the value of assets and counterparties began cutting their exposures. As a result of this scissoring, we saw serious strains in several financial markets. Some of the most severe strains emerged in short-term funding markets and among institutions engaged in liquidity transformation. I will highlight a few. First, we saw a pullback from commercial paper, or CP, markets. In an effort to contain risk in an abruptly slowing economy, investors shortened the maturities at which they were willing to lend in the CP market, in effect rushing for the exit and raising the possibility that lending might stop completely. Indeed, term CP markets did essentially shut down for some period. At the same time, some prime and tax-exempt money market funds experienced large redemptions, forcing these funds to sell assets. In addition, we saw large outflows at corporate bond funds and exchange traded funds. Corporate bond funds promise daily liquidity, but the underlying assets often take a longer time to sell. This creates conditions that can lead to runs on these funds in times of stress. Indeed, each of these three developments--the pullback from CP and the elevated redemptions at prime money funds and at corporate bond funds--can be viewed as a kind of run by investors. A run occurs when investors concerned about potential losses clamber to withdraw funds or sell their positions before other investors do. These actions can lead to sharp declines in asset prices and impair the ability of businesses to fund their operations, leading to strains across the financial system and declines in employment and spending. A fourth area of strain was in the Treasury market--one of the largest and deepest financial markets in the world. Treasury securities play a central role in short-term funding markets, such as the repo market, where they are a favored form of collateral. Significant amounts of Treasuries are held by institutions that use short-term funding, like broker-dealers and money market funds. And, the structure of the Treasury market has evolved substantially in recent years, with the growth of high-speed and algorithmic trading, and a growing share of liquidity provided by new entrants alongside established broker-dealers. The new Treasury market structure has had notable episodes of market volatility and stress, but none to compare with the COVID event. Treasury market conditions deteriorated rapidly in the second week of March, when a wide range of investors sought to sell Treasuries to raise cash. Foreign official and private investors, certain hedge funds, and other levered investors were among the big sellers. During this dash for cash, Treasury prices fell and yields increased, a surprising development since Treasury prices usually rise when investors try to shed risk in the face of bad news or financial stress, reflecting their status as the ultimate safe asset. While trading volumes remained robust, bid-ask spreads widened dramatically, particularly for older off-the-run Treasuries, but this soon spilled over into the more liquid on-the-run segment of the market, as well as the futures markets. The intense and widespread selling pressures appear to have overwhelmed dealers' capacity or willingness to absorb and intermediate Treasury securities. In the end, the Federal Reserve took a number of steps to support smooth market functioning, which I will describe in a moment. Fortunately, even with these strains in financial markets, banks were able to remain a source of strength to the financial system and the economy. Banks entered this crisis with much stronger balance sheets than the last one--with more and higher-quality capital, more liquid assets, and less reliance on fragile funding. This is a testament to reforms implemented by the Fed and other agencies in the aftermath of the GFC. Not surprisingly, however, the magnitude of the economic and financial disruptions from the COVID event posed some major challenges to banks. First, in March, many businesses--unable to satisfy their large cash demand through CP or corporate bond issuance, for the reasons I described earlier--drew down on their existing credit lines with banks in order to raise cash. As a result, commercial and industrial (C&I) loans in the banking system increased by nearly $480 billion in March--by far the largest monthly increase ever. Banks were able to fund these loans without notable problems through inflows of core deposits, other borrowing, and, to a lesser extent, by using their buffers of liquid assets. The inflow of deposits resulted from increased demand for safe haven assets, reflecting confidence in U.S. banks. While banks were a source of strain during the GFC, they were a source of strength during this crisis. After March, as the economy started to recover, many firms repaid these drawdowns and C&I lending by banks declined. If the drawdown of credit lines tested the resilience of banks to liquidity shocks, financial distress at borrowers has been testing the resilience of banks to losses. The COVID event has made it harder for many borrowers--businesses as well as households--to repay their debt. Encouraged by supervisors, banks have been working actively with their customers and have agreed to grant forbearance to millions of borrowers. At the same time, banks have recognized that the credit quality of many loans has deteriorated considerably, and they have made sizable provisions to prepare for expected loan losses. While banks have continued to lend, we have seen a notable tightening of bank lending standards. In the July Fed survey of senior loan officers, banks cited the uncertain economic outlook and industry-specific problems as the main reasons for tighter lending--the tightening was not due to capital or liquidity pressures. the overall contraction in credit availability is less severe than during the GFC, tighter lending standards may make it difficult for some businesses and households to borrow during the pandemic. While the continued ability of banks to lend to creditworthy borrowers has been good news, a lot of credit in the United States is provided by nonbank financial institutions and markets. Indeed, almost two-thirds of business and household debt in the United States is held by nonbanks, though much of the origination of the debt held by nonbank investors is done or facilitated by banks. And in March, this lending by non- banks dried up. In addition to the strains in short-term funding markets, some vital long- term lending markets were virtually closed. As the extent of the economic disruptions became clear, the cost of borrowing rose sharply for businesses issuing corporate bonds, for state and local governments issuing longer-term municipal debt, and for issuers of asset-backed securities (ABS), such as originators of auto and student loans. Spreads in some cases widened to post-crisis highs. Exacerbated by the problems in short-term funding markets and at bond funds, market functioning and liquidity deteriorated, and issuance of new debt in long-term markets slowed markedly or stopped altogether. Effectively, the ability of creditworthy households, businesses, and state and local governments to borrow, even at elevated interest rates, was threatened. In light of these unusual and exigent circumstances, the Federal Reserve took a series of emergency actions to support liquidity in markets and the flow of credit to households, businesses, and communities. I won't review in detail the kaleidoscopic gallimaufry of actions that we took to address the dysfunctions I've just been describing: emergency lending facilities under section 13(3) of the Federal Reserve Act to support liquidity in funding markets; similar facilities to support credit to nonfinancials; direct purchases of Treasuries; swap lines and repo facilities with foreign central banks. These are fully described elsewhere. Fundamentally, each measure was designed to address an aspect of the pressures created by the large demand for cash in the real economy and the temporarily limited willingness of financial firms to provide it. Our liquidity facilities relieved pressure on markets created by mass liquidations of assets driven by the demand for cash, as did our direct purchases of Treasuries. Our credit facilities satisfied the cash demand of borrowers more directly. Our swap lines and repo facilities with foreign central banks alleviated the shortage of dollars to satisfy dollar-denominated cash needs abroad. The result of this quite muscular intervention has been the fairly rapid return to stable market function despite the severe pressures I have been describing. Interestingly, in many cases our facilities had their effect less by actually providing liquidity or credit, than by providing a backstop. The "announcement effect" of the Fed's willingness to step in returned confidence to market participants and function to markets, without the facilities themselves seeing large amounts of use. Looking back at these events since the COVID event, what have we learned about the U.S. financial system? One lesson is that several short-term funding markets proved fragile and needed support - the commercial paper market and prime and tax-exempt money market funds, as key examples. The runs on prime money funds and commercial paper were particularly disappointing, since in many ways they resembled runs that we saw in these markets during the GFC. Money fund reforms implemented in 2016 were followed by investors shifting away from prime money funds and towards MMFs that hold securities backed by either the U. S. government or government-sponsored enterprises. Because they hold safer assets, government funds are less fragile. At the same time, some prime funds can still "break the buck" by suffering losses, or can put up "gates" that limit redemptions. Investors worried about losses at a money fund may feel some incentive to be among the first to withdraw from the fund, before it breaks the buck or puts up redemption gates in the face of large outflows. The shortening of maturities in the commercial paper market was similarly reminiscent of the GFC. It appears that these short-term funding markets remain an unstable source of funding in times of considerable financial stress. The Fed and other financial agencies have accomplished a lot in requiring or encouraging market participants to rely less on unstable short-term funding, but it is worth asking whether there may be other steps needed to secure these very important sources of liquidity. A second lesson we learned last spring is that the Treasury market is not immune to the problems of short-term and dollar funding markets. In light of the importance of the Treasury market to many other financial markets as well as to monetary and fiscal policy, this further heightens the need to think about additional steps addressing vulnerabilities in short-term funding markets. In addition, we have to ask: What can be done to improve Treasury market functioning over the longer term so that this market can withstand a large shock to demand or supply? I will simply raise that question, but not attempt to answer it here. A third, broader lesson from this event is that the regulatory framework for banks constructed after the GFC, with the refinements and recalibrations we have made over the last few years, held up well. We did not see a recurrence of the problems faced by the banking sector during the GFC, and the financial system and the economy would have been much worse off if we had seen it. Instead, banks have been a source of strength. I also believe that this conclusion is entirely consistent with the significant emergency measures undertaken by the Fed. Almost all of these measures were targeted towards financial markets, nonbank financial institutions, and the real economy. Moreover, the unprecedented and in many ways unimaginable nature of the shock posed by the COVID event made it appropriate to take these steps when we did, to backstop the functioning of markets essential to the financial system. Their creation was an unmistakable signal to market participants of the capability and willingness of the Fed to restore market functioning, and the fact that this functioning was restored so quickly, with relatively little borrowing, shows this message was received, and believed. The system worked. Looking across the areas in which strains suggest a need for further reforms, I am struck at the prominence of the continued need to focus on vulnerabilities associated with short-term funding. In some sense, this should not be surprising. Vulnerabilities associated with short-term funding have always been at the heart of financial crises and central banks' efforts to promote financial stability. Such vulnerabilities led to Walter Bagehot's 19th century dictum that central banks need to stand ready to lend freely against good collateral during periods of financial strain. Such vulnerabilities triggered the panic of 1907 and led to the establishment of the Federal Reserve. Such vulnerabilities led to runs on banks in the Great Depression and a series of reforms, including the establishment of deposit insurance. And such vulnerabilities were among those that precipitated the Global Financial Crisis. Following in that vein, at the bankers, market regulators, and international organizations to oversee the FSB's work on nonbank finance, and to help coordinate work across the range of global standard setting bodies that oversee the financial sector. The group is currently completing a holistic review of the COVID event to better understand the role that vulnerabilities stemming from nonbank financial institutions played in those events and to define a work program to address such vulnerabilities during 2021. One might look to the emergence of strains in short-term funding markets in March of this year as an indication that previous reform efforts fell short. Perhaps, and we will be looking at this at the FSB. But I have, as well, a more hopeful outlook, based on the extent of the test we faced and the outcome. The COVID event precipitated the most abrupt decline in U.S. and global economic activity in recorded history. It is far from shocking that funding strains emerged, and it is heartening that the banking system remained resilient and that policy efforts were able to calm financial markets relatively quickly. The lessons we draw from this year's events as we seek to strengthen our regulatory framework will leave us better positioned for the next shock and thereby support financial stability and sustained economic growth.

r201019a_FOMC

united states

U.S. Economic Outlook, Monetary Policy, and Initiatives to Sustain the Flow of Credit to Households and Firms

clarida

It is my pleasure to meet virtually with you today at the Unconventional I look forward to my conversation with Rob Nichols, but first, please allow me to offer a few remarks on the economic outlook, Federal Reserve monetary policy, and some of the initiatives we have announced to support the flow of credit to households and firms during these challenging times. In the first half of this year, the COVID-19 (coronavirus disease 2019) pandemic and the mitigation efforts put in place to contain it delivered the most severe blow to the an almost 32 percent annual rate in the second quarter, and more than 22 million jobs were lost in March and April. This recession was by far the deepest one in postwar history, but it also may go into the record books as the briefest recession in U.S. history. The flow of macrodata received since May has been surprisingly strong, and GDP growth in the third quarter is estimated by many forecasters to have rebounded at roughly a 30 percent annual rate. This development is especially noteworthy when set in relief against the surge in new COVID-19 cases that were reported this summer in a number of U.S. states and the coincident flatlining in a number of high-frequency activity indicators that we follow to track the effect of the virus on economic activity. Although spending on many services continues to lag, the rebound in the GDP data has been broad based across indicators of goods consumption, housing, and investment. These components of aggregate demand have benefited from robust fiscal support--including expanded unemployment benefits and the Small Business efforts by the Federal Reserve to sustain the flow of credit to households and firms. In the labor market, about half of the 22 million jobs that were lost in the spring have been restored, and the unemployment rate has fallen since April by nearly 7 percentage points to 7.9 percent as of September. I remind you that in the spring, many voices questioned what good rate cuts, forward guidance, asset purchases, and lending programs could do in an economy in which people do not venture out to buy cars or build houses nor do companies invest to augment their capital stock. Well, the data indicate that with rates low, credit available, and incomes supported by fiscal transfers, the answer is--at least so far--that they do build houses, buy cars, and order equipment and software. That said, the COVID-19 recession threw the economy into a very deep hole, and it will take some time, perhaps another year, for the level of GDP to fully recover to its previous 2019 peak. It will likely take even longer than that for the unemployment rate to return to a level consistent with our maximum-employment mandate. However, it is worth highlighting that the Committee's baseline projections summarized in the most recent Summary of Economic Projections foresee a relatively rapid return to mandate-consistent levels of employment and inflation as compared with the recovery from the Global Financial Crisis (GFC). by the end of 2023--a little more than three years from now--the unemployment rate will have fallen to 4 percent, and PCE (personal consumption expenditures) inflation will have returned to 2 percent. Following the GFC, it took more than eight years for employment and inflation to return to similar mandate-consistent levels. My baseline outlook is close to these projections, but I must also acknowledge that the economic outlook is unusually uncertain, and, moreover, that the ultimate course the economy follows will depend on the course of the virus, social-distancing norms, and mitigation efforts put in place to contain it. At our September FOMC meeting, the Committee made important changes to our policy statement that upgraded our forward guidance about the future path of the federal funds rate, and that also provided unprecedented information about our policy reaction function. We indicated that, with inflation running persistently below 2 percent, our policy will aim to achieve inflation outcomes that keep inflation expectations well anchored at our 2 percent longer-run goal. We said that we expect to maintain an accommodative stance of monetary policy until these outcomes--as well as our maximum-employment mandate--are achieved, and also that we expect it will be appropriate to maintain the current 0 to 1/4 percent target range for the federal funds rate until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment, until inflation has risen to 2 percent, and until inflation is on track to moderately exceed 2 percent for some time. We also stated that the Federal Reserve will, over coming months, continue to increase our holdings of Treasury securities and agency mortgage-backed securities at least at the current pace to sustain smooth market functioning and help foster accommodative financial conditions, thereby supporting the flow of credit to households and businesses. In recent months, the Federal Reserve has announced several initiatives to support the efforts of our nation's banks to sustain the flow of credit to households and firms during these challenging times. Along with the other federal banking agencies, we have encouraged banks to work constructively with borrowers who have been affected by COVID-19--offering a customer a responsible loan modification can be a safe and sound banking practice and can help facilitate the economic recovery. Turning to some issues of particular importance to small banks, we have provided temporary regulatory relief on the community bank leverage ratio, on regulatory reporting deadlines, and on appraisal requirements. We have also streamlined our bank examinations for small banks. These actions are providing banks with additional time and resources to adjust their operations to prioritize the financial needs of their customers and communities, and to play the vital role of lending to small businesses through the PPP. With regard to actions taken that are relevant for larger institutions, we have adapted our stress-testing framework to better identify the potential effects of the pandemic on the capital positions of our banks. In June, we released the annual stress- test results and an additional sensitivity analysis that explored vulnerabilities of banks to the downside risks to the economy arising from the pandemic. At the same time, to ensure resilience of the largest banks, we required them to resubmit their capital plans, imposed limitations on capital distributions, and recently provided new scenarios that will be used for a second round of stress tests later this year. Among other actions to support financial intermediaries during the pandemic, in April, the Board issued an interim final rule that would exclude, on a temporary basis, U.S. Treasury securities and deposits at Federal Reserve Banks from large bank holding companies' supplementary leverage ratio. The rule has helped ease strains in the U.S. Treasury market and continues to facilitate the significant inflow of customer deposits at banks that has occurred since the onset of the event. Looking ahead, in September, the Board published an advance notice of proposed strengthening, clarifying, and tailoring CRA regulations to ensure that they reflect the current banking landscape and better meet the core purpose of the CRA, addressing inequities in credit access and ensuring an inclusive financial services industry. ANPR proposes special provisions for minority depository institutions (MDIs), women- owned financial institutions, low-income credit unions, and community development financial institutions. Because of feedback received about lack of awareness of existing MDI provisions in the CRA regulations, the Board plans to highlight all MDI special provisions and make the credit they receive more prominent and clear in revised regulation, examination guidance, and other public documentation. In addition, we also propose four specific new MDI provisions. Finally, the CRA also proposes to create incentives for bank investments in geographic areas of need outside of traditional assessment areas. While recovery since the spring collapse in economic activity has been robust, let us not forget that the full economic recovery from the COVID-19 recession has a long way to go, with the unemployment rate still elevated at 7.9 percent as of September and inflation still running below our 2 percent longer-run objective. It will take some time to return to the levels of economic activity and employment that prevailed at the business cycle peak in February, and additional support from monetary--and likely fiscal--policy will be needed. Speaking for the Fed, I can assure you that we are committed to using our full range of tools to support the economy and to help ensure that the recovery from this difficult period will be as robust and rapid as possible.

r201020a_FOMC

united states

Modernizing and Strengthening CRA Regulations: A Conversation with the Housing Community

brainard

I want to thank David Dworkin for inviting me to participate in this discussion. I am pleased to be with you to talk about Community Reinvestment Act (CRA) modernization and how this process can help address the housing challenges facing minority and low- and moderate-income (LMI) communities around the country. National Housing Conference (NHC) is an important voice in housing and community development policy, so I look forward to hearing from you. During the mortgage foreclosure crisis, many families around the country suffered the devastating loss of their home through no fault of their own, and homeownership rates have not recovered to pre-crisis levels for the affected groups. Now, the COVID-19 pandemic is raising a new set of housing challenges for renters and the rental market. The current crisis is hitting LMI households with limited financial resources the hardest, and this is especially true for Black and Latinx households. Data from the Census Household Pulse Survey indicate that 25 percent of Black renters and 22 percent of Hispanic renters were behind on their rent payments as of September, along with 12 percent of White renters. Among homeowners, Black and Hispanic households have been "significantly more likely to miss or defer monthly mortgage payments and experience uncertainty about making next month's payment than white households" during the pandemic. payments and supplemental unemployment benefits provided vital support to households in the initial stages of the crisis, and the mortgage forbearance period of up to 360 days in the Act and eviction moratoriums at the federal, state, and local level have provided vital stop-gap stability for many families. There is growing concern about what will happen to individuals who may be behind on their rent or mortgage payments as a result of job loss or reduced hours when eviction moratoriums and mortgage forbearance programs come to an end, especially given uncertainty about whether there will be further fiscal support. The housing challenges resulting from the COVID-19 pandemic are layered on top of existing challenges in both the homeownership and rental markets. Affordable housing is essential to providing low-income households the stability necessary to engage in employment and schooling, provide for essential needs, and accumulate some financial cushion for emergencies. However, the need for affordable housing has grown at a faster pace than the supply. With limited supply of lots and other challenges, new construction in many places has been oriented to higher-end units, leaving more limited supply for households with lower incomes, especially in higher cost cities. Many households have been unable to purchase a home since the last financial crisis due to a confluence of factors, including higher home prices and stricter lending standards. For those who have purchased a home, higher home prices have translated into higher debt levels relative to household income. For renters, available subsidies or programs for affordable housing have fallen short of the need, particularly in higher cost cities, while new higher-end rental housing has increased significantly since the financial crisis. The high cost of renting leaves many families paying a higher share of their income for housing. American Community Survey data from 2019 show that 45 percent of renter households spend more than 30 percent of their monthly income on rent. While 22 percent of renters pay more than half of their income toward rent, this figure jumps to nearly 38 percent for renters earning This leaves families with little to no room to save for emergencies, such as the COVID-19 pandemic. This growing shortage underscores the importance of the incentives provided by the CRA for the production and rehabilitation of affordable housing. With the demand for affordable units significantly exceeding supply, it is essential to strengthen the incentives for these loans and investments as part of CRA modernization. Increasing access to affordable housing is critical to creating opportunities for homeownership for LMI households and with it the chance to build wealth through home equity. Here too, CRA plays a role, not only in providing incentives for the provision of affordable housing, but also in encouraging access to credit for homeownership for LMI households and communities. Indeed, mortgage lending has long been at the center of evaluating CRA performance. The challenges facing LMI and minority renters and would-be homeowners underscore the importance of getting CRA modernization right. The Federal Reserve Board unanimously voted to approve an Advance Notice of Proposed Rulemaking The ANPR was published yesterday in the , and the comment period will end on February 16, By providing a 120-day comment period, we hope to receive comments from a wide range of stakeholders and build on the already robust feedback that informed the development of the ANPR. Throughout this process, NHC has provided the Federal Reserve with valuable insights into the unique role and needs of affordable housing providers. Your members support community development projects in communities throughout the country, and we have benefited from the engagement of NHC and its members both in the form of detailed comment letters and through meetings to discuss different aspects of CRA reform. The CRA is a critical law, enacted along with other complementary federal civil rights laws during the late 1960s and 1970s. The intent of these laws was to address redlining and systemic inequities in access to credit and other financial services for LMI and minority communities. The core purpose of CRA remains as important as ever, especially given the national conversation we are having about racial equity in our society and the disproportionate impact that COVID-19 is having on LMI and minority communities. Even with these critical laws, the wealth gap remains stubbornly wide. Survey of Consumer Finances for 2019 found that the typical White family has eight times the wealth of the typical Black family. For many American families, homeownership is the single most important component of their wealth. In 2019, the homeownership rate for Black households was 42.1 percent, as compared to the 73.3 percent for White households. percentage points wider than a decade ago. The Board's ANPR seeks to advance the law's core purpose of addressing unequal access to credit for LMI and minority communities and disinvestment in underserved communities. A modernized CRA should help move the needle on credit access, wealth building, and the availability of community development financing. This includes strengthening the regulations to ensure that a wide range of low-income and minority banking needs are being met. It also includes promoting financial inclusion by proposing incentives for further bank investments in Minority Depository Institutions, activity in designated areas of need outside of assessment areas, such as Indian Country. The ANPR also seeks to provide greater certainty, tailor regulations based on bank size and business model, and minimize burden. For example, the ANPR introduces a metrics-based approach that would separately evaluate retail lending and community development financing activity. The use of standardized metrics would provide greater clarity and transparency on how lending and investment activity is evaluated. These proposed metrics would also use thresholds that are tailored to local market conditions, while also retaining a focus on targeted performance context factors. Lastly, we hope the ANPR will provide a foundation for the agencies to converge on a consistent approach that has broad support among stakeholders. Stakeholders, including the NHC, have expressed strong support for the agencies to work together to modernize CRA. By reflecting stakeholder views and providing a long public comment period, we believe that the ANPR provides the basis for the agencies to establish a consistent approach that has broad support. Before concluding, I want to highlight a few proposals in the ANPR that have particular relevance to affordable housing. First, the ANPR proposes two separate tests for evaluating the CRA performance of large retail banks--a Retail Test and a Community Development Test--in response to the overwhelming stakeholder feedback we heard about the vital importance of both retail and community development activities. In the ANPR, each of these tests would have a subtest that focuses on financing and a subtest that focuses on services, resulting in four overall subtests for large retail banks. Second, the ANPR proposes evaluating a bank's retail lending in its major product lines using metrics that measure the number of loans a bank makes, not the dollar-value of these loans. As a result, a larger mortgage loan would count the same as a smaller-dollar mortgage under the proposed metrics. We think this is important to avoid providing incentives to serve borrowers seeking to finance higher-priced homes at the expense of lower-income borrowers seeking finance for lower-priced homes. Third, the ANPR proposes combining consideration of community development loans and qualified investments, including originations and purchases, into one metrics- based Community Development Financing Subtest. We believe this could encourage the provision of patient capital because both new originations and those already on the balance sheet would be included in the evaluation metric. Fourth, stakeholders have emphasized the critical importance of CRA-motivated capital as a source of funding for affordable rental and single-family housing for LMI populations. Given the significant unmet need for affordable housing, the ANPR provides an opportunity to carefully reconsider how we define affordable housing in the CRA regulations and how we can strengthen existing provisions for the creation and preservation of affordable housing, both rental and owner-occupied. The ANPR proposes new regulatory language that would specify that a housing unit would be considered affordable if it is purchased, developed, rehabilitated, or preserved in conjunction with a federal, state, local, or tribal government affordable housing program or subsidy, with the bona fide intent of providing affordable housing. This definition is intended to capture a wide variety of subsidies, including tax credit subsidies, and state and local government direct subsidies for the production or preservation of affordable housing. These programs could be for rental housing or homeownership. The suggested language is also intended to capture programs that do not provide monetary subsidies, but that have the express intent of producing or preserving affordable housing, such as a loan in support of a land bank program. In addition, many stakeholders have noted the importance of preserving unsubsidized housing that is affordable to LMI households and ensuring units retain their affordability in gentrifying areas. In response to these concerns, the ANPR seeks to clarify the criteria under which banks can receive CRA consideration for investing in unsubsidized, or naturally-occurring, affordable housing. We are also considering other options to ensure that housing-related community development financing activities maintain long-term affordability, limit displacement, and encourage affordable housing located in all communities. As experts in this field, we look forward to receiving your feedback on what specific data sources and criteria we should consider to promote the preservation of naturally-occurring, affordable housing. Fifth, the ANPR seeks feedback on the appropriate CRA treatment of mortgage- backed securities (MBS) that are backed by loans that finance subsidized multifamily rental housing, loans for mixed-income housing that includes affordable housing for LMI families, or loans to LMI borrowers. While issuance of qualifying MBS can improve liquidity, and thereby increase capacity for lenders that make home mortgage loans to LMI borrowers, some stakeholders have expressed concern that MBS purchases may be undertaken in lieu of other more impactful community development financing activities that may require greater effort. Finally, the ANPR seeks feedback on extending to CDFIs the status that is extended to Minority Depository Institutions, women-owned financial institutions, and low-income credit unions. Such an approach would effectively give banks CRA consideration for loans, investments, or services in conjunction with a CDFI anywhere in the country. Additionally, the ANPR discusses granting automatic CRA community development consideration for qualified activities in conjunction with U.S. Department of the Treasury-certified CDFIs for activities in a bank's assessment area(s). We hope that you will provide us with feedback on how to modernize the CRA in a way that supports affordable housing and promotes housing-related credit and investments to LMI and minority individuals and communities. We thank you for your engagement and look forward to hearing more from you and your members through the rulemaking process.

r201020b_FOMC

united states

The Financial Stability Board’s Roadmap for Addressing NBFI Vulnerabilities

quarles

Thank you for the invitation to be with you today. The Securities Industry and issues that are timely and relevant to the current work of the Financial Stability Board, or FSB, and I am grateful for the opportunity to be part of it. The shocks related to COVID-19 and the associated containment measures, which I refer to as the "COVID Event," have sharpened the FSB's focus on the role of capital provision, the functioning of financial markets, and different aspects of nonbank financial intermediation, or NBFI for short. The FSB's annual NBFI monitoring report estimates that the sector now accounts for almost 50 percent of total financial intermediation globally, up sharply in the last decade. With this growth has come greater interconnectedness. Many NBFIs rely on the banking system for credit and backstop liquidity. The interconnectedness of our financial system means that it is not enough to understand the vulnerabilities arising from the banking sector. We must also understand vulnerabilities in the nonbank sector and how shocks are transmitted to or from the nonbank sector. To address this need for a broader perspective, last year I formed a high-level steering group of central bankers and market regulators to oversee the FSB's work on nonbank finance and to help coordinate with various global financial standard-setting bodies. he COVID Event in March tested the resilience of the financial system, and the NBFI steering group has used the past few months to begin identifying the parts of the NBFI sector that did not exhibit sufficient resiliency. While our analysis is not final, the group is currently completing a holistic review of the impact the COVID Event had on financial markets in March, especially dislocations in key funding markets and credit supply, to better understand the role that vulnerabilities stemming from the NBFI sector played. Today, I want to share with you some of the emerging elements of the FSB's review of the COVID Event, primarily how the shock moved through the financial system and which critical vulnerabilities it exposed. I also want to outline further work that the FSB plans to conduct in light of this experience, including a more in-depth assessment of how various segments of the NBFI sector performed. Going forward, I expect the NBFI sector to be an ongoing focus of the FSB. When COVID-19 emerged early this year, the global financial system was in several ways fundamentally different than it was at the outset of the financial crisis of more than a decade ago. Regulatory reforms implemented in response to that crisis, changes in technology, developments in U.S. dollar funding, and, importantly, the growth of NBFI all contributed to a changed landscape. Beyond the growth of the NBFI sector, there has also been considerable change within this sector. Business models and financial services provided by NBFIs have become more diverse. This variation can be seen in new products, services, and financial models. New types of markets--for example, private debt markets--and new forms of intermediation, such as fintech credit, have sprung up. Investments by nonbank entities in certain credit products, such as fixed income exchange traded funds and collateralized loan obligations, and participation in some credit segments, such as mortgage and consumer finance, has grown. Change is also evident in how the sector operates in different jurisdictions. For example, provision of credit by nonbank fintech lenders varies greatly across FSB member jurisdictions. In sum, nonbanks now play a larger and more diverse role in financing the real economy and managing the savings of households and companies. The past decade also saw an evolution in the global U.S. dollar funding landscape. While the U.S. economy forms a smaller percentage of global gross domestic product than in the past, the U.S. dollar still dominates international finance as a funding and investment currency, and its widespread use has given rise to a complex and geographically dispersed network of financial relationships. This means global economic and financial activity is highly dependent on the ability of U.S. dollar funding to flow smoothly and efficiently between users. In contrast to bank intermediation, market-based financing in U.S. dollars has outpaced the growth of the global economy. Nonbank institutions--such as insurers, pension funds, and central counterparties--have become more important users of U.S. dollar funding, though they lack access to funding backstops, such as central bank facilities, in times of stress. Cross-border links between banks and nonbank entities have also increased, and there has been a shift of global portfolios toward U.S. securities and cross-border lending into emerging market Changes in the functioning of financial markets have also affected how the financial system provides liquidity and transmits price changes, and many of the recent changes stem from the increased role of nonbank players. In markets with more standardized products, electronic trading has grown, increasing the use of high-frequency trading and the role of principal trading firms in providing liquidity. By contrast, other markets, such as funding markets for corporate credit, have grown significantly in size but continue to be traded over-the-counter with low levels of automated trading. The outbreak of COVID-19 and efforts to contain it generated simultaneous hits to aggregate supply and demand. Voluntary and mandated quarantines, lockdowns, and social distancing efforts lowered aggregate demand, caused large job losses, and sharply increased uncertainty. Workplaces closed and travel was curtailed, disrupting global supply chains. Important sectors of the global economy, such as tourism and transportation, came to a rapid stop. As the concern about the virus spread, these effects grew. According to figures from the International Monetary Fund, we ultimately wound up with the deepest and broadest global recession since the Great Depression. As businesses scrambled to remain liquid amidst this global "sudden stop," demand for liquidity in U.S. dollars increased globally. Commercial entities with debt denominated in U.S. dollars sought to increase their holdings of U.S. dollars. Unprecedented asset price volatility and record or near-record trading volumes led to significant margin calls, which amplified the demand for cash. Some market participants may not have anticipated the size of these margin calls, and they were forced to sell less liquid assets rapidly to meet them. Those forced sales on top of other pricing pressures, resulted in unwanted procyclicality. Traditional sources of cash were unable to handle the significant and sudden increase in demand. Normally, market participants can generate cash by converting assets to cash in secured funding markets or by issuing debt. Through late February and early March, as the COVID Event began to unfold in Europe, these mechanisms mostly functioned as expected. However, only a few days, the surge in demand for cash-- apparently triggered by the World Health Organization's designation of the virus as a global pandemic on March 11 and simultaneous lockdowns in a number of countries-- overwhelmed dealers and impaired price discovery. Repurchase rates increased sharply and liquidity in securities markets declined precipitously. Bid-ask spreads increased, in some cases to levels greater than those observed during the global financial crisis. As traditional sources of liquidity became limited, market participants had to either pay a premium for cash, or search for it in other ways. One alarming feature of the COVID Event involved the way in which the shock propagated through core government bond markets. Amid increased demand for cash and short-dated assets, institutional investors sold large volumes of longer-dated bonds-- including those usually considered as most liquid--in favor of cash. The price of government bonds relative to futures prices decoupled, putting significant volumes of derivatives trades out of the money and thereby increasing margin calls. Global authorities sold a significant number of government bonds, perhaps to satisfy U.S. dollar funding needs or to stabilize foreign exchange rates. All together, the pressure on longer- dated government bonds was sufficient to impair pricing for some of these bonds in this normally deep and liquid market, an outcome that we would not normally expect. The mismatch last spring in the demand and supply of cash exhibited some self- reinforcing tendencies. As market participants became more risk averse and hoarded liquidity, they became unwilling to provide short-term unsecured funding. Dealers reached their limits in holding large amounts of securities--in some cases internal risk limits, in other cases limits imposed by regulation--rendering them unable or unwilling to absorb significant asset sales from other market participants. As companies were increasingly unable to gain access to traditional sources of liquidity, they turned to banks and drew on credit lines, decreasing cash held by banks that they could have used for other lending. Stresses in debt markets also fed into one another. Widespread forced sales of securities, combined with limited dealer intermediation contributed to increased volatility and illiquidity. In particular, the increased volatility led to margin calls, further increasing the demand for liquid assets. All of these pressures increased the demand for cash, which increasingly was only available by selling assets. The volume of sales was sufficient to impair pricing in certain markets, starting the cycle anew. The sharp reduction in market liquidity likely exacerbated asset price declines, and it may have hindered other investors from behaving in a countercyclical fashion by purchasing under- valued assets. Let me focus briefly on U.S. money market funds, specifically prime and tax- exempt funds, as an example of how some of these strains played out during the COVID Event. Money market funds are perceived as very safe and liquid investments by most financial market participants, and yet in the COVID event and in the earlier global financial crisis, the Federal Reserve and the U.S. Treasury were compelled to create significant government backstops to contain runs on these funds that had the potential to destabilize the financial system. The crux of the issue stems from the fact that investors run from these money market funds in times of stress. In 2008, investors ran from money funds in part because of the first-mover advantage created by their stable net asset values (NAVs); in 2020, investors appear to have run from money funds in part because of fears of impending redemption fees or redemption suspensions. In March of 2020, among institutional prime money market funds offered publically as well as retail prime funds, the pace of outflows actually exceeded that in the fall of 2008. Those outflows from money funds increased stress in short-term funding markets. Conditions in markets for commercial paper and negotiable certificates of deposit (CDs) began to deteriorate rapidly, and spreads for money market instruments jumped to levels not seen since the last financial crisis. In the COVID Event, one advantage the public sector had was the experience of the global financial crisis which helped us act quickly and decisively to halt a further intensification of the market shock. These interventions were unprecedented in scale and scope. Central banks around the world expanded their asset purchases, significantly increasing their balance sheets. Central banks also implemented liquidity support, including traditional operations to fund banks, but also through liquidity facilities to support other entities. For example, the Federal Reserve established facilities to provide liquidity to dealers, commercial paper markets, money funds, nonfinancial corporates, and municipal bond markets. In an effort to support the global demand for U.S. dollars, the Federal Reserve established swap lines with central banks all over the world to support international trade. In addition, regulators and supervisors have strongly encouraged banks to deploy capital and liquidity buffers to support lending, made modifications to certain regulatory requirements, or delayed the implementation of new requirements. These decisive actions have succeeded in alleviating market strains to date. While swift and decisive policy action succeeded in calming markets, this does not mean that our work is complete. While central bank action succeeded in restoring market functioning, this support does not address the underlying vulnerabilities spotlighted by the COVID Event. The COVID Event revealed a banking system that withstood this shock quite well with limited official sector support, and a nonbank system that was significantly more fragile. By this measure, the COVID Event demonstrates that we have work to do. The FSB is in the early stages of this work. In November, we will deliver to the G20 Summit, and publish, our holistic review of the COVID Event. The report will provide a diagnosis of the shock from a financial stability perspective, including how it was absorbed and amplified. The report also will identify areas where policy consideration may be warranted. Recognizing the critical importance of the interconnections between the banking and NBFI sectors, the FSB set up a working group to map the current financial system, including the bank and NBFI sectors and the links among and between the two. This exercise will identify nodes and channels of risk transmission in the system, which will also help policymakers identify and understand the pathways for both amplification and absorption of risk in the financial system. Further, the FSB's initial analysis on the beginning stages of the COVID Event has revealed a number of issues that may have caused liquidity imbalances or propagated stress. For example, there are signs that margin calls were larger than expected and may have stretched the liquidity of some market participants. Questions about the functioning and resilience of the core government funding markets also remain, especially in relation to the role of leveraged investors and dealer capacity to intermediate in these markets. We know already that work needs to be done to improve the resiliency of money market funds before the vulnerabilities in these funds amplify another shock. This will require careful consideration of financial stability, investor protection, and efficiency objectives alongside an understanding of the benefits of money market funds that should be preserved. Additionally, other types of open-ended funds, especially those invested in less liquid assets, also experienced large outflows, and further work is likely needed to understand liquidity risks in these funds. I believe that, as with the work undertaken in the aftermath of the global financial crisis, the FSB will provide a forum for international experts to understand vulnerabilities in NBFIs, promptly prescribe reasonable policy solutions, and monitor the implementation and effectiveness of any agreed-upon reforms. Global coordination through the FSB has helped reveal a number of issues associated with particular types of market participants and mechanisms that may have caused liquidity imbalances and propagated stress. Since the start of the pandemic, FSB members regularly connected to share experiences, analyses, and concerns about coming events. In so doing, the membership as a whole has been agile, coordinated, and quick to respond. We have seen that decisive action helped to stabilize markets through facilitating funding to support the economy. Addressing vulnerabilities in the financial system going forward, therefore, will require a holistic perspective given the various linkages within nonbank financial intermediation and between nonbanks and banks. We have gained some clarity regarding areas of the market that needed significant bolstering and have to look closely at whether and how resilience in these segments can be improved. Next month, when the FSB delivers our NBFI report and proposals to the G20 Summit, we will be doing what the FSB does best: leveraging the strength of our broad and diverse membership to provide a clear path forward to strengthen the resilience of the global financial system.

r201021a_FOMC

united states

Achieving a Broad-Based and Inclusive Recovery

brainard

I want to express my appreciation to Kevin Daly for inviting me to participate in The U.S. economy saw a strong initial bounceback from the depths of the recovery remains highly uncertain and highly uneven--with certain sectors and groups experiencing substantial hardship. These disparities risk holding back the recovery. The Federal Reserve is committed to providing sustained accommodation to achieve a broad- based recovery. Further targeted fiscal support will be needed alongside accommodative monetary policy to turn this K-shaped recovery into a broad-based and inclusive recovery. Targeted interventions, along with adaptations in the behavior of households and businesses, have enabled economic activity to recover. All told, after an unprecedented contraction in the first half of the year, U.S. gross domestic product appears likely to have reversed more than one-half of that decline in the third quarter. But within the overall improvement, some groups and sectors continue to see depressed employment, income, and revenues. Sustained disparities can hold back the recovery and lead to worse overall outcomes. Over the past month, the Federal Reserve Board has held three meetings with community groups, mission-oriented lenders, and representatives of frontline workers to hear about these disparities and their implications for the recovery. Overall, total consumer expenditures in the United States have recovered about three-fourths of their spring decline through August. Interest-sensitive sectors such as residential real estate and autos have rebounded strongly--a welcome reminder of the power of monetary accommodation, especially when coupled with necessary fiscal support. Consumer spending on goods posted robust gains over the summer, and August levels exceeded those in January. In sharp contrast, however, consumer spending on services through August has recovered only about 60 percent of its spring decline and remains well below pre-COVID-19 levels. At the aggregate level, indicators of business investment, including shipments of capital goods, have been stronger than anticipated and point to a solid increase in equipment and investment spending in the third quarter. In contrast, investment on nonresidential structures remains depressed. Activity in some sectors remains substantially below pre-COVID-19 levels. For instance, a irline passenger traffic is still 60 percent below its pre-pandemic level, contributing to the decline in aircraft orders this year, and hotel revenue per available room is only half the level of a year earlier. Our actions have helped promote the flow of credit to households and businesses. Borrowing costs are low along the yield curve, and liquidity is abundant. Amid historically low corporate bond yields, gross issuance of both investment- and speculative-grade corporate bonds was strong in the third quarter. In contrast to the favorable financing conditions for large businesses with access to capital markets, financing conditions for small businesses remain tight, with lower lending activity and signs of deteriorating loan performance. Small businesses tend to be concentrated in sectors that entail high direct contact, operate with relatively tight cash buffers, and rely on bank credit rather market-based finance. In the most recent Census Bureau Small Business Pulse Survey from early October, more than 30 percent of small businesses report having one month or less of cash on hand. the Paycheck Protection Program (PPP) provided a critical lifeline for small and medium- sized businesses, but also that credit availability has otherwise tightened. Driven primarily by PPP-related loans, originations of new small business commercial and industrial loans in the second quarter of 2020 were more than nine times the size of originations in either the first quarter of 2020 or the second quarter of 2019. 44 percent of respondents, on net, indicate loan standards tightened over the second quarter. About 43 percent of respondents, on net, reported a deterioration in the credit quality of small business applicants--the largest decline since the inception of the survey and only the second time in which respondents of all bank sizes, on net, reported a decline. Minority small businesses have been particularly hard hit. According to recent research, between February and April, the economy saw a 41 percent decline in Black business owners and a 32 percent decline in Latinx business owners, compared with a 22 percent overall decline. The labor market recovery to date has been more rapid than the initial pace following the Global Financial Crisis, but it has been uneven, and the easiest improvements are likely behind us. The pace of labor market improvement is decelerating at a time when employment is still far short of its maximum level. As of September, total nonfarm payroll employment had recovered about half of the jobs that were lost in March and April, and it remained about 11 million jobs below its February level. Private payroll gains in September were less than in July and August and came in far below the gains posted in May and June. Although the number of persons on temporary layoff has dropped back sharply from the highs in the spring to a level of 4.6 million in September, the number of permanent job losers has been rising since February and was at a level of 3.8 million in September. The job-finding rate for those who are permanently laid off is less than half the rate of those on temporary layoff, so the speed of labor market improvement is likely to decelerate further if these trends continue. Similarly, after seeing large declines during much of the summer, initial claims for unemployment insurance have crept up recently and remain elevated. The 1/2 percentage point decline in the unemployment rate in September to 7.9 percent was accompanied by a 0.3 percentage point decline in the labor force The recent decline in prime-age labor force participation has been due primarily to women. September marks the third consecutive monthly decline in the prime-age female LFPR since it bounced back in May and June. The decline in September, when many schools moved to virtual instruction, was especially pronounced for women ages 35 to 44. Indeed, the fraction of prime-age respondents to the Current Population Survey in September with children ages 6 to 17 who reported being out of the labor force for caregiving reasons was about 14 percent, up nearly 2 percentage points from a year earlier. If not soon reversed, the decline in the participation rate for prime-age women could have longer-term implications for household incomes and potential growth. The COVID-19 pandemic is exacerbating existing disparities in labor market outcomes. Although employment fell sharply for all groups between February and April, the decline was steeper for Black and Hispanic workers than for white and Asian workers, steeper for women than for men, and steeper for non-college-educated workers than for college graduates. At 12.1 percent, the unemployment rate for Black workers is more than 4 percentage points higher than the aggregate. Occupation and industry affiliation can explain only part of these COVID-19 labor market disparities. In the years before the pandemic, I was encouraged to see prime-age individuals in all demographic groups drawn into the strong labor market, reversing the previous decline in participation and boosting the productive capacity of the economy. spells out of employment risk harming not only the prospects of these individuals, but also the economy's potential growth rate. Regarding the other side of our dual mandate, the 12-month change in total personal consumption expenditures (PCE) prices picked up from 0.5 percent in April to 1.4 percent in August. Over the same period, core PCE price inflation picked up from 0.9 percent to 1.6 percent, supported lately by increases in prices of durable goods, including those for used cars and household appliances. While inflation may temporarily rise to or above 2 percent on a 12-month basis next year when the March and April price readings fall out of the 12-month calculation, my baseline forecast for inflation over the medium term is for it to remain short of 2 percent over the next few years. Recent research indicates that the Coronavirus Aid, Relief, and Economic Security (CARES) Act played a significant role in supporting aggregate demand in the spring and summer. Enhanced unemployment benefits offset the lost income of many lower-wage and services workers, in some cases at greater-than-wage-replacement rates. 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. The Survey of Consumer Finances indicates that cash-constrained households make up a significant fraction of the population. With unemployment and reduced hours likely to persist, many of these households are unlikely to be able to sustain recent levels of consumption without additional fiscal support as well as extended loan forbearance and eviction moratoriums. The financial security of displaced workers will depend importantly on whether unemployment benefits will be extended or supplemented--and if this will occur before any remaining savings accrued from the CARES Act funding run out. Analogous questions arise with regard to the many hard-hit small businesses that were sustained early in the crisis by PPP loans, whose finances are becoming increasingly strained as revenue shortfalls persist. Similarly, the state and local governments that were able to weather tax-and-fee revenue shortfalls early in the crisis are likely to find it more difficult to sustain employment and spending levels the longer the pandemic persists in the absence of further fiscal support. Continued targeted support to replace lost incomes will be an important factor in determining the strength of the recovery. Apart from the course of the virus itself, the most significant downside risk to my outlook would be the failure of additional fiscal support to materialize. Too little support would lead to a slower and weaker recovery. Premature withdrawal of fiscal support would risk allowing recessionary dynamics to become entrenched, holding back employment and spending, increasing scarring from extended unemployment spells, leading more businesses to shutter, and ultimately harming productive capacity. The recovery will be broader based, stronger, and faster if monetary policy and fiscal policy both provide continued support to the economy. While monetary policy has helped keep credit available and borrowing costs low, fiscal policy has replaced lost incomes among households experiencing layoffs and businesses and states and localities suffering temporary drops in revenue. Finally, let me turn to how the new Statement on Longer-Run Goals and Monetary Policy Strategy will help monetary policy achieve its goals. The new statement on goals and strategy seeks to align monetary policy with key longer-run changes in the economy. The combination of a low neutral interest rate, underlying trend inflation below 2 percent, and the low responsiveness of inflation to resource slack embodied in a flat Phillips curve reduces the amount we can cut rates to buffer the economy, weakens inflation expectations, and could lead to worse employment and inflation outcomes over time. Consequently, it is important to strengthen our ability to achieve our employment and inflation goals by committing to a path of policy and lowering borrowing costs along the yield curve. The new statement on goals and strategy makes several key changes that should significantly improve the way the Committee conducts monetary policy. It eliminates the previous reference to a numerical estimate of the longer-run normal unemployment rate and instead defines the statutory maximum level of employment as a broad-based and inclusive goal. It commits that the Committee will aim to eliminate shortfalls of employment from its maximum level, rather than the previous reference to deviations, which could be in either direction. By eliminating the rationale for removing accommodation preemptively when the unemployment rate nears estimates of the natural rate in anticipation of high inflation that is unlikely to materialize, the new framework will avoid an unwarranted loss of opportunity for many Americans. The broad-based and inclusive definition of maximum employment calls for a more comprehensive assessment of areas of slack in the labor market, such as the disparities in employment outcomes I discussed earlier. To address the downward bias associated with the proximity of the policy rate to its lower bound, the new statement on goals and strategy adopts a flexible inflation averaging targeting (FAIT) strategy that seeks to achieve inflation that averages 2 percent over time. Under an inflation averaging strategy, appropriate monetary policy will aim to achieve inflation moderately above 2 percent for a time to compensate for shortfalls during a period when it has been running persistently below 2 percent. in September gives concrete expression to the new strategy outlined in the new statement of goals and strategy. The forward guidance sets out outcome-based criteria that it expects to be achieved before the Committee lifts the policy rate from the lower bound. The labor market must reach " levels consistent with the Committee's assessments of maximum employment." Inflation would need to rise to 2 percent, and, in addition, the Committee would need to assess that inflation is on track to moderately exceed 2 percent for some time. The new FAIT framework is implemented not only through these outcome-based conditions for the liftoff of the policy rate, but also through the commitment that monetary policy will remain accommodative after liftoff for some time in order to achieve " inflation moderately above 2 percent for some time so that inflation averages 2 percent over time," consistent with longer-term inflation expectations anchored at 2 percent. This implies there likely will be a period after liftoff when the policy rate remains below neutral to support the inflation makeup strategy and maximum employment. Research indicates that an important precondition for forward guidance to be effective is that the public understands and believes the policymakers' commitment to making it happen. It will be important for the Committee to communicate clearly about our intentions and stay the course resolutely. How will we know if the new FAIT strategy is working? In addition to carefully monitoring labor market and inflation outcomes, it will be important to monitor a variety of indicators to see evidence that longer-term inflation expectations are moving sustainably to 2 percent. Inflation expectations are difficult to measure directly, so I generally consult a set of indicators to provide a more complete picture than any one measure on its own. Changes in expectations reported in s urveys provide one important source of information. For instance, median 5- and 10-year PCE inflation expectations from the Survey of Professional Forecasters both dropped considerably in the second quarter and stand at 1.7 percent and 1.85 percent, respectively, for the third quarter, which are the second lowest, and lowest, readings, respectively, in each series. The moved down in October to 2.4 percent, toward the lower end of its range in recent years, which is almost 1/2 percentage point below its range before 2014. In addition to survey data that are available at a monthly or quarterly frequency, we monitor market-based measures of inflation expectations that are available daily. To use market-based measures of inflation compensation based on Treasury Inflation- Protected Securities (TIPS) or inflation swaps, the signal on inflation expectations must be separated from liquidity and term premiums through model-based methods. making those adjustments, TIPS-based 5- and 10-year inflation expectations were 1.41 percent and 1.66 percent, respectively, on the final day of the third quarter, up from the lows experienced in March but well below their historical average. Finally, it is useful to consult measures of underlying trend inflation. A variety of estimates using time-series models suggest that underlying trend inflation may have moved down by as much as 1/2 percentage point over the past decade. It is difficult to anticipate how long it will take to achieve the conditions set out in the forward guidance. The September Summary of Economic Projections shows that most participants do not currently anticipate that the policy rate will depart from its lower bound by the end of 2023. When it does lift off, the policy rate could be expected to change only gradually, reflecting the commitment to remain accommodative until inflation has moderately exceeded 2 percent for some time. Of course, the pace of the recovery will dictate the actual path of monetary policy, as implied by the conditional outcome-based forward guidance adopted in September. Indeed, a key benefit of outcome-based forward guidance is that it conveys the Committee's monetary policy reaction function in a manner that is transparent and responsive to changes in economic conditions. In conjunction with the forward guidance on the policy rate, the commitment to continue asset purchases at least at the current pace over coming months is also helping to achieve our goals by keeping borrowing costs low for households and businesses along the yield curve. As noted in the September FOMC minutes, in the months ahead, we will have the opportunity to deliberate and to clarify how the asset purchase program could best work in combination with forward guidance to support achievement of maximum employment and 2 percent average inflation. While the strong bounceback in activity from the initial devastation of COVID-19 was heartening, the recovery thus far has been highly uneven, and the path ahead is highly uncertain. By pledging to provide accommodation until shortfalls from maximum employment have been eliminated and average inflation of 2 percent has been achieved, the new forward guidance will ensure that the recovery reaches those who have been disproportionately affected, leading to a broad-based and strong recovery. Continued asset purchases will help achieve these outcomes by keeping borrowing costs low for households and businesses along the yield curve. This strong support from monetary policy--if combined with additional targeted fiscal support--can turn a K-shaped recovery into a broad-based and inclusive recovery that delivers better outcomes overall.

r201110a_FOMC

united states

Modernizing and Strengthening CRA Regulations: A Conversation with the National Congress of American Indians

brainard

Good afternoon and thank you to President Fawn Sharp and Kevin Allis of the As the oldest and largest American Indian and Alaska Native organization serving the broad interests of tribal governments and communities, your voice is vitally important on economic issues affecting Indian Country. We appreciate your engagement on our work to reform the Community Reinvestment Act (CRA) regulations to better address credit and investment needs in Indian Country. Two years ago, I had the pleasure of visiting with the Thunder Valley Community the major housing, small business, and community development mixed-use project, which was under construction. Despite the importance of the Thunder Valley project to the community, banks were not among the funders listed for this important project. Their absence underscores the broader challenge underserved communities such as the Pine Ridge Reservation face when they are included in only one bank's CRA assessment area. I thought about this challenge frequently as we worked on the Board's proposal to reform CRA. We recognize the importance of engaging with Indian Country to inform research Reserve System in fulfilling our responsibility to Indian Country. The CICD is led by Casey Lozar, who is an enrolled member of the Confederated Salish and Kootenai Tribes, and the CICD's Native staff have deep expertise in community and economic development in Indian Country. I greatly value the research and thought leadership of the CICD, as well as their input on policy decisions regarding Indian Country and work to deepen our engagement with tribal communities. The COVID-19 pandemic is bringing hardship to all our communities, and the health of tribal communities is suffering disproportionately. Hospitalization rates for Native Americans are 4.3 times the rate for Whites, adjusting for age, according to the We are thinking about those in Indian Country who have lost loved ones and those who are struggling with the virus. The COVID-19 pandemic is also causing significant economic hardship in Indian Country, affecting the many small businesses that are the backbone of tribal economies. Indian Country faces significant challenges associated with " various data collection and reporting issues, such as small sample size or large margins of error," which are sometimes referred to by the term This lack of data makes it challenging to evaluate how economic developments are impacting Indian Country. assess the real-time economic impacts of COVID-19 on Indian Country's economic conducted a series of pulse surveys with tribal governments, tribally owned enterprises, and tribal member businesses, as well as hosted meetings with tribal leaders and national organizations. The surveys found that two-thirds of businesses in Indian Country saw a revenue reduction of at least 20 percent, and one in six businesses reported losing all of their revenue due to the pandemic. Tribal governments have experienced similar revenue declines, with over half of tribal government respondents anticipating continued declines of more than 20 percent over the next six months. Despite this, over 60 percent of tribal small businesses reported they had not laid off or furloughed workers. Maintaining these employee/employer relationships will be critical for Indian Country economic recovery, but cash-strapped small businesses are finding it increasingly challenging to maintain payrolls as the pandemic continues. Only 20 percent of tribal small businesses reported they had enough cash on hand to maintain operations beyond a three-month period. Emergency lending programs aimed at providing pandemic relief, such as the critical support to small businesses, so it was extremely important to make sure they were accessible to tribal enterprises. Valuable feedback from tribal leaders and lending institutions led us to change requirements in the Main Street program to allow tribally owned enterprises to participate in Main Street lending while still continuing to provide distributions back to their tribal governments. Similarly, we expanded the PPP Liquidity Facility to include non-depository community development financial institutions (CDFIs) because of their ability to reach minority small business owners, including those in Indian The COVID-19 pandemic has exacerbated an already challenging landscape for credit unions, and CDFIs are making exceptional efforts to serve Native Americans on and off tribal lands. In 2018, the Board worked with the CICD to convene Native American financial institutions on the Flathead Indian Reservation in Montana and discuss how best to collaborate to maximize the impact for their communities. We remain committed to helping these vital financial institutions provide critical financial services in their communities. Despite the significant efforts of Native banks, CDFIs, and credit unions, for many Native Americans, banking and credit access remain challenging. Over 16 percent of American Indians and Alaska Natives were unbanked in 2019, and survey research finds that only one in three Native American respondents have a strong or very strong relationship with lenders. One reason for these low levels of banking relationships is a lack of proximate bank branches. Majority-Native American counties, on average, have only 3 bank branches, which is below the 9-branch average in nonmetro counties, and well below the 26-branch overall average for all counties. This is exacerbated by low rates of broadband and cellular access in Indian Country, where it is reported that 28 percent of tribal lands and 48 percent of rural tribal lands are not covered by broadband. Native small businesses struggle to access bank capital even during normal economic times. Native-owned small businesses also struggle to access CRA-motivated loans. From 2014 to 2018, the total dollar amount of CRA small business and small farm lending per capita in majority-Native American or Alaska Native census tracts was less than half of what it was in majority-non-Hispanic White areas. These data make it clear that we still have a long way to go in improving access to banking services and capital in Let me spend a few minutes talking about how CRA reform might help address these systemic economic inequities in Indian Country. Over 45 percent of the American Indian and Alaskan Native population live in low- and moderate-income (LMI) or distressed or underserved census tracts. Yet, feedback from stakeholders like yourselves indicates that many of these locations fall outside of where banks currently serve. In September, the Federal Reserve Board unanimously voted to approve an reforming CRA regulations based on ideas advanced by a broad set of stakeholders, including the NCAI. I hope you will continue to engage throughout the rest of this process. It has been 25 years since the banking agencies last substantially reformed CRA, so it is important that we get it done right. The Board's ANPR seeks to advance the law's core purpose of addressing unequal access to credit for LMI and minority communities and disinvestment in underserved communities. A modernized CRA should improve credit access and the availability of community development financing. This includes strengthening the regulations to ensure that a wide range of banking needs are being met. Another key objective the Federal Reserve has focused on in the ANPR is providing greater certainty, tailoring regulations based on bank size and business model and local conditions, and minimizing burden. For example, the ANPR proposes using a complementary set of metrics to separately evaluate retail-lending activity (like mortgage lending) and community development financing activity (like investing in affordable rental housing). Looking at these activities separately helps to ensure that we are comprehensively evaluating bank activity and that we are taking both retail and community development activity into consideration. Third, we also hope the ANPR will provide a foundation for a consistent approach that has broad support among stakeholders. Stakeholders have expressed strong support for the agencies to work together to modernize CRA. By reflecting stakeholders' views and providing a long public comment period, we believe the ANPR provides the basis for the agencies to establish a consistent approach that has broad support. As we embark on CRA reform to strengthen the law's core purpose, we have a unique opportunity to design a regulation that better addresses the needs of individuals and communities in Indian Country. There are several proposals in the ANPR that I would like to highlight that advance that goal. First, we have specific proposals in the ANPR that would allow banks to receive credit for eligible CRA activities in Indian Country, even when those activities are outside of a bank's assessment area(s). For instance, the ANPR proposes providing CRA credit for retail lending activity like mortgage lending or small business lending in Indian Country, even when it takes place outside of CRA assessment areas. For example, under the ANPR's proposals, a mortgage, small business, small farm, or consumer loan made by a bank on the Flathead Indian Reservation in Montana could be qualified as part of that bank's overall rating, even without the loan being within the assessment area of any bank. In addition, the ANPR proposes expanding consideration of CRA community development activities to specific areas of need outside of a bank's assessment area(s), with Indian Country being one of the proposed designations. As a result, the Board's proposal makes clear that a bank in any part of the country could receive credit for community development activities in Indian Country. Banks could receive credit for investments in affordable rental housing, broadband expansion, or building community and elder centers in rural areas and other areas of persistent economic distress. We hope that this proposal responds to stakeholders' feedback emphasizing the critical importance of community development in banking deserts, and we look forward to feedback on this during the comment period. The Board understands that broadening eligibility of CRA activities in Indian Country beyond assessment areas is only part of what is required to address structural economic inequities. We are particularly mindful of the importance of community voice on community development projects, especially in Indian Country. Given this, the ANPR seeks feedback on how best to incorporate government or tribal planning in qualifying community development consideration for revitalization and stabilization projects. This is critically important to increase banks' certainty that they will receive CRA credit when they make impactful investments that have the support of tribal governments and leaders, and to increase certainty about how these activities qualify for CRA credit. Second, the ANPR proposes to encourage and reward banks for activities that are responsive to community needs, particularly in harder to serve areas. The ANPR proposes the use of impact scores for community development activities as a way to ensure that performance evaluations adequately reflect the relative importance of loans and investments within communities. Under the proposed approach, examinations would assess the impact of a bank's community development activities, including those in Indian Country. We hope that this approach will encourage banks to extend additional CRA activities to areas with unmet needs, such as in Indian Country. The ANPR also proposes clear steps to ensure that eligible activities taking place outside of assessment areas are adequately reflected in a bank's CRA ratings. Third, the ANPR contains several proposals that better support mission-focused partners, including those working in Indian Country, to address challenges in credit access and wealth building. Although a significant portion of household wealth is held through homeownership for the U.S. overall, buying a home on trust land can be a complicated transaction. help Native Americans purchase homes, but the required application process can require special expertise. expertise and are experienced in working with Native Americans across the country to purchase homes on and off tribal lands. For example, the Chickasaw Community Bank in Oklahoma, which is both an MDI and a CDFI, has a mission of helping Native Americans around the country achieve homeownership and is one of the nation's largest The ANPR includes several provisions to support MDIs like Chickasaw Community Bank. Activities with MDIs can receive credit nationwide even when they take place outside of assessment areas, and the ANPR asks for feedback on whether these activities with MDIs should be a potential pathway to an outstanding rating. In an effort to support mutually beneficial partnerships between MDIs, the ANPR also would provide credit for MDIs and women-owned financial institutions investing in other MDIs, women-owned financial institutions, and low-income credit unions, as well as in their own institutions. We believe these and other ideas to support MDIs can help provide incentives for majority-owned institutions to capitalize and to partner with these institutions, which will ultimately support more equitable financial access to low-income and minority consumers and communities. In addition, the Federal Reserve has consistently heard that bank partnerships with experienced CDFIs can play an important role in helping banks more effectively make Indian Country loans and investments. During the pandemic, Native CDFIs have played an outsized role in supporting tribal businesses and homeowners, providing financial counseling, or extending loan terms for borrowers. For example, Lakota Funds in South Dakota, led by Tawney Brunsch, helped 37 businesses access more than $100,000 in COVID-19 emergency relief funds and provided more than $120,000 in small grants to Native ranchers, businesses, and homeowners. Despite their valuable work, Native CDFIs face substantial funding gaps. To encourage bank partnerships that advance financial inclusion and address unmet credit needs, the ANPR seeks feedback on extending to CDFIs the status that is extended to MDIs, women-owned financial institutions, and low-income credit unions. This approach would effectively give banks CRA consideration for loans, investments, or services in conjunction with a CDFI anywhere in the country. We look forward to feedback on this potential approach, including the role this could play in Indian Country. In short, we recognize the challenges you face are great and we want to ensure CRA reform helps you to improve credit access and financial inclusion in tribal communities. I am hopeful that the changes the Federal Reserve is considering will help spur new partnerships and encourage greater bank investment for tribal communities that have had inequitable access to financial services for too long. We need your input on these proposals and we are ready to listen. Over the next three months, the Federal Reserve System will host CRA ANPR outreach meetings and listening sessions around the country, including in Indian Country. We encourage your feedback as part of these events, in addition to submitting written comments by the deadline of February 16, 2021. We thank you for your engagement thus far and look forward to hearing more from you and your members through the rulemaking process .

r201116a_FOMC

united states

The Federal Reserve's New Framework: Context and Consequences

clarida

The new framework has important implications for the way the FOMC going forward will conduct monetary policy in support of its efforts to achieve its dual-mandate goals in a world of low neutral policy rates and persistent global disinflationary pressures. At the September 16 FOMC meeting, the Committee made material changes to its forward guidance for the future path of the federal funds rate to bring the guidance into line with the new policy framework and, in so doing, provided transparent outcome-based guidance linked to the macroeconomic conditions that must prevail before the Committee expects to lift off from the effective lower bound (ELB). In my remarks today, I would like to look ahead and offer my individual perspective on the consequences of our new framework for the conduct of monetary policy over the business cycle, and I also want to provide some context that connects key elements of our new framework to the literature on optimal monetary policy subject to an ELB constraint that binds in economic downturns. Let me say at the outset that when I am not quoting directly from the consensus statement and the September FOMC statement, the views expressed are my own and do not necessarily express the views of other Federal Reserve Board members or FOMC participants. The plan of my talk is as follows. I will first highlight and discuss the five elements of the new framework that define how the Committee will seek to achieve its price-stability mandate over time and how, in September, it revised its forward guidance on the federal funds rate to bring the FOMC's policy communications into line with the new framework. I will then provide my perspective on how these key elements of the new framework and the related forward guidance connect to the literature on conducting optimal monetary policy at--and after lifting off from--the ELB. I will next discuss how the Committee's conception of its maximum-employment mandate, a sixth element of the new framework, has evolved since 2012, what this evolution implies for the conduct of monetary policy, and how I plan to factor in this information as I think about the appropriate path for setting the federal funds rate once the conditions for liftoff have been met. I will conclude with a brief recap of my thesis before joining David Wessel, Seth Carpenter, and Annette Vissing-Jorgensen in what I am sure will be an engaging virtual conversation. In my remarks today, I will focus on six key elements of our new framework and the forward guidance provided by our September FOMC statement. Five of these elements define how the Committee will seek to achieve its price-stability mandate over time, while the sixth pertains to the Committee's conception of its maximum- employment mandate. Of course, the Committee's price-stability and maximum- employment mandates are generally complementary, and, indeed, this complementarity is recognized and respected in the forward-guidance language introduced in the September FOMC statement. However, for ease of exposition, I will begin by focusing on the five elements of the new framework that define how the Committee will seek to achieve over time its price-stability mandate, before discussing how maximum employment is defined in the new framework and what this definition implies for the conduct and communication of monetary policy under the new framework. Five features of the new framework and September FOMC statement define how the Committee will seek to achieve its price-stability mandate over time: The Committee expects to delay liftoff from the ELB until PCE (personal consumption expenditures) inflation has risen to 2 percent on an annual basis and other complementary conditions, consistent with achieving this goal on a sustained basis and to be discussed later, are met. With inflation having run persistently below 2 percent, the Committee will aim to achieve inflation moderately above 2 percent for some time in the service of having inflation average 2 percent over time and keeping longer- term inflation expectations well anchored at the 2 percent longer-run goal. The Committee expects that appropriate monetary policy will remain accommodative for some time after the conditions to commence policy normalization have been met. Policy will aim over time to return inflation to its longer-run goal, which remains 2 percent, but not below, once the conditions to commence policy normalization have been met. Inflation that averages 2 percent over time represents an ex ante aspiration of the FOMC, but not a time-inconsistent ex post commitment. I believe that a useful way to summarize the framework defined by these five features is temporary price-level targeting (TPLT, at the ELB) that reverts to flexible inflation targeting (once the conditions for liftoff have been reached). Just such a framework has been analyzed by Bernanke, Kiley, and Roberts (2019) and Bernanke (2020), who in turn build on earlier work by Evans (2012) and Reifschneider and Williams (2000), among others. Each of the five elements of the new framework highlighted previously is consequential. I now discuss each in turn and provide some context for how I understand them to relate to the monetary economics literature on First element A policy that delays liftoff from the ELB until a threshold for average inflation has been reached is one element of a TPLT strategy. In our September FOMC statement, we communicated that, along with other complementary conditions, inflation must have risen to 2 percent before we expect to lift off from the ELB. This condition refers to inflation on an annual basis. TPLT with such a one-year memory has been studied using Second element An alternative version of TPLT would commit the central bank to delay liftoff until inflation has averaged 2 percent over a longer period--say, three years (Bernanke, Kiley, and Roberts (2019) study the case of TPLT with a three-year memory as well as the case of TPLT with a one-year memory) or perhaps an even longer period that commences when the policy rate hits the ELB itself (as in Bernanke's (2017a) original TPLT proposal). In these versions of TPLT, inflation would likely have to moderately exceed 2 percent for some time before the condition for liftoff is met. For example, if TPLT with a three-year memory were chosen and inflation in three consecutive years equaled 1.9 percent, 2 percent, and 2.1 percent, then liftoff would not occur until inflation hit 2.1 percent for one year. Note, however, that TPLT with a longer memory does not define ex ante the amount by which inflation must exceed 2 percent before liftoff is considered, nor does it specify for how long inflation exceeds 2 percent before liftoff is considered. For example, under TPLT with a three-year memory, if inflation instead equaled 1.8 percent, 2 percent, and 2.2 percent for three consecutive years, then liftoff ex post could not occur until inflation hit 2.2 percent for one year. But if, instead, inflation equaled 1.8 percent, 2.1 percent, and 2.1 percent, then inflation would exceed 2 percent for two years before liftoff were contemplated. In the case of the Federal Reserve, the FOMC chose a one-year memory for the inflation threshold that must be met before liftoff is considered, but it also indicated in September that the Committee expects to delay liftoff until inflation is "on track to moderately exceed 2 percent for some time." What "moderately" and "for some time" mean will depend on the initial conditions at liftoff (just as they do under versions of TPLT with a longer memory). Crucially, the Committee's judgment on the projected duration and magnitude of the deviation from the 2 percent inflation goal will, at the time of liftoff and every three months thereafter, be The SEP has served this purpose before. For example, in 2018, as the FOMC factored in an unexpected tailwind from a mid-cycle fiscal expansion and chose to maintain a gradual pace of normalization to return the federal funds rate to its projected neutral stance, the median participant at the September 2018 FOMC meeting projected that core PCE inflation would moderately exceed 2 percent for three years. The FOMC statement itself can, in the new regime, also be used as a platform to communicate the Committee's tolerance for deviations of inflation from the 2 percent longer-run goal, and, indeed, it has served this purpose in the past--for example, with the threshold-based guidance linked to inflation outcomes introduced in the FOMC statement in December 2012. Third element In the TPLT framework studied by Bernanke, Kiley, and Roberts (2019), policy reverts to an inertial Taylor rule after liftoff, so policy remains accommodative for some time, which depends in their formulation on the degree of policy inertia in the reaction function. Our September FOMC statement also calls for policy to remain accommodative for some time after liftoff. Once the conditions to commence policy normalization have been met, the SEP "dot plot" will convey the median participant's projections over a three-year horizon not only for inflation, but also for the pace of liftoff as well as the ultimate destination for the policy rate. I will have more to say shortly about a relevant policy rule benchmark that I believe is consistent with the new framework. Fourth element The new framework is asymmetric. That is, as in Bernanke, Kiley, and Roberts (2019), the goal of monetary policy after lifting off from the ELB is to return inflation to its 2 percent longer-run goal, but not to push inflation below 2 percent. In other words, after liftoff from the ELB, monetary policy reverts to simple flexible inflation targeting targeting post-liftoff is implemented with an inertial Taylor rule that satisfies the Taylor principle (that is, the policy responds to the difference between actual inflation and the 2 percent target with a coefficient that exceeds unity). The policy is flexible in that the desired pace of return to 2 percent can reflect considerations other than the 2 percent longer-run goal for inflation that are relevant to the Committee's mandate. In the case of the Federal Reserve, we have highlighted that making sure that inflation expectations remain anchored at our 2 percent objective is just such a consideration. Speaking for myself, I follow closely the Fed staff's index of common inflation expectations (CIE) as a relevant indicator that this goal is being met. Other things being equal, if at the time of liftoff the CIE index is below its pre-ELB level, then my desired pace of policy normalization post-liftoff to return inflation to 2 percent--as well as the projected pace of return to 2 percent inflation--would be somewhat slower than if the CIE index at the time of liftoff is equal to its pre-ELB level. Another factor I will consider in calibrating the pace of policy normalization post-liftoff is the average rate of PCE inflation since the new framework was adopted in August 2020--a time, as it happened, that the federal funds rate was constrained at the ELB. If average inflation since August 2020 turns out to be notably below 2 percent, then my desired pace of policy normalization post- liftoff--and the implied pace of return to 2 percent inflation--would, other things being equal, be somewhat slower than if average inflation since adoption was close to or equal to 2 percent. It is important to note, however, that the goal of the new framework is to keep inflation expectations well anchored at 2 percent, and, for this reason, I myself plan to focus more on indicators of inflation expectations themselves--especially survey- based measures--than I will on the calculation of an average rate of inflation over any particular window of time. Fifth element Our framework aims ex ante for inflation to average 2 percent over time, but it does not make a (time-inconsistent) commitment to achieve ex post inflation outcomes that average 2 percent under any and all circumstances and constellations of shocks. The same is true for the TPLT regime studied in Bernanke, Kiley, and Roberts (2019) featuring TPLT with a one-year memory. In this regime, the only way in which average inflation enters the policy rule is through the timing of liftoff itself. Yet in stochastic simulations of the FRB/US model under TPLT with a one-year memory that reverts to flexible inflation targeting after liftoff, inflation does average very close to 2 percent in the stochastic simulations reported in their paper. The model of Mertens and Williams (2019) delivers a similar outcome: Even though the policy reaction function in their model does not incorporate an ex post makeup element, it delivers a long-run (unconditional) average rate of inflation equal to target by aiming for a moderate inflation overshoot away from the ELB that is calibrated to offset the inflation shortfall caused by the ELB. It is important to note that, as our new consensus statement emphasizes, the Federal Reserve is committed to using all of our available tools--not just the federal funds rate and forward guidance, but also large-scale asset purchases--to achieve our dual-mandate goals. Since our March 2 FOMC meeting, the federal funds rate has been reduced by 150 basis points to its ELB and we have increased our Treasury and mortgage-backed securities holdings by a total of $3.3 trillion; we continue to add to these holdings at a pace of $120 billion per month. These large-scale asset purchases are providing substantial support to the economic recovery by sustaining smooth market functioning and fostering accommodative financial conditions, thereby supporting the flow of credit to households and businesses. At our November FOMC meeting, we discussed our asset purchases and the critical role they are playing in supporting the economic recovery. Looking ahead, we will continue to monitor developments and assess how our ongoing asset purchases can best support achieving our maximum- employment and price-stability objectives. In this regard, I note that the simulation results reported in Bernanke (2020) suggest that, in general, a monetary policy at the ELB that combines threshold forward guidance, such as I have discussed in these remarks, with large-scale asset purchases, such as we have had in place since March, is best equipped ex ante to achieve inflation outcomes that are consistent with price stability and well-anchored inflation expectations at the 2 percent objective. An important evolution in our new framework is that the Committee now defines maximum employment as the highest level of employment that does not generate sustained pressures that put the price-stability mandate at risk. As a practical matter, this definition means to me that, when the unemployment rate is elevated relative to my SEP projection of its long-run level and other indicators--such as the prime-age employment-to-population and labor force participation ratios--are depressed relative to recent business cycle peaks, monetary policy should, as before, continue to be calibrated to eliminate such employment shortfalls as long as doing so does not put the price- stability mandate at risk. Indeed, in our September FOMC statement, we indicated that we expect it will be appropriate to keep the federal funds rate in the current 0 to 25 basis point target range until inflation has reached 2 percent (on an annual basis) and labor market conditions have reached levels consistent with the Committee's assessment of maximum employment. In our new framework, when in a business cycle expansion labor market indicators return to a range that, in the Committee's judgment, is broadly consistent with its maximum-employment mandate, it will be data on inflation itself that policy will react to, but going forward, policy will not tighten solely because the unemployment rate has fallen below any particular econometric estimate of its long-run natural level. This guidance has an important implication for the Taylor-type policy reaction function I will consult. In particular, I will continue--as I have done since joining the Fed--to consult policy rules that respect the Taylor principle as a benchmark for calibrating the pace and destination of policy rate normalization once, after the inflation and employment thresholds have been reached, the process of policy normalization commences. Consistent with our new framework, the relevant policy rule benchmark I will consult after the conditions for liftoff have been met is an inertial Taylor-type rule with a coefficient of zero on the unemployment gap, a coefficient of 1.5 on the gap between core PCE inflation and the 2 percent longer-run goal, and a neutral real policy rate equal to my SEP projection of long-run r*. As discussed earlier, the degree of inertia in the benchmark rule I consult will depend on initial conditions at the time of liftoff, especially the reading of the staff's CIE index relative to its February 2020 level. Such a reference rule, which becomes relevant once the conditions for policy normalization have been met, is similar to the forward-looking Taylor-type rule for optimal monetary policy derived in Clarida, Gali, and Gertler (1999). The stability properties of Taylor-type rules in dynamic stochastic general equilibrium models have been studied by Bullard and Mitra (2002) and Gali (2008), among others, and they show that for the standard Taylor coefficient of 1.5 on the inflation gap and a coefficient of zero on the unemployment gap, the rational expectations equilibrium is unique for standard parametrizations. One dimension along which our new framework may appear to differ from the threshold forward-guidance proposals advocated by some others is that our September FOMC guidance explicitly requires that, at the time of liftoff, in addition to inflation reaching 2 percent (on an annual basis), labor market conditions must have also reached levels consistent with the Committee's assessments of maximum employment, and I offered earlier the metrics on some of the labor market indicators I will follow to make that assessment. However, any difference between our September FOMC guidance and similar threshold guidance policies that depend only on realized inflation is, I believe, more apparent than real. The reason is that proponents of inflation-based threshold guidance typically acknowledge that liftoff following an ELB episode should be conditioned on the judgment that inflation has sustainably reached the target before liftoff is contemplated (Bernanke, 2017b), and such an assessment of sustainability in most circumstances would, I believe, be informed by an assessment of labor market conditions first half of 2012, when core PCE inflation reached 2 percent at a time when the unemployment rate remained elevated at 8.2 percent, well above the top of the range of FOMC estimates of its longer-run normal level. The Committee at that time wisely, in my judgment, chose not to lift off in 2012, and I would hope--and, under our September rate guidance, expect--a future Committee would reach the same judgment under similar circumstances. In closing, I think of our new flexible average inflation-targeting framework as a combination of TPLT at the ELB with flexible inflation targeting, to which TPLT reverts once the conditions to commence policy normalization articulated in our September 2020 FOMC statement have been met. In this sense, our new framework indeed represents an evolution, not a revolution. The Committee is committed to using all available tools, including threshold-based forward guidance as well as large-scale asset purchases, to achieve the price-stability and maximum-employment goals specified in our new consensus statement. Thank you very much, and I now look forward to my virtual conversation with Annette, David, and Seth. . . . vol. 109 vol. 37 no. 1, . and Banking . . . vol. 32

r201117a_FOMC

united states

Strengthening Diversity and Inclusion in Economics

brainard

It is a pleasure to be here today to talk about the future of economics with the next generation of economists who will shape it. I hope you will take away from what you hear today that a rigorous grounding in economic analysis can help you succeed in whatever field you choose. I will share a few thoughts on what economics can do for you and what you can do for the field of economics. Let me start with what economics can do for you. Just as there are a variety of reasons that people decide to pursue economics, so too there are many career fields where a degree in economics can be a powerful enabler. I have to admit I had some reservations that led me not to major in economics as an undergraduate. That changed during my first job out of college, when I recognized that economics can provide powerful tools to analyze and design programs to improve opportunities and financial security for workers and their families. Economics can give you a powerful framework to explore the questions that matter most to you. Let me give a few examples of some important questions and the economic practitioners who made a big impact in addressing them. So here's one: How can we help protect working women and men and their families from the financial devastation of job loss due to forces beyond their control? Frances Perkins first began thinking about that question as a young White girl in the manufacturing hub of Worcester, Massachusetts in the 1880s. When Frances asked her father why nice people could fall into poverty, he replied that this was a question little girls should not concern themselves with. Fortunately, Frances did not listen to him. In college, Perkins took an economics class where she started exploring the impact of rapid industrialization on the lives of working people. Her professor encouraged students to visit local factories to see firsthand some of the brutal working conditions facing women and children. That early field research sparked Perkins' determination to bring about improved working conditions and established her careful attention to gathering data. Perkins went on to become a key author of the New Deal, and served as Labor Secretary for a record 12 years, despite considerable opposition to the appointment of the first woman Cabinet secretary. She persuaded Roosevelt to put in place a system of unemployment insurance and built the Labor Department's capability to compile the necessary employment statistics. She worked hard to secure legislation codifying core labor rights, and she played a key role in designing and implementing Social Security. As Perkins was advocating for policies to improve working conditions facing women and children, another young economist was gathering evidence on the lives of examined the living standards of Black families who were migrating to Philadelphia to meet the demand for labor brought about by World War I. Alexander would become the first Black American to earn a PhD in economics. She would subsequently become the first woman to receive a law degree from the University of Pennsylvania because of the barriers she encountered in the field of economics. Black workers were fleeing the South, Alexander explained in her dissertation, because of poor wages, segregation, lynching and disenfranchisement, seeking higher wages, better education, "the ballot," and "greater justice" in the North. And what did those Black workers migrating to Philadelphia find? Alexander's path-breaking research showed that one-third of Black families earned less than what she defined and calculated to be a fair standard of living. About one-quarter of the Black families she studied were underfed. Keep in mind Alexander wrote this in 1921, almost 50 years before the U.S. government adopted a formal definition of the poverty level. Alexander decried the systemic discrimination in housing, education, and so much more that held Black people back in Philadelphia. And yet, Alexander was optimistic that Black workers moving North for better paying jobs would eventually attain the education and standard of living Since that time, a college degree has become more important for financial security. That raises the vitally important question of how to make college more affordable for low-income students. It turns out Lois Dickson Rice spent much of her career addressing that question. As the daughter of a janitor and a maid determined to send their five children to college, Rice was inspired by her parents' dedication to education. Denied an alumni club state scholarship because she was Black, Lois, with the help of her high school teachers, secured a better scholarship directly from Radcliffe. From there, she went on to a career at the College Board, becoming widely known as the over almost half a century later, the program Rice designed and her tireless work to make college accessible to all, have helped around 200 million Americans afford a college education. Economics can also provide powerful answers to questions such as, "What is the cost of discrimination?" This question was explored extensively by Andrew Brimmer, a child of sharecroppers who earned his PhD in economics at Harvard. Brimmer served with great distinction as the first Black governor of the Federal Reserve Board from 1966 to 1974, where he contributed to decision-making on monetary policy, and went on to publish research on systemic risk in capital markets and the Fed's lender of last resort function. Brimmer estimated that discrimination cost the U.S. economy 3.8 percent of gross domestic product in 1993. In case you are wondering about the cost in today's economy, Dana Peterson, who is the chief economist of the Conference Board and served as a research assistant at the Federal Reserve Board, estimated closing racial gaps could add roughly $5 trillion to the economy over the next five years. I wanted to share these examples of pathbreaking economic scholar-practitioners who overcame daunting barriers to make important contributions on economic questions that touch the lives of working people all around our country. We created to help you answer the question of whether economics is right for you. Today you will hear from my colleagues about why they chose economics, and you will learn about the many rewarding career opportunities available to you. Through our partnership with Howard University, you will see how students there are working with our economists to take a hands-on approach to research. I want to thank our colleagues in Federal Reserve Education for cohosting and helping to make this event available to students, educators, and groups across the nation. So that should give you a sense of what economics can do for you. What can you do for economics? You can bring your diverse backgrounds and life experiences and unique talents and interesting questions to strengthen the study and practice of economics. Economics is a powerful field that influences public policy and the economic opportunities facing all Americans. We should not be satisfied until the people in our field and those sitting around every economic decisionmaking table represent America in all its strength and diversity. A growing body of research and evidence makes clear that the quality of the economics profession and its contribution to society will be greater when it reflects a broader range of people and perspectives. Research shows that greater diversity results in better outcomes--it broadens the range of ideas and perspectives brought to bear on solving problems, and it brings important insights to the analysis of our economy. As demonstrate the benefits of diversity for group deliberations and decisionmaking. For instance, one well-known experiment found that racially diverse groups of students outperformed other groups in solving problems, and another found similar benefits from gender diversity. A review of 2.5 million research papers across the sciences found that those written by ethnically diverse research teams received more citations and had a greater impact than papers by authors with the same ethnicity. It is notable that when Congress established the Federal Reserve System, it took great care to ensure that there would be a diversity of perspectives around the decisionmaking table with regard to regional representation. That is why we have 12 have not yet lived up to that standard on racial and ethnic diversity. For instance, it was not until 2017, more than 100 years after the creation of the Federal Reserve, that the first We need to address the stubbornly persistent gap in the awarding of economics degrees. Among U.S. citizens and permanent residents earning a doctorate in economics from U.S. universities, the representation of those identifying as Black, Hispanic, or Native American was 10 percent in 2018. The share of women overall obtaining a doctorate in economics was slightly above 30 percent in 2018, little changed from 1994. By contrast, Blacks and Hispanics make up 13 percent of medical students and women overall make up just over half of all medical students in the country. Economics also lags behind law as well as science and engineering in the share of underrepresented minorities and women receiving advanced degrees. But the gap starts at the undergraduate level, as highlighted by Rhonda Sharpe. Black women accounted for only 1.5 percent of undergraduate economics degrees, compared with their 6.2 percent share of all undergraduate degrees. Diversity and inclusion need to be priorities for every economics department around the country and for the think tanks, governments, businesses, and many other organizations that train and employ economists. Many of my colleagues in economics and education are working hard to make progress, including by developing programs to support and mentor diverse talent interested in this consequential discipline. We need to make it a national goal to catch up to medicine, science, engineering, and other fields in developing robust programs, conducting ongoing evaluation, and constantly adapting to improve the inclusivity of economics and our ability to recruit and retain diverse talent. We want to be known within the profession as a place where minorities and women are confident they have the opportunity to make an impact and feel they are respected and heard by leadership. We must continue to make progress towards a more just society, and I am hopeful that economists will contribute to that progress. Studying economics will provide you with a powerful, intellectual framework for asking and answering questions that to you. It will enable you to influence people's lives for the better. It will enable you to craft policy to change our world. It will enable you to teach and help shape the next generation. It will enable you to pursue a range of opportunities, not just in economics, but also in business, finance, policy, and nonprofits. I wish you good luck and success in your studies, and I trust that I will soon be reading about the questions--and answers-- that matter most to you.

r201119a_FOMC

united states

The Changing Structure of Mortgage Markets and Financial Stability

bowman

Good afternoon, everyone. It is a pleasure to join you here today and to share a few of my thoughts on financial stability issues with you. I would like to thank the Cleveland Fed and the Office of Financial Research for hosting this conference and for that very kind introduction. It is encouraging to see so many great minds devoting their time and attention to studying financial stability. At the Board, we dedicate considerable attention to this topic as well, and I would like to thank my colleagues, Vice Chair for Lael Brainard, for their leadership on these issues both internationally and at the Board. It seems especially relevant to look closely at financial stability at this time, as the COVID-19 pandemic has had a profound impact on the U.S. economy and has tested the resilience of our financial system over the past nine months. Efforts to contain the virus triggered an economic downturn that was unprecedented in both its speed and its severity. Early on, more than 22 million jobs were lost in March and April, and though a significant number of people have returned to work since that time, we still face a shortfall in employment relative to its level before the onset of the pandemic. Fortunately, both our economy and our financial system were very strong when the pandemic hit. Most banks began 2020 with higher capital ratios and more liquid assets than they had in previous downturns, which helped them remain a source of strength in March and April. As the crisis intensified in March, serious cracks emerged in several areas of financial intermediation crucial to the health of the economy, including Treasury markets, corporate and municipal bond markets, money market mutual funds, mortgage real estate investment trusts, and residential mortgage markets. Today I am going to focus on the strains in mortgage markets. To address strains in mortgage finance, the Federal Reserve took prompt action to purchase large quantities of agency-guaranteed mortgage-backed securities (MBS), because as we learned during the previous financial crisis, the proper functioning of mortgage markets is necessary for monetary policy to support the economy. Unfortunately, the problems in mortgage finance in this crisis were broader than just the MBS markets. This crisis period has also revealed a number of new--or, in some cases, renewed--vulnerabilities related to lending and loan servicing by nonbank mortgage companies, which I will refer to from here on as mortgage companies. These vulnerabilities were not entirely a surprise to me. When I served as a banker and, subsequently, as the state bank commissioner in Kansas, I saw firsthand the increasing share of mortgage companies in mortgage origination and servicing as well as some of the weaknesses in the mortgage company business model. And in my role as a Board member with a focus on community banks, I frequently hear about the issues that have caused some regional and community bankers to pull back from originating and servicing mortgages. I view this as a significant problem, because I believe firmly that a healthy financial system must have a place for institutions of many different types and sizes that are able to serve the varying needs of different customers. I will begin today by describing the evolving role of mortgage companies in mortgage markets and the risks to financial stability that activity entails. I will then focus on developments in mortgage markets during the COVID-19 pandemic and discuss how actions by the Federal Reserve and the other parts of the government helped stabilize financial markets and prevent more severe damage to the economy. Finally, I will explain how vulnerabilities associated with mortgage companies could pose risks in the future, and I will review ongoing work across the regulatory agencies to monitor and address these vulnerabilities. I will end by enlisting your help. Figuring out how to achieve a balanced mortgage system--one that delivers the best outcomes for consumers while being sufficiently resilient--is a highly complex task that could benefit from the insights of those of you here today. In the 1980s and 1990s, the share of mortgages originated by mortgage companies increased considerably, as expanded securitization of mortgages allowed mortgage companies, which lack the balance sheet capacity of banks, to compete with banks in the mortgage market. The role of mortgage companies increased further in the 2000s with the growth of the private-label mortgage market, where MBS sponsors are private firms without government support. But the last financial crisis and the prolonged housing slump that followed led to a sharp contraction in mortgage company activity. In 2006, mortgage companies accounted for around 30 percent of originations; by 2008, at the bottom of the housing crisis, this share had fallen to around 20 percent. In the past few years, the market share of mortgage companies has risen sharply, well surpassing their share before the housing crisis. Today these firms originate about half of all mortgages, including more than 70 percent of those securitized through Ginnie Nonbanks also service roughly three-fourths of mortgages securitized through Ginnie Mae and about one-half of those securitized through the GSEs. Although some mortgage companies specialize in origination or servicing, most large firms engage in both activities. The expanding presence of mortgage companies has brought benefits to consumers and the economy. Among the benefits are increased competition and technological innovation. Mortgage companies are generally able to react more nimbly to changes in market conditions and have been faster to deploy new technologies such as online mortgage origination platforms. But the rising market share of mortgage companies has also brought with it increased risks. I will focus here on the risks most relevant to financial stability. One major vulnerability of mortgage companies is liquidity--that is, their ability to finance their portfolios of assets. Unlike banks, mortgage companies typically do not have access to liquidity from the Federal Home Loan Banks or the Federal Reserve System. Mortgage companies also do not have access to deposits as a stable funding source. So while banks will hold some originations on their balance sheets, mortgage companies first fund their originations on warehouse lines of credit that are usually supplied by banks. Typically, after a couple of weeks, the mortgage company repays the warehouse line and securitizes the mortgages. During the last financial crisis, when the private-label mortgage securitization market started to freeze, mortgage lenders could not transition their originations from the warehouse lines to securitization. Warehouse lenders became concerned about their exposures to the nonbank companies and cut off their access to credit. As a result of this funding crunch and other factors, many lenders failed, including household names like New Century Financial Corporation. The risk of events like this one repeating is probably more limited today because mortgage companies primarily originate mortgages that are securitized through the far more stable GSE or Ginnie Mae markets. Instead, the main liquidity concern today comes from mortgage servicing. If borrowers do not make their mortgage payments, mortgage servicers are required to advance payments on the borrowers' behalf to investors, tax authorities, and insurers. Although servicers are ultimately repaid most of these advances, they need to finance them in the interim. The servicers' exposure is greatest for loans securitized through Ginnie Mae, as they require servicers to advance payments for a longer period than the GSEs. In some cases, servicers may also have to bear large credit losses or pay significant costs out of pocket. Because mortgage companies are now the major servicers for Ginnie Mae, this liquidity risk--and possibly solvency risk--is a significant vulnerability for these firms if borrowers stop making their payments. If these firms collapse, what are the repercussions? Clearly, there is considerable potential for harm to consumers, and that harm would likely be concentrated in communities that are traditionally underserved. In recent years, mortgage companies originated the majority of the mortgages obtained by Black and Hispanic borrowers as well as the majority of mortgages to borrowers living in low- or moderate-income areas. What does this have to do with financial stability? One aspect of financial stability is the amplification of shocks--in other words, how a problem initially confined to one part of the financial system can spread to involve broader swaths of borrowers and investors. During the housing crisis, the fragility of mortgage companies was an important source of this kind of amplification. In particular, rising mortgage defaults led to the collapse of many mortgage companies, which in turn was one of the key drivers of a significant pullback in the supply of mortgage credit. That tightening in credit then weighed on house prices, as potential homebuyers, who once would have been able to get a loan, found mortgages expensive or impossible to obtain. As a result, even families who had not been involved in the mortgage frenzy of the mid-2000s found the prices of their homes falling sharply. Today's housing market is much more robust, and the risk of a financial crisis originating from this sector is currently low. Nonetheless, if some large mortgage companies fail and other firms do not step in to take their place, we could see adverse effects on credit availability. Against this backdrop, the massive economic shock triggered by the COVID-19 pandemic broadly tested the resilience of our financial system. As the pandemic unfolded, strains occurred across financial markets as investors dashed for cash amid widespread lockdowns and fears about the economic and financial outlook. Mortgage markets, in particular, began to show significant signs of stress. The MBS market, like those for other fixed-income securities, became extremely volatile, and with the unemployment rate spiking, market participants worried that borrowers would be unable to make their mortgage payments. The Federal Reserve's response to the crisis, which was prompt and forceful, included moving the policy interest rate to the effective lower bound, conducting large- scale purchases of Treasury securities and agency MBS, and implementing a number of emergency lending facilities to support the continued flow of credit to families, businesses, nonprofits, and state and local governments. Economic Security Act) provided economic stimulus checks and enhanced unemployment benefits to individuals as well as eviction moratoriums for renters and a requirement that mortgage servicers grant borrowers up to 12 months of forbearance. All of these policy responses were crucial in easing the stresses in financial markets and helping us weather the period when much of the economy was shuttered. An unfortunate consequence of the mortgage forbearance measure was the pressure it put on the funding needs of servicers, particularly mortgage companies, which are required to continue advancing payments on loans in forbearance. In April, Ginnie Mae alleviated these strains somewhat by announcing a program that provides servicers with financing for principal and interest advances, and which would not be considered a default by the servicer. (FHFA) announced that servicers would be required to advance only four months of missed payments for GSE loans. Although we continue to closely monitor the path of the virus and the public response to it, economic and financial conditions have improved much more than many had expected in the spring. It is a great relief that the most dire scenarios that seemed possible in the spring have not come to pass, which is largely due to supportive fiscal and monetary policy. In addition, the near-term stresses in financial markets have abated, providing support for the very strong recovery to date. The Federal Reserve's interest rate actions and MBS purchases have contributed to exceptionally low mortgage rates, which have boosted housing demand and the associated mortgage originations for new home purchases. We are also seeing a surge in mortgage refinancing. As a result, mortgage companies have experienced an influx of cash and an increase in profitability, and they have not had difficulties financing the advance payments. To date, mortgage delinquencies and the take-up on forbearance appear to be limited and well below early fears of significant problems. The increase in employment since April, income support from stimulus payments, programs such as the Paycheck Protection Program that helped small businesses retain workers, and enhanced unemployment insurance all helped borrowers continue making their mortgage payments. And forbearance provisions in the CARES Act to homeowners with mortgages securitized by the GSEs or Ginnie Mae (around 65 percent of outstanding mortgages in the United States) have, so far, helped prevent foreclosures, which also supports home prices. The share of mortgages in forbearance rose above 8 percent last spring, but it has since fallen to below 6 percent. And of those loans in forbearance, about one in six are current in their payments, reflecting the broader economic recovery. This improvement has not been uniform, though, and the decline in the forbearance rate for loans in Ginnie Mae pools has been slower than those in GSE pools. And, of course, significant uncertainties remain, including the fact that forbearance for federally backed mortgages is set to expire in the first quarter of next year. Even as we take some comfort in these positive developments, we are also giving due consideration to the financial market vulnerabilities that were made evident in this crisis, and we are examining ways to address them. One prominent vulnerability, which I have described here today, relates to the funding and liquidity profile of mortgage companies. In different circumstances, the large-scale delinquencies and defaults we saw last spring could have caused some mortgage companies to fail, especially if the surge in origination and refinancing income had not materialized. Because many mortgage companies both originate and service mortgages, strains in these firms' servicing books could also weigh on their origination activities. As I noted a moment ago, any reduction in credit availability would be most acute for borrowers from traditionally underserved communities, where mortgage companies have a particularly high market share. Even before the pandemic, regulators had widely recognized that the oversight and regulatory infrastructure for mortgage companies is much less well developed than for banks, and it could benefit from an update. To that end, Ginnie Mae announced new requirements for its servicers last year; the FHFA announced that it will propose updated minimum financial eligibility requirements for the GSE loan sellers and servicers; and, more recently, the Conference of State Bank Supervisors proposed a set of prudential standards for state oversight of nonbank mortgage servicers. And, finally, the Financial Stability Oversight Council has been working closely with regulatory agencies to analyze risks related to nonbank servicers and to facilitate coordination among agencies. An encouraging feature of all of these proposals is that they recognize the complexity of the mortgage company regulatory structure. The states are the primary regulators, but most large mortgage companies operate in multiple states and are also subject to counterparty requirements from the GSEs and Ginnie Mae. These proposals have all moved toward being more consistent with each other, which should reduce regulatory complexity and burden for mortgage companies and regulators. The harder task, however, is thinking about what the overarching regulatory framework should be for mortgage companies. The risks that mortgage companies face are different from those that banks face. Mortgage companies will be more affected by shocks to the mortgage market than banks, which have much more diversified portfolios. As I have mentioned, mortgage companies have less access to liquidity than banks; at the same time, they do not pose the risk of a claim on the deposit insurance fund. These factors suggest that the optimal regulatory framework for mortgage companies should differ from that of banks. These are difficult questions, and a casual observer might wonder if it is really necessary to grapple with them, especially as the industry appears to have successfully weathered the strains of the past few months. But I would argue that this "success" was reliant on rising home prices, low defaults, and massive fiscal and monetary stimulus. But we certainly can't count on all of these factors being present in future periods of economic stress. Around the world, regulators are deliberating about how to address a variety of nonbank entities that can pose systemic risks. In work published last week, the FSB highlighted the need for a macroprudential approach to nonbank financial intermediation. Members of the FSB are not calling for bank-like regulation for nonbanks, but they recommend a framework of supervision and regulation that takes into account systemic risks that can be posed by nonbanks. I would also note one lesson we learned in March, which is that conditions in financial markets can deteriorate very rapidly and unexpectedly. I'm paying close attention to the issues highlighted in my remarks today, and keeping an open mind. But I think it's clear, that doing the hard thinking and planning now--at a time when conditions afford us the time do so--is a very worthwhile investment. Our financial system and our mortgage market will be more resilient when they welcome and appropriately manage the risks associated with both bank and nonbank mortgage firms.

r201201a_FOMC

united states

Modernizing and Strengthening CRA Regulations: A Conversation with the Chicago Community Trust

brainard

Good morning. I want to thank Dr. Helene Gayle for inviting me to join this conversation, along with the staff, grantees, and partners of the Chicago Community the opportunity to discuss economic inclusion and the Community Reinvestment Act (CRA) and learn more about the Trust's work with its partners in Chicago. The effect of COVID-19 has underscored the importance and urgency of your the nonprofits and communities hardest hit by the pandemic, and I know you have been thinking critically about doing this work in a way that supports an equitable recovery for Black and Latinx communities. I commend the Trust for your leadership on these principles. The disproportionate effects of the pandemic on low-income and minority households and the importance of an equitable recovery are also a key focus of the Federal Reserve. While creating hardship for all, the pandemic has inflicted disproportionate economic pain on vulnerable businesses, sectors, and demographic groups, which risks entrenching a K-shaped recovery that is weaker overall. Small businesses in consumer-facing sectors, along with many low-income workers, women workers, and Black and Hispanic workers, are at a precarious stage of the pandemic. Even as we are buoyed by news that effective vaccines may be widely available by next summer, COVID case counts are resurgent, and many low- and moderate-income households are facing the exhaustion of unemployment benefits, the depletion of savings the fear that eviction moratoriums and forbearance for mortgages and student loans will soon end. While the Paycheck Protection Program provided some relief to many small businesses earlier in the year, that sector remains under pressure, and many small businesses in sectors hit hard by virus restrictions are facing dwindling cash buffers. In addition, states and localities are confronting difficult choices as they respond to increased needs in the face of reduced revenues. The combination of highly supportive fiscal policy and monetary policy was critical in driving the initial strong bounceback from the first wave of the pandemic. Similarly today, it is vitally important to provide a lifeline to hard-hit households and businesses facing the harsh reality of a resurgent COVID second wave as a bridge to the time an effective vaccine will be widely available. The Federal Reserve is committed to providing sustained accommodation through its forward rate guidance and continued asset purchases to achieve our maximum employment and 2 percent average inflation goals. In parallel, additional fiscal support is essential to bridge past COVID's second wave in order to avoid labor market scarring, reductions in crucial state and local services, and bankruptcies. Such additional support is critical to turn this K-shaped recovery into a broad-based and inclusive recovery that is stronger overall. As we support a broad-based and inclusive recovery, the Board is focused on updating and strengthening CRA regulations to better meet their core purpose. You know the associated challenges well, given the Trust's mission to close the racial and ethnic wealth gap and the role you play in fostering opportunity and inclusion in communities across Chicago. The CRA was enacted in response to inequities in access to credit for communities that were redlined as a result of discriminatory government policies and market practices. Now, in light of the persistence of systemic credit disparities and in response to changes in the banking landscape, it is time to strengthen and modernize the CRA. In September, we proposed a framework for reforming the CRA that would advance the following principles. First and foremost, the CRA should focus on addressing credit disparities and financial inclusion in low- and moderate-income and minority communities to fulfill its core purpose. One way our proposal addresses this first principle is by emphasizing minority depository institutions and community development finance institutions, and we are continuing to look for more ways to achieve this goal. Our proposal also makes a special effort to address the challenges of underserved rural communities. A related goal is to ensure that the CRA encourages banks to meet the broad spectrum of credit needs of communities. Our proposal considers how to evaluate banks across a number of areas, such as a bank's retail lending, which includes their home mortgages and small business loans. It also focuses on essential banking products and services like low-cost checking accounts. Community development activities are another point of emphasis, including financing for affordable housing and other needs, or volunteer activities, such as financial counseling, and providing clearer and stronger incentives to invest in the areas of need that lie outside of existing branch-based assessment areas. Another key objective is to provide greater certainty; tailor regulations based on local community needs, bank size, and business model; and minimize burden. Ultimately, we hope that our proposal provides a foundation for the three banking agencies to converge on a consistent approach that has broad support among stakeholders. The next step for us is to continue to gather feedback on our proposal from a wide range of stakeholders, including local communities. In addition to participating in conversations like this one today, we hope to receive as many comments as possible through our formal comment process, which has a deadline of February 16, 2021. We value this feedback tremendously, and our proposal includes specific questions where we are especially interested in input. Given the expertise and leadership of the Trust on racial equity, we will be particularly interested in your comments on the second question in our proposal: "In considering how the CRA's history and purpose relate to the nation's current challenges, how can we strengthen the CRA to address ongoing systemic inequity in credit access for minority individuals and communities?" I thank you for your valuable engagement in this process thus far and look forward to hearing your ideas today and in the months to come. With your continued engagement, I am confident we can come together on a stronger approach to the CRA that will benefit communities across the country.

r201204a_FOMC

united states

Technology and the Regulatory Agenda for Community Banking

bowman

I am delighted to be speaking with you and especially pleased to see the summit's focus on innovation. The ThinkTech accelerator represents the type of resourcefulness necessary to help community banks tackle their greatest challenges, among them ensuring that banking services and credit support are available to customers in all communities, regardless of where they are located. Today, I will share my perspective that technological innovation is essential to the future of community banking in America, and reiterate my intent to elevate those issues related to innovation to the top of the regulatory agenda. There are certain points in history when an event can fundamentally change how society and entire industries function. In addition to the other ways that COVID-19 has affected us, this could be one of those moments. The pandemic has demonstrated the importance and unique role of technology in responding effectively to new challenges. In this case, the challenge has been an unprecedented disruption in our lives. One year ago, it would have been difficult to imagine the extent to which we are now working and conducting routine aspects of our lives from home and online. Take health care as an example. One recent report on telemedicine trends notes that the number of patients treated through video-enabled physician visits has increased between 50 percent and 175 percent compared to before the pandemic. While virtual consultations with a health care professional haven't replaced physical examinations and medical procedures, they are serving a vital role in the industry's response to the pandemic and they will likely play a significant role in how the health-care industry serves its customers in the future. When this health emergency has come to an end, I expect that telehealth, home grocery delivery, and a variety of online services and communications will continue at a higher frequency than before our recent experience. In the financial sector, I believe we may be seeing a quantum leap in the use of digital deposit, digital payments and online lending. One large financial service provider reported a 200 percent increase in new mobile banking registrations during the early phases of the pandemic. Customers who reacted to the physical limitation on visiting a bank branch or ATM are learning to bank using online banking or through an app on their smartphone may not be as willing to stand in line or wait for in-person service at their bank branch in the future. Recent surveys show that consumers with access to digital and mobile banking are more likely to continue using those convenience products and services in a post-pandemic world. The adoption of digital banking services can also be essential for historically underserved and disadvantaged communities, assuming they have bank accounts and access to internet-based tools like smartphones. In some cases, fintech can lower costs and improve services, particularly for small businesses or lower-income consumers who are less likely to have access to credit. While electronic banking certainly didn't start with the pandemic, acceleration of its adoption has undoubtedly led banks of all sizes to rethink how they will meet their customers' needs in the long term. I have noted on many occasions how vital community banks are to those they serve and to a strong and stable financial system. Successful innovation is not just about adopting the latest technologies. It involves aligning a bank's strategy with its innovation plans to clearly map a purpose and desired outcome for the adoption of new technology. The continued success of many community banks depends on their willingness to engage in strategy-based innovation-led growth. We have seen and are encouraged by many examples of entrepreneurial community banks embracing technological innovation. Developments such as digital deposit and lending products, regulatory technology solutions, and application program interfaces (APIs) have increasingly become more popular in the banking industry. When implemented effectively, they can result in greater efficiencies and effectiveness. A number of community banks have already taken advantage of these opportunities. Still, perspectives on the need for change vary across the industry. I recognize that while it seems clear that the industry is changing, there remains a wide distance between fintech's promise of a future driven by technology and what many community bankers experience today. From my perspective, it is unlikely that fintech will ever completely eliminate what is the hallmark of community banking--personal interaction and building relationships with customers and communities. One trend is clear, however: more and more community banks are expressing interest in fintech partners to help them open new lines of business, help with customer acquisition, enhance customer service, and improve operational functions. Through the Fed's engagement with fintech companies and small banks during our Innovation Office Hours, we learned that a wide range of partnership models are emerging, with varying benefits and challenges. Some banks are engaged in customer-oriented partnerships, where a bank selects a fintech partner to improve the customer experience, develop new products or services, or acquire new customers. In one case, a bank partnered with a fintech company to centralize each customer's financial data and provide personal financial management tools. Other banks are engaging fintech partners to automate or improve the efficiency and effectiveness of compliance and regulatory processes, which is often referred to as "regtech." For example, a fintech partner automating the Bank Secrecy Act/anti-money-laundering process may be able to provide notable cost savings and enhance compliance, while freeing up resources for other areas. We have also seen instances where a bank offers its financial services to a fintech partner that, in turn, offers financial products or services to its customers. In this type of relationship, a bank plays an important part in the delivery of products and services. The list goes on. My point is there is great possibility and a wide variety of options for engagement. And everyone, from the banks to customers to the regulators, needs to be thinking about these changes and their implications. With the emergence of additional core-service providers, we are also seeing more opportunities for community banks to access the technology infrastructure they need to improve basic banking activities. These basic banking activities include tasks like reconciling transactions to the general ledger or simply offering expanded digital services. Furthermore, there are new opportunities for integration of cloud-based platforms and APIs. Community banks should take advantage of the new technologies that make sense for their business and the communities they serve. Still, even as community banks prepare for the future, there is the very real challenge of finding partners and knowing how to navigate the regulatory environment once an institution has identified a potential partnership arrangement. We certainly understand this concern. From the fintech perspective, one provider noted the challenges they face during the onboarding process with financial institutions, including struggles to navigate siloed compliance and risk-management functions. Participants in the Fed's Innovation Office Hours told us that they would benefit from the Fed broadly sharing information on the current landscape of such partnerships, on a range of practices, and on relevant guidance for banks to consider. In response, early next year we plan to publish a white paper that documents examples of community bank partnerships with fintech companies and outlines effective practices for managing those arrangements. This white paper would describe a range of distinct options for such partnerships and seek to identify benefits and challenges of the different approaches. We are also continuing to pursue a range of community bank projects to provide pathways to innovation that I mentioned earlier this year. While it is essential to safety and soundness that banks understand, monitor, and mitigate risks associated with their third parties, I am sensitive to the burden that due diligence can pose. Being unsure of the questions to ask a third-party vendor, or whether a response is sufficient, should not keep community banks from accessing innovation, yet we continue to hear that these are real challenges. To address this problem, I have directed Federal Reserve staff to work with their interagency colleagues to develop a vendor due diligence guide, aligned with existing supervisory expectations, which would include sample questions for vendors and guidance on appropriate responses. This guide would also be specific about the documents and information that community banks need in order to successfully complete their due diligence. In addition to the due diligence guide, I expect that Federal Reserve staff will work with our colleagues at the Office of the Comptroller of the Currency and Federal Deposit Insurance Corporation to enhance and align interagency guidance for third-party risk management. The guidance would eliminate the need for community banks to navigate multiple supervisory guidance documents on the same issue. It is my expectation that the combination of refreshed and aligned interagency guidance and the community bank due diligence guide will meaningfully enhance clarity on supervisory expectations for community bank partnerships with fintech companies. There are also opportunities within our existing supervisory program to improve our regulatory response to innovation, without creating additional burden for community banks. The federal banking agencies' service provider supervision program plays an important role in assessing the rigor of risk management and controls at key service providers. It is important that reports of supervisory assessments be readily available to banks that rely on service providers so that banks can use the reports to support their third-party risk management. Since I last spoke about the program in February, the federal regulatory agencies have made notable progress in creating a process to automatically distribute those reports to all client banks. Proactively sending reports to community banks removes the inefficient step of each bank hunting for reports on their own. For banks supervised by the Fed, the aim is to begin automatic distribution in the first quarter of 2021. Finally, I would note that as we consider the types of financial services technology that may be useful to the banks we supervise, our rules and guidance need to keep pace. The Federal Reserve is also considering whether the rise of artificial intelligence and machine learning in banking might require an adjustment in regulation and supervision. AI is becoming more prevalent in customer service and machine learning can offer real opportunities to assess risk and find new customers. Community banks face limits on the resources they can dedicate to researching and evaluating third party providers of these new services. Regulators and supervisors should consider ways to encourage innovation by simplifying the process of third party selection, due diligence and monitoring. To that end, staff from the Federal Reserve and other agencies have been jointly conducting significant outreach to industry and other stakeholders over the past several months. We want to hear from you. In addition to this outreach, a conference planned for January, 2021 will include views from academic researchers on the potential benefits and risks posed by artificial intelligence for banks of all sizes. Technological innovation holds great promise to help community banks compete and succeed in the evolving financial services landscape. I look forward to continuing to engage on these issues in 2021 and to work with the ICBA and other stakeholders to foster an environment where communities and the banks that serve them continue to thrive.

r201211a_FOMC

united states

The Eye of Providence: Thoughts on the Evolution of Bank Supervision

quarles

Federal Reserve staff who have played a key role. And an equally huge thanks to all of the moderators and panelists who are participating in today's event and to all of you who are tuning in. I have very much enjoyed the discussion so far, and I hope that the conference will encourage both more and a wider variety of academic work on bank supervision. In many respects, the focus of today's conference on bank supervision, rather than regulation, and the relatively recent efflorescence of scholarly attention to that topic, are welcome new developments. In other respects, however, the question of the proper scope of bank supervision is not a new topic at all. In going through some family papers recently, I came across this cri de coeur from one Elton Hall, president of a small bank in Victor, Idaho, as The government has so governed [my] bank that [I] no longer knew who owned it. I am inspected, examined and re-examined, informed, required, restrained, and commanded. . . . I am supposed to be an inexhaustible supply of money . . . , and because I will not sell all I have and go out and beg, borrow, or steal money to give away, I have been cussed, discussed, boycotted, talked to, talked about, lied to, lied about, held up, hung up, robbed and nearly drained, and the only reason I am clinging to life is to see what in hell is coming off next. Were Mr. Hall transported to the District of Columbia in 2020, he would immediately realize that he had clearly had no idea what was "coming off next" if he had thought he was over-imposed upon in Idaho's Teton Valley in the winter of 1921. But before the bankers in the congregation become too inclined to commiserate with him, I should note that the reason I know anything about Mr. Hall, and the reason his quote is among those family papers, is because his bank failed not so many years thereafter, as did nearly half the small banks in the country between 1920 and 1930. Mr. Hall's bank on the western slope of the Tetons was acquired by a visionary young banker from Utah by the name of Marriner Eccles. This was during the Roaring '20s, well before the Great Depression and the Banking Crisis of 1933. Before the evolution of modern supervisory practices, bank failures were extremely common, even in boom times. So, how should we think about this new, yet very old, question? I'd like to begin as many of you have today, by focusing first on regulation--as a way of throwing into relief some key issues that are both important and hard about its cousin supervision. One of my goals at the Board of Governors has been to make our regulatory framework simpler, more consistent, more predictable, and more efficient. This approach is not new. It draws on many decades of practical experience and public policy analysis. At its most basic, this approach rests on the premise that we should continuously challenge ourselves to make sure that our policies are achieving their intended objectives, based on evidence and a data-driven assessment of their impact on the public. These principles--simplicity, consistency, and predictability--are all connected to what is perhaps a more fundamental principle of regulation, and indeed of law itself--transparency. Transparency makes the intent of regulators clear and their actions more predictable to those regulated. Regulations are more effective when they are well understood and more effective when their predictability and consistency build respect for the fairness of regulation that encourages compliance. Transparency helps guard against regulation that is arbitrary or capricious. Transparency is enshrined in statutory process protections such as those in the Administrative Procedure Act, which facilitates understanding and communication. All these principles--simplicity, predictability, transparency, efficiency--lead to better regulatory outcomes. All other things equal, simpler rules are better because they are easier to understand, to implement by banks, and to supervise by examiners. Predictable, consistent, and clear rules are more effective because they are consistent across firms and over time. In addition, we develop rules through an iterative process that takes place in the open. Through this process we learn about potentially unanticipated consequences--which allows us to avoid these surprises, which are in no one's interest. The public comment process also naturally facilitates a dialogue with the organizations that would be subject to the rules, as well as any interested party, helping the government to produce a regulatory framework that takes into account both benefits and costs. A focus on efficiency helps ensure that we avoid any unnecessary burden and externalities. We relied on these principles in establishing the new regulatory framework in the wake of the global financial crisis. The essential elements of that framework--which now includes dynamic and risk-sensitive capital requirements and rules-based, quantitative liquidity standards--all reflect extensive and significant consultations with the public and careful analysis of the impact that these rules will have on individual banks and the U.S. banking system. Our benchmark for capital adequacy is now based on standardized measures of risk and leverage across all banks. This is supplemented by an annual stress test with extensive transparency and disclosure around the process and results that provides additional, consistent risk sensitivity. We now regulate liquidity as one of our enhanced prudential standards for large banks, with two clear quantitative standards--the short-term liquidity coverage ratio (LCR) and long-term net stable funding ratio (NSFR) requirements--and clear expectations for liquidity risk management, articulated in a regulation that went through a public notice and comment process. Partly as a product of these improvements, we have made our regulations more efficient by better differentiating among risks. Our capital rules require firms that hold riskier positions either to maintain capital that addresses those risks or to take steps to de-risk. Our liquidity rules similarly require firms with more unstable funding to hold more liquid assets or to improve the stability of their funding. In addition, last year the Board adopted changes to our overall regulatory capital and liquidity frameworks that differentiates among the systemic risks presented by individual banks. Under the revised framework, the most complex, systemically important firms are subject to the most stringent requirements, and less-complex firms are subject to less-stringent requirements. In the long run, these changes will lead to fairer, more efficient results, while preserving the safety and soundness of the U.S. banking system and broader financial stability. Because of the improved regulatory framework in place early this year, banks were in a strong position to deal with the challenges of the COVID event. For example, in March of this year, customers of U.S. banks drew down nearly $480 billion on existing lines of credit to cover cash needs during the severe disruption in revenues in the early days of the COVID event--by far the largest monthly increase in history. Banks were able to fund these loans without notable problems in part by drawing on liquidity buffers created by the new regulatory system. They have not only maintained, but actually increased their capital during this time--notwithstanding the large provisions taken earlier in the year. And they have continued to extend credit throughout the protracted evolution of the COVID event, to this point largely satisfying the demand for credit in the economy. Of course, having clear, consistent, predictable, and efficient rules of the game is not the end of the story. Our rules are not an academic exercise. They represent concrete, binding requirements on real people and real businesses. Our obligations to the public mean we need to verify that our rules are being followed, detect emerging risks, and make sure any deficiencies are swiftly addressed. This is the task of the bank supervisor, rather than the bank regulator. Regulation and supervision are different tasks, and I have spent this time reviewing how we have pursued the goals of simplicity, predictability, transparency, and efficiency in regulation in part to lay the groundwork for showing how much harder it is to pursue those goals in the realm of supervision. Regulation and supervision both flow from the statutory authority granted to the Federal Reserve and the other banking agencies by Congress establishing our duty to promote a safe and sound banking system. Regulation does that on a generalized, system-wide basis. Supervision, in contrast to regulation, looks at firm-specific issues, such as how a firm's idiosyncratic risks are evaluated under our regulations, and at risk-management frameworks that cannot easily be assessed through standardized risk measures. For example, while our capital rules require banks to hold a specific level of capital, our exams focus on subjects such as the plans of management to make sure they can meet those capital requirements on an ongoing basis. Supervisors summarize the results of these examinations and their overall assessment of a firm in the form of a supervisory rating, the importance of which I will discuss shortly. The progress we have made on regulation creates an opportunity for us to focus more of our attention on supervision and the principles of simpler, more consistent, more predictable, and more efficient supervisory standards. For example, because the Board found that there had been significant improvements in risk management since the global financial crisis, we removed the "qualitative objection" from our stress testing process. Similarly, we simplified our capital framework through the introduction of a stress capital buffer (SCB) requirement. How should supervision evolve in light of the new stronger and more comprehensive regulatory edifice we now have in place? An example: after we emerge from the COVID event, we will no longer need to maintain temporary limitations on capital distributions by large banks and can instead rely on the regulatory capital framework that the Board established earlier this year--the SCB. Among its many advantages, under this framework we will no longer need to review periodic requests from banks for additional capital distributions. Instead, the SCB sets a clear and explicit capital target that firms must stay above at all times. As a result, firms can rely on that SCB target to define how much capital they can distribute in any given calendar quarter. This is a better process because it is more predictable and more efficient. That said, we may still want to conduct a limited review of the capital plans of banks to give some insight into risks that the stress test might not fully pick up. For example, if a firm enters a new line of business and does not yet have a good framework for assuring its managers can measure the results of that business in light of its risks, supervision can detect that shortcoming and the firm can help address this vulnerability before the uncaptured risks materialize. Similarly, our new long-term stable funding rule--the NSFR rule--provides objective standards to address risks that fall outside the boundaries of our short-term funding requirement--the LCR rule--and thereby takes some pressure off supervisors to monitor these risks on a case-by-case basis. However, the LCR and NSFR do not address all sources of liquidity risk, and poor dynamic liquidity risk management can lead to a firm's failure just as surely as a present-tense lack of liquidity. In these ways, bank supervision can act as an early warning system and identify risks before they metastasize into problems that drain a firm's financial resources or liquidity position. Yet as important as the practice of supervision is, these examples also show that it is inherently more judgmental, nuanced, discretionary, variable, and opaque than the practice of regulation. And variability and opacity breed distrust, even when that distrust is not at all merited. The point here is that all the benefits that come from simplicity, predictability, and transparency would be equally valuable in supervision--but necessarily much harder to obtain while maintaining the benefits of supervision, which are substantial if we are not to return to a world where half the small banks in the country will fail during one of the most prosperous decades in our history. Keeping all this in mind, and given the success of our refinement of the overall regulatory framework, I believe it is natural to reflect on our overall supervisory communications, including our supervisory ratings framework, to consider ways to simplify it and make it more efficient, and especially make our ratings more consistent and more predictable. We already have a good deal of transparency around our supervisory standards--we publish our supervisory manuals, we publish guidance, and we seek public comment on the most significant guidance. We also recently published standards for how we would assign firms to the large institution supervision coordinating committee, or LISCC, portfolio. However, in contrast to the rulemaking process, and in order to appropriately protect a bank's confidential business information, the vast majority of the communication about the bank supervision process takes place confidentially. The most notable exceptions are when we find material deficiencies at a bank and take a public enforcement action to correct them. Supervisory ratings are an interesting and special case because they are confidential communications that can have public consequences. A supervisory rating is a confidential assessment of the strength of a bank in one or more risk areas, or, in some cases, a composite view of the aggregate risks facing the bank. Ratings have the obvious benefit of summarizing the overall condition of a firm. Among other considerations, this summary includes qualitative judgments about risk management and an assessment of whether the firm is in compliance with applicable regulations, such as capital and liquidity requirements. Ratings also promote comparative analysis across firms that face similar risks. Ratings date back to the first half of the 20th century, and possibly earlier, when they were used to classify banks, in much the same way as examiners assign ratings today. modern version of ratings was the result of the establishment by Congress of the Federal "CAMEL" rating system in the same year to promote consistent examination practices across depository institutions. The Federal Reserve followed suit with a supervisory rating system for bank holding companies in 1979. Since that time, ratings have become enshrined in the federal banking laws. In particular, they play a role in interstate branching requirements and in determining whether or not holding companies can engage in expanded financial activities. While the ratings themselves remain confidential supervisory information, the Federal Reserve has taken steps to provide information to the public around the rating process. For example, the standards we use to assign the ratings have always been published. In addition, the Board has sought public comment on the two most recent iterations of its ratings systems for holding companies, the RFI rating system and the LFI rating system. And in the past year, the Board began publishing aggregate data on supervisory ratings--organized by different bank cohorts--as part of its report on bank supervision. One concept that is inextricably linked to a supervisory rating is whether or not a firm is "well managed." By law, in order to be well managed a firm must have at least a satisfactory management rating, if any is given by its supervisor, and a firm also must have at least a satisfactory overall or composite rating. When the Gramm-Leach-Bliley Act expanded the range of financial activities that were permissible for companies that own banks, such as securities underwriting and insurance underwriting, it did so with certain conditions. To elect to be a "financial holding company" and be eligible to engage in these types of expanded financial activities, a bank holding company and its lead depository institution subsidiary, among other things, must be and remain well-managed. Because of these significant consequences, I believe it is appropriate to take note of the process distinctions between the development of rules and the development of supervisory ratings. Rules are drafted in full view of the public, subject to a comment period before they become final, and federal agencies have an obligation to provide a rationale for their rules. In contrast, supervisory ratings are confidential and have immediate effect. Banks are not permitted to disclose them. Although, as I have discussed, there are published standards as to how bank supervisors should assign these ratings, there will always be borderline cases and close calls, and these decisions are made out of the view of the public. There are at least two reasons why it is critical that we get ratings correct. The first is that the supervisory rating is the most important communication that we have with firms. It encapsulates our expert judgment of the firm and lets the firm know how its performance compares with our standards. And second, as discussed, ratings have material real-world consequences. A firm with unsatisfactory ratings faces significant competitive disadvantages relative to firms deemed to be satisfactory. As noted, these firms are prohibited from expanding their range of financial activities and will generally face headwinds in acquisitions. Since the financial crisis, our supervisors have identified potential weaknesses at firms and encouraging them to address those weaknesses. And firms now have substantially stronger and more resilient risk-management systems. They are better able to identify, measure, and manage their risks. These improvements have not gone unnoticed. As our supervision report demonstrates, the overall ratings trajectory in the industry has been quite positive. There are some straightforward steps we could take to simplify our ratings, with no loss of effectiveness. We already have a model for a simpler ratings framework. The new framework that applies to our largest firms, the LFI ratings framework, focuses on the three areas that are the core of our supervisory focus: capital, liquidity, and governance. We could consider a similar simplification to the RFI rating system that applies to less-systemic holding companies and the CAMELS ratings system that applies to depository institutions. In terms of improving regulatory efficiency through ratings, being clearer to firms about how we apply these standards would help to promote a more efficient banking system. In particular, we could be clearer about how we weight the various factors that generate the rating. Banks could benefit because they would be better positioned to anticipate supervisory feedback and understand what steps they need to take to improve their ratings. Supervisors can benefit by being grounded in more predictable criteria. My concern is that, despite the fact that our examiners have used ratings for almost 100 years, we don't have a particularly well-developed theory of ratings--principles regarding the internal processes and standards that promote consistency and predictability in our assessment of the condition of banks. As I've discussed, there is broad agreement that ratings are a beneficial, even necessary, part of bank supervision. Yet we have very few studies or other empirical support for this conclusion. This stands in sharp contrast to the analysis behind the long list of regulatory achievements that I mentioned. To give an example, we have a pretty good idea, grounded in economic analysis, about how much capital a global systemically important bank, or G-SIB, needs to maintain to promote its safety and soundness but not nearly as much support for our view about where to draw the line between a satisfactory rating and an unsatisfactory rating. For example, at a large global financial firm, what should be the difference between a satisfactory and unsatisfactory rating on capital planning, provided the firm otherwise has strong capital levels? Where should we draw that line? How do we decide the close calls, and what is our default for ties? I don't know what the right answer is, and I suspect that it will vary depending on the circumstances. Although there will be a range of qualitative factors that affect our conclusion, it must be the case that we can learn from our previous experiences and distill a presumptive answer. That sort of approach, one grounded in analysis and based on evidence, has ably supported our regulatory framework. I would like to see what science can bring to ratings. I think this could be especially helpful in terms of the consistency and predictability of ratings. Since ratings are assigned by humans and humans are fallible, being more deliberate about the processes behind them can only help us. While we have made some progress in making ratings simpler and therefore more efficient, and more consistent with actual supervisory practices, I would like to see our approach to ratings made more express and deliberate. Since the global financial crisis, the Fed, along with the other prudential supervisors, has implemented a number of controls to improve consistency and support appropriate calibration of ratings, as we view them internally. We have tools in place to monitor ratings and detect whether there is any unusual variability in them. I suspect there is more work that could be done to use evidence and make sure our processes facilitate consistent results. As I have alluded to, most of these efforts have been inward-facing, and we could benefit from efforts to show the public that our ratings are consistent and predictable. I see two paths to achieve this goal. One of those is oriented toward processes and procedures. One is more substantive. They are not mutually exclusive. In terms of processes and procedures, there is always the question of whether ratings are consistent when administered in different circumstances by different people. I would like to explore approaches to ratings that would yield similar results when those ratings are assigned by different staff and across different points in time. One way to do this would be to subject ratings to the scrutiny of multiple parties with a range of perspectives and experiences. This is how the public rating agencies, such as Moody's, Fitch, and S&P, approach ratings, through ratings committees. And this is how we approach rating the largest, most systemically important firms through the LISCC, where a committee that includes independent Federal Reserve experts has an opportunity to provide feedback on the ratings of the firms in the LISCC portfolio. Designing this process so that it is reliably consistent and predictable for all banks is an area we should study further. Another method we could explore is to dedicate some portion of our exam work to reviewing compliance with concrete regulatory standards, such as some of our liquidity risk- management standards, where the standards lend themselves to that approach. And we would commit in advance to giving the findings from these reviews a particular weight in our ratings discussions. I think this overall model--where the supervisory assessment is vetted by a Federal Reserve committee with independent views, or at least reviewed by staff within the Federal Reserve outside the normal assessment process, and where we explicitly take compliance with regulatory standards into account in assigning ratings--could be a good one for helping to promote greater consistency and predictability, especially in cases where the subject matter lends itself to such standards. Another process improvement involves guidance. At times, we find it helpful to elaborate on our regulatory standards through supervisory guidance. Some risk areas that don't easily lend themselves to regulation, such as certain kinds of risk management, also can benefit from supervisory guidance. In both cases, we can enhance the predictability of our supervisory process by inviting public feedback on any applicable guidance or other supervisory standards. For example, in connection with a recent rule on our capital planning requirements, we invited public feedback on our outstanding supervisory guidance on capital distributions for firms of all sizes. In the recent past, we also have sought comment on our approach to risks associated with governance and internal controls. We will continue to look for feedback on our guidance. All of these approaches will improve the predictability of our ratings and also improve their legitimacy. In terms of substantive changes to show the public that ratings are consistent and predictable, my lodestar would be to rely wherever possible on empirical analysis to direct our policy choices and to be open to change where supported by this analysis. As supervisors, we should be extremely supportive of efforts to better understand ratings as an assessment and communication tool, as well as those that make our supervision processes have more repeatable outcomes. We should encourage our examiners and economists to conduct more empirical analysis around supervisory ratings. For example, some recent scholarship suggests ratings can have a positive impact on reducing the insolvency risk of supervised firms. We should do more analysis and careful examination to identify what drove those results. As we conduct this analysis, my sense is that we should focus on two main variables: the consequences of the ratings that I've described--for example, a firm having its activities or acquisitions curtailed--and whether or not these consequences are properly calibrated relative to the circumstances that gave rise to the rating. To illustrate, let's return to the earlier example of a firm with a deficiency related to the risk management of its capital adequacy but that has proven itself through our stress tests to have sufficient financial resources. In contrast, imagine a bank that does not share the risk-management deficiency but whose stress test results indicate that the firm has inadequate capital. Our assessment for both firms may be that each should receive an unsatisfactory capital rating. In my opinion (and I acknowledge that there are some who would reasonably disagree with me) between the two firms, the firm that faces a potential capital shortfall should be the graver concern. Yet, the essential message to both firms and a likely consequence of the rating--the risk of falling out of well-managed status--is identical. To me, this outcome makes no sense. Why should the firm that is objectively weaker face the same consequences as the firm that is objectively stronger? Although the law dictates the most material consequences of an unsatisfactory management rating, we have the authority to define that rating and its calibration, as well as to define any additional supervisory consequences that are not prescribed in the law. I believe it is well worth our while to consider this calibration. Accordingly, I have directed Board staff to look into the following issues: First, the placement of the qualitative elements of our ratings frameworks. There is somewhat more discretion in applying these elements relative to the quantitative regulatory requirements. These elements traditionally have been spread across all the ratings components, including capital and liquidity. Is this the best placement? Second, ways of being clearer to the public about how we, as supervisors, weight the qualitative and quantitative elements of our ratings. How could we best go about communicating this weighting? Are the relative weights that we apply correct? Third, the conclusions, if any, we can draw about the effectiveness of our new LFI ratings framework relative to our RFI ratings framework. For example, has the lack of a composite rating in the LFI ratings framework been beneficial from a supervisory communications standpoint, as intended? If our ratings are poorly calibrated, we run the risk of being less effective in our supervision. We also could be providing aggregate ratings that are misleading. Although I believe our examiners do rate banks accurately and dispassionately, based on our written standards, a closer look would help identify any instances where that's not the case and what improvements and changes might be needed. I believe the Federal Reserve has a duty to assess our supervisory practices with the same vigor as we have assessed our regulations. Providing ratings that are based on well-calibrated, consistent, and predictable standards can only be to the benefit of everyone. Even if we were to make no changes to our ratings frameworks, going through the process of assessing this calibration will surely provide a valuable learning experience. It would also increase our conviction in the legitimacy of our ratings frameworks and our confidence as a prudential supervisor. Thank you. I look forward to the discussion that follows.

r201217a_FOMC

united states

Modernizing and Strengthening CRA Regulations: A Conversation with the Consumer Bankers Association

brainard

Good afternoon and thank you for inviting me to take part in the Consumer meeting. The CRA officers and teams at your institutions play an important role in identifying community priorities and building partnerships with stakeholders to implement effective CRA programs. We appreciate the opportunity to hear feedback from CBA members and this committee reflecting your extensive experience making loans and investments to support local communities. on CRA modernization earlier this fall. The ANPR seeks to strengthen the regulation in alignment with the CRA statute, and the discussion in the ANPR recognizes the historical context of redlining and racial discrimination prior to the CRA's enactment in 1977. We believe that the CRA remains an important tool to promote economic and financial inclusion, and we have specifically asked for feedback about what modifications and approaches would strengthen CRA regulatory implementation in addressing ongoing systemic inequity in credit access for minority individuals and communities. We also recognize the need to update the regulation to reflect the changes that have happened in the banking industry over time. In addition, the ANPR reflects other key objectives like providing greater consistency and transparency in CRA examinations, effectively tailoring regulations, and minimizing data burden. We're looking forward to feedback on these big-picture questions and objectives in addition to the specific proposals discussed in the ANPR. Many of the ideas in the ANPR reflect interagency discussions, and our hope is that the ANPR provides a foundation for the agencies to converge on a consistent approach to CRA modernization that also has strong stakeholder support. Let me take a minute to highlight some of the key proposals addressed in the First, we propose a CRA evaluation framework that incorporates the use of metrics and tailored standards that take into account differences across local communities and reflect differences in bank size and business model. We heard feedback about the importance of separately evaluating retail and community development activities in order to capture the distinct importance of each type of activity in meeting community needs. Therefore, the ANPR proposes that large retail banks would be evaluated under two separate tests--a Retail Test and a Community Development Test. Each of these tests is further divided into two subtests, which would result in large banks being evaluated under four subtests in each assessment area. Small retail banks, however, would be able to choose whether to be evaluated under the current framework or under the new framework. Small retail banks that elect the new framework would be assessed solely under a Retail Lending Subtest, unless they elect to have other activities considered. grounded in a transparent, metrics-based approach to evaluating CRA performance. We propose using metrics that are tailored to local market conditions and that reflect changes across the business cycle. In addition, we have also asked for feedback on ways to pair the use of metrics with targeted performance context considerations about the impact and responsiveness of retail lending and community development financing activities. In considering the use of metrics, the ANPR also proposes ways to tailor evaluations to a bank's business model and major product lines. For example, it proposes a major product line threshold of 15 percent of the dollar value of the bank's mortgage, small business, or small farm lending in a specific assessment area. This threshold would be separately applied to each of these product lines and would create more transparency and certainty about which lending products are evaluated in an assessment area. We also recognize that consumer lending is a unique business line, and we ask for feedback on approaches specific to evaluating consumer lending. In proposing metrics-based approaches, we recognize the tradeoff between providing greater clarity and certainty, as against the potential burden of additional data collection and reporting requirements. The proposed metrics in the ANPR would rely on existing data to the greatest extent possible. Small banks would be exempt from deposit data collection and reporting requirements, and data used for the lending analysis would be the same as is used for current examinations. For large banks, we propose using existing data sources where possible, and we ask for feedback about potential ways to minimize the number of larger banks that would need to collect and report more-granular deposits data for a metrics-based approach. Second, the ANPR seeks feedback on several options for updating the approach for defining assessment areas where a bank's performance will be evaluated. With the changes in the banking system and the growth of mobile and internet banking, many banks are increasingly doing business beyond the boundaries of their branch-based assessment areas. However, we have also received feedback and have reviewed data that branches continue to play a critical role in lower-income and rural communities. The ANPR proposes maintaining facility-based assessment areas while also exploring options for defining new assessment areas. Specifically, we ask for feedback on whether new assessment areas should be based on some threshold of deposits or lending in areas where the bank does not have a physical presence, and the ANPR discusses a potential option of allowing internet banks to have a national assessment area. Finally, with respect to community development, we have heard feedback from stakeholders that it would be helpful to have more upfront clarity on what activities count for the CRA. We proposed providing an illustrative, non-exhaustive list of activities that meet the requirements for CRA consideration and are requesting feedback on how such a list should developed and maintained. And we ask for input on developing a preapproval process for activities and whether the process should focus on specific transactions or on more general categories of eligible activities. The ANPR also seeks feedback on how to clarify elements of existing community development definitions. For example, within the affordable housing definition, we seek feedback on defining naturally occurring affordable housing, which is not financed by any type of public subsidy and provides an important source of affordable housing in many communities. In all of these proposals, we aim to modernize the CRA in a way that advances the core purpose of the statute, while also providing greater certainty, tailoring regulations, and minimizing burden. Over the next few months, the Federal Reserve System will host outreach meetings and listening sessions like this one around the country. We encourage the public to submit written comments by the deadline of February 16, 2021, and I look forward to your feedback.

r201218a_FOMC

united states

Strengthening the Financial System to Meet the Challenge of Climate Change

brainard

I want to thank the Center for American Progress for inviting me to join you in discussing climate change and the U.S. financial system. Let me start by noting these are my own views and do not necessarily reflect those of the Federal Reserve Board or Climate change and the transition to a sustainable economy have important implications for the financial system. The financial system can be a powerful enabler to help the private sector manage climate-related risks and invest in the transition. It is vitally important to strengthen the U.S. financial system to meet the challenge of climate change. Climate change is one of the major challenges of our time. There is growing evidence that extreme weather events related to climate change are on the rise-- droughts, wildfires, hurricanes, and heatwaves are all becoming more common. Climate-related events are already adversely affecting the lives of many Americans. The economic and financial impacts are also increasingly evident: we are already seeing elevated financial losses associated with an increased frequency and intensity of extreme weather events. Some have described Pacific Gas and Electric's bankruptcy as the first climate-related bankruptcy of a major U.S. corporation. Average annual insured weather-related catastrophe losses have increased over the past decade. With losses increasing, insurers are incorporating the impact of climate change into their underwriting assumptions, pricing, and investment decisions. Climate change is also likely to have a notable impact on coverage availability. 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. Similarly, mortgages in coastal areas are vulnerable to hurricanes and sea level rise. New mortgages issued for U.S. coastal homes have, in aggregate, exceeded $60 billion annually in recent years. Recent research suggests that lenders hit by hurricanes, particularly in areas not typically affected by natural disasters, tend subsequently to securitize more of their mortgage loans, which could have higher climate risks, higher borrower defaults, and lower collateral values. Homeowners could also face increased hardship, since many homeowner insurance policies exclude flooding. Just as there are risks, there are also promising opportunities for private-sector investments in low-carbon innovation, infrastructure, energy, and transportation. With support from accounting standard setters, credit rating agencies, and regulators, the financial system can provide useful signals to help the private sector manage climate risks and facilitate a smooth transition. Climate change could pose important risks to financial stability. That is true for both physical and transition risks. A lack of clarity about true exposures to specific climate risks for physical and financial assets, coupled with uncertainty about the size and timing of these risks, creates vulnerabilities to abrupt repricing events. For example, a shift in the perceived frequency or severity of climate-related events, such as storms, floods, or wildfires, could rapidly change perceptions of risk and lead to rapid repricing of assets. Similarly, changes in investor expectations about future climate policies could lead to rapid and unexpected price changes that ripple through the financial system. Assessing climate risk effects is complex because the predicted path of climate change is nonlinear and has likely tipping points, beyond which changes in climate conditions could occur rapidly, and climate forecasts based on historical data are no longer relevant. This uncertainty in climate forecasts may reduce the accuracy of risk models used by investors, risk managers, asset managers, financial infrastructures, and leveraged financial institutions. With accounting standards and disclosure frameworks for climate risk in the early stages of development and adoption, investors may lack transparency around the range of climate-related exposures facing financial firms, and non-financial short-term investors may be disinclined to fully price in longer-term climate effects. Some studies suggest that even well-informed investors may underestimate the likelihood of large shocks related to climate. Combined with the uncertainty in the timing and magnitude of climate change itself, this mispricing could lead to financial volatility as conditions evolve and perceptions shift. Consistent, comparable, and actionable disclosures are critical to understanding firms' exposures to climate risks and to accurately pricing that risk. The Task Force on support from the Financial Stability Board, provides a consistent global framework for companies and other organizations to improve standardization of climate-related financial disclosures. As of October 2020, nearly 1,500 organizations with a combined market capitalization of $12.6 trillion, including financial institutions that own or manage assets of $150 trillion, had expressed their support for the TCFD framework. This support signifies strong demand from the private sector and investors for greater transparency around climate-related risks to better inform decisionmaking. We are improving our understanding of climate risks and their impact on financial stability through staff research and engagement with other central banks on topics like climate scenario analysis. One useful approach to assessing the effect of climate-related risks is through scenario analysis of how the financial system is exposed and how it may respond to climate-related risks. Climate scenario analysis identifies climate-related physical and transition risk factors facing financial firms, formulates appropriate stresses of those risk factors under different scenarios, and measures their effects on individual firms and the financial system as a whole. In part because of the different nature of climate-related risks relative to financial and economic downturns and the significantly longer planning horizon, this is distinct from established regulatory stress tests at banks, which are used to assess capital adequacy over a relatively short horizon. Supervisors are responsible for ensuring that supervised institutions are resilient to all material risks, including those associated with climate change. The economic and financial market consequences of climate change and the accompanying economic transition will have direct implications for bank balance sheets, strategies, and operations, and could increase credit, market, liquidity, or operational risk at banks. These climate- related developments may affect the creditworthiness of corporate, household, and government borrowers. Climate-related risks may reduce a borrower's repayment capacity or the value of assets collateralizing a loan, exposing banking institutions to losses. Similarly, climate-related risks may impact the level and volatility of asset prices, thus affecting the value of a bank's portfolios. Severe weather events may disrupt a bank's data centers or operations and impede its ability to provide financial services to customers. Although the transmission channels through which climate risks affect banks are increasingly apparent, quantification of those risks remains challenging. To date, measurement efforts have been hampered by data gaps and methodological hurdles, many of which are unique to climate change and contribute to elevated uncertainty in estimates of climate-related risks. For instance, assessment of the potential impact of climate change on a bank may require precise data on the geolocation of a counterparty's assets and operations, as well as information on local weather patterns for those locations. It may also require knowledge of a counterparty's carbon emissions and of policies in different industries and jurisdictions. Data at this level of granularity are often unavailable or extremely difficult to acquire, presenting challenges in calculating the magnitude of climate-related financial risks. Two-thirds of respondents to a recent survey of members of the Basel Committee on Banking Supervision's Task Force on reliable data necessary to run climate risk assessment models. Filling these data gaps is critical for measuring the banking sector's exposure to climate risk and analyzing the implications for financial stability and prudential risks. Federal Reserve staff are participating in a new Network for Greening the Financial detailed list of gaps in data items at the macroeconomic level, the market level, and the financial market participant level needed to model climate risk. Climate change also poses distinct modelling challenges. The several decades over which climate risks are projected to materialize far exceed a bank's typical risk management and planning time horizon. Moreover, financial risk models are often backward-looking and extrapolate historical trends, which, in the case of climate, may be unreliable predicators of future outcomes. New tools and forward-looking approaches will be required. We continue to strengthen our understanding of how banks are measuring and managing climate risks. Over time, it will be important to develop a framework for evaluating how banks are taking into account climate-related risk in their modelling and management of credit, market, liquidity, and operational risks. Some jurisdictions have developed programs to provide banks with supervisory expectations to manage their risks associated with climate change. As a financial industry association has noted, "Climate risk analysis and measurement is--rightly--rising quickly on both the industry and regulatory agenda. Both regulators and firms want to better understand risk profiles to ensure effective management of transition and physical risks as well as potential adequacy of financial resources." We benefit from continued engagement both domestically and internationally with colleagues from other regulatory agencies, supervisory authorities, and international standard setting bodies. For instance, the Federal Reserve co-chairs the Basel Committee The TFCR is mapping the transmission channels and studying the measurement methodologies of climate-related financial risks to the banking system. It will also examine the extent to which climate-related financial risks are incorporated in the existing Basel Framework. Based on this analysis, the TFCR is charged with and is developing recommendations for effective supervisory practices to mitigate climate-related financial risks. Financial institutions can also help communities and individuals build greater resilience to climate risk. Recent research highlights the significant ways in which lower- income households and underserved areas are affected by natural disasters and climate risk. Lower-income households with low levels of liquid savings tend to be less resilient to the temporary loss of income, property damage, displacement costs, and health challenges they face from disasters. In addition, low- and moderate-income (LMI) communities are often located in areas that are particularly vulnerable to climate- related risks, have greater health-related impacts due to climate change, or have housing that is more susceptible to disaster-related damage. obligation to meet the needs of their local communities, including LMI communities. Existing CRA regulations allow banks to receive CRA credit for activities to revitalize and stabilize communities after a natural disaster has occurred in certain federally designated disaster areas. For natural disasters that have caused widespread devastation and economic impact, such as Hurricanes Katrina and Maria, the Board has worked with other banking regulators to provide CRA consideration for bank investments in stabilization and revitalization outside of a bank's assessment area or regional area. It is important to LMI communities and other underserved communities to be proactive in working to equitably mitigate the risks of climate change in advance. Reflecting this, the Federal Reserve's recent advance notice of proposed rulemaking on the CRA for the first time seeks feedback on providing CRA credit to encourage loans and investments that promote disaster preparedness and climate resilience. We want to encourage lenders to invest and rebuild in ways that will increase resilience to future climate risks in underserved and local LMI communities. We look forward to receiving comment on our questions regarding disaster preparedness and climate resilience by the A year ago, I laid out some of the important areas where climate change matters for the Federal Reserve's statutory responsibilities. making important progress in laying the groundwork to incorporate climate considerations where they are material and relevant to our statutory responsibilities, today and in the future. Across the Federal Reserve System, we have sought to deepen our understanding of the implications of climate change for the U.S. economy and financial system, including through the Virtual Seminar on Climate Economics series, internal groups focused on the emerging climate literature, and academic conferences at several Federal Reserve staff are collaborating and sharing knowledge through our System Climate Network and other forums. We have recruited economists with expertise in climate-related topics and obtained a variety of climate-related data resources. first time an analysis of the ways climate change could present risks to financial stability. how climate-related risks can create microprudential risks and how supervisors are working to better understand, measure, and mitigate these risks. Last quarter, the Federal Reserve released a CRA proposal that for the first time highlighted the importance of investing in climate resilience for LMI and underserved communities. Building on this foundation, this week the Federal Reserve Board became a full member of the NGFS. We look forward to learning from and collaborating with foreign central banks on addressing data gaps and undertaking research on the implications of climate change for financial stability and the economy. In the years ahead, there will be significant opportunities for collaboration across the U.S. regulatory agencies in strengthening the U.S. financial system to meet the challenge of climate change. Together, these efforts can help equip the deepest financial market in the world to support our dynamic private sector in assessing and addressing climate-related risks and investing in the transition.

r210108a_FOMC

united states

U.S. Economic Outlook and Monetary Policy

clarida

It is my pleasure to meet virtually with you today at the Council on Foreign I regret that we are not doing this session in person, as we did last year, and I hope the next time I am back, we will be gathering together in New York City again. I look forward to my conversation with Steve Liesman and to your questions, but first, please allow me to offer a few remarks on the economic outlook, Federal Reserve monetary policy, and our new monetary policy framework. In the second quarter of last year, the COVID-19 (coronavirus disease 2019) pandemic and the mitigation efforts put in place to contain it delivered the most severe blow to the U.S. economy since the Great Depression. Economic activity rebounded robustly in the third quarter and has continued to recover in the fourth quarter from its depressed second-quarter level, though the pace of improvement has moderated. Household spending on goods, especially durable goods, has been strong and has moved above its pre-pandemic level, supported in part by federal stimulus payments and expanded unemployment benefits. In contrast, spending on services remains well below pre-pandemic levels, particularly in sectors that typically require people to gather closely, including travel and hospitality. In the labor market, more than half of the 22 million jobs that were lost in March and April have been regained, as many people were able to return to work. Inflation, following large declines in the spring of 2020, picked up over the summer but has leveled out more recently; for those sectors that have been most adversely affected by the pandemic, price increases remain subdued. While gross domestic product growth in the fourth quarter downshifted from the once-in-a-century 33 percent annualized rate of growth reported in the third quarter, it is clear that since the spring of 2020, the economy has turned out to be more resilient in adapting to the virus, and more responsive to monetary and fiscal policy support, than many predicted. Indeed, it is worth highlighting that in the baseline projections of the Economic Projections (SEP), most of my colleagues and I revised up our outlook for the economy over the medium term, projecting a relatively rapid return to levels of employment and inflation consistent with the Federal Reserve's statutory mandate as In particular, the median FOMC participant projects that by the end of 2023--a little less than three years from now--the unemployment rate will have fallen below 4 percent, and PCE (personal consumption expenditures) inflation will have returned to 2 percent. Following the GFC, it took more than eight years for employment and inflation to return to similar mandate- consistent levels. While the recent surge in new COVID cases and hospitalizations is cause for concern and a source of downside risk to the very near-term outlook, the welcome news on the development of several effective vaccines indicates to me that the prospects for the economy in 2021 and beyond have brightened and the downside risk to the outlook has diminished. The two new SEP charts that we released for the first time following the December FOMC meeting speak to these issues by providing information on how the risks and uncertainties that surround the modal or baseline projections have evolved over time. While nearly all participants continued to judge that the level of uncertainty about the economic outlook remains elevated, fewer participants saw the balance of risks as weighted to the downside than in September. Although a little more than half of participants judged risks to be broadly balanced for economic activity, a similar number continued to see risks weighted to the downside for inflation. At our most recent FOMC meetings, the Committee made important changes to our policy statement that upgraded our forward guidance about the future path of the federal funds rate and asset purchases, and that also provided unprecedented information about our policy reaction function. As announced in the September statement and reiterated in November and December, with inflation running persistently below 2 percent, our policy will aim to achieve inflation outcomes that keep inflation expectations well anchored at our 2 percent longer-run goal. We expect to maintain an accommodative stance of monetary policy until these outcomes--as well as our maximum-employment mandate--are achieved. We also expect it will be appropriate to maintain the current target range for the federal funds rate at 0 to 1/4 percent until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment, until inflation has risen to 2 percent, and until inflation is on track to moderately exceed 2 percent for some time. In addition, in the December statement, we combined our forward guidance for the federal fund rate with enhanced, outcome-based guidance about our asset purchases. We indicated that we will continue to increase our holdings of Treasury securities by at least $80 billion per month and our holdings of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward our maximum-employment and price-stability goals. The changes to the policy statement that we made over the fall bring our policy guidance in line with the new framework outlined in the revised Statement on Longer- our new framework, we acknowledge that policy decisions going forward will be based on the FOMC's estimates of " shortfalls [emphasis added] of employment from its maximum level"--not "deviations." This language means that going forward, a low unemployment rate, in and of itself, will not be sufficient to trigger a tightening of monetary policy absent any evidence from other indicators that inflation is at risk of moving above mandate-consistent levels. With regard to our 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 in a world in which an effective-lower-bound constraint is, in downturns, binding on the federal funds rate. To this end, the new statement conveys the Committee's judgment that, in order to anchor expectations at the 2 percent level consistent with price stability, 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." As Chair Powell indicated in his Jackson Hole remarks, we think of our new framework as an evolution from "flexible inflation targeting" to "flexible average inflation targeting." While this new framework represents a robust evolution in our monetary policy strategy, this strategy is in service to the dual-mandate goals of monetary policy assigned to the Federal Reserve by the Congress--maximum employment and price stability--which remain unchanged. While our interest rate and balance sheet tools are providing powerful support to the economy and will continue to do so as the recovery progresses, it will take some time for economic activity and employment to return to levels that prevailed at the business cycle peak reached last February. We are committed to using our full range of tools to support the economy and to help ensure that the recovery from this difficult period will be as robust as possible.

r210112a_FOMC

united states

Supporting Responsible Use of AI and Equitable Outcomes in Financial Services

brainard

Today's symposium on the use of artificial intelligence (AI) in financial services is part of the Federal Reserve's broader effort to understand AI's application to financial services, assess methods for managing risks arising from this technology, and determine where banking regulators can support responsible use of AI and equitable outcomes by improving supervisory clarity. The potential scope of AI applications is wide ranging. For instance, researchers are turning to AI to help analyze climate change, one of the central challenges of our time. With nonlinearities and tipping points, climate change is highly complex, and quantification for risk assessments requires the analysis of vast amounts of data, a task for which the AI field of machine learning is particularly well-suited. The journal recently reported the development of an AI network which could "vastly accelerate efforts to understand the building blocks of cells and enable quicker and more advanced drug discovery" by accurately predicting a protein's 3-D shape from its amino acid sequence. In November 2018, I shared some early observations on the use of AI in financial services. Since then, the technology has advanced rapidly, and its potential implications have come into sharper focus. Financial firms are using or starting to use AI for operational risk management as well as for customer-facing applications. Interest is growing in AI to prevent fraud and increase security. Every year, consumers bear significant losses from frauds such as identity theft and imposter scams. According to the Federal Trade Commission, in 2019 alone, "people reported losing more than $1.9 billion to fraud," which represents a mere fraction of all fraudulent activity banks encounter. AI-based tools may play an important role in monitoring, detecting, and preventing such fraud, particularly as financial services become more digitized and shift to web-based platforms. Machine learning-based fraud detection tools have the potential to parse through troves of data--both structured and unstructured--to identify suspicious activity with greater accuracy and speed, and potentially enable firms to respond in real time. Machine learning models are being used to analyze traditional and alternative data in the areas of credit decisionmaking and credit risk analysis, in order to gain insights that may not be available from traditional credit assessment methods and to evaluate the creditworthiness of consumers who may lack traditional credit histories. Bureau has found that approximately 26 million Americans are credit invisible, which means that they do not have a credit record, and another 19.4 million do not have sufficient recent credit data to generate a credit score. Black and Hispanic consumers are notably more likely to be credit invisible or to have an unscored record than White consumers. Federal Advisory Council, which includes a range of banking institutions from across the country, recently noted that nontraditional data and the application of AI have the potential "to improve the accuracy and fairness of credit decisions while also improving overall credit To harness the promise of machine learning to expand access to credit, especially to underserved consumers and businesses that may lack traditional credit histories, it is important to be keenly alert to potential risks around bias and inequitable outcomes. For example, if AI models are built on historical data that reflect racial bias or are optimized to replicate past decisions that may reflect bias, the models may amplify rather than ameliorate racial gaps in access to credit. Along those same lines, the opaque and complex data interactions relied upon by AI could result in discrimination by race, or even lead to digital redlining, if not intentionally designed to address this risk. It is our collective responsibility to ensure that as we innovate, we build appropriate guardrails and protections to prevent such bias and ensure that AI is designed system that is affecting people's lives has to be explicitly built to focus on increasing equity and not just optimizing for efficiency...[W]e need to make sure that we put guidelines in place to maximize the chances of the positive impact while protecting people who have been traditionally marginalized in society and may be affected negatively by the new AI systems." Recognizing the potential and the pitfalls of AI, let us turn to one of the central challenges to using AI in financial services--the lack of model transparency. Some of the more complex machine learning models, such as certain neural networks, operate at a level of complexity that offers limited or no insight into how the model works. This is often referred to as the "black box problem," because we can observe the inputs the models take in, and examine the predictions or classifications the model makes based on those inputs, but the process for getting from inputs to outputs is obscured from view or very hard to understand. There are generally two reasons machine learning models tend toward opacity. The first is that an algorithm rather than a human being "builds" the model. Developers write the initial algorithm and feed it with the relevant data, but do not specify how to solve the problem at hand. The algorithm uses the input data to estimate a potentially complex model specification, which in turn make predictions or classifications. As Michael Tyka puts it, "[t]he problem is that the knowledge gets baked into the network, rather than into us. Have we really understood This is somewhat different from traditional econometric or other statistical models, which are designed and specified by humans. The second is that some machine learning models can take into account more complex nonlinear interactions than most traditional models in ways that human beings would likely not be able to identify on their own. The ability to identify subtle and complex patterns is what makes machine learning such a powerful tool, but that complexity often makes the model inscrutable and unintuitive. Hod Lipson likens it to "meeting an intelligent species whose eyes have receptors [not] just for the primary colors red, green, and blue, but also for a fourth color. It would be very difficult for humans to understand how the alien sees the world, and for the alien to explain it to us." While the black box problem is formidable, it is not, in many cases, insurmountable. The AI research community has made notable strides in explaining complex machine learning models--indeed, some of our symposium panelists have made major contributions to that effort. One important conclusion of that work is that there need not be a single principle or one-size- fits-all approach for explaining machine learning models. Explanations serve a variety of purposes, and what makes a good explanation depends on the context. In particular, for an explanation to "solve" the black box problem, it must take into account who is asking the question and what the model is predicting. So what do banks need from machine learning explanations? The requisite level and type of explainability will depend, in part, on the role of the individual using the model. The bank employees that interact with machine learning models will naturally have varying roles and varying levels of technical knowledge. An explanation that requires the knowledge of a PhD in math or computer science may be suitable for model developers, but may be of little use to a compliance officer, who is responsible for overseeing risk management across a wide swath of bank operations. The level and type of explainability also depends on the model's use. In the consumer protection context, consumers' needs and fairness may define the parameters of the explanation. Importantly, consumer protection laws require lenders who decline to offer a consumer credit-- or offer credit on materially worse terms than offered to others--to provide the consumer with an explanation of the reasons for the decision. That explanation serves the important purposes of helping the consumer to understand the basis of the determination as well as the steps the consumer could take to improve his or her credit profile. Additionally, to ensure that the model comports with fair lending laws that prohibit discrimination, as well as the prohibition against unfair or deceptive practices, firms need to understand the basis on which a machine learning model determines creditworthiness. Unfortunately, we have seen the potential for AI models to operate in unanticipated ways and reflect or amplify bias in society. There have been several reported instances of AI models perpetuating biases in areas ranging from lending and hiring to facial recognition and even healthcare. For example, a 2019 study by Science revealed that an AI risk-prediction model used by the U.S. healthcare system was fraught with racial bias. The model, designed to identify patients that would likely need high-risk care management in the future, used patients' historical medical spending to determine future levels of medical needs. However, the historical spending data did not serve as a fair proxy, because "less money is spent on Black patients who have the same level of need, and the algorithm thus falsely concludes that Black patients are healthier than equally sick White patients." Thus, it is critical to be vigilant for the racial and other biases that may be embedded in data sources. It is also possible for the complex data interactions that are emblematic of AI--a key strength when properly managed--to create proxies for race or other protected characteristics, leading to biased algorithms that discriminate. For example, when consumers obtain information about credit products online, the complex algorithms that target ads based on vast amounts of data, such as where one went to school, consumer likes, and online browsing habits, may be combined in ways that indicate race, gender, and other protected characteristics. Even after one online platform implemented new safeguards pursuant to a settlement to address the potential exclusion of consumers from seeing ads for credit products based on race, gender, or other protected characteristics, Professor Alan Mislove and his collaborators have found that the complex algorithms may still result in bias and exclusion. Therefore, it is important to understand how complex data interactions may skew the outcomes of algorithms in ways that undermine fairness and transparency. , notes that "...[I]t is of paramount importance that policymakers, regulators, financial institutions, and technologists critically examine the benefits, risks, and limitations of AI and proactively design safeguards against algorithmic harm, in keeping with societal standards, expectations, and legal protections." I am pleased that the symposium includes talks from scholars who are studying how we can design AI models that avoid bias and promote financial inclusion. No doubt everyone here today who is exploring AI wants to promote financial inclusion and more equitable outcomes and ensure that it complies with fair lending and other laws designed to protect consumers. In the safety and soundness context, bank management needs to be able to rely on models' predictions and classifications to manage risk. They need to have confidence that a model used for crucial tasks such as anticipating liquidity needs or trading opportunities is robust and will not suddenly become erratic. For example, they need to be sure that the model would not make grossly inaccurate predictions when it confronts inputs from the real world either that differ in some subtle way from the training data or that are based on a highly complex interaction of the data features. In short, they need to be able to have confidence that their models are robust. Explanations can be an important tool in providing that confidence. Not all contexts require the same level of understanding of how machine learning models work. Users may, for example, have a much greater tolerance for opacity in a model that is used as a "challenger" to existing models and simply prompts additional questions for a bank employee to consider relative to a model that automatically triggers bank decisions. For instance, in liquidity or credit risk management, where AI may be used to test the outcomes of a traditional model, banks may appropriately opt to use less transparent machine learning systems. Researchers have developed various approaches to explaining machine learning models. Often, these approaches vary in terms of the type of information they can provide about a model. As banks contemplate using these tools, they should consider what they need to understand about their models relative to the context, in order to determine whether there is sufficient transparency in how the model works to properly manage the risk at issue. Not all machine learning models are a black box. In fact, some machine learning models are fully "interpretable" and therefore may lend themselves to a broader array of use cases. By "interpretable" I mean that developers can "look under the hood" to see how those models make their predictions or classifications, similar to traditional models. They can examine how much weight the model gives to each data feature, and how it plays into a given result. Interpretable machine learning models are intrinsically explainable. In the case of machine learning models that are opaque, and not directly interpretable, researchers have developed techniques to probe these models' decisions based on how they behave. These techniques are often referred to as model agnostic methods, because they can be used on any model, regardless of the level of explainability. Model agnostic methods do not access the inner workings of the AI model being explained. Instead, they derive their explanations post hoc based on the model's behavior: essentially, they vary inputs to the AI model, and analyze how the changes affect the AI model's outputs. In effect, a model agnostic method uses this testing as data to create a model of the AI model. While post hoc explanations generated by model agnostic methods can allow inferences to be drawn in certain circumstances, they may not always be accurate or reliable, unlike intrinsic explanations offered by interpretable models. Basing an explanation on a model's behavior rather than its underlying logic in this way may raise questions about the explanation's accuracy, as compared to the explanations of interpretable models. Still, such explanations may be suitable in certain contexts. Thus, one of the key questions banks will face is when a post hoc explanation of "black box" model is acceptable versus when an interpretable model is necessary. To be sure, having an accurate explanation for how a machine learning model works does not by itself guarantee that the model is reliable or fosters financial inclusion. Time and experience are also significant factors in determining whether models are fit to be used. The boom-bust cycle that has defined finance for centuries should make us cautious in relying fully for highly consequential decisions on any models that have not been tested over time or on source data with limited history, even if in the age of big data, these data sets are broad in scope. Recognizing that AI presents promise and pitfalls, as a banking regulator, the Federal Reserve is committed to supporting banks' efforts to develop and use AI responsibly to promote a safe, fair, and transparent financial services marketplace. As regulators, we are also exploring and understanding the use of AI and machine learning for supervisory purposes, and therefore, we too need to understand the different forms of explainability tools that are available and their implications. To ensure that society benefits from the application of AI to financial services, we must understand the potential benefits and risks, and make clear our expectations for how the risks can be managed effectively by banks. Regulators must provide appropriate expectations and adjust those expectations as the use of AI in financial services and our understanding of its potential and risks evolve. To that end, we are exploring whether additional supervisory clarity is needed to facilitate responsible adoption of AI. It is important that we hear from a wide range of stakeholders-- including financial services firms, technology companies, consumer advocates, civil rights groups, merchants and other businesses, and the public. The Federal Reserve has been working with the other banking agencies on a possible interagency request for information on the risk management of AI applications in financial services. Today's symposium serves to introduce a period of seeking input and hearing feedback from a range of external stakeholders on this topic. It is appropriate to be starting with the academic community that has played a central role in developing and scrutinizing AI technologies. I look forward to hearing our distinguished speakers' insights on how banks and regulators should think about the opportunities and challenges posed by AI.

r210113b_FOMC

united states

Full Employment in the New Monetary Policy Framework

brainard

I want to thank the Canadian Association for Business Economics for inviting me to join you today, particularly president Bonnie Lemcke and past president Armine Yalnizyan. It is a pleasure to be here with Carolyn Wilkins. I am honored to deliver the inaugural Mike McCracken Lecture on Full Widely known for his critical contributions in bringing computer modeling to Canadian economic forecasting, Mike McCracken is perhaps best known for his tireless advocacy that "lower unemployment remains the most important goal for the economy," which is particularly resonant for me, along with his emphasis on thinking critically and expansively about full employment. A similar theme was highlighted by community and labor representatives as well as educators at our events, and it is now reflected in the Federal Reserve's new monetary policy framework. Lifting the lives of working people is at the heart of economic policymaking. The deep and disparate damage caused by the pandemic, coming just over a decade after the financial crisis, underscores the vital importance of full employment, particularly for low- and moderate-income workers and those facing systemic challenges in the labor market. Two years ago, the Federal Reserve began an in-depth review of its monetary policy framework. The design of our review process incorporated features from the quinquennial renewal of its inflation-control framework agreement, such as input from stakeholders and the focused research undertaken by staff members, academics, and outside experts. Our review was prompted by changes in key long-run features of the economy: The recognition that price inflation is much less sensitive to labor market tightness than historically--that is, a flat Phillips curve; that the equilibrium interest rate is much lower than in the past; and that trend underlying inflation has moved somewhat below 2 percent. These developments reduce the amount we can cut interest rates to buffer the economy, weaken inflation expectations, and could lead to worse employment and inflation outcomes over time if not addressed. In response, we have made changes to monetary policy that can be expected to support fuller and broader-based employment than in earlier recoveries, improving opportunities for workers who have faced structural challenges in the labor market. Whereas our previous strategy had been to minimize deviations from maximum employment in either direction, monetary policy will now seek to eliminate shortfalls from maximum employment. In other words, the new framework calls for policy to address employment when it falls short of its maximum level, whereas the previous framework called for policy to react when employment was judged to be too high as well as too low. The new monetary policy framework also eliminates the previous reference to a numerical estimate of the longer-run normal unemployment rate and instead defines the maximum level of employment as a broad-based and inclusive goal for which a wide range of indicators are relevant. Additional changes address the persistence of below-target inflation and the decline in the equilibrium interest rate. Research and experience indicate that persistent low equilibrium interest rates increase the frequency and duration of periods when the policy rate is pinned close to zero, unemployment is elevated, and inflation is below target. As a result, actual inflation and inflation expectations will tend to be biased below the 2 percent target, further eroding policy space and exacerbating the effects of the lower bound, risking a downward spiral for actual and expected inflation. From the inflation objective in January 2012 through the most recent data in November, monthly readings of 12-month personal consumption expenditure (PCE) inflation have averaged 1.4 percent and have been below 2 percent in 95 out of the 107 months. To address the downward bias, the new framework adopts a flexible average inflation-targeting strategy (FAIT) 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. Under a FAIT strategy, appropriate monetary policy aims to achieve inflation moderately above 2 percent for some time to make up for shortfalls during a period when it has been running persistently below 2 percent. These changes could have a beneficial effect on the robustness of employment as well as the economy's potential growth rate. In current circumstances, where a strong labor market can be sustained without the emergence of high inflation, the conventional practice of reducing policy accommodation preemptively when unemployment nears its estimated longer-run normal rate is likely to lead to an unwarranted loss of opportunity for many workers. For instance, the labor market healing that took place after the unemployment rate reached the 5 percent median Summary of Economic Projections estimate of the longer-run normal unemployment rate, from the fourth quarter of 2015 until the fourth quarter of 2019, included 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. The gains in employment may have come sooner and been greater if the new monetary policy framework had been in place throughout the previous recovery. The new policy approach, by avoiding the need to tighten preemptively, could support labor market conditions that help to reduce persistent disparities. This could, in turn, boost activity and increase potential growth by drawing individuals from groups facing structural challenges into more productive employment. 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. event, Amanda Cage, who now heads the National Fund for Workforce Solutions, observed, "What we see is huge disparities in what unemployment looks like for She highlighted the challenges facing those communities where unemployment remains at or above 15 percent even when unemployment falls below 4 percent at the national level. Recent research indicates that additional labor market tightening is especially beneficial to disadvantaged groups when it occurs in already tight labor markets, compared with earlier in the labor market cycle. For example, the gap between the Black and White unemployment rates fell to an all-time low of 2 percentage points in August 2019--well below its average of 6.3 percentage points. Late last year, the Committee integrated the framework changes into its monetary policy. The September 2020 FOMC statement adopted outcome-based forward guidance for the policy rate tied to shortfalls from maximum employment and 2 percent average inflation, and the December 2020 FOMC statement adopted outcome-based forward guidance for asset purchases. Our monetary policy approach should support a stronger, broader-based recovery from the deep and disparate damage of COVID-19. The guidance indicates that the Committee expects the policy rate to remain at the lower bound until employment has reached levels consistent with the Committee's assessments of maximum employment, and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. The forward guidance reflects the important lesson that, with a significantly smaller scope to cut the policy rate than in past recessions, the Committee can provide needed accommodation by making forward commitments on the policy rate that are credible to the public. The outcome-based forward guidance communicates how the policy rate will react to the evolution of inflation and employment. It makes clear that the timing of liftoff will depend on realized progress toward maximum employment and 2 percent average inflation. The FOMC statement notes that monetary policy will remain accommodative after liftoff in order to achieve "inflation moderately above 2 percent for some time so that inflation averages 2 percent over time." Even after economic conditions warrant liftoff, changes in the policy rate are likely to be only gradual to support the inflation makeup strategy and maximum employment. Market expectations appear to have adjusted in response to the changes in the Bank of New York indicates a shift in expectations following the release of the new monetary policy framework. The median expected rate of unemployment at the time of liftoff moved down from 4.5 percent in the July survey, before the release of the framework, to 4.0 percent in the September and subsequent surveys, following the release of the new framework. Similarly, the median level of 12-month PCE inflation anticipated at the time of liftoff rose from 2 percent in the July survey to 2.3 percent in the September survey and beyond, following the introduction of FAIT. The forward guidance adopted in December expands the goals of the asset purchases beyond market functioning by establishing qualitative outcome-based criteria tied to realized progress on our employment and inflation goals. This approach integrates the forward guidance on the policy rate and on asset purchases, rather than establishing distinct criteria. The December guidance clarifies that the pandemic asset purchases will continue at least at the current pace until substantial further progress is made on our employment and inflation goals. In assessing substantial further progress, I will be looking for sustained improvements in realized and expected inflation and will examine a range of indicators to assess shortfalls from maximum employment. If we look ahead, effective vaccines and additional fiscal support are important positive developments, but the near-term outlook is challenging due to the resurgence of the pandemic, and the economy remains far from our goals. The most recent spending indicators point to a considerable loss of momentum late in the fourth quarter. Sales of consumer durable goods--such as furniture, electronics, and appliances--declined in November, after surging since the spring. The rise in cases in November and the associated social distancing resulted in a decline in already low services consumption, with sales at restaurants and bars falling by 4 percent, the largest drop since April. Continued social distancing over the cold winter months is likely to generate a significant drag for spending on services that require personal contact. Additionally, state and local income and sales tax and gaming and energy-related revenues remain depressed, and the most recent payrolls report indicates that state and local governments are having difficulty sustaining employment levels as the virus persists. Inflation remains very low; core PCE inflation ran at 1.4 percent over the 12 months ending in November. Even though some of the survey-based measures of inflation expectations have picked up recently, they still remain close to the lower end of their historical ranges. Market-based measures of inflation compensation have also picked up. While disentangling inflation expectations from liquidity and term premiums is imprecise, staff models attribute a significant portion of the movement in inflation compensation to an increase in expectations, bringing them up from the lows seen in March but still below their historical averages. Inflation may temporarily rise to or above 2 percent on a 12-month basis in a few months when the low March and April price readings from last year fall out of the 12-month calculation, but it will be important to see sustained improvement to meet our average inflation goal. The COVID-19 pandemic is exacerbating disparities, and employment remains far from our goals. Last Friday's payroll report highlighted the effects of the resurgence of the virus, with the first overall decline in payrolls since April and a stark 498,000 decline in leisure and hospitality jobs. Overall, payroll employment is still nearly 10 million jobs below its February level. If we adjust the 6.7 percent headline unemployment rate for the decline in participation since February and the Bureau of Labor Statistics estimate of misclassification, the unemployment rate would be 10 percent, similar to the peak following the Global Financial Crisis. The damage from COVID-19 is concentrated among already challenged groups. Federal Reserve staff analysis indicates that unemployment is likely above 20 percent for workers in the bottom wage quartile, while it has fallen below 5 percent for the top wage quartile. respectively, in December, while White unemployment was 6.0 percent. Labor force participation for prime-age workers has declined, particularly for parents of school-aged children, where the declines have been greater for women than for men, and greater for Black and Hispanic mothers than for White mothers. The K-shaped recovery remains highly uneven, with certain sectors and groups experiencing substantial hardship. All told, real gross domestic product likely declined by about 2-1/2 percent in 2020, with the damage concentrated disproportionately among some groups of workers and sectors as well as smaller businesses. Fortunately, fiscal support looks set to resume playing a vital role in the form of stimulus payments and extended unemployment benefits, particularly for the cash-constrained households that make up a significant fraction of the population. The additional Paycheck Protection Program financing will be a vital support for the many hard-hit small businesses facing continued revenue shortfalls and declining cash balances. The damage would have been much greater in the absence of substantial fiscal and monetary support. The unprecedented scale and composition of fiscal support made a vital difference in replacing lost income and supporting demand in the middle of last year and is expected to do so again in the months ahead. The unprecedented speed and breadth of the monetary policy response through an expanded set of tools is supporting lower borrowing costs along the yield curve for households and businesses as well as better inflation and employment outcomes. The outlook will depend on the path of the virus and vaccinations. While the number of new cases is high and rising, the distribution of multiple effective vaccines is under way. Spending on in-person services is likely to return to pre-pandemic levels only as conditions around the virus improve substantially. Most forecasts predict a significant rebound in aggregate spending this year. And there is some risk to the upside if the efficient delivery of vaccines across many jurisdictions ultimately results in a globally synchronized expansion. We are strongly committed to achieving our maximum-employment and average- inflation goals. It is too early to say how long it will take. The Committee has stated clearly that it needs to see substantial further progress toward our goals before adjusting purchases. The economy is far away from our goals in terms of both employment and inflation, and even under an optimistic outlook, it will take time to achieve substantial further progress. Given my baseline outlook, I expect that the current pace of purchases will remain appropriate for quite some time. Of course, the outlook is highly uncertain, and forecasts are subject to revisions--a key reason why our forward guidance is outcome based and tied to realized progress on our goals. The recovery thus far has been uneven, and the path ahead is uncertain. We remain far from our goals, with core PCE inflation only at 1.4 percent and payroll employment nearly 10 million below its pre-pandemic level. The Committee's forward guidance will help keep borrowing costs low along the yield curve for households and businesses, improve inflation outcomes, and enable the labor market to heal, leading to a broader-based and stronger recovery. The strong support from monetary policy, together with fiscal stimulus, should turn the K-shaped recovery into a broad-based and inclusive recovery that delivers full employment, as Mike McCracken would have wished. Thank you.

r210113a_FOMC

united states

The Federal Reserve's New Framework: Context and Consequences

clarida

At its September and December FOMC meetings, the Committee made material changes to its forward guidance to bring it into line with the new policy framework. Before I discuss the new framework in detail and the policy implications that flow from it, please allow me to provide some background on the reasons the Committee felt that our framework needed to evolve. 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 were 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 released in December, the median FOMC participant currently projects a longer-run r* equal to just 0.5 percent, consistent with a neutral setting for the federal funds rate of 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. This 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 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. The 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's research with Thomas Mertens. 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. Six features of the new framework and fall 2020 FOMC statements define how the Committee will seek to achieve its price-stability and maximum-employment mandates over time. First, the Committee expects to delay liftoff from the ELB until PCE (personal consumption expenditures) inflation has risen to 2 percent and other complementary conditions, consistent with achieving this goal on a sustained basis, have also been met. Second, with inflation having run persistently below 2 percent, the Committee will aim to achieve inflation moderately above 2 percent for some time in the service of keeping longer-term inflation expectations well anchored at the 2 percent longer-run goal. Third, the Committee expects that appropriate monetary policy will remain accommodative for some time after the conditions to commence policy normalization have been met. Fourth, policy will aim over time to return inflation to its longer-run goal, which remains 2 percent, but not below, once the conditions to commence policy normalization have been met. Fifth, inflation that averages 2 percent over time represents an ex ante aspiration of the FOMC, but not a time-inconsistent ex post commitment. As I highlighted in a speech at the Brookings Institution in November, I believe that a useful way to summarize the framework defined by these five features is temporary price-level targeting (TPLT, at the ELB) that reverts to flexible inflation targeting (once the conditions for liftoff have been reached). Just such a framework has been analyzed by Bernanke, Kiley, and Roberts (2019) and Bernanke (2020), who in turn build on earlier work by Evans (2012), Reifschneider and Williams (2000), and Eggertsson and Woodford (2003). Each of these five elements of the new framework is consequential. I now discuss each in turn and provide some context for how I understand them to relate to the monetary economics literature on TPLT. A policy that delays liftoff from the ELB until a threshold for average inflation has been reached is one element of a TPLT strategy. Starting with our September FOMC statement, we communicated that inflation reaching 2 percent is a necessary condition for liftoff from the ELB. This condition refers to inflation on an annual basis. TPLT with such a one-year memory has been studied by Bernanke, Kiley, and Roberts (2019). The FOMC also indicated in these statements that the Committee expects to delay liftoff until inflation is "on track to moderately exceed 2 percent for some time." What "moderately" and "for some time" mean will depend on the initial conditions at liftoff (just as they do under other versions of TPLT), and the Committee's judgment on the projected duration and magnitude of the deviation from the 2 percent inflation goal will be communicated in the quarterly SEP for inflation. In the TPLT studies I cited earlier, policy is assumed to revert to an inertial Taylor rule after liftoff, and therefore policy remains accommodative for some time thereafter, which depends on the degree of policy inertia in the reaction function. Our three most recent FOMC statements also call for policy to remain accommodative for some time after liftoff, and, once the conditions to commence policy normalization have been met, the SEP "dot plot" will convey the Committee's projections for the pace of liftoff as well as the ultimate destination for the policy rate. Our new framework is asymmetric. That is, as in the previously cited TPLT studies, the goal of monetary policy after lifting off from the ELB is to return inflation to its 2 percent longer-run goal, but not to push inflation below 2 percent. In the case of the Federal Reserve, we have highlighted that making sure that inflation expectations remain anchored at our 2 percent objective is just such a consideration. Speaking for myself, I follow closely the Fed staff's index of common inflation expectations (CIE) as a relevant indicator that this goal is being met (see the figure). Other things being equal, my desired pace of policy normalization post-liftoff to return inflation to 2 percent--as well as the projected pace of return to 2 percent inflation--would be somewhat slower than otherwise if the CIE index is, at time of liftoff, below the pre-ELB level. Another factor I will consider in calibrating the pace of policy normalization post-liftoff is the average rate of PCE inflation since the new framework was adopted in August 2020--a time, as it happened, when the federal funds rate was constrained at the ELB. Our framework aims ex ante for inflation to average 2 percent over time, but it does not make a (time-inconsistent) commitment to achieve ex post inflation outcomes that average 2 percent under any and all circumstances. The same is true for the TPLT studies I cited earlier. In these studies, the only way in which average inflation enters the policy rule is through the timing of liftoff itself. Yet in stochastic simulations of the FRB/US model under TPLT with a one-year memory that reverts to flexible inflation targeting after liftoff, inflation does average very close to 2 percent (see the table). The model of Mertens and Williams (2019) delivers a similar outcome: Even though the policy reaction function in their model does not incorporate an ex post makeup element, it delivers a long-run (unconditional) average rate of inflation equal to target by aiming for a moderate inflation overshoot away from the ELB that is calibrated to offset the inflation shortfall caused by the ELB. Regarding our maximum-employment mandate--a sixth element--an important evolution in our new framework is that the Committee now defines maximum employment as the highest level of employment that does not generate sustained pressures that put the price-stability mandate at risk. As a practical matter, this definition means to me that when the unemployment rate is elevated relative to my SEP forecast of its long-run natural level, monetary policy should, as before, continue to be calibrated to eliminate such employment shortfalls so long as doing so does not put the price-stability mandate at risk. Indeed, in our September and subsequent FOMC statements, we indicated that we expect it will be appropriate to keep the federal funds rate in the current 0 to 25 basis point target range until inflation has reached 2 percent (on an annual basis) and labor market conditions have reached levels consistent with the Committee's assessment of maximum employment. In our new framework, when in a business cycle expansion labor market indicators return to a range that, in the Committee's judgment, is broadly consistent with its maximum-employment mandate, it will be data on inflation itself that policy will react to, but going forward, policy will not tighten solely because the unemployment rate has fallen below any particular econometric estimate of its long-run natural level. This guidance has an important implication for the Taylor-type policy reaction function I will consult. Consistent with our new framework, the relevant policy rule benchmark I will consult once the conditions for liftoff have been met is an inertial Taylor-type rule with a coefficient of zero on the unemployment gap, a coefficient of 1.5 on the gap between core PCE inflation and the 2 percent longer-run goal, and a neutral real policy rate equal to my SEP forecast of long- run r*. Such a reference rule, which becomes relevant once the conditions for policy normalization have been met, is similar to the forward-looking Taylor-type rule for optimal monetary policy derived in Clarida, Gali, and Gertler (1999). In closing, I think of our new flexible average inflation-targeting framework as a combination of TPLT at the ELB with flexible inflation targeting, to which TPLT reverts once the conditions to commence policy normalization articulated in our most recent FOMC statement have been met. In this sense, our new framework indeed represents an evolution, not a revolution. Thank you very much, and I now look forward--as always-- to the discussion with the participants in this virtual Hoover event. . vol. 109 . speech delivered at "The Economy and Monetary Policy," an event hosted by the . vol. 37 no. 1, . and Banking . vol. 32

r210210a_FOMC

united states

Getting Back to a Strong Labor Market

powell

Today I will discuss the state of our labor market, from the recent past to the present and then over the longer term. A strong labor market that is sustained for an extended period can deliver substantial economic and social benefits, including higher employment and income levels, improved and expanded job opportunities, narrower economic disparities, and healing of the entrenched damage inflicted by past recessions on individuals' economic and personal well-being. At present, we are a long way from such a labor market. Fully realizing the benefits of a strong labor market will take continued support from both near-term policy and longer-run investments so that all those seeking jobs have the skills and opportunities that will enable them to contribute to, and share in, the benefits of prosperity. We need only look to February of last year to see how beneficial a strong labor market can be. The overall unemployment rate was 3.5 percent, the lowest level in a half-century. The unemployment rate for African Americans had also reached historical lows (figure 1). Prime-age labor force participation was the highest in over a decade, and a high proportion of households saw jobs as "plentiful." Overall wage growth was moderate, but wages were rising more rapidly for earners on the lower end of the scale. These encouraging statistics were reaffirmed and given voice by those we met and conferred with, including the community, labor, and business leaders; retirees; students; and others we met with during the 14 events we conducted in 2019. Many of these gains had emerged only in the later years of the expansion. The labor force participation rate, for example, had been steadily declining from 2008 to 2015 even as the recovery from the Global Financial Crisis unfolded. In fact, in 2015, prime- age labor force participation--which I focus on because it is not significantly affected by the aging of the population--reached its lowest level in 30 years even as the unemployment rate declined to a relatively low 5 percent. Also concerning was that much of the decline in participation up to that point had been concentrated in the population without a college degree (figure 2). At the time, many forecasters worried that globalization and technological change might have permanently reduced job opportunities for these individuals, and that, as a result, there might be limited scope for participation to recover. Fortunately, the participation rate after 2015 consistently outperformed expectations, and by the beginning of 2020, the prime-age participation rate had fully reversed its decline from the 2008-to-2015 period. Moreover, gains in participation were concentrated among people without a college degree. Given that U.S. labor force participation has lagged relative to other advanced economy nations, this progress was As I mentioned, we also saw faster wage growth for low earners once the labor market had strengthened sufficiently. Nearly six years into the recovery, wage growth for the lowest earning quartile had been persistently modest and well below the pace enjoyed by other workers. At the tipping point of 2015, however, as the labor market continued to strengthen, the trend reversed, with wage growth for the lowest quartile consistently and significantly exceeding that of other workers (figure 4). At the end of 2015, the Black unemployment rate was still quite elevated, at 9 percent, despite the relatively low overall unemployment rate. But that disparity too began to shrink; as the expansion continued beyond 2015, Black unemployment reached a historic low of 5.2 percent, and the gap between Black and white unemployment rates was the narrowest since 1972, when data on unemployment by race started to be collected. Black unemployment has tended to rise more than overall unemployment in recessions but also to fall more quickly in expansions. Over the course of a long expansion, these persistent disparities can decline significantly, but, without policies to address their underlying causes, they may increase again when the economy ultimately turns down. These late-breaking improvements in the labor market did not result in unwanted upward pressures on inflation, as might have been expected; in fact, inflation did not even rise to 2 percent on a sustained basis. There was every reason to expect that the labor market could have strengthened even further without causing a worrisome increase in inflation were it not for the onset of the pandemic. The state of our labor market today could hardly be more different. Despite the surprising speed of recovery early on, we are still very far from a strong labor market whose benefits are broadly shared. Employment in January of this year was nearly 10 million below its February 2020 level, a greater shortfall than the worst of the Great After rising to 14.8 percent in April of last year, the published unemployment rate has fallen relatively swiftly, reaching 6.3 percent in January. But published unemployment rates during COVID have dramatically understated the deterioration in the labor market. Most importantly, the pandemic has led to the largest 12-month decline in labor force participation since at least 1948. Fear of the virus and the disappearance of employment opportunities in the sectors most affected by it, such as restaurants, hotels, and entertainment venues, have led many to withdraw from the workforce. At the same time, virtual schooling has forced many parents to leave the work force to provide all-day care for their children. All told, nearly 5 million people say the pandemic prevented them from looking for work in January. In addition, the Bureau of Labor Statistics reports that many unemployed individuals have been misclassified as employed. Correcting this misclassification and counting those who have left the labor force since last February as unemployed would boost the unemployment rate to close to 10 percent in January Unfortunately, even those grim statistics understate the decline in labor market conditions for the most economically vulnerable Americans. Aggregate employment has declined 6.5 percent since last February, but the decline in employment for workers in the top quartile of the wage distribution has been only 4 percent, while the decline for the bottom quartile has been a staggering 17 percent (figure 7). Moreover, employment for these workers has changed little in recent months, while employment for the higher-wage groups has continued to improve. Similarly, the unemployment rates for Blacks and Hispanics have risen significantly more than for whites since February 2020 (figure 8). As a result, economic disparities that were already too wide have widened further. In the past few months, improvement in labor market conditions stalled as the rate of infections sharply increased. In particular, jobs in the leisure and hospitality sector dropped over 1/2 million in December and a further 61,000 in January. The recovery continues to depend on controlling the spread of the virus, which will require mass vaccinations in addition to continued vigilance in social distancing and mask wearing in the meantime. Since the onset of the pandemic, we have been concerned about its longer-term effects on the labor market. Extended periods of unemployment can inflict persistent damage on lives and livelihoods while also eroding the productive capacity of the economy. And we know from the previous expansion that it can take many years to reverse the damage. At the start of the pandemic, the increase in unemployment was almost entirely due to temporary job losses. Temporarily laid-off workers tend to return to work much more quickly, on average, than those whose ties to their former employers are permanently severed. But as some sectors of the economy have continued to struggle, permanent job loss has increased (figure 9). So too has long-term unemployment. Still, as of January, the level of permanent job loss, as a fraction of the labor force, was considerably smaller than during the Great Recession. Research shows that the Paycheck Protection Program has played an important role in limiting permanent layoffs and preserving small businesses. The renewal of the program this year in the face of another surge in COVID-related job cuts is an encouraging development. Of course, in a healthy market-based economy, perpetual churn will always render some jobs obsolete as they are replaced by new employment opportunities. Over time, workers and capital move from firm to firm and from sector to sector. It is likely that the pandemic has both increased the need for such movements and brought forward some movement that would have occurred eventually. So how do we get from where we are today back to a strong labor market that benefits all Americans and that starts to heal the damage already done? And what can we do to sustain those benefits over time? Experience tells us that getting to and staying at full employment will not be easy. In the near term, policies that bring the pandemic to an end as soon as possible are paramount. In addition, workers and households who struggle to find their place in the post-pandemic economy are likely to need continued support. The same is true for many small businesses that are likely to prosper again once the pandemic is behind us. Also important is a patiently accommodative monetary policy stance that embraces the lessons of the past--about the labor market in particular and the economy more generally. I described several of those important lessons, as well as our new policy framework, at the Jackson Hole conference last year. I have already mentioned the broad-based benefits that a strong labor market can deliver and noted that many of these benefits only arose toward the end of the previous expansion. I also noted that these benefits were achieved with low inflation. Indeed, inflation has been much lower and more stable over the past three decades than in earlier times. In addition, we have seen that the longer-run potential growth rate of the economy appears to be lower than it once was, in part because of population aging, and that the neutral rate of interest--or the rate consistent with the economy being at full employment with 2 percent inflation--is also much lower than before. A low neutral rate means that our policy rate will be constrained more often by the effective lower bound. That circumstance can lead to worse economic outcomes--particularly for the most economically vulnerable Americans. To take these economic developments into account, we made substantial revisions to our monetary policy framework, as described in the FOMC's Statement on Longer- This revised statement shares many features with its predecessor, including our view that longer-run inflation of 2 percent is most consistent with our mandate to promote maximum employment and price stability. But it also has some innovations. The revised statement emphasizes that maximum employment is a broad 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. Recognizing the economy's ability to sustain a robust job market without causing an unwanted increase in inflation, the statement says that our policy decisions will be informed by our "assessments of the shortfalls of employment from its maximum level" rather than by deviations from its maximum level." This means that we will not tighten monetary policy solely in response to a strong labor market. Finally, to counter the adverse economic dynamics that could ensue from declines in inflation expectations in an environment where our main policy tool is more frequently constrained, we now explicitly seek to achieve inflation that averages 2 percent over time. This means that 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 in the service of keeping inflation expectations well anchored at our 2 percent longer-run goal. Our January postmeeting statement on monetary policy implements this new framework. In particular, we expect that it will be appropriate to maintain the current accommodative target range of the federal funds rate until labor market conditions have reached levels consistent with maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. In addition, we will continue to increase our holdings of Treasury securities and agency mortgage-backed securities by $80 billion and $40 billion per month, respectively, until substantial further progress has been made toward our maximum-employment and price-stability goals. Seventy-five years ago, in the wake of WWII, the United States faced the challenge of reemploying millions amid a major restructuring of the economy toward peacetime ends. Part of Congress's response was the Employment Act of 1946, which states that "it is the continuing policy and responsibility of the federal government to use all practicable means . . . to promote maximum employment." As later amended in the Humphrey-Hawkins Act, this provision formed the basis of the employment side of the Fed's dual mandate. My colleagues and I are strongly committed to doing all we can to promote this employment goal. Given the number of people who have lost their jobs and the likelihood that some will struggle to find work in the post-pandemic economy, achieving and sustaining maximum employment will require more than supportive monetary policy. It will require a society-wide commitment, with contributions from across government and the private sector. The potential benefits of investing in our nation's workforce are immense. Steady employment provides more than a regular paycheck. It also bestows a sense of purpose, improves mental health, increases lifespans, and benefits workers and their families. I am confident that with our collective efforts across the government and the private sector, our nation will make sustained progress toward our national goal of maximum employment.

r210216a_FOMC

united states

My Perspective on Bank Regulation and Supervision

bowman

Good morning. I want to thank the American Bankers Association for inviting me to speak to you today. Two years ago, I gave my first speech as a Federal Reserve governor at this conference in San Diego, and it is always great to be with you-- even if remotely from our recording studio at the Board. It's fair to say that a lot has happened over the past two years. It is an understatement to say that the COVID-19 pandemic has created significant challenges inside and outside the banking sector. Bankers significantly adapted operations to continue serving their communities and customers. You overcame staffing challenges and other hurdles, kept the virtual doors open, worked with your customers, and provided assistance to workers and businesses through the Paycheck Protection Program. Those efforts have made, and continue to make, a huge difference in the lives of many people affected by the pandemic, and I thank you. Since becoming a member of the Federal Reserve Board, I have made it a priority to enhance the Federal Reserve's dialogue with community bankers. I have embarked on an effort to meet with the leaders of every community bank and regional bank supervised by the Federal Reserve. This valuable interaction helps build an understanding of issues affecting small and regional banks, support supervisory decision-making, and shape some of my perspective. It has also helped the Federal Reserve identify initiatives to support the vital role of community banks in serving the financial needs of communities. Today, I would like to share my approach to supervision and regulation, which has helped guide the Fed's efforts to improve oversight of community banks over the past few years and shaped our priorities for 2021 and beyond. In most cases, my points about banking regulation also apply to supervision. I will then focus on several Federal Reserve initiatives that are underway to support community banks during the pandemic and into the future. The first principle is fundamental to regulation but sometimes bears repeating-- regulation should always strike the right balance. For banking regulation, that means a balance between actions that promote safety and soundness and actions that promote an acceptable and manageable level of risk-taking. The challenge is doing neither too little to be effective to achieve the public benefit of government oversight, nor too much to prevent the regulated businesses from meeting their customers' needs. Some regulation is appropriate and necessary but striking the right balance means that at some point regulation can go too far and end up reducing the public's welfare. In recent years, the Federal Reserve and other agencies have made oversight more effective by better differentiating prudential regulation and supervision based on the asset size of banks, the complexity of their activities, and the related risks they pose to the financial system. This is especially important for community banks, most of which managed risks well before and during the 2008 financial crisis and have managed their risks well since. Achieving these principles also requires following consumer protection laws and regulations, including fair lending laws, to ensure fairness and broad access to credit and financial services that enable economic opportunity for individuals and communities. The second principle is that the regulatory framework should be effective, but also efficient, and that means assessing the impact of the requirements. For the Federal Reserve, it means that we consider both a rule's benefit to safety and soundness and any potential negative effect, including limiting the availability of credit and services to the public, and the implications of compliance costs on banks. The wisdom in this approach is evident when considering the effect of a regulation on community banks and their role in providing financial services to their communities. Community banks have often been one of the few or only sources of credit and financial services to their customers. Their smaller operational scale relies on fewer staff to reach a more disbursed customer base with limited resources for compliance activities. Regulations should consider the potential impact on the availability of services in a community, as well as the costs to the bank of implementing a rule, particularly in more rural locations. It is necessary that a full and careful practical analysis of costs and benefits be a part of every rulemaking. The third principle is that regulation and supervision should be consistent, transparent, and fair. Regulators are obligated by law to act in this manner, and it also makes good practical sense. These principles enhance safety and soundness and consumer compliance by making sure supervisory expectations are clear and that banks understand and respect the regulatory requirements. Supervisors should not and cannot be everywhere at every moment. But they should be available to provide clarification or answer questions when needed. A clear understanding of the rules and our expectations and a respect for the reasonable application of them is an effective approach to ensure effective compliance. By promoting respect and trust between regulators and the supervised institution, banks are more likely to communicate throughout the examination cycle to inform supervisors of changes they may be considering or challenges they may be facing and how best to resolve or approach them from a regulatory perspective. A final principle that flows from consistency, transparency, and fairness is that rules and supervisory judgments must have a legitimate prudential purpose, and in the majority of cases must not be solely punitive. The goal should be to encourage sound business practices and activities by supervised institutions. By clearly communicating our objectives, we build respect for the rules and make it more likely that any remedial actions against an institution will not be necessary because we encourage compliance through our supervisory approach. When a supervisory action or formal enforcement action is required to address violations at an institution, those actions should be framed in a way that seeks to promote safe, sound, and fair practices and not simply as punishment. These principles that guide my approach to regulation and supervision are consistent with many of the major steps that the Federal Reserve has taken to improve community bank oversight since the implementation of the rules following the 2008 financial crisis. Some predate my arrival at the Fed, and some I have played a significant role in achieving. Most of these actions involve tailoring rules that treated community banks in the same way as larger, more complex institutions. For example, the Volcker rule was aimed at curbing proprietary trading by large banks, but it ended up creating significant compliance costs for community banks, which are not involved in this type of trading. Many of the most important improvements to the Federal Reserve's regulatory framework involve tailoring rules to fit to the size, business model, and risk profiles of community banks. For example, we raised the asset threshold for small banks to qualify for an 18-month exam cycle and similarly raised the threshold for small bank holding companies to be exempted from consolidated risk-based capital rules. The concept of tailoring is also expressed in our community bank supervisory framework, which has BETR program allows examiners to identify higher and lower risk activities and, in turn, streamline the examination process for lower risk community banks, thereby reducing burden. In fact, Federal Reserve examiners have tailored examinations by spending approximately 65 percent less time on low/moderate risk state member bank exams than they do on high-risk exams. We also implemented the community bank leverage ratio that allows institutions to opt out of risk-based capital requirements. The Federal Reserve and the other agencies also raised the threshold for when an appraisal is required for residential real estate loans and tailored safety-and-soundness examinations of community and regional state member banks to reflect the levels of risk present and minimize regulatory burden for banks. These improvements in regulation and supervision have helped right the balance I spoke of earlier between safety and soundness and consumer protection, on the one hand, and the ability to provide financial services and best meet the needs of their customers. We have also considered the impact of our actions, seeking to revise rules that impose significant costs to community banks but provide limited benefit to safety and soundness, consumer protection, or financial stability. As a part of this approach, I have also prioritized efforts to improve the consistency, transparency, and reasonableness of regulation and supervision. One of those efforts is promoting greater consistency in supervisory practices across the Federal Reserve System. For example, we are actively working to improve the timeliness of providing banks with consumer compliance exam findings. Further, we are exploring ways to strengthen our ability to understand, monitor, and analyze the risks that are affecting community banks. A key aspect of consistency is ensuring the same supervisory approach and outcomes for similarly situated institutions, with the goal of ensuring, for example, that a "one" composite or component rating in a particular region would be the same for an institution with similar activities and practices in another region. This applies to all areas of our supervisory responsibility, whether safety and soundness, consumer compliance, or analyses of financial stability risk. I'd like to expand on one important area of focus, which is essential to the future success of the community banking sector: accessible innovation and technology integration. This subject is one that I speak about frequently with stakeholders and our staff at the Board. We are committed to developing a range of tools that will create pathways for banks to develop and pursue potential partnerships with fintech companies. This includes clearer guidance on third-party risk management, a guide on sound due diligence practices, and a paper on fintech-community bank partnerships and related considerations. These tools will serve as a resource for banks looking to innovate through fintech partnerships. Technological developments and financial market evolution are quickly escalating competition in the banking industry, and our approach to analyzing the competitive effects of mergers and acquisitions needs to keep pace. The Board's framework for banking antitrust analysis hasn't changed substantially over the past couple of decades. I believe we should consider revisions to that framework that would better reflect the competition that smaller banks face in an industry quickly being transformed by technology and non-bank financial companies. As part of this effort, we have engaged in conversations and received feedback from community banks about the Board's competitive analysis framework and its impact on their business strategies and long-term growth plans. We are in the process of reviewing our approach, and we are specifically considering the unique market dynamics faced by small community banks in rural and underserved areas. Soon after the pandemic began early last year, the Federal Reserve took several actions to support community banks and their ability to help affected customers. We paused examinations and issued supervisory guidance that made it clear that we would not criticize or take public enforcement actions against a bank that was taking prudent steps to help customers and making good faith efforts to comply with regulations. This certainty of regulatory treatment created an environment that built trust between regulators and bankers. It enabled banks to continue to meet the needs of their customers who were struggling with circumstances through no fault of their own. Let me conclude by again commending the important role that community banks have played in providing financial services during these challenging times. You responded quickly to the needs of your customers and communities to provide financial services with limited, if any, interruption. You persevered to implement the largest proportion of Paycheck Protection Program funds to small businesses, whether they were your existing customers or new customers. These relationships are the hallmark of community banking, and as we look toward the future, community banks will continue to play an essential role in supporting customers, delivering financial services, and providing resources to their communities and customers. Let me stop here and thank the organizers for another opportunity to speak to you at this important conference. I look forward to your questions, Rob.

r210218a_FOMC

united states

The Role of Financial Institutions in Tackling the Challenges of Climate Change

brainard

I want to thank the Institute of International Finance for inviting me to join this discussion. Let me start by noting that these are my own views and do not necessarily Climate change is already imposing substantial economic costs and is projected to have a profound effect on the economy at home and abroad. Future financial and economic impacts will depend on the frequency and severity of climate-related events and on the nature and the speed at which countries around the world transition to a greener economy. Climate change and the transition to a low-carbon economy create both risks and opportunities for the financial sector. Financial institutions that do not put in place frameworks to measure, monitor, and manage climate-related risks could face outsized losses on climate-sensitive assets caused by environmental shifts, by a disorderly transition to a low-carbon economy, or by a combination of both. Conversely, robust risk management, scenario analysis, and forward planning can help ensure financial institutions are resilient to climate-related risks and well-positioned to support the transition to a more sustainable economy. The economic consequences of climate change are already in evidence. There is growing evidence that extreme weather events related to climate change are on the rise-- droughts, wildfires, hurricanes, and heat waves are all becoming more common. disasters are a major source of losses to households and businesses; one study finds that natural disasters have resulted in more than $5.2 trillion in losses globally since 1980, more than 70 percent of which was not insured. Extreme weather events have been shown to disrupt corporate supply chains and impact corporate profitability. flooding and sea level rise negatively impact property values. These events are expected to increase in frequency and severity over time, which could impact borrower creditworthiness or collateral values. With climate-related risks on the rise, governments, regulators, corporations, and investors are mobilizing to accelerate the transition to a greener economy, including through ambitious targets for reducing greenhouse gas emissions. Unanticipated or abrupt shifts in policy, technology, or investor sentiment have the potential to produce abrupt repricing events that could result in losses on financial institution balance sheets. Over a longer horizon, such shifts could also have implications for their business strategies. Climate change can affect the financial system through both of these channels. "Physical risks" refer to damages caused by an increase in the frequency or severity of weather events or other climate shifts. "Transition risks" arise from changes in policy, technology, or consumer behavior that lead to a lower-carbon economy. These physical and transition risks could materialize as traditional financial risks to supervised institutions, including through increased credit, market, operational, reputational, and liquidity risk. We are already seeing financial institutions responding to climate-related risks by encouraging borrowers to adapt to and manage the risks associated with a changing climate, responding to investors' demands for climate-friendly portfolios, and funding critical private-sector initiatives to move toward more climate-friendly business models. As noted by members of our Federal Advisory Council, "[t]here has been increasing awareness among financial institutions of the need to define and develop risk management frameworks that incorporate these [climate-related financial] risks into strategic decision making on multiple levels, including investment approaches and the long-term structuring of portfolios." Supervisors have a responsibility to ensure that financial institutions are resilient to all material risks--including those related to climate change--both currently and into the future. It is essential that financial institutions--and the financial sector as a whole-- are resilient to and prepared for the challenges of climate change. A recent survey of central banks found a large majority view it as appropriate "to act within their existing mandate to mitigate climate-related financial risks" that "could potentially impact the safety and soundness of individual financial institutions and could pose potential financial stability concerns for the financial system." Addressing climate-related risks and opportunities, however, will not be easy. It will require a sustained commitment--both from financial institutions and their regulators--to invest in expertise, modeling, and data, and a willingness to learn and improve over time. Climate change presents a number of complex conceptual and practical challenges that must be considered as we work together to develop a framework to ensure financial institutions are resilient to climate-related risks. Despite the challenges, it will be critical to make progress, even if initially imperfect, in order to ensure that financial institutions are resilient to climate-related financial risks and well-positioned for the opportunities associated with the transition to a more sustainable economy. I will touch on a few of the conceptual challenges that will need to be addressed as we consider the implications of climate change for our mandated responsibilities and determine how best to incorporate climate-related risks into our supervisory framework. While the scientific evidence for climate change is unequivocal, estimates of the magnitude of climate-related financial risks are highly uncertain. This uncertainty stems from a number of factors. Predicting the timing and magnitude of physical risk drivers such as hurricanes, wildfires, or droughts is inherently complex. The predicted path of climate change may be nonlinear and may include tipping points or critical thresholds that, when exceeded, can lead to a significant change in the state of the climate system. There is also transition-related uncertainty associated with policy developments, technological change, and shifts in behavior and preferences. Moreover, the economic and financial market impacts of climate-related risks vary across geographies, sectors, and jurisdictions and depend importantly on the existence of feedback loops. Finally, the long time horizon associated with climate change, the lack of historical data, the potential for sudden shifts in asset valuations, and the paucity of information on the climate-sensitivity of exposures complicate the translation of climate- related risks into measures of credit, market, liquidity, reputational, and operational risks. Improved data, disclosures, and modelling techniques will be crucial to reducing uncertainty around the potential magnitude of risks related to climate change. Financial institutions are collecting data and experimenting with scenario analysis and other techniques to better understand the potential impact of climate-related risks to their balance sheets and business models. Similarly, the Federal Reserve is investing in data and empirical work to analyze the transmission of climate-related risks to the economy and developing methodologies to measure these risks, as are other central banks. Financial institutions note that "the development of uniform data standards and metrics for disclosures will be critical to adequately identify and compare climate risks across businesses and sectors." That underscores the importance of efforts such as the toward consistent climate-related financial disclosures to improve transparency, reduce uncertainty, and help market participants appropriately assess and price climate-related risks and opportunities. Current voluntary disclosure practices are an important first step, but they are prone to variable quality, incompleteness, and a lack of actionable data. Ultimately, moving toward standardized, reliable, and mandatory disclosures could provide better access to the data required to appropriately manage risks. Even with improved data and disclosures, uncertainty about the future climate trajectory will remain. This residual uncertainty should not stand in the way of making prudent investments in risk-management practices in the near term to strengthen the financial sector against climate-related risks. Instead, supervisory approaches should encourage institutions to take the necessary risk-management steps to ensure their business models and strategies are robust to the wide range of potential outcomes that may evolve over time--including the possible use of new tools where appropriate. Climate-related risks have unique characteristics that may warrant consideration of new approaches to measuring and managing risk, and new or enhanced supervisory tools. Determining whether the existing supervisory toolkit is adequate or if changes are needed will require careful thought and rigorous analysis of the unique aspects of climate risks, including their long-time horizon, variability across geographies and sectors, and data challenges. As always, supervisory approaches will be informed by analytical assessments and transparent discussions. Supervised institutions are beginning to adapt their governance, risk- identification, and risk-management processes, and business models to reflect climate- related risks. It is clear that physical and transition risks could have significantly different impacts on institutions of varying sizes, complexities, and business models, and with exposures to different geographies. Banks have told us that, "prospective guidance and regulation should be (1) designed to assist institutions of all types and sizes to measure, monitor, and disclose the associated financial risks [from climate change]; and (2) tailored to the complexity of specific types of institutions." In light of the high uncertainty inherent in estimating climate risks, scenario analysis may be a helpful tool to assess the microprudential and macroprudential implications of climate-related risks under a wide range of assumptions. Climate scenario analysis identifies climate-related physical and transition risk factors facing financial firms, formulates appropriate stresses of those risk factors under different scenarios, and measures their effects on individual firms and the financial system as a whole. To be clear, scenario analysis is distinct from our traditional regulatory stress tests at banks. Scenario analysis is an exploratory exercise that allows banks and supervisors to assess business model resilience to a range of long-run scenarios. It seeks to understand the effects of climate-related risks on a range of financial markets and institutions, as well as the potentially complex dynamics among them. By contrast, traditional stress tests are a regulatory exercise to assess the capital adequacy of banks to specific macroeconomic scenarios and financial market shocks over the short-run. We are closely following the climate scenarios being developed by other central banks and supervisory authorities and engaging with those institutions so we can learn from their experiences. It will be important to think carefully about the potential for scenario analysis to support microprudential and macroprudential objectives and to consider how stress testing and scenario analysis may complement one another. There is unlikely to be a single "right" approach to a challenge as complex as the financial impact of climate change. Microprudential supervisors and regulators generally aim to promote the goals of a safe and sound banking system in the way that is as efficient and effective as possible. Developing an effective framework is likely to be a complex undertaking in considering the linkages between climate change, the economy and financial markets, and ultimately the risks faced by individual banks. For instance, consider model development and scenario analysis. At first glance, it might appear most efficient and least burdensome to apply a prescriptive approach that specifies the appropriate data and a scenario and leverages a particular credit model to produce a standardized output across firms. Although there are benefits to standardization in some areas such as data and taxonomies, it is not clear a highly prescriptive approach would be the most effective way to ensure financial institutions are well-prepared for the range of possible impacts of climate change, even if the execution burden is low. Ultimately, the outcomes are likely to be more robust if we innovate and experiment, and leverage a range of complementary approaches being developed in both the private and the public sectors. In considering the trade-off here, we should strive for an appropriate balance that allows for innovation and learning across the public and private sectors, iterating in the most effective way possible. While recognizing the challenges, the Federal Reserve is making strides in better understanding climate-related risks and determining how best to incorporate them into our supervisory framework. The Federal Reserve announced last month the creation of a It will strengthen the Federal Reserve's capacity to identify and assess financial risks from climate change. The SCC will work to develop an appropriate program to ensure the resilience of supervised firms to climate- related financial risks. It will leverage expertise from across the Federal Reserve System to develop a robust, tailored program that reflects risk differences across types of firms and geographies. The SCC is focusing on engagement with the private and official sectors to understand the potential impact of climate-related risks. It is engaging with a diverse group of supervised institutions and industry groups to learn how banks of different sizes, with different business models and different geographic exposures are considering both climate risks and opportunities and what they are doing to prepare for the transition to a low-carbon economy. We are learning a great deal from these discussions, and we look forward to continued engagement with the industry on this topic. The microprudential work of the SCC is one part of our efforts to take into account climate-related risks in carrying out the responsibilities Congress has assigned to us. The SCC will work with staff in our financial stability, community development, international coordination, and research and data areas to build a coordinated approach to integrating climate-related risks where they affect our responsibilities. The Federal Reserve is engaging with colleagues from other regulatory agencies, central banks, and standard-setting bodies. At home, this includes exploring with members of the U.S. Global Change Research Program the ways additional scientific data, models, and other information would be used to expand our analysis of weather- related disasters and climate-related risks. Climate change is a global challenge, and we recognize the benefit of collaboration across the official sector, while also taking into account important differences across jurisdictions. The Federal Reserve is co-chairing the Basel Committee Having completed a stock-take of members' existing regulatory and supervisory initiatives on climate-related financial risks, the TFCR is now focused on finalizing by midyear a report exploring the transmission channels of climate risks to the banking system and a report that describes the methodologies used by banks and supervisors to measure these risks. Next, the TFCR will turn its attention to developing supervisory practices to mitigate climate-related financial risks where there are potential gaps in the Basel framework. Already, many banks are incorporating supervisory expectations with regard to management of climate-related risks in foreign jurisdictions, for instance from work will be helpful in strengthening supervisory collaboration across jurisdictions, which is important to banks that are internationally active. change. Building on previous reports on climate-related risk-transmission channels in the financial system, with a particular focus on amplification mechanisms and cross-border effects, the FSB is now assessing the availability of data through which climate-related risks to financial stability could be monitored, as well as any data gaps. In addition, the FSB is exploring ways to promote globally comparable, high-quality and auditable standards of disclosure based on the recommendations in the TCFD. The Federal Reserve recently became a full member of the Network for Greening the Financial System (NGFS), a network of more than 80 central banks and supervisory authorities from around the world that focuses on sharing research and identifying best practices to ensure the financial system is resilient to climate-related risks. Through the NGFS, we are engaged in work on the microprudential and macrofinancial impacts of climate change, trends in green finance, data gaps, and research. In wrestling with the many complexities and challenges related to climate change, there are likely to be significant opportunities for collaboration with the private and official sectors. These are not easy problems, and they will not have easy solutions. We will undoubtedly reach better outcomes if we tackle these challenges through open dialogue, information sharing, and transparency. Together, we can help ensure the financial system is resilient to the risks that arise from climate change and well- positioned to support the transition to a greener economy.

r210222a_FOMC

united states

Economic Inclusion in Lower-Income Communities

bowman

Thank you, President Kaplan, our Advance Together partners, and everyone here for joining us today. I am honored to participate in this event and welcome the awardees of this important initiative to celebrate your success. Today marks a significant milestone in this effort to improve economic opportunity for residents of 25 counties across the way to promote initiatives in Texas that reduce inequities in education and workforce development, and these Implementation Awards recognize outstanding examples of furthering those goals. At the Federal Reserve, our community development mission is to promote economic growth and financial stability across the country, particularly in vulnerable communities. The ability to access quality education and training to build workforce skills is critical for low-income workers seeking greater opportunity for themselves and their families. Likewise, reducing the disparities in labor market opportunities among individuals in our society helps to support broader economic growth and financial stability. These issues have taken on even greater importance over the past year. The COVID-19 pandemic has upended our personal and professional lives and continues to cause economic hardship for many Americans. While the economy has recovered substantially from the effects of the pandemic, it is concerning to see signs that the improvements have been uneven, with some households continuing to struggle with unemployment and facing financial difficulty. and Decisionmaking, or SHED, provides evidence of these disparities. responses to the SHED, many households reported major employment disruptions due to COVID-19, including layoffs, reductions of hours, or unpaid leave. By mid-summer, many of the affected individuals had returned to work, and many were receiving unemployment insurance benefits and other financial assistance. Even so, unemployment remained very high in July, and 23 percent of SHED respondents said they were either "just getting by" or "finding it difficult to get by." Not surprisingly, those experiencing employment disruptions disproportionately reported that they were likely to have difficulty paying their bills. The survey showed that employment disruptions and financial challenges disproportionately affected people of color and low-income families. And, unlike during previous recessions, a larger share of working women than men were laid off from their jobs. For many families, the pandemic exacerbated existing financial challenges. Economic mobility is largely driven by family financial stability and geographic resources such as transportation, quality education, and broadband access. The Fed's research and its ongoing work in community development show that there is no quick fix for the disparities in household financial stability. And no single organization or government agency can solve these complex problems alone. This brings me to the importance of collaboration to address multidimensional community issues. While affordable housing and quality jobs are two very visible needs for low-income households, meeting these needs requires strategies that stretch across the fabric of the whole community, including childcare, education and training, transportation, and a safe and healthy environment. Collaboration between individuals and organizations of different talents and strengths can help find the kind of holistic solutions needed to bring greater opportunity to those at risk of being left behind in the recovery. Today, we are here to celebrate Advance Together, one such effort to foster economic inclusion through innovative and collaborative programs. In 2020, the Federal Reserve completed a review of "place based" community development initiatives, those focused on a single community or area, across its 12 districts. While the place-based initiatives varied in purpose, scope, and approach from community to community, the very best of those local collaborations are reflected in Advance Together's winning proposals. Most notably, each of these community-driven initiatives uses evidence-based research, fosters public-private partnerships, and promotes a collective vision for success. The four winners that we are honoring today are the Educate Midland and It has truly been a pleasure to learn about the unique and innovative efforts each of you are undertaking to address the education and workforce challenges in your own student data to deepen their understanding of student outcomes by race and to identify practices that can reduce inequities in education and workforce development that limit economic opportunity. The Big Country Manufacturing Alliance is streamlining training and job placement for young workers interested in manufacturing careers. The Family Pathways 2-Gen Coalition supports students with children on their path to a college degree. And, finally, the Deep East Texas College and Career Alliance is helping rural and first-generation college students attain post-secondary credentials that are in demand by employers. Just as Advance Together benefited from past place-based initiatives, the lessons learned from your local collaborations will inform and influence new community strategies going forward. I look forward to following your efforts to create economic opportunity in communities across Texas. It's really an honor to join in your celebration today. Congratulations to the winners and thank you to all of the participants.

r210224b_FOMC

united states

How Should We Think about Full Employment in the Federal Reserve's Dual Mandate?

brainard

I want to thank Jason Furman and David Laibson for inviting me to join your economics class. I often found it difficult in introductory economics to connect the abstract concepts in the textbooks to the real-world issues I cared about. So the one message I hope you remember from today is that economics provides powerful tools to enable you to analyze and affect the issues that matter most to you. With jobs down by 10 million relative to pre-pandemic levels, one issue that matters fundamentally to all of us is achieving full employment. So today I want to talk about both the Federal Reserve's responsibilities with regard to full employment and different approaches to assessing where we are relative to that goal. The belief that the federal government has a responsibility for full employment has its roots in the Great Depression. It was given statutory expression at the end of the Second World War when policymakers and legislators feared that the millions of American soldiers returning to the labor market would face Depression-era conditions. In the Employment Act of 1946, the Congress directed the federal government as a whole to pursue "conditions under which there will be afforded useful employment for those able, willing, and seeking work, and to promote maximum employment, production, and purchasing power." The postwar policy discussion raised important issues surrounding the definition and measurement of full employment. In 1950, the published a symposium titled "How Much Unemployment?" which debated the accuracy of the Census Bureau's value for unemployment. Dr. Palmer was a critical contributor to the symposium. Palmer was a professor at Wharton, a fellow of the American Statistical Association, a worldwide expert on manpower and labor mobility, and a consultant with the Office of Statistical Standards. She argued that "a single figure of unemployment, regardless of how it is defined or derived, is inadequate as a basis for selection among [policy] programs. Inherent in the phenomena being measured are so many degrees and kinds of labor force activity that no single definition or classification can adequately summate them." With concerns about employment again on the rise, in 1976, Senator Hubert Humphrey joined with Congressman Augustus Hawkins to sponsor legislation promoting full employment. in 1977 specifically assigned monetary policy responsibility for promoting "the goals of maximum employment, stable prices, and moderate long-term interest rates," commonly referred to as the dual mandate . This amendment was followed by the Humphrey-Hawkins Full Employment and Balanced Growth Act, passed in 1978, requiring that the Federal Reserve regularly report to the Congress on how monetary policy was supporting the goals of the act. Congressman Hawkins was a prominent advocate of full employment, emphasizing its importance not only for providing a job to every American seeking work, but also for reducing poverty, inequality, discrimination, and crime and improving the quality of life of all people. A congressman from southern California, Hawkins was one of the founders of the Congressional Black Caucus and played a major role in the drafting of the Civil Rights Act of 1964. He was also an undergraduate economics major. Hawkins's views were influenced by his experience representing the Watts neighborhood in Los Angeles, where depression levels of joblessness persisted even when the nation overall was experiencing good times. He was also influenced by the work of economists such as Robert Browne and Bernard Anderson, which highlighted the persistent disparity between Black and white employment and the connection between elevated Black unemployment and economic challenges facing Black communities. Hawkins emphasized that "without genuine full employment it would be impossible to eliminate racial discrimination in the provision of job opportunities." Hawkins Act noted that "increasing job opportunities and full employment would greatly contribute to the elimination of discrimination based upon sex, age, race, color, religion, national origin, handicap, or other improper factors." The centrality of achieving full employment for all Americans is as pressing today as it was in 1930, 1946, and 1977. The measurement challenges highlighted by Dr. Gladys Palmer and the racial disparities highlighted by Robert Browne and Bernard Anderson are just as relevant in today's economy. And the statutory dual mandate assigned to monetary policy has ensured an unwavering, strong focus on maximum employment as well as price stability at the Federal Reserve in research and measurement no less than policymaking. The Federal Reserve recently concluded a review of our monetary policy framework, which included extensive outreach to a broad range of people over the course events in communities around the country, we heard testimonials that would have sounded strikingly familiar to Congressman Hawkins. At a time when the national headline unemployment rate was at a multidecade low, community and labor representatives and educators noted "it's always a recession" in their communities. They challenged whether the overall economy could be characterized as at "full employment" while unemployment remained in the double digits in their communities. Reflecting this input, and in light of persistently below-target inflation, low equilibrium interest rates, and low sensitivity of inflation to resource utilization, we made several important changes to the monetary policy framework. Two changes have particular relevance for the employment leg of the dual mandate. The new framework calls for monetary policy to seek to eliminate shortfalls of employment from its maximum level, in contrast to the previous approach that called for policy to minimize deviations when employment is too high as well as too low. The new framework also defines the maximum level of employment as a broad-based and inclusive goal assessed through a wide range of indicators. So how should we assess this broad-based and inclusive concept of maximum employment? When discussing aggregate indicators about the labor market, people tend to focus on the headline U-3 measure of the unemployment rate. Although the unemployment rate is a very informative aggregate indicator, it provides only one narrow measure of where the labor market is relative to maximum employment. Recalling Gladys Palmer's dictum, I would not recommend relying on any single indicator, but rather consulting a variety of indicators that together provide a holistic picture of where we are relative to full employment. So let us start by seeing what insights we gain by disaggregating the unemployment data into different groups of workers. The unemployment rate has improved very rapidly from its peak of 14.8 percent last April to 6.3 percent today. But this number is closer to 6.8 percent when taking into account a substantial number of people on temporary layoff, who have been misclassified as "employed but on unpaid absence" but instead should be counted as unemployed." Disaggregating the overall unemployment rate reveals that workers in the lowest wage quartile face Depression-era rates of unemployment of around 23 percent. part, this rate likely reflects the concentration of lower-wage jobs in service industries that are strongly reliant on in-person contact, or at least in-person work, while a larger proportion of higher-wage jobs are currently being performed remotely or with reduced levels of in-person contact. There is also important information in the disaggregation of unemployment by different racial and ethnic groups. Figure 1 shows the prime-age unemployment rate overall and on a disaggregated basis. There are notable persistent gaps between different racial and ethnic groups, and the sizes of those gaps tend to vary over the business cycle. For example, historically, the ratio of the Black unemployment rate to the white unemployment rate is around 2 for prime-age workers. On average, a 1 percentage point increase in the white unemployment rate is accompanied by a 2 percentage point increase in the Black unemployment rate. This gap narrows considerably the longer an expansion progresses. At the beginning of 2015, a time when many economists believed the overall unemployment rate had reached its "normal" rate, the gap between the Black and white prime-age unemployment rates stood just under 5 percentage points, roughly at its average level since 1972. By September 2019, that gap had reached a historical minimum of 1.7 percentage points, and the gap between the Hispanic and white prime- age unemployment rates had fallen to 0.3 percentage point. The unemployment gaps between racial and ethnic groups widened again during the pandemic. Currently, for prime-age individuals, the gaps between the white unemployment rate and the Black and Hispanic unemployment rates are roughly 4 percentage points and 3 percentage points, respectively. The unemployment rate obscures important information about people leaving and entering the workforce. Each adult in the population is classified as employed, unemployed, or not in the labor force. The unemployment rate is the number of individuals who are not currently working but are actively looking for a job, divided by the size of the labor force, which includes only those people who are either working or actively seeking work: Changes in labor force participation contain important information about the strength of the labor market that is not captured in the unemployment rate. The labor force participation rate (LFPR) is the number of individuals who are either working or are seeking work, divided by the working-age population: When we take into consideration the more than 4 million workers who have left the labor force since the pandemic started, as well as misclassification, the unemployment rate is close to 10 percent currently--much higher than the headline unemployment rate of 6.3 percent--and similar to the peak unemployment rate following the financial crisis. This is shown in Figure 2. A decline in participation by prime-age women is an important contributor to the overall participation decline. Some portion of the decline reflects the increase in caregiving work at home with the shutdown of schools and daycare due to COVID-19. On average over the period from November 2020 to January 2021, the fraction of prime- age respondents with children aged 6 to 17 who were out of the labor force for caregiving was about 14 percent, up 1-3/4 percentage points from a year earlier. For mothers, the fraction who were out of the labor force for caregiving was 22.8 percent, an increase of 2.4 percentage points from a year earlier, while for fathers the fraction was 2.2 percent, an increase of about 0.6 percentage point. If not soon reversed, the decline in the participation rate for prime-age women could have longer-term implications for household incomes and potential growth. While there are long-term structural trends in participation, such as population aging, there are also cyclical dynamics that are important for our assessment of maximum employment. The two panels in figure 3 show prime-age unemployment and labor force participation over the previous recession and recovery. Following the onset of the global financial crisis, as the number of unemployed people was rising, the size of the labor force was also contracting, pushing the numerator of the unemployment rate up and the denominator down. When the unemployment rate started to decline at the end of 2010, this decline in part reflected unemployed people dropping out of the labor force through 2013. As the labor market healed further, prime-age LFPR leveled out and started to increase at the end of 2015. The subsequent seemingly modest decline in the unemployment rate from 4.3 at the end of 2015 to 3 percent at the end of 2019 was much more significant, taking into account that more than 3-1/2 million prime-age workers joined or rejoined the labor force during that period. This brings me to figure 4 and the employment-to-population (EPOP) ratio, which is the number of individuals employed divided by the working-age population: The EPOP ratio synthesizes the information contained in the unemployment rate and LFPR. For instance, as you can see in figure 4, a decline in participation almost entirely offset the decline in unemployment in 2010 and 2011, leaving the prime-age EPOP ratio essentially flat at 75 percent. The EPOP ratio then improved steadily over the subsequent seven years, moving up to 80.4 percent in late 2019. As the effects of the virus and measures to combat it took hold of the economy, the EPOP ratio plummeted last April, and, after staging a sharp but partial recovery, improvements in the prime-age EPOP ratio have moderated in recent months. A glance back at figure 3 shows that the reductions in employment last spring were accompanied by many prime-age workers leaving the labor force, and the participation rate among prime-age workers has declined further since last May. The prime-age EPOP ratio currently stands at 76.4 percent, well below the 80 percent level that was reached during each of the past two expansions. Figure 5 shows the patterns in the EPOP ratio for prime-age workers in different racial and ethnic groups. gap opened to more than 10 percentage points in mid-2011 before shrinking to under 5 percentage points as labor markets tightened further during 2018 and 2019. In contrast, the Hispanic-white EPOP gap was smaller than the Black-white gap, and it fluctuated in a much narrower range over the business cycle. During the pandemic, labor market performance as shown by the EPOP measure has been fairly similar for Black and Hispanic prime-age workers and markedly worse than for white workers. Research indicates that Black and Hispanic workers are overrepresented in industries particularly hard hit by the pandemic, such as hotels and restaurants. It also shows that Black and Hispanic workers are overrepresented in essential industries at lower pay, and that they are significantly less likely to be able to telework. Figure 6 shows one more EPOP snapshot, this time for prime-age women overall, as well as for Black and white subgroups. Following the financial crisis, a gap opened up between the prime-age EPOP ratios for Black and white women. That gap closed in 2015, and employment for both groups surged over the next four years. Between January 2015 and February 2020, the EPOP ratios for white and Black prime-age women each increased roughly 5 percentage points, reaching historical highs in the months just before the onset of the pandemic. As the pandemic took hold in the subsequent months, once again a gap opened up between the EPOP ratios for white and Black women, though the current gap of roughly 2 percentage points is not as large as in the previous downturn. While the EPOP ratio is a strong indicator of the extensive margin in the labor market, or how many people are working, there is also important information in the intensive margin--that is, how much work each person is doing. The part-time for economic reasons (PTER) indicator shown in figure 7 measures those who are working part time because they are unable to find a full-time job or whose hours have been reduced and who would prefer full-time employment. This indicator is an important measure of labor market slack, which tends to jump rapidly during recessions and improve more slowly than headline unemployment during recoveries. PTER jumped during the financial crisis as workers who were unable to secure full-time employment moved to part-time work, accounting for more than half of the increase in involuntary part-time work during 2008. Today there are 6.0 million people working part time who would prefer full-time work, up 1.6 million relative to the pre-COVID level. The Bureau of Labor Statistics has six alternative measures of labor underutilization, the most expansive of which is the U-6 measures, which adds to the headline unemployment rate those employed part time for economic reasons, along with all persons marginally attached to the labor force as a percentage of the civilian labor force. The U-6 measure stood at 11.1 percent in Figure 8 shows the large amount of cyclical variation across PTER for several racial and ethnic groups. The incidence of involuntary part-time work was especially notable for Hispanic workers at the trough of the Great Recession, nearing 12 percent of employment and almost double its rate before the recession. This gap between Hispanic and white PTER narrowed substantially during the recovery and fell to just above 1 percentage point in the summer of 2019. Research indicates that gaps in involuntary part-time employment rates remain for Blacks, as well as Hispanics, relative to whites after controlling for age, education, marital status, and state of residence, although education and occupation can explain a portion of the gap for Hispanics. Before concluding, I would like to point to two other labor market indicators that provide useful evidence of the extent of labor market slack. The quits rate, shown in figure 9, is a measure of voluntary separations that provides information about how confident people are that they will be successful in finding a new job they prefer and, relatedly, of how aggressively firms are pursuing talent. Research indicates that the quits rate and wage growth are highly correlated, suggesting that these voluntary job-to- job transitions reflect individuals moving up a "job ladder" to higher-paying jobs. quits rate fell rapidly during the 2008 recession as workers' options became more limited, then recovered slowly, only surpassing its pre-financial crisis level of roughly 2.5 percent in 2018. In contrast, the bounceback from the pandemic trough has been much more robust, with quits already reaching 2.6 percent in December. As undergraduates, the quits rate may soon become relevant to you, as research indicates that job-to-job transitions are most frequent for young workers and that this measure has trended down in recent decades. Finally, measures of compensation are closely monitored for evidence on labor market slack. Figure 10 shows the 12-month growth rate of the employment cost index for total compensation for private industry workers (ECI). Just as quits fell during the Great Recession, so did the ECI. About two years after the onset of the financial crisis, the ECI moved up slightly in 2010 and then remained essentially flat at an annual growth rate of 2 percent over a five-year period between 2010 and 2015. There was a pickup of the ECI at the end of 2015, which coincided with the turning point in the prime-age LFPR. Even so, the growth rate of the ECI did not return to the levels experienced before Unlike the other indicators I have discussed, the pandemic appears to have made fairly little imprint on the ECI. The ECI declined slightly over the second and third quarters of 2020 and moved up in the fourth quarter. It is difficult to draw any firm conclusions from these developments; while the ECI is not as susceptible to composition effects as some other measures, smaller composition effects are still possible. So, what conclusions can we draw from this high-level overview of a variety of labor market indicators, their current readings, and their performance in the previous expansion? First, the headline unemployment rate by itself can obscure important dimensions of labor market slack, so it is important to heed Dr. Palmer's dictum and consult a broad set of aggregated and disaggregated measures. Second, groups that have faced the greatest challenges often make important labor market gains late in an expansion, consistent with Augustus Hawkins's emphasis on the importance of full employment for all Americans. So where does this leave us today? Jobs are still down by 10 million relative to pre-COVID levels, and COVID has disproportionately harmed certain sectors, groups of workers, businesses, and states and localities, leading to a K-shaped recovery. The fiscal support that is enacted and expected will provide assistance to vulnerable households, small businesses, and localities and a significant boost to activity when vaccinations are sufficiently widespread to support a reopening of in-person services. Monetary policy will continue to provide support by keeping borrowing costs for households and businesses low. The assessment of shortfalls from broad-based and inclusive maximum employment will be a critical guidepost for monetary policy, alongside indicators of realized and expected inflation. The Federal Open Market Committee has said it expects the policy rate to remain in the current target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. It has noted that asset purchases will continue at least at the current pace until substantial further progress has been made toward the maximum-employment and inflation goals. In assessing substantial further progress, I will be looking for sustained improvements in realized and expected inflation and examining a range of indicators to assess shortfalls from maximum employment. I will be looking for indicators that show the healing in the labor market is broad based, rather than focusing on the narrow aggregate U-3 unemployment rate, in light of the significant decline in labor force participation since the spread of COVID and the extremely elevated unemployment rate for workers in the lowest wage quartile. For nearly four decades, monetary policy was guided by a strong presumption that accommodation should be reduced preemptively when the unemployment rate nears its normal rate in anticipation that high inflation would otherwise soon follow. But changes in economic relationships over the past decade have led trend inflation to run persistently somewhat below target and inflation to be relatively insensitive to resource utilization. With these changes, our new monetary policy framework recognizes that removing accommodation preemptively as headline unemployment reaches low levels in anticipation of inflationary pressures that may not materialize may result in an unwarranted loss of opportunity for many Americans. It may curtail progress for racial and ethnic groups that have faced systemic challenges in the labor force, which is particularly salient in light of recent research indicating that additional labor market tightening is especially beneficial for these groups when it occurs in already tight labor markets, compared with earlier in the labor market cycle. Instead, the shortfalls approach means that the labor market will be able to continue to improve absent high inflationary pressures or an unmooring of inflation expectations to the upside. Inflation remains very low, and although various measures of inflation expectations have picked up recently, they remain within their recent historical ranges. PCE (personal consumption expenditures) inflation may temporarily rise to or above 2 percent on a 12-month basis in a few months when the low March and April price readings from last year fall out of the 12-month calculation, and we could see transitory inflationary pressures reflecting imbalances if there is a surge of demand that outstrips supply in certain sectors when the economy opens back up. While I will carefully monitor inflation expectations, it will be important to see a sustained improvement in actual inflation to meet our average inflation goal. Today the economy remains far from our goals in terms of both employment and inflation, and it will take some time to achieve substantial further progress. I look forward to the time when this K-shaped recovery becomes a broad-based and inclusive recovery and when vaccinations are widespread, the services sector springs back to life, and all Americans enjoy the benefits of full employment. I cannot think of a more meaningful time to be studying economics or a more important time to be thinking about the different ways to assess our shared goal of full employment.

r210224a_FOMC

united states

U.S. Economic Outlook and Monetary Policy

clarida

It is my pleasure to meet virtually with you today. I look forward to our conversation, but first, please allow me to offer a few remarks on the economic outlook, the Federal Reserve's monetary policy, and our new monetary policy framework. In the second quarter of last year, the COVID-19 (coronavirus disease 2019) pandemic and the mitigation efforts put in place to contain it delivered the most severe blow to the U.S. economy since the Great Depression, but economic activity rebounded sharply in the third quarter, supported by a robust and unprecedented fiscal and monetary policy response. More recently, the pace of recovery has moderated in part because of a winter resurgence in COVID-19 cases and hospitalizations. A number of macroeconomic data releases have been weaker than expected in recent months. Spending on services has continued to remain well below pre-pandemic levels, particularly in contact-intensive sectors, including travel, leisure, and hospitality. The pace of improvement in the labor market has slowed notably in recent months. Although more than half of the 22 million jobs that were lost last spring have been regained, the unemployment rate remained elevated at 6.3 percent in January, and once one factors in the decline in the labor force since the onset of the pandemic and misclassification, the true unemployment rate is closer to 10 percent. Core PCE (personal consumption expenditures) inflation is running at just 1.5 percent, and, for those sectors that have been most adversely affected by the pandemic, price increases remain subdued. Of course, we have also received some encouraging data. Retail sales stepped up considerably in January, retracing the decline late last year. The housing sector has more than fully recovered from the downturn, supported in part by low mortgage interest rates. Business investment and manufacturing production have also rebounded robustly. And while the economy might not continue to grow at the once-in-a-century 33 percent annualized rate of growth reported in the third quarter of 2020, it is clear that the economy has turned out to be more resilient in adapting to the virus, and more responsive to monetary and fiscal policy support, than many predicted. Indeed, it is worth highlighting that in the baseline projections of the Federal Open Market Committee December, most of my colleagues and I revised up our outlooks for the economy over the medium term, projecting a relatively rapid return to levels of employment and inflation consistent with the Federal Reserve's statutory mandate as compared with the recovery In particular, the median FOMC participant projected in December that by the end of 2023--a little less than three years from now-- the unemployment rate will have fallen below 4 percent, and PCE inflation will have returned to 2 percent. Following the GFC, it took more than eight years for employment and inflation to return to similar mandate-consistent levels. While the winter surge in new COVID cases and the spread of new variants of the virus are cause for concern as well as a source of downside risk to the very near-term outlook, the welcome news on the development of several effective vaccines and the passage by the Congress in late December of a package of fiscal relief measures indicate to me that the prospects for the economy in 2021 and beyond have brightened and the downside risk to the outlook has diminished. At our most recent FOMC meetings, the Committee made important changes to our policy statement that upgraded our forward guidance about the future path of the federal funds rate and asset purchases, and that also provided unprecedented information about our policy reaction function. As announced in the September statement and reiterated in the following statements, with inflation running persistently below 2 percent, our policy will aim to achieve inflation outcomes that keep inflation expectations well anchored at our 2 percent longer-run goal. We expect to maintain an accommodative stance of monetary policy until these outcomes--as well as our maximum-employment mandate--are achieved. We also expect it will be appropriate to maintain the current target range for the federal funds rate at 0 to 1/4 percent until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment, until inflation has risen to 2 percent, and until inflation is on track to moderately exceed 2 percent for some time. In addition, in the December statement, we combined our forward guidance for the federal funds rate with enhanced, outcome-based guidance about our asset purchases. We indicated that we will continue to increase our holdings of Treasury securities by at least $80 billion per month and our holdings of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward our maximum-employment and price-stability goals. The changes to the policy statement that we made over the past few FOMC meetings bring our policy guidance in line with the new framework outlined in the Committee approved last August. In our new framework, we acknowledge that policy decisions going forward will be based on the FOMC's estimates of " shortfalls [emphasis added] of employment from its maximum level"--not "deviations." This language means that going forward, a low unemployment rate, in and of itself, will not be sufficient to trigger a tightening of monetary policy absent any evidence from other indicators that inflation is at risk of moving above mandate-consistent levels. With regard to our 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 in a world in which an effective-lower-bound constraint is, in downturns, binding on the federal funds rate. To this end, the new statement conveys the Committee's judgment that, in order to anchor expectations at the 2 percent level consistent with price stability, 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." As Chair Powell indicated in his Jackson Hole remarks, we think of our new framework as an evolution from "flexible inflation targeting" to "flexible average inflation targeting." While this new framework represents a robust evolution in our monetary policy strategy, this strategy is in service to the dual-mandate goals of monetary policy assigned to the Federal Reserve by the Congress--maximum employment and price stability--which remain unchanged. While our interest rate and balance sheet tools are providing powerful support to the economy and will continue to do so as the recovery progresses, it will take some time for economic activity and employment to return to levels that prevailed at the business cycle peak reached last February. We are committed to using our full range of tools to support the economy and to help ensure that the recovery from this difficult period will be as robust and rapid as possible.

r210225a_FOMC

united states

Themistocles and the Mathematicians: The Role of Stress Testing

quarles

One of the principal themes of human history--and certainly of economic history -is that of a sudden technological breakthrough originally deployed for one purpose being gradually refined over time until new and better versions of it are eventually deployed for a much broader range of purposes. The breakthrough supplies the drama, but it's the steady incremental improvement over time that makes the greatest difference. The Phoenicians dramatically improved the speed and cargo load of their commercial voyages with the invention of the trireme--massive boats, powered with three tiers of oarsmen, rather than the standard one or two--dispatched from Tyre and Sidon in the service of exploration, commerce, and colonization. But the Greeks improved on the design, bit by bit, and over many years, until they became not commercial vessels ferrying cargo from Carthage to Cadiz, but warships that revolutionized naval combat and enabled Athens--led by the obstinate upstart Themistocles who built a fleet of 200 triremes, the largest navy Greece had ever seen--to challenge and defeat the Persian King. Or, somewhat closer to home, consider the development of radar in World War II. That initial innovation was instrumental in winning the war but continued refinement has led to technologies that can promptly warn us of tornados or even steer our cars. In the world of bank supervision, our equivalent of the trireme has been the stress test. The initial innovation of stress testing gave us an urgently needed tool to measure how much additional capital banks with mounting losses needed to survive the financial crisis more than a decade ago. But because we continued with the refinement, we now have a tool that also helps us to set capital requirements credibly in the banking system, in good times as well as times of financial stress. Today, I'd like to share with you my perspective about how stress testing has enhanced the credibility of our capital adequacy framework, highlight some features of the upcoming stress test, and offer some thoughts on the importance of continued innovation in supervision. In particular, I will discuss how stress testing serves as both a general tool to set bank capital requirements throughout the credit cycle and recently as a specialized tool to provide an analytical grounding for the decisions we have made on capital distributions during the COVID event. Then I will briefly review the recently released scenario for the 2021 test and discuss other changes for the upcoming stress testing cycle. We now use stress testing in two important but different ways: to set capital requirements during normal times and to assess capital adequacy during exigent times. In March of last year, the Board of Governors finalized the stress capital buffer requirement, which uses the Fed's stress test results to set capital requirements for large banks, and by doing so, simplified our overall capital regime. While this new framework has the same goal as the previous Comprehensive help ensure that banks have sufficient capital to survive a severe recession while still being able to lend to businesses and household--it integrates our stress testing regime with our ongoing capital requirements so that large banks now have a single suite of dynamic and risk-sensitive capital requirements. While that framework is simpler, it is no less stringent than the CCAR framework--a framework that contributed to a more than doubling of the common equity ratio at banks between 2009 and 2019. At the time we made the stress capital buffer final last March, we estimated that the stress capital buffer would have further increased capital requirements for the largest and most complex banks. By design, the new framework better captures systemic risk by requiring those banks to establish a buffer to absorb losses they'd take in a severe recession in addition to their G-SIB surcharges. It is useful here to pause and put stress testing in the context of bank supervision in general. Both supervision and stress testing specifically have roles during normal times as well as times of stress, but those roles are somewhat different depending on the circumstances. Like all supervision, stress testing conducted during normal times of solid economic growth and financial stability is aimed at helping ensure banks remain in safe and sound condition. We use it to set the capital buffers, which give firms incentives to hold capital during normal times, so they are prepared to weather downturns. During periods of economic and financial turmoil, the goals shift to understanding banks' exposure to the turmoil and to ensuring that banks can support households and businesses by continuing to lend. The modern bank stress testing regime was born in the solvency crisis of 2009 but remains a flexible tool that can be used to understand the implications of a range of macroeconomic and financial conditions. That includes conditions that few could have imagined, such as those that descended last spring. The temporary shutdown of large segments of the economy caused an unprecedentedly large and swift drop in economic activity. Equally unprecedented was the degree of uncertainty, both downside and upside, about how the economy would progress throughout the remainder of 2020. We responded to that abrupt change in environment by adapting stress testing to conduct a sensitivity analysis, an application of the stress testing models used to inform the Board of Governors about risks to bank solvency during those rapidly changing conditions. The sensitivity analysis we conducted was possible because we routinely collect standardized data from banks on their exposures and have developed our own loss and income models at the Fed. Thus, we were able to conduct this analysis purely internally, without putting additional burdens on banks during an already-difficult time. That analysis used the same models as the regular stress test, but we made several changes with the goal of gaining a real-time understanding of the implications for bank capital of quite plausible downside scenarios. The sensitivity analysis included three additional scenarios that reflected the potential economic implications of the COVID event, as we understood them at the time. We also incorporated targeted adjustments to account for material changes to bank balance sheets resulting from the COVID event, such as large drawdowns on corporate credit lines. At that time of great uncertainty, this sensitivity analysis helped sharpen our understanding of how banks might fare under the wide range of possible paths of the economy. We published that analysis to bolster public confidence in the financial system by providing a rigorous and timely assessment of the condition and prospects for the banking sector, based on data and well-established analytical methods. The additional analysis gave the public a view into the intellectual underpinnings of the policy actions the Board took, which included special limitations on--but not a complete elimination of--capital distributions and a requirement for all firms to re-assess their capital needs and submit another capital plan in late 2020 in light of the economic uncertainty. The December round of stress tests that followed informed an adjustment to and extension of the distribution limitations into the first quarter of 2021, and we are continuing to use insights from the stress tests as we consider when to lift the limitations. Throughout the COVID event, the stress test has provided analysis necessary to tailor our actions to the risks we faced, and we have used the results from it to provide the public with transparency into the analysis that informs our decisions. The investment we've made in the Fed's own stress test models gave us an extra tool relative to regulators in other jurisdictions, who generally rely on banks' own models for projections of losses and revenues in their supervisory stress tests. While those other jurisdictions cancelled or postponed their scheduled stress tests to avoid putting additional burdens on banks to run models during a period of financial stress, we expanded our internally-run analysis to meet the evolving conditions. We used the opportunity to inform ourselves about the impact of various plausible paths that the recovery might take and to provide the public with more frequent assessments of bank health. And as a result of the measures taken by the Board and the banks, U.S. bank capital levels actually increased last year, despite substantial increases in loan loss reserves--funds that banks set aside to cover expected losses. The aggregate common equity ratio across large banks increased from 12 percent at the end of 2019 to 12.8 percent at the end of 2020. During this same time, large banks built roughly $90 billion in loan loss reserves. It may not have been possible to use stress testing in such a central way had we not done the work to establish its credibility over the past decade. That credibility is built on a foundation of cutting-edge models, which estimate how different bank assets would respond to economic stresses. Our careful execution of those models allows us to confidently disclose detailed results to the public. Those innovations prepared us to adapt quickly and respond to the unprecedented shock associated with the COVID event, which confirmed that stress testing is still effective in these unprecedented times. The Fed's stress testing models are subject to continual development by experts in credit risk measurement, borrower behavior, and financial markets. Like a barometer, the models give us an early warning of stormy financial conditions ahead by distilling bank positions and scenarios into estimates of potential losses and revenues. These models are reviewed by a group of experts inside the Fed but outside the stress testing process that challenges their assumptions, further improving their credibility. The models span all material exposures held by banks, providing a comprehensive assessment of the risks different types of scenarios pose to overall bank capital. Our disclosures of the results stemming from those models, along with transparency about the model assumptions, have given banks, markets, and the broader public a lens through which to understand risk in the system. We have built credibility over time through our consistent and increasingly detailed public disclosures. For nearly a decade, we have published the scenarios and results, and a few years ago we greatly expanded our disclosure of the modeling methodology in an additional annual publication. Continuing in that tradition, two weeks ago we initiated the 2021 stress test with the publication of this cycle's stress scenarios. As we've said many times, the scenarios are not projections or predictions. They are designed according to a longstanding framework that we published after incorporating feedback from the public. This year, the macroeconomic scenario envisions a severe global recession accompanied by a period of heightened stress in U.S. commercial real estate and corporate debt markets. As discussed in recent financial stability reports, the current environment presents unique challenges for those asset classes, and our focus on them in the scenarios is consistent with the salient risks they pose to banks. The scenario layers additional significant stress on top of the stress already absorbed by banks over the past year, with the unemployment rate rising back to nearly 11 percent and stock prices falling more than 50 percent. In March, we will publish the details of the methodologies that underlie our models. This will mark the third year since we enhanced the disclosures to provide significantly more information about the stress testing models relative to earlier years. That information includes ranges of loss rates, estimated by using the models, for actual loans held by CCAR firms; portfolios of hypothetical loans with loss rates estimated by the models; and more detailed descriptions of the models, such as equations and key variables that influence the results of the models. These disclosures enhance the ability of the public to understand and interpret the supervisory stress test results. And as I've noted before, I believe these enhanced disclosures have been a step in the right direction toward striking the right balance between rigor and transparency. They do not reveal everything about our models--lest we find ourselves in a "model monoculture" where supervisors and banks converge on the same sets of risks, ignoring other potential problems. In June we'll publish the firm-level results from the test. Though 2021 is a year in which smaller firms are not subject to the supervisory stress test, the Board recently made final a rule that will allow them to opt in. Should they do so, their results will also be disclosed, and their stress capital buffers will be updated using the stress test results we publish in June. These actions, including greater transparency around our stress testing models and greater flexibility in our stress testing process for smaller firms, represent innovations that I believe help to improve the effectiveness and efficiency of supervision. As we look to the future, the Fed must continue to innovate so that stress testing remains effective. In the near term, we must strive to understand the implications of the COVID event on how we measure financial risk. Borrowers are facing unemployment, cash flow disruptions, and continued economic uncertainty. The programs put in place to help those borrowers are critical for our recovery but will further complicate risk modeling as borrower stress may be obscured by temporary stimulus. For example, it is difficult to tell whether a borrower who has continued to make loan payments during the COVID event is able to do so because of stimulus payments or because they have continued to earn income. Borrowers benefitting from temporary forbearance may or may not be able to resume payments once the forbearance ends. Over the longer term, we must continue to sharpen our thinking around the interrelationships between bank risk and broader changes, such as advancing technologies and growth in non-bank finance. Those forces are undoubtedly altering bank risk, and it will take creative and timely research to understand the implications. Our agenda also includes initiatives that could reduce the volatility in the stress test results without sacrificing either their probative value or their rigor. We will continue to explore those possibilities. At the same time, we regularly get calls from the public to review various aspects of our models. For example, in recent years, representatives from an affordable housing group noted that the global market shock for real estate investments also affected certain lower-risk public welfare investments, thereby discouraging investment in affordable housing. We deliberatively studied the issue, concluded that the public welfare investments indeed posed a lower risk to bank capital than the other real estate investments, and adjusted downward the shock we apply to those investments in advance of the 2020 stress test. More recently, we received feedback from banks via appeals of their stress capital buffers. I was encouraged by the fact that a number of the issues the banks raised were already on our research agenda. The banks, however, did raise issues relating to interest rate hedges, loss-sharing agreements, and loans that use fair value option accounting that the Board directed staff to investigate and address promptly. I am hopeful that the feedback we receive from the public as well as our own analysis will help us set the right priorities in our research and development work. But innovation is not just about improving tools like stress testing. It is also about identifying new ways to apply those tools to a broader set of problems faced by the Board, in supervision, and perhaps beyond. The sensitivity analysis I described earlier demonstrates how we are able to adapt and apply a familiar tool in a new way to conduct critical analysis at a critical moment. Drawing on that experience, I believe there is a need for more data and data- driven analysis broadly in supervision, which is related to the larger goal of enhanced transparency. Important aspects of supervision are appropriately private, to protect a bank's confidential business information and to avert speculation about a bank's finances that could be destabilizing. And not every aspect of a supervisor's work can be quantified. But I believe that there is room for supervisors to be more transparent about their analytical processes in general, and more forthcoming about the data used as the basis for supervisory judgments. Stress testing can serve as an example of what may be possible as we explore those avenues. Themistocles saw the possibilities of an evolving technology in a changing world. That applies, too, to the ongoing work of reviewing, adjusting and improving supervision and stress testing to ensure that banks can continue supporting households and businesses in good times and in those that are more challenging.

r210301a_FOMC

united states

Some Preliminary Financial Stability Lessons from the COVID-19 Shock

brainard

It has now been one year since the devastating effects of the first wave of the COVID-19 pandemic hit our shores, a year marked by heartbreak and hardship. We look forward to a brighter time ahead, when vaccinations are widespread, the recovery is broad based and inclusive, and the economy fully springs back to life. But we should not miss the opportunity to distill lessons from the COVID shock and institute reforms so our system is more resilient and better able to withstand a variety of possible shocks in the future, including those emanating from outside the financial system. Investor sentiment shifted dramatically in the early days of March 2020 with the realization that COVID would disrupt the entire global economy. Short-term funding markets became severely stressed as market participants reacted to the advent of this low-probability catastrophic event. The abrupt repositioning and repricing of portfolios led to a dash for cash, as even relatively safe Treasury holdings were liquidated, volatility spiked, and spreads in Treasury and offshore dollar funding markets widened sharply. Forceful and timely action by the Federal Reserve and other financial authorities was vital to stabilize markets and restore orderly market functioning. Although some parts of the financial system that had undergone significant reform in the wake of the Global Financial Crisis remained resilient, the COVID stress test highlighted significant financial vulnerabilities that suggest an agenda for further financial reform. I will briefly comment on these areas of vulnerability as well as areas where earlier reforms led to greater resilience. The COVID shock brought to the fore important vulnerabilities in the systemically important short-term funding markets that had previously surfaced in the Global Financial Crisis. Signs of acute stress were readily apparent in intermediaries and vehicles with structural funding risk, particularly in prime money market funds (MMFs). Indeed, it appears these vulnerabilities had increased, as assets held in prime MMFs doubled in the three years preceding last March. When the COVID shock hit, investors rapidly moved toward cash and the safest, most liquid financial instruments available to them. Over the worst two weeks in mid-March, net redemptions at publicly offered institutional prime MMFs amounted to 30 percent of assets. This rush of outflows as a share of assets was faster than in the run in 2008, and it appears some features of the money funds may have contributed to the severity of the run. The run in March forced MMFs to rapidly reduce their commercial paper holdings, which worsened stress in short-term funding markets. Funding costs for borrowers shot up, and the availability of short-term credit at maturities beyond overnight plunged. These markets provide the short-term credit many businesses need to keep operating and meet payrolls. So when short- term funding markets shut down, it can imperil many businesses, too. For the second time in 12 years, a run on MMFs triggered the need for policy intervention to mitigate the effect on financial conditions and the wider economy. To head off the risk of widespread business failures and layoffs, the Federal Reserve took a number of actions, including announcing the Commercial Paper Funding Facility on March 17 and the of these facilities, prime MMF redemptions slowed almost immediately, and other measures of stress in short-term funding markets began to ease. The March 2020 turmoil highlights the need for reforms to reduce the risk of runs on prime money market funds that create stresses in short-term funding markets. The President's Working Group on Financial Markets has outlined several potential reforms to address this risk, and the Securities and Exchange Commission recently requested comment on these options. properly calibrated, capital buffers or reforms that address the first-mover advantage to investors that redeem early, such as swing pricing or a minimum balance at risk, could significantly reduce the run risk associated with money funds. Currently, when some investors redeem early, remaining investors bear the costs of the early redemptions. In contrast, with swing pricing, when a fund's redemptions rise above a certain level, the investors who are redeeming receive a lower price for their shares, reducing their incentive to run. Similarly, a minimum balance at risk, which would be available for redemption only with a time delay, could provide some protection to investors who do not run by sharing the costs of early redemptions with those who do. Capital buffers can provide dedicated resources within or alongside a fund to absorb losses and reduce the incentive for investors to exit the fund early. To be sure, domestic money market funds are not the only vulnerable cash-management investment vehicles active in U.S. short-term funding markets. For example, offshore prime money funds, ultrashort bond funds, and other short-term investment funds also experienced stress and heavy redemptions last March. The runs on offshore MMFs that hold dollar- denominated assets like commercial paper underscore the importance of working with international counterparts to increase the resilience of short-term funding markets. We are supporting the work of the Financial Stability Board to assess options for mitigating the vulnerabilities of MMFs globally and report on them later this year. The COVID shock also highlighted the structural vulnerabilities associated with the funding risk of other investment vehicles that offer daily liquidity while investing in less-liquid assets, such as corporate bonds, bank loans, and municipal debt. Open-end funds held about one-sixth of all outstanding U.S. corporate bonds prior to the crisis. Bond mutual funds, including those specializing in corporate and municipal bonds, had an unprecedented $250 billion in outflows last March, far larger than their outflows at any time during the 2007-09 financial crisis. The associated forced sales of fund assets contributed to a sharp deterioration in fixed-income market liquidity that necessitated additional emergency interventions by the Federal Reserve. In assessing possible reforms to address this run risk, swing pricing could be helpful, because it reduces the first-mover advantage for running from a fund by imposing a cost when redemptions are high. Swing pricing has been used for more than a decade in European mutual funds, where it has been shown to slow redemptions in stress events. States, mutual funds have not adopted swing pricing, in part because of technical obstacles. The COVID shock also revealed vulnerabilities in the market for U.S. Treasury securities. The U.S. Treasury market is one of the most important and liquid securities markets in the world, and many companies and investors treat Treasury securities as risk-free assets and expect to be able to sell them quickly to raise money to meet any need for liquidity. Trading conditions deteriorated rapidly in the second week of March as a wide range of investors sought to raise cash by liquidating the Treasury securities they held. Measures of trading costs widened as daily trading volumes for both on- and off-the-run securities surged. Indicative bid-ask spreads widened by as much as 30-fold for off-the-run securities. Market depth for the on-the- run 10-year Treasury security dropped to about 10 percent of its previous level, and daily volumes spiked to more than $1.2 trillion at one point, roughly four standard deviations above the 2019 average daily trading volume. Stresses were also evident in a breakdown of the usually tight link between Treasury cash and futures prices, with the Treasury cash-futures basis--the difference between prices of Treasury futures contracts and prices of Treasury cash securities eligible for delivery into those futures contracts--widening notably. Selling pressures were widespread, reflecting sales by foreign official institutions, rebalancing by asset managers, a rapid unwinding of levered positions, and precautionary liquidity raising. Available data suggest that foreign institutions liquidated about $400 billion in Treasury securities in March, with more than half from official institutions and the remainder from private foreign investors, at a time when offshore dollar funding markets also experienced acute stress. Domestic mutual funds sold about $200 billion during the first quarter, selling their less-liquid Treasury securities in order to raise cash to meet investor redemptions. Hedge funds reduced long cash Treasury positions by an estimated $35 billion. Dealers play a central role in the Treasury market by buying and selling securities and providing financing to investors. Their capacity or willingness to intermediate these flows was strained amid the elevated uncertainty and intense and widespread selling pressure in mid- March. Operational adjustments associated with the rapid move to remote work may also have inhibited intermediation. The acute stresses in the Treasury market necessitated emergency intervention by the purchases of Treasury securities and agency mortgage-backed securities (MBS) "in the amounts needed" to support smooth market functioning of these markets. April 15, the Federal Reserve increased its holdings of Treasury securities by about $1.2 trillion and agency MBS by about $200 billion. The Federal Reserve provided overnight and term repurchase agreement (repo) operations to address disruptions in Treasury financing markets. These actions rapidly restored market functioning, and a variety of indicators had returned to pre-COVID levels by the summer. While the scale and speed of flows associated with the COVID shock are likely pretty far out in the tail of the probability distribution, the crisis highlighted vulnerabilities in the critically important Treasury market that warrant careful analysis. A number of possible reforms have been suggested to strengthen the resilience of the Treasury market. For instance, further improvements in data collection and availability have been recommended to enhance transparency related to market participants, such as broker-dealers and hedge funds. Some have suggested that the Federal Reserve could provide standing facilities to backstop repos in stress conditions, possibly creating a domestic standing facility or converting the temporary Foreign possible avenues to explore include the potential for wider access to platforms that promote forms of "all to all" trading less dependent on dealers and, relatedly, greater use of central clearing in Treasury cash markets. These measures involve complex tradeoffs and merit thoughtful analysis in advancing the important goal of ensuring Treasury market resilience. The global dash for cash also led to severe stress in offshore dollar funding markets, where foreign exchange swap basis spreads increased sharply to levels last seen in the Global Financial Crisis. Foreign banking organizations serve as key conduits of dollar funding for foreign governments, central banks, businesses, nonbank financial institutions, and households. . They hold $14 trillion in dollar-denominated claims--about half of the total global dollar claims of banks. The Federal Reserve and several other central banks responded swiftly to distress in the offshore dollar funding markets by announcing the expansion and enhancement of dollar liquidity swap lines on March 15, followed on March 19 by the reopening of temporary swap lines with the nine central banks that had temporary agreements during the Global Financial support the liquidity of Treasury securities held by foreign monetary authorities, an important innovation. Following these interventions, foreign exchange swap basis spreads started moving down almost immediately and within a few weeks reached their levels before the COVID shock. The reforms put in place pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) in response to the previous crisis appear to have supported the resilience of the financial system as it absorbed the COVID shock. Importantly, regulators instituted global reforms to encourage and, in some cases, mandate central clearing after observing the loss of confidence in key banking intermediaries during the Global Financial Crisis associated with the opaque web of bilateral derivatives contracts. As a result, during the COVID turmoil, the greatly expanded scope of central clearing, with the attendant reduction in counterparty and settlement risks, supported the orderly functioning of critical securities and derivatives markets amid sharply increased trading volumes and spiking volatility. Moreover, several central clearing platforms (CCPs) successfully handled problems that emerged at a few smaller market participants, without noticeable spillovers to other markets and institutions. However, as part of the risk controls that are inherent in central clearing, the COVID market turmoil generated exceptionally large flows of cash through CCPs from market participants with mark-to-market losses to those participants with corresponding gains. Furthermore, during the March COVID turmoil, a number of CCPs collected significantly higher financial resources from their members to protect against increased risk as captured by their risk models. These demands for liquidity were met adequately, and the markets operated efficiently and effectively, although the sudden spikes in CCP requirements may have stressed the liquidity positions of some trading firms. And while CCPs performed well during this period of stress, forceful public emergency interventions and the strong capitalization of banks likely mitigated the risks of large clearing member defaults. The COVID-19 shock presents an important opportunity to reflect on lessons learned about central clearing by the public and private sectors. CCPs could consider the effects of the market dysfunction on their liquidity risk-management plans, including their assumptions regarding the ability to raise cash from noncash assets or securities. In addition to reassessing their liquidity planning, CCPs could also assess the tradeoffs between their own risk- management decisions and broader financial stability concerns, particularly in light of how CCPs may have contributed to deleveraging by some market participants in March by the magnitude of the increases in financial resources they collected when trading and volatility spiked. CCPs could assess their margin models, consider improvements to reduce pro-cyclicality, and consider increased transparency to help clearing members anticipate margin calls during periods of volatility. The holistic review by the Financial Stability Board, in which we participate, could provide important insights into these issues. The resilience of the banking sector in response to the COVID shock underscores the importance of guarding against erosion of the strong capital and liquidity buffers and risk- management, resolution, and stress-testing programs put in place pursuant to the Dodd-Frank Act. Banks entered the pandemic with strong capital and liquidity buffers, especially those banks whose size and complexity are systemically important. Strong capital and liquidity buffers allowed the banking system to accommodate the unprecedented demand for short-term credit from many businesses that sought to bridge the pandemic-related shortfalls in revenues. Banks' capital positions initially declined because of this new lending and strong provisioning for loan losses but have since risen above their pre-pandemic levels, reflecting better-than-expected loan performance and a reduction in credit provision as well as caps on dividends and restrictions on share repurchases in the past several quarters. Strong capital and liquidity positions will remain important, as banks still face significant challenges--including an environment of higher-than-normal uncertainty. For instance, some sectors of commercial real estate loans and commercial and industrial loans are more vulnerable than before the crisis. Similarly, net interest margins could remain in the lower part of their historical ranges for some time. Although losses and delinquency rates on bank loans are currently low, performance could deteriorate as borrowers exit forbearance, with particularly hard-hit businesses and households facing arrears on rent and mortgage payments. developments have been encouraging, but downside risks remain, which could delay recovery and lead to higher losses. Bank resilience benefited from the emergency interventions that calmed short-term funding markets and from the range of emergency facilities that helped support credit flows to businesses and households. While the results of our latest stress test released in December 2020 show that the largest banks are sufficiently capitalized to withstand a renewed downturn in coming years, the projected losses take some large banks close to their regulatory minimums. According to past experience, banks that approach their regulatory capital minimums are much less likely to meet the needs of creditworthy borrowers. It is important for banks to remain strongly capitalized in order to guard against a tightening of credit conditions that could impair the recovery. Structural vulnerabilities such as those discussed earlier could interact with cyclical vulnerabilities in the financial system, potentially magnifying the associated risks. Valuations are elevated in a number of asset classes relative to historical norms. After plunging as the pandemic unfolded last spring, broad stock price indexes rebounded to levels well above pre- pandemic levels. Some observers also point to the potential for stretched equity valuations and elevated volatility due to retail investor herd behavior facilitated by free online trading platforms. Risk appetite in credit markets is also elevated, with high-quality investment-grade (IG) corporate debt trading at slightly negative real yields and issuance of leveraged loans returning to 2019 levels. While financial markets are inherently forward-looking, taking into account the prospects of widespread vaccinations and substantial fiscal support, a variety of risks related to the virus could result in a sudden change in investor risk sentiment. This could, for instance, trigger outflows from corporate bond mutual funds and other managed funds with an investor base that is sensitive to fund performance. Commercial real estate prices are susceptible to declines if the pace of distressed transactions picks up or if the pandemic leads to permanent changes in patterns of use--for instance, a decline in demand for office space due to higher rates of remote work or for retail space due to a permanent shift toward online shopping. Debt loads at large nonfinancial firms were high coming into the pandemic and remain so. Measures of leverage at large firms remain near the historical highs reached at the beginning of 2020, with the aggregate book value of debt exceeding 35 percent of assets in the third quarter. A large portion of IG debt is currently at the lowest IG rating, making this debt vulnerable to downgrades. Such downgrades may bring insurers, mutual funds, and other regulated institutional investors closer to internal or statutory thresholds on their holdings of non- IG securities, potentially forcing these institutions to shed assets. Over a longer horizon, changes in the economic environment associated with low equilibrium interest rates, persistently below-target trend inflation, and low sensitivity of inflation to resource utilization could be expected to contribute to a low-for-long interest rate environment and reach-for-yield behavior. In these kinds of environments, it is valuable to deploy macroprudential tools, such as the countercyclical capital buffer, to mitigate potential increases in financial imbalances. The COVID shock subjected the financial system to an acute stress that necessitated emergency interventions on a massive scale by financial authorities around the world. The COVID turmoil underscores the importance of ensuring the financial system is resilient to a wide range of shocks, including those emanating from outside the financial system. Regulators and international standard-setting bodies have an opportunity to draw important lessons from the COVID shock about where fragilities remain, such as in prime MMFs and other vehicles with structural funding risk. A number of common-sense reforms are needed to address the unresolved structural vulnerabilities in nonbank financial intermediation and short-term funding markets.

r210302a_FOMC

united states

U.S. Economic Outlook and Monetary Policy: An Update

brainard

It has been one year since the first wave of the COVID-19 pandemic hit our shores--a year marked by heartbreak and hardship. We are all looking forward to a brighter time ahead, when vaccinations are widespread, the recovery is broad based and inclusive, and services, schools, sports, and social life are in person. The expected path of the U.S. economy has strengthened with the prospect of widespread vaccinations and additional fiscal stimulus, but risks remain, and we are currently far from our goals. After a dark winter with elevated case counts and setbacks on service-sector jobs, case counts have come down and spending is picking up. Economic forecasts for growth during the first quarter have been significantly upgraded in response to the better-than- expected data. January data for household spending overall came in strong--confirming that the renewal of fiscal support at the end of the year provided a much needed boost to household incomes and spending at the turn of the year. The income support provided by fiscal authorities to hard-hit workers, households, businesses, and states and localities, as well as the actions of the Federal Reserve to promote orderly functioning in financial markets and low borrowing costs for households and businesses, have been providing vital support for the economy. In recent weeks, vaccinations have been increasing, while weekly cases, hospitalizations, and deaths have decreased. The seven-day moving average of daily COVID deaths, which peaked in mid-January, declined about 35 percent during the month of February, although sadly it is still at high levels. As of yesterday, nearly 77 million vaccination doses had been administered. While the progress on vaccinations is promising, jobs are currently down by 10 million relative to pre-pandemic levels. Improvements in the labor market stalled late last year after rebounding partway in the summer and fall of 2020. When we take into consideration the more than 4 million workers who have left the labor force since the pandemic started, as well as misclassification errors, the unemployment rate is close to 10 percent currently--much higher than the headline unemployment rate of 6.3 percent. Labor force participation by prime-age workers stands lower now, on net, than it did in June after it had bounced back partway from the decline in April. The decline in labor force participation relative to last June is largely a result of lower participation by prime-age women, which, in turn, partly reflects the increase in caregiving work at home with the move to remote schooling and the shutdown of daycares due to COVID. On average, over the period from November 2020 to January 2021, the fraction of prime-age women with children aged 6 to 17 who were out of the labor force for caregiving had increased by 2.4 percentage points from a year earlier, while for men the fraction had increased by about 0.6 percentage point. If not soon reversed, the decline in the participation rate for prime age women could have scarring effects, with longer-term implications for household incomes and potential growth. Roughly 90 percent of the shortfall in private payroll employment relative to the pre-COVID level is concentrated in service-providing industries, with half of these service job losses in leisure and hospitality. The concentration of job losses in services has had a disproportionate effect on the lowest-wage workers. Workers in the lowest- wage quartile face an extremely elevated rate of unemployment of around 23 percent. The advent of widespread vaccinations should revive in-person schooling and childcare along with demand for the in-person services that employ a significant fraction of the lower-wage workforce. Realized inflation remains low, although inflation expectations appear to have moved closer to our 2 percent longer-run target. Both core and headline measures of 12- well below our longer-run 2 percent inflation goal. Longer-term inflation expectations appear to have moved up in recent months, consistent with the Federal Open Market Committee's (FOMC) new commitment to achieving inflation that averages 2 percent over time. Market-based indicators of inflation expectations increased over recent months, with Treasury Inflation-Protected Securities-based measures of inflation compensation over the next 5 years and 10 years rising about 40 and 30 basis points, respectively, since the end of last year. Some survey measures of inflation expectations have also moved up in recent months, although, on balance, they have only moved up toward their pre-COVID levels. In many foreign countries, growth moderated at the end of 2020, as a spike in COVID hospitalizations and deaths led to tighter public health restrictions in many economies. Retail sales and measures of services activity weakened even as manufacturing and exports remained more resilient. Foreign activity should strengthen later this year as vaccinations rise, COVID case counts decline, and social distancing eases. It should also be aided by some rundown in the stock of excess savings, continued fiscal and monetary support, and strong U.S. demand. The turnaround in growth in each country will hinge on success in controlling the virus and limiting economic scarring from the past year's downturn, as well as on available policy space, and underlying macroeconomic vulnerabilities. So, what do these developments suggest for the U.S. outlook? Increasing vaccinations, along with enacted and expected fiscal measures and accommodative monetary policy, point to a strong modal outlook for 2021, although considerable uncertainty remains. It is widely expected that we will continue to make progress controlling the virus, reducing the need for social distancing, but variants of the virus, slow take-up of vaccinations, or both could slow progress. Additional fiscal support is likely to provide a significant boost to spending when vaccinations are sufficiently widespread to support a full reopening of in-person services. Various measures of financial conditions are broadly accommodative relative to historical levels and should remain so. The labor market should strengthen, perhaps significantly, as the virus recedes, social distancing comes to an end, and the service sector springs back to life. Inflation is likely to temporarily rise above 2 percent on a 12-month basis when the low March and April price readings from last year fall out of our preferred 12-month PCE measure. Transitory inflationary pressures are possible if there is a surge of demand that outstrips supply in certain sectors when the economy opens up fully. The size of such a surge in demand will depend in part on the effects of additional fiscal stimulus, along with any spend-down of accumulated savings, which are uncertain. But a surge in demand and any inflationary bottlenecks would likely be transitory, as fiscal tailwinds to growth early this year are likely to transition to headwinds sometime thereafter. A burst of transitory inflation seems more probable than a durable shift above target in the inflation trend and an unmooring of inflation expectations to the upside. When considering the inflation outlook, it is important to remember that inflation has averaged slightly below 2 percent for over a quarter-century. In the nine years since the FOMC's announcement of a 2 percent inflation objective, 12-month PCE inflation has averaged under 1-1/2 percent. Readings of 12-month inflation have been below 2 percent in 95 of those 109 months. According to recent research, statistical models estimate that underlying core PCE inflation ranges from one- to four-tenths of 1 percentage point below our 2 percent longer-run target. Recall that at the end of 2019, with unemployment at a multidecade low and after the addition of almost 1-1/2 million workers to the labor force during the previous year, PCE inflation was 1.6 percent for the year. With that outlook in mind, let me turn to monetary policy. After an extensive review, the FOMC revised its monetary policy framework to reflect important changes in economic relationships characterized by a low equilibrium interest rate, inflation persistently below target, and low sensitivity of inflation to resource utilization. The new framework calls for monetary policy to seek to eliminate shortfalls of employment from its maximum level, in contrast to the previous approach that called for policy to minimize deviations when employment is too high as well as too low. It emphasizes that maximum employment is a broad-based and inclusive goal assessed by a wide range of indicators. In addition, in order to keep longer-term inflation expectations well anchored at our 2 percent goal, monetary policy will seek to achieve inflation that averages 2 percent over time. Consequently, 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. These changes mean that we will not tighten monetary policy solely in response to a strong labor market. The long-standing presumption that accommodation should be reduced preemptively when the unemployment rate nears estimates of the neutral rate in anticipation of high inflation that is unlikely to materialize risks an unwarranted loss of opportunity for many of the most economically vulnerable Americans. It may curtail progress for racial and ethnic groups that have faced systemic challenges in the labor force. Instead, the shortfalls approach will enable the labor market to continue to improve absent clear indications of high inflationary pressures or an unmooring of inflation expectations to the upside. The FOMC has set out forward guidance on the policy rate and asset purchases that implements the new framework. The guidance indicates an expectation that it will be appropriate to maintain the current target range of the federal funds rate until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. Even after economic conditions warrant liftoff, changes in the policy rate are likely to be only gradual, as the forward guidance notes that monetary policy will remain accommodative in order to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time. In addition, asset purchases are expected to continue at least at their current pace until substantial further progress has been made toward our goals. In assessing substantial further progress, I will be looking for realized progress toward both our employment and inflation goals. I will be looking for indicators that show the progress on employment is broad based and inclusive rather than focusing solely on the aggregate headline unemployment rate, especially in light of the significant decline in labor force participation since the spread of COVID and the elevated unemployment rate for workers in the lowest-wage quartile and other disproportionately affected groups. Likewise, while I will carefully monitor inflation expectations, it will be important to achieve a sustained improvement in actual inflation to meet our average inflation goal. The past decade of underperformance on our inflation target highlights that reaching 2 percent inflation will require patience, and we have pledged to hold the policy rate in its current range until not only has inflation risen to 2 percent but it is also on track to moderately exceed 2 percent for some time. Of course, we will be vigilant in parsing the data. Given the path of inflation to date, our framework calls for inflation moderately above 2 percent for some time. If, in the future, inflation rises immoderately or persistently above target, and there is evidence that longer-term inflation expectations are moving above our longer-run goal, I would not hesitate to act and believe we have the tools to carefully guide inflation down to target. Today the economy remains far from our goals in terms of both employment and inflation, and it will take some time to achieve substantial further progress. Jobs are still 10 million below the pre-COVID level, and inflation has been running below 2 percent for years. We will need to be patient to achieve the outcomes set out in our guidance.

r210318a_FOMC

united states

Closing Remarks

powell

I would like to thank Sir Jon Cunliffe and the Committee on Payments and Market Infrastructures (CPMI) for inviting me to close out the first day of this conference on pushing the frontiers of payments. to coordinate the development of a roadmap on how the global community could enhance cross-border payments. It has long been acknowledged that the existing system, while safe and dependable, suffers from frictions, including processes that make it difficult to comply with anti-money-laundering and countering-terrorist-financing requirements, difficulty in managing payments across time zones, and, in certain areas, a reliance on outdated technology. Moreover, these frictions contribute to higher costs for cross- border transactions. As with many aspects of life these days, the COVID-19 pandemic has shined a light on the less efficient areas of our current payment system and accelerated the desire for improvement and digitalization. Even before the pandemic, advancements in the private sector served as a catalyst to get the attention of consumers and to prompt more engagement by the public sector. The goal of the FSB roadmap is simple--to create an ecosystem for cross-border payments that is faster, cheaper, more transparent, and more inclusive. A year into the process, I am encouraged that we are making meaningful progress. The stage 3 report released in October laid out a practical set of steps for moving ahead on the 19 building blocks that will bring about an improved system. Indeed, the themes discussed in the four sessions of the conference today correspond well to approaches described in the building blocks. The title of the first panel sets up a choice between "improving existing rails or laying new tracks." As the roadmap makes clear, one of the keys to moving forward will be doing both--improving the existing system where we can while also evaluating the potential of and the best uses for emerging technologies. As an example, the Federal Reserve is working to improve the current system through the introduction of instant or fast payments via the FedNow The service will be designed to maintain uninterrupted processing--24 hours a day, 7 days a week, 365 days a year--with security features that will ensure payment integrity and data security. The target launch date is sometime 2023.* The Federal Reserve is also doing its part to examine the role of new technologies. Experiments with central bank digital currencies (CBDCs) are being conducted at the Board of Governors, as well as complementary efforts by the Federal Reserve Bank of Boston in collaboration with researchers at MIT. In addition, a recent report from the Bank for International Settlements and a group of seven central banks, which includes the Fed, assessed the feasibility of CBDCs in helping central banks deliver their public policy objectives. Relevant to today's topic, one of the three key principles highlighted in the report is that a CBDC needs to coexist with cash and other types of money in a flexible and innovative payment system. Improvements in the global payments system will come not just from the public sector, but from the private sector as well. As today's second panel, "Of Lions and Unicorns," described, the private sector has the experience and expertise to develop consumer-facing infrastructure that improves and simplifies how the public engages with the financial system. Digitalization of financial services, combined with an improved consumer experience, can help increase financial inclusion, particularly in countries or areas with a large unbanked population. highlight that improving the system must be a collaborative effort. By definition, cross- border payments involve multiple jurisdictions. So it will only be through countries working together, via all of the international forums--the Group of Seven, the G-20, the CPMI, the FSB, and others--that solutions will be possible. And, finally, it is only by engaging all stakeholders--policymakers, private-sector participants, and academia--as this conference is doing, that we will achieve the improved payments ecosystem we are striving toward. The COVID crisis has brought into even sharper focus the need to address the limitations of our current arrangements for cross-border payments. And as this conference amply demonstrates, despite the challenges of this last year, we still have been able to make important progress. I again thank the CPMI and Jon Cunliffe for their leadership and look forward to working together as we improve these payments for businesses and individuals alike.

r210322a_FOMC

united states

The Economic Outlook and Prospects for Small Business

bowman

Thank you, Doug, and thank you to the members of the Economic Club of Oklahoma for the opportunity to speak about a subject of vital interest to all of us--the outlook for the U.S. economy in 2021. Our nation has made considerable progress since COVID-19 hit the economy with great force a year ago, but we still have further to go, and risks remain. As we all know, starting in late February or March of last year, widespread economic and social lockdowns and other effects of the COVID-19 pandemic caused the swiftest and deepest contraction in employment and economic activity since the Great Depression. Money markets, the Treasury market, and other parts of the financial system seized up, and there were fears of another severe financial crisis. The Federal Reserve stepped in quickly to assist, reviving several lending facilities used in the previous crisis and creating several new facilities. We also cut short-term interest rates to near zero and began purchasing large quantities of Treasury and agency securities to help sustain the flow of credit to households and businesses. Congress and the Administration also worked together to provide effective and timely support. Calm was restored in financial markets, and employment and output began growing in May, but it was a very deep hole to fill. Rapid progress over the summer gave way to slower growth over the past winter as COVID-19 infection rates surged. But in recent weeks, with steep declines in virus- related hospitalizations and deaths, the outlook has brightened. Job creation had stalled over the winter months but picked up in February, with an increase of around 380,000 jobs. The pace of vaccinations has accelerated, COVID-related restrictions on economic activity are beginning to ease, and the latest round of stimulus is boosting consumer spending. Despite the news of the spread of more-contagious COVID-19 variants, efforts to increase vaccine shipments and recently announced plans for distribution to the broader public are encouraging and, if successful, give me some confidence that our economic performance will continue to improve quickly over the remainder of the year. My outlook for the economy is broadly in line with the median of projections of meeting last week. Most of my FOMC colleagues expect the economy to grow between 5.8 percent and 6.6 percent in 2021, and the median projection is that the unemployment rate will fall to 4.5 percent by the end of the year. My own expectation is for strong growth and a rebound in the labor force participation rate once the economy fully reopens. This would include schools resuming fulltime in-person learning, which would enable parents who reduced their hours or left the workforce to oversee virtual education and childcare to return to fulltime work. As of February, the level of payroll employment is still 9-1/2 million below the pre-pandemic peak and more than 11 million below where it would have been based on the trend before the pandemic. I believe that job creation will continue, but I still see considerable uncertainty about the strength of that improvement and how long it may take to reach the Federal Reserve's maximum-employment goal. I am also concerned that the extended period of economic restrictions will contribute to further business closures. Severe restrictions on mobility and commerce were implemented in many areas to control the spread of the virus, but they came at a very high economic cost. There is some evidence, which I will discuss in a moment, that small businesses fared better in states with less-stringent restrictions. While the headline unemployment rate has continued to fall, the number of people who report being unemployed for more than six months has continued to rise, suggesting a risk of scarring--meaning that some individuals could see an erosion of their skills and their connections to the labor market. Although economic activity in the travel, leisure, and hospitality sectors has continued to lag the recovery, there have been some bright spots elsewhere. Two that are particularly important for Oklahoma are agriculture and energy. Commodity prices for some crops have increased dramatically in the past few months, particularly soybeans and corn, reflecting higher export demand and some limits on global supply. Increased prices are providing better cash flow and improved credit terms for farmers. Agricultural manufacturers and other suppliers are reporting order backlogs through the summer months, and there are some reports of firmer or increased prices for farmland. Meanwhile, the recent surge in oil prices has returned West Texas Intermediate back up near the levels of early 2020, when it began to fall sharply. The rebound in prices reflects the improved outlook for the global economy given significant progress toward widespread vaccinations in many countries. This recovery has not had a dramatic effect yet on businesses engaged in or supporting oil and gas extraction, but there are signs of a turnaround. So far this year, retail gasoline prices have been rising sharply, and the North American rig count is now the highest it has been since last April. But in contrast to the broadening improvements in many sectors of the economy, an area I continue to be concerned about is the outlook for U.S. businesses, particularly small businesses, which have borne the brunt of the effects of the pandemic. We are now more than a year into the pandemic, and many small businesses are continuing to struggle in their efforts to remain open. Recently, the Bureau of Labor Statistics (BLS) released counts of business closures for the second quarter of last year, when most face-to-face businesses were largely shuttered. In that quarter, the closure rate for establishments showed a sharp increase to 9 percent, compared with an average of about 5 percent during 2019. As part of the fiscal stimulus package passed in June last year, the Paycheck Protection Program (PPP) and other government supports helped many businesses withstand the extended period of inactivity over the spring and summer. Many of the shuttered businesses were at least partially reopened in the second half of last year. But as virus cases surged toward the end of 2020, many state and local governments reimposed restrictions on business activity, and others postponed plans to lift their existing restrictions. Even today, more than a year later, some sectors, like restaurants, leisure, and tourism, are continuing to face major effects from pandemic-related social distancing, forced closures, and capacity limits. These restrictions may have been helpful in containing the pandemic, but they appear to have disproportionately impeded small firms' ability to maintain their operations and revenue sources, leading to substantial cash flow pressures. Small businesses will be helped in the near term with a new round of PPP lending, which included adjustments to terms that will make forgiveness of these loans less onerous than before. Even with this, financial pressures on many small businesses remain acute, and I am concerned that a growing number of small businesses have already been closed permanently or are on the verge of failure. The BLS data are not yet available beyond the second quarter of last year, so, from that source, it's difficult to assess the full extent to which the COVID-19 pandemic resulted in permanent business closures. But research by the Board's staff using nontraditional data sources finds that, in 2020, business exits were especially elevated among small firms and particularly in industries most sensitive to social distancing. authors found that the permanent exit rate of restaurants in 2020 was about 50 percent higher than average historical rates. On a related note, I would emphasize that, up to this point, the national data on business loan delinquencies and bankruptcy filings have not been especially concerning. That said, small businesses are often unincorporated, and many go under without declaring bankruptcy or defaulting on loans. In fact, many small business owners rely on credit cards or home equity loans for financing, so their failure to make timely payments would not be reflected in data on business loan delinquencies. Elsewhere, evidence of small business finance fragility is shown in Federal Reserve survey data. In the latest reading from the Small Business Credit Survey conducted in October 2020, 80 percent of firms reported seeing a decline in revenue over last year, and two-thirds of those reported declines of at least 25 percent. Since then, there have been indications that things have gotten worse. For example, in February, survey data from the National Federation of Independent Business indicate that a net majority of small businesses reported declines in earnings over the past three months, and a net majority expect their sales to worsen over the next three months. These economic data align with conversations that I have had with bankers across the country, which consistently point to the emerging credit challenges among small and medium-sized businesses as a major source of concern. Bankers note that the substantial support from the Paycheck Protection Program and other fiscal policies have postponed, but not eliminated, these financial pressures. The bankers I speak with have also noted that, while monetary policy has successfully delivered favorable borrowing conditions, many firms are reluctant to take on debt or additional borrowing because of the highly uncertain business climate. Recent data from the from the Fed's Senior Loan Officer that survey showed a majority of banks reporting weaker demand for commercial and industrial loans to firms of all sizes. The sharp, and largely voluntary, pullback in consumer spending that followed the onset of the pandemic was undoubtedly a major trigger for the financial struggles that businesses are now facing. But in addition, there is evidence that the economic restrictions imposed by many state and local governments have played a role in the deteriorating health of small businesses. Using data from the Small Business Pulse Survey conducted by the Census Bureau, the Board's staff found that, in states with tighter restrictions on business activity, small firms were more likely to report large declines in their business operations. Firms in relatively restrictive states were also more likely to report that they expect to operate at reduced capacity for an extended period, and they were more likely to expect to need financial assistance in the next six months. While obviously not conclusive, the visible relationship between state-level economic restrictions and small business damage is both striking and concerning. You may be tempted to ask why I am so focused on small businesses. For one, it is because the roughly 32 million small businesses in the United States comprise an important source of job growth in the macroeconomy, and they have an outsized impact on their local communities. Over the past decade, small businesses created 10.5 million net new jobs, accounting for roughly two-thirds of overall net new job creation. This, as I see it, is why the potential for a wave of small business failures is one of the main risks to my expectation that our economy will make further substantial progress toward our goal of full employment. Moreover, from my vantage point as a former community banker, I see other potential negative consequences: Because small businesses often form the backbone of the communities where they are located, their disappearance could have profound and long-lasting community-level effects as well. As I look further down the road, there are some tentative signs that the pickup in overall economic activity will eventually bring an improvement in conditions for small businesses. For example, the latest responses to the same Small Business Pulse Survey I mentioned earlier now indicate that expectations of small business failures--which were quite high during most of 2020--have dropped noticeably and are now tracking below the average rate of failures observed over the five years preceding the pandemic. I spoke earlier about employment, and I will now turn to the price-stability side of the Fed's mandated goals for monetary policy. In recent months, we have seen consumer price inflation moving up, and I anticipate that the 12-month rates in the next few months will very likely track above our 2 percent benchmark as the unusual softness in prices that we saw in April and May last year drops out of the calculation. The marked rise in food prices over the past 12 months has also pushed up the headline measures of price inflation. For many other categories of consumer goods, high order backlogs and tight supplies of key production inputs--like lumber and semiconductors--as well as logjams at the nation's ports and a shortage of truck drivers are likely to push up prices over the next several months. But I expect that these pricing pressures will be temporary, easing over the course of this year as supply bottlenecks are gradually resolved. Beyond this year, some observers have expressed concern that a rapid recovery in aggregate demand amid substantial fiscal support and accommodative monetary policy could lead to undesirably high inflation. While I expect that the stronger economy will push up inflation somewhat, let me explain why I do not expect pricing pressures to be excessive and why I believe the Federal Reserve is likely to continue supporting the economy for some time through accommodative monetary policy. Here I will point to what has in the past seemed to be a relationship between inflation and unemployment, known as the Phillips curve. Over the past several decades, despite large swings in unemployment, inflation has been extremely stable. As an example, up to the beginning of the pandemic, when the economy was growing and unemployment was at a 50 year low of 3.5 percent, inflation was still very low and stable. Economists often attribute this so-called flat Phillips curve to the fact that individuals' inflation expectations are well anchored and unlikely to respond to short-term pricing movements. Survey data on long-run inflation expectations tend to back up this idea. They have been remarkably stable over the past decade, and, although they declined moderately during the middle of last year, most measures have edged up again in recent months and now stand roughly at the levels observed during the pre-pandemic period. With all of that said, given our lack of historical experience with both this level of substantial fiscal stimulus and highly accommodative monetary policy, my outlook for inflation is fairly uncertain. When making monetary policy decisions, we would be concerned about a significant increase in inflation above our 2 percent goal that was sustained for some time. But as my Fed colleagues and I have said many times, monetary policy is not on a preset course. I will continue to monitor economic developments carefully, and, if my outlook for inflation were to change materially, my assessment of the appropriate stance of monetary policy would change as well. I will wrap up by noting that the economy has made great progress since last spring, and I am optimistic that will continue in 2021, but we still have significant ground to make up and new strains of COVID-19 could slow progress in containing the pandemic. Last year's sharp contraction in economic activity was like nothing we had seen before, and we are still assessing its impact. One unresolved question, in my mind, is how resilient small businesses will prove to be after the extended period of reduced activity. What does all of this mean for the outlook for monetary policy? As we indicated in the policy statement released last week, my FOMC colleagues and I expect to maintain an accommodative stance of monetary policy until employment and inflation achieve levels consistent with our maximum employment and inflation goals. At this point, the economy is still a long way from those goals. We are making progress, but I think it will take some time for us to get there.

r210322b_FOMC

united states

Keynote Remarks

quarles

I am pleased to join this first symposium being held by the Alternative Reference Rates Committee (ARRC) to mark the key year of the LIBOR transition. I have had a vantage point in supporting this transition in my roles both as Chair of the Financial coordinate global benchmark rate reform efforts at the request of the Group of Twenty, and as a member of the Federal Reserve Board, which convened the ARRC in 2014 under the auspices of then-Governor Jay Powell. Since these groups were first formed, we have seen great progress in building markets and infrastructures designed to facilitate the transition. This year, however, it is finally time for everyone to actively transition away from using LIBOR. Authority (FCA) had secured a voluntary agreement with the remaining panel banks submitting to LIBOR to continue their submissions through 2021, we in the official sector have emphasized that LIBOR would eventually end, but the market has lacked clarity on exactly when it would end. Because the FCA had committed to avoiding the use of its powers to compel any bank to remain on the panels after the agreement ended, the decision to submit for a further period or to depart was up to the banks themselves. And while the panel banks had committed to continue submissions through the end of this year, they had not stated what they planned to do afterward. Although one might have expected that a statement from the regulator that a benchmark would stop might cause people to think twice before using it even if the exact end date were uncertain, many have kept using LIBOR. It may be that the ambiguity about a precise end date encouraged some to believe that it would not actually end. If so, the recent statements from the administrator of LIBOR and FCA should erase any remaining doubts as to exactly when and whether LIBOR will end. To summarize, thanks to recent statements by the FCA and ICE Benchmark Administration (IBA, the administrator of LIBOR), we now know the following: IBA will no longer have the necessary panel bank submissions to continue to publish any nondollar LIBOR tenors or one-week or two-month U.S. dollar IBA will no longer have the necessary panel bank submissions to continue publishing overnight, one-month, three-month, six-month, or one-year USD Adjusting to a new reality can be difficult, so let me be clear: These statements are definitive. Some may speculate that the June 2023 date could be pushed back, but IBA has now stated that it will not have sufficient panel bank submissions after this date, the FCA has officially recognized this date, and the spread adjustments under the been set accordingly. There is no scenario in which a panel-based USD LIBOR will continue past June 2023, and nobody should expect it to. Seeking to provide the same kind of clear statement about supervisory expectations, U.S. regulators issued supervisory guidance in November of last year. In a letter to the banking organizations that we regulate, the Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency noted that there are safety and soundness risks associated with the continued use of USD LIBOR in new transactions after 2021. Accordingly, we have encouraged supervised entities to stop new use of LIBOR as soon as is practicable and, in any event, by the end of this year. As with the statements about LIBOR's end, there should be complete certainty about this guidance from U.S. regulators: after 2021, we believe that continued use of LIBOR in new contracts would create safety and soundness risks, and we will examine bank practices accordingly. It is helpful to think about these separate announcements as essential pieces of a map, which, once put together, provide a complete picture of the path from here to LIBOR's end. When that larger picture comes into focus, I think you can see clearly that we have laid out a sensible way forward that provides certainty while also recognizing the need to address legacy contracts in a way that makes sense in the U.S. context. These announcements are absolutely not meant to support new LIBOR activity or continued business as usual. Instead, they are meant to completely end the new use of LIBOR while allowing a significant portion of legacy contracts to roll off before the key dollar LIBOR tenors stop publication. Three years ago, the ARRC estimated that there were approximately $200 trillion in outstanding financial contracts using USD LIBOR as a reference rate. The ARRC also estimated that more than 80 percent of those contracts would mature by the end of this year. If market participants had stopped new use of LIBOR at that time, we would today have a considerably smaller amount of legacy LIBOR contracts. Instead, despite the warnings of the official sector concerning LIBOR, use of USD LIBOR has actually increased in the intervening years. As a result, the ARRC now estimates that there are currently almost $223 trillion in financial contracts based on USD LIBOR. Many of those contracts have better fallback language than was once the case; the ARRC has spent considerable time in recommending more robust fallback language for new LIBOR cash products , and ISDA has now published its IBOR protocol, which has allowed market participants to incorporate more robust fallbacks into legacy derivatives. Still, given the sheer size of current exposures, we cannot afford to ignore the problems that an abrupt cessation of USD LIBOR would cause. The path we have laid out--ending new use of LIBOR while providing further time for existing contracts to mature--will give businesses, consumers, and all parties to a contract more certainty that they can count on the original terms of a legacy contract until mid-2023. The ARRC's updated estimates indicate that 67 percent of current LIBOR exposures will mature before mid-2023. Although more would roll off if the end date was further off, the IBA has stated clearly that it will not have sufficient panel bank submissions after June 2023 to publish LIBOR on a representative basis. June 2023 represents a realistic outcome that will allow the majority of outstanding contacts to mature. Of course, we will also be left with the 33 percent of contracts that will not mature before mid-2023, an estimated $74 trillion in financial contracts. Some of these contracts should already have workable fallback language, but many still have no effective means to replace LIBOR upon its cessation. We continue to believe that legislation is a necessary step to address these contracts. The ARRC has proposed legislation with the state of New York, which may be appropriate given that many of the contracts that the ARRC's proposal seeks to address are governed by New York law. Members of Congress are also considering federal legislative solutions, and we support these efforts as well. Of course, although it is vital, we cannot take any legislative solution for granted until it becomes law. The continued publication of LIBOR will help provide more time to make sure that we are fully ready with the necessary solutions when LIBOR stops. It will also potentially allow other jurisdictions more time to craft their own legislative proposals. The European Union has already passed legislation that is similar to the ARRC's proposals. The United Kingdom is considering legislation that would grant the FCA powers to require IBA to produce a synthetic LIBOR, and the FCA has said that it will consult on using these powers to require IBA to produce synthetic sterling LIBOR and Japanese yen LIBOR rates. For legacy LIBOR contracts governed by U.S. law, we believe that a U.S. legislative solution, be it in New York or at the federal level, represents the best solution. I should stress that no one should assume that there will be a Having talked about the end game for legacy contracts, let me return to the other key component of the plan, winding down new use of dollar LIBOR. Earlier this month, the Federal Reserve Board issued supervisory letter SR 21-7 instructing examiners to assess supervised institutions' plans to transition away from the use of LIBOR. highlighted that continued use of LIBOR in new contracts would create safety and soundness concerns after 2021 and highlighted the supervisory focus on firms' ending the issuance of new LIBOR contracts as soon as is practicable and, in any event, by . SR 21-7 outlines factors that examiners should consider in assessing transition efforts and states that, if supervised firms are not making adequate progress in transitioning away from LIBOR, examiners should consider issuing supervisory findings or taking other supervisory actions. Recognizing that smaller banks generally are less reliant on LIBOR, we have tailored our supervisory approach for community banks and firms under $100 billion in assets. Examiners are looking closely to see whether firms have comprehensively assessed their exposure to LIBOR and, if exposures are sizable and complex, have strong plans in place. Firms should prepare for the LIBOR transition with respect to six key Transition plan: The detail and scope of each firm's transition plans should be commensurate with its LIBOR exposures. Large firms should have a LIBOR transition plan with defined timelines, a governance structure that clearly defines roles and responsibilities, and an appropriate budget and resources to support the plan. Financial exposure and risk assessment: Each firm should accurately measure its financial exposures to LIBOR and report them to senior management. Large firms should measure their exposures frequently--for example, quarterly--identifying exposures by product, counterparty, and business line and identifying the proportion of exposures that will run off before the relevant LIBOR tenor ceases. Operational preparedness: Each firm should identify any internal and vendor- provided systems and models that use LIBOR as an input and make necessary adjustments to provide for their smooth operation ahead of LIBOR's cessation. Legal contract preparedness: New LIBOR contracts should have robust fallback language that includes a clearly defined alternative reference rate, and each firm should develop a plan regarding the steps it will take to modify any contracts that may be negatively affected by LIBOR's cessation. Communication: Communication with customers and counterparties is especially important and should be an area of keen focus during 2021. Commensurate with its exposures, each firm should communicate to its counterparties, clients, consumers, and internal stakeholders about the LIBOR transition. Each firm should ensure compliance with requirements of the Truth in Lending Act and other applicable laws and regulations. Oversight: Finally, each firm should provide regular updates to senior management. Large firms should provide timely updates to the board of directors, and the board should hold senior management accountable for effectively implementing the firm's plan. While we will examine against all of these points, what is most important this year is that firms should end new use of LIBOR. The extension of the most-used dollar LIBOR tenors should allow firms to focus in the near term on using alternative rates in new contracts and to deal more intensively with legacy contracts later. Market participants have had many years to prepare for the end of LIBOR, yet over the last few years they have actually increased use of LIBOR. Given the announcements of the FCA and the IBA, that must obviously change this year - that's just the laws of physics -- and the firms we supervise should be aware of the intense supervisory focus we are placing on their transition, and especially on their plans to end issuance of new contracts by year- end. Before I turn this over to Tom Wipf and Tushar Morzaria, let me thank them for all of the work that they have done with the ARRC and the Working Group on Sterling Risk-Free Rates. There is more work ahead for both groups, but these announcements lay out a clear framework that will help everyone understand exactly what should now to be done.

r210323a_FOMC

united states

Remaining Patient as the Outlook Brightens

brainard

It has now been a year since the onset of COVID-19 in the United States. The past year has been marked by heartache and hardship, especially for vulnerable communities, as well as by the resilience and extraordinary efforts of Americans everywhere, particularly those on the front lines. The past year has also seen determined efforts on the part of policymakers--public health, fiscal, and monetary--to do what is necessary and stay the course until we return to full strength. These determined efforts have contributed to a considerably brighter economic outlook. Summary of Economic Projections (SEP) and the first projection following the onset of the pandemic, in June of last year, highlights the improvement in the outlook. The change in the SEP median suggests an improvement in the projected level of gross domestic product of 6 percent at the end of 2021 and 2022, a decline in the unemployment rate of 2 percentage points at the end of 2021 and 1-1/2 percentage points at the end of 2022, and an upward revision to the headline inflation rate of 0.8 percentage point at the end of 2021 that narrows to a 0.3 percentage point upward revision at the end of 2022. The expected improvements in the outlook reflect progress on controlling the virus, nearly $3 trillion in additional fiscal support, and forceful and timely support from monetary policy. Although the outlook has brightened considerably, the fog of uncertainty associated with the virus has yet to lift completely, and current employment and inflation outcomes remain far from our goals. The focus on achieved outcomes rather than the anticipated outlook is central to the Committee's guidance regarding both asset purchases and the policy rate. The emphasis on outcomes rather than the outlook corresponds to the shift in our monetary policy approach that suggests policy should be patient rather than preemptive at this stage in the recovery. Recent data indicate that activity has picked up this year. After a dip in the final months of 2020, personal consumption expenditures (PCE) stepped up considerably so far this year, and spending on durable goods has been particularly strong. This pattern appears consistent with a quick spend-out from the Consolidated Appropriations Act (CAA) stimulus checks at the turn of the year, particularly among lower-income households that may have previously exhausted the Like the spending data, the labor market data turned more positive in January and February following weakness at the end of 2020. Although the unemployment rate has moved down 1/2 a percentage point since December, the K-shaped labor market recovery remains uneven across racial groups, industries, and wage levels. The employment-to-population (EPOP) ratio for Black prime-age workers is 7.2 percentage points lower than for white workers, while the EPOP ratio is 6.2 percentage points lower for Hispanic workers than for white workers--an increase in each gap of about 3 percentage points from pre-crisis lows in October Workers in the lowest-wage quartile continued to face staggering levels of unemployment of around 22 percent in February, reflecting the disproportionate concentration of lower-wage jobs in services sectors still sidelined by social distancing. The leisure and hospitality sector is still down almost 3.5 million jobs, or roughly 20 percent of its pre-COVID level. This sector accounts for more than 40 percent of the net decline in private payrolls since February 2020. Overall, with 9.5 million fewer jobs than pre-COVID levels, we are far from our broad-based and inclusive maximum-employment goal. Inflation similarly remains far from the goal of 2 percent inflation on average over time. Both headline and core PCE inflation were below 2 percent on a 12-month basis throughout 2020 and came in at 1.5 percent in January. Finally, while vaccinations are continuing at an accelerating pace, over two-thirds of the adult population have yet to receive their first dose, and there are risks from more contagious strains of the virus, social-distancing fatigue, and vaccine hesitancy. As the economy reopens, the potential release of pent-up demand could drive stronger growth in 2021 than we have seen in decades. However, it is uncertain how much pent-up consumption will be unleashed when social distancing completely lifts, and how much household spending will result from the new stimulus and accumulated savings. With PCE accounting for roughly 70 percent of the economy, this uncertainty about consumption spending contributes to uncertainty about activity, employment, and inflation. In part, the outcome will hinge on distributive questions that are imperfectly understood. Households accrued considerable additional savings that led to a $2.1 trillion increase in liquid assets by the end of last year. Higher-income households appear to have cut back on discretionary services spending over the past year and increased their purchases of durable goods, which may see some satiation going forward. For moderate-income households that are not cash constrained, it is possible there will be a lower near-term spend-out from the American Rescue Plan payments relative to the CAA payments, given that less than 75 days elapsed between the two rounds of payments. Households whose cash flows were improved by the CAA stimulus may save more of the most recent stimulus for precautionary reasons. That said, there is upside risk if a substantial fraction of stimulus payments and accumulated savings are spent in 2021 rather than more slowly over a longer time period. On the other side, there is potential for some leakage abroad if, as anticipated, foreign demand growth in some regions is weaker than in the United States. Imports soared during the second half of last year and grew further in January, even with worsening backlogs at U.S. ports. As port congestion and supply chain bottlenecks ease, international spillovers could lead to some slippage between the increase in domestic demand and resource utilization, which has implications for employment and inflation. In the labor market, as vaccinations continue and social distancing eases, businesses in hard-hit services sectors will increase hiring, accelerating the pace at which workers find employment. The strong and timely support from fiscal as well as monetary policy likely reduced the extent of scarring during the pandemic, which should aid the pace of hiring at in- person services establishments once the virus is well controlled. The speed of further improvement in the labor market following the initial rush of reopening is less clear, however. Some employers may be cautious about significantly increasing payrolls before post-COVID consumption patterns are more firmly established. Others may be implementing measures to stay lean and contain costs. In the December Duke CFO survey, roughly one-half of CFOs from large firms and about one-third of those from small firms reported "using, or planning to use, automation or technology to reduce reliance on In addition to greater use of technology, there is likely a significant amount of slack on the participation and part-time margins. The EPOP ratio among workers ages 25 to 54 is still a full 4 percentage points below its pre-COVID level, and the number of workers working part time because they cannot find a full-time job is 1.7 million higher than pre-COVID. Although core and headline PCE inflation came in at 1.5 percent on a 12-month basis in January, the well-anticipated base effects from price declines in March and April of last year will cause inflation to move above 2 percent in April and May. It also seems likely that a surge of demand may be met by some transitory supply bottlenecks amid a rapid reopening of the economy, leading PCE inflation to rise somewhat above 2 percent on a transitory basis by the end of 2021. Entrenched inflation dynamics are likely to take over following the transitory pressures associated with reopening. Underlying trend inflation has been running persistently below 2 percent for many years. In addition, research suggests that although increasing labor market tightness may show through to wage inflation, the pass-through to price inflation has become highly attenuated. These results suggest that businesses tend to respond to increased labor costs by reducing margins rather than increasing prices later in the cycle. Thus, as resource utilization continues to tighten over coming years, recent decades provide little evidence to suggest there will be a material nonlinear effect on price inflation. The FOMC has communicated its reaction function under the new framework and provided powerful forward guidance that is conditioned on employment and inflation outcomes. This approach implies resolute patience while the gap closes between current conditions and the maximum-employment and average inflation outcomes in the guidance. By focusing on eliminating shortfalls from maximum employment rather than deviations in either direction and on the achievement of inflation that averages 2 percent over time, monetary policy can take a patient approach rather than a preemptive approach. The preemptive approach that calls for a reduction of accommodation when the unemployment rate nears estimates of its neutral rate in anticipation of high inflation risks an unwarranted loss of opportunity for many of the most economically vulnerable Americans and entrenching inflation persistently below its 2 percent target. Instead, the current approach calls for patience, enabling the labor market to continue to improve and inflation expectations to become re- anchored at 2 percent. One simple illustration of this difference is the way in which FOMC communications under the new framework have shifted market expectations around the conditions associated with the lift off of the policy rate from the lower bound. This shift is suggested by a comparison of the surveys of primary dealers and market participants conducted by the Federal Reserve Bank of New York in the most recently available surveys, in January 2021, and under the prior policy framework, in March 2015. In the January 2021 surveys, the median respondent expected the unemployment rate to be a bit below 4 percent at the time of liftoff, as compared with 5.3 percent in the March 2015 surveys. Similarly, in the January 2021 surveys, the median respondent expected a 12-month headline PCE inflation rate of 2.2 to 2.3 percent at the time of liftoff, as compared to roughly 0.5 percent in the March 2015 surveys. The most recently available surveys suggest that market participants expect policy to look through the rolling off of base effects as well as possible transitory price increases due to short-term supply-demand imbalances. The FOMC has stated that in order to anchor inflation expectations at 2 percent, it seeks to achieve inflation that averages 2 percent over time. This language recognizes that the public's expectations of inflation are linked to the experience of inflation outcomes. In the nine years since the Committee formally defined price stability as annual PCE inflation of 2 percent, the average 12-month PCE inflation reading has been 1.4 percent. Persistently low inflation creates the risk that households and businesses come to expect inflation to run persistently below target and change their behavior in ways that reinforce low inflation. With inflation expected to rise above 2 percent on a transitory basis, I will be closely monitoring a dashboard of indicators to assess that inflation expectations remain well anchored at levels consistent with the Committee's objective. These indicators include survey and market- based measures, along with composite measures like the staff's Index of Common Inflation Survey measures have picked up a little but remain around pre-COVID levels. inflation compensation have moved up almost 1 percentage point since last summer and are now at levels last seen in 2013 and 2014. These changes likely reflect both the improvement in the anticipated outlook and market participants' understanding of the Committee's new reaction function. The overall price-stability objective of achieving inflation that averages 2 percent over time provides an important guidepost for assessing the path of inflation. Along with realized inflation, I will be monitoring a range of average inflation concepts in the literature to assess the path of policy that would be consistent with closing the inflation gap under a variety of make-up strategies. While the outlook has brightened considerably, with jobs nearly 10 million below the pre-COVID level and inflation persistently below 2 percent, the economy remains far from our goals, and it will take some time to achieve substantial further progress. By taking a patient approach based on outcomes rather than a preemptive approach based on the outlook, policy will be more effective in achieving broad-based and inclusive maximum employment and inflation that averages 2 percent over time. The combination of patient monetary policy, together with accelerating progress on vaccinations and substantial fiscal stimulus, should support a strong and inclusive recovery as the economy reopens fully.

r210325a_FOMC

united states

U.S. Economic Outlook and Monetary Policy

clarida

It is my pleasure to meet virtually with you today at the 2021 Institute of I regret that we are not doing this session in person, but I do hope next time we will be gathering together in Washington. I look forward, as always, to a conversation with my good friend and one- time colleague Tim Adams, but first, please allow me to offer a few remarks on the economic outlook, Federal Reserve monetary policy, and our new monetary policy framework. In the second quarter of last year, the COVID-19 pandemic and the mitigation efforts put in place to contain it delivered the most severe blow to the U.S. economy since annual rate in the second quarter of 2020, more than 22 million jobs were lost in March and April, and the unemployment rate rose from a 50-year low of 3.5 percent in February to almost 15 percent in April. Since then, economic activity has rebounded, and it is clear that the economy has proven to be much more resilient than many forecast or feared one year ago. GDP grew by almost 8 percent at an annual rate in the second half of last year, and private forecasters project that GDP will grow roughly 6 percent--and possibly If these projections are realized, GDP will grow at the fastest four-quarter pace since 1984. And, as this is a virtual meeting of the IIF, I would be remiss if I did not highlight that if these projections for U.S. economic activity are realized, rising U.S. imports will serve as an important source of external demand to the rest of the world this year and beyond. As with overall economic activity, conditions in the labor market have recently improved. Employment rose by 379,000 in February, as the leisure and hospitality sector recouped about two-thirds of the jobs that were lost in December and January. Nonetheless, employment is still 9.5 million below its pre-pandemic level for the economy as a whole. The unemployment rate remains elevated at 6.2 percent in February, and once one factors in the decline in the labor force since the onset of the pandemic and the misclassification of some workers on temporary layoff as employed, the true unemployment rate is closer to 10 percent. It is worth highlighting that in the baseline projections of the FOMC presented in the latest SEP released last week, my colleagues and I substantially revised up our outlook for the economy, projecting a relatively rapid return to levels of employment and inflation consistent with the Federal Reserve's statutory mandate as compared with the recovery from the Global Financial Crisis. In particular, the median FOMC participant now projects the unemployment rate to reach 4.5 percent at the end of this year and 3.5 percent by the end of 2023. With regards to inflation, the median inflation projection of FOMC participants is 2.4 percent this year and declines to 2 percent next year before moving back up to 2.1 percent in 2023. Over the next few months, 12-month measures of inflation are expected to move temporarily above our 2 percent longer-run goal, owing to a run of year-over-year comparisons with depressed service-sector prices recorded in the spring of 2020 and supply bottlenecks limiting how quickly production can respond in the near term. However, I expect most of this increase to be transitory and for inflation to return to--or perhaps run somewhat above--our 2 percent longer-run goal in 2022 and 2023. This outcome would be entirely consistent with the new framework we adopted in August 2020 and began to implement at our September 2020 FOMC meeting. In our new framework, we aim for inflation outcomes that keep inflation expectations well anchored at 2 percent. This means that following periods when inflation has been running below 2 percent--as has been the case for most of the past decade--monetary policy will aim for inflation to moderately exceed 2 percent for some time. And this brings me to the next topic. At our most recent FOMC meetings, the Committee made important changes to our policy statement that upgraded our forward guidance about the future path of the federal funds rate and asset purchases, and that also provided unprecedented information about our policy reaction function. As announced in the September statement and reiterated in the following statements, with inflation running persistently below 2 percent, our policy will aim to achieve inflation outcomes that keep inflation expectations well anchored at our 2 percent longer-run goal. We expect to maintain an accommodative stance of monetary policy until these outcomes--as well as our maximum-employment mandate--are achieved. We also expect it will be appropriate to maintain the current target range for the federal funds rate at 0 to 1/4 percent until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment, until inflation has risen to 2 percent, and until inflation is on track to moderately exceed 2 percent for some time. In addition, in our December FOMC statement, the Committee combined our forward guidance for the federal funds rate with enhanced, outcome-based guidance about our asset purchases. We indicated that we will continue to increase our holdings of Treasury securities by at least $80 billion per month and our holdings of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward our maximum-employment and price-stability goals. The changes to the policy statement that we made over the past few FOMC meetings bring our policy guidance in line with the new framework outlined in the Committee approved last August. In our new framework, we acknowledge that policy decisions going forward will be based on the FOMC's estimates of " shortfalls [emphasis added] of employment from its maximum level"--not "deviations." This language means that going forward, a low unemployment rate, in and of itself, will not be sufficient to trigger a tightening of monetary policy absent any evidence from other indicators that inflation is at risk of moving above mandate-consistent levels. With regard to our 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 in a world in which an effective-lower-bound constraint is, in downturns, binding on the federal funds rate. To this end, the new statement conveys the Committee's judgment that, in order to anchor expectations at the 2 percent level consistent with price stability, it will conduct policy to achieve inflation outcomes that keep long-run inflation expectations anchored at our 2 percent longer-run goal. As Chair Powell indicated in his Jackson Hole remarks, we think of our new framework as an evolution from "flexible inflation targeting" to "flexible average inflation targeting." While this new framework represents a robust evolution in our monetary policy strategy, this strategy is in service to the dual-mandate goals of monetary policy assigned to the Federal Reserve by the Congress--maximum employment and price stability--that remain unchanged. While our interest rate and balance sheet tools are providing powerful support to the economy and will continue to do so as the recovery progresses, it will take some time for economic activity and employment to return to levels that prevailed at the business cycle peak reached last February. We are committed to using our full range of tools to support the economy until the job is well and truly done to help ensure that the economic recovery will be as robust and rapid as possible.

r210329a_FOMC

united states

Treasury–Federal Reserve Cooperation and the Importance of Central Bank Independence

waller

By way of introduction, I spent the first part of my career as an economics professor and researcher. One of my main fields of inquiry was monetary policy theory. I have long been a strong believer in the virtues of central bank independence, and today I will devote my remarks to that topic. As a result of the COVID-19 crisis, tremendous monetary and fiscal measures have been taken to provide economic relief to American households and businesses. The Federal Reserve took a host of actions, including lowering its policy rate to zero and purchasing securities to support market functioning and provide monetary accommodation. The Congress enacted several packages that funded the health response to the pandemic, expanded unemployment insurance, and provided economic assistance payments to households and businesses. The virus also created uncertainty and turbulence in financial markets, which led the Federal Reserve to establish emergency lending programs to serve as lending backstops and support the flow of credit to households, businesses, nonprofits, and state and local governments. Establishing these programs under section 13(3) of the Federal Reserve Act required substantial cooperation between the Department of the Treasury and the Federal Reserve. The Congress has provided spending of roughly $5.8 trillion during the past year to deal with the pandemic and its effects on the economy. This action has pushed the ratio of publicly held U.S. debt to nominal gross domestic product to more than 100 percent for the first time since World War II. government debt has risen to around $7 trillion, with about $2.5 trillion of that total resulting from its asset purchase program aimed at smoothing credit market functioning and providing monetary accommodation. Because of the large fiscal deficits and rising federal debt, a narrative has emerged that the Federal Reserve will succumb to pressures (1) to keep interest rates low to help service the debt and (2) to maintain asset purchases to help finance the federal government. My goal today is to definitively put that narrative to rest. It is simply wrong. Monetary policy has not and will not be conducted for these purposes. My colleagues and I will continue to act solely to fulfill our congressionally mandated goals of maximum employment and price stability. The Federal Open Market Committee (FOMC) determines the appropriate monetary policy actions solely to move the economy towards those goals. Deficit financing and debt servicing issues play no role in our policy decisions and never will. Chair Powell made this same point in his recent comments to the Economic Club of New York. My objective today is to reinforce that message. This does not mean, however, that the Treasury and Federal Reserve should never work together. My comments today will focus on the issue of cooperation--on when and how much is beneficial and on the potential costs that should not be overlooked. Let me point out that there are two fronts for interaction between the Treasury and the Federal Reserve. The first is what I will call "back office" operations. By this term, I mean the range of fiscal agency services that the Federal Reserve provides to the Treasury by statute. For example, the Federal Reserve maintains the Treasury's operating account, accepting deposits, paying checks, and making electronic payments on behalf of the Treasury. It provides securities services on behalf of the Treasury, supporting the auction, issuance, and redemption of marketable Treasury securities. It also provides application development and infrastructure support services, assisting in the Treasury's efforts to improve government cash- and debt-management processes. Since the Federal Reserve is the fiscal agent for the Treasury--and to play that role efficiently and at low cost--the Federal Reserve and the Treasury must always work closely together on operations issues. The second form of interaction involves the Treasury and the Federal Reserve working together on certain macroeconomic policy issues. I will discuss two areas where differing degrees of interaction could occur, emergency lending facilities and economic stabilization, and one area where that interaction should not, and does not, occur--debt financing. First, let me talk about emergency lending facilities authorized by section 13(3) of During a financial crisis or extreme market malfunctioning, cooperation between the fiscal and monetary authorities is imperative. An important role of a central bank is to step in and provide liquidity to ensure market functioning during those "unusual and exigent circumstances." And under those circumstances, since the Secretary of the Treasury is required to approve any new programs under the Federal Reserve's emergency lending authority. As I mentioned, the Federal Reserve and the Treasury undertook this kind of coordinated response a year ago, as uncertainty about the economic effect of the virus caused markets to begin seizing up. Many section 13(3) facilities were established to support the flow of credit to households, businesses, and state and local governments. All of these emergency programs required the approval of the Secretary of the Treasury, and many of them were supported by the Treasury's financial backing, using funds specifically appropriated by the Congress for these facilities in the Coronavirus Aid, At times like these, cooperation between the fiscal and monetary authorities strengthens financial stability. A financial crisis is not a time for uncooperative behavior from either side. However, with regard to the second area, economic stabilization, it is imperative that the central bank remain independent from the fiscal authority. There are sizable costs if cooperation turns into fiscal control. To understand this point, consider a situation where the economy is hit with a negative shock that depresses aggregate demand. The Macro 101 textbook policy response we teach students is for the monetary and fiscal authorities to enact stimulative policies to increase aggregate demand. This effort involves fiscal actions, such as increasing spending and cutting taxes, which increase the deficit. The finance ministry's job is to finance the deficit that results from these fiscal policy actions. Greater borrowing by the finance ministry to finance these policies will tend to put upward pressure on interest rates, which crowds out private sector spending. In this textbook example, the monetary authority should respond to this upward pressure on interest rates by adopting a more accommodative policy stance to bring rates back down. From an institutional design viewpoint, what would be the appropriate arrangement to ensure this type of policy response? One obvious solution would be to give the finance ministry control of monetary policy to ensure a coordinated policy response. This logic suggests central bank independence is an impediment to optimal stabilization policy. So why have an independent central bank? Why create an impediment to socially beneficial cooperation? In the situation where monetary policy is under control of the Treasury, and thus the executive branch in the United States, political motivations may influence decisions. To return to my stabilization example, as the economy recovers, with all of the monetary and fiscal stimulus in place, this stimulus may lead to undesirable inflation pressures. The standard monetary policy response is to evaluate the current employment and inflation situations and raise interest rates when deemed appropriate. However, if monetary policy is under the control of the Treasury, then to further juice the economy for short-term political gains, this action could be delayed past the date the central bank would want to raise rates. Consequently, the argument goes that a hot economy may cause substantial inflation pressures that are hard to rein in politically, and which ultimately harm Americans in the longer run. This view is backed up by the political economy literature, which argues that having monetary policy under the control of political authorities may lead to excessive inflation and economic volatility that is not socially optimal. Put another way, it can lead to an unstable economy, on which households and businesses cannot rely. Subsequent academic research, including mine, focuses on ways in which the central bank could be designed to prevent this undesired outcome from happening. of those ways is delegating decisionmaking to a policy committee that is insulated from short-term political pressures. Institutional details that enhance insulation include giving central bankers long terms and prohibiting removal from office for political reasons. This literature provides the theoretical foundations for central bank independence and the importance of central bank credibility. A look across countries is instructive. Operational independence with clearly specified goals for monetary policy has become the norm for central banks in advanced economies, reflecting the consensus that has emerged over the past 30 years concerning the benefits of central bank independence. The Congress was fully aware of the potential misuse of monetary policy for political reasons, and it purposefully created the Federal Reserve as an independent central bank. The design features of the Federal Reserve minimize political influence over monetary policy while still maintaining accountability to the Congress and to the electorate for its policy actions. Eventually, in 1977, the Congress mandated that the Federal Reserve conduct monetary policy to effectively promote the goals of maximum employment and price stability. By having monetary policy overseen by independent officials, the incentive to misuse stabilization policy for partisan purposes is reduced. Monetary policymakers can focus on what is best for the economy over the long run. Finally, we come to the third area of potential interaction between the central bank and the Treasury: debt financing. When governments run up large debts, the interest cost to servicing this debt will be substantial. Money earmarked to make interest payments could be used for other purposes if interest rates were lower. Thus, the fiscal authority has a strong incentive to keep interest rates low. who chaired the Federal Reserve at the time, favored financing the war by coupling tax increases with wage and price controls. But, ultimately, he and his colleagues on the FOMC concluded that winning the war was the most important goal, and that providing the government with cheap financing was the most effective way for the Federal Reserve to support that goal. So the U.S. government ran up a substantial amount of debt to fund the war effort in a low interest rate environment, allowing the Treasury to have low debt servicing costs. This approach freed up resources for the war effort and was the right course of action during a crisis as extreme as a major world war. After the war was over and victory was achieved, the Treasury still had a large stock of debt to manage and still had control over interest rates. The postwar boom in consumption, along with excessively low interest rates, led to a burst of inflation. Without control over interest rates, the Federal Reserve could not enact the appropriate interest rate policies to rein in inflation. As a result, prices increased 41.8 percent from January 1946 to March 1951, or an average of 6.3 percent year over year. This trend, led to the Treasury-Fed Accord of 1951, which restored interest rate policy to the Federal Reserve. The purpose of the accord was to ensure that interest rate policy would be implemented to ensure the proper functioning of the economy, not to make debt financing cheap for the U.S. government. The upshot of these examples is that cooperation between the Federal Reserve and the Treasury is important to address macroeconomic policy issues. But research shows that, to avoid distortions in using monetary policy for deficit financing, it is important to have an independent central bank with a clear and credible inflation target, which the Central bank independence is critical for maintaining that target and keeping inflation expectations in line with that target. My message today is that the Federal Reserve and the Treasury should work together at key times and along certain dimensions. Back-office operations are done efficiently and effectively in this manner. And in times of crisis, coordination allows policies to be implemented quickly and forcefully to set the stage for a strong path of recovery. But for this arrangement to work, the political independence of the Federal Reserve is essential--it is the best way for the Federal Reserve to meet its congressional mandate and allow policymakers to meet the longer-term needs of the American people. The Treasury and the Federal Reserve both recognize this necessity and have issued joint statements to this effect in the past. With this independence, of course, the FOMC is committed to being accountable and transparent about our actions to both the Congress and the public--and the Federal Reserve strives to continually improve its transparency. In 2020, for example, the FOMC new framework explains how we interpret the mandate that the Congress has given us and describes the broad framework that we believe will best promote our maximum- employment and price-stability goals. Going forward, the monetary policy choices of the FOMC will continue to be guided solely by our mandate to promote maximum employment and stable prices. These congressionally mandated goals always drive our decisions; partisan policy preferences or the debt-financing needs of the Treasury will play no role in that decision. Cooperation in times of crisis, like during the initial phases of the COVID crisis, was crucial for staving off an economic disaster, putting us on the road to recovery, and helping avoid long-run scarring and was the appropriate way to serve the Fed's dual mandate. But the independence of the Federal Reserve is in the nation's best interest and should be valued and protected by all.

r210330a_FOMC

united states

The FSB in 2021: Addressing Financial Stability Challenges in an Age of Interconnectedness, Innovation, and Change

quarles

Thank you for inviting me today. It's an honor and a pleasure to speak here at the Peterson Institute, a group that has driven much of the most important discussion of international economic issues over my entire working life. I only wish that we could all gather in person -- perhaps soon. A little over 420 years ago, a crowd-pleasing local fabler on a lightly populated island in the North Atlantic made popular a phrase that has entered into our language: "Beware the Ides of March." Caesar ignored the soothsayer, and the results weren't good; if recent history is any indication, perhaps we should keep the warning in mind as well. In March 2008, we witnessed a significant domino fall in a chain of events that March of the following year saw the nadir of the Dow Jones average -- a 50% drop from just over a year earlier. And the margin calls and liquidity crunch in March of 2020, was a salient echo of the other significance of the Ides of March for the Romans: the deadline for settling debts, which have had an unsettling habit of coming due in March in our recent financial history. Indeed, this time last year, both domestically and internationally, the financial regulatory community fortified itself as COVID-19 and related containment measures spread across the globe, what I refer to as the COVID event. The Financial Stability Board (FSB) moved into high gear, holding weekly, and even daily, meetings with the most senior leaders of central banks, finance ministries, and market regulators -- to share information and shape a synchronized global approach to the financial stability challenges at hand. This ability to spring into action on short notice is exactly why the FSB was established in the wake of the GFC. Its mandate, to promote international financial stability by coordinating the development of regulatory, supervisory, and other financial sector policies, at a global level, reflected a recognition of the growing interconnectedness across our markets and economies. My focus today will be on the future and the challenges we face going forward-- in particular, nonbank financial intermediation, or NBFI, and cross-border payments. These are only a portion of the FSB's comprehensive work plan, but they are priority areas that will have significant impact on the financial landscape going forward. Since the GFC of 2008, the NBFI sector has grown and evolved considerably, accounting for almost half of all global financial assets at the start of the COVID event. With this growth has come greater interconnectedness and complexity in intermediation chains. Even before the market turmoil of last March, the need to understand the vulnerabilities arising from the banking sector as well as those risks that have moved outside the banking system was viewed as critical to achieving and maintaining financial stability. The March market turmoil helped focus our attention on NBFI and pushed the FSB to give further priority to work in this area. Because of the way this diverse sector is structured, developing an NBFI perspective requires bringing together regulatory, supervisory, and market perspectives and taking a broad view of how our financial ecosystem works. Even ahead of the COVID event, in my role as chair of the FSB, I formed a high-level group of central bankers and market regulators to oversee and coordinate work on NBFI -- which, by March, was clearly a fortunate decision. Under direction of this senior group, the FSB carried out its , which examined not only how different sectors of the market were affected, but also how these effects were transmitted throughout the system and which aspects of the financial system structure may have amplified stress. The Holistic Review underscored how vulnerabilities in the financial system amplified the economic shocks of the COVID event. In particular, it highlighted the dependence of the system on readily available liquidity, and vulnerabilities if liquidity strains emerge -- in money market mutual funds (MMFs) and open-end funds, through margin calls and in core bond markets. Importantly, it provides a high-level view on how these parts of the financial ecosystem operate and transmit risk while under stress. In my view, one of the most significant findings relates to MMFs. The Holistic Review documented how the extremely high demand for liquidity, combined with a flight-to-safety, triggered a "dash for cash" that hit institutional prime money market funds particularly hard. In the US, prime MMFs publicly offered to institutional investors had outflows of roughly $100 billion, or 30 percent of the funds' assets, over two weeks in mid-March. This was a faster run, in terms of the percentage of fund assets redeemed, than during the turmoil in September 2008. Similar patterns were also seen in Europe, particularly for US dollar-denominated MMFs. Other funds that are active in short-term funding markets, such as ultrashort bond funds, also saw unprecedented outflows in March. The March market turmoil is the second time in roughly a decade that we have witnessed destabilizing runs on MMFs. More concerning this time, however, is that we had taken steps between these events precisely to reduce the likelihood of such runs. The FSB will publish a report in July for consultation that will set out consequential policy proposals to improve MMF resilience. The proposals should also reduce the likelihood that government interventions and taxpayer support will be needed to halt future MMF runs. This work will also consider the relationship between MMFs and short-term funding markets, with a particular focus on commercial paper and certificate of deposit markets and the impact of dealer behavior. Continued work on other open-end funds, margining and bond market structure, and liquidity will come on the heels of the MMF deliverables. As a first step, the focus will be on enhancing our understanding of vulnerabilities that could emanate from these sectors, including risk transmission channels. Addressing systemic risk in a dynamic sector that continues to evolve is no small feat. I expect policy-related discussions and recommendations to follow the analytical work, though that will likely extend past this year. Although my time is limited to provide more detail, I would like to note that the disruptions in bond markets also raised questions about the role of leveraged investors and the willingness and capacity of dealers to intermediate in times of stress. Work is underway to gather data and analyze dealer behavior to develop a comprehensive view on their impact on financial market functioning and determine whether policy responses are necessary. Turning to a different part of our NBFI work plan, the March market turmoil demonstrated the benefits that central clearing brings for global financial stability. Indeed, central counterparties (CCPs) demonstrated resilience during this tumultuous period. Given their systemic importance, however, we continue to advance work to improve CCP resilience and resolvability, as set out in the FSB 2020 resolution report. I am coordinating with the Chairs of the Committee on Payments and Market FSB Resolution Steering Group on shaping these details. We expect to launch a workstream this year aimed at further strengthening the resilience and resolvability of CCPs in default and non-default loss scenarios, including assessing whether any new types of resources would be necessary to enhance CCP resolvability. The FSB and other standard-setting bodies have also begun work on margin activity in centrally cleared and non-centrally cleared markets during the peak of the market volatility last year. We observed that margin calls by some CCPs may have been larger than expected. While we need to ensure that CCPs are sufficiently margined as critical nodes in the financial system, clearing members and their clients also need sufficient transparency and predictability to be able to manage their exposures. To be successful, this broad and comprehensive agenda, which serves as a cornerstone of the FSB work program for 2021 and beyond, will require strong coordination, commitment, and resources from the international regulatory community, including at the FSB and other standard-setting bodies. Further, to ensure a sound, practical, and effective way forward, these workstreams will also require transparency and engagement among the public. The FSB is, therefore, seeking the input of market participants and other parties. This NBFI work alone would be an ambitious agenda. But I believe the FSB is well equipped to address this challenge while also furthering the other important elements of our broad agenda. Let me spend some time talking about another of these important objectives: enhancing cross-border payments. In 2019, the G20 identified enhancing cross-border payments as a key priority and the FSB has been dedicated to advancing this important work ever since. The challenges associated with cross-border payments are widely known and longstanding. Prior attempts to make improvements have struggled to gain traction. In October 2020, the FSB delivered a multi-year roadmap to the G20 leaders who endorsed the way forward and committed to advancing meaningful change aimed at increasing the efficiency and effectiveness of cross-border payments. Ultimately, we are focused on addressing the core challenges associated with cross-border payments: cost, speed, accessibility, and transparency. It goes without saying that making improvements is easier said than done. Frictions underlying existing processes span multiple legal, operational, processing, technological, and structural issues, which can differ greatly by region. To break down the magnitude of our task, the roadmap includes a set of practical actions designed to address specific topics, which we refer to as "building blocks." We are taking a comprehensive approach and engaging the public and private sectors because both need to be a part of the solution if we are to achieve the ambitious goals we have set for ourselves. To begin, we must decide what the actual improvements are that we want to see, and how we will monitor our progress in achieving them. These decisions will define the level of ambition, create accountability and shape how the roadmap is operationalized at the global, regional, and national levels. As a first step, the FSB has formed a task force that is responsible for setting specific, quantitative targets. These targets will set the tone and pace for work that follows and are therefore among the most important deliverables the FSB will complete this year. We plan to publish a consultative paper in May and deliver a final set of targets to the G20 in October. Several groups are charged with advancing one or more building blocks over the course of this year, with the FSB providing annual updates to the G20. To deliver the roadmap, we are collaborating closely with the Committee on Payments and Markets Infrastructures of the Bank for International Settlements, which has a key role given the position of central banks in the payments ecosystem. In addition to setting targets, the FSB is leading multiple elements of the roadmap, advancing those building blocks that are more exploratory in nature, for example, the soundness of global stablecoin arrangements. On this particular topic, last year, the FSB issued high-level recommendations for the regulation, supervision, and oversight of global stablecoins, and we will report to the G20 this year on the progress achieved at both international and national levels. By their nature, cross-border payments are global and involve many other countries outside of the G20 membership. We must therefore be inclusive in our approach, while remaining well organized to meet the milestones we have set for ourselves. To this end, we have partnered with the World Bank and International Monetary Fund given their respective missions and global reach. It will also be important to engage with financial institutions, service providers, industry groups, practitioners, and academics as we advance this work. We plan to communicate information and seek feedback through public consultations, conferences, and bilateral and multilateral outreach. The roadmap sets our path, but the practical reality is, we need consensus among, and action by, many different -- even competing -- stakeholders to achieve success. We have purposely built into the roadmap opportunities to course correct because we expect to learn more as we go. The FSB will report annually to the G20 Summit and the public, sharing progress and seeking confirmation on the next steps for this immensely important and ongoing work. What I have just discussed covers a large portion of the FSB's 2021 work plan, but I would be remiss if I did not mention a few other significant areas. We are, of course, continuing to closely monitor vulnerabilities stemming from the COVID event, including the rise in nonfinancial sector debt and measures of bond and equity market valuations. In April, the FSB will report on key considerations involved in amending or unwinding COVID-19 support measures, as appropriate. The FSB will play an important role once unwinding measures begin, given its work to support international information sharing on COVID-19 policy responses. The FSB also plans to assess initial lessons learned from the COVID event for financial stability and share them with the G20 in July. The COVID event has underscored the financial sector's susceptibility to operational risks especially those related to cybersecurity. The speed of technological change and a growing reliance on third-party, technology-based services is increasingly introducing new risks and vulnerabilities to the sector. To begin to address this, the FSB is focused on achieving greater convergence in areas such as regulatory reporting of cyber incidents, and we will deliver those recommendations to the G20 in October. -- an Next month, the FSB will release the final report of its most ambitious evaluation of the effects of post-GFC banking reforms. The report on too-big-to-fail (TBTF) reforms is the FSB's most analytically rigorous evaluation carried out to date. When looking at these reforms, indicators of systemic risk and moral hazard moved in the right direction, and effective TBTF reforms seem to have brought net benefits. In fact, at the beginning of the COVID event, we observed a far more resilient banking sector than that which entered the 2008 crisis. Yet, if the benefits of TBTF reforms are to be fully realized, there remains further work to do. The FSB outlines this work in its forthcoming evaluation. Further analysis of such reforms, international financial standards, agreed G20 and FSB commitments, recommendations, and other initiatives will provide us with better insights into whether the reforms are working as intended or conflict with one another, are structured efficiently, and if they are in need of refinement. One last particular item to mention: LIBOR. Transitioning away from LIBOR is a significant undertaking that the FSB has been engaged in for almost a decade. The FSB set forth a roadmap for clear actions that financial firms and their clients can take to ensure a smooth transition away from LIBOR. This year, the FSB will report to the G20 on ongoing progress and issues related to the LIBOR transition, including supervisory issues related to the benchmark transition. We faced a confluence of events over the past year that demanded international coordination in several key areas, and that is precisely why the FSB was created more than ten years ago; a beacon at the end of another fateful March. The span of territory and topics covered can admittedly seem bewildering at times -- I've covered only a few of them today. Yet as the FSB builds its agenda for each coming year, the process is much like a pointillist painting. Each topic, viewed by itself is a series of complex data points -- but, upon stepping back, we see the connection and interdependence of the various elements. The role of the FSB is to orchestrate a unified image and coherent approach; to ensure we continually monitor and address those hazards, the shape and form we have already identified, while allowing for vicissitudes like the COVID event, which arise quickly, with little notice, and that require extra space on the canvas. There is little margin for error in our work. Achieving our objectives requires the utmost in diplomacy and rigorous analysis. In light of all the challenges we have faced over this extraordinary year, I am proud of what my colleagues in the FSB have done. My fellow public servants from across the globe working on FSB topics are steadfast in their daily pursuit of a unified mission --to promote international financial stability. I think the work we have laid out for 2021 does just that.

r210414a_FOMC

united states

The Federal Reserve's New Framework and Outcome-Based Forward Guidance

clarida

September and December FOMC meetings, the Committee made material changes to its forward guidance to bring it into line with this new policy framework. discuss the new framework and the policy implications that flow from it, I will first review some important changes in the U.S. economy that motivated the Committee to assess ways we could refine our strategy, tools, and communication practices to achieve and sustain our goals in the economy in which we operate today and for the foreseeable future. Perhaps the most significant change in our understanding of the economy since the Federal Reserve formally adopted inflation targeting in 2012 has been the substantial decline in estimates of the neutral real interest rate, r*, that, over the longer run, is consistent with our maximum-employment and price-stability mandates. Whereas in January 2012 the median FOMC participant projected a longer-run r* of 2.25 percent and a neutral nominal policy rate of 4.25 percent, as of March 2021, the median FOMC participant projected 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 Global Financial Crisis (GFC) is a global phenomenon that is widely expected by forecasters and financial markets to persist for The substantial decline in the neutral policy rate since 2012 has critical implications for monetary policy because it leaves the FOMC with less conventional policy space to cut rates to offset adverse shocks to aggregate demand. This development, in turn, makes it more likely that recessions will impart elevated risks of more persistent downward pressure on inflation and inflation expectations as well as 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. With regard to inflation expectations, there is broad agreement that achieving price stability on a sustainable basis requires that long-run inflation expectations be well anchored at the rate of inflation consistent with the price-stability goal. The pre-GFC important result that a credible inflation-targeting monetary policy strategy that is not constrained by the effective lower bound (ELB) can deliver, under either rational expectations or linear least-squares learning (Bullard and Mitra, 2002), 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." And, indeed, in the 15 years before December 2008, when the federal funds rate first hit the ELB--a period when, de facto, if not de jure the Federal Reserve conducted a monetary policy that was interpreted to be targeting an inflation rate of 2 percent (Clarida, Gali, and But this "copacetic coincidence" no longer holds in a world of low r* in which adverse aggregate demand shocks drive the economy in downturns to the ELB. In this case, 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 (Mishkin, 2016). This finding is the crucial insight in my colleague John Williams's research with Thomas Mertens (2019) and in the research of Bernanke, Kiley, and Roberts (2019). 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. Two other, related developments that have also become more evident than they appeared in 2012 are that price inflation seems empirically to be less responsive to resource slack, and 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 (SEP). 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 and labor's share I will now discuss the implications of the new framework for the Federal Reserve's price-stability mandate before turning to its implications for the maximum- employment mandate. Five features of the new framework and fall 2020 FOMC statements define how the Committee will seek to achieve its price-stability mandate over time. First, the Committee expects to delay liftoff from the ELB until PCE inflation has risen to 2 percent and other complementary conditions, consistent with achieving this goal on a sustained basis, have also been met. Second, with inflation having run persistently below 2 percent, the Committee will aim to achieve inflation moderately above 2 percent for some time in the service of keeping longer-term inflation expectations well anchored at the 2 percent longer-run goal. Third, the Committee expects that appropriate monetary policy will remain accommodative for some time after the conditions to commence policy normalization have been met. Fourth, policy will aim over time to return inflation to its longer-run goal, which remains 2 percent, but not below, once the conditions to commence policy normalization have been met. Fifth, inflation that averages 2 percent over time represents an ex ante aspiration of the FOMC but not a time inconsistent ex post commitment. As I highlighted in speeches at the Brookings Institution in November and the Hoover Institution in January, I believe that a useful way to summarize the framework defined by these five features is temporary price-level targeting (TPLT, at the ELB) that reverts to flexible inflation targeting (once the conditions for liftoff have been reached). Just such a framework has been analyzed by Bernanke, Kiley, and Roberts (2019) and Bernanke (2020), who in turn build on earlier work by Evans (2012), Reifschneider and Williams (2000), and Eggertsson and Woodford (2003), among many others. A policy that delays liftoff from the ELB until a threshold for average inflation has been reached is one element of a TPLT strategy. Starting with our September FOMC statement, we communicated that inflation reaching 2 percent is a necessary condition for liftoff from the ELB. TPLT with such a one-year memory has been studied by Bernanke, Kiley, and Roberts (2019). The FOMC also indicated in these statements that the Committee expects to delay liftoff until inflation is "on track to moderately exceed 2 percent for some time." What "moderately" and "for some time" mean will depend on the initial conditions at liftoff (just as they do under other versions of TPLT), and the Committee's judgment on the projected duration and magnitude of the deviation from the 2 percent inflation goal will be communicated in the quarterly SEP for inflation. Our new framework is asymmetric. That is, as in the TPLT studies cited earlier, the goal of monetary policy after lifting off from the ELB is to return inflation to its 2 percent longer-run goal, but not to push inflation below 2 percent. In the case of the Federal Reserve, we have highlighted that making sure that inflation expectations remain anchored at our 2 percent objective is just such a consideration. Speaking for myself, I follow closely the Fed staff's index of common inflation expectations (CIE)--which is now updated quarterly on the Board's website--as a relevant indicator that this goal is Other things being equal, my desired pace of policy normalization post liftoff to return inflation to 2 percent would be somewhat slower than otherwise if the CIE index at the time of liftoff is below the pre-ELB level. Our framework aims ex ante for inflation to average 2 percent over time but does not make a commitment to achieve ex post inflation outcomes that average 2 percent under any and all circumstances. The same is true for the TPLT studies I cited earlier. In these studies, the only way in which average inflation enters the policy rule is through the timing of liftoff itself. Yet in stochastic simulations of the FRB/US model under TPLT with a one-year memory that reverts to flexible inflation targeting after liftoff, inflation does average very close to 2 percent (see the table). The model of Mertens and Williams (2019) delivers a similar outcome: Even though the policy reaction function in their model does not incorporate an ex post makeup element, it delivers a long-run (unconditional) average rate of inflation equal to target by aiming for a moderate inflation overshoot away from the ELB that is calibrated to offset the inflation shortfall caused by the ELB. I turn now to the maximum-employment mandate. An important evolution in our new framework is that the Committee now defines maximum employment as the highest level of employment that does not generate sustained pressures that put the price-stability mandate at risk. As a practical matter, this means to me that when the unemployment rate is elevated relative to my SEP projection of its long-run natural level, monetary policy should, as before, continue to be calibrated to eliminate such employment shortfalls, so long as doing so does not put the price-stability mandate at risk. Indeed, in our September and subsequent FOMC statements, we indicated that we expect it will be appropriate to keep the federal funds rate in the current 0 to 25 basis point target range until inflation has reached 2 percent (on an annual basis) and labor market conditions have reached levels consistent with the Committee's assessment of maximum employment. Moreover, in our December and subsequent FOMC statements, we have indicated that we expect to continue our Treasury and MBS purchases at least at the current pace until we have made substantial further progress toward achieving these dual mandate goals. In our new framework, when in a business cycle expansion labor market indicators return to a range that in the Committee's judgment is broadly consistent with its maximum-employment mandate, it will be data on inflation itself that policy will react to, but, going forward, policy will not tighten solely because the unemployment rate has fallen below any particular econometric estimate of its long-run natural level. Of note, the relevance of uncertainty about the natural rate of unemployment or the output gap for monetary policy reaction functions is a long-studied topic that remains important. example, Berge (2020) provides a discussion around the difficult task of estimating the These considerations have an important implication for the Taylor-type policy reaction function I consult. Consistent with our new framework, the relevant policy rule benchmark I will consult once the conditions for liftoff have been met is an inertial Taylor-type rule with a coefficient of zero on the unemployment gap, a coefficient of 1.5 on the gap between core PCE inflation and the 2 percent longer-run goal, and a neutral real policy rate equal to my SEP projection of long-run r*. The most recent features a box on policy rules, including a Taylor-type "shortfalls" rule in which the federal funds rate reacts only to shortfalls of employment from the Committee's best judgment of its maximum level but reverts to the rule previously described once that level of employment is reached (see figure 4). In closing, I think of our new flexible average inflation-targeting framework as a combination of TPLT at the ELB, to which TPLT reverts once the conditions to commence policy normalization articulated in our most recent FOMC statement have been met. In this sense, our new framework indeed represents an evolution, not a revolution, from the flexible inflation-targeting framework in place since 2012. Thank you very much for your time and attention, and I look forward to my conversation with . . . vol. 109 . . speech delivered at "The Economy and Monetary Policy," an event hosted by the . vol. 37 no. 1, . and Banking, . . Review of . vol. 84 vol. 52 vol. 32

r210503a_FOMC

united states

Community Development

powell

Good afternoon. It is a pleasure to be with you today. Together, over the past year, we have been making our way through a very difficult time. We are not out of the woods yet, but I am glad to say that we are now making real progress. While some countries are still suffering terribly in the grip of COVID-19, the economic outlook here in the United States has clearly brightened. Vaccination levels are rising. Fiscal and monetary policy are providing strong support. The economy is reopening, bringing stronger economic activity and job creation. That is the high-level perspective--let's call it the 30,000 foot view--and from that vantage point, we see improvement. But we should also take a look at what is happening at street level. Lives and livelihoods have been affected in ways that vary from person to person, family to family, and community to community. The economic downturn has not fallen evenly on all Americans, and those least able to bear the burden have been the hardest hit. The pain is all the greater in light of the gains we had seen in the years prior to the pandemic. COVID swept in as the United States was experiencing the longest expansion on record. Unemployment was at 50-year lows, and inflation remained under control. Wages were moving up, particularly for the lowest-paid workers. Long-standing racial disparities in unemployment were narrowing, and many who had struggled for years were finding jobs. It was not until the later years of that expansion that its benefits had started to reach those on the margins. During our events, we met with people around the country and heard repeatedly about the life-changing gains of the strong labor market, particularly at the lower end of the income spectrum. Just a few months later, those stories changed to ones of job losses, overextended support services, and businesses built over generations closing their doors for good. While the recovery is gathering strength, it has been slower for those in lower- paid jobs: Almost 20 percent of workers who were in the lowest earnings quartile in February of 2020 were not employed a year later, compared to 6 percent for workers in the highest quartile. SHED report--which will be published later this month, will show that, for prime-age adults without a bachelor's degree, 20 percent saw layoffs in 2020 versus 12 percent for college-educated workers. And more than 20 percent of Black and Hispanic prime-age workers were laid off compared to 14 percent of white workers over the same period. Small businesses have also faced immense difficulties. Fed research found that 80 percent of those surveyed reported a decline in revenue, with two-thirds of those businesses experiencing losses of at least 25 percent. report looked specifically at the impact on businesses owned by people of color, who reported greater challenges. For example, 67 percent of both Asian- and Black-owned firms and 63 percent of Hispanic-owned firms had to reduce their operations compared to 54 percent for their white counterparts. Our upcoming SHED report notes that 22 percent of parents were either not working or working less because of disruptions to childcare or in-person schooling. Black and Hispanic mothers--36 percent and 30 percent, respectively--were disproportionately affected. In a similar vein, labor force participation declined around 4 percentage points for Black and Hispanic women compared to 1.6 percentage points for white women and about 2 percentage points for men overall. The Fed is focused on these long-standing disparities because they weigh on the productive capacity of our economy. We will only reach our full potential when everyone can contribute to, and share in, the benefits of prosperity. Achieving broadly shared prosperity will take action from across society, from fiscal and other government policy to private-sector initiatives to the work everyone here does. The Fed can contribute as well. Using our monetary policy tools, the Fed promotes maximum employment and price stability--two foundations of a strong, stable economy that can improve economic outcomes for all Americans. We view maximum employment as a broad and inclusive goal. Those who have historically been left behind stand the best chance of prospering in a strong economy with plentiful job opportunities. Our recent history highlights both the benefits of a strong economy and the severe costs of a weak one. Supervisory tools also have a role to play. As part of our policy responsibilities, the Board of Governors enforces both the Fair Housing Act and the Equal Credit Opportunity Act, the federal fair lending laws that prohibit discrimination in lending. Violations of the fair lending laws, along with other illegal credit practices, are taken into see our robust supervisory approach as critical to addressing racial discrimination, which can limit consumers' ability to improve their economic circumstances, including through access to homeownership and education. The Fed's community development function plays a role as well, studying what works, convening stakeholders on both the national and District level, and helping financial institutions find opportunities to invest and expand credit opportunities in low- and moderate-income communities. The economic landscape has changed, and efforts to provide access and credit to communities must change with it. Last year, the Fed issued a proposal for a strengthened, modernized CRA framework, with the objective of building broad support among both external stakeholders and participating agencies. Our goal is to strengthen the core purpose of meeting the credit needs of low- and moderate-income communities. We especially appreciated NCRC's feedback on the proposal. We will continue to do our part, and we appreciate the ways our work and that of NCRC members have intersected. Last April, for instance, the Fed expanded the Paycheck Protection Program Liquidity Facility in order to broaden its reach to include some nondepository lenders. That included CDFI (community development financial institution) loan funds, which many of the people here represent. Your work provided small businesses with invaluable technical assistance to help them weather the downturn, and you have helped them get the funds they need to support their businesses. NCRC member groups have contributed in so many ways. You helped workers who lost their jobs get retrained. You supported working parents. You helped homeowners struggling with payments and connected renters to federal assistance programs. You brought more people into the banking system, helped strengthen financial literacy and capabilities, and worked to address digital divides in areas of need-- particularly in rural communities--at a time when connectivity is essential. I would like to close by saying thank you. You have been working hard through this crisis, and an enormous amount of work still lies ahead. But what you do is essential. You provide an invaluable service: You make people's lives better. There is no higher calling. Thank you.

r210505a_FOMC

united states

The Economic Outlook and Implications for Monetary Policy

bowman

Thank you for this opportunity to address the members of the Colorado Forum, which has been an arena for thoughtful discussion and debate for more than 40 years. Today I would like to discuss a subject that I expect is of great interest to Coloradans and others: the outlook for the U.S. economy in 2021. I believe that the economy has gained momentum in the past several months and is well positioned to grow strongly in 2021. Nevertheless, we have further to go to recover from the economic damage inflicted by the COVID-19 pandemic, and risks remain. As we all know, starting in late February or March of last year, widespread economic and social lockdowns and other effects of the pandemic caused the swiftest and deepest contraction in employment and economic activity since the Great Depression. Money markets, the Treasury market, and other parts of the financial system seized up, and there were fears of another severe financial crisis. The Federal Reserve stepped in quickly to assist, reviving several lending facilities used in the previous crisis and creating several new facilities. We also cut short-term interest rates to near zero and began purchasing large quantities of Treasury and agency securities to help sustain the flow of credit to households and businesses. Congress and the Administration also worked together to provide effective and timely support. Calm was restored in financial markets, and employment and output began growing in May, but it was a very deep hole to fill. Since that time, progress in controlling the pandemic has been a dominant force driving the economic recovery. Rapid progress last summer gave way to slower economic growth over the turn of the year, as infection rates once again surged. But after a substantial pickup in vaccinations and steep declines in virus-related hospitalizations and deaths, the economic outlook has brightened. Job creation had stalled over the winter months but improved again starting in February. Over the past year, we've seen a return of nearly 14 million jobs. Another significant factor contributing to the recovery is the resilience of private- sector businesses. Our economic recovery has been more rapid and stronger than many forecasters expected, partly due to the ability of businesses to adapt to conditions that none of them had planned for, and few even imagined could be possible. Initially, government assistance was important, but millions of businesses were at risk of closure. Instead, many are open and growing today due to the resourcefulness and determination of entrepreneurs and workers and their ability to adjust business plans and operations to deal with the effects of social-distancing and operating restrictions. Of course, technology helped a great deal, but businesses were able to find many other ways to maintain operations and sustain their connections to customers. In writing the history of these eventful times, I hope that the efforts of these businesses and the strength of America's market-based economy get the considerable credit they deserve. Recently, the incoming data indicate that economic activity is on an upswing, and the risks of more negative outcomes--especially those from COVID-19--appear to be easing. Vaccinations and the easing of operating and social-distancing restrictions are boosting consumer and business confidence, with the results clear to see in the data on spending. Retail sales surged nearly 10 percent in March and are actually above the trendline that was interrupted by the pandemic a year ago. One particularly encouraging signal in that report was a sharp expansion in spending on food services. I hope this is an indication that consumers are finally returning to in-person dining as spring arrives and local authorities allow restaurants to accommodate more diners. If so, and my fingers are crossed, it is a very good sign of further progress in one of the sectors hardest hit by the pandemic. In the job market, job gains rebounded to 916,000 in March. At our March meeting, my view was broadly in line with the median of projections of other members of grow between 5.8 percent and 6.6 percent in 2021. But the outlook has improved since then, and it now appears that real gross domestic product may increase close to or even above the higher end of that range. This annual increase would be the largest in 36 years. Likewise, the FOMC median in March was for unemployment to fall to 4.5 percent at the end of 2021, and now it seems possible that it may fall even further. With the economy continuing to reopen, I expect the pace of job creation to remain unusually strong over the spring and summer. Over the past few months many schools have resumed some form of in-person learning, which should translate into a rebound in labor force participation as more parents overseeing virtual education and child care are able to increase hours or return to the workforce. The biggest risk to the outlook continues to be the course of the pandemic. I see good reasons to be optimistic. Vaccinations are proceeding at a rapid pace, and this progress is supporting decisions by state and local leaders to relax economic restrictions. Most importantly, deaths related to the virus have continued to fall steadily and are at roughly the rate as in early October of last year. I remain hopeful that progress in the economic recovery can stay ahead of new challenges that might emerge, like the spread of new virus variants. That would allow states and localities to continue easing economic and social distancing restrictions and encourage consumers and businesses to return to normal activities. I understand that in Colorado, for example, officials are considering lifting social-distancing restrictions on individuals and businesses. I would be interested to hear from this group about how businesses in Colorado have been faring and whether they have seen an improvement in demand as the pandemic conditions are easing. am optimistic about the ongoing recovery, one lesson of the past year is the significant degree of uncertainty about the course of the virus and its effect on the economy. We experienced periods of considerable progress last year, but we saw some of that progress overtaken by waves of the infection late in the year. Likewise, economic growth rebounded much more quickly than many had expected, but then slowed late in 2020 before regaining speed following the availability of the vaccine. Even with recent encouraging reports on food services, activity in the travel, leisure, and hospitality sectors is still severely compromised, but is showing glimmers of activity. It may be some time before we know whether old habits will resume or new habits have developed that may define a post-pandemic new normal. As I noted in a recent speech, I am particularly concerned about the longer-term effect on small businesses, many of which have held on with government aid and loan forbearance programs that will soon expire. It will be several months before we know the final count of permanent small business closures from 2020, but it could be more than we expect. I will now turn to how the Federal Reserve is proceeding in light of the strong signals of momentum building in the economy. The economic recovery is not yet complete, and the uncertain course of the pandemic still presents risks in the near term, which is why my colleagues and I on the FOMC decided last week to maintain our highly accommodative stance of monetary policy. Despite the progress to date and the signs of acceleration in the recovery, employment is still considerably short of where it was when the pandemic disrupted the economy and it is well below where it should be, considering the pre-pandemic trend. In particular, our maximum employment mandate is intended as a broad and inclusive goal increasing employment and opportunity, but I remain concerned that employment gains for some minority groups have lagged behind those of others. While job creation has been and is expected to remain strong, the pace will eventually slow as the share of those who have been unemployed for the longer-term increases among those who are looking for work. We are making good progress toward our full employment goal, but we still have a long way to go, and risks remain. This brings me to the other side of our policy mandate. Over the next several months, I expect that headline inflation measures will move above our long-run target of 2 percent. A main reason I expect this outcome is simply the fact that the very low inflation readings during last spring's deep economic contraction will drop from the usual calculation of 12-month price changes. But in addition, the unusually rapid rebound in economic activity that we've seen, along with the pandemic-driven shift towards goods purchases, has led to supply-chain bottlenecks in a number of areas, which in turn have pushed up prices for many goods. One prominent example is with semiconductor producers and their need to dramatically alter the mix of production to meet demands of the high-tech and automotive industries. Although I expect these upward price pressures to ease after the temporary supply bottlenecks are resolved, the exact timing of that dynamic is uncertain. If the supply bottlenecks prove to be more long-lasting than currently expected, I will adjust my views on the inflation outlook accordingly. At this point, the risk that inflation remains persistently above our long-run target of 2 percent still appears small. In summary, let me say that I am encouraged by the recent pace of the economic recovery, and I remain optimistic that this strength will continue in the coming months. One reason for my optimism is that businesses have been effective in responding to the challenges posed by the pandemic and by economic restrictions implemented in efforts to contain it. We really can't know how the pandemic will proceed and how that will affect the U.S. economy, but I think we are currently on a good path, and our policy is in a good place. Thank you again for inviting me to speak to you today, and I would be happy to respond to your questions.

r210511a_FOMC

united states

Patience and Progress as the Economy Reopens and Recovers

brainard

I want to thank Heather Long and the Society for Advancing Business Editing and Writing for inviting me to join you today. Strong fiscal support and increasing vaccination rates drove a strong rebound in activity in the first quarter, and the second quarter looks to be even stronger. The outlook is bright, but uncertainty remains, and employment and inflation are far from our goals. While more balanced than earlier this year, risks remain from vaccine hesitancy, deadlier variants, and a resurgence of cases in some foreign countries. The latest jobs report is a reminder that the path of reopening and recovery--like the shutdown--is likely to be uneven and difficult to predict, so basing monetary policy on outcomes rather than the outlook will serve us well. With the renewal of fiscal support, real disposable personal income surged 61 percent on an annualized basis in the first quarter after a decline of 10 percent in the supporting a robust 6.4 percent growth rate in real gross domestic product (GDP) in the first quarter, despite a large runoff of inventories amid supply chain bottlenecks. The second quarter appears primed to exceed the strong first quarter as progress on vaccinations continues, and more consumers return to the sectors adversely affected The combination of fiscal support and depressed discretionary services spending during the shutdown have enabled households to accumulate considerable savings that could continue to fuel spending. Personal savings rose to 21 percent in the first quarter, according to Bureau of Economic Analysis data, on top of the $2.1 trillion increase in household liquid assets reflected at the end of last year. While the incoming spending data, elevated household savings, and progress on vaccinations point to a very strong modal outlook, there is greater than usual uncertainty about the economy's path. For instance, the strength of domestic demand this year relative to next will depend on how quickly or slowly a large share of accumulated household savings is spent out. This, in turn, hinges in part on the distribution of household savings and how much is concentrated among households who are less likely to spend, perhaps because their services consumption returns only to pre-COVID levels or their near-term demand for durable goods has largely been satiated. There is also uncertainty about how much of the strong domestic aggregate demand will leak abroad rather than translating into domestic output. As supply chain and shipping bottlenecks ease, international spillovers could lead to some slippage between the increase in domestic demand and domestic resource utilization. In addition, some of this year's tailwinds are likely to become next year's headwinds. While the fiscal support provided to households is raising consumer spending and GDP this year, the absence of similar transfers will lower the growth rate of spending next year relative to this year. The boost to spending from pent up demand this year as the economy reopens is also unlikely to be repeated next year. The latest jobs report reminds us that while there are good reasons to expect the number of jobs and the number of people wanting to work will make a full recovery, it is unlikely they will recover at the same pace. Over the past few months, the demand for workers has strengthened as COVID-affected sectors have reopened. Labor supply has also improved, with many people coming back into the labor force and others extending their hours of work, but there are indications that many other workers still face virus- related impediments. Although the fraction of the population ages 25 to 54 that is employed has improved in each month of this year, the current prime-age employment- to-population (EPOP) ratio of 76.9 percent is still far from the 80 percent level reached during both of the past two expansions. On the demand side, we saw a welcome increase of 331,000 jobs in the hard-hit leisure and hospitality sector in April following a 206,000 increase in March. But bottlenecks on inputs such as semiconductors appear to be limiting production and hiring in industries such as motor vehicles, contributing to a decline of 18,000 jobs in the manufacturing sector. The increase in average hours worked and the reduction in people who are working part time but would prefer full-time work suggest some employers are responding to the increase in demand by lengthening workweeks. On the supply side, the number of people entering the labor force strengthened for the second month in a row in a welcome sign that more people are actively seeking work as job opportunities and vaccinations increase. But we are also hearing anecdotal accounts that many people face virus-related impediments in returning to full-time work, and many businesses face hiring challenges. With less than one-in-four individuals ages 18 to 64 fully vaccinated at the end of the survey period for the April jobs report, health and safety concerns remain important for in-person work and for people relying on public transport, and childcare remains a challenge for many parents. Childcare remains an impediment for many parents because the return to fully in- person school is still incomplete and childcare options are still limited in many areas. the time of the April jobs report, nearly two-thirds of students had yet to return to fully in-person schooling, and this share had only increased by 8 percentage points since Consistent with this, the labor force participation rate of women ages 25 to 45 was unchanged in April, after an increase in March that coincided with a surge in education hiring and school reopening. Similarly, April saw a small increase in the number of women who reported that they wanted a job but were out of the labor force for family responsibilities, following a large decline in March. Recent research shows that the pandemic has taken a particularly significant toll on the labor market status of many Black and Hispanic mothers and mothers with lower incomes. Aggregate average hourly earnings increased by 0.7 percent in April in a positive development for workers. Wage increases were broadly distributed across sectors, including an increase of more than 1-1/2 percent, month over month, in hourly earnings in the leisure and hospitality sector. While labor market conditions have improved in aggregate, significant disparities persist. Although the prime-age EPOP ratio has increased for all racial groups over the past four months, the ratio for Black prime-age workers, at 72.1 percent, is still over 6 percentage points lower than the white prime-age EPOP ratio, while the gap for Hispanic prime-age workers relative to white workers is almost 5 percentage points. Job losses are disproportionately concentrated in low-wage, high-contact sectors, suggesting that the workers least able to shoulder the economic effect of job loss have faced the greatest challenges. Despite the more than 900,000 jobs gained in the leisure and hospitality sector in the first four months of 2021, jobs in this sector remain nearly 3 million below their pre-COVID level. The leisure and hospitality sector alone accounts for 41 percent of the net loss in private payrolls since the onset of the pandemic. There is good reason to expect a strong rebound in employment over coming quarters, although the different forces affecting demand and supply may lead to uneven rates of progress. But today, by any measure, employment remains far from our goals. The unemployment rate remains elevated at 8.9 percent when we adjust the narrow 6.1 percent U-3 measure of unemployment to also reflect workers who have left the labor force since the pandemic started and those who are misclassified. As of the latest reading, there is an employment shortfall of 8.2 million relative to the pre-pandemic level, and the employment shortfall is over 10 million if we take into account the secular job growth that would have occurred over the period since February 2020 in normal circumstances. The path of inflation is also difficult to predict, although there are a variety of reasons to expect an increase in inflation associated with reopening that is largely transitory. Most immediately, base effects are likely to contribute substantially to the 12- month readings of headline and core PCE inflation in April and May as the price declines of March and April 2020 roll out of the 12-month calculation. I also anticipate that the recent surge in energy prices, which contributed about 1/2 percentage point to the March 12-month headline PCE reading, will fade over time, although recent pipeline disruptions add some uncertainty. It is much more difficult to predict the size and duration of supply-side bottlenecks and how these will interact with the pattern of demand to feed through into inflation. The production of certain semiconductors may take some time to ramp up, and the feedback effects between shipping delays and container shortages appear to be only slowly working themselves out. In contrast, the manufacturing capacity taken offline by the harsh weather in Texas in February is coming back online rapidly. If past experience is any guide, production will rise to meet the level of goods demand before too long. The supply-demand imbalances in the in-person services sector are expected to be resolved within a few quarters with progress on virus control and the return of in-person schooling. And demand growth itself is expected to moderate after a reopening surge, broadly coinciding with the time when some of the current tailwinds from fiscal support and makeup consumption turn to headwinds. Of course, there may be additional demand and supply surprises that could further complicate the inflation picture. To the extent that supply chain congestion and other reopening frictions are transitory, they are unlikely to generate persistently higher inflation on their own. A persistent material increase in inflation would require not just that wages or prices increase for a period after reopening, but also a broad expectation that they will continue to increase at a persistently higher pace. A limited period of pandemic-related price increases is unlikely to durably change inflation dynamics. Past experience suggests many businesses are likely to compress margins and to rely on automation to reduce costs rather than fully passing on price increases. roughly one-half of chief financial officers from large firms and about one-third of those from small firms reported "using, or planning to use, automation or technology to reduce reliance on labor." The pandemic-induced shift to virtual, or contactless, versions of many previously in-person interactions is likely to lead to some durable shifts in the use of technology. Thus, there are compelling reasons to expect the well-entrenched inflation dynamics that prevailed for a quarter-century to reassert themselves next year as imbalances associated with reopening are resolved, work and consumption patterns settle into a post-pandemic "new normal," and some of the current tailwinds shift to headwinds. I will be carefully monitoring measures of longer-term inflation expectations to ensure they are well anchored at 2 percent. To date, various measures suggest inflation expectations remain well anchored and broadly consistent with our new framework. The Index of Common Inflation Expectations moved back to 2 percent in the first quarter, returning to its level in 2018, which is lower than its level prior to 2014. In addition, the term structure of market-based measures of inflation compensation is consistent with market participants expecting a limited period of inflation above 2 percent. A straight read of the difference between the forward nominal Treasury curve and the forward Treasury Inflation-Protected Securities curve implies inflation compensation is expected to be higher for the next two years and to decline subsequently and remain stable 5 and 10 years into the future. I will remain attentive to the risk that what seem like transitory inflationary pressures could prove persistent as I closely monitor the incoming data. Should this risk manifest, we have the tools and the experience to gently guide inflation back to our target. No one should doubt our commitment to do so. But recent experience suggests we should not lightly dismiss the risk on the other side. Achieving our inflation goal requires firmly anchoring inflation expectations at 2 percent. Following the reopening, there will need to be strong underlying momentum to reach the outcomes in our forward guidance. Remaining patient through the transitory surge associated with reopening will help ensure that the underlying economic momentum that will be needed to reach our goals as some current tailwinds shift to headwinds is not curtailed by a premature tightening of financial conditions. The outlook is bright, but risks remain, and we are far from our goals. The latest employment report reminds us that realized outcomes can diverge from forward projections and underscores the value of patience. As the economy reopens fully and the recovery gathers momentum, it will be important to remain patiently focused on achieving the maximum-employment and inflation outcomes in our guidance.

r210512a_FOMC

united states

U.S. Economic Outlook and Monetary Policy

clarida

It is my pleasure to meet virtually with you today at the National Association for So much has happened since we last met in Washington in February 2020, but I am grateful that technology is allowing us to gather once again, if only virtually. I look forward, as always, to my conversation with Ellen Zentner, but first, please allow me to offer a few remarks on the economic outlook, Federal Reserve monetary policy, and our new monetary policy framework. In February 2020, none of us could have imagined that in a few short weeks the COVID-19 pandemic and the mitigation efforts put in place to contain it would deliver the most severe blow to the U.S. economy since the Great Depression. Gross domestic product (GDP) collapsed by more than 30 percent at an annual rate in the second quarter of 2020; more than 22 million jobs were lost, wiping out a decade of employment gains; the unemployment rate rose from a 50-year low of 3.5 percent in February to almost 15 percent in April; and inflation plummeted in response to a collapse in aggregate demand that dwarfed the contraction in aggregate supply. But with the benefit of hindsight, it is clear that the economy has proven to be much more resilient than many forecast or feared one year ago. With timely support from monetary and fiscal policy--unprecedented in both scale and scope--and the rapid development and deployment of several effective vaccines, the economy stabilized and began a robust recovery in the second half of 2020 that both we and outside forecasters expect to pick up steam this year. So far, the economic activity data we have received this year is consistent with this outlook. For example, GDP rose by an impressive 6.4 percent in the first quarter, with real final sales to private domestic purchasers up an eye- popping 10.6 percent. Household spending on goods is rising robustly, and spending on services is also picking up as contact-intensive sectors begin to reopen and recover. Business and residential investment have more than fully recovered from the 2020 collapse and are operating above pre-pandemic levels. However, after looking at the details of Friday's disappointing employment report, the near-term outlook for the labor market appears to be more uncertain than the outlook for economic activity. Employment remains 8.2 million below its pre-pandemic peak, and the true unemployment rate adjusted for participation is closer to 8.9 percent than to 6.1 percent. At the recent pace of payroll gains--roughly 500,000 per month over the past three months--it would take until August 2022 to restore employment to its pre- pandemic level. But what this necessary rebalancing of labor supply and demand means for wage and price dynamics will depend importantly on the pace of recovery in labor force participation as well as the extent to which there are post-pandemic mismatches between labor demand and supply in specific sectors of the economy and how long any such imbalances persist. Readings on inflation on a year-over-year basis have recently increased and are likely to rise somewhat further before moderating later this year. Over the next few months, 12-month measures of inflation are expected to move above our 2 percent longer-run goal, largely reflecting, I believe, transitory factors such as a run of year-over- year comparisons with depressed service-sector prices recorded last spring as well as the emergence of some supply bottlenecks that may limit how quickly production can rebound in certain sectors. However, under my baseline outlook, these one-time increases in prices are likely to have only transitory effects on underlying inflation, and I expect inflation to return to--or perhaps run somewhat above--our 2 percent longer-run goal in 2022 and 2023. This outcome would be entirely consistent with the new framework the Federal Reserve unanimously adopted in August 2020 and began to At FOMC meetings convened since the new framework was announced last August, the Committee made important changes to our policy statement that upgraded our forward guidance about the future path of the federal funds rate and asset purchases to bring it in line with our new framework. As announced in the September 2020 FOMC statement and reiterated in the following statements--including the most recent one-- with inflation running persistently below 2 percent, our policy will aim to achieve inflation outcomes that keep inflation expectations well anchored at our 2 percent longer- run goal. We expect to maintain an accommodative stance of monetary policy until these outcomes--as well as our maximum-employment mandate--are achieved. We also expect it will be appropriate to maintain the current target range for the federal funds rate at 0 to 1/4 percent until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment, until inflation has risen to 2 percent, and until inflation is on track to moderately exceed 2 percent for some time. In addition, in our December 2020 FOMC statement, the Committee combined our forward guidance for the federal funds rate with enhanced, outcome-based guidance about our asset purchases. We indicated that we will continue to increase our holdings of Treasury securities by at least $80 billion per month and our holdings of agency mortgage-backed securities by at least $40 billion per month until substantial further progress, measured relative to the December 2020 announcement, has been made toward our maximum-employment and price-stability goals. In our new framework, we acknowledge that policy decisions going forward will be based on the FOMC's estimates of " shortfalls [emphasis added] of employment from This language means that, going forward, a low unemployment rate, in and of itself, will not be sufficient to trigger a tightening of monetary policy absent any evidence from other indicators that inflation is at risk of moving above mandate-consistent levels. With regard to our 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 in a world in which an effective-lower-bound constraint is, in downturns, binding on the federal funds rate. To this end, the new statement conveys the Committee's judgment that, in order to anchor expectations at the 2 percent level consistent with price stability, it will conduct policy to achieve inflation outcomes that keep long-run inflation expectations anchored at our 2 percent longer-run goal. As Chair Powell indicated in his Jackson Hole remarks, we think of our new framework as an evolution from "flexible inflation targeting" to a "flexible form of average inflation targeting." While this new framework represents a robust evolution in our monetary policy strategy, this strategy is in service to the dual-mandate goals of monetary policy assigned to the Federal Reserve by the Congress--maximum employment and price stability--that remain unchanged. Notwithstanding the recent flow of encouraging macroeconomic data, the economy remains a long way from our goals, and it is likely to take some time for substantial further progress to be achieved. Our guidance for interest rates and asset purchases ties the path of the federal funds rate and the size of the balance sheet to our employment and inflation goals. We are committed to using our full range of tools to support the economy for as long as it takes until the job is well and truly done.

r210513a_FOMC

united states

The Economic Outlook and Monetary Policy

waller

Thank you, Kathleen, and thank you, George and the Global Interdependence Center, for the invitation to speak to you this afternoon. I am with you to talk about my outlook for the U.S. economy and the implications for monetary policy. In the last week we have received employment and inflation reports that have garnered a lot of attention. Incorporating this information into my outlook, I have two messages today. The first is that, despite an unexpectedly weak jobs report, the U.S. economy is hitting the gas and continuing to make a very strong recovery from the severe COVID-19 recession. Let's remember, and this applies to latest inflation data too, that a month does not make a trend--the trend for the economy is excellent. My second message is that, despite the unexpectedly high CPI inflation report yesterday, the factors putting upward pressure on inflation are temporary, and an accommodative monetary policy continues to have an important role to play in supporting the recovery. The pandemic and resulting public health response led to the sharpest drop in employment and output the United States has likely ever experienced--22 million jobs lost in eight weeks and an annualized decline of 30 percent in real gross domestic output for the second quarter of 2020. These numbers are simply staggering, and they left us in a deep, deep hole. Not so long ago, it seemed like the economic damage from COVID- 19 might be with us for a long time, and that a full recovery could take many years. But thanks to the rapid development of vaccines and aggressive fiscal and monetary policy, the economy is recovering much faster than anyone expected six months ago. I said a few weeks ago that the economy was ready to rip, and in many respects, that is exactly what it is doing. The initial estimate of first quarter real gross domestic product (GDP) growth came in at a 6.4 percent annual rate, surpassing the level of output in the first quarter of 2020, before the full force of COVID-19 hit the economy. Second- quarter growth is likely to be as much as 8 percent, and the prospects are good that GDP will be close to trend output by the end of 2021. New home sales continue to be strong. We are seeing robust household spending on durable goods despite supply bottlenecks that I will discuss in a moment. Surveys of purchasing managers point to continued solid growth in both manufacturing and business services. So, what about that jobs report? That thud you heard last Friday was the jaw of every forecaster hitting the floor. It was a big surprise for me and most people, but it probably should not have been, because it fits with what we have been hearing from businesses about labor supply shortages. GDP is back to its pre-pandemic level, but we have recovered only 14 million of the 22 million jobs lost last spring. To fully understand how the labor market is performing, I like to refer to the Federal Reserve Bank of Atlanta's labor market distribution spider chart. The chart plots data for 15 different labor market indicators in an easy-to-read manner. Using this chart, you can compare all these indicators for February 2020, April 2020, and March 2021. Looking at these months allows one to compare the very healthy labor market of February 2020 with the depths of the pandemic decline in April 2020 and see both how well we have rebounded since then and how much farther we still have to go. The takeaway from that chart is that the labor market has recovered on many dimensions, such as hiring plans, job openings, quits rates, and firms unable to fill job openings. But on other dimensions, the labor market is far from recovering to its pre- pandemic level. Employment, as I said, is still below where it was in February 2020, by 8 million jobs. The unemployment rate is still 2.5 percentage points higher than it was in February 2020, and we know that it is even worse for some groups--nearly 10 percent for Black workers and nearly 8 percent for Hispanics. The employment-to-population ratio continues to be depressed from February 2020. The upshot is that several measures of labor market conditions have fully recovered, but other measures indicate that the overall labor market has a long way to go to get back to full strength. In short, some of the labor market's cylinders are firing away, and some are still sputtering, so monetary accommodation continues to be warranted. This chart, like the disappointing jobs report for April, shines a light on a current puzzle characterizing the U.S. labor market--a lot of job openings, but high unemployment rates and a low labor force participation rate. We hear repeatedly from our business contacts about firms boosting wages yet still being unable to attract workers. While clearly this is a real problem for some firms at the moment, I believe this mismatch is temporary. I think of the current problem as follows. When the pandemic hit, both labor demand and labor supply fell dramatically. The combination of widespread vaccines and fiscal and monetary stimulus caused consumer demand to recover sharply. This situation, in turn, caused labor demand to rebound quickly, particularly in goods-producing industries. However, due to factors like continued fears of the virus, the enhanced unemployment insurance, child-care issues, and early retirements, labor supply has not rebounded in the same fashion, which led to a situation with excess demand for labor and upward pressure on wages. And that is exactly what we saw in the April jobs report. Average hourly earnings rose 20 cents in April for private-sector nonsupervisory But it is likely the labor supply shortage will be temporary. As vaccinations continue to climb, fears of reentering the labor force should decline. By September, most schools and daycare facilities are expected to fully reopen, resolving recent child-care issues for many families. Finally, the enhanced unemployment benefits passed in response to the pandemic expire in September, and research has shown repeatedly that the job-finding rate spikes as unemployment benefits run out. Thus, while labor demand is currently outrunning labor supply, supply should catch up soon. Now let me turn to the other leg of the Fed's dual mandate, price stability. That second thud you heard yesterday was forecasters' bodies following their jaws to the floor after the CPI report was released. It was a surprise, but a look at its causes doesn't alter my fundamental outlook, which is that the main pressures on inflation are temporary. First, let me address concerns that strong growth threatens to unleash an undesired adopted a new policy framework that includes flexible average inflation targeting and a policy stance based on economic outcomes as opposed to economic forecasts . Flexible average inflation targeting means we aim to have inflation overshoot our 2 percent longer-run goal if inflation had been running persistently below target. Given that we missed our inflation target on the low side consistently for the past eight years or so, the FOMC has said that it will aim to moderately overshoot its inflation target for some period but then have it return to target. Our willingness to aim for above-target inflation also means we will not overreact to temporary overshoots of inflation--we need to see inflation overshoot our target for some time before we will react. An outcomes-based policy stance means that we must see inflation before we adjust policy--we will not adjust based on forecasts of unacceptably high inflation as we did in the past. Call this the "Doubting Thomas" approach to monetary policy--we will believe it when we see it. We asked to see it, and lo and behold, we are now starting to see inflation exceeding our inflation target. But the critical question is: for how long? Although inflation is starting to exceed our 2 percent target, in my view, this development is largely due to a set of transitory factors that are occurring all at once. I can think of at least six. First, there is what we economists call "base effects," which is the simple arithmetic of what happens when the very low inflation readings of the first half of 2020 fall out of our 12-month measure of inflation. That adjustment will be over in a few months. A second temporary factor is higher energy prices, which have rebounded this year as the economy strengthens but are expected to level off later this year. Retail gasoline prices have jumped in some areas due to the disruption of the Colonial Pipeline, but the effect on inflation should be temporary also. A third factor is the significant fiscal stimulus to date. Stimulus checks put money in people's pockets, and when they spend it, there will be upward pressure on prices. But when the checks are gone, the upward pressure on prices will ease. A fourth factor is a reversal of the very high savings that households have built up over the past year. As households draw down these savings, demand for goods and services will increase, which again will put upward pressure on prices. But, just like stimulus checks, once the excess savings is gone, it is gone, and any price pressures from this factor will ease. A fifth factor is supply bottlenecks that manufacturers and importers are currently experiencing; supply chain constraints are boosting prices, particularly for goods--less so for services. One strength of a capitalist system is that markets adjust. If demand and prices rise for a product, supply will follow, and bottlenecks will dissipate. So once again, price pressures induced by bottlenecks should reverse as supply chains catch up and orders get filled. Finally, the excess demand for labor I described earlier is likely to continue to push wages up in the next couple of months. How much of this increase gets passed through to prices is unknown, but some of it will. However, as I argued earlier, once labor supply catches up, this wage pressure should ease. I expect that all of these factors will cause inflation to overshoot our 2 percent longer-run goal in 2021. But they will not lead to sustained, high rates of inflation. Financial markets seem to think the same--5-year breakeven inflation expectations are around 2.5 percent, and 5-year, 5-year-forward measures are around 2 percent, when adjusted for the difference between CPI (consumer price index) and PCE (personal consumption expenditures) inflation rates. Hence, markets do not believe the current factors pushing up inflation will last for long. While I fully expect the price pressure associated with these factors to ease and for some of the large increases in prices to reverse, it may take a while to do so. Shortages give producers pricing power that they will be reluctant to let go of right away. Wage increases for new workers may cause firms to raise wages for existing workers in order to keep them. Consequently, there may be knock-on effects from the current wage increases. The pandemic has also caused firms to restructure their supply chains, and, as a result, bottlenecks may last longer than currently anticipated as these supply chains are rebuilt. There are also asymmetric price effects from cost shocks--prices go up very quickly but often tend to come down more slowly, as consumers slowly learn that the bottlenecks have gone away. For these reasons, I expect that inflation will exceed 2 percent this year and next year. After that, it should return to target. And in my view, this fluctuation is okay--our new framework is designed to tolerate a moderate overshoot of inflation for some time as long as longer-term inflation expectations remain well-anchored at 2 percent. Before I turn to the implications of all this for monetary policy, a word about the housing market. As I said earlier, housing is a bright spot in the economy that is encouraging investment and lifting household wealth, which is all good, but with memories of recent history in mind, the fast growth in housing prices in most areas of the United States does bear close watching. Housing is becoming less affordable, and that price increase has the biggest effect on low-income individuals and families who have struggled the most since last spring and who are always the most vulnerable to rising rents and home prices. Prices for lumber and other inputs for housing are skyrocketing, and while that occurrence is not having a significant effect on inflation, it is limiting the supply of new homes and helping feed the house price boom. Fortunately, the banking system is strong and resilient--going through multiple Fed stress tests and a tough, real- life stress test this past year. Nevertheless, I am watching this sector closely for signs of stress and will continue to do so. So, in summary, the economy is ripping, it is going gangbusters--pick your favorite metaphor. But we need to remember that it is coming out of a deep hole, and we are just getting back to where we were pre-pandemic. Labor market indicators are more mixed with 8 million workers still without jobs. But many of the problems holding back labor supply will dissipate over time, and we should return to the robust labor market we had in February 2020. Inflation is currently being driven above our 2 percent inflation target but is expected to return to target in subsequent years as transitory inflation shocks fade. Highly accommodative monetary policy, in conjunction with unprecedented fiscal support, has supported a rapid recovery from a uniquely sharp, pandemic-caused recession. The improving economy is helping repair the significant economic damage suffered by individuals, families, and businesses, but there is still a way to go before we fully recover. In light of that fact, I expect the FOMC to maintain an accommodative policy for some time. We have said our policy actions are outcome based, which means we need to see more data confirming the economy has made substantial further progress before we adjust our policy stance, because sometimes the data does not conform to expectations, as we saw last Friday. The May and June jobs report may reveal that April was an outlier, but we need to see that first before we start thinking about adjusting our policy stance. We also need to see if the unusually high price pressures we saw in the April CPI report will persist in the months ahead. The takeaway is that we need to see several more months of data before we get a clear picture of whether we have made substantial progress towards our dual mandate goals. Now is the time we need to be patient, steely- eyed central bankers, and not be head-faked by temporary data surprises. Thank you for the opportunity to speak to you, and I would be happy to respond to your questions.

r210517a_FOMC

united states

Sovereign Markets, Global Factors

clarida

Good morning, and thank you, Raphael. I am delighted to participate in the 25th this year focuses on the role of central banks in fostering a resilient economy and financial system. Central banks can indeed make important contributions to the resilience of the economy and the financial system. In the case of the Federal Reserve, our responsibilities include ensuring that banks are well supervised and regulated, working with other government agencies through the Financial Stability Oversight Council to promote financial stability, and, of course, conducting a U.S. monetary policy that aims to achieve our dual-mandate goals of maximum employment and price stability. As the title of my talk suggests, my remarks today will focus on the importance of some specific global financial linkages that are relevant to the execution and communication of U.S. monetary policy aimed at achieving our domestic mandates. Signs of financial globalization are abundant and evident across markets for many asset classes. But why and in what possible ways is financial globalization relevant for national monetary policies charged with achieving domestic mandates? A comprehensive and complete answer to this fundamental question is, of course, beyond the scope of a single speech, and so in my remarks today, I will focus specifically on two ways in which the integration and globalization of sovereign bond markets is relevant to the execution and communication of national monetary policies. Central banks rightly pay a lot of attention to domestic sovereign bond yields "across the curve" for at least two reasons. First, yield curves for nominal and inflation- indexed bonds provide useful--if also noisy--information about the expected future path of the policy rate, inflation, the business cycle, and the term premium required to hold sovereign bonds. Second, yields on long-maturity bonds represent, generally, a key channel in the transmission of monetary policy to the real economy and, specifically, are a fundamental building block markets use to discount cash flows relevant for valuing financial assets. To anticipate my bottom line, the message of this speech is that global integration of sovereign bond markets has important implications not only for how central banks extract relevant signals from observed yields on bonds issued by the domestic sovereign, but also for how central banks calibrate the transmission of policy and policy guidance to the real economy via the yields on long-maturity bonds that are relevant for saving, investment, and asset valuation. There is a rich academic and practitioner literature devoted to modeling and interpreting fluctuations in domestic sovereign yield curves. A fundamental empirical regularity that motivates much of this research is that, across time and geography, yields along any given sovereign curve tend to rise and fall--and steepen and flatten--together over time. This empirical regularity led Litterman and Scheinkman (1991) to hypothesize and demonstrate that in the market for U.S. Treasury securities, a very small number of common factors--two or, at most, three--are able to account not only for most of the time-series variation, but also for the cross-sectional dispersion in yields across the entire Treasury curve. Moreover, the two most empirically important factors extracted statistically from the Treasury yield curve have intuitive geometric effect on yields across the maturity spectrum--thus, changes in the level factor are often referred to as "parallel shifts" in the yield curve--and accounts for most of the variance in yields across the full range of maturities. The "slope" factor has an effect that is increasing (monotonically) in maturity--thus, changes in the slope factor are often referred to as "steepening" or "flattening" pivots in the yield curve. The original Litterman and Scheinkman (1991) factor model, with its geometric interpretation of level and slope factors, has held up remarkably well over the ensuing three decades and has been replicated for sovereign yield curves across scores of countries around the world, revealing similar regularities. Indeed, many, if not most, major central banks--and certainly their central bank watchers--estimate yield curve models and extract the factors that are reflected in their domestic sovereign yield curves. So, for example, for the three major economies included in figure 1, one can easily extract--using the methodology developed in Diebold and Li (2006)--on a country-by- slope factors. As is clear from figure 1, level and slope factors extracted from these individual sovereign yield curves are highly correlated across these major sovereign bond markets. Economic theory suggests at least two reasons why the factors embedded in sovereign yield curves may be correlated across countries. First, this correlation will be present if the underlying macro fundamentals--for example, productivity growth, saving-investment imbalances, and longer-term inflation expectations--that drive the factors are correlated across countries. Second, as is emphasized in Clarida (2019c) and Obstfeld (2020), this correlation will also be present if countries are tightly financially integrated even if fundamentals themselves are independent across countries. From any set of level and slope factors extracted across a collection of sovereign yield curves, one can in turn extract a global level factor and a global slope factor that account for the correlation among the country-specific level and slope factors. As can be seen in figure 1, the global level factor (the blue line) accounts for most of the evident downward trend and much of the variation relative to that trend in the estimated U.S., U.K., and German level factors. But what is this global level factor? Plausibly, the global level factor embedded in these three sovereign yield curves reflects the contribution of possibly several global macro fundamental drivers--including global productivity growth, the balance between global saving and investment, and longer-term inflation expectations--and likely also other "market" or "technical" factors specific to the trading of these sovereigns in the global bond market. As can be seen in figure 2, however, most of the trend and variation in the global level factor about this trend can be accounted for by the evolution of estimates of the neutral real interest rates in these countries. Figure 2 plots the global level factor against a simple average of the Holston, Laubach, and Williams (2017, henceforth HLW) time- series estimates of r*--the neutral real interest rate consistent with trend growth and stable inflation--for the United States, the United Kingdom, and Germany. Now, while it is certainly intuitive that an r* index for these countries would be correlated with the global level factor extracted from their yield curves, the degree to which this simple index can account for the trend and variation in the global level factor around this trend is striking. And because central banks, including the Federal Reserve, typically channel Milton Friedman (1968) and believe that the evolution of r* primarily reflects nonmonetary factors that are beyond the central bank's control, an "r* theory" of the level factor--if true--has important implications for how central banks extract signal from noise from sovereign yield curves as well as for how they calibrate the stance of monetary policy consistent with a credible inflation target. Under this interpretation, and as was anticipated years ago by Greenspan (2005), Bernanke (2005), Clarida (2005), and others, credible inflation-targeting central banks operating in an integrated global capital market--at least when they are operating away from their effective lower bound (ELB)-- are primarily in the yield curve "slope" business, but much less so in the yield curve Figure 3 shows the relationship between the yield on a 10-year Treasury note and an estimate of the neutral nominal U.S. policy rate, which I set equal to the HLW estimate of r* for the United States plus a 2 percent inflation objective, a proxy for the neutral nominal interest rate when longer-term inflation expectations are anchored at the 2 percent target. As is evident from the figure and as can be verified econometrically, there has been since at least the 1990s a stable, mean-reverting dynamic relationship between the benchmark nominal Treasury yield and a neutral nominal interest rate proxy derived from the HLW time-series estimates for r* in the United States. I would now like to illustrate what I mean when I say that the slope of the yield curve is an important channel through which monetary policy is transmitted. Figure 4 figure 1--against the spread between the HLW estimate of the U.S. neutral nominal policy rate and the actual federal funds rate (hereafter the "policy rate spread"). As is evident from figure 4, most of the variation in the DL slope factor for the Treasury yield curve can be accounted for by changes in the U.S. policy rate spread. A simple spread shown in figure 4 yields an of 0.84 with a coefficient on the policy rate spread of 1.23. In other words, over the past 20 years, more than three-fourths of the variance of the Treasury slope factor can be accounted for by the policy rate spread, which is obviously something the Federal Reserve can control when it sets the federal funds rate. The remaining variance of the benchmark Treasury slope factor is, by construction, accounted for by factors that are uncorrelated with the U.S. policy rate spread. A similar empirical relationship between the policy rate spread and the slope factor embedded in gilt and bund yield curves is also evident in the data, although there is some evidence in these markets of a structural break in these relationships between the slope factor and the policy rate spread sometime after the Global Financial Crisis. In the interest of time, I shall not put forward a theory of what accounts for the residual variance of yield curve slope factors after accounting for the policy rate spread itself, but obvious candidates (certainly at the ELB) would include forward guidance about the path of the future policy rate as well as actual and prospective large-scale asset purchase (LSAP) programs. It is a truism that "correlation is not causation," and this is especially the case when trying to interpret contemporaneous correlation among asset prices generally and among bond yields in particular. Having identified one possible, parsimonious set of economic fundamentals that can help account for yield curve fluctuations in three major sovereign markets, I will now review what the empirical evidence has to say about the direction of causality reflected in observed correlations among sovereign yields. I will explore two possibilities. The first possibility is that, in reality, there are no latent "global" factors whatsoever, but rather there are just U.S. factors that exogenously fluctuate and cause the global correlations in bond yields we observe in the data. There is a vast literature (Claessens, Stracca, and Warnock, 2016, provide an overview) that documents the existence of spillovers from U.S. monetary policy, especially to emerging market (EM) financial conditions, although the recent paper by Hoek, Kamin, and Yoldas (2020) suggests that the degree of those spillovers depends importantly on the policy. In particular, as summarized in figure 5.1, they identified FOMC actions associated with "growth news" as those that were immediately followed by changes in the 10-year Treasury yield and the S&P 500 index in the same direction, whereas actions associated with "monetary news" elicited changes in yields and equity prices in opposite directions. Their key finding, illustrated in figure 5.2, was that FOMC policy rate surprises attributed to stronger U.S. growth generally have only moderate spillovers to EM financial conditions, whereas FOMC policy rate surprises attributed to U.S. inflationary pressures trigger more substantial spillovers to EM financial conditions. Regardless of the type of FOMC policy action, Hoek, Kamin, and Yoldas (2020) also found compelling evidence that the size of the spillover effects from the United States depends importantly on the degree of macroeconomic vulnerability of each emerging market economy (EME), with more vulnerable EMEs experiencing larger spillovers. While I certainly believe that both fundamental and financial shocks originating in the United States propagate throughout the global financial system and likely account for a significant share of the asset price correlations across global markets that we observe in the data, the evidence--and introspection--suggests to me that causality can and often does run both ways. Anecdotally, it is not difficult to recall events-- plausibly exogenous to the United States--that have triggered spillovers from foreign sovereign markets to the U.S. Treasury market. A prominent example would be the surprise Brexit vote of June 23, 2016. As the news of the Brexit vote filtered through global markets that day, sovereign yields plunged in both Germany and the United States. Indeed, as is shown in figure 6, on that day, the 10-year Treasury yield fell almost 20 basis points, the single largest one-day decline in the eight years--and over 2,000 trading The evidence that two-way causality is reflected in sovereign bond yield correlations is not limited to one-off geopolitical events such as Brexit. For instance, Curcuru, De Pooter, and Eckerd (2018) examined 12 years of monetary policy of 266 monetary policy communications--focusing on how sovereign yields in one jurisdiction responded to monetary policy announcements made in the other. Their main findings are summarized in the two panels in figure 7. The left panel presents some of the evidence of the well-known, statistically significant spillovers from FOMC policy announcements to euro-area bond markets. But, as is shown in the right panel, the authors found that the spillover effect from ECB policy announcements to U.S. yields is roughly as large as that from the FOMC announcements to bund yields. In another influential study using a very different identification methodology, Ehrmann, Fratzscher, and Rigobon (2011) estimated significant and approximately equal spillovers from U.S. bond market shocks to EU bond markets, and from EU bond market shocks to the U.S. Treasury market. They attributed their findings to significant incipient and anticipated portfolio allocation flows across the two jurisdictions that respond elastically to expected rate-of-return differentials. To sum up, I believe that in extracting signal from noise from the Treasury yield curve, it is essential to incorporate the fact that observed yields in the United States and other major sovereign markets are determined in a global general equilibrium that is reflected, at least in part, in the global level of neutral policy rates and the state of longer- term global inflation expectations. Conditional on neutral policy rates and longer-term inflation expectations, the Federal Reserve and other major central banks can be thought of as calibrating and conducting the transmission of policy--be it through rates, forward guidance, or LSAPs--primarily through the slopes of their yield curves and much less so via their levels. Thank you very much for your time and attention. I look forward to my conversation with Raphael. . . Global Risk, Uncertainty, and Volatility, cosponsored by the Bank for . Journal of . Journal of . July, available at . . . Journal of en.html . Review of We derive in this appendix a simple model that can be used to interpret the empirical relationship between Treasury yields, the neutral real interest rate, and the policy rate spread. Begin with the identity that the policy rate spread equals the difference between the neutral interest rate and the current policy rate: . Now define the n -period term premium through the long-term rate definition: . Consider a simple data-generating process consistent with Laubach and Williams (2003) for the neutral real interest rate and a simple first-order autoregression for the policy rate spread , where and are assumed to be some unforecastable disturbances. Then at any horizon we have . on the policy rate spread where and are regression parameters and is the residual, and we have (cf. So yields at each maturity are anchored by the common neutral nominal rate and the neutral interest rate is a linear function of the policy rate spread with a loading that depends on the dynamics of the policy rate spread as well as the covariance between the spread and the term premium.

r210524a_FOMC

united states

Private Money and Central Bank Money as Payments Go Digital: an Update on CBDCs

brainard

Technology is driving dramatic change in the U.S. payments system, which is a vital infrastructure that touches everyone. The pandemic accelerated the migration to contactless transactions and highlighted the importance of access to safe, timely, and low-cost payments for all. With technology platforms introducing digital private money into the U.S. payments system, and foreign authorities exploring the potential for central bank digital currencies (CBDCs) in cross-border payments, the Federal Reserve is stepping up its research and public engagement on CBDCs. As Chair Powell discussed last week, an important early step on public engagement is a plan to publish a discussion paper this summer to lay out the Federal Reserve Board's current thinking on digital payments, with a particular focus on the benefits and risks associated with Four developments--the growing role of digital private money, the migration to digital payments, plans for the use of foreign CBDCs in cross-border payments, and concerns about financial exclusion--are sharpening the focus on CBDCs. First, some technology platforms are developing stablecoins for use in payments networks. A stablecoin is a type of digital asset whose value is tied in some way to traditional stores of value, such as government-issued, or fiat, currencies or gold. Stablecoins vary widely in the assets they are linked to, the ability of users to redeem the stablecoin claims for the reference assets, whether they allow unhosted wallets, and the extent to which a central issuer is liable for making good on redemption rights. Unlike central bank fiat currencies, stablecoins do not have legal tender status. Depending on underlying arrangements, some may expose consumers and businesses to risk. If widely adopted, stablecoins could serve as the basis of an alternative payments system oriented around new private forms of money. Given the network externalities associated with achieving scale in payments, there is a risk that the widespread use of private monies for consumer payments could fragment parts of the U.S. payment system in ways that impose burdens and raise costs for households and businesses. A predominance of private monies may introduce consumer protection and financial stability risks because of their potential volatility and the risk of run-like behavior. Indeed, t he period in the nineteenth century when there was active competition among issuers of private paper banknotes in the United States is now notorious for inefficiency, fraud, and instability in the payments system. It led to the need for a uniform form of money backed by the national government. Second, the pandemic accelerated the migration to digital payments. Even before the pandemic, some countries, like Sweden, were seeing a pronounced migration from cash to digital payments. To the extent that digital payments crowd out the use of cash, this raises questions about how to ensure that consumers retain access to a form of safe central bank money. In the United States, the pandemic led to an acceleration of the migration to digital payments as well as increased demand for cash. While the use of cash spiked at certain times, there was a pronounced shift by consumers and businesses to contactless transactions facilitated by electronic payments. The Federal Reserve remains committed to ensuring that the public has access to safe, reliable, and secure means of payment, including cash. As part of this commitment, we must explore--and try to anticipate--the extent to which households' and businesses' needs and preferences may migrate further to digital payments over time. Third, some foreign countries have chosen to develop and, in some cases, deploy their own CBDC. Although each country will decide whether to issue a CBDC based on its unique domestic conditions, the issuance of a CBDC in one jurisdiction, along with its prominent use in cross-border payments, could have significant effects across the globe. Given the potential for CBDCs to gain prominence in cross-border payments and the reserve currency role of the dollar, it is vital for the United States to be at the table in the development of cross-border standards. Finally, the pandemic underscored the importance of access to timely, safe, efficient, and affordable payments for all Americans and the high cost associated with being unbanked and underbanked. While the large majority of pandemic relief payments moved quickly via direct deposits to bank accounts, it took weeks to distribute relief payments in the form of prepaid debit cards and checks to households who did not have up-to-date bank account information with the Internal Revenue Service. The challenges of getting relief payments to these households highlighted the benefits of delivering payments more quickly, cheaply, and seamlessly through digital means. In any assessment of a CBDC, it is important to be clear about what benefits a CBDC would offer over and above current and emerging payments options, what costs and risks a CBDC might entail, and how it might affect broader policy objectives. I will briefly discuss several of the most prominent considerations. Preserve general access to safe central bank money Central bank money is important for payment systems because it represents a safe settlement asset, allowing users to exchange central bank liabilities without concern about liquidity and credit risk. Consumers and businesses don't generally consider whether the money they are using is a liability of the central bank, as with cash, or of a commercial bank, as with bank deposits. This is largely because the two are seamlessly interchangeable for most purposes owing to the provision of federal deposit insurance and banking supervision, which provide protection for consumers and businesses alike. It is not obvious that new forms of private money that reference fiat currency, like stablecoins, can carry the same level of protection as bank deposits or fiat currency. Although various federal and state laws establish protections for users, nonbank issuers of private money are not regulated to the same extent as banks, the value stored in these systems is not insured directly by the Federal Deposit Insurance Corporation, and consumers may be at risk that the issuer will not be able to honor its liabilities. New forms of private money may introduce counterparty risk into the payments system in new ways that could lead to consumer protection threats or, at large scale, broader financial stability risks. In contrast, a digital dollar would be a new type of central bank money issued in digital form for use by the general public. By introducing safe central bank money that is accessible to households and businesses in digital payments systems, a CBDC would reduce counterparty risk and the associated consumer protection and financial stability risks. Improve efficiency One expected benefit is that a CBDC would reduce or even eliminate operational and financial inefficiencies, or other frictions, in payments, clearing, and settlement. Today, the speed by which consumers and businesses can access the funds following a payment can vary significantly, up to a few days when relying on certain instruments, such as a check, to a few seconds in a real-time payments system. Advances in technology, including the use of distributed ledgers and smart contracts, may have the potential to fundamentally change the way in which payment activities are conducted and the roles of financial intermediaries and infrastructures. The introduction of a CBDC may provide an important foundation for beneficial innovation and competition in retail payments in the United States. Most immediately, we are taking a critical step to build a strong foundation with the introduction of the FedNow Service, a new instant payments infrastructure that is scheduled to go into production in two years. The FedNow Service will enable banks of every size and in every community across America to provide safe and efficient instant payment services around the clock, every day of the year. Through the banks using the service, consumers and businesses will be able to send and receive payments conveniently, such as on a mobile device, and recipients will have full access to funds immediately. Promote competition and diversity and lower transactions costs Today, the costs of certain retail payments transactions are high and not always transparent to end users. Competition among a diversity of payment providers and payment types has the potential to increase the choices available to businesses and consumers, reduce transactions costs, and foster innovation in end-user services, although it could also contribute to fragmentation of the current payments system. By providing access to a digital form of safe central bank money, a CBDC could provide an important foundation on which private-sector competition could flourish. Reduce cross-border frictions Cross-border payments, such as remittances, represent one of the most compelling use cases for digital currencies. The intermediation chains for cross-border payments are notoriously long, complex, costly, and opaque. Digitalization, along with a reduction in the number of intermediaries, holds considerable promise to reduce the cost, opacity, and time required for cross-border payments. While the introduction of CBDCs may be part of the solution, international collaboration on standard setting and protections against illicit activity will be required in order to achieve material improvements in cost, timeliness, and transparency. We are collaborating with international colleagues through the Bank for International stays abreast of developments related to CBDC abroad. We are engaging in several international efforts to improve the transparency, timeliness, and cost-effectiveness of cross-border payments. It will be important to be engaged at the outset on the development of any international standards that may apply to CBDCs, given the dollar's important role as a reserve currency. Complement currency and bank deposits A guiding principle for any payments innovation is that it should improve upon the existing payments system. Consumers have access to reliable money in the forms of private bank accounts and central bank issued currency, which form the underpinnings of the current retail payments system. The design of any CBDC should complement and not replace currency and bank accounts. Preserve financial stability and monetary policy transmission The introduction of a CBDC has the potential to have wide-reaching effects, and there are open questions about how CBDC could affect financial stability and monetary policy transmission. Some research indicates that the introduction of a CBDC might raise the risk of a flight out of deposits at weak banks in favor of CBDC holdings at moments of financial stress. Other research indicates that the increase in competition could result in more attractive terms on transactions accounts and an overall increase in banking system deposits. Banks play a critical role in credit intermediation and monetary policy transmission, as well as in payments. Thus, the design of any CBDC would need to include safeguards to protect against disintermediation of banks and to preserve monetary policy transmission more broadly. While it is critical to consider the ways in which a CBDC could introduce risks relative to the current payments system, it may increase resilience relative to a payments system where private money is prominent. Protect privacy and safeguard financial integrity The design of any CBDC would need to both safeguard the privacy of households' payments transactions and prevent and trace illicit activity to maintain the integrity of the financial system, which will require the digital verification of identities. There are a variety of approaches to safeguarding the privacy of payments transactions while also identifying and preventing illicit activity and verifying digital identities. Addressing these critical objectives will require working across government agencies to assign roles and responsibilities for preventing illicit transactions and clearly establishing how consumer financial data would be protected. Increase financial inclusion Today 5.4 percent of American households lack access to bank accounts and the associated payment options they offer, and a further 18.7 percent were underbanked as of 2017. The lack of access to bank accounts imposes high burdens on these households, whose financial resilience is often fragile. At the height of the pandemic, the challenges associated with getting relief payments to hard-to-reach households highlighted that it is important for all households to have transactions accounts. The Federal Reserve's proposals for strengthening the Community Reinvestment Act emphasize the value of banks providing cost-free, low-balance accounts and other banking services targeted to underbanked and unbanked communities. And a core goal of FedNow is to provide ubiquitous access to an instant payments system via depository institutions. CBDC may be one part of a broader solution to the challenge of achieving ubiquitous account access. Depending on the design, CBDC may have the ability to lower transaction . costs and increase access to digital payments. In emergencies, CBDC may offer a mechanism for the swift and direct transfer of funds, providing rapid relief to those most in need. A broader solution to financial inclusion would also need to address any perceived barriers to maintaining a transaction account, along with the need to maintain up-to-date records on active accounts to reach a large segment of the population. To explore these broader issues, the Federal Reserve is undertaking research on financial inclusion. The Federal Reserve Bank of Atlanta is launching a public-private sector collaboration as a Special Committee on Payments Inclusion to ensure that cash-based and vulnerable populations can safely access and benefit from digital payments. This work is complemented by a new Federal Reserve Bank of Cleveland initiative to explore the prospects for CBDC to increase financial inclusion. The initiative will identify CBDC design features and delivery approaches focused on expanding access to individuals who do not currently use traditional financial services. Multidisciplinary teams at the Federal Reserve are investigating the technological and policy issues associated with digital innovations in payments, clearing, and settlement, including the benefits and risks associated with a potential U.S. CBDC. For example, the TechLab group at the Federal Reserve Board is performing hands-on research and experimentation on potential future states of money, payments, and digital currencies. A second group, the Digital Innovations Policy program, is considering a broad range of policy issues associated with the rise of digital payments, including the potential benefits and risks associated with CBDC. To deepen our research on the technological design of a CBDC, the Federal Reserve Currency Initiative on Project Hamilton to build and test a hypothetical digital currency platform using leading edge technology design options. This work aims to research the feasibility of the core processing of a CBDC, while remaining agnostic about a range of policy decisions. MIT and the Boston Fed plan to release a white paper next quarter that will document the ability to meet goals on throughput of geographically dispersed transactions with core processing and create an open source license for the code. Subsequent work will explore how addressing additional requirements, including resiliency, privacy, and anti-money-laundering features, will impact core processing performance and design. Research and experimentation are also occurring at supervised banking institutions to explore new technology to enhance their own operations and in response to demands from their clients for services such as custody of digital assets. While distributed ledger technology may have the potential to improve efficiencies, increase competition, and lower costs, digital assets pose heightened risks such as those related to Bank Secrecy Act/anti-money laundering, cybersecurity, price volatility, privacy, and consumer compliance. The Federal Reserve is actively monitoring developments in this area, engaging with the industry and other regulators, and working to identify any regulatory, supervisory, and oversight framework gaps. Given that decisions at one banking agency can have implications for the other agencies, it is important that regulators work together to develop common approaches to ensure that banks are appropriately identifying, monitoring, and managing risks associated with digital assets. In light of the growing role of digital private money in the broader migration to digital payments, the potential use of foreign CBDCs in cross-border payments, and the importance of financial inclusion, the Federal Reserve is stepping up its research and public engagement on a digital version of the U.S. dollar. Members of Congress and executive agencies are similarly exploring this important issue. As noted above, to help inform these efforts, the Federal Reserve plans to issue a discussion paper to solicit public comment on a range of questions related to payments, financial inclusion, data privacy, and information security, with regard to a CBDC in The Federal Reserve remains committed to ensuring a safe, inclusive, efficient, and innovative payments system that works for all Americans.

r210526a_FOMC

united states

The Economic Outlook and Monetary Policy

quarles

Thank you, David, and thank you to Brookings and the Hutchins Center for the opportunity to lead things off and be part of this very distinguished panel. Today, I will explain why I expect the U.S. economy to continue growing strongly over the remainder of this year and what the implications of that outlook are for monetary policy. After the shutdowns and other measures taken in response to the COVID-19 outbreak last spring caused the swiftest and deepest recession in U.S. history, the economy has made a powerful recovery. Households and businesses adapted, supported by the flexibility and inherent strength of our market-based economy, by the continued resilience of our banking system, and by significant fiscal and monetary policy support. Highly accommodative monetary policy by the Federal Reserve has fostered strong growth in interest rate-sensitive sectors of the economy such as housing and durable goods, offsetting some of the historic weakness in the service sector last year. With the service sector reopening while other household and business spending remains strong, I expect rapid growth to continue for some time before slowing to a still robust pace next year. Inflation is running significantly above the Federal Reserve's longer-run goal of 2 percent primarily as a result of three factors: the surge in demand as more services come back on line while goods spending remains robust, the emergence of bottlenecks in some supply chains, and the very low inflation readings recorded last spring dropping out of the calculation of 12-month inflation. For reasons I will detail in a moment, I expect that a significant portion of that recent boost to inflation will be transitory, and that it will not interfere with the rapid growth driving progress toward the Fed's maximum- employment goal. We've come a long way since last spring, but reopenings over the past year have been uneven, so it will still be some time before we repair all the economic damage. Supply bottlenecks will likely hinder the quick expansion of production in some industries in the next few months and raise some costs--in some cases significantly. The progress in reopening has been slower in countries that are among our largest trading partners, weighing on U.S. growth by reducing demand for U.S. exports. But even with those impediments, I believe the strong recovery will keep rolling forward. Let me walk through the evidence for that optimistic view. First, I see increasing recognition by the private and public sectors that a broad reopening can proceed safely. dropped most social-distancing recommendations for vaccinated people. Although local COVID-19 restrictions on schooling and economic activity continue in some areas, most schools are teaching in person at least part time and more than half of states have dropped all capacity constraints on restaurants, bars, and retail establishments. More than a dozen more states are planning to do so over the coming weeks. With these reopenings, consumer spending, which is two-thirds of gross domestic product (GDP), will remain robust, supported by personal income that has, thanks to significant fiscal support, now surpassed the trend it was on before the COVID event. April's retail sales results were flat, but that came after enormous gains in March that were boosted by the latest round of stimulus checks. Looking beyond the headline numbers, sales were up 13 percent in March and 3 percent in April at restaurants and bars, one of the sectors hardest hit by the COVID-19 event. April and March were the third- and fourth-best months for vehicle sales to consumers in U.S. history, if you filter out sales to car rental companies, a sector just beginning to recover. You might expect this bounce will subside after consumption regains the strong trend it was on pre-COVID-19, but one reason I think it will continue is the still high rate at which people have been adding to their savings. Even as personal consumption expenditures rose at a huge 10 percent annual rate in the first quarter of 2021, the saving rate averaged 21 percent over those three months. Again, a lot of that reflected the most recent round of stimulus payments, but as employment grows and people return to normal life and work, the accumulated stock of savings will support spending for many months to come. Business investment took a big hit in the first half of 2020 but has come back strongly and is now running above pre-pandemic levels. Current indicators of business spending are pointing to continued elevated levels of investment in the months ahead. Supply bottlenecks have depleted inventories for many goods and rebuilding those inventories will be an important supplement for business spending and factory output. I see two potential headwinds for the economy: the uneven global recovery and the aforementioned supply bottlenecks. Strong U.S. demand is boosting imports, but weaker demand outside the United States, where recovery is slower, is restraining exports, and that problem may not resolve for some time. Supply bottlenecks are more prevalent now, especially in the auto and housing industries, with shortages of inputs leading to slower production that reduces employment growth. Although I expect employment to rise significantly in coming months, the picture is more mixed for the labor market than it is for spending. The unemployment rate remains at 6.1 percent, compared with 3.5 percent pre-COVID-19, and there are 8 million fewer jobs. Despite recent gains amid reopenings, employment in the travel, leisure, and food services sectors remains well below pre-pandemic levels. My optimism here reflects the apparent recovery in overall labor demand--by many metrics, job openings are above 2019 levels, including for workers without a college degree, a group especially affected last year. In the Job Openings and Labor Turnover Survey data for March, private-sector job openings as a percentage of total employment increased to 5.6 percent, which is above the previous record for that series set in November 2018. Job growth of 266,000 in April was a disappointing slowdown from recent months, but good news lurked beneath the headlines: For those who were working, average hours increased; the number of people working part time because they couldn't find full-time jobs decreased significantly; and wage growth was very strong. The underlying strength in hours and wages lends support to widespread reports that worker shortages are impeding hiring. Labor force participation remains about 3-1/2 million people lower than before COVID-19. Among the many factors driving this shortage, as indicated by the Federal Reserve's report is parents who need to care for their children because of remote school and aftercare. We have also seen a wave of retirements by older workers in the past year. And, although the evidence is mixed, we have received plenty of anecdotal reports about the influence of generous unemployment benefits and large cash payments on the willingness of workers to return to work. But those benefits are slated to expire over the summer, and I hope that a fuller reopening of schools in the fall will ease the pressure on parents. The spike in retirements may well moderate in a stronger economy, as we saw in the year or two before the pandemic. So, while labor shortages could weigh on job creation in coming months, I don't yet perceive this development as significantly slowing the U.S. economy beyond the next few months. Now let's turn to the other half of the Federal Reserve's economic goals, inflation. As I mentioned last week during congressional testimony, I agree with the and most private forecasters that the recent rise in inflation to well above 2 percent is driven by temporary factors. I expect inflation to begin subsiding at some point over the next several months and to be running close to 2 percent again at some point during 2022. Market-implied inflation expectations have risen only to the levels that prevailed in the early 2010s, after which inflation never ran consistently above 2 percent, and most survey measures are sending similar signals. Therefore, I consider these recent increases in inflation expectations a welcome development, reversing the large declines seen last spring and perhaps edging up in response to the message in the FOMC's new policy framework. That said, my optimistic outlook for growth and employment places me among those who see the risks to inflation over the medium term as weighted to the upside, relative to my baseline forecast. Broadly speaking, there are three reasons for this. First, there are wage pressures. A moment ago, I celebrated the upturn in wages in April, but it may be a sign that the torrid growth of the economy and labor supply shortages have begun pushing up wages faster than occurred with the moderate economic growth over much of the past decade. Wages are a large component of business costs that could pass through to prices more readily than increases in the cost of other inputs. It seems like a paradox that there could be labor supply problems and wage pressures at 6 percent unemployment, but it is also a fact. Some of this surprising outcome reflects temporarily lower labor force participation coming out of the enormous economic shock last spring, but some of the Fed's business contacts have said that shortages of skilled laborers--particularly in manufacturing, transportation, and construction--predated COVID-19 and are likely to persist. Another factor that I referred to earlier--fiscal policy--carries potential costs as well as obvious benefits. Even as the huge amount of stimulus money in people's pockets has been boosting income and spending in eye-popping ways, much of that stimulus was saved. A larger-than-expected or faster release of those accumulated savings while the economy is already growing rapidly could result in output exceeding potential output by more than it has in decades. It is reasonable to ask if the strength of spending stemming from this unprecedented fiscal stimulus will put significant upward pressure on inflation as households and businesses emerge further from the COVID event. But, at least to date, the latest round of stimulus seems to be supporting spending and growth without causing an inordinate rise in interest rates or inflation expectations. That outcome aligns with the advice of those in the economics profession who have produced research in recent years that leaves them much more comfortable with high deficits and debt, at least in countries with low interest rates, than they used to be. In 2006, when I was serving as Under Secretary of the Treasury, we were subject to harsh criticism for running a deficit of not quite $250 billion, with total debt held by the public at 35 percent of GDP. By contrast, in 2021, the deficit is currently projected to be $3.4 trillion, and total debt held by the public at the end of fiscal year 2020 was 100 percent of Further fiscal policy actions are, of course, the purview of the Congress and the Administration. History tells us that once the dreadnought of government spending gathers speed, it is difficult and slow to turn around. Surely the deficits being run to offset the COVID-related shocks have made it even more critical to address the sustainability of government debt in the years ahead. And, finally, recent monthly readings on import prices, producer prices, and consumer prices have all come in above consensus expectations. These upside surprises cannot be attributed to base effects. It is true that many of the factors driving the April consumer price index report and other inflation surprises continue to be supply bottlenecks, and it is reasonable to conclude that these will ease over time. But clearing some of those supply disruptions will require additional investment and the time to expand production capacity. If these shortages persist into 2022, people may adjust their expectations higher for future inflation, which could make above-target inflation more persistent than we currently expect. I don't want to overstate my concern--I am not worried about a return to the 1970s. We designed our new monetary policy framework for the very different world we live in now, which involves an equilibrium for the economy with slow workforce growth, lower potential growth, lower underlying inflation, and, therefore, lower interest rates. One of those differences is that the kinds of "wage-price spirals" that characterized inflation dynamics in the 1970s have not been present for a long time. It's quite possible that this situation now prevails because inflation is never high enough for long enough to enter decisionmaking in a material way. So, what are the implications for monetary policy? I am fully committed to the FOMC's new monetary policy framework and the two pieces of related guidance that we have put in place for asset purchases and the federal funds rate to implement that framework. The conditions required to change the pace of asset purchases and those required to increase the federal funds rate are sequential: The latter requires improvement in the economy that clears a much higher bar. Let me address each of those in turn. The guidance on asset purchases, introduced in December, commits us to increasing our holdings of securities at least at the current pace until substantial further progress has been made toward the Committee's maximum-employment and price- stability goals. My personal view is that the rise in inflation--even after discounting temporary factors--and inflation expectations since December will prove sufficient to satisfy the standard for inflation in the guidance around asset purchases later this year, but improvement in the labor market has been slower than I would have liked. For instance, the unemployment rate has decreased only 0.6 percentage points to 6.1 percent, and the labor force participation rate is still nearly the same as it was at the time of the December meeting. Therefore, we need to remain patient in the face of what seem to be transitory shocks to prices and wages so long as inflation expectations continue to fluctuate around levels that are consistent with our longer-run inflation goal. For me, it is a question of risk management. The best analysis we currently have is that the rise in inflation to well above our target will be temporary. But those of us on the FOMC are economists and lawyers, not prophets, seers and revelators. We could be wrong; and what happens then? Part of the calculus in balancing the risks of either overshooting or undershooting our 2 percent goal is that the Fed has the tools to address inflation that runs too high, while it is more difficult to raise inflation that falls below target. If we're wrong, we know how to bring inflation down. But if our assessment is correct that inflation is temporary, it would be unwise for us to take actions that might slow the recovery prematurely by trying to stay ahead of inflation, when our best estimate is that we are not far behind. If my expectations about economic growth, employment, and inflation over the coming months are borne out, however, and especially if they come in stronger than I expect, then, as noted in the minutes of the last FOMC meeting, it will become important for the FOMC to begin discussing our plans to adjust the pace of asset purchases at upcoming meetings. In particular, we may need additional public communications about the conditions that constitute substantial further progress since December toward our broad and inclusive definition of maximum employment. This standard presents inherent communications challenges because it cannot be summarized by a single labor market indicator, such as the unemployment rate thresholds used in the Committee's interest rate forward guidance between late 2012 and late 2013. In contrast, the time for discussing a change in the federal funds rate remains in the future. The guidance for the federal funds rate commits to maintain the current rate until labor market conditions are consistent with our goal of maximum employment and inflation not only has reached 2 percent, but also is on track to moderately exceed 2 percent for some time. In the FOMC's most recent Summary of Economic Projections, no participants--even those with optimistic growth forecasts such as I've outlined today--thought it appropriate that liftoff occur before 2022. Perhaps even more important than the timing of liftoff will be the expected trajectory of rate increases afterward, and you can see that even among participants with an earlier expected liftoff, those paths are quite shallow. Thus, I expect that monetary policy will remain highly accommodative for some time. Let me conclude with a few thoughts on financial stability. As the Fed's most recent notes, the bright outlook, ample supply of credit, and accommodative fiscal and monetary policy have pushed some asset valuations to very high levels that could be subject to sharp reversals if expectations are not met. Likewise, business debt is high relative to past experience, which is a good reason to carefully weigh the risks. But the strong economy reassures me here: Earnings are growing, many businesses have ample stockpiles of cash, expected bond defaults are below their long- run medians, and the pace of credit rating downgrades has slowed to a trickle. When I think about financial stability, I think most directly about resilience to shocks, and it would be hard to imagine a better test of that resilience than what occurred in the spring of 2020. Banks met extraordinary demands for credit last spring from nonfinancial businesses and households while simultaneously providing forbearance on millions of existing loans and building substantial loss reserves, all without significant strains to their overall health. The largest banks at the core of the financial system are better capitalized than they have been in decades, and these institutions are sitting on large amounts of highly liquid assets while relying on relatively low levels of short-term funding. The banking sector is strong. I also see a resilient household sector. Household credit is primarily owed by borrowers with prime credit scores, rising home prices have most homeowners flush with equity, and, as I noted earlier, households are sitting on a large stock of savings. It is true that there are structural vulnerabilities in the nonbank financial sector, particularly money funds and hedge funds, and these are being scrutinized by U.S. and international authorities, including the Financial Stability Board under my chairmanship. But I believe these risks are manageable, and I come down on the side of the research that concludes these and other concerns are best addressed by targeted financial regulation and supervision rather than the blunt tool of monetary policy. At a crucial moment in our recovery from the COVID-19 event, the utility of using monetary policy to try to address financial stability concerns would be greatly outweighed by the costs to employment and growth. Before ending, I'd like to reemphasize that I am quite optimistic about the path of the economy. While prices will run above our 2 percent target this year, I believe most of this increase will be transitory. After an exceedingly difficult year, we are poised to enter a robust and durable expansion. Thank you again for the invitation to be here today, and I look forward to our discussion.

r210601a_FOMC

united states

Remaining Steady as the Economy Reopens

brainard

It is a pleasure to join the Economic Club of New York for this discussion. Consumer demand is strong, vaccine coverage is expanding, and pandemic-affected sectors are reopening in fits and starts. As was the pandemic shutdown with its ebbs and flows, the reopening is without precedent, and it is generating supply-demand mismatches at the sectoral level that are temporary in nature. Separating signal from noise in the high-frequency data may be challenging for a stretch. The supply-demand mismatches at the sectoral level are making it difficult to precisely assess inflationary developments and the amount of resource slack from month to month. Looking through the noise, I expect we will see further progress in coming months, but the economy is far from our goals, and there are risks on both sides. The best way to achieve our maximum-employment and average-inflation goals is to be steady and transparent in our outcome-based approach to monetary policy while remaining attentive to the evolution of the data and prepared to adjust as needed. Last week's updated estimate of first-quarter real gross domestic product continued to show strong annualized growth of 6.4 percent. I expect a further acceleration in output growth driven by consumer demand during the current quarter as the reopening of the economy broadens. Looking through the month-to-month variation, the data suggest that very strong underlying spending growth is continuing this quarter, fueled by recent fiscal support and continued reopening. Real personal consumption expenditures (PCE) stepped down slightly in April after surging 4.1 percent month over month in March due to a strong spend-out that month of fiscal support from the American Rescue Plan. A similar pattern of moderation in April following outsized strength in March is also evident at the level of individual goods categories, including clothing and general merchandise, as well as spending at sporting goods, hobby, books, and music stores. Spending growth is strong in the pandemic-affected services sectors that are reopening, with spending at restaurants and bars increasing 3 percent in April after surging 13.5 percent in March. The shift in the spending data from March to April provides a useful reminder to exercise caution in extrapolating from individual data points in the current environment. Growth this year is expected to be the strongest in decades as the economy bounces back from the depressed level associated with the pandemic. The supplemental savings accumulated over the course of the pandemic from fiscal support and constrained services consumption hold the potential for a substantial amount of additional spending, but there is uncertainty about how much of it is likely to be spent out this year as opposed to being spent out more slowly over time. While the early spend-out from fiscal support in the first quarter of this year was exceptionally strong, whether that strength will be maintained depends in part on the distribution of the remaining additional savings. Spending could moderate, for instance, if the additional savings is concentrated among higher-income households that may have already completed many of their durable goods purchases and may return to pre- pandemic consumption of discretionary services rather than making up for the underconsumption during the shutdown. The timing of household consumption out of the accumulated savings will be very important for the strength of demand not just this year, but also next. Today's fiscal tailwinds are projected to shift to headwinds next year. So an important question is how much household spending will continue to support growth into next year as opposed to settling back to pre-pandemic trends, which would be an additional headwind relative to the strong makeup consumption we have seen so far this year. During the current reopening phase, the surge in demand is hitting some sectors before the supply side has had a chance to catch up. Many businesses shrank in order to survive the pandemic and now may be struggling or moving cautiously to expand capacity. These mismatches are exacerbated in some sectors by idiosyncratic supply disruptions, such as in semiconductors, steel, and lumber. Importantly, the reopening pains associated with mismatches between demand and supply in most sectors are temporary in nature and are likely to be resolved as pent-up demand moderates and businesses hire and expand. These temporary reopening mismatches are evident in recent data on both the employment and inflation sides of our mandate. The reopening dynamics are evident in the April inflation readings. I had been anticipating a notable move up in inflation beginning in April and lasting several months due to a combination of base effects and temporary reopening supply and demand mismatches. Core PCE inflation moved up to 3.1 percent on a 12-month basis in April, while 12-month total PCE inflation rose to 3.6 percent amid high energy prices. A significant portion of these 12-month readings reflect contributions from base effects that resulted from the pandemic-related price declines in March 2020 dropping out of the 12- month calculation. Core PCE inflation is estimated to be 2.4 percent in April after adjusting for base effects. Apart from base effects, the underlying factors driving the increase in inflation are consistent with my expectations that we would see temporary price increases associated with sectoral supply-demand imbalances, and that the timing and sectoral incidence of these increases would be difficult to predict. While the level of inflation in my near-term outlook has moved somewhat higher, my expectation for the contour of inflation moving back towards its underlying trend in the period beyond the reopening remains broadly unchanged. The increases in a few categories that were prominent contributors to the month- over-month April core PCE reading of 0.66 percent illustrate the role of temporary frictions associated with the economy's unprecedented reopening. Used vehicles, airfares, and accommodations together contributed nearly one-third of month-over-month core PCE inflation in April even though the cumulative weight of all three components in the core PCE basket is only 3 percent. The major contributors to the April core PCE inflation increase are not significant drivers of core inflation historically. The used vehicles category contributed just over 0.1 percentage point to the April core PCE reading. On the demand side, stimulus payments and low borrowing rates have given households additional capability to purchase vehicles, and the pandemic appears to have increased the relative value of private transportation. On the supply side, with the limited production of new cars due to the semiconductor shortage, rental car companies have become buyers in the used vehicles market in order to restore the capacity they had shuttered during the pandemic, whereas they would normally be net sellers in this market. As a result, used car prices, which had followed a slight downward trend in the years leading up to the pandemic, jumped a record 10 percent in April. While these pressures may persist over the summer months, I expect them to fade and likely reverse somewhat in subsequent quarters. Similarly, the travel-related accommodations and airfare sectors also contributed nearly 0.1 percentage point to month-over-month core PCE inflation. Prices in these categories are recovering from depressed values well below their pre-COVID levels. Prices are expected to continue to rise amid renewed summer travel, but the natural limitations to making up spending on foregone travel are likely to result in a normalization of demand growth after a few quarters, and the capacity in these sectors will likewise increase from their depressed pandemic levels as hiring proceeds. In assessing the risk that such transitory pricing pressures get embedded in persistently high inflation, it is critical to remember that inflation averaged less than 2 percent over the past quarter-century, and that statistical measures of trend inflation ran consistently below 2 percent for decades before the pandemic. Relative to the entrenched inflation dynamics that existed before the pandemic, the sharp temporary increases in some categories of goods and services seem unlikely to leave an imprint on longer-run inflation behavior. To be sure, I will keep a close watch on a range of indicators for any signs of an unwelcome change in longer-term inflation expectations. The measure of breakeven that the recent inflation data have not disturbed longer-run inflation expectations. Indeed, since the April consumer price index data were released, TIPS-based breakeven inflation compensation for the next five years, as well as those for the five-year, five-year-forward, have moved down, not up. The TIPS measures suggest that market participants are demanding less compensation for expected longer-term inflation than they were before the April inflation data were released, rather than more. Survey-based measures of inflation expectations are mixed. The most recent Survey of Professional Forecasters showed an increase in median PCE inflation expectations over the next five years from 2 percent to 2.2 percent, and a smaller increase for inflation expectations over the next 10 years, from 2 percent to 2.1 percent. to the market-based measures, this survey measure implies a slight decline in the forward inflation measure used to proxy for longer-term inflation expectations relative to medium-term expectations. In contrast, the median response in May to the University of Michigan Survey of Consumers regarding inflation over the next 5 to 10 years moved up to a level last reached in 2013. Expectations, which combines the most recent signals from both market- and survey- based indicators, edged up a few basis points, reaching the bottom end of its range of values before the 2014 decline. The inflation dynamics seen over the past few decades have led to inflation that is somewhat below target and relatively stable. Inflation dynamics have generally evolved very gradually. Longer-term inflation expectations have been well anchored, so when some developments have pushed inflation above or below target, the rise has not been embedded in the ongoing inflation rate. A temporary mismatch between the surge in demand and a fitful supply response at the sectoral level is also evident in recent employment data. While job openings are at the top of their range, the payroll data in April were surprisingly weak. In part, the weak payrolls reflected some sectors where supply chain disruptions are limiting production despite strong demand. While motor vehicle sales were robust through April, a semiconductor shortage has resulted in production limits and the idling of a number of These plant closings were evident in a decline of 27,000 jobs in the manufacturing of motor vehicles and parts in April, more than accounting for the 18,000 decline in manufacturing employment overall. Similarly, employment in construction was flat in April after increasing notably in March, as single-family housing starts dropped 13 percent over the month amid shortages of lumber that constrained contractors' activity. The lackluster 218,000 increase in private payrolls in April also reflects post- pandemic sectoral reallocation. Sectors that expanded employment substantially in response to COVID-related demand appear to be shedding jobs in preparation for a post- pandemic world, with delivery services jobs declining by 77,000 and grocery store jobs With the most recent Job Openings and Labor Turnover Survey data showing a record 8.1 million job openings at the end of March, it appears that labor supply is lagging behind labor demand in several sectors, in part reflecting ongoing concerns about the virus and caregiving responsibilities. At the time of the April survey, 2.8 million people reported being out of the labor force because of the pandemic, and only 23 percent of the 18-to-64-year-old population were fully vaccinated. The vaccinated fraction of the working-age population had increased to 40 percent by mid-May. Constraints related to schooling and childcare are ongoing, and these have disproportionately affected Black and Hispanic mothers and mothers in lower-income households. While it is now rare for a school district to be fully remote, recent estimates indicate that just over one-half of U.S. students are in school districts that continue to operate in a hybrid learning environment rather than fully in person. There is some debate about whether the supplemental funds provided by unemployment insurance (UI) benefits are leading workers to stay on the sidelines. high level of employment gains in the lowest-wage sector and the reduction in continued claims seem inconsistent with supplemental UI benefits playing a large role in the April employment report. The largest employment gains in the otherwise tepid April employment report were in the low-wage leisure and hospitality sector, where UI replacement rates are among the highest. In addition, between the March and April reference weeks, continued UI claims, inclusive of Pandemic Emergency Unemployment Compensation and Extended Benefits, fell by about 1.3 million--indicating that many workers returned to work despite previously receiving UI benefits. It is difficult to disentangle the effects of concerns about contracting the virus or caregiving responsibilities brought on by the pandemic from those of UI benefits. All of these factors are likely to diminish by autumn with the return to fully in-person school, continued progress on vaccinations, and the expiration of supplemental UI benefits in early September--or earlier, in many states. For all these reasons, the supply-demand mismatches in the labor market are likely to be temporary, and I expect to see further progress on employment in coming months. That said, today employment remains far from our goal. Jobs are down by over 8 million relative to their pre-pandemic level, and the shortfall is over 10 million jobs if we take into account the secular job growth that would have occurred over the past year in normal circumstances. As of April, the overall prime-age employment-to-population (EPOP) ratio is 76.9 percent, more than 3 percentage points below its pre-pandemic level. The shortfall in the prime-age EPOP ratio is around 5 percentage points for Black and Hispanic workers relative to their October 2019 peaks. Although continued vigilance is warranted, the inflation and employment data thus far appear to reflect a temporary misalignment of supply and demand that should fade over time as the demand surge normalizes, reopening is completed, and supply adapts to the post-pandemic new normal. Under our guidance, adjustments in the path of monetary policy are transparently tied to realized progress on our maximum-employment and 2 percent average-inflation goals. Jobs are down by between 8 and 10 million compared with the level we would have seen in the absence of the pandemic. And it will be important to see sustained progress on inflation given the preceding multiple year trend of inflation below 2 percent. While we are far from our goals, we are seeing welcome progress, and I expect to see further progress in coming months. I am attentive to the risks on both sides of this expected path. I will carefully monitor inflation and indicators of inflation expectations for any signs that longer-term inflation expectations are evolving in unwelcome ways. Should inflation move materially and persistently above 2 percent, we have the tools and experience to gently guide inflation back down to target, and no one should doubt our commitment to do so. Just as it is important to be attentive to upside risks, it is also important to be attentive to the risks of pulling back too soon. In the previous monetary policy framework, the customary preemptive tightening based on the outlook to head off concerns about future high inflation likely curtailed critical employment opportunities for many Americans and embedded persistently below-target inflation. The entrenched pre- pandemic combination of low equilibrium interest rates, low underlying trend inflation, and a flat Phillips curve is likely to reassert itself after reopening is complete. This type of environment creates asymmetric risks, since the lower bound constraint means that policy can respond more readily when inflation surprises to the upside than to the downside. Remaining steady in our outcomes-based approach during the transitory reopening surge will help ensure the economic momentum that will be needed as current tailwinds shift to headwinds is not curtailed by a premature tightening of financial conditions. The best way to achieve and sustain our maximum-employment and average- inflation goals is by remaining steady and clear in our approach while also being attentive to changing conditions.

r210603a_FOMC

united states

Jet Flight, Mail Bags, and Banking Regulation

quarles

As many of you know, I am speaking to you from Salt Lake City, which, among its myriad other virtues, was the home of one of the earliest passenger airlines--Western Air Express, which ran its first passenger flight in the spring of 1926: Eight hours in a Douglas M2 between Salt Lake City and Los Angeles, with one stop in Las Vegas for fuel. Two of the first passengers sat on the mail sacks in the back, and those early plane travelers were adventurers in other ways as well. That year there were 12 fatal commercial airplane crashes and that number rose to 59 a year by 1930. That's not total deaths--that's fatal crashes, with many people on each plane. Comparing hours flown and number of flights, that would be as if we had 7,000 fatal airplane crashes in a typical year today, with hundreds of thousands dead. But we did not have 7,000 fatal crashes last year. We had five in the entire world. The year before we had eight. Air travel is famously the safest way to get from point A to point B, as a result of decades of innovation in technology and operating processes. Importantly, however, even as the airline industry was improving safety, it was equally focused on improving efficiency--especially as we moved into the era of jet travel in the 1960s. The eight-hour trip between Salt Lake and Los Angeles now takes an hour and a half even counting all the nosing around on the ground (although an argument can be made that a typical coach seat may not be that much more comfortable than sitting on the mail bags). Yet average fuel burn has been falling every year since 1960 and continues at a strong pace--in the first decade of the 21st century, fuel efficiency on domestic flights increased by another 40 percent. The airlines recognized that the public has a strong interest in safety, but that it also has a strong interest in other values as well. A more efficient airline is easier on the environment, cheaper for the consumer, and a stronger contributor to the overall economy. And, obviously, these continuing improvements in operation have been achievable without any compromise in safety. I think you can see where I am going with this. In the aftermath of the Great Financial Crisis, the Federal Reserve, the international regulatory community, and the banking industry took action to radically improve the safety of the banking system: new capital and liquidity rules, new stress testing requirements, a new resolution framework. Together, these have greatly strengthened the safety of the financial system. Actual common equity capital ratios for large banks have roughly doubled since the crisis (and are at least six times as great as the pre-crisis But in implementing these safety requirements, we did not pay as close attention to efficiency. Yet the public interest in efficiency is also strong, so over the last four years we have comprehensively sought ways to improve the efficiency of the system while maintaining its safety--which is every bit as possible in the financial system as it has been for the airlines. While this has been a broad project, today I want to focus on four examples of measures that illustrate this phenomenon. These measures have enjoyed support across the political spectrum because they have brought measurable benefits to the American people. The first that I would cite is our broad work since 2018 on tailoring our bank regulatory framework. That year, a bipartisan majority in Congress passed the Economic Growth, Dodd-Frank Act and called on the banking agencies to further tailor regulation to better reflect the business models and activities of the different banking firms that we supervise. The legislation recognized that it is possible to keep the system just as safe while allowing the financial system more capacity to support the real economy and more flexibility in doing so. As I have said before, one of my goals as Vice Chair for Supervision has been to make our regulatory framework as simple, transparent, and efficient as possible. In particular, we must always ask whether the cost of regulation--whether in reduced economic growth or in increased frictions in the financial system--is outweighed by the benefits of the regulation. If we have a choice between two methods of equal effectiveness in achieving a goal, we should choose the one that is less burdensome for the system. This principle guided our activity in differentiating among firms based on their risk profile and applying tailored standards accordingly. In keeping with the intent of EGRRCPA, the Fed adopted a revised tailoring framework for the application of our enhanced standards to large firms. That framework rightly differentiates standards, including capital and liquidity requirements, based on the risk profile of an individual firm. Our previous framework relied heavily on a firm's total assets to determine the stringency of our regulatory requirements. However, the tailoring framework relies on a broader array of indicators--size, as well as measures of short-term wholesale funding, non-bank assets, off-balance sheet exposures, cross- jurisdictional activity--to better align our prudential standards with the risk of a firm. Under the tailoring framework, the most complex, systemically important firms are subject to the most stringent requirements, while less complex firms are subject to commensurately reduced requirements. This allows firms to focus resources more on their core lending function to support the real economy, which was certainly in evidence during the booming economy in the run-up to COVID. Our tailoring of regulation was not limited to just large banks. The banking agencies worked on a range of measures to better reflect the risk profile of smaller banking organizations. These include expanded eligibility for our small bank holding company policy statement, and an increased scope of banks eligible for longer examination cycles. Most prominently, we also adopted a simple measure of capital adequacy for qualifying community banks--the community bank leverage ratio. These measures also made our regulatory framework more efficient, tailoring the regulation of community banks to their risks. Another key change to improve the efficiency of our framework was the introduction of the stress capital buffer requirement, which integrated our stress testing and regulatory capital frameworks. The stress capital buffer requirement is a firm-specific capital requirement that is calibrated based on the results of the stress test and was designed to provide a through-the-cycle, unified approach to capital distribution restrictions. This change enhanced our framework by better differentiating between firms that posed the most systemic risk and other large banks. Additionally, this change contributed to simplifying our capital framework by reducing the number of capital requirements to which large banks are subject from 18 to 8 without reducing its resiliency--a material improvement in efficiency, and thus in the ability of banks to focus on service to customers rather than duplicative compliance In addition to tailoring regulation, we have tailored supervision. As an example, the so that it now encompasses all Category I firms, or U.S. GSIBs, and only those foreign banks with U.S. operations that would be identified for Category I standards if they were housed within a bank holding company. The adjustment resulted in certain foreign banks being moved out of the LISCC portfolio and into a separate supervisory portfolio with all other foreign banks along with domestic banks of similar sizes and risk profiles. The removal of these foreign banks from the LISCC portfolio reflects their significantly reduced risk profile and size in the United States--since 2008, the size of their 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 $360 billion, a reduction of more than 80 percent. As a result of these substantial changes, it has clearly become appropriate to supervise the present-day U.S. operations of these foreign banks alongside domestic and foreign banks with a similar risk profile in our Large and Foreign This means that these organizations will be horizontally assessed against other foreign banks. By grouping foreign banks together, this portfolio reassignment enhances the ability of supervisors to take into account, in a comprehensive fashion, of the structural features and specific risks associated with the cross-border character of foreign banking operations in the United States. It is obviously incorrect to say that this is "weaker" supervision: these banks are subject to the same capital and liquidity requirements that they were before and the supervisors in our LFBO portfolio are expert public servants. Indeed, this approach may be more effective in identifying risks unique to foreign banks. For example, the Archegos exposures in foreign banks outside the United States that resulted in recent losses outside the United States--losses that could not have been picked up by LISCC supervision--might have benefited from a supervisory structure that was more focused on foreign-bank-specific risks. The third example of a decision we have made to improve the ability of the banking system to provide support to a strong economy has been our treatment of the countercyclical capital buffer, or CCyB. Large banks are subject to a potential CCyB, which 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. There were many calls from outside the Fed for us to activate the CCyB in the years before the COVID event. It is clear now that those calls were mistaken. The Board's CCyB 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. Our policy has been to maintain a 0 percent CCyB when vulnerabilities are within the normal range and, when they rise to a level meaningfully above normal, to increase the CCyB to a level that compensates for the rising vulnerabilities. As you no doubt have noticed, we did not increase the CCyB in the strong economy before the COVID event. That is because we have a consistent, disciplined, and comprehensive framework that lays out the proper factors to evaluate when deciding to turn the CCyB on or off, and the framework did not suggest vulnerabilities were particularly high. That framework has guided our decisions over the past few years and provided clear and transparent guidance to the public. The Federal Reserve should only turn on the CCyB in times of significant irrational exuberance; for example, in the face of a self-reinforcing cycle of borrowing and asset prices of the kind we saw in 2004-06. Yet, in my view, our through-the-cycle capital levels--that is, our fixed capital requirements--in the United States have been set so high, that our CCyB is effectively already "on." As a result, existing capital requirements for banks in the United States were already at a high enough level to maintain financial stability. When capital levels are sufficiently high, it would needlessly reduce the ability of firms to provide credit to their customers to turn on an additional capital requirement like the CCyB. Indeed, as I said at the time, the problem under our framework would instead be finding ways to turn down the CCyB thus embedded in our through-the-cycle capital requirements when the system was hit by a shock. Although the Fed had no formal CCyB to release when the COVID event struck, the U.S. banking system played a major role in taking deposits from, and extending credit to, households and businesses in 2020, and we did indeed have to take temporary measures to "turn down" our implied CCYB through limited exemptions to some of our capital requirements. The U.S. banking system performed very well in the COVID event compared to other jurisdictions that did have a CCyB that they released. Finally, a fourth example: changes to the implementation of the Volcker rule that have had the effect of providing greater ability for banks to support dynamism and innovation through venture capital funds, including incentives for banks to make investments in low-income areas, benefitting different groups, including minority entrepreneurs. Over the past four years, the agencies responsible for implementing the Volcker rule have broadly simplified the rule's compliance requirements. We have adhered to the intent of the rule while providing greater clarity and certainty for permissible activities. In particular, the most recent revisions opened up opportunities for banks to invest in the communities they serve through a variety of fund structures without running afoul of the Volcker rule restrictions. Our clarification of the definition of "covered funds" in the Volcker rule has allowed banks to make a broader range of fund investments that support communities, with the confidence that they are permissible. In passing the Community Reinvestment Act, Congress found that regulated financial institutions have a continuing obligation to help meet the credit needs of their local communities, so it is eminently sensible that the Volcker rule regulations allow banks to meet these important obligations. Other changes finalized last year allow banks to make investments in rural business investment companies and qualified opportunity funds. Rural business investment companies promote economic development and job creation in rural areas, while qualified opportunity funds support long-term investments in economically distressed communities. Together, these changes have given greater certainty to banks about what is permissible and what is not under the Volcker rule--a clear efficiency gain--while also allowing them to make a broader range of investments that support innovative growth and benefit local communities. These are just a few examples of changes we have made over the last four years that have bettered the ability of the system to perform its function of providing credit to households and businesses. But have we been as successful as the airlines in making efficiency improvements while continuing to make the system safer? That proposition faced a significant test in the spring of 2020, with the arrival of COVID-19 and the severe effects that measures to contain it had on the economy and financial system. It allowed us to gauge not only the resilience of our regulatory framework but the effectiveness of our efforts over the last four years to ensure that our framework did not hamper banks' ability to perform their critical function to lend to households and businesses and serve as financial intermediaries. When the COVID event began last year, the magnitude of the economic and financial disruptions was staggering. Voluntary and mandated quarantines, lockdowns, and social distancing efforts hammered aggregate demand, caused unfathomably large job losses clustered in certain service sectors, and sharply increased uncertainty. Workplaces closed, travel was curtailed, and global supply chains were disrupted. Large sectors of the global economy, such as tourism and transportation, came to an abrupt stop. As concerns about the virus and measures to contain it spread, these effects grew. At the same time, certain critical financial markets seized up or ceased to function effectively. Short-term liquidity markets were strained as investors "dashed for cash," focusing on their own liquidity. The commercial paper market, where companies raise cash by issuing short-term debt, seized up to an extent similar to the fall of 2008. And as in the financial crisis, investors in certain prime and tax-exempt money market funds with immediate cash needs submitted redemption requests that resulted in significant outflows from these funds. Equity prices plunged and yields on corporate bonds widened significantly. Perhaps I can simply underscore the peril of the time by noting that the Treasury market--the lifeblood of the financial system--became highly dysfunctional, something that didn't even happen in 2008 or 2009. This was truly a massive global shock. As businesses closed and consumers stayed home, 22 million jobs were lost in scarcely two months. The unemployment rate soared from 3.5 percent in February 2020 to 14.8 percent in April 2020, well above the highest rates experienced in the United States since the Great In addition to the immediate and apparent impact of the COVID event, there was also tremendous uncertainty regarding the path of future government responses. Macroeconomic experts, both at the Federal Reserve, and elsewhere, constructed many different plausible scenarios for how the economy would fare, and this was reflected in scenario-writing related to stress tests. Our June 2020 stress tests included a sensitivity analysis, designed in April 2020, that used three alternative downside scenarios that spanned the wide range of projections made at that time by professional forecasters. Those scenarios included peak unemployment rates ranging from 16 percent to 19.5 percent and assumed no additional fiscal measures to support the economy. So how did the bank regulatory system do? By any measure, quite well. Entering the COVID event, the banking system was fortified by over 10 years of work to improve safety and soundness, both by regulators and by banks themselves. Higher levels of capital and liquidity, better risk management, and more robust systems enabled the banking system to absorb an unprecedented shock--while providing refuge from market instability, delivering essential public aid, and working constructively to support borrowers and communities. In short, the full set of post-2008 reforms--as refined and recalibrated by the work of the last four years--ensured that this time would truly be different than the last. With respect to capital, banks actually built capital during the COVID event, thanks to actions from regulators and their own voluntary actions, even despite setting aside close to $100 billion in loan loss reserves. The aggregate common equity tier 1 capital ratio for the banking system in the second half of 2020 materially exceeded its pre-COVID-event level. Capital ratios remain well above regulatory minimums for all firms. Banks also strengthened their liquidity positions during the COVID event, primarily due to an influx of deposits and their reinvestment in reserves. The share of bank liquid assets as a share of total assets far exceeds the pre-COVID- event metric. Banks also served as a source of strength to the economy. With respect to lending, businesses were able to draw on pre-existing credit lines to meet the massive demands for cash. Banks of all sizes also funded the bulk of the more than $795 billion in Paycheck Protection Program loans. According to our weekly data, commercial and industrial loans increased $715 billion between the week of February 26th and their peak on May 13th. For millions of struggling households, interest and principal payments on loans were delayed. In addition, through May 2021, more than $2.2 trillion of central bank reserves and roughly $3.7 trillion of deposits had been absorbed by banks. Overall, the regulatory framework for banks constructed after the financial crisis, with the refinements and recalibrations we have made over the last few years, has held up well. The banking system remained strong and resilient, and banks served as a source of strength to the economy, and our stress tests indicated this would have been the case even without the substantial fiscal assistance provided to the rest of the economy. We have already learned many new lessons regarding our financial system during this experience. One lesson in particular I wanted to highlight is that our rigorous, forward-looking capital framework, which includes the stress capital buffer, works very effectively. Beginning in the third quarter of 2020, we required large banks to resubmit their capital plans and restricted their capital distributions. Those restrictions are slated to end following this quarter if large banks perform well on the upcoming stress test. While it was sensible at the time, given that this was the first real world test of our system, for us to use the belt and suspenders approach of additional, temporary capital distribution restrictions, we now know that we can have particular confidence in the stress capital buffer framework, as it is informed by a real-time stress testing regime. In the future, having learned the lessons of this test, we will be able to rely on the automatic restrictions of our carefully developed framework when the stress test tells us the system will be resilient, rather than using ad hoc and roughly improvised limitations. We cannot say, however, that the entirety of the financial system performed well, even parts that were subject to reforms following the financial crisis. As I have mentioned previously, the run on prime money funds and commercial paper were particularly concerning, as they resembled the runs faced during the financial crisis, despite subsequent reforms to those markets. The government had to step in yet again to stem the outflows from the prime money funds to stabilize financial markets. Addressing the shortcomings we saw among non-banks continues to be a focus of both domestic policymakers and the international community, particularly under my chairmanship of the Financial Stability Board. We cannot afford to allow the same things to happen again. In the end, our banking system performed well over the challenges of the last year. U.S. banks remain in good condition. First-quarter data showed that aggregate capital ratios increased, and banks continued to maintain ample levels of liquidity. We must, of course, remain vigilant in safeguarding our banking system. New threats can, and will, emerge. In a few weeks, we will learn the results of our annual stress test and will publicly release an update on the health of large banks, evaluating their balance sheets against a quite severe hypothetical recession. The COVID event did, however, serve to reinforce that the safeguards we have built and maintained since the financial crisis have passed the strictest stress test of all.

r210623a_FOMC

united states

Building Economic Resilience in Communities

bowman

Thank you, Emily, and thank you to the Federal Reserve Bank of Cleveland for hosting this policy summit. I'd also like to thank the participants and attendees for taking part in these critical conversations. It's really a pleasure to be here with you to support the discussions of economic resiliency that will take place over the next several days. Considerations of what builds resilient communities are at the top of the list as we look back at the economic impact from the pandemic and look ahead, as we experience a recovery that we want to benefit everyone. I would also like to highlight that three of the sessions taking place over these next few days will provide an opportunity for all of you to convey your own perspectives on the economic recovery from the pandemic. We would like to hear directly from you about how you see the recovery progressing in your own communities, whether you see unique aspects to the way businesses and families in your communities experienced the downturn and ongoing recovery, and what opportunities or challenges you think may lie ahead as we all adjust to lasting changes in the economy following the pandemic. These discussions will be the first of several aimed at continuing the initiative that began in 2019 and was part of the Federal Reserve's broad review of its monetary policy framework. The initial purpose of was to interact in a public setting with members of the public and community groups to hear about issues relating to our dual-mandate goals of maximum employment and price stability. The insights gained from these conversations proved to be highly valuable. Even though our framework review concluded last year, we are continuing the initiative with a focus this year on the economic recovery from the pandemic. We expect these listening sessions will benefit the Federal Reserve's ongoing policymaking process, while also providing important insights from affected communities, and enhancing transparency and public accountability. With that in mind, let me briefly describe what I see as the current state of national economic conditions. As we continue to see progress toward the recovery, including the lifting of economic and social-distancing restrictions, the economy is growing at the fastest pace in decades. Economic output has likely surpassed its pre- pandemic peak, but even with this progress, there are over 10 million people still without jobs who are either actively looking for employment or have since left the labor force. Employment has been recovering rapidly in the sectors of the economy related to goods production and sales, but the services economy has been much slower to recover. Employment in the leisure and hospitality sectors is down by more than 3 million jobs since February of 2020. As the recovery in the labor market and spending on goods and services continues to gain momentum, we are seeing upward pressures on consumer prices. In recent months, inflation has risen to well over the Federal Reserve's longer-run goal of 2 percent. This rise has reflected, in part, the fact that inflation numbers at the onset of the pandemic were very low. As those low values drop out of the 12-month average of price changes, this measure of inflation has increased and will likely increase further. But there is more to the recent rise in inflation than just these measurement issues. The impressive upswing in economic activity has played an important role as it has led to a number of supply chain bottlenecks and put upward pressure on prices for many goods. These upward price pressures may ease as the bottlenecks are worked out, but it could take some time, and I will continue to monitor the situation closely and will adjust my outlook as needed. We know that economic downturns are hardest for lower-income people, those with less education, and some minority groups. I believe that government responses to the pandemic--the lockdowns, school closures, and economic restrictions on businesses--significantly widened differences by income, education, race, and gender, and those disparities have persisted during the recovery. For example, we know that those with a high school education or less were among the hardest hit in the downturn last spring, and I am concerned about those individuals falling behind. In 2020, 20 percent of prime-age adults with less than a bachelor's degree experienced a layoff, 8 percentage points higher than for those with at least a bachelor's degree. It seems that women, and especially minority women, have shouldered a larger share of adverse labor market impact because of limited child care options and the need to assist school-aged children with remote learning during the pandemic. The impact of COVID-19 has been especially hard for Black and Hispanic women in the workforce. Over 3.5 percent of Black and Hispanic women dropped out of the labor force altogether, compared with 1.7 percent of women overall. We also see divergent outcomes for small business owners across race and Asian-owned, nonemployer small businesses reported their financial conditions as poor, compared with 38 percent of Hispanic-, 36 percent of Black-, and 28 percent of White- owned firms. The Federal Open Market Committee views the maximum level of employment as a broad-based and inclusive goal. Thus, these gaps in employment and other measures of economic wellbeing can be interpreted to show that more progress is needed to reach maximum employment. The goal is to promote an economy in which all can contribute to and share in the benefits of economic growth. Community voices With the experiences of the pandemic fresh in our minds, an event like this policy summit offers insights and perspectives from a broad range of community voices about what is working on the ground. I find it especially rewarding and valuable to hear from groups like those attending this summit. Conversations with the leaders of community groups inform me and other Fed policymakers of community and consumer experiences in real time. Just last month, for example, the Board of Governors met with our Community Advisory Council (CAC). This council consists of a diverse group of experts and representatives of consumer and community development organizations and interests. In our conversation, they provided thoughtful insights about the recovery as it is evolving in communities across the country. Their perspectives touched on the disparities the pandemic has exacerbated and on the challenging road ahead. Perspectives on economic resilience In the time I have with you this morning, I'd like to offer my perspective on economic resilience. I often find striking similarities between urban and rural communities, just as the upcoming panel on the "common ground in urban and rural America" will explore. When it comes to building economic resilience, there are a few key elements that facilitate a quicker recovery across different kinds of communities after challenging times. There are a wide range of topics on this conference's agenda, from broadband access to workforce development to affordable housing to small business development--I will focus on just a few of these. One key element to community resiliency is the engagement of local financial institutions in providing access to credit and supporting small businesses with funding and technical assistance. As a former community banker, I know that few understand their communities better because they live in the local economy and can step in to lend in a targeted way to those best prepared to benefit. During the pandemic, community bankers and other lenders such as community development financial institutions (CDFIs) were the key to making sure that healthy businesses temporarily hurt by lockdowns, economic restrictions, and social distancing were able to access the multiple rounds of In other ways, community banks once again showed how irreplaceable they were in responding to the needs of consumers and small business clients. While I have heard from community groups that small businesses struggled to navigate the PPP application process, especially those that did not have a preexisting banking relationship, community banks and CDFIs made a concerted effort to meet small business needs. The 2021 Small Business Credit Survey results showed that small banks were the most common source for PPP loans among employer firms, and applicants leveraging assistance from smaller banks were the most successful in obtaining all of the PPP funding they applied for. Additionally, I heard from the CAC last month that CDFIs were also effective in lending to smaller borrowers with limited or no financial institution relationships. An environment that supports resilient small businesses means more jobs and economic growth in local communities--both urban and rural. In the past 10 years, small businesses created over 10 million net new jobs, or about two-thirds of net new job creation, overall. In rural counties, 65 percent of the total jobs, which is a significant majority, were provided through employment in a small business. Creating and encouraging an environment that supports small business growth and entrepreneurship is a vital component of economic vitality and advancing a more broad-based recovery. This is exactly the type of environment that the Federal Reserve has been working to encourage with accommodative financial conditions promoting the flow of credit to households and small businesses. And finally, as all of us are acutely aware after more than a year of pandemic- related shutdowns, broadband access has become even more of an essential utility. It's something that families need for children attending virtual school online, for expanding work opportunities, and for remotely accessing goods and services. This essential service is often unavailable or considered a luxury in many rural and lower-income urban communities. Data from the Census Bureau show that only about 65 percent of households in both rural and lower-income counties pay to have a subscription to internet services, compared with the national average of about 80 percent. A report from the Federal Reserve Bank of Philadelphia also found income- and race-related gaps in both broadband availability and adoption rates across neighborhoods in Philadelphia. Internet access has become necessary for those looking for a job, and, not surprisingly, the unemployment rate for those without a computer connected to the internet was about 3 percentage points higher than the unemployment rate for those with a computer with internet access . Investing in the infrastructure to increase broadband availability and to support broadband adoption in these communities could help close the employment gaps. Additionally, it can help level the playing field for children attending school, open opportunities for adults to pursue more stable and better-paying jobs and online education, and also enable access to online banking and other internet-based financial services. In summary, it seems clear that much progress remains to be made in these areas. The Federal Reserve is committed to supporting the economic recovery and will do so through our monetary policy tools, supervisory responsibilities, and community development function . I'm looking forward to seeing how the opportunities from your collaborations and the creative solutions arising from this summit will help support vulnerable communities in adapting to and recovering from economic shocks. Through this approach, and with partnerships among practitioners like those here today, we can ensure that those who experienced the greatest effects from the pandemic are included in the economic recovery. Thank you again for this opportunity to be here today, and I wish you a productive and successful conference.

r210628a_FOMC

united states

Parachute Pants and Central Bank Money

quarles

I have been reflecting recently, and in connection with this speech, on America's centuries-long enthusiasm for novelty. In the main, it has served us and the world well, by making America the home of so many of the scientific and practical innovations that have transformed life in the 21 century from that of the 19 . But, especially when coupled with an equally American susceptibility to boosterism and the fear of missing out, it has also sometimes led to a mass suspension of our critical thinking and to occasionally impetuous, deluded crazes or fads. Sometimes the consequences are in hindsight merely puzzling or embarrassing, like that year in the 1980s when millions of Americans suddenly started wearing parachute pants. But the consequences can also be more serious. Which brings us to my topic today: central bank digital currencies, or CBDCs. In recent months, public interest in a "digital dollar" has reached fever pitch. A wide range of experts and commenters have suggested that the Federal Reserve should issue--and in fact may need to issue--a CBDC. But before we get carried away with the novelty, I think we need to subject the promises of a CBDC to a careful critical analysis. In offering my views on this and other issues related to CBDCs, I am speaking for myself as a member of the Board of Governors, and not for the Board itself or any other Fed policymakers. And, indeed, you will all have seen Chair Powell's recent announcement that we are preparing a comprehensive discussion paper on this issue that will be the first step in a thorough public process to conduct just this sort of critical analysis, which I do not want to prejudge. But I do want to give some sense of the issues I think we will need to grapple with in this process, how I will be thinking about them, and the high bar that I think any proposal to create a U.S. CBDC must clear. So, let's begin with a basic question: what problem would a CBDC solve? To answer, we first need to define the term CBDC and assess the current state of the U.S. payment system. The Bank for International Settlements has defined a CBDC as "a digital payment instrument, denominated in the national unit of account, that is a direct liability of the central bank." My first observation is that the general public already transacts mostly in digital dollars--by sending and receiving electronic balances in our commercial bank accounts. These digital dollars are not a CBDC, because they are liabilities of commercial banks rather than the Federal Reserve. Importantly, however, digital dollars at commercial banks are federally insured up to $250,000, which means that for deposits up to that amount--which means for essentially all retail deposits in the United States--they are as sound as a central bank liability. The Federal Reserve also provides digital dollars directly to commercial banks and certain other financial institutions. Federal law allows these financial institutions to maintain accounts with--and receive payments services from--the Federal Reserve. Balances in Federal Reserve accounts serve a vital financial stability function by providing a safe and liquid settlement asset for the U.S. economy. To summarize then, the dollar is already highly digitized. The Federal Reserve provides a digital dollar to commercial banks, and commercial banks provide digital dollars and other financial services to consumers and businesses. This arrangement serves the nation and the economy well: the Federal Reserve functions in the public interest by promoting the health of the U.S. economy and the stability of the broader financial system, while commercial banks compete to attract and effectively serve customers. So, given the existing digitization of the U.S. dollar, how would a CBDC differ from the digital dollars we use today? The key distinction is that, when most commentators speculate about a Federal Reserve CBDC, they assume that it would be available to the general public directly from the central bank. A CBDC of this nature could take different forms. One is an account-based model, in which the Federal Reserve would provide individual accounts directly to the general public. Like the accounts that the Federal Reserve currently provides to financial institutions, an accountholder would send and receive funds by debit or credit to their Federal Reserve account. A different CBDC model could involve a CBDC that is not maintained in Federal Reserve accounts. This form of CBDC would be closer to a digital equivalent of cash. Like cash, it would represent a claim against the Federal Reserve, but it could potentially be transferred from person to person (like a banknote) or through intermediaries. I am skeptical that the Federal Reserve has legal authority to pursue either of these CBDC models without legislation. Nevertheless, the recent clamor over CBDCs makes it appropriate to explore the benefits, costs, and practicalities of implementing one in the United States if such legislative authority were granted. Let's start with a look at the current U.S. payment system that a Fed CBDC would fit into. The Federal Reserve and private-sector interbank payment services already offer an array of options that facilitate efficient, electronic U.S. dollar payments. A few statistics related to the main large-value payment systems for U.S. dollars are illustrative. processes nearly $4 trillion in payments every day . These payments settle instantly in a operates a large-value payment system that settles nearly $2 trillion in payments every day. These payments do not settle in Federal Reserve accounts, but they are underpinned by balances on the books of a Federal Reserve Bank. Smaller-value payments often settle more slowly than large-value payments, but a variety of efforts to speed up settlement have been completed or are underway. For example, The Clearing House has developed an instant payments service that focuses on smaller-value payments. Similarly, the automated clearinghouse (or ACH) network--a batch-based payment network that first developed in the long-ago 20 century--now enables same-day settlement of ACH payments. And the Federal Reserve is developing an instant payment service--FedNow(sm)--that will soon provide recipients of small-value payments with immediate access to their funds in commercial bank accounts. The payment system is not perfect--some types of payments should move more quickly and efficiently. Payments across international borders, for example, remain a key area of concern because they often involve high costs, low speed, and insufficient transparency. The Financial Stability Board, an international group that I chair, produced a roadmap last year that is intended to address these concerns. Additionally, private- sector stablecoins (which I will discuss in more detail in a moment) may facilitate faster and cheaper cross-border payments. In addition, some types of payments have not fully digitized or are subject to ongoing contention between businesses with competing economic interests. For example, paper checks remain widely used for certain types of payments (although the interbank check collection process is now almost entirely electronic). Debit and credit card payments offer a convenient digital platform for consumers and retailers, but there has been considerable controversy between banks and retailers over who will capture the economics surrounding the fees associated with card transactions. Finally, many more Americans could benefit from digital payments by increasing their use of banking services, which can be promoted by wider use of low-cost, basic bank accounts. In summary, the U.S. payment system is very good, and although it is not perfect, work is already underway to significantly improve it. Yet, proponents of a Federal Reserve CBDC believe that it would solve a number of significant problems. They suggest, for example, that a Federal Reserve CBDC may be necessary to defend the critical role the U.S. dollar plays in the global economy. Others say that a CBDC would overcome longstanding economic inequalities in American society. As we begin our Fed analysis of these issues, I will have to be convinced that a CBDC is a particularly good tool to address either of these issues, about which I am skeptical, and I will especially have to be convinced that the potential benefits of developing a Federal Reserve CBDC outweigh the potential risks. Let's examine some of the arguments raised by CBDC supporters. The first argument is that the Federal Reserve should develop a CBDC to defend the U.S. dollar against threats that would be posed by foreign CBDCs, on the one hand, and the continued spread of private digital currencies, on the other. Taking the threat from foreign CBDC's first, this argument presumes that at least some foreign currencies--all of which are already highly digitized in our current international banking system in the same way the dollar is and yet which do not pose a significant challenge to the international role of the dollar--will suddenly pose a much greater challenge to the dollar if that digitization is accomplished through a direct central bank digital currency instead of through the current digital payments system. In this view, the U.S. dollar will lose its place in the global economy if the Federal Reserve does not offer a similar product. I think it's inevitable that, as the global economy and financial system continue to evolve, some foreign currencies (including some foreign CBDCs) will be used more in international transactions than they currently are. It seems unlikely, however, that the dollar's status as a global reserve currency, or the dollar's role as the dominant currency in international financial transactions, will be threatened by a foreign CBDC. The dollar's role in the global economy rests on a number of foundations, including the strength and size of the U.S. economy; extensive trade linkages between the United States and the rest of the world; deep financial markets, including for U.S. Treasury securities; the stable value of the dollar over time; the ease of converting U.S. dollars into foreign currencies; the rule of law and strong property rights in the United States; and last but not least, credible U.S. monetary policy. None of these are likely to be threatened by a foreign currency, and certainly not because that foreign currency is a CBDC. CBDC supporters also suggest that private digital currencies pose a threat to the U.S. dollar. Private digital currencies come in multiple flavors, but for this purpose I will divide them into two categories: stablecoins and non-stablecoins, or cryptoassets, such as bitcoin. Let's begin with stablecoins. The value of a stablecoin is tied to one or more other assets, such as a sovereign currency. There are multiple existing and potential stablecoins that are or would be tied in value to the U.S. dollar. Some commentators argue that the United States must develop a CBDC to compete with U.S. dollar stablecoins. Stablecoins are an important development that raise difficult questions. For example, how would widespread adoption of stablecoins affect monetary policy or financial stability? How might stablecoins affect the commercial banking system? Do stablecoins represent a fundamental threat to the government's role in money creation? In my judgment, we do not need to fear stablecoins. The Federal Reserve has traditionally supported responsible private-sector innovation. Consistent with this tradition, I believe that we must take strong account of the potential benefits of stablecoins, including the possibility that a U.S. dollar stablecoin might support the role of the dollar in the global economy. For example, a global U.S. dollar stablecoin network could encourage use of the dollar by making cross-border payments faster and cheaper, and it potentially could be deployed much faster and with fewer downsides than a CBDC. And the concern that stablecoins represent the unprecedented creation of private money and thus challenge our monetary sovereignty is puzzling, given that our existing system involves--indeed depends on--private firms creating money every day. We do have a legitimate and strong regulatory interest in how stablecoins are constructed and managed, particularly with respect to financial stability concerns: the pool of assets that acts as the anchor for a stablecoin's value could--if use of the stablecoin became widespread enough--create stability risk if it is invested in multiple currency denominations; if it is a fractional rather than full reserve; if the stablecoin holder does not have a clear claim on the underlying asset; or if the pool is invested in instruments other than the most liquid possible, principally central bank reserves and short-term sovereign bonds. All of these factors create "run risk" --the possibility that some triggering event could cause a large number of stablecoin holders to exchange their coins all at once for other assets and that the stablecoin system would not be able to meet such demands while maintaining a reasonably stable value. But these concerns are eminently addressable--indeed, some stablecoins have already been structured to address them. When our concerns have been addressed, we should be saying yes to these products, rather than straining to find ways to say no. Indeed, the combination of imminent improvements in the existing payments system such as various instant payments initiatives combined with the cross-border efficiency of properly structured stablecoins could well make superfluous any effort to develop a CBDC. In contrast to stablecoins, cryptoassets like bitcoin are not tied to the value of an asset like a sovereign currency. Rather, they seek to create value in the coin through other means, usually some intrinsic mechanism to ensure scarcity, like bitcoin's mining process, or some characteristic of the coin that cannot be matched by the traditional payment system, such as inviolable anonymity. Some commentators assert that the United States must develop a CBDC to counter the appeal of cryptocurrencies. This seems mistaken. The mechanisms used to create such cryptoassets' value also ensure that this value will be highly volatile--rather similar to the fluctuating value of gold, which, like bitcoin, draws a significant part of its value from its scarcity, and like bitcoin, does not play a significant role in today's payments or monetary system. Unlike gold, however, which has industrial uses and aesthetic attributes quite apart from its vestigial financial role, bitcoin's principal additional attractions are its novelty and its anonymity. The anonymity will make it appropriately the target for increasingly comprehensive scrutiny from law enforcement and the novelty is a rapidly wasting asset. Gold will always glitter, but novelty, by definition, fades. Bitcoin and its ilk will, accordingly, almost certainly remain a risky and speculative investment rather than a revolutionary means of payment, and they are therefore highly unlikely to affect the role of the U.S. dollar or require a response with a CBDC. A second broad argument raised by proponents of CBDCs is that a Federal Reserve CBDC would improve access to digital payments for people who currently do not keep bank accounts because of their expense, a lack of trust in banks, or other reasons. This is a worthwhile goal. However, I believe we can promote financial inclusion more efficiently by taking steps to make cheap, basic commercial bank accounts more available to people for whom the current cost is burdensome, such as the Bank On accounts developed in collaboration between the Cities for Financial Empowerment Fund and many local coalitions. Between 2011 and 2019, the percentage of households that are unbanked dropped from 8.2 percent to an estimated 5.4 percent. Banks and regulators are working to shrink this percentage further still. I am far from convinced that a CBDC is the best, or even an effective, method to increase financial inclusion. Last, some believe that a Federal Reserve CBDC would spur and facilitate private-sector innovation. This is an interesting issue that merits further study. I am puzzled, however, as to how a Federal Reserve CBDC could promote innovation in a way that a private-sector stablecoin or other new payment mechanism could not. It seems to me that there has been considerable private-sector innovation in the payments industry without a CBDC, and it is conceivable that a Fed CBDC, or even plans for one, might deter private-sector innovation by effectively "occupying the field." In brief, the potential benefits of a Federal Reserve CBDC are unclear. Conversely, a Federal Reserve CBDC could pose significant and concrete risks. First, a Federal Reserve CBDC could create considerable challenges for the structure of our banking system, which currently relies on deposits to support the credit needs of households and businesses. An arrangement where the Federal Reserve replaces commercial banks as the dominant provider of money to the general public could constrict the availability of credit, fundamentally alter the economy, and expose the public to a host of unanticipated, and undesirable, consequences. Among other potential problems, a dominant CBDC could undermine the consumer and other economic benefits that accrue when commercial banks compete to attract customers. A Federal Reserve CBDC could also present an appealing target for cyberattacks and other security threats. Bad actors might try to steal CBDC, compromise the CBDC network, or target non-public information about holders of CBDC. The architecture of a Federal Reserve CBDC would need to be extremely resistant to such threats--and would need to remain resistant as bad actors employ ever-more sophisticated methods and tactics. Designing appropriate defenses for CBDC could be particularly difficult because, compared to the Federal Reserve's existing payment systems, there could be far more entry points to a CBDC network--depending on design choices, anyone in the world could potentially access the network. Critically, we also would need to ensure that a CBDC does not facilitate illicit activity. The Bank Secrecy Act currently requires that commercial banks take steps to guard against money laundering. Policymakers will need to consider whether a similar anti-money-laundering regime would be feasible for a Federal Reserve CBDC, but it may be challenging to design a CBDC that respects individuals' privacy while appropriately minimizing the risk of money laundering. At one extreme, we could design a CBDC that would require CBDC holders to provide the Federal Reserve detailed information about themselves and their transactions; this approach would minimize money-laundering risks but would raise significant privacy concerns. At the other extreme, we could design a CBDC that would allow parties to transact on a fully anonymized basis; this approach would address privacy concerns but would raise significant money-laundering risks. A final risk is that developing a Federal Reserve CBDC could be expensive and difficult for the Federal Reserve to manage. A Federal Reserve CBDC could, in essence, set up the Federal Reserve as a retail bank to the general public. That would mean introducing large-scale, resource-intensive central bank infrastructure. We will need to consider whether the potential use cases for a CBDC justify such costs and expansion of the Federal Reserve's responsibilities into unfamiliar activities, together with the risk of politicization of the Fed's mandate that would come with such an expansion. To conclude, I emphasize three points. First, the U.S. dollar payment system is very good, and it is getting better. Second, the potential benefits of a Federal Reserve CBDC are unclear. Third, developing a CBDC could, I believe, pose considerable risks. So, our work is cut out for us as we proceed to rigorously evaluate the case for developing a Federal Reserve CBDC. Even if other central banks issue successful CBDCs, we cannot assume that the Federal Reserve should issue a CBDC. The process that Chair Powell recently announced is a genuinely open process without a foregone conclusion, although obviously I think the bar to establishing a U.S. CBDC is a high one. The upcoming discussion paper that constitutes the first step in this process will importantly ask for input from the public. I look forward to reviewing public input on the discussion paper, which will inform the Federal Reserve's ultimate evaluation of a potential CBDC.

r210711a_FOMC

united states

Disclosures and Data: Building Strong Foundations for Addressing Climate-Related Financial Risks

quarles

Thank you for inviting me today. It is an honor to be here and, after more than a year of remote conversations, it is truly wonderful to see so many people in person. with the FSB membership on the most pressing issues affecting financial stability. those issues, one of increasing focus is understanding and monitoring climate-related financial risks. Given the global nature of climate change, this demands a coordinated international effort. The FSB published last Wednesday a Climate Roadmap that presents a comprehensive and coordinated plan to address climate-related financial risks. The FSB's roadmap dovetails broader sustainable finance roadmap. Today, in my role as Chair of the FSB, I would like to focus on the two foundational components of the FSB roadmap: disclosures and data. Globally consistent, comparable, and reliable disclosures, as well as a broader set of high-quality, relevant data, together, can provide the basis to assess climate-related financial risks and the impact on financial stability. The FSB was an early leader in bringing attention to the importance of reliable, entity- level disclosures to assess and manage climate-related financial risks and opportunities. In 2015, the FSB submitted a proposal to the G20 to create an industry-led disclosure task force on climate-related risks. Disclosures, or TCFD, has led to greater recognition of the importance of climate-related financial risk and of comparable and reliable disclosure. The early development of industry-led recommendations and a usable framework by users and producers of this information was critical. The four core elements of the TCFD recommendations have provided a widely accepted framework for disclosures--covering governance, strategy, risk management, and metrics and targets. The task force has continued to provide significant support to those seeking to disclose and has encouraged steadily increasing uptake. These initial steps greatly helped to define appropriate parameters, drive towards consistency, and give the public sector a running start in developing their own approaches. Now it is time to build on that work. It will be useful to establish a globally consistent baseline standard for climate-related disclosures. Globally consistent and comparable entity- level disclosures by non-financial companies, banks, insurers, and asset managers are increasingly important to market participants and financial authorities as a means of providing information needed to assess and manage risks. The G20 Presidency, in developing its 2021 work program, asked the FSB to encourage more consistency in disclosure practices. As a start, the FSB surveyed what financial authorities across our membership were doing to promote disclosures. Almost all our members have already set requirements, guidance, or expectations or plan to do so. We found some heterogeneity in the approaches they were taking. Some members prefer mandated disclosure while others would make it voluntary. There is also variation in the desired scope of disclosures. However, there is a trend towards an important baseline that focuses on one-way materiality--or the financial risk that climate change could have on a particular entity--based on the TCFD recommendations. The majority of our membership are already using the TCFD recommendations as a baseline for their own requirements or guidance. other international organizations, will develop a set of standards, starting initially with climate and building upon these TCFD recommendations. As reflected in our December 2020 statement, the FSB supports IFRS's advancement of an International Sustainability Standards Board to take this work quickly forward. This work holds the promise of providing baseline standards that could inform or be built upon by national authorities as they develop their approaches to climate- related financial disclosure or broader sustainability disclosure. The initial focus of the IFRS will be on climate standards, while allowing for interoperability with individual jurisdictions' frameworks, that may go beyond climate-related impacts. Consistency in one-way disclosures would provide a needed avenue for accurate and appropriate risk assessment and comparability to assess investment decisions. Simultaneously, the IFRS standards are intended to provide flexibility for national authorities to build on the baseline. The "interoperability" feature will allow jurisdictions to address broader or jurisdiction-specific concerns in a manner consistent with their legal and regulatory frameworks, and indeed to go further in scope or faster if they wish. Given the importance of this work, we encourage the IFRS to press forward as quickly as possible. In the interim, the FSB continues to encourage jurisdictions that are implementing frameworks to base them on the TCFD recommendations to avoid unnecessary fragmentation. The need for high quality, reliable data doesn't stop at firms' disclosures, however. International initiatives are needed to improve data quality and address data gaps, and ultimately to establish a basis of comprehensive, consistent, and comparable data for global monitoring and assessing climate-related financial risks. We published a separate report on this topic last week. Our data needs include data on the underlying drivers of physical and transition risk and financial institutions' exposures. The challenges here are considerable. To understand the financial risks, better information is needed on the underlying physical risks, including the sorts of extreme weather events that pose greatest risks to the balance sheets of households, firms, and financial institutions. Comparable data is also needed on the nature of jurisdictions' climate- change targets and progress in meeting them. All this information needs to be related to financial risks--including financial institutions' exposures to non-financial counterparties. This is not an easy task. The current lack of usable data is a reflection of difficulties in transforming existing information on the drivers of climate risk into reliable metrics that quantify financial risks. The key here is to find metrics that are forward-looking, recognizing that the nature and magnitude of future climate-related risks may differ from those in the past. Improved financial risk data can also help achieve the financial stability mandates of financial authorities. For example, the FSB is exploring how to assess the degree to which climate-related risks might be transferred or amplified by different financial sectors, including the interdependence of banks and insurance firms. Climate-related risks vary across jurisdictions, and we need to look at how risks might be amplified by feedback loops with the real economy. Such analysis will contribute to a more comprehensive and global understanding of how to assess climate change and potential effects on the financial system, but those efforts are hampered by a variety of data limitations. The FSB is working with international bodies, such as the International Monetary Fund, and other international groupings, such as the Network for Greening the Financial System (NGFS), to assess climate data gaps and to identify steps to address them, with a special emphasis on ensuring cross-sectoral and international consistency. For example, the FSB plans to coordinate work with the NGFS on the issues surrounding scenario analyses, which some jurisdictions are using or contemplating, and the financial metrics that would be useful for such an analysis, both at the level of the firm and the overall system. Examining scenario analysis presents many challenges: A very long time horizon--which requires dynamic balance-sheet analysis--and the need to capture the interplay between the macro-economy and drivers of climate-related risks are two such challenges that would need to be overcome. Today, the FSB is well-positioned to lead in the next phases of the work required to assess and address climate-related financial risk. The FSB's mandate, its diverse membership, and its connection to the G20 make it the ideal forum to forge a consensus on the appropriate path forward. The FSB, as laid out in its roadmap, has taken on a critical role in coordinating and carrying forward work that will make the global financial system more resilient to the threats posed by climate change. The roadmap establishes a strategic vision for addressing climate- related financial risks, which sets out how we will coordinate with other standard-setting bodies and international organizations in order to progress towards our goal. Our Climate Roadmap leverages the FSB's strength as a coordinating body, provides some structure to the vast amount of work on climate-related financial risks currently going on internationally, and clarifies interdependencies between workstreams and between issues. The Climate Roadmap sets the course and promotes consistency through, among other things, building consensus around common principles, best practices, and cross-jurisdictional alignment. These include the two broad objectives that I have focused on today--establishing consistent, comparable, and reliable information through a global baseline standard for disclosures and through improving the availability and quality of data. The roadmap also includes work on analytical tools and policy approaches developed for identifying and managing climate-related financial risks. We have a long road ahead of us, but every journey begins with the first steps. The FSB will continue to leverage its strengths to coordinate and contribute to understanding and addressing the challenges to the financial system that arise from these risks.

r210730a_FOMC

united states

Assessing Progress as the Economy Moves from Reopening to Recovery

brainard

The economy is reopening, consumer spending is strong, and hundreds of thousands of workers are finding jobs in the hard-hit leisure and hospitality sector each month. Pent-up demand has outstripped capacity in some sectors, as businesses that had pared back to survive the pandemic are encountering bottlenecks as they rehire and restock. These mismatches have made it more difficult to interpret the first few months of reopening data. The second quarter of 2021 saw a large wave of demand buoyed by fiscal transfers, resulting in annualized real personal consumption expenditures (PCE) growth of 11.8 percent. Real gross domestic product grew at an annual rate of 6.5 percent in the second quarter of 2021, slightly less than many forecasters had projected, as that strong consumer demand outstripped production, resulting in a significant decline in inventories. The tailwinds to growth from the fiscal stimulus during the first half are shifting to headwinds that will continue through the remainder of 2021 and 2022. Even so, pent- up consumption and full reopening are expected to more than offset fiscal headwinds in the second half such that PCE is expected to grow at a robust rate, and growth is expected to remain strong through the remainder of the year. By the end of the year, the U.S. economy is expected to achieve average annualized growth of 2.2 percent since the onset of COVID-19--slightly above most estimates of longer-term potential output growth. In short, growth this year is expected to compensate fully for last year's sharp contraction-- as a result of the strong policy response, effective vaccines, and the resilience and adaptability of American households, workers, and businesses. While we are seeing progress on employment, joblessness remains high and continues to fall disproportionately on African Americans and Hispanics and lower-wage workers in the services sector. Last December, the Committee indicated that asset purchases would continue until substantial further progress toward our employment and inflation goals had been achieved. The June data showed that there is a shortfall of 6.8 million jobs relative to the pre-pandemic level and 9.1 million jobs relative to the pre-pandemic trend, respectively. The employment-to-population (EPOP) ratio is 3.2 percentage points short of its pre- pandemic level for prime-age workers, a group that is not affected by the elevated level of early retirements during the pandemic. Thus, as of June, we had closed between one- fourth and one-third of the employment shortfall relative to last December according to a variety of measures. Although the EPOP ratio for Black individuals has improved more strongly than the overall ratio over the course of 2021, closing about 40 percent of the December gap, it remains more than 3 percentage points below its pre-pandemic level and more than 2 percentage points below the current level of the EPOP ratio for white individuals. Currently, it is difficult to disentangle the effects on labor supply of caregiving responsibilities brought on by the pandemic, fears of contracting the virus, and the enhanced unemployment insurance that was designed in part to address such constraints. Importantly, I expect to be more confident in assessing the rate of progress once we have data in hand for September, when consumption, school, and work patterns should be settling into a post pandemic normal. I fully expect progress to continue, ultimately leading to a labor market as strong or stronger than we saw before the pandemic. Looking ahead, if jobs were to continue to increase at the second-quarter average monthly pace, about two-thirds of the outstanding job losses as of December 2020 and nearly half of the gap relative to the pre-pandemic trend would be made up by the end of 2021. If, instead, the rate of job growth were to accelerate notably, those levels could be reached somewhat sooner. Today's data showed that core PCE inflation rose 0.45 percent in June, once again driven by outsized contributions from a handful of categories. New and used vehicles contributed just under 40 percent of the June increase in core PCE, while price increases for travel-related items like hotels, airfares and rental cars contributed another 25 percent. All told, price increases associated with vehicles and vacations, categories that comprise about 8 percent of the core PCE basket, were responsible for over 60 percent of the June core PCE price increase. Recent high inflation readings reflect supply-demand mismatches in a handful of sectors that are likely to prove transitory. In assessing inflation, an annualized 24-month measure that looks through the steep declines and subsequent rebound in prices in categories affected by the pandemic currently has core PCE inflation running at 2.3 percent and headline PCE inflation running at 2.4 percent. It is reasonable to expect these measures to remain near those levels for much of the rest of the year. By comparison, this 24-month measure was running at 1.6 percent in December 2020. I am attentive to the risk that inflation pressures could broaden or prove persistent, perhaps as a result of wage pressures, persistent increases in rent, or businesses passing on a larger fraction of cost increases rather than reducing markups, as in recent recoveries. I am particularly attentive to any signs that currently high inflation readings are pushing longer-term inflation expectations above our 2 percent objective. Currently, I do not see such signs. Most measures of survey- and market-based expectations suggest that the current high inflation pressures are transitory, and underlying trend inflation remains near its pre-COVID trend. Since the June FOMC meeting, five-year, five-year-forward inflation compensation based on Treasury Inflation- Protected Securities has declined a little less than 20 basis points, on net, and it currently stands at 2.2 percent, at the low end of its range of values prior to the 2014 decline. The second-quarter reading from the Federal Reserve Board's index of common inflation expectations stands at 2.05 percent, which is at the bottom of the range that prevailed from 2008 to 2014, when 12-month total PCE inflation averaged 1.7 percent. Many of the forces currently leading to outsized gains in prices are likely to dissipate by this time next year. Current tailwinds from fiscal support and pent-up consumption are likely to shift to headwinds, and some of the outsized price increases associated with acute supply bottlenecks may ease or partially reverse as those bottlenecks are resolved. Lumber prices have fallen, wholesale used car prices appear to have peaked, and auto semiconductor production is projected to expand. While there is good reason to expect that the inflation dynamics that prevailed for a quarter-century will reassert themselves on the other side of reopening, I will remain vigilant to any signs that inflationary pressures are likely to prove more persistent or that expectations are moving above target. If inflation moves persistently and materially above our target, we would adjust policy to guide inflation gently back to target. There are risks on both sides of the outlook. There are upside risks to consumption spending associated with the high level of households' savings. There are downside risks associated with the Delta variant. While the economy's momentum is strong, vaccination rates remain low in some areas, and fears related to the Delta variant may damp the rebound in services and complicate the return to in-person school and work in some areas and slow the rotation from goods to services that account for three- fourths of the shortfall in jobs In coming meetings, we will continue to assess progress and the conditions under which it will be appropriate to start paring back the pace of our asset purchases. Twenty- four-month core PCE inflation is now running at a 2.3 percent average annualized rate. In contrast, employment is still down by 6.8 million to 9.1 million relative to its pre- COVID level and trend, respectively, and it has closed about one-fourth to one-third of its December gap. The determination of when to begin to slow asset purchases will depend importantly on the accumulation of evidence that substantial further progress on employment has been achieved. As of today, employment has some distance to go. It is important to emphasize that the achievement of substantial progress that will determine when the Committee starts reducing the pace of asset purchases is distinct from the maximum employment and inflation outcomes that are in the forward guidance for the policy rate. Remaining attentive to changing conditions and steady in our step-by- step approach to implementing policy under our new framework should ensure that the economy's momentum is sufficient when tailwinds shift to headwinds to achieve and sustain maximum employment and inflation robustly anchored at 2 percent.

r210803a_FOMC

united states

Welcoming Remarks

bowman

Welcome, and thank you for joining us to discuss a number of topics important to the nation's economy. This research seminar is the Federal Reserve's first in a new series called "Toward an Inclusive Recovery." The series is cosponsored by the community development offices of all 12 Federal Reserve Banks as well as the Board of Governors. Today's opening seminar is hosted by the Board and will focus on what the recovery may look like for workers. Since this event is a community development initiative, we have invited accomplished researchers to discuss their work--and what practical lessons we might draw from it--to inform community development practice and public policy considerations. This focus of this series on an inclusive recovery holds special importance as we think about the uneven economic effects from the pandemic. For many of us, combating the virus meant being disconnected from friends and family. Furthermore, most children were not permitted to return to school, leaving parents and caretakers to adapt. while the spread of the virus universally upended our personal lives, our employment situations frequently dictated our ease of adaption. In November of last year, for instance, almost half of workers with a college degree or more said that they worked entirely from home, according to the Board's Survey of Household Economics and Decisionmaking (SHED). At the same time, only 10 percent of workers with a high school degree or less said that they worked entirely from home. Additionally, people who lost jobs were typically those who earned less or had less education. Hispanic and Black workers were hit harder than others, on average, reversing the recent improvements they had been seeing. Early in the pandemic, many workers experienced layoffs but expected to return to their jobs. Unfortunately, not all have had the opportunity to do so. Public policy actions, including those taken by the Congress and the Federal Reserve, aimed to provide support to households and employers in the wake of these unprecedented disruptions. We see evidence of how these actions helped, but many households still face challenging times. As we continue on the path to recovery, it is time to consider what the labor market may look like post-COVID-19. While there is a lot we know about jobs and how they may be changing, there is always more that we can learn. For instance, as companies struggled to keep afloat while meeting social-distancing directives, it will be instructive to learn more about how they may have adjusted operations to adapt. These changes may have included automation or utilization of telework. In certain circumstances, the changes driven by the virus may have sped up or slowed down preexisting trends in the labor market, and changes in supply chains may have affected workers. It remains to be seen whether the recent changes in remote work and employer flexibility will last and influence how people balance work and family. Currently, some people face difficult choices regarding the availability of jobs and changing lines of work. So it may take time for some people to reenter the labor force. The record number of job openings in May is a very promising sign that opportunities are increasing, and I think that development bodes well for both households and the country. Despite the encouraging pace of recent hiring, employment is still far below where it was. In June of this year, there were 6.8 million fewer jobs than there were in February 2020. Over 6 million people were either not working or working fewer hours in June because their employer had closed or lost business due to the pandemic. am hopeful that we will continue to build on this recent positive momentum, since there is more work to be done to get the economy back on strong footing, as it was before the public health emergency. I believe that data, evidence, and research can help policymakers and practitioners think more clearly about the implications for improving economic outcomes for everyone. It is helpful to think about the needs of workers as employers may be making changes. Are there ways to better support workers living on low incomes or ways to help them manage the volatility of their paychecks? Are there effective strategies to better prepare returning workers and young people newly entering the workforce? Finally, what does it take to make work rewarding for everyone? To help think about some of these questions, today's discussion should be particularly informative, and I hope that the research presented is useful to you in your work. Community development professionals in our audience may get ideas on how they might deliver their services more effectively. Policymakers may look more closely at how workers are affected by their decisions. And researchers may be inspired to begin new lines of inquiry that will shed further light on these important topics. Our work at the Federal Reserve will certainly be enhanced through our continuing exploration of these issues. Thank you for taking the time to join us today.

r210804a_FOMC

united states

Outlooks, Outcomes, and Prospects for U.S. Monetary Policy

clarida

With the release of the gross domestic product (GDP) data last week, we learned that the U.S. economy in the second quarter of this year transitioned from economic recovery to economic expansion. Given the catastrophic collapse in U.S. economic activity in the first half of 2020 as a result of the global pandemic and the mitigation efforts put in place to contain it, few forecasters could have expected--or even dared to hope--in the spring of last year that the recovery in GDP, from the sharpest decline in activity since the Great Depression, would be either so robust or as rapid. In retrospect, it seems clear that timely and targeted monetary and fiscal policy actions--unprecedented in both scale and scope--provided essential and significant support to the economic recovery as it got under way last year. Indeed, just recently, the National Bureau of that began in March of last year ended in April, making it not only the deepest recession on record, but also the briefest. Moreover, with the development and distribution of several remarkably effective vaccines, the monetary and fiscal policies presently in place should continue to support the strong expansion in economic activity that is expected to be realized this year, although, obviously, the rapid spread of the Delta variant among the still considerable fraction of the population that is unvaccinated is clearly a downside risk forecast, the economy by the end of 2021 will have entirely closed the output gap opened up by the recession. If so, this would be the most rapid return following a recession to the CBO estimate of the trend level of real GDP in 50 years. Importantly, while it is customary in business cycle analysis to date the transition from the recovery phase to the expansion phase according to the calendar quarter in which the level of real GDP first exceeds the previous business cycle's peak, in past U.S. business cycles, the recovery in employment has always lagged the recovery in GDP, and this cycle is no exception. Indeed, at the end of the second quarter of this year, even though the level of real GDP was 0.8 percent above the level reached at the previous business cycle peak, the level of employment as measured by the household survey remained about 7 million below the level reached at the previous business cycle peak. So while it is accurate to say we are in the expansion phase of the cycle in terms of economic activity, we remain in the recovery phase of the cycle in terms of aggregate employment. In June, the Federal Reserve released its most recent Summary of Economic Projections (SEP) for GDP, the unemployment rate, inflation, and the federal funds rate. The SEP provides summary information about the empirical distribution of the individual submitted by each of the FOMC participants (currently 6 Governors and 12 Reserve Bank presidents). Each individual submits projections for the modal, or most likely, outcome for each variable in the survey under his or her assessment of the appropriate monetary policy path. Of course, if a participant's subjective distributions for possible outcomes for GDP, unemployment, and inflation are symmetric, the mode of each distribution submitted by each participant will equal its mean (and median), but in general, there is no presumption that the subjective distributions--or, for that matter, observed empirical distributions--for these variables are symmetric. Indeed, an important addition to the SEP introduced in December 2020 is a set of charts showing the historical evolution of diffusion indexes for the assessment of the balance of risks to the GDP, unemployment, and inflation projections submitted by each participant. In the June SEP round, my individual projections for GDP growth and the unemployment rate turned out to be quite close to the path of SEP medians for each of these variables over the 2021-23 projection window. Under the "median of modes" outlook in the SEP, GDP growth this year is projected to be 7 percent on a Q4-over-Q4 basis, which, if realized, would represent the fastest four-quarter GDP growth since the 1980s. Under the projections, GDP growth does step down to 3.3 percent in 2022 and further to 2.4 percent in 2023, but to a pace that still exceeds the projected pace of long- run trend growth in all three years of the projection window. Not surprisingly, the projected path of robust GDP growth in the SEP translates into rapid declines in the projected SEP path for the unemployment rate, which is projected to fall to 4.5 percent by the end of this year, 3.8 percent by the end of 2022, and 3.5 percent by the end of 2023. This modal projection for the path of the unemployment rate is, according to the Atlanta Fed jobs calculator, consistent with a rebound in labor force participation to its estimated demographic trend and is also consistent with cumulative employment gains this year and next that, by the end of 2022, eliminate the 7 million "employment gap" relative to the previous cycle peak I mentioned earlier. As is the case for GDP growth and the unemployment rate, my projections for headline and core PCE (personal consumption expenditures) inflation are also similar to the paths of the SEP median of modal projections for these variables. Under the projected SEP path for inflation, core PCE inflation surges to at least 3 percent this year before reverting back to 2.1 percent for the next two years. Thus, the modal baseline outlook for inflation over the three-year projection window reflects the judgment, shared with many outside forecasters, that most of the inflation overshoot relative to the longer- run goal of 2 percent will, in the end, prove to be transitory. But, as I have noted before, there is no doubt that it is taking longer to fully reopen a $20 trillion economy than it did to shut it down. Although in a number of sectors of the economy the imbalances between demand and supply--including labor supply--are substantial, I do continue to judge that these imbalances are likely to dissipate over time as the labor market and global supply chains eventually adjust and, importantly, do so without putting persistent upward pressure on price inflation, wage gains adjusted for productivity, and the 2 percent longer-run inflation objective. But let me be clear on two points. First, if, as projected, core PCE inflation this year does come in at, or certainly above, 3 percent, I will consider that much more than a "moderate" overshoot of our 2 percent longer-run inflation objective. Second, as always, there are risks to any outlook, and I believe that the risks to my outlook for inflation are to the upside. In September 2020, the FOMC introduced--and since then has, at each subsequent meeting, reaffirmed--outcome-based, threshold guidance that specifies three conditions that the Committee expects will be met before it considers increasing the target range for the federal funds rate, currently 0 to 25 basis points. This guidance in September of last year brought the forward guidance on the federal funds rate in the statement into alignment with the new policy framework adopted in August 2020. quote from the statement, these conditions are that "labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some While, as Chair Powell indicated last week, we are clearly a ways away from considering raising interest rates and this is certainly not something on the radar screen right now, if the outlook for inflation and outlook for unemployment I summarized earlier turn out to be the actual outcomes for inflation and unemployment realized over the forecast horizon, then I believe that these three necessary conditions for raising the target range for the federal funds rate will have been met by year-end 2022. inflation since February 2020--a calculation window that smooths out any base effects resulting from "round trip" declines and rebounds in the price levels of COVID-19- sensitive sectors and, coincidentally, also measures the average rate of core PCE inflation since hitting the effective lower bound (ELB) in March 2020--is running at 2.7 percent through June 2021 and is projected to remain above 2 percent in all three years of the projection window. Moreover, my inflation projections for 2022 and 2023, which forecast somewhat higher inflation than do the SEP medians, would also, to me, satisfy the "on track to moderately exceed 2 percent for some time" threshold specified in the statement. Finally, while my assessment of maximum employment incorporates a wide range of indicators to assess the state of the labor market--including indicators of labor compensation, productivity, and price-cost markups--the employment data I look at, correlated with the unemployment rate. My expectation today is that the labor market by the end of 2022 will have reached my assessment of maximum employment if the unemployment rate has declined by then to the SEP median of modal projections of Given this outlook and so long as inflation expectations remain well anchored at the 2 percent longer-run goal--which, based on the Fed staff's common inflation expectations (CIE) index, I judge at present to be the case and which I project will remain true over the forecast horizon--commencing policy normalization in 2023 would, under these conditions, be entirely consistent with our new flexible average inflation targeting framework. I note that under the June SEP median of modal projections, annualized PCE inflation since the new framework was adopted in August 2020 is projected to average 2.6 percent through year-end 2022 and 2.5 percent through year-end 2023. the context of our new framework, it is important to note that while the ELB can be a constraint on monetary policy, the ELB is not a constraint on fiscal policy, and appropriate monetary policy under our new framework, to me, must--and certainly can--incorporate this reality. Indeed, under present circumstances, I judge that the support to aggregate demand from fiscal policy--including the more than $2 trillion in accumulated excess savings accruing from (as yet) unspent transfer payments--in tandem with appropriate monetary policy, can fully offset the constraint, highlighted in our the ability of an inflation-targeting monetary policy, acting on its own and in the absence of sufficient fiscal support, to restore, following a recession, maximum employment and price stability while keeping inflation expectations well anchored at the 2 percent longer- run goal. Before I conclude, let me say a few words about our Treasury and mortgage- we indicated, and have reaffirmed since then, that we will maintain the pace of Treasury and MBS purchases at $80 billion and $40 billion per month, respectively, until "substantial further progress" has been made toward our maximum-employment and price-stability goals. Since then, the economy has made progress toward these goals. At our meeting last week, the Committee reviewed some considerations around how our asset purchases might be adjusted, including their pace and composition, once economic conditions warrant a change. Participants expect that the economy will continue to move toward our standard of "substantial further progress." In coming meetings, the Committee will again assess the economy's progress toward our goals. As we have said, we will provide advance notice before making any changes to our purchases. The outlook I have described in these remarks is, of course, only one of many possible paths that the economy may take. I began by noting that the recovery to date has been surprising, and it is plausible--indeed, probable--that more surprises are in store. The economic outlook is always uncertain, both because new shocks can arrive-- which, by their nature, cannot be foreseen--and because our knowledge of the workings of the economy is imperfect. Additionally, the recovery and expansion following the pandemic are unlike any we have ever seen, and it will serve us well to remain humble in predicting the future. In light of these uncertainties, the Committee is rightly basing its judgments on outcomes, not just the outlook. Looking ahead, our policy decisions will continue to depend on the data in hand at the time, along with their implications for the outlook and associated risks. Thank you very much for your time and attention. I look forward, as always, to my conversation with Adam Posen. . . vol. 119 event hosted by the Hutchins Center on Fiscal and Monetary Policy at the . . . . .

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united states

CBDC: A Solution in Search of a Problem?

waller

The payment system is changing in profound ways as individuals demand faster payments, central banks including the Fed respond, and nonbank entities seek a greater role in facilitating payments. In all this excitement, there are also calls for the Federal Reserve to "get in the game" and issue a central bank digital currency (CBDC) that the general public could use. Chair Powell recently announced that the Federal Reserve will publish a discussion paper on the benefits and costs of creating a CBDC. This topic is of special interest to me, since I have worked on monetary theory for the last twenty years and researched and written about alternative forms of money for the last seven. My speech today focuses on whether a CBDC would address any major problems affecting our payment system. There are also potential risks associated with a CBDC, and I will touch on those at the end of my remarks. But at this early juncture in the Fed's discussions, I think the first order of business is to ask whether there is compelling need for the Fed to create a digital currency. I am highly skeptical. In all the recent exuberance about CBDCs, advocates point to many potential benefits of a Federal Reserve digital currency, but they often fail to ask a simple question: What problem would a CBDC solve? Alternatively, what market failure or inefficiency demands this specific intervention? After careful consideration, I am not convinced as of yet that a CBDC would solve any existing problem that is not being addressed more promptly and efficiently by other initiatives. Before getting into the details, let me start by clarifying what I mean by "CBDC." Put simply, a CBDC is a liability of the central bank that can be used as a digital payment instrument. For purposes of this speech, I will focus on general purpose is, CBDCs that could be used by the general public, not just by banks or other specific types of institutions. A general purpose CBDC could potentially take many forms, some of which could act as anonymous cash-like payment instruments. For this speech, however, I will focus on account-based forms of CBDC, which the Bank for International Settlements recently described as "the most promising way of providing central bank money in the digital age." Any such general purpose, account-based CBDC would likely require explicit congressional authorization. It is useful to note that in our daily lives we use both central bank money and commercial bank money for transactions. Central bank money (i.e., money that is a liability of the Federal Reserve) includes physical currency held by the general public and digital account balances held by banks at the Federal Reserve. The funds banks put into these accounts are called reserve balances, which are used to clear and settle payments between banks. In contrast, checking and savings accounts at commercial banks are liabilities of the banks, not the Federal Reserve. The bulk of transactions, by value, that U.S. households and firms make each day use commercial bank money as the payment instrument. Under current law, the Federal Reserve offers accounts and payment services to commercial banks. These accounts provide a risk-free settlement asset for trillions of dollars of daily interbank payments. Importantly, the use of central bank money to settle interbank payments promotes financial stability because it eliminates credit and liquidity risk in systemically important payment systems. Congress did not establish the Federal Reserve to provide accounts directly to the general public; the Federal Reserve instead works in the background by providing accounts to commercial banks, which then provide bank accounts to the general public. Under this structure, commercial banks act as an intermediary between the Federal Reserve and the general public. The funds in commercial bank accounts are digital and can be used to make digital payments to households and businesses, but commercial banks promise to redeem a dollar in one's bank account into $1 of U.S. currency. In short, banks peg the exchange rate between commercial bank money and the U.S. dollar at one-to-one. Due to substantial regulatory and supervisory oversight and federal deposit insurance, households and firms reasonably view this fixed exchange rate as perfectly credible. Consequently, they treat commercial bank money and central bank money as perfect substitutes--they are interchangeable as a means of payment. The credibility of this fixed exchange rate between commercial and central bank money is what allows our payment system to be stable and efficient. I will return to this point later. This division of functions between the Federal Reserve and commercial banks reflects an economic truth: that markets operate efficiently when private-sector firms compete to provide the highest-quality products to consumers and businesses at the lowest possible cost. In general, the government should compete with the private sector only to address market failures. This brings us back to my original question: What is the problem with our current payment system that only a CBDC would solve? Could it be that physical currency will disappear? As I mentioned before, the key to having credible commercial bank money is the promise that banks will convert a dollar of digital bank money into a dollar of U.S. physical currency. But how can banks deliver on their promise if U.S. currency disappears? Accordingly, many central banks are considering adoption of a CBDC as their economies become "cashless." Eliminating currency is a policy choice, however, not an economic outcome, and Chair Powell has made clear that U.S. currency is not going to be replaced by a CBDC. Thus, a fear of imminently vanishing physical currency cannot be the reason for adopting a CBDC. Could it be that the payment system is too limited in reach, and that introducing a CBDC would make the payment system bigger, broader, and more efficient? It certainly doesn't look that way to me. Our existing interbank payment services have nationwide reach, meaning that an accountholder at one commercial bank can make a payment to an accountholder at any other U.S. bank. The same applies to international payments-- accountholders at U.S. banks can transfer funds abroad to accountholders at foreign banks. So, a lack of connectedness and geographic breadth in the U.S. payment system is not a good reason to introduce a CBDC. Could it be that existing payment services are too slow? A group of commercial banks has recently developed an instant payment service (the Real-Time Payment Service, or RTP), and the Federal Reserve is creating its own instant payment service, . These services will move funds between accountholders at U.S. commercial banks immediately after a payment is initiated. While cross-border payments are typically less efficient than domestic payments, efforts are underway to improve cross- border payments as well. These innovations are all moving forward in the absence of a CBDC. Consequently, facilitating speedier payments is not a compelling reason to create a CBDC. Could it be that too few people can access the payment system? Some argue that introducing a CBDC would improve financial inclusion by allowing the unbanked to more readily access financial services. To address this argument, we need to know, first, the size of the unbanked population, and second, whether the unbanked population would unbanked in 2019. The FDIC survey also found that approximately 75 percent of the unbanked population "were not at all interested" or "not very interested" in having a bank account. If the same percentage of the unbanked population would not be interested in a Federal Reserve CBDC account, this means that a little more than 1 percent of U.S. households are both unbanked and potentially interested in a Federal Reserve CBDC account. It is implausible to me that developing a CBDC is the simplest, least costly way to reach this 1 percent of households. Instead, we could promote financial inclusion more efficiently by, for example, encouraging widespread use of low-cost commercial bank accounts through the Cities for Financial Empowerment project. Could it be that a CBDC is needed because existing payment services are unreasonably expensive? In order to answer this question, we need to understand why the price charged for a payment might be considered "high." In economics, the price of a service is typically composed of two parts: the marginal cost of providing the service and a markup that reflects the market power of the seller. The marginal cost of processing a payment depends on the nature of the payment (for example, paper check versus electronic transfer), the technology used (for example, batched payments versus real-time payments), and the other services provided in processing the payment (for example, risk and fraud services). Since these factors are primarily technological, and there is no reason to think that the Federal Reserve can develop cheaper technology than private firms, it seems unlikely that the Federal Reserve would be able to process CBDC payments at a materially lower marginal cost than existing private-sector payment services. The key question, then, is how a CBDC would affect the markup charged by banks for a variety of payment services. The markup that a firm can charge depends on its market power and thus the degree of competition it faces. Introducing a CBDC would create additional competition in the market for payment services, because the general public could use CBDC accounts to make payments directly through the Federal Reserve--that is, a CBDC would allow the general public to bypass the commercial banking system. Deposits would flow from commercial banks into CBDC accounts, which would put pressure on banks to lower their fees, or raise the interest rate paid on deposits, to prevent additional deposit outflows. It seems to me, however, that private-sector innovations might reduce the markup charged by banks more effectively than a CBDC would. If commercial banks are earning rents from their market power, then there is a profit opportunity for nonbanks to enter the payment business and provide the general public with cheaper payment services. And, indeed, we are currently seeing a surge of nonbanks getting into payments. For example, in recent years, "stablecoin" arrangements have emerged as a particularly important type of nonbank entrant into the payments landscape. Stablecoins are digital assets whose value is tied to one or more other assets, such as a sovereign currency. A stablecoin could serve as an attractive payment instrument if it is pegged one-to-one to the dollar and is backed by a safe and liquid pool of assets. If one or more stablecoin arrangements can develop a significant user base, they could become a major challenger to banks for processing payments. Importantly, payments using such stablecoins might be "free" in the sense that there would be no fee required to initiate or receive a payment. Accordingly, one can easily imagine that competition from stablecoins could pressure banks to reduce their markup for payment services. Please note that I am not endorsing any particular stablecoin--some of which are not backed by safe and liquid assets. The promise of redemption of a stablecoin into one U.S. dollar is not perfectly credible, nor have they been tested by an actual run on the stablecoin. There are many legal, regulatory, and policy issues that need to be resolved before stablecoins can safely proliferate. My point, however, is that the private sector is already developing payment alternatives to compete with the banking system. Hence, it seems unnecessary for the Federal Reserve to create a CBDC to drive down payment rents. Returning to possible problems a CBDC could solve, it is often argued that the creation of a CBDC would spur innovation in the payment system. This leads me to ask: do we think there is insufficient innovation going on in payments? To the contrary, it seems to me that private-sector innovation is occurring quite rapidly--in fact, faster than regulators can process. So, spurring innovation is not a compelling reason to introduce a Could it be, however, that the types of innovations being pursued by the private sector are the "wrong" types of payment innovations? I see some merit in this argument when I consider crypto-assets such as bitcoin that are often used to facilitate illicit activity. But a CBDC is unlikely to deter the use of crypto-assets that are designed to evade governmental oversight. Could the problem be that government authorities have insufficient information regarding the financial transactions of U.S. citizens? In general, the government has sought to balance individuals' right to privacy with the need to prevent illicit financial transactions, such as money laundering. For example, while the government does not receive all transaction data regarding accountholders at commercial banks, the Bank Secrecy Act requires that commercial banks report suspicious activity to the government. Depending on its design, CBDC accounts could give the Federal Reserve access to a vast amount of information regarding the financial transactions and trading patterns of CBDC accountholders. The introduction of a CBDC in China, for example, likely will allow the Chinese government to more closely monitor the economic activity of its citizens. Should the Federal Reserve create a CBDC for the same reason? I, for one, do not think so. Could the problem be that the reserve currency status of the U.S. dollar is at risk and the creation of a Federal Reserve CBDC is needed to maintain the primacy of the U.S. dollar? Some commentators have expressed concern, for example, that the availability of a Chinese CBDC will undermine the status of the U.S. dollar. I see no reason to expect that the world will flock to a Chinese CBDC or any other. Why would non-Chinese firms suddenly desire to have all their financial transactions monitored by the Chinese government? Why would this induce non-Chinese firms to denominate their contracts and trading activities in the Chinese currency instead of the U.S. dollar? Additionally, I fail to see how allowing U.S. households to, for example, pay their electric bills via a Federal Reserve CBDC account instead of a commercial bank account would help to maintain global dollar supremacy. (Of course, Federal Reserve CBDC accounts that are available to persons outside the United States might promote use of the dollar, but global availability of Federal Reserve CBDC accounts would also raise acute problems related to, among other things, money laundering.) Finally, could it be that new forms of private money, such as stablecoins, represent a threat to the Federal Reserve for conducting monetary policy? Many commentators have suggested that new private monies will diminish the impact of the Federal Reserve's policy actions, since they will act as competing monetary systems. It is well established in international economics that any country that pegs its exchange rate to the U.S. dollar surrenders its domestic monetary policy to the United States and imports U.S. monetary policy. This same logic applies to any entity that pegs its exchange rate to the U.S. dollar. Consequently, commercial banks and stablecoins pegged to the U.S. dollar act as conduits for U.S. monetary policy and amplify policy actions. So, if anything, private stablecoins pegged to the dollar broaden the reach of U.S. monetary policy rather than diminish it. After exploring many possible problems that a CBDC could solve, I am left with the conclusion that a CBDC remains a solution in search of a problem. That leaves us only with more philosophical reasons to adopt a CBDC. One could argue, for example, that the general public has a fundamental right to hold a riskless digital payment instrument, and a CBDC would do this in a way no privately issued payment instrument can. On the other hand, thanks to federal deposit insurance, commercial bank accounts already offer the general public a riskless digital payment instrument for the vast majority of transactions. One could also argue that the Federal Reserve should provide a digital option as an alternative to the commercial banking system. The argument is that the government should not force its citizens to use the commercial banking system, but should instead allow access to the central bank as a public service available to all. As I noted earlier in my speech, however, the current congressionally mandated division of functions between the Federal Reserve and commercial banks reflects an understanding that, in general, the government should compete with the private sector only to address market failures. This bedrock principle has stood America in good stead since its founding, and I don't think that CBDCs are the case for making an exception. In summary, while CBDCs continue to generate enormous interest in the United States and other countries, I remain skeptical that a Federal Reserve CBDC would solve any major problem confronting the U.S. payment system. There are also potential costs and risks associated with a CBDC, some of which I have alluded to already. I have noted my belief that government interventions into the economy should come only to address significant market failures. The competition of a Fed CBDC could disintermediate commercial banks and threaten a division of labor in the financial system that works well. And, as cybersecurity concerns mount, a CBDC could become a new target for those threats. I expect these and other potential risks from a CBDC will be addressed in the forthcoming discussion paper, and I intend to expand upon them as the debate over digital currencies moves forward.

r210817a_FOMC

united states

Welcoming Remarks

powell

Thank you, Gigi and Scott, and thanks to everyone for your work in bringing us together today, particularly the Economic Education Group. Congratulations on the launch of Economic Education Month as well. We're very proud of this initiative and looking forward to what you have in store for us in October. It's a pleasure to be here, albeit in a very different format than we're used to. The downside is that we don't get to connect in quite the same way as we do in person. The upside is that we're able to include a lot more people. And wear much more comfortable clothes. Before I turn to your questions, I want to say a few words to recognize the incredibly powerful work you all do as teachers. It would be important to mention this in any year, but especially now, in the 17th month of our upended reality. At the Fed, we take the value and responsibility of public service pretty seriously, and there really is no greater contribution to the common good than teaching. The pandemic has been tough on everyone, but it has asked more of some than others. Making it through this time has been no small feat for anyone, but teachers deserve distinct praise and appreciation. Educators have had to restructure their teaching, adapt to new platforms, and help their students make their way through added stresses and pitfalls. That must have been especially tough without the day-to-day interactions that help you connect. It is clear that so many teachers have gone above and beyond the call of duty to remain a consistent, reliable resource for their students. Parents deserve a shout-out as well for their part in helping reconstruct something as enormous and consequential as our entire education system. And students have also shown remarkable courage and resilience. For all of us, daily life has been disrupted, milestones like birthdays and graduations have been missed, and a once-in-a-lifetime crisis has cast a shadow of insecurity and uncertainty. But to take on that burden as a formative experience is extraordinary. You should all feel proud. Finding the bright side to the past 17 months is not easy, but the crisis has given us a unique opportunity to see the big picture and consider our place in it. This is a historical inflection point, and this generation of students is in a position to turn its lessons into profound tools of change. And I hope some of you will use those tools in public service. The students here today are the policymakers and legislators of the future. Your teachers are the ones with the daunting task of preparing you for that future. You will see the world differently than your predecessors. You have been forced, sooner than most people, to consider what in life is truly important. You have seen a world upended, but you have also seen a world that is rapidly changing--sometimes more in one week than some of us have experienced over the course of decades. I hope this will cause you to think about how you want to make your mark, knowing that things do change, and sometimes they change quickly. This is an extraordinary time, and I believe that it will result in an extraordinary generation. As long as we continue to have extraordinary educators to guide them there. Education is the foundation of our economy, indeed, of our society. Teachers have always been tasked with nurturing and overseeing our most valuable national resource. It is the highest call within the higher calling of public service. I want to thank all of the teachers--those here today and the rest across the country--as well as the parents and students who have come together to make it through the past year and a half. Thank you, and I look forward to your questions.

r210827a_FOMC

united states

Monetary Policy in the Time of COVID

powell

Seventeen months have passed since the U.S. economy faced the full force of the COVID-19 pandemic. This shock led to an immediate and unprecedented decline as large parts of the economy were shuttered to contain the spread of the disease. The path of recovery has been a difficult one, and a good place to begin is by thanking those on the front line fighting the pandemic: the essential workers who kept the economy going, those who have cared for others in need, and those in medical research, business, and government, who came together to discover, produce, and widely distribute effective vaccines in record time. We should also keep in our thoughts those who have lost their lives from COVID, as well as their loved ones. Strong policy support has fueled a vigorous but uneven recovery--one that is, in many respects, historically anomalous. In a reversal of typical patterns in a downturn, aggregate personal income rose rather than fell, and households massively shifted their spending from services to manufactured goods. Booming demand for goods and the strength and speed of the reopening have led to shortages and bottlenecks, leaving the COVID-constrained supply side unable to keep up. The result has been elevated inflation in durable goods--a sector that has experienced an annual inflation rate well below zero over the past quarter century. Labor market conditions are improving but turbulent, and the pandemic continues to threaten not only health and life, but also economic activity. Many other advanced economies are experiencing similarly unusual conditions. In my comments today, I will focus on the Fed's efforts to promote our maximum employment and price stability goals amid this upheaval, and suggest how lessons from history and a careful focus on incoming data and the evolving risks offer useful guidance for today's unique monetary policy challenges. The pandemic recession--the briefest yet deepest on record--displaced roughly 30 million workers in the space of two months. The decline in output in the second quarter of 2020 was twice the full decline during the Great Recession of 2007-09. the pace of the recovery has exceeded expectations, with output surpassing its previous peak after only four quarters, less than half the time required following the Great Recession. As is typically the case, the recovery in employment has lagged that in output; nonetheless, employment gains have also come faster than expected. The economic downturn has not fallen equally on all Americans, and those least able to shoulder the burden have been hardest hit. In particular, despite progress, joblessness continues to fall disproportionately on lower-wage workers in the service sector and on African Americans and Hispanics. The unevenness of the recovery can further be seen through the lens of the sectoral shift of spending into goods--particularly durable goods such as appliances, furniture, and cars--and away from services, particularly in-person services in areas such as travel and leisure (figure 1). As the pandemic struck, restaurant meals fell 45 percent, air travel 95 percent, and dentist visits 65 percent. Even today, with overall gross domestic product and consumption spending more than fully recovered, services spending remains about 7 percent below trend. Total employment is now 6 million below its February 2020 level, and 5 million of that shortfall is in the still-depressed service sector. In contrast, spending on durable goods has boomed since the start of the recovery and is now running about 20 percent above the pre-pandemic level. With demand outstripping pandemic-afflicted supply, rising durables prices are a principal factor lifting inflation well above our 2 percent objective. Given the ongoing upheaval in the economy, some strains and surprises are inevitable. The job of monetary policy is to promote maximum employment and price stability as the economy works through this challenging period. I will turn now to a discussion of progress toward those goals. The outlook for the labor market has brightened considerably in recent months. After faltering last winter, job gains have risen steadily over the course of this year and now average 832,000 over the past three months, of which almost 800,000 have been in services (figure 2). The pace of total hiring is faster than at any time in the recorded data before the pandemic. The levels of job openings and quits are at record highs, and employers report that they cannot fill jobs fast enough to meet returning demand. These favorable conditions for job seekers should help the economy cover the considerable remaining ground to reach maximum employment. The unemployment rate has declined to 5.4 percent, a post-pandemic low, but is still much too high, and the reported rate understates the amount of labor market slack. Long-term unemployment remains elevated, and the recovery in labor force participation has lagged well behind the rest of the labor market, as it has in past recoveries. With vaccinations rising, schools reopening, and enhanced unemployment benefits ending, some factors that may be holding back job seekers are likely fading. While the Delta variant presents a near-term risk, the prospects are good for continued progress toward maximum employment. The rapid reopening of the economy has brought a sharp run-up in inflation. Over the 12 months through July, measures of headline and core personal consumption expenditures inflation have run at 4.2 percent and 3.6 percent, respectively--well above our 2 percent longer-run objective. Businesses and consumers widely report upward pressure on prices and wages. Inflation at these levels is, of course, a cause for concern. But that concern is tempered by a number of factors that suggest that these elevated readings are likely to prove temporary. This assessment is a critical and ongoing one, and we are carefully monitoring incoming data. The dynamics of inflation are complex, and we assess the inflation outlook from a number of different perspectives, as I will now discuss. 1. The absence so far of broad-based inflation pressures The spike in inflation is so far largely the product of a relatively narrow group of goods and services that have been directly affected by the pandemic and the reopening of the economy. Durable goods alone contributed about 1 percentage point to the latest 12-month measures of headline and core inflation. Energy prices, which rebounded with the strong recovery, added another 0.8 percentage point to headline inflation, and from long experience we expect the inflation effects of these increases to be transitory. In addition, some prices--for example, for hotel rooms and airplane tickets--declined sharply during the recession and have now moved back up close to pre-pandemic levels. The 12-month window we use in computing inflation now captures the rebound in prices but not the initial decline, temporarily elevating reported inflation. These effects, which are adding a few tenths to measured inflation, should wash out over time. We consult a range of measures meant to capture whether price increases for particular items are spilling over into broad-based inflation. These include trimmed mean measures and measures excluding durables and computed from just before the pandemic. These measures generally show inflation at or close to our 2 percent longer-run objective (figure 3). We would be concerned at signs that inflationary pressures were spreading more broadly through the economy. 2. Moderating inflation in higher-inflation items We are also directly monitoring the prices of particular goods and services most affected by the pandemic and the reopening, and are beginning to see a moderation in some cases as shortages ease. Used car prices, for example, appear to have stabilized; indeed, some price indicators are beginning to fall. If that continues, as many analysts predict, then used car prices will soon be pulling measured inflation down, as they did for much of the past decade. This same dynamic of upward inflation pressure dissipating and, in some cases, reversing seems likely to play out in durables more generally. Over the 25 years preceding the pandemic, durables prices actually declined, with inflation averaging As supply problems have begun to resolve, inflation in durable goods other than autos has now slowed and may be starting to fall. It seems unlikely that durables inflation will continue to contribute importantly over time to overall inflation. We will be looking for evidence that supports or undercuts that expectation. We also assess whether wage increases are consistent with 2 percent inflation over time. Wage increases are essential to support a rising standard of living and are generally, of course, a welcome development. But if wage increases were to move materially and persistently above the levels of productivity gains and inflation, businesses would likely pass those increases on to customers, a process that could become the sort of "wage-price spiral" seen at times in the past. Today we see little evidence of wage increases that might threaten excessive inflation (figure 6). Broad-based measures of wages that adjust for compositional changes in the labor force, such as the employment cost index and the Atlanta Wage Growth Tracker, show wages moving up at a pace that appears consistent with our longer-term inflation objective. We will continue to monitor this carefully. 4. Longer-term inflation expectations Policymakers and analysts generally believe that, as long as longer-term inflation expectations remain anchored, policy can and should look through temporary swings in inflation. Our monetary policy framework emphasizes that anchoring longer-term expectations at 2 percent is important for both maximum employment and price stability. We carefully monitor a wide range of indicators of longer-term inflation expectations. These measures today are at levels broadly consistent with our 2 percent objective (figure 4). Because measures of inflation expectations are individually noisy, we also focus on common patterns across the measures. One approach to summarizing these patterns is the Board staff's index of common inflation expectations (CIE), which combines information from a broad range of survey and market-based measures. index captures a general move down in expectations starting around 2014, a time when inflation was running persistently below 2 percent. More recently, the index shows a welcome reversal of that decline and is now at levels more consistent with our 2 percent objective. Longer-term inflation expectations have moved much less than actual inflation or near-term expectations, suggesting that households, businesses, and market participants also believe that current high inflation readings are likely to prove transitory and that, in any case, the Fed will keep inflation close to our 2 percent objective over time. 5. The prevalence of global disinflationary forces over the past quarter century Finally, it is worth noting that, since the 1990s, inflation in many advanced economies has run somewhat below 2 percent even in good times (figure 7). The pattern of low inflation likely reflects sustained disinflationary forces, including technology, globalization and perhaps demographic factors, as well as a stronger and more successful commitment by central banks to maintain price stability. unemployment ran below 4 percent for about two years before the pandemic, while inflation ran at or below 2 percent. Wages did move up across the income spectrum--a welcome development--but not by enough to lift price inflation consistently to 2 percent. While the underlying global disinflationary factors are likely to evolve over time, there is little reason to think that they have suddenly reversed or abated. It seems more likely that they will continue to weigh on inflation as the pandemic passes into history. We will continue to monitor incoming inflation data against each of these assessments. To sum up, the baseline outlook is for continued progress toward maximum employment, with inflation returning to levels consistent with our goal of inflation averaging 2 percent over time. Let me now turn to how the baseline outlook and the associated risks and uncertainties figure in our monetary policymaking. The period from 1950 through the early 1980s provides two important lessons for managing the risks and uncertainties we face today. The early days of stabilization policy in the 1950s taught monetary policymakers not to attempt to offset what are likely to be temporary fluctuations in inflation. Indeed, responding may do more harm than good, particularly in an era where policy rates are much closer to the effective lower bound even in good times. The main influence of monetary policy on inflation can come after a lag of a year or more. If a central bank tightens policy in response to factors that turn out to be temporary, the main policy effects are likely to arrive after the need has passed. The ill-timed policy move unnecessarily slows hiring and other economic activity and pushes inflation lower than desired. Today, with substantial slack remaining in the labor market and the pandemic continuing, such a mistake could be particularly harmful. We know that extended periods of unemployment can mean lasting harm to workers and to the productive capacity of the economy. History also teaches, however, that central banks cannot take for granted that inflation due to transitory factors will fade. The 1970s saw two periods in which there were large increases in energy and food prices, raising headline inflation for a time. But when the direct effects on headline inflation eased, core inflation continued to run persistently higher than before. One likely contributing factor was that the public had come to generally expect higher inflation--one reason why we now monitor inflation expectations so carefully. Central banks have always faced the problem of distinguishing transitory inflation spikes from more troublesome developments, and it is sometimes difficult to do so with confidence in real time. At such times, there is no substitute for a careful focus on incoming data and evolving risks. If sustained higher inflation were to become a serious our tools to assure that inflation runs at levels that are consistent with our goal. Incoming data should provide more evidence that some of the supply-demand imbalances are improving, and more evidence of a continued moderation in inflation, particularly in goods and services prices that have been most affected by the pandemic. We also expect to see continued strong job creation. And we will be learning more about the Delta variant's effects. For now, I believe that policy is well positioned; as always, we are prepared to adjust policy as appropriate to achieve our goals. That brings me to a concluding word on the path ahead for monetary policy. The Committee remains steadfast in our oft-expressed commitment to support the economy for as long as is needed to achieve a full recovery. The changes we made last year to our today's challenges. We have said that we would continue our asset purchases at the current pace until we see substantial further progress toward our maximum employment and price stability goals, measured since last December, when we first articulated this guidance. My view is that the "substantial further progress" test has been met for inflation. There has also been clear progress toward maximum employment. At the FOMC's recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year. The intervening month has brought more progress in the form of a strong employment report for July, but also the further spread of the Delta variant. We will be carefully assessing incoming data and the evolving risks. Even after our asset purchases end, our elevated holdings of longer-term securities will continue to support accommodative financial conditions. The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test. We have said that we will continue to hold the target range for the federal funds rate at its current level until the economy reaches conditions consistent with maximum employment, and inflation has reached 2 percent and is on track to moderately exceed 2 percent for some time. We have much ground to cover to reach maximum employment, and time will tell whether we have reached 2 percent inflation on a sustainable basis. These are challenging times for the public we serve, as the pandemic and its unprecedented toll on health and economic activity linger. But I will end on a positive note. Before the pandemic, we all saw the extraordinary benefits that a strong labor market can deliver to our society. Despite today's challenges, the economy is on a path to just such a labor market, with high levels of employment and participation, broadly shared wage gains, and inflation running close to our price stability goal. Thank you very much. Journal of . . . . Orphanides, eds., . .

r210909a_FOMC

united states

Community Bank Access to Innovation

bowman

Thank you to the American Bankers Association for inviting me to address this year's Government Relations Council meeting. Although we had all hoped that this meeting would be in person, we will have to settle for the opportunity to convene virtually once again. As we do so, I continue to reflect on the way the pandemic has transformed businesses and sectors of the economy, much as it has changed life for all of us. Unfortunately, some aspects of the way we live and interact may be significantly altered for some time. But focusing on today, I will share some of my perspectives about the impact of the pandemic on the community bank sector and the potential of technology to help meet the challenges of this new environment. The financial services industry has experienced rapid technological change over the past few years, and there is no sign that this change will slow any time soon. Innovative technologies were already driving greater efficiency and creating opportunities for banks and their customers before the onset of the pandemic. In the past year and a half, these trends have accelerated, and I expect this level of performance to establish a new threshold of industry expectation. Let's look at education as another example of an industry that has been transformed. We saw schools throughout the country quickly leverage technology to shift to online learning last year. Schools implemented innovative technology solutions to continue curriculum, and to creatively engage students and build virtual student-teacher relationships. While the implications of a period of prolonged online learning are not yet clear, technology enabled the expansion of the range of learning alternatives and essentially prevented the American education system from grinding to a halt. Some of these new tools will likely continue to be used even as in-person instruction returned this fall. We are seeing service providers in a variety of industries leverage technology to engage with their customers--from education, to retail shopping, to fitness training and beyond. In the banking industry, technology continues to encourage new ways of interacting with and serving customers that can help banks meet the needs and preferences of their customers and communities. Such innovation creates important opportunities for banks of all sizes and business models. As regulators, it is also important that we monitor how banks are adapting and evolving in response to these changes, and that we offer insights and clear expectations to help banks manage associated challenges. Community banks continue to play a vital role in supporting local communities. Their ability to thrive in an increasingly digital landscape is critical to the economic well- being of those communities. Through my regular engagement with community bank leaders, I do see innovation thriving. When banks can be agile in developing relationships with third-party providers to meet unique customer needs, they can find their own paths to innovation. For example, community banks approach the evolving payment needs of tech savvy customers from many different angles. Their solutions include partnering with financial technology (or fintech) companies, developing peer-to- peer payment solutions with their core providers, and even hiring outside developers to create their own apps that will best serve customers' needs. While positive trends in community bank innovation are encouraging, I am also attuned to the challenges community banks face when seeking to innovate. I have heard from many community bankers about the constraints they face in taking advantage of new technologies--both in terms of the resources and the expertise required to adopt innovative technologies in a responsible manner. The cost of conducting due diligence on prospective partners can be high for community banks already facing capacity constraints. Seeking a partnership with a newly established fintech company may introduce additional complications. For example, a less experienced partner may be able to offer a product that fits a community bank's needs but may not understand the bank's regulatory obligations or have fully developed operational or compliance frameworks. Gaps in the ability to demonstrate or guarantee compliance can introduce risk that a community bank will need to fully understand and ultimately to manage. In December 2020, I spoke about several initiatives being pursued by the Federal Reserve targeted at promoting access to innovation for community banks and overcoming related challenges. Today I am happy to provide updates and announcements about those initiatives. I hope that each provides additional clarity and serves as a valuable resource to community banks as they pursue their own innovation strategies. The first initiative is the publication of a paper highlighting some of the promising ways that community banks are partnering with fintech companies. It lays out some important issues that banks must consider to maximize the effectiveness of the partnership. This paper is the product of an extensive outreach effort with community banks, fintechs, and industry stakeholders. It involved discussions focused on the strategic and tactical decisions that support effective partnerships in a responsible manner. Community banks engage in a range of partnerships with fintechs, each pursued for different reasons, with varying levels of investment of time and resources. The paper describes key partnership types and the associated benefits, risks, and challenges that community banks experience with each type. The paper also identifies fundamental considerations for effective partnerships as described by community bankers. Some valuable insights emerged from our outreach, which may benefit community banks at various stages of the innovation process. Two important themes stood out: the first is establishing trust and aligning with fintech partners, and second, building a long-term culture committed to innovation. Let me elaborate on each of these themes. In our outreach, bankers noted that it is critical for partnerships to be built upon a foundation of mutual trust and alignment of values. In some cases, due diligence efforts reveal that potential partners do not share the banks' values or objectives. One bank, for example, began discussions with a fintech company that could assist it with the bank's Paycheck Protection Program loan originations by providing a customer-facing application portal. After learning that this partner intended to sell the small business customer information it would obtain, the bank opted out of the partnership. Instead, the bank looked to other fintech partners with values more closely aligned with its own. Harnessing the full potential of technology innovation also requires a long-term, strategic commitment to innovation. Many bankers spoke of the importance of knowing exactly what new technology is solving for, building a team they trust, and securing buy- in from both senior management and the staff responsible for implementation. Bankers who have forged successful partnerships don't innovate for the sake of being innovative but instead have a clear vision of their goals. For example, one bank partnered with a fintech company to roll out limited banking services to teenagers. Its intention was to promote financial literacy among young people in the community and to prepare the bank to accommodate the preferences of a new generation. The bank also hired local college students to work with staff, combining the technological expertise of these more recent hires with the deep compliance background of the bank's long-standing employees. In addition to the paper, the Federal Reserve, Office of the Comptroller of the published a vendor due diligence guide to assist community banks with their risk assessment when considering a new relationship with a fintech. I have often heard from community bankers that the manpower and other costs related to due diligence are formidable barriers for banks seeking to establish new third-party relationships. A recent survey of community banks confirms that burdens related to due diligence are indeed an impediment to new third-party relationships, including those with fintechs. This guide was developed to help reduce these burdens by providing a practical resource for community banks when assessing the risks of potential fintech partnerships. This optional and customizable resource does not establish new regulatory expectations but it can serve as a starting point for banks in their due diligence process. A community bank can tailor how it uses the guide to meet its unique circumstances and the specific risk-management needs posed by each fintech relationship. A community bank can also share the guide with potential partners to help them understand the bank's risk-management requirements. Specifically, the guide contains relevant considerations, sources of information, and illustrative examples within six key areas of due diligence. These include, but, of course, are not limited to, business experience and qualifications, financial condition, and legal and regulatory compliance. I hope this guide will encourage responsible innovation that takes into account the range of potential risks of a partnership in addition to its potential benefits. While the Federal Reserve will continue to focus on developing resources for the community bank sector, it is also important to ensure that guidance is up to date, it supports the evolving range of partnerships, and it is consistent across all banking agencies. In July, the Federal Reserve, the OCC, and the FDIC published for comment proposed guidance for banks managing the risks of third-party relationships, including those with fintechs. This guidance should reduce unnecessary burden by eliminating variation in supervisory views. It is also my hope that this guidance will better address the landscape of the third-party relationships that exist today. I am particularly interested in hearing from a wide range of community banks on whether the guidance is clear, helpful, and appropriately calibrated to address the risks associated with these arrangements. The final topic for my remarks today is the use of artificial intelligence (AI). Through clear, consistent supervisory guidance combined with useful tools and resources, supervisors can continue to support community banks in their efforts to navigate an increasingly complex world. In pursuit of this goal, in March of this year, the agencies published a request for information on financial institutions' use of artificial intelligence. As part of this request for information, the agencies sought details about banks' challenges in developing, adopting, and using this technology, including those challenges related to third-party services. While we are still reviewing and processing the feedback, initial reactions from Federal Reserve staff indicate that these responses are very helpful in our consideration of next steps. So, I would like to thank those who provided comments in response to the agencies' request, especially those pertaining to the use of artificial intelligence by community banks. Comment letters confirmed our understanding that at times community banks choose to engage with fintech partners and their models to tap into the benefits of AI. We have also heard loud and clear that acting on an interagency basis to ensure regulatory consistency is very important. As we consider the information collected and the potential next steps, I will encourage Federal Reserve staff to continue exploring opportunities to provide supervisory clarity on this topic and more generally to consider ways to help community banks innovate in the application of new technologies. In conclusion, I welcome comments and feedback not only on the resources the Federal Reserve and other agencies have published recently but also regarding additional resources that may be helpful for community banks as they continue to pursue access to innovation. And in the coming weeks, I look forward to participating in two upcoming innovation-focused programs oriented toward community banks. The Federal Reserve will host an "Ask the Fed" program later this fall focused on community banks and service providers, and the Board and the Kansas City Reserve Bank will jointly host an Innovation Office Hours event later this month. Frequent and continued engagement with bankers, fintechs, and other third parties has demonstrated the nuance, complexity, and many considerations involved in promoting community bank access to innovation. It is my sincere intention that the community bank/fintech partnership paper, the vendor due diligence guide, and proposed third-party, risk-management guidance serve as a foundation upon which the Federal Reserve will continue to build.

r210924a_FOMC

united states

Introductory Remarks

powell

Nearly three years after we started holding Fed Listens events around the country, the program has proved to be even more valuable than we could have imagined. Its original purpose was to elicit broad feedback as part of our monetary policy framework review. However, the Fed has long viewed community outreach as a vital part of our economic understanding, and these discussions have delivered such value that Fed Listens has evolved to join the other regular staples of our outreach work. These events enable us to hear directly from people on the ground, at the heart of the sectors and industries you represent, from communities across the country, to add tone, contour and greater depth to the nation's economic portrait. These insights are particularly valuable as we move through this challenging and precedent shattering period. The speed and intensity of this downturn - and the rapidity of the recovery in many areas - are without modern precedent. I am very glad you could all join us today to offer your thoughts, and I want to thank you on behalf of the entire Federal Reserve System for both your presence today and for your continued feedback and participation. Some of the issues you are confronting are shared across sectors, while others are unique to your fields. Most of you are contending with changed workplaces, from safety protocols whose half-lives are unclear to fundamental shifts in how your industries operate, in everything from feeding people to how movies are released. Business plans have been reworked, outlooks have been revised, and the future continues to be tinged with uncertainty. While uncertainty often results in immobility for businesses, it can also spell opportunity, and the creativity and adaptability on display over the past 18 months have been among the few bright spots. I have been amazed and inspired by the flexibility and ingenuity, particularly that of small businesses, in shifting to meet the demands of a new reality. All of us are very much looking forward to the discussion today. You provide a wealth of information by sharing your experiences and those of your colleagues, customers, and communities. That has always been crucial in how we conduct monetary policy but means even more in extraordinary times such as these. I want to thank you again for providing that insight and look forward to the conversation.

r210927a_FOMC

united states

Navigating Delta Headwinds on the Path to a Full Recovery

brainard

It is a great honor to join the community of NABE Fellows, and I want to express my appreciation to the Board of Directors of NABE. Given the unprecedented nature of the pandemic shock, it should be no surprise that the recovery is not proceeding in a straight line. The economy continues to make welcome progress, but the Delta variant has been more disruptive than initially expected. The headwinds from Delta are a reminder that the virus continues to pose downside risks to the outlook. Delta highlights the importance of being attentive to economic outcomes and not getting too attached to an outlook that may get buffeted by evolving virus conditions. Indeed, Delta disrupted both demand and supply. Many forecasters have downgraded consumer spending in the second half of the year, as Delta has limited the acceleration in services spending that had been anticipated to help offset the drag on activity from fiscal support shifting from being a tailwind to a headwind. Although the retail sales print for August was stronger than expected, the level of spending in August was not much changed from June. High-frequency data indicate that consumption of discretionary services, such as restaurants and travel, stalled or may have even moved lower in some categories since July. This development doesn't appear to be sensitive to regional variations in vaccinations, perhaps reflecting the high transmissibility of Delta. For example, the consumption of food services has declined recently even in states with relatively high vaccination rates and low case counts. Delta has also prolonged supply bottlenecks. Single-family home construction permits declined again in August for the third consecutive month despite very strong housing demand, as builders faced shortages of materials. Auto production was paused at a number of North American plants in early September following COVID-induced shutdowns of semiconductor production in Malaysia and Vietnam. Industry contacts have highlighted the unusually low elasticity of global shipping such that COVID- induced port closures in China ripple through the interdependencies in shipping supply chains and magnify backlogs. All told, private sector forecasters have revised down growth projections for 2021 over recent months by slightly more than 1 percentage point on average. Even with this Delta downgrade, I anticipate that growth this year and next will be sufficient such that by the end of next year, average annual growth since the onset of the crisis should exceed pre-crisis trend growth. The strength of the recovery despite the unprecedented challenges associated with COVID reflects powerful fiscal and monetary support and the resilience of American workers, businesses, and households. Delta has also slowed progress on employment. Payroll gains in leisure and hospitality unexpectedly fell to zero in August following average monthly gains of 375,000 over the previous three months. Delta-induced spending declines for travel, recreation, and other discretionary services likely reduced the intensity with which employers in these industries sought new hires. The data reported by "Indeed" show job openings moving sideways from July through August before edging up again in early September. Similarly, the number of households reporting in the Current Population Survey that they were unable to work because their employer closed or lost business due to COVID ticked up in August after falling significantly through July. As of the end of August, payroll employment remains over 5 million below pre- COVID levels and nearly 8 1/2 million below where it would have been in the absence of COVID. Roughly one-third of the gap to pre-COVID employment levels is concentrated in the frontline leisure and hospitality sector. While the headline unemployment rate declined to 5.2 percent in August, the unemployment rate adjusted for COVID-related nonparticipation remained elevated at The employment-to-population (EPOP) ratio for prime-age workers stood at 78 percent in August--2.4 percentage points below its pre-COVID level. So overall, the labor market is making progress, although at a slower pace than earlier in the year. Relative to December, payrolls have closed nearly 50 percent of their gap to pre-COVID levels and the prime-age EPOP ratio has closed around 40 percent of the gap to pre-COVID conditions. In contrast, the labor force participation rate of 61.7 percent in August has shown little progress so far. Some observers argue that labor force participation has moved permanently lower, and the labor market is already tight, such that we should not expect a return to pre-COVID employment conditions. But the decline in labor force participation appears to reflect COVID-related constraints that have been prolonged by Delta rather than permanent structural changes in the economy. For instance, the number of respondents to the Census Household Pulse Survey indicating they were not working due to either being sick with COVID or caring for someone sick with COVID more than doubled between late July and early September, returning to levels seen early this year. While I am hopeful for improvements in the September employment report with the return to in-person education, the effects of Delta have likely prolonged caregiving constraints. For example, through last week there had been just over 2,000 school closures for COVID across nearly 470 school districts in 39 states. While the disruptions last just under six days on average, the possibility of further unpredictable disruptions could cause some parents to delay their plans to return to the labor force. Similarly, COVID-related challenges have reduced the availability of day care, preschool, and after-school care, further complicating parental return-to-work decisions. Research has shown that the pandemic has taken a significant toll on the labor market status of many mothers, particularly Black and Hispanic mothers, mothers with younger children, and mothers with lower incomes. With record-high job openings and an unemployment rate just above 5 percent, the headline vacancy-to-unemployed (V/U) ratio has risen above 1 vacancy per job seeker and is now at pre-pandemic levels. Some cite this ratio of job openings to job seekers as indicating we are close to full employment. But virus conditions may be driving an important wedge between labor supply in the near term relative to the medium term. It is instructive to consider the period 2017 to 2019 when the V/U ratio remained in a tight range around a value of 1.2, similar to its July value. Although prime-age unemployment declined by less than half a percentage point over this period, that modest decline was accompanied by a 2 million increase in the prime-age labor force, which raised the prime-age EPOP ratio about 1 1/2 percentage points. So, the headline V/U ratio may not be as informative when there are substantial lags in the recovery of labor force participation. Lagging participation is likely to be particularly important currently, in the presence of COVID constraints such as fears of contracting the virus and caregiving responsibilities. While these constraints have been prolonged by the Delta variant, they are not permanent or structural. Therefore, it is more informative to rely on a V/U ratio that adjusts the unemployment rate for pandemic- related nonparticipation and misclassification. After adjusting for pandemic-related nonparticipation, the ratio of job openings to job seekers was about 0.85 in July--nearly one-third below the headline ratio--and similar to levels last seen between 2014 and 2016--suggesting there is ample room for a full recovery in employment. The assertion that labor force participation has moved permanently lower as a result of a downturn is not new. Indeed, it has been a regular feature of the early stages of recent recoveries. Research demonstrates that the labor force participation rate cycle lags that of the unemployment rate by years. So, it is important to consider indicators beyond the headline unemployment rate when assessing progress toward maximum employment, as participation gains might come late in the recovery for some groups. For these reasons, I see no reason employment should not reach levels as strong or stronger than before the pandemic. Next let's consider price stability. Inflation is currently elevated. This is creating challenges for consumers and businesses alike. But the high inflation readings from the spring and early summer were disproportionately driven by a few sectors experiencing specific supply bottlenecks. In May and June, new and used vehicle prices accounted for half of the outsized monthly increases in core consumer price index (CPI) inflation. These categories were lesser contributors in July, and in the August CPI their joint contribution declined to essentially zero, as prices finally began to retreat for used cars, offsetting increases in new car prices. I am closely monitoring incoming data for any indications that the breadth of inflation pressures is rising. Twenty-four-month core personal consumption expenditures (PCE) inflation provides one approach to smoothing through the distortions from the pandemic: It is estimated to have been 2.5 percent in August, above the 2 percent target, but well below the 12-month measure. The Dallas trimmed mean inflation measure provides another indicator of the breadth of inflation pressures: It came in at 2.0 percent in July--well below the 12-month measure of core PCE inflation. The currently elevated level of inflation is driven by COVID-related disruptions. As these COVID-related disruptions subside, most forecasters expect inflation to move back down toward the Federal Reserve's 2 percent long-run objective on its own. That is the sense in which currently high inflation is likely to be transitory. In that regard, the August monthly CPI reading was the first month with a notable retrenchment among COVID-sensitive categories like hotels, used cars, and rental cars. So, I expect inflation to decelerate, and pre-COVID inflation dynamics to return when COVID disruptions dissipate. But with Delta disrupting the rotation from goods to services and prolonging supply bottlenecks, it is uncertain just how fast and how much inflation will decelerate over the remainder of the year and into next year. Therefore, I am monitoring a few upside risks closely. First, while rent and owners' equivalent rent both rose a moderate 0.3 percent in the August CPI data, if housing services inflation moved up substantially more than expected, it could provide durable upward pressure on inflation. Second, there is a risk that goods prices may not decelerate and return to pre- COVID trends as is widely expected, for instance, if excess savings or disruptions to services result in persistently elevated goods demand. Third, I will be watching for any signs that wage gains are feeding into higher inflation more broadly, but the evidence so far suggests that wage gains are broadly in line with productivity growth, and the labor share of income remains low relative to historical levels. To date, high markups and non- wage input costs appear to be more notable contributors to inflation than wage pressures. Finally, I am vigilant for any signs that the current high level of inflation might push longer-term inflation expectations above levels consistent with our 2 percent inflation objective. Market-based measures of inflation compensation suggest inflation expectations remain well anchored. For instance, the five-year, five-year-forward CPI inflation compensation measure based on Treasury Inflation-Protected Securities has remained range bound around 2.2 percent since declining about 0.2 percentage point in June--consistent with the FOMC's 2 percent objective for PCE inflation. Survey-based measures also suggest longer-run expectations remain well "in August 2021 consumers' five-year ahead inflation expectations were as well anchored as they were two years ago, before the start of the pandemic." Longer-term inflation expectations in the University of Michigan Survey of Consumers have moved mostly sideways in the past four to five months, and the current reading of the Federal Reserve Board index of common inflation expectations remains well within the range that prevailed before 2014. While one-year ahead measures in the SCE and the Michigan survey have seen large increases, these short-term measures tend to move with consumers' experience of contemporaneous inflation. So what do these developments imply for the path ahead? One clear lesson is that we need to be humble about our ability to correctly anticipate future economic conditions given the unpredictability of the virus. We had expected a smooth rotation from goods spending to services spending during a complete reopening this fall, but Delta has slowed this process. Partly as a result, employment gains flatlined in August in the leisure and hospitality sector, where many of the job losses have occurred. As a result of Delta, the September labor report may be weaker and less informative of underlying economic momentum than I had hoped. Payroll employment is now between 5 and 8 1/2 million short of where it would be in the absence of the pandemic. The unemployment rate adjusted for pandemic-related nonparticipation is 7.5 percent. Employment is still a bit short of the mark on what I consider to be substantial further progress. But if progress continues as I hope, it may soon meet the mark. While inflation has been well above target for the past six months, affecting consumers and businesses alike, it previously spent roughly a quarter century below 2 percent. There are good reasons to expect a return to pre-COVID inflation dynamics due to the underlying structural features of a relatively flat Phillips curve, low equilibrium interest rates, and low underlying trend inflation. While the playbook for guiding inflation back down to target following a moderate overshoot is well tested and effective, experience suggests it is difficult to guide inflation up to target from below. Once COVID constraints recede, I see no reason the labor market should not be as strong or stronger than it was pre-pandemic. The forward guidance on maximum employment and average inflation sets a much higher bar for the liftoff of the policy rate than for slowing the pace of asset purchases. I would emphasize that no signal about the timing of liftoff should be taken from any decision to announce a slowing of asset purchases. We have learned this summer that it is important to remain highly attentive to the data and to avoid placing too much weight on an outlook that remains highly uncertain. In implementing policy step by step, we must remain faithful to our new framework and attentive to changing conditions in order to ensure sufficient momentum as fiscal tailwinds shift to headwinds to achieve our maximum employment and inflation goals.

r210928a_FOMC

united states

Creating a New Model for the Future of Supervision

bowman

Good afternoon. I'm pleased to be able to join you again virtually for this year's research and policy conference. Although I think we would all prefer to be together in person, in the shadow of the St. Louis Arch, I'm optimistic that next year (which will be the 10 anniversary of the conference, by the way) will give us the opportunity to finally gather in person after a two-year hiatus. For nine years, this conference, which brings together researchers, regulators, and community bankers, has enabled us to hear from top academics around the world who conduct research to help us better understand the community bank business model. It's not an accident that this conference is sponsored by three agencies involved in the and the FDIC--as the work of this conference has informed, and will continue to inform, how we think about the supervision of our nation's community banks. Our conference sponsors entered this partnership with the belief that what we learn here will deepen our understanding of the benefits of, and the challenges facing, the community bank business model, which, in turn, helps to make us better bank supervisors. It's natural then to ask: What have we learned from this conference that is applicable today? What might we apply in the future to the supervision of community To answer that question, or quite frankly, to answer many questions that pertain to the regulation and supervision of banks, it's instructive to first go back a bit in history. In this case, I'd like to take you all the way back to. . .2019. Seems like a lifetime ago. Way back then, we were concerned about liquidity. Banks were concerned about a potential run-off of deposits as consumers found new, more technology-centric ways to manage their money, often outside of the insured banking system. Although we also saw a decline in technology costs that enabled banks of all sizes to offer a wider array of digital products and services to their customers, the innovation taking place outside the banking sector was often seen as outpacing the innovation in the banking sector. Consumers seemed to increasingly weigh convenience over safety, as a number of non-banks increased their market share. To a lesser degree, but still concerning, was that of the convenience factor. It drove some small business borrowers to move away from lenders with whom they had longstanding relationships. In some cases, those borrowers were even willing to pay much more for credit for the sake of convenience. Unfortunately, some borrowers learned the hard way that convenience does not always outweigh a banking relationship--particularly when a business or community experiences a significant hardship such as a natural disaster. I regularly heard stories of how small businesses that borrowed from an online lender were unable to reach anyone to discuss their situation during a crisis and ultimately had their loans called because of missing a payment. In these situations, I also heard stories of how the local community bank that understood the local situation and wanted to see the business and the community survive, would step in, and refinance the original loan to help the small business return to more normal operations. I also heard about challenges with core processors and how legacy contracts and a lack of competition for core processing services was stifling innovation. We saw several fintechs become "mainstream" nationally, and we saw a proliferation of technology solutions targeted at helping community banks become nimbler in adding new products and services. From a supervisory perspective, the Federal Reserve actively explored ways to reduce regulatory burden and provide greater transparency into the work of bank supervisors. Using research presented in prior years at this conference, we applied findings showing the disproportionate regulatory burden borne by our smallest institutions and looked across our processes to find ways to tailor our supervisory model to more accurately reflect the risk posed by these smaller financial institutions. And then came March 2020 and the arrival of the COVID-19 pandemic in the Despite the many choices consumers have for managing their money and purchases outside of the traditional banking system, we witnessed a systematic flight to the safety of FDIC-insured deposits in state or nationally chartered banks. Specifically, total deposits at all FDIC-insured institutions increased by 22 percent when comparing deposit data from 2019 to 2020. Small business lending also increased significantly. From the end of 2019 to the end of the second quarter of 2020 alone, small loans to businesses at community banks, a proxy for small business lending, increased by 39 percent. The Impact of the PPP during the Pandemic One driver for the increase in small business lending was, of course, the Small by the U.S. Treasury Department through forgivable loans that enabled small businesses to maintain payroll, retain employees who may have been laid off in response to the social distancing protocols that went into effect in April 2020, or to cover other overhead costs. To support the PPP, the Federal Reserve provided a liquidity backstop to PPP recognition of the evolution in the banking landscape that I referenced a few moments ago, the PPPLF was designed to not only provide a liquidity backstop to banks and credit unions, but also to serve non-bank fintechs, community development financial institutions, and agricultural finance companies that participated in the PPP. Given the important role minority-owned banks play in the allocation of credit in their communities, the Federal Reserve also actively engaged minority depository institutions to ensure they had the tools they needed to benefit from the Fed's emergency liquidity programs. To be sure, the PPP and the PPPLF will provide significant research material for years to come. I understand from reviewing the papers accepted into this year's proceedings that it has already driven the work of several economists you'll be hearing from over this two-day conference. In reviewing the data on these programs, however-- Transformational Trends" program--we see that a substantial majority of PPP loans, nearly 73 percent, were made by insured depository institutions. These loans also accounted for nearly 90 percent of the aggregated loan amount for all PPP loans. Getting a bit more granular, we can see that community banks made 32 percent of all PPP loans while large banks made 35 percent of all PPP loans, with credit unions and savings banks accounting for the rest of the loans made by banking institutions. Fintechs accounted for approximately 13 percent of all PPP loans and more than half of those were made as a result of a partner bank relationship. offers additional detail on the roles these different types of lenders played in allocating credit through the PPP during the pandemic. The authors found Community banks originated the majority of PPP loans when the program first launched, while large banks were the majority lender during the second phase of the program. Community banks provided more loans to middle income borrowers while large banks provided more PPP loans to upper income borrowers. Community banks and large banks made loans to lower and moderate-income borrowers in approximately equal proportions. Fintech firms, on the other hand, made more loans in zip codes with fewer bank branches, lower incomes, and larger minority populations. The authors also found that fintech lending, instead of taking market share from traditional banks, mostly expanded the overall supply of credit and other financial services. From my perspective, these findings offer evidence of the continuing importance of community banks to our economy during both "normal" times as well as during times of extreme financial stress. Or, to paraphrase Mark Twain, "reports of the demise of community banks are greatly exaggerated." The NBER paper also highlights how new entrants to banking can meet an unmet need. The experiences of banks and bank supervisors during the pandemic also offer insights into how we should think about the Federal Reserve's approach to supervision in the future. For the remainder of my talk, I will offer my thoughts on a key principle that I believe should guide our thinking: The future of community banking and the future of banking supervision are deeply interconnected. My earlier comments should not be interpreted as suggesting that there aren't real challenges facing the community bank business model. But I am suggesting that new technologies, new entrants into banking, and changes in customer preferences that have led to predictions about the end of the community banking business model simply have not been substantiated. If anything, this conference has highlighted that the diversity in business models of small financial institutions is an essential part of our economy. There is strength in being small that enables institutions to know their customers on a much deeper level. Small financial institutions can quickly customize products and services to address their customers' needs and, in some cases, they can leverage the flexibility of their business models to take advantage of new business opportunities. This flexibility allows banks to maintain strong relationships with customers--particularly those customers who don't fit a "typical" borrower profile. It also explains why community banks have a long history of providing essential financial services to households, small businesses, and small farms in communities across the country. During the pandemic, I personally began speaking to the leaders of the more than 650 state member community banks in the Federal Reserve's supervisory portfolio. The conversations to date have provided important regional insights and perspectives that can only be gleaned from leaders who know their markets and customers at a very deep level. While I heard that lobby traffic was down and that lending opportunities were not as robust as they once were, I mostly heard optimism. I heard that the value proposition of the traditional community bank was on full display in many communities, urban and rural. I heard that bank business customers needed bankers who truly knew them and their businesses, and who could work with them to provide the customized support they needed during that time of great uncertainty. As banks changed to meet the challenges of the pandemic, we asked ourselves at the Federal Reserve, do bank supervisors need to change? By necessity, the immediate answer, of course, was "yes." The Federal Reserve did so by pausing all on-site exams and using technology that enabled us to remotely supervise the safety and soundness of our institutions as well as monitor their compliance with relevant consumer compliance laws and regulations. To be sure, we adjusted our supervisory expectations accordingly based on the guidance we were providing banks. We also greatly expanded our outreach and engagement with financial institutions. We deployed the full range of communications tools that we've developed over many years to provide banks with real-time information on supervisory expectations as well as the emergency lending programs that were put in place to forestall any systematic deterioration in the health of our financial system. As evidenced by the continued strength of bank balance sheets and the general absence of bank failures during the pandemic, I think we can confidently say that the actions of banks, bank supervisors, and policymakers during the pandemic allowed us to avoid the challenges that plagued our banking system during 2008 financial crisis. The pandemic heightened our awareness of this important linkage between banking and supervision. Had we not tailored our supervisory approach during the pandemic, I believe the impact on our banks, our economy, and on consumers would have been much more severe. From the beginning, we worked closely with our federal and state counterparts-- many of whom are represented at this conference--to develop a sense of joint action and to agree to work together in a holistic way. I knew from my experience as both a community banker and a state bank regulator, that we needed to avoid overreacting and instead approach supervision in a more measured way that allowed banks the flexibility to work with their customers. We needed to empower banks to manage those key relationships in their loan portfolios in a way that was beneficial to their customers without exposing the banks to risk. What we saw, as a result of this approach, is that the industry made responsible decisions that kept credit flowing throughout the pandemic and enabled businesses across the U.S. to continue operating. But the question remains: how should supervisors, and banking supervision itself, apply what we learned going forward? During the pandemic, we changed our supervisory approaches based on necessity, but now we need to look ahead and make sure that we're adjusting our supervisory model in ways that allow banks greater flexibility to innovate to compete in today's quickly evolving banking environment-- without sacrificing important consumer protections or the health and safety of our banking system. To start, we must acknowledge the interconnectedness of the future of banking and the future of bank supervision. Supervision has to evolve because the banking industry is evolving. Available technology, analytical capabilities, and customer and workforce preferences are driving this evolution in how financial sector products and services are delivered. We recognize that our workforce, processes, and technology must align with these changes to ensure that an effective, transparent, and timely supervision program is maintained. Therefore, the Federal Reserve is embarking on an initiative to investigate the implications of these changes for the Federal Reserve's Supervision function. The goal of this initiative is to ensure our supervisory approaches accommodate a much broader range of activities while ensuring we don't create an unlevel playing field with unfair advantages, or unfair disadvantages, for some types of firms versus others. This will include investigating technology and innovative business practices that increase our agility and efficiency. Innovation is a way of life for banks, it should be for supervisors as well. But we must do this in a way that also preserves what we know works and what we learned can work during the pandemic. Before sharing my views on the underlying principles that need to guide our thinking on our future supervisory approaches, I'll first offer some thoughts on a few aspects of Federal Reserve supervision that I believe must be preserved even as we think expansively about the future: The first being the Federal Reserve's Supervisory structure. Although the Fed's supervision and regulation of banks is the responsibility of the Board of Governors, the day-to-day supervision of banks is delegated to the Reserve Banks. This distributed system ensures we have most of our examination workforce living and working in the same communities served by our community banks. This structure, perhaps more importantly, gives our examiners deep insights into thousands of local economies across the U.S. and helps us understand the local industries that are vital to the long-term health and success of these communities. This local knowledge is what enables our examiners to tailor our supervision of institutions based not only on the complexity of the bank but based on the unique characteristics of the industries they support. The second is the Federal Reserve's direct outreach and engagement with banks and financial institutions. Since the 2008 financial crisis, the Federal Reserve has built an extensive communications infrastructure--through national programs, such as (r), and though hundreds of local Reserve Bank programs--to share important supervisory and regulatory information with banks. The goal was simple: provide a mechanism that enables us to quickly share information and perspectives with institutions outside of the exam process, provide timely and accurate responses to questions, and give the banks the tools they need to meet our supervisory expectations. I believe supervision works best when supervisors clearly communicate their expectations with banks--there shouldn't be any "surprises" about our expectations during an exam. In my calls with bankers, I'm reminded that one of the biggest sources of regulatory burden is regulatory and supervisory uncertainty. By clearly communicating our expectations, by engaging the industry directly to understand the impact of these expectations and, when appropriate, providing banks with tools and resources to meet those expectations, we reduce uncertainty for banks. We continued to expand our communication approach this past July with the SCALE tool. SCALE gives community banks a tangible tool to help with their calculation of loan loss allowance under the Current Expected Credit Losses methodology. Our effort to identify simple and practical ways to implement CECL that would help reduce costs and complexity for smaller community banks was supported by the Financial Accounting Standards Board. The launch of SCALE represents a significant cultural shift in how we intend to supervise in the future: when there is significant uncertainty around a new regulation, supervisory expectation, or practice, we will look beyond our traditional communications tools to find innovative ways to reduce that uncertainty. So, what will this new approach to supervision look like and what principles will guide us? First, we must maintain a firm commitment to preserving the stability, integrity, functionality, and diversity of our banking system. Second, we must maintain consumer protection as we innovate and ensure that banks can safely offer financial products and services that consumers demand and are uniquely tailored to their circumstances and goals. Third, as we adjust our supervisory approach, we must avoid adding new burdens on banks, particularly on those that maintain a more traditional business model. We must be consistent in how we view similar activities at similar institutions, but our approach must also allow for de novo banks and allow for greater innovation at our nation's banks. And we need to continue to provide examiners with the ability to tailor their expectations based on the risks posed by individual institutions. We must move even further beyond the "one size fits all" supervisory model that defined our approach in the past. Fourth, we must enhance transparency around our supervisory expectations for safety and soundness and consumer compliance matters and be timelier in our feedback to banks. We must fully leverage our distributed structure to delegate decision making to our Reserve Banks, without diminishing the Board's important policymaking and oversight role over the supervision of banks. And fifth, we must ensure that we are always able to adjust our supervisory expectations effectively and efficiently as conditions warrant to enable banks to be more flexible in serving their communities and in providing credit to the areas of our economy that most need it. When I spoke at this conference in 2019, I discussed a number of very practical problems that we needed to solve. These included understanding how technology, competition, regulation, and other factors drive industry consolidation, quantifying the benefits community banks provide to their communities, and defining the full economic effects a community bank has on its community. As we move forward with modernizing our supervisory approach, these questions remain at the forefront of our thinking. But, based on our experiences of the past few years, we also have a number of new questions that we'll need to address if we are to be successful. For example, what do banks see as the most transformative technological innovations that will drive changes to their business models? How do banking institutions prefer to interact with their supervisors, and what do they think makes for a successful relationship between the supervisor and the supervised? The factors that are identified through this initiative as having the greatest potential influence on future bank business models will vary based on several factors, including size, complexity, geography, staff capacity, and business strategy, but, taken together, they will give us important insights into how we, as bank supervisors, might need to evolve our supervisory practices as the bank business model evolves. And as we consider our own evolution in the face of these changes, we will need to ask ourselves: What changes to the Federal Reserve System Supervision function's workforce, processes and technology are necessary to execute our supervisory activities given the factors affecting the industry? How should the Federal Reserve structure its supervisory activities across its portfolios of supervised firms? Where are we aligned across the Supervision function in conducting our work? Where might we be out of alignment? Should innovations in technology, such as artificial intelligence, be used to better accomplish supervision? In the future, I look forward to sharing our progress on this initiative and providing specific examples of how our supervisory practices are evolving alongside those of the industry. Times of crisis, such as the COVID-19 pandemic, provide us a unique opportunity to see how our banking system operates under stress--and to see both the strengths of our current system of supervision as well as opportunities for improvement. The lessons we learned over the past 18 months, supported by research from this conference and from other sources, offer important lessons on how we can appropriately evolve our supervisory approaches. What we learn over the next two days from the researchers, policymakers, and community bankers presenting during this year's conference proceedings will factor into our overall thinking as we embark on this journey to modernize our supervisory practices and develop new supervisory approaches that can meet the needs of today, and the challenges of tomorrow.

r211005a_FOMC

united states

Goodbye to All That: The End of LIBOR

quarles

Now that business travel has started to pick back up as we emerge from the COVID event, a prosaic but insistent problem has reappeared: what to read on a long plane flight. Like most of you, I try to get some work done--but, also like most of you, out of an amalgam of security concerns and indolence, I often don't succeed. Something must improve the hours, but Kant is a little heavy, P.G. Wodehouse a little light, and T.S. Eliot looks like you're just showing off. So, over the last few weeks, I've been re- reading Joan Didion while making my way from point A to point B: , , and . As it turns out, Joan Didion is a particularly apt author to be reading on the way to this conference--not because the conference is being held in Las Vegas, although her four-page summation of this "most extreme and allegorical of American settlements" is a classic. But rather, because a nearly constant theme of her writing is change: how hard it is to recognize that things have changed; how hard it is to come to terms with it once recognized; how insistent people can be that surely, they will be OK. And given that introduction, I'm sure you have now guessed what I intend to talk to you about today: LIBOR, the benchmark formerly known as the London Interbank Offered Rate. LIBOR was the principal benchmark used to set interest rates for a vast number of commercial loans, mortgages, securities, derivatives, and other products. For a number of years--certainly at least since July of 2017, and really for several years before--it has been clear that LIBOR would end, but some believed it was not clear exactly when LIBOR would end. And, as a result, many market participants have continued to use LIBOR as if that end date would surely be in some indefinitely distant future, as if LIBOR would remain available forever. Earlier this year, however, things changed, and changed significantly. Two things happened which together make clear that LIBOR will no longer be available for any new contracts after the end of this year, just 86 days from now. First, the United Kingdom's Administration (IBA), which administers LIBOR, announced definitive end dates for So, now there was a definitive and immovable date fixed for the end of LIBOR. However, the second thing that happened made clear that long before that end date in 2023, LIBOR would not be available for any new contracts after the end of this year. Following the FCA and IBA announcements about the end of LIBOR, the Federal Reserve and other regulators published guidance making clear that we will focus closely on whether supervised institutions stop new use of LIBOR by the end of this year--86 days from now. If LIBOR will not be available for new contracts, what is the point of IBA continuing to provide USD LIBOR quotes until mid-2023? Those LIBOR quotes will allow many existing contracts to mature according to their terms, thus greatly reducing the costs and risks of this transition. Otherwise, many banks would have had to re- negotiate hundreds of thousands of loan contracts before December 31, an almost impossible task. But the whole process only works if no new LIBOR contracts are written while the legacy contracts are allowed to mature. So, those new LIBOR contracts will not be made. Change is difficult, but it is inescapable. LIBOR was intended to be a measure of the average interest rate at which large banks can borrow in wholesale funding markets for different periods of time, ranging from overnight to one month, three months, and beyond. LIBOR is an unsecured rate, which means that it measures interest rates for borrowings that are made without collateral and therefore include some credit risk. At first blush, it may seem peculiar that a borrowing rate for banks in London has been used so widely. Why, for example, are more than $1 trillion of residential mortgages in the United States tied to LIBOR? The answer is that, over time, LIBOR's pervasiveness became self-reinforcing. Lenders, borrowers, and debt issuers relied on LIBOR because, first, everyone else used LIBOR, and second, they could hedge their LIBOR exposures in liquid derivatives markets. Today, USD LIBOR is used in more than $200 trillion of financial contracts worldwide. Federal Reserve officials have described LIBOR's flaws on numerous occasions. The principal problem with LIBOR is that it was not what it purported to be. It claimed to be a measure of the cost of bank funding in the London money markets, but over time it became more of an arbitrary and sometimes self-interested announcement of what banks simply wished to charge for funds. That might not have become such a debacle had it been clear to everyone what the ground rules were, but the ground rules for LIBOR were anything but clear. As a result of subsequent changes to the process, LIBOR panel banks now provide evidence of actual transactions where possible. A fundamental problem, however, is that LIBOR has been unable to separate itself from its perception as a measure of bank funding costs, yet the market on which LIBOR is based--the unsecured, short-term bank funding market--dwindled after the 2008 financial crisis. This means that, for many LIBOR term rates, banks must estimate their likely cost of such funding rather than report the actual cost. Many LIBOR panel banks are uncomfortable estimating their funding costs in producing a benchmark perceived by many to measure actual funding costs. As a result, the great majority of the panel banks have determined that they will not continue participating in the process. This is why the FCA and IBA have announced definitive end dates for LIBOR. I should note here that regulators have warned about LIBOR-related risks for international Financial Stability Board, which I currently chair, expressed concern that the decline in unsecured short-term funding by banks could pose serious structural risks for unsecured benchmarks such as LIBOR. To mitigate these risks and promote a smooth transition away from LIBOR, the Federal Reserve convened the Alternative As I will describe further in a moment, the ARRC has worked to facilitate the transition from LIBOR to its banking organizations we regulate noting that, after 2021, the use of LIBOR in new transactions would pose safety and soundness risks. Accordingly, we encouraged supervised institutions to stop new use of LIBOR as soon as is practicable and, in any event, by the end of this year. The letter also noted that new contracts entered into before December 31, 2021, should either use a reference rate other than LIBOR or have robust fallback language that includes a clearly defined alternative reference rate after LIBOR's discontinuation. Recently, a number of institutions have asked what would qualify as "new" use of LIBOR after 2021. We are working with other agencies to provide additional guidance about this issue. In my view, however, "new" use of LIBOR would include any agreement that creates additional LIBOR exposure for a supervised institution or extends the term of an existing LIBOR contract. Earlier this year, the Federal Reserve issued another supervisory letter that provided guidance concerning supervised institutions' LIBOR transition plans. As the end of LIBOR approaches, Federal Reserve examiners have intensified their focus on supervised institutions' transition planning. In general, institutions of all sizes have acknowledged year-end as the stop date for new LIBOR contracts and are operationally prepared to offer alternative rates. However, based on data from the second quarter of 2021, we estimate that large firms used alternative rates for less than 1 percent of floating rate corporate loans and 8 percent of derivatives. To be ready for year-end, lenders will have to pick up the pace, and our examiners expect to see supervised institutions accelerate their use of alternative rates. A handful of firms have said that they may want more time to evaluate potential alternative rates. There is no more time, and banks will not find LIBOR available to use after year-end no matter how unhappy they may be with their options to replace it. I would note that the ARRC has been publishing tools to facilitate the use of SOFR for almost four years. SOFR is a broad measure of the cost of borrowing cash overnight, collateralized by Treasury securities. It rests on one of the deepest and most liquid markets in the world. It is calculated transparently by the Federal Reserve Bank of New York, engendering market confidence. And it can be used for all types of transactions. Notably, the ARRC recently recommended SOFR term rates, which will facilitate the transition from LIBOR to SOFR for market participants who wish to use a forward- looking rate. Given the availability of SOFR, including term SOFR, there will be no reason for a bank to use LIBOR after 2021 while trying to find a rate it likes better. This is especially true for capital markets products. As I described recently in remarks to the Financial Stability Oversight Council, it is critical that capital markets and derivatives markets transition to SOFR. Market participants have expressed nearly universal agreement that this is the right replacement rate for such products. ARRC did not recommend any other rate for capital markets or derivatives, and market participants should not expect such rates to be widely available. Loans, however, are different from derivatives and capital markets products, and raise different issues. With respect to loans, the Federal Reserve, OCC, and FDIC issued a letter last year explaining that we have not endorsed a specific replacement rate. have not changed that guidance. A bank may use SOFR for its loans, but it may also use any reference rate for its loans that the bank determines to be appropriate for its funding model and customer needs. But a bank will not find LIBOR available after year-end, even if it doesn't want to use SOFR for loans and hasn't chosen a different alternative reference rate. Reviewing banks' cessation of LIBOR use after year-end will be one of the highest priorities of the Fed's bank supervisors in the coming months. If market participants do use a rate other than SOFR, they should ensure that they understand how their chosen reference rate is constructed, that they are aware of any fragilities associated with that rate, and--most importantly--that they use strong fallback provisions. To conclude, I emphasize that market participants should be ready to stop using LIBOR by the end of 2021. One-week and two-month USD LIBOR will end in only 12 weeks. The remaining USD LIBOR tenors will end in mid-2023, but the LIBOR quotes available from January 2022 until June 2023 will only be appropriate for legacy contracts. Use of these quotes for new contracts would create safety and soundness risks for counterparties and the financial system. We will supervise firms accordingly. Market participants should act now to accelerate their transition away from LIBOR. The reign of LIBOR will end imminently, and it will not come back. To return to where we started, the year of magical thinking is over.

r211007a_FOMC

united states

Building Climate Scenario Analysis on the Foundations of Economic Research

brainard

I want to thank all of you for joining our research conference and the organizing committee for inviting me to share some thoughts on climate scenario analysis. Economic analysis suggests that climate change could have profound consequences for the level, trend growth, and variability of economic activity over time and across regions and sectors. Some of these effects could occur gradually, while others could occur relatively quickly in the presence of "tipping points." Policy, technology, and behavioral responses could similarly have material financial consequences. Against this backdrop, the Federal Reserve is carefully considering the potential implications of climate-related risks for financial institutions and the financial system, with scenario analysis emerging as a potential key analytical tool for that purpose. Climate change is projected to have profound effects on the economy and the financial system, and it is already inflicting damage. The Sixth Assessment Report by the increases, some compound extreme events with low likelihood in [the] past and current climate will become more frequent, and there will be a higher likelihood that events with increased intensities, durations and/or spatial extents unprecedented in the observational record will occur." We can already see the growing costs associated with the increasing frequency and severity of climate-related events. The total cost of U.S. weather and climate disasters over the last 5 full years exceeds $630 billion, which is a record. During this period, massive flooding in the Midwest has caused billions of dollars in damages to farms, homes, and businesses. growing problems with the availability of fire insurance for homeowners, and the state legislature provided new protections for wildfire survivors. Last year was the sixth consecutive year that the United States experienced ten or more billion-dollar weather and climate disasters. And this summer, Hurricane Ida alone is estimated to have caused more than $30 billion in insurance losses. The pandemic is a stark reminder that extreme events can materialize with little warning and trigger severe financial losses and market disruptions, and the IPCC Sixth Assessment Report is a reminder of the high uncertainty and potential costs associated with climate-related risks. It will be important to systematically assess the resilience of . large financial institutions and the broader financial system to climate-related risk scenarios. As we are learning from the pandemic, risks emanating from outside the economy can have devastating financial consequences. As part of our prudential and financial stability responsibilities, we are developing scenario analysis to model the possible financial risks associated with climate change and assess the resilience of individual financial institutions and the financial system to these risks. The future financial and economic consequences of climate change will depend on the severity of the physical effects and the nature and speed of the transition to a sustainable economy. So it is important to model the transition risks arising from changes in policies, technology, and consumer and investor behavior and the physical risks of damages caused by an increase in the frequency and severity of climate-related events as well as chronic changes, such as rising temperatures and sea levels. From the IPCC's work, we know that the physical risks related to climate change will grow over time, while the transition risks will depend in part on how abruptly policy, technology, and behavioral changes take place. Since financial markets are forward looking, a change in expectations regarding climate-related risks could lead to a sharp repricing of assets at any time. Acute hazards, such as damaging hurricanes, or climate- related policy changes could quickly alter perceptions of future risk or reveal new information about the value of assets. Sudden asset price changes can lead to financial instability when they interact with other vulnerabilities, such as high leverage or correlated exposures. Scenario analysis is a useful tool in assessing the links between climate-related risks and economic outcomes because it requires assessing the implications for financial stability and individual financial institutions in a systematic way. The interactions across institutions and market segments must be traced out, and missing data must be identified, acquired, and analyzed, leading to a clearer picture of the transmission of risks. Scenario analysis should ultimately facilitate estimating the possible effects on individual financial institutions as well as on financial markets more broadly. By systematically modeling the effects of climate-related risks across the financial system, scenario analysis can help inform risk management at the level of individual financial institutions and more broadly. Given that this conference is about stress testing, it is worth revisiting some lessons from the first generation of bank stress tests. Bank stress tests were developed at the height of the 2007-09 financial crisis to provide a more systematic way to assess the effects of complex and interrelated exposures within the financial system. The first test, with limited data inputs. Despite substantial uncertainty about the economy's path, the SCAP was broadly viewed as successful. It provided a solid foundation for building out the stress-testing program over the subsequent decade. The stress test infrastructure and granular models and data that are currently available bear little resemblance to that first stress test. In parallel, banks have improved their risk-management operations, and large banks now routinely use their own stress tests to assess and manage their risks. So what are the lessons for scenario analysis? Starting down the path of climate scenario analysis, even with a rudimentary first attempt, will help with risk identification and suggest useful lessons to inform subsequent improvements in modeling, data, and financial disclosures. Although we should be humble about what the first generation of climate scenario analysis is likely to deliver, the challenges we face should not deter us from building the foundations now. There is a growing international consensus that climate scenario analysis is a vital tool for assessing the effects of climate-related risks on financial institutions and the financial system. Since 2017, a group of regulators from across the world has been sharing best practices regarding climate-related risk management within the Network of Reserve joined this international collaboration late last year. Several countries have already made substantial progress on climate scenario analysis. The scenarios produced by the NGFS, with appropriate tailoring to local conditions, have been incorporated in climate change analysis by the European Central Bank (ECB) as well as by financial regulators in Canada, France, and the United Kingdom. For instance, the ECB published results from its analysis of climate-related risks in September 2021, and the Bank of England published scenarios in June 2021 with results expected in the middle of 2022. The Federal Reserve is actively learning from these early adopters. There are challenges to quantifying the effects of climate-related risks on the economy and the financial system. Climate scenario analysis faces the challenge of having to consider plausible but novel combinations of risks that are associated with substantial uncertainty. For traditional financial risk scenarios, modelers can draw on the historical record to help gauge the plausible repercussions for different asset classes as well as the economic consequences at the national level. Even in the case of the COVID- 19 pandemic, modelers could draw useful lessons from previous pandemics, such as the 1918 influenza. By contrast, there may not be analogous historical precedents to draw on in the formulation of appropriate climate scenarios and the quantification of their effects on different asset classes, regions, and sectors. In addition, climate scenario analysis may need to consider interdependencies across the financial system. Banks and other financial institutions often rely on insurance and other hedging strategies to reduce potential losses. With climate risk raising insurance premiums charged to property owners or reducing the availability of insurance in certain geographies and on certain asset classes, it may be important to assess the resilience of insurance and other hedging strategies and the associated implications for supervised institutions. Stress could be transmitted through a sudden repricing of insurance contracts or by a withdrawal of coverage, as we are already seeing in the case of wildfires and flooding in certain areas. While reinsurance contracts and agreements among investors can transfer risk across the financial system, some level of risk is likely to remain. Climate-related risks could build up in hidden ways that could result in cascading losses. The costs and timing of the transition to a low-carbon economy will depend on hard-to-predict policy, technology, and behavioral changes. While an orderly and steady transition to a sustainable economy may have manageable economic consequences, more costly changes would likely accompany an abrupt transition. A disorderly scenario could generate sizable economic consequences that vary substantially across geographies, sectors, and assets. Some of these effects could manifest in the near term if investment sentiment were to change suddenly. That said, the long tradition within economics of estimating the effects of policy changes can be applied to the modeling of transition risks, even disorderly scenarios. Whereas existing economic tools can be applied to transition risks, the building blocks for assessing the economic consequences of physical risks in the presence of substantial uncertainty are still in development. The literature on the economic consequences of physical risk is growing, but there are still some challenges in linking this literature to the formulation of scenarios. For instance, extrapolating from the historical experience of sporadic extreme weather events may turn out to be misleading. Economic activity has tended to rebound quickly after sporadic extreme weather events in recent experience, often supported by significant reconstruction. In contrast, climate change is an ongoing, cumulative process that could significantly increase the prevalence and severity of extreme events as well as contribute to chronic changes. These cumulative and chronic changes could have economic effects that differ substantively from the historic experience, for example, if they contribute to shifts in the location of economic activity or the sectoral composition within a region. The physical manifestations of climate change could increase the volatility of economic activity and slow economic growth. The cumulative effects associated with climate change could lead to irreversible "tipping points" that introduce new climate shocks and change the relationships between climate-related shocks and economic variables. Tipping points, such as melting ice sheets and loss of permafrost or forests, have the potential to create large disruptions in weather systems, regional water supplies, and the habitability of large land masses. The potential cumulative effects of climate- related shocks as well as potential climate-related tipping points for the economy and financial system could reduce the accuracy of forecasts based on historical experience. The consequences of climate change are likely to be highly differentiated by region and economic sector, which can bring both risks and opportunities for financial institutions. Regional and sectoral differentiation has important implications for scenario analysis. Climate-related risks can be expected to have direct effects not only on the valuation of assets on the balance sheets of financial institutions, but also on revenues and costs. While standard models for projecting the net revenues of financial institutions are typically driven by national-level proxies of aggregate demand, such as growth and unemployment levels, additional sectoral and regional granularity will be necessary for climate scenario analysis. And while standard models for projecting losses on assets account for regional and sectoral characteristics, climate scenario analysis will require capturing the potential intensification of climate-related risks. These efforts to systematically assess climate-related risks will require substantial work to address current data gaps. Financial institutions are collecting data and developing scenario analysis to understand the potential effect of climate-related risks. Similarly, the Federal Reserve is gathering key data resources, such as acquiring external data and making existing publicly available climate data more useful for modeling and research capabilities. Current voluntary climate-related disclosures are an important first step in closing data gaps, but they are prone to inconsistent quality and incompleteness. Without harmonization of the definitions and methods underlying these disclosures, it will be challenging to make comparisons across firms and exposures. Consistent, comparable, and, ultimately, mandatory disclosures are likely to be vital to enable market participants to measure, monitor, and manage climate risks on a consistent basis across firms. Securities and Exchange Commission has responsibility for this critical workstream in Going forward, it will be important to improve our understanding of climate- related financial risks and vulnerabilities. The Federal Reserve's Supervision Climate Committee is engaging with domestic stakeholders and other supervisors from a prudential perspective. Ultimately, I anticipate it will be helpful to provide supervisory guidance for large banking institutions in their efforts to appropriately measure, monitor, and manage material climate-related risks, following the lead of a number of other countries. assessing climate-related risks to financial stability from a macroprudential perspective-- that is, one that considers the potential for complex interactions across the financial system. Both the prudential and macroprudential work programs will benefit from the development of climate scenario analysis. Together these efforts can help ensure that the financial system is resilient to climate-related risks and well positioned for the transition to a sustainable economy. Our conversations with climate experts, large banking institutions, other financial intermediaries, stakeholders, and regulators underscore the complexity of the connections between the climate and economic and financial systems. To better understand these connections, several foreign regulators have already undertaken climate scenario analysis, affording us the opportunity to learn from their experiences. It will be helpful to move ahead with the first generation of climate scenario analysis to identify risks and potential issues and to inform subsequent refinements to our models and data. We will reach better outcomes if we tackle these challenges through open dialogue and continued engagement of the kind exemplified by today's conference.

r211012a_FOMC

united states

U.S. Economic Outlook and Monetary Policy

clarida

It is my pleasure to meet virtually with you today at the 2021 Institute of I regret that we are not meeting in person, but I look forward, as always, to a conversation with my good friend and one- time colleague Tim Adams. But first, please allow me to offer a few remarks on the economic outlook and Federal Reserve monetary policy. Indicators of economic activity and employment reveal that the economy continues to strengthen. Real gross domestic product (GDP) rose at a strong 6.4 percent pace in the first half of the year, and growth is widely expected to continue at a robust, if perhaps somewhat slower, pace in the second half of the year. If so, GDP growth this calendar year could be the fastest since 1983. That said, the data also indicate that a surge in COVID-19 cases in the summer and supply-chain bottlenecks held back economic activity in the third quarter. As with overall economic activity, conditions in the labor market have continued to improve. Job gains as measured by the payroll survey have averaged 550,000 per month over the past three months. Labor market progress this year, as measured by the of 24 labor market indicators since December 2020 closing two-thirds of its shortfall relative to its pre-pandemic level. Nonetheless, factors related to the pandemic, such as caregiving obligations and ongoing fears of the virus, continue to weigh on employment and participation. Thus, the course of the labor market, and indeed that of the economy, continues to depend on the course of the virus. inflation is running at a 2.9 percent annual pace that is well above what I would consider to be a moderate overshoot of our 2 percent longer-run goal for inflation. Fully reopening the $20 trillion economy this year is taking longer and costing more than it did to shut it down last year. In particular, the reopening has been characterized by significant sectoral shifts in both aggregate demand and supply, and these shifts are causing widespread bottlenecks and triggering substantial changes in the relative price and wage structure of the economy. A similar reopening dynamic is playing out in other advanced economies, such as Canada and the United Kingdom. As these relative price adjustments work their way through the economy, measured inflation rises. But I continue to believe that the underlying rate inflation in the U.S. economy is hovering close to our 2 percent longer-run objective and, thus, that the unwelcome surge in inflation this year, once these relative price adjustments are complete and bottlenecks have unclogged, will in the end prove to be largely transitory. And this is a forecast that is shared by the vast majority of economists in the private sector, such as those surveyed by Bloomberg and Blue Chip. That said, I believe, as do most of my colleagues, that the risks to inflation are to the upside, and I continue to be attuned and attentive to underlying inflation trends, in particular measures of inflation expectations, including the Board staff's index of common inflation expectations. As Chair Powell has indicated, if we did see indicators of inflation expectations moving up and running persistently above levels consistent with our price stability mandate, monetary policy would react to that. But that is not the case at present. Let me now say a few words about the decisions reached at our September FOMC meeting. Since our December 2020 meeting, the Committee has indicated that it will continue to maintain the pace of Treasury and mortgage-backed securities purchases at $80 billion and $40 billion per month, respectively, until "substantial further progress" has been made toward our maximum-employment and price-stability goals. At our September meeting, the Committee continued to discuss the progress made toward these goals, and I myself believe that the "substantial further progress" standard has more than been met with regard to our price-stability mandate and has all but been met with regard to our employment mandate. If progress continues broadly as expected, the Committee in September judged that a moderation in the pace of asset purchases may soon be warranted. At our meeting, we also discussed the appropriate pace of tapering asset purchases once economic conditions satisfy the criterion laid out in the Committee's guidance. While no decisions were made, participants generally view that, so long as the recovery remains on track, a gradual tapering of our asset purchases that concludes around the middle of next year may soon be warranted. It is important to note that any future decision the Committee might make with regard to the pace of asset purchases will not be intended to carry a signal about the timing of a future decision to raise the target range for the federal funds rate, a policy decision for which we have articulated a different and substantially more stringent test. As we reaffirmed in September, we continue to expect that it will be appropriate to maintain the current 0 to 1/4 percent target range for the federal funds rate until labor market conditions have reached levels consistent with the Committee's assessment of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. At least half of the 18 FOMC participants in their threshold conditions for liftoff will be met by December 2022, and all participants but 1 project that these conditions will be met by December 2023. These projections are entirely consistent with the new monetary policy framework adopted unanimously by the In the context of our new framework, as I have noted before, while the effective lower bound (ELB) can be a constraint on monetary policy, the ELB is not a constraint on fiscal policy, and appropriate monetary policy under our new framework, to me, must--and certainly can--incorporate this reality. Indeed, under present circumstances, I judge that the support to aggregate demand from fiscal policy-- including the nearly $2 trillion in accumulated excess savings accruing from (as yet) unspent transfer payments--in tandem with appropriate monetary policy, can fully offset the constraint, highlighted in our Statement on Longer-Run Goals and Monetary Policy Strategy, that the ELB imposes on the ability of an inflation-targeting monetary policy, acting on its own and in the absence of sufficient fiscal support, to restore, following a recession, maximum employment and price stability while keeping inflation expectations well anchored at the 2 percent longer-run goal. Thank you very much for your time and attention. I look forward, as always, to my conversation with Tim. . . vol. 119 event hosted by the Hutchins Center on Fiscal and Monetary Policy at the . . . .

r211013a_FOMC

united states

The View from Here: The Outlook for the U.S. Economy and Implications for Monetary Policy

bowman

It has been a privilege to travel across and explore this beautiful state over the past several days and to be here in Brookings with you this evening. And I'm pleased to have the opportunity to share with you, the students of South Dakota State University (SDSU), my experience as a member of the Federal Reserve Board of Governors and my outlook for the U.S. economy. Today I will speak to you about my outlook for the U.S. economy and what the Federal Reserve has been doing to support economic activity during the COVID-19 pandemic recovery. I will also touch on a few details about what I've learned of the economic conditions here in South Dakota. Over the past few days, I've had the opportunity to meet with a number of business and community leaders here in your state. Beginning on Monday in Rapid City, I made a quick pre-dawn visit to Mount Rushmore on Tuesday while en route to a Native American Indian reservation. Later in the day, I met with state, business, and tribal leaders in Pierre, and here in Brookings earlier today. Hearing directly about the successes and challenges from their perspective provides important context for understanding economic conditions that cannot be obtained from economic data. These conversations help us see through the data from the eyes of the people, businesses, and communities that make up the American economy. That information is very helpful to me and to us at the Federal Reserve as we make our policy decisions. But before I turn to the outlook and its implications for Federal Reserve decisions, let me share some basics about the Fed's responsibilities and how we carry out those responsibilities. As students of economics, you may already know that the Federal Reserve conducts monetary policy to support a strong and stable economy in the United States. Our official mandate from the Congress is to pursue two goals, maximum employment and stable prices. Together, we commonly refer to these objectives as our dual mandate, and pursuing both at the same time means that we seek the maximum level of employment that is consistent with price stability. Regarding the price-stability goal, our framework references an annual inflation rate of 2 percent as most consistent with our price-stability goal over the longer run. The Fed pursues its monetary policy goals using a variety of tools, but the main policy tool is the federal funds rate, a key interest rate for overnight borrowing by commercial banks that influences other interest rates throughout the economy. Lower interest rates tend to stimulate demand--for housing, cars and other durable goods, and business investment, for example--which boosts economic activity and has the potential to push up inflation. Higher interest rates tend to slow the economy and tend to push inflation down. In normal times, monetary policy decisions are made eight times each year preparation for each meeting, the FOMC participants analyze the latest economic data and assess where the economy stands relative to our two mandated goals. And, because monetary policy decisions take some time to flow through to, or have their full effect on, the economy, FOMC participants must form a view about how they think the economy will evolve in the coming months and years. In addition to understanding where the economy is at any given point in time, making a judgment about where it is headed is also crucial to monetary policy. As I have learned in my nearly three years and almost 20 meetings as an FOMC member, economic forecasting is challenging, to say the least. Despite all of the data and economic models at our disposal, the economy is exceedingly complex, the product of countless decisions made every day by human beings, who have varied goals and motives. Economic data, sometimes received with a considerable time lag, can give us only a rough, backward-looking picture of the economy, and judging where the economy is headed in the future is even more difficult. Even the most accurate forecasts about the economy are often wrong, simply because of the uncertainty that is inherent in the task of interpreting and predicting future economic conditions. Yet our responsibility is to do just that--make predictions about how economic activity will evolve, and act on those forecasts in real time, to ensure that monetary policy can help support a strong economy. As part of this process, FOMC members also consider the different ways that our outlook may be wrong. We consider a number of alternative scenarios for the future and try to manage the relative risks of a policy decision if the future does not turn out as expected. I would compare that task with the judgments other professions might be required to make throughout the year. Since we are in South Dakota and farming is a familiar industry, let's use that as a comparison. Every farmer has an outlook for the costs of seed, fertilizer and other inputs, and the prices the crop might yield at the end of the growing season. Inherent in this outlook is considerable uncertainty, and a farmer has to be able to manage the risks and possible costs of being wrong in one way or another about prices. Decisions made before the growing or breeding season can have significant effects on profits after the crop is harvested or the livestock are sold. As with each member of the FOMC, this often involves careful decisions in the near term that can play out for months and years ahead. These are some of the challenges faced by members of the FOMC. Now let me tell you a bit about how I approach our monetary policy decisions. In preparation for each FOMC meeting, I regularly conduct extensive outreach to gather timely information from a broad range of industries and geographies. To me, it is important that economic discussion captures what is really going on in people's lives. With this in mind, I recently restarted the process at the Board, in which we focus not on monetary policy and hear from a range of different people about how the economy is affecting them. As the member of the Board of Governors with experience in community banking, I often speak to local bankers, who are excellent sources to understand the important effects of monetary policy decisions on Main Street. With this perspective, and relying on my rural Kansas background, I also pay special attention to developments in rural communities and in the agriculture sector, monitoring the effect of Fed policy in those areas. For example, during my visit to South Dakota over the past few days, I have had the opportunity to tour parts of the Pine Ridge Reservation and discuss community development efforts and economic conditions with a number of tribal and community leaders. It is concerning to see that South Dakota's tribal communities, particularly those on rural reservations, are experiencing a slower employment recovery than in other parts of the country. I also heard firsthand about the challenges that some Native Americans, especially those living on reservations, face in accessing reliable financial services and finding affordable credit and housing. Understanding the barriers to financial inclusion is particularly important to ensuring that our financial system works for everyone. For this reason, I am pleased that an international network of central banks committed to engaging with Indigenous peoples and understanding and addressing their unique economic and financial challenges. I will serve as the Board's representative to this group and look forward to continuing our outreach and work in this area. As much as any other preparation for FOMC meetings, all of these conversations are vital inputs for my consideration of the data influencing my monetary policy decisions every six to eight weeks. To cite one example, in the early weeks of the pandemic, our outreach and communication with community bankers led the Fed to create a special lending program to help banks that were participating in the Paycheck Protection Program (PPP), which loaned and granted funding to small businesses. The Fed's PPP liquidity facility was crucial in ensuring that lenders had the liquidity they needed to get PPP funds out to businesses as quickly as possible, which resulted in the preservation of millions of jobs. Now that I've given you an idea of what this process looks like for me as a member of the FOMC, let me describe my view of current economic conditions, my outlook for the economy, and how I believe monetary policy can continue to support the recovery. Along the way, I will also highlight a few factors that I believe could pose a risk to continued progress toward our maximum-employment and inflation goals. First, looking at the job market, stringent economic and social distancing restrictions imposed in an effort to contain the spread of the virus resulted in enormous job losses in the early months of the pandemic, with the unemployment rate surging from middle of last year, however, as the economy started to reopen, we have seen steady progress toward maximum employment. That progress continued in September, with the unemployment rate moving down to 4.8 percent. Although the September increase in payrolls was smaller than many had expected, over the past three months we've seen an average of 550,000 jobs created, just down from the remarkable average pace of 567,000 per month in the first half of the year. At least part of the recent slowing in payroll growth seems to reflect a limited supply of labor. That's certainly what I've heard in South Dakota. Employers are having a very tough time filling jobs. I was told one ethanol plant needed to fill 15 jobs and got four applicants. In contrast, indicators of labor demand, such as unfilled job openings, remain exceptionally strong. On balance, I anticipate that employment will continue to move up in the months ahead, although for several reasons that are unrelated to the stance of monetary policy, I don't expect that we will see employment fully return to pre-pandemic levels any time soon. First, despite all of the economic progress, it is clear that switching off economic activity for such a long period has had lasting consequences, and expectations of a smooth resumption of production, transportation, and business operations may not be met for some time. Many workers that were initially laid off temporarily have left the workforce altogether, which is especially true for women, with nearly 2 million women leaving the workforce since the pandemic began. In addition, many older workers dislocated by the pandemic effectively retired and probably will not rejoin the workforce even in a much stronger job market. While I would not want to place too much weight on one or two months of data, the most recent reports on employment and anecdotal reports from a wide range of businesses suggest that, even when offering higher wages and signing bonuses, many employers are finding it difficult to fill open positions. History tells us that the longer workers remain out of the workforce, the less likely it is that they will return to employment and the greater the likelihood that they will lose skills and connections with the job market, which could weigh on labor force participation for years to come. The Federal Reserve's policy tools are useful for promoting a strong job market, but they are not well suited to addressing these harmful effects on labor supply. Another reason for my cautious outlook for employment growth is that, while large firms have adequate resources, funding options, and flexibility to withstand pandemic-related disruptions, many small businesses without those advantages have closed permanently. I continue to hear concern about the future from small business owners, which is also reflected in the latest readings from broader surveys of small business sentiment. While many factors lead to this perspective, I have heard specific reference to continued rising costs, supply chain issues, labor shortages, and uncertainty about other factors, like tax increases and vaccine mandates. Let me turn now to our other monetary policy goal, price stability. Earlier this year, as the economy was reopening, we saw a pronounced pickup in inflation, as prices for motor vehicles, electronics, and other goods rose especially rapidly. Most of these increases could be traced to bottlenecks in global supply chains. The bottlenecks were often the direct result of shortages of labor and key materials used in production and distribution. Demand for semiconductors has surged because of a sharp increase of spending on high-tech equipment and consumer electronics, investment in new wireless networks, and increasing usage of semiconductors in motor vehicles, appliances, and other goods. But throughout the pandemic, the supply of semiconductors has been significantly restrained by pandemic-related production disruptions, most recently in Malaysia and Vietnam. We are seeing shipments at record levels, and more capacity is expected to come on line, but the combination of strong demand and intermittent disruptions to this complex supply chain poses a risk that it could be some time before semiconductor supply issues are resolved. The motor vehicle industry is a prominent example of a downstream sector that has been adversely affected by the semiconductor supply crunch. Every new car and truck produced today has many semiconductors included in its electrical components. As a consequence, the shortage of automotive chips has considerably reduced the number of new cars completed in the manufacturing process, driving up prices for those that have been produced. The lack of new cars for sale on dealer lots has also boosted demand and prices this year for used cars and spilled over to the rental car market, leading to soaring car rental prices. Fortunately, these prices eased a bit in September, but they are still elevated, and this causes spillovers in the broader economy as well. When an auto assembly plant shuts down for several weeks and its workers are furloughed, a whole community and its businesses feel the ripple effects of that closure. For instance, when an auto assembly plant in Ohio was closed for several weeks last summer, we heard anecdotal reports of an outsized drop in bookings at a nearby hotel chain. The semiconductor shortage highlights the global nature of many supply chains, where a disruption in one link can have wide and unexpected effects across the globe and in many industries. As another example, beyond the motor vehicle industry, supply chain disruptions have also limited the availability of major appliances, which impairs the completion and delivery timeline for homebuilders and puts further pressure on the limited housing inventory. Supply chain problems can have surprising spillovers. In the past couple of days, I've heard that the pheasant-hunting season in South Dakota may be disrupted by a shortage of shotgun shells. Nationally, these effects have led some firms to consider shifting their manufacturing from overseas or sourcing inputs from suppliers closer to home in an effort to reduce supply chain risks. In the longer run, these efforts may lead to more resilient supply chains, but the short-term transition could introduce different vulnerabilities. I will be watching these developments closely. As the various supply bottlenecks we are currently seeing are gradually resolved, we should see monthly inflation readings step down further from the high rates we have observed this year. Nevertheless, I still see a material risk that supply-related pricing pressures could last longer than expected. Another source of inflation risk comes from the lower labor force participation, which, as I mentioned earlier, has led some firms to offer inducements to bring potential workers back, including hiring bonuses and higher wages. Even with these incentives, however, many firms are struggling with staffing, and some are also offering training programs for new hires to develop required job skills. Wage increases and these additional employee investments are increasing firms' costs, potentially adding to inflationary pressures. In the agricultural sector, prices for most major commodities remain above pre- pandemic levels, and farm income is expected to be higher than a year ago for the second consecutive year. But since farmers lock in prices for inputs before planting, the effects of substantial price increases for inputs like fuel and fertilizer have not yet been fully realized. In their planning for next season's planting, farmers are much more concerned about input cost inflation. Some estimates show that farmers could pay 30 to 70 percent more for fertilizer for the 2022 season. In addition, if they can even find equipment or land to buy, prices for these assets have continued to increase. Another source of inflationary pressure is the rapid increase in house prices, something that also raises potential concerns about valuation pressures. The ongoing strength in housing demand is also notably driving up rental costs. Higher house prices also make it much more difficult for low- to moderate-income households to become homeowners, as larger down payments and other financing requirements, in effect, lock these households out of the housing market. Amid the booming real estate market, some bankers I spoke with recently cited concerns about a possible house price bubble and growing concerns about potential risks to financial stability. These concerns are a notable change from our conversations a year ago, when most bankers were appreciating the frenzied activity in this market as a means to boost income in a very low-rate environment. Given the experience of the previous financial crisis, this development is something we should closely monitor. Now, unlike the conditions leading up to that crisis, homeowners have fewer financial obligations and debts, and many of the financial system vulnerabilities that existed have been addressed. But homes are a widely held asset, and even a modest shift in the housing market, especially a decline in home prices, could have significant ripple effects throughout the economy. If elevated inflation readings continue into and through the next year, we may begin to see an imprint on longer-run inflation expectations. While short-term inflation expectations have moved up with the recent period of increased inflation, longer-term measures have remained relatively stable. As we know, after reaching uncomfortably high levels in the 1970s and early 1980s, in more recent decades, inflation has run close to our 2 percent goal, helping anchor the public's inflation expectations at levels that seem consistent with our goal. This is relevant because the Fed has long considered the anchoring of inflation expectations an important condition for meeting our monetary policy goals. Finally, let's turn to the implications for monetary policy more broadly and the FOMC's most recent decision at our meeting in September. When actions taken to mitigate the spread of COVID-19 began to disrupt the U.S. economy and financial markets in the first half of last year, the FOMC cut short-term interest rates to near zero and began purchasing Treasury securities and agency mortgage-backed securities. These actions helped stabilize financial markets and sustain the flow of credit to U.S. households and businesses. By the middle of last year, we were seeing signs of resilience in economic activity, with labor market conditions beginning to recover from the economic effects of the pandemic. In December, we indicated that we would start scaling back our asset purchases after the U.S. economy had made "substantial further progress" toward our maximum- employment and price-stability goals. We have been closely monitoring that progress since then, and, at our most recent policy meeting, we noted that, if the economy continues to improve as expected, this scaling back, or tapering of our asset purchases, may soon be warranted. I fully supported that assessment. Provided the economy continues to improve as I expect, I am very comfortable at this point with a decision to start to taper our asset purchases before the end of the year and, preferably, as early as at our next meeting in November. In my view, our asset purchases were an important part of our response to the economic effects of the pandemic, but they have essentially served their purpose. I am mindful that the remaining benefits to the economy from our asset purchases are now likely outweighed by the potential costs. In particular, I am concerned that our asset purchases could now be contributing to valuation pressures, especially in housing and equity markets, or that maintaining a highly accommodative monetary policy stance at this stage of the economic expansion may pose risks to the stability of longer-term inflation expectations. If the expansion continues as I expect, I will support a pace of tapering that would end our asset purchases by the middle of next year. In closing, I would say that our economy has made great strides this year, which is a testament to the resilience of U.S. households and businesses and the many challenges faced throughout the pandemic experience. While many risks to the outlook remain, I expect that the recovery will continue in the coming months, and that steady progress will be made toward our maximum-employment and price-stability goals.

r211013b_FOMC

united states

Financial Inclusion and Economic Challenges in the Shadow of the Pandemic: A Conversation with Tribal Leaders

brainard

I would like to join Esther George in expressing my appreciation to the leaders of tribal nations assembled here for this opportunity to listen and learn from this afternoon's conversation. I also want to thank Governor Anoatubby for hosting us. I am humbled to be here at the First Americans Museum, which is promoting a richer understanding of Native American history by sharing the cultural diversity, history, and resilience of the 39 Native nations of Oklahoma. In addition to civic and cultural contributions whose impact reaches far beyond tribal lands, I want to recognize the important economic contributions Native American communities are making, despite daunting impediments that were exacerbated by the COVID-19 pandemic. By working together to address economic challenges and improving access to financial services, we can build a more inclusive economy that supports the economic potential of Native communities here in Oklahoma and across the country. Tribal nations have long been a critical source of economic opportunity and stability. For the U.S. economy overall, tribes provided over 1.1 million jobs prior to the pandemic. Here in Oklahoma, when looking at how the economic activity of tribes compares with different industries in the state, tribes would rank 9 in output, at over $7 billion, and 11 in job creation--greater than either the construction or utilities industries. By one estimate, tribal government activities supported nearly 100,000 jobs in the state and brought nearly $5 billion in wages and benefits to Oklahoma workers as of 2017. Oklahoma tribes also contributed nearly $43 million for the construction and maintenance of Oklahoma roads, bridges, and other transportation infrastructure that are used by all Oklahomans. The resilience of Native communities was evident in the strong response of tribal nations to the pandemic. As early as April 2020, just a month after the pandemic swept across the U.S., tribal nations were proactively offering COVID-19 testing for the general public. Once vaccines began to roll out in early 2021, tribal nations distributed them under a prioritized and phased timeline developed in accordance with Centers for Disease Control and Prevention guidance. This assistance from tribal nations helped make Oklahoma one of the top 10 states for vaccine rollout. But the pandemic added to sharp economic disparities that are longstanding. Prior to the households was about $20,000 lower than for non-Hispanic White households. American women faced particularly large disparities with 18 percent living in poverty before the pandemic--about 12 percentage points higher than White women. women overall are considered financially fragile. Such disparities were only exacerbated by the pandemic. Development, a research institute dedicated to tribal economic development, estimates that the employment-to-population ratio for AI/AN households is 2.5 percentage points lower than the national average in August 2021, down from June 2020, when the gap was over 4 percentage points. The pandemic also led to significant declines in the revenues of tribal governments and businesses at a time when their services were more important than ever. In recent surveys by the Center for Indian Country Development, many respondents reported large, persistent revenue losses, with only one in five tribal entities indicating they have stable revenues. At the same time, they reported facing substantial increases in their operational costs that they expected to remain elevated for at least six months. To address these disparities, it will be important to understand and make progress on key impediments to financial access. Native communities face impediments to accessing a range of financial services, including banking, mortgage financing, small business credit, and financial education. Perhaps most fundamentally, access to banking services is important to ensure the financial wellbeing of individuals and the vitality of the communities in which they live. Over 16 percent of AI/AN households were unbanked in 2019--three times higher than the national average. The low levels of banking relationships are partly due to a lack of proximate bank Majority-Native American counties, on average, have only three bank branches, which is below the nine-branch average in nonmetro counties, and well below the 26-branch overall average for all counties. Just the basic act of opening a bank account is challenging when the nearest bank branch is, on average, 12 miles away from the geographic center of a reservation and may be more than 60 miles away--in comparison to less than 1 mile on average for most counties. Native households also face barriers to homeownership, which is a vital tool to build wealth. According to the 2019 Survey of Consumer Finances, the median homeowner has 40 times the household wealth of a renter. While 75 percent of Native households reported a strong desire to own their home, Native American communities face significant impediments. First, they face a lack of adequate supply. Overcrowding and physical housing problems are far more severe than in other parts of the country. Development assessment concluded that to alleviate substandard and overcrowded homes in Indian Country, 68,000 units need to be built. Second, tribally designated housing authorities reported that the credit readiness of individual tribal borrowers was a key challenge in obtaining credit, followed by the lack of homebuyer education. In addition, tribal members have trouble obtaining home loans, especially for properties located on trust land due to the complexity in using trust property as collateral. Overcoming these challenges to expand homeownership options on trust and restricted land could strengthen reservation economies and the well-being of tribal members. new homes and preserving older ones employs a wide range of workers and provides opportunities to build valuable skills. These activities have a ripple effect as related jobs are spread over other sectors of the community, including manufacturing, retail, and business services. Native small businesses also face special challenges in obtaining credit. Small businesses can be the lifeblood of a community, providing jobs, goods and services, and stability as well as the opportunity for owners to build wealth. businesses and enterprises exist in the U.S. today, generating around $50 billion of revenue a year. Native American business owners have made their mark in various industries, including tourism, gaming, energy, agriculture, forestry, manufacturing, and federal contracting. Yet, Native small businesses struggle to access bank credit, a critical part of encouraging small business growth and formation. Data from the Survey of Business Owners and Self- Employed Persons show far fewer AI/AN-owned businesses were started by using bank financing compared with all business owners. These differences are supported by anecdotal perspective that Native Americans have more difficulty financing their new businesses with loans from traditional lenders than non-Natives do. In addition, Native business owners consistently reported using credit cards to finance business startups at a greater rate than other startups. concludes a possible explanation is that Native business owners have more difficulty accessing lower-cost standard bank loans than do other entrepreneurs. Native small businesses faced much greater challenges as a result of the COVID-19 pandemic, and generally received less robust support. Small businesses in tribal areas were both less likely to receive Paycheck Protection Program assistance and received less, on average, than businesses in non-tribal areas. Financial literacy and personal financial management skills are critically important, especially for households with low liquid savings and wealth. While there are limited data about financial behaviors in Indian Country, available information suggests that Native Americans face higher levels of financial fragility than many other groups. Given these challenges, Native American youth may stand to benefit from opportunities to develop personal finance skills and financial management experience. As Native communities tackle these impediments to financial inclusion, collaborative efforts across a range of public-sector, private-sector, and nonprofit organizations can be helpful. As part of our mission to build a strong, inclusive economy, the Federal Reserve has a role to play in supporting economic growth and financial inclusion in Native communities. The CRA is one powerful tool in building a more inclusive economy for individuals and communities. As one of several landmark civil rights laws to address systemic inequities in credit access, the CRA confers an affirmative obligation on banks to help meet the credit needs of the local communities in which they do business, including low- and moderate-income neighborhoods. The CRA prompts banks to be not only more active lenders in LMI areas, but it also encourages activities with minority depository institutions (MDIs) that are especially important to serving the credit and investment needs of minority communities. We are working with the other banking agencies to propose CRA reforms that should improve financial inclusion and the availability of community development financing in underserved communities. As we work together to propose reforms to strengthen the law's core purpose, we have a unique opportunity to design a regulation that better addresses the credit needs for Native communities and in Indian Country--including increasing banking services, access to credit for households and businesses, and funding for community development. Two years ago, I had the pleasure of visiting with the Thunder Valley Community housing, small business, and community development mixed-use project, which was under construction. Despite the importance of the Thunder Valley project to the community, banks were not among the funders listed for this important project. This illustrates the broader challenge faced by underserved communities where there are few bank branches. I want to highlight two of the proposals that the Federal Reserve Board (the Board) sought feedback on in the September 2020 Advance Notice of Proposed Rulemaking to strengthen CRA regulations. Recognizing that many places in Indian Country have few bank branches and are located outside of branch-based assessment areas, the Board proposed that a bank in any part of the country could receive credit for eligible CRA activities in Indian Country, even when there is not a branch nearby. Banks need to be confident about receiving CRA credit to seek out activities and investments in these areas. The Board has also sought feedback on ways to encourage and reward banks for activities that are responsive to community needs, particularly in harder-to-serve areas. One approach is the use of impact scores for community development activities to ensure that performance evaluations adequately reflect the relative importance of loans and investments within communities. As we work toward a set of interagency proposals on how to strengthen CRA regulations, we will continue to focus on and seek feedback on how to best encourage impactful CRA activities in Indian Country, including for building climate resilience where needed. In addition to traditional banks and credit unions, a robust CDFI ecosystem can also be a lifeline to support credit access in underserved communities. Between 2001 and 2021, the number of Native CDFIs increased fivefold from just 14 to 71 in the U.S. loans tend to be small--the average loan size was just $16,000 in 2017--they fill a critical gap, especially for those who have thin credit profiles or have poor credit profiles. CDFIs can help improve clients' credit and boost their financial access. Native CDFIs in Oklahoma have been highly successful in providing financial access to Native Americans, supporting mortgage lending, small business growth, and economic activity more broadly. Despite the challenges presented by the pandemic, Native CDFIs across the country avoided the increases in delinquencies and charge offs that were anticipated early on, and only a few have had to restructure their organization's corporate debt as a result of COVID- 19 so far, highlighting the quality of Native CDFI investments. department supports Native CDFIs and Native MDIs in a number of ways with a focus on convening, facilitation, and resource development. For example, staff support state-wide CDFI working groups in Oklahoma and New Mexico, which both have significant representation of links banks with CRA-eligible activities. Since its creation in 2011, Investment Connection has enabled $50 million in loans and grants to be connected with community organizations. funds have supported work in affordable housing, small business development, and workforce development, among other areas. Several organizations working in Indian Country have been able to make successful, CRA-eligible connections through FRB Kansas City's Investment will continue to be a resource to provide information and best practices for CDFIs as more tribes seek information about establishing their own financial institution. from the Atlanta and Kansas City Reserve Banks has been committed to providing tribal nations and Native communities in Oklahoma and across the country with personal finance and economic education programming. Understanding the diversity of Native languages and cultures, the programming offers the flexibility to adapt to local needs. This work, led by Megan Cruz, a citizen of the Osage Nation, who is here today, brings financial education to tribal programs spanning all ages--including early childhood learning, youth programs, housing, reservation schools, higher education, workforce development, children and family services, and elder programs. A pervasive lack of data makes it difficult to evaluate how economic developments are impacting Indian Country. The limitations of the data available on Indian Country are due to data collection and reporting issues, such as small sample size or large margins of error . At the and conducts economic research and analysis to help resolve the critical need for accurate and timely data. One of the steps they have taken includes publishing a labor market data tool, which presents estimates of the labor force participation rate, employment-to-population ratio, and The Center for Indian Country Development also focuses on applied research and engagement in Indian Country to support long term economic prosperity and inclusion. Recent research has centered on the role tribal enterprises play in economic opportunity and how tax revenues in Indian Country can help improve the economic infrastructure and financial inclusion for tribal communities. Through policy webinars and its upcoming inaugural research summit, the Center is working alongside tribal leaders to leverage data and research to improve the economic well-being of Indian Country. The Reserve Banks play a unique and important role in increasing our understanding of local needs and regional issues, and in the Federal Reserve Districts with large Native American populations and stakeholders, our Banks are very engaged with Indian Country activities. We welcome the diverse perspectives of Native Americans, from serving on our boards and advisory councils to joining us as full-time employees, to better inform our decisionmaking. Tawney Community Advisory Council, which offers diverse perspectives on the financial services needs of communities, with a focus on lower- to moderate-income neighborhoods. Earlier today, the Federal Reserve announced we had joined the Central Bank Network Matua, the Bank of Canada, and the Reserve Bank of Australia. The mission of the Network is to foster ongoing dialogue and raise awareness of Indigenous economic and financial issues, share knowledge and best practices, and promote engagement and education on Indigenous economy and history, in partnership with Indigenous Peoples. It is a welcome opportunity for us to better understand how each central bank is working to improve financial inclusion for and with Indigenous Peoples. We look forward to learning from our Indigenous partners and central bank members in the Network. In closing, I want to affirm that it is important to us at the Federal Reserve to deepen our understanding of tribal nations and strengthen our relationships with Native communities. We welcome opportunities such as today's conversation to learn from you as tribal leaders about the economic issues that are most pressing for your citizens and communities. Today's discussion is part of an ongoing conversation we hope to continue that will help us better reflect the economic experiences of Native Americans.

r211018a_FOMC

united states

Financial Stability and Coordination in Times of Crisis

quarles

Thank you, Pablo, for the kind welcome. It is an honor to be here at this important conference on financial stability. And it is great to be here in Madrid and see all of you in person. I commend the organizers for their attention to detail in bringing us together as we all emerge from the events of the last 18 months. today the FSB stands at an inflection point. From here, we can look back at the events and actions of the last 18 months to see what we have learned. And--in light of that--we can then look forward, to see how the FSB will address ongoing and future financial stability challenges. All of the researchers attending this conference are no doubt doing something similar--looking back to learn so that we can better prepare for the future. Living through the events of last year was an experience of near chaos. The world had stopped functioning the way it should, leading to unexpected--and in some cases almost unimaginable--outcomes, including in our financial markets. As we got some distance from the turmoil and studied pieces of the problems, patterns started to emerge. We began to appreciate nuances that we hadn't appreciated in the moment. This conference is being held just a few blocks from where Picasso's hangs, and in preparing these remarks I reflected on the first time I saw the painting, almost half a century ago--at that time at the Museum of Modern Art in New York, before Picasso would let the painting come to its home in Spain. One's first look at is chaotic, dizzying, viscerally frightening, hard to comprehend. But after looking about it, thinking about it, living with one's memory of the images for some time (in my case, I still think I'm understanding new things about it after 50 years), we start to see the story told by the bits and pieces. The economic and financial shock created by the outbreak of COVID-19 and the global imposition of attendant containment measures--what I typically refer to as the "COVID event"--was precisely the kind of global crisis that the FSB was created for, and--as was envisaged--the FSB has played a central role. But our work is not finished. As we emerge from the acute phase of the COVID event, the FSB's focus is shifting from crisis management to addressing forward-looking issues. At an event last October, I spoke about some of the lessons of the COVID event for the U.S. financial system. Today, speaking as FSB Chair, I'd like to reflect on the role the FSB played. How did we respond in the crisis? What lessons can we draw? And where can we sharpen our focus for the road ahead? The period between the Global Financial Crisis and the onset of the COVID event provided some calm for an organization that was built to address crisis. But the FSB was not idle. During that decade, FSB members focused on enhancing the global financial system's resilience to shocks. Together, we strengthened our respective frameworks for analyzing vulnerabilities and monitoring risks. We developed measured policy responses to address those vulnerabilities and risks and assessed reforms made in the wake of the Global Financial Crisis. FSB members have been working alongside one another for since 2009 to improve tools for resilience. Just as important, members have built trust among themselves, been transparent with their actions, and coordinated with each other. This has all been vital in preparing us to work together in the unprecedented and unpredictable landscape of the last 18 months. Early in the crisis, as the COVID event unfolded, the FSB provided a forum where members met regularly--some part of the FSB was meeting almost constantly in the early weeks--to exchange information about the trajectory of the COVID event, policy responses across member jurisdictions, and areas where the potential for spillovers needed to be addressed. Navigating a crisis is no small feat. As we, collectively, moved through the experience, we did not have much opportunity to share details on how we worked together to forge a coherent path. In outlining the many steps we took together, I hope to provide an anatomy of coordination through crisis. Given the openness of information sharing, FSB members were able to quickly identify areas of concern that required action. We used real-time input to focus on four critical nodes of the global financial system: financing of the real economy; access to U.S. dollar funding; meeting financial intermediaries' liquidity demands; and monitoring counterparty risks. This open communication and real-time monitoring improved policymakers' clarity around executing emergency measures to help stabilize domestic economies. Additionally, this information sharing helped FSB members ensure coordinated steps and minimize opportunities for harmful spillovers. Throughout the COVID event but especially in the spring of 2020, FSB members convened every week--sometimes every day. Our staff in Basel regularly presented data for members to consider and discuss, in addition to members sharing their own jurisdiction-specific information and analysis. To provide deeper analysis for policymakers, the FSB formed several expert groups to examine and assess specific issues as they unfolded. This coordination helped enable the swift and bold interventions that maintained market functioning globally. Many of the supervisors in the FSB's membership provided banks with flexibility for their capital and liquidity buffers and encouraged banks to work with borrowers on loan modifications. The FSB also supported the delay of non-critical work to reduce the operational burden on firms and authorities. Collectively, these steps sent a strong signal about our resolve to lessen the economic fallout from the COVID event and helped prevent a disorderly sale of assets. The supervisors and the regulators in the FSB membership also convened more frequently to discuss market developments and to coordinate on the measures they were taking. The FSB also cataloged the thousands of steps our members took to respond to the COVID event so that a playbook of sorts is available for the future. Getting broad stakeholder input was also important to the FSB and to me personally, particularly given the varied impact of the COVID event and divergent paths to recovery. The FSB consulted directly with private-sector stakeholders, gathering input from academics, financial-sector participants, and trade associations. This input remains critical as we consider our path forward, including how to unwind emergency policy measures. A key lesson of the COVID event is that non-bank financial intermediation is a critical area for action--especially short-term funding markets, where the money market fund sector has more than $8 trillion in assets under management globally. During normal times, companies and retail investors treat shares in money market funds like cash--as fully fungible, riskless, and payable on-demand. But the funds' promise of liquidity and investors' resulting expectations are not always well-aligned with the liquidity of the instruments in which money funds invest. This misalignment--or "liquidity transformation"--creates incentives for money market fund investors to redeem when market liquidity becomes scarce. And that's exactly what happened during the COVID event. Runs on some types of money market funds in March of last year were similar in scale to the devastating runs in 2008 and again contributed to stress in systemically important short-term funding markets. Even before the COVID event, the FSB had assembled a senior group from central banks and market regulators to assess vulnerabilities in the non-bank sector and to coordinate and drive forward any needed reform. We were fortunate to have had this group in place when the COVID event brought these vulnerabilities into sharp focus. The FSB swiftly undertook a review of financial markets in March of 2020, which remains the most financially volatile and uncertain period of the COVID event. The set the stage for an ambitious work program aimed at enhancing resilience in non-bank financial intermediation. One of the first fruits of that program was published a week ago. Our report, , sets out a framework for assessing vulnerabilities in money market funds and a policy toolkit. Using the analysis of vulnerabilities contained in this report, each member will take a close look at the specific money fund vulnerabilities in its jurisdiction and will use the toolkit to address those vulnerabilities. To monitor for progress, the FSB, working with the International Organization of Securities Commissioners, will review members' progress in two years. In five years, the FSB will then do a more thorough assessment across our membership of the effectiveness of the measures in addressing risks to financial stability. The aim of this work is to enhance money market fund resilience and minimize the need for future extraordinary central bank interventions to support the sector. The lessons learned from the COVID event were not confined to the non-bank sector. In fact, the FSB is publishing a series of reports covering a broad range of topics related to the COVID event, including our interim findings on the lessons learned. The findings of that report, to be finalized later this month, will drive our future work agenda. Let me share a few of my own views on the key lessons learned. My first takeaway is that the global financial system entered the latest crisis more resilient than the last. Although extraordinary support measures were still necessary to mitigate the impact of the COVID event, the implementation of the G20-endorsed reforms from the last crisis helped contribute to our shared resilience. Basel III, which has led to a near doubling of capital ratios since 2011, positioned banks to better absorb the macroeconomic shock. In addition, derivatives markets are safer with better transparency, central clearing, and margin requirements. My second observation from the COVID event is the importance of policy flexibility for each of our jurisdictions. Of course, baseline consistency across standards is necessary. But indeed, one size rarely fits all. Our varied policy needs and tools make coordination even more important to achieving common goals and results. The global regulatory framework, done right, is like a tightly woven piece of fabric. It can get pulled in different directions at the same time, and it won't shred or unravel. In times of crisis, the warp and woof of policy tools across the globe need to be woven tightly enough for the fabric of our financial system to withstand the stress, but flexibly enough that it will not tear. Uncoordinated regulation can create flaws: gaps, fragmentation, and arbitrage opportunities, which are the types of defects the FSB strives to prevent. But excessively granular harmonization can create regulation that doesn't jibe with the circumstances in a particular jurisdiction. We try to ensure that our members are weaving a strong fabric in concert. A third observation is that there are instances where policy may fail to have the desired effect. I found banks' apparent reluctance to use buffers an interesting lesson from the COVID event. Some evidence suggests that banks may have been hesitant to use their regulatory capital buffers to meet credit demand (despite the stated intent from supervisors that banks should use their buffers under stress). This may be due to uncertainty regarding potential future losses or the wider market stigma that may result if a bank were to use its buffers. Perhaps the extensive fiscal and monetary support provided to borrowers averted banks' need to use buffers. Research into this reluctance will be important so that we can improve our macro- and micro-prudential tools for the next time we need them. As "normal" slowly returns, the FSB is setting upon the daunting task of refreshing its workplan. The FSB's comparative advantage lies in convening policymakers and experts to tackle cross-border and cross-sectoral threats to financial stability. Non-bank financial intermediation remains at the top of the FSB's priority list because of the urgency to address vulnerabilities. Our policy proposals for enhancing money market fund resilience give jurisdictions a good start on assessing and addressing vulnerabilities in their jurisdictions. Other areas, such as short-term funding markets, open-ended funds, and margin requirements, also require further assessment. The FSB is actively engaged in work in each of those areas. Even as we address the most acute vulnerabilities, the highly interconnected and innovative nature of our global financial system requires constant vigilance to ensure stability. The FSB must learn more about those risks to financial stability that are less well understood. One of these areas is climate-related financial risk. Although there is a vast amount of international work ongoing in this area, there remains much to learn about the climate-related complexities outside the financial system as well as within it. In light of the increasing amount of international work related to climate, the FSB has developed for the G20 a roadmap to help guide global efforts to understand and address the financial risks from climate change. Progress on the FSB's climate roadmap will depend on the collective efforts of the FSB, its membership of national authorities, and international organizations. It sets out in one place the way forward on disclosures, data, vulnerabilities analysis, and regulatory and supervisory approaches. The FSB is also closely watching cryptoassets and stablecoins. In the last 18 months, cryptoassets' market capitalization has grown from less than $200 billion to as much as $2.4 trillion. Stablecoins have increased from less than $10 billion in market cap to more than $130 billion. Almost exactly one year ago, in October 2020, the FSB released high-level recommendations for the regulation, supervision, and oversight of global stablecoin arrangements. Technology and innovation continue to advance rapidly. We need to be mindful of whether our regulatory and supervisory approaches appropriately address risks while preserving the benefits that innovation can bring. As these continue to develop, we continue to explore difficult questions. Are these digital assets currencies? Or securities? Deposits? They don't fit neatly into our regulatory buckets, and they operate in the digital ether where they can easily cross national borders. The FSB issued a new report last week to highlight our own findings as we monitor progress and seek to coordinate the regulation of global stablecoins. Digital assets may not be current threats to global financial stability. Yet as we've learned from some forms of non-bank financial intermediation, those products, services, and institutions that fall between the regulatory cracks one day can become systemic problems the next. The goal of our work is to guard against new risks that emerge from innovation without stifling this same innovation. Indeed, the global financial system's reliance on information technology remains a known risk, but one that has been well managed during the crisis. Technology has allowed us to coordinate and communicate more effectively throughout the COVID event. Virtual calls have quickly replaced in-person meetings. It may seem like second nature now, but we only dreamed of having this ability 20 years ago. While these advances bring us great benefits, financial authorities must remain highly vigilant to the ever-present risk of cyber-attacks on our financial system. As we remain vigilant to these known risks and vulnerabilities, the FSB last month rolled out a new forward-looking surveillance framework for monitoring and assessing vulnerabilities. The surveillance framework reflects the learning of the past decade and prepares us to face the challenges of an ever-evolving financial landscape. When the FSB was founded in the wake of the global financial crisis, the "science" of financial stability was still nascent. Now, more than a decade later, we have furthered our understanding of how financial crises result from shocks that act on existing vulnerabilities. This new framework will better account for resilience, our capacity to absorb shocks, in order to better appraise net vulnerabilities and identify gaps. It will also systematically scan the financial landscape to better capture new and emerging vulnerabilities and emphasize those that may prompt cross-border spillovers. The indicators will be dynamic and will include asset prices and asset quality, funding, liquidity, leverage, complexity, cross-border linkages, and operational considerations. The framework also incorporates monitoring of the balance sheets of non-financial sectors like households, corporates, and sovereigns. Along with these indicators, the new framework will obtain input for assessing vulnerabilities from qualitative surveys, working groups, and private sector workshops. It will preserve flexibility and recognize our members' inherent differences. I see the new surveillance framework as an important communication and framing device within the FSB, with the G20, and with the public. Unforeseeable and exogenous shocks, like COVID-19, will require us all to be resilient, vigilant, and agile. The FSB welcomes public comment and discussion regarding the new framework, and I expect it to be a useful construct for years to come. In conclusion, the COVID event was the first great test of the FSB, and I think we did the job we were born to do. I want to thank the many of you here today who are researching these issues, sharing your findings at conferences like this one, and enriching the work of the FSB. For our part, the FSB will continue convening G20 policymakers and experts to assess vulnerabilities, coordinate policy responses, and evaluate effectiveness. In doing so, we will always strive to consult with a wide variety of stakeholders to help us respond to the most pressing financial vulnerabilities of our time. Continued collaboration and cooperation among financial sectors, regulators, governments, academia, and international organizations will be one of our greatest advantages as we prepare for the next crisis.

r211019b_FOMC

united states

Welcoming Remarks

bowman

Good afternoon. It is a pleasure to be able to join you today for this conversation, and as a bank regulator and former banker, I am pleased that this conference is making the case for diversity in terms that everyone in business can understand. At any time, but especially now when attracting and keeping skilled and talented employees is so challenging, it only makes sense that you'll get the best employees if both men and women see a business with diverse leadership, and the opportunity to advance. And when a large share of your customers are women, when understanding their perspective is so important to your business, having women in leadership positions will help you serve these customers better and make you a more profitable and successful enterprise. In the year and a half since the pandemic began, life has changed in many ways, deeply impacting how we work and how we spend our time and money. The effects of these changes on the economy have been significant. So today, I would like to focus my discussion on how all of this has affected women in the labor market. Of course work has changed for nearly everyone in the labor force, but for women, the changes have arguably been greater during this time than any other since World War II. Back then, millions of women entered the workforce to step into roles historically reserved for men, and this time millions left the workforce to deal with school closures and other changes to home life caused by the pandemic. One question is how durable these changes may be. Therefore, today, I will also consider how these shifts may affect women's long-term financial prospects and will end with ideas about potential ways to make it easier for women to join or rejoin the workforce. When considering the level of employment, I tend to focus on both the unemployment rate and the labor force participation rate. Let's start with the unemployment rate. The economic and social distancing restrictions imposed at the onset of the pandemic resulted in enormous job losses, with the unemployment rate surging from 3.5 percent in February, which was a 50-year low, to 14.8 percent in April 2020. Women were affected more than men, which is a change from previous recessions, when men typically suffered greater job losses than women. In February 2020, the unemployment rate for women was slightly lower than for men, but by April it had risen to 16.1 percent, compared to 13.6 percent for men. That difference continued only until September, but this statistic does not reveal the fact that many women were leaving the workforce, and therefore not counted in unemployment. Their labor force participation fell more than the participation rate for men and at last count, there were two million fewer women in the labor force than before the pandemic. The difference in employment for men and women held true across some minority groups. So, what led to this decline in women's employment and what specific factors contributed to women's employment and their choice to leave the labor force? And why has this time been different than other points in our history, resulting in larger declines for women relative to men? In contrast to previous crises, COVID-19 had a larger impact on occupations with higher numbers of female workers. Women are disproportionately represented in high-contact jobs with less flexible work conditions, including lodging, food service, eldercare, and childcare, which were among the sectors most affected by the crisis. Most of these jobs cannot be performed from home or have less flexibility in the timing of when they can be performed. Roughly a quarter of women worked in these jobs, compared with around 10 percent of men. This is one reason why female unemployment rose dramatically in comparison to male unemployment during the spring of 2020. Women's labor participation declined as the pandemic affected their ability to participate in the workforce. The lockdowns and layoffs in response to COVID disrupted daycare centers, schools, and other organized childcare, which continue in some areas even today. Traditional family supports, like extended family and grandparents, were also limited due to concerns about the virus and social distancing. Another factor was that caregiving responsibilities increased significantly during the pandemic, especially for women, including those who were participating in the workforce. Balancing work and family obligations has long been the reality for women. Studies have shown that women spend about twice as much time caring for and helping with children than men, and there is a significant disparity in many families where both men and women work. Even before the pandemic, most working mothers said they came home to a "second shift" of work. The pandemic served to amplify those family responsibilities, and I don't think it is surprising that as a result women dropped out of the workforce at a higher rate than explained by industry-mix and labor dynamics. Even more striking, the data show that while labor force exits increased for all women, they increased by more among women living with children under the age of six. We saw more exits by single mothers and mothers with lower earnings at the beginning of the pandemic, perhaps because they were less able to find alternative childcare arrangements. Even now, as childcare centers have reopened, worker shortages and related cost increases are limiting the number of children who can be cared for at each facility. Higher childcare costs impact single and lower-income mothers disproportionately. Therefore, I see a risk that lack of childcare availability will continue to hold women back from participating in the labor force, which could be a drag on the economy. The final factor to consider is retirements. Many older workers who left the labor force are unlikely to return, and more of those workers were women. The Bureau of Labor Statistics reports that labor force participation among women 65 and older has fallen significantly more sharply than among men. Many additional workers over 55 dropped out of the labor force and over time will effectively retire. The loss of these workers will limit the productive capacity of the economy, and may make it harder, or even impossible in the near term, to return to the high level of employment achieved before the pandemic. s As the economic expansion continues, the lingering effects of the pandemic could have long-lasting implications for women's job opportunities and in the longer term for their careers. As the job market strengthens, many women, particularly minority women, say they are considering returning to the labor force. History tells us that the longer workers remain out of the workforce, the less likely it is that they will return to employment and the greater the likelihood that they will lose skills and connections with the job market, which could weigh on labor force participation and earnings for years to come. There are also effects that are difficult to quantify on the careers of parents who have to juggle even more responsibilities. Employees who kept their jobs but reduced their hours or struggled to balance work and home life may find themselves in weaker positions for promotions, raises, and other advancement. These issues extend to women business owners. Compared to male business owners, women have reported worse financial health and have less confidence in the future of their businesses. Some longer-term factors affecting women's careers are hard to measure, and it may be some time before the full effects of the pandemic are clear. Even those who are working may face fewer opportunities to switch careers, or their employment and finances may be too tenuous to take time out to enhance their education or skills. While it's helpful to talk about the issues and their impact on women and employment, and I appreciate the opportunity to discuss them, it is also necessary to encourage research on potential solutions. What can we do to increase opportunities for women who must balance work and home, and what could help keep them from dropping out of the labor force? First, we should recognize the importance of caregiving for young children in the lives of working parents. Many of our Federal Reserve Banks are exploring how important early childhood education and care are for working families. Many are also conducting research on childhood education investments, challenges facing the childcare sector, and the longer-term benefits that childcare and education provide. recently published a case study of the success of early childhood education in Danville, Virginia, which is part of the fifth District. In 2010, this rural community had few and fragmented early child care and educational services. Strong partnerships and investments in this area have created an early-childhood ecosystem, connecting providers, local services, and parent education classes. I'd like to commend my colleagues in the Federal Reserve System who are adding to our base of knowledge through these types of initiatives. Finally, we need more research to understand the many ways that women's work opportunities and experiences are different from men. I'm happy to share that these are topics the Federal Reserve will continue to explore over the next few weeks. On October 21st, the Federal Reserve Banks of Dallas and Kansas City will hold a seminar on Understanding and part of our ongoing community development research seminar series. And the Federal Reserve Board will also host a virtual conference on Gender and the Economy Thank you again for inviting me to join you today, and I look forward to our discussion.

r211019a_FOMC

united states

The Economic Outlook and a Cautionary Tale on “Idiosyncratic” Price Changes and Inflation

waller

Thank you to the institute for the opportunity to speak to you. Today my goal is to explain my outlook for the U.S. economy as well as how that perspective shapes my views on the appropriate approach to monetary policy. I have three points I would like you to take away from my comments. First, while there has been a significant slowdown in third quarter gross domestic product (GDP) growth, it should rebound in the first half of 2022. Second, I believe that substantial progress has been made on both the inflation and employment legs of our dual mandate. Hence, I believe that we should soon commence tapering our asset purchases. Finally, the next several months are critical for assessing whether the high inflation numbers we have seen are transitory. If monthly prints of inflation continue to run high through the remainder of this year, a more aggressive policy response than just tapering may well be warranted in 2022. In terms of economic growth, data for the third quarter of 2021 show that the economic recovery slowed as the effects of the Delta variant caused consumers and businesses to start pulling back on some forms of economic activity such as travel and leisure. Measures of consumer mobility, which are a good indicator of spending, grew strongly starting last winter but then started falling in June, around when the effects of Delta started to become significant. I and most other forecasters expected that real GDP would grow close to the very strong rate posted in the first half of the year, but it now appears that GDP growth will be closer to 3 percent at an annual rate. The two major causes of this slowdown have been the extent of the economic effects of the Delta surge and the extent of supply constraints, both of which had larger effects than I and most forecasters expected. That was due to both the disappointingly low levels of vaccination in some areas and how highly contagious Delta proved to be. Meanwhile, we have seen labor shortages in many regions and many sectors that seem unwarranted given the level of unemployment and other indicators of slack in the labor market. And supply constraints have been very widespread, with many causes, only some of them directly related to COVID-19. U.S. imports have been disrupted both at the point of export and at U.S. ports, with backups at major ports larger than some have ever experienced. Thus, a lack of inputs and a lack of labor to use them have created a dramatic headwind for GDP. Fortunately, there is already evidence that the Delta surge has begun to wane and, with the reopening of schools (and the expectation that they will remain open in most areas), that the worst effects of Delta, medically and economically, may be behind us. Likewise, fears that Delta would lead health officials to mandate more severe business restrictions have not materialized. Furthermore, the spread of the Delta variant has raised vaccination rates even in areas where they had been low, which will help contain the spread of the Delta variant. All of this recent experience encourages me to believe that the moderation in the expansion of economic activity in recent months that is directly related to the Delta surge will be a temporary phenomenon. I expect that this slowdown has only delayed the economic recovery into the first half of 2022, and thus I moved what I thought would be strong growth in the second half of this year into the first half of next year. This delay means that my medium-term outlook for economic growth really has not changed much at all, and that I forecast the strong recovery will continue. Let me now turn to the recent job reports. For the month of August, I and many forecasters expected the economy would create 700,000 jobs or more, but the initial number came in at a disappointing 235,000. Hopes turned to September, but that report disappointed as well, with 194,000 jobs created. Despite these unexpectedly low numbers, there is still some good news from the September report--namely, that the disappointing number was due to unexpected declines in employment by state and local governments that may be attributed to limited labor supply that will work itself out in coming months. Private payrolls increased a healthy 317,000 jobs in September, and the July and August payrolls were revised up by 169,000 jobs. Nevertheless, the numbers are concerning, given that as many as 8 million workers may have rolled off unemployment insurance programs in September. It is difficult to imagine that, going forward, these workers will continue to remain on the sidelines. This suggests we may be in for very healthy job gains in the last quarter of this year as these workers begin to fill the enormous number of available jobs. The September jobs report also showed the unemployment rate falling four-tenths of 1 percent, from 5.2 percent to 4.8 percent. It is striking that, in 16 months, the unemployment rate has fallen from 14.8 percent in April 2020 to just 4.8 percent now. So we are clearly most of the way back to the very strong labor market that we achieved before the pandemic. However, one data series, such as the unemployment rate, is insufficient at capturing the overall status of the labor market. Our assessment of the labor market must be broad based, which is why I look at more comprehensive measures of labor market health. Two that I find particularly useful are the Atlanta Fed's labor market distributions spider chart and the Kansas City Fed's Labor Market Conditions The Kansas City chart nicely condenses 24 different measures of the labor market, and the index is now above its long-run historical value. The Atlanta Fed spider chart shows where each of 15 labor market indicators sits relative to different dates, such as February 2020 and September 2021. The spider chart reveals that 9 of the 15 indicators, including those for wages and job openings, are either better than February 2020 or nearly as good. Consequently, both broad measures of labor market performance reveal a significant degree of healing in the U.S. labor market. Now let me focus on the Federal Reserve's goals for monetary policy. As the many participants judge that we have achieved substantial progress on our inflation goal. With regard to substantial further progress on our employment objective, I believe we have now met that criterion despite the disappointing jobs reports for August and September. We lost 22 million jobs during the early months of the pandemic recession. Two million of those jobs are likely gone forever due to early retirements. We have now regained approximately 17 million of those jobs, or 85 percent of what was lost after adjusting for early retirements. Furthermore, the September unemployment rate of 4.8 percent is not that far from the 3.5 percent unemployment rate that was realized in In summary, the labor market has experienced a healthy recovery, but it is not fully healed. While there is still room to improve on the employment leg of our mandate, I believe we have made enough progress such that tapering of our asset purchases should commence following our next FOMC meeting, which is in two weeks. Inflation has been running higher this year than I and most forecasters expected. It has not been high for just a month or two--it has been high all year. It is important to acknowledge that. The unexpected inflation we have observed has raised costs for households and businesses and complicated their planning, which has a real effect on people's lives. For the Fed, the question is whether higher inflation this year undermines moving toward our economic goals. On that score, I continue to believe that the escalation of inflation will be transitory and that inflation will move back toward our 2 percent target next year. That said, I am still greatly concerned about the upside risk that elevated inflation will not prove temporary. have seen substantial increases in many prices. Lumber prices skyrocketed through May but have largely retraced that increase in the past few months. Prices for used cars rose substantially from mid-2020 to mid-2021 but now seem to have stabilized at this higher level. At present, I am closely watching prices for housing services (rent and owners' equivalent rent), which saw modest increases last year but have picked up recently. In addition, energy prices have moved up noticeably in recent months, and market conditions suggest risk of further increases. As I said earlier, I still see supply and demand working here to moderate price increases so that inflation moves back toward 2 percent. But I also see some upside pressures on inflation that bear watching. Bottlenecks have been worse and are lasting longer than I and most forecasters expected, and an important question that no one knows the answer to is how long these supply problems will persist. Through our business contacts, we continue to hear stories about bottlenecks at almost every stage of production and distribution--for example, plants that shut down because of a shortage of one or more crucial inputs; a poor cotton crop in the United States due to weather, which is driving up prices; and clogged ports and trucker shortages. Meanwhile, wage gains have been strong. That apparently has not made its way into prices yet, but how long before it becomes a factor driving inflation? Firms are reporting that they have more pricing power now than they have had in many years, as consumers seem to be accepting higher prices. The simple answer is that I believe the next few months will be crucial to understanding whether elevated rates of inflation last and if that will trigger a lasting effect on the U.S. economy. We will know more as time goes on about whether inflation in the prices of those goods and services will level off or even fall, as lumber prices have, and how other prices will evolve. But, importantly, we will also know whether this period of higher inflation has started to affect expectations of future inflation. A critical aspect of our new framework is to allow inflation to run above our 2 percent target (so that it averages 2 percent), but we should do this only if inflation expectations are consistent with our 2 percent target. If inflation expectations become unanchored, the credibility of our inflation target is at risk, and we likely would need to take action to re-anchor expectations at our 2 percent target. This raises a couple of key questions: Whose inflation expectations do we examine, and how do we determine if they are unanchored? With regard to the first question, we measure inflation expectations two ways. First, we survey the public and ask them what they expect the inflation rate to be in coming years. The University of are examples of this "survey approach." Second, we can infer inflation expectations from differences in yields between Treasury securities that are indexed for inflation and those that are not. These breakeven inflation measures from the Treasury Inflation-Protected Securities market are referred to as "market based" measures of inflation compensation. Survey measures give us an idea of what the average household expects inflation to be in the coming years. Presumably, this measure of expectations is important because it should influence households' wage demands as they seek compensation for an increasing cost of living. A key drawback of these measures is that the respondent incurs no benefit or cost from the accuracy of their forecast. This is why I have always preferred market-based measures of inflation expectations, because they are formed by investors who are betting with real money about future inflation. In short, they have skin in the game. This brings us to another question: Are inflation expectations anchored around our inflation target of 2 percent? Survey measures have shown a dramatic increase in inflation expectations over the past few months. The recent New York Fed measure has short- and medium-term inflation expectations at 5.3 percent and 4.2 percent, respectively. This is eye opening and a genuine cause for concern should households embed these expectations in wage demands. However, market-based measures of inflation expectations and the five-year inflation expectations from the New York Fed survey continue to be anchored near our 2 percent target. I also look at the Board of Governors staff's common inflation expectations measure, which distills a signal from both surveys and market-based inflation gauges. At this point, at least, it remains near its average over the past decade. This gives me some comfort that the recent run of high inflation readings has not led to an unanchoring of inflation expectations. It is important to account for all measures of inflation expectations and not "cherry pick" the measure that one finds most comforting. I would like to follow up on this last point as it pertains to thinking about inflation. As I mentioned earlier, a lot of commentators, including me, have deflected concerns about high inflation readings being the result of "outliers" or "idiosyncratic" price movements. As a result, recent high inflation readings are transitory and not broad based. But there is a fallacy in doing so that one should avoid in judging whether higher inflation is indeed transitory. A basic tendency of statistical analysis is to exclude outlying or more volatile data. There are sound reasons for this, such as when we exclude volatile food and energy prices to get a measure of "core" inflation; that kind of measure often is more stable and can tell us whether the underlying forces behind inflation are moving as rapidly as it might seem from headline inflation. A similar logic applies to trimmed mean measures of inflation, such as the Cleveland Fed trimmed mean consumer price index and the Dallas Fed trimmed mean PCE (personal consumption expenditures) inflation rate. These measures censor the tails of the price change distribution to avoid having average inflation distorted by extreme price movements. However, inflation is distilled from many prices, and those prices do not move uniformly. As a result, we may be led to "falsely" dismiss certain price movements and risk being misled as to the true inflation rate. Let me use a simple example to illustrate this point. Consider a three-good economy with goods A, B and C, and look at how their prices increase over time. In one world, the price of each good goes up 2 percent every year. Thus, average inflation is 2 percent every year, and there is no reason to question that measure, as it is broad based. This is typically what we have in mind when we think about trend inflation. In this world, inflation is meeting the FOMC's 2 percent target and there is no need for a policy change. Now consider a world in which there are sharp price changes that are staggered across the goods. In year 1, the price of good A goes up 5 percent, while the price of goods B and C increase 2 percent. If we assume equal weights for each good, the inflation rate for this economy is 3 percent. This repeats in year 2, with the price of good B increasing 5 percent while the other two have increases of 2 percent. In year 3, good C sees the largest increase. In this economy, inflation averages 3 percent each year, which is above the FOMC's 2 percent inflation target. Now, one could look at this data and manipulate it in several common ways. First, if one used a trimmed-mean measure of inflation, you would throw out the highest and the lowest readings for each year. What do you get? The average inflation rate would be 2 percent every year. Thus, over a three-year period, a trimmed mean measure of inflation would be 2 percent and indicate we are hitting our inflation target when the true measure would be 3 percent per year. A second way of manipulating the data is to say in year 1, "Look, inflation is being driven by good A, which had an idiosyncratic, outsized price increase. If you throw it out, the underlying inflation rate is 2 percent." Then in year 2, you say, "Good B had an idiosyncratic price increase, so throw it out." Repeat for year 3. Again, by selectively throwing out unusually high price increases for individual goods, you would conclude that inflation over the three-year period is 2 percent and we are hitting the inflation target when, in fact, it was 3 percent. Third, one can justify throwing out good A in the first year by saying it did not reflect a broad-based price increase--the prices of 67 percent of the goods rose 2 percent. So, based on these goods, we are hitting our inflation target. You would be correct but, again, misguided. Finally, one could claim, correctly, that the large price increase for good A is "transitory"--it went up strikingly in year 1 but then dropped back, meaning inflation should fall back to our inflation target in coming periods. But that will mislead you in terms of understanding the true inflation rate, because you are putting zero probability that a large spike in inflation will happen to another good in the future. The moral of this little example is that one needs to be careful when selectively ignoring data series--be it used car prices, food and energy prices, or household surveys of inflation expectations. All of these series convey important information about the evolution of inflation, and one should exhibit caution in dismissing data as outliers. We must keep our eyes open to inflationary pressures, wherever they come from, with consistency and rigor and stand ready to adjust policy if we conclude that such a change is warranted. This brings me to how I believe monetary policy should evolve in the coming months, based on the outlook I have described. The near-term decision we face is when to begin slowing the pace of asset purchases, which have each month been adding to the level of financial accommodation provided by the Fed to support the economy. Our test for this step was making "substantial further progress" toward our employment and inflation goals. After years of running below 2 percent, the recent and sustained increase in inflation clearly represents substantial progress toward our goal. And the continued gains in employment, despite a couple of months of a slowdown, along with results across a range of labor market indicators, indicate to me that there has also been substantial further progress toward maximum employment. I support the FOMC beginning to reduce asset purchases following our meeting in November. Importantly, this action should not tighten financial conditions, since a later 2021 tapering has already been priced in by most participants. One issue on which we should also be clear is the pace of tapering. I have said in the past that I favor a pace of tapering that would result in the end of asset purchases by the middle of 2022. Of course, if economic conditions and the outlook were to deteriorate significantly, we could slow or pause this tapering. And if the economy were to strengthen more than expected, the plan to rapidly end purchases would provide policy space in 2022 to act sooner than now anticipated to begin raising the target range for the federal funds rate. Based on my outlook for the economy, however, I do not expect liftoff to occur soon after tapering is completed. The two policy actions are distinct. I believe the pace of continued improvement in the labor market will be gradual, and I expect inflation will moderate, which means liftoff is still some time off. That said, as I mentioned earlier, if my upside risk for inflation comes to pass, with inflation considerably above 2 percent well into 2022, then I will favor liftoff sooner than I now anticipate. A major consideration will be my judgment about whether inflation expectations are at risk of becoming "unanchored"--rising substantially and persistently above 2 percent. My FOMC colleagues and I will be watching all of the data carefully in the coming weeks and months and will adjust policy as needed to help ensure the U.S. economy continues to recover from the effects of COVID, and that we continue to make progress toward our economic goals.

r211020a_FOMC

united states

How Long is Too Long? How High is Too High?: Managing Recent Inflation Developments within the FOMC’s Monetary Policy Framework

quarles

Thank you to the Milken Institute for the opportunity to join you today. This morning I'd like to outline my view of current economic conditions and the economic outlook and then turn to the implications for monetary policy. In particular, with employment still well below its February 2020 peak, I will focus on how the escalation in inflation this year is testing the monetary policy framework adopted by the Federal Open Recent data suggest that growth in the third quarter is likely to be lower than we had expected, but the foundations remain in place for strong economic growth over the remainder of this year and next. Employment is growing, financial conditions are accommodative, businesses are investing, and households, in the aggregate, have a large stock of savings to draw on for future spending. Weaker growth in payrolls in August and September, along with uneven consumer spending in July and August, appear to reflect ongoing concerns in some parts of the country about the spread of COVID-19, especially in high-contact service industries. Supply bottlenecks and labor shortages that have been more widespread and persistent than many expected are camouflaging continued strong underlying demand for goods, services, and workers. Supply constraints are particularly evident in interest-sensitive parts of the economy, such as residential investment and vehicle sales, limiting the scope for additional monetary accommodation to stimulate activity in those sectors. I expect that these developments, however, have for the most part simply postponed activity temporarily and that robust growth will return in the coming months. There is evidence in recent weeks that we seem to be moving into a new phase of the economy. Nominal retail sales rose seven-tenths of 1 percent in September on the heels of a nine-tenths increase in August, an indication that consumers kept up their pace of spending. Robust business investment in equipment and intangibles continued in the second quarter, and indicators suggest another gain in the third quarter. Forward indicators of business spending and the need for firms to replenish depleted inventories point to strong investment into next year. Without a doubt, the headline job gains in August and September were lower than expected, but, as I will show, based on almost every other major labor market indicator, there is ample evidence that the demand for labor is strong. At last measure, the Labor Department reported that job openings remained near a record high in August, and a record number of workers were voluntarily quitting their jobs, an indicator of their confidence in finding a better one. Other measures of job openings by education level indicate that jobs are plentiful even for less-skilled workers who have been affected the most by the COVID event. Another indicator I've been watching closely is the so-called U-6 unemployment rate, which consists of people who are working part time but prefer full-time work and discouraged workers who want a job but have given up looking. U-6 unemployment declined significantly over the past two months to 8.5 percent in September, roughly the same level as in the middle of 2017, when most everyone considered the job market to be quite healthy. In fact--and this will not be news to most of you--shortages of skilled workers in many occupations predated the COVID event and are likely to persist after its effects have faded. Some of this shortage reflects the aging of the workforce, changes in the types of jobs people want to do, and the time it takes to train workers. Strong demand for labor is outpacing supply, and, naturally, that development is putting upward pressure on wages. Through September, average hourly wages are up 4.6 percent over the past 12 months, the largest and most sustained increase in wages for workers since the 1990s. I noted the imbalance between the demand and supply for labor, and some of the labor market indicators that are still well short of pre-COVID levels are those related to labor force participation, which has been about unchanged this year on balance. I expect that as conditions normalize, this measure will pick up, but it is unlikely to return to its February 2020 level. One reason is that a disproportionate number of older workers responded to the initial shock of the COVID event by retiring, which may be an area where participation and employment struggle to retrace lost ground. Longer-lasting changes in labor force participation could make wage pressures more persistent and have implications for the assessment of maximum employment. Since the middle of last year, the Fed has been increasing its holdings of Treasury securities and agency mortgage-backed securities by $120 billion a month to foster smooth market functioning and to support the economy by putting downward pressure on interest rates. Conditions had improved considerably by the time we announced our forward guidance for asset purchases in December, but the unemployment rate remained at 6.7 percent, near-term growth was being constrained by heightened social-distancing restrictions amid surging hospitalizations from COVID-19, and inflation was running significantly below 2 percent. As we sit here today, demand for labor is strong, and unemployment has declined to 4.8 percent. We have exceeded the previous high for real gross domestic product and are close to reaching the pre-COVID trend. Inflation, about which I will say more shortly, is running at more than twice the FOMC's longer-run goal. Taking all of the evidence into account, I think it is clear that we have met the test of substantial further progress toward both our employment and our inflation mandates, and I would support a decision at our November meeting to start reducing these purchases and complete that process by the middle of next year. Bear in mind that asset purchases are pressing down on the accelerator, adding each month to the amount of accommodation the Fed is providing to the economy through downward pressure on longer-term interest rates. Reducing purchases and ending them on this schedule is not monetary tightening, but a gradual reduction in the pace at which we are adding accommodation. A move to reduce the pace of asset purchases soon also is entirely consistent with the FOMC's plan to pursue our longer-run maximum-employment and price-stability goals, and our new monetary policy strategy, which we refer to as our framework. The forward guidance that we put in place for asset purchases was an operationalization of the new framework. Last December, with inflation running well below 2 percent and unemployment still elevated, we committed to continue purchasing assets at least at the current pace until we had made substantial further progress toward our goals. In most situations, those goals are complementary. That is, high unemployment usually coincides with subdued inflationary pressures. Therefore, at the time, we did not foresee those goals coming into conflict. But we are facing a situation now where inflation is high even though employment has yet to fully recover from the COVID event. In that case, according to the FOMC's monetary policy framework, when objectives are not complementary, the Committee "takes into account the employment shortfalls and inflation deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate." Applying those principles throughout 2021, we have been very patient and focused on the need for the labor market to recover as quickly as practicable from the severe damage experienced during the darkest days of the COVID event. We are remaining patient because, despite some periods of rapid progress, the recovery in jobs has been uneven and is still incomplete. Early on, patience was easy: In December of last year, my FOMC colleagues and I were expecting much lower inflation--the median projection for 2021 by FOMC participants was 1.8 percent. The FOMC's preferred inflation gauge did not crack 2 percent until March 2021. But, by June, prices had risen 4 percent over the previous 12 months, ticked up to 4.2 percent in July, and increased further to 4.3 percent in August. The median of the most recent projections by FOMC participants traces a path in which inflation ends the year just a touch lower than the current level. Nonetheless, I do not see the FOMC as behind the curve, for three reasons: Most of the biggest drivers of the very high current inflation rates will ease in coming quarters, some measures of underlying inflation pressures are less worrisome, and longer-term inflation expectations are anchored, at least for now. First, let me address the big drivers of this year's price increases. The inflation we have experienced so far has been very unusual and largely related to supply constraints associated both with production and distribution problems related to COVID and with a demand shock arising from the unprecedented and rapid reopening of the economy. We all saw the remarkable price increases and shortages in the used car market. There have been a few other very specific and identifiable supply problems that have driven some other prices to very high levels--the semiconductor shortages that led to auto production slowdowns, for example, and, in some cases, labor shortages or restrictions related to the COVID event were associated with trade disruptions. Second, if we recognize that much of the excessive inflation we are seeing this year is directly attributable to disruptions that, like the COVID event, will end, then monetary policy often can look through those types of disruptions to consider what inflation will be in the future when this episode passes. To get a fix on where inflation is headed, it is helpful to consider measures of inflation that try to filter out the most unusual and presumably transitory price increases that may be driving headline inflation. The Federal Reserve Bank of Dallas's trimmed mean measure of inflation systematically removes prices that are increasing or decreasing at abnormally large rates, in order to get some perspective on underlying inflation pressures. For the 12 months through August, the Dallas trimmed mean inflation was an even 2 percent. Of course, while this metric may provide a better indicator of future PCE (personal consumption expenditures) inflation, I do not mean to suggest that this is necessarily a better reading on current inflation--consumers and businesses have to pay for the goods whose prices have risen sharply, and those increases are being felt. That brings us to the third reason that I do not think the FOMC is behind the curve: anchored inflation expectations. We monitor longer-term expectations of future inflation because we believe they influence changes in actual inflation over the medium term. In fact, our new framework recognizes that stable, well-anchored inflation expectations help return inflation to 2 percent when it is running high, as it is now, as well as when it has fallen somewhat below that goal, as it often does during a recession. So far, market-based measures of longer-term inflation expectations, as well as surveys of professional forecasters, have increased only moderately this year, moves that more or less reversed declines in those expectations over the previous half-dozen years. Measuring expectations is an inexact science, but smoothing through the ups and downs in expectations in recent years leaves these indicators within a range that has been consistent with inflation near our 2 percent goal. Going forward, the question is not only whether inflation will fall in the coming months, but also how far it will fall and if it will fall soon enough to avoid spurring a concerning rise in longer-term inflation expectations. I agree with my FOMC colleagues and most private forecasters that inflation likely will decline considerably next year from its currently very elevated rate. For instance, most of the September Summary of Economic Projections forecasts for PCE inflation in 2022 were between 1.9 and 2.3 percent, with a minimum of 1.7 percent and a maximum of 3.0 percent. significant upside risks to my current inflation outlook. Supply constraints in production and distribution already have become more widespread and have lasted longer than most forecasters anticipated. As noted earlier, labor supply constraints are making it difficult for businesses to keep up with demand. This dynamic will continue to support robust wage growth, putting further upward pressure on prices. Moreover, there is evidence in the past couple of months that a broader range of prices are beginning to increase at moderate rates, and I am closely watching those developments. The fundamental dilemma that we face at the Fed right now is this: Demand, augmented by unprecedented fiscal stimulus, has been outstripping a temporarily disrupted supply, leading to high inflation. But the fundamental productive capacity of our economy as it existed just before COVID--and, thus, the ability to satisfy that demand without inflation--remains largely as it was, and the factors that are disrupting it appear to be transitory. Looked at purely in that light, constraining demand now, to bring it into line with a transiently interrupted supply, would be premature. Given the lags with which monetary policy acts, we could easily find that demand is damping just as supply is increasing, leading us to undershoot our inflation target--and, in the worst case, we could depress the incentives for supply to return, leading to an extended period of sluggish activity and unnecessarily low employment. discovering that it's going to take more time than we had thought for supply to return to normal, and with demand already high during that time, I am monitoring the extent to which it could be further boosted by the additional fiscal programs currently under discussion. If those dynamics should lead this "transitory" inflation to continue too long, it could affect the planning of households and businesses and unanchor their inflation expectations. This could spark a wage-price spiral that would not settle down even when the logistical bottlenecks and supply chain kinks have eased. So the central question we have to answer is "How long is too long?" I am among those who see a good chance that inflation will remain above 2 percent next year, but I am not quite ready to conclude that this "transitory" period is already "too long." We haven't yet met the more stringent tests for liftoff that we have laid out in forward guidance about the federal funds rate. Let me quote from the latest FOMC statement: Raising rates will not be appropriate "until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time." Importantly, the level of uncertainty around the paths for inflation and employment are higher than normal as we navigate the unprecedented reopening of the world economy. Therefore, we will remain outcome based, waiting to see further improvements in employment and the evolution of inflation pressures in coming months. And, if the broadly held expectation that inflation will recede next year turns out to be wrong or if inflation expectations show signs of becoming unanchored to the upside, I am confident that the monetary policy tools at our disposal can bring inflation down toward our 2 percent goal. I said just now that the central question is "How long is too long?" I am also keenly aware, however, that inflation of 4 percent or more certainly cannot be characterized as only "moderately" above 2 percent, and thus we also have to deal with the question of "How high is too high?" Moreover, the two questions are obviously related: we can tolerate inflation of 2.5 percent as supply returns to normal without dramatically affecting inflation expectations, for a much longer period than we can tolerate inflation of 4.5 percent. So, how high is too high? I cannot speak for my FOMC colleagues on this issue, but I will conclude with some thoughts of my own. In 2012, the FOMC formally adopted a longer-run inflation target of 2 percent, and since then, that target has been reaffirmed annually by the Committee including in our new framework adopted in August 2020. The key innovations in the new framework relative to the previous incarnation are designed primarily to address the risk that inflation and inflation expectations could settle below our 2 percent target. That risk emanates from the understanding that several longer-run changes in the U.S. economy may have conspired to reduce the level of the equilibrium federal funds rate--the level at which it is neither slowing nor speeding up economic activity. In turn, a lower average level of interest rates would make it more difficult, on balance, for the Federal Reserve to respond to negative shocks to the economy with sizable cuts to interest rates. The inability to cut interest rates sufficiently can then reinforce downward pressures on inflation such that it begins to run persistently below the FOMC's 2 percent goal and causes inflation expectations to fall with it. As is well known by now, those revisions to the Fed's monetary policy framework put new emphasis on reaching maximum employment and introduced new flexibility in how to account for progress toward our price-stability goal by seeking inflation that averages 2 percent over time to ensure longer-term inflation expectations remain anchored at this level. This revision implies that monetary policy will provide more support for economic activity over a typical business cycle than had been the case, in order to prevent longer-term inflation expectations--and, ultimately, inflation itself-- from settling below 2 percent. In this low interest rate environment, some researchers have suggested going further than our current framework does in allowing inflation to run moderately above 2 percent for some time following periods where it has run persistently lower than 2 percent, and actually raising the inflation target to 2.5 percent or 3 percent or even 4 percent. At the outset of our recently completed review, we reaffirmed that inflation at a rate of 2 percent is most consistent over the longer run with our congressional mandate for price stability. I believe that any future discussion of a higher target would need to address whether it remained consistent with that congressional mandate. I would also emphasize that at this point, the public is very accustomed to a world of inflation near 2 percent, which has allowed households and businesses to operate with considerable certainty. Research shows that such certainty is valuable for households and businesses to make sound financial decisions and to avoid economic distortions that could hinder economic growth. My strong support for our consensus framework is predicated not only upon its new features designed to address inflation that falls too low, but also its commitment to prevent longer-term inflation expectations from rising materially above a level consistent with our 2 percent goal. In this sense, the current elevated rates of inflation are not challenging our new framework any more than they would have challenged our previous framework or, for that matter, most reasonable frameworks for conducting monetary policy. As I said earlier, when our price-stability and employment goals are not complementary, the framework calls for policy to depend on the remaining shortfall from our maximum-employment goal, on the extent to which inflation continues to exceed 2 percent, and on the amount of time we expect it will take for employment and inflation to meet our goals. I remain quite optimistic about the capacity and willingness of consumers and businesses to power a robust expansion as we put the COVID event behind us, even with the headwinds coming from the supply side. But that forecast for growth and uncertainty about the resolution of supply constraints mean that there are upside risks to inflation next year. So my focus is beginning to turn more fully from the rapidly improving labor market to whether inflation begins its descent toward levels that are more consistent with our price-stability mandate, as most forecasters and most of my colleagues on the FOMC expect over the next year. I would also be quite wary of further increases in inflation expectations in this environment. If inflation does remain more than moderately above 2 percent, be assured that the FOMC has the framework and the tools to address it.

r211022a_FOMC

united states

The Lack of New Bank Formations is a Significant Issue for the Banking Industry

bowman

Good morning. I appreciate the opportunity to be part of this symposium on "Banking on the Future," especially since the future of banking is one of the highest priorities in my work at the Board. Today, I will focus my remarks on the importance of community banks to our financial system and the challenges they face. In particular, I will focus on the formation of new banks and pose two key questions concerning the recent scarcity of these "de novo" banks. The first question: Why have there been so few de novo bank formations over the last And second, what can be done to encourage more de novo banks? I will begin with some background on community banks and bank formations. By serving communities, households, and businesses that may be underserved by larger institutions, community banks play a key role in advancing diversification in the U.S. banking system. First and foremost, community banks provide critical financial services to their communities and to many customers who might have limited geographic access to banking services. Because community bankers are active participants and leaders in their communities, they typically know their customers and their needs better than a banker at a branch of a larger institution. Community banks draw upon this knowledge and conduct "relationship" lending versus relying on automated underwriting models that are typical in larger institutions. Therefore, community banks are more willing to underwrite loans to creditworthy customers based on an assessment of qualitative factors that automated models do not consider. Since community bankers are part of the fabric of their communities, they better understand the local market and economic conditions in the area compared to larger institutions that are not resident within the community. Collectively, community banks are critical in advancing the health and stability of the U.S. economy as evidenced by their participation in the Small Business Administration's $429 billion, which accounted for nearly 60 percent of the program's total loan amount. comparison with the banking industry as a whole, these banks provided more loans to traditionally underserved communities and population segments: community banks provided 87 percent of total PPP loans to minority-owned businesses, 81 percent to women-owned businesses, and 69 percent to veteran-owned businesses. Despite the local and national significance of community banks, their numbers, as well as the number of insured banks in general, have been declining for several years. This erosion of community bank charters is not just an issue in our rural communities. In urban areas, these banks, including minority-owned banks, serve businesses and households that may also be overlooked by larger institutions. I am concerned that the contraction of community banks could lead to an unhealthy level of similarity in the banking system. As a result, this could limit the ability of households and small businesses to access credit and other types of financial products and services. The beauty of community banks is in their differences--whether in their personality or business model. Each is unique in its mission, service delivery, and profile. While I am troubled by the declining community bank footprint, I am not surprised that banks are choosing to merge or to be acquired. I am well aware of the significant challenges that smaller banks face. Since joining the Board, and increasingly over the past year, I have met with many state member bank CEOs who share these challenges with me. These CEOs have expressed frustrations with ever-increasing compliance burden, which distracts their attention from prudent revenue generating activities. As I discussed in recent remarks at the community bank research conference in late September, public policymakers must avoid adding regulatory burden on the smallest banks, particularly on those that maintain a more traditional business model. Therefore, policymakers need to achieve a meaningful balance in our supervisory approach for community banks. Otherwise, community banks will continue to face a regulatory and supervisory framework that is ill-suited for a lower-risk profile and activities that are less complex than those of larger institutions. The underlying question remains: why have there been so few de novo bank formations over the last decade? There have been only a handful of new bank charter applications over the past decade. In fact, only 44 de novo banks have been established, which include both state and national charters. A 2014 study by Federal Reserve Board economists noted that from 1990 to 2008, over 2,000 new banks were formed, which on average is more than 100 per year. In contrast, the study noted that only seven new banks were formed from 2009 to 2013. The 2014 Board study suggests that "low interest rates and depressed demand for banking services--both of which depress profit for banks, and particularly new banks--may also have discouraged entry." The conclusions from a Federal Reserve Bank of Kansas City study completed this year align with observations from the 2014 Board study. In this more recent study, the authors noted that new bank formations tend to be cyclical, accelerating during periods of economic expansion and slowing during recessions. While regulatory burden has also contributed to depressed de novo formations, the authors pointed to the weak economy following the 2007-2009 financial crisis and low profitability for banking as overriding factors. A recurring theme that has surfaced through my discussions with bankers and other industry stakeholders is the regulatory burden imposed upon de novo banks. In particular, community bankers noted the challenges in raising the capital required to establish a new bank. The 2014 Board study noted that the states' statutory capital requirements for a new state- chartered bank could be as low as $10 million, but in practice could be as high as $30 million. Given the high initial capital requirement, a de novo bank has a small margin of error in implementing its business strategy and meeting profit projections. In establishing a new bank, bank executives explained the challenges in developing a business plan and risk-management framework that addresses how the bank can generate a sufficient profit to provide an adequate return to shareholders. For a de novo bank, the cost and burden of starting from ground zero in establishing their risk-management and internal controls are high. De novo banks make strategic decisions in establishing risk-management processes and controls that may delay the launch of revenue-generating products and services. Further, a de novo bank faces the pressure to grow quickly, which in turn, may lead to riskier lending and other activities. Indeed, experience has shown that pronounced problems often surface in the early years of a de novo bank's operations, which explains the elevated capital and supervisory expectations for these banks. The Federal Reserve and the other banking agencies generally expect a de novo bank to maintain a Tier 1 leverage ratio of at least 8 percent for the first three years of its existence and they examine the bank on a more frequent schedule. For a de novo bank, there is a heightened need to hire experienced staff who are quickly able to establish the bank and show progress in meeting the operating goals and profit projections in the business plan. As we all know, difficulty in finding skilled workers is an issue more broadly in the economy, but community bankers frequently tell me of their ongoing challenges in attracting and retaining experienced staff. These challenges are even more acute for de novo banks who require staff with experience in regulatory compliance and internal controls. A Kansas City Reserve Banks study echoes these anecdotes, which indicate that the volume and complexity of regulations require specialized expertise that can be costly and difficult to find. The competitive landscape for financial services and products is also a key consideration in developing and executing a de novo bank's business plan. I often hear the perspective from bankers that non-regulated financial entities have a competitive advantage over regulated financial institutions in providing financial services and products. It would be helpful to appropriately acknowledge this competitive disadvantage for banks and tailor the regulatory framework based on the risks and complexity of their activities. As a result, the economic, regulatory, and market realities discourage the formation of de novo banks, as investors have many other options for entry into the financial services market. For example, they may choose to acquire an existing bank charter and subsequently establish branches in new markets. Further, they can acquire a branch office from an existing bank. And finally, they may choose to establish or acquire a nonbank financial firm that is subject to less regulation than a chartered and insured financial institution. So, let's address the second question: what can be done to encourage more de novo Simply the fact that I am speaking about this topic today should give you the sense that I am concerned about the impact of the declining number of community banks. While the loss of a single community bank may be inconsequential to U.S. financial stability, that loss may have profound consequences to households and businesses in that community. This is particularly true in rural communities and remote areas and in certain urban areas when the loss of the local bank may leave customers in a banking desert, void of tangible, relationship-based financial services. But we should also be concerned about how a continued decline in the number of community banks, in part due to the lack of de novo formations, will affect the banking and financial services system more broadly. When banking services are limited, it is much more difficult for people to fully participate in the economy, or to manage their finances when times are tough. A shrinking community bank sector may lead to a weaker banking system and weaker economy. It is crucial to provide a balanced, transparent, and effective regulatory framework that promotes a vibrant community bank sector. Public policymakers need to ensure that the regulatory and supervisory framework promotes safety and soundness, while recognizing the reduced risk of these banks' noncomplex services and activities. As large institutions and nonregulated financial companies expand their reach into markets traditionally served by community banks, policymakers need to ensure that the regulatory and supervisory framework does not exacerbate this competitive disadvantage. If we are not able to achieve an appropriate balance, I am concerned that there will continue to be fewer de novo banks as well as a decline in the overall population of community banks. These banks are a key segment of the industry in that they provide financial services and products to a wide range of consumers and businesses. Looking to the future, policymakers need to appropriately refine the regulatory and supervisory framework to minimize unnecessary compliance costs for smaller banks and address impediments to bank formations. In conclusion, I have raised two important questions about why there so few de novo banks and what can be done to encourage new bank formations. It is important for us to fully understand why we have seen the steady decline in bank formations, and to continue to explore ways to encourage community banks in such a competitive environment. Identifying answers to these questions should enable the federal banking agencies to identify potential regulatory and policy constraints on the formation of new banks. To further this effort, I have asked Federal Reserve staff to continue to study trends in community banking so that we can fully understand the economic and regulatory factors that constrain the ability of community banks to form, compete, and thrive. I appreciate the opportunity to raise these questions with you. And I look forward to further discussions about tailoring our regulatory and supervisory framework to ensure that community banks remain an essential part of the future of the U.S. financial system.

r211108a_FOMC

united states

The U.S. Housing and Mortgage Market: Risks and Resilience

bowman

Good afternoon, everyone. It is a pleasure to join you today. Thank you for the invitation. Developments in the housing and mortgage markets have a major effect on the economy and the financial system, so the Federal Reserve Board monitors these markets closely. I am happy to share some of my observations about these markets and to learn from your knowledge and experiences as well. I know I am speaking to an audience with considerable expertise in these areas, and so you know already that 2020 and 2021 have been interesting times, to say the least, in housing and mortgage markets. I will focus my comments today on three areas: the strong increase in home prices in the past year and a half, the wind-down of forbearance programs enacted after the advent of COVID-19, and what we learned about the financial stability risks associated with nonbank mortgage companies during the pandemic. As I hope will become apparent during these remarks, these three topics may seem unrelated but they are actually connected. I will start with some comments on home prices. Home prices had been rising at a moderate rate since 2012, but since mid-2020, their growth has accelerated significantly. In total, home prices in September were 21 percent higher than in June 2020. Home price increases are also widespread. In September, about 90 percent of American cities had experienced rising home prices over the past three months, and the home price increases were substantial in most of these cities. These sharp increases raise the concern that housing is overvalued and that home prices may decline. Historically, large home price increases are somewhat less concerning if they are supported by economic fundamentals rather than speculation. Fundamentals certainly seem to be a large part of the story behind the increases we've seen since the middle of last year. The demand for housing has risen for several reasons. Interest rates are low, families have accumulated savings, and income growth in the past 18 months has been quite strong. Families are also reconsidering where, and in what kind of home, they want to live. Purchases of second homes, for example, have been somewhat high in the past 18 months. Meanwhile, the supply of new homes has been held back by shortages of materials, labor, and developed lots. Another reason to be less concerned about the recent escalation in home prices is that we do not see much of the decline in underwriting standards that fueled the home price bubble in the mid-2000s. Mortgage underwriting standards have remained conservative relative to the mid-2000s, in part because of the mortgage policy reforms that were put in place in the aftermath of the housing crisis. Investor activity is subdued relative to that time as well. Nonetheless, home prices do decline from time to time. In inflation-adjusted terms, U.S. home prices fell from 1979 to 1982 and from 1989 to 1993, although by much less than from 2006 to 2012. Although the declines in national home prices were modest in some of these episodes, some areas of the country experienced sharp declines. As we all know, home price declines cause problems and strain throughout the economy. To give just one example, families and small business owners borrow against their homes to fund big-ticket purchases and business expansions, and house price declines make it harder to use homes as loan collateral. This effect can be amplified if a credit crunch occurs, in which lenders react to the decline in house prices by pulling back on their lending. With banks and the broader financial system currently quite robust, such a credit crunch seems unlikely. Nonetheless, I know how painful these declines can be, especially in certain markets. For example, from my experience living in rural Kansas, I understand how smaller communities with a less diversified housing and employment base can take a long time to recover from a fall in home prices. I wonder also about communities with a sizable share of second-home owners. So I will continue to watch the incoming data closely. Falling home prices would certainly be very dramatic, but continued outsized increases could also be problematic. First, high home prices make it more difficult for low- to moderate-income households to become homeowners, as larger down payments and other financing requirements effectively lock these households out of the housing market. Second, and related to one of the Federal Reserve's monetary policy goals, rising home prices and rents raise the cost of housing. Because housing costs are a large share of living expenses for most people, these increases are adding to current inflationary pressures in the economy. Indeed, we are already seeing sizable increases in rent and owners' equivalent rent in many parts of the country. In addition, there are signs of underlying supply and demand imbalances that will contribute to increases in housing costs and inflation. Early in the pandemic, the strength in home prices was thought to be driven by the decline in mortgage rates. But it has become increasingly clear that the low supply of homes, in combination with a strong demand for housing, is an important part of the story. Before this past year, the pace of construction of new homes was below its long-run average for more than a decade. The supply chain bottlenecks that I mentioned earlier are slowing down construction further. These issues affect the rental market too: The multifamily rental market is at historic levels of tightness, with over 95 percent occupancy in major markets. I anticipate that these housing supply issues are unlikely to reverse materially in the short term, which suggests that we are likely to see higher inflation from housing for a while. I am also watching carefully what happens as borrowers reach the end of the forbearance on mortgage payments. As of October, 1.2 million borrowers were still in forbearance, down from a peak of 4.7 million in June 2020. Of these remaining borrowers, 850,000 will reach the end of their forbearance period by the end of January 2022. Meanwhile, the temporary limitations on foreclosures put in place by the Consumer Financial Protection Bureau will expire at the end of the year. Forbearance has been an important support for workers dislocated by the pandemic and for their families. Transitioning the remaining borrowers from forbearance to a mortgage modification or other resolution may be a heavy lift for some servicers. Each transition requires getting in contact with the borrower, discussing options, and figuring out which resolution makes the most sense for each borrower. This is time- consuming and detailed work. It is also crucially important. Obviously, we want to ensure that borrowers who are struggling financially receive the help that they need, and I want to acknowledge that many of these borrowers are from communities that have traditionally been underserved by the mortgage market. In addition, if servicers handle loan modifications poorly and on a large scale, the macroeconomy and financial stability can be affected as well. In the aftermath of the last financial crisis, the flood of foreclosures led to downward pressure on home prices. The same dynamic has not unfolded during the pandemic. Forbearance, foreclosure moratoriums, and fiscal support have kept distressed borrowers in their homes. Fed supervisory staff are communicating with significant supervised institutions to ensure that they are preparing for the increased operational risks. If the transition out of forbearance is handled smoothly, I am cautiously optimistic that it will not have a material effect on the larger economy. The share of mortgages in distress--defined as those in forbearance or seriously delinquent--was about 4.5 percent in October 2021, about half the share of mortgages that were seriously delinquent in 2010. In addition, many of the mortgages in distress now are insured by the Federal Housing Administration or the Department of Veterans Affairs, and these agencies can require that certain mortgage modification protocols are followed. Outside of these mortgages, the share of borrowers who are not making mortgage payments has returned to pre-pandemic levels. Nonetheless, we are aware of the risks and will monitor this situation closely. Mortgage servicing, however, has increasingly moved from Fed supervised banks and into nonbank mortgage companies that are supervised by state regulators. In a speech late last year, I focused on some of the possible financial stability risks associated with nonbank mortgage servicers. I would like to update you on my thinking about this issue today. When widespread forbearance was introduced last year, concerns were raised that it would impose strains on nonbank servicers. That is because when a borrower does not make a mortgage payment, the servicer is required to make the payment on the borrower's behalf. Servicers are eventually reimbursed for these advances, but they are required to finance the unpaid amounts. And unlike banks, nonbanks cannot turn to the As it turned out, nonbank mortgage servicers had cash to meet their operational needs. Mortgage refinancing surged because of the drop in long-term interest rates, and nonbank servicers used the proceeds from these refinacings to fund the advances associated with forbearance. However, if home prices had fallen, instead of rising so sharply, many borrowers might have faced obstacles to refinancing because their homes had fallen in value, and so nonbank servicers would not have had revenue from refinancing to put toward paying advances. Some nonbank servicers might obtain funds by borrowing against their mortgage servicing rights (MSRs). MSRs are a significant asset for nonbanks. In total, nonbanks hold about four times as much in MSRs as they do in cash. in value when home prices fall, and so this borrowing might also have been less available as a funding source in those circumstances. The Financial Stability Oversight Council raised concerns about the financial resilience of nonbank mortgage companies in its 2020 annual report and recommended that state and federal regulators coordinate closely to collect data, identify risks, and strengthen oversight of nonbank mortgage companies. I think this is appropriate. The ideal mortgage finance system must have a place for institutions of many different types and sizes--both bank and nonbank--that are able to serve the varying needs of different customers. For this system to be sustainable, though, I think like activities should be treated in a like manner, and I am concerned about some of the differences in the prudential oversight of banks and nonbanks in the mortgage market. To return to my theme at the beginning: These are interesting times for housing and mortgage markets. And in such times, I think we can all agree that it's wise to closely monitor developments and be prepared for whatever the future may bring. Fortunately, that is exactly what Women in Housing and Finance is all about. So I would encourage all of us--including the tremendous talent assembled here today--to continue thinking hard about how we can continue to build a resilient and dynamic housing market that meets the needs of the American people.

r211108c_FOMC

united states

Flexible Average Inflation Targeting and Prospects for U.S. Monetary Policy

clarida

The U.S. economy in the second quarter of this year made the transition from economic recovery to economic expansion. Given the catastrophic collapse in U.S. economic activity in the first half of 2020 as a result of the global pandemic and the mitigation efforts put in place to contain it, few forecasters could have expected--or even dared to hope--in the spring of last year that the recovery in gross domestic product (GDP), from the sharpest decline in activity since the Great Depression, would be either so robust or as rapid. In retrospect, it seems clear that timely and targeted monetary and fiscal policy actions--unprecedented in both scale and scope--provided essential and significant support to the economic recovery as it got under way last year. Indeed, the in July that the recession that began in March of last year ended in April, making it not only the deepest recession on record, but also the briefest. The recovery that commenced in the summer of 2020 was quite robust, and, with one quarter to go, GDP growth in 2021 is projected by the Fed and many outside forecasters to be the fastest since 1983. However, it must be noted that the course of the economy this year and beyond will depend on the course of this virus. That said, under the median projection for GDP growth in the September Summary of Economic projections, the level of real GDP will have returned to its pre pandemic trend growth trajectory by the fourth quarter of 2021, which if realized would represent one of the most rapid such recoveries in 50 years. In the September SEP round, my individual projections for GDP growth, the unemployment rate, inflation, and the policy rate path turned out to be quite close to the path of SEP medians for each of these variables over the 2021-24 projection window. Under these projections, GDP growth steps down from 5.9 percent this year to 3.8 percent in 2022 and further to 2.5 percent and 2 percent in 2023 and 2024, respectively. Not surprisingly, the projected path of above-trend GDP growth in 2021 and 2022 translates into rapid declines in the projected path for the unemployment rate, which is projected to fall to 3.8 percent by the end of 2022 and 3.5 percent by the end of 2023. This modal projection for the path of the unemployment rate is, according to the Atlanta Fed jobs calculator, consistent with a rebound in labor force participation to its estimated demographic trend and is also consistent with cumulative employment gains this year and next that, by the end of 2022, eliminate the 4.2 million "employment gap" relative to the previous cycle peak. My projections for headline and core PCE (personal consumption expenditures) inflation are, alas, also similar to the median SEP numbers. Under the projected SEP path for inflation, core PCE inflation surges to at least 3.7 percent this year before the baseline outlook for inflation over the three-year projection window reflects the judgment, shared with many outside forecasters, that under appropriate monetary policy, most of the inflation overshoot relative to the longer-run goal of 2 percent will, in the end, prove to be transitory. But as I have noted before, there is no doubt that it is taking much longer to fully reopen a $20 trillion economy than it did to shut it down. Although in a number of sectors of the economy the imbalances between demand and supply-- including labor supply--are substantial, I do continue to judge that these imbalances are likely to dissipate over time as the labor market and global supply chains eventually adjust and, importantly, do so without putting persistent upward pressure on price inflation and wage gains adjusted for productivity. But let me be clear on two points. First, realized PCE inflation so far this year represents, to me, much more than a "moderate" overshoot of our 2 percent longer-run inflation objective, and I would not consider a repeat performance next year a policy success. Second, as always, there are risks to any outlook, and I and 12 of my colleagues believe that the risks to the outlook for inflation are to the upside. In September 2020, the FOMC introduced--and since then has reaffirmed-- outcome-based, threshold guidance that specifies three conditions that the Committee expects will be met before it considers increasing the target range for the federal funds rate, currently 0 to 25 basis points. This guidance in September of last year brought the forward guidance on the federal funds rate in the statement into alignment with the new flexible average inflation targeting framework adopted in August 2020. To quote from the statement, these conditions are that "labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time." While we are clearly a ways away from considering raising interest rates, if the outlooks for inflation and unemployment I summarized a moment ago turn out to be the actual outcomes realized over the forecast horizon, then I believe that these three necessary conditions for raising the target range for the federal funds rate will have been met by year-end 2022. Core PCE inflation since February 2020--a calculation window that smooths out any base effects resulting from "round trip" declines and rebounds in the price levels of COVID-19-sensitive sectors and, coincidentally, also measures the average rate of core PCE inflation since hitting the effective lower bound (ELB) in March 2020--is running at 2.8 percent through September 2021 and is projected to remain moderately above 2 percent in all three years of the projection window. Moreover, my inflation projections for 2023 and 2024, which forecast inflation rates similar to the SEP medians, would by year-end 2022, to me, satisfy the "on track to moderately exceed 2 percent for some time" threshold specified in the statement. Finally, while my assessment of maximum employment incorporates a wide range of indicators to assess the state of the labor market--including indicators of labor compensation, productivity, and price-cost markups--the employment data I look at, such as the Kansas City Fed's Labor Market Conditions Indicators, are historically highly correlated with the unemployment rate. My expectation today is that the labor market by the end of 2022 will have reached my assessment of maximum employment if the unemployment rate has declined by then to the SEP median of modal projections of 3.8 percent. Given this economic outlook and so long as inflation expectations remain well anchored at the 2 percent longer-run goal--which, based on the Fed staff's common inflation expectations (CIE) index, I judge at present to be the case--a policy normalization path similar to the median SEP dot plot on page 4 of our September 2021 projections would, under these conditions, be entirely consistent, to me, with our new flexible average inflation targeting framework and the policy rate reaction function I discussed in remarks here at Brookings in November 2020. In the context of our new framework, it is important to note that while the ELB can be a constraint on monetary policy, the ELB is not a constraint on fiscal policy, and appropriate monetary policy under our new framework, to me, must--and certainly can--incorporate this reality. Indeed, under present circumstances, I judge that the support to aggregate demand from fiscal policy--including the roughly $2 trillion in accumulated excess savings accruing from (as yet) unspent transfer payments--in tandem with appropriate monetary policy, can fully offset the constraint, highlighted in our Statement on Longer-Run Goals and Monetary Policy Strategy, that the ELB imposes on the ability of inflation-targeting monetary policy, acting on its own and in the absence of sufficient fiscal support, to restore, following a recession, maximum employment and price stability while keeping inflation expectations well anchored at the 2 percent longer-run goal. Before I conclude, let me say a few words about our Treasury and mortgage- we indicated that we would maintain the pace of Treasury and MBS purchases at $80 billion and $40 billion per month, respectively, until "substantial further progress" has been made toward our maximum-employment and price-stability goals. Since then, the economy has made progress toward these goals. At our meeting last week, the Committee decided to begin reducing the monthly pace of its net asset purchases by $10 billion for Treasury securities and $5 billion for agency mortgage-backed securities. Beginning later this month, the Committee will increase its holdings of Treasury securities by at least $70 billion per month and of agency mortgage-backed securities by at least $35 billion per month. Beginning in December, the Committee will increase its holdings of Treasury securities by at least $60 billion per month and of agency mortgage- backed securities by at least $30 billion per month. The Committee judges that similar reductions in the pace of net asset purchases will likely be appropriate each month, but it is prepared to adjust the pace of purchases if warranted by changes in the economic outlook. The Federal Reserve's ongoing purchases and holdings of securities will continue to foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses. Thank you very much for your time and attention. I look forward to the . . vol. 119 event hosted by the Hutchins Center on Fiscal and Monetary Policy at the . . . . .

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united states

Opening Remarks

powell

Good morning. I am pleased to welcome everyone to today's conference on gender and the economy. Thank you for being here, for participating, and for lending your expertise on this important topic. We have gathered an impressive lineup of speakers and panelists, who will address a range of timely and important issues. To open the conference, I will give a brief tour of the important research on display here, then discuss how the pandemic has affected the economy along gender lines. The speakers and panelists will be exploring a wide range of topics, from a historical review of gender issues and the economy to how someone's education options--and the financing of those choices--affect that person's early career and financial stability. Speakers and panelists will also be looking at the influence of family and caregiving on career advancement and will discuss timely topics of wealth and retirement. The pandemic widened deep-rooted inequities in our economy. Along racial, gender, and socioeconomic lines, those least able to bear it, unfortunately, were those who were most affected. Women make up the majority of frontline workers, who have been under substantial strain--and subject to personal risks--during the pandemic. Additionally, women took on the majority of caring responsibilities, for older relatives and children alike. As schools closed and childcare services shuttered during the worst of the pandemic, that added responsibility and stress made working more difficult for some and took many away from their jobs. These burdens are real and have been an additional challenge during an already challenging time. In a reversal of previous recessions, women suffered more from job losses in the COVID-19 recession than men. In April 2020, the unemployment rate for women was 16.1 percent, compared with 13.6 percent for men. The gap persisted until September of that year, and while it has since reversed, it does not account for the many women who left the workforce entirely. Increased childcare responsibilities during the pandemic also affected many parents' working lives. Mothers of small children were more likely to exit the labor force during the pandemic compared with previous periods. These increases were larger among mothers who earned less before the pandemic. This issue was widespread and had significant financial consequences on many Decisionmaking shows that the pandemic disrupted childcare or in-person schooling for nearly 70 percent of parents, with 25 percent of mothers reporting they did not work or worked less as a result. Many faced substantial financial difficulty. Only 37 percent of mothers who reported not working or working less because of childcare or schooling disruptions would cover a $400 expense with cash or its equivalent. As households and the economy continue to recover, the lessons learned during this era will help inform how policymakers and communities work to bridge those gaps. Long-standing disparities weigh on the productive capacity of our economy, which can only realize its full potential if everyone has a solid chance to contribute to, and to reap the benefits of, broad-reaching prosperity. In closing, I want to thank you all for taking the time to join this discussion. These are vital issues not just to the economy, but to families across the country. There is more to be done, but this conference highlights the number of world-class researchers, practitioners, and policymakers who are dedicated to understanding and addressing these deeply entrenched issues. As a group, we have an opportunity to reaffirm the importance of gender parity and diversity in our professions, in our research, and in our policymaking. Thank you.

r211109a_FOMC

united states

Opening Remarks

powell

For release on delivery by at the sponsored by the Bank of Canada, the Bank of England, the Board of Governors Good morning. It is a pleasure to welcome you to today's discussion and to host this third Conference on Diversity and Inclusion in Economics, Finance, and Central Banking. My colleagues and I are proud to cosponsor this conference along with the We are truly honored by this impressive array of panelists, discussants, and speakers, which include eminent research economists as well as current and former policymakers from here and around the world. We are grateful for the time, energy, and insights you have committed to this work, and we look forward to the day when we can gather together again in person. To kick off today's discussions, I would like to touch briefly on these subjects from two distinct perspectives. First, I will discuss some of the ways we at the Federal Reserve approach issues of persistent economic inequities. Then I will review some of how we as central banks are addressing the issues around diversity and inclusion in economics as institutions and employers. Taking the first of these topics, we know, of course, that an economy is healthier and stronger when as many people as possible are able to work. If entrenched inequities prevent some Americans from participating fully in our labor markets, not only will they be held back from opportunities, but our economy overall will not realize its potential. And those who have historically been left behind stand the best chance of prospering in a strong economy with plentiful job opportunities. Our recent history highlights both the benefits of a strong economy and the severe costs of a weak one. In the later years of the long expansion that ended with the pandemic, the benefits of employment continued to spread more widely and to reach those at the margins of the economy. Prior to the pandemic, unemployment was at 50-year lows. Wages had been moving up, and meaningfully so, especially on the lower ends of the pay scale. Many who had struggled for years were finding jobs. Racial disparities in unemployment were narrowing. In contrast, one of the great cruelties of the COVID-19 recession is the toll it took on workers who were finally beginning to experience the benefits of a period of historically long economic growth. Those same groups, unfortunately, disproportionately shouldered the brunt of the pandemic's burden. Most entrenched inequities are beyond the power of monetary policy to address. The specific goals given to us by Congress, however, to foster achievement of our dual mandate of maximum employment and price stability, form the foundation of a strong and stable economy. It was with this in mind that my colleagues and I on the Federal Open Market Committee, as part of last year's update to the Fed's monetary policy framework, defined maximum employment as a broad and inclusive goal. This innovation recognizes that a strong labor market delivers broad-reaching benefits and extends those benefits in particular to low- and moderate-income communities. While monetary policy does not target any particular group of people, when we assess whether we are at maximum employment, we purposely look at a wide range of indicators, and we are attentive to disparities in the labor market, rather than just the headline numbers. Diversity and inclusion play a role in policymaking as well. As policymakers working on behalf of the entire public, we benefit greatly by seeking out and listening to the perspectives and experiences of people who represent the diverse landscape of the economy. We regularly meet with a broad range of groups as we assess the economy. And as we worked to update our monetary policy framework, we hosted a series of listening events across the country before and during the pandemic, and these conversations factored importantly into our thinking and our new framework. Next, I would like to turn to an issue facing many of us at this conference-- namely, how central banks as institutions and employers grapple with and confront diversity and inclusion within economics. Collectively, we are among the largest employers in the field of economics, which both affects our own workplaces and affords us an opportunity to help influence and shape the evolution of the profession. Throughout my career, in both the public and the private sectors, I have seen that the best and most successful organizations are often the ones that have a strong and persistent commitment to diversity and inclusion. These organizations consistently attract the best talent, by investing in and retaining a world-class workforce. I know that the central banks represented here today are indeed working diligently to do just that. At the Fed, we are hosting events like this one, where high-quality economic research is brought to bear. We are working to foster an inclusive workplace environment where staff can feel comfortable at work and to promote a similarly inclusive culture within the profession. We are working to broaden our reach by recruiting at historically black colleges and universities and Hispanic-serving institutions, as well as by hosting events to promote career opportunities at the Fed. My colleagues and I know that both the opportunities and the challenges are great and that the work is never truly done. Whether you are a researcher bringing your analytical skills to bear, or you are on the front lines of improving the diversity of the economics pipeline, or perhaps you are in an institution where you are redoubling your efforts to attract diverse talent, your endeavors are making a difference. As a group, we are fortunate to have opportunities like this to reaffirm the importance of diversity in our professions, in our research, and in our policymaking, and I am glad that we are here today to continue this work. Thank you.

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united states

Reflections on Stablecoins and Payments Innovations

waller

The U.S. payment system is experiencing a technology-driven revolution. Shifting consumer preferences and the introduction of new products and services from a wide variety of new entities have led to advancements in payments technology. This dynamic landscape has also sparked an active policy debate--about the risks these new developments pose, how regulators should address them, and whether the government should offer an alternative of its own. Earlier this year, I spoke about the last of these questions: whether the Fed should offer a general-purpose central bank digital currency (CBDC) to the American public. My skepticism about the need for a CBDC, which I still hold, comes in part from the real and rapid innovation taking place in payments. My argument--simple as it sounds--is that payments innovation, and the competition it brings, is good for consumers. The market and the public are telling us there is room for improvement in the U.S. payment system. We should take that message to heart and provide a safe and sound way for those improvements to occur. My remarks today focus on "stablecoins," the highest-profile example of a new and fast-growing payments technology. Stablecoins are a type of digital asset designed to maintain a stable value relative to a national currency or other reference assets. Stablecoins have piggybacked off the recent increase in crypto-asset activity, and their market capitalization has increased almost fivefold in just the past year. Stablecoins can be thought of in two forms. Some serve as a "safe, liquid" asset in the decentralized finance, or DeFi, world of crypto-trading. Examples include Tether and USD Coin. Alternatively, there are stablecoins that are intended to serve as an instrument for retail payments between consumers and firms. Although these types of stablecoins have not taken off yet, some firms are working to assess the viability of such stablecoins as a retail payment instrument. This growth in usage of stablecoins and their potential to serve as a retail payment instrument has prompted regulatory attention, including a new report from Congress to limit the issuance of "payment stablecoins" to banks and other insured depository institutions. Fostering responsible payments innovation means setting clear and appropriate rules of the road for everyone to follow. We know how to handle that task, and we should tackle it head-on. The PWG report lays out one path to responsible innovation, and I applaud that effort. However, I also believe there may be others that better promote innovation and competition while still protecting consumers and addressing risks to financial stability. This is the right time to debate such approaches, and it is important to get them right. If we do not, these technologies may move to other jurisdictions--posing risks to U.S. markets that we will be much less able to manage. Stablecoin arrangements involve a range of legal and operational structures across a range of distributed ledger networks. They are a genuinely new product, based on genuinely new technology. But despite the jargon surrounding stablecoins, we can also understand them as a new version of something older and more familiar: the bank deposit. As I have said before, both the government and the private sector play indispensable roles in the U.S. monetary system. The Federal Reserve offers both physical "central bank money" to the general public in the form of physical currency and digital "central bank money" to depository institutions in the form of digital accounts. Commercial banks, in turn, give households and businesses access to "commercial bank money," crediting checking and savings accounts when a customer deposits cash or takes out a loan. This privately created money serves as a bridge between the central bank and the public. Commercial bank money is a form of private debt. The bank issuing that debt promises to honor it at a fixed, one-to-one exchange rate with central bank money. The bank itself is responsible for keeping that promise. However, the bank is supported in that task by a tried-and-true system of public support. That includes regulation and supervision, which ensure banks are safe and sound, not taking imprudent risks in their day-to-day business; the availability of discount window credit, which ensures well- capitalized banks can meet their emergency liquidity needs; and deposit insurance, which protects consumer deposits if the bank fails. Put together, those programs leave very little residual risk that a depositor in good standing will ever have to leave the teller empty handed. They make a bank's redemption promise credible, and they make commercial bank money a near-perfect substitute for cash. As a result, households and businesses overwhelmingly use commercial bank money for everyday transactions. This arrangement has many advantages. Small retail customers do not have to spend their time vetting the safety and soundness of their banks--regulators and supervisors do that for them. Consumers have a safe place to keep their savings and a nearly risk-free way to make payments, which are settled in ultrasafe central bank liabilities. Banks can focus their effort on investments, products, and services from a place of safety and soundness. Communities and customers benefit from those efforts in the form of more efficient capital allocation and higher-quality, lower-cost financial products. These advantages, however, are not cost free. Regulation ensures that commercial banks issue "sound money" by making sure those banks are safe and stable, and that they bear the risks of their own investment decisions. But regulation also imposes costs, from the expense and time required to seek a banking charter to the costs of compliance with an array of regulations. While regulations are necessary, they also limit free entry into at least some of the markets in which banks operate. As a result, regulatory oversight can insulate banks from some forms of direct competition. The Congress has long recognized the importance of private-sector competition and customer choice, particularly in payments, and the Congress and the Federal Reserve take regular steps to preserve a competitive payments marketplace. The objective of stablecoins is to mimic the safe-asset features of commercial bank money. They typically offer a fixed exchange rate of one-to-one to a single asset or a basket of assets. Payment stablecoins tend to choose a sovereign currency as their anchor, typically the U.S. dollar. Stablecoin issuers suggest that one can redeem a stablecoin from the issuer for one U.S. dollar, although redemption rights are not always well defined. Nor is the entity responsible for conducting redemption always clearly specified. To enhance the credibility of redemption at par, some stablecoin issuers go further, promising to limit the investments they make with the money backing each stablecoin by keeping it in cash or other highly liquid assets. In this respect, stablecoins can resemble a "narrow bank," a well-known payment-only banking structure that monetary economists have studied for more than half a century. Constructed this way, stablecoins also resemble currency boards, which peg a foreign currency to the dollar and hold dollar reserves to back up redemption promises. Although stablecoins try to mimic commercial bank money, they differ dramatically in terms of the payment networks they use. Dollar-denominated commercial bank money is a settlement instrument in a wide range of asset markets, and customers can transfer it using a wide range of payment platforms. However, commercial bank money is not "native" to public blockchains, the distributed networks that support trading and other activity involving crypto-assets. Stablecoins help fill that gap as a less volatile anchor for crypto-asset transactions and an "on-ramp" for digital asset trading. This role--as a more stable private asset in digital markets that otherwise lack such assets--has meaningful benefits by itself, helping make those markets deeper and more liquid. A well-designed, well-regulated stablecoin could also have other benefits, which go well beyond digital asset markets. It might allow for different activity on distributed ledger technology, or DLT, platforms, like a wider range of automated (or "smart") contracts. It might serve as an "atomic" settlement asset and thus help bring some of the speed and potential efficiencies of digital asset markets into more traditional ones. With the right network design, stablecoins might help deliver faster, more efficient retail payments as well, especially in the cross-border context, where transparency can still be low and costs can still be high. Stablecoins could be a source of healthy competition for existing payments platforms and help the broader payments system reach a wider range of consumers. And, importantly, while stablecoins and other payment innovations could create new risks, we should not foreclose the possibility that they may help address old ones--for example, by providing greater visibility into the resources and obligations that ultimately support any system of privately issued money. These benefits are substantial, and even where they are still uncertain, it is important to recognize them. But to capture those benefits, stablecoins must bridge the biggest gap between them and commercial bank money: robust, consistent supervision and regulation and appropriate public backstops. Strong oversight, combined with deposit insurance and other public support that comes with it, is what makes bank deposits an acceptable and accepted form of money. Today stablecoins lack that oversight, and its absence does create risks. The PWG described several such risks in its report, but I will highlight just three. The first is the risk of a destabilizing run. The United States has a rich history of privately created money, stretching back to promissory notes that merchants and lawyers issued on the early frontier. Some of these instruments worked well for long periods; others came from unregulated or unscrupulous issuers, who promised safety and stability at a more attractive rate of return. When these instruments went bad, the consequences could extend well beyond the depositors, investors, or even institutions who put their principal at risk. It is important not to overstate these risks; if the investors that participate in stablecoin arrangements know their money is at risk, then a run on one issuer is less likely to become a run on all of them. But without transparency into those risks, or with retail users that are less able to monitor them, the possibility of widespread losses is more of a concern. As I mentioned, for commercial bank money, regulation, supervision, deposit insurance, and the discount window make this dynamic more remote by giving a bank's creditors less reason to run. The second risk is the risk of a payment system failure. Stablecoins share many of the functions of a traditional payment system. If stablecoins' role in payments activity grows--which, again, could be a good development--their exposure to clearing, settlement, and other payment system risks would grow, too. Stablecoins also present some unique versions of these risks because responsibility for different payment functions is scattered across the network. The United States does not have a national payments regulator, but it does have strong standards for addressing payment system risk, especially where those payment systems are systemically important. Regulators should draw on those standards with care and take a fresh look at what should or should not apply in the stablecoin context. The third risk is the risk of scale. Stablecoins, like any payment mechanism, can exhibit strong network effects; the more people use a payment instrument, the more useful it is, and the greater the value it delivers to each participant. For this same reason, network effects can be (and usually are) highly beneficial. As a result, rapid and broad scaling of a payment instrument is socially desirable. In fact, in a perfect world, there would be one payment system and one payment instrument that everyone uses. The problem with this is that, in our imperfect world, this would confer monopoly power over the payment system. Any entity that has control over a large and widely used payment system has substantial market power and thus the ability to extract rents in exchange for access--which, again, hurts competition and decreases the network benefits to consumers. Thus, there is a tradeoff between the efficiency of having one large network and the cost of monopoly control of that network. I believe that we are a long way from a monopoly in stablecoin issuance; I see a lot of interest in offering this type of payments competition and ensuring that there are relatively few barriers to entry. In my view, having stablecoins scale rapidly is not a concern as long as there is sufficient competition within the stablecoin industry and from the existing banking system. In this world, some form of interoperability is critical to ensure that competition allows consumers to easily move across stablecoin networks, just as they can move between different commercial bank monies or sovereign currencies. Jurisdictions around the world are grappling with these same risks, trying to foster the potential benefits of stablecoin arrangements while minimizing their costs. The PWG report described one approach to that cost-benefit equation: restricting the issuance of "payment stablecoins" to insured depository institutions and imposing strict limits on the behavior of wallet providers and other nonbank intermediaries. Given the economic similarities between payment stablecoins and bank deposits, I have no objection to the idea of banks issuing both instruments. The United States has a tried-and-true system for overseeing and supporting the creation of commercial bank money, and there is no reason to suggest it could not be adapted to work in this context. However, I disagree with the notion that stablecoin issuance can or should only be conducted by banks, simply because of the nature of the liability. I understand the attraction of forcing a new product into an old, familiar structure. But that approach and mindset would eliminate a key benefit of a stablecoin arrangement--that it serves as a viable competitor to banking organizations in their role as payment providers. The Federal Reserve and the Congress have long recognized the value in a vibrant, diverse payment system, which benefits from private-sector innovation. That innovation can come from outside the banking sector, and we should not be surprised when it crops up in a commercial context, particularly in Silicon Valley. When it does, we should give those innovations the chance to compete with other systems and providers--including banks-- on a clear and level playing field. To do so, the regulatory and supervisory framework for payment stablecoins should address the specific risks that these arrangements pose--directly, fully, and narrowly. This means establishing safeguards around all of the key functions and activities of a stablecoin arrangement, including measures to ensure the stablecoin "reserve" is maintained as advertised. But it does not necessarily mean imposing the full banking rulebook, which is geared in part toward lending activities, not payments. If an entity were to issue stablecoin-linked liabilities as its sole activity; if it backed those liabilities only with very safe assets; if it engaged in no maturity transformation and offered its customers no credit; and if it were subject to a full program of ongoing supervisory oversight, covering the full stablecoin arrangement, that might provide enough assurance for these arrangements to work. There should also be safeguards for other participants in a stablecoin arrangement, like wallet providers and other intermediaries. Again, however, not all of the restrictions that apply to bank relationships might be necessary. For example, there is no need to apply restrictions on commercial companies from owning or controlling intermediaries in these arrangements. The separation of banking and commerce is grounded in concerns about captive lending--the idea that banks might lend to their owners on too favorable terms, giving the owners an unfair subsidy and putting the bank on shaky ground. These traditional concerns do not apply to wallet providers and other intermediaries who abstain from lending activities. There are new questions to consider, such as around the use of customers' financial transaction data, but where anticompetitive behavior happens, existing law (and particularly antitrust law) should still apply. Policymakers will continue to work through these questions in the coming months, but in the process, we should not let the novelty of stablecoins muddy the waters. The United States has a long history of developing, refining, and integrating new payment technologies in ways that maintain the integrity of its financial institutions and its payment system. Stablecoins may be new, but their economics are far from it. We know how to make this kind of privately issued money safe and sound, and, in designing a program of regulation and supervision to do so, we have plenty of examples to draw on. In the interest of competition and of the consumers it benefits, we should get to work.

r211119a_FOMC

united states

Perspectives on Global Monetary Policy Coordination, Cooperation, and Correlation

clarida

In my remarks today, I would like to offer some perspectives on global monetary policy correlation and what it can--and cannot--reveal about the prevalence and value of global monetary policy coordination or, in the limit, binding global monetary cooperation . Collapse (GPC), major central banks around the world responded by cutting policy rates to, and then keeping them at, their effective lower bounds (ELBs); by increasing their balance sheets through ambitious and expansive large-scale asset purchase and lending programs; and by offering forward guidance--both Delphic and Odyssean--on the stance of their future monetary policies. As these examples make clear, we certainly do observe that national monetary policies are often correlated, and such examples are not confined to recent experience. Indeed, the international monetary economics literature abounds with historical and empirical studies of correlated global monetary policy cycles, not to mention the evident secular downtrend in global monetary policy rates observed in recent decades. Moreover, global monetary policies often also do appear at least sometimes to be coordinated. that provide such opportunities. By contrast with evidence of central bank correlation and coordination, the historical record suggests that, since the collapse of the Bretton Woods system 50 years ago, rarely, if ever, do major sovereign central banks actually enter into, at least publicly--let alone respect--binding commitments to pursue formal cooperative policies. Here and throughout the lecture, I shall reserve the meaning of the adjective cooperative, as in "cooperative" central bank policies, to define policies that can, at least conceptually, be thought of as policies pursued by sovereign central banks that fully incorporate any spillovers from one central bank's policies to the other central bank's mandates. Cooperative policies defined this way will, in general, differ from noncooperative policies--in the sense of the Nash equilibrium concept--designed to achieve domestic mandates assigned by sovereign institutions while taking other central bank policies as given. In these remarks, I will draw on perspectives informed not only by economic analysis--including my own academic research on the theory and empirics of central banks' policymaking--but also by my observations and experiences serving as Vice Chair of the Federal Reserve Board during what has certainly been an eventful three years. To begin with the theory, it has long been appreciated that in the sorts of economic models used by central banks around the world, the calibrated gains to international monetary policy cooperation are found to be rather modest relative to a status quo ante in which each country runs a sensible policy, taking as given the sensible policies of the other countries. Today I will make a somewhat different, and less often discussed, case questioning formal global monetary policy cooperation--that, in practice, adopting it could plausibly erode central bank credibility and public support for central bank instrument independence. International monetary policy coordination, which I think of as including the sharing of information and analysis among central banks regarding the evolution of their individual economies as well as the considerations that govern the setting of their policy instruments--in other words, information about their policy reaction functions--can, and in my observation certainly does, enhance the design and effectiveness of monetary policy execution for each country. I shall give some examples later. But while international monetary policy coordination may enhance the efficiency of monetary policy execution, I am skeptical that in practice there are additional material, reliable, and robust gains that would flow from a formal regime of binding monetary policy cooperation, at least among major G-7 economies with flexible exchange rates, open capital accounts, and central bank mandates that include price stability. Or, more precisely, it seems that whatever gains might exist in theory, they likely do not exceed the full cost of committing to such an arrangement in practice. In such a regime, national monetary policies in each country would be constrained to be set in such a way so as to jointly maximize some metric for global price stability and perhaps also other objectives. The reason is that there can be global externalities to monetary policy that create such theoretical gains to cooperation. However, as Clarida, Gali, and Gertler (2002), among others, have shown in the context of central banks with domestic price-stability mandates, to achieve the theoretical gains to international monetary policy cooperation, policy in each country must be set with reference to an index of inflation in all countries party to the cooperative agreement. This is a policy that no central bank would choose were it not bound to the agreement to achieve domestic price stability while taking other central banks' policies as given, which, of course, raises the question of how such an agreement might be enforced. In theory, if central banks were bound to set policy based solely on a policy rule that is a function of observed macroeconomic data, enforcement would be simple. But in practice, no sovereign central bank outsources its policy to an Excel spreadsheet, and, moreover, best-practice policy rules incorporate inputs--such as the neutral rate of interest or expected inflation--that are unobserved and time varying and thus difficult to monitor. Finally, central bank mandates vary across sovereign jurisdictions. For example, the Federal Reserve is mandated to pursue policies that achieve "maximum treaty to pursue price stability but also has a secondary mandate to contribute to achieving the objectives of the European Union, which include balanced economic growth and full employment. Similarly, the Bank of England's primary objective is to achieve the U.K. government's target of 2 percent inflation, but its secondary objective is to support the government's policy aims, including those for employment, growth, and-- more recently--environmental sustainability. So even though all major central banks are mandated to achieve "price stability" in some form or fashion, their mandates typically include other obligations that vary across jurisdictions. Because these obligations can, and sometimes do, require central banks to make a tradeoff--for example, in the United States, between inflation and employment in the presence of supply shocks--defining the objective that a cooperative agreement would choose to maximize would be a formidable task. I believe that, in practice, beyond the issue of enforcement and agreement on terms, there could well be another challenge with policy cooperation that is absent from most theoretical discussions. Simply stated and in the context of a price-stability mandate for each central bank, the problem--as I see it--is the threat to the credibility of the central bank, the challenges to central bank communication, and the resulting potential loss of support for its policy actions from the public when the policy choices that would be required by binding monetary policy cooperation react not only to home inflation deviations from target, but also to deviations of foreign inflation from target. In theoretical models, the commitment to the inflation target is just assumed to be perfect and credible, but in practice, credibility appears to be a function of central bank communication and of the policies actually implemented pushing inflation toward--and, in the absence of shocks, keeping inflation at--target. I suspect that, in practice, central banks would have a hard time maintaining credibility and independence as well as communicating a policy that raised home interest rates aggressively not because home inflation is too high but because foreign inflation is! While, perhaps for these reasons, we do not have many confirmed sightings of genuine binding monetary policy cooperation, we do observe many examples of monetary policy correlation (see figure 1). Monetary policies will obviously be correlated if countries are subject to common shocks--such as in the GFC and the GPC--but can also be correlated as a consequence of integrated global capital markets. The Clarida, Gali, and Gertler (2002) model provides a simple illustration of how this correlation can come about. In the "home" country, the optimal inflation-targeting monetary policy can be written as a Taylor-type rule: , where r is the "neutral" interest rate in the home country consistent with price stability and trend growth and p is inflation in the home country. The ratio captures the extent to which the home central bank trades off its inflation and gross domestic product (GDP) objectives when they are in conflict. The parameter a indexes the priority the central bank places on stabilizing GDP growth relative to its trend path. When a is large, the central bank leans against high inflation less aggressively than it would were a small. With an integrated global capital market, the neutral policy rate at home is a function of trend GDP growth at home as well as expected foreign GDP growth: . Now, to the extent the foreign central bank has a comparative advantage in tracking or forecasting foreign output growth--which, of course, it should, since such growth will depend on the foreign central bank's monetary policy--sharing this information with the home central bank can improve that institution's estimate of the home equilibrium real interest rate and thus the effectiveness of its policy rule in meeting its domestic objectives. The foreign central bank sets its policy rate in an analogous fashion: The ratio captures the extent to which the foreign central bank trades off its inflation and GDP objectives when they are in conflict, and note that this tradeoff may be different than that of the home central bank. With an integrated global capital market, the neutral policy rate abroad is given by This simple example illustrates one channel through which globally integrated capital markets can introduce policy correlation even in the absence of policy coordination or cooperation. For example, even if home and foreign inflation rates and trend growth rates are uncorrelated across countries, sensible monetary policies can be correlated across countries if neutral policy rates are correlated, as they appear to be in the data (see figure 2, which is based on Holston, Laubach, and Williams, 2017). A recent working paper, Ferreira and Shousha (2021), models the determinants of the neutral policy rate in the United States and includes in the empirical specification an index of global productivity growth and demographic trends. Their empirical estimates attribute 85 basis points of the decline in U.S. neutral real interest rates since 2000 to global spillovers from the slowdown in global trend growth and demographic trends. So policy correlation can be an outcome of noncooperative monetary policy operating in an integrated global capital market and not evidence, in and of itself, of policy coordination, let alone cooperation. Before continuing, I consider briefly how monetary policy would differ under binding cooperation in the simple example sketched out earlier. Under international monetary policy cooperation, the policy rate is set according to So, intuitively, while policy in the home country does place more weight on home inflation when setting the interest rate, it also reacts to foreign inflation as well, as I discussed earlier. Consider the case with home inflation high and foreign inflation low. As can be seen from the preceding equation, the optimal policy under cooperation calls for the home interest rate to be lower--more accommodative--than it would be in the absence of cooperation. In practice, the home central bank's credibility as an inflation targeter to satisfy its domestic price-stability mandate might well suffer if it failed to respond aggressively to high domestic inflation because of, say, serious deflation abroad. There is a vast literature that documents the existence of international spillovers Hoek, Kamin, and Yoldas (2020)--suggests that the extent and consequences of such spillovers depend importantly on the source of a shift in U.S. monetary policy. Their key finding, illustrated in figure 3, is that Federal Reserve policy rate surprises attributed to stronger U.S. growth generally have only moderate spillovers to EM financial conditions, whereas U.S. policy rate changes attributed to U.S. inflationary pressures trigger more substantial spillovers to EM financial conditions. The authors also find compelling evidence that the magnitude of the cross-border spillovers attributed to U.S. monetary policy shifts depends on a country's macroeconomic vulnerability--as measured by inflation, current account deficit, international reserves, government debt, external debt, and private-sector credit growth, with more vulnerable EM countries experiencing larger spillovers from U.S. monetary policy. compares the consequences of ECB policy actions for U.S. financial conditions and the consequences of Federal Reserve policy actions for euro-area financial conditions. Their main findings are summarized in the two panels in figure 4. The left panel presents evidence of statistically significant spillovers from Federal Open Market Committee (FOMC) policy announcements to euro-area bond markets. But, as shown in the right panel, the authors find that the spillovers from ECB policy announcements to U.S. yields are roughly as large as those from FOMC announcements to bund yields. While I will certainly acknowledge that both fundamental and financial shocks originating in the United States, including shifts in the direction of U.S. monetary policy, can and do propagate globally (see, for example, Miranda-Agrippino and Rey, forthcoming), the evidence suggests that causality can and does run in both directions. It is not difficult to recall external events that have triggered spillovers from foreign sovereign markets to the U.S. economy that have had observable implications for U.S. monetary policy. resulted in substantial declines in economic activity in emerging markets but had only a modest effect on the U.S. economy. One reason for this outcome was "safe haven" flows into the dollar assets that pushed down U.S. bond yields. But 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, and these events triggered a policy response by the Federal Reserve that cut the federal funds rate 75 basis points between September and November of that year. When in the next year the global financial system stabilized, the Federal Reserve reversed those actions and returned the federal funds rate to the level prevailing before those events. In more recent times, global shocks have also been consequential for U.S. economic prospects and monetary policy. Examples include the 2011-13 euro-zone crisis and the China devaluation and capital flight episode of 2015-16, 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 adverse global shocks triggered safe- haven flows that pushed U.S. Treasury yields down. But despite the drop in Treasury yields, overall financial conditions in the United States tightened, weighing on aggregate demand. U.S. monetary policy responded to these global "headwinds," helping stave off actual contractions of U.S. activity. During the 2011-13 euro-zone crisis, the Federal Reserve was already pursuing very accommodative policies in the wake of the GFC, but the introduction of the maturity extension program in September 2011 and the announcement in September 2012 of the third installment of quantitative easing were in part aimed at offsetting the effect of these global headwinds on U.S. aggregate demand. statements and transcripts from that time indicate that concerns about these developments and their effect on the U.S. economy were a factor that contributed to the delay in implementing previously signaled policy rate increases. episode discussed earlier, once the "storm had passed," the previously signaled policy normalization process commenced in 2017. The monetary policy framework reviews conducted by the Federal Reserve and the ECB provide another example of monetary policy correlation. In February 2019, the Federal Reserve System launched a review of its monetary policy strategy, tools, and communication practices. A key motivation for the Fed's review as well as the ECB's review was the substantial decline in estimates of the neutral real interest rate, r*, that, over the longer run, is consistent with price stability. This decline has critical implications for monetary policy because it leaves central banks with less conventional policy space to offset adverse shocks to aggregate demand. As discussed in Clarida (2020), the Fed's review, from the outset, built on three pillars: a series of events, a flagship research conference, and a series of rigorous briefings for the Committee commencing in July 2019 and running through While our plans to conclude the review earlier in 2020 were, like so many things, delayed by the arrival of the pandemic, in August 2020, the Federal Reserve did announce, with unanimous support, an evolution of its monetary policy strategy to flexible average inflation targeting. Similar to the Federal Reserve, the ECB launched a review of its monetary policy strategy in January 2020. Since the time of its previous strategy review in 2003, like the Fed, the ECB observed profound structural changes in the global and euro-area economies that have driven down neutral interest rates and increased the incidence and duration of episodes in which nominal policy interest rates are close to the ELB. So the ECB's review sought to adapt its monetary policy to the current economic environment and to ensure that its policy could remain effective at the ELB. In its review, the ECB heard from a wide variety of European organizations and citizens, including through a series of events. The ECB's Governing Council engaged in a series of deliberations, also informed by extensive staff background analysis on a range of topics. In July 2021, with unanimous support from its Governing Council, the ECB announced its new strategy. Key elements of that strategy are a symmetric 2 percent inflation target, a view that the ELB requires especially forceful or persistent monetary policy measures to keep inflation expectations from drifting lower, and the affirmation that the full range of measures it has used in recent years will remain in its toolkit. The similarities in the two framework evolutions are due to the fact that powerful common global forces are driving down neutral policy rates and limiting the effectiveness of monetary policy in downturns to offset declines in aggregate demand. This asymmetry of policy effectiveness caused by the ELB imparts a secular downward bias to inflation that, if not offset, could de-anchor inflation expectations below the central bank's price- stability objectives. In addition, the similarities in the processes according to which these two framework reviews were conducted reflected also a convergence in thinking about best practices for such reviews that was facilitated by a working group on central bank frameworks set up by the BIS. In this speech, I have offered some perspectives on global monetary policy correlation and what it can--and cannot--reveal about the prevalence and value of global monetary policy coordination or, in the limit, binding global monetary cooperation. I have argued that, while there are several recent and historical examples where we certainly do observe that national monetary policies are often correlated, adopting formal global monetary policy cooperation could plausibly erode central bank credibility and public support for central bank independence. But I also observe that international monetary policy coordination, defined as including the sharing of information and analysis among central banks regarding the evolution of their individual economies and information about their policy reaction functions, can enhance the design and effectiveness of monetary policy execution for each country. Thank you very much for your time and attention. I look forward to my conversation with Sylvain. . . . vol. 49 . press release, January 23, . . press release, July 8, . . . Journal of .

r211119b_FOMC

united states

Economic Outlook

waller

It is a pleasure to speak today at the Center for Financial Stability, and I look forward to our conversation. Let me take the next several minutes to speak about the continued improvement of the U.S. economy, recent inflation data, and their implications for monetary policy. recent decision to begin reducing monthly purchases of securities and how incoming data may affect the pace of tapering. Finally, I will address issues concerning the size of our balance sheet. Let me start with my views on the economy. Since I last spoke on the subject exactly a month ago, the basic shape of my outlook hasn't changed: The economy continues to grow and add jobs at a strong pace, making steady progress toward the Federal Reserve's goal of maximum employment. New data shows that employment gains were better than first reported in August and September and were back to a strong level in October. But we also have learned that supply constraints--both bottlenecks and labor shortages--are having a larger and more persistent effect on the economy. Due to a combining of those supply constraints with strong demand, inflation pressures are becoming more widespread and may last longer into 2022 than I thought they would. These factors haven't dented my optimism that the strong recovery will continue but they have raised the risks that supply constraints may limit job gains and output growth, and that inflation may complicate the FOMC's management of monetary policy in 2022. These factors weighed on output growth in the third quarter, which was down considerably from the three months before but which I expect will rise again to a strong rate in the fourth quarter. The explanation for the downturn is the same story we have all been living through since March 2020: the ups and downs of the pandemic. The Delta variant and supply chain problems threw the economy off its very strong growth track in the third quarter, but I anticipate it will return to that path in the fourth quarter, as society continues to learn how to manage the disease and ever-improving treatments reduce the likelihood of death and hospitalization. Assuming another damaging COVID-19 variant does not arise this winter, I expect gross domestic product (GDP) to resume its robust growth not only in the fourth quarter of 2021 but also in the first half of 2022. In terms of the job market, households and businesses perceive that conditions are as tight as or tighter than they were pre-COVID, even though the unemployment rate is more than a percentage point higher. There are certainly ample data showing labor demand is very strong. Job openings remain at a record level. New businesses are starting up at a much higher pace than they did from 2017 to 2019. People are quitting jobs, either to take new ones or because they are confident that they can find new ones, likewise at a record rate. The improvement I expect in managing COVID should drive demand higher but also provide a boost to labor supply as those who have been on the sidelines return to a job market that keeps improving. With respect to employment data, revisions to the August and September job numbers indicated that the summer slowdown in job gains wasn't nearly as bad as initial reports suggested. Job creation averaged 442,000 a month from August to October, down from the 641,000 average for the other seven months of 2021. Nevertheless, this is a healthy pace for job creation and will speed the recovery of the labor market if it continues. Adjusting for early retirements, we are only 2 million jobs short of where we were in February 2020. Regarding the unemployment rate, in October the rate stood at 4.6 percent. Compared with one year ago, that rate has fallen 2.3 percentage points. If the decline continues at about that pace in coming months, the unemployment rate could be below 4 percent before too long. In light of these data, in my view, the labor market is rapidly approaching maximum employment. But I will be watching for factors, from continued supply bottlenecks and a winter surge of COVID cases, that could slow this progress. Turning to inflation, inflation has escalated substantially this year, along with a significant rise in inflation expectations. The October consumer price index report showed an unexpected surge in inflation. The monthly print corresponds to an annualized rate exceeding 10 percent, while the year-over-year increase was 6.2 percent--the highest since December 1990. Despite the highest wage gains in years, inflation this year has wiped out any real wage increase for the average worker. High inflation is painful to Americans who have little choice about the goods and services they buy for everyday living. Prices are up significantly at the grocery store, which is a major problem for many individuals and families. Unlike earlier this summer, price pressures are no longer concentrated in a few categories, they appear to have broadened. has been a notable increase in the prices of energy, food, goods, and services as well as the cost of owning a home. Even trimmed mean measures of inflation that exclude some big price increases, such as the Cleveland Fed and the Dallas Fed measures, report inflation rates above the Fed's 2 percent target. Diffusion indexes of price changes, which are often useful in detecting turning points in the data, show an increasing number of categories with 3 or 12-month inflation exceeding 3 percent, compared with earlier this year. I expect that these pressures are related to both supply constraints, which may be beginning to improve, and strong demand, which shows no sign of abating. Wages continue to grow quickly on a more sustained basis than they have in more than 20 years, most recently reflected in a striking increase in the employment cost index, which considers both pay and benefits. Wages and employment costs seem to be widespread across industries and among businesses of different sizes. Crucial to the path of inflation will be whether we see input cost increases consistently reflected in final goods prices. Our business contacts report that companies are comfortable passing along these cost increases to their customers. It has been argued that because price pressures connected to supply constraints are transitory, they will come to an end, so monetary policy does not need to respond to temporary price pressures. I find this argument puzzling for a few reasons. First, all shocks tend to be transitory and eventually fade away; by this logic, the Fed should never respond to any shocks, but it sometimes does, as it should. Second, the macroeconomic models we use to guide policy typically have cost shocks built in that cause inflation to move. In those models, appropriate monetary policy responds to these inflation movements; it doesn't ignore them, even though they are transitory. Finally, the choice to take a policy action depends on how large the shocks are and how long they are expected to persist. To make this point clearer, consider a snowfall, which we know will eventually melt. Snow is a transitory shock. If the snowfall is one inch and is expected to melt away the next day, it may be optimal to do nothing and wait for it to melt. But if the snowfall is 6 to 12 inches and expected to be on the ground for a week, you may want to act sooner and shovel the sidewalks and plow the streets. To me, the inflation data are starting to look a lot more like a big snowfall that will stay on the ground for a while, and that development is affecting my expectations of the level of monetary accommodation that is needed going forward. Inflation expectations on the part of the public also play a role in the conduct of monetary policy. Two surveys of consumers--by the University of Michigan and the New York Fed--show medium inflation expectations running over 4 percent, and bond investors are requiring over 3 percent compensation for future inflation and inflation risks. It is very concerning to me that households and markets are no longer expecting us to keep inflation near our 2 percent target over the next three to five years. Now, it is true that there is some evidence that these consumer survey measures of future inflation tend to move around a lot based on changes in current inflation. So I hope these large movements in inflation expectations are--wait for it--transitory and will come back down as bottlenecks and labor shortages resolve themselves over the coming months. But if these measures were to continue moving upward, I would become concerned that expectations would lead households to demand higher wages to compensate for expected inflation, which could raise inflation in the near term and keep it elevated for some time. This possibility is a risk to the inflation outlook that I'm watching carefully. So, what are the implications of all these considerations for monetary policy? The economy made faster progress in 2021 than most of us expected back in December 2020. This substantial progress toward our dual mandate goals allowed us to begin reducing the $120 billion a month in asset purchases that are aiding the recovery by steadily providing accommodation to financial conditions. When we started tapering a few days ago, it happened several months earlier than was expected by market participants in the early months of 2021. We cut both the amount of Treasury securities purchases to $70 billion per month from $80 billion per month, and the amount of agency mortgage-backed securities (MBS) to $35 billion from $40 billion. We will make another $10 billion and $5 billion cut to the monthly purchases in mid-December. The next few months will be critical, however, in determining how the tapering process plays out. The Committee has been very clear, in the months leading up to our decision, and in making that decision, that the pace of reducing asset purchases would depend on progress toward our dual mandate goals. If COVID or some other factor substantially slows the recovery, hindering the progress toward maximum employment, the FOMC could slow the taper. But if the economy makes quick progress toward maximum employment or inflation data show no signs of retreating from their currently high readings, the Committee may choose to speed up the taper, which would position it to accelerate subsequent steps in tightening monetary policy if necessary. The timing of any policy action is a decision for the FOMC, but for my part the rapid improvement in the labor market and the deteriorating inflation data have pushed me towards favoring a faster pace of tapering and a more rapid removal of accommodation in 2022. Another policy action already being discussed in public by market participants is the timing of the first increase, or liftoff, of the target range for the federal funds rate. The FOMC has described the conditions that must be met to consider liftoff. They are when the economy has reached maximum employment, and when inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. Assuming inflation expectations are well-anchored, I judge that the timing of liftoff is any time after both of these conditions have been met. I believe the condition for inflation has been met and we are making great strides towards achieving the employment leg of our mandate. I will be looking at the incoming data to determine when we have achieved both these criteria. After that point, whenever the Committee ultimately decides to raise the target range for the federal funds rate from zero, monetary policy will still be providing an extraordinary extent of support for the economy--short-term interest rates will still be very low, and the large amount of securities holdings on the Fed's balance sheet will continue to put significant downward pressure on longer-term interest rates. This fact leads to another policy action that the FOMC needs to consider: when to begin reducing securities holdings. It is important to remember that the FOMC makes monetary policy decisions with the best interest of the American people in mind and not based on how these actions affect the balance sheet. Between March of 2020 and today, the Fed's securities holdings have increased by $4.2 trillion to stand a bit over $8 trillion. These holdings are about 35 percent of the level of annual real GDP. This percentage sounds quite large, but the Fed's share is not out of line with what is found on the balance sheets of other advanced foreign economies' central banks. For example, our share is larger than that of the Bank of Canada, but it is about the same as the Bank of England's, and much smaller than the shares of the European Central Bank and the Bank of Japan. One must remember that there is no economic theory that tells us what the optimal size of a central bank balance sheet should be. So, just because our balance sheet is "large" does not mean there is anything wrong with it. However, arguments can be made that we should reduce the size of our balance sheet. First, we expanded it for emergency reasons due to the pandemic. As the emergency passes, we can undo those actions and get the balance sheet down to something close to its pre-pandemic trend. Second, by doing so, we free up balance sheet space in the event we need to expand it in the future to deal with economic shocks. Third, the private sector appears to be inundated with liquidity, as evidenced by the large take-up at our overnight reverse repurchase agreement facility. Draining some of this liquidity would help maintain smooth market functioning. Going forward, the Committee will need to decide what type of reinvestment policy to have in place. Currently, when securities on the Fed's balance sheet mature, the proceeds are reinvested in new securities, keeping the balance sheet growing in line with net purchases. Under this policy, when net asset purchases cease, reinvestment will keep the balance sheet constant at the size at that time. Based on past experience, an effective way to gradually reduce the balance sheet to a more efficient level is to change that reinvestment policy to limit, or cease, reinvestment. Allowing this "runoff" was the main way the FOMC shrank the balance sheet before the pandemic. I expect the reinvestment strategy will be heavily influenced by the Fed's experience with this policy between 2017 and 2019. During that time, the FOMC recognized that the monthly maturity of securities was lumpy; some months there were many securities maturing, and others few. The FOMC ensured a gradual and predictable roll-off of securities that allowed market participants to plan for the Fed's gradual retreat from the Treasury and MBS markets, which was done by instituting monthly redemption caps that gradually increased over time. I would support a similar process when the time comes to alter reinvestment policy. As securities holdings declined, so did reserves in the banking system. In mid- September 2019, upward pressures emerged in funding markets as reserves dropped to about $1.4 trillion or 6.6 percent of GDP at that time. Most thought the Fed's balance sheet could be reduced further. In fact, the median of the respondents to the June 2019 primary dealer survey conducted by the Federal Reserve Bank of New York indicated reserves could fall to $1.2 trillion. But, the underlying level of reserves wanted by financial markets seemed to be more than we anticipated. In response to the emerging pressures at that time, the Fed stopped redemptions and instituted a number of actions over a few days that boosted reserves to at least the level seen in early September of that year. With this experience in hand, we will need to proceed with caution with future securities redemptions. That said, clearly today's balance sheet is elevated, and we can decrease our holdings. Should we drain reserves too quickly, we have a new tool to help correct this action should our pace of runoff prove to be too fast again. The standing repurchase agreement facility provides a backstop in cases where demand for liquidity is more than the Fed otherwise thought. Counterparties can come to the facility and obtain financing for their Treasury securities. Of course, I do not anticipate reducing reserves to a level where this tool would be used, but it is nice to know that, as we move forward, we have an additional support available to us that we did not have in 2019. To close, I have outlined how I see the economy evolving and mentioned several policy steps in the future that underly that outlook. The tapering of our asset purchases has started and should continue over coming months. Then the Fed will turn to normalizing other aspects of monetary policy as the economy continues to recover from the severe COVID shock we encountered last year. I believe that policy may need to pivot to a faster taper based on incoming data that I will be monitoring.

r211129a_FOMC

united states

Engagement, Research and Policy: Integrating Indigenous Voices into Economic Inclusion at the Federal Reserve

bowman

Thank you to the Bank of Canada for the invitation to speak at today's symposium. It is an honor to be with you virtually today as the Federal Reserve Board's representative to the Central Bank Network for Indigenous Inclusion. I am pleased to add my voice to those of my colleagues today and to recognize and acknowledge that the United States and the foundation of its economy were built on land enriched by its original Indigenous inhabitants, and their stewardship of its natural resources. The economic well-being of Indigenous people is an important aspect of the Federal Reserve's goal to increase economic inclusion for all Americans, and it is one of the reasons we are participating in today's symposium and the Central Bank Network for Indigenous Inclusion. Over time, it has become evident that opportunities to succeed and build a better life for all economic participants is a central concept for a healthy and growing economy and a stable and strong financial system. The negative effects of past policies and a lack of economic opportunity have impacted Indigenous people for generations. I would like to acknowledge this history, but also to acknowledge that no great nation can prosper when its people are left behind. The Federal Reserve, with all of the powerful tools at its disposal, can't fully succeed unless Native people, and others that have existed on the margins of the economy, have the opportunity to become full participants. The discussions today, including those regarding access to credit for Indigenous communities, can advance this goal. The Federal Reserve also makes progress on economic inclusion through the process of engagement. We rely on discussions like those from our events series to supplement the quantitative data upon which central bankers rely to make decisions that may have life-changing consequences for households across the United Governors recently held a event in Oklahoma to learn from tribal leaders that represent the 39 federally recognized tribes in that state. The Board also gains perspective from formal advisory bodies like its Community Advisory Council. The council "provides the Board with diverse perspectives on the economic circumstances and financial services needs of consumers and communities, with a particular focus on the concerns of low- and moderate-income populations." Indigenous leader on the council regularly shares insights on the economic conditions and opportunities within Indigenous communities. In the U.S. context, effective outreach must be regular and extensive, so we are able to capture the wide range of perspectives represented within and across 574 federally recognized tribes. Each tribal community's experience differs and is shaped by its own often-complex history. I met with some of these leaders on a recent trip to South Dakota, and they reminded me of the importance of building understanding by meeting people where they are to better grasp what they have experienced. That said, there are some common experiences across Native American communities that are reflected in data: Per-capita income among Native Americans is about half that of the rest of the United But since 1990, Native Americans' gross domestic product per capita has nearly doubled in real terms. While reservation economies often offer fewer, less-diverse job opportunities relative to other rural areas, firms in Indian Country showed high levels of resiliency during the last financial crisis. Bank branches are harder to find in Indian Country. Credit is often more expensive for reasons not fully explained by available borrower characteristics alone. priced" compared with eight percent for other populations. In response, the number of the past two decades. Country's credit needs, but research and pilot programs demonstrate the power of cultural fit as they bring credit, financial services, and consumer education into tribal communities. In the context of the recent pandemic, we have also seen some Native communities' approach to the pandemic health response be considered as potential case studies for future best practice. Federal government stimulus has also led to historic levels of funding for tribal communities in the wake of COVID-19, which may help to address housing and other infrastructure needs created and exacerbated by generations of unfulfilled treaty and trust obligations. Many of the issues I have discussed today are the subject of extensive Fed research. Continued research conducted by central banks can play an important role in generating new work to better understand where gaps may exist. Central banks can also leverage their unique role in the economy and society by fostering important connections between lenders, funders, other public agencies, and academics working with Indigenous communities. In recent years, the Board of Governors has organized gatherings like the Native research, and ensures that Indigenous-led institutions are served through collaborations like the Partnership for Progress with minority depository institutions. Our regional banks also support Indian Country in many ways. Six years ago, the Federal Reserve Bank of Minneapolis formalized decades of Indian Country work and national leader in qualitative and quantitative research highlighting economic and credit conditions in Native communities. CICD's practice is guided by a tribal leadership council, and active engagement with American Indian, Alaska Native, and Native Hawaiian community leaders. CICD staff lead research within tribal communities, gather information through surveys of tribal institutions, and study financial markets for Indian Country as a whole. CICD functions as a true public resource, providing accessible information and data that can serve as a foundation for the research of others. Their events serve as important meeting grounds, where partnerships can form, and ideas can be thoughtfully considered. Banks of Atlanta and Kansas City provides multiple tribal nations and Native communities across the United States with personal finance and economic education programming. This culturally relevant programming offers the flexibility to adapt to local needs, including the use of Native language, to strengthen financial literacy in the tribal communities served. Other Federal Reserve community development staff partner with tribes on best-practice manuals and convene regional and national leaders to encourage connections between tribal leaders and lenders. Of course, research and outreach are not ends in and of themselves. Two recent examples highlight how the Fed's work in Indian Country translates information into practice. The first example comes from the Main Street Lending Program, a credit program created to address pandemic related financial challenges for certain businesses during the COVID-19 pandemic. The program's initial rules made the application process and funding approval challenging for tribal-nation-owned enterprises. In response, the procedures were quickly adapted to accommodate these entities, which improved the effectiveness of the program and its reach to Indian Country applicants. The second example comes from our work to modernize the Community Reinvestment Act, or CRA. Among other things, the CRA provides a framework to assess banks' service to and investments in economically distressed areas. In our first steps to modernize the regulation, we posed a set of questions to the public. We included questions about Indian Country, and CICD reached out to Indigenous leaders and organizations to highlight the opportunity to provide feedback resulting in a significant number of public comments highlighting Indian Country considerations. As we move forward with the CRA modernization process, the consideration of these and other comments will result in a more effective outcome. My remarks today have really only scratched the surface of the Federal Reserve System's efforts to improve our engagement with Indigenous communities. While these efforts have much room to grow, I am very pleased that they inform our System's work to support economic opportunity during this important time. Today's symposium has provided me with much to consider and reflect upon as we continue our collective efforts to work with and support Indigenous people. I look forward to beginning our ongoing work together to understand how central banks can more effectively include Indigenous communities.

r211129b_FOMC

united states

Opening Remarks

powell

Good afternoon. It is a pleasure to welcome everyone, including colleagues from the The pace of technological change and innovation over the last decade has led some to argue that we are on the brink of a fourth industrial revolution--a digital revolution. Certainly, rapid innovation, including through the application of advanced digital technologies, machine learning, artificial intelligence, and big data, is revolutionizing the financial sector. The Federal Reserve has a mandate to understand and, in some cases, manage these changes, but it also has a responsibility to be at the forefront of change to deliver to the American people--and the international community--a reliable, efficient, and inclusive monetary and financial system. Furthering the efforts around the Federal Reserve System to harness the power of innovation, I am delighted to welcome the opening of the New York Innovation Center. Located at the Federal Reserve Bank of New York, in the heart of the most important financial center in the world, this Innovation Center will draw on the expertise at the bank, in the Federal Reserve System, and from the broader financial community, as well as experts around the world to analyze and bring technology to bear on improving the global financial system. Increasing the synergies of the New York Innovation Center will be its strategic partnership with the BIS Innovation Hub, recently established to foster dialogue, collaboration and knowledge-sharing among central banks and other authorities and institutions. In particular, the partnership will support our analysis of digital currencies--including central bank digital currencies; help to improve our current payment system--with a particular focus on making cross-border payments faster and less expensive; and it will provide new tools to aid our supervision of the financial system. Linking up with the BIS in this way will enhance our ability to collaborate with central banks around the world and will ensure that the best and most up-to-date information, research, and practices are flowing freely. Since its inception in January 2020, I have served as head of the BIS Innovation Hub Advisory Committee and am very pleased that the Federal Reserve will be able to partner with the Hub in this important way. So I want to extend my thanks to President Williams, Agustin Carstens, and all those that worked on the establishment of this center. And I look forward to the advances of both these institutions in supporting innovation in service to the safety and soundness of the financial system. Thank you.

r211130a_FOMC

united states

Federal Reserve Independence: Foundations and Responsibilities

clarida

The COVID-19 pandemic and the mitigation efforts put in place to contain it delivered the most severe blow to the U.S. and global economies since the Great Gross domestic product (GDP) collapsed at a nearly 33 percent annual rate in the second quarter of 2020. More than 22 million jobs were lost in just the first two months of the crisis, and the unemployment rate rose from a 50-year low of 3.5 percent in February to a postwar peak of almost 15 percent in April 2020. A precipitous decline in aggregate demand pummeled the consumer price level. The resulting disruptions to economic activity significantly tightened financial conditions and impaired the flow of credit to U.S. households and businesses. The fiscal and monetary policy response in the United States to the COVID crisis was unprecedented in its scale, scope, and speed. Legislation passed by the Congress in The Federal Reserve acted decisively and with dispatch to deploy each and every tool in its conventional kit and to design, develop, and launch within weeks a series of innovative facilities to support the flow of credit to households and business. The facilities the Federal Reserve either relaunched or designed and developed anew in response to the COVID crisis were established under the authority of section 13(3) of the Federal Reserve Act; under section 13(3), these facilities can be established only in "unusual and exigent circumstances" and with approval of the Treasury Secretary. occasion in the past dozen years in which the Federal Reserve invoked its emergency lending powers to help forestall severe financial market disruptions--the first occasion to reflect on the Federal Reserve's response to the GPC in the context of our institution's history and structure and to highlight not only the privileges that flow from, but also the responsibilities that are required to respect, our institutional independence. Let's begin with some history. At the urging of Treasury Secretary Alexander States in 1791. Like similar institutions in other countries--most notably, the Bank of England--the First Bank of the United States was owned by the private sector, was publicly chartered, and carried out some of the operations that would be thought of today as those of a central bank. That First Bank played a key role in executing Hamilton's vision to put the young federal government's finances on a sound footing, to promote the stabilization of the purchasing power of the U.S. dollar, and to support economic growth. Nevertheless, that First Bank became embroiled in politics, and the Congress failed to renew its 20-year charter in 1811. In 1816, the Congress did charter a Second Bank of the United States, which was designed along similar lines to its predecessor. But it, too, generated political controversy--Andrew Jackson was not a fan and was not shy in saying so--and its 20-year charter expired without renewal in 1836. For the next 77 years, the United States operated without a central bank. There was significant financial-sector development during this time, with commercial banks, equity markets, and corporate bond markets all playing a growing role in financial intermediation in the U.S. economy. This period also witnessed several major financial panics that substantially disrupted economic activity. One of those panics--the Panic of 1907--galvanized the Congress to establish a new central bank. The Federal Reserve was charted by the Congress in 1913 and directed specifically to promote the stability of the financial system. An important goal of the Federal Reserve in those early years was to smooth the large seasonal swings in interest rates and credit conditions associated with the harvest season that, in the past, had contributed to financial panics. The principal tool provided in the Federal Reserve Act to accomplish this goal was the ability of the Federal Reserve to lend funds to commercial banks against sound collateral through its "discount Through the compromises and choices made in designing the Federal Reserve system, the Congress created an institution that received broader and more durable political support than had been the case for the First and Second Banks of the United which was composed of public officials nominated by the President and confirmed by the Senate. In this initial incarnation, the Board included the Secretary of the Treasury as an ex officio distributed across a dozen geographic Districts--which were designed to be responsive to and report on regional economic conditions. Although the Congress assigned the Federal Reserve a statutory set of goals and tools, policymakers from the very first days had substantial independence in how they used those tools to pursue the assigned goals. For example, the interest rate charged on discount window loans--rates that had an important bearing on overall financial conditions in the country--was set by Federal Reserve policymakers, with little interference from the Congress or the executive branch. The same was true of Federal Reserve purchases or sales of Treasury securities. These open market transactions were found, over time, to be another effective tool with which to influence overall financial conditions. In response to the Great Depression and reflecting a growing recognition that the Federal Reserve's original institutional design was in need of improvement, the Congress restructured the Federal Reserve System in the 1930s. Greater authority over policy decisions was placed with the Board--whose members, given their presidential nomination and Senate confirmation, were thought to be more clearly accountable to the nation as a whole. At the same time, the Congress gave the Board increased independence from the executive branch by removing the Secretary of the Treasury's status as an ex officio member. Decisions regarding open market purchases of U.S. government securities, which were becoming the most important monetary policy tool of which consists of the members of the Board of Governors and a rotating subset of the Reserve Bank presidents. In the FOMC structure set up in the mid-1930s and remaining in force today, only five Reserve Bank presidents are voting members of the FOMC at any one time, leaving the seven Board Governors typically in a majority position. This arrangement has served the Federal Reserve well during the past 85 years, as it promotes a diversity of views and a healthy debate regarding the policy options available. It is also worth noting a distinction that bears on decisionmaking powers regarding monetary policy and lending policy. In contrast to monetary policy, the power to make decisions about the structure of Federal Reserve lending programs, including the authority to launch emergency programs, resides solely with the Board. Subsequent decades saw further changes to the governance of monetary policy. A notable development occurred in 1951, when the Federal Reserve obtained its current level of independence from the Treasury Department on monetary policy, as codified in Reserve Reform Act of 1977, which assigned the Federal Reserve its current statutory mandate to achieve price stability and maximum employment. Monetary policy had, in effect, pursued these goals since the accord, and the Federal Reserve's maximum- employment and price-stability goals had been embedded in previous acts of the Congress. But the statutory formalization of this "dual mandate" was important in specifying congressional intent and defining the Fed's goals. In the decades after the Great Depression, while systemic financial disruptions in the United States were not unknown--the Latin American debt crisis of the 1980s and the savings and loan crisis of the 1990s were certainly major events--systemic liquidity crises were relatively uncommon. And the Federal Reserve was able to address the disturbances that did occur using its traditional tools of providing discount window loans to banks, a tool that had been in its toolkit since 1913. This half-century of relative financial stability in the United States was shattered in 2008 by the GFC, a crisis that disrupted financial markets and impaired financial intermediation around the world. In the United States, many of the most severe disruptions occurred in wholesale funding markets and involved nonbank financial firms--such as broker-dealers, money market funds, nonbank mortgage lenders, and nonbank finance companies. These nonbank financial institutions, which had become a major source of financial intermediation in the United States in the decades leading up to the GFC, were typically lightly regulated, highly leveraged, and overly reliant on unstable sources of short-term funding. And because they were not banks, the Federal Reserve would have faced enormous challenges stemming the crisis solely by use of traditional discount window lending to depository institutions. Funding markets during the GFC faced enormous stress. A number of major financial firms failed, Fannie Mae and Freddie Mac were forced into conservatorship, and the flow of credit to businesses and households was severely impaired. The Federal Reserve responded by using not only its traditional authority to lend to banks, but also, for the first time, its authority to lend to nonbank institutions under section 13(3) of the Federal Reserve Act in unusual and exigent circumstances. The GFC emergency lending facilities that were stood up under this authority were designed to support short-term funding markets and to provide loans to nonbank financial firms, which in turn could then continue to intermediate credit to the private sector. made section 13(3) loans to individual distressed nonbank firms, like Bear Stearns and The Federal Reserve's emergency lending programs established during the GFC stabilized the financial system and helped prevent another great Depression. Consistent with the central bank's statutory authority, the facilities were designed to minimize the Federal Reserve's exposure to credit risk, and all of the facilities were wound down over time without any loss to taxpayers. In the wake of the GFC, the Congress made several changes to the Federal Reserve's emergency lending authority. First, the Federal Reserve would be required to provide loans to nonbanks only through broad-based facilities: Bilateral loans to individual nonbank firms were no longer permissible. Second, all emergency lending programs would now require approval by the Secretary of the Treasury. Third, the Federal Reserve going forward would be required to provide enhanced and timely transparency with regard to any emergency lending facilities set up under section 13(3). In addition to these changes to the Federal Reserve's authority, the GFC also spurred wide-ranging financial regulatory reforms--in particular, the Dodd-Frank Wall Street Reform and Consumer Protection Act--meant to improve the stability of the financial system. The Federal Reserve's experience in the GFC reinforced a set of important principles guiding how it would respond to a future systemic financial crisis: Act rapidly and decisively. Act on a large scale with a variety of tools. Be mindful that announcement effects can be vital for promoting confidence. Design and price facilities as backstops to smooth a return to private-sector financial intermediation as quickly as possible. The lessons learned from the Federal Reserve's response to the GFC were invaluable, as it had to assess, develop, and execute its response to the GPC in a matter of weeks. In the first two weeks of March 2020, the FOMC lowered its target range for the federal funds rate by 1 1/2 percentage points, thereby bringing the range to its effective lower bound of 0 to 1/4 percent. The Committee also provided forward guidance on the federal funds rate, stating that it expected to maintain the existing target range until it was confident that the economy had weathered recent events and was on track to achieve its maximum-employment and price-stability goals. engaged in substantial purchases of Treasury securities and agency mortgage-backed securities to support market functioning and further ease financial conditions. Reflecting the heightened uncertainty of mid-March 2020, there was a surge in demand for liquidity across the global financial system. Spreads in some short-term credit markets, such as that for commercial paper, surged to levels nearing those of the 2008 financial crisis; investors ran on prime and tax-exempt money funds; and some firms found it difficult to obtain the credit needed to finance critical operations. Many businesses sought to draw down on lines of credit with banks to augment the amount of liquidity they had readily available. To relieve these strains, the Federal Reserve encouraged depository institutions to turn to the discount window, lowered the rate on discount window borrowing, and made it easier for institutions to borrow from the Federal Reserve at longer maturities. As conditions in U.S. credit markets were severely stressed, the Board determined once again that circumstances were unusual and exigent and acted rapidly and decisively to prevent financial collapse. With approval of the Treasury--and, in some cases, drawing on equity capital invested by the Treasury--the Board announced and stood up several section 13(3) short-term liquidity facilities similar to those established during the GFC. And because dollar funding pressures were not limited to the United States, the Federal Reserve stabilized global dollar funding markets by expanding its swap line arrangements with foreign central banks and by lending dollars against U.S. Treasury securities to foreign central banks. Against the background of concerns about major economic disruptions stemming from the pandemic, strains also emerged in the corporate bond market, the municipal debt market, and asset-backed securities markets. Issuance of new debt in these markets slowed sharply, and the cost of corporate credit increased considerably. Financing challenges were also faced by state and local governments as well as by small and medium-sized businesses traditionally reliant on bank lending. In response to the crisis, the Congress passed the Coronavirus Aid, Relief, and the Treasury to make sizable equity investments in Federal Reserve section 13(3) facilities. On the basis of this legislation, the Federal Reserve established several novel section 13(3) lending facilities to promote intermediation in credit markets. Among other measures, the Federal Reserve purchased corporate bonds in the secondary market under the corporate credit facilities, made loans to smaller nonfinancial companies through the Main Street Lending Program, and made loans to state and local governments through the These section 13(3) facilities promoted the flow of credit to households and businesses and helped stabilize financial and economic conditions. It is notable that they accomplished their goals even though credit provided by the facilities was priced in a manner consistent with their status as backstops rather than as full-fledged replacements for private-sector intermediation. Indeed, some facilities recorded little or no use. But their very existence as backstops appears to have contributed in substantial ways to calming markets and promoted the revival of activity in private credit markets as conditions normalized. The public health policy response to contain the COVID-19 virus triggered an unprecedented disruption to the U.S. economy. The economic policy response to the crisis was equally unprecedented. As I have described, because of the breadth and depth of the dislocations in the U.S. financial system caused by the GPC, the Federal Reserve's credit facilities had to be designed to reach counterparties well beyond those associated with its traditional lending facilities. The Federal Reserve's actions during the GPC were taken to fulfill its long-standing statutory mandate to stem financial panics. The facilities established in 2020, in conjunction with the Federal Reserve's other actions and a robust fiscal policy response, provided crucial support to the U.S. economy as GDP was collapsing and unemployment was surging. Then, as the distress in financial markets abated and the economy regained its footing, the facilities were wound down and the emergency tools were, appropriately, put back in the toolbox with no adverse impact on credit conditions. For example, the Federal Reserve completed its sales of assets from managing the paydown of assets in our other CARES Act facilities as they wind down In conclusion, in central banking, as in other endeavors, with privilege comes responsibility. The Federal Reserve recognizes and has acted according to the principle that its section 13(3) authorities are to be deployed only in unusual and exigent circumstances, and, in both the GFC and GPC, it took its responsibilities seriously and did so in a timely way. Outside of such circumstances, the Federal Reserve has been granted instrument independence by the Congress to set short-term interest rates and to purchase and sell U.S. government securities to achieve its statutorily assigned goals of maximum employment and price stability. Thank you for your time and attention, and I look forward to my conversation with President Mester. Journal of pp. 701 . . . Journal of .

r211202a_FOMC

united states

Between the Hither and the Farther Shore: Thoughts on Unfinished Business

quarles

When I joined the Board of Governors as Vice Chair for Supervision in the fall of 2017, the Federal Reserve was in the latter stages of a decade-long effort to build a new financial regulatory framework, responding to the financial crisis of 2008. Yet, although the mortar was not yet dry on that construction project--based on the blueprint created by Congress, central banks, and supervisors around the world--there was already broad recognition across the political spectrum that the framework could be improved upon, based on the experience of how it had worked over the decade of its implementation. That was the judgement of the authors of the post-crisis blueprint, former Senator Chris It was also the recommendation of one of my predecessors at the Fed, Dan Tarullo--a principal architect of this framework-- who, in his final speech as a Fed governor, proposed several significant changes. I came to the Fed in order to take on that task of making the system better: more simple, more efficient, more transparent. Congress also took up this effort in the broadly adjusted our regulatory framework to better align our requirements with the risk posed by firms to the financial system. We maintained and, in fact, raised regulatory standards for the most systemically important firms and simplified regulatory requirements for smaller firms without diminishing the resilience of the system as a whole. In the midst of our work to improve our framework, we faced the unique experience of the COVID event, which tested that resilience. This real-life stress test demanded emergency action with respect to our regulatory framework and more broadly, including through the establishment of 13 emergency lending facilities under our role as the lender of last resort to help stabilize the financial system. Now, as my tenure as a member of the Board comes to a close, I would like to use this final speech to discuss issues that my successor, and his or her colleagues, will confront--areas of unfinished business. In the near term, there will need to be further refinements to the bank supervisory and regulatory framework, based on the accumulating evidence and experience of how these ideas, rules, and procedures have worked in practice. In the longer term, the Fed will at some point need to grapple with the implications of some of the novel emergency lending facilities we established during the onset of the COVID event. I supported these facilities in light of the specific challenges the country faced that grueling spring, but I believe it is possible to draw some lessons from the experience and set out some principles for the Fed's emergency lending to prevent this precedent - or some vision of what it represents--from exceeding reasonable bounds in the future. Finally, in my capacity as the outgoing Chairman of the Financial Stability Board (FSB), I have some reflections on the upcoming agenda for the As I have noted previously, the post-crisis regulatory framework is strong, as evidenced by how well it fared against a severe real-life stress test--the COVID event. Banks entered the COVID event with high levels of capital and liquidity, and served as a source of strength to the economy in a time of need. Some have argued that the time of COVID was not a true test of the system, because of the unprecedented level of fiscal and other support provided to the real economy during that time, from which the financial sector indirectly benefited. Such an argument ignores, however, that the Federal Reserve did not take such support for granted during the throes of the crisis itself, and as a result we ran multiple stress tests throughout the COVID event, with three separate and distinct scenarios, along with a "sensitivity analysis," which itself included three additional hypothetical recessions. Each of these stress tests assumed no additional fiscal or other measures to support the economy, and demonstrated that, even without such support, the banking industry would have fared very well. In my view the resilience of banks during the COVID event, coupled with the results of our stress tests, demonstrate that the overall level of capital in the banking system is more than ample. In addition to the demonstrated hardiness of our regulatory framework, I believe our supervisory framework is also stronger now than it was four years ago. In January 2020, I spoke about the importance of transparency, accountability, and fairness in bank supervision. Every agency of the federal government has a legal, constitutional, and, I believe, moral responsibility to be accountable to the public we serve, and one of the principal ways we do this is through transparency. The banking agencies (including the Fed) have for decades not been transparent in the way that we have conducted supervision--yet, especially since 2008, we had been accomplishing more and more of our work through this opaque mechanism with limited accountability. In that light, I am quite proud of the improvements we have made in increasing the transparency and public accountability for our activities overseeing banks. The Fed fostered the public conversation on transparency in supervision when we organized a conference on supervision and actively participated in the discussion with academics and other members of the public. An important part of monetary policy transparency is the semiannual process where the Fed reports on its activities to Congress and the Chair submits to questions from both houses of Congress. I am pleased to say that there is now a similar twice-yearly process in which the Fed produces a public, written report on supervision and regulation and then submits to questions from lawmakers. Our Supervision and Regulation Report--instituted early in my term-- regularly provides the public with insights about our supervisory process, including aggregate supervisory ratings trends and supervisory priorities for our different portfolios--information that was previously hard to find, and sometimes not public at all. I believe one concrete and successful change to supervision was to our stress testing process, where we have greatly increased transparency, and thus accountability. Transparency does not mean giving answers to tests in advance--an inapt analogy given the structure of these tests--but is more akin to ensuring that students have been given the textbook. It means balancing rigor and fairness, and ensuring that the Fed's intentions are understood well enough to advance our goal--and our goal is not to develop the most recondite test, but rather for banks to improve their resilience to extraordinary stress in the financial system. The evidence that we succeeded is how well banks weathered the extraordinary stress that arrived in the spring of 2020, consistent with the results of our stress tests. Transparency, accountability, and the public legitimacy it confers have empowered the Fed to meet the great challenges that our economy and financial system have faced in recent years. If the Federal Reserve is to continue to play that vital role, then it must also continue to extend transparency to all of its important responsibilities. As I look ahead to the future of regulation and supervision at the Federal Reserve, I believe that the Fed will be more effective in overseeing banks, and more effective in promoting the stability of the financial system, if it maintains its commitment to be open and transparent in how it conducts its work. In the same spirit, while our regulatory and supervisory framework is strong, there are further refinements that could be made to improve the framework. A number of them were on my agenda when the COVID event shifted the Fed's focus to deal with the emergency. I am proud of what we accomplished in my time here, but there is certainly more to be done. One of the principal matters that the Fed will have to take up in the very near term is the calibration of our leverage capital standards. Our capital framework includes two types of requirements: risk-based and leverage capital requirements. Risk-based requirements are risk-sensitive and change depending on the riskiness of an asset. Leverage capital requirements set a minimum floor for required capital by disregarding risk-sensitivity measures. Our capital framework includes two leverage requirements, with increasingly strict requirements for the largest institutions. While a leverage ratio is an important backstop, it can result in perverse incentives if it becomes the primary constraint on a bank's investment decisions. Because a leverage ratio is not sensitive to risk, a firm that is "bound" by such a ratio has an incentive to avoid adding safe assets to its portfolio. During times of stress in the financial system, when it is most important for banks to be able to continue serving businesses and households, or intermediating transactions, a binding leverage constraint--or even one that threatens to become binding--may discourage banks from engaging in safe activities, such as those involving U.S. Treasury securities. That is not to say that a leverage requirement should never be the constraining requirement for a firm. In times of stress, a leverage ratio can serve as a transparent measure of capital when our risk weights may be called into question. In addition, it guards against behavior by a supervised institution to game those risk weights. Finally, a leverage ratio leans against the inherent tendency of bank leverage to increase in an economic boom and fall during a recession. What we are seeing today, however, is that supervised firms are increasingly being constrained by the supplementary leverage ratio not for any of these valid reasons, but simply because of a rise in the level of safe assets in the U.S. financial system. The supplementary leverage ratio was originally calibrated for a financial system with a far lower level of central bank reserves and a much smaller Treasury market. The current environment is, of course, much different. Treasury issuance is at an all-time high and the banking system is awash with central bank reserves. To provide some context to the degree of this trend, for the largest banks, the amount of reserves they hold is $1.35 trillion and the amount of Treasury securities is $1.38 trillion, each roughly double the amount they held when our supplementary leverage ratio rule was finalized. Even at these lower levels of safe assets, some on the Board worried that the SLR might be too tightly calibrated--but they took comfort from the staff's projection that reserves in the system were likely to fall, creating more elbow room within the envelope created by the SLR. Indeed, when we finalized our leverage requirements for the largest banks, staff projected the amount of reserves in the system would decline to $25 billion by year end The current total of approximately $4.16 trillion in reserves is about 165 times that amount. During the onset of the COVID event, regulators took emergency action to exclude U.S. Treasury securities and deposits at Federal Reserve Banks from the supplementary leverage ratio to provide banks with additional flexibility to act as financial intermediaries in that period of financial stress. That exclusion expired as scheduled on March 31, 2021. I supported that expiration, with the commitment that the Fed develop a longer-term solution to the perverse implications of the current calibration of the SLR. With respect to the enhanced supplementary leverage ratio (eSLR) that applies to U.S. global systemically important banks (G-SIBs), the best way to address this problem is the approach endorsed by the Basel Committee: recalibrating the fixed 2-percent eSLR buffer requirement to equal 50 percent of the applicable G-SIB capital surcharge, with corresponding recalibration at the bank level. This is an approach previously proposed by the Board and the OCC. This is preferable to other options, such as excluding central bank reserves or U.S. Treasury securities, or both, from the ratio's denominator. Excluding only central bank reserves would exacerbate a structural preference for reserves over Treasuries in bank portfolios, which could have perverse consequences for the operation of the Treasury market (as we saw in September of 2019). Trying to reduce this preference by excluding both reserves and Treasuries could result in a significant lowering of capital levels and exacerbate the incentive for the banking system to prefer funding the government to funding private enterprise. If we were to attempt to offset the lowering of capital levels by increasing the leverage capital requirement on non-excluded assets, this disincentive to fund private enterprise would only grow stronger. But whatever the form of the adjustment, this issue needs to be addressed to ensure that our capital framework does not lead to increased risk taking and reduced safe-asset intermediation. As it stands, we are driving deposits out of the highly regulated banking system and requiring that cash be held in other, less stable parts of the financial sector, such as money market funds. If we enter another crisis with this issue unaddressed, the leverage ratio fundamentalists will have much to answer for. International cooperation regarding our prudential requirements is critical to promote global resilience in the banking sector, and I have been strongly committed since my arrival at the Board to implementing the final phase of the Basel III capital reforms here in the United States. I had hoped that the US would have led the world in setting out a concrete proposal to implement the Basel III endgame by the end of last year, but the intervention of COVID set back that timetable, and although we are working hard with the other banking agencies to iron out the last issues, our proposal will have to come after my departure. A major issue that we are grappling with is how to implement these reforms, which reduce the role of bank internal models on bank capital requirements, while maintaining the overall level of aggregate capital requirements. As I noted earlier, the experience of the COVID event has made clear that capital requirements in the United States are ample--yet, other things being equal, implementing the remaining elements of Basel III could result in a material increase in capital levels, perhaps up to 20 percent for our largest holding companies. Endlessly increasing capital levels is not costless. In the real world, as opposed to the world from which certain pundits and kibitzers make their occasional visits to our planet, excessively high capital levels constrain the ability of the banking system to provide credit to the real economy, and we pay the cost in jobs and living standards. What policymakers will need to do as they implement the Basel III reforms is determine whether adjustments to other parts of the capital framework are necessary to ensure that we do not unduly increase the level of required capital in the system. The most logical place to make such an adjustment would be the G-SIB surcharge. In the US, we have calibrated the G-SIB surcharge at twice the internationally agreed level, and we did so expressly noting that we would revisit the surcharge calibration periodically to reflect current conditions. We have not followed through on our commitment to revisit the surcharge calibration, and once these last elements of the Basel framework are implemented, there will be little justification for a super-calibrated G-SIB surcharge. But many people have an emotional attachment to the G-SIB surcharge, and if that emotion should overwhelm the logic of the case, there are other less talismanic candidates for re-calibration in the existing capital framework that could achieve the same purpose of keeping aggregate capital roughly constant while completing Our stress testing framework is a cornerstone of our prudential framework, and I am proud of how well it performed during the COVID event, helping to ease stress in the financial system by demonstrating the capital adequacy of banks. The stress testing framework is used to set capital requirements for large firms, and the volatility of these requirements from year to year indicates that we still do not have those requirements quite right. As I have said previously, excessive volatility in a firm's capital requirements limits the firm's ability to manage its capital effectively. While some measure of volatility is expected and desirable in a dynamic stress test, we must guard against excess volatility when it has no particular relationship to changing risks at firms. It is difficult to justify large year-over-year swings in capital requirements for individual banking firms that are simply artifacts of the stress testing process rather than reflecting a genuine change in a firm's business. I have wrestled for some time with the question of how best to address excessive volatility. In the end, I think the simplest and most effective approach would be to average the results of the current year's stress test with the corresponding stress test results from the previous two years. This would not affect the overall stringency of the tests but would mean that firms that hold the risk profile of their balance sheets relatively constant would not see a large spike or plummet in their required capital from year-to- year based on changes in the Fed's scenario choices. In May 2018, I spoke about the vital importance of cross-border banking to global financial stability and prosperity. The Fed's work internationally on pre-positioning, ring-fencing, and market fragmentation is still vital, and we should continue efforts to find the right balance between flexibility for the parent bank and certainty for host country authorities. Striking that balance properly is essential in order to encourage the international cooperation that is so critical during times of global financial stress. As I noted previously, while a home regulator will by nature prefer flexibility in resolution, the host regulator will prefer certainty that local resources will be available in stressful conditions. The host regulator, however, must recognize that flexibility in a single point of entry resolution may further the success of the resolution of the entire group, which will ultimately benefit the host regulator. Domestically, the United States needs to do its part in its role as a host regulator by making sure that our U.S. pre- positioning requirements for foreign banks with significant U.S. operations are appropriately calibrated. U.S. intermediate holding companies of foreign-owned G-SIBs are required to issue a minimum amount of loss-absorbing instruments to their foreign parents. These requirements with respect to what is known as internal total loss absorbing capacity include a separate minimum unsecured long-term debt requirement. Our internal total loss-absorbing requirements for these firms are currently at the top end of the scale set forth by the FSB and willingness by the United States to consider adjusting that calibration to a lower level within the FSB-agreed range may prompt other jurisdictions to do the same. Such a global recalibration, which would do nothing to diminish the loss absorbency requirements that apply at a consolidated group level, could better the prospects of successful resolution both for foreign G-SIBs operating in the United States and for U.S. G-SIBs operating abroad in a future period of financial stress. We also should consider further simplification of our regulatory framework by streamlining our currently separate and somewhat redundant total loss-absorbing capacity and long-term debt requirements. It is important that we do not create conditions that will make any resolution more difficult in the future. I have already noted that transparency and accountability--and the legitimacy they confer--have helped the Fed to meet the great challenges of recent years. As I look ahead to the future of supervision at the Federal Reserve, I believe that if the Fed maintains its commitment to openness and transparency in how it conducts supervision, it will be more effective in overseeing banks and promoting the stability of the financial system. Being open and transparent does not mean relaxing supervisory standards. Greater transparency makes supervision more effective by ensuring that our expectations are well understood. And by more clearly explaining and justifying those expectations, we enhance the legitimacy of our standards and build respect for the rules, which is critical to promoting and producing compliance in any legal regime. We need to do more here, and while we have made many of the improvements to transparency I discussed in my January 2020 speech, there is still unfinished work. greatest focus should be on improving our supervisory communications process. We can do so in a few ways. First, we should restore the "supervisory observation" category for less urgent items of concern, which could increase the quality of feedback provided to a firm as it would allow an examiner to give notice about a supervisory concern even if that concern has not risen to the level of a matter requiring attention, or MRA. We should be vigilant that future MRAs are limited to violations of law, violations of regulation, and material safety and soundness issues to improve the fairness of our supervisory process given the weight MRAs carry with respect to a bank's supervisory rating. We have committed to this practice, but in the absence of a supervisory observations category it remains too common that we issue MRAs for supervisory concerns that do not truly rise to that level. We need a framework that allows us to communicate all our concerns, while recognizing that "when everything's urgent, nothing is." Finally, we should implement a routine practice of independent review of important supervisory communications and guidance documents. We want to make sure our supervisory communications focus on violations of law and material safety and soundness issues. Together, these approaches will greatly improve our supervisory communication and enhance our supervisory process. Finally, before turning to some longer-term issues, I would like to discuss digital assets, which the banking agencies have all said will be an area of significant focus in the coming year. The Federal Reserve, and our fellow regulators, should welcome responsible innovation, and we should create a regulatory environment that not only allows for such innovation, but encourages it. Digital assets, such as stablecoins, are just such an area of welcome innovation. It is clear that there is a strong demand for these assets among bank customers, and well- regulated banks should be allowed to engage in activities regarding these assets. We do have some legitimate concerns that must be addressed by any provider of these assets: the structure of the asset must be stable (no fractional reserve; no liquidity mismatch; limited currency volatility), the consumer must be protected (clear legal claims on asset pools), and criminal activity must be deterred (transparency to law enforcement). But once these concerns are addressed--and many of the companies active in this area are eager and able to address them--we should let the ingenious and inventive private sector move rapidly. I am concerned, however, that regulators are contemplating steps that could hamper these innovations unnecessarily. For example, the President's Working Group on Financial Markets recently issued its report on stablecoins and, while the report sensibly discusses the risks associated with stablecoins, it contemplates approaches that I don't believe are warranted, such as limiting wallet providers' affiliation with commercial entities. It is one thing to say that a stablecoin issuer itself must be a regulated bank--I think that is probably overkill, as there are perfectly effective ways for nonbanks to meet our legitimate regulatory concerns, but there is at least a clear relation between the existing framework of bank regulation and the specific measures that stablecoin issuers must address to operate safely. It is, however, quite another thing to contemplate that wallet providers may need to be completely separated from commercial firms. It is not at all clear what regulatory interest would be furthered by such a limitation, which is much more restrictive than we require for nondigital assets. While digital asset-related activities may be novel, regulators need not treat these activities differently simply because of the nature of the technology. We must focus with care on the unique risks posed by these activities and avoid unnecessarily impeding their promise. For that reason, I am hopeful that regulators will show reasoned constraint in the regulation of digital assets. To this point, I have been addressing issues that the Fed will have to deal with in the near term. Let me now turn to a longer-term challenge: the implications of our emergency actions in the recent crisis. The COVID event caused an unprecedented-- indeed, unimagined--shutdown of economic activity in the United States and much of the world. The Federal Reserve responded to the COVID event with the same vigor it showed when the Great Financial Crisis threatened a worldwide Depression, employing our ample emergency power under Section 13(3) of the Federal Reserve Act to stabilize the economy and financial system. In this case, we reactivated forms of the lending facilities employed during the Great Financial Crisis, and then went farther to create new lending facilities to support households, businesses, and state and local government entities that, it was feared, would be frozen out of credit markets. In all, the Federal Reserve created 13 lending facilities with the statutorily required approval of the Secretary of the Treasury. I supported these actions, and still do, as the right response when faced with the specific challenges we faced in the spring of 2020. But I did at the time, and still do, have concerns about the possible precedents that have been created by the novel facilities that we created. It starts with a distinction between liquidity facilities designed to bolster market functioning by providing short- term loans to financial firms when such credit is suddenly not available, and what I would call credit facilities , which support the extension of long-term credit to the real economy--households, businesses, and governments. The two different types of facilities have materially different characteristics. The liquidity facilities are largely "wholesale" ; the term of the funding they offer is generally quite short; operating them calls on expertise that Fed staff either have or that is quite similar to existing expertise; the risk of loss is minimal, given the nature of the facilities; and withdrawing from them is relatively straightforward, either selling the assets or letting them mature, which happens quickly given the short term and penalty rate of the funding. The credit facilities, by contrast, are largely "retail" ; the end-users of the credit support are households, businesses, and governments that attract significant political interest, meaning pressure for continued expansion of credit will be great; the credit facilities involve longer-term lending; operating the credit facilities requires expertise that the Fed does not have and that is not highly analogous to existing Fed expertise; the potential for troubled loans (and thus potential loss) is material, which will also require expertise and administrative attention that the Fed is ill suited to provide; the penalty rate needed for 13(3) lending can reduce the effectiveness of the facilities (and encounter significant political opposition), given the purpose of the credit support and the nature of the beneficiaries; and withdrawing from the facilities will involve telling specific beneficiaries that their funding will not be extended (another politically fraught event). Equally important, from outside the technocratic halls of the Fed there will emerge, from many directions, persistent political pressure to pursue, through the ostensibly monetary mechanism of central bank emergency lending, fiscal policy objectives that ought--as a matter of fundamental economics and fundamental governance--to be decided upon by elected representatives operating within the budgetary constraints of the appropriations process. As a prospective shortcut around those constraints, extended provision of credit to broad sections of the economy through the mechanism of 13(3) without either a required appropriation or effective limit could easily prove an impossible lure for future Congresses to resist, under the guise of one "emergency" or another: having established the precedent that the Fed can lend to businesses and municipalities for the COVID event, there will inevitably be those whose plans are grand and whose patience with democratic accountability low who will begin to ask why the Fed can't fund repairs of the country's aging infrastructure, or finance the building of a border wall, or purchase trillions of dollars of green energy bonds, or underwrite the colonization of Mars. An entity that can do that without any need for Congressional appropriations, would have the vastest political consequence and political control of it would be a great prize. It would encourage dangerous fiscal irresponsibility, and the attendant pressures would turn us from a technocratic, nonpolitical institution with a crucial but focused mandate and great autonomy in the pursuit of that mandate, into the most politically entangled organization in the country--and the damage to our core monetary policy and financial regulatory mission would be great. Fortunately, there were no major problems with the COVID credit facilities. While political pressure related to the credit facilities waxed and waned, the economy recovered quickly enough that the facilities could be wound down within several months with relatively little opera. However, these good outcomes had more to do with good luck than good structure. While the economy and financial system were under intense stress for several months in spring of 2020, the reopening of the economy and rapid recovery that began in May of that year was a major reason that material losses, political pressures, and operational problems were avoided. To cite one example, the crisis in the municipal bond market, which seemed possible that spring, never materialized. We cannot undo the precedent we have established (nor should we--if we face a similar challenge in the future, the Fed should respond forcefully), but in breaching the long unbreachable firewall of offering direct lending to non-financial businesses, both large and small--as well as a wide range of state and municipal governments--we face a fundamental problem: the extension of funds to these borrowers, and management of these loans, inherently involve the allocation of credit, which is both a fiscal and a political action that is being made primarily by an unelected body. For all these reasons, I believe we should establish a clear understanding that, should the Fed ever again use its 13(3) authority to establish credit facilities similar to those of the COVID event, Congress will without delay create a structure to transfer the ongoing funding and governance of the credit facilities into a non-Fed vehicle that will fund, manage, and eventually wind down the extraordinary credit support. Section 13(3) creates a standing power of the Fed to act rapidly and forcefully to address a crisis. 13(3) allows the nature of that response to be flexible depending on the nature of the crisis. Financial market dysfunction can be addressed through 13(3) liquidity facilities that fit comfortably within the Fed's operations and expertise, and in many cases might not require any use of Treasury equity or other Congressionally appropriated funds. But if the shock is one--like the COVID event--that requires real economy credit support to address its root causes, the Fed can use 13(3) to provide the same rapid and forceful response (with appropriate Treasury equity for credit protection), but we should establish the expectation that this credit support will be moved into a separate, non-Fed structure as quickly as Congress can manage. In the same way that the 13(3) facilities developed in 2008 served as templates in 2020, greatly increasing the speed of our response, the template outlined here that we create for the future here should ideally become the default expectation of Congress, markets, and the public should the Fed ever again be called upon to provide credit facilities under section 13(3). There are many precedents for such an approach. During the Great Depression, emergency credit to the real economy, expressly steering clear of the problems that would naturally have been associated with using the Federal Reserve for such a purpose. RFC had a limited life, separately appropriated capitalization, and separate borrowing authority in order to fund direct lending to borrowers. More recently, during the 1990s financial and economic crisis in Sweden, Norway, and Finland, after initial stabilizing responses from their central banks, these countries established new governmental agencies outside their central banks to manage the broader, continuing support programs. Measures such as these have a number of advantages: A separate entity can be expressly stated to be an emergency vehicle with a limited life. It can be legally required to extend credit for a short, specified period and then be wound down. Providing credit support through a separate vehicle establishes a clear division between fiscal measures and monetary policy. Lending through a separate organization allows more flexibility on the interest rate and other terms of government-sponsored credit support. While we were lucky in the COVID event, one could easily have imagined the economic crisis deepening to the point where achieving the purposes of widespread credit support would have called for lending at a market or even subsidized rate, rather than the penalty rate required for central bank lending. Doing so is a decision that should be made by Congress, rather than the Fed. The separate incorporation and funding of a separate vehicle would give transparency and clear boundaries to the degree of government financial support being provided to the economy. Placing the inherently political decisions around the allocation of credit in a separately governed entity will keep the Fed from being fundamentally transformed by efforts to politicize the credit-granting mechanism. Finally, having a separate entity will facilitate hiring the necessary people with the necessary expertise, which will likely be quite different from the expertise usually found in either the Treasury or the Federal Reserve. a. In particular, the types of personnel and expertise required to work out troubled loans made with government credit support are very different from the personnel and expertise widely available in either the Fed or the This would not be a U-turn from our decisive response to the COVID event, but rather simply the logical next step. In addition to providing clarity for the public as to what to expect in future crises, adopting this model going forward could reduce concerns a future Fed might have that a forceful response could entangle it in difficult political problems. This could help give a future Fed the freedom to determine what it believes is truly the right technocratic response to a particular future shock. Adoption of such a framework would also reduce the attraction of the Fed as a general purpose funder of credit-intensive political projects--we would have established that the piper will not only always have to be paid, but paid promptly. This framework also gives an appropriate role to 13(3), consistent with the clear authority granted to us, but also consistent with what we have learned about the entanglement of central banks with fiscal policy and politics in the years since 13(3)'s enactment. We would not be ignoring the credit support authority 13(3) gives us, rather we would be anchoring it in its appropriate emergency context. As we continue to grapple with a future framework for emergency lending, the United States is not alone. Around the world, financial authorities are reflecting on the lessons from the COVID event while exchanging experiences and views at the FSB, which I have chaired for the past three years. My FSB term ended just yesterday, but there remains much to be done at the FSB. One of the most important tasks is addressing vulnerabilities related to non-bank financial intermediation, or NBFI. This has been a critical focus of my chairmanship and is reflected in the FSB's ambitious multiyear workplan to enhance NBFI resilience. One set of initiatives under the workplan focuses on specific risk factors that appear to have propagated stress, including liquidity strains during the COVID event. The FSB has made considerable progress in the NBFI space in a short amount of time. As a first major deliverable under the NBFI work program, the FSB recently published policy proposals to address structural vulnerabilities in money market mutual funds (MMFs). Although we've made good progress, we cannot lose momentum. It is critical that jurisdictions make meaningful progress in MMF reforms, building on the FSB's policy proposals. FSB members have clearly noted the importance of this task by committing to reviewing the progress made by members in two- and five-years' time. The FSB and international standard-setting bodies must also advance policy work on specific risk areas, such as open-ended funds and margining practices, that appear to have contributed to stress during the COVID event. We also need to develop a shared understanding of how vulnerabilities in the NBFI sector may cause spillover effects or impact broader market functioning in the future. To achieve this aim, the FSB will continue to examine the structure and drivers of liquidity in government and corporate bond markets during stress and develop a broad, systemic risk perspective on NBFI as well as policies to address such risks. As chair of the FSB, I have had the opportunity to work with brilliant and dedicated colleagues around the world. Under pressure from the severe tests of the COVID event, together we delivered--true to our mandate--through cooperation, analytical rigor, and broad engagement. I depart the Financial Stability Board knowing it is well-prepared to complete the tasks at hand and face the challenges of the future. I am told that Dan Tarullo's final speech as a Fed Governor was 26 pages long, and this one is only 25--consistent with my relentless quest to improve the Fed's efficiency and simplicity. Yet even at this Mahabharatan length, I have only hit the highlights of what my successor will need to address. Fortunately, he (or she) will benefit from the same principal advantages I have had over the last four years: the intellectual horsepower, analytical rigor, and disciplined expertise of the Federal Reserve's staff. These are powerful advantages indeed, even with so complex and sustained an agenda. I wish her (or him) well.

r211217a_FOMC

united states

A Hopeless and Imperative Endeavor: Lessons from the Pandemic for Economic Forecasters

waller

Thank you, Mike, for the introduction. It is a privilege for me to address fellow macroeconomic forecasters, and I thought an appropriate subject would be the challenge of forecasting during the pandemic. First, a few remarks about my outlook. Then I will discuss some lessons learned from the pandemic--lessons about the economy's response to this unprecedented event relative to what forecasters, including myself, first thought. In light of November's job report, I believe the economy is closing in on maximum employment. Though job creation was lower than expected last month, the number indicated another solid increase in jobs. Accounting for retirees leaving the workforce, I estimate that employment is only about 1-1/2 million jobs below its February 2020 level, when monetary policy was less accommodative and unemployment estimates of the longer-run unemployment rate. The unemployment rate dropped to 4.2 percent in November, just a touch above the median of FOMC participants' longer-run level of 4 percent. The economy seems to be on track to grow at an annual rate of 6 to 7 percent this quarter and by nearly that much in the first quarter of 2022. Turning to inflation, it is alarmingly high, persistent, and has broadened to affect more categories of goods and services, compared with earlier this year. Wages are rising, and business contacts are reporting in the Fed's Beige Book that they are comfortable passing on increases in input costs to their customers. I have argued for some time that there are upside risks to inflation, and with inflation exceeding the FOMC's 2 percent target for some time now, I strongly supported the Committee's decision this week to speed up the pace of the tapering of asset purchases. This action gives us increased flexibility to adjust monetary policy as needed in 2022. Assuming this new pace of reductions in our monthly asset purchases continues, the FOMC will end purchases in March. The appropriate timing for the first increase in the policy rate, of course, will depend on the evolution of economic activity, something that I will be closely monitoring. But given my expectations for inflation and labor market conditions, I believe an increase in the target range for the federal funds rate will be warranted shortly after our asset purchases end. One big uncertainty about this outlook, of course, is the Omicron variant. We still don't know how serious a public health threat it will be, so we don't know if it will slow the U.S. economy, as the Delta variant briefly did, or even possibly slow progress toward maximum employment. Cutting the other way, we also do not know if Omicron will exacerbate labor and goods supply shortages and add inflation pressure, derailing the moderation of inflation next year that is my baseline. Over the past couple of years, forecasters have gotten pretty used to sudden changes in the outlook, and my colleagues and I on the FOMC will adjust as needed. pontificate a bit on the nature of the forecasting business. Forecasting typically involves answering the following question: Given the data we see today, what will be the value of some variable, such as gross domestic product (GDP), some period into the future? If the only metric of success is the accuracy of the forecast, then one should use a purely statistical model that looks for the variables that have the best predictive power. In this world, no one asks why those variables have predictive power--they just do. But that is not the only thing that a forecaster's clients want--they also want an explanation for why you are making this forecast. Using a recent example, in May 2021 inflation readings were over 4 percent. If your statistical model predicted that inflation would fall to 2 percent by the end of 2021, you would be asked why you are making that prediction. To answer this question, you need an economic model. But by resorting to an economic model, which is an abstract representation of the true economy, you are potentially making a tradeoff between the statistical accuracy of the forecast and the logic of an abstract economic model to explain that forecast. On top of that, you must resort to a stochastic economic model, where future states of the world occur with probabilities of less than one. So not only do you need to specify future states of the world from an economic model, you also need to specify the probability for each possible state of the world. Unfortunately, God does not hand us the probability distribution for future states of the world, so we must come up with that on our own. We do that by looking at history and trying to tease out empirical estimates of those probabilities, hoping that history is a good guide to what will happen in the future. But one thing that history makes clear is that past behavior is not always a good predictor of future behavior. Thus, to forecast well, one needs a good economic model, knowledge about future states of the world, and an accurate probability distribution over those future conditions. Even if we believe we have all of these elements in our forecasting toolbox, we still face the daunting task of forecasting turning points and judging the effect of unusual shocks. As a result, economic forecasting is a pretty hopeless endeavor. So why do we do it? Because of how much is riding on the outcome. All economic activity--every one of the billions of economic decisions that will be made today, and every day--is guided by a view of the future. It is based on assumptions about economic conditions down the line. If the view is that conditions will be prosperous, consumers will be more likely to buy that new, bigger TV, and business owners will be more likely to expand and hire. But if their views are that conditions will get worse, they will be more likely to save than spend. Without a set of beliefs about the future, no one would be able to decide to spend or invest. The cumulative effect of all those decisions determines whether the economy grows or contracts, whether a business thrives or fails, and whether families can pay their bills. So, fully aware of the dismal prospects of getting a forecast right, we soldier on, in pursuit of the scintilla of understanding it may provide about a future that everyone is interested in. It is often said that, based on our performance, economic forecasters need to approach this work with humility, but I think it is exactly the opposite. It takes bravado and some chutzpah to stand up and express confidence in an economic forecast that will almost certainly be wrong. But we do it and take the hits when we are wrong, because so much depends on that view of where the economy is headed. Now, let us look at the forecasting community's performance over the past couple of years. It has been almost exactly two years since reports began to circulate of a novel virus in Wuhan, China. In March 2020, health experts in the United States and elsewhere were recommending social distancing, avoiding crowded public places, and maintaining at least six feet of distance from other people. At that time, many economies, and eventually much of the United States, instituted lockdowns that kept school kids and nonessential employees at home. The effect was a sudden and severe drop in economic activity and significant stress in the financial system, including a significant disruption in Treasury markets. Unlike other severe economic shocks in the past century, such as the Global Financial Crisis (GFC), the COVID crisis was a health emergency. The response was a planned shutdown of key sectors of the U.S. economy--something that had never been done before. Obviously, the pandemic has been a great hardship for many people, and it was very challenging for anyone trying to forecast the effect of the virus on the economy. While we all knew that a recession was in the cards, forecasters lacked the historical analog to give us an idea of the severity of the recession. To say there was massive uncertainty in predicting the effect of the virus is an understatement. While shutdowns and lockdowns were more severe in March and April 2020 in some parts of the country than in others, most of the country was affected, and the drop in employment and spending was larger and faster than the United States had ever experienced. Twenty-two million jobs were lost in March and April. The unemployment rate more than quadrupled from a 50-year low of 3.5 percent in February to 14.8 percent in April. Real GDP fell at an annualized rate of 31 percent in the second quarter of 2020, which was three times faster than ever recorded. Before the start of the pandemic, the top and bottom 10 respondents of the Blue Chip survey (meaning those with the highest and lowest forecasts) had an average forecast for 2020 GDP growth of 1.5 percent and 2.2 percent, respectively, which is a very tight range. Once the pandemic started, this range exploded, with GDP growth forecasts ranging from negative 1.1 to negative 7.4 percent. Pre-pandemic forecasts for for the Q4 unemployment rate ranged from 5.4 to 13.7 percent. It is clear from these disparate forecasts that there was tremendous uncertainty regarding the future states of the world and the probabilities associated with those states of the world occurring, which impaired the effort to model that future. Just as we lacked the background and experience to forecast the negative effects of the pandemic, we also lacked the experience to understand the extraordinary rebound that followed. GDP grew at a 33 percent annualized rate in the third quarter . Half of the jobs lost were regained in four months, and in seven months the unemployment rate had fallen to 6.7 percent. By comparison, after the GFC, it took more than two years to regain half of the jobs lost and more than four years to return unemployment to 6.7 percent. So, given this unprecedented shock and the response of the economy to that shock, what are some lessons I learned from the pandemic for understanding the behavior of an economy, and how do those lessons affect my forecasts going forward? I think a principal lesson from this experience is that forecasters have to consider the nature and the novelty of an economic shock and quickly adapt our models to new situations. Some adaptations will work well and others will not, but you must adapt and, through trial and error, sort out how to modify one's model to account for novel shocks. At the onset of the pandemic, there was a lot of learning about the nature of the shock and how to adapt economic models. Economists had to quickly incorporate epidemiology models of disease transmission into their economic models to try to understand how the spread of the virus would affect the overall economy. As a simple example, how should we capture the economic effects of social distancing in models in which the concept of distance doesn't exist? I cannot say how much forecasters relied upon their existing models or historical data to adjust their outlooks as 2020 progressed, but it was not enough to avoid large and persistent forecasting errors. For example, figure 1 shows the evolution of the Blue Chip summation of private forecasters' outlook for the average level of the unemployment rate in the fourth quarter of 2020. In March, like everyone else, these forecasters had no sense of what was coming; the consensus was for an unemployment rate of 3.7 percent near the end of the year. By April, there was a clear sense that the shock was bad. Forecasters adjusted their expectation for the unemployment rate to average near 9 percent in the fourth quarter of 2020. In May, with numbers in hand showing unemployment averaging around 14 percent for March and April, the consensus Blue Chip forecast then suggested a slowly declining unemployment rate that would average a bit over 10 percent in Q4. A slow decline in unemployment is what we experienced after the GFC, so it made sense to project a similar slow decline after the virus hit. But this time really was different. In fact, the unemployment rate dropped to 6.7 percent in November, and that is where it ended the year. Even after the dramatic economic rebound in May and June, the change in the consensus view for the unemployment rate later that year was extremely gradual. Something seemed to prevent forecasters--me included--from seeing the rapid improvement that was happening before our eyes. Same thing for the inflation forecast this year. As figure 2 shows, in January and February, the Blue Chip consensus was for consumer price inflation for Q4 to average about 2 percent. This forecast slowly ticked up to 2.4 percent through September. It was only in November that the consensus forecast moved above 4 percent and then jumped to reported at 6.8 percent for the 12 months ending November, the largest 12-month increase since mid-1982. I don't mean to single out private forecasters; my colleagues and I on the FOMC did no better forecasting during the pandemic. In June 2020, when the rebound in activity was under way, our median projection was for a drop in GDP that was more than twice as large as it turned out to be. Instead of an unemployment rate of 6.7 percent at year-end 2020, we predicted 9.3 percent. And even at the end of last year, nearly a year into the pandemic shock, we continued to have large forecast errors. We predicted that inflation based on personal consumption expenditures would be 1.8 percent this year, instead of the 5 percent it hit in October. Data suggest it will remain elevated through year-end. Today at the Federal Reserve, we have learned from the COVID experience, and over the past two years we have improved our models and data collections in many ways. One enhancement has been to supplement our models with additional high- frequency and microdata, such as data on school closures, airline passenger traffic, and mass transit ridership, to help us understand movements in various aspects of the economy. We gave more weight to weekly data on credit card purchases to supplement monthly retail sales reports. Both weekly paid employment and active employment from ADP have provided insight into the labor market ahead of when monthly employment numbers are released. We have also dug into very disaggregated data on prices to see where the upward and downward pressures are concentrated to help guide our thinking of how each of the sectors might adjust in the future. Another improvement in our approach to modelling is to incorporate epidemiological models to assist in thinking about the transmission of COVID over time and how vaccines have helped slow that spread and stabilize the economy. The lesson from this experience is that economists need to continually adapt their models to the economic situation they are faced with, and when they are faced with a severe shock, they should ask themselves if they need to adapt their standard models and find other methods for forecasting the economy. Another lesson we learned was that unprecedented shocks, such as a pandemic, can generate unexpected and unfamiliar stress in the financial system. When the lockdowns and business closures started, it was reasonable to wonder whether banks would come under pressure, as they did during the Global Financial Crisis. As it turned out, banks were in pretty good shape and weathered the spring of 2020 pretty well, after a decade of effort by them and by government to strengthen regulation and supervision. On the other hand, probably the last thing that we expected to see was severe stress in the Treasury market, the most liquid and stable financial market in the world. But as it became clear that earnings and all sorts of payments could be disrupted to households, businesses, and state and local governments, there was a huge dash for cash and other liquid assets. Instead of flocking to Treasuries, people were trying to sell them into a rapidly deteriorating market. So we learned that even a Treasury security can become illiquid for certain types of shocks. We also learned that the Fed has potent tools to deal with even such an unfamiliar crisis. The Fed stepped in, lowered rates for discount window lending, revived lending facilities from the financial crisis, and created numerous new facilities to lend or support lending to households, small and large businesses, and state and local governments. In all, the Fed created 13 different lending facilities. In most cases, merely announcing these backstops succeeded in stabilizing markets, and, in fact, several facilities experienced very few requests for loans, which I consider a success. So we learned that when the Fed acts quickly and decisively, our tools can quickly restore confidence, even when that loss of confidence is felt as widely as it was in the spring of last year. In addition, when the Fed makes it clear that it is prepared to act without hesitation as a backstop, that fact alone can be sufficient to stem a crisis. After two years of surprises, persistently elevated inflation is the biggest surprise for me, and I am carefully watching how this plays out in the next few months. High inflation is a heavy burden for households that have no choice about paying higher prices for groceries and other necessities. It hurts small business owners who have a harder time balancing their costs and the prices they charge for goods and services. One of the Federal Reserve's most important responsibilities is keeping prices stable and inflation under control. Like most economists, after the performance of inflation over the past decade, it would have been hard for me to believe that it could run as high and as long as it has. I didn't expect it in 2020 as the pandemic took hold, and I was still in some doubt early this year. Likewise, I have been surprised at the persistence of the bottlenecks and other supply disruptions that have been a prominent source of elevated inflation. Like others, I expected that markets would adjust quickly and that these problems would be fixed, but that clearly isn't happening, and at this point, with COVID continuing to crimp supply, I don't know when it will. We are learning that the long and complex supply chains that have facilitated trade and driven down production costs in recent years are quite fragile and are taking longer to repair than I would have expected. Similarly, I would have expected that labor supply shortages would have eased as the vaccine became widely available, unemployment benefits faded, and wages improved at the fastest rate in decades. Labor force participation increased last month, but I would have expected that more people would have joined the workforce after businesses and schools reopened. COVID has changed a lot of things, and we need to consider if it has persistently changed a significant number of people's desire to go back in the labor force. This brings me back to my outlook for the economy in 2022, and the implications for monetary policy. The economy is set to continue growing very strongly through at least the first half of next year, and I expect employment to keep growing. With the unemployment rate at 4.2 percent in November, I believe we are very close to meeting the FOMC's maximum-employment goal. For inflation, as I said earlier, the next few months will be crucial in determining whether price increases will begin to moderate, as I still expect in my baseline outlook. However, I will be closely watching indicators of inflation expectations for signs that consumers and investors have come to expect high inflation well into the future, a development that could signal that the moderation in inflation I expect will not be coming soon. So, by choosing to speed up our reductions in asset purchases, the FOMC is providing flexibility for other adjustments to monetary policy, if needed, as early as spring to accommodate changes in the economic outlook. Omicron, as I said earlier, could slow the recovery or exacerbate inflation pressures, so we will have to be ready in the coming weeks to adjust as needed.

r220218a_FOMC

united states

Preparing for the Financial System of the Future

brainard

The financial system is undergoing fast-moving changes associated with digitalization and decentralization. Some of these innovations hold considerable promise to reduce transaction costs and frictions, increase competition, and improve financial inclusion, but there are also potential risks. With technology driving profound change, it is important we prepare for the financial system of the future and not limit our thinking to the financial system of today. In recent years, there has been explosive growth in the development and adoption of new digital assets that leverage distributed ledger technologies and cryptography. The market capitalization of cryptocurrencies grew from less than $100 billion five years ago to a high of almost $3 trillion in November 2021 and is currently around $2 trillion. In parallel, we have seen rapid growth in the platforms that facilitate the crypto platforms facilitate a variety of activities, including lending, trading, and custodying crypto-assets, in some cases outside the traditional regulatory guardrails for investor and consumer protection, market integrity, and transparency. The growth in the crypto finance ecosystem is fueling demand for stablecoins-- digital assets that are intended to maintain stable value relative to reference assets, such as the U.S. dollar. Stablecoin supply grew nearly sixfold in 2021, from roughly $29 billion in January 2021 to $165 billion in January 2022. There is a high degree of concentration among a few dollar-pegged stablecoins: As of January 2022, the largest stablecoin by market capitalization made up almost half of the market, and the four largest stablecoins together made up almost 90 percent. Today, stablecoins are being used as collateral on DeFi and other crypto platforms, as well as in facilitating trading and monetization of cryptocurrency positions on and between crypto and other platforms. In the future, some issuers envision that stablecoins will also have an expanded reach in the payment system and be commonly used for everyday transactions, both domestic and cross-border. So it is important to have strong frameworks for the quality and sufficiency of reserves and risk management and governance. As noted in a recent report on stablecoins by the President's Working Group on Financial Markets, it is important to guard against run risk, whereby the prospect of an issuer not being able to promptly and adequately meet redemption requests for the stablecoin at par could result in a sudden surge in redemption demand. It is also important to address settlement risk, whereby funds settlement is not certain and final when expected, and systemic risk, whereby the failure or distress of a stablecoin provider could adversely affect the broader financial system. The prominence of crypto advertisements during the Super Bowl highlighted the growing engagement of retail investors in the crypto ecosystem. Research found that 16 percent of survey respondents reported having personally invested in, traded, or otherwise used a cryptocurrency--up from less than 1 percent of respondents in 2015. There is also rising interest among institutional investors. So it is perhaps not surprising that established financial intermediaries are undertaking efforts to expand the crypto services and products they offer. If the past year is any guide, the crypto financial system is likely to continue to grow and evolve in ways that increase interconnectedness with the traditional financial system. As a result, officials in many countries are undertaking efforts to understand and adapt to the transformation of the financial system. Many jurisdictions are making efforts to ensure statutory and regulatory frameworks apply like rules to like risks, and some jurisdictions are issuing or contemplating issuing central bank currency in digital form. Preparing for the Payment System of the Future The Federal Reserve needs to be preparing for the payment landscape of the future even as we continue to make improvements to meet today's needs. In light of the rapid digitalization of the financial system, the Federal Reserve has been thinking critically about whether there is a role for a potential U.S. central bank digital currency (CBDC) in the digital payment landscape of the future and about its potential properties, costs, and benefits. Our financial and payment system delivers important benefits today and is continuing to improve with developments like real-time payments. Nonetheless, certain challenges remain, such as a lack of access to digital banking and payment services for some Americans and expensive and slow cross-border payments. Growing interest in the digital financial ecosystem suggests that technology is enabling potential improvements that merit consideration. In addition, it is important to consider how new forms of crypto-assets and digital money may affect the Federal Reserve's responsibilities to maintain financial stability, a safe and efficient payment system, household and business access to safe central bank money, and maximum employment and price stability. It is prudent to explore whether there is a role for a CBDC to preserve some of the safe and effective elements of the financial system of the present in a way that is complementary to the private sector innovations transforming the financial landscape of the future. The public and private sector play important complementary roles within the over a century of experience working to improve the infrastructure of the U.S. payment system to provide a resilient and adaptable foundation for dynamic private sector activity. In parallel, private sector banks and nonbanks have competed to build the best possible products and services on top of that foundation and to meet the dollar- denominated needs of consumers and investors at home and around the world. The result is a resilient payment system that is responsive to the changing needs of businesses, consumers, and investors. While the official sector provides a stable currency, operates some important payment rails, and undertakes regulation and oversight of financial intermediaries and critical financial market infrastructures, the private sector brings competitive forces encouraging efficiency and new product offerings and driving innovation. Responsible innovation has the potential to increase financial inclusion and efficiency and to lower costs within guardrails that protect consumers and investors and safeguard financial stability. As we assess the range of future states of the financial system, it is prudent to consider how to preserve ready public access to government-issued, risk-free currency in the digital financial system--the digital equivalent of the Federal Reserve's issuance of physical currency. The Board recently issued a discussion paper that outlines the Federal Reserve's current thinking on the potential benefits, risks, and policy considerations of a The paper does not advance any specific policy outcome and does not signal that the Board will make any imminent decisions about the appropriateness of issuing a U.S. CBDC. It lays out four CBDC design principles that analysis to date suggests would best serve the needs of the United States if one were created. Those principles are that a potential CBDC should be privacy-protected, so consumer data and privacy are safeguarded; intermediated, such that financial intermediaries rather than the Federal Reserve interface directly with consumers; widely transferable, so the payment system is not fragmented; and identity-verified, so law enforcement can continue to combat money laundering and funding of terrorism. Given the Federal Reserve's mandate to promote financial stability, any consideration of a CBDC must include a robust evaluation of its impact on the stability of the financial system--not only as it exists today but also as it may evolve in the future. In consideration of the financial system today, it would be important to explore design features that would ensure complementarity with established financial intermediation. A CBDC--depending on its features--could be attractive as a store of value and means of payment to the extent it is seen as the safest form of money. This could make it attractive to risk-averse users, perhaps leading to increased demand for the CBDC at the expense of other intermediaries during times of stress. So it is important to undertake research regarding the tools and design features that could be introduced to limit such risks, such as offering a non-interest bearing CBDC and limiting the amount of CBDC an end user could hold or transfer. As I noted at the start, the digital asset and payment ecosystem is evolving at a rapid pace. Thus, it is also important to contemplate the potential role of a CBDC to promote financial stability in a future financial system in which a growing range of consumer payment and financial transactions would be conducted via digital currencies such as stablecoins. If current trends continue, the stablecoin market in the future could come to be dominated by just one or two issuers. Depending on the characteristics of these stablecoins, there could be large shifts in desired holdings between these stablecoins and deposits, leading to large-scale redemptions by risk-averse users at times of stress that could prove disruptive to financial stability. In such a future state, the coexistence of CBDC alongside stablecoins and commercial bank money could prove complementary, by providing a safe central bank liability in the digital financial ecosystem, much like cash currently coexists with commercial bank money. It is essential that policymakers, including the Federal Reserve, plan for the future of the payment system and consider the full range of possible options to bring forward the potential benefits of new technologies, while safeguarding stability. Analysis of the potential future state of the financial system is not limited to the domestic implications. The dollar is important to global financial markets: It is not only the predominant global reserve currency, but the dollar is also the most widely used currency in international payments. Decisions by other major jurisdictions to issue CBDCs could bring important changes to global financial markets that may prove more or less disruptive and that could influence the potential risks and benefits of a U.S. CBDC. Thus, it is wise to consider what the future states of global financial markets and transactions would look like both with and without a Federal Reserve-issued CBDC. For example, the People's Bank of China has been piloting the digital yuan, also known as e-CNY, in numerous Chinese cities over the past two years. The substantial early progress on the digital yuan may have implications for the evolution of cross-border payments and payment systems. And it may influence the development of norms and standards for cross-border digital financial transactions. It is prudent to consider how the potential absence or issuance of a U.S. CBDC could affect the use of the dollar in payments globally in future states where one or more major foreign currencies are issued in CBDC form. A U.S. CBDC may be one potential way to ensure that people around the world who use the dollar can continue to rely on the strength and safety of U.S. currency to transact and conduct business in the digital financial system. More broadly, it is important to consider how the United States can continue to play a lead role in the development of standards governing international digital financial transactions involving CBDCs consistent with norms such as privacy and security. Given the dollar's important role as a payment instrument across the world, it is essential that the United States be on the frontier of research and policy development regarding CBDC, as international developments related to CBDC can have implications for the global financial system. Given the range of possible future states with significant digitization of the financial system, it is important that the Federal Reserve is actively engaging with the underlying technologies. Our work to build 24x7x365 instant payments rails leverages lessons from some of today's most resilient, high-performing, and large-scale technology platforms across the globe. It is providing important insights on the clearing and settlement models associated with real time payments as well as on fraud, cyber resilience, cloud computing, and related technologies. In parallel with the Board's public consultation on CBDC, the Federal Reserve Bank of Boston, in collaboration with the Massachusetts Institute of Technology, has developed a theoretical high-performance transaction processor for CBDC. recently published the resulting software under an open-source license as a way of engaging with the broader technical community and promoting transparency and verifiability. Moreover, the Board is studying how innovations, such as distributed ledger technology, could improve the financial system. This work includes experimentation with stablecoin interoperability and testing of retail payments across multiple distributed payment ledger systems. The Federal Reserve Bank of New York recently established an Innovation Center, focused on validating, designing, building, and launching new financial technology products and services for the central bank community. These technology research and development initiatives are vital to our responsibilities to promote a safe and efficient payment system and financial stability, whatever the future may bring. The financial system is not standing still, and neither can we. The digital financial ecosystem is evolving rapidly and becoming increasingly connected with the traditional financial system. It is prudent for the Board to understand the evolving payment landscape, the technological advancements and consumer demands driving this evolution, and the consequent policy choices as it seeks to fulfill its congressionally- mandated role to promote a safe, efficient, and inclusive system for U.S. dollar transactions. To prepare for the financial system of the future, the Federal Reserve is engaging in research and experimentation with these new technologies and consulting closely with public and private sector partners.

r220221a_FOMC

united states

High Inflation and the Outlook for Monetary Policy

bowman

Before we get to our conversation on community banking, I would like to briefly discuss my outlook for the U.S. economy and my view of appropriate monetary policy. As I see it, the main challenge for monetary policy now is to bring inflation down without harming the ongoing economic expansion. Inflation is much too high. Last year I noted that inflationary pressures associated with strong demand and constrained supply could take longer to subside than many expected. Since then, those problems have persisted and inflation has broadened, reaching the highest rate that Americans have faced in forty years. High inflation is a heavy burden for all Americans, but especially for those with limited means who are forced to pay more for everyday items, delay purchases, or put off saving for the future. I intend to support prompt and decisive action to lower inflation, and today I will explain how the Fed is pursuing this goal. In the near term, I expect that uncomfortably high inflation will persist at least through the first half of 2022. We may see signs of inflation easing in the second half of the year, but there is a substantial risk that high inflation could persist. In January, the Consumer Price Index rose to a 12-month rate of 7.5 percent, which, consistent with other recent monthly readings, was even higher than expected. Employment costs for businesses, as measured by average hourly wages, also rose last month. And continued tightness in the labor market indicates that upward pressure on wages and other employment compensation is not likely to moderate soon. My base case is that inflation will moderate later this year, which will depend, in wage growth lagging behind inflation for the past year, many families may find it challenging to make ends meet and continued rising home prices will likely prevent many from entering the housing market. In addition, rising costs and hiring difficulties continue to be burdens for small businesses. Turning to the labor market, which continues to tighten, indications are that the Omicron infection surge earlier this year has not left a negative imprint on the economy or slowed job creation. I expect to see continued strength in the job market this year, with further gains in employment, and my hope is that more Americans return to the labor force and find work. The strength in job creation is a big positive for those seeking employment and for their families. Even with the improving labor market, I still hear from businesses that qualified workers are difficult to find, and labor shortages remain a drag on hiring and on economic growth. Now let me turn to the implications of this outlook for monetary policy. In my view, conditions in the labor market have been and are currently consistent with the FOMC's goal of maximum employment, and as such, my focus has been on the persistently high inflation. In part, the high inflation reflects supply chain disruptions associated with the economic effects of the pandemic and efforts made to contain it. Unfortunately, monetary policy isn't well-suited to address supply issues. But strong demand and a very tight labor market have also contributed to inflation pressures, and the FOMC can help alleviate those pressures by removing the extraordinary monetary policy accommodation that is no longer needed. In our most recent monetary policy statement--which was released following our January meeting--we indicated that "with inflation well above 2 percent and a strong labor market," we expected that it would "soon be appropriate to raise the target range for the federal funds rate." I fully supported that assessment, and the data we have seen since then have only increased the urgency to get on with the process of normalizing our interest rate stance and significantly reducing the size of the Federal Reserve's balance sheet. I support raising the federal funds rate at our next meeting in March and, if the economy evolves as I expect, additional rate increases will be appropriate in the coming months. I will be watching the data closely to judge the appropriate size of an increase at the March meeting. In early March, the FOMC will finally stop expanding the Federal Reserve's balance sheet. The resulting end of our pandemic asset purchases will remove another source of unneeded stimulus for the economy. In the coming months, we need to take the next step, which is to begin reducing the Fed's balance sheet by ceasing the reinvestment of maturing securities already held in the portfolio. Returning the balance sheet to an appropriate and manageable level will be an important additional step toward addressing high inflation. I expect that these steps will contribute to an easing in inflation pressures in the coming months, but further steps will likely be needed this year to tighten monetary policy. Looking beyond this spring, my views on the appropriate pace of interest rate increases and balance sheet reduction for this year and beyond will depend on how the economy evolves. I will be particularly focused on how much progress we make on bringing down inflation. My intent would be to take forceful action to help reduce inflation, bringing it back toward our 2 percent goal, while keeping the economy on track to continue creating jobs and economic opportunity for Americans. I appreciate the opportunity to share my views on monetary policy with you this morning. But since we are here to talk about community banking, let's get back to that important topic. Certainly prior to, but especially over the course of the pandemic, we have seen a heightened focus and urgency in incorporating technology and innovation into community banking. The adoption of technology and innovation is really at the heart of the major issues facing community banks. We see banks, fintech companies, and tech firms exploring various technologies to enhance their payments systems, expand consumer access, improve back-office operations, and create new financial products and services. This interest and the increasing interest in crypto- and digital assets have created a need to work together with the other federal banking agencies to give the industry better and more useful regulatory feedback as banks consider approaches to integrating crypto- and digital asset related activities into their service offerings. Given the popularity of these types of assets, and the growing interest of banks in participating in the market, it's increasingly necessary for regulators to be able to engage with the industry on these issues. Evolving financial services, a sharper focus on efficiency and timeliness in the industry, and the rapid increase in technology advances have also led the Federal Reserve to explore the potential benefits and risks of a central bank digital currency (CBDC). We recently issued a discussion paper as a first step in fostering a broad and transparent public dialogue about CBDCs. The paper is not intended to advance any specific policy outcome and no decisions have been made at this time. We are genuinely committed to hearing a wide range of voices on this issue. The paper was published earlier this year with a 120-day comment period. We encourage your comments and feedback-- generally, and in response to specific questions posed in the paper. As we engage in this dialogue and evaluation process, and throughout this initiative, I intend to keep an open mind about the usefulness of and potential business case for a CBDC. I strongly encourage community bankers and all of the other stakeholders who would be impacted by the creation of a CBDC to submit your comments and views to the Fed by May 20, the end of the scheduled public comment period. Another area of intense interest is the expansion of financial activities beyond the traditional chartered banking institution construct. We are seeing an increase in the proposal of novel charter types under consideration across the country. These changes, and the coming availability of the Fed Now instant payment service, have the potential to vastly change the landscape of financial services and opportunities in the market. In anticipation of this evolution, our Federal Reserve Banks are receiving an increased number of requests for membership and access to Reserve Bank master accounts from institutions with these novel charters. Recognizing the importance of clarity and transparency in this space, and to facilitate and evaluate these activities in a consistent manner, the Board is in the process of issuing clearer guidance around the application and review process for novel bank charters and account access at the Federal Reserve. I look forward to discussing these and other issues with you in just a few minutes, so I will stop there. It's such a pleasure to be in person with you again at the ABA's Conference for Community Banks, and I am looking forward to our conversation.

r220224a_FOMC

united states

Fighting Inflation with Rate Hikes and Balance Sheet Reduction

waller

Thank you Peter, and thank you to the UCSB Economic Forecast Project for the invitation to speak today. My plan is to start with my outlook for the U.S. economy in 2022, and then describe what I consider the appropriate path of monetary policy to keep the economy on a healthy and sustainable course. But, before I get into that discussion, let me comment on what I think is on everyone's minds today, Russia's attack on Ukraine. Obviously, there are people in harm's way and we shouldn't lose sight of them. It is far too early to judge how this conflict will affect the world, or the world economy, and what the implications will be for the U.S. economy. But this situation adds uncertainty to my outlook and will be something I will be monitoring very closely. As my speech will say, we will need to carefully look at the incoming data, especially during a time of heightened uncertainty. Turning to my outlook for the economy, my greatest concern is continued elevated inflation. Inflation is too high, and I think concerted action is needed to rein it policy, and I will go into some detail about how I believe the Fed should approach increasing the target range for the federal funds rate and reducing the size of the balance sheet. But let me start with the outlook for economic activity. I expect the economy to continue expanding at a healthy rate this year, slower than in 2021 but still at a solid pace that will keep employment growing strongly. While there are some signs that the effects of the Omicron variant have dampened economic growth in the last month or two, it does not appear to have affected hiring, given the healthy jobs report for January. Even COVID-sensitive sectors such as leisure and hospitality saw big job gains last month. With COVID cases dropping sharply, I expect this latest surge in infections will not be a major factor affecting the economy in 2022. Supply bottlenecks and labor shortages, some of them related to the pandemic, continue to weigh on economic output, but I expect those to diminish later this year. The combination of strong consumer demand and supply constraints has produced very high inflation. The consumer price index (CPI) was up 7.5 percent for the 12 months through January, the highest yearly rate in 40 years. With appropriate monetary policy, and the expected easing in supply constraints, I am hopeful inflation will move down over the course of this year, even with the recent geopolitical developments. Nevertheless, the path of inflation is the biggest risk to my outlook. As we move through this year, I can't emphasize enough how much this outlook, and the appropriate stance of monetary policy, will be influenced by the data that we see about the performance of the economy. I know, I know. Saying you need to be data dependent is like saying you are for motherhood and apple pie--who would disagree? But in the current situation, it is urgently important to be data dependent. For example, like most people, I expected the Omicron surge would hammer job creation in January, but the data showed that this didn't happen. The ups and downs in forecasts during the pandemic should be evidence enough that policy decisions this year, more than ever, will need to be guided by the data, and not by what past experience suggests should happen. Missouri, which is home for me, is the Show Me State, so if you want to know how my outlook will evolve, show me the data. With that in hand, I will evaluate the outlook with respect to the Fed's dual mandate in determining the appropriate setting for monetary policy. Let's start with where the economy stands with respect to maximum employment. In December, I said that we were "closing in" on this objective. Since then, the labor market has continued to strengthen. I now believe we have achieved the FOMC's objective of maximum employment. So, what has changed and made me more certain about that? A big factor was the jobs report for January, which included very strong data for that month, upward revisions for November and December, and revisions for all of 2021. What we learned from those changes was that a reported slowdown in job creation in the second half of the year never happened, and that in fact job creation was remarkably steady throughout the year, averaging 555,000 a month and never deviating very far from that trend. These revisions helped explain why we saw such large and steady declines over the year in the unemployment rate, which fell from 6.4 percent in January 2021 to 4 percent in January 2022, which happens to be the median of FOMC participants' December estimates of the longer-run unemployment rate. Accounting for retirees leaving the workforce, I estimate that employment is close to the levels of February 2020, right before the pandemic shock hit the economy and when the target range for the federal funds rate was much higher than the current target range. The January job numbers were just one monthly report, but one reason I have the confidence to declare that maximum employment has been reached is the message January sent about the durability of the continuing recovery. Based on recent data, including a big increase in retail sales in January, it sure looks like a very significant surge in COVID has failed to derail or even appreciably slow the economy. It has been hazardous to predict much about the economic effects of the pandemic more than a month or two out, but I'm comfortable saying we are at maximum employment in part because of the evidence that the labor market is continuing to strengthen. Another message from the January report, including the revisions to each month of 2021, is that, so far at least, labor shortages do not seem to be having a huge effect on the economy's capacity to create jobs. Job creation didn't slow appreciably in November and December as originally reported; it actually was higher than the average for the rest of the year. Labor force participation isn't growing as much as one would expect with the hot job market, but apparently it's growing enough to keep the job creation machine humming. Another factor that signals we are at maximum employment is the continued rise in measures of labor compensation. The broadest measure of labor compensation, covering wages and benefits, is the employment cost index, which for private sector workers rose at a 4.7 percent annual rate in October, November and December, the fastest pace in 20 years. Average hourly earnings also continue to grow more strongly than they have in decades, and the gains are widespread across sectors. Job vacancies also indicate labor demand is exceptionally strong with nearly 3 million more vacancies than individuals looking for work. While I will continue to watch data on the labor market, I am focusing most of my attention on inflation, which is far too high and needs to come down. In December, some people were a little surprised to hear me say that inflation was "alarmingly high," but after the latest inflation numbers, I think we all should be alarmed. It is alarming because high inflation is especially painful for lower- and middle-income people, who don't have a choice about paying more for gasoline, groceries, shelter, and other necessities. It is alarming because of the risk that high inflation could become ingrained in people's expectations and prove difficult to rein in, undermining economic growth. The 7.5 percent increase in the CPI in January came after a 7.1 percent increase in consecutive month that inflation exceeded 2 percent. The FOMC targets another measure of inflation, the price deflator for personal consumption expenditures (PCE), which will be reported tomorrow. But for both measures, inflation has been increasingly broad-based for quite some time. For the CPI, better than 70 percent of items measured are up 3 percent or more in the last 12 months, and for PCE inflation, 60 percent of items were up that much in December. High inflation is a significant problem for individuals and families, and it makes it difficult for businesses to control costs and adjust prices. There is also the risk that the public's expectations of future inflation rise significantly, which affects spending decisions in the short term and thus can have the effect of driving inflation even higher. Keeping longer-term inflation expectations anchored is vitally important for monetary Strategy emphasizes that longer-term inflation expectations that are well anchored at 2 percent foster price stability and enhance the Committee's ability to promote maximum employment in the face of significant economic disturbances. Surveys of consumers' expected inflation over the next year moved up quite notably through 2021 and are currently elevated. And the public's expectations of inflation over the next five years have risen as well. That said, five-year inflation expectations are where they were over the past couple of decades when inflation stayed low. Importantly, longer-term expectations are much more stable. For example, future inflation measured by investors trading inflation-adjusted securities has 5-to10-year implied compensation around 2.2 percent, which, adjusted for the FOMC's preferred measure, PCE, is close to 2 percent. In the same way that expectations of much higher inflation can drive a cycle of ever-increasing inflation, when expectations are "anchored" and don't move significantly, it can have the effect of helping moderate surges in inflation, such as the one we have seen over the past year. As for what inflation does next, I think anyone who makes a forecast has to own the fact that very few of us foresaw how much inflation would increase in 2021. We underestimated the extent to which supply constraints--from bottlenecks to labor supply shortages--and strong demand would drive up inflation, and we thought bottlenecks and shortages would begin to resolve sooner than now. I think we have a clearer idea today of the effect of those factors on inflation but going forward we need see how geopolitical effects influence energy, commodity, and other prices. With some humility, while I am alarmed about the level of inflation and a bit uncertain about how the near-term may play out, I am hopeful that these factors and their price effects are likely to ease in the second half of 2022 and that with appropriate monetary policy, inflation will be coming down significantly by year end. I will be watching closely the data on supply pressures and how those feed into total consumer prices, and I'll be monitoring carefully to see whether expectations rise out of a range that would suggest they are becoming unanchored. As I said earlier, it is too soon to know how Russia's attack on Ukraine will affect the U.S. economy, and it may not be much easier by the time of our March meeting. Now let me spell out what my outlook implies for appropriate monetary policy over the course of 2022. Based on the inflation data in hand, I believe the Fed needs to act promptly to begin tightening monetary policy. As I said earlier, I believe that we have achieved our employment goal and that the labor market will keep improving, which means there should be no delay in responding to inflation that is significantly above our target. The FOMC has already taken actions to end asset purchases in early March, and I believe that the recent inflation and jobs reports have made the case to begin raising the target range for the federal funds rate at our March FOMC meeting. Based on my outlook, my preference is to increase the target range 100 basis points by the middle of this year. That is, I expect inflation to remain elevated and only show modest signs of deceleration over the next several months. As a result, I believe appropriate interest rate policy brings the target range up to 1 to 1.25 percent early in the summer. That would be a bit below where rates were at the outbreak of the pandemic, when inflation was considerably lower, and before we more than doubled the Fed's balance sheet, so I consider this a necessary and prudent start to tightening policy. The pace of tightening will depend on the data. One possibility is that the target range is raised 25 basis points at each of our next four meetings. But if, for example, tomorrow's PCE inflation report for January, and jobs and CPI reports for February indicate that the economy is still running exceedingly hot, a strong case can be made for a 50-basis-point hike in March. In this state of the world, front-loading a 50-point hike would help convey the Committee's determination to address high inflation, about which there should be no question. Of course, it is possible that the state of the world will be different in the wake of the Ukraine attack, and that may mean that a more modest tightening is appropriate, but that remains to be seen. With the economy at full employment and inflation far above target, we should signal that we are moving back to neutral at a fast pace based on the performance of the economy, and a 50-basis point hike would help do that. Consequently, should the data break against us in the coming weeks, we need to be prepared to hike the policy rate by 50-basis points. No matter the near-term path of reducing accommodation, the FOMC must respond decisively to the data so as to maintain our credibility that we will bring down inflation. We constantly say we have the tools to fight inflation, and now we must demonstrate the will to use them. While I believe that we should raise the target range by 1 percentage point over the next several months, I will be assessing the incoming data to decide whether further rate increases in 2022 are warranted and, if so, at what pace they should be implemented. If high inflation persists, then I would most likely support that we continue hiking, and potentially increase the pace of tightening. If inflation moderates in the second half of the year, as I expect, and as market participants expect, then we can slow the pace of tightening or even pause. As I said earlier--show me the data. Turning to balance sheet policy, as I noted, the Committee has decided to end asset purchases in early March. Initially, we will be keeping the size of the Fed's balance sheet constant by reinvesting the proceeds of maturing securities. The FOMC has not decided when to begin the reduction in the size of the balance sheet, but we issued a set of principles last month that make it clear that changing the target range of the federal funds rate is our principal monetary policy tool, and that balance sheet reductions through the "runoff" from maturing securities would commence after rate hikes have begun. I support starting this process no later than the July FOMC meeting. The pace of the reduction in asset holdings has not been determined but will be consistent with promoting the FOMC's employment and inflation goals and will be communicated well in advance to the public so that the plan is predictable. The last time we reduced our balance sheet we did the following: First, we waited two years after our first-rate hike before commencing balance sheet runoff. Second, we imposed monthly caps on the amount of maturing securities that we would let run off. These caps started out very low and were gradually lifted over a period of 12 months. So, why not follow the same strategy this time? First, back in 2017 and 2018 we had never intentionally reduced our balance sheet before. This was new territory for the Fed, so we went slow. Second, the Committee was considering moving to an ample reserves regime for conducting monetary policy, where we wanted to keep the banking system flush with reserves. Thus, we had no idea how far we could let reserves fall before we might cause an unwelcome shortage of reserves. Third, the economy was in a much different place; in particular inflation was much lower. Finally, we only expected to run off about $2 trillion of securities from our balance sheet. In that environment it made sense to go slow and gradual in terms of balance sheet reduction. Fast forward to today. This is now the second time we have done balance sheet reduction and we learned from experience and can go faster than before. Policymakers and markets have a good understanding now of how the process works. In terms of the appropriate size of the caps, I believe they can be larger than last time for several reasons. First, we have a very large balance sheet--securities holdings have increased $4.5 trillion since the start of the pandemic and the balance sheet is nearly $9 trillion. So even with a hefty reduction in holdings over the next year, we will still have a balance sheet that will be more than sufficiently large enough to conduct monetary policy. Second, the Fed's overnight reverse repurchase agreement facility, put in place to help conduct monetary policy, receives a large amount of deposits each day. The daily average take-up of $1.6 trillion so far in 2022 tells me that there is tremendous excess liquidity in financial markets. Large redemption caps will assist in removing this excess liquidity. Third, we have learned a lot about operating in an ample reserves regime over the past decade. And we learned lessons from the 2019 experience in reducing reserves. In the first quarter of 2019 the ratio of reserves to nominal gross domestic product (GDP) was approximately 8 percent and financial markets worked well and banks were flush with liquidity. Right now, reserves are far more than ample, standing at 17 percent of GDP. When evidence suggests that we are getting closer to a more appropriate and sustainable level of reserves, we can slow the pace of redemptions. Finally, we have the newly established standing repurchase facility, which acts as a backstop to buffer any unexpected liquidity needs. This facility can help assist us with any unexpected bumps along the way. With large caps and sizable amounts of securities maturing over the course of the next year or two, I do not see the need to consider asset sales anytime soon. However, because the Fed's mortgage-backed securities (MBS) holdings have long maturities and are quite sizable, prepayments are unlikely to bring these holdings down to de minimis levels over the next decade. So, MBS sales could be something the Committee considers down the road to satisfy our balance sheet principles long run goal of holding primarily Treasury securities. But that is a conversation for another day. In the meantime, I would support having no caps on MBS redemptions so our MBS holdings decline as fast as prepayments allow, which would modestly assist in moving us toward an all-Treasury portfolio. Thinking about possible monetary policy actions in 2022, I expect it will be a very fluid year. The Chair has said we will be nimble. I believe nimble describes how we acted in 2021 as well, when nimbleness and good communications served the FOMC well. Think back to the middle of 2021. Just last June, markets expected tapering to begin sometime in 2022, the majority of FOMC participants called for liftoff in 2023, and primary dealers surveyed in July by the Federal Reserve Bank of New York predicted a decline in the balance sheet wouldn't start until the middle of 2025. Wow, how things have changed. Over the course of the second half of last year, market expectations of the taper's beginning quickly moved to November, and then a month after it started, markets predicted it would be completed this March. Soon after, markets were pricing liftoff in March, with several rate hikes over the course of 2022. And now markets are also focused on the start of the decline in the balance sheet sometime this year. It is interesting to note that these dramatic changes in actual and anticipated monetary policy have occurred without volatility or strain in financial markets. I believe the FOMC has been highly effective in communicating its shifting outlook for the economy and appropriate policy actions as the data revealed that inflation was increasing much more than forecasters expected. Another point to make about the big changes in actual and anticipated monetary policy is that they are showing up in the financial data today. Financial conditions are tighter, I believe, because of the credible, forward guidance policymakers have communicated to the public. Although the Fed hasn't started raising rates or reducing the balance sheet, interest rates have moved up notably. For example, the 2-year Treasury yield is more than 1 percentage point higher today than at the start of the third quarter of last year. The 10-year Treasury yield is up 1/2 percentage point, and the 30-year fixed mortgage rate is up about 1 percentage point over this period. Going forward, policymakers will adjust policy as needed, which will reinforce the Fed's credibility. Let me conclude by saying I hope my remarks today contribute to the Fed's effective and credible communications. One message you should take away is that the course of policy is not pre-set, and the course I favor will be determined by my interpretation of new data. In the past couple months, inflation and employment data have been sending the same, unequivocal message--it is time to start tightening monetary policy. We need to take the first step in March to get off the effective lower bound. Then we should continue with hikes as well as begin to reduce our balance sheet. I will continue to monitor the geopolitical situation to assess the appropriate timing of this near-term monetary policy tightening. These actions will get us into the second half of the year, when we will have six months of inflation data, and we can assess what the appropriate path will be for the rest of 2022. Our goal is a soft landing for the economy that keeps output and employment growing at a healthy pace and inflation moving toward the FOMC's 2 percent objective.

r220318a_FOMC

united states

Welcoming Remarks

bowman

When we started the initiative, we wanted input from the public on one big decision that the Fed faced, which was making changes to our goals and strategy for monetary policy. After holding a number of public meetings in communities across the country, and after issuing a new statement on our goals and strategy that was enriched by what we heard, we decided that this kind of input could continue to inform and enrich the other important decisions we face. So the listening has continued, and the agenda has evolved to include pressing issues in the wake of the COVID-19 pandemic, such as today's conversation on education and work opportunities for young people. I am pleased to continue the process for the Board of Governors because I believe that providing the public with greater access to policymakers and gathering a diverse set of perspectives will help us better understand how our decisions affect individuals, families, and businesses. It will help us better understand the challenges people face and consider how we can help address those challenges in our work promoting a healthy economy and financial system. One thing I know is that America can't thrive economically or financially unless young people thrive. I have school-age kids, and like many other families, we have faced challenges the past couple of years, dealing with the impact of the pandemic, trying to make sure that our kids have every opportunity to succeed and that they don't miss out on experiences outside of school to learn and grow. I know that this has been a very difficult period for young people and for parents, many of whom were forced to choose between work and caring for their children. I am hopeful that these difficult choices are behind us, and that the end of the pandemic will allow us to focus intently on what young people need most to succeed. Their success is directly connected to the Fed's mission. Educating young people and preparing them for the demands made on the 21st century workforce will have a huge impact on the productivity of the U.S. economy. Rising productivity allows living standards to rise without contributing to inflation. So the Fed's goals for monetary policy--to promote maximum, inclusive employment and price stability--are closely related to the topics that we will be discussing today. The decisions that we at the Fed face on interest rates and other matters must be, and will be, informed by the perspectives that all of you bring to the table today about how to help young people thrive. Those decisions will be better decisions after we have heard you and gained a better understanding of the challenges and possible solutions. Thank you again for the opportunity to hear your views, and I am really looking forward to our discussion.

r220321a_FOMC

united states

Restoring Price Stability

powell

Thank you for the opportunity to speak with you today. Let me first pause to recognize the millions who are suffering the tragic consequences of Russia's invasion of Ukraine. At the Federal Reserve, our monetary policy is guided by the dual mandate to promote maximum employment and stable prices. From that standpoint, the current picture is plain to see: The labor market is very strong, and inflation is much too high. My colleagues and I are acutely aware that high inflation imposes significant hardship, especially on those least able to meet the higher costs of essentials like food, housing, and transportation. There is an obvious need to move expeditiously to return the stance of monetary policy to a more neutral level, and then to move to more restrictive levels if that is what is required to restore price stability. We are committed to restoring price stability while preserving a strong labor market. At our meeting that concluded last week, we took several steps in pursuit of these goals: We raised our policy interest rate for the first time since the start of the pandemic and said that we anticipate that ongoing rate increases will be appropriate to reach our objectives. We also said that we expect to begin reducing the size of our balance sheet at a coming meeting. In my press conference, I noted that action could come as soon as our next meeting in May, though that is not a decision that we have made. These actions, along with the adjustments we have made since last fall, represent a substantial firming in the stance of policy with the intention of restoring price stability. In my comments today, I will first discuss the economic conditions that warrant these actions and then address the path ahead for monetary policy. To begin with employment, in the last few years of the historically long expansion that ended with the arrival of the pandemic, we saw the remarkable benefits of an extended period of strong labor market conditions. We seek to foster another long expansion in order to realize those benefits again. The labor market has substantial momentum. Employment growth powered through the difficult Omicron wave, adding 1.75 million jobs over the past three months. The unemployment rate has fallen to 3.8 percent, near historical lows, and has reached this level much faster than anticipated by most forecasters (figure 1). While disparities in employment remain, job growth has been widespread across racial, ethnic, and demographic groups. By many measures, the labor market is extremely tight, significantly tighter than the very strong job market just before the pandemic. There are far more job openings going unfilled today than before the pandemic, despite today's unemployment rate being higher. Indeed, there are a record 1.7 posted job openings for each person who is looking for work. Record numbers of people are quitting jobs each month, typically to take another job with higher pay. And nominal wages are rising at the fastest pace in decades, with the gains strongest for those at the lower end of the wage distribution and among production and nonsupervisory workers (figure 2). It is worth considering why the labor market is so tight, given that the unemployment rate is actually higher than it was before the pandemic. One explanation is that the natural rate of unemployment may be temporarily elevated, so wage pressure is greater for any given level of unemployment. The sheer volume of hiring may have taxed the capacity of the market to bring workers and jobs together. The Delta and Omicron variants complicated hiring, and the strong financial position of households may have allowed some to be more selective in their job search. Over time, we might expect these factors to fade, reducing pressure in the job market. A second source of labor market tightness is that the labor force participation rate dropped sharply in the pandemic and has only partly recovered. As a result, the labor force remains below its pre-pandemic trend (figure 3). Total demand for labor, measured by total employment plus posted job openings, has substantially recovered and far exceeds the size of the workforce. About half of the shortfall in labor force participation is attributable to retirements during the pandemic. History suggests that most of those retirees are unlikely to reenter the workforce. But some nonparticipation is due to factors that may fade with time, such as caregiving needs and fear of contracting COVID-19. With prime-aged participation still well below its pre-pandemic level, there is room for further progress. A more complete rebound is, however, likely to take some time. Increases in labor force participation often substantially lag declines in unemployment. Overall, the labor market is strong but showing a clear imbalance of supply and demand. Our monetary policy tools cannot help with labor supply in the near term, but in a long expansion, the factors holding back supply will likely ease. In the meantime, we aim to use our tools to moderate demand growth, thereby facilitating continued, sustainable increases in employment and wages. Turning to price stability, the inflation outlook had deteriorated significantly this year even before Russia's invasion of Ukraine. The rise in inflation has been much greater and more persistent than forecasters generally expected. For example, at the time of our June 2021 meeting, every Federal Open Market Committee (FOMC) participant and all but one of 35 submissions in the Survey of Professional Forecasters predicted that 2021 inflation would be below 4 percent. Inflation came in at 5.5 percent. For a time, moderate inflation forecasts looked plausible--the one-month headline and core inflation rates declined steadily from April through September. But inflation moved up sharply in the fall, and, just since our December meeting, the median FOMC projection for year-end 2022 jumped from 2.6 percent to 4.3 percent. Why have forecasts been so far off? In my view, an important part of the explanation is that forecasters widely underestimated the severity and persistence of supply-side frictions, which, when combined with strong demand, especially for durable goods, produced surprisingly high inflation. The pandemic and the associated shutdown and reopening of the economy caused a serious upheaval in many parts of the economy, snarling supply chains, constraining labor supply, and creating a major boom in demand for goods and a bust in services demand. The combination of the surge in goods demand with supply chain bottlenecks led to sharply rising goods prices (figure 4). The most notable example here is motor vehicles. Prices soared across the vehicles sector as booming demand was met by a sharp decline in global production during the summer of 2021, owing to shortages of computer chips. Production remains below pre-pandemic levels, and an expected sharp decline in prices has been repeatedly postponed. Many forecasters, including FOMC participants, had been expecting inflation to cool in the second half of last year, as the economy started going back to normal after vaccines became widely available. Expectations were that the supply-side damage would begin to heal. Schools would reopen--freeing parents to return to work--and labor supply would begin bouncing back, kinks in supply chains would begin resolving, and consumption would start rotating back to services, all of which could reduce price pressures. While schools are open, none of the other expectations has been fully met. Part of the reason may be that, contrary to expectations, COVID has not gone away with the arrival of vaccines. In fact, we are now headed once again into more COVID-related supply disruptions from China. It continues to seem likely that hoped-for supply-side healing will come over time as the world ultimately settles into some new normal, but the timing and scope of that relief are highly uncertain. In the meantime, as we set policy, we will be looking to actual progress on these issues and not assuming significant near- term supply-side relief. As the magnitude and persistence of the increase in inflation became increasingly clear over the second half of last year, and as the job market recovery accelerated beyond expectations, the FOMC pivoted to progressively less accommodative monetary policy. In June, the median FOMC participant projected that the federal funds rate would remain at its effective lower bound through the end of 2022, and as the news came in, the projected policy paths shifted higher (figure 5). The median projection that accompanied last week's 25 basis point rate increase shows the federal funds rate at 1.9 percent by the end of this year and rising above its estimated longer-run normal value in 2023. The latest FOMC statement also indicates that the Committee expects to begin reducing the size of our balance sheet at a coming meeting. I believe that these policy actions and those to come will help bring inflation down near 2 percent over the next 3 years. As always, our policy projections are not a Committee decision or fixed plan. Instead, they are a summary of what the FOMC participants see as the most likely case going forward. The events of the past four weeks remind us that, in tumultuous times, what seems like the most likely scenario may change quite quickly: Each Summary of Economic Projections reflects a point in time and can become outdated quickly at times like these, when events are developing rapidly. Thus, my main message today is that, as the outlook evolves, we will adjust policy as needed in order to ensure a return to price stability with a strong job market. Let me now turn to three questions about the likely evolution of policy. How will fallout from the invasion of Ukraine affect the economy and monetary Russia's invasion of Ukraine may have significant effects on the world economy and the U.S. economy. The magnitude and persistence of these effects remain highly uncertain and depend on events yet to come. Russia is one of the world's largest producers of commodities, and Ukraine is a key producer of several commodities as well, including wheat and neon, which is used in the production of computer chips. There is no recent experience with significant market disruption across such a broad range of commodities. In addition to the direct effects from higher global oil and commodity prices, the invasion and related events are likely to restrain economic activity abroad and further disrupt supply chains, which would create spillovers to the U.S. economy. We might look to the historical experience with oil price shocks in the 1970s-- not a happy story. Fortunately, the United States is now much better situated to weather oil price shocks. We are now the world's largest producer of oil, and our economy is significantly less oil intensive than in the 1970s. Today a rise in oil prices has mixed effects on the economy, lowering real household incomes and thus demand, but raising investment in drilling over time and benefiting oil-producing areas more generally. On net, oil shocks tend to weigh on output in the U.S. economy, but by far less than in the Second, how likely is it that monetary policy can lower inflation without causing a Our goal is to restore price stability while fostering another long expansion and sustaining a strong labor market. In the FOMC participant projections I just described, the economy achieves a soft landing, with inflation coming down and unemployment holding steady. Growth slows as the very fast growth from the early stages of reopening fades, the effects of fiscal support wane, and monetary policy accommodation is removed. Some have argued that history stacks the odds against achieving a soft landing, and point to the 1994 episode as the only successful soft landing in the postwar period. I believe that the historical record provides some grounds for optimism: Soft, or at least soft-ish, landings have been relatively common in U.S. monetary history. In three episodes--in 1965, 1984, and 1994--the Fed raised the federal funds rate significantly in response to perceived overheating without precipitating a recession (figure 6). In other cases, recessions chronologically followed the conclusion of a tightening cycle, but the recessions were not apparently due to excessive tightening of monetary policy. For example, the tightening from 2015 to 2019 was followed by the pandemic-induced recession. I hasten to add that no one expects that bringing about a soft landing will be straightforward in the current context--very little is straightforward in the current context. And monetary policy is often said to be a blunt instrument, not capable of surgical precision. My colleagues and I will do our very best to succeed in this challenging task. It is worth noting that today the economy is very strong and is well positioned to handle tighter monetary policy. Finally, what will it take to restore price stability? The ultimate responsibility for price stability rests with the Federal Reserve. Price stability is essential if we are going to have another sustained period of strong labor market conditions. I believe that the policy approach that I have laid out is well suited to achieving this outcome. We will take the necessary steps to ensure a return to price stability. In particular, if we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so. And if we determine that we need to tighten beyond common measures of neutral and into a more restrictive stance, we will do that as well. Our monetary policy framework, as embodied in our Statement on Longer-Run Goals and Monetary Policy Strategy, emphasizes that having longer-term inflation expectations anchored at our longer-run objective of 2 percent helps us achieve both our dual-mandate objectives. While we cannot measure longer-term expectations directly, we monitor a variety of survey- and market-based indicators. In the recent period, short- term inflation expectations have, of course, risen with inflation, but longer-run expectations remain well anchored in their historical ranges (figure 7). The added near-term upward pressure from the invasion of Ukraine on inflation from energy, food, and other commodities comes at a time of already too high inflation. In normal times, when employment and inflation are close to our objectives, monetary policy would look through a brief burst of inflation associated with commodity price shocks. However, the risk is rising that an extended period of high inflation could push longer-term expectations uncomfortably higher, which underscores the need for the Committee to move expeditiously as I have described. The past two years have been extraordinarily challenging for many Americans. Two years ago, more than 20 million people were losing their jobs, millions were falling ill, and lives were being disrupted. We have made enormous strides since then. Today, as I have discussed, the labor market is very strong. But, to end where I began, inflation is much too high. We have the necessary tools, and we will use them to restore price stability. job openings."

r220324a_FOMC

united states

The Red Hot Housing Market: the Role of Policy and Implications for Housing Affordability

waller

For release on delivery Remarks by at a conference sponsored by Thank you, Debra, and thank you to the Alrov Institute and the Rutgers Center for Real Estate for the invitation to be part of this conference. Today, I would like to talk to you primarily about developments in the residential real estate market since the start of pandemic and then look ahead at the outlook for housing. I will consider how rental and home prices have increased and how monetary and fiscal policy have affected these prices. trends pretty closely because they have a bearing on our pursuit of maximum employment and price stability. Real estate makes a sizable contribution to gross domestic product, from both housing investment and consumption spending on housing services, which is what renters and homeowners pay for the shelter and amenities provided by housing. Real estate also matters for inflation. Housing services represent about 15 percent of the Personal Consumption Expenditure price index, and it represents an even larger share of another well-known inflation yardstick, the Consumer Price Index. Real estate is also a large and broadly held asset class, so it is important for the Federal Reserve's mission of promoting financial stability. So, my colleagues and I on the Board of Governors and the FOMC share your interest in what is happening and will happen in real estate markets. As we all know, a singular feature of the U.S. expansion since the COVID-19 recession has been the red-hot housing market. Trust me, I know it is red hot because I am trying to buy a house here in Washington and the market is crazy. Both house prices and rents are up significantly across the nation, while vacancy rates for rented and owner- occupied homes are down. Let's start with rents, because rents give us the most direct information on how affordable housing services are. Early in the pandemic, rent growth slowed as demand dropped to live in dense areas where rental housing tends to be concentrated while some people, especially young adults, moved in with family and friends. However, more recently rents have accelerated sharply. On net, rents have risen 6.5 percent since That is not out of line with the pace of rent increases seen in the CPI over the previous five years. But there is good reason to think this number doesn't fully reflect the extent to which rents have grown. CPI measures rents that people are currently paying, under leases that can be slow to reflect market conditions. Meanwhile, measures of market rent have increased a lot more than 6.5 percent over the last two years. For example, CoreLogic's single family rent index rose 12 percent over the 12 months through December, and RealPage's measure of asking rent for units in multifamily buildings rose 15 percent over the 12 months through February. Based on various measures of asking rents, some recent research suggests that the rate of rent inflation in the CPI will double in 2022. If so, rent as a component of inflation will accelerate, which has implications for monetary policy. Rent is a significant share of monthly expenses for many households, but lower income households spend a larger fraction of their budget on housing, so rising rents hit these households harder. In 2019, those in the lowest quintile of household income dedicated 41 percent of their spending to housing, while those in the top quintile spent only 28 percent. One piece of better news for low-income renters is that rent increases have not been larger in the neighborhoods where they tend to live. Specifically, data from RealPage suggest that asking rents rose 16 percent in both low- and moderate- income neighborhoods from January 2020 to February 2022, the same as in higher income neighborhoods. That's the story on rents. What about the affordability of purchasing a home? House prices are up a cumulative 35 percent since the beginning of the pandemic, according to the Zillow Home Value Index. That rate of increase is much faster than the previous five years and even faster than during the housing boom of the mid-2000s. Looking over the past two years, one would think the large increase in home prices would have made it more difficult for renters to become first-time buyers. Surprisingly, we have not seen evidence of that yet. The fraction of renters aged 20 to 45 who transitioned into home ownership last year was the highest since the Great Recession. It could be that time spent at home during the pandemic made renters more interested in owning a home, or that people are getting help from family or friends with down payments, or that some people are choosing to buy smaller homes than they would have a few years ago when prices were lower. Whatever the causes, the increase in first time buyers is clear. Home buying during the pandemic has been strong among minority families as well. In 2020, 7.3 percent of home purchase loans for owner-occupied properties were taken out by Black families, the highest level since 2007 and well above the low of 4.8 percent in 2013. Still, the gap in homeownership rates between minority and white families remains very wide. Moreover, according to Census Bureau data, homeownership rates for Black and Hispanic families appear to have edged down during 2021. These trends may reflect that the negative economic effects of the pandemic were felt disproportionately by minority households. Indeed, research shows that minority homeowners were much more likely to miss mortgage payments and enter mortgage forbearance than white homeowners. While federal and private sector forbearance programs helped many households keep their homes, families experiencing more permanent or severe income losses may have had to sell their homes and exit homeownership. Now, a household's ability to afford the purchase of a home is also a function of borrowing costs. Monetary policy actions have had a noticeable effect on mortgage rates. The Fed's primary tool, the target range for the federal funds rate, was reduced to the effective lower bound in March 2020. And, it was expected that the policy rate would remain low until the economy weathered the severe COVID-19 shock. This setting and forward guidance on the target range put downward pressure on both shorter and longer- term interest rates, including mortgage rates. The Fed also purchased Treasury securities and agency mortgage-backed securities (MBS) to help foster smooth market functioning and support accommodative financial conditions. Research shows that the marginal effect of the agency MBS purchases in response to the COVID shock lowered mortgage rates about 40 basis points. On net, rates for 30-year mortgages fell about 1 percentage point from January 2020 to January 2021, which helped dampen the costs of rising house prices over that period. Through most of 2021 30-year mortgage rates held pretty steady around 3 percent or less before beginning to rise at the end of the year. Today, 30-year mortgage rates are well above 4 percent and are now somewhat higher than they were when the pandemic began. This increase can be partly attributed to Fed communications and actions. Specifically, communications at the end of 2021 indicated that, with substantial recovery of the economy and elevated inflation, monetary policy accommodation would begin to unwind. First, we acted by reducing and then stopping our asset purchases. Second, earlier this month, we raised the target range for the federal funds rate above the effective lower bound and signaled that more policy tightening is likely appropriate in coming months. As a result of these communications, mortgage rates began to increase in late 2021. So, while lower rates may have made home purchases a bit more affordable early in the pandemic, the more recent rebound in mortgage rates and the continued rise in prices have made home purchases less affordable for many people. In a nutshell, housing costs--measured either by rents or by the average monthly payment by homeowners--have increased substantially during the pandemic. Economics tells us that some combination of growing demand and limits on housing supply has driven this change. Let me talk about each of these in turn. Demand for housing space has been especially strong during the pandemic. Lockdowns as well as remote work and school may have spurred people to seek homes with more space, leading to an increase in demand for larger and otherwise better homes. In fact, the average size of new single-family homes increased in 2021, reversing a downward trend from 2015 through 2020. Retail sales at building supply stores surged during the pandemic, as homeowners added space or made other improvements that could increase the quality of their homes. In January, this spending was 42 percent higher than the average for 2019, and even after adjustment for the sharp increase in the price of building materials, it was still up 19 percent. One indication of people trading up for housing is evident by comparing Zillow's Home Value Indexes by housing type. The index for single-family homes has increased more than that for condominiums since January 2020. In addition, purchases of second homes have increased. Second homes averaged about 3 1/2 percent of home purchase loan originations from 2014 to 2019 but about 5 percent of originations in 2021. The 2021 share was in line with the peak seen during the last housing boom. Meanwhile, changes in household formation may have been contributing to increases in housing demand over the past year or so. While many households increased in size during the early months of the pandemic, as young people returned to their parents' homes, this change appears to have largely reversed by the end of 2021. The fraction of adults aged 18 to 30 who are the heads of their own households is now back near its 2017-2019 average. The surge in the number of households has pushed down housing vacancy rates from already-low levels. Rental and homeowner vacancy rates fell considerably during the pandemic, reaching lows in the fourth quarter of last year that haven't been seen since the 1980s. The pandemic-related changes in demand for housing, rented and owned, coincided with a longer-run increase in demand to live in certain parts of the country. For the past several decades, demand for living in cities with high-paying jobs and many urban amenities has surged, pushing up housing costs in these areas. Among metro areas in the top quartile of local housing demand, population increased 80 percent, and single- family home prices rose more than 110 percent from 1990 to 2019 after adjusting for inflation. For the nation as a whole, population only increased 32 percent and house prices rose 59 percent. While this trend towards urban living supported commercial real estate demand and prices for years, post pandemic, more people are working at home and there has been a corresponding decline in demand for office space, particularly in downtown areas. Office entry card swipes are down 50 percent from pre-pandemic levels in large cities, and office vacancy rates are up nationwide, from 12 percent in 2019 to 16 percent in the fourth quarter of 2021. The increases have been larger in urban areas, and particularly in the downtown areas of big coastal cities. We'll need to see if people continue working from home. While low COVID case rates may induce some workers to return to the office, some may only return part-time, while others may not return at all, as many organizations have made adjustments to function effectively with remote workers. That's the demand side. The supply side has been pushing in the same direction--towards tighter housing markets and more expensive shelter. U.S. housing supply has probably been more constrained lately than at any time since the end of World War II. One estimate is that the current growth in the supply of new housing units is about 100,000 less per year that would be needed to support trend increases in demand from household formation and replacement of depreciating units. Supply adjusts to changes in the economy more slowly than demand because of the time it takes to plan and build. With workers at home and supply bottlenecks, there were pandemic-related drops in the production and importation of many construction materials. These supply shortages contributed to skyrocketing input prices. In January 2022, lumber prices included in the Producer Price Index were 92 percent higher than the 2019 average. Even with increased materials costs, suppliers have been unable to keep up with demand. The volume of lumber now being sold is more than 150 percent higher than last August and is similarly larger than the average volume over the previous ten years. Labor is also a key input in home construction. The supply of construction labor, like other sectors, has been held down by pandemic-specific issues like early retirement. One measure of labor market tightness for the construction industry increased steadily from 2010 to 2019 and then in 2021 was more than double the level recorded during the construction boom of the mid-2000s. Local land use regulations have also played a role in constraining housing supply over the past several decades. Probably not by accident, these regulations have tended to be more restrictive in areas with high housing demand. There has been a growing public debate about these restrictions on local home building, not just at the local level, but among governors and state legislatures. While some local regulations have been changed to allow more housing construction in high demand areas, the effects will take time, and it remains to be seen whether the increases in supply created by these regulatory changes will be enough to satisfy local demand. I've mentioned the impact of monetary policy on housing markets, now let me touch on the role of fiscal policy. The rescue plan passed by the Congress in 2020, consisting of stimulus payments, grants to small businesses to maintain their payrolls, and supplemental unemployment benefits, surely helped many people who lost income during the pandemic continue to pay their rent and mortgages. Rental delinquency only increased a bit during the first year of the pandemic, and although mortgage non-payment increased by a larger amount, it remained well below the level experienced in the Great Recession. Another policy tool that was used quite effectively in the earlier stages of the pandemic was mortgage forbearance. Borrowers with government-backed and federally- insured mortgages were given up to 18 months of forbearance, and many private lenders also offered forbearance. Indications are that the extra time this bought for borrowers really helped. Many borrowers who exited forbearance in 2021 were able to resume making payments, or, in the hot housing market, were able to sell their homes and walk away with equity. For other borrowers, simple mortgage modification plans have helped mortgage servicers to quickly and easily modify mortgages to help people stay in their homes at a lower monthly payment. That said, we must remember that there are institutions on the other side of the mortgage forbearance process. Servicers of mortgages in MBS pools are required to continue to make payments to the investors who hold these securities, even when they are not receiving payments from the borrower. Banks were well-prepared to extend forbearance because of their access to an array of liquidity sources such as deposits, the Federal Home Loan Bank system, and the Fed's discount window. Moreover, many banks entered the pandemic with a strong capital position and improved risk management practices as a result of changes after the Global Financial Crisis. However, more than half of mortgages are serviced by nonbanks, which do not have access to the same liquidity sources as banks. So, the announcement of forbearance in 2020 caused an acute concern about liquidity for nonbanks. Thankfully, a large wave of mortgage refinancing helped to provide nonbank servicers the needed liquidity. In addition, a facility created by Ginnie Mae to lend to nonbank servicers, as well as limits on the number of payment advances required for loans by government sponsored enterprises, helped to further mitigate the liquidity concerns. In the end, forbearance never reached the high level that many analysts expected. But, looking ahead, this experience points to the importance of building resilience among non-banks engaged in mortgage lending and servicing. An important question I will keep my eye on is whether the sharp and ongoing increase in home prices poses risks to financial stability. My short answer is that unlike the housing bubble and crash of mid 2000s, the recent increase seems to be sustained by the substantive supply and demand issues I have detailed--not by excessive leverage, looser underwriting standards, or financial speculation. In fact, mortgage borrowers entered the pandemic with stronger balance sheets than in the mid 2000s and are therefore better prepared to handle a drop in home prices than they were in the last housing downturn. As for banks, as I just said, large banks are substantially more resilient today than two decades ago. In last year's stress test, which featured a severe global recession that included a decline in home prices of over 20 percent, we projected the largest banks could collectively maintain capital ratios at more than double their minimum requirements--even after withstanding more than $470 billion in losses. I am hopeful that at least some of the pandemic-specific factors pushing up home prices and rents could begin to ease in the next year or so. The level of new housing units completed in 2021 was higher than at any point since 2007. The demand for extra space at home might level off, or even reverse if people start to spend more time away from home again as the pandemic eases. That said, input prices continue to rise, with lumber prices increasing past their eye-popping 2020 peak, even with much more supply. Longer term, many issues will continue to put upward pressure on home prices and rents. The strong demand to live in cities with tight housing supply is likely to continue. Regulatory supply constraints may be starting to ease in some places, but they will persist and continue to limit home building in many high demand areas. And while prices for lumber and other materials may come down, with the economy already at maximum employment and experiencing a shortage of skilled workers, labor supply will likely continue to hold back the pace of new construction. As housing costs continue to increase, housing will likely become an ever-larger share of household budgets. This is not a recent development. In 1972-1973, the average household spent 24 percent of expenditures on rent or imputed rent. This share rose to 27 percent in the late 1980s, and in 2019 that was up to 35 percent. No doubt the share in 2022 will be larger still. With housing costs gaining an ever-larger weight in the inflation Americans experience, I will be looking even more closely at real estate to judge the appropriate stance of monetary policy.

r220405a_FOMC

united states

Variation in the Inflation Experiences of Households

brainard

It is a pleasure to join you to discuss differences in how households at different income levels experience inflation. I look forward to hearing from the panelists, who are doing important and interesting research on this topic. By law, the Federal Reserve is assigned the responsibility to pursue price stability long recognized the connection between stable, low inflation and maximum employment. Forty years ago, Paul Volcker noted that the dual mandate isn't an either-or proposition and that runaway inflation "would be the greatest threat to the continuing growth of the economy... and ultimately, to employment." Maximum employment and stable, low inflation benefit all Americans, but are particularly important for low- and moderate-income families. The combination of good job opportunities and stable, low inflation provides purchasing power to fill up gas tanks and grocery carts and pay housing and medical costs, leaving room to build emergency cushions and invest in education; retirement; and, for some, small businesses. Indeed, the Employment Act of 1946 called on the federal government to promote "maximum employment, production, and purchasing power." While national data do not directly disaggregate the differential effects of inflation by household income groups, a variety of evidence suggests that lower-income households disproportionately feel the burden of high inflation. Lower-income families expend a greater share of their income on necessities; have smaller financial cushions; and may have less ability to switch to lower-priced alternatives. Arthur Burns noted in the late 1960s that "there can be little doubt that poor people...are the chief sufferers of Today, inflation is very high, particularly for food and gasoline. All Americans are confronting higher prices, but the burden is particularly great for households with more limited resources. That is why getting inflation down is our most important task, while sustaining a recovery that includes everyone. This is vital to sustaining the purchasing power of American families. In assessing inflation faced by American consumers, economists and policymakers generally rely on the change in the consumer price index (CPI) or the change in the price index for personal consumption expenditures (PCE). 2012, the Committee's price-stability goal has been specified as a longer-run goal of 2 percent in terms of annual PCE inflation. Both CPI and PCE inflation metrics are assembled from a collection of underlying elementary price indexes for narrow subsets of goods and services. The price changes each month for the goods and services in these subsets are combined into measures of overall inflation by calculating a weighted average of all these subindexes, where the weights are based on average aggregate consumer expenditures in each category. Using a national average of consumer expenditures to weight the categories has intuitive appeal. This measure is particularly useful, for example, in adjusting measures of overall expenditure for changes in prices to determine how much real growth has occurred between two periods. However, using a national average of expenditures to weight the categories has limitations when it comes to representing the true cost of living experienced by different types of households. Each household in the United States has a particular consumption bundle whose prices and quantities combine to make up that household's cost of living. If we could start with each individual household's cost of living and aggregate across households by giving equal weight to each household, it would create an economy-wide cost-of-living index. The change in such a cost-of-living index would represent the average inflation experienced by U.S. households. Instead, because the CPI and PCE indexes weight every dollar of expenditure equally, these indexes implicitly weight each household's cost of living proportionally to their total expenditure. Since lower-income households represent a relatively smaller share of overall expenditure, the inflation associated with their consumption baskets is underrepresented in the official consumer price indexes. It would be useful to have data about consumer inflation broken out by demographic groups, similar to labor market and personal-income data, in order to assess the differential effect of inflation across different groups of households. agencies do not collect the information needed to accurately assess inflation at a household level, and it would require a large change in the way these agencies go about their work to do so. Nonetheless, recent research has begun to assess variation in the ways different households experience inflation. Households at different income levels could experience differential inflation effects for several reasons: Consumption shares could differ systematically for low- and high-income households; the goods and services within each consumption category could differ; the ability to substitute for lower-priced alternatives of the same item could differ; and prices paid for the same good could differ systematically due to differences in access. I will briefly touch on these four reasons. First, low- and moderate-income households could experience inflation that diverges from the average because their consumption baskets differ systematically from the average. Lower-income households spend 77 percent of their income on necessities--more than double the 31 percent of income spent by higher-income households on these categories. Several studies have found that the consumption baskets of lower-income households have experienced higher-than-average inflation rates over time. Research from the Bureau of Labor Statistics (BLS) has examined the effect of different consumption baskets by using the same elementary price indexes as used in the official CPI but assigning the weights of these components to reflect the consumption bundles of different types of households. A 2021 working paper by BLS staff based on data from 2003 to 2018 found that a price index reflecting the consumption basket for households in the lowest-income quartile grew faster than the overall CPI, while a price index reflecting the consumption basket for households in the highest-income quartile grew more slowly than the overall CPI. A 2015 BLS study found a similar result using data from 1982 to Of course, the recent sharp increases in inflation may have affected the consumption bundles of lower-income households relative to the average differently than in previous cycles. While these studies allow for differences in the weighting of price indexes across different income groups, they rely on the same elementary price indexes for subcategories of goods and services. As a result, they may miss additional sources of variation in the inflation rates experienced by households at different income levels. This consideration brings us to the second point: Households with different levels of income may purchase significantly different items even within the same elementary index categories for goods and services. To take an extreme example, caviar and canned tuna are both in the same elementary index. The demand and supply dynamics for those products are likely quite different, meaning that their relative price dynamics are poorly described by a single index. Third, households at different income levels may have differing abilities to substitute for lower-priced alternatives within an elementary category. Consider a price increase for a breakfast cereal that increases the prices of both the brand-name cereal and the corresponding lower-priced store-brand cereal but maintains a differential between them. A household that had been purchasing brand-name cereal could save money by purchasing store-brand cereal instead, perhaps even eliminating any effect of the price increase on their actual spending while purchasing the same quantity of cereal in that narrow category. However, a household that was already purchasing the store brand would have to either absorb the increase in cost or consume less within that category. Finally, beyond the variation in inflation that comes from households buying different goods, research also shows that differences in inflation can result from households paying different prices for identical goods. Using transaction-level data, researchers found that almost two-thirds of the variation in inflation across households comes from differences in prices paid for identical goods, with only about one-third coming from differences in the mix of goods within broad categories. As a result of these differences, households with lower incomes, more household members, or older household heads experienced higher inflation on average. Variations in the prices paid for identical goods could reflect differences in the ability of some households to stock up when prices are discounted or to buy in bulk and save--options only available to households with the means to buy in larger quantities, adequate capacity to store larger quantities, or the flexibility to delay purchases if there is an opportunity to save in the future. In addition, evidence suggests that inflation could be lower for items purchased online rather than from brick-and-mortar stores, suggesting that households who do not have full access to online shopping options could face a higher cost of living. One study of online transactions made between 2014 and 2017 found that online inflation averaged more than 1 percentage point per year lower than the equivalent CPI measure of the relevant product categories. We are only beginning to understand the ways in which inflation experiences vary from household to household, how this variation correlates with income and demographic information, and how these divergent inflation experiences change over time. developing area of research will benefit from conferences like this one that help expand the frontier of our knowledge about the heterogeneity of experienced inflation. Implications for the Outlook and Policy High inflation places a burden on working families who are concerned about how far their paychecks will stretch as well as seniors living on fixed incomes. So now let me turn briefly to what we are seeing on inflation and the outlook for jobs and growth. Headline PCE inflation for February came in at 6.4 percent on a 12-month basis. Food and energy account for an outsized one-fourth share of this high level of inflation and also constitute an outsized share of expenditure for lower-income Americans, who spend 26 percent of their income on food at home and transportation, compared with 9 percent for high-income Americans. Core inflation is also elevated, and inflationary pressures have been broadening out. Housing contributed about one-tenth of total PCE inflation in February and is the single greatest category of expenditures by far for lower-income Americans, who spend 45 percent of their income on housing, compared to 18 percent for high-income Durable goods inflation, particularly in autos, accounted for slightly more than one-fifth of total PCE inflation in February, representing a much greater contribution to inflation than was the case pre-pandemic. High durable goods inflation reflects pandemic-related supply constraints as well as persistently elevated demand associated with the pandemic. I will be carefully monitoring the extent to which demand rotates back to services and away from durable goods, where it has remained consistently above pre-pandemic levels, and the extent to which the services sector is able to absorb higher demand without generating undue inflationary pressure. Russia's invasion of Ukraine is a human tragedy and a seismic geopolitical event. The global commodity supply shock associated with Russia's actions skews inflation risks to the upside and is expected to exacerbate high prices for gasoline and food as well as supply chain bottlenecks in goods sectors. The recent COVID lockdowns in China are also likely to extend bottlenecks. These geopolitical events also pose downside risks to growth. That said, the U.S. economy entered this period of uncertainty with considerable momentum in demand and a strong labor market. As of the March labor report, payroll employment has increased at a pace of 600,000 jobs per month over the past six months, and the unemployment rate has fallen by a percentage point over that period and is now close to its pre-pandemic level. In contrast, until recently, the recovery in labor force participation was lagging far behind. So it is particularly noteworthy to see that the pandemic constraints on labor supply are diminishing for the prime-age workforce: The prime-age participation rate jumped 0.7 percentage points for women in March, following a similar-sized jump for men in February. An increase in labor supply associated with diminishing pandemic constraints combined with a moderation in demand associated with tightening financial conditions, slowing foreign growth, and a large decrease in fiscal support could be expected to reduce imbalances later in the year. Against that backdrop, I will turn to policy. It is of paramount importance to get inflation down. Accordingly, the Committee will continue tightening monetary policy methodically through a series of interest rate increases and by starting to reduce the balance sheet at a rapid pace as soon as our May meeting. Given that the recovery has been considerably stronger and faster than in the previous cycle, I expect the balance sheet to shrink considerably more rapidly than in the previous recovery, with significantly larger caps and a much shorter period to phase in the maximum caps compared with 2017-19. The reduction in the balance sheet will contribute to monetary policy tightening over and above the expected increases in the policy rate reflected in market pricing and the Committee's Summary of Economic Projections. I expect the combined effect of rate increases and balance sheet reduction to bring the stance of policy to a more neutral position later this year, with the full extent of additional tightening over time dependent on how the outlook for inflation and employment evolves. Our communications have resulted in broad market expectations for an expeditious increase in the policy rate toward a neutral level and a more rapid reduction in the balance sheet compared with 2017-19. Consistent with these expectations, we have already seen significant tightening in market financing conditions at longer maturities, which tend to be most relevant for household and business decisionmaking. For instance, 30-year mortgage rates have increased more than 100 basis points in just a few months and are now at levels last seen in late 2018. Looking forward, at every meeting, we will have the opportunity to calibrate the appropriate pace of firming through the policy rate to reflect what the incoming data tell us about the outlook and the balance of risks. For today, every indicator of longer-term inflation expectations lies within the range of historical values consistent with our 2 percent target. On the other side, I am attentive to signals from the yield curve at different horizons and from other data that might suggest increased downside risks to activity. Currently, inflation is much too high and is subject to upside risks. The Committee is prepared to take stronger action if indicators of inflation and inflation expectations indicate that such action is warranted. We are committed to bringing inflation back down to its 2 percent target, recognizing that stable low inflation is vital to maintaining a strong economy and a labor market that works for everyone.

r220506a_FOMC

united states

Reflections on Monetary Policy in 2021

waller

I want to thank the organizers for inviting me to speak here today. The discussion has focused on the following question: "How did the Fed get so far behind the curve?" My response is to relate how my view of the economy changed over the course of 2021 and how that evolving view shaped my policy position. When thinking about this question, there are three points that need to be considered. First, the Fed was not alone in underestimating the strength of inflation that revealed itself in late 2021. Second, to determine whether the Fed was behind the curve, one must take a position on the evolving health of the labor market during 2021. Finally, setting policy in real time can create what appear to be policy errors after the fact due to data revisions. Let me start by reminding everyone of two immutable facts about setting monetary policy in the United States. First, we have a dual mandate from the Congress: maximum employment and price stability. Whether you believe this is the appropriate mandate or not, it is the law of the land, and it is our job to pursue both objectives. Second, policy is set by a large committee of up to 12 voting members and a total of 19 participants in our discussions. This structure brings a wide range of views to the table and a diverse set of opinions on how to interpret incoming economic data and how best to respond. We need to reconcile those views and reach a consensus that we believe will move the economy toward our mandate. This process may lead to more gradual changes in policy as members have to compromise in order to reach a consensus. Committee (FOMC) laid out guidance for raising the federal funds rate off the zero lower bound and for tapering asset purchases. We said that we would "aim to achieve inflation moderately above 2 percent for some time" to ensure that it averages 2 percent over time and that inflation expectations stay anchored. We also said that the Fed would keep buying $120 billion per month in securities until "substantial further progress" was made toward our dual-mandate objectives. It is important to stress that views varied among FOMC participants on what was "some time" and "substantial further progress." The metrics for achieving these outcomes also varied across participants. A few months later, in March 2021, I made my first submission for the Summary of Economic Projections as an FOMC member. My projection had inflation above 2 percent for 2021 and 2022, with unemployment close to my long-run estimate by the second half of 2022. Given this projection, which I believed was consistent with the guidance from December, I penciled in lifting off the zero lower bound in 2022, with the second half of the year in mind. To lift off from the ZLB in the second half of 2022, I believed tapering of asset purchases would have to start in the second half of 2021 and conclude by the third quarter of 2022. This projection was based on my judgment that the economy would heal much faster than many expected. This was not 2009, and expectations of a slow, grinding recovery were inaccurate, in my view. In April 2021, I said the economy was "ready to rip," and it did. I chose to look at the unemployment rate and job creation as the labor market indicators I would use to assess whether we had made "substantial further progress." My projection was also based on the belief that the jump in inflation that occurred in March 2021 would be more persistent than many expected. There was a range of views on the Committee. Eleven of my colleagues did not have a rate hike penciled in until after 2023. With regard to future inflation, 13 participants projected inflation in 2022 would be at or below our 2 percent target. In the March 2021 SEP, no Committee member expected inflation to be over 3 percent for 2021. As I argued in a speech last December, this view was consistent with private- sector economic forecasts. When inflation broke loose in March 2021, even though I had expected it to run above 2 percent in 2021 and 2022, I never thought it would reach the very high levels we have seen in recent months. Indeed, I expected it would eventually fade, due to the nature of these shocks. All the suspected drivers of this surge in inflation appeared to be temporary: the one-time stimulus from fiscal policy, supply chain shocks that previous experience indicated would ease soon, and a surge in demand for goods. In addition, we had very accommodative monetary policy that I believed would end in 2022. The issue in my mind was whether these factors would start fading away later in 2021 or in 2022. Over the summer of 2021, the labor market and other data related to economic activity came in as I expected, and so I argued publicly that we were rapidly approaching "substantial further progress" on the employment leg of our mandate. In the June Summary of Economic Projections, seven participants had liftoff in 2022 and only five participants projected liftoff after 2023. Also, unlike the March SEP, every Committee participant now expected inflation to be over 3 percent in 2021 and just five believed inflation would be at 2 percent or below in 2022. In addition, the vast majority of participants now saw risks associated with inflation weighted to the upside. The June 2021 minutes also describe the vigorous discussion about tapering asset purchases. Numerous participants said that new data indicated that tapering should begin sooner than anticipated. Thus, in June, after observing high inflation for only three months, the Committee was moving in a hawkish direction and was considering tapering sooner and pulling liftoff forward. At the July FOMC meeting, the minutes show that most participants believed that "substantial further progress" had been made on inflation but not employment. was not viewed as imminent by most participants. Again, individual participants had different metrics for evaluating the health of the labor market, and this approach influenced how each thought about policy. So, in my view, one cannot address the question of "how did the Fed get so far behind the curve?" without taking a stand on the health of the labor market as we moved through 2021. Based on the incoming data over the summer, my position was that we would soon achieve the substantial further progress needed to start tapering of asset purchases-- in particular, our purchases of agency mortgage-backed securities--and that we needed to "go early and go fast" on tapering our asset purchases to position ourselves for rate hikes in 2022 should we need to tighten policy. I also argued that, if the July and August job reports came in around the forecast values of 800,000 to 1 million job gains per month, we should commence tapering our asset purchases at the September 2021 FOMC meeting. The July report was indeed over 1 million new jobs, but then the August report shocked us by reporting only 235,000 new jobs when the consensus forecast was for 750,000. I considered this a punch in the gut and relevant to a decision on when to start tapering. Nevertheless, the September FOMC statement noted that the economy had made progress toward the Committee's goals and that, if progress continued, it would soon be time to taper. inflation was actually slowing. As shown in Figure 1, it went from 0.62 percent in April to 0.24 percent for the month of September. The September jobs report was another shock, with only 194,000 jobs created. So, up until the first week of October 2021, the story of high inflation being temporary was holding up, and the labor market improvements had slowed but were continuing. Based on the incoming data, the FOMC announced the start of tapering at its early November meeting. It was the October and November consumer price index (CPI) reports that showed that the deceleration of inflation from April to September was short lived and year-over- year inflation had topped 6 percent. It became clear that the high inflation realizations were not as temporary as originally thought. And the October jobs report showed a significant rebound with 531,000 jobs created and big upward revisions to the previous two months. It was at this point--with a clearer picture of inflation and revised labor market data in hand--that the FOMC pivoted. In its December meeting, the Committee accelerated tapering, and the SEP showed that each individual participant projected an earlier liftoff in 2022 with a median projection of three rate hikes in 2022. These forecasts and forward guidance had a significant effect on raising market interest rates, even though we did nothing with our primary policy tool, the federal funds rate, in December 2021. It is worth noting that markets had the same view of likely policy-- federal funds rate futures in November and December called for three hikes in 2022, indicating an economic outlook that was similar to the Committee's. Given this description of how policy evolved over 2021, did the Fed fall far behind the curve? First, I want to emphasize that forecasting is hard for everyone, especially in a pandemic. In terms of missing on inflation, policymakers' projections looked very much like most of the public's. For example, as shown in table 1, the median SEP forecast for is a compilation of private sector forecasts. In short, nearly everyone was behind the curve when it came to forecasting the magnitude and persistence of inflation. Second, as I mentioned, you cannot answer this question without taking a stand on the employment leg of our mandate. There was a clear difference in views on this and on what indicators should be looked at to determine whether we had met the 'substantial further progress" criteria we laid out in our December 2020 guidance. Some of us concluded the labor market was healing fast and we pushed for earlier and faster withdrawal of accommodation. For others, data suggested the labor market was not healing that fast and it was not optimal to withdraw policy accommodation soon. Many of our critics tend to focus only on the inflation aspect of our mandate and ignore the employment leg of our mandate. But we cannot. So, what may appear as a policy error to some was viewed as appropriate policy by others based on their views regarding the health of the labor market. Third, one must account for setting policy in real time. The Committee was getting mixed signals from the labor market data in August and September. Two consecutive weak job reports didn't square with a rapidly falling unemployment rate. Later that fall, and then with the Labor Department's 2021 revisions, we found that payrolls were quite steady over the course of the year. As shown in table 2, revisions to changes in payroll employment since late last summer have been quite substantial. From the original reports to the current estimate, the change in payroll employment has been revised up nearly 1.5 million. As the revisions came in, a consensus grew that the labor market was much stronger than we originally thought. If we knew then what we know now, I believe the Committee would have accelerated tapering and raised rates sooner. But no one knew, and that's the nature of making monetary policy in real time. Finally, if one believes we were behind the curve in 2021, how far behind were we? In a world of forward guidance, one simply cannot look at the policy rate to judge the stance of policy. Even though we did not actually move the policy rate in 2021, we used forward guidance to start raising market rates starting with the September 2021 statement, which indicated tapering was coming soon. The 2-year Treasury yield, which I view as a good market indicator of our policy stance, went from approximately 25 basis points in late September 2021 to 75 basis points by late December. That is the equivalent, in my mind, of two 25 basis point policy rate hikes for impacting the financial markets. When looked at this way, how far behind the curve could we have possibly been if, using forward guidance, one views rate hikes effectively beginning in September

r220524a_FOMC

united states

Welcoming Remarks

powell

Good morning, and welcome. It is a great pleasure to welcome all the attendees strong and consistent partner to the Federal Reserve, collaborating with us on small business COVID surveys, serving on the Leadership Council for the Minneapolis Fed's Center for Indian Country Development, and moderating our policy webinar series on tribal enterprise diversification, just to name a few. Trust is earned and developed through relationships. This is particularly important in Indian Country. The Federal Reserve has built an enduring and sturdy bond with the National Center, and we value that partnership. We are excited to be participating in this year's conference, learning alongside you. There is undoubtedly more research and engagement to be done on the specific and unique economic needs of tribal nations and Indigenous communities. RES 2022 is a great meeting ground for such collaboration. The best insight and analysis come from people who live and work in communities and have an inside view of the struggles and opportunities within. The Federal Reserve System has made a priority of engaging with leaders and stakeholders on opportunities most relevant to tribal economic prosperity. For example, input from tribal stakeholders has been invaluable to informing the important work of modernizing the Community Reinvestment Act, which was incorporated into the recently published proposal that we are looking forward to getting comments on. We also value the growing representation of tribal voices on our boards of directors and advisory councils at Reserve Banks, helping us to better understand economic conditions in Indian Country. our national institute dedicated to helping tribes reach their full economic potential. We are excited to be expanding its capacity to conduct economic research and data analysis to support the long-term economic prosperity of Indian Country, in partnership with Indian Country. We look forward to CICD's ongoing collaboration with tribal communities on research and data. Additionally, an initial St. Louis Fed partnership with the Osage Nation, to provide youth financial education, has led to partnerships with tribal governments across the country that provide personal finance education, often in their Native languages. Tribal leaders nationwide have also joined recent listening sessions to discuss the impacts of inflation. Similar sessions were held on our pandemic response facilities, which were adapted after hearing their input. Other Federal Reserve partnerships with Indian Country include initiatives on access to credit; Native community development financial institutions; financial education programs tailored to early childhood, secondary, and higher education; workforce development; housing; social services; and elder programs. And as part of our ongoing effort to deepen our understanding of tribal economies, last year, the Federal Reserve Board announced that we had joined the Zealand, the Bank of Canada, and the Reserve Bank of Australia. This is part of our commitment to learning best practices and expanding our international partnerships with central banks that are similarly invested in supporting Indigenous people and communities. The Federal Reserve works for all of us, and our research and analysis must reflect the specific needs and circumstances of all of our communities. I am grateful for and I want to thank you, as well as all our colleagues, advisors, and stakeholders who help us work toward a stable and inclusive economy for all. Thank you.

r220525a_FOMC

united states

Commencement Remarks

brainard

It is an honor to be here today. Thank you, Dean Steinberg, members of the faculty and staff, members of the Board, distinguished guests, parents, and family members. To the Class of 2022, congratulations. I am honored to be here with you to celebrate this day for which you have worked so hard and on which you go out to make your mark in the world, fortified with an incredible intellectual arsenal and lifelong friends from your time at the Johns Hopkins School for Advanced International Studies (SAIS). As a parent, I would like to extend a special welcome to the parents and families who have joined this celebration today. I'm sure many of you must be filled, like I am often, with awe and admiration for our amazing offspring and the good they will do in the world. To be honest, when Dean Steinberg invited me to speak, I was concerned that you might not be excited to hear from a central banker. Central bankers are dull by design. We use 17 words when 2 would suffice. We make a virtue of using language that is prosaic and concrete. Our pronouncements are carefully calibrated so they are understood exactly as intended, leaving nothing to the imagination. In short, we are the opposite of the poetry, drama, and inspiration that are the stuff of launching gifted graduates on their career quest. But a friend reminded me that if there's anywhere a central banker might be a good fit for graduation, it's SAIS. At SAIS, you are required to not only take, but pass monetary theory. No doubt your parents must be wondering--monetary theory? How is that going to help your career? Is it too late to become a doctor or a lawyer? But that is the point. You have chosen a different path. Two years ago, when a novel coronavirus struck, when fear and panic spread, you decided you wanted to learn more. When economies and markets struggled, you chose to focus on developing solutions. When travel and trade trickled to a stop, you made a commitment to a life in global affairs. You have endured lockdowns and Zoom lectures to get an education that will help you understand and address the complexities of our world. Your generation has had to show resilience and strength in the face of a once-in-a-hundred-year pandemic and prepare for a world where once-in-a-hundred-year events occur every couple of years. That strength and learning will serve you well as you embark on your life's work. As you do so, I hope some of you are considering a career in public service. Others, not so much. I get it. Public service is not glamorous. Still, I hope many of you will consider devoting a part of your life's work to a public mission and will do so with enthusiasm and urgency, because public service has a profound effect on the lives of people and communities across the country. And it can be motivating and satisfying in ways that are rare. So perhaps I could provide a glimpse of the hopes and dreams that animate my journey and guide my work, as a reminder that you can and must dream big and stay true to your chosen mission as you navigate your journey with as much passion as professionalism and as much integrity as intellect. So let me start by tracing back what I do today to what I cared about when I was a young American growing up in Europe. Ever since I was a little girl observing life in Poland under Soviet rule, I have been making mental checklists of the communities around me: gray apartment block with cratered walls and broken glass, dilapidated factory with an open furnace, long line at the bread shop. I noticed the contrast between the bright colors and bustle of the farmers selling produce from their own plots of land and the gray bleakness of communist factories and poorly stocked shelves. And the even greater contrast with West Germany at a time when it was fast integrating with its western neighbors: new cars, thriving small businesses, packed store shelves. What I observed around me as I came of age, I later understood, were features of the Cold War battle over the ideals of freedom and enterprise and the kind of political systems and institutions that could best uphold those ideals. In those early days it was hard to imagine the rise of Solidarity and the fall of the wall. Three decades later, it is inspiring to stand with a united and free Europe as it opposes Russia's war of aggression against Ukraine. Once I started working, I found myself compiling these checklists in Maggie Thatcher's industrial towns, in auto assembly plants in Detroit, in financial-crisis-stricken Mexico City, in agricultural towns in Senegal. Whether I am on vacation or a community visit, I read neighborhoods the way that some people survey land for planting or spreadsheets for weak links or legal briefs for inconsistencies: boarded up rowhouse, not a grocery store in sight, multilane highway splitting the old commercial district. As I have traveled around this country from Milwaukee to the Mississippi Delta, from Atlanta to Appalachia, from Detroit to the Colonias, and from Scranton to the Pine Ridge Reservation, in urban and rural areas alike, it is striking how much the opportunities and challenges facing families are shaped by the health of their communities and the broader economy. At the most foundational level, what animates my job at our nation's central bank is the opportunity to lift up the livelihoods and lives of working families in communities across America. As central bankers, we don't think of inflation or unemployment as blue or red. We focus on data and proven solutions, and our mission is to serve all Americans. We see time and time again that the families that have the smallest financial buffers and the communities with the least resilience suffer the most when turbulence strikes. The risk that turbulence will strike is always present, as I have learned from the many financial crises that have punctuated my own career. In the past decade alone, our communities have contended with the devastation of the Global Financial Crisis, the European Debt Crisis, the COVID-19 pandemic, and now the burden on stretched household budgets from Russia's war of aggression against Ukraine. The arc from the collapse of the Berlin Wall to the response to the COVID-19 pandemic is this: Ideas and actions can change the course of communities and countries. Let me share with you three examples of how individuals have come together to shape policy for the greater good. Ninety years ago, the first woman Cabinet Secretary, Frances Perkins, convinced a skeptical Franklin Roosevelt that unemployment insurance wasn't a handout but a smart investment. Not only would it be an effective self-financed approach to help families smooth through periods when work was hard to find through no fault of their own, but it also would support the health of the broader economy when demand weakened. So, two years ago, when a global pandemic struck, the application of Perkins's logic through an expanded set of programs and facilities sustained millions of families and saved countless small businesses. After returning from a meeting in Europe in late February 2020 when COVID was starting to spread globally, I had a startling realization that these are the moments we are here for, when communities around the country rely on us to act. With a shocking 20 million Americans laid off from their jobs in one short month, with U.S. stock market capitalization down by 12 percent in one day, with main street businesses shuttering and 94 percent of classes moving to distance learning, it was vital to respond with boldness and creativity as we committed to using all our tools to provide vital support for communities around the country. In contrast to the devastation wrought by the inaction in the lead-up to the Great Depression, the COVID response showed that swift, decisive action can stave off catastrophe. When there is the will to do so, with the support of Congress, we can and must use our tools to help protect families, businesses, and their communities from crisis and make the broader economy more resilient so it rebounds faster. The second example is of Augustus Hawkins, a Black Congressman who in the 1970s was a key architect of the statute enshrining the words "full employment" in the Federal Reserve's mandate along with price stability. He knew that only with maximum employment would there be true opportunity for workers of all races, ethnicities, and genders. Every day, I am mindful that the opportunities and prosperity of working people all across the country rest in part on our commitment to the prosaic words "maximum employment and price stability," which, like policy work itself, belie the enormity of their effect. Maximum employment and stable low inflation benefit all Americans but are particularly important for those earning less. Price stability is of greatest importance for lower-income families because they spend more than three-quarters of their paychecks on essentials like groceries, gas or bus fare, and rent--more than double the 31 percent spent by higher-income households. High inflation is our most pressing challenge. That is why we are taking strong actions that will bring inflation back down. The third example took place 45 years ago, when civil rights leaders, banks, and community groups worked together with leaders in Congress to enact the Community of restricting access to credit in neighborhoods, often on demographic grounds-- Congress assigned banking regulators with the responsibility to ensure banks serve the credit needs of their entire communities. As of today, this responsibility remains the foundation of the ecosystem supporting credit, investment, and financial inclusion in communities that face the greatest challenges. By revitalizing the CRA, we provide shopkeepers, entrepreneurs, first-time homebuyers, and families better opportunities to thrive individually and, in turn, to contribute to the broader vibrancy of our economy. A commitment to mission, to providing opportunities in all communities, to embracing change, to taking bold action--these guidelines that have been important for me may also be important for you as you embark on your professional journey. They will be important whether you work in the public, private, or nonprofit sector, and whether you work within borders or across them. I noted that in the early days, the demise of the Iron Curtain was virtually inconceivable. But when the tides turned, the change came hard and fast. The digital revolution similarly heralded a recognition at a visceral level that we were hurtling toward a new era. Your generation is experiencing change of this magnitude at a breathtaking pace. We are living through a profound shift in our individual and collective histories. This great reordering gives you a unique opportunity to shape what comes next. You are headed into the world at the exact moment that your ability to change it has never been more important. You understand the need to embrace change--to understand it and shape it, not hide from it. And you came to the right place to do so. SAIS was founded in 1943--during World War II. It was established one year before the Bretton Woods Conference, two years before the United Nations was established, and four years before the National Security Council first met. SAIS was established during a crisis to enable its graduates to make a better world. Sound familiar? As SAIS graduates, you are equipped with an intellectual framework that enables you to work across disciplines as much as within them, at both a national and global level. I guarantee that no challenge worthy of your attention will be simple. The challenges your generation faces are multifaceted, requiring you to think and act across disciplinary boundaries to develop effective solutions. As SAIS graduates, you understand that whatever your professional calling may be--whether in finance or technology or development or diplomacy--you are called to do so by a mission that animates you and that holds its own inspiration and poetry for you. As SAIS graduates, you are supremely well positioned to combine theory and practice in the arena and to be nimble and agile in adapting to even the most extreme events. You will have your own moment when you realize with startling clarity that you are called to act with boldness and resolve. I encountered two groups of people when I was navigating the aftershocks of the Global Financial Crisis and the complexities of the with , and SAIS graduates I worked for . They were excellent, dedicated, and inspiring. So, I am confident that your education here has equipped you well to understand and act on the big forces that will continue to drive change. Finally, as SAIS graduates, you embark on your professional journey equipped not only with a powerful intellectual framework but a lifelong network of friends, mentors, and collaborators here and around the world that will sustain and support you as you rise to meet challenges that may be impossible to even imagine right now. Indeed, this SAIS community may turn out to be the greatest gift of your time here. So let me conclude by saying to each of you and to your families:

r220530a_FOMC

united states

Responding to High Inflation, with Some Thoughts on a Soft Landing

waller

For release on delivery Remarks by at Thank you, Professor Wieland, for the introduction, and thank you to the Institute for Monetary and Financial Stability for the opportunity to speak to you today. I come here at a moment of great challenge for Germany and Europe, and a moment in which it has never been more evident that the interests of Europe and the United States are closely aligned. America stands with Europe in defending Ukraine because we all understand that an assault on democracy in Europe is a threat to democracy everywhere. We also face the common challenge of excessive inflation, which is no coincidence, since Germany and other countries are dealing with many of the same forces driving up inflation in the United States. Fortunately, in response to this moment of common challenges and interests, Europe and the United States have strengthened our ties and I believe we are more unified today than we have been for decades. We see that in the deepening and possible broadening of our security commitments, and we also see it in the strong commitment that central banks in Europe and elsewhere have made to fight inflation. In today's distinguished lecture I will deal with two distinct topics, both of which I believe will be of interest. First, I will provide my outlook for the U.S. economy and how the Federal Reserve plans to reduce inflation and achieve our 2 percent target. Then I will pivot to a more academic discussion of the labor market and the possibility of a soft landing in which taming inflation does not harm employment. Let me start with the economic outlook for the United States. Despite a pause early this year in the growth of real gross domestic product (GDP), the U.S. economy continues to power along at a healthy pace. The contraction in output reported in the first quarter was due to swings in two volatile categories, inventories and net exports, and I don't expect them to be repeated. Consumer spending and business investment, which are the bedrock of GDP, were both strong, and more recent data point toward solid demand and continuing momentum in the economy that will sustain output growth in the months ahead. Another sign of strength is the labor market, which has created 2 million jobs in the first four months of 2022 at a remarkably steady pace that is down only slightly from the 562,000 a month last year. Unemployment is near a 50-year low, and both the low numbers of people filing for unemployment benefits and the high number of job openings indicate that the slowdown in the economy from the fast pace of last year isn't yet weighing on the job market. Some look at labor force participation, which is below its pre-COVID-19 level, as leaving a lot of room for improvement. However, there are underlying factors that explain why participation is depressed, including early retirements and individual choices associated with COVID concerns. Whatever the cause, low participation has contributed to the fact that there are two job vacancies for every one person counted looking for a job, a record high. Before the pandemic, when the labor market was in very solid shape, there was one vacancy for every two unemployed people. As I will explain, this very tight labor market has implications for inflation and the Fed's plans for reducing inflation. But on its own terms, we need to recognize that robust job creation is an underlying strength of the U.S. economy, which is expanding its productive capacity and supporting personal income and ongoing economic growth, in the face of other challenges. Let me turn now to the outlook for the Fed's top priority, inflation. I said in December that inflation was alarmingly high, and it has remained so. The April consumer price index (CPI) was up 8.3 percent year over year. This headline number was a slight decline from 8.5 percent in March but primarily due to a drop in volatile gasoline prices that we know surged again this month. Twelve-month "core" inflation, which strips out volatile food and energy prices, was also down slightly to 6.2 percent in April, from 6.5 percent the month before, but the 0.6 percent monthly increase from March was an acceleration from the February to March rate and still too high. Meanwhile, the Fed's preferred measure based on personal consumption expenditures readings relative to CPI reflect differences in the weights of various categories across these indexes. No matter which measure is considered, however, headline inflation has come in above 4 percent for about a year and core inflation is not coming down enough to meet the Fed's target anytime soon. Inflation this high affects everyone but is especially painful for lower- and middle-income households that spend a large share of their income on shelter, groceries, gasoline, and other necessities. It is the FOMC's job to meet our price stability mandate and get inflation down, and we are determined to do so. The forces driving inflation today are the same ones that emerged a year ago. The combination of strong consumer demand and supply constraints--both bottlenecks and a shortage of workers relative to labor demand--is generating very high inflation. We can argue about whether supply or demand is a greater factor, but the details have no bearing on the fact that we are not meeting the FOMC's price stability mandate. What I care about is getting inflation down so that we avoid a lasting escalation in the public's expectations of future inflation. Once inflation expectations become unanchored in this way, it is very difficult and economically painful to lower them. While it is not surprising that inflation expectations for the next year are up, since current inflation is high, what I focus on is longer-term inflation expectations. Recent data that try to measure longer-term expectations are mixed. Overall, my assessment is that longer-range inflation expectations have moved up from a level that was consistent with trend inflation below 2 percent to a level that's consistent with underlying inflation a little above 2 percent. I will be watching that these expectations do not continue to rise because longer-term inflation expectations influence near term inflation, as well as our ability to achieve our 2 percent target. When they are anchored, they influence spending decisions today in a way that helps inflation move toward our target. To ensure these longer-term expectations do not move up broadly, the Federal Reserve has tools to reduce demand, which should ease inflation pressures. And, over time, supply constraints will resolve to help rein in price increases as well, although we don't know how soon. I cannot emphasize enough that my FOMC colleagues and I are united in our commitment to do what it takes to bring inflation down and achieve the Fed's 2 percent target. Since the start of this year, the FOMC has raised the target range for the federal funds rate by 75 basis points, with 50 basis points of that increase coming at our meeting earlier this month. We also issued forward guidance about the likely path of policy. The May FOMC statement said the Committee "anticipates that ongoing increases in the target range will be appropriate." I support tightening policy by another 50 basis points for several meetings. In particular, I am not taking 50 basis-point hikes off the table until I see inflation coming down closer to our 2 percent target. And, by the end of this year, I support having the policy rate at a level above neutral so that it is reducing demand for products and labor, bringing it more in line with supply and thus helping rein in inflation. This is my projection today, given where we stand and how I expect the economy to evolve. Of course, my future decisions will depend on incoming data. In the next couple of weeks, for example, the May employment and CPI reports will be released. Those are two key pieces of data I will be watching to get information about the continuing strength of the labor market and about the momentum in price increases. Over a longer period, we will learn more about how monetary policy is affecting demand and how supply constraints are evolving. If the data suggest that inflation is stubbornly high, I am prepared to do more. My plan for rate hikes is roughly in line with the expectations of financial markets. As seen in slide 1, federal funds futures are pricing in roughly 50 basis point hikes at the FOMC's next two meetings and expecting the year-end policy rate to be around 2.65 percent. So, in total, markets expect about 2.5 percentage points of tightening this year. This expectation represents a significant degree of policy tightening, consistent with the FOMC's commitment to get inflation back under control and, if we need to do more, we will. These current and anticipated policy actions have already resulted in a significant tightening of financial conditions. The benchmark 10-year Treasury security began the year at a yield of around 1.5 percent and has risen to around 2.8 percent. Rates for home mortgages are up 200 basis points, and other credit financing costs have followed suit. Higher rates make it more expensive to finance spending and investment which should help reduce demand and contribute to lower inflation. In addition to raising rates, the FOMC further tightened monetary policy by ending asset purchases in March and then agreeing to start reducing our holdings of securities, a process that begins June 1. By allowing securities to mature without reinvesting them, the Fed's balance sheet will shrink. We will phase in the amount of redemptions over three months. By September, we anticipate having up to $95 billion of securities rolling off the Fed's portfolio each month. This pace will reduce the Fed's securities holdings by about $1 trillion over the next year, and the reductions will continue until securities holdings are deemed close to the ample levels needed to implement policy efficiently and effectively. Although estimates are highly uncertain, using a variety of models and assumptions, the overall reduction in the balance sheet is estimated to be equivalent to a couple of 25-basis-point rate hikes. All these actions have the goal of bringing inflation down toward the FOMC's 2 percent target. Increased rates and a smaller balance sheet raise the cost of borrowing and thus reduce household and business demand. On top of this, I also hope that over time supply problems resolve and help lower inflation. But the Fed isn't waiting for these supply constraints to resolve. We have the tools and the will to make substantial progress toward our target. The United States is not alone in facing excessive inflation, and other central banks also are responding. There is a global shift toward monetary tightening. In the euro area, headline inflation continued to edge up in April, to 7.5 percent, while its version of core inflation increased from 2.9 percent to 3.5 percent. Based on this broadening of price pressures, communication by the European Central Bank (ECB) is widely interpreted as signaling that it will likely start raising its policy rate this summer and that it could raise rates a few times before year-end. Policy tightening started last year, as emerging markets including Mexico and Brazil increased rates substantially amid expectations of accelerating inflation. Several advanced-economy central banks, including the Bank of England, began raising interest rates in the second half of last year. Like the Fed, the Bank of Canada lifted off in March and, also like the Fed, picked up the pace of tightening with a rate hike of 50 basis points at its most recent meeting. Central banks in Australia and Sweden pivoted sharply to hike rates at their most recent meetings after previously saying that such moves were not likely anytime soon. Slide 2 shows the similarly timed policy responses across advanced and emerging economy central banks in terms of actual and anticipated increases in their policy rates. Emerging market economies started the year with a policy rate that averaged around 3.5 percent, and they are expected to end the year averaging a bit over 5 percent. Advanced foreign economies started a bit below zero and at this point are expected to move up, on average, by around 1 percentage point. This worldwide increase in policy rates, unfortunately, reflects the fact that high inflation is a global problem, which central banks around the world recognize must be addressed. Finally, like the Fed, many other advanced-economy central banks that expanded their balance sheets over the past two years are now reversing course. In recent months, as shown in slide 3, the Bank of Canada and Bank of England have begun to shrink their balance sheets by stopping full reinvestment of maturing assets, similar to what the Fed will commence in June. Although the ECB has committed to reinvesting maturing assets for quite some time, it has tapered net purchases substantially since last year and has indicated it will likely end those purchases early in the third quarter. Some have expressed concern that the Fed cannot raise interest rates to arrest inflation while also avoiding a sharp slowdown in economic growth and significant damage to the labor market. One argument in this regard warns that policy tightening will reduce the current high level of job vacancies and push up unemployment substantially, based on the historical relationship between these two pieces of data, which is depicted by something called the Beveridge curve. Because I am now among fellow students of economics, I wanted to take a moment to show why this statement may not be correct in current circumstances. First, a little background. The relationship between vacancies and the unemployment rate is shown in slide 4. The blue dots in the figure show observations of the vacancy rate and the unemployment rate between 2000 and 2018. The black curve is the fitted relationship between the log of vacancies and the log of unemployment over this period. It has a somewhat flat, downward slope. From this, the argument goes, policy to slow demand and push down vacancies requires moving along this curve and increasing the unemployment rate substantially. But there's another perspective about what a reduction in vacancies implies for unemployment that is just as plausible, if not more so. Slide 5 shows the same observations as slide 4 but also adds observations from the pandemic. The two larger red dots show the most recent observation, March 2022, and January 2019, when the vacancy rate had achieved its highest rate before the pandemic. These two dots suggest that the vacancy rate can be reduced substantially, from the current level to the January 2019 level, while still leaving the level of vacancies consistent with a strong labor market and with a low level of unemployment, such as we had in 2019. To see why this is a plausible outcome, I first need to digress a bit to discuss the important determinants of unemployment. Many factors influence the unemployment rate, and vacancies are just one. Thus, to understand how a lower vacancy rate would influence unemployment going forward, we need to separate the direct effect of vacancies on the unemployment rate from other factors. To do that, we first need to review the factors that account for unemployment movements. There are two broad determinants of unemployment: separations from employment (including layoffs and quits), which raise unemployment, and job finding by the unemployed, which lowers unemployment. Separations consist largely of layoffs, which are typically cyclical, surging in recessions and falling during booms. Job finding is also highly cyclical, rising as the labor market tightens and falling in recessions. To see how separations and job finding affect the unemployment rate, it's helpful to start with equation (1) on slide 6, which states that in a steady state (that is, when the unemployment rate is constant), flows into unemployment, the left side of equation (1), must equal flows out of unemployment, the right side. Flows into unemployment equal the separations rate, , times the level of employment. For simplicity, I've normalized the labor force to 1, so that employment equals 1 minus unemployment, . Flows out of unemployment, the right side of the equation, equal the rate of job finding, , times the number of unemployed. Rearranging this equation yields an expression for the steady- state unemployment rate, equation (2). Because flows into and out of unemployment are quite high, the actual unemployment rate converges to the steady-state unemployment rate quickly, and the steady-state unemployment rate typically tracks the actual rate closely. So, going forward, I'm going to think of the steady-state unemployment rate as a good approximation of the actual unemployment rate. Now let me focus on job finding, which is often thought to depend on the number of job vacancies relative to the number of unemployed workers. To see why, start with equation (3) on slide 7, which states that the number of hires is an increasing function of both the number of job vacancies and the number of unemployed individuals searching for jobs: The more firms there are looking for workers and the more workers there are looking for jobs, the more matches, or hires, there will be. For convenience, I'm assuming a mathematical representation of this matching function takes a Cobb-Douglas form. If we divide both sides of equation (3) by unemployment, we get equation (4), which expresses the job-finding rate as a function of the ratio of vacancies to unemployment, or labor market tightness. Because we have data for both the left and right sides of equation (4), we can estimate it and obtain parameter values for the elasticity of job finding with respect to labor market tightness, sigma, and matching efficiency, mu. Matching efficiency represents factors that can increase (or decrease) job findings without changes in labor market tightness. On the one hand, if the workers searching for jobs are well suited for the jobs that are available, matching efficiency will be high; on the other hand, if many searching workers are not well suited for the available jobs, matching efficiency will be low. The last step is to plug our expression for job finding into equation (2), the steady- state unemployment rate, yielding equation (5). Equation (5) shows how vacancies affect the unemployment rate. To illustrate this relationship, I solve equation (5) for different values of and , holding the matching efficiency parameters constant. That is, I pick a separation rate at some level and trace out what happens to the unemployment rate as the vacancy rate changes. Then I pick a different separation rate and again trace out the effect of vacancies on unemployment. The result is shown on slide 8, which plots four curves showing the effect of vacancies on unemployment for four different separation rates. Each curve is convex; as the number of vacancies increases relative to the number of individuals looking for work, it becomes harder for firms to fill jobs with suitable workers, and more jobs remain vacant. This is exactly the situation many employers are now experiencing. Because more vacancies generate fewer and fewer hires, they result in smaller and smaller reductions in unemployment. But large numbers of vacancies are, of course, a hallmark of tight labor markets and additional vacancies continue to strongly boost wage growth and quits. The curve farthest to the right, labeled s=2.5, represents a situation when the separations rate is 2.5 percent, a historically high level. This rate is approximately the level seen in the middle of 2020, just after the onset of the pandemic. You can see that when the separations rate is this high, the unemployment rate is also going to be high, no matter the level of vacancies. Now let's think about what happens as the economy recovers, as it has over the past two years. In an expansion, layoffs fall, pushing down separations and moving the curve to the left. At the same time, greater labor demand increases vacancies, causing the labor market to move up the steep curves. The combination of these movements is shown in slide 9 as the black fitted curve, which I've reproduced from slide 4. As you recall, the black curve fits the actual observations on unemployment and vacancies we saw before the pandemic. And we now can see that these observations are produced by a combination of changes in vacancies and separations (as well as other influences on unemployment). Decreases in the separations rate reduce the unemployment rate without changing vacancies, imparting a flatness to the fitted curve relative to the steeper curves that only reflect the effect of vacancies. If we want to just focus on the effect of vacancies, then we should be looking at the steep curves, especially when the labor market is tight, as it is now. What does all this suggest about what will happen to the labor market when, as I expect, a tightening of financial conditions and fading fiscal stimulus start to cool labor demand? Slide 10 focuses on the Beveridge curve (the relationship produced by the direct effect of changes in vacancies on unemployment) when the separations rate is low, as it is now. The March 2022 observation lies at the top of the curve and is labeled point A. If there is cooling in aggregate demand spurred by monetary policy tightening that tempers labor demand, then vacancies should fall substantially. Suppose they decrease from the current level of 7 percent to 4.6 percent, the rate prevailing in January 2019, when the labor market was still quite strong. Then we should travel down the curve from point A to point B. The unemployment rate will increase, but only somewhat because labor demand is still strong--just not as strong--and because when the labor market is very tight, as it is now, vacancies generate relatively few hires. Indeed, hires per vacancy are currently at historically low levels. Thus, reducing vacancies from an extremely high level to a lower (but still strong) level has a relatively limited effect on hiring and on unemployment. Now, I also show the January 2019 observation of vacancies and unemployment. Recall, this is also where the economy was over the year prior to the pandemic. As you can see, moving from the March 2022 observation to the January 2019 observation is not that different from the change in the unemployment rate predicted by my estimated Beveridge curve, which suggests the predicted small increase in unemployment is a plausible outcome to policy tightening. If labor demand cools, will separations increase and shift the curve outward, increasing unemployment further? I don't think so. As shown on slide 11, outside of recessions, layoffs don't change much. Instead, changes in labor demand appear to be reflected primarily in changes in vacancies. Now, it's certainly possible, even probable, that influences on the unemployment rate other than vacancies will change going forward. In terms of the equations we have been discussing, layoffs could increase somewhat, instead of staying constant. Matching efficiency could also improve or deteriorate. The vacancy rate could also change more or less than I have assumed. Thus, I'm not arguing that the unemployment rate will end up exactly as the Beveridge curve I've drawn suggests. But I do think it quite plausible that the unemployment rate will end up in the vicinity of what the Beveridge curve currently predicts. Another consideration is that non-linear dynamics could take hold if the unemployment rate increases by a certain amount, as suggested by the Sahm rule, which holds that recessions have in the past occurred whenever the three-month moving average of the unemployment rate rises 0.5 percentage point over its minimum rate over the previous 12 months. We certainly need to be alert to this possibility, but the past is not always prescriptive of the future. The current situation is unique. We've never seen a vacancy rate of 7 percent before. Reducing the vacancy rate by 2.5 percentage points would still leave it at a level seen at the end of the last expansion, whereas in previous expansions a reduction of 2.5 percent would have left vacancies at or below 2 percent, a level only seen in extremely weak labor markets. To sum up, the relationship between vacancies and unemployment gives me reason to hope that policy tightening in current circumstances can tame inflation without causing a sharp increase in unemployment. Of course, the path of the economy depends on many factors, including how the Ukraine war and COVID-19 evolve. From this discussion, I am left optimistic that the strong labor market can handle higher rates without a significant increase in unemployment. In closing, I want to again thank the institute for the invitation to address you today, at a time of considerable challenge for Germany and the United States. It's not the first time we have faced such moments together. Just south of the Frankfurt Airport is a surprising sight--a couple of antique military cargo planes, parked on the side of the Autobahn. They were built by Douglas Aircraft, nearly 80 years ago, and stand today as monuments to one of the greatest achievements of cooperation between the freedom- loving people of Europe and those of the United States. For 11 months, these two planes, and many others, took off and landed in perpetual motion, delivering 2.3 million tons of food, fuel, and other essentials to the people of Berlin, who were surrounded and besieged by Soviet forces. The commitment and ultimate triumph of this improbable airlift was in many ways the beginning of an alliance that has included ongoing economic cooperation that has strengthened both our democracies. In that spirit, I am certain we can both overcome the economic challenges that lie ahead. . vol. 1 . Review of

r220603a_FOMC

united states

Risk in the Crypto Markets

waller

Thank you for the chance to be part of this interesting discussion. It's a pleasure to speak with such a good mix of academic, industry, and official-sector experts about a topic with real importance to the future of the financial system. I know my remarks are coming after a long day, and I plan to keep them short. My goal tonight is not to weigh in on whether and how crypto- asset markets should be regulated. Instead, I want to make some observations that I hope will help focus discussion of that question in the right place. The main issue in crypto-asset regulation isn't how to protect sophisticated crypto-investors; it's how to protect the rest of us. By any measure, the last five years have been a stretch of incredible growth in crypto- asset markets. Every aspect of them has expanded, from protocols and platforms, to instruments and intermediaries. Public awareness and government attention have increased. Above all, crypto itself has evolved from a limited set of coins meant to provide an alternative means of payment to decentralized finance, or "DeFi," arrangements, meant to provide alternatives to a range of financial products and services. Innovation is happening fast, and many of the people and groups represented in this room have found new uses in finance for this technology. By law or by practice, many crypto-related products and activities fall between the cracks of traditional legal and regulatory structures, outside the so-called "regulatory perimeter." In that environment, the normal backstops and safety nets of traditional finance do not necessarily or reliably apply. High volatility is the rule, not the exception; fraud and theft occur regularly, often at large scale. Your whole pot is always on the table; you take part at your own risk. Some DeFi traders understand these dynamics well. If they don't embrace them, they still accept them as the natural state for a new, exciting, and still relatively unregulated marketplace. And they have a point: Crypto and DeFi may be new, but these kinds of freewheeling markets aren't. They often emerge--to quote Professor Debora Spar--after: "a sharp movement along the technological frontier--a moment in time when innovation leap[s] suddenly outward, creating new opportunities for commerce and tremendous enthusiasm among aspiring entrepreneurs. In each case...the technological leap also create[s] a political gap. Innovation, in other words, enable[s] firms to play in some new sphere of activity, free from the rules or regulations that might bind them in another, more established realm." That was true with long-distance ocean trade in the 1400s; with the spread of railroad transportation in 19 century America and the explosive growth of banks to fund it; with "homebrew" computing in the '60s and '70s; and with the internet in the '90s. New technology--and a lack of clear rules--meant some new fortunes were made, even as others were lost. There's a lot to like about these kinds of markets. Entry is often cheap, and exit is often swift. Competition can be fierce. And inefficiency can be fatal, so improvements can happen quickly. The ideas, practices, and technologies that survive in these rough waters can eventually disrupt and improve older and calmer markets. As I've said previously in the context of stablecoins, those positive spillovers can (under the right circumstances) make everyone better off. From the perspective of many market participants--the ones who survive and thrive in this rough and tumble--regulation isn't just unnecessary, it's counterproductive. It drives up costs, creates barriers to entry, and stifles innovation. From some crypto advocates, I have heard this argument as well as a related one: that these experienced investors know what they're getting into, and that they're not asking for protection because they believe they don't need it. Given all of that, the argument goes, why should anyone bring regulation into a space that's not asking for it? Let's focus on crypto-asset users, who are a very different group than just a few years ago. The Federal Reserve's most recent found that 12 percent of adults used or held cryptocurrency in the past year, and more than 90 percent of these adults held them for investment purposes rather than payments. Center put the number of users even higher at 16 percent, and other polls as high as 20 percent. Some of these users are seasoned professional investors, but others, of course, are not--they're attracted to a new and complicated market by curiosity, by stories of newly minted crypto billionaires, or by promises of high and reliable returns on their life savings. New retail users, by definition, do not have crypto experience. They don't know how to independently buy a crypto asset, how to obtain and protect a private key, how to conduct trades on a DeFi protocol, or how to write a smart contract. They need help, and for a price, a range of fast-growing exchanges, wallet providers, and other intermediaries are willing to provide it. But while intermediaries can potentially help monitor and manage risk, they can't eliminate it. In such a volatile market, any user still has a meaningful chance of losing their money. What happens in the aftermath of these losses? On an individual level, one possibility is a dispute between the intermediary and its customers over poor due diligence, poor financial advice, poor management practices, and so on. Resolving those disputes individually can be costly. So, it's no surprise that intermediaries would ask for some kind of protection from them--some standard rules of the road that, if followed, create at least some presumption of proper conduct. As a result, intermediaries can eventually demand regulation to protect themselves. From a social perspective, there is another possible outcome when losses become widespread: Those losses become practically, politically, or morally intolerable. When everyday investors start losing their life savings, for no reason except wanting to participate in a hot market, demands for collective action can mount quickly. History shows that there will be demands to make individual investors "whole" by socializing their individual losses. We saw it just a few weeks ago after what can only be described as a run on the Terra ecosystem, when everyday users were seeking restitution and even experienced DeFi players were discussing ways to compensate retail investors. This leads us to the main reason, in my view, that society wants to regulate new and poorly understood markets for financial products. It's not to protect high-net-worth investors but to protect society from the often-irresistible pressure to socialize the losses of investors with limited resources, and to limit the spread of financial stress. The desire for a backstop can emerge even in an isolated failure--to say nothing of a systemwide event--when uncertainty or private information moves stress from one asset class to others. By definition, those financial externalities--which central banks, including the Fed, monitor closely--can create losses that innocent parties never signed up for and couldn't have controlled. Those are the kinds of losses that the public often gets asked to cover--and when they do, very often, the public also asks for new oversight and regulations, so the same mistakes don't happen again. In summary, financial regulation is typically demanded (1) by financial intermediaries as a form of liability protection and (2) by the taxpayer to prevent socialization of individual losses. It does not arise to protect sophisticated, experienced, well-informed investors. On the contrary: Large-scale losses can easily occur even if these investors are getting the information they need to make decisions and are otherwise following the rules. If we want to allow broad access to the crypto ecosystem, then the question isn't about what experienced users of that ecosystem want-- it's about what the rest of the public needs to have confidence in the ecosystem's safety, and for better or worse, you can't program confidence. That question doesn't always have a clear answer, and it involves real and difficult tradeoffs. But it's a question that every new and fast- growing financial product must address if it wants to last very long. Thank you.

r220617a_FOMC

united states

Welcoming Remarks

powell

Good morning, and welcome to the inaugural conference on the International Roles of the U.S. Dollar. Thank you all for participating and for lending your expertise on this important topic. This conference marks the first use of our new Martin Conference Center, which I hope you enjoy. The international financial and monetary system that emerged after World War II has been defined by the centrality of the dollar. It is the world's reserve currency and the most widely used for payments and investments. As outlined in recent work by Board staff, this global preeminence has been supported by the depth and liquidity of U.S. financial markets, the size and strength of the U.S. economy, its stability and openness to trade and capital flows, and international trust in U.S. institutions and the rule of law. Professor Barry Eichengreen will expand on some of these themes later this morning. The dollar's international role holds multiple benefits. For the United States, it lowers transaction fees and borrowing costs for U.S. households, businesses, and the government. Its ubiquity helps contain uncertainty and, relatedly, the cost of hedging for domestic households and businesses. For foreign economies, the wide use of the dollar allows borrowers to have access to a broad pool of lenders and investors, which reduces their funding and transaction costs. The benefits of the dollar as the dominant reserve currency have generated an extensive academic literature. Yesterday's paper on the Treasury market by Alexandra Tabova and Frank Warnock extends that work in meaningful ways. The Federal Reserve's strong commitment to our price stability mandate contributes to the widespread confidence in the dollar as a store of value. To that end, my colleagues and I are acutely focused on returning inflation to our 2 percent objective. Meeting our dual mandate also depends on maintaining financial stability. The Fed's commitment to both our dual mandate and financial stability encourages the international community to hold and use dollars. The wide use of the dollar globally can also pose financial stability challenges that can materially affect households, businesses, and markets. For that reason, the Federal Reserve has played a key role in promoting financial stability and supporting the use of dollars internationally through our liquidity facilities. The central bank liquidity swap lines provide foreign central banks with the capacity to deliver U.S. dollar funding to institutions in their jurisdictions. And the Foreign and International Monetary dollars. These facilities serve as liquidity backstops so that holders of dollar assets and participants in dollar funding markets can be confident that strains will be eased when these markets come under stress. That assurance, in turn, mitigates the effect of such strains on the flow of credit to U.S. households and businesses. Both facilities enhance the standing of the dollar as the dominant global currency. The swap lines were extensively used during the Global Financial Crisis, the 2011 euro-area debt crisis, and the financial turmoil at the outset of the COVID-19 pandemic in 2020. The paper on central bank swap lines presented yesterday by Gerardo Ferrara, level evidence on the usefulness of swap lines in providing cross-border liquidity to support the real economy. Looking forward, rapid changes are taking place in the global monetary system that may affect the international role of the dollar in the future. Most major economies already have or are in the process of developing instant, 24/7 payments. Our own FedNow service will be coming online in 2023. And in light of the tremendous growth in crypto-assets and stablecoins, the Federal Reserve is examining whether a U.S. central bank digital currency (CBDC) would improve on an already safe and efficient domestic payments system. As the Fed's white paper on this topic notes, a U.S. CBDC could also potentially help maintain the dollar's international standing. As we consider feedback from the paper, we will be thinking not just about the current state of the world, but also how the global financial system might evolve over the next 5 to 10 years. The paper by Jiakai Chen and Asani Sarkar, which is on today's program, and our distinguished panelists on this topic this afternoon, will provide important insights on this issue. To summarize, I would like to stress the importance of the dollar to the U.S. and global economies and financial markets. It is critical that we understand the channels, connections, and effects of the role of the dollar. In closing, I want to thank you all for taking the time to join our discussion on the dollar's international roles. This conference brings together world-class researchers, practitioners, and policymakers dedicated to understanding and addressing these vital issues. I look forward to their insights and I hope you enjoy the conference.

r220618a_FOMC

united states

Lessons Learned on Normalizing Monetary Policy

waller

Thank you, Meredith and Cullum and thank you to the Society for the invitation another significant step toward achieving our inflation objective by raising the Federal Funds rate target by 75 basis points. In my view, and I speak only for myself, if the data comes in as I expect I will support a similar-sized move at our July meeting. The Fed is "all in" on re-establishing price stability, and part of that effort involves understanding the forces that have boosted inflation and also examining how policymakers responded. Today, I intend to look back on monetary policy in 2020 and 2021, as I have before in recent speeches, but go a bit further and try to discern some lessons learned. In addition to the Federal Reserve's emergency lending programs, the monetary policy actions taken during this time were deemed extraordinary. We swiftly lowered the target range for the federal funds rate to close to zero--the effective lower bound--and made an open-ended commitment to purchasing securities. It was only the second time that the Fed had taken such dramatic steps. But the first time for these actions was scarcely a decade ago, and there is good reason to think such a response may not be extraordinary anymore. Structural changes in the economy have tended to lower interest rates and limit the room that the Federal Reserve will have to cut rates during a slowdown. I hope we never have another two years like 2020 and 2021, but because of the low-interest-rate environment we now face, I believe that even in a typical recession there is a decent chance that we will be considering policy decisions in the future similar to those we made over the past two years. Because of that likelihood, it is especially useful to consider the lessons learned. Let's start at the beginning, when the United States was faced with the economic shock from COVID-19. Over several weeks starting in early March 2020, the FOMC lowered the target range for the federal funds rate to the effective lower bound and began Fed established numerous liquidity and credit market facilities. All these actions were taken to support liquidity in the financial system and keep credit flowing to households, businesses and state and local governments. Asset purchases were undertaken in response to disruptions in financial markets, particularly in the normally stable U.S. Treasury market. Besides supporting smooth market functioning, asset purchases also aided in the transmission of monetary policy to broader financial conditions. Financial markets stabilized relatively quickly. Over the course of 2020, the Fed's liquidity and credit facilities saw reduced demand and most of the emergency programs were decommissioned around year end. Perhaps the most straightforward takeaway for monetary policy is that in times of severe stress, lending facilities, along with sharp cuts to the federal funds rate and the introduction of large-scale asset purchases, are very effective in reviving the economy. There are some other lessons, I think, from the experience of tightening monetary policy, a process which was put in motion by the guidance that the FOMC issued in 2020 about how long it would keep the federal funds rate at the effective lower bound and continue asset purchases. In September and December of 2020, the FOMC provided criteria or conditions in the meeting statement that would need to be met before the FOMC would consider raising interest rates and begin to reduce asset purchases, respectively. These conditions were, in effect, the FOMC's plan for starting the process of tightening policy. This guidance was short term, specific to the task of when to tighten policy in this current cycle, and focused on specific tools. Let me make an important distinction here. A bit earlier, in August 2020, the Committee completed a multi-year review of our overall strategy for achieving and sustaining our economic goals. The strategy statement is very different than the tightening guidance--it is about longer-run goals, not specific actions related to the current circumstances. The goals in the strategy statement apply in all economic circumstances and don't include any details on the settings of policy tools. I mention this distinction because some have argued that the FOMC's new strategy was a factor that led the Committee to wait too long to begin tightening monetary policy. A bit later, I will explain why I do not believe this is the case, and I will explain how the guidance for tightening policy, laid out in the FOMC's post-meeting statements, was the basis for our decisions. So, let's think about how the economy evolved and how the criteria for that guidance steered the path of policy. In early 2021, the Committee began noting whether the economy was making progress toward our employment and inflation goals, and thus getting closer to decisions on unwinding our highly accommodative policy. Based on our positive experience with unwinding after the Global Financial Crisis (GFC), we thought it would be appropriate to use the same sequence of steps: taper asset purchases until they ceased, then lift rates off the effective lower bound, then gradually and passively reduce our balance sheet by redeeming maturing securities. Most importantly, through various communications, we made it clear that tapering of asset purchases would have to be completed before rate liftoff to avoid the conflict that would occur by easing via continuing asset purchases versus tightening through rate hikes. In the previous episode of tightening policy after extraordinary accommodation, this process was very gradual. Tapering of asset purchases took 11 months, and then the first rate hike did not occur until more than a year after purchases ended. Balance sheet reduction began more than a year and half after that. This gradualism worked well then, and it surely influenced the Committee's approach this time. Implementing this approach required two pieces of guidance: first, criteria for beginning the tapering process, and, second, criteria to begin raising the policy rate from the effective lower bound. Through explicit language in FOMC statements, we told the public the necessary conditions that needed to be met before we would adjust these two policies. For asset purchases, the Committee declared that tapering would wait "until substantial further progress has been made toward the Committee's maximum employment and price stability goals." Meanwhile, the FOMC said that it would keep rates near zero until our employment goal had been reached and until inflation had reached 2 percent and was "on track to moderately exceed 2 percent for some time." A fair question is: what did these words mean? And, in particular, what did the phrases "substantial further progress" for tapering and "for some time" for liftoff mean? In large part the interpretation hinged on how the Committee viewed the economy would recover from the pandemic. Looking across forecasts at the time by Committee participants and the private sector, no one expected substantial progress toward both our goals to happen very soon. The economy had begun the recover, but at the end of 2020 COVID was bad and getting worse and vaccines were just arriving, so we didn't know how soon schools would reopen and people would get back to work. In November and December 2020, the unemployment rate was 6.7 percent and inflation seemed to be in check: 12-month personal consumption expenditures inflation was declining, and core inflation, which excludes volatile energy and food prices, was more or less steady at 1.5 2020 had the unemployment rate moving down to 4.2 percent at the end of 2022 and inflation moving up to 2 percent only in 2023. Only one participant had liftoff occurring by the end of 2022. Based on this SEP, the Committee did not expect the economy to recover quickly. back in January of 2021, the median respondent thought tapering would start in the first quarter of 2022 and liftoff wouldn't be until the end of 2023 or later. To move forward, policymakers had to evaluate "substantial further progress" and "for some time." The phrases, admittedly, are not concrete in their meaning. Inflation averaging doesn't define how much above 2 percent is moderate and how long some value of elevated inflation should be tolerated. In addition, for assessing progress on the health of the labor market, different policymakers will prefer different measures that may not provide the exact same signal. On top of this, the data used to measure progress in the labor market can revise substantially and reshape the evaluation of the strength of this market quite quickly. For example, a key input--payroll data--in the latter half of 2021 painted a picture of a slowing labor market. But revised data over several subsequent months revealed that the slowdown never happened. Instead, job gains were quite robust. In particular, initial reports of job creation between August and December were a cumulative 1.4 million, but by February of this year that number was revised up to nearly Overall, the economy evolved rapidly in 2021. I won't get into the month-by- month details, as I have in recent speeches, but by October and November, policymakers thought the economy had improved enough to meet the criteria to start tapering at the early November meeting. Then, later that month, data indicated inflation was accelerating, so the Committee hastened the pace of tapering at the December meeting, making a plan to wind down purchases by early March. Between December and March of this year inflation data came in very elevated, and at that point there was no question that inflation had been above 2 percent for "some time." Given continued improvement in the labor market and the high inflation readings, the Committee began raising interest rates in March, as soon as asset purchases were completed. With these actions in the rearview mirror, we can now ask: knowing what we know now, should we have done anything differently? To be clear, by asking this question my intent is not to criticize the decisions of the Committee. Rather, it is to assess our policy strategies should we be confronted with another crisis in the future. One question to ask is whether the guidance we issued was too "restrictive"; in other words, did it allow enough flexibility for the FOMC to begin raising the policy rate when it was appropriate to? Recall, we had decided that raising the policy rate would not occur until the tapering of asset purchases had finished. But to finish, tapering must start--for a given pace of tapering, the longer it takes to start tapering, the longer it will be before the policy rate can be raised. Of course, one can keep the liftoff date fixed and simply taper at a much faster rate, including the possibility of a hard stop of asset purchases. But concerns about financial market functioning, including the ability of markets to absorb the purchases the Fed stops making, typically limits how fast the tapering can be, particularly given the amount of asset purchases we were making at the time ($120 billion per month). Given the tapering criteria and subsequent data, we ultimately had to pivot hard to accelerate the tapering pace and, in fact, completed the tapering of purchases just a few days before we lifted off. Unlike the normalization timeline after the financial crisis, we did not have flexibility to raise the target range sooner. However, if we had less restrictive tapering criteria and had started tapering sooner, the Committee could have had more flexibility on when to begin raising rates. So, by requiring substantial further progress toward maximum employment to even begin the process of tightening policy, one might argue that it locked the Committee into holding the policy rate at the zero lower bound longer than was optimal. My takeaway is that a less restrictive tapering criteria would have allowed more flexibility to taper "sooner and gradually,' as opposed to the relatively "later and faster" approach that occurred. Experience has shown that markets need time to adjust to a turn from accommodation to tightening, and that surely was a factor for FOMC statements over the years in framing criteria for key policy actions during the recovery from the GFC and the pandemic. So, I'm supportive of issuing such criteria but we need to be careful to use language that allows the Committee the flexibility it needs to respond to changing economic and financial conditions. Now let's turn to the liftoff criteria. It was also quite restrictive. The liftoff criteria required the economy to be in a situation where our dual mandate had been achieved. It can be argued that this meant getting the economy back to its 2019 state with very low unemployment and inflation near 2 percent. But the policy rate in 2019 was well above zero and close to its neutral value. Consequently, if the state of the economy is telling you to be at neutral and you are at zero, then any Taylor rule would say the policy rate needs to rise much faster than was typically done in the past. So, it should not have been a surprise that the policy rate would rise fast in 2022. Rate hikes would need to be larger and more frequent, relative to the 2015-2018 tightening pace, to get back to neutral. Looking back, should the Committee have signaled a steeper rate path once the liftoff criteria had been met? Perhaps another lesson is that giving forward guidance about liftoff should also include forward guidance about the possible path of the policy rate after liftoff. In closing, I hope that our country is not faced with another crisis as severe as the one precipitated by COVID, and that the Fed is not faced with the challenges of setting monetary policy under such conditions. But if we again face those challenges, we now have the additional insight that only experience can bring. I hope that this latest experience will help us approach the future with a more complete understanding of the policy choices and tradeoffs.

r220623a_FOMC

united states

The Outlook for Inflation and Monetary Policy

bowman

Thank you to the Massachusetts Bankers Association for the opportunity to speak to you today. It is often good to get away from Washington to gain some perspective, and it's always worthwhile for me when I can get some perspective from bankers. I will touch on some of the banking issues I expect are on your minds, but one of the biggest issues for everyone right now is inflation, what the Fed is doing to get inflation under control, and the implications for your businesses, your customers, and your communities. Inflation is the highest we have seen in the United States in 40 years and so far it shows little sign of moderating. At the same time, the economy is growing at a moderate pace, and the labor market is extremely tight, as indicated by a variety of measures including reports of many employers unable to find workers despite significantly raising wages. That tightness is contributing to inflation, because labor is the largest input cost for producing goods and providing services. Inflation is a significant challenge for everyone, but it hits lower- and moderate-income people the hardest, since they spend a larger share of their incomes on necessities and often have less savings to fall back on. Inflation is also a burden for businesses that must somehow balance unpredictable costs while setting prices that aren't so high that they discourage customers from purchasing. Inflation that continues at these levels is a threat to sustained employment growth and to the overall health of the economy. The inflation data show that, after moderating slightly for a short time, price increases for motor vehicles have picked up again, energy prices rose sharply in May, and prices for food have risen more than 10 percent from a year ago. The inflationary effect from the invasion of Ukraine has proven to be lasting for both energy and food commodity prices, with little prospect of the conflict or those price pressures abating very soon. More broadly, global supply chain issues continue, in part because of the effect of ongoing COVID-19 lockdown policies in China that have slowed production and shipping. One important factor that we often point to in driving today's spending decisions and inflation outlook are expectations of future inflation. Near-term expectations tend to rise as current inflation increases, but when inflation expectations over the longer-term-- the next 5 to 10 years--begin to rise, it may indicate that consumers and businesses have less confidence in the Fed's ability to address higher inflation and return it to the Federal above our 2 percent goal, it would make it more difficult to change people's perceptions about the duration of high inflation and potentially more difficult to get inflation under control. As we see surveys like the Michigan survey report higher longer-term inflation expectations, we need to pay close attention and continue to use our tools to address inflation before these indicators rise further or expectations of higher inflation become entrenched. As I mentioned earlier, one force driving inflation is the extremely tight labor market. The benefits from a tight labor market are easy to see--the U.S. economy continued to add jobs at a pace of 400,000 per month for the past three months, which is remarkable considering the low number of people looking for work. Today, most people who want to work can find a job, and wages and salaries have risen faster than they have in decades. Even with these gains, wages have not kept pace with inflation, which has made it much more difficult for many workers to make ends meet in the face of soaring housing, energy, and food costs. Job creation signals strong labor market demand, particularly in the current environment, with a large number of available jobs and fewer job seekers. In addition, the tightness of the labor market is exacerbated by a labor force participation rate that remains far below the pre-pandemic benchmark, representing millions of workers sitting on the sidelines. Many of these are early retirees, some incentivized to retire during the pandemic, and those with family caregiving challenges including very high costs for childcare. While the strong job market has brought some of these workers back into the workforce, it seems that many are still waiting or may not return, meaning that labor shortages will likely persist in many sectors of the economy. I've laid out many of the challenges, so now let me talk about what the Federal Reserve is doing to get inflation under control. In the face of inflation that continues to be much too high and in light of the recent high readings, the FOMC raised the federal funds rate by 75 basis points at our most recent meeting last week. That increase followed two rate hikes totaling 75 basis points earlier this year, and we indicated that further increases will likely be appropriate in the months ahead. On June 1, the Fed took a separate step to tighten monetary policy by beginning to reduce its large balance sheet of securities holdings. I strongly supported the FOMC's decision last week, and I expect to support additional rate increases until we see significant progress toward bringing inflation down. Based on current inflation readings, I expect that an additional rate increase of 75 basis points will be appropriate at our next meeting as well as increases of at least 50 basis points in the next few subsequent meetings, as long as the incoming data support them. Depending on how the economy evolves, further increases in the target range for the federal funds rate may be needed after that. The case for further rate hikes is made stronger by the current level of the "real" federal funds rate, which is the difference between the nominal rate and near-term inflation expectations. With inflation much higher than the federal funds rate, the real federal funds rate is negative, even after our rate increases this year. Since inflation is unacceptably high, it doesn't make sense to have the nominal federal funds rate below near-term inflation expectations. I am therefore committed to a policy that will bring the real federal funds rate back into positive territory. While I expect that the labor market will remain strong as the FOMC continues to tighten monetary policy, these actions do not come without risk. But in my view, our number one responsibility is to reduce inflation. Maintaining our commitment to restore price stability is the best course to support a sustainably strong labor market. The Fed's credibility, earned over decades of low inflation, is a powerful policy tool that is critical to our long-term success. If that credibility erodes, it must be re-earned. As a step toward that goal, I also supported the Committee's action to begin reducing the Fed's balance sheet, which is providing unneeded economic stimulus making inflation worse. The current balance sheet is composed of Treasury securities and a significant amount of agency mortgage-backed securities (MBS). Since the longer- term goal of the balance sheet reduction plan includes a Treasuries-only balance sheet, it would make sense to eventually incorporate MBS sales into the plan so that reaching this goal does not take too long. My longer-term goal would be to get the Fed out of the business of indirectly intervening in the real estate market. In closing, I know that inflation, and our efforts to lower it, may present challenges for banks. The first session on your agenda this morning discussed interest rate risk, and I would be interested to learn how you are managing this risk so far and what you expect as the year progresses. Many of your sessions and speakers overlap with the Fed's work in supervision and much of what I'm focused on, including innovation and how best to use technology like AI and fintech to level the playing field for banks. Attracting and retaining talent, along with succession planning, are absolutely critical for long-term sustainability. One other matter is the recently issued Community Reinvestment Act (CRA) proposed rule that would significantly change supervisory implementation and qualifying activities. I strongly encourage you to review this proposal and comment so that banks subject to the CRA understand the changes and will be able to continue to effectively serve their customers and communities. I look forward to hearing your thoughts on these issues, and I look forward to our discussion. Thanks again for the invitation to join you this week--it's great to be here with you to discuss these and other important matters.

r220708a_FOMC

united states

Crypto-Assets and Decentralized Finance through a Financial Stability Lens

brainard

Recent volatility has exposed serious vulnerabilities in the crypto financial system. While touted as a fundamental break from traditional finance, the crypto financial system turns out to be susceptible to the same risks that are all too familiar from traditional finance, such as leverage, settlement, opacity, and maturity and liquidity transformation. As we work to future-proof our financial stability agenda, it is important to ensure the regulatory perimeter encompasses crypto finance. New technology often holds the promise of increasing competition in the financial system, reducing transaction costs and settlement times, and channeling investment to productive new uses. But early on, new products and platforms are often fraught with risks, including fraud and manipulation, and it is important and sometimes difficult to distinguish between hype and value. If past innovation cycles are any guide, in order for distributed ledgers, smart contracts, programmability, and digital assets to fulfill their potential to bring competition, efficiency, and speed, it will be essential to address the basic risks that beset all forms of finance. These risks include runs, fire sales, deleveraging, interconnectedness, and contagion, along with fraud, manipulation, and evasion. In addition, it is important to be on the lookout for the possibility of new forms of risks, since many of the technological innovations underpinning the crypto ecosystem are relatively novel. Far from stifling innovation, strong regulatory guardrails will help enable investors and developers to build a resilient digital native financial infrastructure. Strong regulatory guardrails will help banks, payments providers, and financial technology companies (FinTechs) improve the customer experience, make settlement faster, reduce costs, and allow for rapid product improvement and customization. We are closely monitoring recent events where risks in the system have crystallized and many crypto investors have suffered losses. Despite significant investor losses, the crypto financial system does not yet appear to be so large or so interconnected with the traditional financial system as to pose a systemic risk. So this is the right time to ensure that like risks are subject to like regulatory outcomes and like disclosure so as to help investors distinguish between genuine, responsible innovation and the false allure of seemingly easy returns that obscures significant risk. This is the right time to establish which crypto activities are permissible for regulated entities and under what constraints so that spillovers to the core financial system remain well contained. Several important insights have emerged from the recent turbulence in the crypto- finance ecosystem. First, volatility in financial markets has provided important information about crypto's performance as an asset class. It was already clear that crypto-assets are volatile, and we continue to see wild swings in crypto-asset values. The price of Bitcoin has dropped by as much as 75 percent from its all-time high over the past seven months, and it has declined almost 60 percent in the three months from April through June. Most other prominent crypto-assets have experienced even steeper declines over the same period. Contrary to claims that crypto-assets are a hedge to inflation or an uncorrelated asset class, crypto-assets have plummeted in value and have proven to be highly correlated with riskier equities and with risk appetite more generally. Second, the Terra crash reminds us how quickly an asset that purports to maintain a stable value relative to fiat currency can become subject to a run. The collapse of Terra and the previous failures of several other unbacked algorithmic stablecoins are reminiscent of classic runs throughout history. New technology and financial engineering cannot by themselves convert risky assets into safe ones. Third, crypto platforms are highly vulnerable to deleveraging, fire sales, and contagion--risks that are well known from traditional finance--as illustrated by the freeze on withdrawals at some crypto lending platforms and exchanges and the bankruptcy of a prominent crypto hedge fund. Some retail investors have found their accounts frozen and suffered large losses. Large crypto players that used leverage to boost returns are scrambling to monetize their holdings, missing margin calls, and facing possible insolvency. As their distress intensifies, it has become clear that the crypto ecosystem is tightly interconnected, as many smaller traders, lenders, and DeFi (decentralized finance) protocols have concentrated exposures to these big players. Finally, we have seen how decentralized lending, which relies on overcollateralization to substitute for intermediation, can serve as a stress amplifier by creating waves of liquidations as prices fall. The recent turbulence and losses among retail investors in crypto highlight the urgent need to ensure compliance with existing regulations and to fill any gaps where regulations or enforcement may need to be tailored--for instance, for decentralized protocols and platforms. As we consider how to address the potential future financial stability risks of the evolving crypto financial system, it is important to start with strong basic regulatory foundations. A good macroprudential framework builds on a solid foundation of microprudential regulation. Future financial resilience will be greatly enhanced if we ensure the regulatory perimeter encompasses the crypto financial system and reflects the principle of same risk, same disclosure, same regulatory outcome. By extending the perimeter and applying like regulatory outcomes and like transparency to like risks, it will enable regulators to more effectively address risks within crypto markets and potential risks posed by crypto markets to the broader financial system. Strong guardrails for safety and soundness, market integrity, and investor and consumer protection will help ensure that new digital finance products, platforms, and activities are based on genuine economic value and not on regulatory evasion, which ultimately leaves investors more exposed than they may appreciate. Due to the cross-sectoral and cross-border scope of crypto platforms, exchanges, and activities, it is important that regulators work together domestically and internationally to maintain a stable financial system and address regulatory evasion. The same-risk-same-regulatory-outcome principle guides the Financial Stability Board's work on stablecoins, crypto-assets, and DeFi; the Basel consultation on the prudential treatment of crypto-assets; the work by the International Organization of Securities Commissions' FinTech network; the work by federal bank regulatory agencies on the appropriate treatment of crypto activities at U.S. banks; and a host of other international and domestic work. In implementing a same-risk-same-regulatory-outcome principle, we should start by ensuring basic protections are in place for consumers and investors. Retail users should be protected against exploitation, undisclosed conflicts of interest, and market manipulation--risks to which they are particularly vulnerable, according to a host of research. If investors lack these basic protections, these markets will be vulnerable to runs. Second, since trading platforms play a critical role in crypto-asset markets, it is important to address noncompliance and any gaps that may exist. We have seen crypto- trading platforms and crypto-lending firms not only engage in activities similar to those in traditional finance without comparable regulatory compliance, but also combine activities that are required to be separated in traditional financial markets. For example, some platforms combine market infrastructure and client facilitation with risk-taking businesses like asset creation, proprietary trading, venture capital, and lending. Third, all financial institutions, whether in traditional finance or crypto finance, must comply with the rules designed to combat money laundering and financing of terrorism and to support economic sanctions. Platforms and exchanges should be designed in a manner that facilitates and supports compliance with these laws. The permissionless exchange of assets and tools that obscure the source of funds not only facilitate evasion, but also increase the risk of theft, hacks, and ransom attacks. These risks are particularly prominent in decentralized exchanges that are designed to avoid the use of intermediaries responsible for know-your-customer identification and that may require adaptations to ensure compliance at this most foundational layer. Finally, it is important to address any regulatory gaps and to adapt existing approaches to novel technologies. While regulatory frameworks clearly apply to DeFi activities no less than to centralized crypto activities and traditional finance, DeFi protocols may present novel challenges that may require adapting existing approaches. The peer-to-peer nature of these activities, their automated nature, the immutability of code once deployed to the blockchain, the exercise of governance functions through tokens in decentralized autonomous organizations, the absence of validated identities, and the dispersion or obfuscation of control may make it challenging to hold intermediaries accountable. It is not yet clear that digital native approaches, such as building in automated incentives for undertaking governance responsibilities, are adequate alternatives. There are two specific areas that merit heightened attention because of heightened risks of spillovers to the core financial system: bank involvement in crypto activities and stablecoins. To date, crypto has not become sufficiently interconnected with the core financial system to pose broad systemic risk. But it is likely regulators will continue to face calls for supervised banking institutions to play a role in these markets. Bank regulators will need to weigh competing considerations in assessing bank involvement in crypto activities ranging from custody to issuance to customer facilitation. Bank involvement provides an interface where regulators have strong sightlines and can help ensure strong protections. Similarly, regulators are drawn to approaches that effectively subject the crypto intermediaries that resemble complex bank organizations to bank-like regulation. But bringing risks from crypto into the heart of the financial system without the appropriate guardrails could increase the potential for spillovers and has uncertain implications for the stability of the system. It is important for banks to engage with beneficial innovation and upgrade capabilities in digital finance, but until there is a strong regulatory framework for crypto finance, bank involvement might further entrench a riskier and less compliant ecosystem. Stablecoins represent a second area with a heightened risk of spillovers. Currently, stablecoins are positioned as the digital native asset that bridges from the crypto financial system to fiat. This role is important because fiat currency is referenced as the unit of account for the crypto financial system. Stablecoins are currently the settlement asset of choice on and across crypto platforms, often serving as collateral for lending and trading activity. As highlighted by large recent outflows from the largest stablecoin, stablecoins pegged to fiat currency are highly vulnerable to runs. For these reasons, it is vital that stablecoins that purport to be redeemable at par in fiat currency on demand are subject to the types of prudential regulation that limit the risk of runs and payment system vulnerabilities that such private monies have exhibited historically. Well-regulated stablecoins might bring additional competition to payments, but they introduce other risks. There is a risk of fragmentation of stablecoin networks into walled gardens. Conversely, there is a risk that a single dominant stablecoin might emerge, given the winner-takes-all dynamics in such activities. Indeed, the market is currently highly concentrated among three dominant stablecoins, and it risks becoming even more concentrated in the future. The top three stablecoins account for almost 90 percent of transactions, and the top two of these account for 80 percent of market capitalization. Given the foundational role of fiat currency, there may be an advantage for future financial stability to having a digital native form of safe central bank money--a central bank digital currency. A digital native form of safe central bank money could enhance stability by providing the neutral trusted settlement layer in the future crypto financial system. A settlement layer with a digital native central bank money could, for instance, facilitate interoperability among well-regulated stablecoins designed for a variety of use cases and enable private-sector provision of decentralized, customized, and automated financial products. This development would be a natural evolution of the complementarity between the public and private sectors in payments, ensuring strong public trust in the one-for-one redeemability of commercial bank money and stablecoins for safe central bank money. Crypto and fintech have introduced competition and put the focus on how innovation can help increase inclusion and address other vexing problems in finance today. Slow and costly payments particularly affect lower-income households with precarious cash flows who rely on remittances or miss bills waiting on paychecks. Many hard-working individuals cannot obtain credit to start businesses or to respond to an emergency. But while innovation and competition can reduce costs in finance, some costs are necessary to keep the system safe. Intermediaries earn revenues in exchange for safely providing important services. Someone must bear the costs of evaluating risk, maintaining resources to support those risks through good times and bad, complying with laws that prevent crime and terrorism, and serving less sophisticated customers fairly and without exploitation. In the current crypto ecosystem, often no one is bearing these costs. So when a service appears cheaper or more efficient, it is important to understand whether this benefit is due to genuine innovation or regulatory noncompliance. So as these activities evolve, it is worth considering whether there are new ways to achieve regulatory objectives in the context of new technology. Distributed ledgers, smart contracts, and digital identities may allow new forms of risk management that shift the distribution of costs. Perhaps in a more decentralized financial system, new approaches can be designed to make protocol developers and transaction validators accountable for ensuring financial products are safe and compliant. Innovation has the potential to make financial services faster, cheaper, and more inclusive and to do so in ways that are native to the digital ecosystem. Enabling responsible innovation to flourish will require that the regulatory perimeter encompass the crypto financial system according to the principle of like risk, like regulatory outcome, and that novel risks associated with the new technologies be appropriately addressed. It is important that the foundations for sound regulation of the crypto financial system be established now before the crypto ecosystem becomes so large or interconnected that it might pose risks to the stability of the broader financial system.