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From Banking and Finance Law Daily, February 12, 2014

Yellen addresses Financial Services hearing for the first time

By Colleen M. Svelnis, J.D.

Chairman of the Board of Governors of the Federal Reserve System, Janet Yellen, testified on the conduct of monetary policy and the state of the economy in front of the House Financial Services Committee and took questions from its members. The hearing, entitled “Monetary Policy and the State of the Economy,” was held on Feb. 11, 2014, and Yellen gave the first of her semi-annual reports to Congress on the state of the U.S. economy and the nation’s financial welfare, as mandated under the Humphrey-Hawkins Act.

Opening statements. Chairman Jeb Hensarling (R-Texas) stated that the most critical issue the committee needed to examine was “the limit of monetary policy to actually promote a healthy economy.” In addition, he stated the intent to review the new banking regulatory powers the Federal Reserve obtained under the Dodd-Frank Act and “why it fails to conduct formal cost-benefit analysis.”

Ranking member Maxine Waters (D-Calif) expressed concern with unemployment levels. “As you know, 3.6 million Americans have been out of work for 27 weeks or more. And I fear that any further delay in addressing the problem could permanently damage the labor force and slow the economy’s ability to grow over the long-term.” She added, “I hope you will press your colleagues on the Federal Open Market Committee to take into account the ongoing impact that this long-term unemployment crisis is having on millions of American families.” Congressman Waters also expressed concern with growing income inequality and issues related to implementation of the Dodd-Frank Act.

Vice Chair Bill Huizenga (R-Mich) stated that he was “eager” to hear Yellen’s insights on monetary policy and the state of the economy, specifically the Volcker Rule. Huizenga noted that “since the creation of the Fed in 1913 the Fed's power has significantly expanded over the last 100 years.” He noted that the Fed was originally created to supervise and monitor the banking systems and called its current role of “the lender of last resort to banking institutions that require additional credit to stay afloat,” something that needs to be explored.

Yellen testimony. Yellen, who was sworn into office on February 3, testified about the current economic situation and outlook, monetary policy, and regulatory reform. In addition she delivered the Fed’s semiannual Monetary Policy Report which was submitted to both houses of Congress. Yellen stated that economic activity has increased and fueled progress in the labor market, citing the addition of about 1.25 million jobs since last July. She acknowledged that the unemployment rate is still well above levels that the FOMC estimates is consistent with maximum sustainable employment and that those out of a job for more than six months continue to make up an unusually large fraction of the unemployed. Yellen also testified that, among the major components of gross domestic product, household and business spending growth stepped up during the second half of last year and inflation remained low. She attributed some of the recent softness to transitory factors, including falling prices for crude oil and declines in non-oil import prices. “My colleagues on the FOMC and I anticipate that economic activity and employment will expand at a moderate pace this year and next, the unemployment rate will continue to decline toward its longer-run sustainable level, and inflation will move back toward 2 percent over coming years,” Yellen stated.

Monetary policy. Yellen emphasized that there would be continuity in the monetary policy approach and said that the strategy is designed to fulfill the Fed’s statutory mandate of maximum employment and price stability. The FOMC has relied on asset purchases and forward guidance “to help the economy move toward maximum employment and price stability.” Yellen said these tools support consumer spending, business investment, and housing construction, and put downward pressure on longer-term interest rates and supporting asset prices.

Regulatory reforms and supervisory actions. Yellen discussed the proposed rule issued in October to strengthen the liquidity positions of large and internationally active financial institutions as well as the implementation of the Volcker Rule in December. Other issues she discussed that the Fed is working on included:

  • finalizing the rules implementing enhanced prudential standards mandated by section 165 of the Dodd-Frank Act;

  • finalizing the proposed rule strengthening the leverage ratio standards for U.S.-based, systemically important global banks;

  • issuing proposals for a risk-based capital surcharge for those banks as well as for a long-term debt requirement to help ensure that these organizations can be resolved;

  • working to advance proposals on margins for non-cleared derivatives, consistent with a new global framework; and

  • evaluating possible measures to address financial stability risks associated with short-term wholesale funding—and continue monitoring for emerging risks.

In response to Chairman Yellen’s appearance at the hearing, Robert Hurt (R-Va) released a statement that said “[t]he bottom line is that the Federal Reserve’s monetary and regulatory policies are harming those Americans living on fixed incomes and are disproportionately impacting Main Street banks and community financial institutions. These policies harm those saving for retirement and restrict access to credit and impose higher costs on those attempting to grow their businesses or increase production on their farms.”

Spencer Bachus (R-Ala), who has expressed concerns about the impact the Volcker Rule could have on the financial health of small and medium-sized banks, asked whether a clarification of the rules exempting some institutions from new rules governing certain financial securities can be expected. In response, Yellen said she did not know what response a working group of regulators might propose, but said she hoped a decision would come “reasonably soon.” Bachus also questioned the employment assumptions that the Fed has relied on to justify its “quantitative easing” program. Bachus said the Fed’s recent stimulus policies are less likely to affect structural changes in the economy and could be more inflationary than anticipated.

Congressional response. Joyce Beatty (D-Ohio) said in a statement that she was interested in hearing Yellen’s strategy and approach on how the Fed will approach achieving both parts of its dual mandate of helping the economy return to full inflation and returning inflation to two percent. Emanuel Cleaver (D-Mo) noted that the economy has continued to grow, even slowly and focused on unemployment when he stated, “We are increasing our GDP, lowering the rate of unemployment, and improving the state of the hard hit housing market.” He added, “I want to see Congress and the Federal Reserve doing more to ensure we reach full employment in this country.”

Other testimony. Dr. Donald Kohn, Brookings Institution, attributed the 3 percent growth in the U.S. economy in the second half of 2013 to a more robust growth in demands for goods and services from households and businesses, in addition to a “one-time boost from an increase in inventory investment.” He cautioned that “the Federal Reserve should remain vigilant for additional indications that the expected strength in spending and hiring is not coming through.”

Although growth has picked up, “the US economy still is very far from where it can and should be. The unemployment rate at a little over 6-1/2 percent is still well above the 5-1/2 percent level that many economists estimate to be its sustainable level,” Kohn said.

With regard to interest rates remaining close to zero, Kohn testified that “the most important such challenge will be deciding when to begin raising interest rates and at what pace they should rise. Raise them too soon or too steeply and growth will soften and inflation remain too low. Raise them too late or too slowly and the economy would over shoot its long-run potential and if it overshoots too much or for too long inflation will settle above its 2 percent target and inflation expectations would begin to rise. In my view, the more serious mistake would be to raise them too soon or by too much.”

Dr. John Taylor, Professor of Economics, Stanford University noted in his testimony that recent data indicate that the U.S. economy continues to underperform, terming the recession recovery “disappointing.” Taylor argued that “the main cause of the poor performance is a significant shift in economic policy away from what worked reasonably well in the decades before. Broadly speaking, monetary policy, regulatory policy, and fiscal policy each became more discretionary, more interventionist, and less predictable starting in the years leading up to the financial crisis and have largely remained in that mode.” Taylor advocated a more rules-based monetary policy, which he asserted would ensure stability and strong sustainable growth.

Dr. Mark Calabria, Director of Financial Regulation Studies at Cato Institute, testified that immediate policy discussions should begin and end with the labor market. He noted that the 113,000 new jobs estimate was considerably lower than expectations and said that it indicates continued weakness in the U.S. labor market. He further stated that the Fed’s “low interest rate policies have contributed to a rise in asset prices, which are likely to reverse as rates rise.”

Abby McCloskey, Program Director of Economic Policy, American Enterprise Institute, testified that the Dodd-Frank Act greatly expanded the regulatory and supervisory authority of the Federal Reserve. She stated that it is important for the Fed to be transparent and accountable in its rule-writing. According to McCloskey, “There are two main ways to increase low-income households’ access to financial services: increase government intervention, or reduce it.” McCloskey said that statutory economic cost-benefit analysis that is both prospective and retrospective should guide the Federal Reserve’s rulemaking, especially as it relates to traditionally underserved populations.

McCloskey also said that there is growing evidence that new rules from the Dodd-Frank Act are having a regressive impact, making it more difficult for low-income consumers to access mainstream banking. Since the passage of the Dodd-Frank Act and other related financial reforms, “prices of basic financial products and services have increased, consumer choice has been restricted, and millions of low-income consumers have been priced out of the market or forced to turn to alternative financial products.”  She concluded that the cost of regulation appears to be a significant factor. Additionally, McCloskey said that the Fed’s rules on overdraft fees and debit interchange fees are partly to blame for rising fees that disproportionately affect low-income consumers. Physical consolidation of branches has also impacted consumers. “As a result of these changes, many low-income households have been shut out of mainstream banking completely.”

MainStory: TopStory DoddFrankAct FederalReserveSystem FinancialStability FOMC VolckerRule

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