July 12, 2017

House Financial Services Committee: Monetary Policy and the State of the Economy

Key Topics & Takeaways

  • Federal Reserve Balance Sheet: Committee members addressed a number of issues regarding the Fed balance sheet. Yellen explained ways the Fed plans to reduce the balance sheet, including diminishing reinvestments as the Fed receives principle payments on treasuries. Yellen indicated timing is very important, and reducing the balance sheet must be done in a “gradual and predictable way.”
  • Regulatory Burden: Yellen stated that the Volcker Rule and incentive compensation regulations should not be applied to smaller community banks, and that regarding Basel III, she believes a simplified capital regime should be in place for community banks.
  • Audit the Fed: Yellen stated she is “strongly opposed” to the legislation as it removes the Fed’s exemption from reviews by the U.S. Government Accountability Office (GAO) of monetary policy decisions, which is the “essence of Fed independence.”


  • The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System

Opening Statements

In his opening statement, Chairman Jeb Hensarling (R-Texas) said that economic confidence is up and unemployment and inflation are low since Chair Yellen’s last testimony before the committee. Hensarling expressed concern that the unemployment rate rests too heavily on a low labor participation rate and high disability payment participation rates, and that paychecks and savings for working Americans still have “considerable room to grow.” Hensarling highlighted that monetary policy must “do its part” and continue on its path to normalization. Hensarling encouraged the Fed to “set out an easily discernible and transparent policy strategy to achieve its mandate,” commence a wind-down of its balance sheet, and allow short-term rates to be set by market forces.


In her opening statement, Ranking Member Maxine Waters (D-N.Y.) expressed concern about the progress of the economy under the Trump administration, including the reversal of a planned cut to Federal Housing Administration mortgage insurance premiums, executive actions to begin to dismantle Wall Street reform, and support for the CHOICE Act. Waters said that while the economy has made “substantial progress” since the height of the financial crisis, key aspects of the economy “have yet to fully recover.”

In his opening statement, Rep. Andy Barr (R.-Ky.) said that labor force participation is at a 40-year low, wages are stagnant, and economic growth has not yet exceeded three percent. Barr said the Federal Reserve is “paying banks not to lend” by paying interest on excess reserves in order to fund its $4.5 trillion balance sheet. Barr expressed his support for the Fed shrinking the balance sheet and following a “well-grounded strategy.”

In her opening statement, Rep. Gwen Moore (D-Wis.) expressed her concern about disparities in labor markets for minority communities. Moore stated that while the disparities are clear among minorities, it is increasing for all working Americans. Moore said Congress should use fiscal policy to address income and wealth inequality in ways monetary policy cannot.


The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System

In her testimony, Yellen said that since her last testimony before the committee, the labor market has strengthened, job gains have averaged 18,000 per month, the unemployment rate has fallen a quarter percentage, and the labor force participation rate has not significantly changed. She stated that going forward, favorable financial conditions coupled with the prospect of continued foreign and domestic spending gains should continue to support business investment, and the economy will “continue to expand at a moderate pace over the next couple of years, with the job market strengthening somewhat further and inflation rising to two percent.”


Yellen addressed current monetary policy, stating that the Federal Open Market Committee (FOMC) will continue to foster maximum employment and price stability as required by law. Yellen said the FOMC will adjust their assessments of the appropriate path of the federal funds rate in response to changes in the economic outlook and to their judgments of the associated risks. Addressing the Fed balance sheet, Yellen highlighted that the FOMC provided additional details on the process the Fed will follow to normalize the size of the balance sheet, including reducing the Federal Reserve’s security holdings by decreasing its reinvestment of the principal payments it receives from the securities held in the System Open Market Account. Yellen highlighted that the committee intends to change the target range for the federal funds rate as a primary means of adjusting the stance of monetary policy, and does not intend to use the balance sheet as an active tool for monetary policy. Yellen stated they are committed to using the “full range of tools” at their disposal, however, if future economic conditions warrant a more accommodative monetary policy.

Question & Answer

Inflation Target
Hensarling asked Yellen if she or members of the Federal Open Market Committee (FOMC) are pursuing an increase in the two percent inflation target, to which she replied no.


Waters asked if the Fed should allow inflation to continue to rise to the two percent objective before additional interest rate increases, and Rep. Brad Sherman (D-Calif.) also inquired about the objective. Yellen replied that the two percent objective “is not a ceiling,” and is instead a “symmetric objective.” She explained that the “unusually low” inflation readings are partly due to temporary factors, and that until those factors “move out,” inflation rates will remain low.


Credit Allocation
Hensarling noted his concern over the “blurring between the lines” of monetary and fiscal policy, especially when it comes to credit allocation, as it can hinder the Fed’s independence. Yellen replied that the FOMC intends to return to a “primarily Treasury-only portfolio” so credit allocation is not influenced.


Fed Balance Sheet
Hensarling stated that reducing the Fed’s balance sheet will enable the Fed to make the primary policy instrument the federal funds rate rather than interest on reserves. Yellen explained that interest on excess reserves is a “key tool” for setting the federal funds rate, and a “key instrument of monetary policy.”

Barr asked why the Fed’s plan to decrease their balance sheet includes Treasury securities at a faster pace than mortgage bonds. Yellen explained that there are slight differences between the two, but that she expects the caps on mortgage-backed securities (MBS) reinvestment to not be binding, and instead “only come into play in exceptional circumstances.”


Rep. Carolyn Maloney (D-N.Y.) asked if the Fed should wait for inflation to improve prior to normalizing the balance sheet. Yellen replied that “exact timing does not matter a great deal,” and that they are working to normalize the balance sheet in a “gradual, predictable way.”


Maloney then asked if increasing interest rates and balance sheet normalization are on separate tracks, or if rates will be impacted by the normalization process. Yellen explained that the FOMC has not made a decision about whether the two will happen at the same time, but that it was agreed to at the June meeting that one additional increase in the federal funds rate this year is appropriate based on the economy.


Rep. David Kustoff (R-Tenn.) asked about the timeline and procedure to shrink the balance sheet. Yellen stated the Fed will shrink the balance sheet by diminishing reinvestments as the Fed receives principle payments on treasuries, only reinvesting to the extent the receipt of principle reaches a cap.


Taylor Rule
Rep. Gwen Moore (D-Wis.) asked Yellen to explain her criticism of the Taylor Rule. Yellen replied that the FOMC looks at multiple rules, to include the Taylor Rule, to decide appropriate policy stances, but that they should not follow any single rule.


Financial CHOICE Act
Moore asked Yellen about the rules-based monetary policy approach found in the CHOICE Act. Yellen replied that she is opposed to the requirements found in the bill, including subjecting the Fed to the appropriations process and inhibiting their independence.


Fed Vacancies
Maloney and Kustoff asked Yellen if she is open to serving an additional term if President Trump were to re-nominate her. Yellen replied that she has not given further thought to it, but that she intends to finish her current term.


Rep. Blaine Luetkemeyer (R-Mo.) requested that the Fed hold off on any new regulations prior to the confirmation of the Vice Chair for Supervision nominee. Yellen noted her pleasure in the nomination and how she is looking forward to the nominee’s input should they be confirmed, adding that the Fed currently has a “relatively light regulatory agenda.”


Treasury Report
Luetkemeyer asked about the recent Treasury report in response to the Executive Order on Core Principles Regulating the U.S., noting his support for several of the inclusions. Yellen replied that there were many useful suggestions that Treasury has considered when it comes to tailoring regulations and reducing the burdens on community banks, and that the Volcker Rule recommendations “are useful,” but that she has a different view on some of the other inclusions.


Regulatory Burden

Rep. Claudia Tenney (R-N.Y.) asked what recommendations Yellen would support to reduce the regulatory burden on community banks. Yellen replied that the Volcker Rule and incentive compensation regulations should not be applied to smaller community banks, and that there is much bank regulators can do to reduce the complexities of capital regulations.


Rep. Trey Hollingsworth (R-Ind.) asked Yellen for her stance on Basel III, to which Yellen replied she believes it should be finalized and other countries should put into place appropriate capital regulation to “level the playing field,” but supports a simplified capital regime for community banks.


Non-Bank SIFIs
Rep. Tom MacArthur (R-N.J.) asked Yellen about state insurance departments doing the regulatory work of a group insurer, and how it impacts the way FSOC looks at non-bank systemically important financial institutions (SIFIs). Yellen replied that FSOC has met with state regulators and that their focus is on protecting policy holders, while FSOC’s focus is on the systemic risk of a company on the financial system.



Hollingsworth asked if Yellen agrees or disagrees that U.S. rules implementing international standards should be revisited, including the global systemically important banks (GSIB) risk-based surcharge. Yellen stated that she participated in the review and recent finalization of the rule and believes it to be appropriate.


Hollingsworth asked if Yellen is supportive in revisiting the calibration of the supplemental leverage ratio (SLR) for G-SIBs. Yellen replied that it is “something we should look at” as possibly having unintended consequences.


Fixed Income

Rep. Bill Huizenga (R-Mich.) asked if there are problems in the fixed income markets. Yellen responded that though the inventories of bonds held by some of the largest banks and market makers have declined, bid-ask spreads are low, corporate bond issuance has been healthy, and the market has done well.


Role of the Federal Reserve in Corporate Board Rooms

Rep. Sean Duffy (R.-Wis.) asked about the role of the Federal Reserve in corporate board rooms at financial institutions, stating that “virtually anything can fall under the umbrella of safety and soundness,” highlighting that the Fed does not have liability. Yellen responded that the Fed has a supervisory role, but does not have civil or criminal liability.


Audit the Fed

Rep. Bill Posey (R-Fla.) highlighted that Audit the Fed was a widely cosponsored and bipartisan legislation, and asked what would justify not auditing the Fed similar to other agencies. Yellen responded that she is “strongly opposed” to the legislation because it removes the Fed’s exemption from reviews by the U.S. Government Accountability Office (GAO) of monetary policy decisions, which is the “essence of Fed independence” and keeping politics out of decisions that “should be technical, professional, and non-partisan.”

For more information on this hearing, please click here.