MCHENRY: In essence, the E.U. is going a different direction when it comes to sovereign debt than we are in the United States. How would you react to that?
YELLEN: I believe the exemption for U.S. debt markets was built into Dodd-Frank. That was explicit in Dodd-Frank.
MCHENRY: OK. So but -- what is your reaction to that? We're policymakers. We could remedy that if you think that, that is a flaw.
YELLEN: You know, we have tried to write a rule that is consistent with Dodd-Frank as it was legislated.
MCHENRY: So if we -- would you look favorably upon us saying that sovereign debt should not be exempt or should comparable to corporate debt?
YELLEN: That's something I would have to look at more carefully. I...
MCHENRY: But did you not look more carefully at this subject matter when you wrote the Volcker rule?
YELLEN: Well, we -- we put into effect the allowance that Congress included in Dodd-Frank to exempt treasury securities.
MCHENRY: Yeah -- well, no, that's treasury securities. I'm asking about sovereign debt, which was excluded from the Volcker rule. Written into the language of Dodd-Frank is exclusion of U.S. sovereign debt, not the exclusion of other sovereign debt.
I would call this a lack of enthusiasm from you.

"I'm one that thinks that Greece could exit, and it could be handled in an appropriate way without causing too much damage, either in Europe or in the U.S.," St. Louis Federal Reserve Bank President James Bullard told Reuters.

I’ve heard Europe’s policy described as kicking the can down the road. But the risk is that Europe might be rolling an ever-growing snowball down a hill.

While difficult work still lies ahead, countries in the euro area have made meaningful progress toward achieving long- term fiscal sustainability.

I do not anticipate further efforts by the Federal Reserve to address the potential spillover effects of Europe on the United States.”

Although U.S. banks have limited exposure to peripheral European countries, their exposures to European banks and to the larger, "core" countries of Europe are more material. Moreover, European holdings represented 35 percent of the assets of prime U.S. money market funds in February, and these funds remain structurally vulnerable despite some constructive steps.  Were the situation in Europe to take a severe turn for the worse, the U.S. financial sector likely would have to contend not only with problems stemming from its direct European exposures, but also with an array of broader market movements, including declines in global equity prices, increased credit costs, and reduced availability of funding.

{The sovereign debt crisis} is causing, as you know, a good bit of -- of anxiety in markets. And that's been affecting our economy, both last summer and now recently as well.

We are spending a lot of time evaluating the exposures of U.S. financial institutions to these countries, including money market mutual funds and so on.

See also a more extensive comment in Bernanke's June 22 press conference.

The banks that we regulate are not significantly exposed to—to {the peripheral European } countries directly, at least. They have significant exposures to European banks in the nonperipheral countries, and so indirectly, they have that exposure. The—and that statement which I just made includes credit default swaps and so on… We have asked the banks to essentially do stress tests and ask, looking at all their positions, all their hedges, What would the effect on their capital be if Greece defaulted? And the answer is that the effects are very small.  

It’s also the case that—well, we don’t oversee the money market mutual funds. We have been keeping a close eye on that situation. There again, the situation is similar in some sense, in that except—with very few exceptions, the money market mutual funds don’t have much direct exposure to the three peripheral countries which are currently dealing with debt problems. They do have very substantial exposure to European banks in the so-called core countries: Germany, France, et cetera. So to the extent that there is indirect impact on—on the core European banks, that does pose some concern to money market mutual funds and is a reason why the Federal Reserve and other regulators are continuing to look at ways to strengthen money market mutual funds.  

See also a similar remark in Bernanke's Senate MPR hearing in July 2011.

Despite the weaker data seen recently, the preconditions for a pickup in growth in 2011 appear to remain in place. Monetary policy remains very accommodative, and financial conditions have become more supportive of growth, in part because a concerted effort by policymakers in Europe has reduced fears related to sovereign debts and the banking system there...

Although output growth should be stronger next year, resource slack and unemployment seem likely to decline only slowly. The prospect of high unemployment for a long period of time remains a central concern of policy. Not only does high unemployment, particularly long-term unemployment, impose heavy costs on the unemployed and their families and on society, but it also poses risks to the sustainability of the recovery itself through its effects on households' incomes and confidence...

Maintaining price stability is also a central concern of policy. Recently, inflation has declined to a level that is slightly below that which FOMC participants view as most conducive to a healthy economy in the long run. With inflation expectations reasonably stable and the economy growing, inflation should remain near current readings for some time before rising slowly toward levels more consistent with the Committee's objectives.

We will soon give notice to the third anniversary since the onset of the global financial crisis. As we mark this occasion--and continue to witness shocks arising intermittently and unevenly--it might be worth debunking some popular views that have become part of the crisis narrative. In their stead, I will begin with what I believe are some truths, perhaps hiding in plain sight all along.

Subprime mortgages were not at the core of the global crisis; they were only indicative of the dramatic mispricing of virtually every asset everywhere in the world. The crisis was not made in the USA, but first manifested itself here. The volatility in financial markets is not the source of the problem, but a critical signpost. Too-big-to-fail exacerbated the global financial crisis, and remains its troubling legacy. Excessive growth in government spending is not the economy's salvation, but a principal foe. Slowing the creep of protectionism is no small accomplishment, but it is not the equal of meaningful expansion of trade and investment opportunities to enhance global growth. The European sovereign debt crisis is not upsetting the stability in financial markets; it is demonstrating how far we remain from a sustainable equilibrium. Turning private-sector liabilities into public-sector obligations may effectively buy time, but it alone buys neither stability nor prosperity over the horizon.

They’ve tightened some with the stock market down, the dollar up, and LIBOR up, which will feed through to some bank loans; below-investment-grade borrowing rates also are higher. That, along with the slowdown in Europe, is going to take something off of growth. I don’t think it’s going to be a major setback. But it will take something off of what already was a gradual expansion.

My sense is that, while the sovereign debt crisis in Europe is indeed a serious matter, the global recovery at this point looks very strong and seems unlikely to be derailed.

Unless events in Europe turn out to be much worse, I think that in the near term, the U.S. is probably a beneficiary of the crisis in Europe... I don’t think it should push back [the date for the Fed to begin tightening].

I am often asked about the possible impact of European difficulties and uncertainties on my forecast... I believe that a European downturn would have only a modest impact on the pace of our recovery.

The actions taken by European leaders represent a firm commitment to resolve the prevailing stresses and restore market confidence and stability. If markets continue to stabilize, then the effects of the crisis on economic growth in the United States seem likely to be modest. Although the recent fall in equity prices and weaker economic prospects in Europe will leave some imprint on the U.S. economy, offsetting factors include declines in interest rates on Treasury bonds and home mortgages as well as lower prices for oil and some other globally traded commodities. The Federal Reserve will remain highly attentive to developments abroad and to their potential effects on the U.S. economy.

How will recent events in Europe affect the U.S. economy?

There are a few channels through which the European sovereign debt problems could influence us here. European efforts to lower debt will likely weigh on their economic growth over the medium term. This will translate into less demand by Europeans for U.S. products. In addition, the dollar already has appreciated relative to the euro. This means that European consumers find our products to be relatively more expensive than before. At the same time, prices for European goods in terms of the dollar have fallen, boosting our demand for European imports. All of these channels work in the direction of lowering U.S. net exports, which, all else being equal, would tend to reduce the outlook for U.S. GDP growth.

However, a couple of factors suggest that these trade effects of the European fiscal situation on the U.S. economy are likely to be limited. Although the euro-11 economy is large, it represents only about 15 percent of U.S. exports...

Nonetheless, if events in Europe evolve so that they have a more severe and broad impact on financial markets, then the scope of the problems for the U.S. could be magnified. Fortunately, our direct exposure to European debt is limited. But an intensification of liquidity or solvency problems in Europe and some related spillover losses in U.S. markets could cause a marked increase in investor risk aversion. More lenders could pull back on intermediation, restricting the flow of credit to fund worthy spending projects of U.S. firms and households.