Jerome Powell

[Fed earnings] remittances averaged about $25 billion per year, or 0.2 percent of GDP, over the decade before the crisis. After the balance sheet is normalized, these remittances should return to a similar, modest share of GDP. From the standpoint of the sustainability of federal fiscal policy, remittances are not a first-order concern. That said, an extended period of zero remittances could certainly bring the Federal Reserve under criticism from the public and the Congress. The question is whether the Federal Reserve would permit inflation and thereby abandon its post in the face of such criticism. There is no reason to expect that to happen.

I want to emphasize the importance of data over date. If the Committee's economic outlook is broadly realized, there will likely be a moderation in the pace of purchases later this year. If the performance of the economy is weaker, the Committee may delay before moderating purchases or even increase them. If the economy strengthens faster than the Committee anticipates, the pace of purchases may be moderated somewhat more quickly. The path of purchases is in no way predetermined; we will monitor economic data and adjust our purchases as appropriate.

Another reform that will take time to complete is the establishment of a global framework for resolving large, systemically important banks...  As many of you know, in the United States, the Federal Deposit Insurance Corporation is developing a preferred approach to resolution for such rare cases: the single-point-of-entry (SPOE) approach. This approach may be gaining some traction internationally. In my view, SPOE can be a classic "simplifier," making theoretically possible something that seemed impossibly complex.

Under the SPOE approach, the home country resolution authority for a failing banking firm would effect a creditor-funded parent company recapitalization of the failed firm. To do so, the resolution authority would first use available parent company assets to recapitalize the firm's critical operating subsidiaries, and then would convert liabilities of the parent company into equity of a surviving entity. This approach would have the effect of concentrating the firm-wide losses on the parent company's private sector equity holders and creditors. The SPOE approach places a high priority on what your own President Weidmann recently described as "the principle of liability," meaning that those who benefit should also bear the costs.

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I will briefly discuss the Fed's proposal for oversight of foreign banks operating in the United States, which carries out a mandate from the Congress under the Dodd-Frank Wall Street Reform and Consumer Protection Act.2 Our proposal represents a targeted set of adjustments aimed at reducing the risks posed by the U.S. operations of large foreign banks to U.S. financial stability that were revealed during, and in the aftermath of, the recent financial crisis. The proposal is not intended to create a disadvantage for foreign banks in the U.S. market. Rather, the proposal is part of a larger set of regulatory reforms that substantially raises standards for all banking organizations operating in the United States and aims to achieve the goals we share with Germany: vigorous and fair competition and a stable financial system. Indeed, in some sense it follows the lead of the European Union and its member states in ensuring that all large subsidiaries of globally active banks meet Basel capital rules. We believe that our foreign bank proposal, which would increase the strength and resiliency of the U.S. operations of these firms, would meaningfully reduce the likelihood of disruptive ring-fencing at the moment of crisis that could undermine an SPOE resolution of a large foreign bank. We are fully committed to the international efforts to address cross-border resolution issues and to maintaining strong cooperation between home and host supervisors during normal and crisis periods.

[T]he case for continued support for our economy from monetary policy remains strong...   [A]s our economy has gradually improved, it has become possible, and appropriate, for the Federal Reserve to provide clearer guidance on the path of monetary policy. In all likelihood, this path will involve continued support from accommodative monetary policy for quite some time.

As auto, mortgage, and credit card loans have become increasingly standardized, community banks have had to focus to a greater extent on small business and commercial real estate lending--products where community banks’ advantages in forming relationships with local borrowers are still important. These are not cheap or easy loans to make, and the loss of some traditional product lines has threatened the stability of some community banks. It is incumbent on the Federal Reserve and other regulators to understand the challenges community banks face and to ensure that our regulatory policies do not exacerbate them.

The September decision not to reduce purchases clearly took some market participants by surprise. For me, the decision was a close call, and I would have been comfortable with a small reduction in purchases. However, as the minutes of the September FOMC meeting reflect, there were legitimate concerns about the strength of incoming economic data, the economic effects of tighter financial conditions and of tighter fiscal policy, and the prospect for disruptive events on the fiscal front.7 I supported the decision as a reasonable exercise in risk management. Events since the September meeting suggest that the concerns regarding fiscal matters were well founded.

I would like to push back against the narrative that the decision at the September meeting has damaged the Committee's communications strategy. In its communications, the Committee seeks to influence market conditions over the medium term in a way that is consistent with its policy intentions… [A]t the end of the day, my own judgment is that market expectations are now better aligned with Committee assessments and intentions.

The September decision underscored the Committee's intention to determine the pace of purchases in a data-dependent way based on progress toward our objectives. Moreover, the modest net tightening in financial conditions since the June meeting has likely reduced the prevalence of highly leveraged, speculative positions. I believe that the market is now prepared for a reduction in purchases when the economic outlook and the broader situation support it.

Short term rates have fallen back since the September meeting, and are now better aligned with the Committee's forward rate guidance. This is particularly important because, as the Chairman stressed in September, the Committee views rate policy as its stronger and more reliable tool.

Fed Governor Jerome Powell acknowledged financial markets had been surprised when the central bank opted not to taper its bond purchase program last month, and conceded there had been a prolonged silence from policymakers ahead of the decision.

"It is fair to point out that there weren't many major policy speeches in the last couple of months leading up to the nomination of Janet Yellen for the chair," he said in response to a question. "So there was a time there when the leadership wasn't speaking."

As reported by Reuters News

Of course, the other side of this coin is that concentrating risk in a central counterparty could create a single point of failure for the entire system. Given their heightened prominence in the financial infrastructure, if CCPs are to mitigate systemic risks they must hold themselves to--and be held to--the highest standards of risk management. In many respects, CCPs are the collective reflection of the financial institutions that are their members and the markets that they support.

The framework requires both financial firms and systemically important nonfinancial firms that trade derivatives to collect both variation margin and initial margin, as is the case for centrally cleared derivatives. The initial margin requirements represent a significant change to existing market practice and will undoubtedly impose some costs on market participants. As originally proposed, the new framework would have required most market participants to collect initial margin from the first dollar of exposure. The International Swap Dealers Association estimated that roughly an additional $1.7 trillion in initial margin would have been required globally.12 In light of this concern, the framework was released for public consultation on two separate occasions and the Basel Committee and IOSCO conducted a detailed impact study to determine the potential liquidity costs of the new requirement.

The final version of the framework addressed these concerns by allowing firms to begin collecting initial margin only as potential future credit exposures rise above $65 million for a particular counterparty. According to the impact study, this revision reduced the estimated global liquidity requirement from roughly $2.3 trillion to $900 billion.14 The result is a margin regime that will protect the financial system from the largest and most systemic exposures while also reducing overall liquidity costs and providing relief to smaller derivatives market participants.

In recent years, two separate developments have called into question the wisdom of that arrangement. I have already mentioned the first one--the emergence of a pervasive pattern of attempted manipulation of LIBOR dating back many years…

A second problem is that unsecured interbank borrowing has been in a secular decline that predates the global financial crisis. Changes in bank behavior following the crisis exacerbated the decline and further weakened the foundation of LIBOR. The result is a scarcity, or outright absence in longer tenors, of actual transactions that banks can use to estimate their daily submission to LIBOR. Ongoing regulatory reforms and the shift away from unsecured funding raise the possibility that unsecured interbank borrowing transactions may become even more infrequent in the future. While it is also possible that activity in these markets could rebound, the threat that this form of borrowing may decline further, particularly in periods of stress, seems likely to remain.

So let me pose a question: Is it wise to rely on a critical benchmark that is built on a market in decline? Clearly not. The risks to market functioning are simply too great. For example, market activity could decline to the point where publication of a rate becomes untenable. And many of the panel banks have expressed concerns about the ongoing legal risks of remaining on the panel. If the publication of LIBOR were to become untenable or if we were to simply "end LIBOR," as some have urged, untangling the $150 trillion in outstanding U.S. dollar LIBOR contracts would entail a protracted, expensive, and uncertain process of negotiating amendments to an enormous number of complex documents--a horrible mess and a feast for the legal profession, to be sure. It does not help matters that the hundreds of trillions of dollars' worth of derivatives contracts referencing LIBOR do not, in general, have robust backups in the event that publication of a rate ceases.

The FSB report identifies ways to improve U.S. dollar LIBOR, and to create alternatives to it, while minimizing transition costs, particularly for end users who bear no blame for the misconduct. 

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In the near term, the Federal Reserve, along with other government agencies, intends to meet with a wide range of market participants, including end users, to hear their views as to how cge can be effected and to begin the work of developing alternatives to LIBOR. Later this year, we will convene a group of the largest global dealers to discuss these issues, following a model that was successfully used to promote derivatives reform… [T]he markets that reference dollar LIBOR are so enormous that there will surely be more than enough liquidity to support both a new risk free rate as well as LIBOR itself.

One of the lessons that I take from our study of LIBOR is that these existing legacy contracts are quite important. As I mentioned earlier, many financial contracts, including derivatives contracts, do not have robust backups in the event that the reference rates they use cease to exist. Some derivatives, such as interest rate swaps, can be quite long lasting, and, over a long enough period of time, there is always a risk that any given reference rate will cease being published. It is important that financial contracts address the need for a backup plan if a reference rate does cease to function. This issue is something that we intend to bring up with market participants and end users as we meet with them.

A number of commentators have argued that the move to central clearing will further concentrate risk in the financial system. There is some truth in that assertion. Moving a significant share of the $700 trillion OTC derivatives market to central clearing will concentrate risk at CCPs. But the intent is not simply to concentrate risk, but also to reduce it--through netting of positions, greater transparency, better and more uniform risk-management practices, and more comprehensive regulation. This strategy places a heavy burden on CCPs, market participants, and regulators alike to build a strong market and regulatory infrastructure and to get it right the first time.

It has also been frequently observed that central clearing simplifies and makes the financial system more transparent. That, too, has an element of truth to it, but let's take a closer look [I]n the real world CCPs bring with them their own complexities. As the figure shows, we do not live in a simple world with only one CCP. We do not even live in a world with one CCP per product class, since some products are cleared by multiple, large CCPs. Also, significant clearing members are often members of multiple CCPs in different jurisdictions. The disruption of a single member can have far-reaching effects. Accordingly, while CCPs simplify some aspects of the financial system, in reality, the overall system supporting the OTC derivatives markets remains quite complex.

To say it as plainly as possible, the purpose of all of this new infrastructure and regulation is not to facilitate the orderly bailout of a CCP in the next crisis. Quite to the contrary, CCPs and their members must plan to stand on their own and continue to provide critical services to the financial system, without support from the taxpayer.

CCPs must adopt plans and tools that will help them recover from financial shocks and continue to provide their critical services without government assistance. It has been a challenge for some market participants to confront the fact that risks and losses, however well managed, do not simply disappear within a CCP but are ultimately allocated in some way to the various stakeholders in the organization--even if the risk of loss is quite remote. This realization has generated a healthy debate among CCPs, members, and members' clients and regulators that has provided fertile ground for new thinking about risk design, risk-management tools, and recovery planning. To ensure that CCPs do not themselves become too-big-to-fail entities, we need transparent, actionable, and effective plans for dealing with financial shocks that do not leave either an explicit or implicit role for the government.

Taken together, developments in U.S. bond portfolios do not indicate a worrisome pickup in risk-taking in external investments. But it is important to recognize that portfolio reallocations that seem relatively small for U.S. investors can loom large from the perspective of the foreign recipients of these flows. At roughly $400 billion at the end of 2012, emerging market bonds accounted for a tiny fraction of the roughly $25 trillion in bonds held by U.S. investors. But to the recipient countries, these holdings can account for a large fraction of their bond markets. Even relatively small changes in these U.S. holdings can generate large asset price responses, as was certainly the case in the summer of 2013. Likewise, a reassessment of risk-return tradeoffs could disrupt financing for projects that are dependent on the willingness of investors to participate in global syndicated loan markets.

We take the consequences of such spillovers seriously, and the Federal Reserve is intent on communicating its policy intentions as clearly as possible in order to reduce the likelihood of future disruptions to markets. We will continue to monitor investor behavior closely, both domestically and internationally.

Recent research by Board staff, using a database of loans primarily to U.S. borrowers but also to some foreign borrowers, suggests that lenders have indeed originated an increased number of risky syndicated loans post-crisis, based on the assessed probability of default as reported to bank supervisors. Regression results confirm that the average probability of default is significantly inversely related to U.S. long-term interest rates. This increase in riskiness of syndicated loans post-crisis has been accompanied by a shift in the composition of loan holders: An increasing share is now held not by banks but by hedge, pension, and other investment funds (figure 2). These nonbank investors also tend to hold loans with higher average credit risk (figure 3). These data suggest that a tougher regulatory environment may have made U.S.-based bank originators unable or unwilling to hold risky loans on their balance sheets.

The Federal Reserve's monetary policy is motivated by the dual mandate, which calls upon us to achieve stable prices and maximum sustainable employment. While these objectives are stated as domestic concerns, as a practical matter, economic and financial developments around the world can have significant effects on our own economy and vice versa. Thus, the pursuit of our mandate requires that we understand and incorporate into our policy decision-making the anticipated effects of these interconnections. And the dollar's role as the world's primary reserve, transaction, and funding currency requires us to consider global developments to help ensure our own financial stability.

By design, accommodative monetary policy--whether conventional or unconventional--supports economic activity in part by creating incentives for investors to take more risk. Such risk-taking can show up in domestic financial markets, in the international investments of U.S. investors, and even, ultimately, in general risk attitudes toward foreign financial markets. Distinguishing between appropriate and excessive risk-taking is difficult, however.

[T]here is a perception that FICC markets and their participants are highly sophisticated and do not need protection. While that may be generally true, the perspective is too narrow, because the importance of these markets extends far beyond the largest participants in them. The market mechanism allocates credit and determines the borrowing costs of households, companies and governments. Proper market functioning is really a public good that relies on confidence and trust among market participants and the public. Bad conduct, weak internal firm governance, misaligned incentives, and flawed market structure can all place this trust at risk.
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The Dodd-Frank Act also imposed rules requiring greater transparency in over-the-counter derivatives markets through the use of central clearing, trade repositories, and swap execution facilities. Given the issues around OTC derivatives during the recent crisis, these clearly are important initiatives. But despite significant progress, there are still a number of impediments to sharing trade report data across regulatory agencies and jurisdictions, leaving us with only a piecemeal picture of the overall market rather than the full transparency that we desire.
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With surveillance and penalties in place, and a new administrator, one might be excused for thinking that there is nothing more to be done {about LIBOR}. In fact, some people do think that. That is emphatically not the view of the FSB Official Sector Steering Group that I now co-chair with Martin, which concluded that it is essential to develop one or more risk free (or near risk free) alternatives to LIBOR for use in financial contracts such as interest rate derivatives. The reasons are related to the structure of both LIBOR and the market that underlies it. Unsecured interbank borrowing has been in a secular decline for some time, and there is a scarcity, or outright absence in longer tenors, of actual transactions that banks can use to estimate their daily submission to LIBOR or that can be used by others to verify those submissions. LIBOR is huge--there are roughly $300 trillion in gross notional contracts that reference it--so the incentives to manipulate it still remain in place. And the structural problems go much further than the incentives for manipulation. Markets need to be fair, effective, and also safe. If the publication of LIBOR were to become untenable because the number of transactions that underlie it declined further, then untangling the outstanding LIBOR contracts would entail a legal mess that could endanger our financial stability.

For these reasons, the Federal Reserve has convened a group of the largest global dealers to form the Alternative Reference Rates Committee. We have asked them to work with us in promoting alternatives to U.S. dollar LIBOR that better reflect the current structure of funding markets. As the Review's consultation document notes, issues of this kind are really global in nature; U.S. dollar LIBOR contracts are traded throughout the world, not simply in the United States. For this reason we are working in close consultation with our foreign regulatory counterparts in this endeavor.

The Congress has wisely given the Fed the tools it needs to implement monetary policy and respond to future crises as well as crucial independence to do its work free from short-term political influence. I would urge caution regarding current proposals that threaten just such political influence and place restrictions on the very tools that so recently proved essential in preventing a new depression. Congressional oversight of the Federal Reserve, including its conduct of monetary policy, is extensive, but no doubt could be improved in ways that do not threaten the Fed's effectiveness.

Asked about this terminology, Mr. Powell said: "I think patience is the appropriate term." He said low inflation gives the Fed some timedespite the transient effects of cheaper oiland the ability to be patient.

"What I want is data that gives me some confidence that inflation is moving back up" toward the Feds 2 percent goal, Powell said in a Monday interview in Washington with Peter Cook on Bloomberg Television.
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"Most of all, wages have been low," he said. "Wages do not suggest any tightness in the labor market yet. Those things tend to indicate that the natural rate of unemployment might be lower than its estimated to be."

[The regulatory reforms that have taken place since the financial crisis] are well advanced and, in my view, have left the global systemically important banks far stronger than they were before the crisis. Together, they significantly reduce the probability of a large bank failure. But they would leave us short of meeting the overriding objective of eliminating the too-big-to-fail conundrum without a fourth reform--a viable resolution mechanism that could handle the failure of these institutions without severe damage to the economy. Until recently, no nation has had a way of handling such failures without that degree of damage.

We need to learn, but not overlearn, the lessons of the crisis. I believe there should be a high bar for "leaning against the credit cycle" in the absence of credible threats to the core or the reemergence of run-prone funding structures. In my view, the Fed and other prudential and market regulators should resist interfering with the role of markets in allocating capital to issuers and risk to investors unless the case for doing so is strong and the available tools can achieve the objective in a targeted manner and with a high degree of confidence.

I wouldn’t use the term stretched. I would say PEs are high, I am not particularly troubled at the level of equity values overall. They are certainly higher than normal. But I mean in a world were financial market assets are expected to give low returns PE should be high. So I don’t make predictions, especially about the future, when it comes to the stock market.

HILSENRATH: There are many critics of the FED, some of whom say that the FED is causing another bubble in areas such as stock valuations, what do you say to them?

POWELL: I just don’t see it. I would love to be Paul Revere and be the one who sees the next financial crisis. Everyone would right? I don’t see it. I don’t see the build up of leverage, I don’t see valuations. There are some measures of equity values that will say it is really high, particularly cyclically adjusted PEs, that is the way you see people cite.

But if you look at the range of valuation, and particularly the gap between the risk free rate -- or bond market returns and expected equity returns you don’t see bubble like conditions. What you really don’t see though is the build up of risk taking, the build up of leverage in the financial markets. And the build up in things that really have been crucial to financial crises like housing values. And you don’t see huge aggregate credit growth. You just don’t see the factors that lead to a financial crisis.

Actually, what {Dudley} said in footnote five of that speech was that you could make a case that the Fed should have moved faster. That’s what he said, he didn’t sort of say that it was a mistake.

Interesting question. I frankly think anyone who says the way we did things before the crisis, we probably should have done them differently, you’re going to get a hearing on any -- any idea of that, that sounds like that. And this is one of those, it’s absolutely worthwhile look at that.

I -- so the real question is, would that have made a -- if the Fed had moved, you know, in a less measured way, measured pace, would that have made a big difference in the financial crisis? And I think the answer is clearly no.

You know, you had a -- you had a housing bubble that was kind of self-contained, it was kind of expectations of market participants, buyers and sellers that housing was always going to go up, up, up, up, there’s no such thing as housing prices going down. You had a bubble, and that happened.

I think the mistakes that were made before the crisis, were much more about regulation, supervision, and really, just imagination. You know, no one thought -- very few people saw this coming. Very few people thought this was coming.

We have an odd structure, it is a really unusually structure this marriage between the reserve banks and the board. And it is complex, it is unique, it is kind of odd. It works. It actually works. It is a successful equilibrium where we get tremendous benefit from the bank presidents coming in and sharing with us what they learned from businesses in their districts and the board works well together. I actually think the thing works quite well.

And I would also say it’s clear that market depth is less, meaning the ability to transact in large quantities is much less in fixed income markets in some fixed income markets than it was before the crisis. There are a variety of factors that are driving that. One of them is smaller risk appetite by firms. They will proudly show you how much less risk they are taking. Another is this advancing technology and another is regulation. It is really hard to disentangle the effects of those three.

So the question is, and I don’t really know the answer, but the question is -- is are we at -- is that a bad equilibrium. You know we got safer core, safe financial markets, large financial institutions, much better capitalized and much less risky. But you have got less depth in bond markets and the issue that some of the asset managers may be, investors in mutual funds for example, may be over estimating the liquidity that they’ll really have in a stressed environment.

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I don’t know. It is not obvious to me that that is a worse equilibrium that we had without those innovations. In any case I don’t think those three forces that I mentioned technology, risk aversion and regulations. I don’t think it is obvious that those are going to change at all. We might at the margin tinker with them but those are things that are probably going to remain.

It is certainly true that market depth is less, and inventories are much less than they were before the crisis. It is also probably true that systematically the cost of supplying liquidity and the cost of holding those assets was underestimated, inappropriately so, before the crisis. So, some of that is good. And again, if you sit down, as I have, with many of the large firms some of them will tell you, “this isn’t you, this is us. We are looking at our risk in a completely different way than we did before the crisis. And this was our risk before the crisis and this is our risk now.”

So it is not obvious it is all because of regulation. I do think there are many other factors. The right question is this, is it a problem? It is certainly possible, it is intuitively likely, that with lower market depth there would be higher volatility for a quantum of news or a shock of some kind. I think that is right.

Again, the question is, is this a better equilibrium? That is something that requires some thought, it is something that we at the Fed are looking very carefully at right now as are many others around the world.

So I would say that I spent a lifetime working with financial models and they are essential and get you about 80 percent of the way there, but if you think the models are going to make your decision for you, then you’re not going to get very far in life. So, this was my world in the financial markets for many years, it’s really not that different.

You can’t do anything without modeling it, but at the same time, that last 20 percent of judgment and experience and understanding and risk management, the weighing of risks, is critical.

Ms. Yellen said in May that “equity-market valuations at this point generally are quite high.” Mr. Powell on Tuesday said overall equity values are “certainly higher than normal” but that he doesn’t see evidence of “bubblelike conditions” in valuations or a buildup of risk-taking and leverage in financial markets.

The Fed likely would raise rates at a gradual pace, Mr. Powell said, in part because inflation is expected to continue undershooting the central bank’s 2% annual target. The precise timing and pace of rate increases will depend on incoming economic data, he said, and officials don’t want to “fall into a pace of mechanical increases.”

Mr. Powell said his forecast “calls for liftoff in September and for an additional increase in December” and further increases of about one percentage point a year are likely. But he cautioned that rate forecasts are accompanied by great uncertainty.

First, the actual pace is going to be dependent on the path of the economy. The chair has been clear, and I certainly agree, that it is not our intention, is not my intention, to fall into a pace of mechanical increases at predictable intervals.

That happened for, I guess, 17 consecutive meetings of 25 basis point increases in the last tightening cycle. It’s not our intention to repeat that, but rather to be more responsive to incoming data.

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[I]t depends on the data and I would say, you know, my own forecast calls for liftoff in September and for an additional increase in December.

I would want to stress that, as I said, I think September liftoff for me is close to a coin flip. It depends on the data. It will depend on how labor market data, growth data, inflation data, global events unfold. And December is even more, you know, even more uncertain given where we are.

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So, markets have been doing that {pricing in a more gradualist path than implied by the dot plot} for a while. The market has been pricing at a lower path and continues to do so, although I think we’re getting into closer alignment. I assume that we will get into pretty close alignment by the time of lift-off. We’re trying to be as transparent as possible about how we’re thinking about interest rates and the economy in all the factors we consider.

There’s so much attention paid to this I think it’s unlikely the FOMC would reach a point of seriously considering a rate increase, and that that wouldn’t be widely understood in the markets. And certainly, it is our design is to be as transparent as possible. That’s the part of it that we control. We have to make these decisions, and, you know, we control our communication and our transparency, and I think we’re in a pretty good place on that right now.

Federal Reserve Governor Jerome Powell said that while the “time is coming” to raise interest rates, he’s waiting to see how economic data bear out before deciding whether to support such a move next month.

“Fortunately, I don’t have to figure it out now,” Powell said Wednesday in a CNBC interview. “I’m going to be very, very focused on the data.”

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“The time is coming. I think most members of the FOMC at the June meeting believed that it was time to raise interest rates sometime this year,” Powell said. “When we do that, there will be -- if the economy continues to grow -- there will be a process of raising rates, gradually, over time.”

Although post-crisis regulatory changes have likely increased the costs of market making, markets were already undergoing dramatic changes well before the crisis. High-frequency and algorithmic trading firms already accounted for a large and growing share of transactions in the interdealer market, altering the speed and nature of market making. As traditional dealers have lost market share, they have sought to remain competitive by internalizing a greater share of their customer trades, finding matches between their own customers and keeping those trades off the public interdealer markets. But internalization does not eliminate the need for a public market, which is where price discovery mainly occurs. Dealers need to place the orders that they cannot internalize onto that market, and at times of market stress such as on October 15, they will likely need to put most of their orders onto the public market.

Ryssdal: Does that mean you guys are ready to go back to the zero lower bound if you have to?

Powell: If you have to, you have to. Yes. It's not impossible. Monetary policy's about forecasts. You have to have a forecast of where things are gonna go and you try to set monetary policy for what you see as the likely path of the economy.

Ryssdal: "Gradually" got a lot of attention in Chair Yellen's press conference the other day. She made great efforts to say, "It's not gonna be a mechanical thing." Without using her favorite phrase, which is, "It's gonna depend on the data," what are you gonna be looking at to think and to know when it's okay to start ratcheting things up again?

Powell: Well we do look at a wide range of things. For me, at the top of the list will be continued progress in the labor market and with it continued progress on inflation. Inflation is in below our target. As I mentioned, the labor market has strengthened quite a bit, but I wanna see continued strong job growth. We've had three years of very strong job growth. I want to see that continue. And as the labor market tightens, I'd like to see wages increasing, and as the economy tightens, we need to see inflation coming up. Underlying inflation, if you look through the changes in gas prices and import prices is probably running at around one and a half percent. Our goal is two percent, so we'd like to see underlying inflation come up to two percent.

Ryssdal: Now that this first hike is behind you, how hopeful are you to get the Fed out of the spotlight, so that every discussion about the economy isn't, "Oh my God, what's the Fed gonna do?"

Powell: Let me say that I'll be glad to stop talking about the first rate increase. But it's the case that there's been too much focus, and it's understandable I guess, on just this one rate increase. Really what's important to people is, are employers hiring? Are their kids getting good job opportunities? Are their wages increasing? Are they feeling confident about the future, are they able to afford a home, things like that. And that's what we've tried to focus on, and that's what the public needs to be focused on. It would be just great to see the Fed get out of the headlines and let people get to more normal considerations.

Although time-based guidance can create communications challenges, I see other factors as having been more important in recent years. In particular, the challenge of deciding when and how to use unconventional tools--and ultimately when and how to reduce that usage--is a great one. The task of communicating clearly about those decisions is equally great. And the reality of the FOMC's size and diversity, not to mention uncertainty about the evolving structure of the economy and the effects of monetary policy actions, means that we are still far from the ideal world of a fully worked out, clearly specified and transparent consensus on what economists call a "reaction function"--a complete description of how policy will respond to changes in economic conditions.

The dot plot presents a number of challenges. The individual dots are not tied to the individual macroeconomic forecasts presented in the SEP, and no information is provided on the identity of the forecaster--for example, voting members of the Committee are not distinguished from non-voting participants. There is no easy path to the identification of a Committee reaction function. The dots speak as of their date of publication after the FOMC meetings held in March, June, September, and December. Three months pass between SEPs. The economic outlook can change quite significantly, making the reigning dots look out of touch. On occasion, the dot plot and the postmeeting statement have seemed to send conflicting signals. The dot plot reflects individual views of appropriate policy, while the postmeeting statement reflects the consensus of the Committee.
The authors weigh these challenges and ponder whether to eliminate the dot plot; some appear to favor that idea. I doubt that most market participants would welcome the elimination of this chart. The SEP provides a number of benefits. It requires FOMC participants to write down their forecasts for inflation, unemployment, and growth, as well as their assessments of appropriate monetary policy. This exercise helps policymakers to be more systematic. In addition, by observing how the SEP changes over time, the public can better understand how Committee members react to changes in the economy. My view is that the dot plot, on balance, is helpful to market participants and hence to the Committee. As the dot plot enters its fifth year of existence, my hope is that we will be able to capture those benefits while avoiding its shortcomings.

Former Chairman Bernanke recounts in his recent book that he saw [open-ended, data-driven] QE3 as akin to Mario Draghi's statement that the European Central Bank would do "whatever it takes." He also notes that FOMC participants held divergent views on the potential costs and benefits of the program. Minutes of the relevant meetings described the complex discussions and differing views. Contemporaneous reports by Wall Street analysts show frustration and confusion about the Committee's intentions.
When various FOMC communications suggested that the time to begin reducing purchases was nearing, long-term rates rose sharply--the so-called taper tantrum. The contention of this paper is that time-based guidance was responsible. But as the paper acknowledges, the open-ended, data-contingent nature of the QE3 program created a strong sense that the Fed was "all in" and that the purchases might go on for a long time. That powerful commitment "would set things up for some fireworks" when the time came to provide more precise guidance as to the timing of tapering, whether that was done through time- or data-based guidance

A data-driven Committee, making decisions meeting by meeting, is likely to surprise markets from time to time. The authors join many others in criticizing the "measured pace" period of 2004 through 2006, during which the Committee increased rates by 25 basis points at 17 consecutive FOMC meetings. A common criticism has been that this high level of predictability made investors complacent, encouraging a buildup of leverage and helping set the stage for the Global Financial Crisis. That criticism may well overstate the importance of the Committee's communications; nonetheless, a number of FOMC participants have said that the Committee intends to be "data driven" and not fall into an excessively predictable, data-insensitive path. Lower predictability implies more surprises.

My view is that these [post-crisis] regulations are new, and we should be willing to adjust them as we learn. That said, we should also recognize that some reduction in market liquidity is a cost worth paying in helping to make the overall financial system significantly safer.

We should distinguish between systemic risk and market risk. The risks to investors generally represent market risk and do not appear to pose risks to the financial system as a whole. The movement of these risks away from the nation's most systemically important financial institutions is one of many reasons that they are far stronger and more resilient than before the crisis.

For the near term, my baseline expectation is that our economy will continue on its path of growth at around 2 percent. To confirm that expectation, it will be important to see a significant strengthening in growth in the second quarter after the apparent softness of the past two quarters. To support this growth narrative, I also expect the ongoing healing process in labor markets to continue, with strong job growth, further reductions in headline unemployment and other measures of slack, and increases in wage inflation. As the economy tightens, I expect that inflation will continue to move over time to the Committee's 2 percent objective.
If incoming data continue to support those expectations, I would see it as appropriate to continue to gradually raise the federal funds rate. Depending on the incoming data and the evolving risks, another rate increase may be appropriate fairly soon. Several factors suggest that the pace of rate increases should be gradual...

There are potential concerns with such a gradual approach... [R]unning the economy above its potential growth rate for an extended period could involve significant risks even if inflation does not move meaningfully above target. A long period of very low interest rates could lead to excessive risk-taking and, over time, to unsustainably high asset prices and credit growth. Macroprudential and other supervisory policies are designed to reduce both the likelihood of such an outcome and the severity of the consequences if it does occur. But it is not certain that these tools would prove adequate in a financial system in which much intermediation takes place outside the regulated banking sector.

[G]ross domestic product (GDP) growth over the two quarters ending in March 2016 is estimated to have averaged only 1 percent on an annualized basis. This estimate may continue to move around as more data come in. And there are good reasons to think that underlying growth is stronger than these recent readings suggest. Labor market data generally provide a better real-time signal of the underlying pace of economic activity. In addition, retail sales surged in April, as did consumer confidence in May, suggesting that the pause in consumption may have been transitory.
...
The tension between labor market and spending data is not a recent phenomenon. Throughout the recovery period, forecasters have consistently overestimated both actual and potential GDP growth while underestimating the rate of job creation and the pace of decline of the unemployment rate (table 1). For example, in 2007, the average expectation for long-run GDP growth from the Blue Chip survey of 50 forecasters was 2.9 percent (table 2). After successive reductions, the estimate now stands at 2.1 percent. Blue Chip forecasters also underestimated the decline in the unemployment rate. Other well-known forecasts followed this same pattern, including those of the Congressional Budget Office, the Survey of Professional Forecasters, and, yes, FOMC participants. The pattern suggests that forecasters have only gradually taken on board the decline in potential in the wake of the financial crisis.

“I have not reached any conclusion that a particular bank needs to be broken up or anything like that,” Mr. Powell said at a banking conference. The point is to “raise capital requirements to the point at which it becomes a question that banks have to ask themselves.”

In saying this, I want to make it clear that LIBOR has been significantly improved... However, the term money market borrowing by banks that underlies U.S. dollar LIBOR has experienced a secular decline. As a result, the majority of U.S. dollar LIBOR submissions must still rely on expert judgement, and even those submissions that are transaction-based may be based on relatively few actual trades. This calls into question whether LIBOR can ultimately satisfy IOSCO Principle 7 regarding data sufficiency, which requires that a benchmark be based on an active market. That Principle is a particularly important one, as it is difficult to ask banks to submit rates at which they believe they could borrow on a daily basis if they do not actually borrow very often.
That basic fact poses the risk that LIBOR could eventually be forced to stop publication entirely. Ongoing regulatory reforms and changing market structures raise questions about whether the transactions underlying LIBOR will become even scarcer in the future, particularly in periods of stress, and banks might feel little incentive to contribute to U.S. dollar LIBOR panels if transactions become less frequent. Market participants are not used to thinking about this possibility, but benchmarks sometimes come to a halt. The sudden cessation of a benchmark as heavily used as LIBOR would present significant systemic risks. It could entail substantial losses and would create substantial uncertainty, potential legal challenges, and payments disruptions for the market participants that have relied on LIBOR. These disruptions would be even greater if there were no viable alternative to U.S. dollar LIBOR that market participants could quickly move to.
These concerns led the FSB and Financial Stability Oversight Council to call for the promotion of alternatives to LIBOR...

While I would not want to make too much of two monthly observations, the strength of the labor market has been a key feature of the recovery, allowing us to look through quarterly fluctuations in GDP growth. So the possible loss of momentum in job growth is worrisome.

We measure inflation expectations through surveys of forecasters and the general public, and also through market readings on inflation swaps and "breakevens," which represent inflation compensation as measured by the difference between the return offered by nominal Treasury securities and that offered by TIPS. Since mid-2014, these market-based measures have declined significantly to historically low levels. Some of this decline probably represents lower risk of high inflation, or an elevated liquidity preference for much more heavily traded nominal Treasury securities, rather than expectations of lower inflation. Some survey measures of inflation expectations have also trended down. Given the importance of expectations for determining inflation, these developments deserve, and receive, careful attention. While inflation expectations seem to me to remain reasonably well anchored, it is essential that they remain so. The only way to assure that anchoring is to achieve actual inflation of 2 percent, and I am strongly committed to that objective.

It is far too early to judge the effects of the Brexit vote. As the global outlook evolves, it will be important to assess the implications for the U.S. economy, and for the stance of policy appropriate to foster continued progress toward our objectives of maximum employment and price stability.

I am often asked why rates remain so low now that we are near full employment. A big part of the answer is that, at least for the time being, the appropriate level of rates is simply lower than it was before the crisis. As a result, policy is not as stimulative as it might appear to be. Estimates of the real interest rate needed to keep the economy on an even keel if it were operating at 2 percent inflation and full employment--the "neutral rate" of interest--are currently around zero. Today, the real short term interest rate is about negative 1-1/4 percent, so policy is actually only moderately stimulative. I anticipate that the neutral rate will move up over time, as some of the headwinds that have weighed on economic growth ease.

The slowdown in essentially all of these processes is seen in declining rates of creation and destruction of both firms and jobs.

Start-ups: Start-ups are a key driver of productivity growth. Although it may feel that we are living in an age of disruption, the birthrate of startups has actually been in decline since the 1970s. New firms can be loosely grouped into two categories: those started by "lifestyle entrepreneurs" who want to be their own boss, but who have little prospect or desire for high growth; and those founded by transformational entrepreneurs who start businesses that aspire to grow dramatically and change their industry. Before 2000, the decline in new firm entry was mainly in the first sort; since 2000, it is also found among the so-called transformational firms. While the drop in the formation of lifestyle-type firms could be neutral or even a positive for productivity, as in the case of the U.S. retail sector, the reduction in the creation of high-performance new firms suggests that lower dynamism could be associated with slower productivity growth.

Labor Market Dynamism: While changing jobs can be painful, job changes in the aggregate are associated with higher compensation, implying higher productivity. But the rewards to job change may have declined. Fewer start-ups has meant lower "job flows," as measured by job creation and destruction, and fewer opportunities for workers to find better jobs. And labor market dynamism across many dimensions has declined by more than can be explained by the reduction in startups. Workers have become less likely to leave their jobs, change jobs, or move geographically to take new jobs.

Dynamism is a relatively new field of inquiry, and there is no consensus yet on the reasons for, or implications of, these developments...

It may be that some government policies, while well intended, have contributed to these trends. One example that may explain a small portion of the reduction in dynamism is the substantial increase in occupational licensing. By some estimates, the fraction of workers who are required to hold a government issued license or certification to perform their jobs has risen from 5 percent in the 1950s to close to 40 percent. Like many policies, licensing has benefits and costs. Among the costs are that it tends to reduce job switching and employment opportunities for excluded workers, and may restrict competition and thus increase prices faced by consumers. Among the benefits may be higher quality products and services and improved health and safety standards. Some researchers have advanced the view that licensing requirements have become overly burdensome and may have contributed to the secular decline in job and worker reallocation.

Dynamism is a fast-developing field of research, and it will be important that public policy react appropriately as this work continues. It goes without saying that economic policymakers should use all available information and tools to create a supportive environment for growth. We need policies that support labor force participation and the development of skills, business hiring and investment, and productivity growth. For the most part, these policies are outside the remit of the Federal Reserve, but monetary policy can contribute by supporting a strong and durable expansion, in a context of price stability.