House Financial Services on the Federal Reserve’s Semi-Annual Monetary Policy Report

House Committee on Financial Services

The Federal Reserve’s Semi-Annual Monetary Policy Report

Wednesday, March 8, 2023

Topline

• Republicans asked Powell about capital requirements and the Fed’s ongoing capital review.
• Democrats warned Powell of the consequences of continued interest rate rises.

Witnesses

• The Honorable Jerome H. Powell, Chair, Board of Governors of the Federal Reserve System

Opening Statements

Chairman Patrick McHenry (R-N.C.)

In his opening statement, McHenry argued that the Federal Reserve is facing strong headwinds from the political left, pressuring Chair Powell to stray from his narrow mandate. He said that since President Biden took office, the U.S. has had inflation not seen since the late 70s and early 80s, which accelerated after the American Rescue Plan. He emphasized committee Republicans’ desire to hear about the Fed’s “holistic” review of bank capital and the Fed’s regulatory regime. He noted that the Fed should not operate within the shadows. Finally, McHenry said that the Fed is laying the groundwork for climate policy with an opening salvo of “scenario analysis.”

Ranking Member Maxine Waters (D-Calif.)

In her opening statement, Waters said that the country has made major progress to improve economic conditions, including adding a record number of jobs, reducing unemployment, and reducing the deficit by $1.7 trillion. She also noted, however, that many families are still struggling with inflation. Specifically, she said interest rate hikes are making borrowing, especially for mortgages, incredibly expensive, and rate hikes have an outsize impact on housing costs. Next, Waters said the country is months away from an economic catastrophe, including spiking interest rates, massive job losses, and global instability. She blamed Republicans for threatening a default if Democrats do not agree to their demands to cut critical programs. Finally, she said that she is pleased about the progress being made on diversity and inclusion in key positions at the Fed.

Testimony

Jerome H. Powell, Chair, Board of Governors of the Federal Reserve System In his testimony, Powell said the Fed is strongly committed to returning inflation to its two percent goal. He noted activity in the housing sector continues to weaken, largely reflecting higher mortgage rates. Powell added higher interest rates and slower output growth appear to be weighing on businesses’ fixed investment. He said the Fed anticipates ongoing increases in the target range for the federal funds rate. Powell said the Fed is prepared to increase the pace of rate hikes if warranted, noting restoring price stability is essential.

Question & Answer

Inflation and the Economy

McHenry asked Powell what he thinks about the March Open Market Committee meeting. Powell said there is additional data to analyze, including the jobs and CPI reports next week. He noted that these will be important in the Fed’s assessment of the overall direction of the economy but noted that they are not on a preset path and will be guided by the data.

Rep. Bill Foster (D-Ill.) asked how the U.S. currently has historically low unemployment and is lowering inflation. He suggested the possibility of less frictional employment in the system. Powell responded that inflation is coming down, but it is still very high. He added that part of the high inflation is likely related to a very tight labor market. Foster then suggested that Chair Powell might be paying too much attention to the lagging indicators and not the leading indicators. Powell noted that the Fed has eyed housing inflation since the beginning, and forecasters are baking in lower rent increases, which is why people think inflation is going to come down in 2023. He concluded that transitory predictions had more to do with goods and thinking that the supply side and labor market disruptions would go away quicker.

Rep. Ann Wagner (R-Mo.) asked about the cost of failing to restore price stability. Powell said that there will be costs to success, but the costs of failure will be even higher. She also asked if the reopening of the Chinese economy will have an inflationary impact in the U.S. Powell said that the faster reopening of China has the potential to put upward pressure on commodity prices, but it could also mean a faster unraveling of problems with the supply chain. He said the Fed does not expect the net effect to be big for the U.S.

Rep. Andy Barr (R-Ky.) asked if the economy will have to suffer a recession to bring inflation down to 2%. Powell said he is aware of the lags with which monetary policy affects economic activity and inflation, but added that slowing down the pace of rate hikes this year is a way to see more of those effects as they come in. Barr also asked if the estimated terminal rate could be higher than 5.5%. Powell said the Fed will release new forecasts on March 22, but the data so far suggests the ultimate level of rates will need to be higher.

Rep. Josh Gottheimer (D-N.J.) asked if 2% is still the right target for inflation. Powell said that 2% is going to remain the Fed’s long term inflation goal. He added that it is the global standard and said this is not the time to think about changing it. Gottheimer also asked about the right assessment of the country’s fiscal health. Powell noted that the traditional focus was on debt to GDP, but said many people pointed out that pre-Covid rates were secularly lower. The Chair warned against assuming that secularly low longer-term rates are going to continue indefinitely, because that does not look likely now.

Rep. Ayanna Pressley (D-Mass.) said that the Cleveland Fed predicted that reaching the 2% goal will not be possible without a recession and we could see the unemployment rate spiking to 7%. She asked if Powell would pause future interest rate hikes to prevent a recession. He said that the Fed is not seeking a recession, and it is not needed to bring price stability back. She also asked about the effect of interest rate hikes on communities, families, and businesses. Powell responded that they are trying to bring down inflation on behalf of those families. Pressley concluded by saying that his plan sounds more like the assertion of a greedy corporation than someone who has a commitment to the people of this country.

Rep. Rashida Tlaib (D-Mich.) asked if inflation is impacted by corporate profiteering, executive pay, and stock buybacks. Powell said he cannot think of how share repurposes would affect inflation and added that any impact by executive pay would be very small. On profits, he cited shortages and supply chain issues, but noted that as those things improve, he expects to see prices, inflation, and profit margins come down. Finally, Tlaib stated that the Fed has been sitting on guidance regarding Section 956 of

Dodd Frank for the past twelve years on the risks around high executive compensation. Powell said that it is a multiple agency rule, and there have been attempts to get agencies to come to an agreement. Tlaib said the Fed is more focused on wages than executive pay, monopolies, and corporate profiteering.

Rep. Bryan Steil (R-Wis.) asked how the Fed factors in fiscal policies and their impact on inflation. Powell noted that energy prices have been coming down, so they are not contributing to headline inflation. Additionally, he noted that aggregate spending has peaked, and the fiscal impulse is negative. He concluded that most of the inflation now comes from the services sector, which is less about fiscal policy.

Capital Standards/Requirements

McHenry said that there are a lot of questions about the process of reviewing capital requirements announced by Vice Chair Michael Barr, including whether that is done by Fed staff or at the Board level. He asked Powell why it is necessary for the Fed to conduct a holistic review. Powell said that as the new Vice Chair for Supervision, Barr is taking a fresh look at everything. He added that the process is conducted under his leadership with input from the staff and discussions with Governors on that committee. Finally, he noted that nothing has been proposed to the Board or formalized at this point, but at that point the Board will be briefed, vote on a proposal, and receive comments.

Wagner noted that bank capitalization remained robust during COVID and questioned Vice Chair Barr’s decision to conduct a review of these rules. She explained her concern about the transparency and clarity in this review. Next, she asked if the Fed has any evidence that banks are undercapitalized. Powell said that American banks are strongly capitalized. He again stated that there are no real proposals to evaluate, but when there are it will be done in a transparent manner. Wagner finally asked if excessively high capital levels constrain banks’ lending capacity. Powell said that it is a balance, as more capital means more safety and the ability to withstand terribly stressful periods, but equity capital is more expensive.

Rep. David Scott (D-Ga.) said he has heard that the Fed and FDIC plan to drop a new rule, which seeks to apply long term and higher capital requirements that were created for larger banks to regional banks. He added that this idea is misguided and could put many regional and small community banks out of business. Powell said they are not going to do this, adding that the Fed believes strongly in tailoring to address the different size and risk characteristics of financial institutions. He said the regionals will not have anything like what the very large, more systemically important, banks have in terms of overall regulation.

Rep. Frank Lucas (R-Okla.) asked Powell to commit to ensuring that changes in the capital requirements will not increase the cost for banks providing commodity derivatives to end users. The Chair responded that he would have to check whether the work addresses that.

Barr asked Powell to commit to not implementing a new capital framework following the holistic review if there is considerable dissent from the board. Powell said he cannot commit to that, but can commit to working towards consensus. He added that changes cannot be made by one person.

Rep. Roger Williams (R-Texas) asked if Powell believes that raising capital requirements would raise the cost of borrowing and add costs to the economy. Powell said that it depends on which banks experience higher capital requirements, and reiterated that there is no proposal to evaluate right now.

Rep. Bill Huizenga (R-Mich.) asked if Powell would commit to withholding support for a new capital rule that increases capital charges on bank activities in traditional energy companies. Powell again said that he cannot promise what he will not vote for since he does not know what will be in the proposal, but added that the issue is not the kind of thing the Fed is looking at.

Rep. Bryan Steil (R-Wis.) echoed concerns about the impact of a significant capital level increase and asked how to quantify the cost of higher capital and any benefits. Powell said it is always a balance between the strength of banks and the cost and availability of capital.

Rep. Dan Meuser (R-Pa.) asked if the Fed has anything that would warrant the need for large bank capital increases. Powell again noted that there is not a proposal to evaluate or talk about yet, but said Barr is assessing whether capital is strong enough.

ESG/Climate

Lucas also said that he is concerned that the Fed could be laying the groundwork for climate related stress tests, which would open up the Fed to political pressure. Powell said that the Feb has a narrow, but real, role on climate around bank supervision. He said he understands that it is a tightly circumscribed role, and the Fed does not want to move into the area of becoming a climate policymaker.

Barr said that there seems to be a disconnect between Powell’s public statements on climate and the rules being put forward. Powell said he feels strongly that climate change is an issue that needs to be addressed by elected people but reiterated that the Fed has a narrow role around making sure banks understand and can manage the risks they are running. Barr asked if the Fed Board voted to approve the creation of the Climate Scenarios Analysis pilot program. Powell said it was already authorized.

Williams also noted that financial leaders should be focusing on runaway inflation, instead of worrying about what financial institutions are doing to monitor climate change.

Rep. Juan Vargas (D-Calif.) said that Republicans are attacking ESG and saying that the Fed is somehow conspiring to ensure that people do not buy oil or coal. He asked if climate change poses a risk, and Powell said it could affect banks in the long run.

Meuser asked if it is the Fed’s commitment regarding ESG not to force investment banks to renege on their fiduciary responsibilities. Powell said the Fed does not have policies in that space. Meuser said that there were some statements by investment banks saying that was the case and added that Powell said some sort of ESG is wanted by banks. Powell responded that regulated financial institutions are subject to climate change issues all over the country, but the SEC regulates investment banks.

Digital Assets

Rep. French Hill (R-Ark.) asked if a digital assets framework would provide more transparency and rules for consumers, developers, and investors. Powell agreed with this statement. Hill also asked if those rules of the road would be beneficial for businesses seeking to use and develop blockchain. Powell said yes, and noted that it would also help to ensure it is done in a safe and sound manner, especially for banks. In response to a question about the role of the states, Powell said that the model works in banking and insurance, and is possible for digital assets. Finally, Hill asked if the issuance of a Central Bank Digital Currency (CBDC) would have to be authorized by Congress. Powell said absolutely, as it relates to a retail CBDC. He noted, however, that there is potential for a wholesale CBDC (just between banks) on which the authority is less clear.

Rep. Brad Sherman (D-Calif.) said that cryptocurrency means hidden money. He added that if Congress imposes Know Your Customer and Anti-Money Laundering statutes to it, it will not be crypto anymore. He concluded that the industry wants part of the ecosystem above the iceberg, and the rest below.

Rep. Stephen Lynch (D-Mass.) asked when Powell expects to share public updates on the status of the Fed’s CBDC work. Powell said the agency requested comments about a year ago and will continue to engage. He added that they are experimenting with how it would work, whether it would work, and what is the technology, but noted that the Fed is at the very early stages and is also still deciding if this is something the country really needs.

Lynch also asked if cryptocurrencies would provide faster payments than FedNow. Powell replied that FedNow will enable any bank to offer instantly available funds and real time payments to customers, and added that a CBDC is going to need years of evaluation. Finally, Lynch asked if stablecoins and other cryptocurrencies will go to zero when the U.S. creates a CBDC with the full faith and credit of the country behind it. Powell said he has never understood the valuation of unbacked cryptocurrencies. He also noted that many stablecoins are drawing on the credibility of the dollar and have dollar-based reserves, but it is unclear what is in the reserves because there is no regulation.

Rep. Warren Davidson (R-Ohio) said that when people feel like a third party is going to steer or shape their money, they do not trust it. He added that part of the appeal of the digital asset space is the permissionless nature of it. Finally, he told Powell that people were concerned by his remarks on Tuesday that permissionless digital assets pose a systemic risk to the financial system. Powell said that the Fed’s digital guidance is careful to note that the agency does not want regulation to oppose innovation, entrench incumbents, or anything like that. He said the language is balanced and goes to the question of protecting the safety and soundness of financial institutions.

Housing

Rep. Ralph Norman (R-S.C.) said that any increase in interest rates is another dagger that is going to kill the housing industry and commercial projects.

Rep. Sylvia Garcia (R-Texas) said that as mortgage rates rise, the population of homebuyers is skewing towards older, whiter, and wealthier communities, and in many cases equity firms are buying up the housing stock. She asked what needs to change in response to this reality. Powell said the U.S. needs to get inflation under control so that interest rates can come back down.

Debt Limit

Waters said that Republicans had no qualms about increasing the debt limit when Trump was in office. She asked Powell about the risk if Congress continues to delay action on the debt limit. Powell said that the Fed seeks no role in the fiscal policy, but made two points: Congress raising the debt ceiling is the only way forward, and people should not assume the Fed can protect the economy from the nonpayment of the government’s bills or a debt default.

Rep. Jim Himes (D-Conn.) said that the time to focus on the deficit is when voting for the spending and tax cuts that created the deficit, not when the full faith and credit of the U.S. is hanging in the balance. He added that the markets will persuade the Republicans to act responsibly, and asked Powell about the market signals to look out for. Powell reiterated the same two points he made to Waters.

Gottheimer asked Powell if he is concerned that higher interest rates will make payments on the debt unsustainable. Powell said the U.S. is on an unsustainable path, and the sooner the issue is addressed the less painful it will be.

Rep. William Timmons (R-S.C.) said that the debt ceiling fight is an opportunity to get the fiscal house in order. He added that policymakers should be focused on saving Social Security by reforming it and transforming the health care system to facilitate a healthy citizenry capable of working.

Steil asked if the impact on the debt factors funnels into deliberations on potential rate increases. Powell said the Fed does not look at that, as they are focused on the job Congress gave them. Finally, he noted that the debt is not unsustainable, but the path is unsustainable because the debt is growing faster than the economy.

Community Reinvestment Act

Norman asked when the Fed will have guidelines on CRA. Powell said that will be done by the whole Board of Governors and the OCC and FDIC. He noted that there has been a lot of industry input.

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