January 24–25, 2012 1 of 314 Meeting of the Federal Open Market Committee on January 24–25, 2012 A meeting of the Federal Open Market Committee was held in the offices of the Board of Governors in Washington, D.C., on Tuesday, January 24, 2012, at 10:00 a.m., and continued on Wednesday, January 25, 2012, at 8:30 a.m. Those present were the following: Ben Bernanke, Chairman William C. Dudley, Vice Chairman Elizabeth Duke Jeffrey M. Lacker Dennis P. Lockhart Sandra Pianalto Sarah Bloom Raskin Daniel K. Tarullo John C. Williams Janet L. Yellen James Bullard, Christine Cumming, Charles L. Evans, Esther L. George, and Eric Rosengren, Alternate Members of the Federal Open Market Committee Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, Presidents of the Federal Reserve Banks of Dallas, Minneapolis, and Philadelphia, respectively William B. English, Secretary and Economist Deborah J. Danker, Deputy Secretary Matthew M. Luecke, Assistant Secretary David W. Skidmore, Assistant Secretary Michelle A. Smith, Assistant Secretary Scott G. Alvarez, General Counsel Thomas C. Baxter, Deputy General Counsel Steven B. Kamin, Economist David W. Wilcox, Economist David Altig, Thomas A. Connors, Michael P. Leahy, William Nelson, Simon Potter, David Reifschneider, Glenn D. Rudebusch, and William Wascher, Associate Economists Brian Sack, Manager, System Open Market Account Michael S. Gibson, Director, Division of Banking Supervision and Regulation, Board of Governors Nellie Liang, Director, Office of Financial Stability Policy and Research, Board of Governors January 24–25, 2012 2 of 314 Jon W. Faust and Andrew T. Levin, Special Advisors to the Board, Office of Board Members, Board of Governors James A. Clouse, Deputy Director, Division of Monetary Affairs, Board of Governors Linda Robertson, Assistant to the Board, Office of Board Members, Board of Governors Daniel E. Sichel, Senior Associate Director, Division of Research and Statistics, Board of Governors Ellen E. Meade, Stephen A. Meyer, and Joyce K. Zickler, Senior Advisers, Division of Monetary Affairs, Board of Governors; Lawrence Slifman, Senior Adviser, Division of Research and Statistics, Board of Governors Eric M. Engen1 and Daniel M. Covitz, Associate Directors, Division of Research and Statistics, Board of Governors; Trevor A. Reeve, Associate Director, Division of International Finance, Board of Governors Joshua Gallin,¹ Deputy Associate Director, Division of Research and Statistics, Board of Governors David H. Small, Project Manager, Division of Monetary Affairs, Board of Governors Chiara Scotti, Senior Economist, Division of International Finance, Board of Governors; Louise Sheiner, Senior Economist, Division of Research and Statistics, Board of Governors Lyle Kumasaka, Senior Financial Analyst, Division of Monetary Affairs, Board of Governors Kurt F. Lewis, Economist, Division of Monetary Affairs, Board of Governors Randall A. Williams, Records Management Analyst, Division of Monetary Affairs, Board of Governors Kenneth C. Montgomery, First Vice President, Federal Reserve Bank of Boston Jeff Fuhrer, Loretta J. Mester, Harvey Rosenblum, and Daniel G. Sullivan, Executive Vice Presidents, Federal Reserve Banks of Boston, Philadelphia, Dallas, and Chicago, respectively Craig S. Hakkio, Mark E. Schweitzer, Christopher J. Waller, and Kei-Mu Yi, Senior Vice Presidents, Federal Reserve Banks of Kansas City, Cleveland, St. Louis, and Minneapolis, respectively 1 Attended Tuesday’s session only. January 24–25, 2012 3 of 314 John Duca2 and Andrew Haughwout,² Vice Presidents, Federal Reserve Banks of Dallas and New York, respectively Julie Ann Remache, Assistant Vice President, Federal Reserve Bank of New York Robert L. Hetzel, Senior Economist, Federal Reserve Bank of Richmond Daniel Cooper,² Economist, Federal Reserve Bank of Boston 2 Attended the discussion of the role of financial conditions in economic recovery. January 24–25, 2012 4 of 314 Transcript of the Federal Open Market Committee Meeting on January 24–25, 2012 January 24 Session CHAIRMAN BERNANKE. Good morning, everybody. I’d like to start by recognizing our colleague, Larry Slifman, who is at his last meeting before his planned retirement. Larry is still fairly junior, having been on the Board staff almost 42 years. [Laughter] He has attended 183 FOMC meetings over 30 years. At one day per meeting, that’s almost exactly six months of FOMC meetings. [Laughter] Larry has shown great economic insight but has also excelled in mentoring others in the art of presenting complex material to the Board in the clearest and most logical manner. Larry, those of us around the table and many predecessors have benefited greatly from your dedicated service. Congratulations and best wishes for the next phase. Thank you very much. [Applause] CHAIRMAN BERNANKE. I’d like to welcome, of course, President Lacker, President Lockhart, President Pianalto, and President Williams to the FOMC. We will have a formal organizational part of the meeting a little bit later this morning, but I thought it would be useful first to begin with our special topic, which we’re looking forward to. The topic is the role of financial conditions in economic recovery: lending and leverage. This was a highly favored pick of FOMC participants when we polled you last year about what you would like to talk about. I particularly want to thank Glenn Rudebusch in San Francisco for organizing this session and acknowledge the presenters, John Duca from Dallas, Andrew Haughwout from New York, and Daniel Cooper from Boston. Let me call on John. MR. DUCA.1 Thank you, Mr. Chairman. I will be referring to the handout on lending and leverage. This presentation, coauthored with Anthony Murphy, links the sluggish recovery in personal consumption expenditures (PCE) to financial factors and then shows how movements in consumption reflect long- and short-run shifts in 1 The materials used by Mr. Duca, Mr. Haughwout, and Mr. Cooper are appended to this transcript (appendix 1). January 24–25, 2012 5 of 314 wealth and the availability of consumer and mortgage credit. We end by discussing how recent consumer spending has been bolstered by some stabilization of household balance sheets, coupled with an upturn in the supply of consumer credit. To provide a benchmark, exhibit 1 plots real per capita consumption normalized around the prior five major business cycle peaks. Consumer spending barely fell during these recessions—whether in terms of the average of those cycles (the black line) or their range (the shaded gray area). In the current cycle (the red line), consumer spending declined by nearly 5 percentage points before hitting bottom. Moreover, in the earlier episodes, consumption recovered rapidly. By comparison, per capita consumer spending has rebounded slowly so far in the current cycle—not even retracing its decline since late 2007. As implied by exhibit 2, weak consumption reflects not only weak income, but also a higher personal saving rate (the red line), which jumped about 4 percentage points during the Great Recession, not noticeably declining until recently. This contrasts with earlier major cycles (the black line) when the saving rate changed little. Turning to exhibit 3, the unusual rise in the saving rate coincides with a large decline in credit availability, as tracked by our credit conditions index (described later). On average, consumer credit conditions (the black line) turned up about a year after a business cycle peak. However, in the current cycle, consumer credit conditions have been noticeably weaker (the red line), taking 10 quarters after the peak to start increasing. The rise in the index in the past four quarters coincides with the recent upturn in nonrevolving consumer credit. Turning to exhibit 4, it is helpful to understand recent developments by reviewing longer-term movements in the personal saving rate. The saving rate (the black line) fluctuated between 8 and 10 percent until the mid-1970s. Apart from some temporary upticks during recessions, the saving rate trended down until 2008:Q1. In the standard lifecycle/permanent income framework, consumption depends on permanent income and on wealth. This implies that the saving rate (the black line) and the ratio of wealth-to-income (the blue line) should generally move in opposite directions, as they do. Nevertheless, the current saving rate is considerably lower than in the 1970s, despite similar wealth-to-income ratios in the two periods. This anomaly does not go away if wealth is disaggregated into different components to reflect their different influences on consumption. Some additional factor is affecting the saving rate. Most of the nonstock wealth-induced movements in the saving rate since the mid- 1970s stem from shifts in the availability of consumer and home equity credit and changes in mortgage credit standards that affected house prices. Our model of consumption, which disaggregates wealth and controls for standard factors—such as income, unemployment, and interest rates—incorporates two important, novel features. First, we estimate shifts in the sensitivity of consumption to housing wealth stemming from regulatory changes and mortgage innovations. This affects the impact January 24–25, 2012 6 of 314 of housing wealth on consumption, the so-called marginal propensity to consume out of housing wealth. Second, we track exogenous shifts in the supply of consumer credit using a consumer credit conditions index. Before using our model to understand the recent behavior of consumption and saving,