Dudley - Still More Lessons from the Crisis

  • Published on:  Wednesday, October 9, 2013
  • Remarks by William C. Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York at the Columbia University World Leaders Forum, New York City on December 7th, 2009

    It is a pleasure to have the opportunity to speak here this evening. I was a freshman here at Columbia nearly 40 years ago. I'm certainly glad to be back, but I must admit that there is a downside: It does make me feel a bit old in the process.

    Tonight, I want to talk about two broad sets of issues: First, the Federal Reserve's role in responding to the crisis and the steps we must take to reduce, as much as possible, the risks of this type of costly and painful episode in the future and, second, the economic outlook for 2010 and some of the challenges that the Federal Open Market Committee (FOMC) faces in the conduct of monetary policy.

    The actions undertaken by the Federal Reserve over the past two and a half years have been critical to stabilizing the financial system and preventing the extraordinary distress in markets from causing a deeper and more protracted economic downturn. Much of the Fed's ability to respond as effectively as it did during this crisis, whether it was from a monetary policy, a "lender-of-last resort" or a supervisory perspective, came from its breadth and depth of knowledge and experience with financial institutions, financial markets and financial market infrastructure, both inside and outside of the United States. That said, there is also no question that the Federal Reserve and other regulators could have done more to prevent this crisis. That is why, even as the Fed has engaged in extraordinary efforts to stabilize the financial system over the past couple of years, it has also been moving quickly to make the internal changes necessary to strengthen our effectiveness. In addition, the Fed has been working with other regulators in and outside of the U.S. to craft and implement the broader changes in regulation and supervision that are necessary to make our financial system more robust and resilient going forward.

    Turning to the outlook, the recession now appears to be over, but the economy is still weak and the unemployment rate is much too high. These circumstances underpin the FOMC's commitment to keeping short term rates exceptionally low for an extended period. However, at the same time, it deserves emphasizing that the Federal Reserve will be willing and able to exit from this period smoothly when the time comes to ensure that inflation stays low and inflation expectations well anchored.

    As always, my comments represent my own views and opinions, not necessarily those of the Federal Open Market Committee or the Federal Reserve System.

    With the benefit of hindsight, it is clear that the Fed and other regulators, both here and abroad, did not sufficiently understand some of the critical vulnerabilities in the financial system, including the consequences of inappropriate incentives, and the opacity and the large number of self-amplifying mechanisms that were embedded within the system. Likewise, we did not appreciate all the ramifications of the growth of the shadow banking system and its linkage back to regulated financial institutions until after the crisis began.

    Of course, understanding now what we did not understand then is only half the battle. We need to respond to ensure that ongoing changes in our financial system do not threaten the stability of the financial system in the future.

    For one, the crisis is provoking a reevaluation of our views on how to respond to asset bubbles. For years, central bank orthodoxy has been that you cannot identify asset bubbles very well. Thus, the strategy has been to move aggressively to clean up such bubbles after they have burst.

    I think our level of confidence in that approach has been considerably reduced in the wake of the crisis that we have just experienced. The costs of cleaning up after the fact have been immense.

    But make no mistake—developing an effective, more proactive approach is not easy. Among the important questions that need to be answered:

    How does one identify bubbles—which I'll define here as persistent large deviations in asset prices from their fundamental value—in real time?

    What instruments can be used to limit the development of bubbles and/or allow bubbles to deflate in non-catastrophic ways that will not damage the economy in other ways? ...

    Full transcript: http://www.newyorkfed.org/newsevents/...