Slowing in the Housing Market might have constrained the rise in household leverage, as mortgage debt growth would have been slower. But the job losses and higher Interest Payments associated with higher Interest Rates would have directly weakened households ability to repay previous debts, suggesting that a sizable tightening may have mitigated vulnerabilities in household Balance Sheets only modestly. Similar mixed results would have been likely with regard to the effects of tighter Monetary Policy on leverage and reliance on shortterm financing within the Financial Sector. In particular, the evidence that low Interest Rates contribute to increased leverage and reliance on shortterm funding points toward some ability of higher Interest Rates to lessen these vulnerabilities, but that evidence is typically consistent with a sizable range of quantitative effects or alternative views regarding the causal channels at work. 4furthermore, vulnerabilities from excessive leverage and reliance on shortterm funding in the Financial Sector grew rapidly through the middle of 2007, well after Monetary Policy had already tightened significantly relative to the accommodative policy stance of 2003 and early 2004. In my assessment, macroprudential policies, such as regulatory limits on leverage and shortterm funding, as well as stronger underwriting standards, represent far more direct and likely more effective methods to address these vulnerabilities. Turning to recent experience outside the United States, a number of foreign economies have seen rapidly rising real estate prices, which has raised Financial Stability concerns despite, in some cases, high unemployment and shortfalls in inflation relative to the Central Banks inflation target. These developments have prompted debate on how to best balance the use of Monetary Policy and macroprudential tools in promoting Financial Stability. For example, canada, switzerland, and the United Kingdom have expressed a willingness to use Monetary Policy to address Financial Stability concerns in unusual circumstances, but they have similarly concluded that macroprudential policies should serve as the primary tool to pursue Financial Stability. In canada, with inflation below target and output growth quite subdued, the bank of canada has kept the policy rate at or below 1 percent, but limits on mortgage lending were tightened in each of the years from 2009 through 2012, including changes in loantovalue and debttoincome caps, among other measures. In contrast, in norway and sweden, Monetary Policy decisions have been influenced somewhat by Financial Stability concerns, but the steps taken have been limited. In norway, policymakers increased the policy Interest Rate in mid2010 when they were facing escalating Household Debt despite inflation below target and output below capacity, in part as a way of guarding against the risk of future imbalances. Similarly, Swedens Riksbank held its policy rate slightly higher than we would have done otherwise because of Financial Stability concerns. In both cases, macroprudential actions were also either taken or under consideration. In reviewing these experiences, it seems clear that Monetary Policymakers have perceived significant hurdles to using sizable adjustments in Monetary Policy to contain Financial Stability risks. Some proponents of a larger Monetary Policy response to Financial Stability concerns might argue that these perceived hurdles have been overblown and that Financial Stability concerns should be elevated significantly in Monetary Policy discussions. A more balanced assessment, in my view, would be that increased focus on Financial Stability risks is appropriate in Monetary Policy discussions, but the potential cost, in terms of diminished macroeconomic performance, is likely to be too great to give Financial Stability risks a central role in Monetary Policy decisions, at least most of the time. If Monetary Policy is not to play a central role in addressing Financial Stability issues, this task must rely on macroprudential policies. In this regard, i would note that here, too, policymakers abroad have made important strides, and not just those in the advanced economies. Emerging market economies have in many ways been leaders in applying Macroprudential Policy tools, employing in recent years a variety of restrictions on Real Estate Lending or other activities that were perceived to create vulnerabilities. Although it is probably too soon to draw clear conclusions, these experiences will help inform our understanding of these policies and their efficacy. If macroprudential tools are to play the primary role in the pursuit of Financial Stability, questions remain on which macroprudential tools are likely to be most effective, what the limits of such tools may be, and when, because of such limits, it may be appropriate to adjust Monetary Policy to get in the cracks that persist in the macroprudential framework. In weighing these questions, i find it helpful to distinguish between tools that primarily build throughthecycle resilience against adverse financial developments and those primarily intended to lean against financial excesses. 12 tools that build resilience aim to make the Financial System better able to withstand unexpected adverse developments. For example, requirements to hold sufficient lossabsorbing capital make Financial Institutions more resilient in the face of unexpected losses. Such requirements take on a macroprudential dimension when they are most stringent for the largest, most systemically important firms, thereby minimizing the risk that losses at such firms will reverberate through the Financial System. Resilience against runs can be enhanced both by stronger capital positions and requirements for sufficient liquidity buffers among the most interconnected firms. An effective resolution regime for sifis can also enhance resilience by better protecting the Financial System from contagion in the event of a sifi collapse. Further, the stability of the Financial System can be enhanced through measures that address interconnectedness between Financial Firms, such as margin and Central Clearing requirements for derivatives transactions. Finally, a regulatory umbrella wide enough to cover previous gaps in the regulation and supervision of systemically important firms and markets can help prevent risks from migrating to areas where they are difficult to detect or address. In the United States, considerable progress has been made on each of these fronts. Changes in bank capital regulations, which will include a surcharge for systemically important institutions, have significantly increased requirements for lossabsorbing capital at the largest banking firms. The federal reserves stress tests and comprehensive capital analysis and review process require that large Financial Institutions maintain sufficient capital to weather severe shocks, and that they demonstrate that their internal Capital Planning processes are effective, while providing perspective on the lossabsorbing capacity across a large swath of the Financial System. The basel iii framework also includes liquidity requirements designed to mitigate excessive reliance by global banks on shortterm wholesale funding. Oversight of the u. S. Shadow Banking System also has been strengthened. The new Financial StabilityOversight Council has designated some nonbank Financial Firms as systemically important institutions that are subject to consolidated supervision by the federal reserve. In addition, measures are being undertaken to address some of the potential sources of instability in shortterm wholesale funding markets, including reforms to the Triparty Repo market and money market mutual fundsalthough progress in these areas has, at times, been frustratingly slow. Additional measures should be taken to address residual risks in the shortterm wholesale funding markets. Some of these measuressuch as requiring firms to hold larger amounts of capital, stable funding, or highly liquid assets based on use of shortterm wholesale fundingwould likely apply only to the largest, most complex organizations. Other measuressuch as minimum margin requirements for repurchase agreements and other securities financing transactionscould, at least in principle, apply on a marketwide basis. To the extent that minimum margin requirements lead to more conservative margin levels during normal and exuberant times, they could help avoid potentially destabilizing procyclical margin increases in shortterm wholesale funding markets during times of stress. At this point, it should be clear that i think efforts to build resilience in the Financial System are critical to minimizing the chance of financial instability and the potential damage from it. This focus on resilience differs from much of the public discussion, which often concerns whether some particular asset class is experiencing a bubbl and whether policymakers should attempt to pop the bubble. Because a resilient Financial System can withstand unexpected developments, identification of bubbles is less critical. Nonetheless, some macroprudential tools can be adjusted in a manner that may further enhance resilience as risks emerge. In addition, macroprudential tools can, in some cases, be targeted at areas of concern. For example, the new basel iii regulatory capital framework includes a countercyclical capital buffer, which may help build additional lossabsorbing capacity within the Financial Sector during periods of rapid credit creation while also leaning against emerging excesses. The stress tests include a scenario design process in which the macroeconomic stresses in the scenario become more severe during buoyant economic expansions and incorporate the possibility of highlighting salient risk scenarios, both of which may contribute to increasing resilience during periods in which risks are rising. 13 similarly, minimum margin requirements for securities financing transactions could potentially vary on a countercyclical basis so that they are higher in normal times than in times of stress. In light of the considerable efforts under way to implement a macroprudential approach to enhance Financial Stability and the increased focus of policymakers on monitoring emerging Financial Stability risks, i see three key principles that should guide the interaction of Monetary Policy and Macroprudential Policy in the United States. First, it is critical for regulators to complete their efforts at implementing a macroprudential approach to enhance resilience within the Financial System, which will minimize the likelihood that Monetary Policy will need to focus on Financial Stability issues rather than on price stability and full employment. Key steps along this path include completion of the transition to full implementation of basel iii, including new liquidity requirements; enhanced prudential standards for systemically important firms, including riskbased capital requirements, a leverage ratio, and tighter prudential buffers for firms heavily reliant on shortterm wholesale funding; expansion of the regulatory umbrella to incorporate all systemically important firms; the institution of an effective, crossborder resolution regime for systemically important Financial Institutions; and consideration of regulations, such as minimum margin requirements for securities financing transactions, to limit leverage in sectors beyond the Banking Sector and sifis. Second, policymakers must carefully monitor evolving risks to the Financial System and be realistic about the ability of macroprudential tools to influence these developments. The limitations of macroprudential policies reflect the potential for risks to emerge outside sectors subject to regulation, the potential for supervision and regulation to miss emerging risks, the uncertain efficacy of new macroprudential tools such as a countercyclical capital buffer, and the potential for such policy steps to be delayed or to lack public support. Given such limitations, adjustments in Monetary Policy may, at times, be needed to curb risks to Financial Stability. These first two principles will be more effective in helping to address Financial Stability risks when the public understands how Monetary Policymakers are weighing such risks in the setting of Monetary Policy. Because these issues are both new and complex, there is no simple rule that can prescribe, even in a general sense, how Monetary Policy should adjust in response to shifts in the outlook for Financial Stability. As a result, policymakers should clearly and consistently communicate their views on the stability of the Financial System and how those views are influencing the stance of Monetary Policy. To that end, i will briefly lay out my Current Assessment of Financial Stability risks and their relevance, at this time, to the stance of Monetary Policy in the United States. In recent years, accommodative Monetary Policy has contributed to low Interest Rates, a flat yield curve, improved financial conditions more broadly, and a stronger labor market. These effects have contributed to Balance Sheet repair among households, improved financial conditions among businesses, and hence a strengthening in the health of the Financial Sector. Moreover, the improvements in household and business Balance Sheets have been accompanied by the increased safety of the Financial Sector associated with the macroprudential efforts i have outlined. Overall, nonfinancial credit growth remains moderate, while leverage in the Financial System, on balance, is much reduced. Reliance on shortterm wholesale funding is also significantly lower than immediately before the crisis, although important structural vulnerabilities remain in shortterm funding markets. Taking all of these factors into consideration, i do not presently see a need for Monetary Policy to deviate from a primary focus on attaining price stability and maximum employment, in order to address Financial Stability concerns. That said, i do see pockets of increased risktaking across the Financial System, and an acceleration or broadening of these concerns could necessitate a more robust macroprudential approach. For example, Corporate Bond spreads, as well as indicators of expected volatility in some asset markets, have fa