You know, conceivably, I think, with the benefit of hindsight, it might have been better to raise rates more rapidly or more during the 2004-06 cycle. I'm -- you know, I'm not certain of that judgment, but I think there's a case to be made.

With the benefit of hindsight, one could argue that the Federal Reserve should have raised short-term interest rates more aggressively over [the 2004-07] period.

The entire FOMC knows the history and the ruinous fate that is meted out to countries whose central banks take to regularly monetizing government debt. Barring some unexpected shock to the economy or financial system, I think we are pushing the envelope with the current round of Treasury purchases. I would be very wary of expanding our balance sheet further; indeed, given current economic and financial conditions, it is hard for me to envision a scenario where I would not use my voting position this year to formally dissent should the FOMC recommend another tranche of monetary accommodation. And I expect I will be at the forefront of the effort to trim back our Treasury holdings and tighten policy at the earliest sign that inflationary pressures are moving beyond the commodity markets and into the general price stream. I am a veteran of the Carter administration and know how easily prices can spin out of control and how cruelly markets can exact their revenge. I would not want to relive that experience.

But risks remain, especially those associated with inadvertently creating false expectations that the Fed is preoccupied with achieving a specific level of the unemployment rate. Our ability to manage those risks will depend on when and how we choose to tighten policy, as eventually we must. To wait until unemployment reaches some predetermined level, as the Martin FOMC did in the 1960s, is likely to mean waiting too long. That strategy proved bitterly disappointing for Martin and his colleagues, and I expect it would prove disappointing for us as well. At some point in the not-too-distant future, we are likely to face an economy growing in a self-sustaining way while the unemployment rate is still relatively high by historical standards. The decisions we make at that time will be the true test of whether we've learned our lessons.

I will leave it to economic historians to assess whether the Panic of 2008 was more anomalous than the period of prosperity that preceded it. I believe that the categorization of recent events as deviant, ultimately, will depend on what happens next. That is, if policy changes cause future economic performance to suffer, then the boom of the last generation may, regrettably, turn out to be more exceptional than the bust.

This recession is often described as the worst in post-World War II history, and that may very well be correct.  From it will flow a host of policy issues that will require careful review and hard choices if we are to assure our national economy's long-term strength and vitality.

The recovery that followed the recession in the early 1990s was fairly sluggish. And with a lackluster recovery after the 2001 recession, the evidence supporting rapid bouncebacks after downturns was weakened further. Some analysts have suggested that those slow recoveries reflected the shallowness of the downturns--indeed, the research on the pre-1990 episodes indicated that the strength of recoveries was correlated with the depth of the preceding recessions, and the slowness of the recoveries from the 1990 and 2001 recessions would be consistent with that correlation. However, many commentators instead attributed the slowness of those recoveries to the drag from structural factors--namely, the financial headwinds in the early 1990s and the need to work off capital overhangs after 2001. All in all, the historical record leaves us with at least two possibilities for the coming recovery: a strong recovery from the deep recession or a sluggish recovery because drag from the underlying structural factors partly offsets the usual forces that generate a rapid bounceback.

Once under way, the pace of the expansion is likely to be subdued for a time. There is historical precedent for this, since the recovery of the early 1990s was initially quite modest, as was the recovery earlier this decade. More importantly, in view of the state of the credit markets, it seems a fair bet that it will take time for momentum to build. But with the passage of time—as we get into the middle of 2010 and beyond—I would expect to see a resumption of healthy growth.

(A)s bad as the initial problems were, the failure to quickly restore banks’ financial health had serious consequences for the Japanese economy, which as you know experienced growth below potential for over a decade.  There are several lessons – admittedly intertwined – that I take from my studies of this experience:

• First, undercapitalized banks behave differently than well-capitalized banks.
• Second, certain bank-regulatory and accounting policies may amplify the business cycle.
• Third, troubled assets need to be moved off bank balance sheets as quickly as possible.

Some economists have argued that tighter monetary policy during that period would have led to better outcomes by limiting the housing boom and thus mitigating the subsequent bust.² While I find this view plausible, again, further research will be required to substantiate this hypothesis.

I think that today's circumstances align, although not perfectly, with the experience of the early 1990s. There is no doubt that a variety of potential borrowers are finding funding more difficult and expensive to obtain. Moreover, while there was a significant contraction in residential construction activity in the late 1980s and early 1990s, the recent correction in this sector has been more severe, especially with the decline in housing values, and is continuing.

It is important to bear in mind, however, that many “initial conditions” prevailing prior to this financial shock were perceptibly better than in the early 1990s. Unemployment, interest rates, and inflation were all lower at the outset of the latest period of turmoil than in the previous headwinds episode. Equally important, the financial condition of both most banking and nonfinancial businesses was relatively healthier at the onset of recent problems.

In my judgment, the 1990s headwinds episode continues to provide a valuable reference point for thinking about economic prospects. For the near-term, I think that this framework suggests further declines in employment and likely softness in consumer spending, with a diminution of inflation, absent a resurgence in energy and other commodity prices.

This is bigger than the S&L. It's broader. It's deeper.  It's not unhealthy. It's the way capitalism works.

As with any forecast, mine is subject to a number of uncertainties. One is the extent of the housing correction ahead of us. If the retrenchment in house prices becomes deeper than anticipated, its effect on lenders and financial markets could further damp overall economic activity. We are in uncharted waters when the financial system becomes so disrupted, though we should consider ourselves fortunate that we have very few similar historical episodes on which to base our judgments. In such circumstances, uncertainty about how credit conditions will evolve and how businesses and households will react to changing terms and conditions means that we can have even less confidence than usual in our economic forecasts.

The 1970s were a horrible period. If there's one thing that has to be very high priority, we don't want to go back to a period that is anything like that.

As reported by Reuters

Thus, as we take on these new challenges, I'll leave you with this quote from 1930 to illustrate my point. It is from Paul Warburg, who was appointed a member of the first Federal Reserve Board by President Woodrow Wilson.

"In a country whose idol is prosperity, any attempt to tamper with conditions in which easy profits are made and people are happy, is strongly resented. It is a desperately unpopular undertaking to dare to sound a discordant note of warning in an atmosphere of cheer, even though one might be able to forecast with certainty that the ice, on which the mad dance was going on, was bound to break. Even if one succeeded in driving the frolicking crowd ashore before the ice cracked, there would have been protests that the cover was strong enough and that no disaster would have occurred if only the situation had been left alone."1

There are many challenges ahead, many choices to make. Some I suspect will be desperately unpopular.