The Federal Reserve has neither the power nor the desire to bail out bad investments. We do have the responsibility to do what we can to maintain normal financial market processes. What that means, in my view, is that we want to see restoration of active trading in assets of all sorts and in all risk classes. It is for the market to judge whether securities backed by subprime mortgages are worth 20 cents on the dollar, or 50 cents, or 100 cents. Obviously, the market will judge different subprime assets differently, based on careful analysis of the underlying mortgages. That process will take time, as it is expensive to conduct the analysis that good mortgage underwriting would have conducted in the first place. Although there is a substantial distance to go, restoration of normal spreads and trading activity appears to be under way, and we can be confident that in time the market will straighten out the problems. We do not know, however, how much time will be required for us to be able to say that the current episode is over.

The Federal Reserve is one of a growing number of organizations that have already taken some implications of behavioral research to heart. This year, we began to automatically enroll new employees into our System’s savings plan, defaulting them into an asset allocation fund that includes fixed income, domestic, and international equity investments. Employees who do not want to participate can, of course, easily opt out. But our early experience mirrors well-known research findings: so far, an overwhelming fraction of employees who were defaulted in remain in. Of course, this choice reflects the Federal Reserve System’s appreciation of the striking findings of behavioral economics concerning the sensitivity of saving decisions to default enrollments.

``If evidence arrives that we need a policy move, of course I will consider it and I will take that evidence seriously,'' he said in an interview with Reuters today. ``That evidence would be of the nature of information that alters the outlook for real spending and inflation.''

``If it lowers growth and real spending, that is going to warrant a lower path for real interest rates,'' Lacker said, adding the impact is `` very unclear.''

As reported by Bloomberg News  

Fixed, or partially fixed exchange rate regimes, of course, also constrain the independence of monetary policy. As capital accounts become progressively more open, few countries can sustain over time a commitment to exchange rate stability without risking price stability. Eventually central banks will run up against limits on their capacity to sterilize the effects of exchange market intervention designed to limit the pace and extent of appreciation of the exchange rate. Although measured inflation in emerging Asian economies remains relatively low, the pace of credit growth and the behavior of asset prices provide some evidence of a growing tension among competing objectives. The longer this policy conflict persists, the greater the distortions building up in the economy, the greater the risk of future inflation and the greater the risk of a bumpy future.

In response to this series of financial panics, the Congress in 1913 founded the Federal Reserve to provide the nation with a safer, more flexible, and more stable monetary and financial system. Specifically, the Fed was established "to furnish an elastic currency, to afford means of rediscounting commercial paper, [and] to establish a more effective supervision of banking in the United States."

Monetary policy decisions are made without the direct input or the immediate approval of the other branches of government. This helps keep monetary policy independent of political pressures and influence. Nevertheless, we are independent within the government - not of the government. Ultimately, we are accountable to Congress for achieving two objectives: price stability and maximum sustainable economic growth.

Despite the favorable results attained by inflation-targeting countries over time, our evidence generally does not suggest that countries that adopt inflation targeting have improved their monetary policy performance beyond that of our control group of nontargeters, all of which are industrial countries with a successful monetary policy...

Nevertheless, the adoption of inflation targeting can have advantages even for industrial countries. Industrialized countries that have not adopted inflation targeting face four problems (see Bernanke and others, 1999; Mishkin, 2005). First, the strong nominal anchor that produced a successful monetary policy is often based on individuals, and their replacements may not be strongly committed to the nominal anchor. Second, the focus on the long run exhibited by successful nontargeters may weaken in the future. Third, the lack of transparency about the goals of monetary policy increases uncertainty. Fourth, the lack of accountability in the absence of inflation targeting could undermine central bank independence in the future, thereby weakening the nominal anchor.  Inflation targeting has the potential to ensure that the successful monetary policy performance of our control group of industrial nontargeters in recent years continues in the future.

[T]here is a further reason why I believe that a central bank should not put too much focus on asset prices. Such a focus can weaken its public support, making it harder for it to successfully conduct monetary policy to stabilize inflation and employment.

A central bank that focuses intently on asset prices looks as if it is trying to control too many elements of the economy. Part of the recent successes of central banks throughout the world has been that they have narrowed their focus and have more actively communicated what they can and cannot do. Specifically, central banks have argued that they are less capable of controlling real economic trends in the long run and should therefore focus more on price stability and damping short-term economic fluctuations. By narrowing their focus, central banks in recent years have been able to increase public support for their independence. A central bank that expanded its focus to asset prices could potentially weaken its public support and may even cause the public to worry that it is too powerful and has undue influence over all aspects of the economy.

With regard to the Federal Reserve's role in promoting the growth of rural communities, the Fed is charged with maintaining credit conditions that are conducive to our nation's progress. To be sure, our main tool, monetary policy, is a blunt instrument that cannot be targeted at individual industries or regions. However, the Federal Reserve can play a critical role in creating a credit climate that fosters rural progress in general, a climate in which the inherent advantages of individual communities can be realized.  We can best promote a progressive credit climate by maintaining an environment of low inflation.

In this prospective new role, I would bear the critical responsibility of preserving the independent and nonpartisan status of the Federal Reserve--a status that, in my view, is essential to that institution's ability to function effectively and achieve its mandated objectives. I assure this Committee that, if I am confirmed, I will be strictly independent of all political influences and will be guided solely by the Federal Reserve's mandate from Congress and by the public interest.  With respect to monetary policy, I will make continuity with the policies and policy strategies of the Greenspan Fed a top priority.

The federal funds futures market and other markets...provide a rich source of information to better understand the effectiveness of the Fed's changes in disclosure policies over the Greenspan era.  It is quite clear that the markets understand Fed policy to a much greater extent than before.

Independence is the freedom to pursue a defined monetary policy objective without consideration of political or private interests, and without fear of subordination to other economic policy objectives...Independent central banks do, in fact, do a better job of achieving price stability. The greater the independence of the central bank, the lower the average level of inflation and the less volatile the inflation rate

Critics argue that while [the Fed] want[s] the public to believe inflation will remain well-anchored in the future, when the future finally rolls around, [it] might want the flexibility to pursue policies that are inconsistent with the earlier promise implied by an inflation target. In other words, [it] might find the commitment implied by [its] announced inflation target constraining. I would argue that this is a flexibility the Fed should be happy to do without.

The spread of computers, advances in telecommunications, and the dramatic growth in the use of the Internet point to innovations in e-money. These will ultimately reshape the payment system and, along the way, present challenges to the Federal Reserve and monetary policy.

Given the slow pace of progress and the strong likelihood that stored-value cards will substitute only for a portion of currency, there is little danger that the Fed's portfolio will shrink to the point at which the Fed will be unable to cover its costs of operation.

The spread of network money, on the other hand, might not reduce the demand for reserves, if network money is subject to reserve requirements. In the absence of reserve requirements against network money, it is still likely that central bank balances would dominate settlement balances at private banks, given the former's lack of default risk. In this case, a system featuring floors and ceilings appears well designed to allow the Fed to continue to implement monetary policy by controlling the federal funds rate.

The public has a right to know what its unelected, as well as elected, officials are doing, and why. And this is the reason that transparency is so important for supporting the independence of the central bank. Transparency facilitates a broad understanding of what the central bank is doing and thereby gives the public the tools to hold the independent central bank accountable. Transparency, in fact, can play a valuable role in reinforcing the institutional independence of a central bank