Although the financial market stresses that emanated from abroad at the start of this year have eased, vulnerabilities in the global economy remain. In the current environment of sluggish global growth, low inflation and already very accommodative monetary policy in many advanced economies, investor perceptions of and appetite for risk can change abruptly.

In circumstances where many economies face common negative shocks or where negative shocks in one country are quickly transmitted across borders, it is natural to consider whether coordination can improve outcomes. Under certain conditions--such as flexible exchange rates, deep and well-regulated financial markets, and flexible product and labor markets--policies designed for the domestic economy can readily offset any spillovers from economic conditions abroad, and policies designed to address domestic conditions can achieve desirable outcomes both within the national economy and more broadly.

In some circumstances, however, cooperation can be quite helpful. If, for example, economies face a common challenge, coordination can communicate to markets that policymakers recognize the challenge and will work to address it. Reducing uncertainty about the direction of policy and addressing concerns about policies working at cross-purposes can boost the confidence of businesses and households. With intensified transmission effects in the vicinity of the zero lower bound, there is a risk that uncoordinated policy on its own could have the effect of shifting demand across borders rather than addressing the underlying weakness in global demand. The difficult start to the year should be a prompt for greater policy coherence and clarity. This might be a good time for policymakers to reaffirm their commitment to work toward the common goal of strengthening global demand.

Liesman: As a central banker do you feel difference being too far ahead of the pack here? Is there a limit to how much the fed can and will do this year because of the weakness overseas?

Williams: So you know, we talk about divergence between the U.S. and the rest of the economy. There's a divergence within the U.S. economy too reflecting that. And that specifically, our domestic demand – consumer spending, investment spending – is actually on a very good trajectory. Where we are getting hit hardest is in terms of our net exports. That's a big drag on our economy. So, you know, the way I see it over the next couple of years, we're going to need significant monetary accommodation, a very gradual pace of rate increases to keep our economy on this 2, 2.25% growth path given the headwinds we're facing, especially from abroad.

What we can do is to do our very best to communicate clearly about our policy, and our expectations, to avoid any type of needless misunderstanding of our policy that could create volatility in the market and potential spillovers as well to emerging markets. And I have been trying to do that now for some time. I've been doing my best to make good on that pledge.

Fed's Bullard says no direct impact on U.S. from Swiss franc move

The currency market turmoil sparked by the Swiss National Bank's lifting of its euro cap will not have a direct impact on the U.S. economy, a top Federal Reserve official said on Friday.

St. Louis Federal Reserve Bank President James Bullard said he was not aware of any warning that the Swiss bank gave to the Fed ahead of its move to lift the cap, which sent the Swiss franc soaring and led to huge foreign exchange losses across the globe.

"The Swiss economy is just too small to have an impact," Bullard said, in a session with reporters here after a speech he gave to the CFA Society.

Bullard said that events have gone against the Swiss National Bank, as Europe's economy has weakened and the European Central Bank is nearing a decision to launch a major bond-buying program, which puts tremendous pressure on the euro/Swiss franc exchange rate.

"I don't want to Monday morning quarterback these guys. But if you want to learn a lesson from it, I think it's got to be that if you're going to undertake a policy like that you also have to have a careful reasoning about under what conditions you expect to remove your policy," Bullard told reporters.

The story, if you will, for 2015 and 2016 is not so much just about the Fed and raising rates, blah blah blah, but really about the global environment, the fact that we have the two biggest central banks outside the Fed acting aggressively in one direction and were going to have the Fed, mostly likely, and maybe a few others working in the other. I think thats going to create some turbulence.

The Federal Reserve's monetary policy is motivated by the dual mandate, which calls upon us to achieve stable prices and maximum sustainable employment. While these objectives are stated as domestic concerns, as a practical matter, economic and financial developments around the world can have significant effects on our own economy and vice versa. Thus, the pursuit of our mandate requires that we understand and incorporate into our policy decision-making the anticipated effects of these interconnections. And the dollar's role as the world's primary reserve, transaction, and funding currency requires us to consider global developments to help ensure our own financial stability.

By design, accommodative monetary policy--whether conventional or unconventional--supports economic activity in part by creating incentives for investors to take more risk. Such risk-taking can show up in domestic financial markets, in the international investments of U.S. investors, and even, ultimately, in general risk attitudes toward foreign financial markets. Distinguishing between appropriate and excessive risk-taking is difficult, however.

Furthermore, many EMEs generally appear to be better equipped today to handle the Fed's prospective exit from its exceptional policy accommodation than they were during past tightening cycles. This reflects the fundamental reforms that EMEs have put in place over the past 15 years, as well as the hard lessons learned from past periods of market stress. Among the positives are: The absence of pegged exchange rate regimes that often came undone violently during periods of acute stress; Improved debt service ratios and generally moderate external debt levels; Larger foreign exchange reserve cushions; Clearer and more coherent monetary policy frameworks, supporting what are now generally low to moderate inflation rates; Generally improved fiscal discipline; and Better capitalized banking systems, supported by strengthened regulatory and supervisory frameworks.

[G]iven the dollars role as the global reserve currency, the Federal Reserve has a special responsibility to manage U.S. monetary policy in a way that helps promote global financial stability.

Like other central banks, our monetary policy mandate has a domestic focus. But, our actions often have global implications that feed back into the U.S. economy and financial markets, and we need to always keep this in mind. For most of us, the market volatility that we saw during the so-called taper tantrum in the spring and summer of 2013 still remains fresh in our minds. EME financial markets were hit hardest, with declines in equity prices, a widening in sovereign debt spreads and a sharp increase in foreign exchange rate volatility. In the U.S., we saw a spike in Treasury yields, with the 10-year rate rising by more than 100 basis points from early May before peaking in early September.

Most commentary about this period has focused on the shift in expectations with respect to U.S. monetary policyand, in particular, to uncertainty about the timing and implications of Fed taperingas the catalyst for these moves. This focus seems generally right to me.

Looking ahead, it seems likely that markets will remain focused on vulnerabilities that they might have ignored prior to the taper tantrum in 2013. The greater premium on strong fundamentals, policy coherence and predictability will likely remain. There will be no one right answer in managing the trade-offs that come with the changed environment, and adjustment will sometimes be difficult. Moreover, we will undoubtedly experience further bumps in the road. The renewed volatility we saw last month is evidence enough of that. Yet, I think we can remain generally optimistic on the outlook so long as market participants continue to appropriately discriminate across countries, rather than treating EMEs as a homogenous group.

Furthermore, many EMEs generally appear to be better equipped today to handle the Fed's prospective exit from its exceptional policy accommodation than they were in past tightening cycles

The impact that changes in Fed policy can have beyond our borders has led to calls for us to do more to internalize those impacts, or even further, to internationally coordinate policymaking. As Ive already noted, Fed policies have significant effects internationally, given the central place of U.S. markets in the global financial system and the dollars status as the global reserve currency. In pursuing our policy responsibilities, we seek to conduct policy transparently and based on clear principles. We are mindful of the global effects of Fed policy. Promoting growth and stability in the U.S., I believe, is the most important contribution we can make to growth and stability worldwide.

The largest problems that countries create for others often emanate from getting policy wrong domestically. Recession or instability at home is often quickly exported. Equally important, growth and stability abroad makes all our jobs easier. This means that there are externalities in the work we do, so that more effective fulfillment of our domestic mandates helps to bring us to a better place collectively. Ensuring global growth and stability is and will remain our joint and common endeavor.

The preponderance of evidence suggests that the Fed's asset purchases raised the prices of the assets purchased and close substitutes as well as those of riskier assets.

Importantly, evidence--including the evidence of our eyes--shows that foreign asset markets have been significantly affected by the Fed's purchase programs.

Although much of the recent commentary on spillovers has focused on the United States, it bears mentioning that other countries' monetary policy announcements can leave an imprint on international asset prices, with market reactions to new initiatives announced by the European Central Bank (ECB) in the past few weeks the most recent example. However, event studies tend to find larger international interest rate spillovers for U.S. policy announcements than for those of other central banks.

It is also worth emphasizing that asset purchases are merely one form of monetary accommodation, made necessary when policy interest rates hit their zero lower bound Studies that have compared the spillovers of monetary policy across conventional and unconventional measures generally conclude that the effects on global financial markets are roughly similar.

In a progressively integrating world economy and financial system, a central bank cannot ignore developments beyond its country's borders, and the Fed is no exception. This is true even though the Fed's statutory objectives are defined as specific goals for the U.S. economy. In particular, the Federal Reserve's objectives are given by its dual mandate to pursue maximum sustainable employment and price stability, and our policy decisions are targeted to achieve these dual objectives.2 Hence, at first blush, it may seem that there is little need for Fed policymakers to pay attention to developments outside the United States.

But such an inference would be incorrect. The state of the U.S. economy is significantly affected by the state of the world economy. A wide range of foreign shocks affect U.S. domestic spending, production, prices, and financial conditions. To anticipate how these shocks affect the U.S. economy, the Federal Reserve devotes significant resources to monitoring developments in foreign economies, including emerging market economies (EMEs), which account for an increasingly important share of global growth. The most recent available data show 47 percent of total U.S. exports going to EME destinations. And of course, actions taken by the Federal Reserve influence economic conditions abroad. Because these international effects in turn spill back on the evolution of the U.S. economy, we cannot make sensible monetary policy choices without taking them into account.

[T]ightening should occur only against the backdrop of a strengthening U.S. economy and in an environment of improved household and business confidence. The stronger U.S. economy should directly benefit our foreign trading partners by raising the demand for their exports, and perhaps also indirectly, by boosting confidence globally. And if foreign growth is weaker than anticipated, the consequences for the U.S. economy could lead the Fed to remove accommodation more slowly than otherwise.

So far, I have focused on the immediate spillovers of U.S. monetary policy abroad and the feedback of those effects to the U.S. economy. More tacitly than explicitly stated has been my view that the United States is not just any economy and, thus, the Federal Reserve not just any central bank. The U.S. economy represents nearly one-fourth of the global economy measured at market rates and a similar share of gross capital flows. The significant size and international linkages of the U.S. economy mean that economic and financial developments in the United States have global spillovers--something that the IMF is well aware of and has reflected in its increased focus on multilateral surveillance. In this context and in this venue, it is, therefore, important to ask, what is the Federal Reserve's responsibility to the global economy?

First and foremost, it is to keep our own house in order. Economic and financial volatility in any country can have negative consequences for the world--no audience knows that more than this one--but sizable and significant spillovers are almost assured from an economy that is large

As the recent financial crisis showed all too clearly, to achieve this objective, we must take financial stability into account [O]ur efforts to stabilize the U.S. financial system also have positive spillovers abroad.

These financial stability responsibilities do not stop at our borders, given the size and openness of our capital markets and the unique position of the U.S. dollar as the world's leading currency for financial transactions.

But I should caution that the responsibility of the Fed is not unbounded. My teacher Charles Kindleberger argued that stability of the international financial system could best be supported by the leadership of a financial hegemon or a global central bank. But I should be clear that the U.S. Federal Reserve System is not that bank. Our mandate, like that of virtually all central banks, focuses on domestic objectives. As I have described, to meet those domestic objectives, we must recognize the effect of our actions abroad, and, by meeting those domestic objectives, we best minimize the negative spillovers we have to the global economy. And because the dollar features so prominently in international transactions, we must be mindful that our markets extend beyond our borders and take precautions, as we have done before, to provide liquidity when necessary.

Obviously as the dollar moves that affects the appropriateness of a given monetary policy to achieve those objectives. And we certainly take it on board just like we take on board what's happening to the stock market, what's happening to the bond market, what's happening to credit spreads, what's happening to credit availability. All those factors sort of drive our assessment of what's happening to financial conditions. And then that influences our economic outlook. And then that in turn then influences the monetary policy response.

The Fed was envisioned as operating within and facilitating adherence to the gold standard. While price stability was an important goal of the founders of the Fed, one to which they expected the Fed to contribute, their focus in founding the Fed was something else entirely. It was to solve "the currency problem." This is an unfamiliar term to modern ears, so it deserves a bit of explanation. Before the founding of the Fed, paper currency was supplied by national banks, but was subject to a collateral requirement that dated back to the Civil War; banks' note issues had to be backed by holdings of U.S. government bonds. The aggregate supply of notes was widely described as "inelastic," because expanding a bank's note issue was often costly and cumbersome. At times, the public demand for notes rose as the public sought to convert bank deposits into paper currency or gold. This typically occurred during the autumn harvest season and the holiday shopping season, as well as during so-called banking panics, when bank customers sought to pull deposits out of banks.

The inelasticity of the physical supply of bank notes meant that other adjustments had to take place instead...

Thus the preamble of the Federal Reserve Act lists as one of its purposes "to furnish an elastic currency." The ultimate objective can be thought of as keeping the defective legislative framework around U.S. banking from damaging domestic and international markets.

International considerations were critical in the crisis of 2007–08. The first special lending program introduced by the Federal Reserve — the Term Auction Facility — was dominated by foreign financial institutions. The TAF, introduced in December 2007, auctioned term credit from the Reserve Banks' discount windows. Foreign institutions held large dollar-denominated positions in illiquid assets, such as mortgage-backed securities, that they had trouble funding. Banks in the U.S. had access to borrowing from the Federal Home Loan Banks and made major use of that source of funds when credit risk premiums rose in the third quarter of 2007.