As best we can tell thus far, the imprint of these developments on economic activity appears likely to be most pronounced in the housing sector.  However, economic activity could be affected more severely in other sectors should heightened uncertainty lead to a broader pullback in household and business spending.  That scenario cannot, in my view, be ruled out, and I believe it poses an important downside risk to economic activity.

My guess is that a great deal of the potential dislocation resulting from corrective reactions to the subprime boom will be resolved by regulatory initiatives rather than by monetary policy...

Any new regulations that might now be crafted to prevent future recurrences must be well thought out, for two reasons. First, financial institutions will quickly adapt to defeat any regulation that is poorly designed, morphing into new, vaccine-resistant strains. Second, heavy-handed regulations are sometimes worse than the disease against which they are meant to protect. I would be wary of any regulatory initiatives that interfere with market discipline and attempts to protect risk takers from the consequences of bad decisions for fear of creating a moral hazard that might endanger the long-term health of our economic and financial system simply to provide momentary relief.  

To live up to what is expected of us, we have to make considered judgments and not react to the latest data point or the "instant analysis" that is ubiquitous on the Internet or in the news media or among the countless financial analysts who pump out commentary like water from a fire hydrant.

A change in monetary policy would be required if the outlook for the economy changes in a way that is inconsistent with the Fed’s goals of price stability and maximum sustainable economic growth. Certainly, standing here today, it is obvious that tighter credit conditions and disruptions in financial markets have increased the uncertainty surrounding our forecasts of the economy. The FOMC continues to monitor incoming data and other economic information for signs that these disruptions are having a broader impact on the economy. In my view, it will be very important to assess such information in light of the Fed’s commitment to achieving its long-run goals of price stability and sustainable economic growth.

We want to be careful not to overweight one piece of information.

Referring to the weak August 2007 payroll data in an interview following his speech, as reported by Bloomberg News.

 I would like to reinforce remarks made last week by Chairman Bernanke on the recent turbulence in financial markets.  In the United States we have seen a fairly sharp downturn in housing markets, and in recent weeks there have been growing investor concerns about mortgage credit performance, particularly with subprime mortgages.  If current conditions persist in mortgage markets, the demand for homes could weaken further, with possible implications for the broader economy.  And financial stress has not been limited just to mortgage markets, but has spread to other markets.  In general, a shift in risk attitudes has interacted with heightened concerns about credit risks and uncertainty about how to evaluate those risks. 

``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  

It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions.  But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy.

...

Well-functioning financial markets are essential for a prosperous economy… The Federal Reserve stands ready to take additional actions as needed to provide liquidity and promote the orderly functioning of markets...

...

The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets.

As you know, the financial stress has not been confined to mortgage markets.

Financial market volatility, in and of itself, does not require a change in the target federal funds rate, in my view. Interest rate policy needs to be guided by the outlook for real spending and inflation. Financial turbulence has the potential to change the assessment of the appropriate rate if it induces a sufficient revision in growth or inflation prospects.

    William Poole, president of the Federal Reserve Bank of St. Louis, said there's no sign that the subprime-mortgage rout is harming the broader U.S. economy, and an interest-rate cut isn't yet needed.   ``I don't see any impact as yet on the real economy or on the inflation rate,'' he said in an interview in the bank's boardroom. ``Obviously, there could be an impact, but we have to rely on some real evidence.''
     Barring a ``calamity,'' there is no need to consider an emergency rate cut, Poole said. His comments were the first by a Fed official since the U.S. central bank joined counterparts in
Europe and Asia to inject emergency funds after a surge in money-market rates. The Fed has added $71 billion of reserves in the past five trading days.
     Poole, 70, said businesses have maintained their hiring and investment plans and banks have sufficient capital to weather the credit-market turmoil. The St. Louis Fed chief stressed that the best course is for policy makers to assess the latest economic data when they next meet Sept. 18. The comments contrast with the certainty that traders put on a rate cut next month.   ``If the data confirm the market's view that the economy is sagging, we'll have to decide whether to share that view,'' said Poole, who votes on the rate-setting Federal Open MarketCommittee this year. He cited the monthly jobs, retail sales and industrial production reports as key gauges he'll be watching.

As reported by Bloomberg News

Consider where this analysis leaves us...  The central bank can hold its policy rate relatively steady and rely on market adjustments in long rates to do much of the stabilization work... The current situation is a perfect illustration. The Fed doesn’t know and market participants do not know either, the full implications of last week’s stock market declines and increases in risk spreads. Market reactions last week may be overdone, or perhaps not. We just do not know. In a situation like the terrorist attacks of 9/11, the Fed knew enough to believe that a quick policy response would be helpful and unlikely to itself be destabilizing.

A typical market upset, such as last week’s, is not at all like 9/11. Most of these upsets stabilize on their own, but some do not. I’m not saying that the Fed should ignore what happened last week—we need to understand what is happening. However, it is important that the Fed not permit uncertainty over policy to add to the existing uncertainty. The market understands, I believe, that the Fed will act in due time, if and when evidence accumulates that action would be appropriate. That is why trading in the federal funds futures market reflects changed odds from two weeks ago on a policy adjustment later this year...

The regularity of Fed behavior I espouse is that the Fed should respond to market upsets only when it has become clear that they threaten to undermine achievement of fundamental objectives of price stability and high employment, or when financial-market developments threaten market processes themselves... [E]ffects on the economy can rarely be understood without passage of time and more information. Occasionally, there is contemporaneous evidence of damage to market mechanisms that might justify quick Fed action.

Right now our policy rate ... is moderately restrictive. Not severely, but modestly so. And that allows for the economy to continue to grow ... and slowly, hopefully, bring down the inflation rates for CPI, the core CPI, to levels even closer to 2 percent as we move forward.

As reported by Reuters

"I think the current funds rate has us on track to achieve what we want," Lacker told reporters after a speech.   I am comfortable with the funds rate where we are now," he said.

As reported by Dow Jones News

An “asymmetric policy tilt” seems appropriate given the risks to inflation.  However, the complexities of the current situation—including uncertainties concerning the behavior of output and employment, as well as growing downside risks to economic growth and the possibility that the neutral level of the funds rate has been lowered by a productivity slowdown—make it appropriate for policy to retain considerable flexibility in responding to emerging data.  The statement thus emphasizes that “Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”  What all of these considerations add up to is that the stance of monetary policy will undoubtedly need to be adjusted in ways that are dictated by shifts in our forecasts for inflation, output, and employment in light of incoming data.