The U.S. economy has proven to be very resilient to all sorts of shocks over the past several decades. In part this reflects the fact that not all sectors of the economy move together, and a decline in one sector does not always imply major problems in the economy as a whole. The economy withstood Hurricane Katrina, oil shocks, and 9/11 with remarkable resiliency.

How does a civilized society with the rule of law deal with losses from violence?...I think we correctly choose to leave the vast majority of risk to be absorbed by the private sector...[However] the type of terrorism that is arising in the context of increasing technologies, which were not available before, has created possibilities of huge losses, and there is no way for a private system to handle that...So long as we have terrorism, which has the capability of a very substantial scope of damage, there is no way you can expect private insurance systems to handle that...To the extent that we socialize risk, we reduce our standard of living.  And so it's a tradeoff.

Going forward, we must remain prepared to deal with a wide range of events. Particularly notable in this regard is the fortunately low, but still deeply disturbing, possibility of another significant terrorist attack in the United States. Our economy was able to absorb the shock of the attacks of September 11 and to recover, though remnants of the effects remain. We at the Federal Reserve learned a good deal from that tragic episode with respect to the impact of policy and, of no less importance, the functioning under stress of the sophisticated payments system that supports our economy.

In addition, at few key junctures in the past five years, the Federal Reserve exercised a more flexible monetary policy than inflation targeting probably would have suggested or allowed. The first occurred in reaction to the "seizing up" of financial markets that followed the Russian debt default in the late summer of 1998. Although forecasts were marked down at this time, the easing was faster and larger than would have been suggested by Taylor-type rules based on our past pattern of behavior and incorporating an implicit inflation target. In effect, to protect against the potential for a really bad outcome for markets and economic activity, the policymakers raised the most likely outcome for inflation--or at least skewed the risks toward the possibility that inflation would pick up. Similarly, in 2001, easing was unusually aggressive, even before September 11, as the extent of the demand shock gradually revealed itself. To be sure, when one looks back, the outcomes in both instances in terms of stable inflation were not any different than inflation targeting would have sought. At issue, however, is whether the FOMC would have responded so aggressively to these shocks if it had been constrained by an inflation target. It is a matter of how the central bank is likely to weigh the risks and rewards of various courses of action--where it takes its chances. My sense is that, given the stress on hitting inflation objectives, the pressures of an inflation target would have constrained flexibility that in the end turned out to be useful.

Fear of terrorist acts, however, has the potential to induce disengagement from activities, both domestic and cross border. If we allow terrorism to undermine our freedom of action, we could reverse at least part of the palpable gains achieved by postwar globalization. It is incumbent upon us not to allow that to happen.

Nobody has the capacity to fathom fully how the effects of the tragedy of September 11 will play out in our economy. But in the weeks ahead, as the initial shock continues to wear off, we should be able to better gauge how the ongoing dynamics of these events are shaping the immediate economic outlook.

For the longer term, prospects for ongoing rapid technological advance and associated faster productivity growth are scarcely diminished. Those prospects, born of the ingenuity of our people and the strength of our system, fortify a promising future for our free nation.