Stanley Fischer

We haven’t made a decision yet, and I don’t think that we should make a decision. We’ve got a little over two weeks before we make the decision, and we’ve got time to wait and see the incoming data and see what, exactly, what is now going on in the economy.

If you don’t understand the market volatility, and I’m sure we don’t fully understand it now ... yes, it does affect the timing of a decision you might want to make.

Several financial sector reform programs were prepared within a few months after the Lehman Brothers failure. These programs were supported by national policymakers, including the community of bank supervisors. The programs--national and international--covered some or all of the following nine areas:

(1) to strengthen the stability and robustness of financial firms, "with particular emphasis on standards for governance, risk management, capital and liquidity"
(2) to strengthen the quality and effectiveness of prudential regulation and supervision;
(3) to build the capacity for undertaking effective macroprudential regulation and supervision;
(4) to develop suitable resolution regimes for financial institutions;
(5) to strengthen the infrastructure of financial markets, including markets for derivative transactions;
(6) to improve compensation practices in financial institutions;
(7) to strengthen international coordination of regulation and supervision, particularly with regard to the regulation and resolution of global systemically important financial institutions, later known as G-SIFIs;
(8) to find appropriate ways of dealing with the shadow banking system; and
(9) to improve the performance of credit rating agencies, which were deeply involved in the collapse of markets for collateralized and securitized lending instruments, especially those based on mortgage finance.

It could be that large banks can finance themselves more cheaply because they are more efficient, that is, that there are economies of scale in banking. For some time, the received wisdom was that there was no evidence of such economies beyond relatively modest-sized banks, with balance sheets of approximately $100 billion. More recently, several papers have found that economies of scale may continue beyond that level. For example, the title of a paper by Joseph Hughes and Loretta Mester, "Who Said Large Banks Don't Experience Scale Economies? Evidence from a Risk-Return Driven Cost Function" suggests that large institutions may be better able to manage risk more efficiently because of "technological advantages, such as diversification and the spreading of information...and other costs that do not increase proportionately with size." That said, these authors conclude that "[W]e do not know if the benefits of large size outweigh the potential costs in terms of systemic risk that large scale may impose on the financial system." They add that their results suggest that "strict size limits to control such costs will likely not be effective, since they work against market forces..."

The TBTF theory of why large banks are a problem has to contend with the history of the Canadian and Australian banking systems. Both these systems have several very large banks, but both systems have been very stable--in the Canadian case, for 150 years. Beck, Demirguc-Kunt, and Levine (2003) examined the impact of bank concentration, bank regulation, and national institutions on the likelihood of a country suffering a financial crisis and concluded that countries are less likely to suffer a financial crisis if they have (1) a more concentrated banking system, (2) fewer entry barriers and activity restrictions on bank activity, and (3) better-developed institutions that encourage competition throughout the economy.32 The combination of the first finding with the other two appears paradoxical, but the key barrier to competition that was absent in Canada was the prohibition of nationwide branch banking, a factor emphasized by Calomiris and Haber in their discussion of the Canadian case. In addition, I put serious weight on another explanation offered in private conversation by a veteran of the international central banking community, "Those Canadian banks aren't very adventurous," which I take to be a compliment.

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Why is the TBTF phenomenon so central to the debate on reform of the financial system? It cannot be because financial institutions never fail. Some do, for example, Lehman Brothers and the Washington Mutual failed in the Great Recession

Almost certainly, TBTF is central to the debate about financial crises because financial crises are so destructive of the real economy. It is also because the amounts of money involved when the central bank or the government intervenes in a financial crisis are extremely large Another factor may be that the departing heads of some banks that failed or needed massive government assistance to survive nonetheless received very large retirement packages.

One can regard the entire regulatory reform program, which aims to strengthen the resilience of banks and the banking system to shocks, as dealing with the TBTF problem by reducing the probability that any bank will get into trouble. There are, however, some aspects of the financial reform program that deal specifically with large banks. The most important such measure is the work on resolution mechanisms for SIFIs, including the very difficult case of G-SIFIs. In the United States, the Dodd-Frank Act has provided the FDIC with the Orderly Liquidation Authority (OLA)--a regime to conduct an orderly resolution of a financial firm if the bankruptcy of the firm would threaten financial stability. And the FDIC's single-point-of-entry approach for effecting a resolution under the new regime is a sensible proposed implementation path for the OLA.

Closely associated with the work on resolution mechanisms is the living will exercise for SIFIs. In addition, there are the proposed G-SIB capital surcharges and macro stress tests applied to the largest BHCs ($50 billion or more). Countercyclical capital requirements are also likely to be applied primarily to large banks. Similarly the Volcker rule, or the Vickers rules in the United Kingdom or the Liikanen rules in the euro zone, which seek to limit the scope of a bank's activities, are directed at TBTF, and I believe appropriately so.

What about simply breaking up the largest financial institutions? Well, there is no "simply" in this area. At the analytical level, there is the question of what the optimal structure of the financial sector should be. Would a financial system that consisted of a large number of medium-sized and small firms be more stable and more efficient than one with a smaller number of very large firms? That depends on whether there are economies of scale in the financial sector and up to what size of firm they apply--that is to say it depends in part on why there is a financing premium for large firms. If it is economies of scale, the market premium for large firms may be sending the right signals with respect to size. If it is the existence of TBTF, that is not an optimal market incentive, but rather a distortion

Would breaking up the largest banks end the need for future bailouts? That is not clear, for Lehman Brothers, although a large financial institution, was not one of the giants--except that it was connected with a very large number of other banks and financial institutions. Similarly, the savings and loan crisis of the 1980s and 1990s was not a TBTF crisis but rather a failure involving many small firms that were behaving unwisely, and in some cases illegally. This case is consistent with the phrase, "too many to fail." Financial panics can be caused by herding and by contagion, as well as by big banks getting into trouble.

In short, actively breaking up the largest banks would be a very complex task, with uncertain payoff.

There are many models of regulatory coordination, but I shall focus on only two: the British and the American. As is well known, the United Kingdom has reformed financial sector regulation and supervision by setting up a Financial Policy Committee (FPC), located in the Bank of England; the major reforms in the United States were introduced through the Dodd-Frank Act, which set up a coordinating committee among the major regulators, the Financial Stability Oversight Council (FSOC).

In discussing these two approaches, I draw on a recent speech by the person best able to speak about the two systems from close-up, Don Kohn. Kohn sets out the following requirements for successful macroprudential supervision: to be able to identify risks to financial stability, to be willing and able to act on these risks in a timely fashion, to be able to interact productively with the microprudential and monetary policy authorities, and to weigh the costs and benefits of proposed actions appropriately. Kohn's cautiously stated bottom line is that the FPC is well structured to meet these requirements, and that the FSOC is not. In particular, the FPC has the legal power to impose policy changes on regulators, and the FSOC does not, for it is mostly a coordinating body.

After reviewing the structure of the FSOC, Kohn presents a series of suggestions to strengthen its powers and its independence. The first is that every regulatory institution represented in the FSOC should have the goal of financial stability added to its mandate. His final suggestion is, "Give the more independent FSOC tools it can use more expeditiously to address systemic risks." He does not go so far as to suggest the FSOC be empowered to instruct regulators to implement measures somehow decided upon by the FSOC, but he does want to extend its ability to make recommendations on a regular basis, perhaps on an expedited "comply-or-explain" basis.

At the end of the day, it remains difficult to disentangle the cyclical from the structural slowdowns in labor force, investment, and productivity. Adding to this uncertainty, as research done at the Fed and elsewhere highlights, the distinction between cyclical and structural is not always clear cut and there are real risks that cyclical slumps can become structural; it may also be possible to reverse or prevent declines from becoming permanent through expansive macroeconomic policies. But three things are for sure: first, the rate of growth of productivity is critical to the growth of output per capita; second, the rate of growth of productivity at the frontiers of knowledge is especially difficult to predict; and third, it is unwise to underestimate human ingenuity.

Prior to the global financial crisis, a rough consensus had emerged among academics and monetary policymakers that best-practice for monetary policy was flexible inflation targeting. In the U.S., flexible inflation targeting is implied by the dual mandate given to the Fed, under which monetary policy is required to take into account deviations of both output and inflation from their target levels. But even in countries where the central bank officially targets only inflation, monetary policymakers in practice also aim to stabilize the real economy around some normal level or path.

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Another important question is whether monetary policymakers should alter their basic framework of flexible inflation targeting to take financial stability into account. My answer to that question is that the "flexible" part of flexible inflation targeting should include contributing to financial stability, provided that it aids in the attainment of the main goals of monetary policy. The main goals in the United States are those of the dual mandate, maximum employment and stable prices; in other countries the main goal is stable prices or low inflation.

What can the central bank do when financial stability is threatened? If it has effective macroprudential tools at its disposal, it can deploy those. If it does not itself have the authority to use such tools, it can try to persuade those who do have the tools to use them. If no such tools are available in the economy, the central bank may have to consider whether to use monetary policy--that is, the interest rate--to deal with the threat of financial instability. At the moment in the U.S., though there may be some areas of concern, I do not think that financial stability concerns warrant deviating from our traditional focus on inflation and employment.

A decision on whether to use the interest rate to deal with the threat of financial instability is always likely to be difficult--particularly in a small open economy, where raising the interest rate is likely to produce an unwanted exchange rate appreciation. So a critical question must be whether effective macroprudential policies are to be found in the country in question.

I had some experience with these issues while at the Bank of Israel... Starting in 2010, the Bank of Israel adopted several macroprudential measures to address rapidly rising house prices…

The success of these policies was mixed. The limit …on the share of any housing loan indexed to the short rate substantially raised the cost of housing finance and was the most successful of the measures. Increases in both the LTV and PTI ratios were moderately successful. Increasing capital charges and risk weights appeared to have little impact in practice.

This experience led me to three conclusions on the effectiveness of macroprudential policies. First, we were very cautious in using these new tools because we did not have good estimates of their strength and effectiveness. Quite possibly, we should have acted more boldly on several occasions. Second, use of these tools is likely to be unpopular, for housing is a sensitive topic in almost every country. And third, coordination among different regulators and authorities can be complicated.

The difficulty of coordinating among different independent regulators makes it likely that the degree to which macroprudential policies can be successful depends critically on the institutional setup of financial supervision in each country…

Overall, it is clear that we have much to learn about both the effectiveness of different macroprudential measures, and about the best structure of the regulatory system from the viewpoint of implementing strong and effective macroprudential supervision and regulation. And, while there may arise situations where monetary policy needs to be used to deal with potential financial instability, I believe that macroprudential policies will become an important complement to our traditional tools. Learning how best to employ all of our potential policy tools, and arrive at a new set of best practices for monetary policy, is one of the key challenges facing economic policymakers.

"What we think now is that the capital markets have it more or less right but we don't ourselves know when we're going to {raise rates}.
"On the basis of our forecasts of the data ... it looks like markets more or less have it right - somewhere in the middle of the year.

The central bank's only official guidance on the timing is that it would wait a "considerable time" after bond-buying ends, a phrase Fed Chair Janet Yellen indicated earlier this year meant something along the lines of six months.
Fischer took a step that essentially downgraded the value of the phrase, saying it meant somewhere between two to 12 months, putting investors on notice that it will be economic data, not the passage of time, that will drive policy change.

"The exchange rates are changing to reflect what is going on... That is appropriate," Fischer, vice chair at the Fed, said on Thursday ahead of the annual meetings of the International Monetary Fund and World Bank in Washington. "We will not intervene to affect the exchange rate."

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.

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.

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.

To achieve financial stability domestically and maintain the flow of credit to American households and businesses, we took action. Importantly, we developed swap facilities with central banks in countries that represented major financial markets or trading centers in order to facilitate the provision of dollar liquidity to these markets.

We did so in recognition of the scope of dollar markets and dollar-denominated transactions outside of our country, the benefits they provide to U.S. households and firms, and the adverse consequences to our financial markets if these centers lose access to dollar liquidity. We have continued to maintain swap facilities with a number of central banks. Although usage is currently very low, these facilities represent an important backstop in the event of a resurgence in global financial tensions.

"The market had the impact it was expecting; it rose from March 9th 2009 to its current levels. Indiscriminant investing took place, in my opinion. That is, all votes rose regardless of their underlying value and I think the market will search out. Now people will actually have to do work. They will actually have to understand analysis in order to make good investments. So, we did have some volatility last week; for me it was not unexpected. Ive warned my colleagues and also in public speeches you know. I said that I could see a correction taking place, but the underlying economy is doing well. We: Mexico, Canada, and North America, are the epicenter of global economic growth right now, so were in pretty good shape"

If the labor market continues to strengthen, and if we see some signs of inflation beginning to increase, then the natural thing is to get the interest rates up, Mr. Fischer said at The Wall Street Journal CEO Council annual meeting. And we call it normalization.

Mr. Fischer, who took on the No. 2 position at the Fed in June, said the first rate rise will be very important. There is a process that is being set off when the first step startsinterest rates are going to go up and they are going to keep going up for some time, he said.

The Federal Reserves vice chairman, Stanley Fischer, said that it was time for the central bank to bring a little more mystery to its relationship with financial markets, suggesting on Friday that the postcrisis era of detailed guidance was drawing to a close.

The Fed has sought to increase its influence over markets since the Great Recession by talking about its future plans: how much money it intended to invest in securities; how much longer it expected to hold its benchmark rate near zero. Most recently, the Fed said in January that it did not plan to raise rates before June.

It seems to me that you unnecessarily constrain yourself,

Mr. Fischer said of such guidance during a panel discussion at an annual monetary policy conference sponsored by the University of Chicago Booth School of Business. Theres no good reason that I can see for us to telegraph every action that we have to take.

The Federal Reserves vice chairman, Stanley Fischer, said that it was time for the central bank to bring a little more mystery to its relationship with financial markets, suggesting on Friday that the postcrisis era of detailed guidance was drawing to a close.

The Fed has sought to increase its influence over markets since the Great Recession by talking about its future plans: how much money it intended to invest in securities; how much longer it expected to hold its benchmark rate near zero. Most recently, the Fed said in January that it did not plan to raise rates before June.

It seems to me that you unnecessarily constrain yourself,

Mr. Fischer said of such guidance during a panel discussion at an annual monetary policy conference sponsored by the University of Chicago Booth School of Business. Theres no good reason that I can see for us to telegraph every action that we have to take.

Mr. Fischer became the latest to express frustration with the excess attention to liftoff and the relative lack of attention to what happens the next day. Fed officials say there is little difference for the economy whether the Fed acts in June or September.

Mr. Fischer also cautioned that investors should not assume the central bank will raise rates in regular increments, as when the Fed raised interest rates by 0.25 percentage points at 17 consecutive meetings from 2004 to 2006.

I know of no plans to behave by following one of those deterministic paths for the next two or three years, he said. I hope that doesnt happen. I dont believe it will happen.

Table 1 provides a summary of various studies' estimated effects of these programs on the term premium on 10-year Treasury securities. For example, the decline in 10-year Treasury yields associated with the first purchase program is estimated to have been as large as 100 basis points. The documented effects associated with subsequent programs are generally smaller. These results raise the question of whether the marginal effect of asset purchases has declined over time. While that question is a valid one, our conclusion is that asset purchases over more recent years have provided meaningful stimulus to the economy, and continue to do so.

[L]et me close by addressing a question that often arises about the use of a supervisory stress test, such as those conducted by the Fed, with common scenarios and models. Such a test may create the possibility of, in former Chairman Bernanke's words, a "model monoculture," in which all models are similar and all miss the same key risks. Such a culture could possibly create vulnerabilities in the financial system. At the Fed we try to address this issue, in part, through appropriate disclosure about the supervisory stress test. We have published information about the overall framework employed in various aspects of the supervisory stress test, but not the full details that banks could use to manage to the test. This--making it easier to game the test--is the potential negative consequence of transparency that I alluded to earlier.

As we consider the decision of policy rate normalization, we are mindful of possible spillovers to other economies, including emerging market and developing economies. In an interconnected world, fulfilling the Federal Reserve's objectives under its dual mandate requires that we pay close attention to how our own actions affect other countries and how developments abroad, in turn, spill back into U.S. economic conditions.

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In order to minimize the likelihood of surprises and thus avoid creating unnecessary market and policy volatility, we are striving to communicate our policy strategy clearly and transparently. Beyond communicating our intentions, we also emphasize that monetary policy normalization in the United States will occur in the context of a strengthening U.S. economy, which should benefit the emerging market and developing economies.

Still, one feature of the era after the first increase of the federal funds rate will, in all likelihood, be higher U.S. and global interest rates compared with their extraordinarily low levels of recent years. The increase in global interest rates could cause investors to adjust their portfolios, triggering capital outflows from emerging market and developing economies.

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Once we begin to remove policy accommodation, the Committee's assessment is that economic conditions will likely warrant raising the federal funds rate only gradually. Thus, we expect that the target federal funds rate will remain for some time below levels viewed as normal in the longer run. But that is only a forecast, and monetary policy will, in practice, be determined by the data--primarily data on inflation and unemployment.

Whereas the Fed used to be able in unusual circumstances to lend to non-banks in a crisis, it cannot now extend help to individual firms under revised laws. It must provide loans to a broader class of institutions with the Treasury secretary’s permission, and with notification being made to Congress. Mr Fischer said this restriction “has gone about as far as it should”.

“If we ever did find ourselves not able to use powers, which are inherent in the institution of a central bank, because someone decided we should manage without that because it creates moral hazard, for example, I think we pay a very high price. I don’t want to throw away things that could be useful because I am worried about this, that or the other,” he said.

“A large part of the current inflation is temporary,” Fischer said in an interview Monday with Tom Keene on Bloomberg Television. After the effects of cheaper oil and other raw materials dissipate, “these things will stabilize at some point, so we’re not going to be as low as we are forever.”

Fischer’s remarks indicate that while he’s pleased with progress on employment, he may be waiting for signs inflation will start moving up toward the central bank’s target. The Federal Open Market Committee meets Sept. 16-17 for a gathering at which many investors and economists expect it will raise interest rates for the first time in almost 10 years.

“Employment has been rising pretty fast relative to previous performance, and yet inflation is very low,” he said. “And the concern about this situation is not to move before we see inflation, as well as employment, returning to more normal levels.”

In the first instance, as already noted, core inflation can to some extent be influenced by oil prices. However, a larger effect comes from changes in the exchange value of the dollar, and the rise in the dollar over the past year is an important reason inflation has remained low.
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The dynamics with which all these factors affect inflation depend crucially on the behavior of inflation expectations. One striking feature of the economic environment is that longer-term inflation expectations in the United States appear to have remained generally stable since the late 1990s. The source of that stability is open to debate, but the fact that the Fed has kept inflation relatively low and stable for three decades must be an important part of the explanation. Expectations that are not stable, but instead follow actual inflation up or down, would allow inflation to drift persistently.
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We should however be cautious in our assessment that inflation expectations are remaining stable. One reason is that measures of inflation compensation in the market for Treasury securities have moved down somewhat since last summer. But these movements can be hard to interpret, as at times they may reflect factors other than inflation expectations, such as changes in demand for the unparalleled liquidity of nominal Treasury securities.

Though I remain concerned that the U.S. macroprudential toolkit is not large and not yet battle tested, that does not imply that I see acute risks to financial stability in the near term. Indeed, banks are well capitalized and have sizable liquidity buffers, the housing market is not overheated, and borrowing by households and businesses has only begun to pick up after years of decline or very slow growth.
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Nonetheless, the limited macroprudential toolkit in the United States leads me to conclude that there may be times when adjustments in monetary policy should be discussed as a means to curb risks to financial stability. The deployment of monetary policy comes with significant costs.

The decision not to raise the interest rate in September has generated a great deal of discussion at this meeting of the IMF and World Bank and elsewhere. The decision was based, in part, on a desire to have more time to appraise recent developments in the global economy, especially those originating in the Chinese economy, before beginning the normalization of interest rates. There may well have been more comments on foreign economic developments in recent FOMC statements than was common in the past. That is natural given the increasing influence of foreign economic developments on the United States economy, both through imports and exports, and through capital account developments.

The September statement notes that we are monitoring developments abroad. Nonetheless, we do not currently anticipate that the effects of these recent developments on the U.S. economy will prove to be large enough to have a significant effect on the path for policy.

The Federal Reserve's accountability structure has been largely stable since the 1970s reforms. At the same time, the Federal Reserve has greatly augmented its public communications about its economic outlook and its policy strategy.
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This increased transparency has been a key complement to the Fed's independence and accountability by regularly demonstrating that the Fed has been appropriately pursuing its mandated goals. Transparency can also make monetary policy more effective by helping to guide the public's expectations and clarify the Committee's policy intentions.

This greater degree of monetary accommodation seems appropriate given the adverse effects on U.S. aggregate demand coming from the rise in the dollar, an associated weakening of foreign economic prospects, and other developments that have restrained spending and kept inflation undesirably low.

While the dollar's appreciation and foreign weakness have been a sizable shock, the U.S. economy appears to be weathering them reasonably well, notwithstanding their large effects on certain sectors of the economy heavily exposed to international trade. Monetary policy has played a key role in achieving these outcomes through deferring liftoff relative to what was expected a little over a year ago. The October 2015 FOMC statement indicated that it may be appropriate to raise the target range for the federal funds rate at the next meeting in December, though the outcome will depend on the Committee's assessment of the progress--realized and expected--that has been made toward meeting our goals of maximum employment and price stability.

"In the relatively near future probably some major central banks will begin gradually moving away from near-zero interest rates,” Fischer on Thursday told the Asia Economic Policy Conference at the Federal Reserve Bank of San Francisco. "We have done everything we can to avoid surprising the markets and governments when we move, to the extent that several emerging market (and other) central bankers have, for some time, been telling the Fed to ’just do it.’”

Despite my assessment of current vulnerabilities, conditions can change quickly. And important blind spots in our view of the financial system remain, in part owing to data gaps. When it comes to financial stability, what you do not know really can hurt you--and there remains a good bit we do not know.

This lack of data can impede the design of regulation. There is a long history of data collection focused on banks, and supervisory data have contributed to our quantitative approach to regulation and supervision. For example, when we examine the likely implications of the failure of an institution's largest counterparty, we learn a great deal about the health of that institution and gain greater insight into its connections, through that counterparty, to other institutions.

But data on a range of activities--including securities lending, bilateral repos, and derivatives trading--that create funding and leverage risks remain inadequate and hence could prove destabilizing if sufficiently large or widespread. We gain some insight into these markets through our supervisory relationships with the largest bank holding companies, but the activities of important nonbank market participants, such as asset managers, and the interconnections across institutions remain more opaque.
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While the steps to improve data taken so far will help, gaps will remain, especially with regard to unregulated or weakly regulated entities. These gaps impede both market participants' ability to discipline the risks taken by institutions and supervisors' ability to take prompt action. Nonetheless, I would also like to emphasize to this group of researchers that better data, by themselves, are only the start of the journey to better understanding.

If asset prices across the economy -- that is, taking all financial markets into account -- are thought to be excessively high, raising the interest rate may be the appropriate step.

Fischer seemed less keen on some other suggestions by economists for dealing with the zero lower bound, including raising the Fed’s inflation target from 2 percent.

“High levels of inflation may also be associated with higher inflation variability,” he said. The costs of that “could be substantial.”

Liesman: Let's talk about just what you brought up, which is the trajectory over the next several years and the trajectory this year. The summary of economic projections says there will be four rate hikes this year. Or at least that's the median forecast of a FOMC member. Is that your view?

Fischer: Well, my view is that we have – those numbers are in the ballpark. You know, the reason we meet eight times a year is because things happen, and as they happen, you want to adjust your policy. Otherwise, we could meet in January and close down sharp until a year later. But we have to react to incoming events, and we will react to them. What's in the survey of economic projections, the famous dot plots, says it will be somewhere around three, four. That's different people's views, and we don’t know enough now to know how many there'll be.

Liesman: Stan, just one quick question on inflation before we go. When we last met, in August, basically, inflation is almost unchanged in that period of time. Even the Fed has brought down its forecast for 2016 and 2017 inflation. Do you remain confident the Fed is going to be able to get inflation back to 2% and over what time horizon?

Fischer: Yeah, I remain confident because the analysis of what's going on now is that continuing declines in the price of oil are quite important in the overall price index. And our estimates of taking account of the exchange rate and the price of oil and food is that we'd be at about 1.4% now, which is a heck of a lot closer to 2 than is almost zero. So we think that as oil stabilizes, and it will stabilize one day, and it will even go up one day, that we'll see this trend beginning to turn. And my confidence is that those trends, those declines in oil and that depreciation of the dollar isn't going to go on forever or for even very long.

Increased concern about the global outlook, particularly the ongoing structural adjustments in China and the effects of the declines in the prices of oil and other commodities on commodity exporting nations, appeared early this year to have triggered volatility in global asset markets. At this point, it is difficult to judge the likely implications of this volatility. If these developments lead to a persistent tightening of financial conditions, they could signal a slowing in the global economy that could affect growth and inflation in the United States. But we have seen similar periods of volatility in recent years that have left little permanent imprint on the economy.

The Committee has indicated that the Federal Reserve will, in the longer run, hold no more securities than necessary to implement monetary policy efficiently and effectively. But that statement leaves open the question of when we should begin to reduce the size of our balance sheet. Because the tools I mentioned earlier--the payment of interest on reserve balances and the overnight reverse repurchase facility--can be used to raise the federal funds rate independent of the size of the balance sheet, we have the flexibility to adjust the size of our balance sheet at the appropriate time. With the federal funds rate still quite low and expected to rise only gradually, I think there is some benefit to maintaining a larger balance sheet for a time.

There are nonetheless three major sources of concern about potential weaknesses in the new framework for financial crisis management that has been introduced since the Great Financial Crisis. The first is its failure to resolve the problem of stigma--that is, the stigma of borrowing from the central bank at a time when the financial markets are on guard, looking for signs of weakness in individual financial institutions at a time of overall financial stress. Indeed, some of the Dodd-Frank Act reporting requirements may worsen the stigma problem.

The second is a concern that arises from the nature of financial and other crises. It is essential that we build strong frameworks to deal with potential crisis situations, and Dodd-Frank has done that. But these plans need to ensure that the authorities retain the capacity to deal with unanticipated events, for unanticipated events are inevitable. Retaining the needed flexibility may conflict with the desire to reduce moral hazard to a minimum. But, in simple language: Strengthening fire prevention regulations does not imply that the fire brigade should be disbanded.

Third, this concern is heightened by a related problem: The new system has not undergone its own stress test. That is, in one sense, fortunate, for the financial system will undergo its fundamental stress test only when we have to deal with the next potential financial crisis. That day will likely come later than it would have without Dodd-Frank and the excellent work done by regulators in the United States and around the world in strengthening financial institutions and the financial system. But it will come, and when it comes, we will need the flexibility required to deal with it.

The large movements in asset prices likely reflect increased concern about the global outlook, particularly ongoing developments in China and the effects of the declines in the prices of oil and other commodities on commodity-exporting nations. Asset price declines may also reflect a reassessment of the prospects for growth in Europe and Japan, and perhaps also a recognition that U.S. gross domestic product and productivity growth have remained stubbornly low.

If the recent financial market developments lead to a sustained tightening of financial conditions, they could signal a slowing in the global economy that could affect growth and inflation in the United States. But we have seen similar periods of volatility in recent years--including in the second half of 2011--that have left little visible imprint on the economy, and it is still early to judge the ramifications of the increased market volatility of the first seven weeks of 2016.

Now, with our next FOMC meeting just three weeks away, I expect most of you are less interested in what we did at our previous meetings, and more interested in what we are going to do at the next one. I can't answer that question because, as I have emphasized in the past, we simply do not know. The world is an uncertain place--sometimes more uncertain than at other times--and all monetary policymakers can really be sure of is that what will happen is often different from what we currently expect. That is why the Committee has indicated that its policy decisions will be data dependent, which is to say that we will adjust policy appropriately in light of economic and financial events to best foster conditions consistent with the attainment of our employment and inflation objectives.

This means that one of the major benefits that were expected from the introduction of inflation-indexed bonds (Treasury Inflation-Protected Securities, generally called TIPS), namely that they would provide a quick and reliable measure of inflation expectations, has not been borne out, and that we still have to struggle to get reasonable estimates of expected inflation.

Since the U.S. economy is now below our 2 percent inflation target, and since unemployment is in the vicinity of full employment, it is sometimes argued that the link between unemployment and inflation must have been broken. I don't believe that. Rather the link has never been very strong, but it exists, and we may well at present be seeing the first stirrings of an increase in the inflation rate--something that we would like to happen.

Empirical work done at the Fed and elsewhere suggests that QE worked in the sense that it reduced interest rates other than the federal funds rate, and particularly seems to have succeeded in driving down longer-term rates, which are the rates most relevant to spending decisions.
Critics have argued that QE has gradually become less effective over the years, and should no longer be used. It is extremely difficult to appraise the effectiveness of a program all of whose parameters have been announced at the beginning of the program. But I regard it as significant with respect to the effectiveness of QE that the taper tantrum in 2013, apparently caused by a belief that the Fed was going to wind down its purchases sooner than expected, had a major effect on interest rates.
More recently, critics have argued that QE, together with negative interest rates, is no longer effective in either Japan or in the euro zone.That case has not yet been empirically established, and I believe that central banks still have the capacity through QE and other measures to run expansionary monetary policies, even at the zero lower bound.Empirical work done at the Fed and elsewhere suggests that QE worked in the sense that it reduced interest rates other than the federal funds rate, and particularly seems to have succeeded in driving down longer-term rates, which are the rates most relevant to spending decisions.
Critics have argued that QE has gradually become less effective over the years, and should no longer be used. It is extremely difficult to appraise the effectiveness of a program all of whose parameters have been announced at the beginning of the program. But I regard it as significant with respect to the effectiveness of QE that the taper tantrum in 2013, apparently caused by a belief that the Fed was going to wind down its purchases sooner than expected, had a major effect on interest rates.
More recently, critics have argued that QE, together with negative interest rates, is no longer effective in either Japan or in the euro zone.That case has not yet been empirically established, and I believe that central banks still have the capacity through QE and other measures to run expansionary monetary policies, even at the zero lower bound.

For some time, at least since the United States became an oil importer, it has been believed that a low price of oil is good for the economy. So when the price of oil began its descent below $100 a barrel, we kept looking for an oil-price-cut dividend. But that dividend has been hard to discern in the macroeconomic data. Part of the reason is that as a result of the rapid expansion of the production of oil from shale, total U.S. oil production had risen rapidly, and so a larger part of the economy was adversely affected by the decline in the price of oil. Another part is that investment in the equipment and structures needed for shale oil production had become an important component of aggregate U.S. investment, and that component began a rapid decline. For these reasons, although the United States has remained an oil importer, the decrease in the world price of oil had a mixed effect on U.S. gross domestic product. There is reason to believe that when the price of oil stabilizes, and U.S. shale oil production reaches its new equilibrium, the overall effect of the decline in the price of oil will be seen to have had a positive effect on aggregate demand in the United States, since lower energy prices are providing a noticeable boost to the real incomes of households.

There was once a great deal of work on the optimal monetary-fiscal policy mix. The topic was interesting and the analysis persuasive. Nonetheless the subject seems to be disappearing from the public dialogue; perhaps in ascendance is the notion that—except in extremis, as in 2009--activist fiscal policy should not be used at all. Certainly, it is easier for a central bank to change its policies than for a Treasury or Finance Ministry to do so, but it remains a pity that the fiscal lever seems to have been disabled.

So the advice to potential policymakers is simple: Learn as much as you can, for most of it will come in useful at some stage of your career; but never forget that identifying what is happening in the economy is essential to your ability to do your job, and for that you need to keep your eyes, your ears, and your mind open, and with regard to your mouth--to use it with caution.

One key lesson from these [DSGE] models is that measuring the natural rate of interest or the output gap is hard. However, estimates of the natural rate of interest from a collection of structural models across the Federal Reserve System indicate that the natural rate fell considerably during the financial crisis, became quite negative in its aftermath, and has subsequently recovered only slowly.

I want to end by briefly addressing several criticisms that have been made of the Dodd-Frank Act's orderly liquidation authority and the Board's TLAC proposal. One criticism is that there is no need for the backup orderly liquidation authority because the Bankruptcy Code provides an adequate framework for the resolution of any financial company. As Title II of the Dodd-Frank Act recognizes, however, the Bankruptcy Code may not be adequate to minimize the systemic impact of the resolution of a systemically important financial firm. The Bankruptcy Code does not direct the judge to take financial stability into account in making decisions, and it does not provide other important stabilizing features of the orderly liquidation authority, such as government liquidity support and stay-and-transfer treatment for qualified financial contracts.

A related line of criticism holds that the orderly liquidation authority enshrines "too big to fail" and provides for taxpayer bailouts of systemically important firms through the orderly liquidation fund. However, under the Board's proposed TLAC rule, a failed GSIB would be recapitalized by its private-sector long-term creditors (whose debt claims would be converted into equity), not by the government. The orderly liquidation fund would be used only to provide liquidity support, not to inject capital...The rating agencies no longer assume that the U.S. government will take extraordinary actions to prevent the failure of systemically important U.S. financial firms.

Finally, one criticism that has been leveled at our TLAC proposal is that imposing long-term debt requirements on GSIBs will lead those firms to increase their leverage and thereby raise their probability of failure, and that they should instead be required to hold higher levels of equity capital... [T]o protect financial stability, we must reduce not only the probability that a GSIB will fail, but also the damage that its failure could do if it were to occur. At the point of failure, a banking firm's equity capital is likely to be zero or negative, so to improve GSIB resolvability, our proposal requires GSIBs to have a thick tranche of gone-concern loss-absorbing capacity to ensure that resolution authorities will have the necessary raw material to manufacture fresh equity and recapitalize and stabilize the firm...

I want to end by briefly addressing several criticisms that have been made of the Dodd-Frank Act's orderly liquidation authority and the Board's TLAC proposal. One criticism is that there is no need for the backup orderly liquidation authority because the Bankruptcy Code provides an adequate framework for the resolution of any financial company. As Title II of the Dodd-Frank Act recognizes, however, the Bankruptcy Code may not be adequate to minimize the systemic impact of the resolution of a systemically important financial firm. The Bankruptcy Code does not direct the judge to take financial stability into account in making decisions, and it does not provide other important stabilizing features of the orderly liquidation authority, such as government liquidity support and stay-and-transfer treatment for qualified financial contracts.

A related line of criticism holds that the orderly liquidation authority enshrines "too big to fail" and provides for taxpayer bailouts of systemically important firms through the orderly liquidation fund. However, under the Board's proposed TLAC rule, a failed GSIB would be recapitalized by its private-sector long-term creditors (whose debt claims would be converted into equity), not by the government. The orderly liquidation fund would be used only to provide liquidity support, not to inject capital...The rating agencies no longer assume that the U.S. government will take extraordinary actions to prevent the failure of systemically important U.S. financial firms.

Finally, one criticism that has been leveled at our TLAC proposal is that imposing long-term debt requirements on GSIBs will lead those firms to increase their leverage and thereby raise their probability of failure, and that they should instead be required to hold higher levels of equity capital... [T]o protect financial stability, we must reduce not only the probability that a GSIB will fail, but also the damage that its failure could do if it were to occur. At the point of failure, a banking firm's equity capital is likely to be zero or negative, so to improve GSIB resolvability, our proposal requires GSIBs to have a thick tranche of gone-concern loss-absorbing capacity to ensure that resolution authorities will have the necessary raw material to manufacture fresh equity and recapitalize and stabilize the firm...

EISEN: George Soros told the European parliament this week Brexit has unleashed a crisis in the financial markets comparable in severe toy 2007/2008. Is he wrong?

FISCHER: George Soros has made a lot of money in the markets so he's been right quite often. I don't particularly want to comment on whether he's right or wrong this time.

FISCHER: Well, one of the things you learn if you're a central banker is never say never. But if there is one thing we don't want to do, it's that. We have no plans to move into negative territory and we will try to avoid ever getting to that position.

EISEN: Do you see it as a policy that doesn't work?

FISCHER: There have been some doubts about what's been happening lately. It's certainly worked – well, it's certainly worked early in its usage in Europe and in Japan, but lately, there have been some questions about it and we are appraising the most recent empirical results that come out of the data and we haven't changed our minds as far as I know, but we certainly look at it all the time.

EISEN: What else is in the tool kit then that would be more preferable to negative interest rates?
Fischer: Well, I mean, there's a whole host of things that we did in the years 2009 through 2014. Purchasing securities, quantitative easing, making statements, decisions about future interest rates, forward guidance, and so forth, so they're all there. They worked. And I don't think it's worth speculating on whether we are going to be driven to any of that. I hope it goes the other way. I hope that we strengthen and that the economy strengthens and that we continue along the slow, very gradual path we've been on and that the rest of the world is recovering in such a way that that wouldn't create negative reflex effects on us that would have to be taken very, very seriously into account. But we'll watch all that.

EISEN: Is the uncertainty what's holding back U.S. growth? How do we get out of this sub 2% or 2.5% level?

FISCHER: Well, technically we have to get something moving on productivity growth and that's not something we're good at doing. We don't know precisely how to do it. And we're all trying to find out whether what's going on is a long term change or a result of the cyclical situation. We'll get that right at some point. And when that changes, we'll go back to higher rates of growth. But it really turns on productivity. We've done everything we can and we've got achievements on employment. But productivity isn't going up and that's the remaining big factor in growth.

EISEN: if this is a long-term sort of secular story, stuck in low growth, as Yellen seemed to hint more so in her last news conference, what does the fed do about that?
FISCHER: Well, we can run as good a monetary policy as we like, but we will not have a direct influence on productivity growth. I mean, being more predictable, et cetera, will encourage more investment. But it isn't going to make an enormous change. People have to get more – we're looking for more investment to help get productivity going.