The situation one would like to avoid is one in which the upturn is characterised by exaggerated optimism and excessive risk propensity. In such a situation, the fall can be dramatic when something causes this sentiment to turn. Prices fall, participants become more pessimistic and risk propensity decreases among both lenders and borrowers. This may result in an extended period during which participants consolidate their balance sheets, consumption and investment develop weakly, and lending becomes exaggeratedly restrictive. Fluctuations in property prices and credit volumes can thus amplify the fluctuations of the real economy. A fall in prices or expectations of such a fall may also lead to financial instability with possible consequences in the form of increased uncertainty, a credit crunch and stresses on central government finances. This is because a credit-driven imbalance can create a significant credit risk if the banks have filled the asset side of their balance sheets with loans based on inflated prices and with high loan-to-value ratios. The credit risk also depends on the manner in which borrowers’ obligations in the event of a default will be regulated, that is to say whether the bank will be able to claim only the actual collateral or whether it will also have a claim on the remaining loan. An individual bank has no reason to take consideration of anything other than the risk to its own balance sheet and can, in general, ignore the effects on the real economy and financial stability: these are external effects.

  Longer-term work to assess what monetary policy framework is most consistent with the goals of monetary policy and financial stability. New York Fed economists have made many contributions to the theory and measurement in New Keynesian models, focusing on monetary policy at the zero lower bound, and incorporating financial frictions into more standard macro models. 2  Dynamic stochastic general equilibrium (DSGE). BIS central bankers’ speeches  3  Microeconomic and regional policy New York Fed economists also have important opportunities supporting microeconomic and regional policy. These include the survey of consumer expectations, which will launch this month, and the consumer credit panel, which, using raw data supplied by Equifax, allows us to develop insights into consumer indebtedness at the micro-level. These panels give us and the public unique insights into household beliefs and behavior. One example is the work highlighting the growing aggregate student loan debt balance and repayment burden. An important responsibility for each of the Reserve Banks is coverage of economic development in its region. A significant aspect of this work at the New York Fed involves our regional press briefings, business surveys, and white papers. One notable example has been the New York Fed economists’ work in developing a white paper that highlighted some key choices that Puerto Rican policymakers might make to eliminate structural constraints that have impinged on the Island’s economic performance. I’m very pleased by the contributions of our economists in the Bank, whether they sit in the Research Group or elsewhere in the Bank.