The late New York intellectual Irving Kristol is reported to have said: “Don’t fall for fantastical notions that have nothing to do with the way people really are.”4 My experience of having worked in real time in the financial markets leads me to a different perspective on financial operators and markets than that of most of my colleagues  1  See www.number10.gov.uk/history-and-tour/prime-ministers-in-history/margaret-thatcher. 2  See “Were 364 Economists All Wrong?” Institute of Economic Affairs, www.iea.org.uk/sites/default/files/publications/files/upldbook310pdf.pdf. 3  See “Were 364 Economists All Wrong?” BBC Newsnight report by Stephanie Flanders, http://news.bbc.co.uk/2/hi/programmes/newsnight/4803858.stm. 4  See “Three Cheers for Irving,” by David Brooks, New York Times, Sept. 22, 2009. BIS central bankers’ speeches  1  at the Federal Open Market Committee (FOMC). This not only affects my views on the implementation of monetary policy, but also shapes my perspective on regulation. Monetary policy and regulation are intricately linked. When conducting its monetary policy, the Fed is governed by a dual mandate: creating the monetary conditions to foster maximum employment growth while constraining inflation and its alter ego, deflation. These goals cannot be realized without financial stability that results from effective regulation. As the FOMC now sets its sights on concluding the accommodative monetary policy it fashioned to stave off financial collapse and deflation, our supervision and regulation team is wrestling with developing the appropriate policy for dealing with the lingering effects of the financial crisis, and, most importantly, erecting a new regulatory framework to substantially reduce the chances of financial crises.

Most regulatory reform initiatives applied since the Banking Act of 1864 have missed the mark. They looked good on paper and appeared to solve the problems of the day but later proved not up to the task. This is especially true with efforts to solve the “too big to fail” problem, in which an unwillingness to follow through on prior policy commitments to actually close down large failures and impose losses on their uninsured creditors has led to what economists call “time inconsistency” in policy. Let’s hope this time will be different, that regulators will make their commitments credible and consistent with future rather than past needs.6 Having come from the financial industry, I take a keen interest in these issues, and I hold some strong opinions as to how we should proceed. I believe there are leverage points for effective reform. There are areas where, if regulators act decisively, they might have profound positive effects and avoid time inconsistency. Conversely, there are other areas where regulatory action would at best generate small benefits and, in the worst case, might actually be counterproductive. 5  See “Regulating Systemically Important Financial Firms,” address by Governor Daniel K. Tarullo at the Peterson Institute for International Economics, June 3, 2011. 6  See “Financial Reforms or Financial Dementia,” keynote address by Richard W. Fisher to the Southwestern Graduate School of Banking, June 3, 2010.