In addition, the damage from the sharp stock market decline was mitigated by the Federal Reserve’s commitment “to serve as a source of liquidity to support the economic and financial system.”5 A contrasting example is the sharp appreciation of the dollar that began in 1978 and reached a peak in March 1985. The persistent strength of the dollar had a significant negative consequence for U.S. trade performance. Our trade deficit widened sharply in 1985 and 1986, which contributed to the sharp slowdown in U.S. manufacturing production growth—and a milder slowdown in GDP growth—over this period. This leads to an important question: When should the FOMC take changes in financial conditions into consideration in its conduct of monetary policy? I don’t think there is a simple answer. Financial conditions matter in influencing the economic outlook, but so do many other factors. It is true that monitoring financial conditions can help improve the effectiveness of the policy decision-making process. However, as I hope is clear from my previous examples, there is no mechanical link between policy rates and financial conditions that monetary policymakers can systematically rely upon to set policy. Another key question is what one should focus on in assessing financial conditions. Again, I don’t think there is a simple answer, as the significance of any particular aspect of changes in financial conditions depends on the economic circumstances and environment. In the early- to mid-2000s, the combination of looser mortgage underwriting practices and home equity withdrawal were major financial factors contributing to that economic expansion.

Benoît Cœuré: Liquidity regulation and monetary policy implementation – from theory to practice Speech by Mr Benoît Cœuré, Member of the Executive Board of the European Central Bank, at the Toulouse School of Economics, Toulouse, 3 October 2013. *  *  *  I wish to thank Conception Alonso and Stefano Corradin for their contributions to these remarks. I remain solely responsible for the opinions contained herein. Ladies and Gentlemen, It is a great pleasure for me to speak at the Toulouse School of Economics. In my remarks today, I would like to discuss the recent developments on liquidity regulation and the interplay between the new liquidity requirements and monetary policy implementation. The recent financial crisis provided a vivid illustration of how liquidity risk that materialises in some segments of the financial system can lead to the drying-up of liquidity in entire market segments, such as unsecured interbank markets, causing a system-wide scramble for liquidity. In that context, central banks have played a role of intermediary for interbank transactions and prevented our bank based financial system from collapsing. At the beginning of my remarks, I will talk about the rationale for liquidity regulation and I will provide an overview of the new set of liquidity requirements that the Basel Committee on Banking Supervision has proposed to complement its revised capital requirements framework. These recent developments give rise to two issues that I would like to address today. First, how do liquidity regulation and monetary policy implementation interact?