We care about financial conditions not for themselves, but instead for how they can affect economic activity and ultimately our ability to achieve the statutory objectives of the Federal Reserve—maximum employment and price stability. Let me provide a few examples. A decline in mortgage rates can lift the demand for owner-occupied housing and support construction activity. A rise in equity prices can boost household wealth, which is one factor that underpins consumer spending. The foreign exchange value of the dollar can affect the relative competitiveness of importers and exporters, which, in turn, influences the country’s trade performance. Narrower credit spreads can reduce the cost of capital for business and help support greater business investment. 1/6  BIS central bankers' speeches  In sum, financial conditions affect households’ and firms’ saving and investment plans, and, therefore, play a key role in influencing economic activity and the economic outlook. This is why the evaluation of financial conditions is so crucial in the conduct of monetary policy. The FOMC traditionally implements monetary policy by adjusting the federal funds rate—the short-term interest rate paid by banks that borrow reserves from other financial institutions. However, few economic decisions directly depend on the federal funds rate. Rather, changes in the federal funds rate affect the economy through their impact on other interest rates, which, consequently, influence broader financial conditions. If financial conditions moved predictably with the policy rate, then there would be no need for the FOMC to focus on financial conditions.

We’re just adding a bit more fruit juice. Before I conclude, let me make a few comments about the Federal Reserve’s balance sheet. As you are undoubtedly aware, the Federal Reserve dramatically expanded the size of its balance sheet during and following the financial crisis to provide accommodation to support the economy when short-term interest rates were constrained by their effective lower bound. Currently, we are reinvesting maturing Treasury securities and agency mortgage-backed securities repayments to keep the size of the balance sheet generally stable. We have said that we plan to continue this policy of reinvestment until we are well along in the process of normalizing the level of the federal funds rate. As the FOMC has raised the federal funds rate three times, this process seems to have proceeded smoothly so far, prompting renewed interest in our balance sheet and reinvestment policy. The anticipation of and actual announcement by the FOMC of changes in reinvestment policy is likely to push up longer-term interest rates and tighten financial conditions somewhat, just as the earlier purchases pushed down long-term interest rates. To what extent is difficult to judge. Presumably, financial conditions would tighten by more if we were to end reinvestments earlier and more abruptly. This suggests a better course may be to taper reinvestments gradually and predictably. 5/6  BIS central bankers' speeches  In addition, because changes in reinvestment policy will likely tighten financial conditions, we will have to take this into account in our interest rate decisions.