also be aided by changes over time in the policies of our trading partners. to some extent, it would seem appropriate for them to use their macroeconomic policies to stimulate domestic spending. in many cases, however, the root cause of deficient demand seems to be more structural than cyclical in nature, and would thus call for more micro - oriented measures. combined, these policy initiatives on the part of our trading partners should yield higher productivity growth, generate more vigorous spending abroad, raise rates of return on their capital investment, and ease their adjustment to smaller u. s. deficits. these changes, in turn, would boost the demand for u. s. exports and could shift portfolio preferences away from dollar - denominated assets. other public policies here and abroad can have an important influence on the transition process by working with markets and facilitating adjustment. for example, governments should strive to maintain and enhance the flexibility of markets. in particular, the united states and its trading partners should vigorously protect the current degree of market openness and should aim to reduce trade barriers further. over time, increased exchange rate flexibility abroad would also be beneficial. these and other types of market flexibility help facilitate needed shifts in spending and prices ; without them, rigidities might impede such stabilizing changes, causing adjustments to break out forcefully in other, more disruptive ways. strong financial institutions are especially important at this time when asset prices could move by large amounts unexpectedly. by ensuring that financial institutions are adequately capitalized and well prepared in general to deal with major changes in asset prices, prudential regulation decreases the risk that the actions of impaired financial institutions could disrupt the flow of credit and thereby intensify what might already be difficult adjustments. in addition, strong institutions should be positioned to weather any necessary changes in short - term interest rates as policy is adjusted. finally, there is the role that monetary policy plays in reacting to these imbalances and their inevitable unwinding. the federal reserve ’ s mandate is to keep inflation low and stable and to promote full resource utilization, with the economy expanding at its maximum sustainable rate. thus, anything that has the potential to threaten the stability of output and prices is of concern to us. these imbalances certainly affect the forces of supply and demand and have consequences for price stability. nevertheless, their direct influence on monetary policy is limited : they are important to us in so far as they affect the macro economy, and in this regard they are just a few of the

seem to require less compensation for the risks inherent in lending over a longer term or of supplying credit to borrowers who usually have a greater chance of defaulting. in this environment, the likelihood that major credit problems will develop would seem limited, and that limited risk makes it not unreasonable for private bond premiums to be at the low end of their historical range. still, investors seem to expect short - term interest rates to remain on the low side of historical averages for some time. these subdued expectations may reflect a belief that underlying global demand will remain damped and that the world will continue to be willing to invest heavily in the united states. a second observation concerns the housing market, which you have already discussed. a couple of years ago i was fairly confident that the rise in real estate prices primarily reflected low interest rates, good growth in disposable income, and favorable demographics. prices have gone up far enough since then relative to interest rates, rents, and incomes to raise questions ; recent reports from professionals in the housing market suggest an increasing volume of transactions by investors, who ( along with homeowners more generally ) may be expecting the recent trend of price increases to continue. even so, such a distortion would most likely unwind through a slow erosion of real house prices, rather than a sudden crash. moreover, experience suggests that consumer spending would respond only gradually to any loss in wealth - an important consideration because a gradual adjustment in spending would give offsetting policy actions time to work. in any event, i take some comfort from the continuing disagreement among close students of the market about whether houses are overvalued, and, given the widespread press coverage of this issue, from my expectation that people should now be aware of the risks in the real estate market. finally, there is the exchange rate. the inability of anyone to predict movement in the dollar accurately and consistently has been evident. presumably, the dollar ’ s value is based partly on market expectations about future interest rates, trade flows, and portfolio preferences, among other things. there is no particular reason to think that these expectations are substantially distorted. certainly no investor out there buying dollar assets could be surprised to learn that the united states has a growing current account deficit! and, i do not anticipate a marked and persistent downshift in u. s. productivity growth that would greatly reduce the expected returns from holding dollar - denominated assets. governments who have been accumulating dollar assets also would seem to have no