raise the ioer rate – pushing up the federal funds rate and other short term rates – to tighten broader financial conditions and reduce demand. 2 if the demand for credit were insufficient to push the economy to full employment, then the federal reserve would reduce the ioer rate – pushing down the fed funds rate and other short term rates – to ease financial conditions and support demand, recognizing that the ioer rate cannot fall below zero. while the mechanism is different, the basic approach is very similar to the way the federal reserve has behaved historically. although our ability to pay interest on excess reserves is sufficient to retain control of monetary policy, it is not bad policy to have both a “ belt and suspenders ” in place. as a result, we have developed means of draining reserves to provide reassurance that we will not – under any circumstance – lose control of monetary policy. these include reverse repo transactions with dealers and other counterparties, auctions of term deposits for banks, or securities sales from the fed ’ s portfolio. a related concern is whether the federal reserve will be able to act sufficiently fast once it determines that it is time to raise the ioer. this concern reflects the view that the excess reserves sitting on banks ’ balance sheets are essentially “ dry tinder ” that could quickly fuel excessive credit creation and put the fed behind the curve in tightening monetary policy. in terms of imagery, this concern seems compelling – the banks sitting on piles of money that could be used to extend credit on a moment ’ s notice. however, this reasoning ignores a very important point. banks have always had the ability to expand credit whenever they like. they didn ’ t need a pile of “ dry tinder ” in the form of excess reserves to do so. that is because the federal reserve ’ s standard operating procedure for several decades has been a commitment to supply sufficient reserves to keep the fed funds rate at its target. if banks wanted to expand credit that would drive up the demand for reserves, the fed would automatically meet that demand by supplying additional reserves as needed to maintain the fed funds rate at its target rate. in terms of the ability to expand credit rapidly, it makes no difference whether the banks have lots of excess reserves on their own balance sheets or can source whatever reserves they need from the fed funds market at the fed funds rate. 3 the ioer rate and the federal funds rate are likely to track each other closely in most circumstances. banks do not have any incentive to lend reserves in the fed

growth rate of real gross domestic product ( gdp ) in the fourth quarter may understate the economy ’ s forward momentum. that is because real gdp growth in the quarter was held back by a sharp slowing in the pace of inventory accumulation. the revival in demand, production and confidence strongly suggests that we may be much closer to establishing a virtuous circle in which rising demand generates more rapid income and employment growth, which in turn bolsters confidence and leads to further increases in spending. the only major missing piece of the puzzle is the absence of strong payroll employment growth. we will need to see sustained strong employment growth in order to be certain that this virtuous circle has become firmly established. with respect to the labor market, there are conflicting signals. on one hand, the unemployment rate has fallen sharply over the past two months, dropping to 9. 0 percent from 9. 8 percent two months earlier ( chart 4 ). this is the biggest two - month drop in the unemployment rate since november of 1958. on the other hand, payroll employment gains have remained very modest – rising by only 83, 000 per month over the last three months bis central bankers ’ speeches ( chart 5 ). such modest payroll growth is not consistent with a sustained drop in the unemployment rate. the true story doubtless lies somewhere in between – but probably more on the side of the household survey that tracks unemployment. that is because measured payroll employment growth in january was probably temporarily depressed by unusually bad winter weather. although some of the recent decline in unemployment is due to a drop in the number of people actively seeking work, the household survey does show a pick - up in hiring. other labor market indicators, such as initial claims and the employment components of the ism surveys for manufacturing and nonmanufacturing, have also shown improvement recently ( chart 6 and chart 7 ), which suggests that the weakness in payroll growth is the outlier. although there is uncertainty over the timing and speed of the labor market recovery, i do expect that payroll employment growth will increase considerably more rapidly in the coming months. we should welcome this. a substantial pickup is needed. even if we were to generate growth of 300, 000 jobs per month, we would still likely have considerable slack in the labor market at the end of 2012. in monitoring employment trends, we also need to recognize that the data are likely to be quite noisy on a month - to - month basis. this is particularly the case during the winter months, when