forces lessen the basic external imbalance, they increase the basic budget imbalance. in the long run, the only way to correct budget deficits is for policymakers to correct them. outside forces there are several outside forces - both natural and as a result of policy - that could influence budget and trade deficits. one generally helpful influence is productivity growth. say the u. s. economy benefits from an exogenous positive shock to productivity growth, as it seemed to have in the late 1990s. this shock would raise the trend path of income, meaning that slightly higher primary budget and trade deficits could still be consistent with debt - to - gdp stability ; in effect, a higher level of g can be plugged into equation 2 ( at least as long as it is not offset by a higher i ). higher productivity could also help lengthen the credibility range, the range in which moderate changes in the debt ratio might not lead to adverse changes in relative prices. among other things, higher productivity could raise the marginal product of capital and make investment in u. s. assets relatively attractive. but even with these favorable developments, the stability conditions discussed above still hold. if they are violated, the natural adjustment mechanisms will eventually take over for the trade deficit, and the primary budget deficit will eventually have to be reduced to stop a growing government debt ratio. one unhelpful measure is trade protectionism. while it might appear that trade protectionism would correct trade deficits, it probably will not. over the medium and long run, the economy should be producing near its natural growth path, perhaps because of timely monetary and / or fiscal policy, perhaps because of natural equilibrating forces in the economy. in this event, trade protectionism would not stimulate added national production. even if protectionist measures reduce imports, the added spending demands for import - competing industries will crowd out other types of production. put another way, equation 1 shows that the trade deficit is ultimately determined by national saving and investment. without a change in these, protectionism merely shifts the types of goods that are produced. it does not increase overall production and, short of cutting off trade altogether, does not even change the trade balance. moreover, as is well known, over the long run, trade protection lowers a nation ’ s standard of living. finally, suppose politicians actually do correct budget deficits, again assuming an economy near its medium - term growth path. as mentioned above, such a fiscal austerity

should they occur, will be a more expansionary fiscal policy. moreover, monetary policy has been and will continue to be responsive to rapidly changing circumstances. all told, as you know, we have taken the federal funds rate down 100 basis points since september 11, in two steps of 50 basis points each. it is too soon to judge the strength of these various forces - - consumer and business behavior, monetary and fiscal policy - - and how they will balance out. risk modeling : benefits and critiques let me turn now to the theme of this conference. risk management, as this audience is very well aware, has been revolutionized in recent years by advances in both theory and technology. this morning, i would like to discuss the nature of better risk management and also some observers ’ criticism that the expanded use of sophisticated techniques for measuring and managing risk may actually increase market volatility and reduce market liquidity. for centuries, financial intermediaries - - lenders, institutional investors, dealers, and insurers - - have engaged in risk modeling. the model was in their heads and was based on judgment and experience, but that model involved categorizing and evaluating the proposed risk and reaching a series of interrelated decisions. for example, in the context of bank lending, for each potential credit those decisions have included : ( 1 ) whether or not to lend, ( 2 ) at what price to lend, ( 3 ) what maturity should the loan have, and ( 4 ) what collateral to accept and how to structure it. formal models for market and credit risk are designed to augment judgment and experience to help make exactly the same decisions. the difference, of course, is that models rely on a clearly specified base of information and do so in a structured way. judgment is still required in determining inputs and evaluating outputs, but the modeling process was inconceivable before the development of both modern finance theory and modern information technology. and, in my opinion, by measuring and managing risk in a formal and structured way, models, when combined with sound judgment, have, on balance, improved the resultant decisions. what have been the benefits of the new model - based approach to risk measurement and management? the most important is that better risk measurement and management contribute to more - efficient resource allocation. when risk is better evaluated, it can be more accurately priced ; if it can be more - accurately priced, it can be more easily spread among a larger number of market participants, improving