, to the alarm of fed officials, leading to the december 1965 confrontation. this was the most dramatic example of attempted political interference with the conduct of monetary policy after the 1951 accord. the minutes of the meeting at which the board decided to raise the discount rate include interesting discussions of the tension between independence and coordination. some governors wanted to defer to, or at least negotiate further with, the administration on this issue because they viewed the administration as having the primary responsibility for the conduct of national economic policy. should the federal reserve frustrate the direction of that policy? and during the congressional hearings that followed there was much discussion about the dangers to a ship with two captains. today, the interaction between the federal reserve and the administration is more informal but also perhaps more continuous. however, that relationship is less focused on monetary - fiscal policy coordination than on regulatory and international economic issues. this change reflects the smaller role of fiscal policy in stabilisation ever since the early 1980s, when the reagan administration shifted the focus to longer - run issues related to encouraging more rapid trend growth. stabilisation policy since that time has been dominated by the federal reserve, with coordination of policies becoming especially important at major turning points in the thrust of fiscal policy - for example, when the clinton administration decided to make a reduction in the structural federal budget deficit the centerpiece of its economic policy strategy in 1993. the secretary of the treasury and the chairman of the federal reserve meet frequently, many times for breakfast or lunch, often two or three times a week. the meetings are generally short, but not always, with no formal agenda and no staff. these meetings date back to the treasury - federal reserve accord in 1951 but today, apart from telephone consultations, they are the main source of ongoing contact between the chairman and the administration. there are a number of other opportunities for regular contact among federal reserve governors and members of the administration ’ s economic team. a governor ( on a rotating basis ) hosts a weekly lunch for senior staff of the treasury and the federal reserve. while the meetings are often social as well as substantive, they are opportunities to discuss issues of mutual concern. some of the most effective meetings are “ theme ” meetings, when we agree in advance to focus on a particular issue. given the treasury ’ s respect for the independence of the fed, participants will rarely discuss monetary policy, although they occasionally touch on the economic outlook. regulatory issues, debt management, or international economic issues tend to dominate. but the contacts made

, greater analytical capacity will need to be built up. analytical tools must be developed to guide policy while we know that there is an overlap between macroprudential policy and monetary policy, we lack models that describe the relationship in much detail. it is a difficult task for a number of reasons : ( a ) in the models currently used by central banks, financial sectors are poorly modelled, so it is difficult to introduce financial instabilities ; ( b ) developments in financial markets are sometimes driven by psychology, which is difficult to replicate in models with rational agents ; ( c ) the risk of a crisis cannot be modelled in the usual way, as it is more like an extra channel in the transmission mechanism ; and ( d ) policymakers want models that can give them guidance on when to act, which is extremely challenging. one approach that i find promising was recently outlined in a presentation by michael woodford. 11 he described a version of a new keynesian model with two possible states for credit spreads : normal and elevated ( that is during a crisis ). he argued that it is the degree of leverage in the financial system, rather than the level of asset prices, that poses a risk to financial stability. in a standard new keynesian model, the optimal policy commitment will be to hold the output - gap - adjusted price level ( the “ optimal target criterion ” ) constant. however, woodford showed that when the likelihood of a crisis increases when leverage increases, the optimal target criterion is altered to include a factor relating to the marginal increase in the expected loss from a crisis per unit increase in the level of leverage. therefore, the central bank should balance its inflation and output stabilisation objectives against its concern about financial instability. an attractive feature of this model is that it shows that, in most cases, the central bank will set the optimal policy rate in the usual manner ( that is, it can disregard the factor relating to the marginal risk of a crisis in the optimal target criterion ) but, if required, the central bank can affect the probability of a crisis by keeping the policy rate higher. an alternative approach is to describe the connection between the taylor rule for monetary policy and a form of taylor rule that describes how regulations vary based on an assessment of, for example, credit growth. 12 the different rules are connected through the stylised view of the monetary policy transmission mechanism presented earlier : the policy rate ( ) is determined by the well - known taylor rule for monetary policy. the interest rate margin