in which monetary policy should play some role in reining in risk - taking behavior. i will return to this point later. in the remainder of my remarks, i will discuss key issues that must be resolved before an effective policy regime for the containment of systemic risk can be established. first, we must understand the sources of systemic risk and design surveillance practices that enable us to detect threats to financial stability early on. second, we must develop a tool kit of supervisory policy instruments – so - called macroprudential policies – and guidelines on how and when to deploy them. and third, we must strive to avoid situations in which macroprudential and monetary policies are working at cross - purposes, given that macroprudential policies affect macroeconomic performance and that monetary policy may affect risk - taking incentives. all of these issues raise complex questions of design and implementation. interesting parallels may be drawn, however, between the design issues we face in macroprudential policy and those we have grappled with in conducting monetary policy. these parallels include the appropriate roles of rules versus discretion, the need for policies that are robust in addressing uncertainty, and the assignment problem, all of which i will discuss later. the fertile field of monetary policy research may therefore offer lessons that can fruitfully be applied to managing systemic risk. systemic risk : sources and surveillance at its most basic level, systemic risk stems from the possibility that some event or sequence of events could result in severe impairment of the financial sector ’ s ability to provide credit in the economy. at their most extreme, such events can trigger panicky attempts to withdraw credit, creating runs that lead to failures of important financial institutions and, ultimately, systemic collapse. if policymakers are to detect emerging threats to the financial system, we must understand the determinants of systemic risk and develop appropriate metrics for measuring it. economists have long studied these issues, and the recent crisis has intensified research on the subject. this work points to several key elements in the buildup of risks in the financial system. let me mention three factors that current research suggests are critical. one factor is the accumulation in the financial sector of very high levels of risk and leverage, along with excessive reliance on unstable short - term funding. the emergence of such behavior among the largest and most interconnected financial institutions is particularly dangerous, since these institutions are linchpins in our financial system and their failure could cause significant damage to large numbers of counterparties and the system as a whole, as the

an art : science in that we will analyze closely a wide range of data that research shows to be diagnostic, and art in that we will have to exercise judgment about when excesses become so dangerous that action is required. the fed and other regulators in the united states and abroad have made important progress in developing systemic risk indicators. still, we must recognize the inherent difficulty in forecasting crises and acknowledge the failure of past risk - monitoring efforts. moreover, we must be mindful of the inadequacy of indicators that focus too specifically on the markets and channels that transmitted the crisis of 2007 and 2008. like tolstoy ’ s unhappy families, every financial crisis is a crisis in its own way. for that reason, we need a flexible approach that combines science and art, and judgmentally weighs information from all indicators. macroprudential policy implementation refining our ability to identify systemic threats is well and good. but when we detect a threat, what will we do about it? this question brings me to the tools and implementation of macroprudential policies. the first tool is information to help focus attention in policy circles, and among investors and the public, on looming systemic risks. the detailed financial stability reports published by the international monetary fund and a number of central banks are intended to serve this purpose. 8 and the financial stability oversight council created under the dodd - frank act is charged with preparing such a report once a year. admittedly, most such reports failed to identify the mechanisms behind the recent crisis. and even when vulnerabilities were identified and warning bells sounded, they were often greeted with yawns, as anyone who remembers the phrase “ irrational exuberance ” can testify. those who sounded the alarms were seen as killjoys who refused to join the party. words are important, but clearly they are not enough. we need strong policies to back them up. we need macroprudential policymakers ready to take away the punch bowl when the party is getting out of hand. we know that market participants won ’ t take kindly when limits are set precisely in those markets that are most exuberant, the ones in which they are making big money. during the late stages of the housing boom, more than a few financial institution chief executive officers dismissed the warnings of their own risk managers with a wave of the hand. so what should be the main tools of macroprudential supervision? many of them are similar to those of microprudential policy. they