thomas m hoenig : hard choices speech by mr thomas m hoenig, president of the federal reserve bank of kansas city, at the town hall meeting, lincoln, nebraska, 13 august 2010. * * * the views expressed by the author are his own and do not necessarily reflect those of the federal reserve system, its governors, officers or representatives. these are trying times for the u. s. economy. the unemployment rate is almost 10 percent, our financial system remains under stress, community bank failures have become weekly news and the central bank is printing money to such an extent that zero interest rates bring little return to those who choose to save. not in decades has the federal reserve seen such challenges in how it conducts monetary policy. with this in mind, this morning i will give you my sense of the issues we face and the hard choices that must be made. i ’ ll begin by focusing on financial reform legislation, including my observations about where we are with too - big - to - fail. then i ’ ll turn to the economy and monetary policy. regulatory choices on march 6, 2009, i gave a speech in omaha called “ too big has failed. ” i shared my thoughts about the financial crisis and my concern for the long - run effects of bailing out investors of the largest financial institutions. that speech hit a nerve by stating what many considered a simple truth, which is that taxpayers should not subsidize our largest financial firms. with our very important federal reserve branch office in omaha, i have been in nebraska many times since then, but this is my first trip back after the passage of financial reform legislation, so it seems an appropriate time to review some of the implications of enacting the 2, 300 - page law. overall, important steps were taken in an effort to strengthen and enhance the regulatory framework and accountability of financial institutions. however, the success of this legislation entirely depends on how well regulatory authorities implement the new requirements. there is, for example, a provision called the volcker rule, which will limit a large firm ’ s ability to set up speculative activities. so - called “ proprietary ” trading and the sponsorship of hedge funds that engage in higher - risk activities must be done outside of commercial banks and bank holding companies, away from direct access to insured funds and the federal reserve ’ s discount window. this is an important provision. however, there are exceptions to the rule and, again, whether it works as intended will depend on how strongly

4. all these complications are making life difficult for policy makers in the region. while asia, having learned well the lessons from the asian financial crisis, has managed to get through the recent global crisis relatively unscathed, we are now entering uncharted waters, and there are both imminent and longer - term policy challenges. 5. first and foremost, it is challenging to manage the large capital flows. the divergence in the growth rates of advanced and emerging economies have been driving fund flows to asia, resulting in signs of overheating in certain pockets of the region. the increasingly negative real interest rates as a result of rising inflation in many regional economies will add fuel to the already high credit growth and heated asset markets. that said, we must also be wary of the risk of reversal of the fund flow. the recent surge in headline inflation and the more favourable near - term cyclical conditions in advanced economies have already brought forward expectations of the start of rising interest rate cycles. with the normalisation of monetary policy stances in the advanced economies becoming more imminent, the risk of an abrupt reversal of international capital flows is increasing. this calls for pre - emptive policy actions to contain the build - up of overheating pressure and another boom - bust cycle in the region before such abrupt reversals of capital flows occur. bis central bankers ’ speeches 6. secondly, some of the conventional wisdoms in monetary policy may be challenged by paradigm shifts in the next phase of growth. conventionally it has been suggested that central bank normally may not need to react proactively to commodity price inflation because of their transitory nature and limited pass - through to core inflation. however, the recent increase of commodities prices such as food and oil could be more sustainable because of structural change in demand and supply. for instance, structural factors such as slowing of crop yield growth, fast population growth and higher income elasticity for food in developing countries would continue to support higher food prices. policy markers would therefore need to pay attention to these developments in calibrating the appropriate degree of monetary tightening. 7. thirdly, there is also a need to diversify the sources of growth for the region, in order to generate sustainable growth and redress global imbalance. in this regard, it is worthnoting some encouraging developments that are underway in the region. the first one is the deepening intraregional trade and increasing orientation towards domestic consumption. the robust economic growth of the regional economies over the past year has mainly