supervisory process and attention to the vulnerabilities of key intermediaries. from the vantage point of, say, 1999, when price - earnings ratios were at lofty levels and forecasts of annual - earnings growth over the longer term were in the high teens, an asset - price correction did not seem like a low - probability event. although such a correction would result in considerable losses for those holding the assets when their prices fell and would damp demand for a time, its macroeconomic effect did not seem likely to be unusually large. banks were well capitalized, and financial institutions more sophisticated in their risk - taking, so that the scope for significant knock - on effects appeared limited. thus the risks seem higher than with many other possible low - probability events that the balance of costs and benefits will turn out to be adverse when monetary policy is aimed away from fundamental objectives to influence asset prices. given these uncertainties, we have chosen to react to the assetprice correction when it occurs rather than to try to head it off. monetary policymakers giving significant weight to low - probability events face several challenges. one serious potential pitfall is paying so much attention to the tails of the distributions of possible outcomes that the central tendencies veer well away from objectives for economic and price stability - in effect paying too much for insurance. a key issue in this regard is judging when to begin reversing the extra easing or tightening put in place to take account of the possible high - impact event. the policy actions we have been addressing are importantly based on concerns about the effects of nonlinearities, and it may be difficult to judge when the threat of those nonlinearities has diminished sufficiently to make unwinding the action - reducing or dropping the insurance policy - advisable. the difficulty is compounded because the reasons for the behavior that leads to heightened potential impact of a low - probability event often are not fully understood - for example, why the markets cracked or why the economy has not responded more strongly to previous stimulus. moreover, when the threat of the low - probability event recedes into the past, policy may need to compensate over time in the other direction to preserve economic and price stability - to achieve the appropriate policy stance on average - a consideration that further complicates the policy decision in these circumstances. another issue raised by some critics in connection with central bank efforts to guard against financial instability and other low - probability, high - impact developments is that such actions encourage undue risk - taking in financial

markets and the economy. however, to the extent that the conduct of policy actually reduces the potential for high - impact events or more generally damps fluctuations in output and prices, risks are genuinely lower, and that situation should be reflected in the behavior of private agents. to me, this criticism is similar to asserting that mandating seat belts in cars has led to more traffic accidents because they give drivers a sense of security. and it is probably true when looked at narrowly. policies should be judged from a general equilibrium perspective, however. damped fluctuations in economic activity and the containment of financial crises has made the populace, at large, better off. that some view this security as reason to be less cautious does not seem especially damaging to welfare. to be sure, adverse consequences for resource allocation, and perhaps even for the stability of output and prices, will occur if private agents overestimate the ability or willingness of central banks to damp volatility in asset prices or the economy. in the context of the sorts of decisions we are discussing on this panel, the question is whether the tendency of a risk - managing central bank to lean particularly hard against the consequences of asset - price declines might not give market participants a false sense of security. however, experience should have taught market participants that risk management by central banks does not prevent sharp movements in asset prices. policy actions in 1987, 1998, and 2001 - 03 cushioned the economy, but they did not stop major declines in the prices of risky credits in 1998 or equities in 1987 or 2001. any asymmetries in central bank reactions were aimed at stabilizing the economy, not achieving particular asset - price configurations. the small effects of monetary policy asymmetries on the asset prices have been overwhelmed by the fundamentals of shifting perceptions of risk and future earnings. in gauging the effects of policy on asset prices, market participants should not be making systematic errors that distort resource allocation. in my view, these potential difficulties should not deter central banks from taking account of low - probability, high - impact events in judging the appropriate stance of monetary policy. to be sure, any such actions cannot be allowed to compromise the primary long - run policy goal of preserving price stability. and policymakers, through their words as well as their deeds, must remind market participants that monetary policy is but one of many influences on asset prices and that the level of those prices is not an objective of policy. but when inflation expectations are firmly anchored