more stable? a bayesian approach based on a markov - switching model of the business cycle ”, review of economics and statistics, vol. 81 ( november ), pp. 608 - 16. kim, chang - jin, james morley, and jeremy piger ( 2005 ). “ nonlinearity and the permanent effects of recessions ”, journal of applied econometrics, vol. 20 ( no. 2 ), pp. 291 - 309. king, robert g., and alexander l. wolman ( 1999 ). “ what should the monetary authority do when prices are sticky? ” in john taylor, ed., monetary policy rules. chicago : university of chicago press, pp. 349 - 98. levin, andrew t., fabio m. natalucci, and egon zakrajsek ( 2004 ). “ the magnitude and cyclical behavior of financial market frictions ”, finance and economics discussion series 2004 - 70. washington : board of governors of the federal reserve system, december. levin, andrew, alexei onatski, john c. williams, and noah williams ( 2005 ). “ monetary policy under uncertainty in micro - founded macroeconometric models ”, in mark gertler and kenneth rogoff, eds., nber macroeconomics annual 2005. cambridge, mass. : mit press, pp. 229 - 88. mishkin, frederic s. ( 2007a ). “ inflation dynamics ”, speech delivered at the annual macro conference, federal reserve bank of san francisco, san francisco, march 23. mishkin, frederic s. ( 2007b ). “ monetary policy and the dual mandate ”, speech delivered at bridgewater college, bridgewater, va., april 10. mishkin, frederic s. ( 2007c ). “ will monetary policy become more of a science? ” finance and economics discussion series 2007 - 44. washington : board of governors of the federal reserve system, september. mishkin, frederic s. ( 2007d ). “ financial instability and monetary policy ”, speech delivered at the risk usa 2007 conference, new york, november 5. mishkin, frederic s. ( 2007e ). “ the federal reserve ’ s enhanced communication strategy and the science of monetary policy ”, speech delivered to the undergraduate economics association, massachusetts institute of technology, cambridge, mass., november 29. rotemberg, julio, and michael woodford ( 1997 ). “ an

significant risks to the macroeconomy. then i will explain how the science of monetary policy can help provide a conceptual framework for a systematic approach to managing these risks, and i will briefly discuss how that framework can be useful for understanding the course of federal reserve policy over the past few months. financial disruptions and macroeconomic risk before considering the appropriate policy response to strains in financial markets, it is essential to consider the sources of these strains and the potential consequences for the macroeconomy. in general, the u. s. financial system is an efficient mechanism for channeling funds to individuals or corporations with worthy investment opportunities, because the financial markets are highly competitive and provide strong incentives for collecting and processing information. i appreciate the comments and assistance of william english, andrew levin, brian madigan, roberto perli, david reifschneider, and david wilcox. although financial markets and institutions deal with large volumes of information, some of this information is by nature asymmetric ; that is, one party to a financial contract ( typically the lender ) has less accurate information about the likely distribution of outcomes than does the other party ( typically the borrower ). 2 historically, banks and other financial intermediaries have played a major role in reducing the asymmetry of information, partly because these firms tend to have long - term relationships with their clients. recent years have witnessed the development of new types of financial institutions and of new markets for trading financial products, and these innovations have had the potential ( not always realized ) to contribute to the efficient flow of information. the continuity of this information flow is crucial to the process of price discovery – that is, the ability of market participants to assess the fundamental worth of each financial asset. during periods of financial distress, however, information flows may be disrupted and price discovery may be impaired. as a result, such episodes tend to generate greater uncertainty, which contributes to higher credit spreads and greater reluctance to engage in market transactions. as i noted in another recent speech, financial disruptions are associated with two distinct types of risk : valuation risk and macroeconomic risk ( mishkin, 2007d ). valuation risk refers to the extent that market participants become more uncertain about the returns on a specific asset, especially in cases where the security is highly complex and its underlying creditworthiness is relatively opaque. in recent months, for example, this type of risk has been central to the repricing of many structured credit products, as investors have struggled to