bond rates reflect a drop in risk premiums because inflation has become better anchored and the volatility of the real economy has fallen. but let me also note that other factors would seem to work in the opposite direction — for example, our large and growing federal budget and trade imbalances could be raising risk premiums. another possibility is that low long - term rates reflect unusually strong demand for long - term securities, for example, by pension funds seeking to improve the match between the durations of their assets and liabilities, by holders of mortgage - backed securities seeking to maintain the durations of their portfolios, or by foreign central banks that have been acquiring dollars. china may have been playing an especially large role, as its central bank has intervened in foreign exchange markets to peg the renminbi at a low level against the dollar. of course, last week the people ’ s bank of china announced that it had revalued the renminbi against the dollar by 2. 1 percent, with the stated intention of managing the renminbi ’ s exchange value against an unspecified currency basket. this is not a large revaluation, but some observers think that it is the beginning of a much bigger move over time. if this is the case, we may gain a better understanding of the impact, if any, that chinese exchange rate policy has had on u. s. bond rates. an alternative to “ special factors ” as an explanation for the low level of long - term yields is the possibility that the flat yield curve reflects the market ’ s assessment that bad news is on the horizon. in other words, investors may expect only modest increases in the funds rate in the future because they think that the drags i ’ ve described will keep demand on the weak side for some time to come. we probably won ’ t know the most important sources of this “ conundrum ” until more time passes, but the causes of the conundrum do matter to monetary policy. if the first class of explanations turns out to be correct, the federal funds rate probably needs to be somewhat higher than would otherwise be appropriate to offset the additional stimulus due to the flat yield curve. if the latter explanation fits the bill, and the market is correct that the drags going forward will be unusually strong, a somewhat easier policy may be appropriate. housing whatever the source of the conundrum, clearly low long - term rates have contributed to the continuing boom in the housing market. the share

rapid gains in house prices. this growth has had to rest on the backs of just a few interest - sensitive sectors — business investment, consumer durables, and housing. from this perspective, it ’ s not all that surprising that housing markets have been hot. my point is that to offset the “ drags ” we ’ ve needed to give the economy a strong dose of stimulus — which inevitably boosted the housing sector. as i ’ ve discussed, if a sizable reversal in house prices were to occur, it probably would affect the economy mainly through the lagged effects of declines in wealth and increases in interest rates, rather than through widespread financial disruptions. this would give monetary policy time to react to any resulting economic weakness by lowering interest rates. in addition, the magnitude of the potential house price overvaluation may be only around half that of the earlier stock market overvaluation. in conclusion, policy still appears to be somewhat accommodative, and given the recent inflation performance and the dwindling of slack, it makes sense to continue the process of removing that accommodation. i hope i ’ ve provided you with some insight on the issues that i think are important to focus on as the fed goes through this process. i look forward to taking your questions. this bis review is available on the bis website at www. bis. org.