roger w ferguson, jr : central banks and markets speech by mr roger w ferguson, jr, vice - chairman of the board of governors of the federal reserve system, at the bond market association 2002 awards dinner, new york, 9 october 2002. * * * i thank the members of the bond market association for selecting me to receive the 2002 distinguished public service award. i am particularly honored to join the company of previous recipients, who have included my colleagues alan greenspan and bill mcdonough, former treasury secretary rubin, and senators christopher dodd and kay bailey hutchinson. i understand that the proceeds from this dinner will be used to support the work of the bond market foundation, whose mission includes advancing the financial literacy of disadvantaged americans. that this is a high purpose is beyond doubt. i know that i could speak for much longer than you care to listen about why the understanding of economics and finance is crucial for individuals in a market economy. knowledgeable and astute consumers can avoid making those investment errors that come from misunderstanding or being misled. they also promote competition among providers, which benefits us all. personal financial security enhances individual well - being. and, at a more fundamental level, our social fabric and national image are intimately connected to our material aspirations. the united states cannot be the land of opportunity unless all of our citizens have both the tools and the ability to use those tools to improve their livelihoods and lives. fortunately, the increasing supply of services provided by our financial system - and the increasing complexity and diversity of product offerings - have increased consumer demand for improved financial education. the bond market foundation, like the federal reserve, has been looking for new ways to meet that demand. there are numerous other ways in which the federal reserve and the bond market association, and the fixed - income markets more generally, work together to improve the well - being of our fellow citizens. obviously, the impulse of monetary policy is transmitted, in part, through interest rates set by the market. we target only the overnight rate, and traders and investors, such as those represented and serviced by those here this evening, determine longer - term interest rates on treasury and private securities. the resulting structure of rates and spreads in the fixed - income markets can in turn be a valuable tool that we can use when analyzing the current state of macroeconomic conditions and forecasting the future. clearly, however, the roles of the fixed - income markets and the federal reserve are complementary, not identical. your role is to allocate

scarce savings among competing demands. ours is to set overall conditions, particularly by maintaining price stability, that allow market prices to accurately reflect supply and demand dynamics. a price system that is accurate in that way supports the market allocation of all resources, including capital, to their most productive uses. at times, markets and federal reserve policy are complementary in an additional way. as we saw last september 11, when conditions in markets become so stressed that they no longer function efficiently for pricing and allocating risk, the federal reserve may be called upon to provide temporary infusions of liquidity. however, it is also important to understand the limits of what the federal reserve, or monetary policy more generally, can do. first, monetary policy action cannot appropriately be targeted to benefit one industry, region, or economic group. we key our policy on the average macroeconomic condition that prevails, knowing that conditions may vary greatly among industries, regions, and groups. of course, that means that those individuals and businesses whose conditions are significantly different from the average might feel aggrieved. a closely related logic applies to relative prices. with one major exception, the federal reserve does not attempt to adjust the relative price of any class of goods, services, or assets. that major exception is the overnight funds rate. in that market, in which we have a monopoly on supply, we set the price and let the market determine the quantity demanded. we do this because we find that adjusting the price of overnight credit is currently the most efficient way to achieve our mandate of low and stable inflation and maximum sustainable growth. but that is where our monopoly ends. short - term interest rates are such a powerful tool for central banks because so many other financial assets are priced based, in part, on the price of short - term credit and market expectations about the future adjustment of that price. in all other markets, the forces of supply and demand determine prices. some have suggested that under some circumstances central banks should adjust the overnight funds rate to affect intentionally the relative price of another asset class, namely equities. but if a central bank elevates another set of relative prices to being targets of policy, i believe that it should have strong conviction in two areas. first, that its tool, the provision of reserves to the banking system, will predictably influence that relative price, and with minimal unintended consequences. second, that adjusting that relative price will, in turn, have a predictable and significant role in achieving our