jeremy c stein : lean, clean, and in - between speech by mr jeremy c stein, member of the board of governors of the federal reserve system, at the national bureau of economic research conference “ lessons from the financial crisis for monetary policy ”, boston, massachusetts, 18 october 2013. * * * the thoughts that follow are my own, and are not necessarily shared by my colleagues on the federal open market committee. i am grateful to tim clark, andreas lehnert, nellie liang, ben mcdonough, and lisa ryu for their input. thank you. the theme of this conference is, “ lessons from the financial crisis for monetary policy. ” given the opportunity to speak about this topic, my first thought was that i should organize my remarks around the familiar “ lean versus clean ” debate. the traditional, precrisis framing of the question went something like this : should policymakers rely on ex ante measures to lean against potential financial imbalances as they build up, and thereby lower the probability of a bad event ever happening, or should they do most of their work ex post, focusing on the clean - up? post - crisis, the emphasis in the debate has shifted. i think it ’ s safe to assume that nobody in this room would now argue that we should be putting all our eggs in the “ clean ” basket. discussion these days tends to focus instead on which ex ante measures are best suited to safeguard financial stability. among these, there seems to be widespread support for unconditional, ( i. e., time - invariant ) tools that increase the overall resiliency of the financial system to shocks. these tools include more robust capital and liquidity requirements, as well as an enhanced capability to resolve a large financial institution that finds itself on the brink of failure. they might also include universal margin requirements on securities financing transactions, as a way of mitigating fire - sales risks. we might argue about various aspects of calibration and implementation, but i don ’ t think there is too much controversy about the basic proposition that strong, comprehensive regulation aimed at enhancing resiliency is essential. there is considerably less agreement about the desirability and effectiveness of ex ante measures that seek to lean against the wind in an explicitly time - varying fashion – that is, measures that can be adapted in response to changing economic or financial conditions. at the risk of caricature, one can distinguish three schools of thought. the first school is generally

response to some shocks ( hamilton, 1989 ; kim and nelson, 1999 ; and kim, morley, and piger, 2005 ). furthermore, the use of a quadratic objective function does not reflect the extent to which most individuals have strong preferences for minimizing the incidence of worst - case scenarios. therefore, given that the central bank ’ s ultimate goal should be to maximize the public welfare, i believe that the design of monetary policy ought to reflect the public ’ s preferences, especially with respect to avoiding particularly adverse economic outcomes. the now - classic textbook on this topic is woodford ( 2003 ) ; refer also to goodfriend and king ( 1997 ) ; rotemberg and woodford ( 1997 ) ; clarida, gali, and gertler ( 1999 ) ; king and wolman ( 1999 ) ; erceg, henderson, and levin ( 2000 ) ; benigno and woodford ( 2003 ) ; giannoni and woodford ( 2005 ) ; levin and others ( 2005 ) ; and schmitt - grohe and uribe ( 2005 ). clarida, gali, and gertler ( 1998, 2000 ) ; sack ( 2000 ) ; english, nelson, and sack ( 2003 ) ; smets and wouters ( 2003 ) ; levin and others ( 2005 ) ; further discussion is in bernanke ( 2004 ). most of the quantitative studies of optimal monetary policy have also assumed that the shocks hitting the economy have a time - invariant gaussian distribution, that is, a classical bell curve with symmetric and well - behaved tails. in reality, however, the distribution of shocks hitting the economy is more complex. in some instances, the uncertainty facing the economy is clearly skewed in one direction or another ; again, this is likely when there are significant financial disruptions. the federal reserve often reports on our judgments regarding the degree of skewness and the associated economic costs by giving assessments of the “ balance of risks ” in the press releases that are issued following fomc meetings. in addition, at least in some circumstances, the shocks hitting the economy may exhibit excess kurtosis, commonly referred to as tail risk because the probability of relatively large disturbances is higher than would be implied by a gaussian distribution. in that light, one element of the recent enhancements to the federal reserve ’ s communication strategy is that fomc participants now provide assessments of the relative degree of uncertainty. for example,