because short - term nominal interest rates cannot fall below zero, real rates cannot become negative enough to equilibrate savings and investment. as i weigh the evidence, i find the case for the liquidity trap scenario more compelling than one for the structural impediments scenario. my assessment has been influenced by the book titled this time is different : eight centuries of financial folly3 by carmen reinhart and kenneth rogoff. reinhart and rogoff document the substantially detrimental effects that financial crises typically impose on the subsequent economic recovery. as we all know, the recent recession was accompanied by a large financial crisis. when i look at the u. s. economy today, i see it tracking reinhart and rogoff ’ s observation that such recoveries are usually painfully slow – and are so for reasons that have little to do with structural impediments in the labor market and the like. liquidity traps are rare and difficult events to manage. they present a clear and present danger that we risk repeating the experience of the u. s. in the 1930s or that of japan over see christiano, eichenmbaum and evans ( 2005 ), smets and wouters ( 2007 ) and chung et al. ( 2010 ). federal open market committee ( 2011 ). reinhart and rogoff ( 2009 ). bis central bankers ’ speeches the past 20 years. however, liquidity traps have been studied over the years in rigorous analytical models by a number of prominent economists, including paul krugman, gauti eggertsson, michael woodford and ivan werning. 4 variants of these models have successfully explained business cycle developments in the united states. the lesson drawn from this literature is that the performance of economies stuck in a liquidity trap can be vastly improved by lowering real interest rates and lifting economic activity using an appropriately prolonged and forward - looking period of accommodative monetary policy. of course, such monetary accommodation is the antithesis of the policy prescription for the structural impediments scenario. a risk - management approach to policy changes of course, i realize that i could be wrong in my assessment. so let us consider how we should conduct policy when we don ’ t know for sure which scenario is really the one we face today. how can we avoid risking a repeat of either the stagflation of the 1970s or the slow growth of the 1930s? the problem, of course, is that policies that are optimal for the

historically low interest rates. on the other hand, such policies have the potential to raise the likelihood of financial instability in the future. so, the questions that i ’ m often asked regarding these matters are as follows : do the regulators and the fed have adequate safeguards in place to mitigate this potential financial risk? if not, should the fomc step away from what we thought was the best monetary policy with respect to our dual mandate? should we discard our nonconventional tools and raise the fed funds rate in order to reduce the possibility of undesirable financial imbalances in the future? i don ’ t believe that such monetary policy adjustment is the right approach. i think the inference that persistently low interest rates pose a danger to financial stability is based on a narrow view of the economy. this narrow view is unlikely to survive a broader analysis that takes into account all the interactions between financial markets and real economic activity. if more restrictive monetary policies were pursued to generate higher interest rates, they would likely result in higher unemployment and a sharp decline in asset prices, choking the moderate recovery. such an adverse economic outcome is unlikely to set a favorable foundation for financial stability. moreover, our short - term interest rate tools are too blunt to have a significant effect only on those pockets of the financial system that are most prone to inappropriate risk - taking. at the same time, these blunt tools could significantly damage other markets, as well as the growth prospects for the economy as a whole. therefore, stepping away from otherwise appropriate monetary policy to address potential financial instability risks would degrade progress toward maximum employment and price stability. this approach would be a particularly poor choice when other tools are available, at lower social costs, to address the risk of financial instability. let me be clear. i am not saying that financial stability concerns are not relevant for the economy or that policymakers should not take decisive action against developments that threaten financial stability. rather, i am saying that the macroprudential tools available to policymakers are better - suited safeguards to addressing financial risks directly. these macroprudential actions can be dialed up or down given the appropriate setting of monetary policy tools ; so, undesirable macroeconomic outcomes are less likely than if we were to resort to premature monetary tightening. indeed, any decision to instead rely on morerestrictive interest rate policies to achieve financial stability at the expense of poorer macroeconomic outcomes must pass a cost – benefit test. and such a test