. minsky ( 1992 ), “ the financial instability hypothesis ( 30 kb pdf ) ”, working paper 74 ( annandale - on - hudson, n. y. : jerome levy economics institute of bard college, may ). see franklin allen, stephen morris, and hyun song shin ( 2006 ), “ beauty contests and iterated expectations in asset markets ”, review of financial studies, vol. 19 ( 3 ), pp. 719 – 52. within this structure, the federal reserve will play an important role. we will supervise all systemically important institutions and, jointly with other regulators in the new financial stability oversight council, establish stricter prudential standards for such firms. we will help ensure the safety of financial market utilities that are critical to our payment, clearing, and settlement systems. and we will actively support the council ’ s mission to identify and address emerging risks to financial stability. at the same time, though, we must take care to preserve incentives for innovation and reasonable risk - taking. we must remain prudent, while avoiding an overly strict approach that unduly impedes financial intermediation and stifles capital formation. vigilance to threats of systemic financial risk must also inform the conduct of monetary policy. we have seen that the eruption of a financial crisis can have severe economic consequences, compromising the ability of a central bank to attain its primary macroeconomic objectives. monetary policymakers should also be aware that the decisions they make in pursuit of price stability and full employment could, in some circumstances, affect the development of systemic risk. for example, if compensation incentives in the financial sector are misaligned, low interest rates might heighten the ability and desire of financial market participants to reach for yield and take on risk. our goal should be to deploy an enhanced arsenal of regulatory tools to address systemic risk, making the financial system far more robust. that way, monetary policy can concentrate on its long - standing goals of price stability and maximum employment. supervision and regulation must serve as the first and main line of defense in addressing systemic risk. we have at our disposal a tool kit of regulatory instruments that are well adapted for this purpose. monetary policy cannot be a primary instrument for systemic risk management. first, it has its own macroeconomic goals on which it must maintain a sharp focus. second, it is too blunt an instrument for dealing with systemic risk. all the same, i cannot unequivocally rule out the possibility that situations could emerge

, resource utilization rising, cost pressures increasing, and short - term interest rates still relatively low, the federal open market committee ( fomc ) over the course of 2005 continued the process of removing monetary policy accommodation, raising the federal funds rate 2 percentage points in eight increments of 25 basis points each. at its meeting on january 31 of this year, the fomc raised the federal funds rate another 1 / 4 percentage point, bringing its level to 4 - 1 / 2 percent. at that [UNK] monetary policymakers also discussed the economic outlook for the next two years. the central tendency of the forecasts of members of the board of governors and the presidents of federal reserve banks is for real gdp to increase about 3 - 1 / 2 percent in 2006 and 3 percent to 3 - 1 / 2 percent in 2007. the civilian unemployment rate is expected to finish both 2006 and 2007 at a level between 4 - 3 / 4 percent and 5 percent. inflation, as measured by the price index for personal consumption expenditures excluding food and energy, is predicted to be about 2 percent this year and 1 - 3 / 4 percent to 2 percent next year. while considerable uncertainty surrounds any economic forecast extending nearly two years, i am comfortable with these projections. in the announcement following the january 31 meeting, the federal reserve pointed to risks that could add to inflation pressures. among those risks is the possibility that, to an extent greater than we now anticipate, higher energy prices may pass through into the prices of non - energy goods and services or have a persistent effect on inflation expectations. another factor bearing on the inflation outlook is that the economy now appears to be operating at a relatively high level of resource utilization. gauging the economy's sustainable potential is difficult, and the federal reserve will keep a close eye on all the relevant evidence and be flexible in making those judgments. nevertheless, the risk exists that, with aggregate demand exhibiting considerable momentum, output could overshoot its sustainable path, leading ultimately - - in the absence of countervailing monetary policy action - - to further upward pressure on inflation. in these circumstances, the fomc judged that some further firming of monetary policy may be necessary, an assessment with which i concur. not all of the risks to the economy concern inflation. for example, a number of indicators point to a slowing in the housing market. some cooling of the housing market is to be expected and would not be inconsistent with continued solid growth of overall economic activity.