general, i think those dual objectives – promoting financial stability and avoiding the creation of moral hazard – are best reconciled by central banks'focusing on the macroeconomic objectives of price stability and maximum employment. asset prices will eventually find levels consistent with the economy producing at its potential, consumer prices remaining stable, and interest rates reflecting productivity and thrift. such a strategy would not forestall the correction of asset prices that are out of line with fundamentals or prevent investors from sustaining significant losses. losses were evident early in this decade in the case of many high - tech stocks, and they are in store for houses purchased at unsustainable prices and for mortgages made on the assumption that house prices would rise indefinitely. these are my views and are not necessarily those of my colleagues on the federal open market committee. to be sure, lowering interest rates to keep the economy on an even keel when adverse financial market developments occur will reduce the penalty incurred by some people who exercised poor judgment. but these people are still bearing the costs of their decisions and we should not hold the economy hostage to teach a small segment of the population a lesson. the design of policies to achieve medium - term macroeconomic stability can affect the incentives for future risk - taking. to minimize moral hazard, central banks should operate as much as possible through general instruments not aimed at individual institutions. open market operations fit this description, but so, too, can the discount window when it is structured to make credit available only to clearly solvent institutions in support of market functioning. the federal reserve's reduction of the discount rate penalty by 50 basis points in august followed this model. it was intended not to help particular institutions but rather to open up a source of liquidity to the financial system to complement open market operations, which deal with a more limited set of counterparties and collateral. the effects of financial markets on the real economy related developments in housing and mortgage markets are a root cause of the financial market turbulence. expectations of ever - rising house prices along with increasingly lax lending standards, especially on subprime mortgages, created an unsustainable dynamic, which is now reversing. in that reversal, loss and fear of loss on mortgage credit have impaired the availability of new mortgage loans, which in turn has reduced the demand for housing and put downward pressures on house prices, which have further damped desires to lend. we are following this trajectory closely, but key questions for central banks, including the federal reserve, are, what is happening

narrow band because we cannot, by law, pay interest on reserves for another four years. at the same time, the term interbank funding markets have remained unsettled. this is evident in the much wider spread between term funding rates – like libor – and the expected path of the federal funds rate. this is not solely a dollar - funding phenomenon – it is being experienced in euro and sterling markets to different degrees. many loans are priced off of these term funding rates, and the wider spreads are one development we have factored into our easing actions. moreover, the behavior of these rates is symptomatic of caution among key marketmakers about taking and funding positions, and this is probably impeding the reestablishment of broader market trading liquidity. conditions in term markets have deteriorated some in recent weeks. the deterioration partly reflects portfolio adjustments for the publication of year - end balance sheets. our announcement on monday of term open market operations was designed to alleviate some of the concerns about year - end pressures. the underlying causes of the persistence of relatively wide - term funding spreads are not yet clear. several factors probably have been contributing. one may be potential counterparty risk while the ultimate size and location of credit losses on subprime mortgages and other lending are yet to be determined. another probably is balance sheet risk or capital risk – that is, caution about retaining greater control over the size of balance sheets and capital ratios given uncertainty about the ultimate demands for bank credit to meet liquidity backstop and other obligations. favoring overnight or very short - term loans to other depositories and limiting term loans give banks the flexibility to reduce one type of asset if others grow or to reduce the entire size of the balance sheet to maintain capital leverage ratios if losses unexpectedly subtract from capital. finally, banks may be worried about access to liquidity in turbulent markets. such a concern would lead to increased demands and reduced supplies of term funding, which would put upward pressure on rates. this last concern is one that central banks should be able to address. the federal reserve attempted to deal with it when, as i already noted, we reduced the penalty for discount window borrowing 50 basis points in august and made term loans available. the success of such a program lies not in loans extended but rather in the extent to which the existence of this facility helps reassure market participants. in that regard, i think we had some success, at least for a time. but the usefulness of the discount window as