of a given stance of monetary policy against the objectives of the federal reserve. while the evolution toward more efficient and globally integrated financial markets is surely a positive for long - run economic growth both here and abroad, it also challenges policymakers to constantly update and question our understanding of the behavior of financial market indicators and the signals that these indicators can provide in the policymaking process. and as financial markets continue to broaden and deepen, the behavior of asset prices will play an important role in the formulation of monetary policy going forward, perhaps a more important role than in the past. what might this mean for the fed and for other central banks in practice? there is a well established, and i believe fundamentally correct, case against directing monetary policy at specific objectives for asset values or the future path of those values. in other words, asset values should be neither a target nor a goal of monetary policy. the rate of increase in asset values alone seems to tell us very little about underlying and future inflation. because we know so little about how to assess the appropriateness of asset values against fundamentals, because we have so little capacity to both forecast and predictably affect the future path of asset prices, and because we know relatively little about how changes in wealth affect the real economy and inflation, we cannot use monetary policy responsibly or effectively to achieve specific objectives for asset values. monetary policy does not today and is unlikely in the future to offer us an effective tool for directly reducing the incidence of large or sustained deviations of asset values from what might turn out to be their fundamental values, what some call bubbles. that said, monetary policy still has to take into account the impact of significant movements in asset values on output and inflation. financial asset prices, by their nature, allocate resources between the present and the future and thereby affect consumption, investment and future growth. history provides us with numerous examples in which significant movements in asset prices have had sizable effects on the path of output relative to potential and on price stability. and experience suggests that asset values can be very sensitive to movements in monetary policy or to the perceptions of future policy moves. the challenge for central banks is to determine how movements in asset values and expected asset values affect the evolution of the economy. there is little to suggest that the task has gotten easier with the increasing complexity of financial markets, and it has more likely gotten harder. the incorporation of asset price movements into monetary policy formation is hard to do, in part, because we don

measures of consumer inflation expectations at longer horizons have remained stable despite the large increases in energy prices, though some of them remain slightly above the 1. 5 to 2. 5 range for the cpi index that some have cited as a reasonable definition of price stability in the united states. these favorable developments in fundamentals have been accompanied by important developments in financial markets. expectations of future inflation have fallen, and there appears to be confidence in continued stable, low inflation. credit spreads and measures of future volatility derived from financial market data have fallen, suggesting that investors and savers expect the greater realized stability in growth is likely to endure. real interest rates at longer horizons have remained relatively low, reflecting at least in part that the global supply of savings has increased relative to demand for investment. a range of different asset prices has risen significantly, and the expected volatility of many asset prices has fallen. these developments in market prices have occurred in the context of important changes in financial intermediation, including the substantial expansion of access to consumer credit and capacity for homeowners to borrow against the equity in their homes, the greater use of financial instruments for transferring and mitigating risk, and the growth of financial flows between countries. and in this context, balance sheets have continued their impressive growth, with assets and liabilities of both households and of economies as a whole growing faster than income. these broad trends are obviously related. less overall concern about inflation and real risk, the positive outlook for productivity growth, and the increasing depth and sophistication of financial markets, all might be expected to induce an increase in the scale of gross liabilities and assets relative to income, for leverage and net borrowing to increase relative to income. while policymakers can witness the movements in key financial market variables, it is difficult to say for sure what their implications are for economic fundamentals, that is, for inflation and output. and even if we had more confidence in the forces behind past movements in asset values, we would still face substantial uncertainty about their future behavior. the relatively low compensation for risk priced into asset markets today does not necessarily mean the future will justify that confidence. this uncertainty surrounding the current behavior of asset values complicates the task of assessing the future trajectory of asset prices, and the impact of alternative monetary policy paths on asset values. and by widening the already substantial degree of uncertainty that surrounds estimates of the equilibrium real rate of interest, these developments complicate the task of assessing the appropriateness