uncertain. still, we will need to be alert to any tendencies for movements in prices for commodities and assets to result in a sustained increase in inflation and inflation expectations ; unanchored inflation expectations would ultimately destabilize output and undermine our ability to foster higher levels of employment. and we need to continue to work with banks to improve their risk - management and creditevaluation systems so that the banks are not vulnerable to unexpected movements in interest rates or asset prices in the future. in sum, it seems to me that under most circumstances monetary policy is not the appropriate tool to use to address asset - price developments or growing vulnerabilities in financial markets. as i argued earlier, microprudential and macroprudential policies seem likely to me to be more effective and targeted at the problem than monetary policy adjustments, and in my view these tools should be the first that policymakers deploy. from my perspective, central bankers would need convincing evidence that such other tools would be inadequate and that significant asset - price misalignments were developing that would have serious economic costs before attempting to use monetary policy to address them. federal reserve tools to provide liquidity in stress situations in addition to highlighting shortcomings in the u. s. regulatory regime, the financial crisis also raised questions about the adequacy of the federal reserve's tools for monetary policy implementation, particularly in periods of economic stress, and for crisis management more generally. in routine circumstances, the federal reserve implements monetary policy primarily through open market transactions, with the discount window playing an important but supporting role. customarily, the bulk of the federal reserve's assets are u. s. treasury securities, and the federal reserve uses short - term repurchase ( repo ) transactions, generally in relatively small amounts, to make the adjustments to the quantity of reserves in the banking system that are necessary to achieve the federal open market committee's target for the federal funds rate. notably, the federal reserve's counterparties for these repo transactions are a small number ( currently 18 ) of broker - dealers, known as primary dealers. even though these dealers do not have reserve requirements, and indeed are not permitted to hold reserves at the federal reserve, the dissemination of reserves from the federal reserve's open market transactions conducted through the primary dealers, who pass the funds on through the highly liquid money markets, is largely sufficient in routine circumstances to implement monetary policy smoothly. ordinarily, little credit is extended through

donald l kohn : policy challenges for the federal reserve speech by mr donald l kohn, vice chairman of the board of governors of the us federal reserve system, at the kellogg distinguished lecture series, kellogg school of management, northwestern university, evanston, illinois, 16 november 2009. * * * i titled my talk " policy challenges for the federal reserve. " i did that before i knew what i was going to discuss, because just about any topic involving the federal reserve would entail policy challenges. so let me begin by narrowing the topic just a bit : i would like to talk about the challenges that lie at the intersection of monetary policy and financial stability. our economy is just beginning to recover from a horrendous episode in which mispricing of risk – especially in home mortgage lending, but more broadly as well – led to financial instability that in turn led to a severe recession. much attention is, appropriately, being focused on the implications of this episode for the reform of financial regulation. the congress, financial regulators, and analysts are debating those critical issues. i will focus on some possible implications of the recent episode for monetary policy. the questions i want to address are, first, how should we take account of financial stability in the conduct of monetary policy – for example, should financial stability be another specific responsibility of monetary policy, in addition to its responsibilities for promoting maximum employment and stable prices? and second, what do the crisis and our response imply for the monetary policy tools of the federal reserve? i don't have the answers to these questions, but i thought it would be useful to discuss them. 1 importantly, i speak only for myself, not for my colleagues on the federal open market committee. 2 monetary policy and financial stability traditionally, most analysts thought that when monetary policy successfully promoted economic stability, it would also promote financial stability. when business cycle swings are moderate and inflation rates are low and predictable, households and firms can make and follow through on long - term plans for spending, saving, and investment. lending institutions can better evaluate the likely profitability of capital projects, thus reducing their risk of credit loss. and the moderate swings in long - term interest rates and other asset prices that were thought to be fostered by such an environment should tend to limit the exposure of balance sheets. however, although monetary policy over the past several decades did help foster economic stability, some have questioned whether it also contributed substantially to the lax practices that led to the buildup of financial vu