william c dudley : the importance of financial conditions in the conduct of monetary policy remarks by mr william c dudley, president and chief executive officer of the federal reserve bank of new york, at the university of south florida sarasota - manatee, sarasota, florida, 30 march 2017. * * * it is a pleasure to be here today. i would like to thank the university of south florida for sponsoring this conference. as always, what i have to say today reflects my own views and not necessarily those of the federal open market committee ( fomc ) or the federal reserve system. 1 one aspect of today ’ s event is the dedication of a financial laboratory to help students learn about financial markets, which i think has great value. knowledge of how financial markets operate is an important aspect of financial and economic literacy, and it leads to greater financial security over time. for example, one important lesson is that when the promised returns on an investment offering are extraordinarily high, it is because the investment is either very risky or fraudulent. when investing, it is important to remember that if it seems to be too good to be true, it likely is! today, i want to take the opportunity to talk about the importance of financial markets in influencing the economic outlook and, in turn, u. s. monetary policy. this is a subject near and dear to my heart. nearly 20 years ago — when i was working in the private sector — my colleagues and i introduced an index of financial conditions. 2 i believe that my long - standing focus on financial conditions has, over time, helped me become a better economic forecaster. and, i am pleased that economists and analysts increasingly incorporate financial conditions into their assessments of the economic outlook. as i will argue, financial conditions in the united states play an important role in influencing economic conditions. because movements in financial markets are a major factor influencing broader financial conditions, it is necessary to understand how financial market developments can affect the economic outlook and, therefore, the appropriate setting of monetary policy. but, this story gets more complicated, as the setting of monetary policy, in turn, affects market developments and financial conditions. this two - way feedback is an important feature of the interaction between financial conditions and monetary policy. to begin, let me be clear about what we mean by “ financial conditions. ” focusing on the united states, financial conditions can be broadly summarized by five key measures : short - and longterm treasury rates, credit spreads,

term interest rates and financial conditions often appear to be larger and more persistent in the united states than in most other advanced economies. there are several reasons for this. first, the u. s. financial system depends less on its banking system to 2 / 6 bis central bankers'speeches intermediate financial flows than in other countries. the share of credit supplied by the banking sector fluctuates around 50 percent in the united states, which is much lower than in the euro area, japan and the united kingdom ( exhibit 2 ). second, in contrast to most other countries, u. s. residential housing is financed mainly by 30 - year fixed - rate mortgages, rather than — as is the case in most other countries — adjustable - rate mortgages with rates that much more closely track their central banks ’ short - term interest rate targets. third, the equity market plays a much more important role in the united states than elsewhere. the total market capitalization of the u. s. equity market is considerably higher than in the euro area and japan ( exhibit 3 ). because the evolution of financial conditions can diverge from the path of the federal funds rate, financial conditions need to be carefully considered in the conduct of monetary policy. however, i want to reiterate that what we care about is not financial conditions themselves, but rather their influence on economic activity. accordingly, we should care much more about longer - term movements in financial conditions than about higher - frequency, transitory movements. that is because behavior in firms and households will be influenced much more by how financial conditions evolve over time, rather than by where they happen to be at a particular moment. to emphasize this point, let me give two contrasting examples — one where financial conditions moved sharply but not persistently, and another where financial conditions moved systematically over a longer time period. we will see that it is the long - lived movements that have the largest influence on the economic outlook. for the first example, consider the u. s. equity market in 1987. the s & p 500 index began the year at 242, shot up to a peak of 337 in august ( an increase of almost 40 percent ) and plummeted to a trough of 225 in october ( a fall of 33 percent ). when the stock market fell more than 20 percent on october 19th — which came to be known as “ black monday ” — many feared that the decline would lead to a recession. after all, that crash was the largest - ever one -