composition of our balance sheet will make it challenging to execute smoothly. there are now more than $ 2. 4 trillion of excess reserves in the banking system. these reserves are not inflationary until they are converted to money and flow out into the economy. but as market rates rise in an improving economy, banks will find it advantageous to begin to increase lending or acquire assets using their reserves. the challenge for the fed is to control the flow of reserves so that we can successfully maintain our 2 - percent inflation target. this may require raising interest rates more quickly than currently anticipated. we have the tools that would enable us to raise rates if we chose to do so. however, the fed may be subject to political pressures or pushback from various interest - sensitive sectors that could result in a more measured response than required. one of the consequences would be higher inflation. history suggests that the fed tends to be behind the curve when it comes time to tighten monetary policy, and in the current environment, that delay could prove to be more costly than when reserves are in limited supply. thus, it ’ s a matter of our will rather than our ability. conclusion in summary, i believe that the economy is continuing to improve at a moderate pace. we are likely to see growth of around 3 percent in 2014. prospects for labor markets will continue to improve gradually, and i expect the unemployment rate will continue its decline to 6. 2 percent by the end of 2014. i also believe that inflation expectations will be relatively stable and that inflation will move up toward our goal of 2 percent over the next year. bis central bankers ’ speeches on monetary policy, the reduction in asset purchases from $ 85 billion a month to $ 75 billion a month is a step in the right direction. i believe the economy has met the criteria of significant improvement in labor market conditions for ending the program and that further increases in the balance sheet are unlikely to provide appreciable benefits for recovery. even after the asset purchase program has ended, monetary policy will still be highly accommodative. the work of the fed, however, is far from over. monetary policy still faces considerable challenges as we seek to normalize policy. the task should be to return to a framework in which a market rate is our primary policy tool, to reduce the size of our balance sheet, and to restore our portfolio to all treasuries. the challenge will be to do so in a way that ensures that inflation remains close to our target,

firms. the longer it takes to reach a resolution on a credible plan to reduce future deficits, the more damage is done to the economy in the near term. the cause of the current fiscal crisis is sometimes attributed to cyclical factors and the magnitude of the recent global recession. it is certainly true that the financial crisis and the policy choices made by governments to deal with the ensuing recession have caused a significant deterioration in fiscal balances and debt levels in many countries. for example, in the u. s., the federal budget deficit is now about 9 percent of gross domestic product, up from less than 2 percent in 2007. however, the underlying trends that are at the root of unsustainable fiscal deficits in many countries, including the u. s., have been in place and known for some time. even after cyclical effects play out, many countries will have large structural budget deficits. in this sense, the financial crisis and recession have simply exacerbated the underlying problems and perhaps moved up the day of reckoning. in some bis central bankers ’ speeches cases, such as greece, that day has come. market participants have begun to question the solvency of governments and their ability to honor their sovereign debt obligations. in europe, the doubts have greatly complicated the political problems as various countries debate the question of “ who pays ” for the anticipated bad debts of individual countries. here too, the protracted nature of the political debate creates uncertainty, which undermines economic growth and exacerbates the crisis. indeed, the argument offered by many that preventing greek default would prevent the crisis from spreading has proven false. the interaction of monetary policy and fiscal policy the fiscal challenges are daunting, yet they also have implications for monetary policy. the policy choices made during the recent global recession have made these implications even more complex and potentially dangerous. but the appropriate relationship between monetary and fiscal policy is not a new topic. indeed, our very first policy forum in 2001 was organized around three questions for monetary policymakers, one of which was how should monetary and fiscal policy interact? it is widely understood that governments can finance expenditures through taxation, debt, or printing money. if public debt levels are high and rising, and fiscal policymakers are reluctant to make the hard choices of cutting expenditures or increasing taxes, history suggests that governments often resort to the printing press to try to escape their budget problems. yet we all understand that this option is a recipe for creating substantial inflation. indeed,