mr mcdonough discusses the role of central banks in the global financial markets remarks by the president of the federal reserve bank of new york, mr william j. mcdonough, before the economic club of new york, new york city, on 14 / 12 / 98. good evening, ladies and gentlemen. i am delighted to be here tonight and to share the podium with my good friend dick grasso. dick and i have worked together for many years now, and i have come to value greatly both his warm friendship and his thoughtful counsel. dick has spoken eloquently about how equity markets have developed globally over the past several years and some of the concerns he has going forward. for my part, i will focus on the global debt markets and the interests of central banks in the stability of these markets. the role of central banks in the fixed - income and related capital markets may not be immediately obvious because, one can argue, debt markets are a zero - sum game. one side of a trade gains what the other loses. if only it were as easy as that! in fact, trading in the global debt markets serves an important purpose and it does not follow that central banks have no interest in the stability of these markets. quite the contrary. central banks are and should be deeply concerned about the functioning of these markets, their dependability, their liquidity, and their transparency. before explaining why i hold such a view, and therefore why we at the federal reserve were so concerned when these markets faltered this past summer, i would like to stand back for a few moments and highlight how the global capital markets have changed over the past several decades. no one doubts that there has been a sea change in the global capital markets in recent years and the ways business is transacted in these markets. these changes are, of course, rooted in the remarkable technological advances we have been witnessing. today, the technology for processing information and making this information widely available has fundamentally altered the way the world channels saving into investment. no longer does the global economy rely primarily on loans from commercial banks to meet its financing and investment needs. rather, more than ever before, the global economy of today looks to funds from the fixed - income and related capital markets to intermediate its credit needs. because the global capital markets have become so important in the credit intermediation process, the economic well - being of us all depends on the orderly flow of funds in these markets. the flow of these funds, in turn

, but also the rush away from risk altogether. in short, it was this seizing up of the credit intermediation process that was of most fundamental concern to us as central bankers. what we learned as a result of this experience was, among other things, that years of historic data on fixed - income market yields and spreads could not have anticipated the size of the movements in credit spreads that in fact occurred in august and september. we also learned that markets that did not previously move together can suddenly do so, that trends that were under way for several years can abruptly come to an end, and that spreads that have been consistently narrow for years can suddenly widen. in the wake of these events, we have become all too aware that liquidity can be illusory – that individual traders may be able to exit a position when they wish but that not all traders can exit their positions at the same time. for many, these lessons have been humbling. going forward, it is important to bear in mind that there most certainly will be further instances when the credit intermediation process is disrupted, when we will face other threats to the wellbeing of our market positions, our institutions and the global economy. these risks are in the nature of the intermediation process itself. as the global capital markets continue to grow and become ever more sophisticated – as i believe they will – what is most important for us as central bankers is to operate with a disciplined sense of priorities. it is clear that we as central banks cannot be responsible for any single bond holder, any single bank or any single financial institution. nor can we control the functioning of the global debt markets or become the regulators of all financial market intermediaries. what we as central bankers can do, however, is to understand the dynamics of the global debt markets – how they are evolving and whether they are sufficiently liquid and transparent. we can also ensure that banks perform their proper role in supporting the trading process through making sound credit decisions. furthermore, we can enhance the price discovery process by promoting transparency in our own actions. finally, and most importantly, we can help create conditions in – 5 – our own economies that will support sustainable, non - inflationary growth. in these ways, we as central banks can encourage the efficient functioning of the credit intermediation process in our countries, and in so doing, promote the welfare of the world economy, of which we are all a part. * * *