, the federal reserve took extraordinary measures to stabilize the financial system – measures that were critical to setting the stage for the current recovery. figure 9 depicts the additions to the central bank ’ s balance sheet from these temporary operations. as you can see in the chart, the liquidity facilities that we set up to restore more effective financial market functioning have wound down. at the same time, however, in response to the severity of the economic recession the federal reserve decided to expand its purchases of mortgage - backed and agency securities. these purchases were undertaken to improve market functioning in the mortgage market, and even more importantly, as a way to reduce a key interest rate at a time when many short - term interest rates were close to, or at, the zero lower bound. the purchase program ended in march, and these balances will naturally be dropping over time as households prepay mortgages, sell their homes, or refinance. this decline in our balance sheet will actually occur without the fed taking any specific actions. but it will occur slowly, and absent any action of the fed ’ s part, the balance sheet will remain elevated for years. this expansion of the federal reserve ’ s balance sheet raises concerns for some observers and commentators. an important side effect of our asset purchases has, necessarily, been a dramatic swelling of so called excess reserves in the banking system. when the central bank if the relationship is weaker, as some researchers suggest, even stronger growth would be required to reduce the unemployment rate to 5 per cent by year end 2013. for example, if the reduction in the unemployment rate resulting from real gdp growth of 1 per cent above potential is one - third of a per cent instead of one - half of a per cent, then real gdp growth of 6. 25 per cent would be needed to reduce the unemployment rate to 5 per cent by year end 2013. purchases assets, it credits the selling institution with reserves. over time, banks could choose to lend out these reserves, which would turn the reserves into broader money – and a rapid expansion of the broader money supply would be inflationary. however, as figure 10 suggests, the current problem is not a rapid expansion in lending and the money supply. in fact, quite the opposite ; banks have been reluctant to lend. many have taken significant losses that have drained their capital ; and, at the same time, the financial condition of many potential borrowers is worse than before the recession. 5 were that situation to change and bank lending to accelerate,

the price of assets that have macroeconomic importance. while we need to be vigilant against the buildup of asset bubbles, there is little evidence of such a problem now. many financial institutions are still deleveraging – a factor in why we are seeing too little lending rather than too much. real estate can be a very important asset because it serves as collateral for many loans. however, in the current situation both residential and commercial real estate are, at best, stabilizing. banks must, of course, maintain their capital ratios. as some banks have taken significant losses that drained capital, they have been reluctant to expand lending, so that the supply of loanable funds has likely been constrained. but this supply - side effect has been exacerbated by the credit condition of potential borrowers in the wake of the great recession. even for banks that are less capital - constrained, with the balance sheets of many potential borrowers in much worse shape than they were before the recession, lenders making prudent lending decisions will be reluctant to lend to high - risk potential borrowers. even if we were to see asset prices rising, it is not obvious that somewhat tighter interest rates will make a significant difference. a more targeted approach would be to examine whether supervisors should require tighter lending standards, or higher capital requirements, in areas where asset prices are appreciating rapidly. this would make sense from the perspective of good risk management – if institutions hold assets that appreciate quickly, they should retain sufficient capital and be vigilant in credit standards to insure that they can weather a quick reversal in asset prices. raising short - term interest rates because of exuberance in one market is a blunt, and possibly ineffective, tool against the exuberance of investors in a particular asset. as a result, in my view, short - term interest rate - setting is better suited for calibrating the growth in the overall economy, rather than focusing on a particular asset class. concluding observations in sum, while the incoming economic data have certainly been more positive of late, we remain far from our “ stated ” destination. even with rapid growth in the economy, spurred by accommodative monetary policy and stimulative fiscal policy, it is likely to take years before we approach the growth and inflation rates that would really reflect achievement of the two elements of the federal reserve ’ s dual mandate. the economy, while in a much better place than a year ago, is still susceptible