, financial markets will tighten at exactly the wrong moment. this was, for example, an important consideration after the stock market crash of 1987, when demand for liquid deposits raised the demand for reserves held at the fed ; and again after 9 / 11, when the loss of life and destruction of infrastructure impeded the flow of credit and liquidity. second, we must determine whether the stance of monetary policy should be adjusted to counteract the effects on the economy of tighter credit supplies and other knock - on effects of financial instability. as a result, meetings of the federal open market committee ( fomc ), often in conference calls if the situation is developing rapidly, have been an element in almost every crisis response. those meetings allow us to gather and share information about the extent of financial instability and its effects on markets and the economy as we discuss the appropriate policy response. other policy instruments that can be used to deal with financial instability - - discount window lending, moral suasion aimed at convincing private parties to keep credit flowing, actions to keep open or slowly wind down troubled institutions - - are, in my judgment, more likely than open market operations or monetary policy adjustments to have undesirable and distortionary effects. hence, they should be, and are, used only after a finding that broader instruments, like open market operations, are unlikely to prevent significant economic disruption. and in my view, when relatively targeted policy interventions are employed, their use should be designed to minimize moral hazard. for example, if the central bank concludes that it must lend to individual depository institutions, any such loans should, in most situations, be on terms sufficiently onerous to encourage a quick return to market funding. the central bank will and must be involved in the management and resolution of financial crises. indeed, a major reason for the founding of the federal reserve in 1913 was the need to address periodic banking crises and financial panics, which had plagued the u. s. economy during the nineteenth and early twentieth centuries. and the need remains today for federal reserve involvement in crisis management and resolution. the federal reserve's ability to conduct open market operations, make discount window loans, and provide funds intraday to key payments system participants are unique tools necessary to ensure that the financial system stays liquid. our monetary policy experience and responsibilities afford us valuable insights into how financial disruptions may be affecting the real economy. our dual role as both a payments system participant and a payments system supervisor helps us manage problems that arise in

donald l kohn : financial stability - preventing and managing crises remarks by mr donald l kohn, vice chairman of the board of governors of the us federal reserve system, at the exchequer club luncheon, washington dc, 21 february 2007. * * * thank you for the opportunity to speak here today. the exchequer club has enriched policy development in washington for nearly a half century by providing a forum for the discussion of important national economic and financial policy issues. i am honored to participate in that discussion. i want to talk this afternoon about some aspects of financial stability, a topic that has received increased attention in recent years from central banks and regulators as well as the financial media. 1 a number of developments have contributed to this trend. just a few years ago, the terrible events of 9 / 11 alerted us to the importance of operational resiliency in a dangerous world. but other forces have also led central banks and other financial supervisors around the world to increase their emphasis on financial stability. perhaps most important, the financial system, once essentially bank - centered, has become more market - centered. of course, banks continue to be core participants in the financial system and to provide an indispensable window on market activities. but the development of a relatively market - oriented system has been accompanied by a large number of new participants, many with global reach, and a much larger array of financial instruments. this vastly expanded web of participants and instruments has increased the number of potential channels for the creation and transmission of financial shocks. and, some of the new financial instruments and markets have not been tested under extended stressful conditions. in addition, supervisory authority in a number of countries abroad has been consolidated and separated from central banks ; these moves have forced the new regulators and their central bank colleagues to learn how to operate not only in a new financial landscape but also in a new regulatory environment. finally, in today's global economy, very settled financial market conditions - - narrow risk spreads and low expected market volatility - - coexist with unprecedented current account imbalances among nations and interest rates that are low by historical standards. in such a world, it would be imprudent to rule out sharp movements in asset prices and a deterioration in market liquidity that would test the resiliency of market infrastructure and financial institutions. while these factors have stimulated interest in both crisis deterrence and crisis management, the development of financial markets has also increased the resiliency of the financial system. indeed, u