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,

. aig ’ s role as one of the world ’ s largest and storied insurance companies meant that its failure likely would have had a contagion effect, causing damage as it spread throughout the insurance industry. policy holders would be hurt. municipalities, who were already reeling from a lack of financing options for their building projects, would have seen their financial protection disappear. workers whose 401 ( k ) plans had purchased $ 40 billion of insurance from aig against the risk that their stable value funds would decline in value would see that insurance disappear. pension plans that had placed funds in aig guaranteed investment contracts, or gics, which function much like deposits in a bank, would have experienced significant losses, losses that would be passed along to retirees or to others whose aspirations to be retirees would surely have been changed. and these indirect consequences of an aig bankruptcy would not have stopped at the u. s. border. aig was global in scope. it conducted its operations in more than 130 countries, and across various parts of the financial industry, insurance as well as banking. the damage from an aig filing would have been felt from the farms of iowa to the streets of san francisco to the far off corners of the world. the unplanned and chaotic bankruptcy of this trillion dollar financial conglomerate ( especially a day after lehman ’ s filing ) would have been a global catastrophe. that catastrophe did not happen. more than a year and a half later, it is easy to forget the level of panic and fear that gripped the world during the week of september 16, 2008. a bankruptcy of aig would have fueled the fear, much as gasoline fuels a fire. and let us not forget what federal reserve and treasury officials have said many times in testimony – we did not have the necessary tools, such as legal authority for a special resolution regime, with which to limit the damage of an aig collapse. we also did not have the luxury of time. aig needed liquidity and it needed it that day. in the early days of the intervention, when we knew precious little about aig, but knew that it needed billions of dollars, we were truly facing a binary choice to either let aig file for bankruptcy or to provide it with liquidity. it is worth noting that this choice fell to the federal reserve because congress had equipped it with an ability to lend to a non bank like aig in extraordinary and exigent circumstances. given aig ’ s situation