target. in contrast, if the transmission mechanism from the fed funds rate to financial conditions and onward to real economic activity were completely predictable, then there would be no need to focus on financial conditions as an intermediate target variable. the level and path of the fed funds rate matters, but it also matters how this gets transmitted to the real economy through the financial sector. over the past 15 years, there have been two important instances in which the relationship between the fed funds rate and financial conditions have diverged significantly. the first was the late 1990s technology stock market bubble and its aftermath. the second was the mid2000s credit market bubble that culminated in the recent financial crisis. during these episodes, the relationship between the fed funds rate and financial conditions was particularly unstable. as a result, developments in the financial markets became very important in the conduct of monetary policy. in my comments, i am going to assume that inflation expectations are always well anchored so that i do not need to distinguish between the real and nominal fed funds rate. in this respect, i would note that financial conditions indicators have implications for “ taylor rule ” formulations for monetary policy. as you all know, taylor - type rules provide a shorthand metric for the appropriate stance of monetary policy. in such rules, the fed funds rate is set at a level equal to the equilibrium real fed funds rate, plus the inflation objective, plus the weighted deviation of output from its potential and of the inflation objective from actual or, if forward looking, expected inflation. often, analysts and economists assume that the equilibrium real fed funds rate is equal to 2 percent, its long - term historical value. although, in principle, such rules allow the equilibrium rate to be time varying, it typically is assumed to be constant. i have always been uncomfortable with this usage of a 2 percent equilibrium real rate assumption because it ignores the possibility that the equilibrium rate changes in response to technology shocks or in response to changes in how monetary policy is transmitted via the financial system to the real economy. for example, in the late 1990s, when trend productivity growth shifted upward, it seemed logical that this would also push up the equilibrium shortterm real interest rate. that is because higher productivity growth, by raising the return on capital, spurs greater investment, thereby driving the equilibrium rate higher. similarly, if stock prices rose sharply in response to higher productivity growth, this should also lead to a higher equilibrium real rate through the effect of greater stock market wealth on consumer spending. higher stock prices meant

devices in highlighting what is important. one loses that benefit when the number of variables becomes large and the indexes become complex. fourth, it would be interesting to know how financial conditions indexes for other countries and regions would differ. the authors focus only on the united states. thus, it is difficult to know whether the value of financial conditions indexes are specific to the united states or should be applied more broadly. fifth, i thought the paper could have gone further in exploring the implications of its results. the focus of the paper is on how to construct a financial conditions index that does a good job of forecasting economic activity. the paper does not tackle the implications for monetary policy stemming from developments in financial conditions as measured by the new fci. if financial conditions evolve in an unanticipated way, how should this influence the conduct of monetary policy? in particular, the authors note that during the 2003 – 06 period, financial conditions tightened less than expected given the rise in the fed funds rate and, during the 2007 – 08 period tightened even as the federal reserve slashed its fed funds rate target. these results raise a number of interesting questions. in particular, does the behavior of the new fci imply that the federal reserve should have tightened more aggressively during the 2003 – 06 period or eased more aggressively during the 2007 – 09 period? the paper ’ s results seem to imply this, but it would be interesting to see whether this is the case or not. it also would be useful to know how qualitatively important these differences are. if the differences are worth only a few basis points on the fed funds rate, then having a good indicator of financial conditions is not going to be a very important input in the formulation of monetary policy. in contrast, if a shift in financial conditions implies that the fed funds rate path was “ off ” by a hundred basis points relative to what actually occurred, then this obviously has big implications for monetary policy. the development of equilibrium models that incorporate financial conditions in a meaningful manner might prove helpful in answering these types of questions. 5 in addition, i would like to know how the various linkages have changed over time. is the linkage between the fed funds rate and financial conditions as measured by the new fci see, for example, tobias adrian and hyun shin, manuscript in preparation for the forthcoming handbook of monetary economics, volume 3, currently circulated as federal reserve bank of new york staff reports, no. 398, october 2009. the work