among other crucial policy issues, we now need to reexamine, with open minds, whether conventional monetary policy should be used in the future to address developing financial imbalances as well as the traditional medium - term macroeconomic goals of full employment and price stability. the key question is whether we are likely to know enough about asset price misalignments and the likely effects of policy adjustments to give us the confidence to deliberately tack away for a time from exclusive pursuit of fostering aggregate price stability and high employment. obviously preventing situations like the current one would be very beneficial. but against this important objective we need to balance the potential costs and uncertainties associated with using monetary policy for that purpose, especially in light of the difficulty in judging the appropriateness of asset valuations. one type of cost arises because monetary policy is a blunt instrument. increases in interest rates damp activity across a wide variety of sectors, many of which may not be experiencing speculative activity. moreover, monetary policy generally operates with one instrument – a short - term interest rate – and using it to damp asset price movements implies more mediumterm variability in output and inflation around their objectives. among other things, inflation expectations could become less well anchored, diminishing the ability of the central bank to counter economic fluctuations. in the current situation, with output expected to be well below its potential for some time and inflation likely to be under the 2 percent level that many fomc participants see as desirable over the long run, tightening policy to head off a perceived threat of asset price misalignment could be expensive in terms of medium - term economic stability. furthermore, small policy adjustments may not be very effective in reining in speculative excesses. our experience in 1999 and 2005 was that even substantial increases in interest rates did not seem to have an effect on dot. com stock speculation in the first instance, and housing price increases in the second. and larger adjustments would incur greater incremental costs. policy adjustments need to damp speculation ; if higher rates just weaken output and inflation without damping speculation, the economy could be even more vulnerable when the speculative bubble bursts. we do not have good theories or empirical evidence to guide policymakers in their efforts to use short - term interest rates to limit financial speculation. for all these reasons, my strong preference would be to use regulation and supervision to strengthen the financial system and lean against developing problems. given our current state of knowledge, monetary policy would be used only if imbalances were building

securities helped to lower long - term interest rates and increase the availability of mortgages to households and bond financing to businesses. in addition, our near - zero policy rate and the improving economic outlook have induced shifts by private investors into longer - term and riskier assets, helping to reverse a portion of the previous spike in spreads that occurred as the economy and financial markets deteriorated. with markets improving and the economy expanding, the fomc has also indicated that it is tapering down its purchases of treasury, mbs, and agency securities. but the cost of credit remains relatively high and its availability relatively limited for many borrowers. although many long - term interest rates are fairly low, spreads in bond markets are somewhat elevated – not surprising, perhaps, as many borrowers are still under stress with the unemployment rate quite high and utilization of the capital stock still very low. some securitization markets continue to be effectively closed or severely impaired, including those for larger home mortgages and commercial real estate loans. under these circumstances, some borrowers will be more dependent than in the past on banks for credit, but banks are still reluctant and very cautious lenders. banks have been reducing their book of loans for about a year ; in part, this drop reflects weaker demand as businesses have cut back on inventories and households have been rebuilding their balance sheets by increasing saving. but the weakness in bank lending also results from cutbacks in supply. our surveys show that through late 2009, banks continued to tighten terms and standards for lending and to raise the rates they charge relative to benchmark rates. i expect bank credit to turn around only slowly as banks rebuild capital and become less uncertain about economic prospects. lingering credit constraints are a key reason why i expect the strengthening in economic activity to be gradual and the drop in the unemployment rate to be slow. even as the impetus from fiscal policy and the inventory cycle wanes later in 2010, however, private final demand should be bolstered by further improvements in securities markets and the gradual pickup in credit availability from banks. in addition, spending on houses, consumer durables, and business capital equipment should rebound from what appear to be exceptionally low levels. we have already seen some hints of this increase in private demand in recent months. but, understandably, households and businesses and bank lenders remain very cautious, and the odds are that the pickup in spending will not be very sharp. in an environment of considerable persisting slack in labor and product markets, and with productivity