, then it's unclear why the policymaker should set aside these direct signals in preference for signals from asset prices that may or may not be out of line with their historical relationships to fundamentals - - the very fundamentals, i should add, that we look at directly in judging the health of the economy. indeed, even in retrospect, our knowledge of what drove the price - earnings ratios for u. s. equities so high in the late 1990s and our ability to estimate what a more " appropriate " level for the price - earnings ratio might have been are very incomplete and, frankly, probably will not improve substantially. additionally, in the current conjuncture, some have expressed a concern that an unwinding of global imbalances, should it occur, might be disorderly and associated with financial instability. others question whether the simultaneous removal of monetary accommodation by central banks in several major economies could possibly trigger a period of financial instability emanating from the inevitable rebalancing of portfolios. should events such as these occur, central bank communication and don h. kim and jonathan h. wright ( 2005 ), " an arbitrage - free three - factor term structure model and the recent behavior of long - term yields and distant - horizon forward rates, " finance and economy discussion series 2005 - 33 ( washington : board of governors of the federal reserve system, august ). understanding market participants'reactions will certainly be important considerations for maintaining financial stability. a third source of anxiety concerning financial market instability arises because some of the more recent crises have been financial in nature. although their effects on the real economy in the united states have been relatively limited, the economies of other nations have been significantly affected, and there is concern that a financial crisis might, at some point, have more severe consequences for the real economy in the united states. when we review these recent cases of financial market turmoil, it appears that each is a unique event. but some common lessons can be learned, and i will outline them after i briefly review two of these crises that have been important in the united states during the past decade. the market turmoil in the fall of 1998 was touched off by the russian debt default in august and then exacerbated by the well - publicized travails of long - term capital management. during this time, nearly all financial indicators portrayed a dour picture of economic prospects - - risk spreads widened sharply, stock prices fell, and banks reported tightening the terms

, the fomc lowered its target for the federal funds rate 50 basis points before the reopening of the markets on monday, september 17, 2001. in explaining its action, the fomc pointed to a less sanguine economic outlook and to significant downside risks associated with that outlook. besides the crisis of 1998 and the september 11 terrorist attacks, other episodes of financial turmoil were important, but these episodes did not raise the same level of concern that the negative shock might be transmitted to the nonfinancial economy in a rapid and disorderly fashion. for example, the significant decline of stock prices starting in 2000 was not accompanied by a major market malfunctioning, and the resulting loss of equity wealth did not seem likely to have negative ramifications for the real economy that were so immediate and severe as to be considered a crisis. similarly, the major accounting and corporate scandals of 2002 led to a significant widening of risk premiums and much anxiety about the veracity of many corporations'financial statements. but for the most part, the markets again functioned smoothly and risks seemed to be priced normally. finally, the more pronounced interest rate volatility during the summer of 2003, which appears to have been significantly amplified by mortgage hedging, created some short - lived market difficulties. but again, this volatility seemed unlikely to have significant effects on the real economy. despite the rarity of internally generated financial crisis, some argue that ongoing trends in the united states should be examined closely for their potential effects on financial stability. four trends are often mentioned. the first is increased concentration in the financial services industry. in particular, consolidation has resulted in a smaller number of firms doing a larger share of the bank lending throughout the world. for example, the origination and servicing of consumer loans have become more concentrated. for the most part, these rising levels of concentration appear to be motivated by cost savings that are often attributed to economies of scale, or by expectations of greater revenue stability derived from either greater diversification of products or greater geographic diversification. while the risks to financial stability that arise from the creation of a small number of large and complex firms are obvious, there may be benefits as well. greater concentration in financial services has the potential to have some positive impact on financial stability because lower costs can allow firms to build the capital reserves that help insulate them from shocks, and greater diversification can reduce firm risk. moreover, the market and financial supervisors are requiring the adoption of