timothy f geithner : reflections on the changing global economy remarks by mr timothy f geithner, president and chief executive officer of the federal reserve bank of new york, at the 46th aci financial markets association world congress, montreal, quebec, 4 may 2007. * * * good morning. i am pleased to be able to join you today. and it is a privilege to be here today with canada's accomplished central bank governor, david dodge. there are few people in central banks or in governments around the world today that have presided over as far reaching and successful a set of macroeconomic policy reforms as has david dodge. i want to offer some reflections about the challenges managing macroeconomic policy in a more open and integrated world economy. and i want to say something about how the international monetary system, and the current framework of exchange rate regimes, might develop in the coming years. for the past century or more, choices about exchange rate regimes have played an important role in economic outcomes across countries. from the gold standard of the late 19th and early 20th centuries through the bretton woods system and the episodes of exchange rate cooperation among the g5 and the g7 in the 1980s and after, the desire to achieve exchange rate stability was a major preoccupation of policymakers. the economic damage inflicted by the disastrous competitive devaluations among the major economies in the 1930s had a profound influence on thinking during much of the postwar period. and for governments and enterprises around the world today, the aversion to large fluctuations in exchange rates remains strong. as the world has become more open to trade and more closely integrated, this sensitivity to exchange rate variability has intensified. and yet, experience suggests that resisting variability makes the adjustment to changing economic conditions more painful. in an increasingly open world economy, the ability to cope with change becomes more important, and for a large fraction of the world economic, exchange rate flexibility is a necessary condition for sustained favorable economic performance. changes in fundamental factors such as productivity growth and the inevitable shocks to demand and supply require changes in relative prices, both domestically and internationally. a flexible exchange rate regime makes it easier for relative prices to move rapidly and effectively in the appropriate direction, and this generally eases the cost of that adjustment. even in a fixed rate regime, this adjustment in response to changing circumstances will ultimately have to take place, of course. but if relative prices cannot adjust through the exchange rate, domestic output and employment will have to bear the brunt of

recession was shallower and shorter than the average of the past helped limit the scale and scope of losses to financial institutions. the forcefulness of the monetary policy response and the large fiscal stimulus provided by the tax cuts and expenditure increases played a significant role in limiting the depth of the downturn and in helping to bring about the recovery. it is significant that the yield curve has been steeper and stayed steep longer in this latest recession than in the previous one. and, finally, the stronger microeconomic fundamentals of the u. s. economy - the shift to just - in - time inventory management, the speed of innovation in the u. s. economy, and other factors that seem to have reduced the amplitude of the business cycle and improved the flexibility and resilience of the u. s. economy in response to shocks - have also contributed to financial stability. changes in the nature of financial intermediation have also played a role in improving the overall resilience and performance of the u. s. financial system that was evident in this latest period of economic recession and financial stress. four different types of changes are particularly important. • innovation in financial technology continues to expand the opportunities for financial institutions to separate and distribute, and to manage and hedge, different types of risk. • the increasingly greater role played by the capital markets in the financial intermediation process relative to banks - both relative to the past and compared with most other major economies - has improved the capacity of our system to handle stress. loans and securities held by commercial banks today account for less than 20 percent of overall u. s. credit market debt, roughly two - - thirds of their 1975 levels. • the increases in the sophistication of risk management techniques and enhancements to risk management processes have delivered substantial improvements in how banks and other financial institutions actually manage risk in practice. banks, for example, have aligned their pricing of credit products much more closely with credit risk. • the increased scale of cross - border financial intermediation, the growing role of securitized financial instruments in those overall flows, and the growth in the size and breadth of financial institutions with global operations may also mean that, as shocks are transmitted more rapidly, they are diffused more broadly. these are positive developments, and they are likely to be enduring. but they have come with new challenges for those of you who manage financial institutions and for those of us charged with supervision and market oversight. the overall return on these changes will depend on