. a few months following y2k, the stock markets began the steep decline that has reversed much of the remarkable rise witnessed over the latter half of the 1990s. that decline has been one source of the weakness that has undermined the expansion of the economy over the past two years. in recognition of that experience, many have characterized the extraordinary rise in stock prices in the late 1990s as a bubble - a significant and protracted departure in asset prices from fundamentals - and the subsequent decline as a popping of that bubble. our recent experience has given renewed spark to a vigorous debate about the appropriate response of monetary policy to financial bubbles, with some economists criticizing the federal reserve for not having done more to stem the expansion of the bubble. economists agree that bubbles can impair the functioning of the economy by promoting a misallocation of resources when they are inflating and by provoking severe dislocations when they pop. but because we are talking about economists, you can be sure their opinions differ substantially after that. one branch of economists holds the view that monetary policy should not be influenced by any perceived financial market bubbles. an extreme version of this view is that bubbles probably do not exist - that rational market processes always price assets at their fundamental value. a more moderate version is that even if bubbles do exist, they cannot reliably be identified, and even if bubbles can be identified, we do not know how they respond to monetary policy. the extreme view at the other end of the spectrum holds that central banks should pop bubbles as soon as they can. according to this view, by raising interest rates when a bubble begins, the central bank can avoid the volatility that occurs when a bubble fully inflates and then pops. central bankers need to be practical, not extreme, and consequently my view falls somewhere in between. on the one hand, i am skeptical that central bankers or anyone else can accurately identify bubbles as they are inflating, and i know of no central banker who understands with great certainty how bubbles respond to monetary policy. on the other hand, the fomc does attempt to take into account the effect of asset values on the economy when setting interest rates and does consider the likely reaction of asset prices to our policy decisions. another type of financial instability that can influence monetary policy in a way that is very difficult to embed in a rule occurs when important intermediaries - banks, securities dealers, hedge funds - fail or when markets seize up in a financial

, the results were less than perfect. but we commend the bankers for their extensive efforts and thank them for their patience in producing results under less - than - perfect circumstances. in the future, we expect to have better assessments of the framework's impact on u. s. banks before it is fully implemented. and as we move forward in this process, we expect that additional information provided by u. s. supervisors - - through rulemaking and guidance - - would allow bankers to produce regulatory capital results that are more accurate and likely more in line with our expectations. one of the most important findings from qis4, obviously, relates to the overall decline in regulatory capital requirements. capital serves as an important backstop against risk - taking and we need to ensure that an adequate level of capital is produced by the basel ii framework. to be frank, the federal reserve would not be comfortable qualifying any bank based on the results of qis4, if basel ii were to be applied today. but as i noted above, qis4 does not represent the final version of basel ii in the united states and we realize that bank data and risk - management systems required by basel ii are not yet fully developed and implemented as expected by the framework. to be sure, by the time that basel ii " goes live, " bankers would have significantly more information regarding our expectations and more robust default and loss - severity data. banks will also have to adhere to the qualification standards set by supervisors. but given some of the uncertainty that still remains about the impact of basel ii, it is important that we continue to effectively use the safeguards designed in the basel ii process. as i just mentioned, qis4 was one of a series of studies conducted with banks to test the methodology and identify implementation issues. the process also requires banks to successfully complete four quarters of running their basel ii systems in parallel with the capital requirements of basel i, before they can qualify for the next stage. the current framework then requires banks to demonstrate continued reliability of their process for two years, during which floors on minimum regulatory capital exist to prevent an unintended drop in capital. the public comment process and transparency in our implementation process would provide added checks and balances. i would also like to emphasize that market participants are also expected to play an important role as basel ii is implemented. not just supervisors will be expected to evaluate information provided by institutions. as basel ii rolls out, bankers would be expected to disclose where their institution is