they inflict significant damage. to be sure, considerable uncertainty attends the near - term outlook for the u. s. economy, and recent readings on production and employment have been disappointing. however, a balanced assessment would also take into consideration the fact that the reduction in iraq - related uncertainties and some recent positive news regarding corporate earnings have caused the tenor of financial markets to improve noticeably : equity prices have risen, risk premiums of corporate debt have fallen, crude oil prices have declined sharply, and consumer confidence has rebounded since the early spring. whether this improvement in overall financial conditions is a precursor to sustained recovery in the broader economy is unclear. fortunately, for the longer term, productivity growth in the united states has remained remarkably robust. rapid growth of output per hour boosts expectations of future advances in wages and profits, leading eventually to higher aggregate demand. another key difference between the two countries is that the u. s. financial system continues to function smoothly. domestic commercial banks are very profitable overall and are well capitalized, and bank regulators have shown a willingness to move quickly to address problems. in contrast, japanese banks remain saddled with a significant volume of nonperforming loans. accordingly, the process of financial intermediation through banks has been constricted, hampering the bank of japan ’ s attempts to increase liquidity and to stimulate the flow of credit. on a related point, the existence of highly developed and integrated u. s. financial markets means that the proportion of financing flows intermediated by the banking system in the united states is considerably smaller than in japan ’ s bank - centered financial system. as a result, the transmission of monetary policy in the united states operates through multiple and complementary channels. japan ’ s dependence on the banking system, a system that has largely ceased to function, represents a further constraint on the transmission of monetary policy in that country. thus, it seems appropriate for japan to continue its efforts to develop deeper and more liquid capital markets. demand for business and consumer credit in the united states is stronger than in japan, and corporate balance sheets are in better shape. the continued rapid pace of technological innovation is likely to create expanding opportunities for profitable investment and thereby strengthen further the demand for credit. although business spending on fixed capital has yet to stage a convincing comeback, firms eventually will have to increase such outlays, given the relatively high rates of depreciation on certain types of capital. finally, as mentioned earlier, by the time the bank of

laurence h meyer : controlling the safety net remarks by mr laurence h meyer, member of the board of governors of the us federal reserve system, at the 37th annual conference on bank structure and competition of the federal reserve bank of chicago, chicago, illinois, 10 may 2001. * * * thank you. it is my pleasure to participate in this distinguished conference. i look forward to a fruitful and stimulating discussion with both my fellow panel members and the audience. the federal safety net for depository institutions – by which i mean deposit insurance, access to the federal reserve's discount window and payment system guarantees, and the implicit certification of soundness that counterparties believe accompanies federal supervision and regulation – has been a potent force for ensuring the stability of the u. s. banking and financial system. we should preserve these benefits. however, as we learned to our chagrin in the late 1980s and early 1990s, this system can impose serious costs because of the unintended consequences of " moral hazard " – the incentive to take excessive risk and the consequent reduction of market discipline. moreover, these costs can be especially large if supervisors tend to delay, or forebear, in resolving troubled and insolvent institutions. in my remarks this morning, i will first review the lessons that i believe we learned from the last banking crisis regarding how best to control the unintended consequences of the safety net ; i will then look forward to what i believe still needs to be done. in the course of my presentation, i will expand on a number of the themes in chairman greenspan's remarks and suggest priorities for our current and future efforts. lessons from the past the banking crisis of the late 1980s and early 1990s led to a number of key reforms that were designed, individually and in total, to limit the unintended consequences of the federal safety net. in 1988, bank supervisors from the united states and the major industrial nations adopted what has come to be known as the basel capital accord. the accord, which had been under development for several years, helped to focus supervisors and the industry on the importance of adequate capital for bank safety and soundness. it was a de facto increase in capital standards for a number of depository institutions, particularly large firms with significant risks from off - balance - sheet activities. in the parlance of finance theory, higher capital standards reduced the value of the put option provided by federal deposit insurance and lowered the exposure of the safety net as a whole. the