, takes as given an objective function such as minimizing the expected value of ( u – u * ) 2 – then one can remain agnostic about the source of variation in risk premiums and still reach the kinds of conclusions that i do in what follows. however, if one asks whether such a mandate is itself normatively optimal in a fully micro - founded model, my intuition is that the source of variation may matter quite a bit. for example, i would conjecture that it might be more normatively appropriate, holding fixed the consequences for aggregate activity and unemployment, to lean against a sharp reduction in risk premiums that is driven by investor sentiment rather than against one that is driven by a rational response to changes in the risk environment. see, for example, hanson and stein ( 2012 ) ; gertler and karadi ( 2013 ) ; and gilchrist, lopez - salido, and zakrajsek ( 2014 ). note that, as an econometric matter, it is easier to establish a causal effect of monetary policy on risk premiums than on broad measures of leverage, because asset prices can be measured on a daily or even intraday basis. so they can be directly related to innovations in the stance of policy, as proxied for by, for bis central bankers ’ speeches however, while this empirical observation sheds some interesting light on how monetary policy influences the real economy, it does not by itself suggest that there is any financial stability dark side – that is, any meaningful increase in what i have been calling fmv – to the lowered risk premiums that go with monetary accommodation. for there to be such a dark side, there would have to be some sort of asymmetry in the unwinding of the effects of monetary policy on these risk premiums, whereby the eventual reversal either happens more abruptly, or causes larger economic effects, than the initial compression. let ’ s take an example. suppose that initially, the credit risk premium on high - yield bonds is 400 basis points, and that, because the unemployment rate is well above target, the federal reserve wants to add monetary accommodation. suppose further that doing so lowers the credit risk premium to 200 basis points temporarily but also increases the odds that this risk premium will, at some point in the next couple of years, revert sharply, moving back in the direction of 400 basis points. what is the downside here? given a desire for accommodation, is it not better to have credit risk premiums pushed

having increased substantially in recent quarters, cost and price inflation should remain quite subdued. in the short run, headline inflation will be driven importantly by movements in energy and food prices ; judging from the structure of futures prices, markets are not expecting a further sharp rise in those prices, and thus headline inflation should retreat toward core inflation. inflation outside of the food and energy sectors has been declining slowly, held up by relatively stable inflation expectations. some further slowing is possible if the economic rebound is as gradual as i think it is likely to be. as i have already noted, keeping inflation expectations anchored will be critical for achieving our objectives for prices and output. the fomc has recently reiterated its expectation that the considerable remaining slack in labor and product markets and subdued trends in inflation and inflation expectations are likely to warrant exceptionally low levels of the federal funds rate for an extended period. monetary policy future the federal reserve will face a number of challenges in the conduct of monetary policy in the period ahead. i will discuss two of them : further exit from our extraordinary measures, including the large volume of reserves, our outsized portfolio of mbs, agency, and treasury securities, and our near - zero policy interest rate ; and evaluating any lessons from the recent experience for the conduct of policy – in particular, the potential role of financial stability and asset prices in monetary policy formulation. exit. i ’ m not going to discuss the technical aspects of an exit from our extraordinary measures ; the federal reserve has kept the public apprised of the development of our exit tools, and the appropriate use and sequencing of these tools is under active discussion by the fomc. but i do want to make some general strategic points. first, we have no shortage of tools for firming the stance of policy, and we will be able to unwind our actions when and as appropriate. because we can now pay interest on excess reserves, we can raise short - term interest rates even with an extraordinarily large volume of reserves in the banking system. increasing the rate we offer to banks on deposits at the federal reserve will put upward pressure on all short - term interest rates. in addition, we are developing and testing techniques for draining large volumes of reserves through reverse repurchase agreements and through term deposits at the federal reserve. and we can sell portions of our holdings of mbs, agency debt, and treasury securities if we determine that doing so is an appropriate approach to tightening financial conditions when the time comes. second, the fiscal