somewhat mysterious, unobservable object. that ’ s no longer true. treasury inflationprotected securities – bonds that are colloquially called tips – make coupon payments that are indexed to the inflation rate. this indexation means that tips coupon payments provide a fixed amount of purchasing power to the bondholder, not a fixed amount of dollars. as a result, tips yields provide a useful measure of the real interest rate. when we look at tips yields, we see that real interest rates have fallen sharply over the past six years. in the first half of 2007, five - year tips had a real yield of about 2. 5 percent and 10 - year tips also had a real yield of about 2. 5 percent. by 2012, both real yields had fallen well below zero, and while they have risen slightly, real yields continue to be low today. the five - year real tips yield is still below zero, around negative 0. 3 percent. the 10 - year real bis central bankers ’ speeches tips yield is only slightly positive – around 0. 4 percent. note that, together, these market prices imply that the five year - five year forward real interest rate is around 1 percent. the 10 year - 10 year forward real interest rate is only slightly higher. why have real interest rates fallen so much? at one level, the answer is obvious : monetary policy. certainly, over the past seven years, the fomc has taken a number of actions designed to put downward pressure on nominal bond yields. with inflationary expectations well - anchored, these actions tend to push downward on real interest rates. but i think that the obvious monetary policy answer is actually deeply misleading. it is true that the fomc takes monetary policy actions so as to influence the real interest rate. but, ultimately, these actions are designed to allow the fomc to achieve its dual mandate of price stability and maximum employment. in 2007, the macroeconomic outlook was broadly consistent with the committee ’ s mandated objectives. in this sense, we can say that the real interest rate of 2. 5 percent was mandate - consistent1 in 2007. the situation is different in 2014. as i ’ ve argued in previous speeches, the outlook for both employment and prices is too low relative to the fomc ’ s goals. for example, personal consumption expenditure inflation – the fed ’ s preferred measure – is currently at 1. 6 percent. i expect it to remain below the fomc ’ s inflation target

for a recent example. bis central bankers ’ speeches financial stability and monetary policy these financial market phenomena could pose macroeconomic risks. in my view, such potentialities are best addressed through effective supervision and regulation of the financial sector. it is possible, though, that these tools may only partially mitigate the relevant macroeconomic risks. how, if at all, should the fomc adapt monetary policy in response to any residual risk? in remarks that i gave earlier this year, i described an analytical mean - variance framework that the committee could use to answer this question. 5 today, i ’ ll simply sketch the elements of that framework. basically, the fomc will need to confront an ongoing probabilistic costbenefit calculation. on the one hand, raising the real interest rate will definitely lead to lower employment and prices. on the other hand, raising the real interest rate may reduce the risk of a financial crisis – a crisis that could give rise to a much larger fall in employment and prices. thus, the committee has to weigh the certainty of a costly deviation from its dual mandate objectives against the benefit of reducing the probability of an even larger deviation from those objectives. in my view, this cost - benefit assessment is relatively clear right now. as i mentioned earlier, employment and prices are expected to be quite low over the medium term. in these circumstances, the cost of tightening policy has to be seen as great. at the same time, the survey of professional forecasters reveals that forecasters see little chance of a large downward movement in employment and prices. these forecasts suggest that there would be little gain, in terms of forestalling adverse macroeconomic outcomes, from monetary policy tightening. however, i expect this assessment to become more difficult for monetary policymakers in the future. eventually, the outlook for employment and prices will improve to be broadly consistent with the fomc ’ s objectives. as i ’ ve described, i expect that the real interest rate will still be unusually low at that juncture. in these circumstances, i anticipate that financial stability considerations are likely to play a substantial role in the determination of the appropriate level of monetary accommodation. i should stress that the committee is in a better position to carry out this kind of probabilistic cost - benefit analysis in 2014 than it was in 2007. the federal reserve system now dedicates a significant amount of our best staff resources to financial system surveillance. the federal reserve bank of minneapolis contributes to these efforts