interest rates and other asset prices are determined importantly by expectations about future policy. these expectations, in turn, are informed ( one hopes ) by a clear understanding of the objectives of the central bank and how it will choose to set policy in the future in response to economic developments. central banks have long recognized the effect their words and actions can have on interest rates and asset prices and, as a result, have increasingly moved toward greater transparency in the policy process. the sharpened focus on transparency has been motivated in part by a desire to avoid short - run misperceptions about policymakers ’ intentions that can distort financial asset prices and ultimately prove detrimental to the real economy. but central bankers have also discovered that transparency, broadly writ, can lead to improved economic performance. market expectations are more likely to remain anchored in the face of various shocks when investors understand that central bankers are committed to key long - run objectives such as price stability and sustainable economic growth. moreover, by operating in a predictable way in response to economic developments, central bankers can foster an “ automatic stabilizer ” of sorts in financial markets. for example, recognizing that the central bank will seek to counter adverse demand shocks, investors will anticipate an easing in monetary policy if they observe aggregate demand weakening ; in turn, that anticipation would soon be reflected in lower long - term interest rates that would cushion the drop in demand even before a change in policy is made. this market dynamic suggests that gauging the overall effect of monetary policy requires an assessment of broad financial conditions, including policy rates, long - term interest rates and foreign exchange rates. although central bankers can use predictable policy actions and the forward - looking nature of financial prices to their advantage, they must also be mindful of the potential market reactions to policy actions that are not fully anticipated or that may be misinterpreted. this, too, is an aspect of monetary policy that may have become more prominent given the evolution of financial markets in recent years. monetary policymakers evaluate the probabilities as well as the costs and benefits of the full range of potential economic and financial outcomes in arriving at a policy decision. one such risk to be evaluated is the potential, particularly during times of stress, for outsized and unintended changes in interest rates and asset prices after an unexpected policy action. of course, the response of central banks to this risk should not be to avoid taking policy actions that are necessary to achieve macroeconomic objectives. but central banks can mitigate

the potential for unintended market reactions by communicating their goals and economic outlook as clearly as possible to inform market expectations and thereby avoid possible misperceptions about the future path for policy. the record shows that on occasion monetary policy has been used to counter financial instability. these incidents arise when financial instability is so great that the financial markets themselves seem to become incapable of intermediating effectively and, partially as a result of these market weaknesses, the economic outlook has been revised down sharply and the downside risks to that outlook have become quite large. naturally, at those moments, asset prices as well as market functioning become a focus for policymakers. however, this does not mean that policymakers have particular targets for those asset prices - - that they seek to place a floor under such prices, as some have inferred. rather, in those situations asset prices are evaluated in the context of all the factors bearing on the economic outlook, just as when markets are orderly, though financial market conditions in all their aspects play a particularly prominent role in such an evaluation when markets are stressed. bank supervision the concentration in banking structures that i referred to earlier, coupled with the growing scope of permissible bank activities paralleling the evolving nature of the world ’ s financial markets, has had some profound effects on bank supervision. for one thing, supervisors worldwide have increasingly shifted the emphasis of their concern toward large banks ’ internal risk - management policies and systems and relatively away from individual bank positions and transactions. much of this shift in emphasis has reflected changes in banks ’ own internal policies, as increases in the scale and scope of operations have required different control and management systems to maximize risk - adjusted profits. in addition, the change has reflected the need to alter supervisory strategy to address the reality that earlier techniques are inadequate for large, complex entities, especially given supervisors ’ limited resources. the same motivations have induced u. s. and other supervisors to emphasize transparency and disclosure by the largest banks in order to exploit the potential market discipline as a supervisory supplement. market discipline, in turn, requires not only disclosure, but also the expectation that bank counterparties face a risk of loss. government guarantees in the name of stability may actually pose a greater risk of bank difficulties by reducing market discipline, or, alternatively, could require more intrusive supervision, reducing the innovative market dynamics i mentioned earlier. if you see in these developments the seeds of basel ii - in their requirements for better risk - management systems and greater disclosure - you understand the