timothy f geithner : liquidity risk and the global economy remarks by mr timothy f geithner, president and chief executive officer of the federal reserve bank of new york, at the federal reserve bank of atlanta's 2007 financial markets conference – credit derivatives, sea island, georgia, 15 may 2007. * * * thank you for giving me the chance to join you today. although this is a conference primarily about credit derivatives, i am going to talk about some of the broader changes we are seeing in financial and credit markets, and their implications for policy. you are meeting during a period of remarkable change and exceptional conditions in financial markets. financial markets over the past several years have been characterized by an unusual constellation of low forward interest rates, ample liquidity, low risk premia and low expectations of future volatility. in some markets, asset prices have risen substantially, and credit growth has expanded rapidly. in credit markets more generally, spreads have declined to levels that reflect very low expectations of near term losses and credit standards have weakened. it would not be accurate to say this is a world without volatility, for we have had a series of episodes of sharp declines in asset prices and increases in volatility. but these episodes have been contained and short lived, with markets recovering relatively quickly and with little appreciable effect on global economic activity. these conditions are global in nature, though they take somewhat different forms in different markets. the forces behind all this are complex and not well understood, and this complicates any judgment of how enduring they will prove to be. the main candidates in terms of fundamental explanations involve change in economic conditions and in the structure of financial markets. there has been a marked improvement in global economic performance, with strong growth, relatively low inflation, and less volatility in both growth and inflation. this seems to have reduced concern about future fundamental risk, in terms of the potential damage of future shocks and in the ability of governments and central banks to both avoid the policy errors of the past and to competently manage some daunting longer - term policy challenges. the global trend toward independent central banks with clearer mandates for price stability has contributed to this confidence, as has the improvement in national balance sheets in emerging markets, with stronger fiscal positions, higher reserves, and less exposure to foreign - currency denominated debt. changes in financial markets, including those that are the subject of your conference, have improved the efficiency of financial intermediation and

for such a modified plt to be effective in anchoring inflation expectations, households and businesses would have to understand how the regime would work, and view the federal 5 / 7 bis central bankers'speeches reserve ’ s commitment as credible. one can imagine that such credibility might be hard to sustain during a long spell of inflation misses to the downside. second, while such a regime might be attractive in broad brush form, the devil lies in the details. if inflation undershot for a few years, what would the desired overshoot path look like? how high would the fomc permit inflation to go above its objective, and for how long? what would happen if the fed failed to fully offset past downside misses and cumulative undershoots became sizable? my view is that we should further study how plt frameworks might work in practice. 15 but, it is possible that a simpler approach of committing to keeping the average inflation rate around 2 percent over the medium term might be just as appealing. it might be sufficient to better anchor inflation expectations while avoiding the communication challenges and complexity of an asymmetric plt regime. in this vein, i also would evaluate whether the inflation goal should be recast as a range of, perhaps, 1½ to 2½ percent, from the current 2 percent objective. a range might have several advantages over a point target. first, it might be viewed as more realistic given that measured inflation will always randomly fluctuate relative to its underlying trend. that is to say, even if the fomc performs its job exceedingly well, very rarely will the inflation rate, as measured by the pce price index, be precisely at 2 percent. second, having a relatively narrow range would send a message that the fomc is discriminating between two regimes — one in which inflation is within the range and concerns about inflation are low, versus another in which inflation is outside the range and concerns about inflation are more elevated. even so, i would not recommend shifting to such a range currently. i would only consider doing so once the fomc has successfully and sustainably pushed inflation back to its 2 percent objective. making such a change now might be viewed as “ moving the goal posts, ” given the persistent shortfall of inflation in recent years relative to the objective. and, doing so now might imply a greater tolerance for missing inflation to the low side in an asymmetric way. that would not be desirable at a time when inflation expectations