##lnerabilities and the resulting severe recession. two aspects of the federal reserve's conduct of monetary policy are cited by these critics. one, some assert that we responded asymmetrically to movements in asset prices, easing aggressively in response to declines and not tightening correspondingly when asset prices rose. this perceived asymmetry is alleged to have given market participants the sense that they could engage in a one - way bet – that the federal reserve would cushion asset - price declines with cheap money but would not increase interest rates to make it more expensive i have addressed the first of these questions before - most recently a year ago in a speech given at the cato institute - but in light of the experience over the past several years, it seems appropriate to reexamine the issue. ( see donald l. kohn ( 2008 ), " monetary policy and asset prices revisited, " speech delivered at the cato institute's 26th annual monetary policy conference, washington, november 19. ) brian madigan of the board's staff contributed to these remarks. for them to finance bets that asset prices would rise. second, some believe that the federal reserve kept policy too loose around 2003 and then tightened too slowly and predictably in 2004 and 2005, in effect encouraging if not underwriting the bubble in house prices that lay behind so many of our troubles over the past two years. my perspective is that policymakers have kept their eyes firmly on medium - term macroeconomic stability – that is, on the legislated objectives of maximum employment and stable prices. we responded to developments in asset and credit markets to the extent that they affected the macroeconomic outlook, but we did not assign them extra weight in our deliberations. in particular we did not react asymmetrically to asset - price developments ; it only looks that way on the surface because asset prices tend to rise slowly and fall rapidly. had we been more ready to ease than to tighten monetary policy, the economy would have tended to run above its productive potential on average and inflation would have risen. in fact, inflation fell over the 1980s and 1990s. inflation did rise from 2004 through the middle of 2008, but largely because the prices of petroleum and other commodities increased. those increases reflected rising demand from rapidly industrializing emerging market economies, not easy monetary policy in the united states. as we went through this period, a variety of measures of resource utilization, underlying inflation rates, and market indicators of future commodities prices gave us good reason to believe that

have sounded much louder if the ec, the imf and others had not suggested that the economy was running below potential. inappropriate reliance on mismeasured output gaps can lead to complacency during good times. bis central bankers ’ speeches i recount this example about how the output gap can be misused in policy debates because once again, as we are coming out of the crisis, some voices are stressing the extent of the output gap that the euro area is facing today, perhaps drawing conclusions about policy that could again be reversed as time goes by. the focus on price stability must remain unrelenting. * * * that said, another lesson is the following : the central bank focus on price stability is insufficient to maintain overall stability in the economy. the crisis has confirmed that a central bank with a price stability objective and insufficient regulatory powers cannot ensure broader financial stability in the economy. the crisis has revealed a general underappreciation of systemic risks in micro - prudential supervision. it has highlighted the need for a more system - wide macro - prudential approach towards supervisory oversight to ensure overall stability in the financial system. as a result, we see a shift in emphasis with new organisations created in some jurisdictions to address this gap. in the euro area, the establishment of the european systemic risk board is meant to serve this role. by definition, micro - prudential supervisors focus on individual institutions and cannot effectively assess the broader macroeconomic risks that pose a threat to the financial system as a whole. this is a task best suited to central banks. but for central banks to better enhance financial stability they must be provided with the right tools. consider, for example, an episode of persistently high credit growth in an environment of price stability. adjusting the interest rate tool is unlikely to be the most appropriate response. ideally, under such circumstances, the central bank should have at its disposal, either directly or through its participation in a macro - prudential body, the macro - prudential levers with which to contain the risk of a potential financial disturbance. these could comprise the power to vary capital requirements, leverage ratios, loan - to - value ratios, margin requirements and so forth. considering the important informational synergies between micro - prudential supervision and systemic risk analysis, bringing micro - supervision close to, if not under the same roof as, other central bank functions seems an attractive proposition. this should contribute to better management of overall economic stability. a concern