significant risks to the macroeconomy. then i will explain how the science of monetary policy can help provide a conceptual framework for a systematic approach to managing these risks, and i will briefly discuss how that framework can be useful for understanding the course of federal reserve policy over the past few months. financial disruptions and macroeconomic risk before considering the appropriate policy response to strains in financial markets, it is essential to consider the sources of these strains and the potential consequences for the macroeconomy. in general, the u. s. financial system is an efficient mechanism for channeling funds to individuals or corporations with worthy investment opportunities, because the financial markets are highly competitive and provide strong incentives for collecting and processing information. i appreciate the comments and assistance of william english, andrew levin, brian madigan, roberto perli, david reifschneider, and david wilcox. although financial markets and institutions deal with large volumes of information, some of this information is by nature asymmetric ; that is, one party to a financial contract ( typically the lender ) has less accurate information about the likely distribution of outcomes than does the other party ( typically the borrower ). 2 historically, banks and other financial intermediaries have played a major role in reducing the asymmetry of information, partly because these firms tend to have long - term relationships with their clients. recent years have witnessed the development of new types of financial institutions and of new markets for trading financial products, and these innovations have had the potential ( not always realized ) to contribute to the efficient flow of information. the continuity of this information flow is crucial to the process of price discovery – that is, the ability of market participants to assess the fundamental worth of each financial asset. during periods of financial distress, however, information flows may be disrupted and price discovery may be impaired. as a result, such episodes tend to generate greater uncertainty, which contributes to higher credit spreads and greater reluctance to engage in market transactions. as i noted in another recent speech, financial disruptions are associated with two distinct types of risk : valuation risk and macroeconomic risk ( mishkin, 2007d ). valuation risk refers to the extent that market participants become more uncertain about the returns on a specific asset, especially in cases where the security is highly complex and its underlying creditworthiness is relatively opaque. in recent months, for example, this type of risk has been central to the repricing of many structured credit products, as investors have struggled to

it is hard to quantify precisely the various ways in which the structure of the economy has changed. the appropriate data are not always available and it may be a long time until the effects are discernible in aggregate economic statistics. importantly, the significance of some of these structural reforms may not be fully apparent until the economy is subjected to a substantial shock. for example, one consequence of globalisation is that supply chains around the world are far more integrated. this is likely to have played an important role in the speed and synchronisation of the world downturn, as the effects of falling demand in a few countries were translated into lower orders and production in many in a matter of weeks. that increased integration is also likely to affect the speed and nature of the recovery. similarly, the technology used to control and manage inventories has changed substantially over the past twenty or thirty years. this may have enabled companies to run down their stocks earlier in this recession than in previous downturns. and indeed there is evidence that firms have already cut back aggressively on their stock levels. a corollary of this sharp correction is that the stock cycle may be shorter lived than in previous recessions. the behaviour of the labour market may also have changed. i have been struck by the number of business people who tell me about the array of measures they have already taken since their orders starting falling sharply last autumn. wages have been frozen or even cut, hours have been reduced, working practices have been adjusted. to the extent that wages and hours are now more flexible, the adjustment in employment may be less. but if it is easier for companies to vary their labour force than in the past, much of this adjustment may come through more quickly than in previous downturns. it is hard to know at this stage how significant these structural changes will be in determining the depth of the recession and the speed of the recovery. but the possibility that there has been a material structural change in our economy highlights a further danger of viewing the current recession through the prism of previous ones. the latest economic data on world trade, output and unemployment are unmistakeably grim, but we must continually challenge ourselves about how to interpret these and the economic data to come. they could be telling us something about the causes and size of the downturn, the impact of the policy measures taken so far, or how changes in economic structure are affecting the response of output and employment. let me now say a little about the role the monetary policy