excesses, which include unsustainable financial leverage, household over - indebtedness, and perhaps the over - extension of the financial industry. this will be painful but inescapable. in view of japan ’ s decade - long experience, there are no palatable alternatives. one more note of caution. because of the pain associated with the unwinding of excesses, we might be leaning toward protectionist measures in trade and finance. but we must resist a descent into protectionism by any means. like protectionism, regulatory overreaction will also undermine the economic efficiency, thereby putting downward pressure on productivity growth. without question, this is the last thing we intend to achieve. challenges ahead : crisis prevention what i have so far said concerns crisis resolution. but crisis prevention is equally important from the longer - term viewpoint. let me sketch this out. first of all, the current crisis presents a challenge for the conduct of monetary policy. it requires a change not only in policymakers ’ way of thinking but also in the theoretical underpinnings on which actual policies have been formulated. in the last two decades, macroeconomics as a professional discipline has evolved with impressive sophistication. if i may put it simply, its implications for policy practitioners might be condensed into three points. first, economic growth potential is maximized under the sustained stability in prices. second, central banks ’ monetary policy should be aimed primarily at achieving price stability. third, as a corollary of the first and the second, the onus for macroeconomic stabilization should be mainly on monetary policy. of course, there is nothing wrong with each of these propositions. but over time, they seem to have created a sense of complacency among us with regard to the potency of monetary policy. for instance, some macroeconomic theorists have claimed that a depression is no longer a real concern. however, the current crisis, including its run - up, demonstrates that a macroeconomic theory does not take proper account of the dynamics in financial systems and the irrational behavior of human being such as herding and indulgence in excessive optimism. therefore, from a preventive vantage point, we need to develop a broader approach. under benign economic conditions, imbalances could accumulate through a number of channels. as we saw in japan in the 1980s and in the us in the early 2000s, expectations of sustained low interest rates often contribute to the build - up of economic excesses through higher

daniel k tarullo : shadow banking and systemic risk regulation speech by mr daniel k tarullo, member of the board of governors of the federal reserve system, at the americans for financial reform and economic policy institute conference, washington dc, 22 november 2013. * * * as illustrated, quite literally, by a chart that new york fed staff produced a few years ago, the term " shadow banking system " encompasses a wide variety of institutions that engage in credit intermediation and maturity transformation outside the insured depository system. 1 in my remarks today, i want to concentrate on short - term wholesale funding and, especially, the pre - crisis explosion in the creation of assets that were thought to be " cash equivalents. " such assets were held by a range of highly risk - averse investors, who were in many cases not fully cognizant that the " cash equivalents " in their portfolios were liabilities of shadow banks – the institutions depicted in the memorable graphic. in some cases, the perception of claims on shadow banks as cash equivalents was based on explicit or implicit promises by regulated institutions to provide liquidity and credit support to such entities. in other cases, the perception came about because market participants viewed the instruments held on the balance sheets of shadow banking entities – notably highly rated, asset - backed securities – as liquid and safe. while reliance on private mechanisms to create seemingly riskless assets was sustainable in relatively calm years, the stress that marked the onset of the financial crisis reminded investors that claims on the shadow banking system could pose far more risk than deposits insured by the federal deposit insurance corporation ( fdic ). once reminded of their potential exposure, investors engaged in broad - based and sometimes disorderly flight from the shadow banking system. this experience of the run on the shadow banking system that occurred in 2007 and 2008 reminds us that similar disorderly flights of uninsured deposits from banks lay at the heart of the financial panics that afflicted the nation in the late nineteenth and early twentieth centuries. the most dramatic of these episodes were the bank runs of the early 1930s that culminated in the bank holiday in 1933. just as it was necessary, though not sufficient, to alter the environment that led to those successive deposit runs by introducing deposit insurance in order to create a stable financial system in the early - twentieth century, today it is necessary, though not sufficient, to alter the environment that can lead to short - term wholesale funding runs in order to create a stable