daniel k tarullo : the present and future of community banking speech by mr daniel k tarullo, member of the board of governors of the federal reserve system, at the federal reserve bank of new york community bankers ’ conference, new york, 8 april 2010. the original speech, which contains various links to the documents mentioned, can be found on the us federal reserve system ’ s website. * * * these are difficult times for many community banks, a reflection of the difficult times for the many workers and businesses across the nation who depend on the loans provided by your institutions. this morning i will address some of the problems that you currently face and offer a few thoughts about the future of community banking. before doing so, however, i thought it would be useful to explain my perspective on the federal reserve ’ s monetary policy posture, which will obviously have great significance for the economic environment in which community banks will be operating. specifically, i want to speak about what has become known as our “ exit strategy ” – that is, the means by which the federal reserve will bring to an end the extraordinary lending and monetary policies that it adopted in response to the financial crisis. planning and implementing an exit strategy in thinking about an exit strategy, it is important to distinguish between two types of policies that the federal reserve adopted, beginning in 2007 and continuing thereafter, beyond its sharp reductions in the target for the federal funds rate. first, the federal reserve created a number of liquidity programs, which provided well - secured, mostly short - term credit to various parts of the financial system that were under increasingly severe strains. among these were the term auction facility ( taf ), which auctioned short - term funds to banks ; the primary dealer credit facility, which served as a backstop liquidity provider for securities firms ; the term asset - backed securities loan facility ( talf ), which was designed to help revive the market for asset - backed securities, and others. second, and separately, the federal open market committee ( fomc ) undertook large - scale purchases of treasury securities, agency mortgage - backed securities, and agency debt. this unconventional monetary policy action was taken because the fomc, after having reduced short - term interest rates nearly to zero, determined that the severity of the economic downturn made additional stimulus necessary. in addition to improving conditions in mortgage markets, these asset purchases helped lower yields on long - term debt ; they also substantially increased the level of reserve balances that depository

their costs, are a good hedge against sharp movements in capital flows. although most economies did not significantly deplete their reserves during the crisis, their sole existence prevents destabilizing capital movements from occurring. on the other hand, the forex intervention mitigates exchange rate adjustments. as we have said before, without the intervention the peso would have appreciated further. still, it is worth pointing out that the appreciation of the chilean peso is not so different from that of the currencies of a large group of emerging or commodity - exporting economies, whether they have intervened their exchange rates or not. let me insist that the forex intervention has only transitory effects. it cannot permanently modify an economy ’ s competitive position. this can only be made with policies that affect the real side of the economy. monetary or forex measures can only have a temporary influence. the impact of a sterilized exchange rate intervention occurs via the currency portfolio composition. because external and internal financial assets are not perfect substitutes, changes in their relative supply have an initial effect on prices, which then fades over time. the imf ’ s latest regional economic outlook for the western hemisphere presents estimates showing that interventions reduce the rate of currency appreciation. additionally, it indicates that the effects are milder in more financially open economies, and shows that rule - based or discretional interventions have similar effects. ours is rule - based, in order not to lose control over our monetary policy. as proven by this evidence, the effects would not be so different if our intervention had been arbitrary. this comes as no surprise, since the effects depend on both the amount of the intervention and the composition of the currency portfolios. it has called the attention of many people that a measure similar to that of 2008 has caused a different behavior of the exchange rate. i don ’ t need to say that the combination of events has also been different, especially abroad. back then the world economy was headed to a severe crisis and risk aversion was growing. this eroded asset value in emerging economies and strengthened the dollar. copper prices and terms of trade began to decline. today the picture is quite different : the dollar is weaker than ever and the copper price has remained very high, and is forecast to stay near its present levels for some time ( figure 8 ). another issue regarding exchange rate ’ s discussion has to do with the effects of capital flows. several emerging economies have seen their capital inflows increasing, which has added