With such heavy trade flows, when the mainland economy does poorly – as during the past year – Puerto Rico’s economy and job growth suffer. Financial regulation also represents an important linkage. Of course, my presence here representing the New York Fed is one example of that particular connection – Puerto Rico is part of the Second District of the Federal Reserve System, along with New York, the U.S. Virgin Islands and parts of New Jersey and Connecticut. I’ll return to the theme of financial regulation shortly. For now, let me just say that we share, along with the rest of the world, a commitment to taking the necessary steps to prevent the type of financial crisis that we just experienced from recurring in the future. The Fed’s role in coping with the crisis and the outlook for the United States The close ties with the mainland means that the broader outlook for the United States is very important for Puerto Rico. The U.S. economy has been through a terrible period, having suffered the worst financial crisis in 70 years. Extensive study of banking crises shows that they tend to be “protracted affairs” with surprisingly similar, if unpleasant, contours. Downturns average four years, during which the unemployment rate rises an average of 7 percentage points. The peak-to-trough decline in output averages 9 percent. Those statistics point out the risks that we faced. Well aware of the threat of a second Great Depression, U.S. policymakers took very aggressive actions to support economic growth in 2008 and 2009.
In the UK that will now be enshrined by putting a Financial Policy Committee alongside the Bank of England’s existing Monetary Policy Committee. The Committee has recently been established, on a non-statutory basis for the interim. But that poses a host of questions. How do we define financial stability? What is the FPC and what is its objective? Why should it be separate from the microprudential supervisor, which is also being moved to the Bank? What will be the FPC’s instruments? Are they all directed at banks? Will they conflict with monetary policy? And, more prosaically, how will the FPC operate and be accountable? I shall set the scene with some general reflections on financial stability, including how it might be defined, and how its scope extends to the resilience of capital markets as well as that of banks (and shadow banks). After those more general observations, I shall try to answer some of the key questions about the FPC. What is financial stability? Why financial stability matters Under legislation introduced in the UK in 2009, the governing body of the Bank of England, Court, is required to set out a strategy for the Bank’s financial stability work. We publish it in our Annual Report. We have tried to clarify why society should care about financial instability.