The challenge ahead is to help manage the transition to a monetary system that provides flexibility in the exchange rates of all the major economic areas, and this has to be handled with care. Even with good policy choices here and in other countries, bringing these imbalances down to a more sustainable level will take time. During this period of adjustment, despite our fundamental economic strengths, we will be vulnerable to an elevated risk of volatility in financial markets. This prospect makes this a good time to examine the health of the financial system. The strength of the financial system is a major factor in determining how well economies respond to shocks - weak financial systems amplify the damage to growth. The stronger the financial system, the more effective policy - monetary policy in particular - can be in cushioning the effects of those shocks and helping to restore expansion. We are fortunate in the United States today to have a strong financial system. This system has a tremendous capacity to match capital to ideas, reward innovation, and channel savings to the highest return. And it has demonstrated a capacity for very considerable resilience and stability in face of shocks. What are the main sources of these strengths? Our banks are stronger than they have been in the past. Their larger earnings capacity, higher capital cushions, and the greater diversity of their activities help shield them from a broader range and greater magnitude of shocks than in the past.
The payments system we live with today is a complex mix of national and cross border systems originally designed for a safer, slower, less complex, more segmented financial world. While many improvements have been made to this system over time, it is important that we work to strengthen further the core infrastructure of the payments system. We also need to promote further evolution in the framework of supervision and regulation of our more complex and integrated global financial system. To paraphrase Bob Rubin in a different context, we need a framework for supervision and regulation that is “as modern as the markets” and that stays abreast of the pace of change and innovation. Perhaps the greatest challenge we face – in macroeconomic policy and in financial supervision - is a challenge of imagination: How do we best prepare for the low probability of an extreme event; a crisis not captured by past experience? How do we generate the will today to build a greater degree of insurance against a more uncertain future, particularly if the risk of adversity seems remote and the immediate future looks strong? We can take considerable reassurance from apparent moderation in overall macroeconomic volatility recently, and from the ease with which our system has handled recent stress. Prudent macroeconomic policy actions will increase the likelihood that these beneficial circumstances will continue. But we cannot know with confidence that the future will bring an enduring reduction in volatility and risk, and it would be imprudent to plan for such a world.