The Fed is in the process of implementing a framework that will embed compensation practices more deeply into the supervisory process. We have made it clear to the major banks and dealers that 2009 compensation should be consistent with the recently developed Financial Stability Board principles on compensation, which emphasize the importance of appropriate incentives. Finally, there is considerable work underway on the “too big to fail” problem. On this front, there are two main strands of work. First, we must improve the resolution mechanisms for large complex bank holding companies and nonbank financial firms that become troubled, and to complement that initiative with efforts to strengthen the financial market infrastructure. If regulators had at their disposal an effective resolution mechanism for large financial firms and the financial system was made more resilient to shocks, then the number of firms that were indeed “too big to fail” would be significantly reduced. Second, after building such a resolution mechanism, we must still act to ensure that no special advantage persists from being perceived by creditors, counterparties and investors as “too big to fail.” After all, it will be hard to build a resolution mechanism that credibly ensures that any firm will be allowed to fail under any circumstance. If there is a chance that a firm may be too big to fail, then there  3  For more on liquidity issues see “More Lessons from the Crisis,” Remarks by William C. Dudley at the Center for Economic Policy Studies (CEPS) Symposium, Princeton University, November 13, 2009.
We should think about how market participants will react to the potential politicization of the monetary policy process. Knowing that a decision to raise interest rates today might be criticized by the GAO six months later, market participants could begin to worry about the Fed’s willingness to make tough choices in terms of tightening monetary policy. If that were the case, inflation expectations could become less well anchored. This, in turn, would make it more difficult to keep inflation under control, even if the fears of market participants about the Fed ultimately turned out to be unwarranted. Our monetary policy decisions are already public and a wide range of Fed officials explain the rationale for our actions. It has been well established around the world that monetary policy independence leads to better outcomes in terms of unemployment and inflation. In my view, any legislation that would cast doubts about the Fed’s independence in the conduct of monetary policy would not be beneficial to this country. Thank you for your kind attention. I would be happy to take a few questions. 8  BIS Review 161/2009