This conclusion stems from the observation that the current economic environment is qualitatively different from previous post-World War II business cycles. Most post-war recessions were preceded by high rates of resource utilization and rising trend inflation. This prompted a tightening of monetary policy, which, in turn, dampened interestrate sensitive spending, particularly on housing and consumer durable goods. Then, as underlying inflation pressures subsided, monetary policy was eased and interest-rate sensitive spending rebounded, often quite sharply. The current business cycle is different in one key respect. It was preceded by a global financial crisis. The financial crisis was due, in large part, to excessive leverage and excessive investment in real estate assets. It will take time to unwind these excesses. Today, I will offer a framework for assessing the forces that have shaped the recent performance of the U.S. economy. This framework will provide context to the fiscal and monetary policy responses to what is now being called the “Great Recession.” Then, I will discuss the economic outlook for the United States over the next year. Before I proceed, I want to emphasize that these views are my own and do not necessarily reflect the views of the FOMC or the Federal Reserve System. Building an analytical framework Say’s law – named after the French economist Jean-Baptiste Say – states that the aggregate value of incomes earned in an economy over some period of time must by definition equal the value of all goods and services produced over that same time period.
This requires many steps, including systemic risk oversight and solving the so-called too-big-to-fail problem. In this respect, we need to think hard about what we can do to prevent the type of speculative bubbles that occurred from causing so much damage in the future. In particular, are there macro prudential tools that the Federal Reserve and other regulators can use to limit leverage and speculation and thus prevent the type of asset price booms and busts that have proved so troublesome? Second, we need viable exit strategies from this recent period of monetary and fiscal policy stimulus. On the monetary policy side, we have been working hard to ensure that we have the tools in place so that we can be effective in tightening monetary policy when the time is right, even with an enlarged balance sheet. Third, we need a rebalancing of global economic growth. That means a smaller share of consumption relative to GDP in the United States and offsetting shifts in Asia. Circumstances have improved considerably from what they were a year ago. But job creation is still much too slow and we have much to do on the regulatory side to make our financial system more resilient and robust. Thank you very much for your kind attention. I would be happy to take a few questions. 5  Financial Market Turmoil: The Federal Reserve and the Challenges Ahead, William C. Dudley. Federal Reserve Bank of New York, March 6, 2010.