by Calculated Risk on 3/09/2006 04:27:00 PM

New York Fed President Timothy Geithner spoke today on U.S. Monetary Policy in the Global Financial Environment

I will focus on two features of what is happening in the world economy and financial markets today ... These are, first, the behavior of forward interest rates in financial markets, and, second, the pattern of external imbalances.

These features are interesting, in part, because they seem somewhat anomalous, or inconsistent with what the past has led us to expect. They seem likely to be related to each other and both are a feature of the changes underway in global financial integration. Understanding the forces behind these phenomena or anomalies is important to thinking through what they mean for policy.

After discussing the possible causes for these two features, Giethner turns to the implications for policy:

What might this mean for the conduct of monetary policy? To the extent that these forces act to put downward pressure on interest rates and upward pressure on other asset prices, they would contribute to more expansionary financial conditions than would otherwise be the case. And, if all else were equal, which of course is unlikely ever to be the case, monetary policy in the affected countries would have to adjust in response; policy would have to act to offset these effects in order to achieve the same impact on the future path of demand and inflation. To do otherwise would run the risk that monetary policy would be too accommodative, pulling resources from the future in a way that would alter the trajectory for the growth of the capital stock, perhaps amplifying the imbalances, and compromising the price stability.
...
Let me conclude by observing that a constellation of factors has aligned to produce the current combination of low world interest rates, low risk premia and large global imbalances. Most of these factors are outside the control of U.S. monetary policy, and we do not fully understand their implications for our economy and for policy. The process of global economic integration makes it ever more important that we work to improve our understanding of how this complex of global monetary arrangements affects our objectives.

I suggest reading the entire speech.