the famous alphabet soup. pslf, pdff and it goes on. but there is method to the madness and i will highlight three precepts that guide our thinking. the first is insurance. don't put all your eggs in one acronym. the second is innovation. this is not your grandfather's fed. and the third is size. in an environment of great uncertainty, as we like to say in chicago, make no little plans. i will discuss each of these precepts in turn before concluding with some thoughts about the return to traditional policies. >> ok. on insurance, to understand the first precept we have to remember the diversity of risk that emerged in the past two years, and the speed at which they emerged. each risk was a challenge to our mandate of fostering sound financial system, stable growth and price stability. indeed, diagnosing each risk

raised difficult questions. we saw failures in parts of the financial system. how serious were they? and how would they affect the rest of the economy? we also saw economic activity begin to deteriorate significantly. how deep would the downturn be? finally, prices declined for the first time in decades. would we slide into an extended period of deflation? the diagnosis was surrounded with much uncertainty, and indeed some dire scenarios, but remedies that we considered brought their own measure of uncertainty as well. by definition we had little experience with these new policies. which treatment was appropriate and could be implemented in a timely fashion? particularly given the practical and legal constraints we were facing. under what circumstances and for how long should it be applied? how should the treatment be scaled back if conditions improve? the fed decided to adopt an approach that would be robust to

these multiple dimensions of uncertainty. rather than rely on any single tool les it prove inadequate, we have put in place a number of different remedies in quick succession in the hope we may learn which ones work best without losing valuable time. now, i won't retrace the complete list of new programs. and diane did a pretty good job with that timeline. i had almost forgotten some of those events as they occurred in rapid succession. these programs have been covered extensively in other speeches. but i will discuss one program because it demonstrates our second recent, which is the need to innovate as quickly as circumstances change. so let's look at the term asset-backed securities loan facility, or as we refer to it in the fed, the talf. the market for these securities has often played a vital role to

consumers and businesses. this market effective shut down in 2008 after the closure of leeman brothers. in response the fed formed talf in 2008. with backing from the treasury, talf provides loans to investors to finance chair purchases of highly rated asset backed securities with the securities themselves as collateral for the loans. and backing was from the treasury, so the tarp funding was instrumental in our ability to be able to do that. as conditions evolved, we modified the facility along multiple dimensions, even before it began its operations in the beginning of april. the first markets targeted by the facility were those for securities backed by relatively simple assets. the securities were familiar to market participants and their pricing was relatively straightforward. then we moved onto more complex and long-lived instruments. initially the only eligible securities were those backed by newly and recently activated

auto credit card and student loans and small business loans guaranteed by the small business administration. in april other securities were made eligible, backed by servicing advances, leases of business equipment or vehicle this month eligibility was broadened to commercial mortgage-backed securities. we changed the acceptable original nation date as well. initially securities were eligible for talf only if they were backed by new or recently issued loans. the intent was to bring the asset backed market back to life by directly financing investors willing to purchase the securities, and therefore indirectly funding the loans that backed them. in march 2009, the fed signaled that talf could be extended to legacy assets with the intention of stimulating the extension of new credit generally by easing balance sheet pressures on potential lenders. finally, the maxima further of talf loans has been extended

from three years to five years. and in february the maximum size of the total operation was increased from $200 billion to $1 trillion to match the growing list of eligible securities. admittedly, talf has generated two opposite concerns. one is that our credit requirements were too conservative and unlikely to fund large volumes. the other is that central bank is taking too much credit risk on its balance sheet. ill think we've struck a good balance between these concerns. we've taken appropriate action to limit our exposure to credit risks through stringent credit quality requirements on the assets, substantial haircuts, and the direct support of the treasury. importantly, talf is not intended to substitute for the a.b.s. markets as they existed before the crisis, nor is it intended to revive them to their former level of activity solely on the back of the federal reserve system.

the goal rather is to jumpstart these markets back to life by mitigating some of the stresses they are experiencing in turn this should allow them to reach their appropriate size in a less disruptive fashion. at this point we see evidence that talf is working as intended. spreads on asset-backed securities have come down. and while much of the recent a.b.s. issuance has been supported by talf loans, some institutional investors are reentering these and that's a very good sign. now the third precept relates to size. until recently, monetary policy tended to change in small steps. a behavior that some have labeled policy gradualism. our response to the the present crisis has moved beyond gradualism, as diane noted our rapid january 2008 cuts in the fed funds rate were one indication and the size of our nontraditional policies is another. last march as the fed gave

notice that talf would be expanded, the they also announced a considerable increase in the size of another program, our large-scale asset purchases in which we buy agency debt, agency-guaranteed, mortgage-backed securities and treasury securities. these actions taken together represented a substantial escalation of our nontraditional policies, and they will probably maintain or increase the size of our balance sheet well above what it was until a year ago. i think this grief move was appropriate considering the many risks we were facing. the direness of some forecasts, and the uncertainty surrounding our new tools. future developments will help us determine if our actions to date have been too much, too little or just right. we've moved swiftly to launch nontraditional policies but some of them have taken time to implement because their proper design required great care. and just as traditional policy is well-known to act with long

lags, nontraditional policies also take time to effect economic activity. so i expect to see further deterioration in some areas, notably job market conditions, before our policies gainful traction. weak economic news by itself would not imply that we have misjudged the size of our latest actions. and unfortunately my forecast sees the unemployment rate continuing to increase into 2010. in my view it would take a significant deterioration relative to our outlook for me to view our current policies as inadequate. over time the degree of success of specific programs will let us reconsider the size of our actions. if we find that a given program is not proving as useful as we anticipated, we would be faced with a choice between making its terms more attractive and taking on more risk or letting it lapse. we will then need to keep in mind that same level of

aggressiveness may not be warranted by the circumstances of the day. indeed, the possibility that the economy is close to a turning point is stronger now than just two months ago. financial spreads have improved even as long treasury and mortgage rates have increased. growth will likely turn positive in the second half. and disinflation air pressures have been weaken than we had feared. part of right sizing will be to decide where boldness ends. now, over time as the economy moves towards sustainable growth and stable prices, the fed will progressively return to its traditional policies. that is setting the fed funds rate, and will reduce its balance sheet in an orderly way. how will it do so? partly on its own. many of our liquidity programs provide short-term loans, so as these programs come to a tend the loans will mature fairly quickly and our balance sheet will shrink.

also, the pricing of our programs is designed to be unattractive in normal times. and most attractive to those who really need them in unusual times of liquidity stress. as they cease to be useful, they will cease to be used. indeed, some programs are already being used less, and we should see that trend continue as conditions in financial markets improve further. nonetheless, a significant portion of our balance sheet may not shrink on its own or at the appropriate rate. we need tools to reduce it actively so that monetary policy can be easily recalibrated. in this respect we can be as creative on the way out as we were on the way in. or put another way, we can be creative with our liabilities the way we have been -- we have been creative with our assets. on the asset side one way to manage our balance sheet is to sell the assets. they can be sold outright or they can be released through reversed, repurchase

transactions. on the liability side another tool is the repayment of interest on reserves which we began last fall. without interest on reserves, rates are raised only by restraining the quantity of reserves available to the market. and that's how we've always done it traditionally. reaching our target could require sharper reductionses in our balance sheet. with interest on the reserves we can raise the interest paid on reserves in tandem with our target rate. this will raise the opportunity cost to banks lending and keep the fed funds rate near the target. finally, as we announced in march, we are seeking with the help of the treasury additional tools through legislative action. an example of such tools would be the authority to issue interest-bearing debt in exchange for reserves or in expansion of the treasury's supplementary financing program. now, what circumstances might require us to use the tools we have and those we may have in the future to reduce our balance

sheet aggressively? one clear concern is price stability. our balance sheet grew very fast in a matter of weeks last fall, and it remains large. there are historical presidents for large increases in central bank balance sheets to result in broader credit expansion and to be subsequently associated with inflation. but i want to emphasize the middle link in this chain. inflation air pressures are unlikely to arise without broader credit expansion. and there's currently no evidence for that. nonetheless, these presidents explain why there is concern on this to reverse the growth in our balance sheet. now, forecasting inflation is never easy. and forecasting comes with this job. in the public's interest generates a mountain of independent views, appropriately. much like a giant auditing

service. but these are particularly difficult times for this type of forecasting. all one has to do is look at the remarkable lack of conners. the spread between the lowest and the highest inflation forecast for 2010 reported by the blue chip economic indicators is more than twice what it was a year ago for inflation in 2009. two conflicting forces could come into play to explain such a wide range of opinions. a high unemployment rate and low rates of capacity utilization such as we now have normally play strong downward pressure on costs and tend to lower inflation. indeed, some statistic cal models have pointed to possible deflation risks in the quarters ahead. but inflation has not fallen to the extent we might have feared, and there is another factor that could come into play, namely consumers and businesss expectations of future

inflation. so far expectations as measured by surveys have remained relatively stable. and that's a bit of a surprise considering the varyity of the downturn. but as economic conditions improve, consumers and business' might expect upward pressure on inflation and experience shows that a rise in inflation expectations, once solidified, becomes embedded in many economic decisions and makes inflation harder to restrain. currently with core inflation near 2% i see inflation at a level acceptable under normal circumstances. but these potentially two strong forces work in opposite direction, and the fed must be in a position to respond to which ever force dominates. in conclusion these have been challenging times and the fed has met the challenge with an array of innovative programs that depart from traditional policy. we pursued this approach in a manner that is both commence rate to the size and robust to the variety of risks we face.

the multiplicity of programs should not obscure the fact that although the means are many, the ends remain unchanged. both traditional and nontraditional policies are aimed at fostering a stable financial system, supporting sustainable growth, and ensuring price stability. as economic conditions improve and we lay the groundwork for an orderly reductions in our balance sheet, these ends remain upper most in our minds. thank you very much. [applause] >> i think i failed to remind everyone that you can write your questions down. and we have those at the center of the table, the cards? and they're collecting the card now. in the interim, charlie, i wanted to start with a couple questions. you started about your forecast and that you expect to see unemployment continue to rise well into 2010, which is a pretty much consensus forecast at this stage of the game.

how high do you expect the unemployment rate to rise and do you have a regional forecast as well? >> that's a great question. most recently the view within the federal reserve as projected by our central tendency of forecast was that the unemployment rate was likely to rise to a point of about 9.5%, and sometime in 2010 it would peak. frankly since we put those forecasts together, you know, events have transpired slightly better than i had envisioned at that time. at least in terms of financial markets and credit spreads. it has been disappointing, though, that unemployment rate leaped up so quickly to 9.4%. so if we previously thought it might top off at 9.5 to 9.75, we're almost there. so i think there is a risk that the unemployment rate is going to get closer to 10% than i thought it possibility that it might peak earlier than i had

previously thought. and i previously thought it might be sometime in the middle of 2010. i can of this year and then coming down. but perhaps at a higher rate than i thought before. i think we'll be seeing positive growth rates in the second half of this year. i think that growth will be sustained in 2010. and unfortunately the dichotomous behavior at the beginning of growth, job losses continue for an uncomfortable period of time is always a source of concern. it's something we had to deal with last time in 2003-2004, and it is upper most in our mind how to respond to. that. now, you know, in terms of the regional economy, you know, obviously in the five-state region that i have in my district we have the state of michigan and of course the front and center with all of the

difficult circumstances with the auto industry. and there of course things are much worse than the nation. chicago is tracking the nation fairly well at the moment. >> in terms of -- you talked about the economy turning positive in the second half, which many forecasters now agree with. the idea of whether or not it's a jobless recovery or not, which is i think what you're referring to with our last two recoveries were very low jobs, many people are sort of arguing that the depth of declines are so big that there is an opportunity maybe that real-time losses in employment, maybe they overshot and it might come back. i just wonder what your perspective was on that in terms of what's the chances of hiring suddenly coming back much quicker than many of us expect, certainly i in my own forecast as well? what do you think the probability of that actually occurring with still limited credit systems? >> so we're definitely experiencing recessions on the order of '74, '75 and '81-'82 which were deeper than the most

recent recessions. and since we're experiencing that unfortunate depth, hopefully we can experience the job rebounds that came much more quickly after those recessions. i think it will depend tremendous amount on how businesses feel about how things are going, looking forward i think that in the -- since the mid 80's businesses have been much more attuned to keeping their inventory in line. they never really became excessive. they've cut back quite a lot during this recession. but because they weren't as -- they didn't have excess inventories, it's just that downturn was so quickly i think that they've right-sized those better. that would be better for growth and presumably employment when growth picks up and you find that you need additional labor input in order to meet the demand, that's ultimately the question that businesses will have to come to grips with. and how optimistic they are for future capital expenditures. but given the amount of

uncertainty that we've faced recently, i would sort of expect a more midland path between those two experiences. >> this sort of lead to the next question here. and that is many people certainly ask this as well. what are the key driving forces to get the u.s. economy out of this recession? and i know you and i know statistickicly what can get us to positive growth in the second half of the year, but getting to self-feeding recovery is a little bit of a different issue. if you can maybe go through those two steps. >> that's always a hard issue. it's easy to sort of dream up reasons why the economy is facing challenges and a little more difficult to see where all the bright spots will be. one thing that we're looking at at the moment is the positive side of the inventory cycle, which is that businesses have already cut inventories to a fairly lean level. there's been tremendous amount of deaccumulation. so we ought to get a positive boost just for sort of cyclical reasons coming out of. that now, hopefully that can jumpstart a better level of confidence and businesses will

start thinking about expanding their capitol expenditures. they're probably thinking at the moment if they have adequate access to funding at a cost toe capital that is reasonable to them about sort of changing vintages of capital investments. normally this is a period if of the recession and the destruction that comes with it, you hopefully should benefit from the creative destruction that comes out of that and the business opportunities that are afforded a number of innovators and entrepreneurs who can take advantage of new opportunities. but the world economy, you know, slowing down and experiencing every bit as much or more than what we have experienced, that is unlikely to be an engine of future growth as well. although our net ex ports behavior has been surprisingly good during this -- >> ex ports falling less than imports. >> that's right. >> not exactly positive. >> but that will continue to be a source of uncertainty for businesses as they think about where to position themselves and how to deploy resources.

that's a bunch of the issues. >> there's a lot of questions here on inflation and how you measure inflation. before we get to that i'm going to take a quote that you made. and that is "disinflationary pressures were weaker than the fed had feared" which does that mean we need to evaluate inflation sooner i guess. and the questions coming up, what are the indicators the fed is using as a measure of inflation today, since we all know there are -- know there are many. are you confident that many are right? and do you think the model is using -- the models that fed is using are effective to forecast inflation? i'm not sure any of us can. but i'm asking you fairly on that one since all of us have been off on that issue. >> right. so there has been a lot of research recently on -- which uncovers something that many people in this room already knew before the effort went into it, which is inflation is devilishly difficult to forecast.

our success in forecasting inflation movements is not especially good, not something that i would write home about. so it is a very large difficulty for all of us. now, during the current environment with the economic contraction that has been so large, we were expecting to see -- and we have seen -- large resource gaps emerge which would tend to put downward pressure on prices. businesses would not have been experiencing upward pressure on their costs, they were coming down. this was after the big rise in commodity prices and enaur prices that was a beneficial effect of those coming off, how much of that would be passed through. but we definitely saw that ben effect. and the fact that workers are being laid off. wage pressures are minimal in that environment. resources are relatively abundant and able to be deployed. it's just very difficult to see inflationary pressures. everything else equal set off by

that set of circumstances. you wouldn't imagine price setting prices to be lower. we have seen some of. that the question is how much would you have expected with an unemployment rate forecast headed upwards of 10%, which is a very large number relative to the sustainable level of unemployment which we probably peg at closer to 5%. that's almost 5 percentage points of, you know, unutilized resources which are very valuable. the offsetting -- so i would have expected inflation to come down a bit more. in fact you can put together a variety of statistic cal models that will follow those forecasts way down for inflation. but inflation so far hasn't come down that quickly. it does -- it is rather inertial. it takes time for it to respond. and we are still concerned that disinflationary forces are out there. but another piece of the equation is inflationary expectation. if the public in setting their

expectations for how prices are going to move, and if that feeds into wage demand and also price setting by businesses, if it's a little bit higher than what we thought it would be that would tend to offset that some amount. so looking for indications that either of those factors are behaving differently or more strongly than we had guessed. so we're well attuned to thinking about how large resource gaps are, and we're looking at all measures that provide an indication of inflationary expectation. surveys from the michigan survey and those move around a bit. they're a bit inertial in terms of the longer 5 to 10-year inflation forecasts. they have not behaved in a way that makes us concerned although they moved up a little bit recently. and then the tips data we're always looking at that. it's a big challenge to sort of parse through the liquidity issues and the premiums which have changed a lot in those

markets. those are some of the things we're looking at. >> this is related bringing about to the industrial midwest what's been going on in the auto industry. one of the arguments of course for bailing out the auto industry was to save the tier two and tier three suppliers because there was a fear that would undermine the entire manufacturing sector, caterpillar, non-auto sectors soar of what was left, ford and toyota in. terms of this credit crisis there's anecdotal evidence that a lot of companies in the supply chain went chapter 7 and chapter 11 during the course of the credit seizure in the fall that could cause a stumbling block to getting ramping up on production and perhaps more inflationary pressures. what's your sense of the anecdotal versus the reality of that? was the bailout of the auto industry or the one that's going on going to stop that from happening? i won't ask if you think it's necessary or not. that's too political to put you in the spot of. that but i just wonder what you thought happened to the supply chain.

one of the big issues of the early 190's was the major -- 1980's was major destruction of distortion. >> i think it's a little too early to know precisely what the effect of the current policies have been. i think it's a real challenge to sort of parse through the financing issues versus the structural issues facing the industry, the disbursed supplier networks, how -- how they are used by each of the companies in that chain. there had been the feeling i know from years before that the supplier chain was a bit larger than needed for the sales and production base that they were looking at. so sort of parsing through probably what needed to take place in the absence of the financing difficulties on top of it with the financing difficulties. i mean there's going to be smaller for sure. but through the this entire economic and financial period of distress, we've been constantly

thinking about spillover effects where companies, state and local governments, are impacted not through fault of their own but because of financing that puts them at greater risk, unnecessarily to the extent that something a bit more orderly can be engineered in terms of easing credit pressures through a transition, not permanently but just in a transitory fashion. that's sort of been the goal. so for the auto suppliers it's a sort of similar type of situation. >> it goes back to the national forum. and ben bernanke recently made a statement to congress about fiscal discipline. and the role that deficits could play in the future in terms of spurring inflation, a little warning shot to congress and the administration to think beyond the current recession. and there's many questions about how badly the current deficit problems could later influence

inflationary pressures, how much will they complicate your job at the federal reserve to not have more fiscal discipline, and what is going to be the interaction. so what's your sort of sense about inflation and the issue of monetary versus fiscal stimulus which i think both you agreed on at the time were certainly needed at the time. but with the exit strategy discussing with the g-7 right now, is that just your exit strategy but it's how do we get out of of fiscal deficits as well. >> so this is an unbelievably difficult time for everybody. and personally i looked at the last election as no matter who won the election, this would be the administration that had to deal with the fiscal issues facing the country and taxpayers coming down the line with changing demographics, the baby boomers retiring, social security, medicare, and everything. >> i think we've eliminated the retirement