TAILIEUCHUNG - Financial Stress: What Is It, How Can It Be Measured, and Why Does It Mattter?

The Nation continues to face extraordinary financial and fiscal challenges. Signs of progress are already evident as Treasury and the Government as a whole continue to develop and implement an array of efforts to foster continued economic recovery. Realizing the true return on those efforts requires perseverance and patience. However, even as the Government continues its current efforts to foster economic growth, it should not lose sight of the long-term fiscal challenges associated with its social insurance programs compared to expected future levels of revenue. The Nation must bring social insurance expenses and resources into balance. | Financial Stress What Is It How Can It Be Measured and Why Does It Matter By Craig S. Hakkio and William R. Keeton ihe . economy is currently experiencing a period of significant financial stress. This stress has contributed to the downturn in the economy by boosting the cost of credit and making businesses households and financial institutions highly cautious. To alleviate the financial stress and counteract its effects on the economy the Federal Reserve has reduced the federal funds rate target substantially and undertaken unprecedented actions to support the functioning of financial markets. There will come a point however when the Federal Reserve needs to remove liquidity from the economy and unwind special lending programs to ensure a return to sustainable growth with low inflation. In past recoveries the decision when to tighten policy was based mainly on the strength of business and consumer spending and the degree of upward pressure on prices and wages. An additional element in the current exit strategy will be determining if financial stress is no longer high enough to endanger economic recovery. As financial conditions begin to improve the various measures of financial stress that the Federal Reserve monitors may give mixed signals. In this situation policymak- Craig S. Hakkio is senior vice president and special advisor on economic policy and William R. Keeton is an assistant vice president and economist at the Federal Reserve Bank of Kansas City. Research associates Ross Dillard Paul Rotilie and John Seliski helped prepare the article. This article is on the banks website at . 5 6 FEDERAL RESERVE BANK OF KANSAS CITY ers would greatly benefit from having a single comprehensive index of financial stress. Such an index could also prove valuable further down the road when the Federal Reserve might again need to decide whether financial stress was serious enough to warrant special attention. This article presents a new index of .

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