I am delighted to be back at Duke University after spending many summers of my childhood here with my family visiting my uncle and his family. As you might know, my uncle Samuel DuBois Cook was a political theorist and the first African American professor tenured at Duke and at a major southern university. My family and I have many fond memories on this campus.

I am also happy to be with you in the Economics Department today to discuss financial stability.¹

My own work as an academic has frequently reinforced the importance of financial stability in the United States and abroad. Early in my career, I examined the impact of underdevelopment in the Russian banking system on growth in post-Soviet Russia and the instability that can occur in a poorly regulated financial system. Years later, as an economist on the Council of Economic Advisers, I saw how weaknesses in the financial system contributed to instability in the euro area. These formative experiences shaped my view that the Federal Reserve's work on financial stability is critical to the well-being of households, businesses, and the broader economy. This is one reason I particularly value the opportunity to serve on the Board's Committee on Financial Stability.

I will focus my remarks on my assessment of financial stability risks, based on the Federal Reserve's framework for monitoring vulnerabilities in the financial system. In my view, our financial system is substantially more resilient than it was in the mid-2000s, reflecting progress by regulators and the private sector in boosting resilience. That said, we cannot be complacent, and I see some important risks.

Achieving the Federal Reserve's dual mandate of maximum employment and stable prices depends on a stable financial system. 2 We all saw how the Global Financial Crisis triggered the Great Recession and brought misery to countless millions who lost their jobs, homes, or investments.

A stable financial system provides households, communities, and businesses with the financing they need to invest, grow, and participate in a well-functioning economy— even when hit by adverse events or “shocks.” Consistent with this view of financial stability, our framework for how we think about this goal—as laid out in our Financial Stability Report (FSR), which was just released in October—distinguishes between shocks to, and vulnerabilities of, the financial system.3 Importantly, and as we economists know, we cannot predict exogenous shocks, which are, by definition, the surprise events that will hit the financial system and economy. By contrast, vulnerabilities—the aspects of the financial system that would exacerbate stress—tend to build up over time and can be identified, assessed, and monitored. In the example of the Global Financial Crisis, although it was widely recognized that housing valuations were high, the magnitude of the ensuing price drop was unexpected, or a shock. That shock was amplified by vulnerabilities that had built up within the financial system over time, including weak bank capital, excessive household debt, lax lending standards, and fragile short-term wholesale funding. One hard-learned lesson of the crisis is that the Fed and other regulators must watch closely for vulnerabilities that may build up within the financial system. 

Based on this experience, other historical episodes, and academic research, we focus, in the Board's FSR and other work, on assessing vulnerabilities across four broad categories related to asset valuations, borrowing by businesses and households, financialsector leverage, and funding risks. We also consider, through contacts with market participants and experts, near-term risks that, if they were to come to pass, could interact with these vulnerabilities.

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