The U.S. economy and financial system remain vulnerable to another asset bubble, and there is "significant risk" of one developing, John C. Williams, president and chief executive of the Federal Reserve Bank of San Francisco, said Friday.

Many "glaring weaknesses" were addressed by regulatory reform, Williams told the International Monetary Fund's annual research conference. "These reforms are vital," he added. "But I am not convinced they will be enough to forestall another major crisis."

It has been said that "financial markets are driven by fear and greed," Williams said, according to a prepared text of his speechs released by the Fed. "Evidently, no law or regulation can completely contain this dynamic."

"Second, recent reforms do not fully address a basic fact bared during the financial crisis: the funding system rooted in the capital markets is inherently at risk for runs, contagions and panics," he said. "It remains untested whether supervisors can successfully complete an orderly resolution of complex, systemically important international financial institutions during a period of heightened uncertainty."

Also, Williams noted, some tools used in past crises may not be available in the future. Dodd-Frank will stop the Fed from providing "liquidity to individual institutions and to nonbank segments of the financial system," he said. In addition, getting the needed action "by the fiscal authority" to guarantee debt could take too long.

Financial stability and macroeconomic stability are linked. "Risks to financial stability are first and foremost risks to future economic activity and inflation," he said.

To fight financial instability, macro-prudential policies should be the "first line of defense," but monetary policy will need to play an active role, Williams said. "The main reason we care so much about financial stability is because financial crises can have devastating consequences for standard macroeconomic variables, such as employment, output and inflation."

"Therefore, in thinking about the role of monetary policy in maintaining financial stability, we need to integrate financial stability into our models of the macroeconomy," he said.

"We can't think of them as separate spheres. Approached this way, the answer to the question whether monetary policy should be concerned with financial stability seems obvious," Williams said. "To the extent that monetary policy actions influence the emergence of risks to financial stability, these actions also indirectly affect the future path of economic activity and inflation."

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