42. Via the FDIC, the American public now explicitly guarantees the bonds of Wall Street firms where bonuses are surging and individual employees can be paid millions of dollars a year. What is your opinion on the morality of this guarantee? The Federal Deposit Insurance Corporation’s Temporary Liquidity Guarantee Program (TGLP) is one of many necessary actions taken to stabilize financial markets during a time of unprecedented financial stress. These actions helped support the flow of credit and mitigated the most severe potential effects of the turmoil on the economy. Many households and businesses benefited from these guarantees. These and similar actions were taken with the sole objective of better achieving the mandate given to us by the Congress, namely (for the FDIC) to mitigate serious systemic risks and (for the Federal Reserve) to promote financial stability, price stability and maximum employment. Hence, they were justified--indeed necessary and appropriate under our Congressional mandate. 43. The importance you place on the output gap is well known. You have often cited “excess slack” in the economy to justify loose monetary policy, arguing that a large output gap lowers the risk of inflation. But economists such as Allan Meltzer have noted that there are "lots of examples of countries with underutilized resources and high inflation. Brazil in the 1970s and 1980s." Moreover, in a new paper dated December 2009 and titled "Has the Recent Real Estate Bubble Biased the Output Gap?", researchers at the Federal Reserve Bank of St. Louis state “Because this (predicted) output gap is so large, several analysts have concluded that monetary policy can remain very accommodative without fear of inflationary repercussions. We argue instead that standard output gap measures may be severely biased by the bubble in real estate prices that, according to many, started around 2002 and burst in 2007.” They conclude with a warning: "We offer a word of caution to policymakers: Policies based on point estimates of the output gap may not rest on solid ground." Please comment on 1) Allan Meltzer's point and 2) the St. Louis Fed's research paper. Why do you continue to put such a high priority on the output gap? I do find the evidence compelling that resource slack, as measured by an output or unemployment gap, is one factor that influences inflation. But it is not the only such factor, and Allan Meltzer is correct that there have been examples of underutilized resources coinciding with high or rising inflation. This was the case in the United States in the 1970s, for example, when large increases in the price of imported oil both raised inflation and held down production. Furthermore, estimates of the output gap are inherently uncertain, and I agree that it is important to keep that uncertainty in mind when we make decisions about monetary policy. Some estimates, such as the one you cite from researchers at the St. Louis Fed, suggest that the output gap is not large at present. However, the bulk of the evidence indicates that resource slack is now substantial, as evidenced by an unemployment rate of 10 percent and a rate of manufacturing capacity utilization of only 68 percent--lower than seen at the trough of every postwar recession prior to the current one. Thus, I continue to expect slack resources, together with the stability of inflation expectations, to contribute to the maintenance of low inflation in the period ahead.
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