Federal Reserve policy actions starting this past August to temper strains in financial markets have generated considerable commentary, some of which reflect concerns that policy action in such circumstances creates moral hazard. The issue is extremely important, and, given that it is so current, this is a good time to reflect in general on the Fed's reactions to financial market developments. A traditional bailout involves governmental assistance to a particular firm, group of firms, or group of individuals. An important reason for opposition to bailouts is that it is essentially impossible for a bailout not to set a precedent for the future. The "Fed put" argument is usually stated in terms of monetary policy reactions to stock market declines. The same Fed policy that succeeds in stabilizing the price level and the real economy should tend to stabilize financial markets as well. Thus, the element of truth in the "Fed put" view reflects expected and desirable outcomes from successful monetary policy.
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