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1. The Recent Slowdown Views about the role of government credit in promoting financial and macroeconomic stability tend to be shaped by views about the role of credit in the business cycle. In one popular view, credit market disturbances, such as the recent rise in losses on mortgage-backed securities, cause banks and other credit intermediaries to pull back credit supply as they attempt to repair their balance sheets. The reduction in lending to households and firms forces them to reduce their spending on goods and services and creates an additional drag on growth. An alternative view is that shocks to the economy affect spending more directly and that as growth declines, the creditworthiness of households and firms deteriorates, causing credit flows to fall and spreads to widen. These two views represent opposite directions of causality between credit and aggregate spending. In reality, both of these directions may well be in operation at the same time, and determining the quantitative importance of each is very hard. But, my reading of recent events emphasizes the second view, in which the effect of slowing growth on credit conditions predominates. This view has received much less attention than it deserves, I believe; so let me say a few words about the current cycle in light of this issue.

These two dimensions of the Fed's response are interconnected, as both involve the use of our balance sheet; but they have different impacts on the economy. So today, I would like to speak about the economic effects of government lending and how that relates to our broader monetary policy goals. In doing so, I will note what I see as important differences between monetary and credit policy; and I will offer my thoughts on the Fed's role in the extension of government credit. And I am sure that you will not be surprised to hear that these are my own views and not necessarily those of any of my colleagues on the Federal Open Market Committee (FOMC).