Maestro

by Bob Woodward

  Blinder said that he thought 1/4 percent would be sufficient. That was the standard Fed increase, and Blinder saw no need for more, given that the Fed had already raised rates four times since the beginning of the year.

  Greenspan disagreed. The economy was hot. The chairman indicated, in no uncertain terms, that more than the normal increase was required.

  Blinder was less concerned about individual rate increases than he was about where the Fed would wind up in this series of increases. Where was this going? How much was enough? What would tell them when to stop? Blinder was in favor of keeping inflation low, but he was worried that the Fed might be headed toward overkill, a crash instead of a soft landing.

  The FOMC didn’t like to accompany its rate decisions with any clear wording, Blinder knew. Zero wording—implying that the rate decision could speak entirely for itself—was beautiful in the world of the Fed. But Blinder thought that the Fed needed to explain itself if it were going to raise rates by 1/2 percent. He asked Greenspan, If the 1/2-percent raise were inevitable, would it be possible to issue a statement declaring that the Fed would go to the sidelines after the rate hike, indicating that no immediate additional rate increases would be forthcoming?

  Greenspan said a statement would be possible.

  Blinder said he thought a statement would be essential if the entire committee were going to vote for a 1/2 percent hike.

  After about 15 minutes of discussion, Greenspan agreed and left. He had promised Blinder a statement of some kind, and Blinder in turn gave the chairman his vote.

  Greenspan knew that Blinder had essentially issued an ultimatum. Ultimatums were not useful around the Fed.

  • • •

  The second Clinton nominee to the Fed board was Janet Yellen, 47, a gray-haired Yale Ph.D. who had taught economics at Harvard and the University of California at Berkeley. She had worked at the Fed in the 1970s as an economist, written extensively and was currently a professor at Berkeley’s business school. Yellen was a strong advocate for low unemployment, which she believed was good for the country and better than any possible government policy for the disadvantaged. She was sworn in several days before the August 16 FOMC meeting.

  At the meeting, Greenspan, the old members and Blinder and Yellen gathered in the second-floor meeting room at the Fed. For more than an hour, Greenspan led a discussion on the state of the economy. Bank presidents and governors talked about the economic performance they saw, ranging from hot to middling to even somewhat cold—reflecting the sometimes wide variation of economic activity in different geographical areas. Blinder said that he thought they could allow unemployment to get lower without inflation. “I’d just like to say I don’t think 6.3 percent unemployment should be the FOMC’s aspiration level,” he said. “I have a strong feeling that we ought to be shooting for a lower unemployment rate than that.”

  Yellen said she agreed and thought it possible to “even shave a few tenths more off the unemployment rate without risking significantly a pickup in inflation.”

  “Let me get started,” Greenspan said after everybody had spoken. As he launched into his customary summation of the economy, the chairman again indicated his strong distrust of the economic growth numbers that the committee had before them. Recent numbers suggested that productivity—the number of goods a worker produces per hour—was down, and Greenspan still didn’t believe it. “I find utterly noncredible the probability that, in the real world, productivity declined,” he said. Profits were up, but prices weren’t. Increased productivity was, in Greenspan’s mind, the only mathematically possible way to account for the increased profits that the Fed district bank presidents were reporting.

  “A statistic we don’t talk about very often,” Greenspan added, “. . . is the extraordinary rise in net business formation.” New business formation had taken a “fairly sharp upswing,” an event that is not consistent with an economy that is in its final and declining stages. A sharp upswing in business formation showed that the momentums in the economy were hardly slowing, as some had argued.

  The situation as a whole made Greenspan nervous. “This stuff is really beginning to move,” he said.

  “I think one has to conclude, as far as policy is concerned, that another upward notch in rates is clearly called for at some point,” he said. The voluminous staff report on the economy, prepared for each committee meeting, estimated that the Fed would eventually have to raise rates a full percentage point. Greenspan said that he didn’t know if this was the right number, but 1/2 point “may be enough if we do it now.” If they moved 1/2 percent now, the chairman said, the chances were better than 50–50 that they would not have to increase rates any further before the end of the year.

  “I’m a little concerned that 1/4 a point would merely raise the issue of when the other shoe is going to drop,” Greenspan continued. He offered his personal assessment of the market reaction to a 1/2-point raise: “My own view—I’m being a little more detailed than I usually am, so I hope people will excuse me in this respect—is that it’s very important if we were to do 1/2 a point, that we not give the impression that somehow we anticipate major accelerations and this is just the beginning of a long series of 1/2 percent increases. . . . I think we have to be very careful to avoid giving that impression. The only realistic way we can avoid that is to issue some type of statement.” The statement could declare the Fed’s “intention to hold for a while without tying our hands, which we cannot do.”

  Pleased that Greenspan was living up to his agreement, Blinder thought there was now a fighting chance that this might be the last needed rate increase.

  “The more I think about that as a potential sort of policy package, the less I like all the other alternatives,” the chairman concluded.

  “I just want to take two minutes to emphasize that it really is a package,” Blinder said shortly after the chairman had finished. “So with such a strong statement, I not only support but support enthusiastically the suggestion of the chairman.” Just in case his point was missed, he added, “Without it, I would not.”

  Greenspan read a draft of a proposed statement, which stated vaguely that the Fed expected the rate hike to be sufficient “at least for a time.” That could mean months or to the end of the year, but the chairman knew that it could also mean precisely 4 minutes and 37 seconds—or less. In other words, the statement meant almost nothing.

  Greenspan called for the votes on the 1/2 percent increase, to be accompanied by the statement.

  Yellen was quite surprised. Despite the on-one-hand, on-the-other-hand quality of some of the discussion and the apparent differences among some of the members, it was clearly a committee that was not going to live with higher inflation and had become incredibly aggressive in raising the fed funds rate. She had heard reliably that the rate increases did not make the president’s day—and here she was, a new Clinton appointee at her first FOMC meeting, being asked to vote for a 1/2 percent increase. There were already 11 votes for the chairman’s proposal. As the junior member, she was the last to cast her vote.

  Yes, she said, making it unanimous. The increase might help them buy a longer expansion, she reasoned.

  After the meeting, Greenspan complimented Blinder and told him that he had earned his pay.

  The interest rate hike caused rallies in the stock and bond markets, where traders saw the Fed’s half-point hike as a strong offensive against inflation. It angered some congressional Democrats and others who believed that the rate hike risked sending the economy into a severe downturn.

  Nearly all of the coverage in the media focused on the 1/2 percent hike, with very little mention of the Fed’s statement regarding its intention “at least for a time” to avoid any further moves.

  A confrontation had been avoided. Blinder felt it was a good outcome, but he also realized that Greenspan was in total control.

  • • •

  Less than two weeks later, most of the FOMC members attended the Kansas City Federal R
eserve’s annual retreat in Jackson Hole, Wyoming. Held at the foot of the Grand Teton mountains, the conference offered much needed relief from Washington, D.C.’s August swamp weather. Central bankers from around the world, in addition to academic economists, policy makers and journalists, attended seminars in the morning and then enjoyed outdoor activities in the afternoon.

  The overall theme of the gathering was “Reducing Unemployment,” and Blinder was asked to give some concluding remarks at the end of the conference on Saturday, August 27.

  He had spoken at the Jackson Hole conference before, as an academic unbound by the customs and responsibilities of working at the Fed. He made it clear at the outset of his 20-minute speech that he understood the difference: “It is quite clear that in my new job, my role is to say nothing—and certainly not to say anything interesting,” he joked.

  In a further attempt to be funny, Blinder quipped that he was happy to see the others in attendance were seriously talking about reducing unemployment, as opposed to increasing it. Fed-induced recessions to control economic growth and avoid inflation had traditionally sent unemployment skyrocketing. Not everybody laughed.

  Blinder then argued that the Fed might be too focused on preserving price stability and fighting inflation. Shouldn’t the Fed embrace with equal intensity the goal of maximum employment, a goal written explicitly into the most recent law governing the Fed? “The central bank does have a role in reducing unemployment,” he said.

  The next day, Blinder was dismayed to read the New York Times story on page 26, which stated that in his speech he “publicly broke ranks with most of his colleagues” and that his comments “revealed an intellectual split” within the Fed. On Monday, August 29, the Times pounced again with a business section front-page story headlined “A Split Over Fed’s Role; Clashes Seen After Vice Chairman Says Job Creation Should Also Be a Policy Goal.” The story drew a sharp contrast between Blinder and Greenspan, who had recently reaffirmed his view that inflation fighting was the primary goal of the Fed.

  As Blinder saw it, he’d been asked to deliver the summation speech at a seminar called “Reducing Unemployment.” What else was he supposed to talk about?

  The Full Employment and Balanced Growth Act of 1978, called the Humphrey-Hawkins Act after its legislative sponsors, mandated that the Fed do its best to achieve maximum employment, and Blinder thought he had merely drawn attention to that responsibility. A New York Times story disagreed, noting that emphasizing jobs over inflation was like “sticking needles in the eyes of central bankers.”

  Greenspan went on vacation without commenting, leaving Blinder to twist in media winds, which eventually dubbed the situation “L’affaire Blinder.” A three-inch stack of stories about a rift at the Fed followed. Newsweek columnist Robert J. Samuelson declared that Blinder was not only soft on inflation, a mortal sin in central banking, but that he also lacked “the moral or intellectual qualities needed to lead the Fed.”

  A simple word or sentence to key Fed reporters from the chairman, even off the record, noting that the whole matter was part of a standard policy debate could have ended the furor, Blinder believed. He interpreted Greenspan’s silence as intentional. For one reason or another, Greenspan wanted to let him twist.

  Yet Blinder did not raise the issue with him directly, realizing that Greenspan had not only plausible but perfect deniability. The chairman hadn’t created the controversy, and surely he couldn’t be held accountable for the media. Blinder didn’t want to go begging. In his mind, the “chairman who wouldn’t speak” took on a life of its own. Blinder believed that Greenspan was manipulating the press. His silence was just as damaging as, if not more so than, any negative comments that he might have made. Nobody, Blinder believed, knew how skillfully Greenspan played the Washington political inside game. He was witnessing its subtle but deadly sting firsthand.

  Though he never said it publicly, Greenspan thought Blinder’s speech was unnecessarily provocative and somewhat muddled intellectually.

  • • •

  Blinder was scheduled to give a speech in a downtown Washington hotel on September 8. Afterward, dozens of reporters and many cameras awaited him. Blinder realized he had a choice either to act like a football player or to stop like a civilized person to answer a few questions. He stopped and answered the questions, downplaying any philosophical rift between himself and the chairman.

  The next day, The New York Times reported that Blinder had held an “unscheduled” press conference. Son of a bitch, he said to himself. It looked as if he were putting himself forward, showboating. Fed governors didn’t have press conferences. If he hadn’t been discussed as a possible contender for Greenspan’s job in 1996, Blinder believed the press attention would have subsided. He consistently maintained that he had never spoken to the White House about the possibility, and he seemed hurt that his relationship with Greenspan had been damaged. Nonetheless, Blinder refused to close the door on the possibility that he might become the next Fed chairman.

  He talked to The Wall Street Journal and was asked if he wanted to succeed Greenspan. “I don’t spend a lot of time thinking about it,” he said, suggesting that he spent at least some time on the subject. “It’s a fantastic opportunity if it comes along. For the time being,” he continued suggestively, “we have a very good chairman of the Fed. The job is not open.”

  • • •

  At the next FOMC meeting six weeks later, September 27, Greenspan paid homage to their “at least for a time” statement and said they would have to have strong evidence to move now. He didn’t think it existed, but at the next meeting they probably would have to raise rates another 1/2 percent.

  In the days before that next meeting on November 15, Blinder thought the economy was looking stronger—too strong. A roar was coming up from the markets, saying that the Fed had goofed with its sideline statement and was behind the curve. Forecasters were beginning to predict that in the current rate-tightening cycle, the fed funds rate that was now at 43/4 would eventually reach 8 percent or higher. Blinder knew that the Fed had to act, but he thought that the predictions of an 8 percent fed funds rate were ludicrous.

  Greenspan asked to see him again. When the chairman arrived, he said he wanted to make a dramatic gesture to show that the Fed was not behind the curve, to show the Fed’s teeth in a big way.

  Blinder agreed, saying that the economy was running hard and something had to be done. He told Greenspan that he would have no trouble with a 1/2 percent increase at the coming meeting, as Greenspan had suggested at the September meeting.

  Greenspan wanted to move a full 3/4 percent.

  Blinder was a little bit surprised. He had concluded that they would eventually have to move a total of 3/4 percent, but he thought that it might be wise to do it incrementally.

  Greenspan wanted to get there right away. He didn’t cite any specific data, focusing instead on his feeling that the pot was boiling and that 3/4 percent was the only way for the Fed to get out ahead of the markets.

  It was a major disagreement. Blinder was worried that a 3/4-point raise all at once could shatter confidence in the markets and have a negative effect on the rest of the economy, particularly on the people who were out there trying to buy homes.

  Greenspan stood firm.

  Hmm-hmm, Blinder finally said noncommittally—a kind of unspoken “I don’t know . . .” He did not indicate to the chairman that he would go along.

  • • •

  Blinder and Yellen conferred about the staff forecast that was circulated to the FOMC members before the meeting. It assumed the Fed would raise rates 11/2 percent over the next several meetings. Given the 13/4 percent increase that year already, the total rate increase would be an astonishing 31/4 percent in one year. Both Blinder and Yellen thought this was way too much. Given the one-year lag in impact, that would mean much of the drag on the economy would occur in 1996—election year. They both decided to speak up at the November 15 FOMC meeting.

 
Blinder had the staff run a model on the impact interest rate changes might have on the overall economy. The strong doses of interest rate decreases put into the system by the Fed in 1991 and 1992 would have their maximum impact in 1993 and 1994 and then wither away, according to the complex mathematical model the staff used. In 1994, the stimulus provided by the easier policies of 1991–92 was causing the economy to grow an additional 11/2 percent, the model said. By 1996, however, the effects of policy in 1991–92—and the additional 11/2 percent growth that that policy brought with it—would have worked their way out of the system.

  Further, if the Fed raised rates by 31/4 percent by early next year, the impact, according to the model, would be to take about 1 percent off the 1996 economic growth rate.

  So the joint effects of the Fed’s interest rate policy from 1994 to 1996 would be stunning. By 1996, they were looking at a total swing of 21/2 percent off the national growth rate. That was a giant number. The economy had grown only 31/4 percent the previous year. If they did what the staff forecast, the Fed could grind the economy to a halt.

  “Now, what concerns me the most,” said Yellen at the November FOMC meeting, “is that the assumed further tightening of 11/2 percent entails considerable downside risk to the economy that will be concentrated in 1996.

  “There is a real risk of a hard landing, instead of a soft landing, if we are too impatient and overact.” Though she supported some increase in rates, she said the 11/2 percent over the next several months could be overkill. She said more than once that it would make itself felt with a hard landing in 1996.

  Blinder pointed out that the staff projection of another 11/2 percent fed funds rate increase in the next several months included a projection that this would have almost no impact on the long rates. An impact on the long-term rates couldn’t be ruled out, he said. It was not impossible. “I think it takes a certain amount of guts to project that,” he said sarcastically. “I commend the staff for having that much guts; it is more than I have.” He took 10 minutes to present his model, showing how the amount of tightening described in the forecast would represent a swing of 21/2 percent in national growth from 1994 to 1996. What they were contemplating was not trivial. “It is very strong medicine,” he said, enough to stop even an economy with considerable momentum. “It is therefore not to be prescribed lightly.”