oh wow. >> he's learned some stuff about the state's. >> that informs a lot of the book because none of this is normal to me. was out. .. >> and for the next hour and a half we're going to be talking about volume two in alan meltzer's magisterial history of the federal reserve. as you know, this is a work long

in coming, and it was a little difficult to know how to summarize 1312 pages to have history of the federal reserve from 1951 to 1986, but then we realized we have the living embodiment of much of that hu ri sitting -- history sitting to my left in terms of palm volcker. he join -- paul volcker. he joined the federal reserve staff in 1952. >> [inaudible] but i joined in '49 for nine months and then went back to graduate school and then came back permanently in '52. >> okay. [laughter] then bracketed by a stint in the private sector, he was directer of financial analysis in 1962 where he first met alan meltzer and then deputy undersecretary for monetary affairs from '69-'74 he was the

undersecretary of the treasury for international monetary affairs, president of the federal reserve bank of new york from 1975-1979 and then chairman of the federal reserve starting in 1979. i'm saying this not because paul volcker needs an introduction to any of you, but rather to underscore that his career is interwoven in the history of the federal reserve that alan talks about in volume two. what i'm going to do this morning is ask a series of questions to alan and chairman volcker including one -- a set for each of the four decades covered by volume two. and then probably by about 10:00, open it up i to questions from the crowd -- open it up to questions from the crowd. so the obvious question, 1312 pages, professor meltzer, is there a single message about the conduct of federal reserve

policy you'd like to leave us with this morning? >> well, let me start by saying 1312 pages is just volume two. you put it with volume one, you get up to 2,000. so that was a massive undertaking, and it wouldn't have been possible -- i think i would still be buried you should federal reserve transcripts -- if it hadn't been for the president of aei during this period who supported the work in a way that, as far as i know, no think tank has ever done with a similar project. it's really a tribute to aei that they were willing to give me the time and resources to do this work. and i also owe a debt to anna schwartz who with read every page and commented on most every page and to my wife, marilyn, who have been supportive through a long struggle. so your question asks what

would, what is most important, and i would say there are two things. the federal reserve started under the gold standard, and that put a strict limit on what they could do. and since that time they've produced the great depression, the great inflation, a number of recessions and the current -- they contributed to the current crisis. so it seems to me it's time to ask the question, shouldn't there be some limits on the amount of discretion? not a formal rule that they have to slavishly follow, but some rule-like behavior. and that's marley rein-- particularly reinforced because from approximately 1985-2003 they ran the whole period in the 97-year history of the fed in which they achieved for a long period, year after year, slow inflation and steady growth punctuated by very mild recessions. so we ought to try that again. the second part of that and

related is one of the reasons i believe that the fed has the record that it does, which is certainly short of being brilliant, is that this is much too much attention to near-term events at the expense of longer-term consequences. you can read the minutes, as i have done and as my helpers did, my assistants did, and you find don little about what are the longer-term consequences of the -- darn little about what are the longer-term consequences of the policies we're taking. there's hardly any discussion -- with one exception. that was when the man on my left was chairman of the fed who pursued a long-term strategy of bringing down the rate of inflation knowing it wasn't something that was going to happen in the next quarter. >> chairman volcker, was that how it lived? do you share allan's focus on rule-based behavior rather than discussion? >> what i share is admiration

for allan's persistence in reading all those open market committee minutes for however many years. i decided recently i ought to read one or two of them. [laughter] including the one which was, should have been most interesting when we changed the operating procedures. i found it difficult to get through one meeting's minutes, content. [laughter] well, you know, it'd be nice to have a rule if we knew what the rule was and could be applied generally. i think that it should be some limits on discretion, but i don't know how to formulate them, and i don't know the rule -- i haven't got a -- well, the popular role for central banks now is somehow price stability, but price stability is interpreted as 2% inflation. 2% inflation you ought to have the price of the currency in the

space of a generation, so it's not exactly my definition of stability, but that is the kind of role that's become central to central banks pretty much around the world, even the united states although they don't state it quite that way. i'd rather just say, price stability ought to be the rule. i'll leave off the 2%. >> in defense of the fmoc minutes as someone who had to draft them for six years, i would say mission accomplished if you found them pretty boring. [laughter] >> well, wait a minute, wait a minute. you said you drafted them, those are verbatim minutes. >> oh, the transcripts, okay. well, sometimes some participants of the fmoc were unintelligible. >> that's right. [laughter] i hope you're excluding the chairman. >> always. so let's, let's tush -- turn to the decades covered by the

history of the federal reserve starting with the 1950s. in the 1950s after the accord, inflation was low, the fed was in the background, there were recessions about every four years on average though. was that the right mix of policy regarding the limited responsibility for the federal reserve and short-term stabilization and a certain opaqueness in the conduct of policy, professor meltzer? >> the 1950s were a period in which the fed was really feeling it way. it hadn't really engaged in monetary policy -- oh, thank you. the fed was feeling its way in the 1950s. it hadn't engaged in policy operations for, since 1934, did very little during the period from 1934 to the beginning of the war, and then it, of course, agreed to hold interest rates constant. so it wasn't until 1951 that it came out from under that and had

to rediscover how to operate a serious monetary policy and went back to doing the things it had been doing in the 1920s and gradually moved away from that and discovered what by the 1960s was a, something that begins to look like what we do now. so, but policy worked pretty well in the 1950s as compared to what came later mainly because we had president eisenhower, the last president before president clinton and the only president from, in -- except president clinton who ran more than one budget surplus. so the fed did not have a lot of deficits to finance, and it didn't finance them. >> chairman volcker, in terms of the policy set in the 1950s, two aspects, the interaction of monetary policy and fiscal policy; that is, does budget

surpluses make it easier for a central banker, and second, the transparency or pickness of the -- opaqueness of descriptions of monetary policy about policymakers and be any comments about the '50s? >> let me go back a little earlier than the 1950s because i was an underyacht in the -- undergraduate in the late 1940s, and i wrote my undergraduate thesis on the federal reserve. and i kind of forgot everything i said there, but i went back and somebody -- in fact, i went back to princeton in teaching, and they quoted something in my final chapter. if federal reserve doesn't do a better job than it was doing recently, then they've got no reason to be independent. and that was back in the days when they were holding interest rates at a fixed pattern at the behest of mr. truman and the treasury, and that started in 1930s.

and they broke loose only in 1951 when i had already graduated. there are a couple of distinguishing features. you didn't have a big budgetary problem, but that was -- i can't say it's the heydey of keynesian philosophy, but it certainly was there. the economy was reasonably stable, and for a while people began thinking monetary policy wasn't with very important anyway. it's interesting looking back, because at that time we used to talk about monetary policy, fiscal policy and debt management as a senate influence on -- significant influence on policy. you don't hear that much anymore. but now i just wring -- brick -- bring it up because there's all this talk about qe2 which basically means they're buying government bonds.

there's been a lot of hull a baa loo on each side. it was routine in the 1950s for the government to buy bonds. they bought bonds and theoretically sold bonds. i don't think they ever sold very many, but they did buy them from time to time. and the big controversy was in the federal reserve in the 1950s, whether that was appropriate or they should only deal in the treasury bill market. bills only, was the doctrine. and there was rather a fierce fight between washington and new york about that. but in the mid '50s sometime it was resolved. the federal reserve holding deal in a very short-term market. now, there's been a few exceptions to that, but this most recent exception -- it's not brand new for the federal reserve to be operating in the bond market. >> there's a piece in one of the

transcripts in which a certain paul volcker says to his staff, what are we doing with these long-term mortgages in our portfolio? let's get rid of them. and they informed him that the members of the house and the senate, housing market people wouldn't particularly care for that. of but there was just a small amount of mortgages, nothing like the present. >> well, there were -- fannie mae obligations, they weren't directly mortgages which was -- in the federal reserve act, you could buy agencies, and they had bought some. but we did kind of stopped that. >> you stopped buying them. >> we stopped buying them, and i was pulling the leg of the staff, if we're not buying them, why don't you get rid of them? that's what you never know whether there was a smile on my face when i said it or not. [laughter] >> [inaudible] >> since we're talking a bit about government debt and quantitative easing, coming out of the war, the stock of government debt was very large

relative to our nominal gdp. but over the first decade covered by the book from '51 to 1960, gross debt, gross public debt as a share of gdp fell from 88% down to 56% by 1960. similarly, just after the accord the federal reserve had a very large stock of government debt, a large balance sheet relative to the scale of economic activity. over the course of the decade, it shrank. the question is, does that tell you you can grow your way out of a debt problem, or was it only possible because of the repressed nature of financial markets in 1950s with ceilings on interest rates, floors on interest rates, very large restrictions on capital flows? allan? >> you could grow your way out of the debt if debt isn't of the massive size that we currently have. we don't have, this if my

opinion, a coherent plan for how we're going to deal with the long-term debt, so -- and it's enormous now. i mean, it dwarfs anything that we've seen in this country as far as dollar magnitudes, and it's pretty close to the peak amount of debt that we had at the end of world war ii. and that debt we got rid of in part by inflating our way out of it and in part, of course, by a very strong growth rate during the '50s and much of the '60s. i don't think we have that prospect now, so we have a problem. and that problem is, in my opinion, exacerbated by the federal reserve's very short-term focus that i spoke of before. there's a chart which i have prepared that is from my book, and it shows one of the reasons why paying attention to the short term at the expense of the longer term.

these are annual figures for the monetary base, the amount of credit that the federal reserve puts out in relation to the interest rate, from 1917 or 1919 to 1997. it's just a page out of the volume. it shows two things which i think are very interesting. first -- or three things. one is it's a pretty much looks like the way economists think it should look. second and quite important, when interest rates got back to the levels of the 1920s sometime in the middle of the 1960s -- [inaudible] was right back where it had been. a lot of stability in that relationship. and, third, when inflation took interest rates very high, it moved up along the right-hand edge of that curve, and then when disinflation occurred under mr. volcker's chairmanship, it moved back right along the same line. so there's a lot of stability in that relationship.

it's annual data. the fed ignores or pretty much pays attention mainly to what's going on in the short term. if it paid more attention to what is going on in the long term, it would, i think, do a better job. >> chairman volcker? >> going back to the '50s is a long time ago, and my memory may be not perfect. but i don't recall any particular worry or concern at that point about the size of the debt. it was going down, came out of world war ii very high, but it was coming down. rapidly at first and then gradually. i don't remember any debate or concern about the size of the federal reserve balance sheet. these questions were not in the forefront. what was in the forefront, allan may not like it, was very much a countercyclical kind of approach. the whole idea was if famous

bill martin's after rich, take away the punch bowl when the party's getting too good, and you tried to put the punch bowl back, i guess, when you had a recession. but it was very much a sicklily-oriented policy. tighten up if you thought things were getting too strong and easing up in the opposite direction. but as i said earlier during those years, monetary policy was not considered as effective as fiscal policy in managing the economy. >> so let's turn to the 1960s now. reading the discussions of the 1960s in -- turning to the 1960s, reading the discussions of policy setting in the '60s, economic policy was importantly driven by external considerations. it appeared that the u.s. benefited from be being reserve

currency, that is the exorbitant privilege, but didn't always live up to its responsibilities as the anchor to the world's trading system. the result was a good deal of improvisation by the technicians; operation twist, the interest equalization tax, a series of stop-gaps in order to keep the, keep everything going. so what does that experience show about the cost and benefits of being the reserve currency? >> well, of course, there are some benefits. people hold their money, and that has an important effect on the price level. it also means that most commodities in the world are traded in dollars, so we employed a lot of the fluctuations that other countries experienced because of that, and there are some other advantages. the, the problem that you address began somewhat earlier. at the end of the war, in desire

to repair some of the mistakes that had been made at the end of the war period, we adopted two pieces of legislation which were in potential conflict. one was the bretton woods agreement which said we had to maintain price stability in order to maintain the dollar fixed price of gold, and then we adapted the full employment act which vaguely described the goal of policy as being maximum employment and purchasing power. but if left undefined what that meant, it got to be interpreted as 4% unemployment by the 1960s, and it stayed 4% unemployment even though demographic conditions changed until sometime in the 1970s. so that set off a conflict, and we resolved that conflict by not doing much about the dollar except stopgaps. and i would say that the end of

that period came when this man on my left became the undersecretary of the treasury. and where his predecessors had used all kinds of stopgaps to do things about the balance of payments, he sent -- wrote a memo to the secretary and then to the president which said we have two years in which the try to negotiate an agreement for sdrs and for the dollar to -- which would have devalued the dollar. and at the end of go years -- two years we're going to be forced to do that. well, he wrote that in 1969, and in all of 1971 -- august of 1971 his forecast came about. >> in the 1960s i was -- a good part of the 1960s i was in the treasury. and those memories are very much in my mind. what allan calls stopgaps we

called active management. [laughter] but, you know, what i would emphasize in those days people in the treasury and president kennedy himself, i'm sure, under advice from his father as the stories have it were dedicated to preserving the fixed dollar relationship with gold and fixed exchange rates. and bretton woods agreement really had just come into real practice late in the 1950s, so we were now in the early 1960s, and there was almost a kind of feeling of religious commitment to maintain that system and maintain confidence in the dollar and the stability of the dollar internationally. and all kinds of initiatives were taken to that end without fundamentally changing either

the price of the dollar, certainly, or full conduct of monetary policy in that respect. and there were conflicts between the treasury and the federal reserve with the treasury being more hawkish on tightening money than the federal reserve was in defense of the dollar. of these were -- these were not, they didn't come to blows, but there was a definite different in interest at times. in the course of time, these actions seemed less and less sustainable against the forces of difference in the world economy. but the magnitudes were so different then. we were disturbed by balance of payments deficit of two or three billion dollars. we were running a trade surplus all during this period. and yet the small deficits we had on an overall basis were very disturbing, and finally the dollar was undercut.

but i just want to emphasize the effort was very -- in a very wholesome way to maintain the dollar, recognize its responsibilities as the reserve currency and maintain its stability. let me make just one point that i don't think is irrelevant. you said when i was deputy undersecretary for monetary affairs and be later undersecretary -- i was undersecretary of of monetary affairs, not international monetary affairs. i make that point because this was responsibility to cover both domestic and international, and i think it's important to keep both sides in mind. that position -- that title doesn't exist anymore. and i think that's unfortunate. now we do have an undersecretary for intermartial and undersecretary for domestic finance and undersecretary for this, that and the other thing,

and be i think, unfortunately, we have lost organizationally the sense that you shouldn't consider international monetary policy as different from domestic monetary policy. so i just express a little regret for extraneous reasons that title was lost. >> i would like to say that the policy from 1961 to 1964-'65 came close to succeeding. you never know whether the counterfactual was going to come true, but the u.s. had lower inflation than the rest of the world, and we were moving in the direction where things might have worked out to preserve the $35 price of gold until, i mean, president kennedy, as you know, was a hawk on the importance of maintaining the balance of payments. and president johnson didn't give much care about it. and, you know, it was a problem when it arose, but the rest of

the time there were other things. and the great society and the great -- and the war in vietnam produced big deficits and fast money growth, and the result of that was that what had been gained in the kennedy years of getting the lower rates of inflation and which had brought the real exchange rate down to the point that looked as though -- and brookings did a study, a big study, very well known at the time that said we're going to solve this problem by 1968. and it looked as though that might turn out to be true. and the result was that it was washed away by the, by the very expansive policies of the johnson administration. >> it's interesting that during that period you said it was lower than these other countries. i guess in the average, that's right. but whether it was lower, it wasn't much. inflation rate, i think, averaged something like 1.5% in the '60s, and we kept getting

accused as now of having taken inflationary policies. in fact, those inflationary policies were not reflected in if actual inflation at that period of time. >> so just following up on a couple of those points, by 1969 as there's this possibility that bretton woods would unravel, at the time did you think that that was just going to be an interago numb to a new monetary arrangement, or did you think the deaths in addition would be -- destination would be floating exchange rates, and is that the right monetary arrangement? why don't we ask the chairman first. >> my memory's quite clear about this. i thought we'd have to float for a while, but i did see it as a kind of interim arrangement for going back to, i don't know, i suppose you'd call it a more ordered system. and we never -- we did the floating part, we never went back to the -- [laughter] >> [inaudible] again, smithsonian agreement

which president nixon called the world's greatest monetary agreement or something like that. it lasted about 15 months. [laughter] >> that was, i mean, they did call it that, but that agreement had some loose ends. [laughter] which i think made it unsustainable. >> the important point, at least for me, was that domestic monetary policy always had precedence over international monetary policy. that is, we were -- people in the 1970s when we're floating or at this point in the nixon administration, president nixon had says he was going to have an end to inflation without a recession. and he instructed paul mccracken who was on the council of economic advisers, and they told him that wasn't going to happen. but that's what he wanted, and he got a chairman of the federal reserve who in his first act,

martin at the end of his tenure, had decided to do something serious about inflation. and the first meeting of the open market committee in 1971 when arthur burns became chairman reversed that policy and began to say we have to do something about recession. and set the pattern that went on throughout the 1990s which was -- 1970s which was we could always do something about inflation until the unemployment rate rose above 7%. and then we had to stop. and the people who were serving on the open market committee at that time would promise themselves, we're going to do something about inflation. we're not going to let this happen. and then the unemployment rate would be 7 or 8 -- 7 or 7.5%. and all that talk disappeared. >> so we have now entered a discussion of the 1970s, and so there's an obvious follow-up

question. if it was that the fed bowed to political pressures, why didn't the mechanisms that are supposed to make it somewhat independent -- bank presidents voighting on the fomc, long testimonies of office for governors, why didn't that insulate it over the course of the '70s? >> that's for me? >> yes. first. >> the answer is hue chesney martin picking up a statement that earlier had been made by marriner eccles and allan sproul often said that the federal reserve is independent within the government but not independent of the government. now, that statement was intriguing. so i had to find out, what did he mean by that? he told us what he meant. he said, if there's a big government deficit, then congress has voted for it, and the president has signed it, and it's not our job to prevent it. so he finance bed deficits -- financed deficits.

>> [inaudible] >> martin. yes. and he, in fact, acknowledged that in 1968 when he said, you know, the horse of inflation is not just out of the barn, it's galloping down the road. because he had been convinced that he had to lower interest rates at the time that johnson got his surtax, finally got his surtax through congress. and in 1968 he began to reverse his -- in 1969 martin began to reverse his field and to do something about inflation really quite drastic about inflation. arthur burns was committed to the success of the nixon presidency which he interpreted as being low unemployment. and that's what the president wanted. and, you know, i listened to the tapes of the conversation between burns and, and nixon in the oval office, and, well,

burns never says, yes, mr. president, i'm going to inflate. he does get as close enough to say to the president, i am not william martin, and i will not do what he did in 1960 which mix son believed cost him the presidency -- nixon believed cost him the presidency in the election. so he was committed to being political. it is sad, and it wasn't -- now, there was considerable political support for the idea that unemployment was the most important problem and that we had to do manager about unemployment -- something about unemployment at the expense of a little inflation, and there were lots of people including very able people like jim tobin who said, you know, inflation isn't really a serious problem, and we don't have to do, you know, so -- and we can trade off a little bit of unemployment for a little bit of inflation for higher, for lower unemployment

rates, and that's to the good and for the social welfare. so that was a strong view. it wasn't a view that i held, and it wasn't a view that paul volcker held. but it was a very dominant view at the time. and, and it wasn't until inflation became the number one topic on the opinion polls that president carter who never had shown a great deal of interest in controlling inflation up to that time invited paul to become chairman of the federal reserve. and to his credit, when he was interviewed, he said, mr. president, i will be harder on inflation than my predecessors have been. and president carter, without quite knowing what he was committing himself to -- [laughter] said, that's what i want. [laughter] and to his credit, aside from the mistake of putting on credit

controls, he did not criticize the fed during the remainder of his term. and at the, under pressure from his advisers to do something to expand the economy in 1980 when he was told if you don't do that with the current high interest rates you're going to lose the election, he didn't do it. >> so, chairman volcker, that leads to a couple questions. first, the first part -- >> [inaudible] on some of this, but go ahead. [laughter] >> why did inflation rise over the '70s? why did the federal reserve lose the anchor? and then, second, did the political class, did the fed, did the public understand how costly disinflation would be in 979? is. >> no. but let me go back to the late '60s when i was not in the government and wasn't in the federal reserve, wasn't in the treasury. there's, clearly, a deal made midway lu -- through the vietnam war. if federal reserve eased money,

it would help the congress pass a tax increase and, therefore, you would get a dampening effect on inflation in the economy. and the federal reserve bought that deal. now, i don't think that's -- i think most people think that was a mistake subsequently, certainly, including the federal reserve. but i don't think i would interpret that as a lack of independence by the federal reserve. they thought they were contributing to a reasonable economic policy for the country. they weren't giving up on inflation in their view, they were turning it over to fiscal policy. it didn't work out, and that's when the inflation really got underway. i am struck myself reading some of this stuff, the nixon white house conversations among themselves or with arthur burns, and i did not realize at that time -- by that time i was in the treasury -- the degree of pressure that was brought upon

purposes. it was pretty rough in terms of pressuring burns to be easier. i don't think burns was ever as easy as the white house would have wanted. so i'm not sure it's a real abdication of independence, but there's certainly a hot -- a lot of pressure brought upon him. now, around to your question. oh, what -- [laughter] that period to me from where i was sitting in the treasury as undersecretary, again, for monetary affairs international and domestic, i thought the federal reserve was too easy because we were struggling to maintain the stability of the dollar, and it kept getting undercut at times by easing of policy at times which didn't fit comfortably with what was going on internationally, to say the least. so i was kind of rebellious. i wasn't in charge of it, but i didn't like the -- i thought monetary policy was pretty much too easy during that period.

now, what contributed to the great inflation was i think monetary policy was not as disciplined as it could have been. obviously, during the 1970s other things went on culminating in the oil crisis early in the 1970s, and that had a big impact. and, you know, we never kind of unwound the inflationary process once it got started, and by the late '70s it was, obviously, feeding upon itself. and, again, reaching into double dim psychiatry levels -- digit levels which we'd never had in this country. and it was very pervasive in people's add tuesday that we were -- attitudes that we were caught in an inflationary spiral, and it was going to continue. and that was not very good for business. >> actually, that leads to a question for allan about the economic profession's contribution to monetary policy

mistakes in the '60s and the '70s. we already heard the example of the coordination of monetary and fiscal policy with the tax surcharge that didn't actually provide the drag that was predicted by some economists. we heard the story of the '70s where the failure to appreciate the role of expectations and inflation determination helped accelerate the process of, in terms of the price be -- price gains. so how much of this is the independence of the federal reserve, how much of this is the received wisdom that professional economists provide to policymakers? >> oh, it's absolutely both. i mean, that is when i quoted chairman martin's famous statement that he made repeatedly about that he had to finance budget deficits at least holding restraints down, he

could do something about private expansions that looked like they were inflationary, but he had to be more circumspect about, about government expansions. and that was a statement that sat well with many academic economists, i must confess that i was not one of them. that said we should coordinate policy. that is, when the deficit is big, we're going to have more money growth, and that's going to make the deficits more effective, and that was sort of a very common view that was certainly the view if you went to -- and after some hearings, the chairman of the banking committee, house banking committee started, the fed took a lot of heat and criticism from academic economists of all kinds. they didn't agree among themselves, but they disagreed with the fed. so they started something called

the consultants. and i went to many of the consultants' meetings where with there was, clearly, a very strong difference of opinion between people like milton friedman and me who would represent the view that the fed would really be concerned about the inflationary consequences and the strength of the dollar and the other view which was that unemployment was the most important problem, and you'd have to coordinate policy. and that was the view, and that view was heavily represented by the vision that the phillips curve was the way in which we could make a permanent trade-off. it wasn't until 1968 that friedman wrote his paper and said, no permanent trade-off. temporary, not permanent. and that did have a big effect on the academic profession and, later, it had a big effect on the fed. but it didn't effect the nixon white house and the economists there who were still -- who believed what friedman had written but didn't want to put

it into practice because they didn't want the unemployment rate to go as high as it was. and there was probably social support for that. but that is why we have an independent central bank, because they have to be bold enough to ignore social support, and that's not an easy thing to do. and i appreciate how difficult it may be, but that's what the advantage of independence is. it is that you do what is unpopular. and, you know, here's a man who did what was unpopular. [laughter] >> [inaudible] interestingly, arthur burns wrote a essay a couple years after he left office which explained his view of the 19750s very clearly -- 1970s very clearly. and the title of this speech is called "the anguish of central banking." and his point was there were so many things going on in the modern economy, so to speak,

that made it, created a kind of inflationary momentum that could only be broken by policies that would be so draconian, they would not be acceptable politically or socially. so he kind of left in a feeling that central banks were caught up in helplessness. almost that strong. not just a budget deficit, but wage processes in particular, all the social programs just created a certain momentum that kept inflation going in way that would be very difficult to break. and so, basically, his conclusion was i wasn't going to break, and the federal reserve wasn't going to break it because the social costs would be too great. >> it would be anguish at central banking. yes. >> another persuasive argument about the '70s is that economists missed the productivity effects of the two oil shocks. in realtime do you see evidence

that the federal redefer as you read the minutes and the triplets were missing -- transcripts missing with economy's potential to produce and what role did that play? >> the, the big error and one which took a while to correct, was to look at the oil price increase as inflation. it was a relative price change. and the short-term focus of fed policy made them think that they had to do something about it. and i know that very well because when alan greenspan was chairman of the fed, he used to have meetings in the white house with the budget directer and the secretary of the treasury and the chairman of the fed. and i went to several of those meetings, and at one meet being i tried to convince -- meeting i tried to convince arthur burns that his policy of trying to head off the inflation in the oil price was a mistake. and, you know, i, it was my

persuasive past that failed completely. he was convinced that he had to do something about it, and they repeated that mistake in 1978-'79 of thinking about the oil price change which is a relative price change. nothing that the fed can do about relative price changes of that kind except kill the economy. and that was a mistake. and it's one of the mistakes that i cite in the book, and by the third big oil price increase which is sometime in the 2000 period when you were responsible for thinking about these things, they didn't repeat that error. they said, it's a relative price shock, it'll go through, and the inflation rate will be the same after it passes through as it was before. that's what people like me were saying in the 1970s. but that was not being listened -- so that was a mistake, and it was a mistake which convinced people that

inflation had gotten up to 17% when, in fact, of course, that was a reading of the numbers but not a scrutiny of the numbers that was important. and be that helped to create the environment in which inflation had to be, something had to be done about inflation, and president carter knowing that he had to run in 1980 understood that he had to do something about that, and that was the beginning of the disinflation, in my opinion. >> so, chairman volcker, what was it like living through the '70s as a policymaker and did that contribute to the policy errors that allan talks about? >> well, the oil shock was a policy question, no doubt about it, and there was a great debate as to what extent is it going to create a general inflation their process. and i don't remember any of the details about it, but it was a

difficult policy problem in the early '70s and the late later '70s and that oil shock in the later '70s came after the inflationary process was well underway. so it further aggravated it. and i must say in my mind i don't think i separate it out as carefully as allan is suggesting the precise impact of the oil price and said, well, that will go away. at that point i didn't think any of the inflation was going to go away. we better do something about it. >> be so that takes us to the '80s. in in in the end after the fact, was the cost of disinflation a surprise to you? and, also, was the fact that, ultimately, the public supported the act, was that also a surprise? let's, first, ask allan. >> it was a surprise to everybody. very competent economists like jim tobin and brookings people

said it'll take ten years at low levels of -- high levels of unemployment to do what we have to do. didn't take anything like that. the crowning moment in my history and in other people who have studied the period came in the spring of 1981. the problem was to convince the public that the disinflation was going to carry, carry through even when the unemployment rate rose. one of the first questions that paul volcker faced at "meet the press" after he'd been appointed was from irving r. levine, a major, well of-known commentator who asked him, essentially, well, fine about bringing down inflation, but what are you going to do when the unemployment rate rises? and paul gave the right answer. he said, we used to think that

you can trade off one for the other, but if you look at the record, the two have risen throughout the '70s, and we're going to bring them down together in the '80s. that's an anti-phillips curve statement. so that was how he set out. now, did he, did he or anyone else anticipate that interest rates would go to 20% or higher before the problem ended? i don't think there was anybody who was making forecasts of that kind, and i don't think they would have been believed if they had been made. but in the spring of 1981 after struggling through the credit control period which meant he had, that the fed had to start all over again in the fall of 1980, people didn't believe that

there would be an end to the inflation when the unemployment rate rose. what changed their mind was in april of 1981 the fed raised interest rates with the unemployment rate, as i recall, around 8%. that was something that had never happened before. within 15 months the inflation rate was down to 4%. now, that was, essentially, the beginning of the end of the disinflation policy. and mr. volcker had lots of people on his open market committee who thought it was a mistake to end the disinflation policy at that point. but banks were failing in the united states and all over the world, and the world was headed to a potential crisis. and that's when the policy came

to an end with the inflation rate of 3-4%. but with the unemployment rate up above 10%, above where it is now but without the benefits that we're having. >> so, chairman volcker, did your wife -- did your life read easier than it lived? what was it like over the time allan's talking about? >> well, you asked whether we were surprised at the cost. i wasn't surprised there would be a cost. but the cost has to be interpreted correctly. i was convinced, and you had to be convinced of this or you probably couldn't carry the process through, that if you didn't act, the ultimate cost was going to be greater than if you did act. and i must say the recession that ensued was longer, i don't know whether it was deeper, but it was longer than one would have wished.

but you could see your way through it, and what made it possible, frankly, in my opinion, was that there was enough feeling of concern on the part of the public about inflation that they were willing to stand for much tougher policies than they would have stood for a decade earlier or two decades earlier. so we had that kind of unvoiced, maybe, support. but i think it was real. it was reflected in president reagan's attitude when he was in and reflected as we said and i think the decision. he was kind of in a box, a feeling of malaise around the country which is very real. whether or not he ever used that term. the country was ready for change. but, no, did i imagine interest rates would get to 21.5%?

no, i did not. [laughter] but they also came down pretty fast when the turn was made. i had, just anecdotally, i don't remember exactly when it was but probably in early '81 a group of businessmen came, somebody brought hem in, we had lunch -- them in, we had lunch. wanted to get their reaction of what was going on, and i gave them my pitch that we were going to be tough, and this was going to be all right, and the inflation rate would come down and we would all prosper together. guy said, i listened to you carefully, mr. volcker, i hear what you have to say, but i have to tell you i created a wage agreement with my own workers last week for 13% increase for the next three years. that's what i think are the prospects for inflation. i always wondered what happened to that guy. [laughter] >> so we made it through 35

years of federal reserve history fairly briskly. just a couple other questions before we turn it over to the crowd. first, arthur burns' secret diary is a surprising bestseller. what would be the biggest surprise in the secret diary of paul volcker? mr. chairman? [laughter] >> oh, boy. i lead a very calm, orderly life. no big secrets. [laughter] no secret for a diary, but i was, i guess, fortunate to be in the government and the treasury at the time of international turmoil, devaluation of the dollar, later the anti-inflation thing, latin american debt crisis. kind of an interesting life when i look back on it. [laughter] much better than being an investment banker all the time. >> so, allan, what entry would

you like to read in the secret diary of paul volcker that would have helped -- >> my secret diary, those damn monotarrists that kept criticizing us all the time. [laughter] expected some control of the money supply that was beyond anybody's technical capacity. nothing we could do would ever satisfy alan meltzer. [laughter] >> so, actually, that leads to a follow-up. first, what entry do can you want to read and, second, did the federal reserve ever use the monetary aggregates in a meaningful way? >> i think it's fair to say that paul tried. [laughter] and it's also fair to say that they were very difficult to control on a quarter-to-quarter basis. the chart shows that they're not so hard to control on an annual basis, but the fed doesn't pay much attention to the annual stuff. they pay attention to the quarter. they're under pressure from a

congress, a public, so on, to do it now. and that's not within their ability. i mean, we can't, they can't get perfection or even close to it in short term, in the short term. so you have to take the pain. and that's, that's something that the public has to accept. i think of when paul volcker went to -- when i first met paul volcker, he was then an anti-inflationist and a believer in fixed exchange rates. strong proponent came out of the new york fed and had the views of the new york fed which was always in favor of fixed exchange rates. so what i would like to read is that, you know, he was the undersecretary who when events

forced you to float the dollar, floated the dollar. and what made the transformation, just the facts? or did he come to the conclusion which is quite relevant now when we think about the e.u., that the very best international economists say fixed exchange rate systems don't last more than eight or ten years at the best? and the reason is because, of course, we're not willing to do the things which put the exchange rate stability above unemployment. and was -- so i'd like to ask in the secret tire ri whether -- diary whether he believes that a fixed exchange rate system would be the best system for the world and how he would go about getting that or whether he thinks that we're going to have to be in a floating rate world,

whether that's the best of all possible world withs or not. worlds or not. >> well, let me make two comments about that. the immediate question of fixed exchange rates is being tested in europe. on a regional scale. it's a very interesting test. but you're right in the sense that i, looking at europe, thought the euro was a good idea and that the volatility in exchange rates within europe and trying to have a cohesive economic union, those things didn't match. volatile exchange rates in europe and a cohesive union and open trade. therefore, the euro made sense. but the concept is being tested very strongly, obviously, when particular countries get out of line and don't have an independent monetary policy. now, looking at a world scale my -- and i'm not making a

speech. i will say at the end of the speech the logical consequence of it totally globalized economic system and financial system would be a single currency. and that is, would maximize the product and effectiveness of the -- productivity and effectiveness of the world economy. but that's not going to happen in my lifetime, i always say. and my lifetime's getting shorter, but even if it was your lifetime or younger lifetimes, it's not going to happen. [laughter] so you have to have some accommodation, and i think there will be, should be room for changes in exchange rate. whether they should be freely floating is the question. and it's hard to know what freely floating means. but i do think that, at least i do not like and i think we can do better than the violent fluctuations we have had in exchange rates in the past decade where you had, for

instance, two big currencies in the world, the dollar and the euro, fluctuating over a range of 100%. those are very big changes for two pretty stable economic units, all things considered, that surely did not have a difference in competitive position or underlying equilibrium of 50% over the course of two or three years. so i think we ought to try to do better than that. >> okay. so now we're going to turn to questions from the crowd. a couple things. first, please, wait until a microphone comes to you. please, identify u.s. and, please, ask a question. we've been pretty careful to be on track, so we want to get in as many questions as possible. burt, in back? >> [inaudible]