in the last few months. we have had this conversation in december or early january. the euro zone was headed into a recession, whose severity was only a question. in the united states, the economy seemed to be barely growing, possibly on the verge of another recession, the fiscal picture here was all screwed up. we had enormous question marks on the question of stimulus, tax cuts, sequesters and the federal government wondering if it had done enough. but you know what a difference -- good news on employment, on retail sales. just to lay the landscape, i would like to ask you, have things gotten that much better as the behavior of the market.

>> we have issues around housing, foreclosures oil prices t euro zone possibilities, so my view at least is though i certainly hope that's right, i think there's still an enormous amount of uncertainty. the consensus forecast is somewhere around -- that is the

short-term perspective that i have at least. >> have the europeans gotten past the existential crisis. >> may i respond in two parts.

>> my impression of being around markets and having -- markets tend to work one way or the other. they either look at the positives or they look at the negatives and disregard the positives. let's take europe for a moment. the euro zone in my judgment at least cannot continue in this form. there's going tobacco major structural reform. i think that's going to take an extended period of time to accomplish. when they reach a stage of interrim stability that can last them whether they do or do not get into long-term reform. the european central bank was to buy time, although i think there's an enormously sensitive question about did they buy all the time we need.

i think at least, i think it's clear actually that the leaders, the euro zone leaders were behind the serve in doing the lease, they remain behind the curve, and they're behind the curve now. they have to balance that against not having too much austerity. their hope under other issues by capital from the banks and so fort. they are got to have reform in labor laws and strict measures that affect business because the crisis companies are noncompetitive and have to take whatever measures they can to promote growth. i think that a failure of the euro zone, say over the next year, could have effects that are somewhere between severe and

extreme. i think on balance, despite the failure of leadership, the euro zone leaper ship has displayed. i think the probability is the extremity of the consequences of failure unbalanced, probably great. but more likely than not scenario that they will ultimately -- they will meet their challenges within this period of time. when you get to the edge of abyss in markets and say fundamentally unsound, you were taking a lot of risks as those markets get out of control. i think that while the probability is somewhat greater than not that they will reach this place of interim stability, i still think there's a lot of risk. >> you said you thought the central bank had bought time, but not as much as people think. central banks can put a lot of

liquidity in the system. i mean how effective do you think it has been? and how much time has it bought the europeans. >> my impression that that is a view now that the ecb has bought it. i think it's lost probably a lot less than most people do. >> we're talking weeks? months? >> the reveiling view is they bought quite a bit less than a year. number one i think there is the risk that if the euro zone leaders don't act, at some point the market right side going to say, these people aren't acting because they're being in effect given this time by the ecb. they're not going to act and then you could have a serious market problem. the other possibility is that the ecb continues to driver

liquidity. or something some variant of it and leaders still have inacted that the markets could say the system is going to be flooded with euros. and if it's flooded with euros, at some point it does raise the question over how ecb is, that could create a market reaction of -- to get rid of and affect all your denominations of securities and that too can create an undermining of the office. i think mary d rrkts og is -- i think there are limits as to how much time will be bought. will the euro zone leaders establish this this vublt or will they continue to kick the approximate ball town the road, i think have -- >> the ecb has bought time, but

the political leaders have to create a more permanent solution. he had two radical views about what that solution is. you can take the german view which is austerity, austerities and third austerity. that means like clearly -- it takes the form of fiscal compacts, every euro done member must amendment its constitution and balance its budget. that is what is going on there. there's another view that austerity is the wrong thing right now, what they need is growth, and that past to growth is to take the rirveg out of sovereign bond markets. it's not their debts which are actually not that extraordinarily large.

from the united states and great britain. >> their bonds are being -- what the lender needs is meet -- these are two awesome types of prescriptions for the problem. >> let me go back to, i think the mutization issue, what you call mutualization, it seems to me almost surely has to be part of the reforms. >> but does it have to be a part of the solution? >> i don't think it can be nor -- it can't be done in the time you need to reach an interim -- a position of interim stability. then you get precisely the debate, that some people think there needs to be this massive austerity to the bond market. you need to find a ball lantsz.

enough austerity to support, to win the confidence of the markets, but not so much as to undermine the economy to the point where you're actually losing the effect of the austerity because you had such an adverse impact on growth. so i think don't think either answer is right. extreme austerity is not right. because that will undermine gdp and no austerity is not right because you will lose the confidence of the markets. by the way you say italy doesn't have large deficits, which is true. spain didn't have large debt to gdp ratios.

let's talk about the federal reserve. this -- mr. volker. so let me ask you, how is the fed doing? >> oh, look, i think ben bernanke's done a good job. he came into an impossibly complex situation and took unprecedented actions which combined with t.a.r.p. and other activities have prevented us from going over an abyss. that's a little different from the question of where are we today and what do we do going forward. gdp for this year is still a

slow recovery. it's very high unemployment. the consent was forecast 2.45%. clearly we have a long way to go. having said that, i think there's a lot of discussion about should there be a qe-3 in one circumstance or another, i think the qe-3 would mean absolutely nothing i'm not an economist, but i was at a group with really distinguished economists. one of them guested that qe-2, had very little effects on interest rates. given the rates are very low. but much more importantly, whatever effect it might accomplish, and i think it would be very limited. that effect on interest rates would have little effect on business and consumer behavior.

compared to what all of this stud -- we all remember -- i guess we all remember from colleges economics, it is this comment about issue -- business and consumers don't want to act and it's all those other factors that influence the market, and i think the interest rates will be irrelevant lly irrelevant. >> i think the principal risk, greg is that i think we are tremendously dependent on the economy of the confidence that the fed will ---i think the risk is, when you keep mon advertising, you go from qe-2 to

qe 3. i think the risk is the local markets lose confidence in your commitment to combatting inflation, and become concerned that you are going to mon advertise the debt itch we continue to have these kinds of fiscal deficits. that will create two problems, one is, not inflation right now, but inflation right now is probably very low. it feeds your expect tigss over a long run. if we don't deal with our fiscal situation at some point we're going to have a real possibility of a severe market crisis. if you have not only the unfound conditions that we have. but you add to that, a heightened fear --

>> that takes us neatly into the next question, which is the whole fiscal side. >> it's the second week of november, we just had a very contentious general election. and the president calls you and he says -- >> sir. >> in zen weeks time, a number of things are going to happen, the payroll tax cut will expire, that goes 1% of gdp. all president bush's tax cuts expire, that's 1% or 20% in gdp, your former colleagues at the

treasury say we only have four or five solid weeks. what do we do? >> i'm adding up your numbers and i'm not sure we got to the same place, but if all those things happen that you describe, you've got a 4% or 5% hit to gdp. and gdp -- growth is already going to be -- the situation which grows already moderate at best slow recovery no matter what, and i think this period, i think all of us should be watching this with enorm plus interest. the post election period, the lame duck or the first couple of months or thereabouts of january are periods of just enormous - i remember during the first, a debt ceiling problem in '95,

that really had a potential of being a crisis, and then the government shutdown. we had to go in day after day afr day and try to figure out how to negotiate. i think it's going to be more intense because the stakes are so enormous. in a broad sense, i think there are three possible outcomes. i may not have gotten to all of them. but three strikes, one is, i think there's a realistic chance this could happen. that the party also decide to work together in some fashion that then produces a constructive and serious response to our fiscal challenges. i don't know what odds to put on that, but i think there is a realistic chance and the polls show that there's an 84%

disapproval rating in congress, and the rest are undecided maybe the electoral officials will recalculate and say maybe we better be more serious about governance. i think that's a real possibility. the other possibility. take the tax cuts, extend them for x period of time, undo the sequester in one form or another. and the third possibility, though i think this is a relatively low probability is that they do absolutely nothing, they need to kick the ball down the road nor have a constructive response, in this case all of the things you said happened, we have a negative impact on gdp and you have the middle class tax cuts go up, which is certainly not what the democrats want, and you had the income taxes going up which the

republicans don't want. so i presume the possibility of that happening is relatively low, but it's not inconceivable. >> of those three scenarios, let's say it's president obama, that does work through the possibilities of your various scenarios and that would be with probably one or both chambers of congress in control by the republicans? >> okay, i obviously would like to see president obama re-elected. i think he's doing a good job but i know there are those who differ with me. i think a divided government would offer a higher probability of getting to a constructive solution than a government that all three parts of the government are controlled by the same party. if you have a divided government and you face the scenario that you outlined before. and if each party says we really do not want the outcomes that

will happen without our acting. then they're going to be forced to work against party lines. th, and the presidency are in the same party, then they might decide to work across party lines and i think there is a real chance. it might be that party isn't going to want to take sole responsibility for the extraordinarily difficult decisions they'll have to make but there is also a possibility they will decide to use the reconciliation procedure which as you know only takes 50 votes in the senate in which case they could do something tilted very much towards their side of the issues. so i think a divided government probably has a higher chance of producing a constructive result although i think one party krolg both would also do so and i think that party simply may decide we don't want to take sole responsibility. we want to share responsibility for the difficult decisions. it does open the possibility of using the reconciliation procedure which is a special procedure which you don't need 60 votes in the senate to adopt something that is more towards

one end or the other of the spectrum. >> we have i think about 10 minutes left. i will try to take one or two questions, but if some folks want to go to the microphone, i will take that opportunity to ask you a couple more questions here. seven weeks is not a lot of time to fix a fiscal problem that has been developing for decades. tax reform, last time we did it as i recall it took years and the final process, you know, was the result of something that had begun before the '84 elections. what are the odds that even with the best of intentions we can get what needs to be done in seven weeks before we hit the debt ceiling, before the sequester kicks in, before all the other stuff happens? >> i think it could be done, greg, but i think your point is extremely well taken. you can't get a comprehensive tax reform in that period of time and you can't get a comprehensive entitlement reform but i think what you could do, and they did an enormous service by setting out a framework, even if you don't agree with the

specifics, and i think i happen to not agree with a lot of the specifics but they did the country a tremendous service by setting out a framework. that framework as you remember was ten years to get to a point with the gdp ratio stabilizes and slightly begins to decline. i think you could not do the tax reform, a degree with that. you could, i think, greg, put together a structure of changes that would get you to a ten-year program that stabilizes debt to gdp and with a few simple measures. you would probably want to defer the implementation of that program for a couple of years to give the recovery more time to get traction and you certainly i think you want robust public investment within that context because as bernie schwartz and others can tell you, we have to have infrastructure. we have to have basic research. we have to have a whole host of other programs if we're going to be competitive.

i think you could do that. if it takes you a few months into 2011 to do it, then what you need is some kind of bridging, a bridging mechanism and i think there are various legislative strategies you could put in place that would bridge you to the point where you did that. the danger with bridging is always that they first bridge and then they can't agree and then you get to the point where they kick the ball down the road instead of acting. i think you could probably put in place a bridging mechanism that's real teeth that would increase the possibility they would have to act. >> how do you prevent that from building a bridge and kicking a can over it essentially. >> you're mixing metaphors. your point is nevertheless, within the mixed metaphors. >> never let me get away with that one. start over here. state your name and affiliation. >> my name is bonnie, and i am an economic supporter of the huffington post, and you mentioned that there could be a market crisis if we don't deal with the fiscal problems soon, but u.s. treasury bond interest

rates are very low right now. why do you think we have to deal with it soon and do you think that -- >> i am sorry, why do you think we have to deal with it soon. >> and also do you think that we should have a public investment program right now that eventually could help stimulate the economy and maybe raise incomes and eventually help raise tax revenues? >> i think i got your questions right. let me give you short answers to both. i think in the context of re-establishing a sound fiscal regime is essential to have -- igd this before, to have robust public investment. we need to be competitive with an emerging market world, china, et cetera, and they're investing heavily in the areas to increase productivity and we have to do the same thing, basic research, infrastructure, and a host of other areas. i think we have to make room for that. i don't think -- i think the problgt of fiscal crisis in the short-term is very low. i think the probability of a serious set of adverse effects

as a result of our fiscal situation if we don't address it at some unpredictable time is extremely high and within that context one of the kinds of adverse effects you can have would be a severe bond and currency market crisis. whether that is a year off or five years off in time or ten years off in time is actually unpredictable. one thing i can tell you for sure is markets can change dramatically and almost instantaneously with no notice. so i think it is imperative that we act and that probability of a crisis increases as time goes on. why are rates so low right now? very little private investment, because a lot of money flowing into this country from all over the place, the problems in europe and some extent out of china and concerns out of china, and also because there is a lot of risk aversion so that there is a desire to have treasuries, but i think not only are we not normalized rates, i think return to normalized rates which would

make our fiscal situation more serious, but i would not take one bit of comfort from that in terms of whether the probability is that at some point though that point may be well off in time or near in time, that we will have extreme -- we have the high likelihood of adverse effects of one kind or another and within that context, a serious risk of a severe crisis. >> would you prioritize public investment or deficit reduction? >> i don't think -- i think that's a false choice. it is a good question. i am not critical of the question. i think it is a false choice. i would have -- i would put in place -- i think president obama gave a speech in april and gave a speech labor day and the monday after labor day in which he set out his economic program and they both did the same thing and i think both they did the same thing which is i would get ourselves back on track fiscally because i think it is imperative, but we will have to significantly increase revenues

and we're going to have to have discipline about priorities and by significantly increasing revenues and having discipline about priorities, and reforming the entitlements on sound financial footing, we have to create room for robust public investment if we're going to be competitive and also if we're going to deal with, you're right, if we're going to deal with what is a very serious income distribution problem in this country, stagnant, medium, real wages and increasing in equality. it is unhelts i economically and certainly unhealthy in terms of social cohesion and it is an important problem to address. >> we're almost out of time and i don't know if this will be answered quickly. there is on op he had by a former exec if i have from goldman sachs, a firm you ran for a number of years before you entered public service and basically argued the culture of his firm and wall street changed from being client focused to firm focused. i wonder if you have any thoughts on the whole notion and more broadly we have been

through a period after the crisis of enormous change, financial reform of all sorts, and so so. do you think the reforms put in place are adequate and do what is needed to avoid what we have been through again? >> sure. i didn't read -- i heard about it. i haven't read it yet. i left by the way december of '92. that's not a comment about anything. i am just saying. i have been away for a little while so i don't have a lot of feel for it. i have not read the article. willet many he comment generally. i think it is a good question. all of your questions are good questions. it is a good question. we have been through a mega crisis that nobody saw coming. there was a tail risk and it was a function of at least in my view a function of a lot of forces operating at the same time, the big institutions didn't see it. i lived my whole life with tail risk. i didn't see it. the analysts consistent see it and the congressional oversight committees didn't see and that was one of the reasons it was so

serious. if a larger number of people had seen it am kos there would have been more preparation action if you will. you wind up with a financial system or financial markets with far more downside than virtually anybody anticipated. we clearly needed to have serious financial reform to put in place measures that would protect us against the level systemic risk nobody thought we had, and i think on the whole what's been done is sound. i think the consumer protection agency absolutely was the right thing to do. not only protect the consumers but reduce systemic risk and i think the provisions on derivatives were the right thing to do and i wrote a book that came out in 2003, a good book by the way for those of thaw haven't read it and it is available in paper back. what i said was that i thought the real solution, i said i thought it did pose a lot of serious problems and i thought that the most effective approach and i still think this and it hasn't been done yet,