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Oral History Interview of Michael W. Keran Conducted by Robert L. Hetzel May 22, 2002 Michael W. Keran: Okay. Well, I got my PhD from the University of Minnesota in 1966. Robert L. Hetzel: And how much monetary theory did you get at the University of Minnesota? Michael W. Keran: Not a lot. I got very Keynesian perspectives on monetary theories from John… Oswald Brownlee was there, and he provided some sympathy for monetarism, but not much. I was mainly a Keynesian approach. My monetary theory came actually after I finished my degree and when I had an opportunity to meet and interact with Milton Friedman in 19-, actually 1963 and 1964, when I was working in Tokyo as the Assistant Financial Attaché. Robert L. Hetzel: So that was before you got your degree? Michael W. Keran: Before I got my degree but after I’d finished all the course work and I was what you call an ADB, all but dissertation. Robert L. Hetzel: And so, you were working for whom? Michael W. Keran: I worked-the working for the U.S.-after I finished my course work and took my preliminary orals, I had a topic in hand and, which wasn’t monetary at all, and I went to work for the U.S. Treasury Department because I needed more money than a graduate student grant would give me. And they sent me to Tokyo to be Assistant Financial Attaché in the embassy, and there I had an opportunity to meet Milton Friedman and Rose; they were making a world trip at the time after he just finished his Monetary History of the United States, and that was in 1962 or 1963, some place in that range. Robert L. Hetzel: Well, A Monetary History was published in ’63. Michael W. Keran: Okay. Well, he had finished writing it. I don’t know whether… When I mention it to him, he insists it was 1962 that we met, but-so that’s 40 years ago. Robert L. Hetzel: And so there was a reception or he came and gave a seminar? Michael W. Keran: The details are that my boss, the financial attaché and Milton, were graduate students at Columbia. My boss took off and said, “He’s having his friend come take care of him while he’s away.” And, so, I spent a week with him basically touring and talking economics, and he gave a number of lectures on monetarist thought which, of course, wasn’t titled monetarism then. And it made Japan snap in to place in ways that the Keynesian approach didn’t, and so I became-I threw away the old subject I was working on and started a new thesis on the Japanese business cycle using a monetarist approach based on the lectures that Milton had had and the interaction I had with him in terms of asking questions and what have you, you know, about an intensive one-week period. Robert L. Hetzel: Well, I don’t want to get sidetracked— Michael W. Keran: Right. Robert L. Hetzel: —but Japan was on the Bretton-Woods System and it had a pegged exchange rate, so, basically its inflation rate was either U.S. inflation rate plus whatever change in the terms of trade there was. So was that an interesting monetary topic for you, or...? Michael W. Keran: Absolute—well, there was a business cycle. I didn’t-the inflation rate was very much as you suggest, the U.S. inflation plus an epsilon for their productivity differences. And the-but they had a-because they’re in the fixed exchange rate, the trade balance drove the balance payments, and the balance payments was allowed to drive the money supply. Robert L. Hetzel: Hm-hmm [affirmative]. Michael W. Keran: And, so, you had a very interesting business cycle phenomena which-where the money supply drove the GDP, GDP drove imports, imports drove trade balance, trade balance drove the money supply, so you had a nice cycle. And basically I wrote my thesis describing that cycle, and Milton Friedman had it published by the University of Chicago Press in 1970. Robert L. Hetzel: Well that’s interesting. I don’t want to get hung up on that— Michael W. Keran: Okay. -2- Robert L. Hetzel: —but I was always sort of interested in why you would get similar temporal relationships between money and economic activity in Japan when they had a pegged exchange rate system, but I think that’s helpful. So your first job after graduating, you were-how long did you-when did youyou went to work for the St. Louis... [00:05:20] Michael W. Keran: The U.S. Treasury. My first job out of graduate school before I got my PhD degree, U.S. Treasury to 1965, when I returned from Tokyo. I went to work for the Federal Reserve Bank of St. Louis. I got that job because Oz Brownlee who was not-was my informal thesis advisor at the University of Minnesota, recommended me as someone who had international experience in money, and they wanted somebody with those two characteristics, and I fit that and ended up in St. Louis. Robert L. Hetzel: And the chief people there, at that time, interested in money must have been Homer Jones and Leonall Anderson. Michael W. Keran: Yes, and Jerry Jordan came a year after I did. Robert L. Hetzel: Hm-hmm [affirmative]. So in terms of monetary expertise, it was still a pretty small department when you had got-when you got there. Michael W. Keran: Oh absolutely. And there was a big fight within it because there were a lot of people left from the previous regimes who were not congenial to a monetary approach. Robert L. Hetzel: Delos Johns had brought in Homer Jones not because he had an interest in monetary policy, per se, but just because he was feisty and was willing to challenge the Board? Michael W. Keran: Right. And he was the president when I got there, but Darryl Francis was the first vice president and became president within a year of my arrival at the St. Louis Fed. Robert L. Hetzel: And, at that point, Homer Jones began the education to Darryl Francis; Darryl Francis had been there as an agricultural economist, right, for some time? Michael W. Keran: Agricultural economist, then he went in to administration, he was-and then became first vice president and then was made president when his predecessor who left. Robert L. Hetzel: I met him at a conference and talked to him, and he was a very pleasant, capable individual, but he wasn’t-he didn’t strike me as a self-taught intellectual; what was the spark that-or the, you know, what caused Homer Joneses seed to germinate in -3- Darryl Francis? Why was Francis-why do you think Francis was receptive to ideas that, that at the time, were quite unorthodox? Michael W. Keran: Well, I really can’t give you much insight on that one. At… I did think that Darryl Francis felt he was a fish out of water as far as monetary policy was concerned. His director of research had some strongly-held views. He did not have stronglyheld views that contradicted it, because he didn’t have any views. Robert L. Hetzel: Yeah. Michael W. Keran: And I think he just got convinced by the fact there was no counter-argument that was as convincing as the one Homer Jones gave. But I must say, I don’t really have any insight beyond that. Robert L. Hetzel: And how about Leonall Anderson? Obviously, I can’t talk to him. He was... Michael W. Keran: Yeah, unfortunately, tragically died of cancer more than, uh, let’s see, probably 15 years ago. Robert L. Hetzel: It’s been a long time. So where was-what was his background? Michael W. Keran: Leonall Anderson was there when I arrived, as was Keith Carlson. Robert L. Hetzel: Okay. Michael W. Keran: They both came from the University of Minnesota. They had been teaching at a small college in Minnesota after they got there—Andy got his degree, Keith never actually finished his degree—at St. Olaf College in Northfield, Minnesota. I’m not sure exactly how they got from there to the St. Louis Fed, but they were both there when I arrived. Robert L. Hetzel: So Anderson’s monetarism, and I guess Carlson’s, too, came after they arrived at the St. Louis Fed. Michael W. Keran: I would think so. Andy came to a-was pretty receptive to it when I got there. Keith was more agnostic. Robert L. Hetzel: So, Homer Jones must have been a very convincing individual— persuasive. [00:09:58] Michael W. Keran: I think what Homer Jones did is encourage people to look at monetary aggregates, and in the process of encouraging people to do that, people then... Andy was a brilliant statistician in the sense of practical statistician, not a theoretical one. -4- And he did some really, you know, with Jerry Jordan, did the experimental work on money and GDP. And I had actually done a little bit of-along those lines, too. I think I originally started it by trying to replicate the Friedman-Meiselman work of several years earlier and seeing whether that still held up. Robert L. Hetzel: Hm-hmm [affirmative]. Michael W. Keran: And it seemed to hold up. Then Jerry Jordan and Leonall Anderson went at it in a much more systematic way, which got out,— Robert L. Hetzel: Well it took you— Michael W. Keran: —which is well known. And that was... But I think that Homer Jones’ role was just to expose people to think about money and let them get the results from their own experience. Robert L. Hetzel: So Jones didn’t come across as a Milton Friedman student. He didn’t... Michael W. Keran: He didn’t-he’s not a Milton Friedman. He’s not a great theoretician. He was always had – he was very humble, let’s just look at the facts, and here’s some facts that people hadn’t been looking at before; we should look at those. Robert L. Hetzel: Well then who wrote the statements for Darryl Francis, because they’re pretty good? So would that have been Homer Jones and Leonall Anderson? Michael W. Keran: Yes. I think so. Those were the key ones, and later Jerry Jordan. But Homer Jones and Leonall Anderson—and it depends on when you start talking about the good statements. You know, we’re talking after 1968— Robert L. Hetzel: Yeah, that’s what I’m talking about, too. Michael W. Keran: —’69. Right. Robert L. Hetzel: The first statement that sort of rings a bell was a distinction between nominal and real bond rates— Michael W. Keran: Correct. Robert L. Hetzel: —and inflation expectations, and that was a quantity theory distinction which seems obvious now, but at the time was hardly... Michael W. Keran: And what was the date on that one; do you remember? Anyway— Robert L. Hetzel: ’68. -5- Michael W. Keran: —there was an article in 1969 by Yohe and Karnosky. Robert L. Hetzel: Right. Michael W. Keran: And they did an empirical study on interest rates and the moneyand the role of real and nominal interest rates. And they were able to show that the rise in nominal interest rates from the mid-50s to ’69 was primarily because inflation premium. Robert L. Hetzel: Hm-hmm [affirmative]. When did Brunner develop some association with the St. Louis Fed? Michael W. Keran: He came to the St. Louis Fed through Jerry Jordan. Jerry Jordan came in probably-came a year after I did, so he probably came in the summer of 19... Well, he came in 19-the end of 1966 or early 1967. I can’t remember exactly. And Brunner was Jerry’s thesis advisor, and I think that brought Brunner and Meltzer in to the St. Louis orbit. Robert L. Hetzel: And did you think of Brunner and Meltzer as pretty much the same sort of mone-kind of monetarist as Friedman? Or did you see them as different-offering different sorts of perspectives? Michael W. Keran: Well they had-their personalities and their approaches were quite a bit different. And actually Milton Friedman had very-had no physical contact with the St. Louis Fed except... He never came to a... He wasn’t an advisor. It was Brunner and Meltzer and the... And it was their kind of Germanic methodology which showed up in much of the early research of the St. Louis Fed. Robert L. Hetzel: When did the St. Louis Research Department develop a persona as a counterweight to the monetary policy of the Board of Governors; when did it begin to see itself as a monetarist challenged to the prevailing orthodoxy? [00:14:46] Michael W. Keran: Well that was emerging when I got there. I mean, they were trying to hire people who could do those things. And that was Homer Jones trying to beef up the staff’s capabilities, so I would say 1965. Now from there on it emerged-and it mainly showed itself, initially, in the Federal Reserve-the St. Louis Feds monthly Review, which focused on monetary aggregate and the relationship to the economic activity, and only gradually then... I did a piece in 1967 on updating Friedman and Meiselman’s stuff, then in 1968 Anderson and Jordan’s famous piece was published. And over that time, you know, the credibility of a monetarist position in-grew, because it helped explain the data. I think the key challenge was in 1969, the-in order to finance the Vietnam War, the Johnson administration put on 10 percent surtax. Robert L. Hetzel: Yeah that was in June of 1968. -6- Michael W. Keran: Was it ’68? Okay. Anyway, in the debate, the Board of Governors debate was this is going to be tight fiscal policy, you better offset it with easy money. So they recommended an easier monetary policy, and the Board of-and the St. Louis Fed based on the largely on the Andersen-Jordan work that going on at the time said, “No, you’re going to... The fiscal policy effects are going to be thwarted by too easy money, and you’re going to get rapid economic growth and higher inflation from easy money.” And, so, and that turned out to have been the case, so that was the first credible state by the Board of Governors, I mean, by the St. Louis Fed where it had an episode which its forecast turned out to be right. Robert L. Hetzel: Yeah. That was a watershed, an intellectual watershed, along with stagflation in 1970— Michael W. Keran: Yes. Robert L. Hetzel: —that caused shock waves in the profession. Michael W. Keran: Right. Robert L. Hetzel: Let me ask you about Chairman Martin; was the staff briefed on FOMC meetings when you were in St. Louis? Michael W. Keran: Somewhat. There was some-it wasn’t like a verbatim, but there would be some feedback, how did our ideas come across? What where the criticisms? It was briefed only in that narrow sense. Robert L. Hetzel: Did you have-develop, at that time, a sense of Martin as chairman of the FOMC; did you have feelings of him as a capable person? Or did you think of him as old-fashioned money-market type, or? Michael W. Keran: I thought of him as both: old-fashioned money-market type and very capable. And I don’t think there was any sense that he was out to get us or, I mean, that I was too low down on the totem pole. And nobody said anything to me to suggest that there was any negative reaction that... But this was a new idea, and it wasn’t dominate ideas, and Martin, I think, allowed Darryl Francis a chance to say his peace. Francis was not a good vehicle for convincing people because he wasn’t trained in monetary economics. He couldn’t-he could read the statement as prepared, but he couldn’t really respond by the questions very effectively. Robert L. Hetzel: Yeah, I think that’s where the main influence on monetary policy comes after the statements are read, it’s in the give and take and in— Michael W. Keran: Right. Robert L. Hetzel: —the ability to come back and argue. And I think we said yesterday that, for example, Al Hayes, who was a defender of the Bretton-Woods System and -7- should have been a hawk, he really was not very effective. He would read his statements, and the statements were good, but then there’d be a debate, and he was not— Michael W. Keran: Right. [00:19:48] Robert L. Hetzel: —you know, it would... This is much more general. There’s no question that William McChesney Martin detested inflation and certainly much, much more than Burns felt that the Federal Reserve System was responsible for inflation. And yet, he left in January of 1970 with almost six percent inflation; how do you think that happened? Afterand he’d been in office since March of 1951— Michael W. Keran: Right. Robert L. Hetzel: —and through-there was basically... Well, there was an incident in ’56 and ’57, but apart from that, there was basically very little inflation over that period through the end of ’65. And so what happened? How did he go so badly wrong? Michael W. Keran: Well, I think that... Here I’m speculating. I really can’t say from first-hand information. But I think that the whole concept of the difference between real and nominal interest rates had blindsided him, and that the rise in interest rates, to his mind, was tightening monetary policy, and that the inflation rate was rising faster because we had a fiscal shock, I mean, which was accommodated by easy-rapid money growth. The interest rates from rising any faster. And I think that he had, without that fiscal shock and money accommodations, the interest rate targeting that he had been doing all his professional life would have worked fine, but he had a shock that was unprecedented in his experience and that blindsided him. Robert L. Hetzel: Hm-hmm [affirmative]. Did you ever meet him? Michael W. Keran: I went to only one FOMC meeting when Martin was chairman, and, of course, I never really met him, I can’t say. Now, I experienced him only once, and I thought he was a perfect gentleman the way he handled things, very—nobody felt intimidated, but yet, he ran a smooth shop. Robert L. Hetzel: That meeting you attended, did any of the members around the FOMC table seem articulate to you, particularly effective in debate; did anyone stand out? Michael W. Keran: Well it’s hard for me to remember back from the time when I was regularly attending in the mid-70s, many of the people were the same. But I’m not sure when Chuck Partee became a governor, he had been on the staff, and I thought we was very effective espousing his views. Robert L. Hetzel: Yeah, maybe, I don’t know, ’75, something like that. -8- Michael W. Keran: That’s when he came on? I don’t remember any more. I can’t really separate the time-the one time I went under Martin when I was at St. Louis Fed and the routine going when I was later at the San Francisco Fed. Robert L. Hetzel: Well, I think Partee must have still been on the staff in ’74 because there was an incident in the summer of 1974 that involved Partee as Burns’ right-hand man and the St. Louis Fed. The Regional Bank presidents were asked to testify before Congress. And the St. Louis Fed wrote a really very effective critique of Burns. Burns was always talking about the deficit as the cause of inflation, and what this statement did was to show the rise in the deficit over time and show the increasing extent to which it was monetized. Michael W. Keran: Right. Robert L. Hetzel: And, so, it really was obviously written by somebody who knew exactly where to shoot, you know, where Burns was vulnerable. And the Regional Bank presidents sent their testimony to the Board, and it came out later that St. Louis had been asked to alter its testimony by Partee and that St. Louis wasn’t willing to do it, and there was a fuss, as you can imagine about that. Michael W. Keran: That was in ’74? Robert L. Hetzel: Yeah, I think that was August ’74. Michael W. Keran: I’d left by then, and I was in San Francisco. [00:25:00] Robert L. Hetzel: Hm-hmm [affirmative]. So you began going to FOMC meetings after you became director of research in San Francisco? Michael W. Keran: Yes. Robert L. Hetzel: Hm-hmm [affirmative]. Michael W. Keran: And I became director of research in July of ’73. I didn’t start going right away, but by ’74, I was going regularly. Robert L. Hetzel: Hm-hmm [affirmative]. Do you remember the change in atmosphere when Burns became FOMC chairman in February of 1970? Did the St. Louis Fed feel more under siege on issues like wage and price controls and... Michael W. Keran: Not initially. I think that people actually were pleased that Arthur Burns was going to be chairman, because he was a renowned economist, he understood the issues so well, seemingly, that people were quite pleased by that. And I think it took... The wage and price controls which came in 1971… I was actually on a temporary assignment back to the U.S. Treasury for one year, and so I was in Washington when that -9- happened, so I can’t say what the reaction was in-at the St. Louis Fed to that event. I was sort of out of the loop for a year. Robert L. Hetzel: So you were at the Treasury in 1971? Michael W. Keran: I went for a one-year temporary assignment from 19—from April of ’71 to March of ’72. Basically the Nixon administration had come in, and they wanted to upgrade the research capabilities of the Treasury’s international shop, the place I had worked some years before when I was in Tokyo. And, so, I, along with a number of other people, went to help them hit the ground running on the research side. And, so, it was a oneyear assignment. So I was on the Treasury side during that episode, and I got very much involved in the Bretton-Woods thing and all those things, which was a pretty interesting time to be at the Treasury because they were-ended up, essentially, floating the currency. And, so, I was very glad to be there then because when you’re an international economist that was trying to work... Paul Volcker then was the Under Secretary of the Treasury, and I was working very closely with him then on the Bretton-Woods, I mean the Smithsonian, sorry, the Smithsonian agreements in December of ’71 about how to reset the exchange rate at a realistic one which would deal with our trade balances. Robert L. Hetzel: So the other people you worked with; did you work with John Auten and then was Petty [ph] there, and who... Michael W. Keran: John Auten, he was on the domestic research side, and I worked with him very slightly because when we were doing this study of, after August of ’71, the devaluation of the dollar, how much it would be? How much of renegotiate? The only piece of research in the Treasury that had dealt with that beforehand was this memo that John Auten had written. So I had dealt with him on that, and then we took that and we went in to a much more elaborate mode of looking at a matrix-exchange rates and trade balances and how we would improve-correct the trade balance by devaluing the currency. So-but that was my only exposure to him. John Macken [sp] was there. I don’t know if you know that name. Robert L. Hetzel: Sure, I had no idea that he was there at that time. That’s interesting. Tom Willett? Michael W. Keran: Willett was not there yet; he came later, but the same group. Robert L. Hetzel: But he was at the Treasury then wasn’t he, or? Michael W. Keran: Tom Willett was at the Treasury, but he wasn’t there when I was there. He came, and he was running that Treasury group. Will Smith was running the Treasury group when I went. He was at the Virginia Tech down in Blackburn, Virginia. - 10 - [00:30:02] Robert L. Hetzel: Yes. Michael W. Keran: And Tom Willett, I mean Will Smith was running that group, and he’s the one that recruited me to go to the Treasury. And Phil Gruber was there. He had subsequently went to Canada, Simon Fraser University. Hanson Chang [sp] from Ohio State, who actually came out, and I recruited him to come to San Francisco later on, John Makin, myself, there were a number of others. Tom Willett came a year or so later after I had left. Robert L. Hetzel: In the summer of 1971, before Camp David and U.S. closed the gold window, did you have a sense that something was going to happen, that something exciting was in the air? Did you really notice the big change after Camp David? Michael W. Keran: It was-there was nothing in the air. I remember listening to Nixon talk on October 15th, and I was completely shocked. I was very positively shocked by allowing the currency to float, and I was negatively shocked by his price controls. So I was too far down the hierarchy to have been involved in any of that before it was announced. Robert L. Hetzel: Were you able to form any impressions about either Volcker or Connally,— Michael W. Keran: Yes. Robert L. Hetzel: —the two people running the show at that time? Or, you know, things seeped down to you about them, or? Michael W. Keran: I thought that Connally was a very strong leader. He asked difficult questions. Sometimes he asked dumb questions, and the staff was so terrorized by him that they started telling him you’ve got a dumb question, let’s reform it to make it a sensible question. They’d go out and do a lot of research to answer the dumb question. And when he got the answer, he knew it was a dumb answer, and he’d get that as the answer, when the problem was he didn’t ask the right questions. But nobody was willing to tell him that. Robert L. Hetzel: Was it because he was intimidating, or was it because...? Michael W. Keran: Yes, he was intimidating. Robert L. Hetzel: Hm-hmm [affirmative]. Michael W. Keran: Volcker was a perfect bureaucrat. He didn’t want to do any studies on devaluation of the dollar prior to the actual event, because he didn’t want it to get leaked. And the Pentagon papers had heard just before that, and he didn’t want a Treasury version of the Pentagon papers being leaked, and, therefore, causing embarrassment about the... Because the Treasury had a very strong fixed exchange rate image, and didn’t want a paper on possible staff studies on devaluation to undermine that, if it ever got leaked. - 11 - Robert L. Hetzel: Right. But, I mean, Volcker never favored floating exchange rates, but he did... Michael W. Keran: Absolutely. No, he never favored it intellectually. He didn’t even want any studies on it. Now, he could have favored a moveable peg. I mean, the peg might have to move, but he never favored flexible exchange rates. But he didn’t want any studies on shifting the peg, because he was afraid they’d get leaked and undermine the fixed exchange rate dogma. So that when the Treasury actually was forced to look at the issue of what do we do now that we’ve abandoned the fixed currency, where do we re-peg it? There weren’t any studies except this very modest one that Auten, I’m not sure how you pronounce his name,— Robert L. Hetzel: Yes. John Auten. Michael W. Keran: —had done. I looked at that and it really wasn’t very helpful. So we almost had to start from scratch. Other parts of the government had models that could have been used to evaluate it; the Treasury had one, the CIA had one. But Volcker didn’t want to use any of their models because by using their models, they would be able to figure out what the Treasury—would have to tip its hand on what was going on, and he didn’t want to tip the Treasury’s hand even within the government. And, so, we had to build a model from scratch, and it was a very crude on. And because I was the senior research person in terms of rank in the group, I got the job. So I got the-I called Keran’s black box, and we automated it so that when he got to the Smithsonian student negotiation, we could do simulations on it. And they finally came up with that eight percent devaluation. [00:35:12] Robert L. Hetzel: But didn’t the staff study show that a 15% devaluation was needed? Isn’t that the number you came up with? Michael W. Keran: I can’t remember what number. We were-the way we were asked to do it was to set up this matrix, that we’d look at exchange rates and trade flows. Then the-we would be-when they were at the negotiating table, they would send back and forth now here’s what the negotiations had. Here, okay, let’s take the numbers that they negotiated, plug them in and see what the results were. And we kept on sending them back results. And I can’t remember anymore whether the... There probably was more than one staff study going on. But the... We were not privy to what the policymakers were doing. They just gave us numbers to run through the computer, and we sent the results back. And I don’t think any of them actually felt the $8 billion trade deficit, but they all moved in the right direction. I’m a little vague about that. - 12 - Robert L. Hetzel: Sure. Well did you ever have personal contact with Volcker or with Secretary Connally? Michael W. Keran: Not with Connally, except I’ve dealt with people who dealt with him. And pretty much the same with Volcker. I had only limited contacts with him. Mainly he was-we would-he worked through my boss, Will Schmidt [sp]. Robert L. Hetzel: So you pretty much overlapped the Connally period, and then you had gone by the time George Shultze got there. Michael W. Keran: Yes. Robert L. Hetzel: What was the intellectual environment like; was it pretty much like the Fed? You know, you were in your own research department, and you could do research, or did it feel a lot more bureaucratic and... Michael W. Keran: Well it was a lot... I wouldn’t say more bureaucratic. I think the difference was that that Fed is dominated by economists, and that a lot of the policymakers are economists, so that there was an understanding of what economists could and couldn’t do. The Treasury is policymakers came out of Wall Street, usually. They were not economists. They had problems to solve day by day, not monetary problems which you could spend six months working on. They had an exchange rate crisis or some other kind of financial crisis, and it happens this afternoon and we need an answer in an hour. Robert L. Hetzel: Yeah. Michael W. Keran: Economists were not very good at getting answers in an hour. So, I think that the Treasury ultimately decided that the experiment with the research group was a failure, and it allowed it to fade away because economists just couldn’t... Now, the people who-the international relations guys who were in the staff, they couldn’t give good answers now, but they could write a memo in an hour and give something plausible in an hour. But economists mostly don’t work that way, unless they can just work off their human capital. And most of these issues that came up the people didn’t have any human capital to work off of. So they had to go back and research the subject. So I think that because of the nature of the quick turnaround and decision making and the people who, at the top, who really wouldn’t talk to economists until they had problem, so the economists could start working on issues ahead of time, that... It was more of a conflict of intellectual perception—disconnect maybe is a better word. And, so, I don’t think economists really worked that well, at least at the time I was there. [00:40:06] - 13 - Robert L. Hetzel: Hm-hmm [affirmative]. And, so, then you went back to St. Louis, and you said you were there for how long? Michael W. Keran: Yeah then I just stayed for a little over a year from April of ’72 to July, or June of ’73. Then I got recruited away to go to San Francisco. Robert L. Hetzel: Seems to me I recall once a long time ago you saying that when you heard that John Balles had become president of the San Francisco Fed, you wrote him a letter asking if he needed a director of research; wasn’t there something like that that you sent? Michael W. Keran: Well, I had-I didn’t know John Balles, but I knew... I heard that when he came on, the St. Louis Fed people were saying, “Hey, here’s a new fresh voice coming on.” They really liked what they heard, so that got me interested. And, actually, I wrote to the then-director of research and said, “Do you need an international economist?” And he wrote back and said, “Well, I’m about the leave, so I’m not in a position to talk about those issues.” So then I wrote to John Balles and instead of the international economist position I was looking for, they offered me the director of research. Robert L. Hetzel: Okay. Well that’s pretty good. Michael W. Keran: Right. Robert L. Hetzel: Was Balles sort of a difficult person to work with? Michael W. Keran: Yes. Robert L. Hetzel: What was his background? Michael W. Keran: Well, he’s a banker. He has a PhD in economics, but his work was in banking. He worked at a bank in the east in, I can’t remember the bank name, but it was in Philadelphia, some Philadelphia bank. Robert L. Hetzel: Yeah. Michael W. Keran: Or Pittsburgh bank, I can’t remember. It was some place in Pennsylvania. And he was a real classic type-A personality. He was-I think he always respected me, and he gave me great latitude on advising him on monetary policy. But he would really give me hell or, if I got the chart for the director’s meeting wrong... And he was a tough guy to deal with. A lot of people had trouble. I had less trouble than most because he could compartmentalize, and so, when it came to monetary policy issues, I had great discretion, and he respected me a lot. But a lot of other issues he was a bit of a tyrant. Robert L. Hetzel: Do you feel like you educated him? Or did he just trust you and he...? - 14 - Michael W. Keran: Oh, I think yes, definitely there was an education process going on. Robert L. Hetzel: Hm-hmm [affirmative]. Let me ask you about something that was going on at the time. There was this sub-committee on the directive,— Michael W. Keran: Oh yes. Robert L. Hetzel: —the Holland Committee, and there was an enormous amount of staff work. Michael W. Keran: Right. Robert L. Hetzel: And I guess it had been going on in different phases since the late 60s. But there was quite an ambitious program, oh ’73, ’74 or so, to combine optimal control with macro-econometric models, Tinsley and [Unintelligible 00:43:50] were working on it, and you were involved in a part of it had to do with how to structure decision making and— Michael W. Keran: Right. Robert L. Hetzel: —the directive. Michael W. Keran: Yeah. Steve Axilrod, myself, and the director of research at the New York Fed were involved in that part of it. His name escapes me right now, but I know it, really, um. Robert L. Hetzel: You mean the director of research? Michael W. Keran: At the New York Fed at the time. Robert L. Hetzel: Yeah, Mike Hamburger. Michael W. Keran: No. No. Robert L. Hetzel: Dick Davis— Michael W. Keran: Dick Davis. Robert L. Hetzel: —was an advisor. Michael W. Keran: Dick Davis, Steve Axilrod and myself were sort of working on a part of that. And that went on for about three years. I was at the San Francisco Fed then, and it was-a great deal of staff work went in to basically how you could use non-borrowed reserves rather than the funds rate as the operating target. And a lot of theoretical work went in to it. A lot of statistical work—even the, uh, Peter Sternlight, the manager at the operating desk in New York, did some staff simulations of how it would work, you know, in real time. - 15 - Robert L. Hetzel: Right. Michael W. Keran: And after three years of work, it was presented to the FOMC, and Arthur Burns shot it down in 30 minutes. And I thought to myself, I’ve never spent so much time in my entire life as that, except it wasn’t the case. Because when Volcker became chairman, and he had to make the switch in operating procedures in October of ’79, he implemented that thing almost to a “T”. So it ultimately to turned out to have been a valuable exercise because it’d gone through all the staff work. But it... [00:46:04] [END TAPE 24, SIDE A] [START TAPE 24, SIDE B] [00:46:09] Michael W. Keran: ...much gnashing of teeth at the Board staff level. But I certainly was gnashing my own teeth, and a few of the people that worked with me. And there was a general sense that he had, among all levels of the staff, that he had just casually thrown this out and that it was a very serious piece of work and it hadn’t-wasn’t given the attention it deserved. Robert L. Hetzel: Hm-hmm [affirmative]. Yeah, I often think it was a tragedy that the Fed didn’t move toward reserve targeting when it would have been feasible to do so, because even though we’d managed to stabilize inflation using a funds rate target, it conveys the message that we control the price system. And, ultimately, that creates pressures on us that kind of force us to act as though we can control the economy. I suppose that gets back to what you said, “Once the people from the ‘70s are gone, then we no longer have this assurance that people will understand what we can and can’t control.” So I think that was one of the deleterious long-run legacies of Arthur Burns. He just had-apparently had no interest in money and monetary control. He thought, you know, velocity was a varied with people’s psychology, and he was going to go directly for that psychology rather than look at money. So you began to attend FOMC meetings in what year did you say, ’75? Michael W. Keran: ’74, late ’74, something like that. Robert L. Hetzel: Did you have a feeling of... Monetary policy was pretty good from spring of ’73 until fall of ’74 in that the Fed was looking at money growth and bringing - 16 - the aggregates down. And then monetary policy became very restrictive in the fall of ’74; did you have a sense of what Burns was looking at and what he was...? Michael W. Keran: Well, a lot of people, at the time, think that that was sort of a serendipitous; that the money supply growth flowed. You know, there’d been a lot of research on that episode. Robert L. Hetzel: Hm-hmm [affirmative]. Michael W. Keran: And under the heading something like Sherlock Holmes of statements, what happened to the missing money? Because most demand for money equations suggested that the money supply should have been much higher than was actually being reported. What happened to the missing money? Robert L. Hetzel: Hm-hmm [affirmative]. Michael W. Keran: And there was actually a Journal of Economic Literature review article written by two people on my San Francisco staff: John Judd and— Robert L. Hetzel: Scadding. Michael W. Keran: —Scadding, who reviewed that whole literature. I think in retr... The part that convinced me, not at the time, but later, was Michael Hamburger’s explanation that the stock market collapse of ’74-’75 had a wealth of-there’s a wealth effect had an interest rate effect. And that wealth effect reduced demand for money because people’s portfolios were smaller and they reduced a lot things, including their money supply. That seemed, I think, when we had the big stock market boom going the other way and suddenly the money supply was rising a lot faster, and they weren’t getting any inflation, that wealth effect story explained both of those episodes. So that’s one that convinced me. I don’t know whether that’s been widely accepted in the profession, probably not. But that certainly convinced me that the money supply slow down was simply a demand for money slow down, if you will. And given the Fed’s operating procedures, the supply of money slowed down, too. Robert L. Hetzel: Do you think that Burns was Burns? Michael W. Keran: Huh? Robert L. Hetzel: Do you think that Burns ever changed the way he looked at the world, the way he— Michael W. Keran: No. Robert L. Hetzel: —responded in ’74, ’75 and then ’76 and ’77. - 17 - Michael W. Keran: I don’t think he changed. I think his-he ignored the money supply, and if it went down, it went down. If it went up, it went up. But he’s going to control that funds rate within an eighth. Robert L. Hetzel: He was-remained a business forecaster, thought he could read the economy and thought he could read it well enough to stimulate the economy and still keep inflation under control. Michael W. Keran: And if-well, some people, as Milton Freidman says, “Arthur Burns thought he was a better politician than he was an economist.” And he turned out to have been wrong. That is, he was willing to submerge his economic instincts for his political instincts. And at the time, the political instincts were to keep the economy moving along, and Arthur Burns was prepared to do that, and that he could deal with whatever adverse economic consequences came later, later. That’s how-I think I agree with that. And, so, Arthur Burns controlled the funds rate, that’s the rate that you can-everybody can see, and he would fight over every eighth of a point on the funds rate. And, of course, because by doing that, and as the inflation rate kept on picking up, the real interest rate was flat or even falling, depending on how fast the inflation rate was going. And he simply ignored that element. I don’t know if it’s—it can’t be because he didn’t understand it. So it had to be that he wanted to keep the economy moving. Robert L. Hetzel: Did you have a sense in 1977 when it was clear there was a recovery, you remember there was the election in ’76, and that summer it had looked like the economy was stalling out, and Carter came in and there was the rebate and yet-and then the economy took off in the spring of ’77. And then Burns was very reluctant to raise rates; he did so, but it only happened very slowly. Did you have any sense at that time was, just as you said, oh, he didn’t want to, you know… Michael W. Keran: Well, he had an argument-he had an argument about the cause of inflation which was structural rather than monetary driven. So he always said, you know, “The role of monetary policy is to keep the economy-the real economy in even keel, and that inflation is structural,” at least the American inflation, he wouldn’t say that it was universally structural and that you raise minimum wage and you increase Social Security payments, and you do all these things. That pushes up prices, so that’s structural. That’s not the Fed’s fault, that’s the rest of the government’s fault. And he pushed that very hard, and Wallich, who was also a governor, he bought that story. Wallich was an inflation hawk in many ways; he thought inflation was theft. But he also believed that inflation was the rest of the government’s dealings, not the Federal Reserve causing inflation. Because I remember having long talks with Wallich about that, and his argument was strictly a structuralist argument about cost push. - 18 - And, as a matter of fact, I so many discussions with Wallich about that, that when Arthur Burns came through and visited the San Francisco Fed, he asked me, basically, to give my views on monetary policy. I basically gave him the dump on why we were having-why it wasn’t structural, it was monetary. And he gave me back the structural stories, and I had had this chance to think about each one of those structural arguments and to debunk them because of my experience with Wallich, that I just gave it back to him. And I got home that night and told my wife, “Well, I might get fired for that one.” But I never heard a thing about it. He just swallowed it. That’s very un-Arthur Burns. Robert L. Hetzel: Wallich had this tips proposal and you were supposed to-you were going to tax increases in the wage rate above the productivity level. Michael W. Keran: He had those structural reasons for inflation. Robert L. Hetzel: Was he an effective member of the FOMC? He had been around since the early ‘50s in one way or the other. He’d been member of the Council of Economic Advisors with Saulnier, so he’s had a lot of experience in governor, was respected as an economist; I guess he came from Yale? [00:56:15] Michael W. Keran: Yes. Robert L. Hetzel: Was he an effective member of the FOMC? Michael W. Keran: I didn’t think he was that effective. Robert L. Hetzel: Hm-hmm [affirmative]. Michael W. Keran: He wasn’t as effective as Chuck Partee because when you’re sitting around the table, it’s-people don’t really-most of the people there don’t sort of buy theoretical arguments. They want what are the facts? And how do those facts affect the economy and inflation? And Chuck Partee was very good at that. Wallich was not that good at it, and I think he pretty much toed Arthur Burns’ line, whatever it was. He may have been intimidated by Burns; I really don’t know that. But in private conversations, he would say the same things that Arthur Burns would say. So, he was probably convinced of it. Robert L. Hetzel: Yeah, I call what you just described real figures for real men. Michael W. Keran: [laughter] That’s it. That’s a good phrase. Robert L. Hetzel: It’s very hard for somebody who really doesn’t really truly believe in his theoretical view of the economy to make a change in the funds rate that’s counterintuitive in terms of what you see going on in the economy, you know? Michael W. Keran: Hm-hmm [affirmative]. - 19 - Robert L. Hetzel: Presidents, they want to know what’s happening to payroll employment. Michael W. Keran: Right. Robert L. Hetzel: And that’s something real, and, you know, they want a common sense behavior of the funds rate in terms of— Michael W. Keran: Right. Exactly. Robert L. Hetzel: —what they actually see. Michael W. Keran: That’s a very good way of putting it. Robert L. Hetzel: And, ultimately, you know, money is an abstraction, and anyway, so. That’s a long topic. Michael W. Keran: The funds rate is not an abstraction; it’s a real thing. Robert L. Hetzel: Yeah, absolutely. Michael W. Keran: And, ironically, you know, pegging the funds rate could work, I mean, if you’re willing to attack it aggressively enough. And I think that was what you-what I’d call-has been Greenspan’s virtue, is he willing to target it relatively aggressively, but Burns wasn’t. He fought over every eighth. Robert L. Hetzel: Well, he—ultimately, I think what he thought drove the economy was the psychology of the businessmen, and as long as you had a recovery in process, he wasn’t going to do anything to upset the psychology of the businessmen, to upset financial market sentiment. I think that he just thought of it as something that exercised a psychological affect on people’s willingness to invest and didn’t want to upset the apple cart, didn’t want to upset things. And I think intellectually he would have understood the difference between real and nominal interest rates, and I think when he wanted to raise interest rates, and had to defend himself before Congress, then he would draw on the distinction. Michael W. Keran: Right. Robert L. Hetzel: But when it came to actually implementing policy and, you know, I think he thought he could get inside the mind of the businessman and understand what would motivate the businessman’s activities and, therefore, you know, drive the U.S. economy. And, I think he would have said well, the businessman doesn’t understand the difference between nominal and real, and I’m not going to have a big change in nominal rates, even if it leaves real rates unchanged, because that will have affects on business confidence. Michael W. Keran: Right. - 20 - Robert L. Hetzel: So ’77 comes around, you get a strong economic recovery, Burns is very reluctant to raise interest rates, and then early in ’78 he’s replaced; did you have a feeling at the time that he felt like he would be re-nominated as FOMC chairman, that he was irreplaceable, that he was the darling of the business community and…? Michael W. Keran: He certainly wanted to be replaced, I knew that. Robert L. Hetzel: Reappointed? Michael W. Keran: Reappointed. Yeah. Replaced, yeah. Reappointed. But I wasn’t really plugged in to anything, inside information on what was going on and what he did to try and achieve that goal. But he certainly wanted to be replaced, and I think he expected to either, also, because he seemed to be prepared to do his master’s bidding at whoever was President. [01:01:08] Robert L. Hetzel: Well, he may have thought that if he were re-nominated, then he could keep things under control; he’d do whatever it took— Michael W. Keran: Right. Robert L. Hetzel: —in the way of raising interest rates, even though he may have felt they were too low in ’77, well come ’78, he could do what was necessary. Michael W. Keran: That’s true, could have been. I don’t have any sense of whether that’s been the case or not. But he certainly wanted to and probably expected to be replaced. I think we were all surprised. Robert L. Hetzel: You know, in retrospect, the person on the FOMC who was ultimately the most important was Paul Volcker, and now, of course, he’s known as the inflation hawk, the Central’s Banker’s central banker. But when he was president of the New York Fed, did he come across that way in FOMC meetings? Or was he haggling about each little eighth of a percentage point change in the funds rate? Michael W. Keran: Well, you had to haggle about that because Arthur Burns made that the debating point. Robert L. Hetzel: Yeah. Yeah. Michael W. Keran: If he was going to participate in the debate, you had to participate in that debate. It could mention the money supply in passing it’s too high, growing too fast, but you had to focus on the funds rate. So, he was also-I got to know him better than when he was at the New York Fed because we were in a couple of-he was like one of the presidents who was supervising this committee on the directive thing, so we’d met with him from time to time on that, updating him on what was happening there. - 21 - Robert L. Hetzel: If he had been FOMC chairman then, would we have still had this problem? I mean, did he have a change in attitude, Paul on the road to Damascus? Or would kind of history been, you know, pretty much the same thing if he had been FOMC chairman? Michael W. Keran: Well, I really couldn’t say. Robert L. Hetzel: Well sure. Michael W. Keran: You know when he became chairman, I said, “I had no idea what he was going to do.” Robert L. Hetzel: Yeah. Michael W. Keran: His whole career up to then had been effectively supporting his principal, whoever that principal happened to be. And if Arthur Burns was his principal when he was New York Fed President, the Treasury Secretary was his principal there. So I had no idea what he would do. He kept his views pretty quiet, and he supported it very effectively, his principal as a curve-stats person and policy adviser. So, a policy maker really. I was as surprised as anybody, and as pleased, as to what he did. Robert L. Hetzel: Did you have a sense when G. William Miller was FOMC chairman how decisions were getting made? Did… Michael W. Keran: It was pretty much the staff. I mean, he didn’t know anything about monetary policy or theory or evidence. He was a lawyer. His only experience was being on the Board of Directors of the Boston Fed. He-the staff fed him, and then they tried, 18 months later, when he shifted over to being Secretary of the Treasury, he was pleased and relieved. I sort of know that personally because by happenstance we took a flight across country together and sat in the seats side by side, when the FOMC, after it was announced that he was become Secretary of the Treasury, and it was very clear just from the casual conversation that he was really looking forward to the switch. I mean, the FOMC was like theologeanists arguing about how many angels can dance on the head of a pin, and he had to get to something that was far more practical, like the Treasury. Robert L. Hetzel: So he was on this flight that you were on, or? Michael W. Keran: Yeah. He was very egalitarian; he wouldn’t fly first class. He was back in the boughs of the plane. And he’d be sitting separately next to a howling baby. So I went up and I said, “Would you like to switch with me?” I figured I at least owed him that much. And he said, “Oh, no, no. But maybe I’ll sit next to you.” So he got away from the howling baby, but he got me. So I got a chance to talk to him, and it was very clear from that conversation that he was really happy to get away the arcane central bank in to something real, where real men deal with Treasury Department issues. [01:06:25] - 22 - Robert L. Hetzel: Did you feel like he treated your bank fairly? There was somethere were some complaints about how he set president’s salaries, that kind of thing. Michael W. Keran: Well if there was I-it was above my grade level. I was not aware of anything like that. Robert L. Hetzel: So, Miller wasn’t dominating or necessarily even guiding policy at this time. So it really was a consensus committee? Michael W. Keran: It was the Board of Governors staff. But, at the time, there was San Francisco Fed and other institutions, too, we made a big push about worrying about the rapid growth of M2, and that this was going to lead to inflation. We had an exchange of correspondent staff papers on the subject, and they would always point out some reason that the demand for money had gone up and that this was not going to be inflationary. And we’d try and point out that no, that’s not the case; the demand for money was remarkably stable. It was then. It didn’t stay that way, but it was then. Robert L. Hetzel: Yeah. Michael W. Keran: And that it was going to lead to more inflation. And, finally, what it comes down to, you can’t-it’s almost impossible to win an argument with a staff person on the theory, you can’t win on the theory because it’s impossible that the demand for money can shift. You can’t win on the empirics because [Unintelligible 01:08:13] money is unobservable, and you only get at it indirectly. Therefore, you can always come up with arguments why it has or has not shifted. And the only way you can win is by the forecast, and it’s too late by then because this thing has already happened. That was the conclusion that I came from, because we had a very extensive, went over months, exchange back and forth the Board of Governors staff. And probably other banks may have done the same thing, I don’t know. But that was the one we had. Robert L. Hetzel: Yeah, I remember that, because you couldn’t win because you could show that money demand had been stable, and then the answer was always financial innovation will render it unstable in the future. Michael W. Keran: Right. Robert L. Hetzel: So, what-so, you know, the future comes and it’s the same argument. It doesn’t make any difference whether money was a good indicator or not. Michael W. Keran: Right. Robert L. Hetzel: So the key staff members at that time were Axilrod and Kichline? Was he…? - 23 - Michael W. Keran: Right. Jim Kichline was the one I was dealing with on this thing. Robert L. Hetzel: And so he was just pretty much straight Keynesian: inflation is a structural cost push thing and we control real things and want to keep the recovery going? Michael W. Keran: Well, I think that he would have intellectually recognized that excessive money growth would be inflationary, and we were debating about whether there was excessive money growth. Robert L. Hetzel: Hm-hmm [affirmative]. And they’d always be… Michael W. Keran: It was really just debate at that level. I mean, we did [Unintelligible 01:09:44], demand for money is your unknown variable that can decide whether you have excessive money growth or not. I mean, he may have not believed the money story, but he was willing to debate along those lines. And maybe if he had believed the money story, he wouldn’t have felt… But you can always take… A Keynesian model is simply a special case of the… I mean a monetarist model is a special case of the Keynesian, and vice versa. So, you can deal with any model framework and treat the other intellectual framework as a special case. What is a monetarist framework but a vertical [Unintelligible 01:10:37] curve? [01:10:41] Robert L. Hetzel: Sure. Sure. Well, the board staff of the FOMC was raising the funds rate, and by historical standards, they were doing it fairly aggressively, although in real terms, it wasn’t-the changes weren’t particularly big. But you get to late ’78, and you get another oil price shock, and you come to early ’79 and then the FOMC backs off, but inflation expectations continue to rise. So real rates fall and what was shaping up as a restrictive monetary policy in ’78 kind of falls apart, and you have this additional kind of period. So you think at that critical point it was the Board staff and their forecast of a recession in early ’79, and their unwillingness to put the economy through a recession? And, you know, you’ve got this oil price shock and you’ve got to accommodate it. Sure you’re going to have more money because you get this, you know, one-time rise in prices. Michael W. Keran: Right. I would have to go back and look at my notes. From ’76 to ’84, I took very detailed notes of these FOMC meetings, and I’m quite-I can’t remember just off the top of my head what the debates were at that point. Robert L. Hetzel: Hm-hmm [affirmative]. Michael W. Keran: If there’s a particular FOMC meeting you’d like to have some comments on, you know, I could—you tell me what it is and I could go back and look through my notes to see what I was-what I wrote at the time. - 24 - Robert L. Hetzel: Yeah, that’s a good idea. The memoranda of a discussion are being extended back in time, but I think they’re only back through 1980 so far, so there’s several missing, of that key period, there’s some missing years and, yeah, I think I might take you up on that for the first several meetings in... Well, December 1978 through June of 1979; I think that was a really critical period. It would be interesting to look at notes on that period, and I don’t think they’re available yet from the… Michael W. Keran: I took almost verbatim notes. John Balles used to question me, was I-should I tape record them? And I said, “No.” I mean, once I heard that I could write down a few words and I’ll have the whole argument a person made because I heard them use it so many times. Robert L. Hetzel: Well did you go back and write them up again, or did you…? Michael W. Keran: Yeah, I went back and I’d write them up, and then I would give the blow by blow to the staff that was involved in preparing for the FOMC meetings. I did that until John Balles told me I had to quit that, that was too much. I still wrote them up after that, but I stopped giving… I would sit down with my notes, and I would basically go through the FOMC meeting quoting everybody at what they-what my notes said they said. They were very detailed. Robert L. Hetzel: Yeah. Well, I’d love to see some for the, like, late ’78, first half of ’79, that would be really interesting. Michael W. Keran: Yeah. Robert L. Hetzel: I’d love to see some of those. Would they be easy to copy or I don’t know how to… I’m sure you sort of feel reluctant to part with them even for… Michael W. Keran: No. I could send them to you, you know, by-with registered mail. Robert L. Hetzel: Okay. Michael W. Keran: And you could send them back the same way. Robert L. Hetzel: Okay. Okay. Michael W. Keran: I don’t have some copying stuff here. Robert L. Hetzel: Oh sure. Well, I can have them copied, it’s just that— Michael W. Keran: Nice. Right. Robert L. Hetzel: —sometimes when people have documents that are valuable, they just don’t want them out of their own personal possession. But if you send them registered mail and insure them for, you know, a couple of hundred dollars, I’m sure they’ll get here. - 25 - Michael W. Keran: Right. I think they would. Robert L. Hetzel: Yeah. Okay. Michael W. Keran: Especially registered, they can track them. Robert L. Hetzel: Yeah. Yeah. So did you have the feeling that after Volcker became chairman, even though there was a disparate group, people who looked at the world very differently, your president and our president and St. Louis, and, on the other hand, the old line democratic governors, but they were all willing to follow Volcker because inflation was the problem then and he was the leader? [01:15:39] Michael W. Keran: Right. I think another thing that helped is that committee on the directive staff study had gone on for so long, it had gotten in to so many different places that it was-what he suggest at doing, you know, shifting on October, ’79, had a lot of credibility because the staff work had been done, and people couldn’t criticize it technically. I think that was very important for people who were on the other side of the issue. And, of course, those who were on our side were just pleased as punch. But I remember that was a meeting that only principals could go to; the staff couldn’t, and they weren’t even supposed to show… But John Balles showed me the proposal that they were going to vote on. And I went through that proposal very quickly, like 30 minutes, and I kicked off all the items that were also on the committee and the directive study, and they were all there. So I said, “Go with it! This has been studied to death. Everything is tied up nice and neat.” Robert L. Hetzel: And-but I don’t think that much of the committee understood the interaction between lag reserve accounting and non-borrowed reserve. Michael W. Keran: Right. That issue came later. Robert L. Hetzel: Certainly the desk did, and Volcker did. And, so Volcker knew how to use these procedures to get what he wanted. Michael W. Keran: Yes. Robert L. Hetzel: And others learned over time. I remember at the time that we thought that a lot of the governors didn’t really understand that if you raise the discount rate, you’d also raise the funds rate; it was a different regime. [Interruption] - 26 - Robert L. Hetzel: We realized right away that if you were to raise the discount rate, you’d also raise the funds rate. But we had the feeling that some of the governors did not understand that initially. Michael W. Keran: Yeah. Okay. Robert L. Hetzel: So, Volcker brought the inflation rate down from 3% to 11%; he was ultimately successful, but he didn’t really do it in the, you know, in a monetarist way; do you have feelings about that final period of Volcker and how he brought the inflation rate down and ultimately do you think he… Michael W. Keran: I think I’ve heard that-the monetarist critique. I think it’s nitpicking myself. Robert L. Hetzel: Yeah. Michael W. Keran: Having attended the meetings and having heard people agonizing about how to hit that money supply target, I think that there was as serious and credible attempt to control the money supply as you could have gotten. Now, you’ve got to remember there were some huge shocks. October ’79 was the change in operating procedures. Then in January of 1980, you know, what are talking about, three months later, the Carter administration dramatically increased the budget deficit by responding to the invasion of Afghanistan and increased defense spending, and that was a shock to the bond market. Robert L. Hetzel: Absolutely. Michael W. Keran: And then we came along with credit controls in April. Robert L. Hetzel: Right. Michael W. Keran: That was another shock to the bond market in the other direction. Then we took them off in July and it went up again. And those shocks to the bond market had a huge affect on the money supply, I mean on GDP and the money supply. So, you can’t blame Volcker for all that rigmarole in 1980. That was basically doing the bidding of the government that we have said was brought in on that. So, leaving that aside and looking at 1981 and the first half of ’82, they were trying to keep the money supply at the target range, five percent, whatever it was. And it was only in October of ’82 when the economy was just tanking like mad, and we were getting the money supply, nice, smooth five percent money supply growth, he said, “There’s a disconnect here. We’ve got to do something else.” And he basically switched back to funds rate targeting. But it was a fundamentally different funds rate targeting; it was a much more aggressive funds rate targeting. - 27 - Robert L. Hetzel: Yeah. You wrote some very interesting papers. You were the first one to summarize the new procedures. It was a combination of nominal output targeting and looking at bond rates and responding aggressively. It may have been some of the first things you did when you went to Prudential. Michael W. Keran: Yeah. I kind of wanted to get that off my chest. All those things that I had been thinking about for years that I really couldn’t write about because-it’s not that anybody ever said that’s what they were doing to me, but it was just clear that that’s what they were doing, and, so, I wrote those-the first couple of things I wrote at Prudential and that was in January, February of ’85 probably. Robert L. Hetzel: Anything else we should cover? I’ve sort of taken advantage of your hospitality for a long, long time now, but we have covered, you know, the period. Michael W. Keran: Okay. Robert L. Hetzel: What else should we…? Michael W. Keran: Well, you might give me your mailing address. Let me get… [01:21:36] [END OF RECORDING] - 28 -